Definition of 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 type of tax system doesn’t provide for any tax deductions and tax credits. Many countries around the globe use the Flat Tax system owning to its simplicity and easiness both in terms of operational flexibility as well as convenience on the part of the Taxpayer.
Explanation
Flat tax implies taxation at a fixed rate irrespective of the Income level. The taxation is simple to understand and apply. It is the same for both businesses as well as for individuals. Business after deduction of admissible business expenses needs to pay tax amount at the Flat Rate as determined by the jurisdiction to which it belongs. Similarly, Individuals have to 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 having taxable Income is charged with a fixed rate making it simple to apply, unlike other progressive tax rates where different tax rates are applied, and so many deductions can be availed. In some jurisdictions, a certain deduction is available in the Flat Tax Rate regime along with the threshold of minimum Income. 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 their Annual income of $140000, $90000, $30000, $20000 respectively. The country where this family stays provides for a minimum threshold Annual tax limit exemption of $25000 and a Flat Tax rate of 10%. Using this Flat tax 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, and for the remaining members of the family, taxable income is arrived at by subtracting the threshold limit from Gross Income and accordingly the flat tax rate is applied to derive the tax liability.
Example of Flat Tax
Let’s understand Flat Tax with the help of an example.
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Ryan, Jacob, and Steven work in the local manufacturing company in San Diego. They held different roles in the Sales, Analytics, and the Finance Department. 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 as well as year on year depending upon the income level and government in power. For instance, Russia has a flat tax rate of 13%, and this rate varies from country to country with some or no deductions available.
Advantages
The flat tax system offers multiple advantages. 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 as well as compliance cost for the business.
- A flat tax system avoids double taxation as it doesn’t result in any indirect taxation such as VAT, Sales Tax, etc.
- It doesn’t differentiate between different taxpayers and make tax assessment easy for them.
- This type of tax system propels people to increase their earnings and disclose the same as well as tax rate doesn’t increase and remains the same even with an increase in income.
Disadvantages
Despite the advantages that the Flat Tax System offers, there are certain disadvantages as well as discussed below:
- 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 normally results 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 |
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 to do better tax 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 lower income level charged less and higher income level charged more. The flat Tax rate has found traction in many countries such as Russia etc., where this system is in use and is being well accepted as well; however, this tax system has often been criticized for being harder on lower Income level 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 in use.
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