In Defense of Armenia’s Flat Tax Proposal

Sorry hippies, a flat tax is good for Armenia

Photo: Serve Daily

Last November, E-Draft.am, the Armenian government’s official draft-legislation portal, published a proposed legal amendment which would greatly simplify Armenia’s tax code. The draft law is intended to address a number of issues with the country’s current personal and corporate tax code. It also contains provisions to simplify the tax burden on startup companies, family-owned businesses and single proprietorships. The proposal calls for the creation of a new category for private entities: the “micro-business,” which would be totally tax-exempt.

Article 17 of the draft proposal has caused some controversy among social justice advocates. This amendment would transform Armenia’s personal income tax code from progressive taxation to a flat tax scheme. A Yerevan-based journalist published an open letter on his Medium page voicing his opposition to this new proposal. The usual medley of social justice activists, human rights advocates and other NGO-types, concerned by the unequal distribution of the country’s wealth, have added their names to the letter.

The current Armenian personal income tax code provides for three tax brackets:

  • Those earning 150,000 AMD (300 USD) per month or less are taxed at a rate of 23 percent.
  • Those earning between 150,000 and 2 million AMD ( 4000 USD) per month are taxed at a rate of 28 percent.
  • Those making above 2 million AMD per month are taxed at a rate of 36 percent.

Taxpayers are also required to contribute a monthly sum equivalent to an additional 2.5 percent of their salary to social security.

The new tax proposal would do away with the existing tiers, replacing them with a single 23 percent tax. This figure is expected to be lowered to 20 percent for all taxpayers, regardless of income. Notably, this amendment does not include any changes to the capital gains or dividend tax rates.

The letter cited three main concerns with the adoption of a flat tax:

  • It would shift the burden of taxation from the wealthy minority to the impoverished majority.
  • It would encourage income inequality.
  • It would polarize Armenian society even further.

Though these apprehensions are undoubtedly genuine, they draw upon flawed economic and moral reasoning. The current tax scheme is not transparent, doesn’t effectively curtail wealth inequality, while harming economic growth and social mobility. A flat tax could actually alleviate some of these issues. For example, one of Armenia’s primary obstacles to prosperity is the perpetual lack of government resources. For proponents of progressive taxation, the budgetary arithmetic would take this form:

Higher taxes on the rich → More government revenue → Effective infrastructure investment

Supporters of a progressive tax scheme argue that financing issues would be resolved if the rich paid “their fair share” of the tax burden, thus allowing the State state to then allocate the extra revenue to the construction of new schools, hospitals and so on. This may seem like a convincing argument. After all, who doesn’t want to invest in our children’s future or the health of our nation?

However, the statist view of government expenditure relies on faulty reasoning, by presupposing a cause-and-effect relationship between taxes, government revenue and infrastructure investment; factors which are not necessarily related. Neither one of these steps leads into the other. A more accurate formula could look like this:

Simple tax code → Increased economic activity & investment → Higher wages & spending power → More tax revenue

A flat tax could stimulate economic activity, which, even if taxed at a lower rate, could translate into larger budgetary income. These extra funds could then be used on the social projects, new schools, hospital and so on, that we desperately need.

The notion that higher taxation increases State revenue deserves particular scrutiny. Since this is an American newspaper, it seems fitting to take the United States as an example.

In the 1950s, the marginal income tax rate on the highest income earners (the so-called 1 percent) was a whopping 90 percent. In the same period, roughly 17 percent of the nation’s total generated productivity (GDP) entered state coffers. By the 1960s, the tax rate on the highest income earners had drastically decreased to the (still high) rate of 50 percent. The share of government revenue however, remained virtually unchanged at 18 percent. In fact, from the 1950s to this day, the share of United States government revenue has remained at a constant 18 to 20 percent of GDP, no matter how the tax brackets were set up. Similar results have been reproduced throughout the world.

This phenomenon can be rationalized in two ways. The first is that higher tax rates reduce productivity, without significantly boosting revenue flow to state coffers. The second reason may sound counterintuitive. Progressive tax systems almost always include provisions for deductions from taxable income. Charitable contributions, mortgage interest, business expenses, deductions related to children, different taxation rates on capital gains or dividends and many other items all serve to reduce taxable income. Thus, ironically, the rich tend to benefit from—and therefore, encourage—complicated progressive taxation systems.

