What is proportional tax?

Understanding proportional tax

A proportional tax is a single-rated tax where all income earners are taxed equally without considering income level. Since the tax is charged the same for everyone (low, middle and high-income groups), it’s also known as the flax tax.

Advocates of proportional taxes believe that the flax tax system helps stimulate the economy by encouraging people to work hard and earn more, with no tax penalty for making more. In fact, an increased income lowers the impact of the tax burden.

David Brillant, an estate lawyer and the founder of Brillant Law Firm, believes proportional tax can affect economic behavior. “From my practice, I’ve observed that tax changes, such as the proposed modifications to capital gains and corporate taxes, can indeed influence economic behavior,” he said.

“For example, the anticipation of the increase in the long-term capital gains rate from 20% to 25% as discussed in 2021, and changes in unified credit against estate and gift taxes significantly impacted our clients' decision-making regarding investments and estate planning,” he continued.

This differs from the progressive tax system, where the tax burden increases as income increases. With that system, low-income earners can even apply for tax relief if offsetting the tax liability will cause a financial strain.

Also, supporters of the proportional tax system argue that businesses are likely to invest more under this system, increasing money circulation in the economy.

Proportional taxation also differs from the regressive tax system, which charges the same dollar amount to all taxpayers.

» MORE: What is tax relief?

How proportional tax works

Critics of the proportional tax system argue it’s a financial burden on low-income earners. Although everyone pays the same percentage of their taxable income, the tax rates impact taxpayers differently depending on their income level. Those with less income struggle more under this tax system.

For example, the U.S. imposes taxes on all retail items sold. The consumer pays the tax to the retailer, who then remits it to the government.

Sales tax is an example of a proportional tax because every consumer pays the same tax rate on a particular product regardless of their income level.

For example, two individuals, Mr. X and Mr. Y, purchase baby clothes of the same value. One article of clothing costs $150, and the sales tax rate is 8%. This means they both pay a tax of $12 (8% of $150):

•  Mr. X earns $1200 per month, so with his income level, the $12 is 1% of his income (12/1200)x100).
•  Mr. Y earns $12,000 per month, so with his income level, the $12 is 0.10% of his income (12/1200)x100).

Even if the two individuals pay the same tax rate, Mr. X, with a lower income, pays a higher percentage of his income than Mr. Y.

Pros and cons of proportional tax

Regardless of the proponents and staunch critics, the proportional tax system has its strengths and weaknesses. For some, the proportional tax system is considered fair as everyone pays the same tax rate. However, the proportional tax rate is rigid, and since every individual must pay the tax amount regardless of their income level, imposing high taxes will burden low-income earners.

Here are more pros and cons to consider:

» MORE: Tax credits

Bottom line

The proportional tax system charges everyone the same percentage of their income, and it’s used in different countries worldwide. Although this tax system is easy to understand, it can be regressive, as it significantly affects low-income earners. It can also harm the economy and have political implications in a country.

Policymakers must consider the advantages and disadvantages of a tax system before implementing it. An effective tax system should be fair and efficient, allowing the government to generate enough revenue for its projects.