Dr. Lyuboslav Kostov
Lecturer, Department of Economics, University of National and World Economy.
Director, Institute for Social and Trade Union Research and Training (ISSIO).
Social justice is as much a moral as it is a macroeconomic category. Unlike most economic indicators, however, there is no single accepted definition of what is socially just and what is not. Take, for example, a country’s tax system. The choice of a taxation system lies within society’s remit and reflects its understanding of the appropriate balance between social justice and economic efficiency.
In Bulgaria, a proportional tax system—better known as a 10% “flat” tax—applies to both individuals and legal entities. Nearly 15 years have already passed under this system. Over this period, sufficient statistics have accumulated to unequivocally refute all the motives on which this flat tax was introduced.
It was adopted for four main reasons, according to the then-stated rationale: (1) to reduce the share of the shadow economy; (2) to reduce inequalities; (3) to increase tax revenues; and (4) to boost foreign direct investment. In fact, the system failed on all four counts.
Income inequality reached record highs precisely in the decade after 2009 and remains so to this day, regardless of the metric—Gini coefficient or decile/quintile groups. According to Eurostat, Bulgaria currently has the largest income inequalities in the EU.
The shadow economy did not decline either. Yes, as a percentage of GDP it may have dropped by a few points, but in absolute terms it increased several-fold. Tell me, which number is larger: 30% of BGN 66 billion (Bulgaria’s GDP in 2009) or 22% of BGN 218 billion (the GDP expected at end-2025)?
Tax revenues did not rise; they fell as a share of GDP. Worse, the ratio of direct to indirect taxes became so skewed that VAT turned into the main revenue source—unlike in advanced economies.
As for foreign direct investment, the data speak for themselves. Just visit the NSI website and compare 2000–2008 with the period after 2009: in the first period FDI averaged about 10% of GDP, thereafter it was three times lower.
In short, the flat tax delivered on none of its stated goals. This is easily verifiable, as all empirical data are public—simply check the NSI website.
If you rewind 15 years and listen to what the architects of the flat tax were saying, you’ll hear claims such as: “In essence the flat tax is regressive, and that is good because it leaves more liquidity with the relatively richer, which should stimulate investment.” Have you felt that investment surge? On the contrary: we see capital concentrating in a few hands, a lack of reinvestment, and ultimately the withdrawal of money from the economy’s circulation. Money became static.
Enough retrospection. Here is the truth: tax systems that rely on indirect taxes as the main revenue source—as in Bulgaria—are considered more regressive in the literature and less effective at tackling inequality. VAT is a consumption tax that violates vertical equity: individuals with different tax capacities bear the same burden, which can widen inequality. Economists therefore view indirect taxes as more regressive—especially when compared to progressive income taxation—because the welfare loss share for poorer individuals under VAT is higher than for richer ones. Households with lower incomes spend a higher share of income on VAT than high-income households, widening the gap between rich and poor.
Did you know that 60% of all tax revenues in the state budget come from a single tax—VAT—which also accounts for just over 20% of all budget revenues (tax and non-tax combined)?
On the other side are the two direct taxes—personal income tax (PIT) and corporate income tax (CIT)—both at 10%. Their impact on income inequality is direct and well established in theory and practice. Bulgaria does not apply progressive taxation to either personal or corporate income; the flat rate without a tax-free threshold is among the lowest in the EU. These two direct taxes largely determine the relatively limited role of the state in the economy, measurable by budget revenues or expenditures as a share of GDP. In fact, Bulgaria is the only country in the world with a flat tax and no tax-free minimum. And the total number of countries with a flat tax worldwide is no more than seven or eight.
For a serious debate, we should at least pause the election cycle mantra that “taxes will not change.” Why not change them, given that the current system means fewer investments, greater inequality, more shadow economy, and a distorted balance between indirect and direct revenues—making the entire system regressive?
