What is More Fair, a Flat Tax or Progressive Tax?
If we put aside all other taxes and just consider the Federal Income Tax, then low-and-middle income families would see an income tax increase under a “true flat tax” and top earners would see an income tax decrease.
If we factor in all other state and federal taxes which actually exist in practice, then the above is even more true. (IMPORTANT: We must consider all taxes here, low-earners have less ability to pay, but also pay a large portion of their income in payroll, excise, and sales tax… it is a myth that low-earners don’t pay taxes, they don’t pay INCOME taxes specifically is all).
Under the current tax system about 1/2 of American families currently pay little to no federal income tax (as an “effective tax rate“) due to deductions, credits, and the progressive bracket structure. Under a flat tax many who currently pay nothing would still pay nothing (as most flat taxes exclude very low incomes), but for those with lower incomes who do pay, a flat federal income tax would raise their average rate beyond what the progressive tax does and thus would raise their effective rates.
Since lower incomes have a lower ability to pay, already spend the majority of their incomes, and even sometimes spend more than their incomes on credit, it really doesn’t seem “fair” to shift the tax burden on them… especially when we consider the rather flat / regressive payroll tax, sales tax, excise taxes, and property tax, and all the other state and federal tax types which tend to disproportionately burden lower incomes.
When we take into account all tax types, we can say: a main reason the average family is struggling with costs and extended on credit, while the rich save more, and the wealth gap widens is… the already rather flat tax structure of most taxes, including the progressive income tax which inclines sharply and fails to account for the wealth gap within the top 1% (see example tax rates below).
Federal taxes are progressive on aggregate (as you can see in the Tax Policy Center images below), but the progressive federal Income tax is essentially the only thing ensuring this under our current system. If we flatten that tax, then lower incomes are squeezed even harder… while higher incomes get a tax break. Simply, that is what is “not fair”, especially in a country that racks up debt each year and lags behind other countries in providing access to things like education and healthcare!
With all of that said, there are some valid lines of reasoning regarding the logic behind a flat tax and its fairness. For example, we can consider plans that flatten the income tax but address issues with other taxes, or muse on more ideological points like “is it fair that individuals with a negative tax rate have a say in tax policy“…. although, that is a slippery slope, as the same could be said for corporations who need to take a loss in a given year for example.
We offer more details on the above argument below, first some graphs from the Tax Policy Center showing a visual of why a flat tax isn’t in practice.
NOTE: The argument above generally applies to federal income-related taxes. So it applies to the federal income tax, the federal capital gains tax, and the federal corporate income tax. For capital gains, we should note that the ultra wealthy make a lot of their income in capital gains, so if we tax regular income but not that, then it is “unfair” for those who don’t invest or invest less. For the corporate tax it is a bit more tricky, but generally we can say small businesses with a tighter profit margins have less “ability to pay” than larger businesses with more profits, and thus we can equate this with the argument for a progressive federal income tax. We won’t make the case for each tax type in full here, but keep in mind the general argument applies for each income-based tax.
FACT: An estate tax is also a “fair” tax. See an argument for the estate tax.
TIP: See a page explaining the mechanics of progressive taxes and the marginal tax rate for definitions.
TIP: See that blue bar on the top 1% side, that is the income tax. The flat tax argument says lets take half that bar and shift it to the bottom 60% of earners with a lower ability to pay who are already over-extended. If that seems fair to you, then please comment below with your logic.
Effective Federal Tax Rates, for all tax units, by Expanded Cash Income Percentile, Adjusted for Family Size, 2016. Notice how most federal taxes are rather flat or regressive, and the only saving grace for the majority of Americans is the very progressive income tax structure. The basic flat tax argument takes this away and leaves the rest. Not fair on my account, what do you think? Consider, the chart doesn’t factor in cost of living or state taxes like sales tax and property tax!
More Arguments for a Progressive Being More Fair
The above concept that a progressive tax is more fair is generally true for any tax type or nation, but as noted above it is specifically true in America when we consider things like deductions, exemptions, loopholes, subsidization programs, and the other tax types related to income, wealth, and property that businesses, individuals, and families face (like payroll and sales tax which burden lower-incomes, property tax which burdens middle-incomes, and the corporate tax, investment income taxes, and estate taxes higher income face).
