What is Proportional Tax?
Proportional tax is a single rated tax, wherein all the incomes, without considering the slabs or other criteria, tax is levied at a flat fixed rate irrespective of the kind of person or kind of income, thus, eliminating the concept of higher and lower earnings.
However, in the case of the progressive tax system, there prevails proper distribution of the tax burden as the individual with more earnings has a more tax burden than those having a low income. Still, in the case of proportional tax, all have to bear the same percentage of tax on their taxable value.
Calculation of Proportional Tax
Some of the countries in the world follow the flat-rate tax system, and they charge the same rate of tax on the earnings of the persons in the country without giving effect to the number of earnings whether the amount is high or low. So, the income tax system in those countries has a proportional tax rate.
For example, a country follows the proportional tax rate on the earnings of any person to calculate the tax payable by him. The rate of the tax is 10 %. During the year, Mr. X earns an income of $ 50,000, and Mr. Y earns an income of $ 5,000. Calculate the tax payable by Mr. X and Mr. Y on their earnings for the year under consideration.
In the above case rate of tax, remains to fix and don’t increases with the increase in the income of the person, so it is the case of the proportional tax so, the tax payable by Mr. X and Mr. Y will be calculated as follows:
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Here Mr. X is earning a total of $ 50,000 per annum, and Mr. Y is earning a total of $ 5,000 per annum. Although there is a huge income gap between the two but as the country in which they are residing follows the system of the proportional tax rate, so they both will be charged tax at the rate of 10 %.
- Tax liability = Taxable value (Income) * rate of tax
- Mr. X Tax liability = $ 50,000 * 10 % = $ 5,000
- Mr. Y Tax liability = $ 5,000 * 10 % = $ 500
Proportional Tax Example – Sales Tax
In the U. S., on the retail items which are sold in the market, sales tax is being imposed and is paid by the consumer to the retailer, which is usually calculated as the percentage of the retail cost. After collecting the sales tax, the retailer submits the payment collected to the respective state to which it belongs. Sales tax is also one of the examples of the proportional tax rate system because, in the case of the sales tax, the entire person pays the same rate of tax at the flat rate on the particular product, irrespective of the income earned by them during the period.
For example, there are two individuals Mr. A and Mr. B, who went to the same cloth shop to purchase the same items of the same value. Each of the persons purchased the cloth worth $ 150 from the cloth shop. The sales tax rate applicable to the cloth is 8 %. So, in this case, both of the individuals will have to pay tax at the rate of 8 % on the value of cloth purchased by them, which comes to $ 12 ($ 150 * 8 %). Now, the tax amount spends as per the current earnings of both of the individuals will be seen to know the tax paid with respect to the earnings gap among the two individuals doing the same transactions.
The first individual Mr. A earns $ 1,200 per month in total from all the works done by him, and the second individual Mr. B earns $ 12,000 per month in total from all the works done by him. If the ratio of tax paid with respect to the total earning is calculated, for the first person, Mr. A percentage of tax paid by him with respect to his income comes to 1 % [(12 / 1,200) *100]. In contrast, for the second person, Mr. B’s percentage of tax paid by him with respect to his income comes to 0.10 % [(12/ 12,000) *100] only.
It can be seen that the amount of sales tax affects both of the persons differently as even though the same rate of tax prevails for both of the individuals, Mr. B, who is having the lower-income, has to pay a higher percentage of tax when compare with Mr. A tax percentage. This flat rate system of charging the same rate of tax to all individuals without considering their earnings is a proportional tax system.
A proportional tax is a type of taxation system wherein all taxpayers (low, middle, and higher-income groups) are taxed at the same rate. Since the tax is charged from everyone at a flat rate, whether they are earning lower income or higher income, so, it is also known as the flat tax.
Thus, this system is the mechanism of taxation in which the tax authorities are levying the same rate of the tax on all the taxpayers irrespective of the amount of income earned by them. The people who are in favor of the proportional taxes believe that this system helps in stimulating the economy as it encourages the people to work hard and more as there is no penalty of tax for earning more income, which is there in case of the progressive tax system. Also, it is believed that businesses working in such a tax system are likely to invest more under this system, which will lead to more money circulation in the economy.
This article has been a guide to what is Proportional Tax? Here we discuss proportional tax calculation along with examples such as income tax and sales tax with detailed explanation. You can learn more about accounting from the following articles –