Tuesday, December 16, 2008

The Flat Tax

The Flat Tax

An alternative to the current individual income tax structure is the flat tax. The flat tax has been proposed since 1983 by various people, including Congressman Richard K. Armey, who was a Republican representative from Texas from 1985 to 2003 and Malcolm S. "Steve" Forbes, Jr., a billionaire candidate for the Republican nomination for the U.S. presidency in 1996 and 2000.

Under most flat tax proposals, the current individual and corporate income tax structures would be replaced by a system in which every taxpayer is subject to the same marginal tax rate.

Proponents of a flat tax system argue that it would simplify the income tax structure because most deductions would be eliminated. A simpler tax system would have a smaller administrative burden and thus would be more efficient.

Opponents of a flat tax argue that it would shift a significant amount of the tax burden from the wealthy to middle class Americans. Thus, they think a flat tax system does not have enough vertical equity. Vertical equity is the principle that taxpayers with a greater ability to pay taxes should pay larger amounts. Vertical equity is a justification for wealthy people to pay more in taxes than poor people.

Under "H.R.1040", the Armey-Shelby Flat Tax proposal of 1997, every worker would pay 17% of what is left of their total annual income from all wages, salaries, and pensions after subtracting a personal allowance. The only four allowances would be:
- $23,200 for a married couple filing jointly- $14,850 for a single person who is the head of a household- $11,600 for a single person who is not the head of a household, - $5,300 for each dependent child
No other tax credits or deductions would be used. The entire tax return form would be simple enough to fit on a postcard.
Source: U.S. Rep. Dick Armey's flat tax summary web site.
Because of the personal allowances, taxpayers would not pay the same percentage of their income in tax. For example, Rep. Armey suggested that given the exemptions shown above, a family of four earning $25,000 would owe no tax. A family of four earning $50,000 would owe 6%, and a family of four earning $200,000 would owe14% in tax.

The flat tax proposal would also eliminate the marriage penalty, almost double the deduction for dependent children, and end multiple taxation of savings.

Social Security and Medicare payroll taxes would not be affected under the flat tax proposal. Social Security benefits would not be taxed.

Businesses would take their total income, subtract total expenses and if the result is a positive amount (profit), pay tax on that amount at a rate of 17%. Expenses would include purchases of goods and services, capital equipment, structures, land, wages and contributions to retirement plans.

Critics of the Armey-Shelby Flat Tax proposal note that much of the complexity of the current system would remain. Businesses would still need to withhold taxes from workers’ wages and record keeping for businesses would not be significantly reduced. Some people would still have an incentive to cheat on their taxes.

According to the U.S. Treasury Department, the Armey-Shelby Flat Tax proposal would have added $138 billion to the annual budget deficit (in 1996 dollars). Even at the break even rate of 20.82%, Rep. Armey’s plan would increase taxes sharply on all income groups except those earning more than $200,000 a year. (Others believe that the break-even rate would have to be considerably higher than the Treasury’s estimate.)

The flat tax proposal of Malcolm S. Forbes, Jr., was similar to Rep. Armey’s. Mr. Forbes suggested larger exemptions from the wage tax: $13,000 per taxpayer plus $5,000 per child. Forbes also considered retaining the earned-income tax credit. Based on the U.S. Treasury's analysis, the Forbes's proposal would have resulted in a revenue shortfall of between $180 and $210 billion a year (in 1996 dollars). Others believed the revenue losses would be much larger.

A flat tax is a type of income tax in which every taxpayer is subject to the same marginal tax rate.


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