Flat Tax: Definition, How It Works, Benefits, Critics, and Example

What Is a Flat Tax?

A flat tax refers to a single tax rate being applied to every taxpayer regardless of income. Typically, a flat tax involves no deductions or exemptions. However, some politicians 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.

Key Takeaways

  • A flat tax applies the same rate to every taxpayer regardless of their income, allowing for no deductions or exemptions.
  • The opposite of a flat tax would be a progressive tax, the rates of which rise as a taxpayer's income rises.
  • Fans of the flat tax note that it makes filing easier, and that it encourages people to earn more because they won't be penalized with a higher tax bill.
  • Flat tax critics argue that the system effectively penalizes lower-income earners, since they shoulder a greater tax burden.
  • U.S. payroll taxes are a type of flat tax.

Understanding a Flat Tax

Supporters of a flat tax system suggest that it gives taxpayers an incentive to earn more because they will not be penalized by higher rates (as with a progressive system where income falls into progressively higher tax brackets). Also, they argue that a flat tax system makes filing tax returns easier.

Critics of flat taxes argue that such a system places an unfair burden on low-wage earners as it lowers tax rates on the wealthy. Some critics believe a progressive tax system is fairer than a flat tax system.

Flat Tax vs. Regressive and Progressive Taxes

Regressive Tax

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 that imposes a greater tax burden on those with lower income than on those with higher income.

The tax is seen as regressive because a larger portion of a lower-income individual's total funds goes to the tax. While the higher-income taxpayer pays the same percentage, their greater amount of income/funds means the financial burden is easier to bear. They have enough income to offset the tax load more easily than those with lower incomes.

A sales tax is an example of a flat tax that is considered regressive. 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 less money spends a larger portion of it on the tax than the person with more money.

Progressive Tax

Progressive tax rates, in contrast, affect a larger percentage of income for high-wage earners and a lower percentage of income for low-wage earners. In the United States, the income tax system is a progressive one and currently has seven income tax brackets with corresponding rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

To illustrate, for tax year 2022, individuals earning $10,275 or less in taxable income paid only a 10% tax on that amount. Those individuals earning over $539,900 pay up to 37% on a portion of their earnings (the top rate reached as taxes are levied progressively on income in all of the preceding six brackets).

For tax year 2023, those figures are $11,000 and $578,125, respectively. The Internal Revenue Service (IRS) adjusts income tax brackets annually to account for inflation.

Real-World Examples of Flat Tax

Russia was the largest nation in the world to use a flat tax, imposing 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. However, both Latvia and Lithuania have now changed to a progressive tax system.

Greenland uses a flat tax system that can be adjusted annually. For individuals, the current rates are 36%, 42%, or 44%, depending on the municipality.

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 country's Social Security and Medicare programs. Employees and employers split the tax evenly. Workers pay 7.65% of the FICA tax, while their companies also pay 7.65% of the tax. Self-employed individuals pay the full amount (15.30%) 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, the Social Security tax comes with an income cap. For tax year 2022, only earnings of $147,000 and below were subject to the Social Security tax. For tax year 2023, that cap rises to $160,200.

How Does a Flat Tax Work?

A flat tax imposes the same tax rate on all individuals, regardless of their income levels. For example, a sales tax is considered a flat tax.

Is a Flat Tax Considered Good or Bad for Those With Lower Incomes?

Generally, a flat tax is seen by critics as unfair when comparing lower-income individuals and higher-income individuals. That's because the same tax rate applied to both ends up taking a greater proportion of total money from those with a smaller amount of funds than those with a larger amount.

Does the U.S. Have a Flat Tax Income Tax System?

No, the U.S. has a progressive income tax system. That is, a person's total income is fit into various tax brackets from low income to higher income, each with a different tax rate (also low to higher). That person then pays the rates applicable to their income in those brackets. So, for example, someone who earns $45,000 in 2023 will pay a total tax of 10% on the first $11,000 of their income (.10 x $11,000 = $1,100) and 12% on the remaining $34,000 (.12 x $34,000 = $4080) for a total of $5180 in tax. That amount works out to an effective tax rate of 11.51%

The 10% and 12% tax brackets are the first two brackets of a total of seven. Those single filers with higher incomes would also pay the rates on each bracket that their income falls within, starting with the 10% and progressing upward as applicable, up to a top rate of 37% for income that falls into the bracket of income over $578,125.

The Bottom Line

A flat tax is a tax that applies the same rate to all income levels. For example, the sales tax is a flat tax. It is considered by critics to be more burdensome on individuals and families with lower income.

Rather than a flat tax for income tax, the U.S. uses a progressive tax system. It places less of a tax burden on low- and middle-income taxpayers. Higher-income individuals and families pay a larger share of taxes.

Article Sources
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  1. Institute on Taxation and Economic Policy (ITEP). "The Pitfalls of Flat Income Taxes."

  2. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments For Tax Year 2023."

  3. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments For Tax Year 2022."

  4. Federal Tax Service of Russia. "Personal Income Tax."

  5. KPMG. "Russia: Progressive Individual Income Taxation Introduced."

  6. PricewaterhouseCoopers (PWC). "Lithuania: Individual - Taxes on Personal Income."

  7. PricewaterhouseCoopers. "Latvia: Individual - Taxes on personal income."

  8. PricewaterhouseCoopersPWC. "Greenland: Individual - Taxes on Personal Income."

  9. Internal Revenue Service. "Topic No. 751, Social Security and Medicare Withholding Rates."

  10. Social Security Administration. "Fact Sheet: 2023 Social Security Changes."

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