Another regressive element beyond indirect taxes is social insurance. It becomes a regressive levy once the maximum contribution base is reached: some people effectively exit the system, and their overall tax-contribution burden tends to 10% regardless of income. In practice, the higher your income, the lower your relative burden compared to low and middle earners. They currently pay 24%, whereas any lev above BGN 4,150 is charged only 10%. Where is the fairness? Why not remove this ceiling, as in the countries we aspire to emulate—or at least raise it substantially?
What about the corporate tax? Bulgaria’s 10% rate ranks second-lowest in the EU, above only Hungary’s 9%. By comparison, the average corporate rate in the EU in 2022 was 21.3%, and in the euro area slightly higher at 23%. Unlike Bulgaria, corporate profit tax rates across EU economies typically range between 19% and 25%. How is it fair that corporate tax revenues are smaller in absolute terms than personal income tax revenues? Households end up paying more direct taxes than business—yet business is said to drive GDP and progress. If so, why does it contribute so little?
Why is the dividend tax 5%? In Belgium it’s 30%, Denmark 26%, Germany 25%, Estonia 20%, France 12.5%, Hungary 15%, Italy 26%, Latvia 20%, Lithuania and Luxembourg 15%, Malta 27%, Netherlands 26%, Austria 27%, Portugal 28%, Slovenia 27%, etc. Why not at least raise the dividend tax to 10%? That would be a start. The benefits are twofold: budget revenues would increase by several hundred million, and the gap between dividend and labor income taxation would narrow, reducing firms’ incentives to pay out large dividends and encouraging reinvestment and wage growth—instead of siphoning cash via low dividend tax and paying “envelope wages” to avoid contributions. This is widespread practice. A concrete measure to reduce undeclared employment is therefore to raise the dividend tax to a level that removes the financial incentive to bypass social contributions, given that such payouts often mask undeclared personnel expenses.
But don’t take my word for it. Consider what smarter people have said about flat and progressive taxation.
Adam Smith, John Stuart Mill, David Ricardo, and John Maynard Keynes all argued for progressive taxation. The foundations of modern market economies—Classical and Keynesian theories—presuppose progression in taxing all economic agents. It could hardly be otherwise: the flat tax was invented in the late 1980s and applied mainly in CEE countries. It has no grounding in established economic theory; it is more of a post-totalitarian experiment.
Nobel laureate Paul Krugman (2008) notes that the Reagan tax cuts primarily benefited very high-income families, while sharp reductions in public spending hit the poor; less redistribution leads to social and macroeconomic imbalances.
Nobel laureate Joseph Stiglitz (2001) has consistently opposed supply-side economics and flat taxes. Nobel laureate James Tobin (1981) argued that under progressive taxation the loss of incentives at the top of the income distribution is negligible and more than offset by stronger incentives at the bottom.
Arthur Pigou, a student of Alfred Marshall, argued that the marginal effect on the economy in terms of added value declines as wealth and incomes rise—an indirect case for progression. Those who have and can should contribute more—absolutely and relatively—to sustain quality public services.
Musgrave and Musgrave wrote that an equitable tax system is one in which each taxpayer contributes in line with the benefits received from public services. They likewise recommend progressive taxation with a mandatory tax-free minimum for the lowest incomes.
Recent empirical work echoes these conclusions. Barious et al. (2020), focusing on CEE countries with microsimulation and econometric models, find that replacing a flat tax with a more progressive system can reduce inequality and support higher long-term growth. Hope and Limberg (2022), using modern panel regressions, show that cutting taxes for the richest increases inequality without boosting growth. Where the tax-contribution burden is regressive—as in Bulgaria—inequality grows faster and becomes a key factor holding growth below potential.
And so on. The literature from a century ago, from fifty years ago, and from five years ago converges on the same results. We simply need to see them.
The persistence of the flat tax in Bulgaria is better explained by psychology than by real arguments. A flat tax relieves policymakers of responsibility: it favors administrative convenience and reduces the need to organize and control tax collection seriously.
We must admit we were wrong. The flat tax is not the instrument that can automatically solve existing problems or substitute for other macroeconomic policies. This model is an archaic zombie rejected by modern theory and practice. The Bulgarian numbers confirm it.
In short: taxing the rich and the poor the same is not equality; it is tacit discrimination.