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Forbes Croatia

Print Edition: April 2011

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

From right: Dr. Alvin Rabushka, Natasha Srdoc and Joel Anand Samy at the Second International Leaders Summit, Zagreb, 2005.

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.

Since 1994, seventeen post-communist countries in central and eastern Europe have replaced the highly graduated progressive tax system with a simple flat tax.  Notably, eight of them are members of the European Union. From the Baltics to the Balkans, nearly 300 million taxpayers on the European continent live in flat tax nations.   Around the world in dynamic regions, thirty-one jurisdictions in total have adopted the flat tax. Without exception, all the countries have achieved the same or higher tax income just one year after the flat tax adoption with higher rates of economic growth and employment.

Why have countries adopted the flat tax?

The idea is simple: the main objective of tax policy is to raise tax revenues allowing the highest economic growth for the longest period of time.

So-called progressive income taxes impose graduated rates on progressively higher levels of income, which distorts investment, and discourages work and saving. In contrast, after allowing for a personal exemption, the flat tax levies a single rate on all taxable income.

A low flat-rate tax is simple, fosters efficiency, and encourages compliance. Simplicity means that the taxpayers are able to understand the law and their obligations. Efficiency means that individuals invest on the basis of economic decisions, not tax preferences.

Compliance means that the government can collect income tax in an accurate, responsible, fair manner, with a minimum of corruption.  In fact, the flat tax is a transparent system.

The flat tax is not a new theory; prior to introducing the progressive tax system advocated by Karl Marx, countries around the world including the US had a low flat tax rate.  The modern flat tax concept was first proposed 32 years ago by economists from Hoover Institution, Stanford University, Palo Alto, California, Dr. Robert Hall and one of the authors of this article, Dr. Alvin Rabushka.

For eastern Europe, the flat tax reform initiative started in Estonia. In 1994, the reform government of Mart Laar, already proven as one of central and eastern Europe's most daring reformers, instituted a flat tax of 26 per cent. In the meantime, Estonia lowered its flat tax rate to 21%.  Estonia’s business flat tax rate is 0% on reinvestments. 

Over the course of the years, reform leaders such as Ivan Miklos, Slovakia’s finance minister, implemented a flat tax of 19% for personal and business tax. Although Slovakia’s socialists campaigned against it, they did not tinker with the flat tax when they came into power; albeit, for a brief period of time. Slovakia’s Ivan Miklos returned as finance minister in the spring of 2010 and The Financial Times on March 3, 2011 reported:

“Slovakia, with a population of 5.4m, has a corporate flat tax rate of 19 per cent, which     has helped attract a flood of foreign investment, mainly in car and electronics production, and given it one of the EU's highest growth rates.”

Simple taxes, easy to pay and difficult to evade, boosted Estonia and Slovakia's competitiveness, lured foreign investment and helped make the Baltic republic and central Europe’s tiger - Europe's fastest growing economies. Slovakia has been a magnet for international investment. The results have been uniformly successful in other countries. After adjusting for inflation, real personal income tax revenue in Russia doubled between January 2001 and July 2004.

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

Regional flat tax competition within SE Europe reveals Albania, Bulgaria, Macedonia, Montenegro, Romania and Serbia having very low flat tax rates. Albania and Macedonia have a 10% flat tax with Montenegro boasting a competitive flat tax rate at 9%.

China has been considering the flat tax to replace its nine-bracket personal income tax with its top rate of 45 percent. India is already benefiting from Mauritius’ low flat tax rate of 15% and  has played a role as the gateway for India’s foreign investments.

When it comes to economic reforms, Croatia has been the region’s noticeable laggard.  Early this year, Hungary, Croatia’s neighbor with a 10 million population adopted the flat tax of 16% for personal income thus intensyfing regional tax competition.  

Croatia’s corporate tax rate of 20% and its top marginal personal income tax rate of 40% is one of the highest in Eastern Europe (except for Slovenia which has the same corporate rate of 20% and 41% top marginal personal income tax rate).

According to the KPMG’s 2010 Individual Income Tax and Social Security Survey  which covered 86 countries, Croatia has the highest combined contribution rate in the world, of 53.3% (in terms of income tax and social contribution rates for employees with an income of US $100,000.

Croatia’s unemployment rate reached 20% and its youth unemployment rate hovers around a troubling 35%. Croatia’s GDP has been falling for two consecutive years, by 5.8% in 2009 and 1.4% in 2010. As nations in the region have been competing for foreign direct investments which lead to job creation and higher rates of economic growth, Croatia can no longer afford to be a laggard.

The Adriatic Institute for Public Policy has presented Croatia’s taxpayers, parliamentarians and its government a revenue-neutral tax reform with the flat tax rate of 15% to compete with the region’s very low competitive tax rates. 

Adriatic Institue’s distinguished leadership board members including Estonia’s former Prime Minister Mart Laar and Slovakia’s Finance Minister Ivan Miklos have visited Zagreb and clearly articulated the benefits of the flat tax as a pro-growth tax reform to Croatia’s politicians and business and media leaders.  These principled reformers from Estonia and Slovakia have done it right - and their nations have benefited from pro-growth solutions.

To maximize its economic growth, create jobs, and raise incomes, Croatia does not have a choice but to compete for investments with other central and eastern Europe countries.

Given the success of the flat tax in countries which have adopted it, Croatia risks being left out, denying its citizens, especially its youth the opportunities for good paying jobs and a higher standard of living. The flat tax has been a positive force in central and eastern Europe, and thus deserves serious consideration by Croatia’s individual citizens, entrepreneurs, parliamentarians and its government.  In order to move out of its economic crisis, Croatia ought to urgently implement the flat tax!

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, MBA and Joel Anand Samy, co-founders of Adriatic Institute for Public Policy, Rijeka, Croatia.
  Robert Hall and Alvin Rabushka of Hoover Institution, Stanford University co-authored The Flat Tax (1981). Srdoc and Anand Samy co-authored a book for central and southeast Europe titled "The Flat Tax: How to implement tax reform and boost economic growth" (2005).

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