A flat tax (short for flat rate tax) is a tax To tax is to impose a financial charge or other levy upon a taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law system with a constant tax rate.^[1] A flat tax may also be called a tax in rem ("against the thing"), such as an excise tax on gasoline of three cents per gallon. Usually the term flat tax refers to household income (and sometimes corporate A corporation is an institution that is granted a charter recognizing it as a separate legal entity having its own privileges, and liabilities distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business profits In accounting, profit is the difference between price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses) being taxed at one marginal rate, in contrast with progressive A progressive tax is a tax by which the tax rate increases as the taxable base amount increases. "Progressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate. It can be applied to individual taxes or to a or regressive taxes A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. In simpler terms, a regressive tax imposes a greater burden on the poor than on the rich — there is an inverse relationship between the tax rate and the taxpayer's ability to pay as measured by assets, consumption, or that vary according to parameters such as income or usage levels. Flat taxes offer simplicity in the tax code, which has been reported to increase compliance and decrease administration costs.^[2]

Flat taxes that allow a tax exemption Various tax systems grant a tax exemption to certain organizations, persons, income, property or other items taxable under the system. Such status may provide a potential taxpayer complete relief from tax, tax at a reduced rate, or tax on only a portion of the items subject to tax. Examples include exemption of charitable organizations from for household The household is "the basic residential unit in which economic production, consumption, inheritance, child rearing, and shelter are organized and carried out"; [the household] "may or may not be synonymous with family" income below a cutoff level are not true proportional taxes A proportional tax is a tax imposed so that the tax rate is fixed as the amount subject to taxation increases. In simple terms, it imposes an equal burden on the rich and poor. "Proportional" describes a distribution effect on income or expenditure, referring to the way the rate remains consistent (does not progress from "low to, because, for household incomes below the cutoff level, taxable income Taxable income is the portion of income that is the subject of taxation according to the laws that determine what is income and the taxation rate for that income. Generally, taxable income refers to an individual's gross income, adjusted for various deductions allowable by statute. The main questions put by most individuals in any jurisdiction are is less than total income.

Tax effects

Distribution

Tax distribution is a hotly debated aspect of flat taxes. The relative fairness hinges crucially on what tax deductions are abolished when a flat tax is introduced, and who profits the most from those deductions.

Proponents of the flat tax claim it is fairer than stepped marginal tax rates In a tax system and in economics, the tax rate describes the burden ratio at which a business or person is taxed. There are several methods used to present a tax rate: statutory, average, marginal, effective, effective average, and effective marginal. These rates can also be presented using different definitions applied to a tax base: inclusive, since everybody pays the same proportion. Opponents of the flat tax, on the other hand, claim that since the marginal value Marginalism refers to the use of marginal concepts in economic theory. Marginalism is associated with arguments concerning changes in the quantity used of a good or of a service, as opposed to some notion of the over-all significance of that class of good or service, or of some total quantity thereof of income declines with the amount of income (the last $100 of income of a family living near poverty being considerably more valuable than the last $100 of income of a millionaire), taxing that last $100 of income the same amount despite vast differences in the marginal value of money is unfair.

Discouraging Wasteful Government Spending

Proponents of the flat tax system point out that there is a strong likelihood that another positive effect would be to discourage increased spending by government. The reason for this would be that any tax increase would affect all taxpayers. In the current tax system, government officials are able to win the approval of the public by raising taxes on certain groups to pay for new spending. If everyone's taxes had to go up with any new spending, every new government program would have to be carefully scrutinized. In the long run, the hope would be that government would become more efficient.

Administration and enforcement

A flat tax taxes all income once at its source. Hall and Rabushka (1995) includes a proposed amendment to the US Revenue Code implementing the variant of the flat tax they advocate.^[3] This amendment, only a few pages long, would replace hundreds of pages of statutory language (although it is important to note that much statutory language in taxation statutes is not directed at specifying graduated tax rates). As it now stands, the USA Revenue Code is over 9 million words long^{[citation needed]} and contains many loopholes, deductions, and exemptions which, advocates of flat taxes claim, render the collection of taxes and the enforcement of tax law complicated and inefficient. It is further argued that current tax law retards economic growth by distorting economic incentives, and by allowing, even encouraging, tax avoidance. With a flat tax, there are fewer incentives to create tax shelters and to engage in other forms of tax avoidance.

Under a pure flat tax without deductions, companies could simply, every period, make a single payment to the government covering the flat tax liabilities of their employees and the taxes owed on their business income.^[4] For example, suppose that in a given year, ACME earns a profit of 3 million, pays 2 million in salaries, and spends an added 1 million on other expenses the IRS deems to be taxable income, such as stock options, bonuses, and certain executive privileges. Given a flat rate of 15%, ACME would then owe the IRS (3M + 2M + 1M) x0.15 = 900,000. This payment would, in one fell swoop, settle the tax liabilities of ACME's employees as well as taxes it owed by being a firm. Most employees throughout the economy would never need to interact with the IRS, as all tax owed on wages, interest, dividends, royalties, etc. would be withheld at the source. The main exceptions would be employees with incomes from personal ventures. The Economist claims that such a system would reduce the number of entities required to file returns from about 130 million individuals, households, and businesses, as at present, to a mere 8 million businesses and self-employed.

This simplicity would remain even if realized capital gains were subject to the flat tax. In that case, the law would require brokers and mutual funds to calculate the realized capital gain on all sales and redemptions. If there were a gain, 15% of the gain would be withheld and sent to the IRS. If there were a loss, the amount would be reported to the IRS, which would offset gains with losses and settle up with taxpayers at the end of the period.

