With flat-rate tax systems, all taxpayers must pay the same tax rate regardless of their income.
For example, a tax rate of 10% would mean that a person who earned $ 30,000 would pay $ 3,000 in taxes. A person who made $ 1 million would pay $ 100,000 in taxes a year.
While such a tax system is just a concept in the United States, introducing it would make tax filing much easier. In fact, most people could file their taxes with a piece of notebook paper and a cell phone calculator. Here’s what you need to know about flat taxes before you next talk to your business nerd friend.
What is the flat tax?
A flat tax rate refers to any tax where all tax rates are the same. Technically speaking, sales tax could be an option, as everyone pays the same tax rate on the products they consume. However, when policymakers talk about flat tax, they are usually referring to a tax that would replace income tax.
The most influential flat tax system was developed in 1985 by Robert Hall and Alvin Rabushka. According to this system, the entire household income would be taxed at a flat rate with some allowances (deductions) for the family size. Subsequent versions of this system were seen as the basis for major changes in tax policy in the United States.
Are there flat taxes in the US?
The United States has had flat income taxes twice in its history. But since 1913, the federal tax system in the United States has been considered “progressive” or “incremental”. That said, the more money you make, the higher the rate you will pay.
Of course, there are deductions and credits, as well as different forms of tax, depending on how you earn your income. That muddies the water a little, but at its core the income tax system in the United States is still progressive.
Still, there are ideas of flat taxes in the United States. FICA (Social Security and Medicare) taxes are what we are most likely to have at the federal level. Each employee pays 7.65% of their income for these taxes. Your employer kicks in another 7.65%. This results in a flat tax of 15.3% on all wage income.
However, income over $ 137,700 is not subject to social security tax. Since the tax does not apply equally to all income, the social security tax is technically declining. Low earners are taxed at a higher rate than high earners.
In addition, many US states have a flat rate income tax. These states allow deductions based on family size, but apply the same tax rate (between 3.07% and 5.25%) to any income above the deductible threshold.
Recent calls for a new federal flat tax
In the course of time, various politicians have called for the changeover to a flat tax system. Most recently, Republican Senator Ted Cruz presented a “Simple Flat Tax Plan” in the run-up to the 2016 presidential election. During a speech in the Senate in 2017, he reiterated his support for the tax reform plan.
Senator Cruz’s plan would have eliminated the “tax bracket” system and replaced it with a flat tax rate of 10%. According to his plan, a family of four would not pay tax on their first $ 36,000 in income. Cruz also promised the plan would stimulate the US economy to grow 14% in a decade.
Advantages of a flat tax system
The flat tax system is an interesting concept that could offer several advantages. Here are some of the most notable potential benefits.
Easy tax collection
The IRS code is extremely complex. The Tax Cut and Employment Act of 2017 reduced the number of taxpayers who would have to pay the alternative minimum tax and would benefit from the breakdown of their deductions. However, a flat tax could simplify both the business and individual codes at a dramatically higher level.
Easier to balance a budget.
The flat tax makes it easier to predict short- and long-term inflows of funds. Knowing how much money it will raise will make it easier for Congress to manage a balanced budget in the long run.
No negative incentives to work
One of the criticisms of the current structure of the social safety net and income tax in the United States is that it provides an incentive to work after a point. Government-provided services are “falling off a cliff” while tax rates are rising.
The result is that escaping a low-work lifestyle can be difficult. Ideally, granting the same tax rate to all would remedy these disincentives and result in every dollar earned being the same value as the previous one.
This means that people with the opportunity to work more will be fully rewarded for their inclusion. Of course, this ideal scenario would require changing existing social programs in addition to the tax code.
Reduce the gaps in the tax code
One of the main benefits of moving to a simplified tax system is that taxpayers have fewer opportunities to “play” the system. Also charging companies a flat rate would discourage the government from creating tax rules that benefit (or violate) certain companies or sectors.
Disadvantages of a flat tax system
Despite some enthusiasm from tax policy centers and neoclassical economists, the flat tax was not received with great enthusiasm in the United States. Here are some reasons why.
Higher tax rates for some people
While considering family size and necessary consumption would technically make it a “fair tax”, it is likely that overall tax rates would increase for low to middle income citizens without offering them any additional benefits.
Conversely, tax rates would likely fall for those at the top of the income spectrum. A study by the Congressional Budget Office (CBO) in the 1990s found that a flat-rate tax system would result in a drop in after-tax income of nearly 22% among the low-income earners, while after-tax income would increase by about 7% among the highest-earners.
This perceived injustice makes the system politically less palatable, even if overall tax revenues increase. In response to these concerns, some experts have recommended the introduction of a flat-rate tax system that only applies to income above a floor of exemption. For example, if the exemption was $ 25,000 and you were making $ 75,000 in wages, you would only be paying income tax on $ 50,000.
Defining “income” can be more challenging than you think
Much of the tax code has nothing to do with tax rates or what you pay – just how do you define income? The current tax code is 2,600 pages long, but the fees you paid occupy only 2 of those pages. The remaining pages define all “Income” – from where or how it is earned to when you need to claim it as income.
While most labor income is pretty easy to define, things can get very complex very quickly when you deal with things like mining, farming, or investing.
In addition, the United States has used the tax code to incentivize (or incentivize) certain activities. For example, to promote home ownership, homeowners receive the mortgage interest deduction. When these types of incentives are no longer part of tax legislation, we either need to find different ways to incentivize activity, or you could argue that we should stop these behaviors.
Tax rates can fluctuate over time
A flat tax rate sounds like a panacea for knowing what your taxes will be. However, budget constraints can drive tax rates higher over time. If the tax rate gets high enough, there could be incentives to leave the United States to avoid taxes.
The tax landscape in the United States leaves much to be desired, and a blanket tax system offers several compelling advantages over the existing system. It’s easy to calculate, would close existing tax loopholes, and make it easier to forecast a government budget. However, it is unlikely that a flat tax will be introduced here in the US anytime soon.
Currently, the United States has progressive tax legislation that offers many options for tax deductions or tax credits. Under the current Code, any taxpayer can receive one or more deductions or tax credits that reduce their tax burden. If you are unsure how to claim any tax deductions or tax credits, consider using tax filing software. This article describes the best tax software for your situation. Be sure to read the section on Maximizing Credits and Deductions.