Prem Sikka
Professor Accounting, University of Essex

Right-wing think-tanks are busy promoting the idea of flat rate taxes. They claim that somehow this will stop tax evasion and avoidance and increase tax revenues.

We have heard all these claims before. In the UK, the top rate of income was reduced from the punitive 83% to 40% and the corporate tax rate was reduced from 52% to 30%. Yet this has not eliminated the tax avoidance industry or reduced tax avoidance which now runs at around £100 billion each year. The reduction in headline tax rates was accompanied by an increase in indirect taxes (or VAT) to the rate of 17.5%. Thus the taxation system is regressive and forces the less well-off to pay a higher proportion of their income in taxes. The UK history does not support any of the claims made by the flat tax brigade.

They claim that countries like Slovakia have benefited from the introduction of  a flat rate of tax. On 1 January 2004, Slovakia adopted a flat rate of 19% for individuals and companies. Before that Slovakia had a progressive system of taxation and individuals paid income tax, depending upon their income, at the rate of 10%, 20%, 28%, 35% and 38%. Now above a certain threshold, individuals will pay income tax  at the rate of 19%.

The previous corporation tax rate of 25% has been reduced to 19%. The dividend tax has been eliminated to appease foreign multinational corporations. Tax holidays can be granted for 5 years to some enterprises with foreign capital.  of course, ,multinational continue to launder profits through tax havens, transfer pricing, arbitrary allocation of costs, income,  profits and abuse of residence/domicile rules.

Slovakian economy is being fundamentally restructured. It GDP consists of 3.5% agriculture, 29.9% industry and 66.6% services. Foreign multinational booking their profits in Slovakia might pay tax at the rate of 19% though in practice it will be routed through tax havens and tax avoidance schemes to ensure that the effective rate is much lower.  Foreign multinationals primarily remain headquartered in Western nations because they have the infrastructure (roads, communications, hospitals, education, etc.) that enables them to function. Their operations in Slovakia and other countries hardly create any jobs and are run by skeletal staff. Resident companies are taxed on worldwide income; non-residents are taxed on their Slovakian-source income only thus giving them further incentives to launder profits.

By introducing the flat rate of tax at 19%, Slovakia may get some inward investment and thus further unleash a 'race-to-the-bottom' i.e. others may emulate with even lower rates. The government also has to make up the lost tax revenues otherwise it cannot provide any long-term social infrastructure investment. So it penalizes other sectors of the economy and the less well-off citizens.

Prior to 2004, Slovkia had two rates of VAT.  A standard rate of 20% and a reduced rate of 14% on many essential items. This has now been replaced by a single standard rate of 19%. Thus the less well-off have to pay the same rate as millionaires. Excise duties on  mineral oils, tobacco and tobacco products, and beer were also increased.

The flat rate tax  was hailed as a success because it  resulted in an increase of tax revenues from SK 200 billion in 2003 to SK 209 billion in 2004. However, Financial Times (29 March 2005) reported that  "income tax revenues fell 21 per cent. The government covered most of the shortfall with higher excise and sales taxes". This is not surprising as due to lower income taxes, the rich paid less in income tax. Flat taxes shift taxes to consumption and labour (see below).  The official sources are silent on the shifts in tax burden and their social consequences.

Local employers are penalized to appease multinationals. Local employment is taxed heavily. For each employee, the employer has to make a social security contribution of 35.2% of the salary. The employee's contribution is 13.4% of the salary. It covers state pension, unemployment and care insurance. An employer is obligated to deduct, immediately, each month, the amount of tax and national insurance due from a salaried worker. A self-employed individual is obligated to make advance payments on income tax that will be offset on filing an annual report. In the case of a new business, the advance payments will be calculated according to the estimates of the owner of the business. The advance payments will be made monthly or quarterly, depending on the amount of the advance payment.

The above means that the employee suffers an effective tax rate of  32.4% (19% + 13.4%) whilst the the employer (companies) suffer an effective tax rate of 54.2% (19% + 35.2%). This is much higher than most Western European countries. It penalizes local employers and distorts competition by favoring the "brass plate" operations. Many Slovaks are unable to save for a decent pension.

Under instructions from the IMF,  the Slovakian government has implemented a form of “shock therapy”  including a raft of privatisations and tax breaks for companies. Further plans to reduce labour costs and rights are being developed. The pension reform applicable from 2004 has increased the statutory retirement age from previously 60 for men and 55 for women to 62 for both genders. Further plans to raise it to 65 are being considered. Falt rate taxes are designed to work people to death.