Flat tax
A flat tax, also called a proportional tax, is a system that taxes all entities in a class (typically either citizens or corporations) at the same rate (as a proportion of income), as opposed to a graduated, or progressive, scheme. The term flat tax is most often discussed in the context of income taxes. The flat tax is currently used very rarely in the developed world on a national level, standing in contrast to the more widely used progressive income tax, in which citizens and corporations with higher incomes pay tax at a higher rate than those with lower income.
Arguments for
The enactment of a flat tax system simplifies the tax code by only taxing income at its source. The U.S. tax code is currently over 9 million words long and contains countless loopholes, deductions, and exemptions that complicate and create inefficiencies in tax collection. The system in its form stifles economic growth by distorting economic incentives and allowing and encouraging tax evasion. With the transparency of a flat tax, there are fewer incentives to create tax shelters and avoid paying one’s share.
A flat tax eliminates double taxation. This is a benefit to retired people collecting from personal savings accounts, corporate dividends, and capital gains, all of which would already have been taxed at the corporate income level. Social security benefits (a tax in itself) would also become free of taxation. Estates taxes, also known as the “death tax”, would be phased out allowing more wealth to be bequeathed to family members.
Usually the flat tax is proposed to kick in at a certain income level, or to exempt income below that level, so that the lowest-income members of society pay no income tax. (some argue that this is technically a two-bracket progressive tax rather than a flat tax, but others maintain that the lowest "bracket" has a zero tax rate, making it an exemption, rather than a bracket). Under Steve Forbes’ plan for his 1996 and 2000 presidential campaign, a family of four would pay no income tax on its first $42,000 dollars. Income above that amount would be taxed at a flat rate of 17%.
Proponents of a flat tax claim that it will result in higher revenues for the government, by simplifying the tax code and removing certain loopholes currently used by corporations and the rich to pay less taxes. For example, under the current system Starbucks is allowed to claim a manufacturing tax credit for the process of grinding coffee beans. The added growth in industry would contribute to higher incomes and therefore higher government revenues. Also, the cost of processing tax returns would become much smaller since the IRS would be abolished.
Charitable giving would be helped by a flat tax in that people give more when their incomes are higher. A survey conducted ranked tax deduction #7 in a list of reasons people have for donating money to worthy causes. The poor will also be helped in that a simplified tax code will eliminate the need for costly tax experts. A flat tax would also include more generous exemptions for adults and children than in the current system. The economic boom that the flat tax will generate will also lead to for jobs and a reduction in unemployment.
Proponents of the flat rate tax point to the countries of Eastern Europe, where this theory has been proven. The Baltic states now have some of the fastest growing economies in Europe after years of stagnation under a socialist-style economy. Ireland entered the EU as one of the poorest members. When it switched to a flat corporate tax, its economy boomed and now it has a higher per capital GPA than Britain, France, or Germany. The tax code in post-Soviet Russia helped lead to its economic collapse in 1998 by creating incentives for rich oligarchs to move assets overseas. Part of Putin’s economic reforms involved a flat tax that helped to stabilize the economic and has created 5 straight years of strong economic growth.
Arguments against
Those who oppose a flat tax claim that it will benefit the rich at the expense of the poor. One argument is that, 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 (i.e. lower-income people will pay a higher proportion of their income in total taxes compared with the affluent). Another argument can be made by looking upon the value of money to various groups and not simply the rate of taxation. While the monetary value of a dollar (or other unit of currency) is the same for everyone, it is argued to be "worth" a lot more to someone who is struggling to afford food than to a millionaire.
Opponents note that by limiting the flat tax to paid wages, wealthier people who earn proportionally more money from investments and savings are not taxed for their additional revenue at all; similarly, the loss of deductions means that some tax reliefs for the middle class will disappear. The wealthy would actually be paying less, as a percentage of their monetary gains, than the less wealthy. Therefore, opponents point out that the flat tax is deceptively advertised as fair, when in fact it shifts the tax burden off the upper class onto the middle class -- the real issues are deductions and what money counts as "income", not where the tax brackets are set.
