A Flat Tax: The Good, the Bad and Why It Probably Won’t Happen

Wish taxes were so simple you could file them on a postcard? Some say a flat tax could make that possible.

With tax season upon us, you may be wondering why the government has to make things so complex.

According to the CCH Standard Federal Tax Reporter, the tax code clocks in at an astounding 73,954 pages as of 2013. It includes seven tax rates, four standard deductions and at least a dozen tax credits for individuals. Then there are the exemptions, the itemized deductions and the special tax rules.

And when you think you’re starting to understand how the system works, the government likes to throw in a few curveballs, like the alternative minimum tax.

Wouldn’t it be easier if we eliminated 73,950 pages of hoops and simply taxed everyone using the same percentage?

Well, that depends on who you ask.

Basics of our progressive system

Before delving into the pros and cons of a flat tax, let’s go over how the current system works first. The current federal income tax system is progressive, meaning the more you earn, the higher percentage of taxes you pay.

Here are the brackets for your 2013 taxes (those would be the ones you’re working on right now):

  • 10 percent.
  • 15 percent.
  • 25 percent.
  • 28 percent.
  • 33 percent.
  • 35 percent.
  • 39.6 percent.

Your tax bracket is determined by both your income and your filing status. Your bracket can also depend on your exemptions and deductions, which bring your taxable income down.

In addition, it’s important to know that the tax rates above are marginal. That means, if you fall into the highest tax bracket, you aren’t paying 39.6 percent on all of your income. You only pay that rate on the portion of your income that falls into that tax bracket. For a single filer, that means you would pay 39.6 percent in taxes on any income in excess of $400,000 for 2013.

To help put it into perspective, here’s an example published in Forbes last year that assumes you earn $100,000 and are in the 28 percent tax bracket.

You would owe 10 percent of $8,925, 15 percent of $27,325 (the difference between the top and the threshold of the second tax bracket), 25 percent of $51,600, and 28 percent of $12,150 (the difference between your income and the threshold of the third tax bracket). That calculation results in $21,293, or an effective (not marginal) tax rate of 21.2 percent.

Why having a flat tax would be awesome

If that all seems about as clear as mud, then you have stumbled upon one of the key reasons some people advocate for a flat tax: simplicity.

A flat tax would make taxes easy. No matter what you earn, you would pay one rate for all your income. A pure flat tax would also eliminate deductions and credits to further streamline tax filing and payment. In arguing for his flat tax proposal three years ago, Texas Gov. Rick Perry said taxes would become so simple that taxpayers would be able to “complete their returns in minutes and submit them on a postcard.”

Proponents of the flat tax also say that beyond being simple, it’s also fair. Since everyone would pay the same tax rate, all would be contributing an equal proportion of their income to the maintenance of government services.

Finally, flat tax supporters say a simplified, uniform tax rate would encourage economic growth. They say that many fast-growing economies are found in countries that have flat, rather than progressive, tax systems.

Why having a flat tax would be awful

Opponents of the flat tax say supporters are blowing smoke and are actually intent on creating a system that favors the wealthy.

While flat tax supporters point to former Soviet countries as examples of nations that saw tremendous economic growth after enacting a flat tax, opponents say the success in Eastern Europe has been overblown. In addition, some countries that had enacted a flat tax are now repealing those laws.

What’s more, opponents say a flat tax may simplify the tax code, but it would do so at the expense of lower- and middle-class families. Most flat tax proposals set taxes in the range of 17 to 20 percent, meaning low earners could pay more while wealthy families get a break. This may be especially true if a pure flat tax is enacted – that is, one that includes no deductions or credits.

Not only would a flat tax widen wealth inequality in the country, opponents say it might allow the rich to duck paying taxes on a large portion of their income. Many proposals exempt investment income, which can be a major source of money for some affluent households. Small businesses may also suffer under a flat tax if they are unable to deduct expenses that cut into profits.

And why you may never see a flat tax

While the debate regarding the flat tax can be interesting and heated, it’s largely theoretical at this point. Consider how many politicians and economists have advocated for a flat tax during the past 30-plus years. Here’s a sampling, compiled by NPR:

  • 1981. Hoover Institution economists promoted a 19 percent flat tax that would exempt lower-income households, such as families of four earning less than $25,500 annually.
  • 1992. California Gov. Jerry Brown, a Democrat, proposed a 13 percent flat tax with limited exemptions. He also suggested we scrap the Social Security tax.
  • 1996. Republican Steve Forbes made a flat tax one of the centerpieces of his presidential bid. His plan would allow standard and dependent deductions while instituting a 17 percent flat tax.
  • 2011. Several Republican presidential candidates embraced the flat tax that year. Herman Cain recommended it be set at 9 percent while Rick Perry proposed an optional 20 percent tax.

