Effective tax systems

Tax Epiphany November 13, 2006; Page A16

A bright light descended from the sky last week and shone upon the world's economic planners. It came courtesy of the World Bank, of all unlikely places; its toiling economists have discovered that simplified tax systems promote economic growth.

In a report titled "Paying Taxes -- The Global Picture," the World Bank and its co-authors at PricewaterhouseCoopers make the case for simplifying business taxes. Burdensome rules and multiple levies, they argue, promote tax evasion even when individual corporate tax rates are low. Make the system transparent and simple, and the private sector will pony up. It's an argument that could be made for personal income taxes, too.

Released as an elaboration of the Bank's broader and valuable "Doing Business Report," the survey examines the tax regimes of 175 countries between April and July this year. It looks at the administrative tax burden that a hypothetical, limited liability company with 60 employees would face.

The Bank's findings echo that of the flat-tax camp; namely, simple tax regimes promote compliance and efficiency. By "simple," the Bank doesn't just mean unifying rates; it includes making the forms easy to read, understand and file. World-wide it takes an average of 332 hours a year for businesses to comply with tax requirements, ranging from 2,600 hours in Brazil to 325 in the U.S. to 68 in Switzerland. There's no reason a tax form can't fit on a few pages, as in Hong Kong, or be filed over the Internet, as in Singapore.

Tax simplification also means trimming the tax regime itself. The Bank found that corporate income taxes compose only 36%, on average, of businesses' annual tax burden. Property, dividend, capital gains, municipal, and social security taxes, among others, make up the rest -- not to mention the various loopholes carved out for certain industries. Countries such as Egypt, which unified its corporate tax rates and eliminated about 3,000 corporate exemptions and tax holidays last year, saw tax filings double. Russia implemented a flat tax in 2004 and saw tax revenues soar.

The Bank pulls no punches for its main clientele: poor countries that have trouble raising funds. Many make the mistake of setting high tax rates. By doing so, they tacitly encourage tax evasion and create opportunities for corruption. Little wonder that the bottom 30 countries in the "Doing Business" survey "are twice as likely as those in the top 30 to report that bribery is a problem."

If only the high-tax prophets at the International Monetary Fund were paying attention. In a recent working paper, three Fund economists -- writing in a "personal" capacity -- put out an anti-flat tax screed. We don't have the space to dissect the entire paper here, but in essence they wave away the experience of Hong Kong and Russia and argue that the pro-market signals flat taxes send won't do any good for developed nations.

We never thought we'd say this, but perhaps the World Bank can lend the Fund a few economists for some re-education assistance. The IMF bias has long been to elevate balanced budgets as the highest fiscal priority, with tax levels and tax incidence as secondary matters. The Bank business tax survey implicitly exposes the error of the Fund's ways. Combined with President Paul Wolfowitz's long-needed campaign against corruption, the tax report also marks a welcome turn at the Bank in a pro-growth direction.

The Bank's report should also inspire a more thoughtful debate over the virtue of value-added taxes, or VATs. More than 130 countries have adopted VATs, with the IMF pushing hard for its implementation in places like Hong Kong. The VAT is a highly efficient tax and in that way has an advantage over a corporate income tax regime with high rates but many loopholes. But that very efficiency also makes a VAT dangerous as an engine of bigger government because its incidence tends to be hidden and politicians are tempted to raise the rate whenever they want a little more revenue. Some built-in restraint on that political impulse is needed.

The overriding goal of any tax system should be to raise the revenue that governments need for public purposes with the least amount of economic distortion and evasion. The lesson of the World Bank report is that the more transparent and simple a tax scheme, the more it will achieve that purpose.

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