The Flat Tax Increases Growth

There is something to be said for tearing it all down and starting again. The flat tax, for example, has long been debated but has never been fully adopted in the United States. After the end of communism, however, many countries in Eastern Europe and Central Asia adopted flat taxes. Brian Wheaton, on the market from Harvard, has a very nice paper which, somewhat surprisingly, is one of the first to really dig into this series of natural experiments.

Between 1994 and 2011,twenty post-communist countries introduced such a tax at varying—but typically quite low—rates as a percentage of income.At their peak, nearly all Eastern European and Central Asian countries had a flat tax in effect.Since 2011, on the other hand, some of these countries have repealed their flat taxes and reverted to a progressive system of income taxation.These policy changes represent an ideal natural experiment through which to test the multitude of claims pertaining to flat taxation.

Using quarterly GDP data on this panel of flat-tax adopters and a difference-in-differences identification strategy, I find that the adoption of a flat tax structure has a strongly significant positive effect of 1.36 percentage points on GDP growth…[lasting about a decade].

Wheaton finds that it wasn’t just lower average tax rates which mattered, holding average rates constant a flatter tax-structure also led to more capital investment and moderately greater labor supply.

Wheaton has many other interesting papers.

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