Federal Income Tax

  1. ABSTRACT:

Of late, tax reform is the main subject widely debated in all the corners of the US. As an alternative to the existing federal income tax system, there are many proposals such as “reduction of tax rates, broadening of tax base, reducing tax to GDP ratios, flattening of tax structure “.  The Flat rate tax system is a viable alternative to the existing tax system as it offers more advantages.

This research paper mainly looks into the various advantages that will accrue to the U.

S economy if it switches to flat rate Federal Income Tax. This research envisages significant macroeconomic gains by substituting the current federal tax system with a flat rate system. All sections of society including upper-income, middle income, corporates will be much benefited because of the flat rate system. This research will also analyse how simplification of tax structure will help to abolish most deductions and tax penchant in both personal tax codes and corporate. This study also reveals that under flat rate tax, the poor shell out lesser income taxes and attains extensive welfare gains.

This study also finds out that flat-tax reform would usher significant gains in productivity and output. This study also discovers that a flat rate tax system will be fair, not complex and confusing and will be stimulating people to save substantially on their income and above all, it helps US manufacturers to be of more competitive globally. This study also reveals how flat rate tax or tax cuts helped the federal revenue to soar and even revenues doubled in 1980 and 1990.

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 This study reveals that flat tax system minimizes the intricacies and inequalities, tax credits, deductions, loopholes of the existing tax system. Further it also reduces the compliance cost and present disincentives to saving and investing are eliminated. Thus economic growth is attained through enhanced savings.

  1. INTRODUCTION:

There is a general opinion that current federal Income tax structure is complex which thwarts US’s growth. The ordinary working class and business community are the worst affected as they are not entitled to tax breaks that are extended to those influential community which is being backed by the high-ranking politicians. Thus why many have started now advocating for the simple and flat rate tax system. As a result of this, Bush has appointed an advisory panel to suggest a total, viable, tax reform that will address all the inherent disadvantages of the current tax system. Law makers and Department of Treasury are exploring the possibility of introduction of flat tax or other reform options.

Affordable tax structure is the significant factor in attracting talents and foreign capital investments. In the past, tax advantage is the most attracting feature for US to attract intellectual talents and top creamy layers who will in turn augment the US economy due to their productivity.  The complying cost of tax burden alone estimated to the tune of $ 205 billion annually or $ 705 per each individual To understand various statutory deductions available, tax credits and other special privileges available in the tax law, it needs a lot of expertise and an ordinary office going citizen or small business owner may not have the enough talent to understand this complex tax structures. Today, US Citizens are over-burdened with highest tax rates and major lion’s share of income is originating from the tax revenues.

Now most of the countries are turning to flat tax rate system. Many other countries are following the suit. The main purpose of flat rate tax structure is to prevent tax evasion and to drive more revenues by bringing more assesses within the tax bracket to pay tax without avoidance or evasion.

Thus consumers are forced to spend more in taxes as compared to necessities like food, clothing and shelter. Higher the tax more will be the reluctance to pay the tax honestly thus in turn will lead to shrinking the nation’s economy.

  1. IDENTIFICATION OF THE PROBLEM:

This study deals with the question whether is it necessary to have tax reform in US?  Why there is a need to introduce a flat rate system? What are all the salient features of the flat rate tax system? How the flat system overweighs the current tax systems? What are all major economic benefits going to be derived from the flat rate tax system? Is the flat tax system is having any fair advantages over the existing tax system?

What are all the disadvantages of the flat rate system? How the flat rate system is going to address the major disadvantages that are being pointed by critics if it is implemented? Whether a stable and consecutive economic growth is possible under flat rate tax system.  Is the flat rate system is prevalent in any other economy and if so the major advantages that economy has derived from the flat rate tax structure? These are the problems that are going to be addressed in this research essay.

  1. LITERATURE REVIEW:

On the economical front, flat-rate taxation would offer both political and economical benefits. On economic point of view, it would encourage employment, saving and capital accumulation. On political aspect, present tax code can be deployed to remunerate or penalize individuals based on their location in accordance with various political affiliations in the society.  Thus we can describe the flat tax regime as an operation of political liberation that would produce economic advantages.

Flat tax rate would replace the existing tax system with a single rate. For example , a federal tax collections are about 10% of U.S total personal income and thus a flat tax of 10% on the whole base of personal income would collect the exact revenue  to the treasury .

