Flat tax assessment provokes strong debate

AuthorIna Kota
PositionIMF External Relations Department
Pages33-48

Page 33

A new IMF working paper on the flat tax has stirred a heated debate about the benefits and drawbacks of the tax. The authors argue that the flat tax experiment is a failure, finding insufficient evidence that flat taxes boost work incentives or compliance with tax laws. They predict that countries that have adopted a flat tax will probably move away from it.

Flat tax supporters say the researchers have made sweeping statements that are not supported by hard evidence.

Page 48

Figuring out the flat tax fracas

Discussing the flat tax always generates heated debate-even about its definition. Proponents claim its simplicity and efficiency can be a key to economic success, while critics argue that it has little effect on economic activity and can be unfair.

A new study by the IMF's Michael Keen, Yitae Kim, and Ricardo Varsano examines the impact of the flat tax in countries where it has been in effect for more than a decade. The authors find little economic evidence that flat taxes boost work incentives, but suggest they have a somewhat beneficial effect on compliance with tax laws. And they question, given political economy considerations, the sustainability of the flat tax in the years ahead.

The study, which has sparked considerable debate, provided the basis for a January 25 IMF seminar. Keen and Varsano were joined by Kevin Hassett (American Enterprise Institute) and Leonard Burman (Urban Institute) for a panel discussion.

New kid on the block

Progressive taxes, where rates rise with income, have long been the norm. They are seen as fairer and better at stabilizing income over the business cycle than flat taxes. But, since 1994 this conventional view has been challenged, with Estonia, Georgia, Lithuania, Latvia, Romania, Russia, the Slovak Republic, and Ukraine adopting taxes with a single strictly positive marginal tax rate on labor income.

Keen pointed out that these flat tax regimes differ considerably from the concept of the flat tax assumed in academic and policy debates in the United States-the so-called Hall-Rabushka tax, which is a combination of a cash-flow tax on business income and a tax on workers' income, both levied at the same, single rate. Moreover, the details of the flat tax regimes differ vastly across countries and, although some countries adopted a single positive marginal rate near the highest from their...

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