Flat Tax Vs Fair Tax

Flat Tax Vs Fair Tax

As the powerhouses in the US pit their wits against two startlingly different tax reforms to ever be implemented, the debate of flat tax vs. fair tax is an engaging one. The enthusiasts for both these taxes concur on one very basic point regarding taxation: that it should be progressive, wherein the richer man ought to have a larger income tax liability than his less moneyed counterpart.

Redistribution of wealth is the primary goal of taxation in an economy. But, with the current taxation system becoming terribly complicated by the day and filing for taxes a hard job overall, people do believe that if there was some way that this arduous process could be smothered out and that too without disturbing the basic goal behind taxation, every one comes out a winner: the taxpayer, the tax man, and the government. So this is where the two most popular tax reform ideas have come up.

Notable Differences

Flat Tax

As the name suggests, it is a taxation method under which everyone will be paying the same amount of tax, at a flat rate. Except, there is a catch. In order to make it a bit fairer, there will be an exemption given to each family, presumably based on the number of members in the family. It will then be calculated at the rate of 17% on the amount over the exemption.

Let me explain this with the help of an example. The flat tax proposes that a family of four be given an annual exemption of USD 35,400 so that they may be able to cover their basic living expenses. So, if the total income of the family is USD 30,000, they will not be liable to pay tax. But, as their income increases to, say, USD 60,000, they will be taxed for the portion of income in excess of the USD 35,400 exemption. So, their 17% tax will be calculated on (USD 60,000 – USD 35,400) USD 24,600. So, the flat tax rate of 17% means that they will be coughing up money somewhere in the region of USD 4,182.

To eliminate your thinking on whether this method is unfair and regressive, take a look at another example. Let’s take another family of four. Only, the income of this family is USD 150,000. So as the formula goes, they will be taxed at 17% of the amount over the exemption (USD 150,000 – USD 35,400 = USD 114,600), which is USD 19,482. Now, calculate both the amounts of tax as a percentage of the income.

In the first case, the family earning USD 60,000 paying a tax of USD 4,182, ends up paying tax at an effective rate of approximately 7%. The richer family on the contrary, pays a tax of USD 19,482 on USD 150,000, which means that they are taxed at a rate of 13%. Hence it can be said that this system is indeed progressive.

The advantage of this tax system is discernible enough. It reduces paperwork and filing taxes becomes pretty easy.

Fair Tax

It is a complete overhaul of the tax system, rather than just a simple tax reform. It calls for abolishing all the taxes such as federal income taxes including personal, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes. All of it. And instead, we will have one tax which is levied on the purchase of goods. The cost of the necessaries will be driven higher and a sizable component of the price will be the tax on it. This way, the more you purchase, the more you pay tax.

It also calls for a rebate or a ‘prebate’, where a family is given a certain amount of money depending on the number of children the family has. The rebate increases with the number of children, and hence, it gives the families some income to work with since the costs of normal daily-use goods stands to increase.

What’s so fair about the fair tax if everyone will be paying the same amount of flat sales tax on retail items? How is that progressive? Well, the theory behind it is that the richer folk tend to buy more stuff as compared to those with less money. They also tend to buy more expensive things, so since the sales tax rate is a percentage of the price of the goods, the tax paid in total is a lot higher. But then again, the poorer lot will be further isolated from the occasional use of luxury items as they suddenly become a lot more pricey.

And of course, the tax filing becomes simpler. All you need to do is buy your stuff and the tax is paid automatically.

Everyone has their own perspective, of course. Perhaps though, driving up the price of necessaries as under the fair tax method will result in a contraction in the demand for goods, more so in case of the goods where the basic price is higher. A flat tax on the contrary, is a much fairer method. Thus, the two systems have their pros and cons, and people can choose what they are comfortable with.