Pros & Cons of a Flat Tax

by Kevin Johnston
Simplifying taxes with a flat tax could complicate the issue of fairness.

If you find the current tax code mind-boggling, you’re not alone. Many politicians and tax professionals recommend that the tax code be scrapped and replaced by a flat tax -- one percentage of income that everybody pays. As simple as that sounds, critics point out several problems a flat tax would cause. Consider whether the benefits of a flat tax outweigh the drawbacks.

Tax Reductions

According to the Tax Policy Center, the flat tax rate under the proposed Hall-Rubushka proposal would lower taxes on the wealthiest individuals. Robert Hall and Alvin Rubushka of the Hoover Institution proposed in the 1980s that the government tax all individuals and companies at 19 percent. This amounts to a reduction for the wealthiest individuals. Some other earners would get a deduction as well. Under the current tax code, many individuals pay an effective rate of 25 percent or more, so taxes for these people would go down.

Tax Increases

A flat tax on everybody would raise taxes on the poorest Americans, who currently pay no taxes. Because of the current earned income credit, poor families can receive a refund of up to $3,370. A flat tax would eliminate that credit and refund and levy a tax on any income earned, no matter how little. As of 2012, the Department of Health and Human Services says one person earning $11,170 or less each year is in poverty. This person would pay $2,122.30 in taxes if the flat rate is set at 19 percent and the taxpayer cannot take any deductions.

Consumption Tax

Some flat-tax plans levy taxes only on money that people use to consume goods and services. That means savings and investments qualify for an exemption from tax. You only pay tax when you withdraw the money and spend it. This would encourage savings among middle and low income earners, who could delay taxes on earnings by putting money in investments. High income earners, however, who already tend to invest, would save proportionately more money under a consumption tax.

Simplicity

A flat tax eliminates deductions, and this simplifies tax preparation. However, "The New York Times” points out that taxpayers would still have to calculate their adjusted gross income. This means you would have to wade through your tax exemptions and exclusions before reporting your taxable income. Tax brackets would be eliminated, but tax adjustments would not. For example, the Hall-Rubushka proposal allows a $25,000 exemption for a family of four. Taxpayers who don’t have a family of four would have to figure their exemption. Businesses would still subtract expenses from income before calculating taxable income, so they would do much of the same accounting they perform under the current tax code.

Charity

A flat tax would eliminate deductions for giving to charity. This could discourage charitable giving. Currently, wealthy donors tend to give to universities and hospitals, whereas low-income wage earners tend to donate to religious institutions. A flat tax could alter that pattern. Religious organizations could argue that they get penalized under a flat-tax system because low-wage earners might stop giving if there is no tax break for charity, whereas wealthy donors might continue to give because they can afford it.

About the Author

Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.

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