Understanding and Weighing the Pros and Cons of Flat Tax

A lot of Americans are unanimous in their perception that the tax codes in the country have become indecipherable. Anytime a lawmaker or someone running for an office joins in with the rest of the crowd to proclaim that the country needs a new tax code, he is being greeted by cheers and admiration. If a vast majority of people can’t really understand the way they are being taxed, calls for a change in the taxation policy are inevitable.

All the concerns with the current tax policy call for a ‘fair’ and ‘flat’ taxation policy – one which addresses the concerns of those earning more than others, and also at the same time makes it simpler for a layman to file his own tax returns. The alternatives that have come up over the past few decades have centered around a flat or a fair tax structure, borrowing from the idea developed by American economists Robert Hall and Alvin Rabushka.

In the current scenario, people are taxed according to the money they make; people who earn higher are taxed at a higher rate than those who earn lesser. This system of taxation is progressive in nature. Also, there are a host of deductions and exemptions that one qualifies for – something which makes the whole process for filing income taxes a nightmare for most people. The idea of a flat tax structure has been put forward to counter the complexity of the current tax system. The proposition has been debated vociferously among the thinkers and academicians, with Congress being also introduced to it, but flat taxation has its own share of challenges that make its implementation imprudent.

Flat tax, simply put, is a single, uniform tax levied on every taxpayer. It doesn’t distinguish between people on the basis of their income and is devoid of any deductions and exemptions in the true sense.

One might find flat tax Utopian, but, in reality, there are some adjustments to the basic rule of flat tax that its proponents want to include. To ensure that low-income families are not penalized unfairly, proponents want to have a personal exemption that will allow larger families to a have a lesser taxable income. The rate of tax that has been proposed ranges between 14% to 21%.

The Case for a Flat Tax System

One of the prime reasons why proponents of flat tax want to change the existing ‘progressive’ tax system is its monstrosity. The current tax code is spread over thousands of pages, and even people with honorable degrees in economics and finance find it difficult to find out the exact amount they owe to the state or the amount of refunds they are entitled to. This was clearly demonstrated to the world by Money magazine, which sent fictional tax returns to 45 different tax-preparers. To everyone’s surprise, each quoted a different amount! Flat tax aims to simplify the very process for filing taxes, so that everyone is able to figure out the process of taxation and the need of tax-preparers is eradicated. According to an estimate by a non-partisan body, Americans shell out around $300 billion every year, not as taxes, but on paying the people who help them with the whole process of tax payments. Consider the amount of money that individuals will be able to save if flat taxation comes into effect.

There are certain loopholes in the current tax system which allow powerful people to gain undue advantage. As these people are able to hire the services of a CPA or a tax-preparer, they use loopholes like the deductions and the exemptions to pay lesser taxes. Poor and middle-class people, who can hardly afford such services end up paying the base rate. Also, a lot has been reported on the misuse of public money on political donations. Implementation of a flat tax system can put an end to all these activities.

The progressive tax system demands that the more you earn, the more you are liable to be taxed. Supporters of flat tax argue that such a system discourages aspiring entrepreneurs. A flat tax system will encourage entrepreneurship, which in turn will lead to creation of new industries and jobs.

The very idea of filing taxes gives most people jitters, and coupled with the complications and the anomalies involved, some people are inclined towards evading taxation. Hiring a tax-preparer or a CPA can be unaffordable for many, which can also contribute towards tax-evasion. With a clear-cut system in place, most people will find it easier to file their taxes rather than risking themselves with law enforcement agencies.

The Case Against a Flat Tax System

Opponents of the flat tax system claim that such a system will unfairly target the poor, who are better off with the current progressive tax system. As people will be taxed at the same rate, people with higher incomes will have higher disposable income to cater to the basic necessities of life. An exemption in the personal income may address this concern, but opponents argue that the basic premise of shifting to a flat tax will be defeated; room for one exemption may lead to other exemptions in future with change in government policies. Even with an exemption in place, many thinkers say that the poor are better off with the progressive tax system as they are paying a low tax (under 10%), and with a uniform tax rate of, say 17%, they will be liable to pay more to the government.

As per the current tax system, workers are entitled to several deductions, like contributions to charities, mortgage payments, earned income credit etc. With the implementation of flat tax, all these deductions will cease to exist and there will be no scope for a tax refund. This will certainly eat into the resources of low-income families.

Although supporters of flat tax system are aware of the repercussions it will have on the revenue generation of the government, they are optimistic that in the long run, there will be enough entrepreneurs and industries to fill up the state coffers. However, the reality is that when a 35% tax rate on the high-income family drops down to below 20%, the revenue generation mechanism will be seriously affected. This in turn will affect the country’s annual budget, making the country economically and politically weaker.

Another concern that has been raised in many quarters is the future of hundreds of thousands of people who derive their livelihood from the confusing tax code that is in place! If flat tax was to be implemented, CPAs and tax-preparers will be out of jobs and a whole industry will cease to exist. Add to this another 100,000 employees of IRS, and you have a potential problem in your hands. Proponents of flat tax also express awareness of the problem, but maintain that it is the duty of the government to employ these people.

In the present scenario, companies get a deduction for contributing to the retirement plans of their employees, however, in case of a flat tax system, there will be no such deduction and the employer will withdraw his share of the contribution. The employees too, will shy away from putting money in their retirement plan in the absence of deductions. Such a scenario will lead to a huge dependency of baby boomers on the government.

On the face of it, a flat tax policy looks every bit any policy for the people should be – it taxes everyone by the same rate, simplifies the whole procedure of filing for tax returns, and rewards investments and entrepreneurship. However, if we dig deeper, we will understand that there are a host of issues that need to be addressed before implementing a flat tax policy. The whole debate on flat tax is nebulous, and voluminous books have been written on this subject, therefore, we don’t claim to have exhausted everything that is there to a flat taxation system. We will be glad to read the opinion of our readers on this subject.