A flat tax is a single tax rate applied to all taxpayers regardless of income. Employing a flat tax structure means taxpayers cannot take deductions or exemptions. Most flat tax systems, or arguments for a flat tax system, do not tax income from dividends, distributions, capital gains, or other investments. The opposite of a flat tax is a progressive tax, where taxation rises with a taxpayer’s income.
Key Takeaways
- A flat tax applies the same rate to every taxpayer regardless of income and allows no deductions or exemptions.
- The opposite of a flat tax is a progressive tax, where taxation rates rise with a taxpayer’s income.
- U.S. payroll taxes and sales tax are a type of flat tax.
Unpacking the Flat Tax Concept
Supporters of a flat tax system suggest that it incentivizes taxpayers to earn more because they will not be penalized by higher rates and higher tax brackets based on their income level. Additionally, a flat tax system may make filing tax returns easier. Critics of flat taxes argue that such a system burdens low-wage earners and lowers tax rates on the wealthy. They believe a progressive tax system is fairer.
As of 2023, the IRS in the United States levies a payroll tax, specifically the Federal Insurance Contributions Act (FICA) tax of 7.65%, on qualified wage-earning taxpayers to support Social Security and Medicare programs.
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 imposes a larger tax burden on those with lower incomes than those with higher incomes 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 income means the financial burden is easier to bear.
A sales tax is an example of a flat tax that is considered regressive. If two individuals each buy $100 worth of T-shirts and pay a 7% sales tax, 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 high-wage earners more than 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%.
For the tax year 2023, individuals earning $11,000 or less in taxable income are subject to a 10% marginal tax. Those earning over $578,125 pay up to 37% on their earnings. For 2024, those figures increase to $11,600 or less and $609,350. The Internal Revenue Service (IRS) adjusts income tax brackets annually to account for inflation.
Marginal Tax Rate
In the U.S., the marginal tax rate for individuals increases as their income rises. The highest dollar earned will fall into a higher tax bracket.
Historical Use of Flat Tax Systems
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 also changed to a progressive tax system.
Greenland uses a flat tax system that can be adjusted annually. For individuals, tax rates range from 36% to 44%, depending on the municipality.
How Does a Flat Tax Work?
A flat tax imposes the same tax rate on all individuals, regardless of their income levels. A sales tax is considered a flat tax.
Does the U.S. Have a Flat Tax Income Tax System?
The U.S. has a progressive income tax system where an individual’s income determines various tax brackets from low income to higher income, each with a different tax rate. The taxpayer pays the rates applicable to their income in each bracket. An individual who earns $45,000 in 2024 will pay a total tax of 10% on the first $11,600 of their income and 12% on the remaining $33,400.
The Flat Tax Debate
Critics of the U.S. progressive or marginal tax rate system commonly propose changes to tax policies. Reforms are often proposed that would mimic other countries, such as Estonia. A flat tax rate on all income such as wages, pensions, and interest could be combined with a standard deduction for individuals and families to accommodate variances in households.
Conclusion
A flat tax is a tax that applies the same rate to all income levels. For income tax, the U.S. imposes a progressive tax system which places a lower tax burden on low- and middle-income taxpayers. Higher-income individuals and families pay a larger share of taxes.
Related Terms: Progressive Tax, Regressive Tax, Marginal Tax Rate, IRS, FICA.
References
- Institute on Taxation and Economic Policy. “The Pitfalls of Flat Income Taxes”.
- Social Security Administration. “Fact Sheet: 2023 Social Security Changes.”
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments For Tax Year 2024”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments For Tax Year 2023.”
- Federal Tax Service of Russia. “Personal Income Tax”.
- Expatica. “Taxes In Russia: A Guide to the Russian Tax System”.
- PricewaterhouseCoopers. “Estonia - Individual Taxes on Personal Income”.
- PricewaterhouseCoopers. “Lithuania: Individual - Taxes on Personal Income.”
- PricewaterhouseCoopers. “Latvia: Individual - Taxes on Personal Income”.
- PricewaterhouseCoopers. “Greenland: Individual - Taxes on Personal Income”.
- Tax Foundation. “Details and Analysis of a Tax Reform Plan for Growth and Opportunity”.
