Definition and Example of a Flat Tax System
A flat tax system requires all taxpayers to remit the same percentage rate, no matter how much they earn. Most flat tax systems exempt those living below the poverty line.
Many U.S. states and several nations use a flat tax system, including Russia, Latvia, and Lithuania. 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.
A sales tax is an example of a flat tax. The tax is a fixed percentage of the product or service sold. Rich or poor, everyone pays the same amount. Sales tax laws generally exempt essential goods like food, to reduce the burden on the poorest consumers.
How a Flat Tax System Works
A flat income tax is notably simpler than a progressive tax. The tax is imposed on the money as it is paid into a household.
Although any number of variations are possible, a flat tax often eliminates most tax breaks like a mortgage interest deduction or a child tax credit. There are usually no additional taxes on interest, capital gains, or dividends.
Nine U.S. states have a flat tax income tax system as of 2022. They include Colorado, Illinois, Indiana, Kentucky, Massachusetts, Michigan, North Carolina, Pennsylvania, and Utah. The rates range from a low of 3.07% in Pennsylvania up to 4.99% in North Carolina.
Part of the FICA Tax Is Flat, Too
Social Security is an example of a flat tax. Employees pay 6.2% of their earnings in Social Security tax up to $147,000 in tax year 2022. While all flat taxes are regressive, the cap on the Social Security tax makes it even more regressive.
This tax is labeled as FICA tax on employees' W-2 forms. Self-employed people pay a comparable SECA tax for themselves plus an employer's share on behalf of their employees.
All employees pay 1.45% of their earnings to Medicare (also included in FICA), and employees who earn more than $200,000 pay an Additional Medicare Tax of 0.9% (for a total of 2.35%). So, oddly, the Medicare portion of the FICA tax is a progressive tax, not a flat or regressive one.
Pros and Cons of a Flat Tax System
Avoids double taxation
Simplifies the tax code
Shifts tax burden to lower and middle classes
- Avoids double taxation: The flat income tax philosophy addresses an issue that its proponents call "double taxation." That is, in a progressive tax system, taxes may be levied on earned income and again on dividends, interest, or capital gains that result from the investment of (post-tax) income.
- Simplifies the tax code: A flat tax generally simplifies the tax code, making compliance easier. Critics point out that the U.S. Tax Code in 2021 was comprised of about 10,000 sections, not counting the volumes of case law.
- Perceived fairness: Another perceived advantage is improved fairness. The federal tax system is not only complex but is subject to interpretation. Those with the most expert tax preparers often pay the least in taxes.
Proponents argue that reducing the top income tax rate by moving to a lower flat tax rate encourages business investment and attracts high-income individuals, increasing overall tax revenue and economic stability.
- Lost revenue: Revenue could be lost with a flat tax system, depending on just how high that flat tax rate is. Federal revenue totaled $1.52 trillion in the first four months of the fiscal year 2022, and more than two-thirds of that came from personal income taxes, including taxes on capital gains, dividends, and interest. The rate could end up being higher than is politically acceptable if a flat-rate tax system were to replace that revenue. A flat tax could also eliminate altogether some taxes that wealthier individuals tend to pay, such as capital gains, dividends, and interest income taxes.
- Shift tax burden to lower and middle classes: A flat tax system could greatly reduce taxes on the richest Americans. Tax rates range from 10% to 37%, depending on income. Assuming that more commonly used deductions are eliminated, the tax burden could shift dramatically to the lower and middle classes.
Some flat tax systems in states get around the issue of shifting the tax burden from the upper to the lower and middle classes by exempting individuals who fall below certain income levels and by offering special exemptions or tax credits for low-income taxpayers.
Flat Tax System vs. Progressive Tax System
|Flat Tax System||Progressive Tax System|
|The same percentage applies to all income levels.||Percentages increase as income rises.|
|Everyone pays the same rate.||Wealthier taxpayers pay higher rates.|
|It often eliminates deductions and credits.||Spending is rewarded through deductions.|
Some American politicians have advocated a flat federal tax system. One proposal came from Republican U.S. Senator Ted Cruz, a presidential candidate in 2016. His plan would have imposed a 10% flat tax rate, raised the standard deduction to 10%, and raised the personal exemption to $4,000. It would have lowered the corporate tax rate to 16%.
A family of four with income below $36,000 would be exempt from taxes under this plan. Families could still claim some existing tax credits as well as deductions for charitable contributions and mortgage interest.
- A flat tax levies the same fixed percentage rate on all taxpayers.
- Examples of a flat tax include the sales tax and Social Security and Medicare taxes.
- The U.S. uses a progressive tax system, in which higher-income residents pay a higher percentage in income tax.
Federation of Tax Administrators. "State Individual Income Taxes."
European Central Bank. "Flat Taxes in Central and Eastern Europe."
Tax Foundation. "What Are Flat Taxes?"
Social Security Administration. "Fact Sheet Social Security."
Internal Revenue Service. "Topic No. 751 Social Security and Medicare Withholding Rates."
eFile. "Income Tax History."
Congressional Budget Office. "Monthly Budget Review: January 2022," Page 2.
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2022."
Tax Policy Center. "An Analysis of Ted Cruz's Tax Plan," Pages 2-3.