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

Russia is the largest nation in the world to use a flat tax. Russia imposes a 13% flat tax on personal income. The nation has considered moving to a progressive tax to boost tax revenue. Other countries that use a flat tax system include Estonia, Latvia, and Lithuania. These countries have experienced economic growth since adopting flat tax rate policies.

In the United States, the payroll tax is a type of flat tax. The IRS levies a 12.4% payroll tax. Employees pay 6.2% while their employers also pay 6.2% of the tax. Self-employed individuals submit the full amount on their own. This tax is considered flat because it imposes the same percentage on all wage earners. However, only earnings below the $137,700 threshold are subject to the Social Security portion of payroll tax in 2020 and below $142,800 in 2021. As a result, this tax is effectively regressive, although it only uses one rate.