Progressive tax systems almost always include provisions for deductions from taxable income… Thus, ironically, the rich tend to benefit from—and therefore, encourage—complicated progressive taxation systems.

Unlike the United States, Armenia’s budgetary troubles stem from improper tax collection, not tax revenue. In the years since independence from the USSR, the Armenian authorities tolerated the creation of a parallel patronage system. The Revenue Service deliberately drafted complicated tax codes designed to shake down smaller entrepreneurs. Government-connected oligarchs engaged in blatant tax evasion while enjoying total impunity. The State’s inability to enforce tax collection, particularly among the ‘oligarch class’ served to perpetuate this vicious cycle.

Karen Karapetyan, having been thrust into the Prime Minister’s office with the unenviable mission of saving Armenia from insolvency, recognized the tax collection issue. His hands tied by the oligarch class’ immunity to tax audits, he set off to liquidate government assets and raise taxes on the middle class to increase revenue. These efforts saw a modest 7 percent increase in tax collection.

His successor, Nikol Pashinyan, faced no such restrictions. In 2018, the Revenue Service collected 1.3 trillion drams ($2.7 billion), a 14 percent increase over the previous year. They even exceeded their expected targets by 4 percent without tweaking the tax rate.

In a Facebook Live address to the nation, the Prime Minister laid bare his displeasure with the current tax code. The complex filing process incentivises tax avoidance and income underreporting in all three brackets. Capital flight has lead to the stashing of hundreds of millions of dollars in offshore bank accounts in Switzerland or Panama.

Opponents of the new proposal would surely not be satisfied with the fiscal reasoning for such a measure. So, what of the moral argument against a flat tax? Surely no representative government would support a plan which would “exasperate, rather than soften the impact of structural inequality and injustice.”

Detractors love to focus their criticism on inequality as if it were anything more than an arbitrary metric. Why should wealth disparity matter so long as as equality of opportunity was guaranteed for the least well-off? Even the egalitarian American political philosopher John Rawls understood that inequality isn’t necessarily immoral, so long as it can benefit the least well-off. He referred to this observation as the Difference Principle. So, advocates of social justice need to ask themselves: Is it truly morally reprehensible to support policies that increase inequality while objectively raising standards for all? Is it really better for society to keep everyone equally poor?

Good policies are judged on their effect, not their intent.

Some might be shocked to find out that policies seemingly designed with “profit over people” in mind actually do benefit the plebs by encouraging investment, job creation and economic opportunities for all. Despite this, it seems as if some prioritize equality to such a degree that they would rather the poor be poorer so long as the rich don’t get richer. One would think that Armenians would shy away from such ideas given our recent seven-decade long experiment with state-sanctioned “equality.”

Ironically, for a system intended to reduce inequality, the progressive income tax scheme hurts the middle class the most. The wealthiest members of Armenian society benefit from multiple revenue streams, like property or dividends, offering many tax loopholes. The middle class, on the other hand, primarily depends on wages for its income, where there are far fewer exemption opportunities.

As such, the current system does nothing to rein in the wealth of top earners. On the contrary, it punishes those who graduate from low to middle-income brackets. Given that in Armenia, the financial disparity between the two is so minute, the compound loss in spending power is glaringly apparent.

The author of the previously cited open letter focuses attention on the relative decline of quality of life for low earners in a flat tax scenario. Yet curiously enough, he failed to address the considerable hurdles to upward mobility under the current scheme. A worker who earns $300 per month actually takes home $220 once the 23 percent income tax and 2.5 percent mandatory pension contribution are subtracted per the low-income tier. Assuming said worker would be rewarded by an employer with a $50 per month raise, they would now qualify under the 28 percent tax middle-income bracket. This translates to an increase of only $30—a trivial amount in a country where penny-pinching is the norm. The average gross salary in Armenia is currently around $350 per month. For reference sake, Armenias jet-set robber-baron class is defined by the tax code as those earning more than $4000 mer month. Those who purport to truly care for the poor should support a tax plan that rewards, not penalizes worker productivity.

