Tax reform in transition economies and its impact on economic performance

Abstract

Starting with Hungary in 1984 and followed thereafter by other countries in Eastern Europe and former Soviet Union, the process of transition from centrally planned socialist economies to market oriented economies has been characterized by uneven performance. Poland, Hungary, Czech Republic, and Slovenia have each made significant progress in economic, political and judicial reforms while Russia, and many other countries of the former Soviet Union have lagged in implementing broad economic and political reforms and their economic performance has suffered as a result. Other countries from Central and Eastern Europe are placed between those two extremes. The objective of my thesis is to examine the development of effective and efficient tax systems in the transitional economies and the influence of tax reform on economic performance. We believe, a priori, that the development of a modern tax system is a crucial element in the transition process. Without an effective tax system the state is unable to collect revenues for financing government expenditures; “gray zones” develop in the economy, which discourage investors and private entrepreneurs; and the rule of law diminishes over time. Without systemic tax reform, we argue, economic growth will slow or decline; the social costs of reform will increase; and political pressure will mount to slow or reverse reforms. In this case, the government may come to crossroads where the option to abandon reform is very tempting.