An idea that failed to gain purchase in the United States is, however, fast winning converts right across central Europe. At the 2003 capitalist ball Mart Laar, a former prime minister of Estonia, was given a special award to celebrate the fact that, in 1994, his country had become the first in Europe to introduce a flat tax, of 26%. At the time, developments in Estonia, a tiny Baltic country which was not then even a member of the EU, did not seem particularly significant. True, Latvia and Lithuania, the two other Baltic countries, swiftly followed suit, but nothing much happened for a while after that.Of course, not exactly everyone is as elated about this:
Then in 2001 Russia, facing widespread tax evasion, moved to a flat tax of 13% on personal income. Over the next two years Serbia and Ukraine followed, with rates of 14% and 13%, respectively. Much as advocates of the privatisation of pensions were sometimes embarrassed to have Pinochet's Chile as their laboratory, so Russia, Serbia and pre-Yushchenko Ukraine were not the ideal poster children for flat taxes. But then Georgia, fresh from a democratic revolution, introduced the lowest flat tax yet: 12%. And the flat-tax experiment that has attracted most attention in the EU has been in Slovakia, where a 19% rate for all personal, corporate and sales taxes was introduced in 2003.
Slovakia's flat tax became a lot more significant when the country joined the EU a year later, thereby gaining complete and unfettered access to Europe's single market. As advocates of the flat tax had long predicted, Slovakia's fiscal innovation helped to spur foreign investment and economic growth, while actually leading to a slight increase in tax revenues. Encouraged by Slovakia's experience, Romania, which is supposed to join the EU in 2007, has just introduced a flat tax of 16%. The centre-right opposition parties in Poland and the Czech Republic are both now pushing the idea of flat taxes set at 15%.
To many in the rich, high-tax countries of western Europe, all of this smacks of the dreaded “race to the bottom”, long forecast by those who feared that the enlargement of the EU would lead to a loss of jobs and an erosion of the welfare state. Joschka Fischer, the German foreign minister, has argued that it is intolerable for his country, struggling with a rising budget deficit and unemployment of over 10%, to finance EU subsidies to countries that are luring investment and jobs out of Germany by slashing taxes. As Mr Fischer sees it, the Slovaks and others can afford to set low flat taxes only thanks to big EU subsidies. Reality is more complex. That tax revenues have actually risen in Slovakia makes it a lot harder to sustain the charge of “fiscal dumping”. The main cost advantage that central Europe has over Germany and France is not low taxes, but low wages: an average Slovak worker is paid about a fifth as much as his German counterpart.Whole thing here.