When we consider a flat income tax, payroll tax, sales tax, and property tax for low-and-middle income families, and then compare that to a flat corporate tax, a flat income tax, and the current estate tax for high income families, we can see how truly unfair a flat income tax would be in terms of equal share of the burden vs. ability-to-pay (in our current system; with no other changes).
Just take another look at the Tax Policy Center charts above and below.
Imagine the blue (income tax) and yellow (corporate tax) go down for the top 20%, and then up for roughly the lowest 80% while the Payroll tax stays the same…. now imagine the leftover money is money to spend (and is thus subject to a sales tax, property tax, and other taxes which burden low-and-middle income Americans, but not higher earners). The rich would build wealth, the poor would pay more, and over time the wealth gap would widen… how is this fair?
Likewise, the same is true for subsidization. Flat subsidization like “everyone gets X in their HSA”, sounds fair on paper, but arguably isn’t when we consider the bigger picture (namely, different income families have different needs).
Ideally taxation should be progressive, subsidization regressive (tapering off slowing, avoiding cliffs), and otherwise as simple as possible while remaining fair. Of course, this assumes the underlying problem is tax structure alone. In reality special interests, loopholes, monopolistic practices, cronyism, and other factors can be just as big if not bigger hurdles in quality of life, tax burden, and general spending vs. revenue debate.FACT: Under a flat tax wage earners are taxed twice (income and payroll) and dividends only once (income). Pair this with the fact that payroll, property tax, and sales tax are already somewhat regressive and flat (as the more you make the less they hurt), and the flat tax argument gets that more difficult to make.
TIP: The maximum amount of wages subject to Social Security taxes for 2016 is $118,500. Since there is a cliff, where when you make more you pay less, the tax can be described as regressive. Since the share paid by employer and employee doesn’t scale with income, it can be described as flat. This tax burdens lower-incomes more than higher ones accordingly. Same would be true for a flat income tax.
Adding Complexity to the Fair Tax vs. Progressive Tax Debate
With the above said, things get less clear cut when we consider that, in-practice, flat tax proposals tend to be modified flat taxes that take into consideration lower income groups and other taxes like the payroll tax.
When we compare these modified flat taxes to our current progressive tax system (loopholes and all), the conversation gets more complex.
Certainly a theoretical modified flat tax that lowered employee payroll taxes and consumption taxes, got rid of loopholes, exempted those below the current filing limit, and increased income taxes to account for this would be “more fair” than one that didn’t… but its still hard to make the case it is fairer than a true progressive tax.
Before we attempt to fully prove this somewhat semantic argument of equity, fairness, and taxes, lets consider how our predecessors framed the flat tax vs. progressive tax back in 1982 when discussing Reaganomics:
Like just about everything else in this imperfect world, the flat rate income tax has its advantages and its disadvantages. In terms of equity, however, the effects of the single tax rate may be considerable. While, in the abstract, the flat rate may appeal to some people as more fair, in practice it would redistribute a significant share of the tax burden from upper-income to middle-income (and possibly even low-income) taxpayers. Many of these middle-income taxpayers already have limited financial flexibility due to contractual mortgage interest and property tax obligations. – TESTIMONY OF Joseph Minarik Deputy Assistant Director Tax Analysis Division Congressional Budget Office Before the Subcommittee on Monetary and Fiscal Policy Joint Economic Committee 3 July 27, 1982. On the fairness and equity of a flat tax (as proposed in the Reagan era), describing how it would funnel money from the lower and middle income earners to the top.
Flat Tax vs. Progressive Tax: Definitions
Below we examine the pros and cons of the progressive tax and flat tax in-depth, first lets offer some basic definitions:
- A flat income tax is a tax system with a constant marginal rate (per dollar rate) for taxable income. A true flat tax would be a proportional tax (everyone pays the same), but in practice implementations are often progressive (those who make more, pay more) and sometimes regressive (those who make more, pay less) depending on deductions, exemptions, and general loopholes. We call the pure proportional tax “a true flat tax” and the others “a modified flat tax”.
