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Forbes Croatia
The Flat Tax: Regional Competition for Capital and Jobs Intensifies
Why is Croatia still out of the competition?

Print Edition, April 2011

By Dr. Alvin Rabushka, senior fellow, Hoover Institution at Stanford University, Palo Alto, California and founding leadership board member, Adriatic Institute for Public Policy; and, Natasha Srdoc and Joel Anand Samy, co-founders of Adriatic Institute for Public Policy, Rijeka, Croatia.

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Ask Albania

July 23, 2007


WSJ Opinion Europe

For a lesson in pro-growth tax policy, may we suggest gazing east, to Albania. This small Balkan country is about to halve its personal income-tax rate, starting August 1, to a flat 10%. The corporate rate is slated to drop to 10% in early 2008.

Albania's flat tax is the latest sally in the intramural tax competition fueling growth in the former communist bloc. It began with Estonia in 1994 -- then-Prime Minister Mart Laar had read Milton Friedman's "Free to Choose" -- and has since extended to a dozen nations.

Political leaders, such as Albanian Prime Minister Sali Berisha, are aware of the example they're setting. When Parliament approved the most recent tax cut -- made in response to lowered rates in neighboring Macedonia -- Mr. Berisha cheered that "the fiscal revolution" will proceed even "faster than forecasted."

Indeed it may: The Czech government has announced that a flat 15% tax next year is "a certainty." And Montenegro plans to reduce both income and corporate taxes to a flat 9% by 2010.

The Adriatic Institute for Public Policy, a think tank based in Croatia, has found that governments that adopt flat-tax regimes see either steady or increased revenues within the first year.

For Western Europeans, the success of their neighbors' low, flat taxes can be seen piled on their very own freight trains. In the first quarter of this year, the euro zone -- dominated by France, Germany and Italy -- for the first time sold more goods to the 11 new Central and Eastern European EU members than to the U.S. Old Europe has these new customers in large part because New Europe is getting its fiscal policy right. Both would be richer if the West took a good look at the flat tax, too.




Business Insight Comment: Flat-Taxers Show the Way

16 05 2007  

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Southeast Europe is learning what star reformers already know - that lower, simpler taxes boost competitiveness.

By Natasha Srdoc in Zagreb


It started in Estonia. In 1994, the government of Mart Laar, already proven as one of central and eastern Europe's most daring reformers, instituted a flat tax. The idea was simple: no matter how much people earned, they paid the same income tax, and it was relatively low at 26 per cent.

The idea was not new in theory; the flat tax concept was first proposed 25 years ago by the American economists Alvin Rabushka and Robert Hall. But it was brand new in practice, and it worked. Simple taxes, easy to pay and difficult to evade, boosted Estonia's competitiveness, lured foreign investment and helped make the Baltic republic Europe's fastest growing economy.

There is much for the economic reformers of southeast Europe to learn from eastern Europe's great success stories, and this is among the greatest.

So it is surprise to hear Ivan Suker, Croatia's finance minister, describing his country's tax system as "perfect". Take a look. Croatia hits its taxpayers with heavy rates such as a 45 per cent marginal income tax and 20 per cent corporate tax and, in the process, entangles them in one of the region's most complicated tax codes.

Meanwhile elsewhere in eastern Europe a flat tax revolution is afoot. It is no longer enough to harmonise tax codes with European Union expectations. Even longtime EU member states themselves are being forced to scale down against more competitive tax regimes to the east, or risk losing business. In an increasingly borderless Europe, this struggle to attract investment and yield growth is constant and real.

On tax, Croatia is a slow learner. Serbia (14 per cent flat tax on personal income and 10 per cent corporate income tax), Montenegro (9 per cent flat tax on corporate income) and Romania (16 per cent flat tax on personal and corporate income) have bought in to the flat tax idea, and the list of converts is growing rapidly.

On January 1 of this year, Macedonia adopted a 12 per cent flat tax on personal and corporate income and plans to cut this to 10 per cent in 2008. On July 1, Montenegro is due to institute a flat tax of 15 per cent on personal income, lowering it to 12 per cent in 2009 and 9 per cent in 2009. In Albania, members of parliament are weighing the possibility of a 10 per cent flat tax on personal and corporate income.

Bulgaria, too, may join the fray. Flat tax proponents there are preparing to hold a major conference, citing concerns that Bulgaria may lose out on investments unless it drops its 24 per cent marginal income tax rate and 15 per cent corporate tax rate - already well below Croatian levels.

