What Is a Flat Income Tax System?

Details on the Flat Tax System

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A "flat tax" is an income tax system in which everyone pays the same tax rate regardless of income. Flat tax is in place in eight U.S. states as of 2019, and several countries use this system as well—including Russia, Latvia, and Lithuania.

The U.S. federal government operates on a progressive tax system. The more you earn, the greater a percentage in taxes you'll pay. For example, single taxpayers pay a 12% tax rate on incomes up to $9,700 in 2020, but they pay 32% on income over $160,725 up to $204,100.

States With a Flat Tax Income System

Colorado, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, Pennsylvania, and Tennessee use the flat tax system as of 2019. Rates range from a low of 3% in Tennessee up to the highest rate of 5.10% in Massachusetts.

Some Federal Tax Rates Are Already Flat

Social Security and Medicare taxes are examples of a flat tax system already in place in the U.S. Employees pay 6.2% of their earnings in Social Security tax up to a wage base of $132,900 as of 2019. Earnings above $132,900 are exempt—the rate doesn't increase. They pay 1.45% of their earnings to Medicare, regardless of how much they earn.

Only Earned Income Is Taxed 

Another aspect of this tax philosophy removes double taxation by taxing only earned income. Dividends, interest on savings, and capital gains that result from investment or increases in asset value are not taxed under a pure flat tax system. This is intended to encourage investment.

The Flat Tax Simplifies Taxation 

Advocates of the flat tax system contend it's fair because everyone pays the same tax rate. This system typically eliminates deductions, tax credits, and most exemptions, which in theory curbs biases toward certain behaviors and activities. It also simplifies the tax code, making compliance easier.

Economic Growth and the Flat Tax

Supporters of a flat tax system claim it encourages economic growth by avoiding a system in which earners with higher incomes are penalized for being productive and earning more money.

Proponents argue that a progressive tax creates penalties for things like hard work, risk-taking, and entrepreneurship. The flat tax is supposed to avoid this by taxing every dollar at the same rate.

Reducing the top income tax rate by moving to a lower flat tax rate is thought to attract and encourage business investment at the state level, and to bring in high-income individuals, increasing overall tax revenue and economic stability.

Arguments Against a Flat Tax System 

Opponents argue that a flat tax system places an undue burden on the lower and middle class by removing deductions and expanding the tax base to include every level of income. They claim that moving to such a system shifts the tax burden from the rich to the poor—those who are most affected by taxation and the least able to pay.

Detractors contend that the working class supports the rich when unearned income is exempted. Some flat tax systems in the United States get around this by exempting individuals who fall below certain income levels and by offering special exemptions or tax credits for low-income taxpayers.

Opponents of the flat tax argue that progressive tax systems are fair because they tax disposable earnings—income minus certain deductible expenses. They argue that the wealthy should pay more because they have more disposable income and therefore a greater ability to pay, and that the economy would be better stimulated by decreasing taxes on the middle class, who make up the largest part of the general public. This would give more people additional disposable income to spend on products, they contend.