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A new study shows that economic freedom is still repressed in southeast Europe, and corruption is the biggest reason why. The article "Why We Aren't Free Yet" was published in Balkan Insight - an online publication of Balkan Investigative Reporting Network.

The First Flat Tax Book with Simulation for Croatia

In the midst of a national debate about tax reform in Croatia, a timely released book "The Case for the Flat Tax in Croatia" (Flat Tax - Kako provesti poreznu reformu i potaknuti gospodarski rast?) co-authored by Natasha Srdoc, MBA and Joel Anand Samy, co-founders of Adriatic Institute for Public Policy and the annualized International Leaders Summit provides an easy to read tax reform guide book for Croatia and includes Croatia's first ever flat tax simulation. The Croatian version of the book was published by Zagreb based IBS.

Flat Tax for Croatia will Boost Economic Growth
Flat tax is a one, low, fair, unique tax rate, which taxes income exactly once (avoiding double taxation) and as close as possible to the source.
The authors present a pro-growth proposal of adopting a 15% flat tax in Croatia based on the integrated Hall-Rabushka flat tax system. Based on the performed simulation for Croatia, this system could be applied in the following manner: 
  • Replace the steeply progressive gradual tax rates for personal income, which in Croatia vary, ranges from 15% to 45%, with a 15% flat tax.
  • Replace the regionally high 20% corporate profit tax with a 15% flat tax.
Through the authors' proposal, the value added tax (VAT) would be gradually decreased from the high of 22% to 19%, then 16% and finally reach 15% in a period of three years. The performed simulation clearly indicates that the proposed model of the flat tax could be adopted immediately, without any negative consequences to Croatia's government budget. The flat tax of 15% will stimulate economic growth.
Since economic growth raises government revenue more rapidly than spending, it will further help reduce the growing budget deficit. In average, Eastern Europe's flat tax countries have doubled the rates of economic growth. Most importantly, flat tax reduces political favoritism, the gray market and corruption. 

In this flat tax proposal, the poor pay no tax at all. The amount above the personal allowance would be taxed with unique 15% flat tax, which will result in a built-in progressivism.  

Taxpayers are the main actors and
bearers of economic activity (instead of the government) for which economic freedom is essential. While taxpayers commit to finance the legitimate functions of the government, this tax burden should not be too excessive so that it slows the economic growth and reduces their standard of living.

The Role of Tax Policy 
Tax policy plays a central role in achieving high rates of economic growth. A low flat tax of 15% provides incentives for entrepreneurs to take risks, local investors to create jobs and most importantly attract new foreign direct investment in Croatia, which will significantly decrease unemployment.
Every new employed person turns from an unemployed tax beneficiary to a taxpayer. The flat tax system increases potential take-home wages, which stimulates employees to increase their work effort and leads to raising total output.  
This simple, efficient, just and neutral flat tax system would result in higher tax income compared to the existing complicated tax system. The current tax system represents one of the major obstacles to domestic and foreign direct investment and higher employment.  
The major objective of the tax policy is to achieve the highest rates of economic growth for the longest possible period of time.
The authors of the book refute "the more just distribution of the tax burden" as an objective of tax policy. The tax policy can not be used to conduct social policy.  The only purpose of the tax policy is to raise taxes in the simple, fair, least-expensive, most effective, most efficient, non-distortive and non-discriminatory way. The question of financing certain necessary social needs get answered at the moment when taxpayers' representatives decide how to spend taxpayers' money, which was previously raised through taxation.
Furthermore, in that manner, government officials can not claim that they have already taken care of helping the poor by taking from the rich (redistribution through taxation), but the focus shifts on how the government is spending money, whether it spends it for legitimate social purposes in helping the needy and whether the government's own expenditures are too high.
The question of redistribution diverts our attention as taxpayers from the real question. The shift in the question should be from "the rich versus poor" to "big government and unaccountable government expenses (higher tax burden) versus economic growth".

