by T. R. Reid
“We had then five income tax brackets, with the top rate at 38%,” Mikloš told me. “And I was told to be radical, so I began looking at the countries that had gone really radical—gone to the flat tax. I liked it; I liked it a lot, because it seemed simple and it had worked, we thought, in Estonia. We did not have a big polarity of income, so we didn’t need stiffly progressive rates to offset inequality, like some countries have. But there was a fiscal dilemma: it just wouldn’t bring in enough revenue. So I had several no-sleep nights. Finally, I decided to give it a try.”
As in New Zealand, Slovakia’s tax reform was driven forward by a finance minister who wanted major change and a chief bureaucrat in the ministry who knew how to bring it about. Mikloš, the finance minister, turned to the ministry’s chief economist, Ludovit Ódor. “Mr. Mikloš had the general idea, and we designed a system that significantly simplified our tax regime,” Ódor said. “And we did have trouble at first with lower revenues. But the flat tax became a strong marketing tool. We needed to market ourselves as a country that wanted investment. And we got it; Audi, Samsung, Hyundai—lots of companies built factories here.”
To enhance the marketing aspect of their new tax system, the Slovaks decided on a fairly unusual system, sometimes called a unified tax code. They set the same rate of tax—it was 19%—for the individual income tax, the corporate income tax, and the national sales tax. Herman Cain would have called it the “19-19-19 plan.” With this change, the largely forgotten nation of Slovakia became a darling of American conservatives. Both Steve Forbes and George W. Bush made the trek to Bratislava to congratulate Ivan Mikloš. In his flat-tax book, Forbes called Slovakia “the poster child for economic reform.”
After the Mikloš reform, Slovakia’s statistics were impressive. As foreign manufacturing companies rushed to invest in Slovakia, GDP shot upward, unemployment fell dramatically, and government revenues gradually began to rise. Sleepy Slovakia was suddenly on the world’s economic map; it was dubbed the “Tatra Tiger,” a name that evokes the nation’s largest mountain range. As in Estonia, though, it is not clear how much of this economic growth was due to the tax reform. Slovakia formally joined the European Union in 2004, the same year the 19-19-19 system took effect. The pension system was changed; some industrial regulations were loosened. Even Ludovit Ódor, the Finance Ministry economist who designed the flat tax, agreed that “it is hard to disentangle one factor to say why our economy improved. We did sort of a big bang of reform all at once. So you can’t tell which part of performance is due to which part of reform.”
The leaders of the Czech Republic were paying close attention to the Slovakian reforms. With a population twice as large as Slovakia’s and an established industrial base, the Czechs didn’t worry much about economic competition from their eastern neighbor for the first decade after the countries parted ways. Once the Tatra Tiger began to roar, though, a movement developed in Prague calling for the Czech Republic, too, to give up its graduated income tax—it had five rates, ranging from 12% to 42%—and shift to a flat tax.
One of the leaders of this campaign was my friend Radim Boháček, an economist at the premier Czech college, Charles University, and a member of the Czech Academy of Sciences—though he looks more like a heartthrob in some teen romance movie, with a square, bronzed face topped by a sweeping wave of brown hair. Professor Boháček studied economics at the University of Chicago—Milton Friedman’s school—and came home to Prague with a Ph.D., nearly perfect English, and a firm belief in the social and economic benefits of low taxes.
“What I learned at Chicago is a basic truth about taxes: rich people will try to of course avoid paying,” Boháček told me. “The more you raise the rates, the more incentive rich people have to hire accountants and strategize. Then they can duck just out. What you want is a broad-based tax without exemptions or loopholes—because once you have special exemptions or deductions, people who can afford lawyers will take of course advantage of them.”
But Boháček and others who agreed with him gained little headway in left-leaning Czechoslovakia—until the Slovakian experiment and its 19-19-19 tax code began to be noticed in Prague. “All the central and eastern European countries were competing for investment,” explained Petr Guth, a tax accountant in Prague. “And we saw that foreign investment heading into Slovakia. Of course you couldn’t say it was all due to the 19-19-19 flat-rate system. But the idea just grew here that in order to compete with the rest of eastern Europe, we had to do it, too.”
In 2008, the Czechs finally paid heed to the low-tax advocates like Radim Boháček, setting the income tax at a single rate of 15%, at the low end of the range of tax rates in eastern Europe.
