Friday, November 28, 2003

VIENNA, Austria. — The “Hong Kong Miracle” describes how an impoverished jurisdiction on the coast of China became the world’s fastest-growing economy over the last 50 years, propelled in large part by its simple and fair flat tax. Ireland went from being the “Sick Man of Europe” to the “Celtic Tiger” thanks to sweeping tax-rate reductions, including a 12.5 percent corporate income tax.

These global success stories have a new rival. Slovakia, a small nation in Eastern Europe, has junked its class-warfare tax code and replaced it with a low-rate 19 percent flat tax. This reform, which will go into effect Jan. 1, almost surely will create the “Slovak Tiger” as entrepreneurs and investors from Western Europe’s stagnant, high-tax welfare states quickly shift productive activity to take advantage of this market-friendly tax system.

The new Slovakian system is not a pure flat tax, since some forms of double-taxation remain, but it is one of the best systems in the world. Corporate profits will only be taxed one time (at the same 19 percent tax rate) and the death tax will be abolished. And since the flat tax was approved by an 85-48 margin, including some support from opposition parties, there is every reason to expect the new system will have the necessary stability to attract long-run investment.

The flat tax is just the tip of the iceberg in Slovakia. Led by a dynamic young finance minister, Ivan Miklos, the government also eliminated all special preferences and penalties in the value-added tax. This will help ensure economic decisions are based on sound economics instead of tax distortions.

Tax reform is big news, but the flat tax is just the tip of the iceberg. The Slovak government also is modernizing the nation’s Social Security system. The new plan, expected to gain final approval in the next couple of months, will allow workers to place 9 percent of their income in personal retirement accounts. This is a very impressive number, rivaled only by a handful of nations, including Australia (which also allows workers to invest 9 percent) and Chile (which permits workers to invest 10 percent of their income).

At a recent international tax competition conference in Austria, sponsored by the Vienna-based Hayek Institute, Finance Minister Miklos also indicated the Slovakian government will make market-oriented changes in the health-care system and education system (if only Republicans in the United States had a similar commitment to reform).

To be fair, Slovakia is not the only Eastern European nation to enact pro-growth policies. Beginning with Estonia and other Baltic States in the 1990s, many formerly communist nations have adopted simple and fair flat-tax regimes.

Even Russia, governed by the former head of the KGB, has a 13 percent flat tax. Ironically, Estonia now plans to reduce its flat tax from 26 percent to 20 percent because so many other nations have lowered tax rates — a step that demonstrates how tax competition leads to better tax policy notwithstanding the complaints from socialist-minded bureaucracies like the European Union and Organization for Economic Cooperation and Development.

Speaking of international bureaucracies, it is worth noting that the International Monetary Fund (IMF) played no positive role in Slovakia’s successful economic reforms. Indeed, in many former Soviet Bloc nations, the IMF has created roadblocks to tax reform, and often has urged governments to raise taxes instead. But perhaps this should not come as a shock. After all, nations that adopt free-market policies will begin to prosper and therefore reduce the need for IMF bureaucrats and their cushy tax-free salaries (which also explains why American social workers opposed welfare reform).

Thankfully, leaders like Ivan Miklos have rejected bad IMF advice and instead are pursuing policies that will create prosperity. To be sure, tax reform and Social Security privatization will not instantaneously offset the damage caused by decades of Soviet control in Eastern Europe. But there is every reason to believe free-market policies will yield big benefits for Slovakia and other nations.

Perhaps the benefits will be so large Washington politicians finally will decide to give Americans a flat tax as well. After all, if former communist nations can implement tax reform, doesn’t the nation that defeated communism also deserve a reward as well?

Daniel J. Mitchell is the McKenna senior fellow in political economy at the Heritage Foundation.

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