Flat Tax

What is 'Flat Tax'

Flat tax is a system that applies the same tax rate to every taxpayer regardless of income bracket. Typically, a flat tax applies the same tax rate to all taxpayers, with no deductions or exemptions allowed, but some politicians such as Ted Cruz and Rand Paul have proposed flat tax systems that keep certain deductions in place. Most flat tax systems or proposals do not tax income from dividends, distributions, capital gains and other investments.

BREAKING DOWN 'Flat Tax'

Supporters of a flat tax system propose that it gives taxpayers incentive to earn more because they are not penalized with a higher tax bracket. In addition, flat tax systems make filing easier. Critics of flat taxes argue the system places an unfair burden on low-wage earners in exchange for lowering tax rates on the wealthy, and claim a progressive tax system is more fair.

Examples of a Flat Tax

Russia is the largest nation in the world to use a flat tax. Russia imposes a 13% flat tax on earnings, but the nation has considered moving to a progressive tax to boost tax revenue. Other nations that use flat taxes including Estonia, Latvia and Lithuania have experienced economic growth since adopting flat tax rate policies.

In the United States, the payroll tax is a type of flat tax. As of 2016, the IRS levies a 12.4% payroll tax. Employees pay 6.2%, while their employers also pay 6.2%. Self-employed individuals pay the full amount on their own, as they are their own bosses. This tax is considered flat because it imposes the same percentage on all wage earners. However, only earnings below the $118,500 threshold are subject to payroll tax. As a result, this tax is effectively regressive, although it only uses one rate.

Flat Taxes vs. Regressive and Progressive Taxes

While a flat tax imposes the same tax percentage on all individuals regardless of income, a regressive tax taxes high-income earners at a lower percentage of their income and low-wage earners at a higher percentage of their income. A sales tax is an example of a regressive tax, although at first glance it may appear to be a flat tax. For example, imagine two people each buy $100 worth of T-shirts and pay a 7% sales tax. Although the tax rate is the same, the individual with the lower income pays more of his wages toward the tax than the person with the higher income, making sales tax regressive.

Progressive tax rates, in contrast, constitute a larger percentage of high-wage earners' incomes and a lower percentage of low-wage earners' incomes. In the United States, income tax is progressive. To illustrate, as of 2016, individuals earning up to $9,275 in taxable income pay 10% in tax, while those earning over $415,050 pay up to 39.6% on their earnings.