The Estonian Miracle
Here’s Cato’s Daniel Mitchell writing in April 2007:
The International Herald Tribune reports that the new government in Estonia plans to lower the rate on the flat tax from 22 percent to 18 percent. Estonia already ranks as one of the world’s most laissez-faire economies. Reducing the flat tax rate – which was originally imposed at a rate of 26 percent – will further enhance Estonian competitiveness and increase the power of tax competition in Europe.
Ah, Estonia:
Estonian GDP Shrinks By An Annual 15.6% In The First Three Months Of 2009
Well, the best thing that can be said about this is that it wasn’t as bad as the 18% contraction recorded in Latvia.
Back to Daniel Mitchell, writing with his colleague Chris Edwards who observe that “Latvia became the third Baltic country to adopt a flat tax . . . Latvia has experience rapid economic growth in recent years . . . like in Estonia, Latvia has been able to cut the overall size of its government.”
Not, of course, that flat taxes breed spectacular economic meltdowns. But many of the “miracle” economies pointed to by the right as proving the virtues of tax cuts—Ireland, the Baltics, to a lesser extent other neoliberal regimes in Central Europe—in fact clearly seem to have powered their past several years worth of growth largely by tapping the credit bubble in even bigger ways than the United States did.
Meanwhile, recall that the shoe of Eastern European defaults hasn’t necessarily finished dropping yet. The impact would be felt primarily in European banks, but it still spells trouble for everyone.
40 Responses to “The Estonian Miracle”
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May 14th, 2009 at 10:17 am
Typical Yglesias – malevolent smirking combined with a bit of lazy hand-waving (casual empiricism).
” Not, of course, that flat taxes breed spectacular economic meltdowns. But many of the “miracle” economies pointed to by the right as proving the virtues of tax cuts—Ireland, the Baltics, to a lesser extent other neoliberal regimes in Central Europe—in fact clearly seem to have powered their past several years worth of growth largely by tapping the credit bubble in even bigger ways than the United States did. ”
And the connection between flat taxes and credit bubbles? Aw shucks, no need to demonstrate that, right? Happened in the same country and that’s enough for Matt.
May 14th, 2009 at 10:21 am
Also, the lessons to learn from even the successes in Eastern Europe must be put in context. It seems highly likely to me that the Baltic states, as former Soviet republics, had a lot of government activity that could have better been dealt with in the private sector. So, reducing government activity there (and even more in Russia and in some former Soviet dominated countries) probably makes sense. It doesn’t give us much information about whether it would be good in the US or western Europe, though. Similarly, adopting flat taxes has been very useful in Russia and some other former Soviet republics, but not for the reasons flat-taxers like here. Rather, it helped reduce tax evasion, which was (and is) rampant, thereby making tax revenue go up as total collections went up. Since a flat tax would not likely do that in the US, the lessons from the former Soviet Union again don’t clearly apply.
May 14th, 2009 at 10:27 am
brm, like many right-wingers, your a liar who wants to distract attention from the fact that right-wingers are both economically ignorant and dishonest. MattY never said that the flat taxes caused the credit bubble. However, you and your dishonest, ignorant cohorts were saying that flat taxes imitating the eastern european example were the answer to everything. The modern world has proven that this was wrong, and the economic pontifications of the right-wingers had only a thin veneer of rhetorical sophistication masking a core of ignorance and lying.
May 14th, 2009 at 10:29 am
I happen to live in Estonia.
In some ways this is a relatively laissez-faire economy – but it’s worth pointing out that the state health care here covers everyone.
But don’t tell American conservatives that – it will pop one of their many, many fantasies.
May 14th, 2009 at 10:34 am
Hey, I’ve got a secret no-tax island nation Upload your headquarters to my server now for only $19.95/mo. !!!
May 14th, 2009 at 10:36 am
When did it do that? I haven’t seen any of this so-called proof… Unless of course, you mean
May 14th, 2009 at 10:43 am
Since you are writing on the flat tax fetishism of Daniel Mitchell at Cato and the pattern of spectacular failure the flat tax miracle economies turned out to be, you should look at this article, written by Mitchell and Hannes Holmsteinn Gissurarson, the chief profet of neoliberal economic ideas in Iceland.
And then everything went poof, and we realized the animal spirits of capitalism, let loose by these fabulous flat taxes, were more destructive than beneficial, and that the entire miracle was built upon leverage and reckless borrowing – made possible by deregulation and lax laws.
