Slovakia, an East European tiger

Article published on June 17, 2005
Article published on June 17, 2005

This article has not been vetted by an editor at Paris HQ

2004 was an important year for Slovakia: after six years of reform, it was finally allowed to join the EU and Nato. But its flat tax rate of 19% has upset many of its new neighbours.

Since the post-communist authoritarian government of Vladimir Meciar was voted out in 1998, Slovakia has seen a real turn around in its fortunes. So much so that, according to the World Bank, last year it was the world’s fastest transforming economy. No doubt, the introduction of a flat tax rate of 19% in January of the same year has contributed to this phenomenon. But is this a good thing?

Foreign investment

Before the tax reform came into force, the value-added tax (VAT) on food was only 5% and the sudden rise to 19% has badly affected families on low incomes. Slovakia has a very small middle-class and so the sharp increase in food prices has touched a large portion of the population. However, the economy as a whole has benefited from this simple and effective tax rate which also applies to personal and corporate income.

The main reason for Slovakia’s booming economy is the increase in the amount of foreign investment, which is closely linked to the advantageous corporate tax rate. For example, last year Slovakia was in direct competition with the other new EU member states of Hungary, the Czech Republic and Poland to play home to the first-ever KIA European car plant. Although labour costs are similar in these countries, the tax rate is not and it was Slovakia that was chosen for the plant, which will bring €1 billion investment and 2,800 jobs to the area. Since this decision, the Czech Republic, which had been hostile to the idea of implementing a flat tax at home, has been rethinking its strategy. It is not just KIA Motors which have decided to opt for Slovakia. Large car manufacturing plants belonging to Peugeot-Citroen and Volkswagen have also sprung up or are planned for the near future, meaning that by 2008 Slovakia will be the biggest car producer per capita in the world.

What about the rest of Europe?

Although the benefits of the flat tax for corporate investment are clear, so far it is only Eastern European countries which have adopted it. However, the countries of “old Europe” have already spotted that as far as foreign investment is concerned, flat tax is, to use the words of the Slovak Minister of Finance, Ivan Mikloš, “a solution that works.” Within the borders of EU, competition for investment is strong and “new Europe“ is winning, at least for now. Some countries, namely France and Germany, do not want this situation to continue and last year Hans Eichel, the German Minister of Finance, proposed introducing a minimum corporate tax rate across Europe to avoid “dumping” by the new member states.

It is interesting that it is the ex-communist countries who have embraced what is essentially a blessing for big business while the established capitalist countries of Western Europe are clinging to Marx’s proposed graduated income tax. But while the old members of the EU struggle to defend their social models and demonise the flat tax, it is clear that it has brought a new impetus into the European economic sphere. As Shigeo Katsu, Vice President of the World Bank, put it, “the new members are something like a life-giving injection for the European Union. A new wave of energy and fresh ideas will come to the Commission and the Union.“ Whether or not the idea of flat tax will catch on, it has certainly put pressure on European leaders to take a long hard look at the economic situation in the EU, which is currently rather stagnant.