Slovakia's Flat-Tax Hit

Editor's Note: There are a lot of ideas on how to "fix" taxes, though many conflict with each other and most fail. From around the world, here is one of several current prescriptions.

Nestled between Poland, Austria, Hungary, Ukraine, and the Czech Republic, Slovakia has become a top destination for companies looking to establish a foothold in Central Europe. Among its appeals are its free-market bent and educated workforce. Slovakia's chief selling point, though, is a 19 percent across-the-board tax rate.

Introduced in 2004, Slovakia's flat tax triggered a surge in foreign direct investment and paved the way for the country's adoption of the euro five years later. The regime is modeled on that pioneered in Eastern Europe by Estonia, which in 1994 began levying a single 26 percent tax on corporate and personal income; the rate is now 21 percent. Estonia has since lowered the rate to 21 percent. "I remember remarks about unfair tax competition," said Slovakia's Finance Minister Ivan Mikloš, who occupied the same post at the time, in an e-mail. "This criticism gave us free publicity and [put us] on the radar screens of investors."

A month after Slovakia introduced its own flat levy, South Korean carmaker Kia Motors announced it would build a new a €1.1 billion ($1.5 billion) plant. Auto-part suppliers such as Germany's Continental and Visteon (VC) of the U.S. soon followed. By 2007, the nation of 5.4 million people was logging annual growth of 10.5 percent, the fastest pace of any member of the European Union. "The rate itself was very important, since at that time it was the most beneficial among neighboring countries," says Dusan Dvorak, the spokesman for Kia's local unit. "The flat tax also increases the transparency of the business environment and simplifies planning."

A total of 11 countries across the region, including Russia, now have a flat tax. Slovakia is one of five that levies the same rate on corporate and personal income. The country also levies a value-added tax on goods and services. The value-added tax rate was set at 19 percent until 2009, when it was notched up to 20 percent to compensate for a slump in tax revenues from the auto industry.

Tired of seeing manufacturing jobs migrate east, Western Europe is pushing back. France and Germany, which tax corporate income at 34 percent and about 30 percent respectively, are behind a drive for a uniform system of corporate taxation throughout the EU. Eastern European nations that received bailouts have also come under pressure from the International Monetary Fund to make changes to their flat-tax regimes. Hungary, which this year began levying a 16 percent flat rate on personal income, recently scrapped plans to introduce a 10 percent flat rate for companies in 2013.

Slovakia has already made it clear that it intends to fight the EU tax harmonization plan. Speaking to reporters in Bratislava in February, Mikloš said, "We wouldn't mind if the corporate tax was harmonized in line with the Slovak model, but we're afraid it's not realistic to think we'll be able to reach a compromise that won't adversely affect our tax system."

The bottom line: Slovakia's flat tax has ignited growth and investment. Others in the EU resent its advantage.

    Before it's here, it's on the Bloomberg Terminal.