Emerging leader of the tax avant-garde: Poland's proposal to institute a flat tax on individual and corporate incomes.

Author:Burba, Andrzej J.


In 1998, Poland's Minister of Finance Leszek Balcerowicz unveiled a plan to restructure the tax system. His flat tax proposal promises numerous benefits to individual and corporate taxpayers with significant reduction in tax rates for both groups. The new plan offers to further strengthen Poland's growing economy--a consequence that is especially significant in light of the country's aspiration to join the European Union. It provides a remedy for virtually every ailment plaguing the current tax system and, most importantly, the reform offers to finance itself. This Note argues that the plan should be adopted immediately for the following reasons: (1) Poland's weak middle class is not likely to oppose it; (2) the danger of harmful consequences to those who rely on the current tax laws is minimal at best; and (3) the reform will send a positive message to the citizens about the country's well-being ten years after its transition to a free-market economy.


    Last year marked the tenth anniversary of Poland's first free parliamentary election since World War II.(1) Today, Poland's economic growth is the fastest in Eastern Europe, inflation is substantially limited and the investment spending is strong.(2) Two-thirds of all jobs are now in the private sector and real wages are on the rise.(3) A recent assessment by the International Monetary Fund characterized Poland's transition to the free market economy as "firmly on track."(4) It commended Poland for "its continued record of impressive economic performance, as reflected in the achievement of sustained strong economic growth with attendant gains in living standards."(5)

    Credit for this continued achievement is largely due to one man--Poland's Minister of Finance, Leszek Balcerowicz. As Deputy Prime Minister in Poland's first democratically elected government, Balcerowicz delineated the course for Poland's transition from a centralized economy to a free-market economy.(6) His scheme, known as the Balcerowicz Plan, provided for rapid decentralization, elimination of price controls, and rationing of consumer goods.(7) He pushed for speedy privatization of large, state-owned enterprises(8) that, until 1989, had been operated as centrally controlled monopolies.(9) Balcerowicz reformed the banking system and pushed for creating mechanisms for channeling private investments.(10) He was instrumental in creating the Warsaw Stock Exchange and revising Poland's tax laws.(11) Due to his reforms, the Polish, trained by the former regime to refrain from making independent economic choices, have increasingly gained confidence in the new free-market environment and regained their entrepreneurial spirits, providing fuel for economic growth.

    Balcerowicz has been in and out of his office in the Ministry of Finance during the past decade, but today the veteran is back in the Cabinet with a new vision. In 1998, he unveiled his proposal to reform Poland's fiscal scheme and to institute a flat-rate tax on all corporate and individual incomes.(12) Balcerowicz promised greater economic growth, across the board fiscal fairness, and greater administrative efficiency.(13) He asked for nothing in return but a little trust from the Polish. By virtue of Balcerowicz's excellent track record and the shear attractiveness of his proposal, this trust is amply merited.


    Nobel Laureate economist Milton Friedman first introduced the flat tax in 1962.(14) Since then, legal scholars, economists, and politicians around the world have embraced the idea. While many variations exist on Friedman's theme, the basic concept behind the flat tax is simple: substantial broadening of the taxable base accompanied by a reduction of marginal rates.(15) Broadening the taxable base is accomplished by methodically eliminating exclusions, deductions and various tax credits.(16) Once the base has been broadened, the rates are converged and lowered to generate the same amount of tax revenues as would have been produced with the narrow-base-high-progressive-rates scheme.(17)

    In practice, the flat tax is not quite flat. Most of today's flat tax proposals involve a progressive scheme of taxation where income, up to a certain amount, is not subject to withholding.(18) Thus, individuals in the initial bracket are taxed at a zero rate.(19) The government taxes all others at a single rate on the excess of their income over the generous tax-free amount.(20) At least two economists, Robert E. Hall and Alvin Rabushka, authors of the proposed reform of the U.S. income tax system, advocate this particular approach.(21)

