Book Review: Flat tax in Bulgaria: History, introduction, results

Institute for Market Economics1

Estonia became the first European country to introduce a flat tax on income when it collapsed a progressive rate structure for personal income with a top marginal rate of 33 percent to a flat (proportional) rate of 26 percent in 1994. At the same time, it reduced its single (i.e. flat) rate on corporate income of 36 percent to the same 26 percent rate as on personal income. Over the following years these rates were gradually reduced until they now stand at 20 percent across the board. To this day Estonia is rated as the most competitive tax system in the OECD by the Washington DC based Tax Foundation.

Estonia’s Baltic neighbors, Latvia and Lithuania quickly followed suit and all three (especially Lithuania) quickly became the fastest growing economies in Europe, growing at more than double the rate of, for example, Germany.

In 2001, Russia switched from a system of 12, 20 and 30 percent tax rates on personal income to a 13 percent flat income tax and lowered its single corporate tax rate from 35 percent to 24 percent and enjoyed rapid economic growth in the years there after. Adjusted for inflation, revenue from Russia’s personal income tax increased by 26 percent2 in the year after a flat tax was implemented, and by nearly one-fifth as a percentage of GDP
Over the next two decades 20 European and Former Soviet Republics had adopted flat taxes of one form or another. Where did such radical ideas come from? Mart Laar, who served as the Estonian prime minister from 1992 to 1994 and 1999 to 2002 saw Estonias’s emergence from communism as an opportunity to reform. Looking to Lescek Balcerowicz, the designer of the Polish economic reformation, Laar noted that a radical economic program, launched as quickly as possible, had a better chance of success than several prolonged measures. As Deena Greenberg writes in “The Flat Tax: An Examination of the Baltic States”3: “In the early years of Estonia’s transition, there were a number of sources that helped shape Laar’s and the early government’s thinking about reforms. Think tanks from abroad, such as the Heritage Foundation, the International Republican Institute, and the Adam Smith Institute in addition to the newly formed local Estonian think tanks, served as one influencing.” (p. 27)

“With regard to the flat tax specifically, Laar looked to Milton Friedman, who proposed a proportional income tax when creating its tax reform.” (p. 29)

Cayman Financial Review editorial board member Daniel Mitchell has long promoted and written about flat taxes. In the case of Russia, Putin’s economic advisor, Andrei Illarionov met Alvin Rabushka in 1997 who discussed the rationale for flat taxes contained in his book on the subject with Robert Hall. In the spring of 2000, together with German Gref, then Russia’s Minister of Economy, Illarionov convinced Russian President Vladimir Putin to adopted a flat tax. Flat tax systems were clearly not the only factors contributing to rapid economic growth in this period. The Baltic countries, again led by Estonia, had adopted currency board rules for their central banks in which the central bank’s passively supply all of the currency the market was willing to pay for at a fixed price for the German mark. This rapidly ended high inflation rates providing a stable foundation for growth. In addition, many other market-friendly reforms were undertaken.

Not only did flat tax countries grow more rapidly, but they raised more tax revenue as well. As explained more fully below, this was primarily because lower, simpler, proportional taxes drew large numbers of people from the informal to the formal, tax paying, sectors. Flat (i.e. proportional) tax systems win the prize for the best tax systems in the category of minimizing distortions in the allocation of society’s productive resources and thus promoting economic growth; similarly for simplicity and enforceability.

The case for fairness is more controversial. Is it fair for a person with twice the income to pay twice the tax, as would be the case with a flat or proportional tax rate? If fairness calls for someone with twice the income to pay more than double the tax, how much more?
Flat taxes come in a variety of flavors. Some have relatively high non-taxable minimum incomes and some have none at all with no deductions for investments (e.g. education) or other costs of generating income or for favored (tax subsidized) activities (e.g. charitable giving). Each of these impacts attitudes toward fairness while generally undermining tax neutrality.

