What is flat tax?

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Every country has its taxing system. For example, in the United States, the government uses the progressive tax system. Other countries, like Estonia, Ukraine and Georgia, use the flat tax system, a single tax rate applied to all taxpayers regardless of their income levels. This means individuals with low incomes pay the same tax rate as high-income earners.

In this guide, we’ll explore the main features of the flat tax and how it works.


Key insights

A flat tax aims at equity by having a single-tax rate for all taxpayers, irrespective of income level.

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Supporters of the flat tax system argue it stimulates the economy by encouraging high-income earners to invest their excess income.

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Critics argue that a flat tax rate system burdens low-income earners, leaving them with a low disposable income.

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Understanding flat tax

A flat tax system is a uniform tax rate for all individuals, regardless of their income level. This tax system doesn't allow deductions or exemptions. Supporters of the flat tax system believe it encourages people to work harder and make more since they won't be “punished” by paying more tax.

Doug Carey, the president of WealthTrace, is a big proponent of the flat tax system. "There is no doubt that a progressive tax system penalizes people for working more and earning more income. Therefore, progressive tax rates reduce the incentive to work," he said.

Carey also believes that a flat tax could positively impact the economy. “By moving to a flat tax rate, people would be encouraged to work more [and] harder because they’d be able to save more of the money they've earned. That would increase federal tax revenues, provide economic stability, and even boost business investment," he said.

Critics of the flat tax argue that the system burdens low-income households and lowers tax rates for high-income earners. They believe the progressive tax system is fairer and more effective.

Progressive and regressive taxes: How they compare

The progressive tax system is not the only one that contrasts with the flat tax. There’s the regressive tax system, which is the opposite of the flat tax. Here’s how the progressive and regressive tax systems compare.

Progressive tax

The tax burden increases in the progressive tax system as the income level increases. In this case, the tax burden is on high-income earners. For example, in 2023, taxpayers earning up to $11,000 pay a tax rate of 10%, and those earning $578,126 and above pay a tax rate of 37%. This is the tax system used in many countries, including the U.S.

The flat tax is also usually lower than the progressive tax rate. For example, the flat tax rate for Estonia in 2024 is 20%, even for high-income individuals.

Regressive tax

A regressive tax system is one in which the tax burden reduces as income increases. The tax is, therefore, regressive because even with everyone paying the same amount, low-income earners spend a bigger portion of their salaries on taxes than high-income earners.

Scandinavian countries like Denmark, the Netherlands, Switzerland and Norway use this system.

» MORE: Tax credits 2023-2024

How flat tax works

As mentioned, individuals with high incomes don't fall under a higher tax bracket under the flat tax system. There's just one tax bracket for everyone. This explains why supporters of the system argue it encourages the rich to invest their excess earnings in the economy.

However, since low-income earners have the same tax rate, they have a low disposable income. Critics of the flat tax system argue this increases the disparity between the poor and the rich.

For example, Mr. X and Mr. Y earn $10,000 and $120,000, respectively. If the tax rate is 12%, this is how their income is affected:

  • Mr. X's tax amount will be $1200 (12/100 x 12,000), and his disposable income will be $8800 ($12000 - $1200) after tax.
  •  Mr. Y's tax amount will be $14,400 (12/100 x 120,000), with a disposable income of $105,600 ($120,000 - $14,400) after tax.

This leaves Mr. Y with a higher purchasing power than Mr. X. Proponents of the tax system argue the taxpayers are left with the same income percentage, so it's fair.

Pros and cons of flat tax

Like any tax system, the flat tax has strengths and weaknesses. Compared to a progressive tax, this system makes filing and tax calculation effortless. Taxpayers don't have to hire a professional to help file flat taxes since it's pretty straightforward.

However, since the tax system doesn't consider income level as a basis for taxing, low-income households struggle to meet their basic needs. Here are the pros and cons.

Pros

  • Simplifies filing
  • Reduces tax fraud
  • Everyone pays same tax rate

Cons

  • Heavy burden on low-income individuals
  • Poor income distribution
  • Low government revenue

» MORE: What is tax relief?

Flat tax vs. progressive tax

The flat tax contrasts with the progressive tax in different ways. Here are the main ways they differ.

Taxing concept

The flat tax system has a single rate for everyone, while the progressive tax has different tax brackets. The latter means a taxpayer's tax rate shifts with their income; the higher the pay, the higher the tax you owe.

Exemptions and deductions

With the progressive tax system, there are several programs taxpayers can utilize to get tax relief. However, the flat tax rate systems don't allow exemptions or deductions.

Also, under the flat tax system, the government excludes other sources of income from the taxable income. This includes investment returns, capital gains, interest on insecurities, and dividends on bonds. Under the progressive tax system, the IRS requires taxpayers to report all incomes when filing taxes.

Income distribution

A flat tax rate burdens low-income individuals, leaving them barely enough to buy necessities. On the other hand, progressive taxes burden high-income earners by taxing them more. The government uses the extra income to improve the economy and living standards for low-income earners.

Simply put, a flat tax is based on equality, while a progressive tax aims to improve income redistribution in society.

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FAQ

What is an example of a flat tax?

Estonia's tax system is an excellent example of a flat tax. Individuals pay a 20% tax rate on their income, excluding personal dividend income. Corporates also pay 20%, which is applied only to distributed profits.

What is the difference between a flat tax and a fair tax?

A flat tax is where all taxpayers pay the same tax rate to the government. A fair tax rate is a proposed tax system in the U.S. that aims at combining all taxes into a single sales tax.

Who is most affected by flat taxes?

Low-wage individuals are most affected by flat taxes because they pay a significant percentage of their income compared to high-income earners.

Bottom line

A flat tax is a single tax rate system in which all individuals pay the same tax percentage regardless of income level. While this seems fair to many, the tax burden falls on low-income earners, who spend a considerable percentage of their income on taxes.

Advocates of the flat tax rate system argue it stimulates the economy by encouraging people to work more without being penalized for earning more. While fairness and simplicity are excellent characteristics of a tax system, they’re not enough to sustain an economy or cater to the welfare of a country's residents. This is why it's not feasible for developed countries.


Article sources

ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:

  1. Republic of Estonia, “Tax rates.” Accessed March 11, 2024
  2. IRS, “Federal income tax rates and brackets.” Accessed March 11, 2024.
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