 |
|
|
|
|
|
Flat Tax
A flat tax generally refers to the taxation of income
of all sorts but can also be applied to consumption. Flat taxes are seldom
seen in advanced economies, where nationwide taxes typically include a
graduated tax on household incomes as well as corporate profits, so that
the marginal tax rate rises as the income or profit of the taxed entity
rises. Household income below a statutorily determined level is exempted
from flat taxes, however, the type and size of the household is used to
determine this lower limit. As a result, a flat marginal rate is entirely
in direct accordance with a progressive average tax rate. If this is not
the case, all income or consumption is taxed at the same marginal
rate.
History and Current Use
Ever since the trends seen in growing economies have been recorded, a flat tax was seen as an important development over a status quo featuring lower tax rates, including zero, for the nobility and clergy. Such a situation in France in the 18th century was one of the causes of the French Revolution. Over the course of the 19th century, most European nations followed suit and adopted flat taxes applicable to most or all incomes.
After the first World War, a system of levying progressive
income taxes was introduced in majority of the countries to fund increased
government spending for social programs and, in particular, incessant
large scale wars. In the more recent years, some people have come to the
conclusion that very high tax rates for the highest income classes are not
of much use: this is owing to the fact that the taxpayers, especially the
rich and mobile ones, evade these taxes. However, the proponents of high
taxes such as George Monbiot claim that they have been an absolute success
in a few countries, an example being Sweden, although detractors claim
that Sweden's government programs are more of a drain on its
economy.
There are many countries levying a flat tax in the
European Union with some of them having a tax rate lower than 20%, and
some others having a tax rate greater than 20%.
The flat tax has made a
comeback of sorts in the recent years. It began in the United States of
America, where former House Majority Leader Dick Armey and Freedom Works
have sought the grassroots' support for the implementation of the flat
system of taxation. In the meanwhile overseas, policymakers have had even
greater success. This is essentially as a result of its application in
several countries of the former Eastern Bloc, where it is believed to have
been successful, although this assessment has been disputed. This has
attracted a lot of interest in countries such as the USA, where it has
played the role of a benefactor having a general swing towards
conservative politics.
The countries that have recently reintroduced flat taxes have done so largely in the hope of giving their economies a boost of growth which they are so much in need of. The Baltic countries of Estonia, Latvia and Lithuania have had flat taxes of 24%, 25% and 33% respectively with a tax exempt amount, right from the mid-1990s. On 1 January 2001, a 13% flat tax on personal income was brought into effect in Russia. Ukraine followed Russia soon after with a 13% flat tax in 2003. Slovakia introduced a 19% flat tax on most taxes like corporate and personal income, VAT etc., with barely any exceptions, but attempted to less damages with a high tax exemption in the year 2004. Romania introduced a 16% flat tax on personal income and corporate profit beginning January 1, 2005.
In the United States of America, while the Federal income tax is progressive, five states namely, Illinois, Indiana, Massachusetts, Michigan and Pennsylvania, tax household incomes at a single rate, ranging from 3% in Illinois which is the lowest to the highest rate of 5.3% in Massachusetts. Pennsylvania has even implemented a pure flat tax system with no zero-bracket amount.
Possible Implementations
A number of flat tax schemes have been proposed, with no scheme in reality amounting to a truly flat system of taxation, under which everyone would pay exactly the same rate irrespective of their income. Schemes also vary in terms of how they define and measure what is liable to be subjected to taxation.
Flat Tax with Deductions
United States Congressman Dick Armey is the one who advocated a flat tax on all income in excess of an amount shielded by household type and size. For instance, the draft legislation proposed by Armey would allow married couples filing jointly to deduct $26,200, unmarried heads of household to deduct $17,200, and single adults, $13,100 and dependents would call for a deduction of $5,300 each. Each household would hence pay taxes at a flat rate of 17% on the excess, and businesses would pay a flat 17% rate on all profits.
There are others also who have put forth similar proposals with various rates and deductions. While on his campaign for the American presidency in 1996 and 2000, Steve Forbes called for replacing the prevalent income tax system by a system of taxation at the flat rate of 17% on consumption, defined as income minus savings, in excess of an amount determined by the type and size of the household. For example, the amount exempted for a family of four would be $42,000 per year.