A 2006 IMF study of flat taxes noted that: “Reforms that involve an increase in the basic tax-free amount are beneficial to both the lowest and the highest earners, and compliance effects may in themselves plausibly lead to an increase in effective progressivity. There is thus no general presumption that movement to a flat tax in itself is associated with a reduction in progressivity, though the commonly used summary indices of progressivity—which, in the few studies of this issue, show an increase in progressivity—may overstate the point.”4

The Economist magazine noted that: “Under systems such as America’s, or those operating in most of western Europe, the incentives for the rich to avoid tax (legally or otherwise) are enormous; and the opportunities to do so, which arise from the very complexity of the codes, are commensurately large. So it is unsurprising to discover, as experience suggests, that the rich usually pay about as much tax under a flat-tax regime as they do under an orthodox code.

“Estimates for the United States, whose tax regime, despite the best efforts of Congress, is by no means the world’s most burdensome, put the costs of compliance, administration and enforcement between 10% and 20% of revenue collected.”5

Compared with most other former Soviet and Eastern European countries Bulgaria was slow to reform, wasting a decade. It adopted its flat tax regime (10 percent on personal and corporate income) in 2007 (implementing it in 2008) one decade after its adoption of currency board rules following the financial/inflation crisis of 1996. The decade following the adoption of currency board rules and preceding the adoption of a flat tax saw strong growth (well above Germany’s).

The Institute for Market Economics (IME) played an important role in bringing the flat tax idea and debate to Bulgaria over a decade before its adoption. It is thus welcomed that IME should publish a collection of studies of Bulgaria’s experience with its flat taxes and the history leading up to their adoption. They address the questions of how did Bulgarians come to support flat taxes, and the income and tax revenue results? The IME publication also addresses the issue of fairness. The studies find that Bulgaria’s adoption of a flat tax was strongly influenced by its wide spread adoption by other European countries, that its very low rates were strongly influence by competition for foreign investments and the low tax rates in the region, that tax revenue increased significantly under the flat tax regime because of a significant increase in compliance (the move of activity from the informal to the formal sector), and that it contributed along with other market reforms to more rapid economic growth. They also find that levying the same tax rate on all income fit Bulgarian’s notion of fairness. This extended to the elimination of the untaxable minimum income, i.e. all income, however large or small is taxed at the same rate.

Some authors were more informative than others. Georgi Sarakostov’s first person singular speculations on tax policy, do not fit well, Petar Ganev’s discussion of the impact of flat income taxes on labor is hard to follow, and Georgi Stoev’s discussion of the fairness of flat tax presents a fallacious calculation. Georgi Ganev’s discussion of fairness is much richer and more convincing.

Krasen Stanchev discussed the impact on growth and efficiency: “In 2006 real GDP per capita was 4,500 euro; in 2014 it was 5,500 euro. The total GDP at the beginning of the period was 22 billion euro and in 2014 it was 42 billion euro. In purchasing power parity terms, Bulgaria’s GDP compared to the average EU level was 38 percent in 2006 and 47 percent in 2014, probably 49 percent in 2015… Unemployment in 2006 was 9 percent, in 2008 it reached its lowest level for the last 20 years, 5.6 percent.” (page 12)

“Since 2006 the efficiency of the Bulgarian tax administration in tax collection has improved four times. It is measured using the ratio of the expenses on the collection of tax revenue to the revenue itself. This indicator ranks Bulgaria before Australia, Belgium, Canada, the Czech Republic, France, Germany, Hungary, Ireland, Japan, Luxembourg, the Netherlands, Poland (two times better) Portugal, Slovakia and Slovenia.” (page 14)

Georgi Sarakostov flagged tax competition: “It is my belief that the decisive role for that change was played by the developing tax competition between countries in combination with the persuasiveness and persistence of economists who had been calling for the introduction of a flat rate since 2003.” (page 15)

Georgi Angelov reviewed the reforms and resulting increase in tax revenue: “In 1993 income tax followed a scale with nine different rates – between 20 and 52 percent (accompanied by high social security tax). Company profits were taxed at almost 40 percent, plus additional payments to the municipalities which reached 10 percent.” (page 22)

“The grey economy in the 90s increased dramatically to reach between 35 and 40 percent according to different estimates, mostly due to the failure in tax payment and social security contributions (including mass scale failure to issue receipts and invoices, employment without contracts, ubiquitous cash payments, taking advantage of ‘loopholes’ and exceptions in tax legislation).