The argument that rich people, or corporations, might move to countries with lower taxes is difficult to argue against in the context of any one country, though it is, perhaps, sometimes overstated. One might ask how many wealthy people would really choose to uproot their lives just to pay slightly less tax?
Perhaps the most important argument against flat rate taxes, and other schemes that reduce taxes for the rich, is to note the predictable result that occurs if every country adopts this view, and lowers taxes to attract wealthy foreigners. This is a race to the bottom in which countries compete to offer ever-lower taxes for the rich, so that the rich become ever richer, while the poor and middle classes, who are less mobile, are left to shoulder the entire cost of all government services, which themselves are subject to ever-worsening under-funding and neglect.
This race to the bottom, many would argue, has indeed been accelerating since the 1970s throughout much of the world. The case is often made by anti-globalization activists that this process severely impacts funding for health, education, and other government functions, especially in the developing nations but increasingly in the richer countries too. It can therefore be argued that the race to the bottom on taxation for the rich is a major contributing factor to the 20-40,000 deaths which occur, on average, per day from malnutrition, according to World Health Organisation figures.
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.
Possible Implementations
There are several ways that flat tax implementation has been proposed, and very rarely has the proposition ammounted to a "true" flat tax where everyone pays exactly the same rate across their taxable income.
The most common flat tax implementation proposition, and the type that has been proposed by Steve Forbes in his presidentail campaign and by Dick Armey to congress, calls for base deductions for people and dependents. For example, the Armey proposition called of $26,200 for married couples filing jointly, $13,100 for individuals, $17,200 for single head of households, plus $5,300 for each dependent. After those deduction (and no other deducations), each family would pay a 17% rate on the difference. Businesses would pay a flat 17% rate across all profits. Other varieties of "flat tax with deductions" have had different deduction amounts and/or allowed deduction for select specific items like charity or home mortgage interest. This type of flat tax is the most commonly discussed because of its relative political moderateness- a true flat tax is a very hard sell, in other words.
Another flat tax variant that has been extremely popular among economists has been the Negative Income Tax that Milton Friedman proposed in Capitalism and Freedom. The basic idea is the same as a flat tax with personal deductions, except that it implements a perfectly neutral wealth redistribution system which ingeneously avoids any possibility of welfare trap incidence while distributing the money in what economists regard as the most efficient manner- as cash (as opposed to food stamps, medicaid, etc). Under an NIT, you would have a deduction system and flat tax rate just like the previously mentioned flat tax schemes. However, under and NIT, persons would be allowed to collect the tax rate of the difference between their deduction and their true income. For our example, let us say that we have a flat tax system where each adult gets a $20,000 deduction, married couples filing jointly receive a $40,000 deduction, and either receives an additional $7,000 in deductions per dependent. The flat tax rate would be 20%. Under such a system, a family of four making $54,000 a year would pay no taxes. A family of four making $74,000 a year would pay 20% on the difference of $20,000, or $4,000 in taxes, just like the previously mentioned personal deduction systems. The difference comes in people who make less than the deduction: if the same family made $34,000 a year, they would pay "negative income tax" (in other words, they would receive money). In this case they would receive a check for $4,000. Such a system would be intended not only to replace our current tax structure, but also our current welfare structure of food stamps, medicare/medicaid, social security, etc. Much of the spirit of this type of reform has been achieved in the form of the Earned Income Tax Credit, although without corresponding drops in other types of welfare spending. Some critics of the NIT do not like that it does not have a work requirement in order to receive welfare, which some welfare systems have recently adopted. Others see the wealth redistribution as simple subsidy to industries that use low cost labor- its important to note that people who make this point would probably be proponents of a true flat tax, as the NIT is no more a subsidy to low skill labor intensive industry than any of the other welfare for the poor that already exists.
