I was still a Soviet citizen when I first read some of the international documents on human, economic, and political rights. I was amazed to learn how weak private property was and how government restrictions were strangling entrepreneurship. Labor laws and regulations on finance and energy were violating property rights and slowing economic growth. But trapped by political incentives, the nations of the world were finding it difficult to radically change their policies.
Even more surprising was that after the breakup of the communist systems in the former Soviet Union, Russia and its neighboring countries were advised to reconstruct their socialist systems by implementing very heavy business regulations and complicated tax systems.
The Experience of Georgia during the Transition Period
Georgia became an independent nation in 1991 after 190 years of, first, annexation by Russia and then forceful incorporation in the Soviet Union. After the Soviet Union collapsed, Georgia experienced the most dramatic peacetime economic decline in human history—a 75% drop in GDP. Georgia needed to restart its economy, and quickly.
To do so, the Georgian government sought to adopt new rules to restore business and entrepreneurship. The entrepreneurial spirit had never been lost in Georgia, which had one of the most developed underground economies in the Soviet Union, so restoration of an above-ground entrepreneurial spirit didn’t take very long. But the implementation of new laws and regulations designed to spur economic activity was a longer and harder battle. Georgia started to adopt new legislation in 1994, which heavily influenced its economic development during the next decade. This decade was very turbulent and difficult for many reasons, and no doubt the new business environment was one of them. The chaotic legislative process accompanied by lobbying, cronyism, and tolerating unwanted international advice made business activity very tough. Complicated compliance rules and a heavy tax burden made it nearly impossible to work openly and legally. In 2003, around one fifth of the 60 thousand registered business entities were involved in bribery and high-level political corruption. Hiding economic activity and revenues and avoiding taxes were necessary to keep working and earning a profit.
Georgia’s tax code, implemented in 1997, is a mixture of ideas brought forth by the Georgian government and the advice of international organizations and their experts. When it was first implemented, it was based on the IMF’s hypothetical tax framework called Tax Code of the Republic of Taxastan. It has been nothing short of a disaster.
The tax code has many mistakes and ill-conceived regulations, mostly due to translation errors and corrupt lobbying. It also included several elements prescribed by the international organizations. These taxes and regulations were a poor fit for Georgia—it was like fitting a round peg into a square hole.
The tax code and other legislation imposed 22 different taxes and fees on a company, including income tax, labor and welfare taxes, fuel consumption and environment taxes, and property and will taxes. The code was reorganized and reformed several times—there were 300 amendments and over 1000 clauses attached to the tax code—making it impossible for even big companies to follow the rules. This encouraged companies to bribe tax collectors to lower their tax burden and make their lives easier.
It’s also a great lesson in unintended consequences. According to the Georgian tax code, tax on salaried labor reached 40% and tax on dividends was only 10%. As a result, employers decided to pay dividends to their employees rather than salaries.
After the dissolution of the Soviet Union, Georgian businesses actually had a period of time when they could operate in a completely liberalized environment. All old Soviet regulations and regulatory institutions were abandoned, and for the first four years of independence government was not even able to adopt laws and a budget.
But in 1995, Georgia began to receive more attention from the international community, at which point it was advised to follow mainstream international economic regulations. Rather than advocating the acceleration of the privatization and entrepreneurial opportunity, many advisers (hired by USAID, the World Bank, etc.) came to teach Georgia how government intervention was good for the economy. This created a mess of regulations and protections including fire protection, labor protection, environmental protection, and energy protection.
To take one example, regulation of currency exchange booths included very strict requirements that included: having a calculator, bullet-proof window, a steel safe, 15 square meters of space, and other security and non-security conditions. While these may seem like prudent regulations, they were cumbersome for businesses who viewed them as too costly. To fulfill all of the regulations was impossible, and many business went back underground (like they had been during the Soviet era) and got involved in corruption. Of course, many of these regulations were implemented to give the bureaucracy the opportunity to receive as many bribes as possible. During this time, Georgia was one of the most corrupt nations in the world. A Transparency International global survey in 2005 ranked Georgia #132 on its corruption index.
The countless tax and business regulations, their amendments, and legislative initiatives (including executive orders) made the situation unmanageable. Economic development was very slow and didn’t improve the standard of living of the people.
But the biggest problem of all that this environment created was the loss of dignity and freedom of individuals.
A majority of the economically active people in Georgia were forced to pay bribes to avoid paying taxes and following regulations. And individuals felt guilty about their attempts to avoid obeying the law. Many of them felt like they were stealing something from the state, from the state employees, from the pensioners and children.
Most importantly, they were terrified that, one day, the government would come and punish them for avoiding taxes and regulations, and so they simply went on supporting the government out of fear. Nobody called for reform. It was a vicious cycle.
The leftists of the 21st century worked hard to detach property rights from human rights. But as the case of Georgia shows, the two cannot be disentangled. When excessive taxes and regulations violate the property rights of citizens, it erodes human dignity, weakening the position of the citizen to monitor government. This creates a perfect environment for government to continue increasing its power. And when the government becomes more powerful, the citizen must collaborate with the state to stay afloat. He loses his dignity and surrenders his voice.