Flat Tax Systems

Passage

In 1994, Estonia became the first country to introduce a “flat tax” on personal and corporate income. Income is taxed at a single uniform rate of 26 percent: no schedule of rates, no deductions. So far eight countries have followed Estonia’s example. An old idea that for decades elicited the response, “Fine be working as well in practice as it does on the blackboard.

Practical types who said that flat taxes cannot work offer a further instant objection, once they are shown such taxes working, namely, that they are unfair. Enlightened countries, it is argued, have “progressive” tax systems, requiring high-income earners to forfeit a bigger share of their incomes in flat tax seems to rule this out in principle.

Not so. A flat tax on personal incomes combines a threshold (that is, an exempt amount) with a single rate of tax on all income above it. The extent to which such a system is progressive can be varied within wide limits using just these two variables. Under the systems operating in as much tax under new flat-tax regimes as they would have paid under the previous codes.

Passage

A lot of people don’t understand graduated, as opposed to “flat,” taxes. They think that if you make more money you pay a higher rate on your entire earnings, which seems unfair. Actually, graduated progressive taxes treat all taxpayers equally. Every taxpayer pays the same rate on equivalent layers of income. People of income over a specified amount. People, not dollars, are treated equally.

All people are created equal, but not all dollars are created equal. Earnings of the working poor go almost entirely for survival expenses such as food, shelter, and clothing. At that level, every dollar is critical; even a small difference causes tremendous changes in quality of life. Middle-income have much greater flexibility in absorbing small fluctuations in income.

Even some of the flat tax proposals recognize this, and want to exempt a primary layer from the tax system. So, since they recognize that survival dollars are different from discretionary dollars, why go suddenly from one extreme (paying no taxes) to the other (paying the top rate)? Since flat tax proposals it is naturally going to fall on the middle class to make up the difference.