Lastly there is the "true" flat tax. It has never been proposed by a politician or public figure (probably out of fear of political backlash) but an article on its mechanics was features in an issue of the popular political weekly, The Economist. If the idea of the personal deduction flat taxes proposed by the likes of Dick Armey and Steve Forbes is tax simplification, reduction of "corporate welfare" through politicians handing out special deductions, and for families to have the ability to send in their tax form on a postcard, then the true flat tax is the ultimate simplification. Under such a system, the flat rate would be applied to every dollar of taxable income and profits without exception or exemption. One possible benefit to such a system is that nobody could be construed as receiving a favorable or "unfair" tax advantage. No industry receives special treatment, the family with 10 kids doesn't receive special treatment, etc. The main advantage of such a system, however, is the simplification of tax reporting. The Economist article points out that it would be possible for companies to just deduct the flat rate from their entire pool of taxable income and send it in to the government along with the check for the flat rate on their profits. As an example, say that in 2005, ACME makes $3 million in profit, spent $2 million on salaries and wages, and a further $1 million on other expenses that the IRS treats as taxable income, such as stock options, bonuses, and certain executive privileges. If the flat tax rate was 15%, the company need only withhold that percent of the listed expenses and send in a single check for $900,000 to the IRS. Most of their employees wouldn't have to send in a check of their own. They would only have to if they made an outisde income from personal ventures. Even if one made money on an equity transaction regarded as "short term capital gains" which is taxed at normal income tax rates, the brokerage could withhold the 15% of the difference and send it in with their taxes. The Economist points out that such a system would reduce the number of filers that need to send in tax forms from the current 130 million individuals, families, and businesses, to a mere 8 million businesses.
Uses of the flat tax
An example of a flat tax proposal was that advocated by Canada's Canadian Alliance party. The party's platform called for the elimination of Canada's three separate tax brackets for low, medium, and high incomes with a single 17% income tax on everyone beyond the 'zero bracket amount' (the very poor would not have to pay taxes). However, this proposed flat tax turned out to be very unpopular among Canadians, and the party dropped it at the beginning of the 2000 general election. Still, a flat tax with a rate of 10.5% was introduced in the province of Alberta, the stronghold of the Canadian Alliance.
The Baltic countries of Estonia and Latvia have had flat taxes of 24% and 25% respectively with a tax exempt amount, since the mid-1990s. On 1 january2001, a 13 percent flat tax on personal income took effect in Russia. Ukraine followed Russia with a 13% flat tax in 2003. Slovakia introduced a 19% "true" flat tax (i.e. on corporate and personal income, for the VAT etc., almost without exceptions) in 2004; the number of new firms registering in Slovakia jumped 12 percent. Romania introduced a 16% flat tax on personal income and corporate profit on January 1 2005.
In the United States, although the national income tax is a progressive one, the flat tax is sometimes found in income taxes for smaller juridictions. Five US states — Illinois, Indiana, Massachusetts, Michigan and Pennsylvania — have a flat state tax on personal income, with rates ranging from 3% in Illinois to 5.3% in Massachusetts (Pennsylvania's is a pure flat tax, with no zero-bracket amount). Proposals for a flat tax for at the federal level have emerged repeatedly in recent decades during various political debates. Jerry Brown, former Democratic Governor of California, made the adoption of a flat tax part of his platform when running for President of the United States in 1992. At the time, rival candidate Tom Harkin ridiculed the proposal as having originated with the "Flat Earth Society". Four years later, Republican candidate Steve Forbes proposed a similar idea as part of his core platform. Although neither captured their party's nomination, in both cases their proposals prompted widespread debate about the current U.S. income tax system.
Flat tax plans that are presently being advanced in the United States also seek to redefine "sources of income"; current progressive taxes count interest, dividends and capital gains as income, for example, while the flat tax plan advanced by Steve Forbes narrows the definition of income to apply only to employee wages.
See Also
External links
- Forbes, Steve (2005). Flat Tax Revolution. Washington, DC: Regnery Publishing, Inc. ISBN 0-89526-040-9
- Syllabus on flat tax
- Editorial - "Legacy Time: Get to Work on the Flat Tax"
- The original and authoritative Hall and Rabushka flat tax