Foreign investment is not the only consideration. Flat taxes also carry a promise to free up economies for growth, by forcing gray economic activity into the legitimate market and simplifying collection. Economic activity increases, and so does honest reporting of income, while tax evasion drops. The result has been, in all countries that have implemented flat taxes so far, steady or increased tax revenue within the first year.

In a region like southeast Europe, such a change should be welcome. Countries of the region are challenged by corruption, inconsistent implementation of laws, high volumes of unregistered trade and low protection of property rights. Flat taxes help counteract such problems by closing loopholes and unmasking evasion techniques.

Under such circumstances, conservatism is the enemy of prosperity. It is in this way that Croatia's robust ties with "old Europe" are proving to be a disadvantage. Yes, investment from EU countries such as Austria continues to play a crucial part in Croatian economic recovery. No, we should not import the excessive economic, regulatory and tax conditions that EU-based companies are so evidently keen to flee.

Yet a characteristically conservative verdict on Croatia's tax system came at a conference on tax policy held last month in Zagreb, as reported in Austria's Der Standard. Participants concluded that Croatia's tax administration is "almost" on par with Austria's. But they failed to note is that Austria's heavyweight tax system is nothing to emulate. Indeed, it is currently in retreat, having recently reduced its corporate tax rate from 35 to 26 per cent, under pressure from neighbouring Slovakia's 19 per cent rate.

At the conference, Nadan Vidosevic, chairman of Croatia's conservative Chamber of Commerce made a passionate case for stability instead of reform, valuing stability and predictability above all. Suker agreed. But stability is only helpful once a system is made competitive, and Croatia is not there yet. How else to explain the under supply of greenfield investments and the accordingly high rate of unemployment, 18 per cent?

Suker blames this on the war, whose influence distinguishes former Yugoslav economies from other transition economies in eastern Europe. But his explanation falls short.

Even western Germany, with its cities and industries utterly devastated after the Second World War, rose from ashes within a decade to become one of Europe's strongest economies. Economic freedom plus foreign investment did the trick. Croatia has already had longer than a decade to rebuild. It has achieved much, but as time drags on, references to yesterdays' suffering increasingly sound like throw-away excuses for today's unimaginative governance.

Some southeast European countries are learning to look forward more daringly, as Estonia once did. The race is on. Let Croatia and other reform laggards take note.

Natasha Srdoc is president of the Adriatic Institute for Public Policy, a free-market think tank in Rijeka, Croatia. Balkan Insight is BIRN's online publication.

COMMENT: Croatia Resists Reform

23 02 2007  Reforms are starting to lag, and the country's leaders are loathe to admit it.

By Natasha Srdoc (Balkan Insight, 23 Feb 07)

On the long and winding road of post-socialist economic transition, Croatia has often outpaced other countries in southeast Europe. Yet now, just when it should be roaring ahead as a magnet for investment in the region, Croatia has reached a crossroads between rhetorical fantasy and economic reality.

Politicians in Zagreb have a habit of describing as a foregone conclusion the country's future within the European Union and NATO. But critical observers cannot help noticing that, increasingly, the facts show a country that, in critically important ways, resists the reforms it needs to go all the way.

External variables such as the European Union's enlargement fatigue are a factor, but there is trouble within as well. Far more important to Croatian citizens are realities on the ground, and these, according to a series of highly influential international indexes and reports, including the EU's own annual Progress Report, are troubling.

Reforms in Croatia are starting to lag, and the country's leaders are loathe to admit it.

The Heritage Foundation and The Wall Street Journal's recent Index of Economic Freedom rated Croatia 109th out of 157 countries worldwide - a pitiful 37th out of 41 nations in the region of Europe.

The index, which scores economic freedom according to an exacting set of objective criteria, described Croatia as 55 per cent economically free, calling it "mostly unfree".

In matters of property rights, rule of law, corruption and freedom from government, the index called Croatia "repressed".

Ratings for investment freedom, labour freedom, and business freedom were "mostly unfree". Financial freedom scored a bit better - "moderately free" - while trade freedom, monetary freedom and fiscal freedom were deemed "mostly free".

The index's criticisms confirmed what other recent analyses from the World Bank, European Union and others also indicate. If Croatia truly intends to scrap its twin legacies of socialist and authoritarian rule, there is much work to do.

Faced with this flood of concern from genuine advocates of freedom and prosperity worldwide, one might expect elected policymakers in Zagreb to respond soberly, with fresh, sincere commitments to make life easier for businesses and families.

Instead, Croatia's government has thrown itself into advanced spin mode. Ivo Sanader, the prime minister, went on record rejecting the data published by The Heritage Foundation and The Wall Street Journal.

