Although the flat tax in modern times seems to be politically infeasible in the United States, it has not been so internationally. In fact, there was a wave of flat tax enactment that occurred in the 1990s and early 2000s. This was the flat tax revolution.
The first nation to examine is Russia. Before delving into the Russian experiment, one caveat: Russia is by no means being endorses as an economic role model. The nation operates under quasi-capitalist conditions, with heavy intervention and favoritism in the government towards select former security colleagues of Vladimir Putin. The nation ranked 2nd in crony wealth according to The Economist, and this is undoubtedly a result of noncompetitive deals involving the privatization of natural resources and banks.
That aside, in the beginning of his presidency, Putin made some positive policy changes in Russia, one of which was a flat personal income tax. The flat tax of 2001 condensed three bracket rates into a single 13% rate, which is markedly less than many of the proposed plans in the United States, all of which shoot for targets of around 17-18%. In addition to the flat tax, the Russian government made policy assurances to all Russian businesses and investors, promising to maintain the current tax structure for the foreseeable future. Time assurances are important, because individuals change their behavior based on the perception of time frames. A short horizon for a tax break encourages the cashing of assets immediately.
The results of the flat tax were astonishing. The flat tax reversed two years of declining revenue, and set Russia on a three year surge of increased revenue. The first, second and third year after enactment, revenue rose (in real terms) by 26%, 21%, and 12% respectively. Explanations vary, but there is little debate that a great deal of this was from increased compliance (as measured using consumption compared to taxed income). Some estimates believe that compliance grew by nearly 33%. Compliance raised the most among those who received the greatest tax decreases. The flat tax left leaves less room for tax evasion, both on the government and the people’s part. Russia also saw extremely high GDP growth from 2003 until 2007, and saw small increases in hours worked by men.
There are, however, strong qualifiers to the results stated above. The first, is that Russia also increased tax enforcement at the same time as it implemented the flat tax. Much of the increased compliance could be due to the increased enforcement. Second, any GDP growth in the 2000s was in the context of strong global price increases in oil and other natural resources that Russia exports. Finally, generalizing Russia’s experience to the United States’ must account for the fact that Russia maintains a larger shadow economy, and had much higher levels of evasion than the United States.
These qualifiers are likely to influence the magnitude of gains from a flat tax, but even a critic would be hard pressed to argue that there would be real compliance gains, not losses, if a flat tax was implemented. The fact still remains that in 2010, tax evasion in the US was $308 billion; not a number to sneeze at.
Beyond compliance, the Russian experience has caused a “comparably small increasing effect on actual net income inequality.” This is to be expected, as any flat tax will cause a decrease in redistribution. But the doomsday increases in inequality often parroted by the left did not materialize. The flat tax also led to some small examples of ultra-rich individuals moving to Russia. Although there have not been large empirical country wide studies done to test whether taxes can cause people to move, the logic present is strong for the affirmative. It makes sense that those with the most money, who can usually afford to leave a country, will consider how much they will have to pay in taxes. And when the choice is between France, which briefly considered a 70% top rate, and Russia, which levies the 13% flat tax, the choice seems clear.
After addressing the case of Russia, the question then becomes: what about the rest of the world? As it turns out, the flat tax has been highly successful across the countries that have chosen to adopt it. In 2007, the average GDP growth for the 13 countries with a flat tax, for which IMF data was available, was a full 10%. (2007 is used because it is the most recent pre-crisis year) This is nearly double the world average in 2007. Of course, correlation does not directly imply causation, but the correlation is strong, and there is reason to believe that the flat tax was a contributor. The ten countries, for which IMF data was available, also experienced remarkable revenue stability during their transitions to a flat tax, averaging only a 0.10% fall in revenue.
The Russia and the world are all testaments to the benefits of a flat tax. They debunk many of the revenue criticisms of the flat tax, and at the very least prove that there is a strong correlation between flat tax adoption and strong growth. The “Case in Flat” is, by now, a case in point.
By Jacob Kohlhepp
The Policy Paladin