flat tax

A flat tax, also called a proportional tax, is a system that taxes all income (typically including both individual and corporate) at the same marginal rate. This differs from progressive income tax systems in which those with higher incomes pay tax at a higher marginal rate than those with lower income.

Most variations of the flat tax also include the elimination of many or all tax loopholes.

see also: income distribution, tax reform, principles of a fair tax system.

Example: a "right wing" Flat Tax Proposal
(based on the Armey Flat Tax)
  • tax incomes of all kinds (wages, profits)at a single rate of 17 percent.
  • increase the personal allowance to $13,100 for single persons, $5,300 for each dependent and $17,200 for a single head of household.
  • eliminate taxes on capital gains and
  • provide basic personal deductions to all individuals and dependants.
  • eliminate almost all other deductions (for home mortgage interest, capital depreciation, tuition, childcare etc.)

Example: a "centrist" Flat Tax proposal
(based on the Mills Single Tax Proposal)
  • a single 25% marginal tax for all Income Sources: Employment income, interest income, dividend income, capital gains income.
  • elimination of almost all deductions and tax credits including: attendant care expenses, moving expenses, workers'compensation payments,stock option and shares deductions, capital gains deduction, northern residents deduction, child care expenses, age related deductions spousal/equivalent deductions,pension deductions
education expenses, medical expenses, labour sponsored funds, political contributions, investment tax credits, Research and Development credits, dividend tax credits
  • enhanced tax credits for families with children, people with disabilites
  • enhanced basic deductions eliminating taxes for those below the poverty line.

Position: Enact a flat tax.

Arguments For:
  • A simpler, flatter tax structure is percieved as more fair and will encourage less tax evasion.
  • A Simpler tax system means it will cost less time and money for individuals and busiensses to complete their annual returns.
  • Lower taxes for the rich in a given country, will encourage wealthy people to live ther, bringing economic benefits as the wealth "trickles down" to the rest of society.
  • A flat tax system may arguably can be progressive with a large personal deduction threshold.
  • Removing certain loopholes will require the the rich to pay more taxes.

Arguments against:

  • the current tax code could be simplified, and the loopholes (various exemptions and deductions) could be removed, without flattening the tax brackets.
  • Since most other taxes (sales taxes etc.) tend to be regressive in practice, making the income tax flat will actually make the overall tax structure regressive.
  • The marginal utility of income argument: An argument can be made that the the value of a dollar to a poor person is greater than the value of that same dollar to a rich person, and as such, taxing all income at the same rate is unfair to lower income earners.
  • exempting capital gains from tax is unfair because wealthier people who earn proportionally more money from investments and savings are not taxed for their additional revenue at all.
  • the loss of deductions means that some tax reliefs woudl disappear.
  • for a once a year activity, the tax system is not overly complicated.
  • flat taxes, because they facilitate easy comparision between jurisdictions, facilitate a race to the bottom.

Opponents of lower taxes for the rich argue that the predictable end result of the race to the bottom is complete social collapse (see also failed states), a situation from which even the richest people in society will derive no benefit. In order to prevent this, they argue, it is the responsibility of local and national governments everywhere to ensure that the rich continue to pay a fair share of the tax burden. Schemes such as "flat rate taxes", therefore, are said to be irresponsible at a global level, even if they may seem to offer the prospect of a temporary advantage at a national level.

Most proposals of a flat tax are motivated primarily by a desire to simplify the tax system, close tax loopholes and make the tax system more fair in the sense that all taxpayers would face the same marginal rate.

The Flat Tax proposal by scholars Robert Hall and Alvin Rabushka, is simply a two-part VAT: the business tax base would be exactly like the VAT except that businesses would be allowed deductions not only for

Individuals would pay tax on wages, salaries, and pension income that exceeded personal and dependent exemptions.
Businesses and individuals would be taxed at a single flat rate.

This implies that the flat tax is a consumption tax.

Required Rates: The US Treasury Department has estimated that a pure flat tax with a 20.8 percent rate would have generated as much revenue as the personal and corporation income taxes and the estate tax in 1996.

Unlike the advocates’ estimates for the sales tax, the flat tax estimates include tax evasion and are based on logically consistent assumptions about price level changes. Nevertheless, in practice, rates would likely be higher for several reasons. Congress would face intense pressure to offer transition relief to businesses that would be treated less generously under the new rules than under current rules. Repeal of the income tax would destroy remaining depreciation deductions for businesses that own capital at the time of transition. Owners of such “old capital” would be at a disadvantage in competition with owners of “new capital” purchased after the implementation of the new tax, which could be expensed. Similarly, companies that have borrowed funds would lose deductions for interest payments and would have a disadvantage in competition with companies that have not borrowed. The flat tax would also eliminate carry forwards relating to net operating losses, alternative minimum tax payments, and other items that business can currently use to reduce future taxes.

Business owners would doubtless seek relief. More generally, taxes are deeply embedded in the structure of existing contracts and other transactions. Moving to a flat tax could upset these arrangements. For example, the flat tax would change the substance of every alimony agreement, because alimony payments are currently deductible and alimony receipts are taxable, but under the flat tax, those treatments would reverse. Likewise, the flat tax would alter every loan repayment plan because interest payments are currently deductible and interest receipts are taxable, but neither activity would affect tax liabilities under the flat tax. These problems would create a dilemma.

Most of the gains in economic efficiency and much of the political appeal of the flat tax derive from low rates made possible by a broad tax base. But providing transition relief would raise rates and would reduce gains in economic efficiency. Transition rules would also erode gains in simplicity.

Beyond transitional concerns, the permanent elimination of existing deductions and credits would prove difficult. Removing deductions for mortgage interest and property taxes would raise tax burdens for about 29 million homeowners who itemize, reduce the real value of homes, and possibly increase mortgage defaults.

Terminating deductions for charitable donations under the personal, corporation, and estate and gift taxes would reduce contributions by about 11–23 percent.