In "The Free Market" No 2 we spoke about Tax Freedom Day. You learnt how many days during the year taxpayers work to pay off the demands of the state. It turned out that, while living in a "developed" society, people do not know what "tribute" they are forced to pay to the government. It did not come as a surprise to anyone familiar with the complicated and sticky web of the tax system. Seeking to eliminate its flaws, the Lithuanian Free Market Institute (LFMI) proposes a conceptual framework for tax policy reform.

Tax Reform for the Benefit of Private Well-Being

One cannot call the Lithuanian tax system irreproachable, rational and respectful with regard to man. The existing nineteen taxes-with a bunch of exemptions, differentiated tax rates and other "subtleties"-complicate tax calculation, leading to government interference in people's private affairs and natural market processes. The unjustified multiplicity of taxation coupled with complicated and unstable rules increases the costs of tax administration, rendering the tax system ineffective and profligate. Not only does it inhibit economic development and fuel the expansion of shadow activity. It also erodes moral values, reduces real incomes and hinders their growth. A tax system like this should not be part of Lithuania's future. It calls for comprehensive reform.

The Lithuanian Free Market Institute has formulated a pro-liberal tax reform proposal whose implementation would alleviate the destructive effects of taxes. The purpose of the reform is to liberate man's creative power, allowing him to enhance well-being by means of efficient work, private ownership, and free exchange.

The proposed reform is designed to abolish direct taxes on personal and corporate income. The fundamental flaw in direct taxation is that it allows the state to interfere with economic processes. Further, the administration of direct taxes is very complex and costly, and their destructiveness is latent, therefore insidious. Indirect value-added tax-if applied universally-prevents manipulations. VAT appears relatively simple to administer and its burden easy to assess. If VAT were the principal source of government revenues, the general tax burden would cease to be a source of unrelenting public concern. Its level would roughly equal that of the rate of VAT.

If the reforms of public functions and budgetary and tax policies proposed by LFMI are put into practice, they will lay the foundations for a shift to an order under which common needs will be satisfied by private markets and on a voluntary basis. The same principles will apply to supporting the needy and the vulnerable.

Seven Principles of a Pro-Liberal Tax System

1. Generating Revenues but Not Regulating

While taxes do exist, the only goal the state should pursue through them is mobilisation of revenues necessary to discharge public functions. Taxes should not be used in artificial attempts to stimulate, or impede, economic processes according to someone's wishes. Let us look at the calls of economic "architects" who demand that Lithuania become "a country of a prospering xxx or yyy". They demand that greenhouse conditions be created for the xxx and yyy; that they be exempted from taxes and stimulated with incentives. It is obvious that the xxx could be replaced with any other activity. The complete inventory of favoured areas would no doubt be very impressive, each item supported with compelling arguments. One should not get surprised though if "his" area fails to be included in the final inventory. For if you believe that the state has the right to take such decisions, you should obediently accept them. There is only one alternative-to refuse to recognise this right consciously and resolutely. Both theory and empirical experience show that regulation through taxes is disastrous. It violates the natural laws of capital allocation and deflects human efforts from the pursuit of maximum benefits. To avoid this, taxes in a pro-liberal system should be a tool, not for regulating the economy, but for raising resources to finance government expenditure. This principle requires that tax rates be uniform for everyone; and that no tax breaks or preferential treatment be applied to stimulate "priority" sectors, enterprises, individuals or products.

2. For Economically Neutral Taxes

Taxes should not affect the taxpayer's decision to undertake one or another activity, to save or to consume, to lend or to borrow. This approach derives from the first principle rejecting the "regulating" role of taxes. Only a narrow-minded person, or one with no time to look deeper into the matter, can hold that saving is more valuable than consumption; that small business is more worthy than large business. Such claims rest either on total ignorance or on group interests. Short-sighted measures cannot change the system fundamentally. They only force people to accommodate and adjust to the new rules of the game. Despite the fact that there are no completely neutral taxes at all, it is vital to ensure that the tax system has as little effect on economic decisions as possible. The enforcement of this principle would provide equal conditions to all, be they firms or individuals, traders or producers, local or foreign.

