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Flat tax reform in Ukraine: Lessons from Bulgaria

Developing a tax system which limits tax evasion is a key challenge for many emerging markets. This column argues that introducing a flat tax as a boost to the post-war recovery in Ukraine is feasible if such a reform can sustain fiscal neutrality. A similar reform in Bulgaria has achieved the desired goal of enlarging the tax base by limiting the size of the informal economy. The flat tax reform is considered fair since, in a progressive tax regime, rich individuals and large companies often take advantage of available loopholes and exceptions to avoid paying any tax at all.

Editors' note: This column is part of the Vox debate on the economic consequences of war.

Tax evasion is a pervasive phenomenon in many emerging markets. It is well-documented that high personal income tax rates are partially responsible for tax evasion, especially in the emerging markets of Eastern Europe and the former Soviet Union (Miklos 2014). High personal income tax rates are also often associated with negative effects on economic activity. The high elasticity of taxable income with respect to tax rates found in the public finance literature implies deadweight losses arising from distorting labour supply and capital accumulation decisions (Feldstein 1995, Djankov et al. 2010). It is for this reason that the Ukrainian government is considering flat tax reform, known as the 10/10/10 initiative, to usher the introduction of a 10% flat tax on personal, corporate, and dividend income (European Business Association 2022). This tax will be temporary in nature, until the economy gets back on its feet after the war (Zhyla 2022).

Fiscal neutrality, the key requirement for support of tax reform by the International Monetary Fund (IMF), can be achieved if the flat tax expands the tax base by reducing the share of informal economic activity, estimated at 40-45% of all economic activity prior to the war (Keen et al. 2006, World Economics 2022). Similar drops in informality have been documented in Bulgaria and Georgia after these countries implemented their versions of flat tax reform (Djankov 2014, Saakashvili and Bendukidze 2014).

The experience of introducing flat tax in post-communist countries

The introduction of flat taxes was a popular reform in Eastern Europe and the former Soviet Union in the past three decades (Martinez-Vazquez et al. 2008, Miklos 2014). The first wave of flat tax adoption took place in the Baltic countries in the mid-1990s, followed by a second wave in Central Europe and several post-Soviet economies (Bulgaria, Georgia, Romania, Russia, Slovakia) a decade later. There is a sharp distinction between the first wave of reforms in the Baltics, characterised by tax rates set at moderate levels—at 20% or higher, close to the highest marginal tax prior to the reform—and the second wave, starting in Slovakia, marked by tax rates that were near the lowest of the pre-reform rates (and in Bulgaria, Georgia, and Romania even lower): closer to 10%.

In 2001 Russia introduced a flat tax reform, becoming the first large economy to do so. The Tax Code of 2001 replaced a conventional progressive personal income tax rate structure with a flat tax rate of 13%. Over the first year after the reform the Russian economy grew at 5% in real terms, while revenues from the personal income tax increased by over 25% in real terms. Besides this superior revenue increase, the flat tax was also associated with beneficial changes in the real economy over the next five years (Gorodnichenko et al. 2009).

In the majority of post-communist countries, the flat tax reform was considered temporary, as a means to reduce informality. The Baltic economies have reverted to progressive personal tax rates. For example, in 2018 Latvia replaced its flat tax with progressive rates of 20%, 23%, and 31.4%; in 2019 Lithuania replaced its flat tax with progressive rates of 20% and 27%. So have nearly all economies in the second wave of reform. In its original form, the flat tax is still maintained only in Bulgaria.

The flat tax reform in Bulgaria

Bulgaria’s entry into the EU in 2007 was marked by a spur of reforms aimed at reducing the large share of informal economic activity, estimated at 43% in 2006. Parliament approved the introduction of a 10% corporate income tax rate for 2007, to be followed by a 10% personal income tax rate the next year. The IMF was wary of this reform, arguing that the simplified tax system would lower the budget surplus and encourage a larger current account deficit. At the time of these discussions, however, the Bulgarian government did not need external financing and proceeded with its reform plans.

The year 2007 brought a huge growth of revenue from corporate income tax (by 39% compared with the previous year) and surpassed the Ministry of Finance’s own forecast (27% year on year). The budget surplus rose despite considerable emergency spending at the end of the year. There were several reasons for this beneficial effect: (i) the tax rate limited the incentives for tax evasion, (ii) the optimism at the beginning of the country’s EU membership, (iii) and the increase in foreign direct investment, which reached an all-time annual record of €9 billion (about 11% of GDP).