However, these proposals and others like them have failed to gain traction. It’s not necessarily because people love the current tax system. Even those who oppose the flat tax say our current tax code is broken.

However, when our Congress can’t even agree on an annual budget, it seems unlikely it will be able to crack open the tax code and make meaningful changes, whether that would be to simplify the current version or replace it altogether.

So for now, it appears we are stuck with 73,954 pages of tax time fun. To make preparation a little less painful this year, check the Money Talks News series on Tax Hacks 2014, which include, among other things, information on how to avoid expensive mistakes and audit-proof your return.

As for the flat tax, what do you think? Do you prefer the simplicity of a flat tax or do you think those with more money should pay more taxes? Let us know in the comments below or on our Facebook page.

Stacy Johnson

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  • Maximus

    There is a major point that has been left out of this article. What is being described here is a flat tax on “income”. Taxing income in the first place is counter intuitive to growth. Essentially we are punishing growth by taxing income. We need to have a fundamental shift in philosophy on how and why we tax. There is a lot of research and information out there that suggests we should be taxing “sales” instead of income. The “Fair Tax” is the best example of this that has multiple benefits. First, you can’t evade a national sales tax. That includes illegal immigrants and other groups that don’t pay taxes. A national flat sales tax is also a much more reliable source of tax revenue and would generate much more tax revenue. It would also boost the economy since everyone would all of a sudden take home their entire paycheck and would therefore spend a bit more. It also encourages saving which many in our country have trouble doing. It would also eliminate the need for the IRS, tax filing, and all the other bureaucracy associated with our current tax system. It would also be more fair in that there wouldn’t be a bunch of loopholes for the wealthy to use in paying less taxes. Everyone pays the same percentage, but since wealthy typically buy more and more expensive things, they would essentially pay a larger portion of the taxes. So it is indirectly progressive in that way. Think about it….

    • While there are absolutely advantages to a national sales tax, there are many drawbacks as well. First, it would be high – some say 20 percent or more. And that would include everything, from houses to services. Making everything 20 percent more expensive could be devastating to the economy, not helpful. In addition, it’s regressive. Those with the least money would pay a much larger percent of their income on taxes than those with the most money. In short, like the flat tax, the idea of a national sales tax has been around for decades. But for similar reasons, it’s probably a non-starter.

      • Maximus

        With all due respect, your figures are a bit inaccurate. First, prices would not go up by 20% because the producers’ costs would go down significantly if our current tax system was eliminated. Prices would pretty much stay the same as the sales tax increase and income tax decrease would balance out. Even if prices rose a small amount, the increase in income would make that rise negligible. In regards to the regressive issue, the Fair Tax for example is set up where people below the poverty line don’t pay any tax at all and actually get a rebate. So it is progressive in several ways. I am not sure why the attitude remains so strong that this would never pass. There is almost universal agreement that our current tax system is detrimental in many ways, yet when a valid alternative is proposed, everyone is crippled with fear and want to poke holes in it. Even with some minor drawbacks that could be corrected over time, the Fair Tax is still many times better than our current system. Why are we so afraid to give it a try? We have no problem overhauling our healthcare insurance programs.

        • Bob K

          I could agree to a sales tax, if it included everything, NOT just stuff the middle class, etc. buy, such as stocks, bonds, mutual funds, houses, real estate, precious metals, money market funds, money put into savings accounts, art, etc.

          • Maximus

            But you would rather tax income? How does that make sense? You think you should be penalized for hard work? I would rather penalize heavy consumers…

    • Bob K

      One can evade a sales tax completely. A hedge fund manager, or anyone else that owned a small or large company, making millions each year in the USA, and who lived overseas, would completely avoid paying any tax on that income. It would increase prices at whatever rate and further erode the earnings of the working poor and the middle class who have seen, respectively since 1985, a 15 to 20% reduction in income or no increase at all, on average.

      • Maximus

        One can evade an income tax entirely too. Your hedge fund manager scenario makes up 0.0001% of the population. If people like that are the only ones not paying taxes, I think we are doing pretty good. The percentage of people that don’t pay any taxes now is probably 50%!

        • Jim Smart

          Another person who mis-states reality. Everyone pays taxes. In fact, total taxes paid are barely progressive at all, ranging from a low of about 17% to a higher of about 23% (averaged over income groups). That’s the problem with all the proposals to shift more taxes onto the poor. Every other tax besides income tax is regressive, costing lower income citizens a higher percentage of their income than wealthier Americans.