Likewise, his government pooh-poohed the results of the World Bank's 2006 Doing Business report, and spun the EU's annual Progress Report, prompting The Wall Street Journal to publish a rebuttal titled "Croatian spin doctors".

Last month, when The Economist published an online report calling Croatia the "soggy bottom" of Europe, a place where "nobody wants to upset the murky and convenient status quo", the government quickly dismissed it as untrue.

This zeal for manipulating the facts only sets back the stated goal of a government whose ultimate policy focus is full membership of the Euro-Atlantic alliance. Indeed, it is reminiscent of how communists in Zagreb once fielded criticism.

This must stop. A lack of candour inhibits freedom - and freedom is what is at stake, most critically in the economic sphere. The reports from the EU and Heritage Foundation elaborate usefully on this point.

The threat to freedom does not end with economy alone. It begins there. Milton Friedman, the Nobel Prize-winning free market economist who died late last year, called economic freedom a prerequisite for political freedom. He was right, and political leaders forget his teaching at their peril.

Croatia's leaders, however, have learned to insulate themselves institutionally from criticism. Sanader has invited the Croatian Chamber of Commerce and National Competitiveness Board to review and respond to the Index of Economic Freedom. It looks good, but in fact he can rely on these institutions to reject the index's findings.

The Chamber of Commerce is still financed by the government, which mandates obligatory membership for every company operating in Croatia; the National Competitiveness Board, founded by USAID, meanwhile, consists of government officials, trade unions representatives and privileged representatives of business such as state-owned companies and large private firms holding state contracts.

By contrast, independent businessmen who speak publicly about corruption face the risk of open reprimand from figures of political authority including the prime minister himself. The effect is to discourage transparency and freedom of speech when Croatia's government needs private individuals, journalists and civic leaders to highlight areas requiring improvement. Independent voices are more likely to call a spade a spade.

Responding to the recent flood of criticism, the government boasts that Croatia receives high ratings from all international institutions, such as the European Commission and International Monetary Fund.

In fact, the EU Progress Report issues a jarring verdict that Croatia has "no overall strategic framework" for reform.

It goes on to describe an environment ripe for corruption. Croatia lacks "clear and transparent rules and procedures with regard to elections and the forming of governments at the local level". The country remains "still some way from enjoying an independent, impartial, transparent and efficient judicial system", and "allegations of corruption remain uninvestigated and corrupt practices usually go unpunished". An additional European Commission report cites major interference of politics with [the] judiciary.

In any such atmosphere, risks of corruption loom large.

And yet post-socialist reform need not be murky. Mart Laar, the former prime minister of eastern Europe's star performer, Estonia, offers simple advice, "The first step in fighting corruption is not to be corrupt yourself." Are Croatia's leaders ready to heed it? To see Estonia's astounding rate of reform-driven economic growth, they should be.

Croatia appears to be unprepared to clean up its own affairs, and yet a cleanup is urgently needed, for the state retains an alarming share of overall economic activity.

Government expenditure is worth 52 per cent of the country's gross domestic product, and yet, in some cases, it uses its position to crowd out private initiative. According to a report from the business news web portal, a substantial minority of public contracts, worth 146 million kuna, has been awarded without public tenders.

The consequent lack of room for private initiative and other hindrances to economic freedom need challenging, or they will only grow.

Croatia's Adriatic Institute for Public Policy last October co-hosted the Libertas Debate Series at the European Parliament with Roger Helmer, a British member of the European Parliament. There, issues of alleged corruption were raised in the cases of two former and two current government ministers.

In the wake of the meetings, the Adriatic Institute sent enquiries regarding the cases to Croatia's government, along with follow-up correspondence from Helmer. The enquiries went unanswered, in violation of Croatia's Freedom of Information Act. The unspoken message was one of contempt for the dignitaries present at the meetings, but more importantly for citizens and taxpayers.

It is time for the EU, World Bank, USAID and others who grant or loan substantial sums of money to Croatia to reexamine their approach. Too often, their funds contribute to systemic inertia when a change of course is needed. Croatia needs an approach more directly emphasising accountability and transparency.

Greater economic freedom should be a condition of future transfers of international support, with greatest emphasis on rule of law, protection of property rights, judicial reform and the complete, transparent privatisation of state-owned enterprises.

Such measures might rouse the government from its current state of denial, and eventually help Croatia to establish the foundations of a freer, more prosperous market economy.

Natasha Srdoc is president of the Adriatic Institute for Public Policy, a free-market think tank in Rijeka, Croatia. Balkan Insight is BIRN's online publication.