    Supporters of flat rate taxation cite a number of inherent benefits of the system. First, a flat tax would serve as an incentive for individuals to work by increasing the amount of post-withholding disposable income that, in turn, would raise the "total output," thereby improving economic performance.(22) Secondly, broadening the tax base would promote neutrality of the taxing scheme, which would reduce the impact of fiscal regulation on the allocation of resources and eliminate existing disincentives to engage in certain types of economic activity.(23) A broad tax base would also mean horizontal equity, a concept requiring that all persons in similar circumstances should pay the same amount of tax.(24) Most importantly, a flat tax fosters simplicity.(25) In their proposal, Hall and Rabushka predict a "postcard" would be a sufficient replacement for "the many pages of schedules the typical [American] taxpayer fills out today."(26)

    Though not without inherent difficulties,(27) flat-rate taxation offers a number of benefits, particularly to a developing economy. Indeed, many of the difficulties associated with implementing the switch to a flat tax come in the transitional stage when the old tax system is replaced with the new.(28) This presents a great opportunity for developing countries with young tax schemes. Because their tax laws are not fully crystallized, they are better suited to withstand the inconveniences of the transitional stage. One such developing economy--Poland's eastern neighbor, Estonia--has recently implemented a flat tax with great success.(29) It joined Denmark and Iceland as the third European state to use a flat rate taxation scheme.(30)


    1. Evolution of the Polish Tax System Since World War II

      1. The Polish Tax System During the Communist Era: 1945-1989

        During the communist era, when the state sector dominated the economy, the phrase "government money" accurately reflected Poland's lack of fiscal policy. State enterprise was managed according to a central plan, in which a "production unit" was the basic economic variable.(31) Producers were accountable for the quantity of items manufactured rather than income generated from production. Under such a system, fundamental concepts of tax law such as gain, cost, and expenditure had no meaning.(32) Only with respect to tax liability of privately operated ventures, a rarity at the time, were those definitions utilized in the very primitive Polish tax code.(33) It would be mendacious to describe Poland's fiscal regulations of the communist era as a tax system.

        Following the end of World War II, Poland reverted to the tax system established during the period between World War I and World War II.(34) Its most fundamental element was the comprehensive income tax scheme.(35) In 1945, an earned-income tax (podatek od wynagrodzen) was singled out and set aside from the scheme, marking the first major step in the tax restructuring process.(36) Within two years, the rest of the income tax section of the Code was repealed along with most other provisions, making room for a system that would better fit the needs of the newly centralized economy.(37) From 1948 to 1951, a new socialist policy emerged.(38) The foundation of that policy was the principle that tax liability depended on the form of ownership of the taxable unit.(39) Consequently, the system provided for three different groups of taxes: taxes imposed on individuals, taxes imposed on the private sector, and taxes imposed on the state-operated sector of the economy.(40)

        1. Tax Treatment of Individuals

          The chronology of the individual income tax in communist Poland begins with the 1945 imposition of the earned-income tax.(41) As a variation on the idea of a comprehensive income tax of the 1918-1939 era, it was the only tax to survive the sweeping changes of the late forties.(42) Effective for some thirty years, the earned-income tax was finally eliminated for public sector employees during the 1971-1975 period.(43) The government continued, however, to impose the tax on individuals employed in the private sector, self-employed taxpayers, individuals receiving income as a result of pursuing scientific careers, and those pursuing careers in the arts and education.(44) The tax remained in effect through the 1991 taxable year when the Polish tax system underwent an extensive overhaul.(45)

          In 1957, the government implemented the equalizing tax (podatek wyrownawczy).(46) The equalizing tax affected both public and private sector employees whose income exceeded the administratively established tax-free amount.(47) Under this scheme, the government allowed deductions for expenses such as building or renovating a house and for costs associated with raising children.(48) After the 1971-1975 changes, the equalizing tax was the only potential source of tax liability for public sector employees.

        2. Tax Treatment of the Private Sector

          Compared to revenues generated by the state-owned entities, the private sector's contribution to the Polish economy was only marginally significant. Still, the government imposed two types of taxes on privately owned enterprises: the operating tax (podatek obrotowy) and the income tax (podatek dochodowy).(49) The basis for the tax liability under the operating...

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