          • Maximus

            I’m afraid you are the one who mis-states reality. If you want references to back up the fact that a great number of people do not pay federal income tax, here it is…..

            In 2009, according to a memo from the Joint Committee on Taxation, a bi-partisan Congressional committee, only 49 percent of Americans owed money on their Federal income tax returns [source:PolitiFact]. So yes, it’s true that more than half of all Americans paid no Federal income tax in the tax year 2009, and the number of people who did pay taxes was even lower — 51 percent, not 53 percent. For tax year 2011, the non-partisan Tax Policy Center estimates that only 54 percent of Americans will pay Federal income tax.

          • Jim Smart

            You stated: “The percentage of people that don’t pay any taxes now is probably 50%!” That’s true of income (although not payroll) taxes, but not taxes in general. Total taxes paid are much less progressive than income taxes. Almost every other tax is regressive. The bottom fifth pay almost 20% of their income in taxes. Look up total tax burden, as opposed to income taxes only, and you’ll find that there is not a great disparity between percent of total income and percent of total taxes paid for the various income groups. Those trying to shift away from progressive income taxes conveniently leave out all other taxes. which hit the lower income levels hardest. I’d be happy with a much simpler tax structure, but I believe income taxes should continue to be progressive. That’s the only way to counteract the regressive state and local taxes.

          • Maximus

            But this article is not talking about “all the other taxes”. We are discussing the federal income tax.

          • Jim Smart

            Yes, and as with every other article of this type, especially those that advocate having the bottom 20% have some “skin in the game”, it talks as if they exist in a vacuum. To your credit, you don’t argue this. However, a national sales tax would decrease the tax burden on the wealthiest Americans. In order to be revenue neutral, that burden would have to be shifted somewhere else. Your proposal would shift it to the middle class.

          • Maximus

            But you are assuming that there would necessarily need to be a shift. Most economists agree that a national sales tax would generate significantly more in revenue than an income tax. I don’t believe there would need to be a shift at all…in fact we could start making significant dents in the deficit to boot.

          • Jim Smart

            If there’s more revenue, someone’s paying more in taxes. Who is it?

          • Maximus

            The people who weren’t paying federal tax to begin with i.e. illegal immigrants, those that work the system with loopholes, etc…

    • Charles Arnold

      I agree a flat sale tax makes more sense than a flat income tax. Not only would you have more money to spend, but also anyone who buys things in the U.S. would be paying it also. So more money in the coffers for the Government. But I doubt it would ever pass, because it would put to many people out of work at the IRS and other Government offices dealing with tax codes.

  • Rebecca

    After reading the comment by Maximum, I’ve got to say that he has a very thought provoking idea; especially due to the fact that it would certainly allow for almost no “exemptions” for folks trying to beat the system! I would, however, be in favor of trying a flat rate system, but would like to see it tiered. ( ie: 5% for those with an income less than $15,000, 10% for less than $25,000 but more than $15,000, 15%. for less than $45,000 but more than $25,000, 20% for less than $75,000 but more than $45,000, 25% for less than $100,000 but more than $75,000 .…. You get the idea. I can’t help but recall a cartoon I saw some years ago. It showed the “latest and greatest” idea from the IRS for the most simplistic tax form yet. It was the size of a 3 x 5 post-it. It read: “Write down what you made. Send it in.”. :)

    • Maximus

      Rebecca, although I understand where your coming from with the tiered tax it really would not be necessary. With the Fair Tax, the effective tax rate is dependent on spending. For someone who spends at or below the poverty level, their effective tax rate is 0%. That effective tax rate increases only as spending increases up to 23% for those spending over $2 million. So in essence it is a progressive tax system. It’s just based on spending instead of income which philosophically makes much more sense. Do we want to punish heavy spending or hard work and income generation?

      • Jim Smart

        Spending is what drives our economy. Additionally,those paying the highest percentage of their income in taxes in your scenario would be middle income Americans. Since you propose exempting low spending and those with the highest incomes don’t spend as much of their money in percentage terms, the highest burden would fall on the middle class. That would never fly.

        • Maximus

          Spending is a relatively short-term drive of our economy since it is not infinitely sustainable. Resources are limited. This is Economics 101. People will spend regardless of whether their income or sales are taxed. With a sales tax, at least the consumer gets to decides how and how much to spend of all his/her income. And the middle tax already carries most of the tax burden, because most of the wealthy have accountants that are able to bring down their effective tax rates. If you look at the Fair Tax effective rate chart, the more money you spend, the higher your effective tax rate. Since wealthy spend much more than the poor or middle class, they will generally have a higher effective tax rate.