- A progressive income tax is a tax in which the tax rate increases as taxable income increases. The term “progressive” refers to the way the tax rate progresses from low to high, with the result that a taxpayer’s average tax rate is less than the person’s marginal tax rate. Progressive taxes are imposed in an attempt to reduce the tax burden of people with a lower ability to pay to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden decreases as an individual’s ability to pay increases.
What is the current income tax system in America? In America we currently have a progressive income tax system (see 2016 tax brackets). However, some like Warren Buffet claim, that even though the rich pay more, the current tax system is already “rather flat” and in some cases even “regressive” (with all deductions, exemptions, and loopholes and businesses related taxes considered; i.e. for instance Buffet’s effective tax rate accounts for a far smaller percentage of his total income than his secretary; he pays far more total in taxes, he just pays a smaller percentage, partly due to him paying the capital gains tax which is taxed at a lower rate). Two big things to note are the PAYROLL TAX which is a major burden for those with lower incomes and SALES TAX which is generally regressive (as well as other similar taxes including property taxes). Taxes like the payroll and sales tax hit lower-incomes the hardest, when we pair this with the fact that a true flat tax also raises this group’s income tax, we get the basis of the argument as to why a true flat tax is more unfair than a progressive one. See For Most Households, It’s About the Payroll Tax, Not the Income Tax.
Taxes: Crash Course Economics #31. This video by PBS has economists look at progressive, regressive, and flat taxes, and how those and other taxes affect America and the world. This is probably the best tax video online. So it is a must watch. Unless you studied economics or do the books for businesses, this video will be eye opening.
A Progressive Income Tax Vs. a Flat Income Tax: Which is More Fair?
Both progressive and flat tax types have their pros and cons, and any meaningful comparison must compare many factors (more than we can fully compare here). With that said, a well structured progressive tax can be shown to be more fair than a true flat tax as a general rule of thumb, especially if (as noted above) we only consider income tax alone or assume no other changes to the tax system.
The justification for the above claim is simple, with a flat tax tax everyone pays the exact same rate (fair as in “exactly the same rate”), while a progressive tax typically shifts the burden to higher earners who have a higher ability-to-pay (fair as in “an equivalent share of the burden” based on total income). The result being those who can afford to pay more do.
- A progressive tax reduces the amount that lower-income citizens pay, and thus reduces the need for subsidies; And it increases what higher incomes pay, and thus reduces the need for higher taxes in general and for other sources of Federal and state revenue.
- Meanwhile, a flat tax charges everyone at the same rate, which requires those with lower incomes to pay more, and gives the top brackets a tax cut. At best this incentivizes trickle down economics, at worst it just means less income for the U.S. and more income for the top earners.
Although the term “fair” is somewhat semantic, we can assume the average person would say that those benefiting more from society paying a little more (rather than shifting the burden to the lower earning families with a lower ability-to-pay) is “more fair”. Thus, at its core, with no additional complexities considered, the progressive structure is “more fair”… even Andrew Carnegie agreed with this, although he would probably be enraged by our low estate taxes (see his Gospel of Wealth).
FACT: The average American pays an income tax rate of 10.1 percent (according to a 2014 U.S. Congress’s Joint Committee on Taxation report), this is because the lower-income Americans’ incomes are off-set by subsides and refunds. While the total tax burden rises progressively with income, this is only true for those who file (and thus can get credits). Americans who earn less than $10,000 per year (and are thus below the filling limit) don’t get enough from their earned income tax credits at tax time to make up for the payroll and excise taxes they pay all year. This group still suffers under a flat tax, unless that flat tax involves sales tax and payroll tax cuts!… Then the conversation becomes nuanced and there are “other considerations”.
As noted at above, when we talk about the actual current tax system (with its deductions, subsidies, exemptions, and loopholes), consider the incentives that different types of taxes (not just income) and loopholes create (in the private and public sectors), consider how different subsidization programs can offset things, consider the fairness of the brackets (the are skewed toward low-incomes currently), and consider alternatives like the Modified Flat Tax (a hybrid of sorts which takes considerations for lower earners) and a consumption tax (a tax that favors sales tax over income and payroll taxes), we have to have a much more nuanced discussion, and things are less clear cut.
Below we will discuss the progressive and flat tax in more depth and look at different alternatives. Not everyone agrees on what tax type is best, so with that in mind, both sides will be considered, and we will give pros and cons of each. Comments are welcome below.