Croatian Government Expenditures are out of Control and Stifling Economic Growth 

There is a significant correlation between government expenditures and the rate of economic growth. The higher the government expenditures as a portion of GDP, the lower the rate of economic growth, that is, lower standard of living of individual citizens are to be expected. In order to achieve higher economic growth and a better standard of living for individual citizens that is urgently needed, the government must perform its legitimate and limited functions. The government needs to move away from the past communist centrally planned system (command and control - state intervention) and simply get out of the economy to usher in a free market economy.
Croatia's government is spending too much of its taxpayers money. The government consumption as a portion of GDP reaches some 52.5%. These are the highest government expenditures and government consumption rates compared to all other transitional countries and even the EU average.

There is a great need for Croatia's government leaders to embrace a dynamic approach
to tax policy. While the static approach is focused on re-distribution, the dynamic approach is primarily focused on economic growth, whereby a lower tax burden leads to higher economic growth and higher economic growth, that is, increased GDP, reduces the portion of the tax burden.

The authors further suggest that in case the Croatian government moves forward to cancel certain tax exemptions in the VAT or make any other change of the existing tax system or described flat tax system, which would result in an increased tax base and higher government tax income, it should simultaneously and immediately reduce the tax burden. For example, the recent proposals for canceling 0% VAT on certain categories of products have to be simultaneously followed by reducing VAT on other categories of products from the high 22% to 19%.

The authors believe that the taxpayers in Croatia deserve a fiscally responsible government that will return the surplus of collected tax income through the reduction of the existing tax burden and significantly reduce government consumption.

15% Flat Tax Simulation for Croatia
The 2006 forecasts for economic growth in the documents of Croatia's Ministry of Finance reach 6.9%. Taking into consideration this forecast and inflation, the authors assumed that under unchanged tax system, the real rate of economic growth could reach 4.5% of GDP in 2006. Based on the experiences of other countries that have adopted the flat tax, the authors conservatively assumed the minimum 2% of higher economic growth as a result of the flat tax adoption according to Hall-Rabushka's model.   

By canceling tax breaks and exemptions in the personal income and corporate profit tax (keeping the personal allowance in the personal income tax only), the tax base will be significantly increased which enables the application of a lower tax rate. The lower flat tax and the principle of taxing income only once - and as close as possible to the source, would motivate taxpayers to save, invest and work more, which would result in higher production of products and services, which means higher economic growth and GDP per capita. The flat tax would attract foreign direct investments, which would lead to higher employment. Shift of the gray economy (total gray economy is estimated at 34% by the World Bank) into the legal market, reporting higher salaries, increased tax base of personal and business income, reduced tax evasion and tax avoidance would all result in increased tax income.

With the implementation of the flat tax on January 1, 2006, the simulation demonstrated that the tax income (from personal income tax, corporate profit tax and VAT) would increase by 66 million kuna in the end of 2006, compared to the base year (in constant prices). The authors' assumptions of economic growth for the next four years are moderate ranging from 6.8% in 2007, 6.5% in 2008, 6.5% in 2009 and 6% in 2010. With simultaneous reduction of VAT from 22% in 2006, to 19% in 2007, 16% in 2008 and 15% in 2009, the tax income has in every year been higher compared to the base year.
The rates of economic growth could be further increased through the implementation of structural reforms, reduction of government consumption, rapid privatization and getting the government out of the economy.
To purchase a copy of the Flat Tax book co-authored by Natasha Srdoc and Joel Anand Samy, please contact Adriatic Institute or

The flat tax train has left the station.  Croatia can watch and wave goodbye, falling irretrievably behind in its quest for investment and jobs.  Croatia can run alongside the train, hoping to keep up, but falling further behind as the train picks up speed.  Or, the best choice of all, Croatia can get on board.  The sooner it boards, the sooner it will get the attention of global investors as they search for attractive investment opportunities.

