Different taxes exist and countries all over the world apply each of them to different companies or entities. Hence, we have the proportional tax, which can also be called a flat tax, the progressive tax, which is known as marginal tax, and the regressive tax.
But for this article, we will focus on what proportional tax is, and understand everything concerning it.
So, if you have questions about proportional tax, you will find your answers as you keep reading.
A proportional tax is simply a balanced taxation system that allows both low-income and high-income earners to pay an equal percentage (of their annual income) of taxes.
However, everyone is not in support of this system of taxation, as some argue that it helps them to save more. Whereas others see it as an undue impediment on their finances.
What Is Proportional Tax?
A proportional tax can be defined as an income tax system that levies the same percentage tax to everyone, irrespective of their earnings. A proportional tax is the same for either the low-income earners, middle-income earners, or high-income earners. This tax can also be called a flat tax.
The proportional tax system allows people to be taxed at the same percentage of their annual income and not their monthly income. People who support the proportional tax system said that it gives taxpayers the chance to earn more because they are not penalized with a higher tax rate. Flat tax systems or proportional tax systems make filing easier.
While people who do not support flat taxes say that the system places an uneven burden on low-wage earners and middle-wage earners in exchange for lowering tax rates on the wealthy.
A proportional tax is established on the assumption that since everyone is equal, taxes ought to even be charged similarly.
In some cases, sales tax can also be regarded as a type of proportional tax since everyone, regardless of earnings, is required to pay the same fixed rate.
While the sales tax rate applies to goods and services, the income of the purchaser is not put into consideration.
This said Russia remains the largest country in the world to use a proportional tax system. Russia imposes a 13% proportional tax rate on all income earners.
However, in January 2021, progressive taxation was introduced to Russia. Russians who earn more than 5 million rubles ($73,000) a year will pay 15% tax on all income above that level.
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Proportional Tax Examples
We’ve defined what a proportional tax system means. We’ve also made it clear that Russia is one of the biggest countries that use it. Thus, to better understand this system, we will look at some proportional tax examples.
To illustrate, if the proportional tax rate is set at 20%, a taxpayer earning $20,000 pays $4,000. In the same vein, anyone earning $50,000 pays $10,000.
And for anyone earning $1 million he or she would pay $200,000 and so on.
So, the first step is to know if your country is operating on the proportional tax system or progressive tax system.
When the tax system is confirmed then you also check out the tax rate and check how much of your earnings are going to taxes.
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Proportional Tax Pros and Cons
There are two sides to a proportional tax rate system – positive and negative. Just as there are always two sides to a coin.
Here are the proportional tax pros.
Pros
Motivates people to earn more:
When people who earn higher-income pay lower levels of tax, it creates an avenue for those with lower incomes to move up into higher brackets. But in the case of progressive tax, it is contrasting because folks are charged higher amounts as they attain higher brackets.
So, for someone earning $39,000, it doesn’t make so much sense to earn $50,000 that takes them into a bracket that pays an additional ten percent.
However, a regressive tax will eliminate this disincentive and do the opposite. This encourages people to move into more productive and higher-paying positions.
Provide higher revenues:
As strange as it may seem, when taxes on the rich are lower, they tend not to take such extreme measures to avoid paying it.
Instead of money going to tax havens, they pay it to the government in taxation. The reason is the incentive to avoid it is lower. For example, tax avoidance costs the rich millions of dollars in lawyers and accountancy fees.
Increases savings and investment of the nation:
Those who earn higher incomes save more, increasing the saving rate of the nation. In turn, those savings become capital accessible for businesses to capitalize on new profitable and more productive economical machinery.
Reduces brain drain:
When tax rates increase as your earnings increase, it can cause loss of talent, also known as ‘brain drain’. Here, skilled experts leave their country to find work elsewhere.
For example, someone who has worked hard for 10 years to become a surgeon earning $150,000 a year may face a progressive tax rate of 50 percent.
All the hard work, only for half their earnings to be taken away. As a result, they may look to other nations that provide a proportional tax system that is objectively fairer.
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Cons
Inequality:
One of the proportional tax cons is inequality. A proportional tax system allocates a higher amount of tax burden on those who earn a lower income than those who earn a higher income. Therefore, it creates a downward burden on the amount of local earnings families can save.
They are coerced into paying a higher amount of their incomes on tax, leaving little for them to save.
With little savings after-tax, it becomes difficult for low-income earners to gain equity. In turn, a poverty trap is created.
