Economic Policy Review ISSN 1313 - 0544

Could we be free?

Author: Svetla Kostadinova / 12.03.2009
Rate This Article:

Exactly 15 years ago the Heritage Foundation, together with the Wall Street Journal began to measure the level of economic freedom around the World. The authors formulated 10 factors which have greatest effect on the level of freedom within an economy - freedom of business, commerce, investments, labor, monetary freedom, freedom from the Government, fiscal freedom and freedom from corruption.

The highest degree of economic freedom represents the absolute right of ownership, entirely implemented freedom of labor movement, capitals and goods. The people are free to work, produce, consume and invest in any way they want and this freedom is maintained, warranted and not limited by the State.

At the first glance these "rules" are not complex. The fact that the countries which increase their economic freedom over the years achieve higher economic growth, lower level of unemployment, higher incomes and good living environment and doing business, must be showing that the system is working. In other words, if a Government wants better results, then the way to achieve them is proven and more than clear.

Bulgaria is given as an example ... this time good

In this year issue Bulgaria is mentioned as one of the countries around the World, which has reduced the direct taxation to unprecedented low levels (10% personal and corporate tax).

The question is whether the Bulgarian rulers are farsighted people who believe in the stimuli or are part of something global, which is happening around the World. 

During 1981 and 1986 Ronald Reagan reduced the highest profit tax in the US from 70% to 28%. The result was an unseen increase in the level of foreign investment and growth.

At the end of the 80's of the 20th century, Hon Kong was the first country to introduce true flat tax. In combination with opening the country to free trade, these were the reasons that the country was ranked first in the ranking for economic freedom for more than 15 years.  

Estonia introduced flat tax during 1994. Mart Laar then sincerely believed that the idea would work and the long term effect would be fast economic growth. That is what happened. 

For the period between 1980 and 2007 Norway reduced the highest tax rate on the personal income with 35 percentage points, Italy - with 29, Mexico - with 27, while France - with 12.

During the same period there were reductions in the corporate profit tax rates - Ireland with 32.5 percentage points, Austria with 30, Sweden with 12, Denmark with 15, while Portugal - with 20.7.

During 2008 China joined the group which was reducing the corporate profit tax and it is now 25% compared to the previous 33%. This reform together with the policy of favorable conditions for foreign investments, the privatization and expansion of the private initiative in the country lead to unseen levels of economic growth.

Germany also carried out a tax reform, although very modest - during 2007 the corporate profit tax was reduced with 9 percentage points.

The most impressive however are the tax reforms in Eastern Europe. From 24 countries with flat tax almost half are from this part of the World. We are talking about Lithuania (27%), Latvia (25%), Estonia (21%), Slovakia (19%), Romania (16%), Czech Republic (15%), Monte Negro (15%), Albania (10%), Bulgaria (10%), Macedonia (10%) and Georgia (12%). The results were not late - all countries mentioned above increased their economic growth, attracted foreign investments and have a real chance for fast growth of the standard of living.

This which the Index does not include is the social security payments. If they are added and the overall tax burden is calculated, than Bulgaria certainly would be among the tax non-free countries. They are so high that they have become the main factor stimulating the concealment of the real incomes. A study by the World Bank shows that social security payments which are higher than 15% of the salary lead to higher costs of labor in the economy, encourage non declaration of income and discourage working in general. 

That is the reason why the social security payments must be reduced. Our government showed that it could reduce certain taxes and have to continue with the social security payments if it wants to increase the income of all working people.

Why is it important that all taxes are low?

  • When the taxes are low the people and the business decide what to do with their incomes - not the State;
  • The corporate taxes have the most negative effect on growth, followed by personal income taxes and than the taxes on consumption, according to a 2008 OECD study; 
  • A 2006 study of the American Entrepreneurship Institute showed the tax burden on the profit is born at the end by the workers in the form of lower wages. The 72 countries included in the study indicated that the salaries in industry are negatively related to the high profit tax rates;
  • The reduction of the personal income tax leads to longer working hours by the workers and in general more people on the labor market hence, lower unemployment;
  • The high taxes change the stimuli of the people and the companies - they select a different country, hide incomes, decide not to work.

The economic freedom in Bulgaria

In the 2009 Index the Bulgarian economy gets a total score for freedom of 64.6 out of 100, which puts it into 56 place out of 183 countries, i.e. we are in the group of moderately free nations.

The reasons that we are in that group are the introduction of the currency board, the opening of the economy for trade, which allows our business to use the common market, taking the company registration out of the courts, which makes it easier for the entrepreneurs and the reduction of direct taxes. Overall this is not enough.

In Bulgaria still:

  • ü The Government distributes more than 40% of the GDP,
  • ü Gives subsidies to the agricultural producers, which is biasing the prices,
  • ü The bureaucracy is large and is burdening the business with expenses,
  • ü The changes in the legal framework are many and often with not clear result,
  • ü Corruption is high, while
  • ü The legal system is not working and impedes local and foreign investments.

These are part of the reforms which must take place in our country as soon as possible.

The Index of economic freedom may have faults (like every index), but this which is irrefutable is that it shows that higher freedom means more prosperity. For that reason every Bulgarian Government (or candidates for such) must use it as a matrix for their government program.

It is a fact that freedom works!

This article is based on the report on Economic Freedom 2009, which local partner in Bulgaria is the Institute for market Economics.