There are different ways to implement a flat tax. One thing that the new tax overhaul proposal lacks, however, is a cut-off for the lowest earners. A negative taxation scheme could go a long way to mitigate any additional burden on the poor.

Good policies are judged on their effect, not their intent. The current tax code does not raise state revenues, nor does it minimize social inequality. It’s in dire need of an overhaul. Armenia would do better to apply policies that promote economic growth rather than linger on equality. In the words of Nobel Prize-winning economist, Milton Friedman: “A society which focuses on equality over liberty will end up with neither.”

A flat tax may be a crucial first step toward economic prosperity that will benefit all Armenians. Such a tax scheme would promote transparency and turn the “billionaire class” into producers of wealth (rather than hoarders of it). These social and economic effects alone should produce a sufficient moral and practical imperative to welcome a flat tax.

Editor’s note 04/02/19: A previous version of this article contained a passage showing the net raise as $15. This typo has been corrected

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Raffi Elliott

Columnist & Armenia Correspondent
Raffi Elliott is a Canadian-born entrepreneur and occasional journalist who likes to ramble on about socioeconomic and political issues in Armenia. He lives in Yerevan with his family. He also holds a masters degree in International Relations.

17 Comments

  1. Interesting article. All the arguments and concerns made by economists and tax experts for and against a flat tax rate have some validity; there are pros and cons.
    There are now 29 countries that have a flat tax rate. It includes the Baltic countries of Estonia, Latvia and Lithuania. Also Russia and Ukraine and some small Caribbean countries.
    A flat tax rate’s major benefit, if correctly formulated and efficiently implemented, is that it simplifies the tax code and makes the work of tax collection agencies easier, simpler and transparent.
    The main concern and factor that needs to be considered is the protection of the poor.
    What threshold and level of income will be tax-exempt. Obviously this will vary from one country to another, depending on income and cost of living.
    I must add that countries that have adopted flat tax rate systems have seen their revenues increase, primarily because loop holes and tax evasion possibilities have been eliminated.
    Hopefully Armenia will make the right decision.
    Vart Adjemian

    • Thanks for the feedback. Indeed,the majority of post-communist eastern European countries have adopted some form of flat tax (or have simplified their tax codes considerably), and their economies have grown considerably ever since. It’s worth noting that there is not enough data to conclusively prove that that’s all thanks to the flat tax (since other factors probably played a role). In Armenia’s case, it should be done in a way which avoids shifting too much of the financial burden on the “have-nots”. That’s why I suggested implementing a “negative-tax” policy to mitigate those effects.

  2. This article is baffling. There is no actual evidence whatsoever that a flat tax rate leads to a better distribution of resources and ample evidence that the opposite is true. Trickle-down economics has NEVER worked. The idea that letting rich people keep more of their money is somehow going to make them more and more benevolent and provide higher wages to their employees is nothing more than an idea. It has never actually happened in the real world. It has only led to rich people hoarding their resources more and INCREASED income inequality. Countries with progressive tax rates – and much more progressive than the current one in Armenia – have the least income inequalities in the world. That is not theory, it is fact.

    • The equation “Simple tax code → Increased economic activity & investment → Higher wages & spending power → More tax revenue” is indeed complete utter nonsense. If it weren’t so sad, one could laugh about it. Letting the rich keep even more money so they will increase the wages of the worker? In what kind of illusion is the author trapped? It’s astonishing to publish such an article – as a foreigner – in a country with an extreme income inequality.

  3. Has anyone ever noticed that the most prosperous period in US history was when we taxed the rich at 90%? To be certain, it was Eisenhower who did this. Today’s GOP would be shocked to learn that there was once a Republican who carried out what they call socialist policies. It’s almost as if making the 1% pay their fair share leads to economic growth.

  4. If you google “tax rate for rich”, you will see a zillion articles both for and against lower and higher tax rates for rich. I doubt you can come up with any single formula for all economies. It all depends on the specifics of the economy in question. I believe it will help the economy, if the rich reinvest that extra money in Armenia to create more jobs. So the question is: is the rich going to reinvest that money in Armenia or buy more mansions with it in US or Europe. I am afraid the superrich in Armenia is mostly the illiterate oligarch type who would end up spending that money on luxury cars instead of new investments that will create jobs.

