Updated July 15, 2023
What is Flat Tax?
Flat tax refers to the tax system in which a flat percent rate is applied to the Taxable Income irrespective of income bracket. It means everyone pays the same rate of tax irrespective of their income level, which in a way, avoids differentiating between taxpayers based on their Income level bracket.
Normally this tax system doesn’t provide any tax deductions and tax credits. Many countries around the globe use the Flat Tax system owing to its simplicity and easiness both in terms of operational flexibility as well as convenience on the part of the Taxpayer.
Explanation
A flat tax implies taxation at a fixed rate irrespective of Income level. Taxation is simple to understand and apply. It is the same for both businesses as well as for individuals. After deducting permissible business expenses, the business needs to pay tax amount at the Flat Rate as determined by the jurisdiction to which it belongs. Similarly, Individuals must pay tax on their taxable income after admissible standard deductions, if any.
How Does it Work?
It works in a very simple fashion. Under this, every individual or business with a taxable income is charged with a fixed rate, making it simple to apply, unlike other progressive tax rates where different tax rates are applied, many deductions can be availed. A specific deduction and minimum income threshold are available in some jurisdictions in the Rate regime. Let’s explain this with a simple example:
Suppose there is a family of four earning members, namely Mr. A, Ms. B, Mr. C, and Mr. D, with Annual incomes of $140000, $90000, $30000, and $20000, respectively. The country where this family stays provides a minimum Annual tax limit exemption of $25000 and a Flat Tax rate of 10%. Using this structure, the tax liability is computed as follows:
|
Particulars |
Threshold limit | Income | Taxable Income | Tax Rate |
Tax liability |
| Mr. A | $25,000 | $140,000 | 115000 | 10% | 11500 |
| Ms. B | $25,000 | $90,000 | 65000 | 10% | 6500 |
| Mr. C | $25,000 | $30,000 | 5000 | 10% | 500 |
| Mr. D | $25,000 | $20,000 | Not Applicable | 10% | Not Applicable |
Thus in the above case, we can see for Mr. D there is no tax liability as the Taxable Income is below the threshold limit. Taxable income is determined for the remaining family members by subtracting the threshold limit from Gross Income. Accordingly, the rate is applied to derive the tax liability.
Example
Let’s understand with the help of an example.
Ryan, Jacob, and Steven work in the local manufacturing company in San Diego. They held different roles in the Sales, Analytics, and Finance Departments. The consolidated Annual Taxable Income of the three was mentioned below:
|
Employee Name |
Annual Taxable Income |
| Ryan | $130000 |
| Jacob | $170000 |
| Steven | $200000 |
As per the taxation system prevalent in the USA, a flat tax rate of 10% is applied to the Taxable Income with a standard deduction of $4000 available to all taxpayers.
Based on the same, the Tax liability of the three is mentioned below:
| Employee Name | Annual Taxable Income | Standard Deduction | Annual Taxable Income Post deduction | Flat Tax Rate | Tax Amount | Net Disposable Income |
| Ryan | $130,000 | $4,000 | $126,000 | 10% | $12,600 | $117,400 |
| Jacob | $170,000 | $4,000 | $166,000 | 10% | $16,600 | $153,400 |
| Steven | $200,000 | $4,000 | $196,000 | 10% | $19,600 | $180,400 |
Flat Tax Rate
Flat tax rates vary from country to country and year to year depending upon the income level and government in power. For instance, Russia has a flat tax rate of 13%, which varies from country to country, with some or no deductions available.
Advantages
There are multiple advantages. A few noteworthy are enumerated below:
- The Flat Tax system promotes higher wealth in the hands of people as tax rates remain the same even when the Income level increases.
- It reduced administrative costs for the exchequer due to its simplicity and easy computation and compliance cost for the business.
- A flat tax system avoids double taxation as it doesn’t result in indirect taxation such as VAT, Sales Tax, etc.
- It doesn’t differentiate between taxpayers and makes tax assessment easy for them.
- This tax system propels people to increase their earnings and disclose the same, and the tax rate doesn’t increase and remains the same even with an increase in income.
Disadvantages
Despite the advantages, there are certain disadvantages as well as discussed below:
- A flat tax system results in higher income inequality as lower income and higher income brackets are taxed at the same rate leading to lower income in the hands of people in the lower tax bracket.
- This tax system results typically in revenue loss for the government as the Flat Tax rate can’t be kept high enough on account of lower tax bracket individuals’ consideration resulting in lower tax collection from higher tax bracket individuals.
Difference Between Flat Tax Rate and Progressive Tax Rate
|
Basis of Comparison |
Flat Tax Rate |
Progressive Tax Rate |
| Concept | It involves a standard fixed tax rate irrespective of income level. | It involves different tax rates based on the Income level, with the tax rate increasing as the Income level increases. |
| Adoptability | It is adopted in fewer countries. | It is widely adopted across different countries. |
| Complexity | It is simple and easy to apply with limited compliance costs. | It is more complex and requires more tax expertise for better management. |
Conclusion
A Flat Tax Rate is a uniform tax rate system that charges tax at a uniform rate, unlike the other progressive tax rate system where the tax rate varies based on the income bracket of the individual with a lower income level charged less and a higher income level charged more. The rate has found traction in many countries, such as Russia, where this system is in use and is well accepted; however, this tax system has often been criticized for being harder on lower-income groups by leaving them with less disposable income in hand. Despite the pros and cons Flat Tax Rate System continues to be an alternate and popular tax system.
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