posted on 06-06-2019

Flat Tax

Updated October 1, 2019

What is a Flat Tax?

A flat tax is a system under which all taxpayers pay taxes at the same percentage rate of their total income.

How Does a Flat Tax Work?

Let's assume that you had $100,000 of taxable income last year. Under a progressive tax system, you might be taxed 0% on the first $25,000, 10% on the next $50,000, and 30% on the remaing $25,000, for a total tax bill of (0 x $25,000) + (0.10 x $50,000) + (0.30 x $25,000) = $12,500. Under a flat-tax system, you might instead simply owe, say, 15% of your taxable income, or $15,000.

[InvestingAnswers Feature: The Most Important Tax Changes to Know Before Filing Your Tax Return]

Why Does a Flat Tax Matter?

The concept of a flat tax is controversial, and many economists and politicians have introduced many different twists and forms of the idea. In many proposals, the flat tax would not apply at all to incomes below a certain amount.

Supporters say flat taxes incent people to work harder, earn more, and engage in wealth-creating activities because the current progressive system penalizes people who make more money (by putting them in higher tax brackets and thus taxing that incremental income at a higher rate). In this vein, supporters say a progressive tax system does not encourage entrepreneurship. Supporters also say the current tax system is too complicated, and that the system of credits, deductions, exemptions, etc. offers too many loopholes with which to take advantage of the system.

The notion of whether the flat tax is "more fair" is perhaps the most controversial aspect of the idea. Under the system, a person with 100 times more income would pay 100 times more in taxes, but that person would be paying the same percentage of his income in taxes as a low-income person would pay.

[InvestingAnswers Feature: How to Avoid an IRS Audit]