Under a flat tax, the government's cost of processing tax returns would become much smaller, and the relevant tax bodies could be abolished or massively downsized. The people freed from working in administering taxes will then be employed in jobs that are more productive. If combined with a provision to allow for negative taxation In economics, a negative income tax is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. Such a system has been discussed by economists but never fully implemented. It was developed by British politician Juliet Rhys-Williams in the 1940, the flat tax itself can be implemented in an even simpler way.

Economic efficiency

A common approximation in economics is that the economic distortion or excess burden from a tax To tax is to impose a financial charge or other levy upon a taxpayer (an individual or legal entity) by a state or the functional equivalent of a state such that failure to pay is punishable by law is proportional to the square of the tax rate.^[5] A 20 percent tax rate thus causes four times the excess burden or deadweight loss In economics, a deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, either people who would have more marginal benefit than marginal cost are not buying the product, or people who would have more marginal cost than marginal benefit are buying the product of a 10 percent tax, since it is twice the rate. Broadly speaking, this means that a low uniform rate on a broad tax base will be more economically efficient Economic efficiency is used to refer to a number of related concepts. It is the using of resources in such a way as to maximize the production of goods and services. One economic system is more efficient than another if it can provide more goods and services for society without using more resources. In absolute terms, a system can be called than a mix of high and low rates on a smaller tax base.^{[citation needed]}

Revenues

Some claim^[who?] the flat tax will increase tax revenues, by simplifying the tax code and removing the many loopholes currently exploited to pay less tax. The Russian Federation is a claimed case in point; the real revenues from its Personal Income Tax rose by 25.2% in the first year after the Federation introduced a flat tax, followed by a 24.6% increase in the second year, and a 15.2% increase in the third year.^[6] The Laffer curve In economics, the Laffer curve is used to illustrate the idea that increases in the rate of taxation do not necessarily increase tax revenue. . Increasing taxes beyond the peak of the curve point will decrease tax revenue. The Laffer curve was popularized by Arthur Laffer (b. 1940) in the 1980s. However, the idea is not new to him, nor did he predicts such an outcome, but attributes the primary reason for the greater revenue to higher levels of economic growth. The Russian example is often used as proof of this, although an IMF study in 2006 found that there was no sign "of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms" in Russia or in other countries.^[7]

Overall structure

Some taxes other than the income tax (for example, taxes on sales and payrolls) tend to be regressive. Hence, making the income tax flat could result in a regressive A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases. In simpler terms, a regressive tax imposes a greater burden on the poor than on the rich — there is an inverse relationship between the tax rate and the taxpayer's ability to pay as measured by assets, consumption, or overall tax structure. Under such a structure, those with lower incomes tend to pay a higher proportion of their income in total taxes than the affluent do. The fraction of household income that is a return to capital (dividends, interest, royalties, profits of unincorporated businesses) is positively correlated with total household income.^{[citation needed]} Hence a flat tax limited to wages would seem to leave the wealthy better off. Modifying the tax base can change the effects. A flat tax could be targeted at income (rather than wages), which could place the tax burden equally on all earners, including those who earn income primarily from returns on investment. Tax systems could utilize a flat sales tax A sales tax is a consumption tax charged at the point of purchase for certain goods and services. The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale. A portion of the sale may be exempt from the calculation of tax, because sales tax laws usually contain a list of exemptions. Laws governing the tax may to target all consumption, which can be modified with rebates or exemptions to remove regressive effects (such as the proposed FairTax The FairTax is a proposed change to the federal government tax laws of the United States intended to replace all federal income taxes with a single broad national consumption tax on retail sales. The plan has been introduced into the United States Congress as the Fair Tax Act . The tax would be levied once at the point of purchase on all new goods in the U.S.^[8]).

Border adjustable

A flat tax system and income taxes overall are not inherently border-adjustable; meaning the tax component embedded into products via taxes imposed on companies (including corporate taxes Corporate tax or company tax refers to a tax imposed on entities that are taxed at the entity level in a particular jurisdiction. Such taxes may include income or other taxes. The tax systems of most countries impose an income tax at the entity level on certain type of entities (company or corporation). Many systems additionally tax owners or and payroll taxes Payroll tax generally refers to two different kinds of similar taxes. The first kind is a tax that employers are required to withhold from employees' pay, also known as withholding, pay-as-you-earn , or pay-as-you-go (PAYG) tax. The second kind is a tax that is paid from the employer's own funds and that is directly related to employing a worker,) are not removed when exported to a foreign country (see Effect of taxes and subsidies on price A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain equal, this will increase the price paid by the consumers , and decrease the price received by the sellers. Alternatively, a marginal tax on consumption). Taxation systems such as a sales tax A sales tax is a consumption tax charged at the point of purchase for certain goods and services. The tax amount is usually calculated by applying a percentage rate to the taxable price of a sale. A portion of the sale may be exempt from the calculation of tax, because sales tax laws usually contain a list of exemptions. Laws governing the tax may or value added tax Value added tax is similar to a sales tax. It is a tax on the estimated market value added to a product or material at each stage of its manufacture or distribution, ultimately passed on to the consumer. Maurice Lauré, Joint Director of the French Tax Authority, the Direction générale des impôts, was first to introduce VAT on April 10, 1954, can remove the tax component when goods are exported and apply the tax component on imports. The domestic products could be at a disadvantage to foreign products (at home and abroad) that are border-adjustable, which would impact the global competitiveness of a country. However, it's possible that a flat tax system could be combined with tariffs and credits to act as border adjustments (the proposed Border Tax Equity Act in the U.S. attempts this). Implementing an income tax with a border adjustment tax credit is a violation of the World Trade Organization The World Trade Organization is an international organization designed by its founders to supervise and liberalize international trade. The organization officially commenced on January 1, 1995 under the Marrakech Agreement, replacing the General Agreement on Tariffs and Trade (GATT), which commenced in 1947 agreement. Tax exemptions (allowances) on low income wages, a component of most income tax systems could mitigate this issue for high labour content industries like textiles that compete Globally.

