ISP Working Paper Number 07-06

Flat Rate Taxes; A Policy Note

Sandra Hadler, Christine Moloi, and Sally Wallace, March 2007

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Abstract:

The objective of this paper is to provide an assessment of flat tax policies for policy makers. To do this, the paper reviews the theoretical impacts of a flat tax - how might a flat tax affect a country's tax administration, revenue generation, and economy - as well as the experience of countries that have recently introduced flat taxes.

This subject is particularly timely, since in recent years the ‘flat tax' has developed an aura as a panacea for some of the ills of tax policy and tax administration. In particular, it has been seen as a vehicle to simplify tax systems both in OECD countries, whose tax systems have become overly complicated with time, and in transition countries, as they have struggled to introduce western-style taxation systems. Some flat tax proponents argue that countries with a weak tax administration and/or those encumbered by complicated tax systems may benefit more from moving to a flat rate income tax than a major reform of its tax system, such as moving to a broader consumption based tax.

To this end, the paper briefly reviews the types of flat taxes that exist, provides a summary of the growing theoretical literature on flat taxes, undertakes some cursory analysis of available international data, and draws policy relevant conclusions.

The paper concludes, inter alia, that there remains considerable confusion among policy makers regarding what a flat tax is as well as its benefits. We believe that the jury is still out on the economic impact of flat taxes that have actually been imposed. To date, most of the existing analysis of the economic effects of flat taxes is theoretical in nature, and as such, provides little concrete evidence as to their impact. Further, there is little documented evidence on the administrative and compliance benefits of flat tax systems, although these may well be significant. The paper also concludes that the overall benefits of a flat tax are a function not only of the specific flat tax proposal, but also of the tax system (both policy and administration) and political environment in the country concerned, at that particular time. Thus, policy makers considering introducing a flat tax would be well advised to undertake a detailed estimation of their administrative and compliance impact and weigh these against the range of estimated economic impacts.