April 26, 2004
The Flat Tax at Work in Russia: Year Three
On January 1, 2001, a 13% flat-rate tax on personal income took effect in Russia. (The general principles and beneficial economic effects of the flat tax appear in The Flat Tax.) Russia's 13% flat tax replaced a three-bracket system, which imposed a top rate of 30% on taxable income exceeding $5,000. The flat tax has been remarkably successful by every conceivable measure, and has encouraged such other countries as Serbia (2003), Ukraine (2004), and Slovakia (2004) to implement flat taxes of their own. Political parties in Poland, the Czech Republic, and Georgia have announced their support for the flat tax and there is interest in Bulgaria and Romania. Even China has taken the step of translating The Flat Tax into Chinese for consideration by the Ministry of Finance.
Let's review Russia's 13% flat tax since its implementation on January 1, 2001. In 2001, personal income tax (PIT) revenue totaled R255.5 billion, an increase of 46.7% in nominal rubles, or 25.2% in real rubles after adjusting for inflation of 21.5%. PIT revenue as a share of consolidated budget tax revenue rose from 12.1% in 2000 to 12.7% in 2001. Since economic growth of 5.1% in 2001 was lower than the post-Soviet record 10.0% growth in 2000, the rise in revenue cannot be attributed solely, or even largely, to growth in 2001. (For a detailed treatment of Russia's 13% flat tax, see "The Flat Tax at Work in Russia.")
In 2002, PIT revenue amounted to R357.1 billion, an increase of 39.7% over 2001. After adjusting for inflation of 15.1%, real revenue rose 24.6%, supplying 15.3% of the consolidated budget. GDP growth in 2002 was 4.7%, a small decline over 2001. (See "The Flat Tax at Work in Russia: Year Two.")
In 2003, PIT revenue generated R449.8 billion, a nominal gain of 27.2% over 2002. After adjusting for inflation of 12.0%, real revenue increased 15.2%, supplying 17% of consolidated budget revenue. GDP growth in 2003 was a more robust 7.3%. Only corporate income tax and value added tax generated more revenue than the PIT.
The composition of PIT revenue in 2003 was as follows: taxes assessed on income at the 13% rate generated 96.9% of all PIT revenue; taxes on dividends, assessed at a higher 30% rate, 1.9%; and taxes on non-residents and individual entrepreneurs, 0.9%.
In the three years since the top rate of PIT was reduced from 30% to 13%, real flat tax revenue has risen by 79.7%. Russia's budget is relatively healthy. Tax compliance has improved. And incentives to work, save, and invest remain strong.
(Anjela and Diana Kniazeva, graduate students in the Department of Economics, Stern School of Business, New York University, provided research assistance for the preparation of this article.)