3. In Pursuit of Lower Taxes

A declining tax burden is another condition for a pro-liberal tax system. It should occur as a result of privatising public functions and trimming their financing. This is the only real way to ease the tax burden and increase people's incomes, thus well-being. A pro-liberal tax system should provide conditions for a steady decline in tax rates without violating the integrity of the system.

4. In Favour of Single Taxation

Tax reform should eliminate double or multiple taxation of one and the same object. The existing income and value added taxes are imposed on the same object, one on top of the other, only at different stages. A closer analysis of all taxable objects drives one to despair about the absurdity of the schemes and their deleterious effects on people's lives. The conclusion is that, even if the revenue target remained as it is now, it would be possible to extract the desired amount in a less painful and more rational way. Revision of revenue needs would only enhance such prospects. Thus, single taxation of value added is an essential element of a pro-liberal tax system.

5. For Clear and Transparent Rules

Taxes should be as clear as possible. The law should set forth accurate and explicit rules for defining taxable objects and paying the taxes. Therefore, the transparency of taxes is a vital attribute of a pro-liberal tax system. Only the adoption of clear and universally applicable tax rules would render tax compliance requirements morally just and workable. It is unacceptable to tax unclear or disputable objects, whose taxable value is difficult to assess. Examples are property taxes. Experience shows that the task of determining the objects of property taxes costs the country more than their yield could possibly offset. In addition to that, their corrosive welfare effects entail grave socio-economic consequences.

6. For Universal, Unavoidable and Automatic Taxes

Taxes should be charged at uniform rates, with no breaks or exemptions being applied to individual sectors, entities or products. The computation and payment of taxes should be automatic and independent of the will, or interpretation, of the tax payer or tax administrator. It should leave the taxpayer and tax administrator no room to cut a deal or to circumvent or minimise taxes. The tax system should leave no room for tax evasion, which results in a heavier burden on the ever-shrinking army of law-abiding tax payers.

7. Efficient Tax Collection

Budget revenues should be generated at least compliance and administrative cost, thus reducing the burden on the private and public sectors.

From Income Taxes to General VAT

Lithuania would not be the first and only state to display concern about, and seek ways to reform, the tax system. A number of countries the world over are attempting to simplify taxes along progressive lines. One of them is the US, which is plagued by complicated tax rules. The widely promoted proportional income tax and Senator Richard Lugar's and the Cato Institute's proposals to abolish income taxes and establish an 18 percent sales tax on all consumer products and services are enjoying wide currency. This and many other examples show that the idea of replacing income taxes with more general and neutral ones is neither new nor extraordinary.

In Lithuania the introduction of VAT resulted in a multi-level tax system under which value added is taxed several times at different stages. Having a stable and reliable budget as an overriding goal, it is completely inexpedient to retain taxes which duplicate one another and whose computation, payment and administration are costly and time-consuming.

Having weighed up alternatives and investigated world-wide trends in tax reform, LFMI is advancing a tax reform proposal whose central idea is the phasing out of income taxes and switching to a general VAT, which, albeit not ideal, best meets the requirements attached to a pro-liberal tax system. Under the proposed system, VAT would be the principal source of budget revenues and other taxes would be repealed and applied only in exceptional cases. One of such cases relates to the taxes endorsed in previously signed international agreements. In the future, though, international agreements that would contradict the principles in question should not be signed.

This article does not deal with other sources of state revenues-inflation and borrowing, and their corrosive impact on the economy and people's lives. The readers of "The Free Market" know that only when taxes become the sole source of internal revenues and when the costs of government cease to be imposed on the nation by means of inflation and borrowing ,will tax reform gain ground.