    • Flat tax make lot of sense everyone has a skin in a
      Game. You make more you pay more. There is nothing wrong with this. Flat tax is the fairest tax, just get all the fony
      Deductibles out of the system

  5. I had this discussion with a supplier some years ago, majority shareholder of a $100 million company, who admitted he paid no income tax, due to contributions and other deductions. Henry Ford II also indicated he paid no income tax. Historically, the very rich pay tax at about 25%, regardless of the vastly different tax rates over the years. The flat tax makes a lot of sense, although the initial rate of 23% seems high.

  6. Why not eliminate loopholes instead of implement a regressive taxation system that will likely also be evaded by the super wealthy? Relying on the benevolence of the super wealthy is the issue- their reinvestment in the Armenian economy will never be proportional to the amount needed to propel it to success since it is in their interest to invest in other economies or hoard money in their real estate or other assets. So by not taxing them at a higher rate and properly enforcing it there is an opportunity cost.

    • There is a reason why no country in the World has a progressive tax system without any loopholes. Its also the reason why so many of super-rich stash their money in off-shore tax havens. The issue with Armenia is that for all the talk of an “oligarch” class, there aren’t actually that many “super-wealthy”. If you taxed them all 100%, you would still not be able to run the entire country’s budget. A better alternative would offer low tax rates to keep wealth in the country where it can be reinvested, generate more economic activity, create more jobs and raise the general standard of living.

  7. Raffi thanks for your completely uninformed piece. if you think Oligarchs should be taxed at the same rate as people who can barely pay their rent, then enough said.
    And there is absolutely no economic basis for your spurious statement or implication that wealth will increase through the flat tax imposition. The fact that Estonia for example has an improvinge conomy is the result mainly of the fact that their trade has increased gretaly since USSR days and that they have developed into the most adavnced high tech industry/country in the owrld bar none.

    • Thanks for the feedback. You’re right that Estonia’s economic success is not only due to a flat tax; there are many factors, this being one of them. However, I wasn’t writing a case study on Estonia so I didn’t go into the details. As the piece clearly points out, I’m obviously not suggesting that a flat tax alone will solve Armenia’s economic problems. Combined with other policies, it would make a difference.

  8. Flat tax is pure nonsense, I cannot imagine an impoverished family paying 23% . There should be an initial tax free allowance, that would make the poor people have a bit more cash in their hands than the oligarchs.

    • Thank you for the comment. impoverished families pay 23% NOW in the current progressive taxation system. Under the new flat tax, this will go down to 18% while the poorest will not be taxed at all.

  9. Raffi, stop spreading misinformation please. You say “Under the new flat tax, this will go down to 18% while the poorest will not be taxed at all.” in your last comment. That’s just not true. It will go down to 20, not 18. And every income-earner will pay the tax, there’s nothing such as “the poorest will not be taxed at all.” And I don’t even want to refer your text and the misinformation and ridiculous ‘arguments’ it contains. Let me just say that your point morality was just…hilarious! From your last comment it’s already obvious that you are either uninformed or you’re willingly not being objective.

    • Hi, and thanks for your wonderful comment. First, obviously, 18% was a typo, yes it’s 20% – in the article itself, I wrote: “This figure is expected to be lowered to 20 per cent for all taxpayers” – Second, if you’re looking for a better moral argument for a flat tax, here’s a simple one: You are not entitled to any share of the wealth generated by others. That’s it.

      Finally, you’re right that I’m not being objective, nor do I claim to be. This is an OPINION column which exists for me to express my opinion on a matter. Now, don’t confuse subjectivity with being “uninformed”.

      – Raffi

  10. Raffi expresses his opinion. As I had said in my previous comment, arguments can be made pro and con. Everyone is entitled to his opinion.
    It is disturbing that some comments are derogatory and insulting.
    There is absolutely no need for that and there should be no space for it. In my view, the AW should delete “insults” from any comment.

    Vart Adjemian

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