Warren Buffet On Why U.S. Taxes Are Too Low For The Wealthy. This is a really good explanation. I get these guys may be considered “left”, but they are also rich and smart. So try to give them a few moments of your attention regardless of your political and economic ideology.
TIP: As noted above, the income tax isn’t the only tax. There is payroll taxes, estate taxes, sales tax, investment income taxes, corporate income tax, and much more (especially for businesses). Almost all taxes favor the rich (and big business), aside the estate tax and a few others, and in many respects the current taxes are already “rather flat” (paraphrasing Warren Buffet, see video above). Even when we consider tax credits (like subsidies and assistance programs), many taxes are “regressive” and burden the lower and middle classes (and businesses) more than the top fraction of a percent. The federal corporate tax rate’s highest bracket is even regressive for very high earning corporations (although, as is commonly known, they don’t actually pay this anyway). Is that “fair”?
TIP: Sometimes the conversation is skewed and political. “Flat tax” is sometimes used as code for giant tax cuts for higher earners and businesses (i.e. large corporate tax rate cuts, estate tax cuts, etc; not sales tax cuts or payroll tax cuts per-say) paired with subsidy cuts for low-income families (as described here). This type of cut isn’t “a true flat tax” or an earnest attempt at a hybrid, its just tax cuts for the rich which hurts America’s bottom line (even if it incentivizes businesses).
Comparing a Progressive Tax to a Flat Tax
Before we move on to examining fairness again, lets do a quick comparison of how a flat tax and progressive tax are different in structure.
What is a Progressive Tax?
A progressive tax is an income tax that increases as you claim more money. At each bracket, you pay the higher rate on each dollar over that amount. So you pay the percentage in the first bracket on the first chunk of money, the second bracket percentage on the next chunk, the third bracket on the next, etc. So the top tax rate only applies to money over X hundred thousand in America.
Below is the current 2016 tax rate in America (for single, joint, and household head), see corporate income tax rate for 2016 (notice the corporate tax goes up and then down again, this type of regressive-progressive tax is also an option, it’s a mix of flat and progressive ideology).
|2016 Taxable Income Brackets and Rates (Estimate)|
|Rate||Single Filers||Married Joint Filers||Head of Household Filers|
|$0 to $9,275||$0 to $18,550||$0 to $13,250|
|$9,275 to $37,650||$18,550 to $75,300||$13,250 to $50,400|
|$37,650 to $91,150||$75,300 to $151,900||$50,400 to $130,150|
|$91,150 to $190,150||$151,900 to $231,450||$130,150 to $210,800|
|$190,150 to $413,350||$231,450 to $413,350||$210,800 to $413,350|
|$413,350 to $415,050||$413,350 to $466,950||$413,350 to $441,000|
|Source: Tax Foundation (Author’s Calculations).|
What is a Flat Tax?
A flat tax is a tax rate where you pay the same taxable amount on each dollar of income regardless of income. As you can see, each dollar you make benefits you more, but those with lower incomes pay more. This hints at why it isn’t as fair as the progressive tax.
|2016 Made Up Flat Tax|
|Rate||Single Filers||Married Joint Filers||Head of Household Filers|
|Over $9,275||Over $18,550||Over $13,250|
Why The Rich Pay Lower Taxes
TIP: Fairness of a tax aside, under our current global system, in countries with Flat taxes (like some Slavic countries, typically ex-Communist countries who went from Communism to flat… not from progressive to flat) and in countries with Progressive taxes (like most western countries), the wealth gap is widening. This indicates that taxes that are not the issue, but tax loopholes and policies fueled by special interest may be. The rich don’t pay their share, regardless of the tax system, and the poor don’t have money, so in many cases the middle pays everything anyway.
In What Ways is a Progressive Tax More Fair Than a Flat Tax?: Further Justifications
Part of the problem with proving one tax system is more fair or equitable than an other is a matter of semantics surrounding the word “fair”.
That said, there are some additional points worth considering that we didn’t explicitly discuss above:
- Those making more money can afford to pay more without the tax payer having to subsidize them, or without sacrificing their quality of life, ability to prosper, or social standing (and influence). This is true for income, but also true for any other tax type.
