This Country is Mopping Up Trickle-Down Economics

(Bloomberg) -- More than two decades after unleashing Europe’s first flat tax, Estonia is calling it a day.

Part of market reforms to aid transition from 50 years of communism, the Baltic nation adopted universal levies for business and personal income in 1994, a move that was later copied by peers including Hungary, Romania, and Russia. But what was lauded as a measure to boost the economy has fallen from favor, after inequality grew and rapid growth fizzled out.

While the new government installed last month has vowed to maintain the single 20 percent rate, changes to tax credits starting in 2018 mean the share Estonians pay will vary along with their income.

“The model we have here is effectively ‘trickle-down economics,’ with benefits to the rich expected to reach everyone else as the economy keeps growing,” said Karsten Staehr, Professor of International and Public Finance at the Tallinn University of Technology. “Now we don’t have high growth any more, this is losing appeal.”

Advocates of flat tax rates, such as the late Nobel Prize-winning economist Milton Friedman, say they boost government revenue by closing loopholes and increase employment by adding incentives to earn and invest more. Opponents complain they actually lower revenue, rewarding the rich at the expense of the poor and curbing funds available for public services. QuickTakeHere's the lowdown on income inequality

Former Estonian Prime Minister Mart Laar, who introduced the flat tax, says he only did so after reading a textbook by Friedman and assuming its ideas had been implemented in the West, where nations have by now largely shunned such thinking. Even so, Laar claimed the step limited joblessness in the aftermath of the Soviet demise by helping create a wave of small businesses. Critics note the period also benefited from state asset sales and the start of market pricing for utilities.

Other countries have also ditched the tax: it lasted about 10 years in Slovakia and Ukraine. But the levy looks set to live on in other parts of eastern Europe, for now, despite Estonia’s loss of faith.

To contact the author of this story: Ott Ummelas in Tallinn at oummelas@bloomberg.net.

To contact the editor responsible for this story: Andrew Langley at alangley1@bloomberg.net, Jeff Black