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Articles

Petr Mach: Flat Tax and Tax Competition

Konference, Hotel Josef, 30.05.2005

published: 14.01.2005, read: 5095×

 

Tax reform, particularly the flat tax proposal, and advocating tax competition belong to principal issues of our think-tank.

I will present you briefly our flat tax proposal, which is to be introduced by the ODS, the main right-wing opposition party, hopefully after the next general elections next year, and I will present you our case for maintaining tax competition in Europe, and in the World.

Need for inter-jurisdictional competition

Coincidentally, it has been just a few hours since French voters rejected the European Constitution. I welcome this fact, because under the proposed Constitution it would be impossible to pursue independent economic policies and our flat tax could be prohibited as "harmful tax competition".

A media cliché says that the French oppose the Constitution for very different reasons than, say, the British or Czech opposition. The common interpretation is that the French consider the Constitution a threat to their socialist model, while the Czechs and British say that the Constitution is a threat to their free market visions.

But there is no paradox in it! Both reject the Constitution because they don’t want other nations to impose their policies on them through the EU institutions.

In this sense, advocating tax competition is superior to advocating a flat tax proposal. We believe that flat taxation is a better taxation. However it is only competition among different tax systems which can result in the best solution. Only competition can prove whether the flat tax is an example worth following or an example to be rather avoided.

The flat tax for the Czech Republic

The crucial aspect of tax competition is the power of example. And the flat tax gives us surprisingly good example. In Central and Eastern Europe, more than half of the countries have introduced a flat tax system. Their growth rate is double in comparison with the remaining half of those who still have a complex system of progressive taxation.

Taking this into account, we believe that also this country would grow twice as fast if it has a flat tax system. There are four main benefits of a flat tax that are worth to enjoy:

· faster economic growth,

· less tax evasion,

· less bureaucracy and administrative costs, both for the government and the taxpayer,

· automatically less need for social benefits for low income families (because of a bigger personal allowance).

Hardly can anybody argue that a flat tax means more bureaucracy or slower growth!

So what can one do with a tax code? You have three choices. You can either leave it as it is, you can simplify it, or you can make it even more complex. Only simplification enables us to load lighter tax burden on citizens without cutting expenditures. Once you have a simple system and want further decrease taxes, you have to cut existing spending programs.

These positive effects of a flat tax altogether enable us to set the rate of a flat tax lower than the average rate in the current complex system.

In the Czech Republic we plan to reform three main taxes: Personal income tax, Corporate Income Tax, and Value added tax.

Personal Income Tax

Currently we have four rates, 15, 20, 25 and 32 % of the personal income tax, and many deductions and exemptions. We propose to have just one rate, 15 %, which is the same as the rate in the lowest bracket so that no one can be worse off, and to abolish all deductions but one single personal allowance higher that the current one, co that no low income group will be worse off.

Corporate Tax

As for the Corporate tax, we propose to entirely abolish the tax on dividends, because it is just costly double taxation. The state can have the same revenue by taxing either only company profits or only dividends.

Secondly, we plan to terminate the system of investment incentives in the form of tax holidays. Currently, the rate on company profits is 26 percent; however there are about 130 firms that pay zero on their profits because they obtained incentives from the governments.

Of course that tax incentives are a kind of tax competition too, but we consider it as unjust and inefficient. The zero taxes for 130 firms are paid for by the remaining thousands. What is an incentive for one is a disincentive for other. If those firms without an incentive remain in the market despite so high taxes vis-a-vis this unfair competition of firms enjoying tax holidays, it means that they must be more efficient. On the other hand, companies with tax incentives can relax.

Instead of having 26 % rate for vast majority of companies and zero for certain investors we propose 15 % rate far all plus no tax on dividends. The proposed rate is the same as for personal income which corresponds with a preposition that all kinds of income regardless whether it is from capital or from labor should have to be taxed by the same rate.

Value Added Tax

Currently there are two rates in the Czech Republic, 5 % and 19 %. We propose to have a single rate of 15 % imposed to all goods and services. An EU directive prohibits having lower than 15 % rate when a country has just one rate.

Competition matters

We believe that we would benefit from flat tax. However we don’t want to introduce our flat tax on the whole Europe as well as we don’t want others to impose their tax systems on us. That is why we are against the proposed European Constitution. We believe that only the inter-jurisdictional competition can result in dynamism, better life, and economic growth.

We believe that inter-jurisdictional competition, i.e. tax competition, currency competition, etc. is an analogy to market competition. As in the market it is only competition that encourages firms to supply better goods and services, among countries it is only competition that encourages states to pursue better policies. Firms and citizens can leave countries with bad policies and head to countries with better policies. In democracies, in addition, voters can vote for policies that have proved to be successful in other countries.

The communist Czechoslovakia, where I used to live for 14 years, was an extreme example how diversity of systems is vital. Some people had tried to escape from communism – they had voted with their feet for a better system, those who had remained eventually revolted, because communists had not been able to hide the flourishing capitalism from their subjects’ eyes. Competition matters – and only competition matters.

We believe that competition works in favor of people not only between capitalism and communism, but also between different sorts of market economies. We believe that the sovereignty of nations is an analogy to the freedom of individuals. It is a necessary condition for peace and prosperity.

Conclusion

So we are prepared to push through the flat tax in this country next year and to fight all attempts by the EU to dictate direct taxes to it member states.

Petr Mach

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