Marx loses his grip, 156 years on

Observations on taxes

A new revolution has erupted in eastern Europe - and it is proving easier to spread than the communist revolution. The flat-rate income tax, whereby all citizens pay the same proportion of their incomes to the state, rather than the rich paying higher proportions, started in the Baltic states in the mid-1990s. Then Russia, with a flat 13 per cent rate for all taxpayers, followed in 2001. Ukraine (13 per cent) and Slovakia (19 per cent) adopted the flat-rate tax this year. In this summer's election to the Euro-pean Parliament, opposition parties that advocated flat taxes topped the polls in the Czech Republic and Poland. If they can follow through their success into domestic elections, it is possible that, within two or three years, a quarter of all EU member states will have flat-rate tax regimes.

A flat tax rate was the norm in the 19th century. Then came Karl Marx's call for "a heavy progressive or graduated income tax" - second in his 1848 manifesto after his demand for the abolition of private property. And this was one Marxist idea that eventually found broad favour. Economists argued that marginal increases in wealth were less important to the rich than to the poor. If you have $1,000, an extra dollar is worth less to you than if you have just $100. Therefore, the greatest happiness for the greatest number came from taxing the rich at a higher rate.

Even so, it took 60 years before the UK's 1908 budget replaced the flat personal income tax rate with a graduated rate. When the US introduced personal income tax for the first time in 1913, it immediately adopted a graduated rate - although, given that the top rate was only 7 per cent, not as graduated as Marx would have liked. In most western countries, including the US, the advocacy of flat tax has been confined to fringe parties.

So how has it been possible for politicians in eastern Europe to push through policies that would seem to appeal only to rich minorities?

The answer, at least in Russia's case, is compliance. Before Russia introduced the 13 per cent rate (lower than its previous lowest rate), the rich hardly paid any taxes. A low flat rate made the costs of evasion and avoidance outweigh the costs of paying up. Moreover, high compliance made it possible for governments to keep the rates low. In 2001, income tax revenues rose roughly 60 per cent, far in excess of the 22 per cent inflation rate. Even the Communist Party abandoned its opposition.

We don't yet know whether the flat tax will stick in countries that have fewer problems collecting taxes. But in Slovakia the governing parties topped the EU parliamentary polls - so the new 19 per cent rate clearly did them no harm.

If flat taxes prove popular in such countries, we could be on the brink of a global tax revolution.

Charles Robertson is chief economist for emerging Europe, Middle East and Africa at ING UK

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