Definition of a Flat Tax
The Flat Tax system is a mechanism in which the same rate of tax is applied to every individual irrespective of their income levels. Also, no deductions or exemptions are allowed in this tax system. In this tax system, the person earning higher wages does not fall into a higher tax bracket, so this system gives incentives to people with higher wages. However, the person earning a lower income is also taxed at the same rate due to which critics argue that this system imposes a burden on the lower-income group.
Features of Flat Tax
#1 – Single rate of tax
A single rate of tax is imposed on every individual irrespective of their income level. Russia is one of the countries which has imposed a 13% flat income tax rate, though the tax rate for companies is different. Russia saw an increase of 25.2% in the first-year flat tax was introduced, followed by 24.6 and 15.2 % increase in the second and third years, respectively. The reason for the increase was the inclusion of more people in the tax bracket. So even though critics say that this system imposes a burden on the lower-income group, an increase in revenue in the hands of government is good for economies as the money can be invested in social welfare schemes.
#2 – Deduction/Exemptions not Allowed
The tax is imposed at a flat rate, and no deduction or exemption is allowed. In some cases, governments do allow certain deductions and exemptions based on conditions.
#3 – Regressive in Nature
A regressive tax is one where the person with low income pays higher taxes, and a person with higher income pays lower taxes. Although the tax percentage remains the same, let us understand how it taxes more to the lower-income group.
Example of Flat Tax
Mr. X, Y & Z have income of $85,000, $95,000 & $120,000 respectively. If we consider the tax rate to be 12% flat rate, then Mr. X has to pay $85,000*12% = $10,200, Mr. Y has to pay $95,000*12% = $11,400 and Mr. Z has to pay $120,000*12% = $14,400.
If we see the calculation above, a flat tax system leaves more amount in the hands of Mr. Z as compared to Mr. X as his income is more compared to Mr. X. Critics argue that this tax system leaves the same percentage of money in the hands of the lower and higher-income groups. That leaves the lower income group with less money to spend on their needs. In some of the countries, politicians argue that a flat tax rate with certain exemptions and deductions to the lower-income group should be introduced.
Sales Tax is also a Flat rate system. The rate of tax is the same for everyone. Let’s say two people with different income groups buy a trouser worth $80, and the tax rate is 7%. Both of these individuals, irrespective of their earnings, pay $80*7% = $5.6 as sales tax. In this case, we see that lower and higher income groups have both been taxed at the same rate.
Goods and Service tax in many countries, Harmonised Sales Tax in Canada, and other indirect taxes across the globe are of flat tax nature. These taxes are levied at a flat rate and individual buying the goods or services has to pay the tax irrespective of the level of his earnings. Also, property taxes, wealth tax, county taxes, and other local taxes are mostly charged at a flat rate for every individual.
- It induces motivation to earn more.
- Tax filing becomes easier.
- Increases the tax collection, which is good for the economy.
- More people fall into the tax net, which improves tax collection and compliance.
- Self-assessment and tax payments become easier for corporates.
- It is easier to calculate and keep track of
- It reduces tax evasionTax EvasionTax Evasion is an illegal act in which the taxpayers deliberately misreport their financial affairs to reduce or evade the actual tax liability. This includes using multiple financial ledgers, hiding or representing lesser income, gains, or profits than actually earned, overstating deductions, & failing to file returns. .
- The same tax rate for the lower-income group is not appreciated by many.
- It is regressive in nature.
- Demotivation for lower-income group people as they pay the same rate of tax as a higher-income group.
- Many countries prefer a progressive taxProgressive TaxProgressive tax refers to the increase in the average rate of tax with the increase in the amount of taxable income so that the liability of paying heavy taxes passes to those who earn a higher income and those with lower income can have a relaxation from the heavy income tax obligations. system and not a flat tax.
- Tax collection may fall in certain scenarios.
- Its regressive nature is always a roadblock for the flat rate system.
- In a fair world, the government prefers the progressive nature of the tax rate system.
- Conditions of economy, working population, and various other factors decide the success or failure of such a tax system.
Points to Note
A flat tax system, when introduced, requires changes to be updated in the accounting system, software, and other fields. Before implementation, any government must study the demographics in detail. If implemented forcefully, there could be social outrage and government failure. The government and tax officials must be in a position to explain how this system will improve the tax collection and beneficial for the economy. Also, it has to keep in mind that the introduction of the flat-rate system does not leave lower-income groups struggling for their basic needs. Once implemented, any change needed in the rate of taxes must be discussed in detail to study its impact on people and the economy.
The flat tax system is a good system and easier to monitors; however, its regressive nature does not go well with many politicians and economists. To make it progressive in nature, a flat tax rate should be introduced with certain exemptions and deductions available to the lower-income group. In that way, the government would be able to justify that lower-income group people are being taxed less as compared to higher-income group people, and that way, the acceptance will be easier. In many countries there has been a significant increase in tax collection after the introduction of a flat tax system, Russia is one. So, we see that if implemented carefully after appropriate analysis, this system can be beneficial for people, government, and country. Also, the straight forward nature of this system makes it easier to comply with and make tax planning and filling easier for individuals and corporations.
This article has been a guide to what is Flat Tax and its definition. Here we discuss the features of Flat income tax system along with examples, advantages, and disadvantages. You can learn more about Finance from the following articles –