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How Estonian Ex-PM Introduced A Flat Tax

by Ulrika Lomas, Tax-News.com, Brussels

31 August 2005

In an interview with the Brussels Journal last week, Mart Laar, ex-Estonian Prime Minister, said he introduced a flat tax in 1992 because nobody had told him it was impossible. Now Estonia has been followed by Latvia, Serbia, Slovakia, Georgia, Russia, Ukraine and Poland.

In 1994 Estonia introduced a flat tax rate of 26% for all personal income and corporate profits, and plans to reduce the rate to 20% next year. In 1997 Russia introduced a flat tax of 13%; the Polish government has announced that it will be following the trend established by Estonia in 1991, and will be putting in place a single 18% rate of corporate tax, income tax, and VAT by 2008.

Mart Laar, a historian by trade, governed Estonia from 1992 to 1995 and from 1999 to 2002. When he became Prime Minister in 1992 at the age of 32 he knew nothing about economy. Laar’s area of expertise were Europe’s 19th-century national movements. “It is very fortunate that I was not an economist,” he told the Brussels Journal. “I had read only one book on economics – Milton Friedman’s “Free to Choose.” I was so ignorant at the time that I thought that what Friedman wrote about the benefits of privatisation, the flat tax and the abolition of all customs rights, was the result of economic reforms that had been put into practice in the West. It seemed common sense to me and, as I thought it had already been done everywhere, I simply introduced it in Estonia, despite warnings from Estonian economists that it could not be done. They said it was as impossible as walking on water. We did it: we just walked on the water because we did not know that it was impossible.”

When Laar became Prime Minister, inflation in Estonia was over 1,000%, the economy was falling at a rate of 30%, unemployment was over 30%, 95% of the economy was state-owned and 92% of Estonian trade was dependent on Russia. Today, inflation is 2.5%, economic growth is between 6 and 7%, unemployment is low, the government budget is balanced and there is a high level of investment.

After Estonia joined the EU last year, it came under attack from high-taxing countries like France and Germany; French presidential hopeful Nicolas Sarkozy even suggested that the lower-taxing new EU member states should lose their EU regional funding if they do not agree to increase their corporate tax rates. Laar's successor, Juhan Parts, condemned his remarks as "not according to European values", observing that: "Companies are always looking for the best opportunities. I would say that it is better that they stay in the EU than move to Asia."

He also took the opportunity to address the implication that the newer members of the European Union are too poor to afford low tax rates, arguing that: "Business-friendly tax rates produce more growth and thus more revenues for the public sector."

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