Sunday, December 16, 2007

Flat tax in action

The Swiss canton (state) of Obwalden has just adopted a flat tax of 1.8% on all personal income, with a deductible of SFr 10,000. What is quite remarkable is not only that this tax rate is extremely low, but also that this tax law was accepted by popular referendum with a 90% majority.

It is not the first time that this canton has had innovative strategies in tax law, with the blessing of the voting population. In 2005, 86% accepted a regressive tax rate. Yes you read right. This tax law was later struck down by the Swiss Federal Court on the grounds that it was anti-constitutional.

Why would such a large proportion of the population be approving a tax regime that, usually, favors the rich? The strategy here is for this small state (population 33,000 in a country of 7 million) to attract the rich from other cantons, or abroad, thus increasing the tax base and making it possible to reduce the tax rate for all.

This is tax competition as its best. But does it really serve the common good, common being defined beyond the borders of Obwalden? At a larger scale, Switzerland has been repeatedly accused of unfair tax competition by the European Union because of the infinite latitude cantons have in designing income taxes. In particular, many cantons have set piecemeal tax agreements with foreigners who take fiscal residence and pay ridiculously low taxes. Imagine if everyone would do that: tax rates would be set so low that it would become impossible for the government to provide significant services. Or would it?

Clearly the issue here is that the tax jurisdiction is very small, atomistic, in that it does not by itself affect the overall tax base. A larger jurisdiction would be more careful in reducing its tax rate, as it does reduce its revenue. So, to prevent excessive tax competition, tax jurisdictions would need to form a cartel, and make sure no one deviates. This not going to happen in Switzerland, where cantons enjoy large liberties from the federal state. But a central state like France can impose significant tax rates on its citizens, as long as they cannot escape to Switzerland or Monaco (which suffered a blockade on this issue).


Anonymous said...

Can this be true? Why set a tax rate at 1.8%. It seems to me the cost of collecting the tax does simply not make it worth imposing a tax at all...

Anonymous said...

It looks like every country has its Delaware sucking on its neighbors.

Anonymous said...

Isn't this the Laffer curve? That is, for high enough tax rates, reducing the tax rate increases tax income. Laffer drew this with one single tax jurisdiction. Here we have the case that we have several competing tax jurisdictions. The tax rate from which a tax reduction increases revenue is then lower, and according to what they believe in this canton, very low. Anxious to see whether this will work out.

Independent Accountant said...

Goverments always need more money. One problem with large governmental areas is they are more difficult to escape and tend toward dictatorship. I say hooray for Switzerland. The European Community doesn't like it, tough. Let it go to war with Switzerland. Lenin was asked in about 1922 if they had elections in the USSR by an American reporter. He said, "Yes. During the revolution the people could have gone to the Czar's lines or our lines. The voted with their feet". I say, "vote with your feet". It's one of the few checks we have on dictatorship.
You and I have very different values.

Economic Logician said...

To independent accountant: I think we agree that tax rates should be kept as low as possible, but there are certain limits. Imagine all income tax rates would be driven down to 1.8% by competitive pressure across jurisdictions. What kind of public service would the governments be able to provide? Virtually nothing, and even you would complain about it.

Anonymous said...

This isn't the Laffer curve at all. It is a simple defection strategy. The small district hopes to lure paper wealth into itself which it can then tax exploiting the free trade zone of which it is a part so some of the usual reasons not to move money to a tax haven don't apply.

Ireland employs a similar strategy. It offers itself as a place to launder corporate profits in order to avoid higher taxes in the rest of europe. Without the rest of Europe to exploit the strategy would not work.

It isn't particularly well defined as a flat tax system though. It's defining feature is that the tax is very low, not that it is flat. A much better description would be a tax haven system.

The moral of the story isn't anything about how great low taxes are, it is that countries with real economies need to avoid opportunities for parasitism in free trade agreements.

John Fast said...

Economic Logician said:
"Imagine all income tax rates would be driven down to 1.8% by competitive pressure across jurisdictions. What kind of public service would the governments be able to provide? Virtually nothing, and even you would complain about it."

Don't count on it! I'm a hard-core libertarian and am skeptical of all government programs.

What kind of services do you think governments should provide, and would not be able to provide at a 2% tax rate, and would not be provided by the market?

Anonymous said...

>I think we agree that tax rates
>should be kept as low as possible

"As possible" doesn't say much. Should they be lower than they are now? Is there any evidence that lowering them further would make for a more prosperous, stable, successful society?

Not really: