#18 - JRL 7187
Business Week
May 26, 2003
A Flat Tax Is Taking Root in, of All Places, Russia
From each according to...oh, never mind
By Jason Bush in Moscow

On May Day this year in Moscow, Communist diehards were on the streets by the thousands waving red flags and blasting the government, as they do every May Day, for selling out Russia to the capitalists. Yet there was one triumph of the new moneyed class that the Karl Marx crowd kept quiet about. A day earlier, Apr. 30, was the deadline for millions of Russians to trudge to the mailbox or down to the local inspectorate to pay their income tax. That tax is a flat 13% for everyone, making Russia one of the few nations that doesn't impose a bigger duty on its richer citizens. Why no protest? Because it's considered a great success in a land where a few years ago it was hard to get anyone to pay taxes at all.

Introduced two years ago by President Vladimir V. Putin, the tax was designed to bring order to the chaos of the chronically underfinanced state budget. One senior government tax official estimates that before the flat tax took effect at the beginning of 2001, Russians on average declared as little as 25% of their income. Since it was introduced, there has been a marked increase in both payment rates and revenue. Official statistics show that income tax revenue rose 28% between 2000 and 2001, and a further 21% by last year, after adjustment for inflation. Total government revenue from personal income taxes shot up from an unadjusted $6.2 billion in 2000 to almost $12 billion last year.

The Kremlin is pleased. "We don't think it's possible to force people to pay taxes through repressive sanctions," says Mikhail Orlov, head of tax policy at the Ministry of Economy. "The tax system may be primitive, but it's simple." And, he added, so far it works.

Part of the credit for the turnaround goes to a clever advertising campaign designed to convince taxpayers that the tax is a bargain. One TV ad during the recent tax season showed two apples, one with a 13% slice cut out of it representing the flat tax and the other missing a 30% chunk, a reference to Russia's former top income tax. The message: Taxes are so low that any reasonable person would pay up. "It's a small amount, so of course it's worth paying," says Natasha Diniliouk, an accountant who lives in Moscow.

Only a minority of Russians question the fairness of taxing lower-, middle-, and upper-income workers at the same low rate. A survey last year by Russia's Public Opinion Foundation showed 43% of Russians polled supported the flat-tax-based system, compared with 36% who want a more progressive tax code. Some offer a cynical explanation. Nobody expects the wealthy and powerful to pay their fair share anyway. "Why have a progressive tax system that doesn't work?" asks Vladimir Redkin, an economist at Russia's Bureau of Economic Analysis.

Moscow's flat tax was the brainchild of Putin's liberal economic advisers, led by Putin chief economic adviser Andrei N. Illarionov. Proponents say that with a single rate and few deductions, there's no need to spend hours with a calculator to figure out how much is owed. "It's an amazing success," says Alvin Rabushka, senior fellow at Stanford University's Hoover Institute, a long-standing flat-tax advocate whose ideas helped shape Illarionov's thinking. And the idea has spread to some of Russia's equally tax-starved neighbors. Ukraine and Slovakia plan to adopt their own flat taxes. The Baltic republics adopted theirs in the 1990s.

To be sure, the flat tax hasn't solved all of Russia's fiscal woes. Tax evasion is still a big problem. What's more, the Russian tax system is still rife with incongruities and disincentives. One problem is the huge burden that employers bear from a payroll tax levied to pay for social security benefits and state pensions. The tax is a thumping 35.6% on the first $3,175 of an employee's income, which means companies have a big incentive to understate their employees' true wages. The government promises to fix the problem, but has yet to come up with a concrete plan.

And some wonder whether the flat tax is such a good idea. "Perhaps this reform was too revolutionary," says Yevsei Gurvich, an economist at the Economic Expert Group, a Russian think tank. He thinks a more progressive tax system would bolster public confidence. Despite government assurances, many Russians worry the flat-tax rate will go up.

Moreover, at some stage politicians and the voters who back them are bound to begin demanding that the rich pay a higher rate of tax. But until then, the country's flat-tax experiment is paying its way in solid, dependable revenues for the government -- and satisfaction among the growing bourgeoisie.