Home » Taxes » Flat Tax Impact On Saving And The Economy

Flat Tax Impact On Saving And The Economy

August 22, 2023
Bill Kimball

Flat tax supporters often cite the nation of Estonia as proof of the system’s benefits. Pinned between Russia and the Baltic Sea, Estonia is a tiny country with under two million residents, roughly the size of Dallas, Texas. In 1994, just three years after separating itself from the Soviet Union, Estonian policymakers made the choice to go to a 26% flat tax, the first in the world to move away from the gradual system.

How can I legally not pay taxes?

If you want to avoid paying taxes, you’ll need to make your tax deductions equal to or greater than your income. For example, using the case where the IRS interactive tax assistant calculated a standard tax deduction of $24,800 if you and your spouse earned $24,000 that tax year, you will pay nothing in taxes.

Because of the income cap, the FICA tax system is not a progressive one. Emily Ernsberger is a fact-checker and award-winning former newspaper reporter with experience covering local government and court cases. Her stint as a legal assistant at a law firm equipped her to track down legal, policy and financial information. Plus church tax for members of certain religions, also at a flat rate. Investopedia requires writers to use primary sources to support their work.

Personal Loans

It had to take a bailout from the International Monetary Fund in order to pay public sector workers. She holds a Bachelor of Science in Finance degree from Bridgewater State University and has worked on print content for business owners, national brands, and major publications. Samantha Silberstein is a Certified Financial Planner, FINRA Series 7 and 63 licensed holder, State of California life, accident, and health insurance licensed agent, and CFA. She spends her days working with hundreds of employees from non-profit and higher education organizations on their personal financial plans. Employees also pay 1.45% of their earnings to Medicare, regardless of how much they earn. The rates range from a low of 3.07% in Pennsylvania up to 5.25% in North Carolina.

What is the argument against a flat tax?

Opponents argue that a flat tax system would transfer the tax burden to lower-income and middle-income taxpayers. A flat tax could also eliminate altogether some taxes that wealthier individuals tend to pay, such as capital gains, dividends, and interest income taxes.

Some American politicians have advocated a flat federal tax system. One proposal came from Republican U.S. Sen. Ted Cruz, a presidential candidate in 2016. His plan would have imposed a 10% flat tax rate, raised thestandard deductionto 10%, and raised thepersonal exemptionto $4,000.

Advantages Of A Flat Tax

Critics believe a progressive tax system is fairer than a flat tax system. A flat-tax system is one in which everyone pays the same rate, regardless of income. While the U.S. federal tax system is progressive, meaning that a worker’s income is taxed according to her level of income, some states have flat taxes on income as well. In general, the question of how to eliminate deductions is fundamental to the flat tax design; deductions dramatically affect the effective “flatness” in the tax rate. Perhaps the single biggest necessary deduction is for business expenses. If businesses were not allowed to deduct expenses, businesses with a profit margin below the flat tax rate could never earn any money since the tax on revenues would always exceed the earnings.

Flat Tax

And it has also earned the nickname “The Baltic Tiger” due to its incredible economic growth rate. From 2000 to 2008, Estonia’s economy grew by an average of 7% per year. The business tax base is sales less investments and less other items. Thus in a recession, if investment drops more than sales, tax payments will rise, rather than falling as they would under the income tax. This double taxation creates tax bias against saving and investment. This leads to lower levels of investment in the economy and a smaller capital stock, or less productive stuff in the economy. The retail sales tax taxes consumption by levying a tax directly on what people purchase at the cash register.


For example, in the United States, short-term capital gains are taxed at a higher rate than long-term gains as means to promote long-term investment horizons and damp speculative fluctuation. Iceland introduced a national flat tax on personal income in 2007, at a rate of 22.75%. With the additional municipal tax, which was already flat, the total tax rate was up to 36%.

  • A capped flat tax is one in which income is taxed at a flat rate until a specified cap amount is reached.
  • A flat tax also would eliminate virtually all compliance costs (e.g., monies paid to professional tax preparers) and reduce red tape significantly.
  • Alas, while the new system would certainly be simpler , proponents of the flat tax are likely to be disappointed by the impact on saving.
  • Many flat-tax proposals have exceptions for investment income, so the interest you earn in a money market account won’t get taxed.
  • That takes the burden off lower-income people and helps reduce income inequality.
  • Others, however, say that these nations rely on exports, which suffered greatly due to the downturn facing major economies.
  • People have purchased homes expecting to receive mortgage interest deductions; businesses have borrowed money and made investments expecting to take write-offs for interest payments and depreciation.

A flat tax system is usually discussed in the context of an income tax, where progressivity is common, but it may also apply to taxes on consumption, property or transfers. A payroll tax is a percentage withheld from an employee’s salary and paid to a government to fund public programs. A proportional tax is an income tax system that requires the same percentage of income from all taxpayers, regardless of their income. To illustrate, as of 2020, individuals earning up to $9,875 in taxable income pay 10% in tax, while those receiving over $518,400 pay up to 37% on their earnings.

Should The U S Switch To A Flat Tax?

As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. From the above calculations, the government takes $27,000 ($6,000 + $9,000 + $12,000) while the three taxpayers get to receive $153,000 ($34,000 + $51,000 + 68,000) cumulatively. Podcast of Rabushka discussing the flat tax Alvin Rabushka discusses the flat tax on PoliTalk. Podcast of Rabushka discussing the flat tax Alvin Rabushka discusses the flat tax with Russ Roberts on EconTalk. The winners and losers if Alberta returns to a flat tax system, Maclean’s, 9 May 2018. Crisis tax also in 2016; the tax rate decreased to 11% Archived 27 September 2016 at the Wayback Machine, Cafe del Montenegro, 14 November 2015.

