Latvia To Abandon Flat Tax Regime

By Global Tax Weekly

Flat taxes were all the rage in the not-too-distant past. But have they had their day? Latvia seems to have fallen out of love with them.

Flat taxes, normally defined as a single rate of tax on personal or corporate income, or in some cases both, are often associated with Eastern Europe, where countries embraced these supposed pro-growth tax policies as they emerged from the economic straight jacket of the Warsaw Pact. But they are found in all corners of the world, from Abkhazia to Tuvalu.

Nevertheless, it was Eastern Europe that many countries looked to when debating the merits of flat taxes versus progressive taxation, including the United States. Indeed, the region has been something of a massive laboratory performing a mass flat tax experiment.

So what can we glean from the results? To my mind, they are inconclusive. Undoubtedly, flat taxes are easier to understand, comply with and administer than progressive systems with their many brackets, marginal rates, and unintended glitches. But whether they are fair is moot, and is always likely to be.

Flat tax proponents would argue that the economic benefits reaped from simpler, lower taxes would outweigh any concerns about fairness. But then there is no hard evidence that flat taxes have driven economic growth in the countries concerned. There could be a range of reasons why an economy grows, and there is simply not enough space here to explore that tangent.

Critics would also say that flat taxes did little to insulate the economies of Eastern Europe in the financial crisis. And they may have actually contributed to fiscal weaknesses in the region as revenues fell. Indeed, there is a growing list of countries which have abandoned flat tax regimes in favor of more progressive taxation, and this includes Albania, Czech Republic, Montenegro, Slovakia, and Ukraine. As mentioned, these will soon be joined by Latvia.

There may have been political rather than purely economic or fiscal reasons for these u-turns, mainly that the governments in question wanted to restore “fairness” to the tax system. Whatever the reason(s), perhaps the tide has turned against the somewhat short-lived flat tax revolution, at least in Eastern Europe.

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