Gissurarson, the co-author of the article with Mitchell, is considered to have been the chief ideologue of the conservative party during the last decade, and much of the 90s. Gissurarson is also a close confidant and friend of the disgraced former prime minister and central bank director, David Oddson.
Needless to say, Gissurarson is a highly controversial figure in Iceland, believed by many to be a trailblazing visionary, while others consider him a fraud and a buffoon.
May 14th, 2009 at 10:45 am
economic pontifications of the
right-wingersleft-wingers [with] a thin veneer of rhetorical sophistication masking a core of ignorance and lyingOooo… I see what you did there!
So much for the “flat tax miracle” espoused by lying right-wingers. Which is true regardless of attempts by dishonest people like brm trying to distract from that simple fact.
May 14th, 2009 at 10:45 am
@7
It’s apparent that one of the chief concerns of government should be saving capitalism from the capitalists.
May 14th, 2009 at 10:58 am
Flat taxes encourage concentration of wealth in the upper income brackets, which encourages the wealthy to take bigger risks in a bubble-based economy.
Oh! I forgot! If you give rich people more money, they will use it to build factories and create jobs.
May 14th, 2009 at 11:01 am
This reminds me of Somalia. Post a few statistics on the deaths per birth compared to the US and liberals think they have a case for free markets failing. Never mind comparing Somalia to other African countries of which is doing better than the majority.
May 14th, 2009 at 11:02 am
Oooo… I see what you did there!
No, you don’t. You assume that my (admittedly, crude) response was in defense of Mitchell. Not quite. My problem is with your notion that everyone who doesn’t agree with your point of view is lying, or dishonest.
Here’s the “simple fact”: People with different economic philosophies can look at the same data, the same evidence, and come up with very different conclusions. So economic conservatives genuinely believe that they are correct, and you are wrong. And you clearly believe that you are correct and they are wrong. That’s fine. So have the debate. It’s a good and interesting debate.
But have the debate in good faith. If you know for a fact that someone is arguing dishonestly, then present the evidence. When you (or anyone on the right, for that matter) dismisses an opponent’s arguments as dishonest without that evidence, it’s childish and counterproductive. It says to me that you don’t really know the economics, and you just want to be part of the mob.
So, show me the proof that Mitchell is lying. And if your “proof” is that it’s obvious because “all the world is clearly seeing the effects of right-wing economic thinking,” then you need to actually do some reasearch. If you don’t have a real argument, shut up and let the grown-ups talk.
May 14th, 2009 at 11:03 am
everyone who doesn’t agree with your point of view is lying, or dishonest.
brm specifically is. I suppose some people are actually stupid enough to think that the benefits, such as they are, of flat taxes in emerging post-comunist economies are exportable (or even desireable) in the USA, however.
May 14th, 2009 at 11:04 am
How did Iceland Go Bankrupt?
May 14th, 2009 at 11:04 am
I can’t tell if the right-wingers in the comments are actually interested in information, but here’s Matt’s argument stripped down:
:Cato proposes a cause and effect relationship (flat taxes / smaller government –> growth)
:Matt attacks that argument by showing that the cause appears without the effect
:As a bonus, Matt proposes an alternate cause and effect (credit bubble —> growth) that works better because the effect disappears when the cause disappears.
May 14th, 2009 at 11:05 am
Ah, Estonia! Livin’ fast and crashin’ hard!
Well it’s apparent CATO and Daniel Mitchell didnt’ see this coming. Their thoughts now? The US government has too much debt (the children!). Is this a non sequitor? Yes.
May 14th, 2009 at 11:14 am
@Nathan
Here’s an article on GDP stats in Latvia – seems pretty much identical.
Note that I have no clue how much Cato hearts Latvia as compared to Estonia. Apparently it’s also got a flat tax, and Mitchell’s in love with it, too.
And here he is on a breakaway Moldovan republic that I’ve never heard of:
Not surprisingly, the flat tax is having a positive impact. The Tiraspol Times now reports that tax revenues have more than tripled and lawmakers understand that lower tax rates can lead to more revenue — just as the Laffer Curve illustrates
May 14th, 2009 at 11:17 am
Brendan – Thank you. I think Matt’s original argument (and your summary of said argument) is entirely fair and worth discussing on its merits. One might reasonably argue that flat taxes/smaller government exacerbate the negative effects of the credit bubble. I don’t necessarily think that the flat tax to growth relationship (absent the credit bubble) has been seriously disproven here, though (which is what I think brm was trying to state).
Tyro – I have no idea whether brm is arguing in good faith or not. But since you still seem to insist that there are only two kinds of people here (those who agree with your economic worldview, and those who are too stupid/dishonest to see that you’re clearly right), it seems silly of me to try and talk you off your soapbox. Knock youself out.
