Where taxes are so low, some people might actually pay…

July 5, 2011
Sofia, Bulgaria

Do you remember those days, 25+ years ago, when the Olympic games were an extension of the Cold War? We heard stories about these Soviet athletes who were groomed, practically from birth, to become champion athletes, taken from their families at a young age to live and train nonstop for the glory of the Communist Party.

Bulgarians historically excelled at summer sports like boxing, wrestling, track & field, and rowing, and today I worked out at a gym that used to house the country’s up-and-coming athletes during Soviet rule.  It’s in a neighborhood of old Soviet-era apartment buildings, all built in that concrete shoebox style that defined Communist architecture.

Such neighborhoods are a constant reminder of the days when they allowed their society to descend into a totalitarian police state. A lot of Bulgarians I’ve encountered seem embarrassed by these Communist remains, brushing the entire period off as ‘experiments in socialism.’

They’re looking to the future now, and they’re cautiously optimistic.

When you survey the various countries in the former Soviet bloc, it’s a truly mixed bag. East Germany, for example, enjoys a lavish economy after being successfully reunited over 20-years ago thanks to an incredible amount of aid and support from the West.

Slovakia has spent the last two decades creating a manufacturing powerhouse for the rest of Europe, and its citizens today enjoy a much higher standard of living than before.

Estonia built a very successful knowledge and services economy by establishing a limited, low-tax, business-friendly government. When Mart Laar took over as Prime Minister after Estonia’s independence in the 1990s, the only economic text he had ever read was Milton Friedman’s Free to Choose. It’s fortunate for his country that it wasn’t Keynes.

Belarus descended even further into totalitarianism; Aleksandr Lukashenko, the country’s first democratically elected president since the fall of the Soviet Union, has remained in power ever since, effectively seizing dictatorial control over every aspect of the economy and society.

Ukraine continues to vacillate between revolution, corrupt cronyism, and economic collapse… yet the country still has a lot of potential thanks to its resource wealth and talented young work force.

Bulgaria, from where I write this letter, is an interesting case. As the poorest member of the EU, there is a lot of opportunity at face value. Labor is dirt cheap. Property is dirt cheap. Living costs are a joke. English is widely spoken and is, in fact, more prevalent than Russian in the capital city.

More importantly, the government is finally beginning to privatize some of its state-owned companies, as well as make some business-friendly decisions related to taxes.

Now, this is not a part of the world where tax compliance is particularly strong. The immediate post-Soviet years turned the entire region into a veritable Deadwood, and devoid of any functioning tax authority, people got used to dealing in all cash and keeping 100% of their earnings.

Several governments, including Russia, Ukraine, and Bulgaria, have tried to make compliance easy by slashing tax rates. At just a 10% flat rate for corporate, individual, and capital gains, and just 5% on dividends, taxes in Bulgaria are now so low that some people might actually pay.

For foreigners, it’s a boon. Bulgaria has an extensive network of tax treaties with countries across Western Europe, Canada, and the United States which ensure foreign-owned Bulgarian companies are only subject to the 10% rate.  Using this ‘tax rate arbitrage,’ multinationals keep a large part of their earnings offshore in lower tax jurisdictions.

At present, a number of multinationals have set up overseas headquarters and manufacturing facilities in Ireland to take advantage of that country’s low tax rate of 12.5%.  Given Ireland’s pending bankruptcy, however, the government is under pressure to raise this rate… and I expect that this will drive a number of companies to move operations to Bulgaria.

Given the country’s low tax rates, cheap minimum wage of just $185/month, and business-friendly policies, Bulgaria is a reasonable alternative for companies that want to stay within the EU’s customs union. Bulgaria is, after all, an EU member… though they likely fabricated their financial statements to gain entry in the same way that Greece did.

Simply put, Ireland’s decline will be Bulgaria’s gain, and the influx of foreign investment will be of great benefit to this economy and asset prices.

Meanwhile, entrepreneurs and investors looking to capitalize on offshore tax treaty advantages, cheap talent, and a cost effective European base may want to consider Bulgaria for their needs.