The Rise of Flat Tax

Governments all over the world generally levy graduated taxes on their population. This means that as the income being taxed increases, the tax rate also increases. Under a graduated tax structure, some amount of income is exempted from the tax. Then, there is a different tax slab, which becomes applicable as soon as the income increases. This progressive structure is supposed to help the government earn more money from corporations that earn more.

There are many governments that are now choosing to break away from this pattern. These governments do not levy taxes, where there are multiple tax rates for different incomes. Instead, these governments levy taxes based on a single rate. This is why the system is called a flat tax system. Flat tax systems have become very popular, particularly in countries that were earlier communist.

There are several benefits of having a flat corporate tax system. Some of these benefits have been listed below:

1. Equality: Flat tax systems treat all taxpayers equally. A basic threshold limit is set. Corporations with income below this limit are not taxed. After this exemption, all companies are taxed at the same rate regardless of the type of business or the size of the company. Many economists believe that this is the best way too tax using the “laissez-faire” policy of economics. When countries use flat-rate tax systems, they do not interfere in the natural process of capital allocation, which takes place in capital markets. As a result, it is believed that flat-rate tax systems help the economy achieve its full potential by achieving an optimum allocation of resources.

2. High Compliance: Countries which levy flat taxes also see a high degree of compliance. Since all the earnings are taxed at a flat rate, the incentive to show less income than the company makes is less. If the tax rate set is reasonable, then the companies are more than willing to pay the tax upfront. This is because evading taxes is also complicated, and companies have to hire experts and spend a lot of time and money in non-productive activities. Countries like Hong Kong have traditionally maintained a flat tax structure and have one of the highest compliance rates in the world.

3. No Preferential Treatment: The biggest advantage of a flat tax system is that it eliminates preferential treatment. Under a graduated tax system, there are a series of laws and rules which provide exemptions to a narrow group of people. Graduated tax systems create special interest groups. Corporations spend a lot of money on lobbying since they believe that obtaining special benefits from the government is possible. Under the pretext of strategic importance, certain sectors or even geographical locations are often given preferential treatment. However, this is incorrect since the allocation of resources should only happen on the basis of the productivity of the project and not on the basis of political patronage.

4. No Corruption: Flat rate tax systems are politically unpopular. However, they are good for the economy. This is why it has been observed that political parties which bring about the flat-rate system are often ousted from power. However, their successors seldom repeal the system. Flat rate tax systems exclude political meddling. There is no scope for a minister or government official to represent certain industries or industrialists and ask for special breaks for them. As a result, the huge sums of money which are spent on lobbying and buying government influence are not wasted. This money can instead be used in productive economic activity, thereby generating more tax revenue.

5. Simplification: Another benefit of the flat-rate tax system is the simplification which it provides. Graduated tax systems are complicated to understand and implement. Governments have to spend a lot of time and money trying to groom employees into tax experts. Also, the government has to spend even more money in order to create software that will help automate the tasks. Since so many rules have to be built into the software, it is complicated and often expensive. Similarly, from the corporation’s point of view, also flat tax rate brings a lot of simplification. They do not have to hire experts to ensure that they are in compliance with the law. The expenses related to filing taxes also get reduced as a result.

6. Avoids Double Taxation: Under the current tax system, certain types of income are taxed twice, whereas others are not taxed at all. For instance, income paid out as a dividend is taxed twice, whereas some income is not taxed at all. Flat rate tax also eliminates other taxes, such as capital gains tax. Also, there are no complicated rules about income being exempt from taxation if it is invested in a certain manner. Flat rate taxation does not influence the manner in which people invest their savings. The rate of tax remains the same regardless of the manner in which the funds are deployed.

The bottom line is that flat-rate tax systems have empirically shown some advantage over graduated tax systems. However, these advantages are from an economic point of view. The political class stands to lose if flat-rate tax systems are implemented all over the world. This is the reason that they are not very eager to implement the same.