“Increased tax collection could not be achieved without lowering the rates and simplifying the tax system, including limiting the “loopholes” in tax laws. What is more, encouragement of the private sector and attraction of investment also required reforms and lowering the rates for direct taxes as many other countries offered much better tax conditions.” (page 23)

Kaloyan Staikov reviewed experience with corporate tax reforms: “A variety of studies show that corporate tax most seriously harms economic growth, followed by personal income tax, consumption tax and property tax…. An IMF study of 170 episodes of fiscal consolidation in 15 developed countries in the last 30 years: lowering public spending is considerably less harmful for short-term economic growth compared with raising taxes.” (page 32)

“In 1999 corporate tax was 34.3 percent while revenue from that tax was 10 percent of tax revenue and 3 percent of GDP. In 2008 the corporate tax rate was already 10 percent and the revenue collected was 9.3 percent of all tax revenue and 2.8 percent of GDP…. At the same time, the real growth of the economy was over 6 percent annually.” (page 33)

“[E]valuation by the Ministry of Finance of the positive effects from the tax policies carried out between 2003 and 2008, even though that was a period of economic crisis followed by a political one. Lowered rates for corporate tax and lowered expenses on tax compliance created positive incentives for investment, fixed capital accumulation and thus – raised productivity, economic growth and wealth in the country. The lowered rates led to no loss in tax revenue.” (page 36)

Desislava Nikolova examined the results of the proportional tax rate on personal income on the revenue raised: “The reasons for this positive impact of flat income tax on the budget can be found mostly in the shrinking of the grey economy, more specifically, in the smaller number of informal employment relationships.” (page 42)

Georgi Ganev concludes the book with what I found to be the most interesting chapter. He explores how Bulgarians came to accept the low flat rate as the fairest. “By 2005 it had already become clear that a personal income tax with an untaxable minimum at the bottom and, further up with a progressive scale of marginal rates: 10, 20, 22, and 24 percent of income over the respective thresholds was practically and experientially indistinguishable from a flat rate with an untaxable minimum and a rate of 23.5 percent. […] By 2007 it was already obvious that flat tax was spreading all over the world. Only among the countries Bulgarians are in the habit of comparing themselves to, after the pioneers from the Baltics, in the years just before the tax was formally proposed in Bulgaria, it was adopted in Russia, Romania, Slovakia, Ukraine, Serbia, Macedonia, Georgia… the feeling that an established international trend was followed also contributed to the idea’s theoretical acceptance.

“The main objection to lowering the rates [to 10 percent] has always been that it will lead to a considerable drop in revenue and thus to a lower capability of modern Bulgaria to be a welfare state. But one decade of rates going down – in the case of the highest personal income tax rate from over 40 percent to 24 percent and in the case of corporate tax from 40 percent to 10 percent, showed no drop or a minimal drop in revenue at most. What is more, in the very year of the debates on flat tax the corporate tax lowered to 10 percent was registering a considerable increase in collection.” (pages 59-60)

“Unlike truly progressive taxes, which, due to the relentless logic of the political process include complex and numerous exceptions, conditions, and possibilities left to the tax collectors’ discretion, flat tax is simple, clear and without exceptions. In combination with the low rate, its simplicity considerably reduces both the opportunities and the stimuli for evasion. Whatever gray economic activity there is in Bulgaria, it has long stopped being caused by attempts to save tax on behalf of individuals.” (page 61) Bulgaria adopted its 10 percent flat personal and corporate income taxes because strong intellectual cases had been made for it and many neighbors had do so with good outcomes, and because of tax competition. Bulgaria’s experience with the resulting tax revenue and economic growth were even better than their high expectations. The mystery is why such successes have stopped spreading.


  1. The book can be downloaded at:
  3. Deena Greenberg, “The Flat Tax: An Examination of the Baltic States” 3/2009, pages 20-21
  5. April 14, 2005