- Small businesses struggle more than big ones, so what is true for low-and-middle-income families is also true for about 90% of America’s businesses (so payroll, corporate tax, and sales tax for businesses should also be considered in a flat tax vs. progressive tax debate).
- A flat tax would ignore the differences between rich and poor taxpayers, which would be (all things considered) more unfair than a progressive tax treating the rich and poor differently. Essentially, rich and poor are different, and so treating them different is fair (see how equality actually works).
Are the Flat Tax Alternatives More Fair?
As noted above, we should other common alternatives to the progressive tax system, namely “a consumption tax” and “modified flat taxes”.
A consumption tax (like the aggravatingly named “Fair Tax“) has the same types of problems. The poor spend more of their total incomes on average, and they typically have less money to spare in any given time period. A low income individual who spent all their money would, pre-bates, rebates, and exemptions aside, be taxed at X rate on 100% of their income (as they would “spend” all their income on necessities and other goods and services). Now just consider how this works with credit! Spending more than you have, and then some on the new consumption tax while the 1% pay no income tax!
However, a Modified Flat Tax, as a hybrid of a progressive and flat tax, and other alternatives reduce some of these problems.
Flat Tax – UT McCombs School of Business.
In What Ways is a Modified Flat Tax More Fair Than a Flat Tax?
A flat tax treats low income brackets and high income brackets the same. However, other factors can curb the inherent unfairness of this, including those implied by some types of “modified flat income tax” plans.
A modified flat tax describes a range of different hybrids that seek to make the true flat tax a little more fair. Some adjust all tax types, and some address issues such as the lowest rungs of income paying more by using subsidization, rebates, or exemptions.
Is a Flat Tax Fair? Warren Buffett on the Bradley Plan, Payroll Tax, Social Security. A discussion on the “fair flat tax” (a type of modified flat tax).
A Modified Flat Tax with a UBI
One solution involves a UBI (a universal income) or Guaranteed Basic Income (where criteria is more strict, such as being willing to work) where the business and high-earner favoring flat tax is paired with a basic income. This idea can work in many ways, but it is notable for being a compromise position.
So, because it is more nuanced, we can say a thoughtful modified flat tax plan could in some ways be a fair system, certainly fairer than a true flat tax, and perhaps even more fair than the current system.
How a flat tax would be fairer than our current system – Whiteboard Wednesday.
TIP: A UBI is a little like the old free-silver argument… but then again, a true flat tax is a little like the old gold-backed argument. American history is largely the history of the debate between individualism and collectivism. The individualist typically favoring tax cuts and less subsidies, the collectivist typically favoring the lower rungs… but cronyism and special interests add layers of confusion. See Free Silver Movement | United States history.
Musing on a UBI: I would personally only think a UBI would make sense if it was regressive (tapering off very slowly to avoid a cliff) and was paired with progressive taxes. To me, the main point of a UBI is simplifying the bureaucracy of our current subsidization programs. While giving people something for nothing goes agains the grain of economics, we have moral social responsibility. That is a conversation for another day, as that is the philosophy of the purpose of taxes and the difference between “government” (a natural system vital to humans arising from the state of nature as the pinnacle of modern moral life; the actor Aristotle’s polity) and “big corrupt gov’ment” (the type that wastes $.95 on every dollar and incentivizes some not to pay their taxes and hide their tax returns).
FACT: Thomas Paine presents one of the earliest arguments for taxation and a guaranteed income, oddly enough, in his masterwork Agrarian Justice (1797).
In What Ways is a Flat Tax More Fair Than a Progressive Tax?
Despite the fact that a progressive tax is more fair, on the whole, there a few ways in which the flat tax is fairer than a progressive tax:
- People who get sudden wealth are less burdened. This is just straight up better (but an exemption for the first ‘X’ dollars in a progressive system would solve this).
- Those trying to amass wealth for the first time (new money) will find it easier to get richer (although the rich, on paper, have the same advantage and more assets to leverage).
- “It treats people the same.” This sounds good in theory, but in practice, it’s a bit like putting a lion and a kitten in a room with two plates of food. The lion will eat the kitten, the food, and maybe both plates. Ensuring liberty and justice for all is complex, and involves not just non-aggression, but the minimum mutilation of values, morality, ethics, and honest comprise.
