A flat tax system is where ALL taxpayers – regardless of income – pay the same tax rate. Having everyone pay the same rate no matter how much they make stirs debate between those who are in support of it and those who are against it. Supporters argue that the system is fair while those who don’t find it an unpleasant situation especially for the lower income class.
While the US adopts a progressive tax system, there are other countries in the world who have imposed a flat tax rate system on both individuals and businesses. The results? Estonia, Lithuania and Latvia have all experienced economic growth since switching to the system.
Estonia adopted the system in 1994 and put a 26% tax on both personal and corporate income. The country experienced an 11.7 percent gross domestic product (GDP) growth in 1997 which continuously grew between 7 and 10 percent throughout the early 2000s. Then again, other factors contributed to the case as well.
But an article by Josh Barro in Bloomberg View in 2013 will argue otherwise. In it was detailed the exit of several central and eastern Europena countries from flat-rate income taxes. The Czech Republic and Slovakia changed theirs to a progressive system. Barro wrote: “Even the poster child for flat-tax fans, Estonia, isn’t looking so hot. Since the 2008 crash, Estonia has resolutely kept its flat tax and signed up for severe fiscal and monetary austerity, even joining the Euro area. Its economy has strongly rebounded since 2010, but only after an extremely hard crash has left its gross domestic product still below its 2007 peak.”
Even more recently, Senator Rand Paul, in an article on The Wall Street Journal, suggested a flat tax rate system for the US. Rand is of course a candidate in the 2016 US Presidential Elections and this is his ticket he hopes would take him to the White House. In his plan, the following would be implemented:
– replacement of complicated personal income tax with a 14.5% flat tax.
– replacement of complicated corporate taxes with a new 14.5% value-added tax.
– elimination of payroll tax.
– elimination of estate and gift taxes.
– elimination of excises and tariffs.
– elimination of most credits, deductions and loopholes.
– elimination of most double-taxation of income.
– elimination of much of the IRS.
The plan is hedged on the GOP’s three goals of tax reform: simplicity, fairness and growth. Paul’s plan does make things simpler and could do very well on growth. However, it’s still rather vulnerable when it comes to fairness.
According to the Tax Foundation, the Paul Plan can increase gross domestic product a full percent each year. Based on static analysis, the plan would raise the deficit by $3 trillion over 10 years.
While some agree that the plan looks good (even conservative pundit Glenn Beck called the plan “erotic”), there are several downsides to it as well. For one, it looks to favor the wealthy – even if it would increase income for everyone in the income scale – as they look to get the biggest gains out of it.
Arguments the Paul Plan mention that it’s not a true flat system as it still preserves several loopholes and exemptions such as the charitable deduction, mortgage-interest deduction, child credit, earned-income credit and tax exclusion for workplace health benefits.
Another argument for the Paul Plan is the system won’t likely stay flat. After all, some countries in Europe have opted out of it when they got into trouble. Just take a look at the tax reforms implemented during Reagan’s time – Reaganomics if you will. It limited taxes on the wealthy on the belief that it would “trickle down” to the lower-income class. While it did partly improve the economy, that system didn’t last long – just four years. And what happened then? The US diverted back to the really sad system that Reaganomics replaced.
The idea of flat tax in the UK has also been thrown around. George Osborne cited Estonia as economies with “lessons we can learn from.” But he also admitted it wasn’t a popular choice for “mature economies.” But just like anywhere else, the idea had dissenters too. Robert Halfon called the measure “deeply regressive and would be hard to defend as fair.”
So, what is it exactly? Is there more harm than good of implementing a flat rate tax system? Let’s take a look at both sides of the argument:
List of Pros of Flat Tax
1. It is fairly simple
Let’s take the US tax bracket as an example. For taxes filed on April 15, 2015, these were the tax rates:
|Tax Rate||Single filers||Married filing jointly or qualifying widow/widower||Married filing separately||Head of household|
|10%||Up to $9,075||Up to $18.510||Up to $9,075||Up to $12,950|
|15%||$9,076 to $36,900||$18,151 to $73,800||$9,076 to $36,900||$12,951 to $49,400|
|25%||$36,901 to $89,350||$73,801 to $148,850||$36,901 to $74,425||$49,401 to $127,550|
|28%||$89,351 to $186,350||$148,851 to $226,850||$74,426 to $113,425||$127,551 to $206,600|
|33%||$186,351 to $405,100||$226,851 to $405,100||$113,426 to $202,550||$206,601 to $405,100|
|35%||$405,101 to $406,750||$405,101 to $457,600||$202,551 to $228,800||$405,101 to $432,200|
|39.6%||$406,751 or more||$457,601 or more||$228,801 or more||$432,201 or more|
What happens then with these brackets when a flat tax is implemented? Eliminated and replaced with just one rate for everyone. It wouldn’t give tax filers a hard time and those at the IRS would welcome the easy computation. Flat rate taxes only one income and that makes it easier to understand and report.
2. It provides a cost benefit for taxpayers
The financial cost of complying with regulations set by the IRS is high. For one, taxpayers may need lawyers, accountants and other resources. That can be eliminated with the implementation of a flat system.
3. It eliminates other taxes
With a flat tax system, a section of the tax code biased against capital formation is removed. In addition, death tax, capital gains tax and double taxation of savings and dividends are eliminated. In other words, families and individuals won’t be asked to report dividends, interest or any other business-related income. As a result, individual taxpayers will do away with paying interest, dividends and other business tax.
Basically, it taxes only earned income.
4. It employs territorial taxation
Territorial taxation is when the government taxes income generated within national borders.
5. It promotes economic growth
Almost every country that has adapted the flat tax system experienced economic growth. It’s worth noting too that former communist nations were the first to apply global tax reform. It started with Estonia in 1994, which is a few years after the demise of the Soviet Union. They were followed by two other Baltic republics of the former Soviet Union: Latvia (opting for 25%) and Lithuania (choosing 33%).
Russia too, inspired by its neighbors, shifted to a flat tax system in 2001. The move yielded some positive results: the economy did prosper and revenues streamed into government coffers. In 2003, Serbia chose a 14% rate and the following year, Slovakia shifted and stuck with a 19% rate. Other countries with a flat rate tax system include:
Ukraine – 13%
Georgia – 12%
Romania – 16%
Kyrgyztan – 10%
6. It is deemed as fair
Let’s say that Person 1 earns $5,000 and Person 2 makes $500,000. With the progressive system, they have to pay different tax rates based on how much they make. With the flat rate system, both will pay the exact same amount.
Also, it should be noted that Person 2 is paying much bigger tax because they have a greater income. But when considered as a whole, the percentage each have to pay is equal.
List of Cons of Flat Tax
1. It penalizes low-income earners
Low-income earners, well, earn much less than others. The fact that they have to spend on the same necessities are more well-placed folk is also an issue as when necessities expense is taken out of the picture, low-income earners are left with so little for anything else.
In other words, the poor get poorer.
2. It eliminates the IRS
This can be taken both ways, actually. With Rand Paul’s flat tax proposition, not everyone was in agreement with retaining a small portion of the IRS. On the other hand, if the IRS gets re-adjusted, then some employees would surely lose their jobs. And that’s another problem to deal with: unemployment.
3. It benefits the rich
Let’s go with another example: Person 1 earns $1,000 while Person 2 makes $10,000. They live in a country where a flat tax system is in place and the rate is 10%. Person 1 would only have $900 left after taxation while Person 2 would have $9,000. Can you spot the discrepancy?
Even with taxes at the same rate, well-paid individuals are well, still well paid. Or put simply, the rich still gets richer.