(E) Tax Policy for a Prosperous Croatia by Daniel J. Mitchell
International Leaders Summit, Zagreb, Croatia:
Tax Policy for a
Tax Policy for a Prosperous Croatia
By Daniel J. Mitchell
Senior Fellow and Chief Tax Policy Expert at the Heritage Foundation
Croatia faces an immense challenge. It must devise a tax system that will help boost growth so the nation can overcome the crippling legacy of socialist mismanagement. This tax system also must be attractive to foreign investors, something that is particularly important because of globalization. Yet this tax system also must raise enough revenue to finance the needs â€“ hopefully limited â€“ of government.
While this is a daunting task, the flat tax is a good solution to help Croatia become prosperous and successful. Economic theorists and public finance experts like the flat tax because it is an ideal system. It has a low tax rate so that people have an incentive to work and little reason to hide their income from the government. It gets rid of various forms of double-taxation such as death taxes and dividend taxes so that there is not a bias against saving and investment. It also eliminates all forms of special preferences and penalties so that peoplesâ€™ decisions are based on economic merit rather than tax consideration.
And if policy makers are unwilling to implement a low-rate flat tax, they can achieve many of the benefits by taking steps in that direction. They can lower tax rates. They can eliminate extra layers of tax on saving and investment. They can simplify the tax system by removing loopholes.
But whether they want fundamental reform or incremental reform, Croatiaâ€™s leaders are going to face a number of major obstacles. Unfortunately, international bureaucracies will very likely be part of the problem. The European Union (EU) and the Organization for Economic Cooperation and Development (OECD), for instance, mostly represent the interests of high-tax nation like France and Germany. These countries already are very upset the some Eastern European nations are lowering tax rates and implementing flat taxes, and they are using the EU and OECD to threaten nations that engage in too much â€śtax competition.â€?
The International Monetary Fund (IMF) also tends to offer bad advice. It is notorious for its opposition to free-market tax policy. In case after case, IMF bureaucrats will enter a country and urge big tax increases. They assert that the tax increases are needed to balance the budget, but the IMF should be focusing on ways to control government spending. The bureaucrats apparently donâ€™t understand that higher tax rates simultaneously discourage work, saving, and investment and encourage tax evasion and tax avoidance. The IMF may be even more dangerous than the OECD and EU since it uses its large budget to bribe nations to follow its advice.
Croatiaâ€™s leaders should reject the bad advice of international bureaucracies. There is not other choice. If tax rates remain too high, people will continue to hide income from the government. Even more important, international investors will choose other nations when deciding where to build factories and create jobs.
Indeed, this is why it is so important to reject EU and OECD arguments against tax competition. If Croatia does not lower tax rates and reform its tax system, it will have very little chance of successfully competing with other nations in the region that have made these changes. Why should an entrepreneur create jobs in Croatia when he can go to Slovakia or Serbia and enjoy a low-rate flat tax? Why should a company build a factory in Croatia, when it can benefit from Hungaryâ€™s 16 percent corporate tax rate? Simply stated, Croatia must compete or perish.
And if the IMF (or even the World Bank) argue that tax reform and tax rate reductions will deprive the government of too much revenue, Croatiaâ€™s leaders should point to what has happened in other nations. In Russia, for instance, income tax revenues have nearly doubled since President Putin shifted from a 30 percent â€śprogressiveâ€? tax to a 13 percent flat tax. Other Eastern European nations have seen similar results because of faster growth and less evasion.
More than forty years ago, President John F. Kennedy of the United States proposed a big reduction in tax rates. His opponents made the same arguments that are being heard from the IMF and other bureaucracies in Croatia today. But President Kennedy persevered. He told critics that:
Our true choice is not between tax reduction, on the one hand, and the avoidance of large Federal deficits on the other. It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget just as it will never produce enough jobs or enough profitsâ€¦ In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.
Croatia should follow this sensible advice. Americaâ€™s economy boomed following the Kennedy tax cuts in the 1960s, and it boomed again when Reagan cut tax rates in the 1980s. Croatia should do the same thing. Cut taxes and reform the tax system! Do not listen to the bureaucrats who represent the backward thinking of high-tax welfare states.
Dr. Daniel Mitchell is Senior Fellow and Chief Expert on Tax Policy and Economy at The Heritage Foundation. Served as Economist for US Senator Bob Packwood and the US Finance Committee. Dr. Mitchell is one of the Founding Advisory Board members of the International Leaders Summit and the Adriatic Institute for Public Policy, Croatiaâ€™s first independent free market think tank.
Dr. Mitchell will be speaking at the International Leaders Summit â€“ Focus on Economic Growth in Zagreb, Croatia on November 5 and 6, 2004 at the Sheraton Zagreb Hotel.
For further information regarding the International Leaders Summit, please contact:
Natasha Srdoc-Samy, MBA
Co-Director, International Leaders Summit
President, Adriatic Institute for Public Policy
Joel Anand Samy
Co-Director, International Leaders Summit
President, World Development and Empowerment