The Economic Advantages of a Flat Tax

A flat tax system fundamentally differs from the progressive tax system of the United States. Tax rates are applied evenly across all income classes rather than adjusted based on income. Tax forms are simple and compact, eliminating the frustration and cost of filing income taxes; subsidies and tax deductions are virtually eliminated. Proponents of a flat tax claim that economies greatly benefit from a flat tax system, citing examples of success in the Baltic region. Opponents claim that a flat tax benefits higher income families much more than lower-income homes.

Flat Tax and Savings

Current tax regulations favor consumption over savings and investment by imposing heavy burdens on capital gains, interest income and dividends. Under a flat tax system, income is taxed once at a flat rate, encouraging people to save and invest more of their income, since their investments will not be taxed at every turn. An economy-wide increase in savings and investment can have positive spillover effects, such as a boost to the housing market, financial services industry and automobile industry.

Flat Tax and Economic Growth

According to a study by the National Center for Policy Analysis (NCPA), "The Economic Effects of a Flat Tax," industrial investment is not structured to favor the most competitive and attractive industries under a progressive tax. Due to subsidies and unequal treatment of diverse industries, it can be more profitable to invest in low-growth or low-profit sectors. The study proposes that a flat tax redistributes investment away from highly subsidized industries, such as farming, towards more competitive industries, such as manufacturing. This can have the effect of increasing production in nearly every industry.

Individuals are encouraged to work harder, earn more money and further their careers under a flat tax system, whereas a progressive tax system tends to punish people for success. This can serve to increase economy-wide spending and small business startups, providing a further boost to a range of industries and the overall tax-base.

Income Effects

Higher-income households will realize significant income benefits under a flat tax system. Besides the obvious effect of lowering base tax rates, which many people in the highest income bracket consider unreasonable under a progressive tax system, a flat tax does not impose itself on interest revenue, dividends, capital gains or inheritance.

Under several flat tax proposals, individuals and families would receive personal allowances – a set amount of income that is tax-exempt – that would limit their taxable income. This would allow the lowest-income brackets to be completely or nearly exempt from income taxes. This fact, coupled with the increase in employment resultant from economy-wide industrial expansion, helps lower-income households to realize significant income benefits as well.

Flat Tax Revenues

A flat tax would seem to lower tax revenues for the government under a superficial analysis, but deeper look reveals several positive possibilities.

The economy-wide increase in production and consumption, as well as the increased productivity of individuals, can lead to higher economy-wide income, resulting in an increase in the overall tax-base. Tax evasion and avoidance would become less profitable, decreasing the number of people who do not pay their taxes, and it would no longer be possible to manipulate the deductions in the tax code to completely negate the tax burden of high-income individuals.

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