catallaxy files

catallaxy in technical exile

The flat tax miracle?

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Analysts at the Heritage Foundation believe in miracles. In a recent opinion piece, ‘Russia’s Flat Tax Miracle,‘ the Foundation’s Daniel Mitchell writes:

The Russian flat tax has been so successful that even American politicians might learn the right lessons. Let’s look at the evidence: Russia’s economy has expanded by about 10 percent since it adopted a flat tax. That may not be spectacular, but it’s better than the United States, and it’s very impressive compared to the anemic growth rates we see elsewhere in Europe.

It also appears, conventional wisdom aside, that a low tax rate doesn’t mean less money for government. Over the last two years, inflation-adjusted income tax revenue in Russia has grown 50 percent. Why? Because people are willing to produce more and pay their taxes when the system if fair and tax rates are low — exactly what Ronald Reagan predicted when he triggered America’s economic boom with lower tax rates 20 years ago.

So is it a miracle? And should Australia and the US follow Russia’s lead?

Heritage has been talking up the flat tax idea for a while now, and Mitchell has recently spoken at a seminar hosted by Sydney’s Centre for Independent Studies. The CIS’ Peter Saunders has been doing the rounds promoting the idea.

The push dates back to the early 1980s when the Hoover Institution’s Alvin Rabushka and Robert Hall published a book on the subject. However, as Clifford Gaddy and William Gale of the Brookings Institution point out, what Rabushka and Hall have in mind and what happened in Russia are two different things. "Despite the 13 percent basic flat rate on most income, the reforms do not add up to a Hall Rabushka (HR) flat tax" say Gaddy and Gale (pdf).

According to the Brookings researchers, “Describing the 2001 reforms as ‘Russia instituted a flat tax’ distorts and oversimplifies what happened." And claims about the new tax regime’s effect on economic growth don’t add up: "Economic growth had begun well before the reforms were introduced. GDP grew twice as fast before the income tax reform as it did after."

Gaddy and Gale aren’t buying Mitchell’s argument about work incentives either. Citing a study by the International Monetary Fund (pdf) they argue that changes in income tax rates had no effect on labour supply.

I’m tempted to say that if Dan Mitchell and Peter Saunders like the flat tax so much they should go live in Russia.

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Written by Admin

November 19, 2005 at 5:24 pm

Posted in Uncategorized

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