One may recall the great fiscal lesson of the 1980 taught that when there is lower tax, it will always generate higher revenues. In 1980 after Regan’s tax cut measures, federal revenues soared from $ 530 billion to $ 1031 billion in 1990. Likewise, tax revenue increased at a 20% faster snip in the 1980s than in 1990s, which witnessed two world record tax increases. [1]

Regan tax cuts had been criticized that the share of income earned by the wealthy 5% of the population increased from 17 % to 19% but they have disregarded the fact that segment’s share of the tax burden also augmented from 38% to 49% of cumulative federal income-tax collections. A reduction in marginal rates would stimulate economic development thereby increasing the size of the taxable assesses. Thus the whole society will be benefited from the increased economic activity.

Further under Flat rate tax, income from dividends, interest, investment gains are exempted from tax. This brings severe tax burden between those who earns income from employment and income earned from investments as the former has to shell more tax than the latter. Further flat rate tax is applicable only to the federal income tax and does not cover social security tax, In other words, the tax burden under social security tax is being kept in tact.  Thus the flat rate tax will be more beneficial to underemployed, unemployed and the rich than the working class as it has to shell more tax. [2]

The concept of flat rate tax revolves around more tax exemptions for individual tax payer and dependent. For instance, let us assume if there is no tax up to $ 40000 on income per annum, a family with less than this annual income need not pay federal income tax. Under this concept, the higher the income, higher will be the income tax to be payable by the assesses A family with a $ 50000. Income would have to pay on only $ 10000 of income and if we assume that flat rate of tax is 17%, then federal income tax will be $ 1700 which is equivalent to 3.4% of its total income. Likewise, if a family with an income of $ 150000, shall to shell out $ 18700, 12.50% of its total income.

Further there is a strong recommendation for keeping in tact the deductions for charitable contributions, local and state taxes on the principle of double taxation avoidance, and home mortgage interest for tax payer’s home. Reduction in marginal tax rates is one another economic gain derived from flat rate tax structure. In other words, minimizing the marginal tax rate results in economic benefit which is the primary advantage of flat rate tax.

When there is a high rate of marginal tax say up to 40%, people generally resort to two types of manipulation one is to evade tax and other is to influence politically for favored tax treatment. Had the marginal tax is in the range of 10 to 20 %, they will rather pay the tax honestly rather than searching for political influence or evasion tactics. For example, the members of ways and means of US congress has the extraordinary power to shape the nation’s tax laws and they always successful in getting about 30% more total campaign funds than the other member of the congress.

The cost to individuals of compliance with the personal income tax is estimated to be $ 157 billion by the Tax Foundation and this will reduce to $ 10 billion if flat rate tax is introduced due to simplified procedures. There are approximately about 890 forms under current tax system and the flat rate tax system only needs two post-card size forms to be filled in and it will be more users friendly.

4.1 FLAT RATE TAX Vs CURRENT TAX SYSTEM

It is an easy, simple, just and assures overall growth where as the current system is complex, ambiguous. Current tax system differentiates the assesses on various categories like use, source and level of income but where as under flat rate all assesses would be treated equally and equal justice is assured to all irrespective of their level of standing in the society . The flat rate tax rates ensure lowering of marginal tax rates and reduce tax bias against saving and investment.

Under current tax system, numerous forms have to be filled in and a lot of procedures are to be adopted. Under flat rate tax system, from large corporations like Xerox to a small pizza store would have to adhere identical rules and there is no longer separate tax rules for partnerships, sole proprietorships, regular corporations and S corporations and further all corporations earning income in US irrespective of the fact that they are US companies or U.S branch of foreign companies.

4.2 ADVANTAGES OF FLAT TAX RATE:

 It will not eradicate all disparaging brunt of taxes but it will put an end to tax code’s prejudice against investment and savings and lowering the tax rates will extend relief to downtrodden and poor. A flat tax would result in increased employment, investment and saving. Flat rate tax would augment the national wealth as it would result in rise of income-producing assets and it would also increase the after-tax stream of earnings that they produce.

Even the Internal Revenue Service admits that the present system compel taxpayers to spare 6.6 billion hours each year in the preparation of tax returns. But in the case of flat rate tax system, the compliance system is so lucid and simple and it would reduce the compliance cost to 10 billion dollars. Flat rate will reduce compliance cost by eliminating the role of political lobbyist, lawyers and accountants.

Flat rate tax remove the marriage penalties as there is only one tax, the income of the spouse won’t push a couple into an elevated tax bracket. One another study reveals that the flat rate tax would augment the size of the U.S economy by 10% and it would reduce interest rates by 25% and this will balance the loss on the home mortgage loan interest deduction.

