Nobody likes to pay taxes, but one of the most infuriating aspects of the income tax system in America is that it’s incredibly complicated. People at different income levels have to pay at different rates, and there are a dizzying array of exemptions, credits, thresholds, deductions, and other factors that must be taken into consideration. A person can spend an immense number of hours gathering the information he needs and then calculating the tax. Even after putting in many hours and hiring an expert, there’s always the lurking suspicion of a mistake that has resulted in an unnecessary overpayment or an illegal underpayment.
Frustration about the US tax code has generated interest in a flat tax instead. The flat tax would, as its name implies, substitute our current system for a single flat rate that everyone pays. At its simplest, people could fit their calculations on one side of a postcard, as it advocates have long claimed. Everyone would simply add their income, multiple by the tax rate, and pay. What could be simpler?
Advocates point to numerous possible benefits. First, the flat tax would be fair…in the sense that everyone would pay the same rate. Today, the US tax code has five rates for federal income taxes, and then different states have their own rate schemes. About half of tax-payers don’t pay federal income tax (though they pay many other types of taxes). The flat tax could, conceivably, eliminate all of those inequalities.
Second, the flat tax is transparent. What’s meant by the term “transparent” is that it’s easy for everyone to see what is being charged. Under the current tax code, it’s almost impossible to judge how a basic financial decision (take a job with higher income, take out a mortgage, pay down student debt) will affect a person’s income taxes because so many other factors will affect the calculation. With a flat tax that is accompanied by an elimination of those complex deductions, it’s simple for a person to judge how a financial decision will affect his or her taxes, and it’s just as easy for the government to predict how changing the tax rate will affect tax revenue.
Finally, advocates of the flat tax argue that simplicity, fairness, and transparency will lead to greater compliance with the tax code. Today, rampant cheating on income taxes occurs (allegedly), and the many ways that deductions can be claimed is considered the primary route through which people cheat. Create a flat tax, cut out those deductions, and cheating will fall.
Before leaving the subject of the flat tax, it should be noted that there are strong arguments against each of the “pro” arguments. Complexity? Well, complexity has arisen because we, as a society, have chosen to provide favorable tax treatment to certain activities that we want to encourage (college loans, saving for retirement) and those that we want to discourage (smoking). Complexity has helped to produce positive social change. Fairness? Is charging a cab driver and a hedge fund manager the same rate really fair? Shouldn’t the wealthy pay more in taxes? Maybe a not-so-flat tax would solve the problem, if it had two rates or a fairly high threshold below which no income taxes were due. Then, it’s still simpler, but it’s not placing an unfair burden on the working poor. Ending cheating? A flat tax isn’t going to change human nature.
In conclusion, the flat tax has many attractive features: simplicity, fairness, and transparency. But these have to be balanced with the likely consequences (and be prepared for facing unanticipated consequences) if a flat tax is ever enacted.