- It would unburden business owners and incentive storing and creating wealth in the U.S… in theory. In practice trickle down didn’t work so well.
The Progressive Income Tax: A Tale of Three Brothers. This is an example of a false narrative. In reality, we need to add a fourth brother, let’s call him Billy. Billy makes tens of millions a year, takes advantage of generous loopholes, owns the land of the brothers, taxes them, and uses his power and influence to make the brothers pass laws that favor him. I’m not sure a progressive tax will help the brothers, but lord knows a flat one won’t either. If Tom hits the lotto, the progressive tax shows a big weakness. The money that could have caught him up to Billy is taken away while Billy uses loopholes to avoid such nonsense! Neither tax is fair, but the way in which the right-wing pushes for a flat tax is a little telling. If PragerU wants, to be honest, make a video with a Billy in it and address the problem with price fixing, monopolies, feudalism, and other such things.
TIP: Those who push for a flat tax are often pushing a false narrative, “that treating a rich person differently than a poor person is unfair in regards to taxes”. This doesn’t make sense in practice, only on paper. Capitalism is inherently unfair. When it comes to money, we start with an unfair distribution and have to curve toward fairness to sustain Capitalism for the long-term. When the rich get richer, they create special interests that influence the law, making them even richer. It is the duty of governments to foresee this time-honored sticking point and curb this behavior.
Is the Current Progressive Tax System in America Fair?
As noted above, although an ideal progressive tax system is fair, the current progressive tax system in America, especially with loopholes and all other taxes considered, is less fair.
The current system is actually rather “flat” and many taxes are rather “regressive”. The tax rate curbs up really fast and then it quickly flattens out. (Thanks, Reagan and Bush for what your tax cuts really did). Some mega-rich know the loopholes, and they pay effective tax rates in the 0-15-25% range while the upper-middle class pays taxes in the 30-40% range. This causes many to see a flat tax, or another tax system, as more fair than a progressive tax.
A flat tax with no loopholes would be much more fair than the current American system, and other types of taxes have fairness and unfairness factors as well.
A sales tax is a very fair tax, but one can skirt this with the internet and certain investments. A payroll tax is a burden on employers and employees who are taxed for working and creating jobs, but the self-employed and investors don’t feel a thing. Tax on Wall Street hurts investors, but not the average joe. The estate tax is a burden on old-money, but the poor didn’t own much in the first place. Tax on consumption hurts the poor, but also could disincentive some more well-off from spending. Etc, etc.
When talking taxes, capitalism, liberty, and politics, we can’t expect things to be “totally fair.” Instead, we have to consider ethics and think about “what is fairest” for individuals, the collective, and future generations. Or maybe at the core, what taxes and regulations incentives a just society can impose while sacrificing only a minimal amount of liberty.
Regardless of how we go about things, tax dollars are needed to keep the system going, and to pay off the national debt. See where else your tax dollars go from the Center on Budget and Policy Priorities.
Regressive Tax. And then there are all the other regressive taxes.
TIP: Ironically, “a fair tax” is also unfair. The fairer taxes tax consumption, but this isn’t where most money is made in a modern economy. This would have worked better in the past.
The 4 Main Types of Taxes We Pay. Unless you own a business you probably don’t realize this extra burden, the payroll tax. Both employers and employees pay this regressive tax which typically burdens both businesses and employees with lower incomes. This is one of many less talked about taxes. This video explains much more.
Is There a Truly Fair Tax?
A truly fair tax is a tax that first and foremost doesn’t burden the poor, next infringes on liberty as little as possible, next contains no loopholes and funds no special interest projects. It’s a tax that benefits people and leaves no room for exploitation by big business or politicians. It makes the nation wealthy and doesn’t overburden its citizens. It prevents wealth and income inequality without sacrificing the principles of Democracy or Capitalism. It is a simple progressive tax with no loopholes that considers all income of all types.
In many ways, it is not the tax system, but rather the systems around it which drive inequality. As long as the loopholes remain in place, there is nothing fair about a progressive tax that the top level incomes don’t pay. In this regard, we could go in any direction and improve the tax situation, or conversely, go in any direction and drastically make things worse by increasing taxes, that the rich and poor won’t pay.
When you tax, but don’t fix loopholes, you squeeze the middle.