Demythologizing the Russian Flat Tax

Clifford G. Gaddy and
Clifford G. Gaddy Former Brookings Expert
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

March 14, 2005

On January 1, 2001, Russia introduced what has frequently been called a flat tax. Over the next several years, the country’s tax revenue and GDP grew dramatically. Some commentators claim those two sets of events were causally related (Mitchell, 2003). Others just link the two repeatedly, being careful never to explicitly assert causation (Rabushka, 2002, for example). In the United States, supporters of the Hall-Rabushka (1995) flat tax often refer to the Russian example as evidence in their favor.

In this paper, we examine the limited research and information available on the effects of Russia’s personal income tax reform and reach five principal conclusions:

(1) The change in the personal income tax was not a stand-alone reform. Rather, it was part of a comprehensive set of fiscal reforms undertaken after the country’s debt crisis of 1998 — a crisis caused in significant part by Russia’s inability to run its tax system.

(2) The personal income tax component of the reform package bears little resemblance to a Hall- Rabushka flat tax. Rather, it looks more like the changes enacted in the United States in the Tax Reform Act of 1986, which retained the income tax, broadened the base by closing capital income loopholes, and reduced rates at the top. In the Russian case, changes in tax administration and enforcement, and other structural changes, appear to be significantly more fundamental and sweeping than the changes in income tax rates.

(3) Economic growth had begun well before the reforms were introduced. GDP grew twice as fast before the income tax reform as it did after.

(4) Microeconomic data suggest that the tax rate reductions had little if any effect on labor supply, which undercuts the notion of a large supply-side response.

(5) Although there was a significant increase in compliance following the 2001 reform, it is more likely attributable to changes in the administration and enforcement of tax laws and to other structural changes than it is to lower rates.