One of the studies has established that it cost to US government $ 1.40 for collection of 1$ under this existing tax system and flat rate would minimize compliance costs by 94%

Further it will eliminate the deductions, credits, loopholes, exemptions and political intimidation. Thus politician’s role will be minimized to zero as they would no longer shed favoritism, help friends and penalize foes and to deploy tax code to inflict their values on the U.S economy.

Erstwhile communist nations like Latvia, Lithuania, and Estonia have introduced the flat rate tax system along with free-market reforms to resurrect their economies. Russia also adopted a flat rate tax structure of 13% from 2001. This has resulted in a spurt in the Russian economy as revenues have risen due to cessation of tax evasion and avoidance. Serbia, Slovakia and recently Romania all joined the band wagon of flat rate tax system.  It is expected that Bulgaria, Croatia and Hungary will shortly switch over to flat rate tax system.

We might have witnessed that some business sells at low margin hoping that increased sales will lead to greater profit. This approach is known as Laffer curve. If we apply the same principle if the tax rate is higher as people will shift their work, investment choices, and savings in a style that will minimize the earnings from the government. Hence the flat rate tax can stimulate the people to engage in work so that they will have some handsome revenue and defer lessor tax.

4.3 DISADVANTAGES:

Flat rate tax exempts tax on capital gains or income and critics is of the opinion that this aspect will enlarge the gap between the rich and poor as the rich will plan such way that most of their income are germinating from capital investment and leave the middle class and poor only to be eligible and pay the federal income tax.

Further the flat rate tax creates wide fissure between the family which earns its income from employment as they have to pay  tax on their entire earning after certain limits but in the case of families which earns income from dividends , interest and capital gains , there will be no tax liability  as these incomes are exempted from tax . But the supporters of the flat tax may argue that in the case of all aforesaid capital income are being subject to tax at the business level.

Another argument against flat rate tax is that it will result in the huge budget deficit. The Treasury department has estimated that there will be a budget deficit of $ 160 billion a year if there is a flat rate tax of 17% in U.S.

Some critics argue that removal of deduction of mortgage interest and deductibility of local property taxes and state taxes may have drastic consequences on housing prices. A flat rate tax may bring negative impact on real estate prices but it would be more advantageous the prosperity and liberty of the U.S citizens.

Currently, deduction is available for the funds invested in Keogh plans, 401 k plans and Individual Retirement Accounts (IRA) and investments on these savings are not taxed until these are withdrawn. But any return on this investment will be subject pretax rate of return. The rate of return on these types of savings would fall if the flat rate of tax system is introduced which could reduce the quantum savings in these forms. Likewise, pension coverage could also fall.

4.4 RUSSIA AND FLAT TAX: A CASE STUDY:

After the collapse of USSR a decade ago, Russia had only a rudimentary tax system. Since the government owned all industries and every one worked for government, Russia could not raise enough revenues by just increasing prices. Thus after the fall of communism, its tax rate are very high specifically for entrepreneurs and business and there was high incidence of tax evasion due to this. Despite of high rates of taxes, the Russian government could not raise adequate revenue through taxes and this had forced to increase its money supply to pay the bills thus resulting in hyperinflation.

The International Monetary fund advised the Russia to legislate new taxes and crackdown on tax evaders but these measures only aggravated the defect of the existing tax system. As the result, the tax revenue of Russia dwindled from 11% to 8.5% in 1998.

Finally Russia felt that tax system had to be overhauled to increase the tax revenue and introduced major tax reforms against the advice of the IMF thereby announced a significant tax reform that lead to a 13% flat rate tax system. As the result of this tax reform, Russia could able to achieve an overall increase of about 50% of tax revenue which risen to 16% of GDP in the year 2001. As a further reform, Russian president Putin announced tax cuts to small business mainly to obviate tax evasion and to augment tax revenue.[3]

  1. METHODOLOGY:

For the purpose of this dissertation, data’s and ideas have been compiled from the published articles from reputed magazines, books and periodicals. Further, recent happenings in the industry like introduction of flat tax in Russia, erstwhile USSR have been included for the purpose of elucidation and understanding. In case of data’s to prove that flat rate tax yields more, previous empirical studies have been analyzed and reference is made wherever necessary. Finally, this research has analyzed that usefulness of flat rate tax system by using secondary data’s various articles published in the reputed magazines and has come to a conclusion that flat rate tax system is a viable alternative to the existing federal tax system.

  1. FINDINGS:

Thus this research has established that the flat rate tax system is a viable alternative to the existing federal income tax. If it is introduced, it will eliminate $ 250 million income tax industry. Further, it will be easier and helps to simplify the business accounting and reporting.  As the cost of goods will be more competitive in the flat rate tax system, it makes the country’s product more economical in the international market and stimulates exports. This will encourage the capital repatriation from tax heavens. Low tax rate helps to attract more investments from internally and also foreign direct investments.