This burdens households with taxes, preventing them from saving enough capital.
Higher prices:
Higher prices are another proportional tax con. Thus, the higher the tax, the higher the price of the goods. Yet for proportional taxes such as tariffs, it is questioned.
The price of a tariff may not always be pushed on to the customer, this is because the imported may take some of the selling prices. But most businesses push the tax to the customer to protect their profits.
The consumer also faces price increases for other goods. For instance, excise taxes are imposed on goods such as sodas, cigarettes, and alcohol – products that are often associated with households who earn a low income.
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Reduces choice:
Proportional taxes such as excise taxes, tariffs, and sales taxes, all help to minimize the demand for goods for a wider variety of firms to make a profit. As prices of goods increase, there is less demand, and because there is less demand for goods, there are fewer chances for competition.
Political unrest:
Taxation will always be a serious issue for any nation. But, when it disturbs a significant number of households negatively, people can become unsatisfied. If they notice, as they do today, that millionaires and multinational companies are paying little tax, it then becomes an important moral issue.
We like to see a just system, so when the public sees the high-income earners paying little or no tax, there is justifiable anger. In return, we then see a quick change in the political sector—either for the better or for worse.
Proportional Tax Vs Progressive Tax
We have been discussing proportional tax, but now we also have progressive tax in the picture. Thus, for better clarification and understanding, we will look at the differences between a proportional tax and a progressive tax. Below are the differences:
A proportional tax is also called a flat tax, whereas a progressive tax is also called a marginal tax.
A proportional tax system charges a fixed rate irrespective of your earnings. While the progressive tax system charges as your earnings increase.
An example of progressive taxes includes estate taxes. It is levied on the high-earning people in the society as their estate increases. And some examples of proportional tax are per capita taxes, gross receipts taxes, and occupational taxes.
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What Critics Think…
Critics believe that the proportional tax system will make people work harder to earn more and also help enterprises to earn and contribute to the economy.
Whereas in the progressive tax system, critics believe that such a country supports the low-income earners more than the high-income earners. In other words, it is inequality.
In a proportional tax system, individual taxpayers pay a fixed percentage of their annual income irrespective of how much they earn. The fixed proportional tax rate doesn’t increase or decrease as income increases or decreases.
For example:
An individual who earns $30,000 annually would pay $3,000 at a 10% rate, whereas someone who earns $250,000 each year would pay $25,000 at that same rate.
On the contrary, the progressive tax system can be illustrated as follows; in a country operating under a progressive tax system, progressive tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The first tax rate of 10% applies to incomes lower than $9,950 for single individuals and $19,900 for married families filing joint tax returns. The highest tax rate of 37% applies to incomes over $523,600 for single taxpayers and $1,047,200 for married taxpayers.
A single taxpayer who has a taxable income of $50,000 in 2021, for example, would not pay the third rate of 22% on their income. Instead, they would owe 10% on the first $9,950 of income, 12% on income from $9,951 to $40,525, and 22% for the amount over $40,525.
This taxpayer would owe a total of $6,748.50—the 10% rate on the first $9,950 is $995, 12% on the $9,950 to $40,525 is $3,669, and 22% on the amount over $40,525 is $2,084.50. This puts the effective tax rate at just below 13.5%.
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Frequently Asked Questions
The following states use a flat tax system where everyone pays the same tax rate regardless of income: Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, and Utah.
As we all know, lowering taxes increases disposable income, allowing the consumer to spend more money, thereby increasing the GNP. So, reducing taxes drives out the aggregate demand curve as buyers request additional goods and services with their higher disposable incomes.
In the United States of America, the federal income tax is progressive. There are graduated tax brackets, with rates starting from 10% up to 37%.
Vatican City with a population of 799, Monaco with a population of 39,783, Saint Barthelemy with a population of 9,945, etc.
They are progressive tax and proportional tax. The progressive tax is also known as marginal tax while a proportional tax is known as a flat tax.
Conclusion
Whether your earnings increase or decrease, it does not affect your proportional tax/flat tax. Unlike the progressive tax, the proportional tax helps and motivates the population to work hard to earn more.
A proportional tax is used by some countries, however, most countries do not accept it. They prefer using the progressive tax system because it is beneficial to all earners whether low-level earners, middle-level earners, or high-level earners.
References
- investopedia.com – Proportional Tax
- investopedia.com – Regressive, Proportional, and Progressive Taxes: What’s The Difference?
- boycewire.com – Regressive Tax Definition, Examples, Advantages, and Disadvantages
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