TCS Daily

Read My Lips: No New Greeces

By Georgi Angelov - November 17, 2004 12:00 AM

In 1997 the corporate tax in Bulgaria was 40.2 percent. At the moment it is 19.5 percent and the government wants to cut it to 15 percent from the beginning of 2005. The personal income tax's top rate was 40 percent in 1997; it is 29 percent now and it will be cut to 24 percent in 2005 according to government plans. Thus in 2005 Bulgaria will have one of the lowest profit and income taxes in Europe. Moreover, the Institute for Market Economy started a campaign for introducing a 10 percent flat rate for all direct taxes - corporate tax, personal income tax and social security tax. So the tax cutting in Bulgaria will most probably continue.

And Bulgaria is not an exception:

There is a zero percent tax on the reinvested profit in Estonia. The corporate tax in Serbia is 14 percent and the government proposed a cut to 10 percent. In Latvia, Lithuania and Macedonia the corporate tax is 15 percent and the Lithuanian government is considering a cut to 12.5 percent. The corporate tax in Hungary is 16 percent and it might be cut to 12 percent.

What all this shows is that tax competition is working in Central and Eastern European countries and most of them are trying to follow the successful Irish example - to have faster economic growth through low taxes and free economy.

However, there are some voices within some of the European Union's old member countries, such as Germany and France, that are trying to stop this development toward lower taxes in the so-called New Europe. The ruling parties in Berlin and Paris are against tax competition (however, it seems that the opposition in Germany is not supporting the government's position).

Their reasoning goes something like this: We (the old members of EU) tax our companies at high rates and give the money to you (the new members of the EU or candidates). You use our money to cut your taxes and that is unfair competition. Let us see if that is true.

First, countries cannot use EU funds to cut taxes, because EU funds are designated for certain purposes (like agrosubsidies for example). Second, if we compare the corporate tax we will see that it is 38.3 percent in Germany and it is 19.5 percent in Bulgaria. It looks like Germany extracts more money from the economy through the corporate tax than Bulgaria. But the reality is different - in Germany there are so many tax loopholes that a lot of companies are paying no taxes at all. In Bulgaria there are almost no exemptions.

So that it is not surprising that according to Eurostat, Germany collects only 0.6 percent of GDP through the corporate tax. In Bulgaria the revenues from the corporate tax are about 3 percent of GDP. Obviously Bulgaria's lower tax rate generates more revenues than Germany's high rate with many loopholes. But this is not a problem of the Bulgarian government - it is a decision of the German government to create such a tax system and only the German government can change that system. If the loopholes are eliminated, the German government can introduce a corporate tax rate of 5-10 percent without any loss of revenue.

At the moment the poor countries of the EU receive subsidies by the richer countries through the budget. If the new countries follow the Irish example successfully they will become rich in a very short time so that they will stop receiving subsidies. Therefore it is in the self-interest of Germany (as a net payer into the EU budget) to support the low taxes and economic reforms in the new member states. If the new countries are forced to levy high taxes they will become like Greece. After many years in the EU Greece is still poor country and it is receiving a huge amount of subsidies every year. Creating many new Irelands is the better choice for the old members of EU than creating new Greeces.

Speaking of EU subsidies it worth noting that most of them are actually an obstacle to the economic development of new EU members and candidate countries. The subsidies are managed by bureaucrats and they do not have incentives to spend money prudently for the general welfare. Moreover, there is a need for more bureaucrats to manage the money. The huge EU subsidies also change the incentives and direct resources toward unproductive activities. Therefore the European Union should either stop subsidizing the poor countries or it should give subsidies in exchange for economic reforms.

It is very important for the German and French governments to remember that lower taxes would increase the economic growth and thus the prosperity of the poor citizens of the former socialist countries. Therefore it would be an act of humanity for Germans and French to support low taxes in New Europe. That will bring better results than any kind of state subsidies.

In the last several months German Chancellor Gerhard Schroder and French Finance Minister Nicolas Sarkozy have spoken out against low taxes in Central and Eastern Europe. However, both of them have poor economic records compared to the former communist countries. The formerly communist East Germany has an average rate of economic growth of 1 percent per year. The economic growth in Bulgaria is four times higher - more than 4.4 percent per year and Bulgaria is not the best example. Estonia and Latvia's economies grew by 5.5-6 percent per year. It seems that the French and German governments should start learning from the New Europe's recent economic experience and stop giving advice on tax policy.

The author is with the Institute for Market Economy, Bulgaria


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