One of the salient features of the flat rate tax system is that it gets rid of the product tax build up in product cycle. A flat rate tax structure will result in lower interest rates. This form of tax system helps to avoid double taxation of gains from business. It also helps to attain major economic growth and industrial development. One may recall the great fiscal lesson of the 1980 taught that when there is lower tax, it will always generate higher revenues. In 1980 after Regan’s tax cut measures, federal revenues soared from $ 530 billion to $ 1031 billion in 1990. Likewise, tax revenue increased at a 20% faster snip in the 1980s than in 1990s, which witnessed two world record tax increases

  1. CONCLUSION:

The problems faced from the present tax rate system can be addressed by the introduction of flat rate tax system. Thus the complex, complicated present system can be replaced by the simple, easy, users-friendly flat rate system. The flat rate system not only helpful to minimize the exorbitant cost involved in the present tax rate system but also helps to plug loop-hole  , minimize the exemptions , deductions and loopholes . The success of the flat rate tax system in erstwhile Soviet Union states and in Russia itself offers hallmark that the flat tax rate system will craft fine tune to the U.S economy

.It is evident that before introduction of flat rate tax, the Russian economy was in turmoil and composite tax revenue of Russia dwindled from 11% to 8.5% in 1998.Then, Russia felt that tax system had to be overhauled to increase the tax revenue and introduced major tax reforms against the advice of the IMF thereby announced a significant tax reform that lead to a 13% flat rate tax system.

As the result of this tax reform, Russia could able to achieve an overall increase of about 50% of tax revenue which risen to 16% of GDP in the year 2001 Russia is the best example to prove that flat rate tax could resurrect the economy from downtrodden status to a developed economy . One another study reveals that the flat rate tax would augment the size of the U.S economy by 10% and it would reduce interest rates by 25% and this will balance the loss on the home mortgage loan interest deduction.

Among various current flat tax rate proposals, government should seriously consider to implement the flat rate tax system at the earliest with necessary adjustments with offer of safeguard to poor and business.

BIBILIOGRAPHY:

 

  1. Alterman, E. (1996, January 22). Deflating the Flat Tax. The Nation, 262, 5+.
  2. Armey, R. K. (1994, December 19). Flat Tax – Flat Wrong? National Review, 46, 4.
  3. Du Pont, P. (1995, February 20). Flat Tax, Other Reforms Are Pro-Family, Pro-Middle Class. Insight on the News, 11, 36.
  4. Hall, R. E. (1996). Fairness and Efficiency in the Flat Tax. Washington, DC: American Enterprise Institute.
  5. Jorgenson, D. W., & Yun, K. (1991). Tax Reform and the Cost of Capital. Oxford: Oxford University.
  6. McIntyre, R. S. (1996, February 12). Flat on Our Backs. The Nation, 262, 5+.
  7. Mcintyre, R. S. (2002, June 17). The Bush Plan: Tax Complification; the President’s Cuts Push Us toward a Flat Rate and More Paperwork. The American Prospect, 13, 19.
  8. Ponnuru, R. (2004, December 13). The Perils of Tax Reform: Frankly, Tiny and Timid Is Better Than Big and Bold. National Review, 56, 32.
  9. Principles of Tax Reform. (2003, June 10). The Washington Times, p. A14.
  10. Rabushka, A. (2002, July/August). Where the Flat Tax Goes from Here. Commentary, 114, 81.
  11. Schwenninger, S. R. (1996, May 13). How to Save the World: The Case for a Global Flat Tax. The Nation, 262, 16+.
  12. Warren, A. C. (1997). Three Versions of Tax Reform. William and Mary Law Review, 39(1), 157-175.
  13. Weisbach, D. A. (2000). Ironing out the Flat Tax. Stanford Law Review, 52(3), 599-664.
  14. A Flat Tax Will Spare Us the Costs of Paying More Lawyers and Accountants. (1996, February 4). The Washington Times, p. 2.

[1]  Stephen Moore, “Flat and Simple, stupid – Flat Tax – National Review –Feb -1996.

[2] Burson, Robert T, Why the flat tax is wrong for America. The Tax Advisor, 1995.

[3]  Bartlett, Bruce, “Russian Experience bolsters flat tax “Human Events, April, 2002.

Cite this page

Federal Income Tax. (2017, Apr 13). Retrieved from http://studymoose.com/federal-income-tax-essay

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