In the U.S. tax code, income tax is tiered according to income levels, and there are also many deductions and credits that taxpayers can claim. Critics of the code complain that such a complex system is too costly to administer and occasionally easy to evade. One alternative would be a flat tax system, in which everyone is charged the same percentage of their income across the board. While simple and streamlined, this system does have some downsides.
A flat tax that charges the same percentage to all, regardless of income level, would disadvantage those who fall below or at the poverty line. Wages at the lower end are the least competitive with the cost of living. Therefore, if those in poverty lose their tax advantages and have to pay proportionately the same as higher-wage earners, they become less able to afford basics such as food and shelter.
Loss of Incentives
Deductions and credits for certain expenditures provide an incentive to citizens to behave in certain ways. For instance, being able to deduct charitable donations provides an incentive to give to good causes. Being able to offset the cost of new windows encourages people to save energy. Thus the government can implement certain social policies through the tax code. A true flat tax with no deductions would mean this tool would be lost.
Millions of U.S. homeowners are locked into long-term mortgages on the understanding that paying mortgage interest entails a tax benefit. Changing the country’s system to a flat tax and removing the tax privileges of mortgage interest could have a devastating effect on the housing market. The economic effects of this could take a long time to work themselves out, as most mortgages have 30-year terms.
Currently, businesses save taxes on the money they contribute to employees’ retirement plans. This encourages prudent saving for retirement in “matching” plans, where employees and employers both contribute. If businesses no longer received a tax advantage for contributing to retirement plans, this could significantly change business strategies and lead to a long-term drain on retirement savings.