May 14th, 2009 at 11:24 am
I think Matt’s original argument (and your summary of said argument) is entirely fair and worth discussing on its merits.
True. Which is why brm wanted to distract from that, dishonestly claiming that MattY said something he didn’t say, in order to take the heat off of his economic religious fundamentalism.
May 14th, 2009 at 11:27 am
Flat taxes encourage concentration of wealth in the upper income brackets, which encourages the wealthy to take bigger risks in a bubble-based economy.
Oh! I forgot! If you give rich people more money, they will use it to build factories and create jobs.
Well they build yachts and second homes and donate to think tanks like CATO, but yeah I think you hit on the main point.
What happenes in that gains in productivity go to the upper classes (Obama has said he doesn’t think this is fair).
Instead of investing/allocating their surplus gains to socially-productive sectors, they invest in the financial sector which provides much bigger returns and which causes the growth of that sector with its overleveraged institutions and complex, “innovative” instruments.
So from the upper classes’ perspecitve it’s all rational, that is until these financial sector institutions start failing b/c of their successful political drive to become unregulated, by either the government which is supposed too look out for systemic risk or by accounting rules. And then the unregulated shadow banking system, which is new, panics at the sight of failing fincial instutions and the credit markets freeze up.
May 14th, 2009 at 11:38 am
Which is why brm wanted to distract from that, dishonestly claiming that MattY said something he didn’t say, in order to take the heat off of his economic religious fundamentalism.
That’s fine if that’s what you were trying to point out. All I was trying to point out is that it’s a big leap from what you state above to declaring “the fact that right-wingers are both economically ignorant and dishonest” (which is simply not true).
May 14th, 2009 at 11:40 am
Anyway, I recall reading that these Baltic miracle states maintain fairly high VATs in addtion to their flat income taxes. So, even if it’s a great system that produces solid results, the American right (shockingly) cherrypicks the factoids they focus on. I doubt many NR readers would support the adoption of, say, a 24% flat income tax AND a 24% VAT.
May 14th, 2009 at 12:15 pm
“And the connection between flat taxes and credit bubbles? Aw shucks, no need to demonstrate that, right?”
As plenty of others here have pointed out, Matt does not claim that there is a connection between flat taxes and credit bubbles. The connection is between credit bubbles and fantastic rates of growth that flat-tax fans have been attributing to flat taxes.
But I’ll go a step further than Matt and note that there seems to be a fairly strong correlation between economies with relatively low, flat taxes and economies whose growth was grossly inflated by asset bubbles. This doesn’t necessarily indict the flat taxes in and of themselves (although putting large amounts of extra cash in the hands of the capital class surely affected the size and scope of the bubbles) but it is interesting that nearly all the worst-hit countries had been dabbling with laissez-faire economic reforms, to say the least.
May 14th, 2009 at 12:16 pm
I agree with Chris S. I have some spent some time in Estonia, and I do not think it should be advertised as a laissez faire paradise. In addition to social health care insurance, there is a rudimentary social insurance system, and socialized support for families and children that doctrinaire free market fanatics would not approve of. Estonia is a middle income country, the social insurance system is underfunded, and coverage is uneven. Grinding poverty exists in some rural areas, and the Russian population in the east is poor. But even in regard to the Russian speaking population, social insurance efforts to serve that population (for example, in dedicating Russian speaking medical personnel to the east) go far beyond anything a free market approach would support.
I heard the ex-Estonian finance minister at speak at a European flat tax conference and their thinking was much different than “shrink the government” free market flat taxers here in the U.S. Part of the rationale for establishing a flat tax was due to the desire of the Estonians to provide more government services than neighboring Baltic countries and Russia. Because Estonia is a small open economy with a newly established state that had fears for failure of its new independent government, issues of tax avoidance and enforcement, effect of the tax system on foreign trade and finance, and population loss, played a large role in their income tax design. The motivation was that the Estonian population desired more government services, but the problem was how to collect the revenue. Laffer curve supply side arguments were not a key part of their thinking, as I remember.
In any event, the economy of Estonia differs in very significant respects from the other Baltic countries and Russia, partly due to large trade and capital flows with Scandinavia and a few Western European countries. So, I am not very impressed by quicky one dimensional comparisons and declarations of miracle states, and other grand pronouncements.
It is true, though, that in some ways Estonia is very ‘free market’ compared to other states -it has (or had, I am not up with recent changes) a very open labor market for example -it is relatively easy to move their for work, but I think it is a distortion to say it is or ever was a showcase for any ideology.