Since a pure flat tax has admittedly been hard to gain acceptance among tax payers, various modified types of flat taxes have been proposed, which would allow deductions for a very few items, while still doing away with the vast majority of existing deductions. Charitable deductions and home mortgage interests have by far been the most discussed exceptions, as these are popular among voters and often used by them. However, according to the "Flat tax fiasco" by renowned economist Douglas Dunn, this is not in reality a true flat tax.
True flat tax
There has been no elected official or policy intellectual
who has advocated a true flat tax, undoubtedly because it is widely seen
as a non-starter. In the article titled 'The flat-tax revolution' dated
April 14, 2005, The Economist made the following arguments. If the goals
are to reduce corporate welfare and instead, to enable household tax
returns to fit on a postcard, then a true flat tax best achieves these
goals. The flat rate would then be applied to the entire taxable income
and profits, without any exception or exemption. Under such a tax, it
could be argued that nobody gets to enjoy a preferential or unfair tax
treatment, no industry receives any special treatment, large households
are not advantaged at the expense of small ones, etc. Moreover, the cost
of tax filing for citizens and the cost of tax administration for the
government would be drastically reduced, as under a true flat tax only
businesses and the self-employed would need to actively interact with the
tax authorities.
None of the flat tax proposals in
the U.S.A. approach the concept of a true flat tax. Most proposals still
make it a point to distinguish between "earned" and "unearned" income, and
tax the earned income component more heavily than its unearned
counterpart. In addition to this, no flat tax proposes to replace the
regressive FICA or the Social Security tax, which does not apply to earned
income above $90,000, and to unearned income. A true flat tax would
ideally also address these shortcomings.
Negative Income Tax
In economics, a Negative Income Tax, abbreviated NIT, is a method of tax reform that is popular among economists but has never been entirely and successfully implemented. It was developed by economists Juliet Rhys-Williams in the 1940s and later by United States economist Milton Friedman in 1962. Negative income taxes can either implement or supplement a guaranteed minimum income system.
The Negative Income Tax or NIT as proposed by Milton Friedman in 'Capitalism and Freedom' which was published in 1962 is a variation of flat tax. Under a Negative Income Tax program, the flat tax rate and the deduction system would be very similar to those of other flat tax programs. The basic idea is the same as that of a flat tax with personal deductions, except that when deductions exceed income, taxable income is allowed to go into a negative value rather than set it to zero. The flat rate is then applied to the resulting negative income, resulting in a negative income tax which the government owes the household, unlike the usual positive income tax, which the household owes the government.
For instance, if we assume that the flat rate is 10%, and let the deductions be $10,000 per adult and $5,000 per dependent. Under such a system, a family of four earning $30,000 a year would owe the government no tax. A family of four making $60,000 a year would owe tax amounting to 0.1(60,000-30,000) = $3,000, as under a flat tax with deductions. However, a family of four earning less than $30,000 per year would owe a negative amount of tax (i.e., it would receive money from the government). For example, if it earned $24,000 a year, it would receive a check for $600.
The NIT is intended to replace not just the ordinary system of USA income tax, but also many benefits currently enjoyed by low income American households, such as food stamps, Medicaid, etc. The NIT is designed to avoid what is called the welfare trap which is in other words, effective high marginal tax rates arising from the existing taxation rules, reducing benefits as market income rises. Some of what the Negative Income Tax system seeks to achieve has already been achieved via the Earned Income Tax Credit. Some object to the way the NIT is, in effect, welfare without a work requirement and the wrong ideas it may give miscreants to give up striving to earn for a livelihood due to the assured income. Those who would owe negative tax would be receiving a form of welfare without actually having to make a good faith effort to obtain employment. Others claim that the NIT would effectively subsidize industries employing low cost labor. The only answer to this objection lies in the implementation of a true flat tax. Moreover, the NIT in reality is no more a subsidy to low skill labor-intensive industry than extant benefits for the working poor.
A negative income tax would thereafter replace the current progressive income tax system used throughout most of the western world. This would be replaced by a flat tax of, say, 25%, but each taxpayer would also be given $10,000 by the government. Thus a person presumably making only $4000 per year would end up paying $1000 in taxes, but overall would receive a net gain of $9,000 from the government. A person earning $40,000 would be at the break-even point and would neither have to pay taxes nor would he receive any benefits from the government. A person making $1,000,000 per year would pay close to the entire 25% tax, as the $10,000 would not help relieve the tax burden.
