Yet the flat tax has already proved an effective way to fight poverty in a host of developing countries. (See nearby table.) For individuals, tax evasion goes down and tax collection goes up because of better compliance. Low corporate rates attract capital, spurring economic growth and job creation. That means there is more money in government coffers to help the needy. Without a laundry list of tax exemptions and loopholes, corruption is thwarted.
Emphasis mine, this thought of reducing corruption brings to mind John McCain saying recently he would rather have a clean government than free speech, he could adopt a flat tax proposal and significantly reduce tax complexity, thereby reducing corruption. Instead he seems focused on reducing free speech.
Another benefit of a flat tax and a good way to sell it would be as an offset of runaway gas prices. From Cafe Hayek:
The average price of unleaded 87-octane gasoline in 2004 was $1.88 per gallon. Today it's about $2.93 -- so, $1.05 per gallon more today than in 2004. Thus, at $2.93 per gallon, we Americans are spending $68.3 billon more per year for gasoline than we spent in 2004. (I'm crudely assuming that this higher price of gasoline doesn't cause the quantity demanded of gasoline to fall. Of course, to the extent that this higher price does cause quantity demanded to fall, the extra amount of money we spend on gasoline per year will be lower than $68.3 billion.)
Let's put this figure in perspective: According to this just-released paper from the Cato Institute, Chris Edwards reports that the annual cost in 1995 of complying with federal-income-tax requirements was $112 billion. In 2005, this compliance cost was up to $265 billion -- $153 billion more in 2005 than in 1995. Adjusted for inflation, this compliance-cost increase is $122 billion (in 2005 dollars).
Note that in 2005 our cost of complying with federal-income-tax regulations was $53.7 billion more, in real 2005 dollars, than the extra amount we're now spending compared to 2004, on an annual basis, for gasoline.
And Congress has the gall to pontificate about the alleged unacceptability of the higher prices now charged by oil companies.
To me, it's clear that a simplified tax code with a flat rate would benefit nearly everyone, clean up some corruption and make the United States even more competitive.
Back to Costa Rica:
The traditional Latin American method of curing the condition known as scarce resources is to raise taxes. But one reason the budget is already strained is that Costa Rica's steeply progressive income tax rates for individuals have provoked skyrocketing evasion. Government estimates say 70% of taxes owed are not paid.
On the corporate side, the current rate of 30% already discourages investment. And Costa Rica's special tax-free zones for exporters need to be phased out by 2009 if the country is to remain compliant with World Trade Organization rules. Thus there are strong incentives to create a new flat tax for both individuals, to boost compliance, and for corporations, to regain competitiveness.
Introducing a flat tax is analogous to hanging out a sign that says: Open for business. Just ask Slovakia, which in 2004 adopted a flat tax for corporations and individuals of 19%. Since then it has been drawing in large amounts of capital from Western Europe and its economy is growing rapidly. After Russia implemented a 13% flat rate for individuals, evasion went down and revenues rose sharply.
Mr. Arias already understands the connection between lower corporate taxes, investment and rising living standards. He has mentioned Ireland, with its 12.5% corporate rate, as a model for Costa Rica. The Costa Rican daily La Nación reported last month that he was considering special corporate tax zones with rates below 10%. Referring to a 15% rate under discussion in Congress, La Nación reported that "Dr. Arias asserted that one cannot fool himself thinking that anyone can compete at that high tax."
That's a promising start for the debate but to be competitive Costa Rica will have to avoid a policy of limiting low flat rates to special economic zones since other flat-tax countries don't attach strings. Moreover, as Chris Edwards of the Cato Institute points out, "Carving out special tax rates and incentives for particular industries and regions is not only inefficient, it is an open invitation for corruption."
There is growing support for a flat tax from some of Costa Rica's opinion makers. An April 10 editorial in La Nación supported the idea and an important former central bank president has come out in favor of it. If Costa Rica introduces a flat tax now, it could get a jump on its Cafta neighbors in attracting investment. With its highly literate population, a flat-tax Costa Rica could easily become a prime destination for multinational investment.
A recent KPMG survey reported that the average corporate rate for the Latin American region is over 28%. That means that any Latin country that adopts a simple, low rate for the entire nation will instantaneously grant itself a vast comparative advantage. Over to you, Mr. Arias.
At this point in Latin America, any country that is pro-business is welcome. Incorporating a flat tax with competitive rates really sends the message, as O'Grady puts it, that you're open for business.
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