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

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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.

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