          • Jim Smart

            It’s not true that the more you spend the higher your rate. It’s the more you spend as a percentage of your income. The poor spend the highest percentage of their income, out of necessity. They also have the highest state and local tax burden by percentage. Changing to a sales tax would take the only progressive tax other than capital gains (income tax) and make it regressive like almost every other tax.

          • Maximus

            That is simply not true. With the Fair Tax, anyone below poverty level doesn’t pay any tax at all. In fact they get a prebate. And philosophically, why should the wealthy have to pay a higher percentage of their income in tax? That is counter intuitive to everything this country is about. There have to be incentives to work, make money, etc…

          • Jim Smart

            The wealthiest 1% make 21.9% of the income and pay 24.0% of the total taxes. The next 4% make 14.3% of the total income and pay 15.3% of the total taxes. The next 5% make 10.1% and pay 10.7% Those numbers don’t scream a lack of equity in total tax burden to me.

          • Christine

            I don’t understand how a flat sales tax would generate an equal tax for all and provide the surplus lost on income tax. What is to keep the ultra wealthy from buying what they need, want outside of the United States thus reducing tax generated and effecting a job loss for American workers?

    • AvidReader

      Thanks! You saved me the time of writing a long post!
      I also agree that a “Tiered” Flat Tax System would be a good idea.
      Do I foresee that coming? No. Because, as others have stated, it would eliminate many IRS and governmental jobs, the wealthier folks would complain (as they’d pay a higher %age and lose all of their loopholes), etc. There are too many “politics” in the tax system for this idea to pass.
      I also think that since this idea isn’t going to pass, the IRS needs to hire additional auditors to oversee the small business/self-employed; to crack down on those that take advantage of the system. I’m speaking primarily of those that claim business deductions that were, in reality, personal. For example: For many years, a former relative has been able to annually deduct more than my total income, by claiming nearly all expenses as business expenses. The vehicle (and it’s gasoline) was expensed as 100% business use (though this person owned no other vehicle and often filled the vehicle at the same time filling watercraft and lawnmower), around 50% utilities expensed to business, though this person was the only employee and worked from home, 100% of personal legal and accounting fees disguised as business expenses, and on and on. I’m sure there are many more small business/self-employed people taking advantage of the system, like this former relative, who, by the way, has never been audited.

  • Maximus

    You just detailed one of the major advantages of a sales tax system….it’s much simpler and there is less bureaucracy. And there is most definitely an incentive to report the transaction….FEDERAL LAW

    • Wood Smith

      Your confusing a deterrent with an incentive. An incentive is something that rewards/benefits someone for their action. A deterrent is something that penalizes someone for their action. There are already federal laws requiring one to report income. And as we know, many people still do not report all their income.

      Even if the Ford dealer does report the sale, there is nothing stopping him from reporting it inaccurately. The dealer could collect $35,000 from Joe but report the sale as only $15,000, thus saving Joe sale taxes on $20,000. This could be part of the negotiation process between the dealer and Joe to close the sale. And there would be no way to disprove the reported values unless all the old income based deductions/itemizations were still tracked and reported.

  • pappadaddyo

    All of the flat tax proposals I’ve seen are based on taxing all EARNED income, not all income is earned. A combination of a value added sales tax. exempting things like food and medication with a flat tax on ALL income of any kind would find a large voter supporting group crossing all party lines. Couple that with a balanced budget law, with an exemption for a constitutionally correct congressional declaration of war, federally funded campaigns to end the prostitution of our government, and we may have a chance of reclaiming our republic!

  • Leslie Standifer

    I would prefer a flat tax I’m tired of working to make more money get raped on taxes throughout the year then owe money at the end on the year. While someone with 5 kids making minimum wage and no ambition gets a hefty refund merely because they have a lot of kids. I would welcome everyone chip in pay your portion and no refunds. people who complain it further distances the rich from the poor don’t realize 20% of 300k is a lot more than 20% of 25.5k….

  • A Lee Lowe

    Flat tax with categories, retired with minimal income no tax. Low earners low flat tax. Business flat tax allow necessary to operate over head deductions, and necessary business expenses only. Pork has to go. File monthly along with tax due. Done deal. Irs checks it, accept or deny, done deal. Paperwork reduction and years of storing documents that offer problems with identity theft. Gone. Trees will love this. This would make more time to deal with large business and they would pay their fair share and less people with access to your whole life at their degression, less employees of IRS and the list goes on.

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