Around the world

Eastern Europe

Advocates of the flat tax argue that the former-Communist states A communist state is a sovereign state with a form of government characterized by single-party rule or dominant-party rule of a communist party and a professed allegiance to a communist ideology as the guiding principle of the state of Eastern Europe Eastern Europe is a region lying in the Eastern part of Europe. The term is highly context-dependent and even volatile, as there are "almost as many definitions of Eastern Europe as there are scholars of the region". A related UN paper adds that "every assessment of spatial identities is essentially a social and cultural construct& have benefited from the adoption of a flat tax. Most of these nations have experienced strong economic growth of 6% and higher in recent years, some of them, particularly the Baltic countries The Baltic states (Estonian: Balti riigid, Latvian: Baltijas valstis, Lithuanian: Baltijos valstybės, Russian: Прибалтика lit."At the Baltic Sea), Baltic Nations or Baltic countries are three countries in Northern Europe, all members of the European Union: Estonia, Latvia, and Lithuania. Between 1918 and 1920 in the aftermath of, experience exceptional GDP growth Baltic Tiger is a term used to refer to any of the three Baltic states of Estonia, Latvia, and Lithuania during their periods of economic boom, which started after the year 2000 and continued until 2006–2007. The term is modeled on Four Asian Tigers and Celtic Tiger, which were used to describe the economic boom periods in parts of East Asia and of around 10% yearly.

• Lithuania Lithuania (/ˌlɪθjuːˈeɪniə/, U.S. usually /ˌlɪθuːˈeɪniə/ ; Lithuanian: Lietuva), officially the Republic of Lithuania (Lithuanian: Lietuvos Respublika) is a country in Northern Europe, the southernmost of the three Baltic states. Situated along the southeastern shore of the Baltic Sea, it shares borders with Latvia to the north,, which levies a flat tax rate of 24% (previously 27%) on its citizens, has experienced amongst the fastest growth in Europe. Advocates of the flat tax speak of this country's declining unemployment Unemployment occurs when a person is able and willing to work but currently without work. The prevalence of unemployment is usually measured using the unemployment rate, which is defined as the percentage of those in the labor force who are unemployed. The unemployment rate is also used in economic studies and economic indices such as the United and rising standard of living. They also state that tax revenues have increased following the adoption of the flat tax, due to a subsequent decline in tax evasion and the Laffer curve In economics, the Laffer curve is used to illustrate the idea that increases in the rate of taxation do not necessarily increase tax revenue. . Increasing taxes beyond the peak of the curve point will decrease tax revenue. The Laffer curve was popularized by Arthur Laffer (b. 1940) in the 1980s. However, the idea is not new to him, nor did he effect. Others point out, however, that Lithuanian unemployment is falling at least partly as a result of mass emigration to Western Europe Western Europe is a loose term for the collection of countries in the westernmost region of Europe, though this definition is context-dependent and carries cultural and political connotations. One definition describes Western Europe as a cultural entity—the region lying west of Central Europe. Another definition was created during the Cold War. The argument is that Lithuania's comparatively very low wages, on which a non-progressive flat tax is levied, combined with the possibility now to work legally in Western Europe since accession Enlargement of the European Union is the process of expanding the European Union through the accession of new member states. This process began with the Inner Six, who founded the European Coal and Steel Community (the EU's predecessor) in 1952. Since then, the EU's membership has grown to twenty-seven with the most recent expansion to Bulgaria to the European Union The European Union is an economic and political union of 27 member states which are located primarily in Europe. Committed to regional integration, the EU was established by the Treaty of Maastricht in 1993 upon the foundations of the European Communities. With over 500 million citizens, the EU combined generated an estimated 28% share (US$ 16.5, is forcing people to leave the country en masse. The Ministry of Labour estimated in 2004 that as many as 360,000 workers might have left the country by the end of that year, a prediction that is now thought to have been broadly accurate. The impact is already evident: in September 2004, the Lithuanian Trucking Association reported a shortage of 3,000-4,000 truck drivers. Large retail stores have also reported some difficulty in filling positions.^[9] However, the emigration trend has recently stopped^{[citation needed]} as enormous real wage The term real wages refers to wages that have been adjusted for inflation. This term is used in contrast to nominal wages or unadjusted wages gains in Lithuania (presumably due to the shortage of workers) have caused a return of many migrants from Western Europe. In addition to that, it is clear that countries not levying a flat tax such as Poland also temporarily faced large waves of emigration after EU membership in 2004.^{[citation needed]}

• Whilst in most countries the introduction of a flat tax has coincided with strong increases in growth and tax revenue, there is no proven causal link between the two. For example, it is also possible that both are due to a third factor, such as new government that may institute other reforms along with the flat tax.

