The Flat Tax and Tax Revenues – A Synthetic Control Approach

In the 1990s and the 2000s a number of countries with economies in transition introduced the flat tax – a proportional tax on personal income, replacing their progressive systems of taxation. Eventually, some of the countries have reverted back to these systems, while others have kept the flat tax. The arguments in favour of the latter suggest that it stimulates economic growth and boosts tax revenues because of its simplicity, transparency, and lower impetus for tax avoidance. While analysis of the effects of the flat tax are often ideologically charged, we try to empirically test how it has affected tax revenues in selected countries from Central and Eastern Europe by applying the synthetic control method. This is a statistical method for causal inference in observational studies, which is used for the evaluation of treatment effects or policy interventions on a single unit over time. The synthetic control serves as a counterfactual to estimate what the development of the unit would have been without the intervention and compare it with the actual development. To our knowledge, this is the first time when this method has been used to study this subject matter and while the results are not conclusive, they suggest that the adoption of the flat tax has a negative effect on revenues and contribute to the debate about the direction of the development of the tax system and of the implementation of tax reforms.