What Is a Flat Tax?

A flat tax system 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, or other investments.

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Understanding a Flat Tax

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

Flat Taxes vs. Regressive and Progressive Taxes

While a flat tax imposes the same tax percentage on all individuals regardless of income, many see it as a regressive tax. A regressive tax is one in which the government taxes high-income earners at a lower percentage of their income and low-wage earners at a higher percentage of their income.

The tax is seen as regressive due to a more significant portion of the total funds available to the low-income earner going to the tax expenditure. While the upper-income payer still pays the same percentage, they have enough income to offset this tax load.

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 spends more of their wages toward the tax than the person with the higher income, making sales tax regressive.

Progressive tax rates, in contrast, constitute a more significant 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 2020, individuals earning up to $9,875 in taxable income pay 10% in tax, while those receiving over $518,400 pay up to 37% on their earnings. For 2021, it will be $9,950 and $523,600, respectively.

Real-World Examples of Flat Tax

Russia was the largest nation in the world to use a flat tax with a 13% flat tax on personal income. In 2021, the nation moved to a progressive tax to boost tax revenue. Other countries that have used a flat tax system include Estonia, Latvia, and Lithuania, but both Latvia and Lithuania have now changed to a progressive tax system.

In the United States, the payroll tax is a type of flat tax. The IRS levies a payroll tax, specifically the Federal Insurance Contributions Act (FICA) tax of 15.3% on all wage-earning taxpayers. Proceeds go to maintain the Social Security and Medicare programs. Employees and employers split the tax: workers pay 7.65% towards the FICA tax, while their companies pay 7.65% of the tax. Self-employed individuals pay the full amount on their own.

This tax is considered flat because it imposes the same percentage on all wage-earners, regardless of their income tax bracket. However, only earnings below $142,800 are subject to the Social Security portion of the FICA tax in 2021; that figure rises to $147,000 in 2022.