By 2008, then, the “Flat Tax Revolution”—as the Wall Street Journal described it—had swept nearly all of eastern Europe (Poland was the notable exception). A grid of flat-rate tax regimes among the former Soviet republics and satellites looked like this:
Country
Date begun
Rate
Estonia
1994
26%
Lithuania
1995
33%
Latvia
1995
25%
Russia
2001
13%
Ukraine
2003
13%
Serbia
2003
14%
Slovakia
2004
19%
Georgia
2005
12%
Romania
2005
16%
Czech Republic
2008
15%
Bulgaria
2008
10%
There was some adjustment of the single rate, up or down; Estonia gradually cut its income tax rate from the initial 26% to 21%. Some countries used the switch to a flat tax as a reason to eliminate some well-entrenched deductions and exemptions; some kept these loopholes in place. None of the flat-rate tax countries relied on the income tax alone for revenue; in most of them, the VAT and Social Security taxes levied against payrolls were just as important for raising government revenue as the flat-rate income tax and corporate tax. The flat-tax countries allowed the lowest-income people to escape the income tax entirely, because the tax didn’t apply to the first few thousand dollars of annual income. This kept some element of progressivity in a flat-tax regime.
As long as the local and global economies were growing, or at least fairly stable, the flat-tax nations of eastern Europe were doing well. Many were attracting investment; the combination of a low, flat-rate tax system, cheap labor rates, and minimal government regulation drew in large sums of foreign money.
But in the wake of America’s Great Recession, the flat tax no longer seemed so sweet. The problem was a predictable one: the flat tax just did not bring in enough money. Financial aid from the European Union, which had been substantial for all of eastern Europe in the first post-Soviet years, began to dry up. The rich nations of western Europe, watching the low-tax countries to their east luring away wealth and investment, were no longer willing to finance nations they came to see as economic competitors.
The flat-tax countries scra
mbled to offset the reduced revenue. Primarily, they did it by raising other taxes. They raised the VAT rate, which increased consumer prices; nearly all the eastern European countries have sales taxes in the range of 20%. Hungary imposed the world’s highest rate of sales tax, 27%, to make up for the revenue shortfall of its flat-rate income tax. Most of the flat-tax countries jacked up their Social Security taxes. In the United States, the Social Security tax on wages is 15%, with half paid by the worker and half paid by the employer.* By comparison, Estonia had to raise its Social Security tax to 34%, all of it paid by the employer. The payroll tax for Social Security in Slovakia went to 47.6%, paid mostly by the employer; in the Czech Republic, the tax was 45.5%, with the worker paying 11.5% and the employer paying 34%. Russia, in a throwback to its Communist days, chose to soak rich investors. The Russians doubled the tax on dividend and investment income to 30% so that people who made their money in the stock market paid significantly more in tax than people working in a factory or on a farm.
Even champions of the flat tax began to despair. “The point we had always worried about,” said Ludovit Ódor, the architect of Slovakia’s 19-19-19 plan, “was finding the correct rate for a flat-rate tax. And after the crisis, we were not really able to do that. In practice, you can’t find a single tax rate that is high enough to raise the revenues you need but low enough for average working people to afford.” As a fiscal matter, governments needed the higher revenues that would come from imposing higher taxes on the upper brackets. As a political matter, there was also a question of fairness. The boom years at the start of the twenty-first century had created a class of “oligarchs”—that is, newly rich investors and industrialists—in many of the former Soviet countries. This created political demands to go after the wealthy and make them pay more.
Countries in eastern Europe began to rethink the idea of the flat tax. The pattern was similar in several countries. After the global recession of 2008–9, they largely adopted tough austerity measures, including wage and benefit cuts, at the direction of the European Union and the International Monetary Fund. As national economies began to revive, in 2011 and 2012, voters lashed out at the austerity regime and began electing left-leaning governments that promised to raise taxes on the rich to fund more government programs.
In Slovakia, the leftist party leader, Robert Fico, became prime minister in the 2012 election after promising to return to a progressive income tax. Fico made the classic argument for graduated rates: it is fair, he said, that the richest, who benefit from many government services, should pay a little more for the common good. When Fico’s party came to power, his finance minister, Peter Kažimír, kept the 19% tax rate for most people but added a second bracket, at 25%, for those earning more than $53,000 a year—a princely sum in Slovakia.
When I met Peter Kažimír, at a café on Bratislava’s medieval central square, I thought at first that this friendly young man must be a driver or an aide to the finance minister. With an easy smile, a good grasp of the millennial generation’s English idiom, and an untamed bush of brown hair, he seemed more like an earnest grad student than a senior member of the national government. In fact, he turned out to be an iron-willed politician who came to office determined to do away with the flat-rate tax no matter who raised hell about it.
“We had campaigned on a promise of progressive taxation, and we had won with it,” Kažimír recalled later. “So I thought at first it would be easy to add an additional bracket for the highest incomes. But there was a backlash—furious!—from the business community and the conservative parties. Well, we were going to add another bracket; that was settled. So I had to come up with a way to deal with all the opposition.”
To cool public anger over scrapping the flat tax, Kažimír devised a policy that I have not found in any other country: a special surtax on the people who write and administer the tax laws. Thus, in addition to creating a new tax bracket for the wealthiest Slovakians, the 2012 tax-reform act stipulated that members of the national parliament and the prime minister’s cabinet would pay 5% higher rates than anybody else in the country. “We did it as a gesture of solidarity,” Kažimír said. “The message was, okay, if the parliament is going to raise taxes, we’ll see to it that members of parliament pay more than anybody else.