• In Estonia Estonia /ɛsˈtoʊniə/ (Estonian: Eesti), officially the Republic of Estonia (Estonian: Eesti Vabariik), is a country in the Baltic Region of Northern Europe. It is bordered to the north by the Gulf of Finland, to the west by the Baltic Sea, to the south by Latvia (343 km), and to the east by the Russian Federation (338.6 km). The territory of, which has had a 26% (24% in 2005, 23% in 2006, 22% in 2007, 21% in 2008, 21% in 2009, planned 20% in 2010, 19% in 2011, 18% in 2012) flat tax rate since 1994, studies have shown that the significant increase in tax revenue experienced was caused partly by a disproportionately rising VAT Value added tax is similar to a sales tax. It is a tax on the estimated market value added to a product or material at each stage of its manufacture or distribution, ultimately passed on to the consumer. Maurice Lauré, Joint Director of the French Tax Authority, the Direction générale des impôts, was first to introduce VAT on April 10, 1954, revenue.^[10] Moreover, Estonia and Slovakia have high social contributions, pegged to wage levels.^[10] Both matters raise questions regarding the justice of the flat tax system, and thus its long-term viability. The Estonian economist and former chairman of his country's parliamentary budget committee Olev Raju, stated in September 2005 that "income disparities are rising and calls for a progressive system of taxation are getting louder - this could put an end to the flat tax after the next election" [26]. However, this did not happen, since after the 2007 elections a right-wing coalition was formed which has stated its will to keep the flat tax in existence. However, critics argue that the tax rates these countries have are actually more progressive than flat.^[11]

• According to a 2010 study^[12] published in the Brussels newspaper L'Anglophone, the tax burden for typical workers in Central and Eastern Europe's "flat tax" countries is slightly higher (40.3% versus 40.2% of the total cost of employment) than that of the progressive systems elsewhere in the EU. "Slovakia has a “flat tax” rate of 19%," wrote the authors^[13], "but its employers pay a 35.2% contribution to social security (higher than the 34.8% in Belgium) and, in addition to the flat income tax, employees have 13.4% deducted for social security (also higher than the 13.07% in Belgium)," adding that a typical Slovak worker's Tax Freedom Day Tax Freedom Day is the first day of the year in which a nation as a whole has theoretically earned enough income to fund its annual tax burden. It is annually calculated in the United States by the Tax Foundation—a Washington, D.C.-based tax research organization. Every dollar that is officially considered income by the government is counted, is a day later than a Finnish worker's.

Countries that have flat tax systems

These are countries, as well as minor jurisdictions with the autonomous power to tax, that have adopted tax systems that are commonly described in the media and the professional economics literature as a flat tax.

• BIH Bosnia and Herzegovina (pronounced /ˈbɒzni.ə hɜrtsɨˈɡoʊvɨnə/ ( listen) or /ˌhɜrtsɨɡoʊˈviːnə/; Bosnian, Croatian, Serbian Latin: Bosna i Hercegovina; Bosnian and Serbian Cyrillic: Босна и Херцеговина) is a country in South-Eastern Europe, on the Balkan Peninsula. Bordered by Croatia to the north, west and south, [27]

• Bulgaria Bulgaria (pronounced /bʌlˈɡɛəriə/ Bulgarian: България, transliterated: Bulgaria, pronounced [bɤ̞lˈɡarijɐ]), officially the Republic of Bulgaria (Република България, transliterated: Republika Bulgaria, [rɛˈpublikɐ bɤ̞lˈɡarijɐ]), is a country in south-eastern Europe. Bulgaria borders five other countries: ^[14]

• Albania Albania ( /ælˈbeɪniə/ al-BAY-nee-ə, Albanian: Shqipëri/Shqipëria, Gheg Albanian: Shqipnia/Shqypnia), officially known as the Republic of Albania (Albanian: Republika e Shqipërisë, pronounced [ɾɛpuˈblika ɛ ʃcipəˈɾiːs]), is a country in South Eastern Europe. It is bordered by Montenegro to the northwest, Kosovo[a] to the northeast, ^[15][16]

• Czech Republic The Czech Republic (pronounced /ˈtʃɛk/ chek; Czech: Česká republika, pronounced [ˈtʃɛskaː ˈrɛpuˌblɪka] ( listen), short form Česko [ˈtʃɛskɔ]) is a country in Central Europe. The country borders Poland to the northeast, Germany to the west and northwest, Austria to the south and Slovakia to the east. The Czech Republic has been a^[17]

• Estonia Estonia /ɛsˈtoʊniə/ (Estonian: Eesti), officially the Republic of Estonia (Estonian: Eesti Vabariik), is a country in the Baltic Region of Northern Europe. It is bordered to the north by the Gulf of Finland, to the west by the Baltic Sea, to the south by Latvia (343 km), and to the east by the Russian Federation (338.6 km). The territory of ^[18][19][20]

• Georgia Georgia (Georgian: საქართველო, IPA: [sɑkʰɑrtʰvɛlɔ] ; English pronunciation: /ˈdʒɔrdʒə/ ( listen)) is a sovereign state in the Caucasus region of Eurasia. Situated at the juncture of Eastern Europe and Western Asia, it is bounded to the west by the Black Sea, to the north by Russia, to the south by Turkey and Armenia, ^[20][21]

• Guernsey The Bailiwick of Guernsey is a British Crown Dependency in the English Channel off the coast of Normandy ^[22]

• Kazakhstan Kazakhstan , officially the Republic of Kazakhstan, is one of the six independent Turkic states. It is located in Eurasia and ranked as the ninth largest country in the world. It is also ranked the world's largest landlocked country, its territory of 2,727,300 km² is greater than Western Europe. It is neighbored clockwise from the north by Russia, ^[23]

• Iceland b. ^ Iceland, the Faeroes and Greenland were formally Norwegian possessions until 1814 despite 400 years of Danish monarchy beforehand ^[22][24][25] Iceland's system differs from the Hall-Rabushka flat tax by taxing investment income and allowing numerous exceptions.^[26]

• Iraq Iraq , officially the Republic of Iraq (Arabic: جمهورية العراق (help·info) Jumhūrīyat Al-Irāq, Kurdish: كۆماری عێراق‎, Komara Îraqê, Assyrian Neo-Aramaic: ܥܸܪܵܩ) is a country in Western Asia spanning most of the northwestern end of the Zagros mountain range, the eastern part of the Syrian Desert and the ^[27][28][29] It is not clear how effectively the Iraqi tax is being collected in practice.

