"It is very fortunate that I was not an economist. I had read only one book on economics - Milton Friedman's "Free to Choose". I was so ignorant at the time that I thought that what Friedman wrote about the benefits of privatization, the flat tax and the abolition of all customs rights, was the result of economic reforms that had been put into practice in the West. It seemed common sense to me and, as I thought it had already been done everywhere, I simply introduced it in Estonia, despite warnings from Estonian economists that it could not be done. They said it was as impossible as walking on water. We did it: we just walked on the water because we did not know that it was impossible."
Mart Laar, 2006
Flat Tax reform is getting more and more popular. Estonia was the first country in Europe to introduce the flat tax in 1994 and now 13 years later, the flat tax has been introduced in more than 10 European countries. Bulgaria is one of the few countries in East European region that still hesitate to turn to flat tax rates. Looking at the success of the other "flat" countries, even the World Bank admits that the flat tax is better, especially for Eastern Europe.
We believe that it is time now for Bulgaria to "walk on water"!
Flat Tax Map 2007
Map design: Petar Ganev & Nikolay Minchev
Recently the World Bank published a comprehensive survey "Fiscal Policy and Economic Growth: Lessons for Eastern Europe and Central Asia". The conclusion is simple:
"Flat-rate income tax reforms have generally had positive effects in Eastern Europe, but need to be complemented with additional steps to modernize tax administration and reduce labor taxation," - World Bank Senior Economist and co-editor Tracey Lane.
The main lessons from the flat tax reforms in ECA, pointed by the World Bank are as follows:
1) The key objectives of the reform should be clearly articulated before turning to specific design issues. In the rush to implement the apparently successful reforms of other countries, governments may overlook their core objectives. There are different objectives for this type of reform, such as improving compliance, broadening the tax base, bringing simplicity to the system, mobilizing higher or lower revenue, reducing the tax burden in the country, and shifting the tax burden from direct to indirect taxation; some of these objectives run counter to each other. Clear objectives should drive design features, such as rates, allowances, tax credits, and the like, as well as other parallel reforms needed.
2) If revenue neutrality is one of the goals of the reform, tax policy in other areas may need to be adjusted as a safeguard against some drop in revenues in the PIT and CIT. If, in parallel, another goal is to shift the burden away from direct taxes and toward indirect taxes, tax policy and administration for the VAT and excises should be strengthened before or in tandem with a flat income tax reform.
3) A comprehensive curtailment of income tax loopholes and ad hoc exemptions is essential to expand tax bases and prevent undue revenue loss with flat income tax reforms. Countries that closed loopholes and reduced exemptions had greater success with simplification, compliance, and revenue collection.
4) Success in expanding the PIT tax base and improving PIT compliance depends in part on complementary reforms in social insurance and contributions. Payroll taxes have almost the same base as the PIT in most countries in ECA, and high marginal rates of payroll taxes (social insurance contributions) can be a major obstacle to improved PIT compliance after the reform.
5) Modernization of tax administration is a key complementary institutional reform. Simultaneous reforms in tax administration will complement policy changes in helping in achieve the goals of the reform (whatever they may be) with fewer fiscal risks.
6) Allowances are critical to the achievement of equity goals. Allowances have proven to be an important safety net for lower-income taxpayers and have enhanced the equity of flat tax reforms. It is important to evaluate trade-offs carefully and set allowances at appropriate thresholds. Allowances should be kept simple, however, to avoid administrative complexity.
7) The timing of the reform is critical. Governments have been able to avoid unmanageable revenue losses by implementing tax reforms during times of strong growth and sound fiscal frameworks.
Finally, communicating the reform, its goals, and its characteristics, and obtaining consensus from all stakeholders is important for success. Informing the public is critical for PIT and CIT reforms and can help to reduce political obstacles. For the CIT, a highly publicized campaign on the benefits of transparency and the need to close loopholes can help counter industry lobbyists who may argue against elimination of exemptions for certain industries.
 Mart Laar - Former Prime Minister of Estonia in 1992 - 1994 and 1999 - 2002