Wednesday, April 26, 2006

Tax

Having had Estonia grow up around me, I take a lot of things for granted. Yet it seems that in a few areas we are very much ahead of the curve, and one of those is taxes.

The story was making the headlines recently about former Estonian PM Mart Laar (the only PM in the history of the newly independent country to get the job twice, although he still couldn't last a full term) getting the Milton Friedman award for promoting freedom. Central amounghis celebrated achievements is the introduction of Estonia's flat tax system.

The reason why I'm having trouble comprehending the complicated tax structure of countries like the US is because ours works so well so naturally. It's bloody obvious that this is how you're supposed to do this stuff. So, a few details:
  • 23% (and dropping every year) personal income tax
Everything you earn, you pay 23% on. The first $150 or so you earn every month are tax exempt. Since your employer handles all the paperwork, they either discount that money right away and it forms part of what you take home, or they don't bother, and you get a rebate in March. The figure you will see in an employment contract and (often) job ad is with this income tax, so what you actually get is just under a quarter less.
  • 33% social tax
Pays for hospitals, education, emergency services, etc. Paid by the employer on your behalf, so unless you're self-employed you aren't even aware this exists. Healthcare in Estonia is free, but mostly run as a private enterprise paid for by the national health insurance agency. Education is free, compulsory up to 9th grade, universally available up to 12th grade, and partially free at university level - the government orders sets of specialists they feel will be needed years from now, so if you're among the top X scorers in entrance exams, you pay no tuition whatsoever. You can also take the exact same program and pay for it - somewhere between $1000 and $2000 per year.

Naturally, I had a state-sponsored spot. Best score of the year; the text was designed to allow a score of 80% for the best students. I got 85.5%.
  • 18% value-added tax
Some categories of product and service, such as utilities or theater tickets, are taxed at 5%. There are EU-imposed loopholes; I recently bought a cruise to Stockholm at zero VAT. This doubles as the import duty, though you can import stuff anywhere else in the EU and sell/use it here with no additional charge.

That's it. There are excise charges on petrol, alcohol and tobacco of course, but otherwise the system is very simple. The rebates are few, but significant: interest on student loans and mortgages is not taxed (meaning you get 23% of interest payments back from the government).

There you have it: the Estonian tax legislation, in half a page of human text. There are no car taxes, no pet taxes, no inheritence taxes, no capital gains taxes - though I'll have to pay income tax on my stock options. To all the theorists who say it could not possibly work, I offer you a delicious factoid. The government of the Republic of Estonia had to pass a supplementary budget in 2005; the law states that our budget has  to be balanced, and the tax revenue for the year exceeded expectations by two billion kroons - around 158 million dollars.

It works alright.

6 comments:

Ward said...

Politically, it would never work, but in terms of revenue, I can't figure out why a government couldn't just say:

Flat tax, x% where x is set to raise the same amount as our current complex structure.

If nothing else, this should release the equivalent of all the money spent on accountants and tax software to be used for more productive things.

Flasher T said...

So why wouldn't it work politically? What's so disgusting about this system to American politicians?

ward said...

I think the main reason is that the current, stupidly complex, system lets politicians and beaurocrats hide all sorts of special treatment for their supporters or favourite groups.

Flasher T said...

True, true.

There's certainly something to be said for a revolution, and starting from scratch. Of course ours was bloodless, which is historically a rare exception.

AllanL5 said...

Congrats. You have a population of around 1.5 million people, and flat tax works for you. Note your flat tax rate is 23% + 33% or 56% total. And you DO have a 'loophole' for student loans and mortgages. Very nice.

However, many Americans would consider that a confiscatory, almost SOCIALIST, if not downright COMMUNIST, taxation. AND we have 200 times your population. If that makes a difference.

You mention "salary", but you don't mention "investement" income. Lowering "capital gains" taxes is also a goal of our conservatives. And what do you do about inheritance taxes?

Don't think I'm being critical. I'm being defensive. There is a difference.

Flasher T said...

I wonder how much Americans actually pay in taxes. Out of the money that the employer spends on them, how much do they take home? Then figure how much they spend on heathcare and education? I'd bet dollars to donuts that Estonians have a bigger percentage of income left.

Investment income gets income tax (23%) and nothing else. Inheritance tax - no such animal.

There's no reason why it would not work for 200 million people as it would for 1.5 million. If anything, it scales infinitely better.

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