• Jersey ^[30]

• Kyrgyzstan ^[22]

• Latvia ^[20]

• Lithuania ^[20][31]

• Macedonia ^[22][32]

• Mongolia ^[33]

• Montenegro ^[34]

• Mauritius ^[22]

• Romania ^[20]

• Russia ^[20][35]

• Serbia ^[36]

• Slovakia ^[20]

• Ukraine ^[20][37]

Also:

• Transnistria, also known as Transnistrian Moldova or Pridnestrovie.^[38] This is a disputed territory, but the authority that seems to have de facto government power in the area claims to levy a flat tax.

Countries reputed to have a flat tax

• Hong Kong Some sources claim that Hong Kong has a flat tax,^[39] though its salary tax structure has several different rates ranging from 2% to 20% after deductions. Taxes are capped at 16% of gross income, so this rate is applied to upper income returns if taxes would exceed 16% of gross otherwise.^[40] Accordingly, Duncan B. Black of Media Matters for America, says "Hong Kong's 'flat tax' is better described as an 'alternative maximum tax.'" ^[41] Alan Reynolds of the Cato Institute similarly notes that Hong Kong's "tax on salaries is not flat but steeply progressive."^[42] Hong Kong has, nevertheless, a flat profit tax regime.

Countries considering a flat tax system

These are countries where concrete flat tax proposals are currently being considered by influential politicians or political parties.

• Panama During the 2008 - 2009 political campaign, presidential candidate Ricardo Martinelli has included on his government plan the replacement of the current tax system implemented by president Martin Torrijos with a 10 or 15% flat tax rate in order to raise employment and wages.
• Hungary^[43]
• Poland In 2007 elections, the Civic Platform gained 41.5% of the votes, running on a 15% flat tax as one of the main points in the party program.^[44]
• Greece There are some articles from 2005 indicating that the Greek government considered a flat tax. If it is still on the table, it apparently hasn't passed yet as of February 2008.^[45][46]

In a subsequent section, various proposals for flat tax-like schemes are discussed, these differ mainly on how they approach with the following issues of deductions, defining income, and policy implementation.

Difficulties and nuances in schema

In devising a flat tax system, several practical difficulties must be dealt with, principally with deductions and the identification of when money is earned. We can divide these into fundamental implementation issues and philosophical ones. Identification of philosophical ones is important for countries moving towards a Flat Tax, since in any given country the ideals of financial fairness are the starting point for comparison.

Defining when income occurs

Since a central philosophy of the flat tax is to minimize the compartmentalization of incomes into myriad special or sheltered cases, a vexing problem is deciding when income occurs. This is demonstrated by the taxation of interest income and stock dividends. The shareholders own the company and so the company's profits belong to them. If a company is taxed on its profits, then the funds paid out as dividends have already been taxed. It's a debatable question if they should subsequently be treated as income to the shareholders and thus subject to further tax. A similar philosophical issue arises in deciding if interest paid on loans should be deductible from the taxable income since that interest is in-turn taxed as income to the loan provider.^[47] There is no universally agreed answer to what is fair. For example, in the United States, dividends are not deductible^[48] but mortgage interest is deductible^[49]. Thus a Flat Tax proposal is not fully defined until it differentiates new untaxed income from a pass-through of already taxed income.

Avoiding deductions

In general, the question of how to eliminate deductions is fundamental to the flat tax design: deductions dramatically affect the effective "flatness" in the tax rate. Perhaps the single biggest necessary deduction is for business expenses. If businesses were not allowed to deduct expenses then businesses with a profit margin below the flat tax rate could never earn any money since the tax on revenues would always exceed the earnings. For example, grocery stores typically earn pennies on every dollar of revenue; they could not pay a tax rate of 25% on revenues unless their markup exceeded 25%. Thus corporations must be able to deduct operating expenses even if individual citizens cannot. A practical difficulty now arises as to identifying what is an expense for a business^[50]. For example, if a peanut butter maker purchases a jar manufacturer, is that an expense (since they have to purchase jars somehow) or a sheltering of their income through investment. How deductions are implemented will dramatically change the effective total tax, and thus flatness, of the tax.^[47] Thus a Flat Tax proposal is not fully defined until it differentiates deductible and non-deductible expenses.

Perhaps the largest logical issue is that if the flat tax system has a large per-citizen deductible (such as the "Armey" scheme below), then it is effectively a progressive tax since the total income tax rate is increasing with increasing income. Any flat tax with an initial threshold deduction is inherently a progressive tax. The admission that such a flat tax is not actually flat at all, would seem to undermine the notion that the "flatness" of the tax is itself a desirable feature. As a result, sometimes the term Flat Tax is actually a shorthand for the more proper marginally flat tax.^[47]

Policy

Taxes are often used as instruments of policy. For example, it is common for governments to encourage social policy such as home insulation or low income housing with tax credits rather than constituting a ministry to implement these policies^[51] . In a true flat tax system (i.e. one without deductions) such policy mechanisms may be curtailed. In addition to social policy, flat taxes can remove tools for adjusting economic policy as well. For example, in the US short term gains are taxed at a higher rate than long term gains as means to promote long term investment horizons and damp speculative fluctuation.^[52] Thus claims that flat taxes are cheaper/simpler to administer than others may need to factor in costs for alternative policy administration.

