Flat tax revolution sweeps in from Eastern Europe

Flat taxes, once a fantasy of free-market ideologues, are sweeping across the European Union and could be introduced in more than 10 of the bloc's 25 member states.

Flat taxes, once a fantasy of free-market ideologues, are sweeping across the European Union and could be introduced in more than 10 of the bloc's 25 member states.

The European commissioner for taxation, Laszlo Kovacs, described flat taxes, - one rate for all income and corporate taxation - as "absolutely legitimate" and said Western European nations may be tempted to adopt them. His comments will fuel debate that low-tax, low-cost economies of the East are undercutting Europe's industrial heartland.

In place in Slovakia and the three Baltic states, which joined the EU last year, flat taxes are credited with helping them grow fast and creating thousands of jobs. French politicians have led complaints about "social dumping" and the risk to their employment and social standards. Others argue that such a regressive system, under which a millionaire and a road-sweeper pay the same rate, can never be fair.

Mr Kovacs, a former Hungarian foreign minister, said: "As far as the position of the EU is concerned, we consider it as absolutely legitimate because the EU does not tackle the issue of income and corporate tax rates.

"Four countries have introduced it and are satisfied, and they claim that it works properly. Some six or seven are considering flat taxes - that makes 10 or 11 member states that could introduce flat tax.

"But it means the majority of the member states do not apply and do not have the aspiration to introduce flat taxes."

Dispensing with the need for exemptions and allowances, flat taxes rely on simplicity: all those whose earnings exceed a threshold pay the same rate.

Sometimes, revenues have increased because fewer people take the risk of evading lower thresholds and there are fewer exemptions for accountants to exploit. Applying a basic - if regressive -system also saves time for citizens completing tax returns and for civil servants.

Mr Kovacs argued: "The advantage is that it limits tax avoidance but also it is more simple, so it reduces the administrative burden and reduces the compliance cost. The disadvantage is the lack of progressivity in the case of personal income." The commissioner did not name the nations considering flat taxes, though Hungary, the Czech Republic and Poland are known to be among them, and the issue has been raised in Cyprus and Malta.

However Mr Kovacs said that the idea is not "specific to the new member states". Greek politicians have debated the subject and Germany's opposition Christian Democrat party discussed a simplification of the tax system - though it would not be a classic flat tax but comprise three income categories. Policy advisers and political parties in the Netherlands and Spain have also given the idea a hearing.

Former Communist countries were open to the experiment because they did not inherit sophisticated tax collection machinery. In 1994, Estonia pioneered the move when its prime minister, Mart Laar, took the plunge, to be followed by Latvia and Lithuania. Others jumped on to the bandwagon including Russia, Serbia, Ukraine and Georgia. Slovakia, which joined the EU last May, introduced a flat tax of 19 per cent on income, corporate tax and VAT, in 2003. Romania - to become a member of the bloc in two years - has followed suit.

In Slovakia, the experiment has gone hand in hand with a boom in foreign direct investment worth €2.29bn (£1.5bn)this year.

The positive impact of flat taxes is almost certainly exaggerated. Slovakia's position as a magnet for car companies, such as VW and Peugeot, is based on a cheap and skilled labour force and its geographical position, rather than its tax regime.

Mihir Kotecha, CEO of Cologne-based Getrag Ford Transmissions, which has invested in Slovakia, said: "The tax rate did not swing our decision. A 19 per cent tax rate is very attractive but will it be there in five years?"