“It’s the same kind of political bullshit you probably have in your Congress,” Kažimír told me. “We needed the extra revenue. And if the way to get it passed was to stick members of parliament with a higher rate—well, I was like, let’s do it.”
The next domino to fall was the Czech Republic, which had been the last of the eastern nations to adopt a flat tax. Just as in Slovakia, a left-leaning party emerged on top in a national election, in the fall of 2013, on a promise to dump the flat-rate tax. In 2014, the Czechs introduced a second, higher bracket for the largest incomes—a tax rate of 22% for people earning more than $61,000 per year (which is to say, the 1% of the Czech population). The new government referred to this 7% additional rate for the rich as a “solidarity tax.” The implication was that rich people could demonstrate a sense of solidarity, a sense of community, by paying more to fund programs that helped everyone.
Efforts from the left to scrap the flat-rate tax have grown stronger in several other flat-tax countries as well, leading some observers to suggest that the experiment will not last much longer. “All the countries need more revenue,” said Andreas Peichl of the German think tank IZA. “And there is a feeling that the economic crisis hurt the poor but spared the rich, and therefore the rich should pay more. But it’s not easy to do that if you only have one tax rate.”7
Back in Estonia, where this particular revolution began, the government has so far stuck with the flat tax. But even there, the policy has sparked a furious controversy.
“I don’t think there’s a single serious economist in this country who would advocate keeping the flat-rate tax,” said Viktor Forsberg, the professor who took me on a tour of the University of Tartu. “You have to look at what we pay for it. To make up for the lost revenue, we had to raise the VAT tax to 20%. That discourages people from buying. To make up for the lost revenue, we have to charge employers 34% of any worker’s wages to fund our social and health-care programs. No wonder we have an unemployment problem! Anybody who wants to hire you has to pay not only your salary but an additional 34% to the government.
“What we don’t need is a single rate of tax for everybody,” the professor continued, his voice rising. “What we do need is to reduce the Social Security taxes, to make it cheaper to hire and get people back to work! What we do need is a lower sales tax, to get people to spend! And the way you pay for all that is the way every wealthy country in the world does it—with progressive taxes!”
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DOES THE FLAT TAX WORK? Yes, a flat-rate income tax regime can work, under certain conditions. The flat tax works in a country that is a former Communist state, with no investment capital and low wage rates, which needs to build a capitalist economy from a base of approximately zero. The flat tax works if people are willing to pay a 20% sales tax on everything they buy, to make up for lower revenue. The flat tax works if employers are willing to pay 34%, or more, in Social Security taxes for every employee they hire. The flat tax works in a country where almost everyone has the same amount of wealth so there’s no need for the distributive effect of graduated rates. And if all these conditions are met, the flat-rate tax will probably work as long as the economy is on a path of steady growth.
For countries that don’t meet these requirements, it probably makes more sense—in terms of fiscal health as well as fairness—to adopt progressive rates, in which the wealthy pay a higher percentage of their income in tax than middle- or low-income people pay. But what happens if a country turns that proposition into a policy of soaking the rich?
7.
THE DEFINING PROBLEM; THE TAXING SOLUTION
In the spring of 2014, the marketing staff at Ha
rvard University Press began to sense that they had a blockbuster bestseller on their hands. This was not a frequent occurrence at the press, a prestigious academic publisher that churns out scores of learned volumes each year in fields like microbial ecology, medieval philosophy, and molecular physiology. But in those early months of 2014, there was enormous prepublication buzz about a forthcoming Harvard book. It was an unlikely blockbuster, to be sure: a 699-page treatise on economics written by a scholar who was hardly a household name even in his own neighborhood in Paris. But Professor Thomas Piketty’s tome Capital in the Twenty-First Century, thick as a brick and somewhat heavier, rocketed to the top of the bestseller lists as soon as it hit America’s bookstores. A New York Times story on the Frenchman’s U.S. book tour was headlined “Economist Receives Rock Star Treatment.”
The reason that an unknown French economist suddenly achieved rock-star stature in the United States was that Piketty’s book focused squarely on an increasingly worrisome issue in the American zeitgeist: the inequality of wealth and income.
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SINCE THE START OF the Great Recession in 2008, Americans have struggled with a nagging new concern: a nation where everybody is supposed to be created equal was, in fact, increasingly unequal, with a widening chasm between a small cohort of extremely rich Americans and everybody else. In 2016, the richest 1% of Americans owned more of the nation’s total wealth than the bottom 90% combined. And only the rich were getting richer. Census data showed that median income for the average American family actually fell by 8.6% in the first fourteen years of the twenty-first century, while a lucky few at the very top were taking in staggering amounts of money.1
