A flat tax system imposes the same tax rate on all taxpayers, regardless of income level.
Proponents of the tax system argue that it is extremely straightforward. Most times, it is not just people who benefit from a simple tax law; several countries offer flat taxes to businesses as an incentive to attract firms and other employers.
While it may appear equal to all, critics still feel that the flat tax system forces an unfair balance between the top earners and the modest earners.
In the next few lines, we’ll define what the flat tax system is and how it works. Carefully read through.
What Is A Flat Tax?
Corporatefinanceinstitute defines flat tax as a system in which a single tax rate is applied to all income levels. This means that people with modest incomes are taxed at the same rate as people with high incomes.
It draws its strength from the common saying that equality is fairness or justice and that everyone should be treated equally or fairly. They deem this system to be a fair system of taxation because it imposes a uniform tax rate or percentage on both high-income earners and low-income earners. For example, imposing a 10% sales tax on both high- and low-income earners.
It is an obligation on taxpayers that is not dependent on income bracket and it permits no exemptions or deductions. This means that low-income earners and high-income earners pay the same percentage of tax regardless of the income bracket or income differences.
A flat tax imposes the same tax rate on all taxpayers, permitting no deductions or exemptions.
It will wise o also read through What is Tax Abatement? Definition, Overview, and How it Works
How Does Flat Tax Work?
The working mechanism of a flat tax is simpliciter ipso factor (by the mere fact). It is the imposition of the same percentage of tax on both high and low-income earners. Therefore, whatever percentage a high-income earner pays as tax should also be paid by low-income earners.
For instance, if there is an imposition of a 10% of sales tax on a high-income earner same should be imposed on a low-income earner. There should be uniformity of tax rates for high and low-income earners which aids to ensure ease of filing and computation by taxing authority.
Flat tax supporters argue that it encourages taxpayers to earn more because it does not penalize them with a higher tax band. Furthermore, flat tax systems make filing simpler. Those on the other side, however, believe that the system unfairly burdens low-wage earners in exchange for reduced tax rates on the wealthy.
Read also; What is Tax Abatement? Definition, Overview, and How it Works
Typical Example of Flat Tax Rate
Joseph, James, and John work in the judiciary. Joseph is a court clerk and earns an annual taxable income of $40,000. James works as a registrar and earns an annual taxable income of $60,000. John works as a Chief Bailiff and earns an annual taxable income of $80,000.
The government imposes a 15% flat tax rate on taxpayers.
Therefore:
- Joseph will pay (15% x $40,000) which is $6,000 in annual taxes, leaving him with $34,000.
- James will pay (15% x $60,000) which is $9,000 in annual taxes, leaving him with $51,000.
- John will pay (15% x $80,000) which is $12,000 in annual taxes, leaving him with $68,000.
From the above calculations, the government will receive the sum of $27,000 in annual taxes from the tax payers ($6,000 + $9,000 + $12,000) while the three taxpayers are left with the sum of $153,000 as income ($34,000 + $51,000 + $68,000) aggregately.
SEE ALSO: What is Tax-Deferred? Definition, Overview, and How it Works
What Are The Benefits Of A Flat Tax System?
Many governments have charged a flat tax on residents and corporations. They have heralded this tax system to have certain major advantages which are based on being fair. Here are a few advantages of a flat tax system:
- The flat tax has a simple attribute or feature which is the imposition of the same percentage of a flat tax on both high and low-income earners.
- The attribute of having the same percentage for both high and modest-income earners enables ease of calculation and filing of tax.
- It promotes a uniform tax rate for both high and low-income earners.
Are There Disadvantages Of The Taxing System?
Even though the system imposes a uniform tax rate for all income categories, here are a few disadvantages of the tax system:
- Critics are of the view that flat tax is unfair because it overburdens the low-income earners compared to higher-income earners despite the uniform tax rate.
- Despite the uniform tax rate, this system leaves the low-income earners with less money to maintain their standard of living and high income with more money to maintain their standard of living.
Flat Tax System vs Regressive Tax System
A flat tax imposes a uniform tax rate for both high and low-income earners while a Regressive Tax imposes or taxes at a lower tax percentage on high-income earners and a higher percentage on small-income earners.
A tax is regressive because it leaves low-income earners with fewer after-tax deductions to maintain their standard of living. On the other hand, they leave the wealthy with more or sufficient money after-tax deductions to maintain their standard of living.
For example, the imposition of a 10% sales tax on low-income earners earning a hundred thousand dollars or below and imposing a 7% sales tax on high-income earners earning a million dollars or above.
Flat Tax System vs Progressive Tax System
A flat tax has a uniform tax rate for both high and low-income earners, whereas a progressive tax has a lower percentage for low-income earners and a greater percentage for high-income earners.
A progressive tax gives low-income taxpayers more money after tax deductions to maintain their level of living while giving high-income earners less money after tax deductions.
An excellent example is the application of a 7% sales tax on low-income earners earning $100,000 or less, and a 10% sales tax on high-income earners earning $100,000 or more.
Frequently Asked Questions on the Flat Tax System
The following countries operate Flat Tax System; Greenland has a flat tax rate of 45%, Mongolia and Kazakhstan have a flat tax rate of 10%, Bolivia and Russia have a flat tax rate of 13%, Hungary and Romania have a flat tax rate at 16%, Lithuania and Georgia have a flat tax rate at 20%.
Sales tax, social security tax, payroll tax, and Medicare tax are good examples of the flat tax system.
The two major drawbacks of a flat tax are: the absence of wealth redistribution and burdening or burdensome on low-income earners.
High-income earners are greatly favored in a flat tax system.
Conclusion
Come to think of it, will the entire world adopt a flat tax one day? I doubt, particularly in the world’s largest economies, which have a long-established tax regime that many people may not want to modify.
Despite recent setbacks, it is likely that smaller and rising countries may realize the benefits of charging everyone the same tax.
Nevertheless, the disadvantages of the flat tax system outweigh the advantages because low-income earners suffer the brunt more than high-income earners.
References
- https://www.investopedia.com/terms/f/flattax.asp
- https://corporatefinanceinstitute.com/resources/knowledge/accounting/flat-tax/
- https://worldpopulationreview.com/country-rankings/countries-with-flat-tax
- https://www.heritage.org/taxes/commentary/flat-tax-the-way-the-future
- https://www.thebalance.com/flat-tax-pros-cons-examples-compared-to-fair-tax-3306329
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