Fairness
This is one of the most hotly debated aspects of flat taxes. Real and perceived fairness depends crucially on what tax categories of deductions are abolished when a flat tax system is introduced, and who profits the most from those deductions. Propagators of the flat tax system claim that it is fairer than progressive taxation, since everybody would end up paying the same amount of taxes. On the other hand, opponents point out that for the state to raise the same amount of money under a flat rate tax requires the rich to pay less and the poor to pay more than they would have had to under a progressive tax system. The issue comes down to how one chooses to define the term fair. Proponents claim that since everybody pays the same rate, it treats everyone equally and thus can be deemed fair to everyone. Opponents of the flat tax, on the other hand, claim that since the value of income declines with the amount of income (for example, the last $100 of income of a family living near poverty being obviously considerably more valuable than the last $100 of income of a millionaire), taxing that last $100 of income in a similar manner despite vast differences in the marginal value of money is unfair. Many flat-tax proponents actually concede this premise owing to the fact that most proposals are not truly totally flat but have a threshold where income below that threshold is not taxed at all. Therefore, with the exception of flat-tax proponents who argue for no deductions and taxation of all income at one flat rate, both proponents and opponents agree in principle if not in degree with the basic idea of this concept. It is for these very reasons that very few, if at all any, politicians have ever dared to propose a true flat-tax since it would find no public support what so ever, thus minimizing their chances of victory.
Claims about the Success of Flat Taxation in Eastern Europe
Advocates of the flat tax system, point to the formerly Communist countries of Eastern Europe as examples favorable to the adoption of a flat system of taxation. Some of these nations, the Baltic Countries in particular, have experienced exceptional economic growth in the recent years. However, there is increasing concern over the effect that flat rates of taxation are having on these countries, both socially and politically, and arguments have been made that flat tax has had less influence on economic growth than previously imagined.
o Lithuania has been one to experience the fastest growth amongst the other countries in Europe, and levies a flat tax rate of 33% on its citizens. Proponents of flat tax applaud this country's declining unemployment and rising standard of living and attribute this to the adoption of the flat tax; they also state that tax revenues have increased and there has been subsequent decline in tax evasion which is explained by the Laffer curve effect. Others point out however, that Lithuanian unemployment is on the decline at least partly as a result of mass emigration to Western Europe. The argument is that Lithuania's comparatively low wages, on which an overly regressive flat tax regime is levied, combined with the possibility now to work legally in Western Europe since accession to the European Union, is forcing people to leave the country in huge numbers. The Ministry of Labor had estimated in 2004 that as many as 360,000 workers may have left the country by the end of that year, a prediction that is now thought to have been broadly accurate. The impact is already evident since in September 2004, the Lithuanian Trucking Association reported a shortage of 3,000-4,000 truck drivers, so have a few large retail stores, which have also reported some difficulty in filling positions.
o Again in Lithuania, it has been argued that while a new urban elite clan is certainly emerging in the country, poverty continues to be a larger than life situation with average salaries pitiably low and that for the vast majority of people things have not substantially improved. According to a report published by the United States Department of State in October 2005, the minimum wage increased in 2005 to $197.50 per month which was the first rise since June 1998), which is still well below the poverty threshold. The threshold average wage stands at $458 per month.
o While in most countries the introduction of a flat tax has coincided with a considerable increase in growth and tax revenue, there is no proven correlation between the two. A study by the International Monetary Fund has shown that sharp increases in the Russian Gross Domestic Product or GDP and tax revenue around the time of the introduction of a 13% flat tax were not in reality the result of the tax reform, it instead was brought into being because of a sharp increase in oil prices, strong real wage growth, and an intensification in the prosecution of tax evasion.
o In Estonia, which has been
levying a 26% flat tax rate since 1994 on its people, studies have shown
that the significant increase in tax revenue experienced was caused partly
by a disproportionately rising Value Added Tax revenue. Moreover, Estonia
and Slovakia have been known to have high social contributions, pegged to
wage levels. Both of these matters do raise questions regarding the
justice of the flat tax system, and the effects in terms of its long-term
viability. An Estonian economist and former chairman of his country's
parliamentary budget committee stated in September 2005 that the rising
income disparities call for an imperative consideration of a progressive
system of taxation and that the flat rate of taxation could well be done
away with by the time the electorate makes its opinion heard at the time
of elections.