Recent and current proposals

Flat tax proposals have made something of a "comeback" in recent years. In the United States, former House Majority Leader Dick Armey and FreedomWorks have sought grassroots support for the flat tax (Taxpayer Choice Act). In other countries, flat tax systems have also been proposed, largely as a result of flat tax systems being introduced in several countries of the former Eastern Bloc, where it is generally thought to have been successful, although this assessment has been disputed (see below).^[53] This has elicited much interest from countries such as the United Kingdom, where it has gone hand in hand with a general swing towards conservatism.^[54]

The countries that have recently reintroduced flat taxes have done so largely in the hope of boosting economic growth. The Baltic countries of Estonia, Latvia and Lithuania have had flat taxes of 24%, 25% and 33% respectively with a tax exempt amount, since the mid-1990s. On 1 January 2001, a 13% flat tax on personal income took effect in Russia. Ukraine followed Russia with a 13% flat tax in 2003, which later increased to 15% in 2007. Slovakia introduced a 19% flat tax on most taxes (that is, on corporate and personal income, for VAT etc., almost without exceptions) in 2004; Romania introduced a 16% flat tax on personal income and corporate profit on January 1, 2005. Macedonia introduced a 12% flat tax on personal income and corporate profit on January 1, 2007 and promised to cut it to 10% in 2008. [28] Albania will be implementing a 10% flat tax from 2008.^[55]

In the United States, while the Federal income tax is progressive, seven states — Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, and Utah — tax household incomes at a single rate, ranging from 3% (Illinois) to 5.3% (Massachusetts). Pennsylvania even has a pure flat tax with no zero-bracket amount.

Greece (25%) and Croatia are planning to introduce flat taxes.^{[citation needed]} Paul Kirchhof, who was suggested as the next Finance minister of Germany in 2005, proposed introducing a flat tax rate of 25% in Germany as early as 2001, which sparked widespread controversy. Some claim the German tax system is the most complex one in the world.^{[citation needed]}

On 27 September 2005, the Dutch Council of Economic Advisors recommended a flat rate of 40% for income tax in the Netherlands.^{[citation needed]} Some deductions would be allowed, and persons over 65 years of age would be taxed at a lower rate.

In the United States, proposals for a flat tax at the federal level have emerged repeatedly in recent decades during various political debates. Jerry Brown, former Democratic Governor of California, made the adoption of a flat tax part of his platform when running for President of the United States in 1992. At the time, rival Democratic candidate Tom Harkin ridiculed the proposal as having originated with the "Flat Earth Society". Four years later, Republican candidate Steve Forbes proposed a similar idea as part of his core platform. Although neither captured his party's nomination, their proposals prompted widespread debate about the current U.S. income tax system.

Flat tax plans that are presently being advanced in the United States also seek to redefine "sources of income"; current progressive taxes count interest, dividends and capital gains as income, for example, while Steve Forbes's variant of the flat tax would apply to wages only.^{[citation needed]}

In 2005 Senator Sam Brownback, a Republican from Kansas, stated he had a plan to implement a flat tax in Washington, D.C..^{[citation needed]} This version is one flat rate of 15% on all earned income. Unearned income (in particular capital gains) would be exempt. His plan also calls for an exemption of $30,000 per family and $25,000 for singles. Mississippi Republican Senator Trent Lott stated he supports it and would add a $5,000 credit for first time home buyers and exemptions for out of town businesses. DC Delegate Eleanor Holmes Norton's position seems unclear, however DC mayor Anthony Williams has stated he is "open" to the idea.

Flat taxes have also been considered in the United Kingdom by the Conservative Party. However, it has been roundly rejected by Gordon Brown, then Chancellor of the Exchequer for Britain's ruling Labour Party, who said that it was "An idea that they say is sweeping the world, well sweeping Estonia, well a wing of the neo-conservatives in Estonia", and criticised it thus: "The millionaire to pay exactly the same tax rate as the young nurse, the home help, the worker on the minimum wage".^[56]

Flat tax proposals differ in how they define and measure what is subject to tax.

True flat rate income tax

As per the definition at the beginning of the article, a true flat rate tax is a system of taxation where one tax rate is applied to all income with no exceptions.

In an article titled The flat-tax revolution, dated April 14, 2005, The Economist argued as follows: If the goals are to reduce corporate welfare and to enable household tax returns to fit on a postcard, then a true flat tax best achieves those goals. The flat rate would be applied to all taxable income and profits without exception or exemption. It could be argued that under such an arrangement, no one is subject to a preferential or "unfair" tax treatment. No industry receives special treatment, large households are not advantaged at the expense of small ones, etc. Moreover, the cost of tax filing for citizens and the cost of tax administration for the government would be further reduced, as under a true flat tax only businesses and the self-employed would need to interact with the tax authorities.

Critics of the flat tax argue that the marginal dollar to the low income is vastly more vital than that of the high income earner, especially around the poverty level. In their view this justifies a progressive taxation system as the added income gained from a flat tax rate to the rich would not be spent on vital goods and services for survival as they might at the poverty level with reduced taxation. However, true Flat tax proponents necessarily contest the concept of the diminishing marginal utility of money and that a marginal dollar should be taxed differently. ^[57].

Marginal Flat Tax

When deductions are allowed a 'flat tax' is a progressive tax with the special characteristic that above the maximum deduction, the rate on all further income is constant. Thus it is said to be marginally flat above that point. One conceit to reconcile the difference between a true flat tax and a marginally flat tax is to say that the latter simply excludes certain kinds of funds from being defined as income.

