It's Morning In Albania


September 30, 2011

(This item originally appeared at Forbes.com on September 30, 2011.)

http://www.forbes.com/sites/nathanlewis/2011/09/29/the-rise-of-the-flat-tax-gives-us-morning-in-albania/

When Robert Ernest Hall and Alvin Rabushka published the book The Flat Tax in 1985, they didn’t have much historical evidence to go on. Only Jersey, Hong Kong and Guernsey had identifiable flat tax systems, plus a few other places like Singapore with similar tax regimes. They were riding on the political wave of Reagan’s tax cuts. It was “Morning in America,” to borrow a phrase from the 1984 presidential election.

Today, the flat tax idea is perhaps even more politically remote, in the United States, than it was in 1985. However, the rest of the world caught on to the idea. Today there are at least forty governments with flat tax type systems, most of which made the switch in just the last decade.

These include: Estonia (1994, 21%), Lithuania (1994,15%), Latvia (1995, 23%), Russia (2001, 13%), Serbia (2003, 12%), Bosnia and Herzegovina (2004, 10%), Slovakia (2004, 19%), Ukraine (2004, 15%), Georgia (2005, 20%), Romania (2005, 16%), Turkmenistan (2005, 10%), Kyrgyztan (2006, 10%), Albania (2007, 10%), Mongolia (2007, 10%), Kazakhstan (2007, 10%), Mauritius (2007, 15%), Tajikistan (2007, 13%), Bulgaria (2008, 10%), Czech Republic (2008, 15%), Belarus (2009, 12%), Seychelles (2010, 15%) and Hungary (2011, 16%).

A number of these countries have been having problems recently, mostly due to unstable money and the generalized effects of the recent global economic difficulties. We could take 2007 as a representative pre-crisis year. How did the flat tax countries do then? For thirteen countries for which information was available from the IMF, the average GDP growth rate was 10.0%, ranging from 6.2% (Slovakia) to 23.1% (Ukraine).


However, even this impressive number hides more dramatic gains. In my opinion, in high-growth areas, the true rate of growth tends to be hidden by inflationary adjustments. Prices rise, but it is not because of the debauchment of the currency, it is because people are getting richer. Rents, restaurants, hotels, medical services, education and so forth all become more expensive. Thus, the nominal GDP figures give perhaps a better impression of the true rate of growth. The average nominal GDP growth among these thirteen flat-tax countries was 21.8% in 2007.

We are not talking about adding a percentage point to growth. We might be adding ten percentage points. The cumulative effects are astounding. Are you getting the idea of why this policy has been so widely imitated?

Another surprising theme has been the amazing stability of tax revenue as a percentage of GDP. Among ten flat-tax countries for which data is available from the IMF, I took the revenue/GDP ratio of the last year of the former tax system and the first year of the flat-tax system. How much did the revenue/GDP ratio change? The average change was … minus 0.10%. Yes, a tenth of a percentage point. Hardly any change at all. Six countries (out of ten) had an increase in the ratio – they actually got more tax revenue, as a percentage of GDP, than with their old tax system. The largest decline was Slovakia, whose revenue/GDP ratio fell to 40.57% from 45.60%. Maybe that was a little high anyway.

However, when you combine the typically high growth in nominal GDP with these stable revenue/GDP ratios, nine out of ten countries experienced an increase in tax revenue in the first year of flat-tax implementation. The average increase in revenue was 17.7% (when excluding outlier Estonia, which had an 81% increase). Even Slovakia, with the biggest decline in revenue/GDP, had a revenue increase of 6.1%. Mongolia, with their 10% flat tax replacing a system with rates up to 40%, experienced a 33% increase in revenue! The only decliner was the Czech Republic, which had a 0.50% reduction in revenue. However, even that could be explained by the fact that the Czech Republic implemented its flat tax in 2008, a year of economic crisis worldwide.

So you see, most of the seemingly-impossible promises of the flat-taxers – higher growth, stable revenue/GDP ratio, rising government revenue – are in fact common and repeatable.

Russia, which implemented its flat tax in 2001, provides one of the best longer-term examples. Between 2000 and 2008, Russia’s GDP (in U.S. dollar terms) grew at an average compounded rate of 26% per annum. The end result was that GDP in 2008 was 546% higher than in 2000.

Russia’s tax revenue/GDP ratio was 31.4% in 2000, and 31.6% in 2008. With this ratio stable, you can see that the Russian government’s tax revenue also grew right alongside the growth in the economy as a whole, increasing to more than six times its 2000 amount in less than a decade.

The funny thing is, between 2000 and 2008, Russia’s population actually declined from 146.7 million to 141.4 million. Blaming economic stagnation on population, as is common regarding Japan today, is a waste of time.

And what about Albania? On January 1, 2008, Albania implemented a 10% flat tax on personal and corporate income, replacing a system with rates from 10-30% on personal income and 20% on corporate income. The result? Tax revenues went up 18.4%, even though 2008 was a crisis year worldwide.