The United States income tax system is a progressive system, in which the percentage of income that taxpayers pay is proportionate to the amount they earn. In simple terms, the more you make, the higher the rate you pay. There have been discussions about switching to a flat tax, in which all taxpayers pay the same percentage rate. A flat tax might be beneficial to some higher-income taxpayers, but it may also place an unfair burden on lower-income earners. It would also be difficult to implement, so a flat tax remains solely in the realm of discussion.
Using a sample flat-tax rate of 20 percent, which is a rough average of the rate in former Communist countries that have adopted a flat tax, a taxpayer who earns $10,000 would pay $2,000 in tax, one who earns $40,000 would pay $8,000 in income tax and a taxpayer who earns $120,000 would pay $24,000. The U.S. income tax rate in 2012 for taxpayers earning $10,000 is 10 percent; the rate for $40,000 is 15 percent; and, the 2012 tax rate for taxpayers earning $120,000 is 25 percent. However, even the taxpayer earning $120,000 would not fare as well as he thinks under a true flat-tax system.
A true flat-tax system does not allow for any deductions or adjustments whatsoever. This means that a taxpayer who has no children pays the same as one who has three children. Under the present U. S. system, the taxpayer with three children gets a credit of $3,800 per child for a total of $11,480. So, the taxpayer with three children who earns $120,000 pays tax at most on only $108,520 of income and now has a tax bill of $27,130. Subtract and substitute other exemptions, such as those for charitable deductions or capital gains, from the tax that even the highest earners owe, and chances are the total tax bill due will be less than the hypothetical 20 percent flat tax rate.
It Won't Work
Tax deductions and credits for certain expenses and investments help to stimulate the economy and promote socially beneficial activity such as charity and installation of energy-saving appliances. These provisions of the American progressive tax code also help people who are saddled with expenses for medical care and other difficult situations. Charitable giving would be seriously affected if there were no tax exemption for it. There would be less of an incentive to invest in businesses that create necessary jobs and products without deductions for such investment. Most of all, having a family would become more of a financial burden under a flat tax system.
It Works Elsewhere
Adoption of a flat tax has brought positive results in former Communist countries. However, these countries had extremely complex and unenforceable tax codes when they first adopted free-market economic systems. They also had no history of a real income tax, so most wages were paid off the record as part of the then-burgeoning black economy. Most importantly, these countries levy a purchase tax on products sold at retail. That means additional revenue is generated whenever anyone, regardless of his income, buys anything except the simplest daily necessities. Such a tax would take a huge chunk out of the bank accounts of a typical American middle class consumer. Without this consumption tax, a flat income tax would bring in far less revenue than the present tax system does.
The present tax system in the United States is complex and imperfect, but at the end of the day, it works. Most Americans pay the amount of tax that they are required to pay every year, and compliance is far higher than in the post-Communist flat-tax countries. The availability of deductions and credits helps make the present system more equitable. These tax benefits ease the burden for those who have additional expenses and reward those whose investments and decisions help the economy or make America a better place. Despite its perceived inequity and notorious complexity, the present American progressive tax code is much fairer than flat-tax regimes in other parts of the world.
John DeMerceau is an American expatriate entrepreneur, marketing analyst and Web developer. He now lives and works in southeast Asia, where he creates websites and branding/marketing reports for international clients. DeMerceau graduated from Columbia University with a Bachelor of Arts in history.