Flat tax with deductions

US Congressman Dick Armey has advocated a flat tax on all income in excess of an amount shielded by household type and size. For example, draft legislation proposed by Armey would allow married couples filing jointly to deduct $26,200, unmarried heads of household to deduct $17,200, and single adults, $13,100. $5,300 would be deducted for each dependent. A household would pay tax at a flat rate of 17% on the excess. Businesses would pay a flat 17% rate on all profits. Others have put forth similar proposals with various rates and deductions. Armey defined income to include only salary, wages, and pensions; capital gains and all other sources of wealth appreciation were excluded from taxation under his proposal.^[58]

While campaigning for the American presidency in 1996 and 2000, Steve Forbes called for replacing the income tax - which would have included a repeal of the 16th Amendment - by a tax at the flat rate of 17% of consumption, defined as income minus savings, in excess of an amount determined by the type and size of the household.^{[citation needed]} For example, the exempt amount for a family of four would be $42,000 per year.

Modified flat taxes have been proposed which would allow deductions for a very few items, while still eliminating the vast majority of existing deductions. Charitable deductions and home mortgage interest are the most discussed exceptions, as these are popular with voters and often used.

Hall-Rabushka flat tax

Designed by economists at the Hoover Institution, Hall-Rabushka is a fully developed flat tax on consumption (taxing consumption is thought by economists to be more efficient than taxing income).^[59] Loosely speaking, Hall-Rabushka accomplishes this by taxing income and then excluding investment. An individual could file a Hall-Rabushka tax return on a postcard. Robert Hall and Alvin Rabushka have consulted extensively in designing the flat tax systems in Eastern Europe.

Negative income tax

The Negative Income Tax (NIT) which Milton Friedman proposed in his 1962 book Capitalism and Freedom is a type of flat tax. The basic idea is the same as a flat tax with personal deductions, except that when deductions exceed income, the taxable income is allowed to become negative rather than being set to zero. The flat tax rate is then applied to the resulting "negative income," resulting in a "negative income tax" the government owes the household, unlike the usual "positive" income tax, which the household owes the government.

For example, let the flat rate be 20%, and let the deductions be $20,000 per adult and $7,000 per dependent. Under such a system, a family of four making $54,000 a year would owe no tax. A family of four making $74,000 a year would owe tax amounting to 0.2(74,000-54,000) = $4,000, as under a flat tax with deductions. But families of four earning less than $54,000 per year would owe a "negative" amount of tax (that is, it would receive money from the government). E.g., if it earned $34,000 a year, it would receive a check for $4,000.

The NIT is intended to replace not just the USA's income tax, but also many benefits low income American households receive, such as food stamps and Medicaid. The NIT is designed to avoid the welfare trap—effective high marginal tax rates arising from the rules reducing benefits as market income rises. An objection to the NIT is that it is welfare without a work requirement. Those who would owe negative tax would be receiving a form of welfare without having to make a try to obtain employment. Another objection is that the NIT subsidizes industries employing low cost labor, but this objection can also be made against current systems of benefits for the working poor.

See also

Economic Concepts

• Fiscal drag (also known as Bracket creep)
• Taxable income elasticity (also known as Laffer Curve)

Tax Systems

• Consumption tax
• FairTax
• Income tax
• Negative income tax
• Progressive tax
• Regressive tax
• Sales tax
• Value added tax

