Every so often, an article or speech will make the rounds about how it would benefit all Americans to replace the current income tax structure with a flat tax. Our CPA firm is exploring what the flat tax is, its advantages and disadvantages over the existing code, and whether we believe a flat tax will replace the existing system.
What Is a Flat Tax?
A flat tax system levies a set tax rate on every citizen, regardless of their income. For example, if the flat tax rate is 20 percent, then a household with an adjusted gross income of $50,000 per year would pay $10,000 in income tax and a household with an adjusted gross income of $500,000 would pay $10,000 per year.
You’ve already received some experience in flat tax. In 2014, North Carolina enacted a flat state income tax of 5.25 percent and eliminated the earned income tax credit and personal exemptions as well as common deductions. However, there is still the standard deduction in place.
So, how does differ from our current system? The federal tax system uses a progressive tax rate, so the more income an individual makes, the higher their tax rate. An initial tax is owed, plus a percentage of any income over a set amount within the bracket. This is a bit complicated, so let’s look at the tax brackets for married couples filing jointly in 2021 before any deductions or exemptions:
- For annual taxable income up to $19,900, the household owes 10 percent of taxable income;
- $19,901 to $81,050, the household owes $1,990 plus 12 percent of any income over $19,900;
- $81,051 to $172,750, the household owes $9,328 plus 22 percent of any income over $81,050;
- $172,751 to $329,850, the household owes $29,502 plus 24 percent of any income over $172,750;
- $329,851 to $418,850, the household owes $67,206 plus 32 percent of any income over $329,850
- $418,851 to $628,300, the household owes$95,686 plus 35 percent of any income over $418,850
- $628,301 or more, the household owes $168,993.50 plus 37 percent of any income over $628,300
Under this progressive tax system, a couple with an adjusted gross income, after standard deductions and child tax credits of $50,000 would pay 5,602 ($1,900 plus 12 percent of the amount earned over $19,900 which is $3,612.). A household with an adjusted gross income of $500,000 would pay $176,806 ($95,656 plus 35 percent of the amount over $418,850, which is $81,150).
Advantages and Disadvantages of a Flat Tax System
Now that we understand what a flat tax system is, let’s look at the pros and cons.
Benefits of a Flat Tax
- Simplicity: Most deductions and exemptions are eliminated in most flat tax plans, and with one simple rate, there’s minimal confusion.
- Fairness: It seems more fair as everyone pays the same rate.
Concerns of a Flat Tax
- Income inequality: A flat tax disproprotionately harms lower and middle income brackets while enriching wealthy households. If a household earning $50,000 is taxed at a flat 20 percent rate, they’ll only have $40,000. It’s not surprising that $10,000 to a household earning $50,000 is a significant amount that can greatly influence financial decisions, like the ability to place a down payment on a house. On the other hand, a household earning $500,000 will still have $400,000 of purchasing power.
Will the U.S. Ever Adopt a Flat Tax?
It is unlikely that the United States will ever adopt a flat tax. Not only will it lead to greater disparity of wealth distribution, it also can affect policy and trends. Tax deductions and exemptions are given to influence the population. For example, a tax deduction for purchasing an electric vehicle encourages consumers to purchase the more environmentally friendly vehicle and deposits to a 529 college savings account are not taxed, encouraging consumers to save for higher education.
With a flat tax system, most of these exemptions and deductions are eliminated, affecting the opportunity to encourage societal changes.
Schedule a Consultation to Discuss Your Income Taxes Today
While you may long for the ease of a flat tax rate, it’s not as simple and clear cut as it would seem. For now, if you’re struggling with the existing income tax code and completing your annual tax returns, we can help. Reach out to our CPA firm in Raleigh for tax preparation assistance and consultation services today at (919) 872-0866 or fill out the form below to get started.