There was no political support for a significant reduction of social security contributions, another possible reform. Nevertheless, at the end of 2007, Parliament voted for both the introduction of a 10% personal income tax rate and lowering social security contributions. After a vote rerun, however, lowering social security contributions was put off until July 2008 and made contingent on the budget surplus being higher than planned. The mid-year surplus in 2008 was in fact higher than expected – with corporate and personal income tax revenues rising by another 16% year-on-year - and social security contributions did get lowered, though only by three percentage points. Attempts to further reduce social security contributions failed in 2010 and 2011, in the wake of the global crisis. Dividend taxes were, however, reduced to 10% and further to 5% where they have remained since.

It is estimated that the flat tax shrank the informal economy by two-thirds in terms of salaried employment between 2008 and 2012 (Djankov 2014). With the introduction of flat tax in 2007 and 2008, two tax exceptions or breaks were eliminated. First, the rates of profit tax for small and big business were equalised. From the economic perspective income from entrepreneurial activity was harmonised with income from shareholding in business. Second, the variety of rates of progressive tax on labour income was replaced by a single rate of 10%. As part of this change the untaxable minimal income was abolished, so that income tax policy came to cover all groups of society equally.

Flat taxation as fairness

Unlike progressive taxes, which include complex and numerous exceptions left to the tax collectors’ discretion, the flat tax is clear cut. In combination with the low rate, its simplicity considerably reduces the stimuli for being informal. Whatever informal economic activity there is still in Bulgaria, circa 2009-2010 it stopped being caused by attempts to save tax on behalf of individuals or companies.

This aspect of the flat tax regime is important from the perspective of how people perceive its fairness. Fairness requires richer people to pay a higher proportion of their incomes in tax. But the reality in countries like Bulgaria and Ukraine often is that with progressive taxes rich individuals and large companies take advantage of available loopholes and procedures to avoid paying any tax. The entire tax burden falls upon the people of average income between the untaxable minimum and the higher rates. In this sense, the flat tax is perceived to be fairer.

It is paradoxical to view a tax reform that involves a tax reduction for the highest earners as causing an increase in fairness. Yet in several Eastern European countries implementing the flat tax has led to a decrease in income inequality after tax (the so-called Gini coefficient). This effect largely depends on expanding the tax base and increasing work incentives (Miklos 2014). A surprise finding in previous flat tax reforms is that the movement to a flat tax plausibly strengthens the macroeconomic automatic stabilisers, thus helping an emerging economy adjust through the economic cycle (Díaz-Giménez and Pijoan-Mas 2006). In such reforms the income poor have also obtained sizeable welfare gains (Conesa and Krueger 2005).


Ukraine’s tax reform initiative is timely and can benefit from plenty of experience in neighbouring economies. Economic opportunity and incentives in the war economy have been greatly distorted and a flat tax trigger to the post-war recovery may be a significant boost of entrepreneurial confidence. Should the Ukrainian government persist in this reform, obtaining welfare gains for the vulnerable parts of the population must be as high of a target as reducing tax evasion. 


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Djankov, S, T Ganser, C McLiesh, R Ramalho and A Shleifer (2010), “The Effect of Corporate Taxes on Investment and Entrepreneurship”, American Economic Journal: Macroeconomics 2(3): 31-64.

Djankov, S (2014), “Bulgaria: The Greatest Vacillations”, in A Aslund and S Djankov (eds), The Great Rebirth: Lessons from the Victory of Capitalism over Communism, Peterson Institute for International Economics.

European Business Association (2022), “Business discussed the “10-10-10” tax reform with the Office of the President”,, 23 September.

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Miklos, I (2014), “Slovakia: The Latecomer That Caught Up”, in A Aslund and S Djankov (eds), The Great Rebirth: Lessons from the Victory of Capitalism over Communism, Peterson Institute for International Economics.

Saakashvili, M and K Bendukidze (2014), “Georgia: The Most Radical Catch-Up Reforms”, in A Aslund and S Djankov (eds), The Great Rebirth: Lessons from the Victory of Capitalism over Communism, Peterson Institute for International Economics.

World Economics (2022), “Ukraine’s Informal Economy Size”, Bulletin 23, 17 November.

Zhyla, N (2022), “Tax reform “10-10-10” in Ukraine: When It Will Be Adopted and What Businesses Can Expect”, Mezha, 17 August.

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