TCS Daily

Flat Tax Peak

By Horia Paul Terpe - November 24, 2004 12:00 AM

The governing program of the DA ("yes") Alliance, the center-right opposition in Romania contains an unprecedented proposal: a flat tax of 16 percent, for both corporate and income tax, coupled with lower compulsory social contributions. Usually, when a party with the best chance to win the parliamentary and presidential elections (scheduled for November 28) offers such a daring proposal, it reflects a massive shift in preferences of the electorate.

How is it that such a change appeared in a country characterized by the slow pace at which it has left communism behind? After the fall of communism, in December 1989, the Social-Democratic party -inheriting the young wing of the former communist party - adopted a progressive taxation system, based on four classical brackets. However, in recent years, this system has become less and less efficient, due to increases in taxation levels and widespread corruption. In the years 2000-2004, the black and gray economy was constantly evaluated at 40 percent.

In real terms, this means that most firms declare zero profit, to avoid taxation, preferring to distribute the money through illegal operations. Often firms employ people with two salaries: a declared (nominal) one, at the lowest level allowed by the law, and a real one, usually two or three times higher. As long as this situation was limited to the high-income level of the population, the bracket system was defended by the social-democratic ideology of social justice based upon comprehensive redistribution.

Nevertheless, constant economic growth began to spread towards the urban low-income categories, and especially toward the rural population, both of them being hardcore supporters of the social-democrats. Thus, a 40 percent black market means that young people moving from rural zones to cities, attracted by a better life, cannot find white market jobs. They can only earn tax-avoiding wages, which cannot, for example, offer access to highly attractive consumer credit. Furthermore, two million Romanians, usually young people from rural areas, have gone abroad to work in low-paid jobs across Europe.

Both these last categories noticed that they do not want the stay-poor social protection offered by the social democratic party. They became a furious category of free market voters, furious that they were cheated with electoral social protection for 15 years, and for another 50 years of communism before. They realized they want to be paid fairly for their work, as in other countries, to be able to have a better life, to get credit and to govern their own lives, without being patronized by a corrupt state.

In fact, on June 6 this year, local elections were held in Romania. While the center-right never even hoped to win in rural areas or in poorer parts like Moldavia, something unbelievable happened: Young people who had gone abroad or to the cities to work called home and told their families in the countryside to vote with the Alliance and to throw out the social-democratic government. In June, the Alliance candidates won in remote places where no center-right wing candidate has won before.

While this major shift in preferences appeared, a few NGOs proposed the flat tax principle at the end of 2003. Immediately adopted by the opposition, the proposal was even supported by the social democratic minister of finance. However, the hard-core, old-school social democrats, grouped around President Iliescu, refused to accept the flat tax, basing their opposition upon the classical social justice argument.

The Alliance built its whole political program, the "Platform of Governing for Romania" on the base of the flat tax. Submitting a macroeconomic projection of the flat tax's impact on the economy, it evaluated the budgetary revenues and expenses based on a 16 percent tax on corporate income. The main argument was simple: while the (nominal) taxation level is at about 23-25 percent, due to evasion, the effective taxation rate is in fact 16 percent. So why not lower the nominal tax rate to match the real one, at 16 percent, thus enlarging the taxation base?

In recent televised debates on the political programs of the two main forces, the Alliance representative supported the flat tax, against the minister of finances (representing the social-democrat party), who proposed some tax cuts through lowering and simplifying the brackets system. As a former supporter of the flat tax, the finance minister was in the uncomfortable position of defending something he does not believe in. Although it was noted that the two candidates won the prize for "most technical discussion ever on television", it was the first time in Romania that the Laffer argument was discussed outside academia.

That the flat tax is such a major issue in the campaign reflects a profound change in the social structure and preferences of the country. When a political force (i.e. the Alliance) believes it can win votes with the revolutionary proposal of renouncing at the progressive taxation, maybe Romania has finally left communism behind.

The author is an advisor to the Liberal Group, in the Romanian Chamber of Deputies.


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