TAKING STOCK : Scrap the income tax

Rakesh Wadhwa


The 1990s saw the break-up of the former Soviet Block. With the collapse of the ‘evil’ Russian empire, its old policies too were junked. Whereas communism preached, ‘from each according to ability and to each according to need’, the new philosophy, with its low taxes, allows you to keep your earnings. No sacrifice for the needy is required. Earlier everything belonged to the state, now you own what you earn. Estonia, Lithuania, and Latvia are three new nations in the Baltics which emerged out of the old Soviet Union. All three adopted flat income tax systems in the 1990s. These tax reforms led to a virtuous cycle of tax competition. Each country tried to ensure that investment, both foreign and domestic, was encouraged by each trying to outdo the other in lowering taxes. As a result these economies are racing forward.

Russia watched with growing jealousy the prosperity which was coming to its ‘babies’ while it itself stagnated. But all that changed in January of 2001. Vladimir Putin, Russia’s president, copied the Baltics. He stunned the whole world by instituting a flat 13 per cent income tax. Russia is thriving today. Its economy has expanded by over 10 per cent since 2001. This is a sea-change from earlier times when its economy was shrinking. Russia is easily outpacing the growth rates in the US and the anemic Western Europe. The lower flat tax has had a dramatic effect on tax compliance too. Tax evasion has plummeted. The past two-and-a-half years have seen the Russian tax revenues zoom by over 60 per cent. This clearly demonstrates that when people think tax rates are fair and low, they pay up. In fact this new tax policy has been such a hit that both Ukraine and Slovakia, though initially hesitant, have now both abandoned their existing tax codes, in favour of the lead taken by Russia and the Baltics, and have brought in their own low flat tax regimes. In Ukraine the income tax is identical to that of Russia - a flat 13 per cent. Slovakia is in the process of implementing a flat 19 per cent tax on income.

These nations understand that they have to bring in capital to prosper. Low taxes play a vital role in ensuring that. High and complicated taxes — which is what Nepal has — lead to a flight of capital and jobs. When I met Estonia’s former prime minister Mart Laar, he told me about how smoothly his country had made the transition from being a Soviet satellite to an open market economy. One of the cornerstones of his policy was to bring in a flat tax for Estonia. He is proud that his tiny country was the first to do it. Since then everyone has vied to do better than his country.

In fact Estonia’s flat tax of 26 per cent looks positively high, seen against the backdrop of half the rate prevailing in Ukraine and Russia. Since the corporate tax on profits reinvested in Estonia is 0 per cent, and most companies avail of this benefit, the average tax rate is already far lower than the 26 per cent figure. However, Estonia plans to reduce its tax further - to a flat 20 per cent by 2006. What does this tale of tax competition amongst the world’s best performing economies tell Nepal. The message is loud and clear. End the income tax. Gone are the days when a mere reduction in tax rates would have brought in a flood of capital to Nepal. These days many countries have realized that it is idiotic to keep tax rates high and tax structures complicated. ‘Lower taxes and thrive’, is the message from shore to shore.

Since every country is hungry for capital, what is it that would make Nepal an attractive destination for investment? Even if Nepal brings in a 13 per cent flat tax like Russia, why would an investor come here? Wouldn’t he favour Russia with its bigger markets? The only way for Nepal to grab the world’s attention and show businessmen that it really means businesses is by ending the income tax. Do it and do it now. (The writer can be contacted at: everest@mos.com.np)