Flat Tax and Fair Tax

The federal income tax was established in 1913 and since then it has become so complex that it requires millions of Americans to seek professional help every year. In addition to that, an expensive federal bureaucracy is required to enforce and administer the tax. The tax law was created to provide programs and services to the people that people wouldn't want to pay for themselves. And through the tax system, we pay for these services that the government provides us. As much as a tax system is needed, many people believe that the income tax system can penalize work, discourage saving and investment, and hinder the competitiveness of business. There have been many efforts and debate about simplifying the tax law, and among the most popular plans are the fair tax and the flat tax. In this paper, I will talk about the features of each tax system and discuss some of the advantages and disadvantages of both proposals while concurrently comparing them to our current tax system.

The flat tax charges all household incomes and corporate profits at the same flat marginal rate. The main advantages of the flat tax are its fairness, simplicity and potential growth. First, the flat tax would be perceived as fair because everybody pays the same marginal rate on their income. One great feature of the flat tax is that families would only be allowed one personal deduction and all other deductions like mortgage interest, donations and credits would be eliminated. Individuals would be able to deduct a personal exemption based on family size from their gross income and anything in excess of the deduction would be paid at the marginal rate. Those with gross incomes below the personal exemption would end up paying no taxes at all. Also, in the absence of tax filing, the opportunities for tax breaks, like deductions and credits, would diminish. Another advantage is that the flat tax would make the tax system a lot simpler to deal with. Most individuals and businesses would fill out a tax return the size of a postcard, which eliminates the various tax return forms that we currently fill out now. The much cheaper costs to prepare tax returns should save a huge amount of money and time needed to monitor our current filing system. We would be able to cut costs due to the reduced need of the IRS, and tax payers would not have to hire professionals to decipher the tax system. Under the current system, the EITC is used to help ease the burden on low-income families, but the process of figuring out the different factors that affect your refund is very complicated and time-consuming. Low-income families receive the benefit without even realizing how they get it not to mention that you also have to file a tax return in order to receive this benefit. Under the flat tax, there would be no confusion because low-income families would be exempt from paying any taxes at all if they fall within the personal exemption. This will save a lot more time and confusion of getting taxes deducted through paychecks and then getting it refunded at the end of the year through the EITC. Finally, the flat tax would increase potential growth in the economy. The flat tax would eliminate the double taxation on savings, dividends and investments, as well as the death tax and the capital gains tax. With the current tax system, for example, income is taxed first at the corporate level and when the remainder comes to you in the form of dividends or interest, it is taxed a second time. If you sell the business, you can be taxed a third time through a capital gains tax on income your investment is expected to generate in the future. The flat tax would only tax income once, when it is earned and realized. This will probably encourage people to invest even more because they will not be penalized for their capital gains and dividends. In comparison to the current tax system, I believe the flat tax will increase simplicity, fairness and the potential for growth in the economy.

There are also many disadvantages of the flat tax to consider. First, the flat tax would probably have a negative impact on charitable donations and home ownership. Currently, donations to charity and mortgage interest are tax- deductible. With these things being eliminated, it might cause a disincentive to donate to charity and take away the tax advantage of owning property. Another disadvantage is that thousands of tax-related jobs would be lost due to the new flat tax system. Although we mentioned this as an advantage in the previous paragraph, this could also be seen as a disadvantage, especially for tax professionals. Businesses and professionals that specialize in tax services would no longer have a market for their services and would have to go out of business. Another issue would be deciding if there was a limit in the tax rate. Currently, the government has a huge deficit to account for, and it is very likely that they may increase the rate in the future. A rate now might be too low of a rate in the future due to inflation and economic growth. I believe one of the greatest concerns is that it seems to hit middle-class people who do not fall below the exemption, because those with lower incomes tend to pay a higher proportion of their income in total taxes than the affluent do. Although the wealthy have to pay a larger amount of taxes, they are still likely to be able to provide for their living expenses without a problem, while the middle-class has to struggle with the burden of paying a larger proportion. Another pressing issue to consider is ensuring the simplicity of the flat tax. While all flat tax proposals propose to eliminate nearly all deductions and credits, most legislators envision keeping, for example, the mortgage interest deduction and possibly some others. Since the current system has so many established deductions, credits and etc, legislators will probably want to allow a certain tax code in order to advance certain policy objectives, and soon enough the tax system will become complex again. Finally, the benefits of a tax system may be hard to measure in the short-term. Obviously, the growth of a population takes many years to realize the effect on the economy. The negative effects of a tax system may not be immediately observable, so the government may not know the system's effectiveness for awhile. Therefore, there are many issues of the flat tax to take into consideration before deciding to implement it.

The fair tax is another proposed tax system that replaces the federal income tax system with a national retail sales tax. Therefore it taxes on the rate of consumption instead of the rate of income and abolishes all federal personal and corporate income taxes, gifts, estates, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes. One feature of the fair tax is that businesses would be required to be a registered seller with the state sales tax authority. By registering

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