Estonia Creates an Economic Miracle

Published July 1, 2006

Mart Laar was barely 32 years old in 1992, when he became prime minister of Estonia, a small nation on the Baltic Sea that had just emerged from decades of Communist oppression as a satellite state of the Soviet Union.

He inherited leadership of a country with 1,000 percent inflation, 30 percent unemployment, and government-owned businesses that were a shambles. Laar’s government removed price controls, cut regulations and welfare programs, sold state-owned businesses, introduced a new currency, and instituted a simple, flat-rate income tax that is being emulated in countries across Central and Eastern Europe. The rate has been lowered several times over the years and is now at 20 percent.

The result? Inflation in Estonia has dropped below 3 percent, unemployment has plunged below 6 percent, and foreign investment has poured in. Estonia has enjoyed the greatest growth in real per-capita income of any of the former Soviet states. Today the country is a member of NATO, the European Union, and the World Trade Organization.

Awarded for Advancing Liberty

For his achievements and continuing commitment to personal and economic freedom for Estonia and elsewhere, Laar on May 18 traveled to Chicago to receive the Cato Institute’s 2006 Milton Friedman Prize for Advancing Liberty. He is the third recipient of the $500,000 biannual prize, named in honor of famed American economist Milton Friedman.

Laar served two terms as prime minister. His accomplishments and those of his team of government reformers are particularly remarkable because Laar is not an economist. He is a historian. He read his first Western book on economics–Friedman’s Free to Choose–shortly before becoming prime minister. Laar determined to put Friedman’s principles of free markets, low and fair taxation, and trust in people into practice.

Budget & Tax News Managing Editor Steve Stanek met with Laar shortly before the latter’s acceptance of the Friedman Prize. Here are Laar’s thoughts on freedom, taxation, and the “Estonia miracle.”

Stanek: I understand the first book on economics you read was Milton Friedman’s Free to Choose. How did someone who grew up under Communism come across a book by Milton Friedman?

Laar: First of all, when you grow up in Communism, you know books on economics are not really on economics. They are Communist political propaganda. It is very hard to believe in Karl Marx when you see what is happening around you. Ronald Reagan once said, “What is the difference between a Marxist and an anti-Marxist? A Marxist reads the books of Karl Marx. An anti-Marxist understands them.”

The first time I heard the name Milton Friedman, it was in propaganda newsletters that said there is one very bad and very dangerous economist, and his name is Milton Friedman. I was quite sure, when he is so dangerous for the Communists to be telling me this, he must be a good man.

Free to Choose was one of the first Western books translated into Estonian at the end of the 1980s. That is how I had the chance to look at these ideas, which, when they were introduced in Estonia, looked quite crazy to many Western people but which to me looked quite logical, I must say.

Stanek: We have some debate in the United States about our income tax system and other taxes. If you had a room full of congressmen and senators here, what would you tell them about the flat tax?

Laar: I think nearly all of them know it is a good thing. When you look logically at how the tax works and at the current tax system in the United States, it is very hard to find anyone who is satisfied with it. The problem is, even when the people know the flat tax is a good idea, it looks like the politicians are afraid to do it. This is because they are afraid to lose the wealth; they are afraid to lose the power; they are afraid of the discussion.

It’s quite radical reform. There are influential groups in the United States who are against this kind of reform, starting with tax lawyers. This is one group that would be out of a job if you could do your taxes on a postcard. Last year in Estonia, 83 percent of people did their taxes electronically, and it took from five to 20 minutes for each of them. So you don’t need tax lawyers or a big tax bureaucracy.

Stanek: Were you surprised at how rapidly Estonia began to improve economically after embracing these ideas?

Laar: I must say we are a little bit surprised, to be very frank, because when we started the reforms, the administration was really very bad. Even as we taught that we would get up and get development, as we started to see development, it was actually more than we expected.

Stanek: Have you been surprised at how many of the other countries in Europe have been embracing the flat tax? I understand eight other countries have a flat tax and others are moving toward it.

Laar: At first everybody was a little cautious to see whether this would work. When it was seen that it worked, they were willing to do it. Our closest neighbors Latvia and Lithuania did it, and then it was some small distance to ask would it work in free countries? And would it be sustainable in the European Union? And when it was seen what was happening [in Estonia, Latvia, and Lithuania], there was the next big wave of tax reform, because it really is a working model. It brings more money to the budget. It supports growth. Its relevance has been proved. It works.

Stanek: What would you say are the greatest benefits Estonia has enjoyed from the transition to a new economy? Are they simply economic, or is it more encompassing, with people feeling better about their lives? Do they feel they have control over themselves and their families that they didn’t have before?

Laar: I think to have control over your life and family is a challenge. It will not always make you happy. Nevertheless, it is one of the greatest feelings you can have.

Liberty is something that, when it’s there, you maybe are not noticing it, but you understand absolutely when you don’t have it. We are coming from a society where we did not have it. And this is something which is very important to us.

I think the most important thing in our reforms is that we gave the power to the people. We trusted the people. We made them free. That was the goal of the tax reform and our other reforms.

Stanek: Tell me a little about your acceptance of the award. What did you think when you learned you were named to receive the Milton Friedman Prize for Advancing Liberty?

Laar: I was quite positively surprised, because I am not an economist. Getting a prize named after a great economist, a man I admire very much, I am very honored.

Of course it is not a prize for me. It is a prize for my countrymen and country, because the government’s task is only to make the conditions. The people are the ones who are doing the miracles.