May 14th, 2009 at 12:53 pm
big article today in the NYT about the economic fortunes of Norway – doing quite well in today’s economic climate.
So where does Nowway fall on the flat tax/socialism scale (it is a Scandinavian country after all) – and why isn’t Norway beting trotted out in these discussions about how wonderful the flat tax is that it solves all a country’s economic problems – except when it doesn’t.
May 14th, 2009 at 1:06 pm
Well, here’s the deal: right-wingers have to occasionally admit that they’ve been wrong about any of a number of economic arguments. In my book a congenital refusal to admit that you’re wrong, ever -> dishonesty and bad faith.
Since I don’t see them doing this as a group, I think it’s perfectly reasonable to tar them with this brush, though individuals may be different of course. Going back to this specific point:
Look, this is just plain wrong. Factually so. You can put in all the caveats after the fact that you want, claim that other factors intervened, etc, but on this basic point, disagreement is either a sign of psychotic stubborness or a marker of bad faith.
May 14th, 2009 at 1:11 pm
I’d like to know if the bottom dropped out of the Baltic tourist economy thanks to the squeeze in the UK, because it became a depressingly popular location for stag/hen weekends in the past few years, or for the kind of Easyjet/Ryanair holidays that were also all the rage.
#25: As the NYT points out, Norway’s politicians have always had support for the idea that since their North Sea oil revenues were always going to be a temporary benefit, albeit on a massive scale, that they should be saved for future generations. (In fact, I think Rick Steves picked up on that point when he did his travel show there.)
And here he is on a breakaway Moldovan republic that I’ve never heard of:
Trans-Dniester? That’s a weird thing. Simon Reeve went there for the BBC and saw how fucking bizarre it was.
May 14th, 2009 at 1:25 pm
I think Matt’s argument could be better refined. It’s not that flat taxes lead to bubbles, but rather that flat taxes are politically associated with an overall program that includes massive deregulation of the financial industry. And it’s the massive deregulation that causes financial bubbles to emerge and pop, causing the crash.
May 14th, 2009 at 1:35 pm
So, small countries dependent greatly on the world economy are most hit by shifts in that same world economy?
Also, take into account the level of growth before the recession.
Of course losing 10% of GDP is a lot, but notice that they’ve been growing at that rate for the last 10 years, so it’s not retreating 10 years, but only one.
May 14th, 2009 at 1:39 pm
Another explanation of the Estonian collapse is an expansion of the money supply followed by a contraction aka Austrian Business Cycle.
http://stefanmikarlsson.blogspot.com/2009/02/rise-and-fall-of-baltic-boom.html
May 14th, 2009 at 3:03 pm
Yeah, I’m with J.
Who cares what Cato said Estonia represented? The truth was well known at the time: like many East European systems making the transition from socialist tax systems to chaotic early-stage market economies, Estonia moved to a flat tax to simplify tax collection, reduce the opportunities for corruption and allow their civil service to focus on useful, productive issues instead of parsing over 100,000 pages of lobbyist-friendly, wealth-friendly tax deductions the way their ‘progressive’ American counterparts are forced to do in the name of “progressivity.’
If the logic of the above posts is followed, should I now start writing articles about how the US financial system imploded and, hey, they have a progressive income tax so it must be the tax that’s to blame?
For Estonia’s goals, a flat tax system is a great system. The fact that their revenue is dropping in the middle of a global recession is beside the point; countries with high rates or progressive rates are experiencing the same turmoil and are in no position to gloat.
Personally, I think many ‘progressives’ are too quick to dismiss the rational benefits of a flat tax system – regardless of whether they support a flat tax as a policy choice or not – and I’m just as sick of the “right wingers said Estonia was great so there…” bickering as I am sick of the right making the same crude generalizations about the left. How would you feel if every conservative spent the next four years constantly reducing every liberal economic thought to “liberals think everything depends on higher taxes” – or rather, how will you feel?
Ok, so don’t make the same mistake.
May 14th, 2009 at 3:34 pm
Canuck, liberals are both smart enough and honest enough to realize that the benefits of the flat tax system in emerging former communist countries are not exportable to the west and, in many cases, shouldn’t be. It the conservaloons claiming that the example of post-communist countries shows that the USA is “doing it all wrong” with their tax system.
As former communist countries develop more effective and more efficient rule of law and bring their black- and gray-market economies out of the shadows, then they will be able to develop a more modern tax system, which will more likely than not be a progressive tax system.