Economists like consumption taxes because they are what is called “temporally neutral.” They are neutral with respect to consumption today and consumption tomorrow . Another way to think about a consumption tax is that it taxes, one-time, all the money people spend today plus the money people save, either when they save it, or when they spend it in the future. Examples of a flat tax include sales tax and Social Security and Medicare taxes. Many flat-tax proposals have exceptions for investment income, so the interest you earn in a money market account won’t get taxed. Modified flat taxes have been proposed which would allow deductions for a very few items, while still eliminating the vast majority of existing deductions.

Flat Tax

Outsiders who flock to Illinois as taxes become more progressive are anticipated net gainers from the tax reform and subsequent expenditures. On the flip side, higher earners will tend to flee the state because they have little appetite to provide these benefits to others. This happened in Maryland over a decade ago, when its sharp income tax increase led to a 30 percent decline in millionaire filers and a 22 percent decline in tax revenues from that same group. The anticipated $106 million revenue haul from the tax increase turned into a $257 million loss. What really matters, according to the Times, is how the additional revenues will be spent. But the Times muddles its account of a progressive tax system by rejecting the benefit theory of taxation, which holds that people are taxed according to the benefit received from government services.

Kentucky State Taxes 2021: Income And Sales Tax Rates

The value-added tax is similar to the retail sales tax, but instead of being levied once at the cash register, it is levied on the business at each stage of production. The woodworking business then makes a chair and sells it for $132.

But the business tax, a central part of all plans, cannot be left out of any serious calculation. It may be possible to fix some of these problems by moving to a cash flow tax at the business level that includes financial flows.

  • The argument goes that the poorest 20 percent of the public are disproportionately exposed to high state, county, and local sales taxes, which total 10.25 percent in Chicago.
  • Zakat has a flat rate of 2.5%, and income tax has a flat rate of 20%.
  • In 2016, US Senator and presidential candidate Ted Cruz proposed the adoption of a 10% flat tax rate in the US.
  • Outflows that are labeled purchases of goods and services or capital investments are deductible, while outflows that are labeled interest payments are not deductible.
  • To illustrate, as of 2020, individuals earning up to $9,875 in taxable income pay 10% in tax, while those receiving over $518,400 pay up to 37% on their earnings.

For example, if realized capital gains were subject to the flat tax, the law would require brokers and mutual funds to calculate the realized capital gain on all sales and redemption. If there were a gain, a tax equal to 15% of the amount of the gain would be withheld and sent to the IRS. The loss would offset gains, and then the IRS would settle up with taxpayers at the end of the period. 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 is one in which the government taxes high-income earners at a lower percentage of their income and low-wage earners at a higher percentage of their income. Second, Pritzker and the Times underestimate the power of the flat tax.

The system that is typically referred to as the “Flat Tax” arrives at a consumption base by taxing wages and salaries, but exempts investment income from taxation. You can think of it as a tax on all current consumption and saving, with no further tax on that what people saved in the future. It is close to the current income tax, but with Roth IRAs for all saving . Sales tax laws generally exempt essential goods like food from the tax to reduce the burden on the poorest consumers. The U.S. federal government uses a progressive income tax system, in which the percentage of taxes owed increases with the income of the taxpayer. Under a regressive tax system, low-income earners lose a higher percentage of their income to government taxes, while the rich pay a smaller percentage, but a higher gross dollar amount. In this tax system, a high tax rate is charged on high-income earners while the low-income earners are charged a lower tax rate.

Many of these subdivisions use a flat rate, even if their national government uses progressive rates. Examples are all counties and municipalities of the Nordic countries, all prefectures and municipalities of Japan, and some subdivisions of Italy and of the United States. However, this simplicity depends on the absence of deductions of any kind being allowed . Furthermore, if income of differing types are segregated (e.g., pass-through, long term cap gains, regular income, etc.) then complications ensue.

These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

In the US , a person earning an annual taxable income under $9,275 pays a 10% income tax, while those earning above $500,000 are charged 37% income tax. The progressive tax system is designed to ease the tax burden on low-income earners; the burden is shifted to high-income earners with a large amount of disposable income. In 2016, US Senator and presidential candidate Ted Cruz proposed the adoption of a 10% flat tax rate in the US.

What Is A Flat Tax?

Take the example of person A and B who earn $10,000 and $100,000 per annum, respectively, and they are subjected to a 15% tax rate for amounts below $50,000, and 5% for amounts above $50,000. This means that person A will pay a tax of $1,500 (15% x $10,000), while person B will pay a tax of $10,000 ($7,500 + $2,500). 07 Natural persons – tax rates and tariffs 2012–2021, Canton of Uri.

  • Taxes, in addition to providing revenue, can be potent instruments of policy.
  • Janet Berry-Johnson is a CPA with 10 years of experience in public accounting and writes about income taxes and small business accounting.
  • For example, if a flat tax system has a large per-citizen deductible (such as the “Armey” scheme below), then it is a progressive tax.
  • Jamaica had a flat tax of 25% on personal income until 2010, when it introduced additional higher rates of 27.5% and 33%.
  • First on board were Estonia’s two Baltic neighbors, Lithuania and Latvia.

Overview of New Hampshire taxes, Department of Revenue Administration of New Hampshire. Overview of individual tax system, Japan External Trade Organization. Flat tax proposals differ in how the subject of the tax is defined.

The rate was changed to 27% in 2006, 24% in 2008, and 15% in 2009. In 2019, Lithuania replaced its flat tax with progressive rates of 20% and 27%.