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Last Updated: Sunday, 11 September 2005, 16:19 GMT 17:19 UK
Tax reformers follow European lead
by Gavin Stamp
BBC News business reporter

Tax form on computer
Critics claim the tax system is too complicated

If two things are certain in life, the fact that taxes are seldom off the radar of politicians and businessmen is surely one of them.

Should further proof be needed, the recent debate about the merits of a 'flat tax' system, provides it.

The concept of a single, flat rate of tax for individuals and businesses was first adopted in Estonia and Lithuania in the mid 1990s.

It has since been introduced in various forms by several eastern European countries.

Opposition parties in Poland, the Czech Republic and Germany are currently calling for a similar approach and the subject is slowly climbing up the political agenda in Britain.

'Serious consideration'

Shadow chancellor George Osborne recently called for the concept to be given "serious consideration", suggesting that he was impressed about how Estonia had made it work.

Estonia, Lithuania (since 1994)
Russia (2001)
Serbia, Ukraine (2003)
Slovakia (2004)
Georgia, Romania (2005)

While acknowledging the obstacles to overhauling Britain's multi-tiered tax system, Mr Osborne has asked an independent commission to study the case for flatter taxes.

The Liberal Democrats have launched a consultation on the subject which is likely to be debated at their party conference next month.

The Treasury, on the other hand, has publicly rejected the idea.

But supporters of the proposal claim that the government's own research into the subject - published last month - showed that officials had accepted many of the principal arguments for the measure.

Work incentives

Proponents of a flat tax claim it would benefit a large number of British taxpayers while giving a significant boost to the British economy.

George Osborne
The Tories say a flat tax deserves "serious consideration"

By eliminating the numerous marginal rates of tax currently in place and replacing them with a single rate - between 10 and 30% - high and middle income earners would be incentivised to increase their earnings.

To counter charges that such a system would be highly regressive and only benefit the wealthy few, the threshold for tax-free personal allowances would be significantly raised.

This would ensure that many of the UK's lowest-paid workers would pay no tax at all.

The wider economic benefits would also be substantial, supporters claim.

Greater compliance

Simplification of the tax system and lower rates would encourage compliance and cut administrative costs.

Furthermore, by eliminating exemptions and loopholes, it would tackle existing distortions and create a more flexible and productive job market.

Most contentiously, supporters claim that a flat tax system would increase economic growth by providing greater work incentives and would, over time, increase the overall tax take.

The apparent objectives of a flat tax are thoroughly desirable but the flat tax itself is a poor way of achieving them
The Institute for Public Policy Research

To back this up, think tanks such as Reform - supported by the former Vodafone chief executive Sir Christopher Gent - herald the economic progress made by countries with a flat tax system.

Countries such as Estonia have grown twice as fast as eastern European nations with variable tax rates since 1995, Reform claims, while foreign direct investment in Estonia has more than quadrupled.

European experience

However, there are those who believe Estonia's experience has been somewhat less positive.

According to a study by the Institute for Public Policy Research (IPPR), the amount the country's government raised via income tax as a proportion of GDP fell from 8.2% in 1993 to 7.2% in 2002.

Although a flat tax has been shown to improve compliance, there is little evidence that it acts as a spur to productivity, the IPPR claims.

A garage in Tallinn, Estonia
Estonia introduced a flat tax in 1994

"The apparent objectives of a flat tax are thoroughly desirable but the flat tax itself is a poor way of achieving them," the Institute's Dominic Maxwell and Rachel O'Brien said in a recent analysis.

The advantages of such a system are overstated, they claimed.

Underpinning the whole case for a flat tax, they claimed, was a discredited agenda prioritising tax cuts over public investment.

"Many of the allowances that exist in complex tax systems are there for a good reason: tax breaks for research and development, more environmentally sustainable fuels and child care, for example."

Simplification of the tax system is ultimately a matter of political will and conviction
David Martin, Centre for Policy Studies

Despite the flurry of interest shown in a flatter tax system by British politicians of several shades, Gordon Brown is unlikely to be swayed.

The Treasury's research into the issue concluded that there was little evidence of significant economic benefits while such a system would prove extremely expensive and potentially regressive.

Step by step

Tax experts say the case for a flatter, simpler tax system is persuasive but for it to make any ground, change must be happen in stages.

David Martin, a tax lawyer and research fellow at the Centre for Policy Studies, believes moving in one big leap to a single flat tax is too risky.

A more sensible step would be to consolidate existing taxes into two personal bands and a single rate for companies, he says.

"Simplification of the tax system is ultimately a matter of political will and conviction," he adds.

"Proponents of a flat tax must be aware of the danger identified by the American commentator HL Mencken who observed 'for every complex problem, there is a solution that is simple, neat and wrong."

How the flat tax method works in Estonia

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