The Flat Tax: An Examination of the Baltic States

The idea of a flat tax, a tax levied at a single rate, has become an increasingly discussed and implemented fiscal strategy across Europe and the rest of the world. Estonia, Latvia, and Lithuania adopted flat tax systems in 1994 and 1995, making them the first modern countries to adopt flat tax structures. They subsequently experienced unprecedented economic growth, shocking the world as they emerged as “Baltic Tigers” at the turn of the century. Russia adopted a flat tax regime in 2001, and more than a dozen countries currently maintain some sort of flat tax structure today. However, the actual effect of the flat tax rate on the Baltic countries’ economic growth remains debated. Though there is clearly timing a correlation between the Baltic States’ economic growth and the implementation of the flat tax, the current economic analysis on the effect of the flat tax rate is largely confined to Russia. Additional research and analysis needs to be completed before determining whether the success of the “Baltic Tigers” can, and if so, to what extent, be attributed to their flat tax policies. The Baltic States are an appropriate laboratory for a number of reasons: they have the longest history for examination, and have many similarities between them including, economy, geographical location, and relationship to Europe. These similarities allow the analysis to control for unique factors in the individual countries and isolate the effect of a flat tax. Looking at revenue, GDP, and labor supply data, this paper attempts to analyze the effect of the flat tax on these three Baltic states. Using the analysis on these countries, this paper attempts to discuss whether a flat tax rate is an effective and potent growth strategy for transitional economies. The findings of these analyses do not indicate that the flat tax has any definitive positive impact on growth, equity, or labor supply. However, without the simplicity of the flat tax such growth may not have been able to occur in the early years of the Baltic states’ independence