May 14th, 2009 at 4:09 pm
Regarding MR PSEUDONYMOUS at ccomment #27
regarding your comment about the effect of stag parties on the Estonian economy . When i heard about Estonia’s problems that was actually the first thing that i thought of !It would be the first case of “lager louts” affecting an economy !
I do know that many people in the Uk bought cheap second homes in places like Romania. I think that in many ways Europe had more of a housing bubble than we did.
The Baltics rose quicker and higher than many other countries.
so natrually they fell the hardest.Let us hope they can recover soon. They have suffered enough in the last 75 years.
May 14th, 2009 at 4:17 pm
You are saying they wrap the money around their hands and magically summon these goods?
May 14th, 2009 at 4:20 pm
REGARDING COMMENT # 4 BY CHRIS . S AND COMMENT # 24 BY J
MR J thank you for writing your comment. It was very informative and interesting . And it was nice to hear from someone who has actually been to the country.
MR . CHRIS S. . Since you live in Estonia , I would be interested to read what YOU think that the problem is with the Estonian economy.Also , is it getting any better or worse ?And how is it affecting the average person ?
With all the statistics flying around, it would be intersting to read about anecdotal instances.
Thanks again to MR CHRIS S. AND MR J FOR THEIR COMMENTS
May 14th, 2009 at 5:08 pm
It’s intellectually dishonest to compare the growth rates of the former Communist economies of Eastern Europe and the market-based economies of Western Europe. It’s apples to oranges. A real comparison would compare the economies of higher tax former Communist economies to lower tax former Communist economies. And guess what- Slovenia, which has adopted a more Western European social democratic model, is wealthier than any of the states that have adopted more neoliberal policies.
May 14th, 2009 at 6:26 pm
Personally, I think many ‘conservatives’ won’t ever admit that they were ever wrong, and that ‘progressives’ were right about many things. Which of course means that as a group, they are arguing in extreme bad faith.
Gee, generalizing is such good fun . . . don’t you agree?
Your complaint might have a trace of merit if in fact there was anything to it, or if in fact that seems to be what a great many ‘conservatives’ have already done for the past thirty years. And it might be nice if you guys weren’t so quick to dismiss the rational benefits of a flat tax system – regardless of whether you support increased taxes as a policy choice or not.
Do I have to be any more heavy handed on the hypocrisy motif, or are you ready to cry uncle yet? Because it is behaviour like yours that turns so many people off before they even hear the policy proposals.
May 14th, 2009 at 9:50 pm
35. pete from baltimore:
Glad you found my comment useful. I have not been back for a couple of years, so don’t have any recent on-the-ground information. The people I know there do not consider themselves conservative free marketers in the U.S. sense by any means -though seems to me vast majority want a Western style market economy. The national attitude most Estonians advertise is cool calm rational pragmatism which values discussion negotiation and social consensus -and that seems reasonably accurate to me. I never saw the degree of ideological battle I see here in the U.S. Certain social attitudes are different: Everyone I know seems very environmentally conscious by U.S. standards. Respect for “the Nature” is considered important. So, not sure how well Estonia fits into the current U.S. style free market libertarian worldview.
There were real estate bubbles all over the world. Not sure what the boom and bust bubble says about any particular country, since so many countries experienced it.
May 14th, 2009 at 10:42 pm
REGARDNG COMMENT # 38 BY MR J
Thank you for your reply. I would agree with you that it is difficult to compare our political parties to other country’s partys.I found it funny when some liberal friends of mine who were against the Iraq war wished that Tony Blair would be voted out of office because he was a “right wing conservative” !I wonder what David Cameron would think ,if he had heard that!
It may be my imagination , but the leaders in some of the Baltic nations seem to be making some hard choices and asking a lot of sacrifice from their people.Much more than over here.I do not know if it is because of how their political system works, or because they have less access to borowing than we do in America .Or simply because of good leadership.
I think that that is the real lesson to be learned from Estonia and others.I do not believe in sacrifice just for the sake of sacrifice.But sacrifices will have to be made in America.And i think that the American people are strong enough to make them !
You have to admire the Estonians, who have suffered greatly over the last 75 years ,and still are willing to make sacrifices.
I wish our own leaders would do the same over here.Obama has done more than previous presidents.But i feel he should ask for more from the American people.
Thank you once again MR. J for your insight into Estonia.
May 14th, 2009 at 11:07 pm
I’d like to see this side by side with Spain, with its Socialist government.
My guess it would look about the same, because the world wide economic downturn basically swampped whatever local policies were implemented over the last two years.