FINDING A fair tax regime is quite difficult. There is near universal agreement, even from the most free market economic minds, that people with more money should pay more. 

But how ‘much more’, often is up to debate and how to achieve that ‘much more’ is even harder to find. Taxes are simply too important to the economy to be determined by blind ideology. 

Taxes around the world

There is often a debate regarding the civil duty of paying taxes. Because all people enjoy public goods for which they do not directly pay, there is a strong case for people to contribute into the pot that builds these things. 

One doesn’t, for example,  pay for a road but benefits from the transportation that it allows. 

A progressive tax system is the most commonly used tax system in the world. That is to say that as individual’s income increases their tax contributions increase. 

This is used throughout the world from Rwanda to the United States. Various countries use differing rates however, in Hong Kong the highest one can pay on their individual income is 15% while in France it has just been increased to 75%. 

What is a fair rate of taxation?

Having established that taxes are necessary and flexible, the next major question addressed by policy makers is how much tax is reasonable. President Barack Obama has argued for the richest of the rich to pay ‘their fair share’. 

He, however, measures these individuals as families making $250,000 a year. While these families may be well off some may argue that it is unfair to lump them in with people making billions of dollars a year. 

Countries such as Norway and Sweden that have high individual tax rates on the well-off often find that their economies suffer from a lack of innovation. 

That is to say, that if an individual knows that a 10% increase in their income will have no effect on economic life because it will increase their tax burden, then this individual may simply choose to not start a business or strive for a better position within their firm 

Arguments for a flat tax

A flat tax argues for a regime where all individuals pay the same rate of tax across the board. This number is usually low and thus encourages consumption. As individuals make more the higher the level of goods they can, and will, consume because they have more available income. 

The arguments for a flat tax are, one, that it is incredibly simple. Everyone knows what they owe in tax. Another strong argument is that it is fairer because it removes the deductibles (dependents, mortgages, capital gains) that allow the rich to circumvent tax codes. 

Lastly, it is believed to increase compliance. At a lower rate people will feel less of an economic pinch paying for tax and will simply comply, therefore increasing the tax base.

This system appears to have worked wonders in many of the former Soviet Union states, with a great example being Estonia. Historically many of the Baltic State’s economies were shackled by communism and the consumption environment did not flourish. 

As they embraced free market principles and worked with the International Monetary Fund on structural adjustment, these states were able to use a flat tax to spur consumption.

Estonia has been dubbed the flat tax miracle. Since instituting a flat tax its economy grew by 9% for over six years. In the five years following the implementation of the flat tax, to 26%, the tax revenue actually increased. From 2003 to 2008 the unemployment rate in Estonia actually decreased by over half. 

The reality of the flat tax

The basic problem with the flat tax is there is not empirical proof that it has been, or can be, responsible for any growth in the case study countries. Many economists argue that competent leadership, low level corruption, infrastructure investment and a sound business environment, may have been the causes.

Another reality is there is no proof that individuals comply any more than they would normally. 

While the tax base may increase, over time, there is no proof (due to the fact that much of this behaviour is fraudulent) that people avoiding tax are paying more tax. 

Taxes aren’t simple

Any idea that is commonly accepted by more practitioners isn’t worthy of much consideration – one does not lose sleep over the merits of the laws of gravity. 

Taxes, however, are an issue that gets an opinion from the vast majority of people. Policy makers should heed caution when making statements about tax. Lower taxes or higher taxes for ideological reasons are foolhardy.

Adam Kyamatare is an economist based in Copenhagen

Twitter: @adamkyam