Foundation

To Compete in a Global Economy, U.S. Must Discard Backward-Looking Tax Policy, Study Concludes

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(Alexandria, VA) -- Rather than consigning America to a global game of economic catch-up, U.S. policymakers should look to the winning performance of Eastern European nations that have adopted fundamental tax reform. That's the conclusion of the latest study from the non-partisan National Taxpayers Union Foundation (NTUF), which found that in addition to the advantages of consumption tax systems, there's also persuasive evidence that flat-rate income tax systems can place countries on a solid competitive footing.

"In the increasingly fluid global economy, money and investment move across borders more easily than ever before," said NTUF Associate Policy Analyst and study author Ryan Kool. "In order to attract and retain these vital infusions of capital, states must find ways to remain competitive -- and, as a great deal of evidence indicates, ditching old-style "progressive" income taxes in favor of a flat tax can provide such an edge."

Kool's in-depth analysis of Estonia, Latvia, Lithuania, and Russia -- the four countries that have had a flat tax in place the longest -- uncovered significant economic trends toward increased tax revenues, accelerated Gross Domestic Product (GDP) growth, and improved levels of Foreign Direct Investment (FDI) since those countries have enacted flat-tax reforms. Among the findings:

  • Since Estonia ratified a flat tax in 1994, annual GDP growth has averaged about 6 percent since 1997 and one-tenth of its domestic base consisted of FDI in 2003. Revenues have also exceeded expectations, prompting policymakers to approve a cut in the 26 percent tax rate to 20 percent (by 2007).
  • During the first five years (1995 -- 2000) of operating its flat tax, Lithuania's GDP jumped an average of 22 percent annually and has trended at 7.4 percent since 2000. Similarly, Latvia's GDP has gained over 11 percent each year since 1997, helping to spur annual growth in government revenues of roughly 10.5 percent during that period.
  • Despite a large "shadow economy," Russia has experienced a 35 percent annual increase in government revenue since enacting a flat tax in 2001 -- perhaps the most convincing evidence thus far that the simplicity and lower rate of a flat tax encourages compliance with tax laws.

Even as this pro-growth movement spreads across Eastern Europe (with ten countries having enacted or announced plans to implement a flat-tax, including five EU-member states), Western European countries faced with stagnating economies and skyrocketing unemployment levels have also been "forced to take note," Kool said. He noted that the U.S. "has much to learn from the present situation in Europe" considering the 6.6 billion hour paperwork burden imposed by the current Tax Code, a "tax gap" that potentially amounts to over two-thirds of the budget deficit, and a dramatic decrease in FDI inflows from 2000 to 2003.

"As the flat tax continues to drive the tax competition movement westward, country after country is enacting serious tax reform in attempts to keep their economies from being on the losing end," Kool concluded. "U.S. policymakers would be wise to enact fundamental changes to our tax laws now -- and either a flat tax or a national retail sales tax would be a winning formula."

NTUF is the research and educational arm of the 350,000-member National Taxpayers Union. Note: NTUF Policy Paper 157, The Flat Tax: A Worthy Competitor in the Global Economic Game, along with more information about tax reform, is available online at www.ntu.org.

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