 Dr. Alvin Rabushka, Senior Fellow, Hoover Institution, Stanford University, USA


Croatia's tax system is a complicated failure that hinders the nation's growth while allowing the politically well-connected to manipulate the system to get special breaks not available to average workers and businesses. This is stimulating a great deal of interest in shifting to a simple and fair flat tax. Croatia should move quickly. In a competitive global economy, jobs and capital flow to jurisdictions with better tax law. Indeed, nine nations in the former Soviet Bloc have adopted versions of the flat tax. These pro-growth reforms are yielding impressive results and are a roadmap for policy makers in Croatia and other countries.

Dr. Daniel Mitchell, Senior Fellow, Cato Institute, USA 

The tax reform did not create a fiscal deficit in Slovakia ?? where the tax system would generate little revenues and thereby leaving the government with too little money to spend on otherwise worthy policies. The overall tax revenues are now virtually the same as before the tax reform. Moreover, there is an expectation that they should increase in time, also thanks to higher economic growth stimulated by the new tax system.

Of course, higher growth means more jobs, higher wages and therefore also better living standards. So perhaphs this type of tax reform may be an example worth following in other countries of Central and Eastern Europe.

Ivan Miklos, Deputy Prime Minister and Finance Minister, Slovak Republic

In Europe we often focus on the structural indicator of the Lisbon process and loose sight on the keys for success. A competitive labor force and the tax system are key indicators of good economic governance. The tax system indicates of how efficient a state is in governing a country and in providing all the public needs of the citizens. The flat tax has many advantages like higher economic growth, lower unemployment, giving incentives to entrepreneurs, fighting the grey economy and corruption and promoting transparency and greater results.

Peter Jungen, Venture Capitalist, Co-President SME Union, Chairman Economic Policy Council of European People's Party (EPP)

The leadership of Croatia today is closely following the German model with its advantages but sadly, with a number of outright mistakes. To burden a transitional economy with a western welfare model tax system is neither social nor just nor efficient. This has to change as fast as possible. So we really hope and indeed actively encourage economic reform as fast and thoroughfully as possible. ETR is hoping to soon include Croatia in the same league as the fast growing and ever-richer flat tax countries.

Gunther Fehlinger, Chairman, Europeans for Tax Reform

As the EPP coordinator of the Committee for Industry, I follow the economic development of Croatia closely and there are many positive developments in this field as well. The only setback from my point of view is the area of taxation. In this strategic area, other countries like Slovakia and Romania have gone much further and Croatia
is lagging behind. Also in my position as President of SME GLOBAL which is a network of Small and Medium Sized Enterprises from all over the world, it is clear that especially small businesses need a simple, fair, transparent and low rate taxation which promotes efficiency and allows creativity to flourish.

Dr. Paul Ruebig, MEP, Austria, European People??s Party (EPP)
President, Global SME Global

Corruption severely disrupts the foundations of every democratic and civil society. It not only invalidates trust, equality, impartiality and stability of the society itself, but also aggravates social relations.

It is positive to hear that the implementation of the flat tax has helped many nations succeed economically and in the areas of combating corruption.  It is encouraging to review flat tax evidences and experiences from some countries in reducing corruption, creating greater transparency and moving a significant part of the grey economy into the legitimate economy. These experiences may certainly be useful for Croatia. 

Vesne Skare Ozbolt, Minister of Justice of the Republic of Croatia


There is much for Croatia to learn from the detail in surveys such as the World Bank's. But the policies that make a country attractive to international investors are not hard to discern. Regulation and red tape discourage inward investment, as do high taxes, complex tax systems and legal uncertainty. The countries that are most successful in attracting foreign investors sweep away such obstacles -- which is why so many of the
transition economies have adopted flat taxes.

John Willman, Chief Leader Writer and Deputy Editor, Financial Times, UK

With the countries of Central and Eastern Europe boldly introducing broad economic reforms led by the adoption of the flat tax, economic growth and development is racing forward in the region faster than anyone could have imagined.  In today's competitive world, to stand still is to fall behind.    Each day that the environment in Croatia remains less favorable than that in its successful neighbors is a missed opportunity.  

Stan Jakubek, Tax Partner, Ernst & Young, Zagreb, Croatia