Notes

1. ^ James, Simon (1998) A Dictionary of Taxation, Edgar Elgar Publishing Limited: Northampton, MA
2. ^ Mitchell, Daniel J. (2005-07-07). "A Brief Guide to the Flat Tax". Heritage Foundation. http://www.heritage.org/research/taxes/bg1866.cfm. Retrieved 2009-04-23.
3. ^ Hoover Institution - Books - The Flat Tax
4. ^ Simpler taxes | The flat-tax revolution | Economist.com
5. ^ Louis Kaplow. "Accuracy, Complexity, and the Income Tax," Journal of Law, Economics, and Organization (1998), V14 N1, p.68.[1]
6. ^ The Flat Tax at Work in Russia: Year Three, Alvin Rabushka, Hoover Institution Public Policy Inquiry, www.russianeconomy.org, April 26, 2004
7. ^ The "Flat Tax(es)": Principles and Evidence
8. ^ Boortz, Neal; Linder, John (2006). The FairTax Book (Paperback ed.). Regan Books. ISBN 0-06-087549-6.
9. ^ http://www.state.gov/e/eb/ifd/2005/42068.htm
10. ^ ^{a b} Niedrige Steuer für alle: Osteuropa: Einige Länder haben die Einheitssteuer. Doch sie ist umstritten | ZEIT online
11. ^ Central Eastern Europe and the “Flat” Tax - a follow up
12. ^ Wages and Taxes for the "Average Joe" in the EU 27
13. ^ Belgian Workers’ Wages are Highest-Taxed in Western Europe. Flat tax? Read the Fine Print
14. ^ The Associated Press. "Bulgarian parliament approves 2008 budget that foresees record 3 percent surplus". [2]
15. ^ Daniel Mitchell. "Albania Joins the Flat Tax Club." Cato at Liberty, April 9, 2007. [3]
16. ^ Jonilda Koci. "Albanian government approves 10% flat tax". Southeast European Times, June 4, 2007. [4]
17. ^ Alvin Rabushka. "The Flat Tax Spreads to the Czech Republic." hoover.org, 27 August 2008. [5]
18. ^ Alvin Rabushka. "Estonia Plans to Reduce its Flat-Tax Rate." March 26, 2007. [6]
19. ^ Toby Harnden. "Pioneer of the 'flat tax' taught the East to thrive." Telegraph, April 9, 2005.[7]
20. ^ ^{a b c d e f g h} Michael Keen, Yitae Kim, and Ricardo Varsano. "The 'Flat Tax(es)': Principles and Evidence." IMF Working Paper WP/06/218.[8]
21. ^ Alvin Rabushka. "The Flat Tax Spreads to Georgia." January 3, 2005
22. ^ ^{a b c d e} Alvin Rabushka. "Flat and Flatter Taxes Continue to Spread Around the Globe." January 16, 2007.[9]
23. ^ The Economist Intelligence Unit, Kazakhstan fact sheet. "In 2007 Kazakhstan introduced several changes to the taxation system. The flat-rate VAT on all goods was reduced from 15% to 14%, and a flat rate of income tax of 10% was introduced, in place of the previous progressive range of 5-20%." [10]
24. ^ Daniel Mitchell. "Iceland Comes in From the Cold With Flat Tax Revolution." March 27, 2007.[11]
25. ^ The Globe and Mail, as quoted on Cato-at-liberty by Daniel Mitchell: "Effective this year, Iceland (population: 300,000) taxes all personal income at a flat rate of 32 per cent — which appears high because it includes municipal as well as national taxes." [12]
26. ^ Daniel Mitchell. "Iceland Joins the Flat Tax Club." Cato Tax and Budget Bulletin, February 2007. [13]
27. ^ Daniel Mitchell. "If a Flat Tax is Good for Iraq, How About America?" Heritage foundation, November 10, 2003. [14].
28. ^ Alvin Rabushka. "The Flat Tax in Iraq: Much Ado About Nothing—So Far." May 6, 2004. [15]
29. ^ Noam Chomsky. "Transfer real sovereignty." znet, May 11, 2004
30. ^ http://ec.europa.eu/economy_finance/publications/publication415_en.pdf
31. ^ Alvin Rabushka. "A Competitive Flat Tax Spreads to Lithuania." November 2, 2005.[16]
32. ^ "The lowest flat corporate and personal income tax rates." Invest Macedonia government web site. Retrieved June 6, 2007. [17]
33. ^ Alvin Rabushka. "The Flat Tax Spreads to Mongolia." January 30, 2007
34. ^ Alvin Rabushka. "The Flat Tax Spreads to Montenegro." April 13, 2007
35. ^ Alvin Rabushka. "Russia adopts 13% flat tax." July 26, 2000
36. ^ Alvin Rabushka. "The Flat Tax Spreads to Serbia." March 23, 2004
37. ^ Alvin Rabushka. "The Flat Tax Spreads to Ukraine." May 27, 2003
38. ^ Transnistrian government web site
39. ^ Daniel Mitchell. "Fixing a Broken Tax System with a Flat Tax." Capitalism Magazine, April 23, 2004.[18]
40. ^ Duncan B. Black. "Hyman falsely claimed Hong Kong imposes flat tax on income," Media Matters, Jan 27, 2005. [19]
41. ^ Duncan B. Black. "Fund wrong on Hong Kong 'flat tax'." Media Matters, Feb 28, 2005. [20]
42. ^ Alan Reynolds. "Hong Kong's Excellent Taxes." townhall.com, but the column was syndicated. June 6, 2005. [21]
43. ^ Hungary govt plans flat tax, public sector wage cut -report
44. ^ "Poland brings in flat tax", Adam Smith Institute
45. ^ Greece joins the flat rate tax bandwagon. By George Trefgarne, Economics Editor. The Telegraph. 2005. [22]
46. ^ "Flat tax rate on the cards." Kathimerini. 11 July 2005
47. ^ ^{a b c} See for example the flat tax resources at idebate.org ]
48. ^ Dividends are deductible in rare instances[23]
49. ^ IRS Tax pub 936. the mortgage interest deduction[24]
50. ^ Deductible bussiness expenses [25]
51. ^ For example the ENERGYSTAR tax credit
52. ^ As a recent example, transaction costs to damp speculation proposed by James Tobin, winner of the 1972 Nobel prize in economics, were recently (2009) proposed to the G20 by British PM Gordon brown as a way to prevent international currency speculation. Krugman
53. ^ Flat-Tax Comeback Bruce Bartlett, National Review, November 10, 2003
54. ^ Cameron is no moderate, Neil Clark, The Guardian October 24, 2005
55. ^ Albanian government to implement flat tax (SETimes.com)
56. ^ Gordon Brown's speech to the Labour party conference September 26, 2005
57. ^ The diminishing marginal utility means that the number of units of additional 'happiness' afforded by an extra unit of additional money, decreases as one spends more money. [http://www.daviddfriedman.com/Academic/Price_Theory/PThy_Chapter_4/PThy_Chapter_4.html
58. ^ The Armey Flat Tax, National Center for Policy Analysis
59. ^ Hoover Institution - Books - The Flat Tax

References

• Steve Forbes, 2005. Flat Tax Revolution. Washington: Regnery Publishing. ISBN 0-89526-040-9
• Robert Hall and Alvin Rabushka, 1995 (1985). The Flat Tax. Hoover Institution Press.
• Anthony J. Evans, "Ideas and Interests: The Flat Tax" Open Republic 1(1), 2005

External links

• The Laffer Curve: Past, Present and Future: A detailed examination of the theory behind the Laffer curve, and many case studies of tax cuts on government revenue in the United States
• Podcast of Rabushka discussing the flat tax Alvin Rabushka discusses the flat tax with Russ Roberts on EconTalk.

Categories: Tax reform | Taxation and redistribution

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• Income Tax: Encyclopedia
• Tax Return: Encyclopedia
• Tax Shelter: Encyclopedia
• IRS Tax Forms: Encyclopedia
• Taxation In the United States

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