The Idea of a National Flat Tax Keeps Popping Up. And It's Still a Terrible Idea

The national flat tax. It’s the right-wing (mostly libertarian) idea that always seems to pop up, gain traction and then disappear into the woodwork — thankfully. It’s back making the rounds on social media as the IRS released it’s updated tax brackets for the 2023 filing (2022 tax year). Ironically, many of the comments I saw on social media regarding this piece of news were saying it was evidence that a flat tax would work better. I say ironically, because the IRS is raising the top income threshold for all tax brackets, both single and married filers, meaning more income will be taxed under a lower rate than had the brackets remained static. Also, in a fun twist of fate, the reason the IRS amended the brackets was due to inflation.

Before I move into the flat tax, let’s take a moment to review the updated tax backets. For starters, the standard deduction is going to be raised $1,800 over last year for married couples to $27,700. For single filers, the standard deduction will go up $900 to $13,850. Simply put, what this means is that filers can subtract the standard deduction from their wages and base their tax bill off the new number. An example: a married couple makes $150,000. Instead of their tax calculation starting at $150,000, they would subtract $27,700 (assuming standard, not itemized deduction) and begin their tax calculation at $122,300 instead.

Here are the marginal rates as taken directly from the IRS press release (link above):

Marginal Rates: For tax year 2023, the top tax rate remains 37% for individual single taxpayers with incomes greater than $578,125 ($693,750 for married couples filing jointly).

The other rates are:

35% for incomes over $231,250 ($462,500 for married couples filing jointly);
32% for incomes over $182,100 ($364,200 for married couples filing jointly);
24% for incomes over $95,375 ($190,750 for married couples filing jointly);
22% for incomes over $44,725 ($89,450 for married couples filing jointly);
12% for incomes over $11,000 ($22,000 for married couples filing jointly).

The lowest rate is 10% for incomes of single individuals with incomes of $11,000 or less ($22,000 for married couples filing jointly).

The EITC (Earned Income Tax Credit) which is generally viewed as one of the best anti-poverty programs in the country, for filers with 3 or more qualified children (i.e. in the approved age range) will rise from $6,935 last year to $7,430 this year.

Now onto the flat tax. The flat tax is much like it sounds: a single rate across the board regardless of income levels. According to its proponents, it would vastly simplify the tax code and put more money into people’s pockets. While the first point is technically true, the second only applies to the rich. Libertarians like Sen. Rand Paul (R-KY) and Grover Norquist, head of the right-wing Americans for Tax Reform, have championed this. Former 2012 presidential candidate Herman Cain made it a central piece of his platform (remember the 9-9-9?). But as a matter of national tax policy, it would be disastrous.

Let’s use a simplistic example to illustrate. We’ll assume the US removed the entire tax code for individuals and replaced it with a 10% flat tax. All income, no matter the source, would be taxed at this rate. It would eliminate all deductions and tax breaks and credits. In other words, it would certainly simplify the tax code.

Now, let’s take 3 people as our case study. They are Jane Smith, a waitress earning $30k a year, John Mann, a project manager earning $100k a year and Michael Person, an investment banker making $1 million a year. They will represent the lower, middle and upper classes. All three are single, but have one child making their family situation equal. They are now subject to the 10% flat tax and begin to work on their taxes.

Jane does the quick math and realizes she owes $3,000 in taxes. John has a tax burden of $10,000 and Michael has a burden of $100,000. Proponents of the flat tax will point at this and say “look, the rich are paying more. Michael’s tax bill is so much higher than both John and Jane combined. So it’s obviously fair.” But what this doesn’t take into account is a vital piece of information: purchasing power. Purchasing power is the amount of goods and services that can be purchased with a unit of currency. We’ll add that in next.

In the above example, we see that Jane now has $27k post taxes. But let’s look at her costs. Her rent is $1,000 (which is below the US median of $1,300). Her bills come out to another $1,000 per month (utilities, car, student loan, phone, etc.). So her monthly expenditures are $2,000 a month or $24,000 a year. But she only has $27,000 from her wages after taxes. That means she’s left with $3,000 to spend on things like food, clothing and other necessities…for the entire year. That comes out to $250 a month. Her purchasing power is close to zero. One week of food shopping will pretty much eat her monthly cash.

Next, we take a look and John. He’s got $90,000 after taxes. His monthly costs look like this: $2,000 for a mortgage (above the US median of $1,100, but average for middle class neighborhoods) and $1,500 for bills for total expenditures of $3,500 a month or $42,000 per year. John has $48,000 left after taxes and mandatory expenditures or $2,000 in cash per month. He’s got good purchasing power for most things, but he might need to save up for larger capital improvements to the house or if he wants to buy a 12 foot boat (kind of stereotypical, but illustrative). He can also likely put money away for his child’s college fund monthly.

Finally, we move on to Michael, the investment banker. He has $900,000 left after his tax bill. He only has a mortgage because he wants to get equity in the real estate. He could have payed cash for the estate. He pays $3,500 a month on it. His bills are $7,000 a month since he likes having top-flight everything. His $9,500 monthly payments equal out to $114,000 a year leaving him with $786,000 a year. He doesn’t care what that comes to monthly. He can buy pretty much whatever he wants in cash or leverage one of his holdings to gain extra liquidity.

You can see from this example that the more money you have, the more money you keep. And the more purchasing power you retain. This is what’s known as regressive taxation. Where rates disproportionately hit the poor more than they do the rich. Our current tax code is considered progressive taxation as it steps up rates based on your income.

Under current tax codes, Jane would have received multiple rebates and credits. She likely would have owed no federal taxes and likely would have gotten a refund based on her earnings and having a child to claim as a dependent. John would likely pay more in taxes because of the graduated brackets, but with existing breaks and credits, his bill would still be zero or fairly small (under $1,000) especially with the eligible child. Michael would be hit the hardest. Almost half of his income would fall under the top bracket of 37%. His tax bill, even with the child credits, would exceed $329,000 according to Forbes tax calculator.

This is just a single example of how a national flat tax would fail to achieve anything close to parity. The effect on the federal budget would be devastating. During the last tax year, the government took in $4.8 trillion in revenues against $5.8 trillion in outlays equaling a $1 trillion deficit (this covers the 2022 tax filing or 2021 fiscal year). It’s not clear how much a 10% flat tax would raise, but it would absolutely be less than $4.8 trillion. That would leave the government with two options: increase the taxes or decrease expenditures. History has taught us that the decrease in spending would be more likely and that the cuts would come to social programs first and not things like defense.

Flat taxes do have a place in our tax portfolios. Sales taxes are flat taxes. Almost every US state implements sales taxes in some form. For example, in Erie County NY, you’ll pay 8.75% sales tax (combination of state and county taxes) on almost anything you buy. That sales tax is the same percentage if you’re buying a candy bar or a car. Value-added taxes (VATs) are another form of flat tax and are used more extensively in Europe. VATs are similar to sales taxes, but add the tax at each stage of production where some value is added, and not just at the point of sale like with sales taxes. It can be viewed as a consumption tax rather than an income tax.

However, both sales taxes and VATs affect the purchasing power for the lower income earners much more than they do the wealthy. And that’s what people need to learn about the debate around taxes. Purchasing power is a key component and it’s almost never brought into the conversation. Hopefully, this changes that at least to a degree.