Flat Tax System

An alternative to the global tax system or comprehensive taxation system is the so called flat tax system. Herewith a flat proportional taxation for all net income types, capital, labor and other income is installed. This taxation system does not consider the taxpayers ability to pay taxes but sets a flat level for all income types. Some east European countries (Russia and Slovakia) have installed this taxation system. Russia replaced its progressive taxation system with a single flat tax rate of 13%.

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. For example, suppose that in a given year, XYZ Company 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%, XYZ would then owe the IRS (3M + 2M + 1M) x0.15 = 900,000. This payment would, in one fell swoop, settle the tax liabilities of XYZ’s employees as well as taxes it owed by being a firm. Most employees throughout the economy would never need to interact with the revenue authorities, as all tax owed on wages, interest, dividends, royalties, etc. would be withheld at the source.

Advantages of the Flat Tax System

Aim of this taxation method is to gain a very simplified and transparent Tax system. Those who perceive the comprehensive taxation system with its progressive effects as unfair often are in favor of a flat tax system and claim it to be fairer to apply the same tax rate to all income sources and amounts.

Because there is only one tax rate for all income, the administration costs are definitely lower and there is a balance between lower tax and lower cost. Additionally every taxpayer can easily calculate his taxes due which are usually not the case in the very complex progressive taxation system.

After Russia installed this tax system the real revenues from its Personal Income Tax rose by 25.2%, 24.6% and 15.2% in the first three years.

Disadvantage of the Flat Tax System

Despite all the Pro arguments the problem of the flat taxation system is that hardly any country could keep it as a fully flat income tax system due to too many special tax treatments. Because everybody has to pay the same percentage of his total income the ability of pay performance is not considered or minded. This is the biggest contra argument of the flat tax system. It only seems to be a fair system but leaves only a small to no gap for a fair sharing of the tax burden.

For many people it is not convincing why rich people should only pay as much as the poorer. And therefore it can hardly survive.

In addition to fairness another adverse point is the fact of the pure flat tax system that the government loses its power to steer the investing behavior. So if it would be of interest to support the private pension reserves, a deduction of capital income taxes on these payments is not possible.

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