Econstudentlog

Flat tax: A review of the Russian experience

Mark Perry points me to an interesting paper. Perry’s graph, the one below, is not in the original paper, but I think perhaps it should have been ( :) ) – it is a graphical representation of a subset of the information contained in table #1 from the appendix:

russia1.jpg

From the conclusion:

In this paper we focus on the impact of the flat income tax rate on tax evasion, an issue that was, and continues to be, a major problem in Russia as well as in many other transition and developing countries. We argue that the flat tax reform was instrumental in decreasing tax evasion and that, to a certain extent, greater fiscal revenues for Russia in 2001 and several years beyond can be linked to increased voluntary tax compliance and reporting.

According to the authors the by far greatest effect of the flat tax is that of increased compliance, the contribution from ie. effects on the labor supply are much smaller. Naturally, both the compliance- and labour supply effects are higher for high income groups, that is the groups where the resulting tax savings from the -reform are high.

The standard economic argument in favour of lower taxes is that taxes are distortionary (remember that it is important which questions you ask here) and that lower taxes means increased efficiency. It’s worth noting that what this paper implies is that even if taxes are not all that distortionary – it’s still a good idea to lover the taxes.

If Kristian Jensen really wanted to lower the amount of undeclared work taking place in Denmark, he should seriously considering a tax reform. I know we just had one, but it didn’t solve any of the major problems – how could it anyway, it was never meant to do that (what the reform was meant to do, in case you were in doubt, was to secure Fogh four more years in office). Even if the effects on the labour supply from a -reform would turn out to be quite low, there might still, judging from this study, be significant compliance effects that would lower the costs of the reform (if it did not turn out to finance itself altogether; under the current tax regime some reforms, flat tax or not, undoubtedly would if they were to lower the top marginal rates).

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February 19, 2008 - Posted by | economics, papers, Russia, taxation

4 Comments »

  1. Pretty weird looking graph. It looks like revenue follows a pretty smooth exponential upwards… even as tax rates falls 30+% over 2 years! No upwards kink or anything!

    Comment by gwern | October 22, 2011 | Reply

    • Yes, that’s true. When it comes to the revenue side there’s a kink around 98 when the tax rate is increased, but if one were to look only at the period from that kink and onwards one’d probably conclude that tax revenues are independent of the tax rate. That’s just weird.

      Maybe the rules concerning tax deductions and so on were at the time of the reforms structured in a way so that nobody paid anywhere near 40% anyway – meaning that the tax rate changes look much bigger on paper than they were in reality? Add to that that it probably took some time before the size of the informal economy really shrank significantly after the reforms and that explains a big part of the subsequent growth in revenue. I don’t know, I don’t remember what the paper had to say about this, if anything, and I don’t really at this moment feel a strong need to reread it.

      Comment by US | October 24, 2011 | Reply

  2. I certainly do not know the whole story, but I have a few… erm… caveats (like US, cannot be bothered to read the paper):

    1) There is no doubt that compliance improved a lot in Russia. This probably is partially due to the lower rates after ’98, but I would surmise that a probably bigger factor was enforcement. Throughout the 90’s Russia was the “Wild East” – corrupt and lawless. Putin (after coming to power in Dec 1999) strengthened the Russian bureaucracy immensely. Soon after people actually feared the bureaucrats, instead of casually bribing them (which they still had to do though).

    2) Which tax rate went down and which tax revenue went up? Whenever you see an income tax rate like 13% in Russia (or the 10% in Bulgaria), remember to ask “What about VAT?” VAT accounts for 35-40% of Russian tax receipts at the federal level. VAT is also notoriously easy to game, which (related to the previous point) was happening on an absolutely massive scale in the 90’s in Russia. Are we mapping apples (income tax rates) against apples (income tax revenue)?

    3) Related to point 2: Another 30% of Russian tax revenue is taxes and tariffs on oil, gas, and mineral resources. Let’s not forget that the post-2000 years were generally years of rising commodity prices.

    A picture can be worth a thousand words, but they may not be truthful words. What was that about correlation and causation? Ah yes, xkcd to the rescue.

    Comment by Plamus | October 25, 2011 | Reply

    • I considered adding a line or two about the Russian 90s and the oil, but I decided against it because I didn’t have the data at hand and didn’t want to just add an imprecise remark without a strong data-foundation. But I might as well go into a bit more detail. When it comes to the 90s, it’s worth rehashing that this period was partly a period of economic adjustment, partly a period of outright stagnation. The figures are of course hugely controversial because nobody can agree on what stuff is supposed to have been worth right after the breakdown of communism, but Maddison’s data gives you a negative net pr. capita growth if you look at the period 1990-2005. Yeah, that’s a negative growth rate over a 15 year period. Most of it was caused by the drop in the beginning of the 90s, but GDP/capita didn’t go back to the level it had in 1994 until the new millenium.

      Here’s how GDP/capita developed during the period according to Maddison’s data.

      Comment by US | October 25, 2011 | Reply


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