Under the flat tax, these issues simply would not arise, because all capital income is exempted from the household-level tax. Eberly and James H. The flat tax could boost saving by raising the after-tax return on saving and by shifting income toward high-saving households. But the actual increase would be smaller, for four reasons. First, our current system is not a pure income tax, but a hybrid between a consumption and income tax.
Funds placed in pensions, k plans, Keoghs and most IRAs, or individual retirement accounts—which together account for about half of private saving—are not taxed until they are withdrawn, just as they would be treated under a flat tax.
This means these investments now earn the full pre-tax rate of return. But even advocates acknowledge shifting to a flat tax should reduce pre-tax interest rates. This will reduce the return on pensions and related plans. Voluntary contributions to such accounts may fall as well.
William G. Second, pension coverage may fall. The pension system has been fueled by its sizable tax advantages. But why should workers and employers continue to accept the high regulatory and administrative costs of pensions if under a flat tax they can get the same favorable tax treatment on saving in any form?
If employers scrap their pension plans, workers will have to set aside the equivalent amounts in their personal saving accounts just to maintain the level of saving. To the extent that workers fail to do so, saving will fall. Third, if the mortgage interest deduction is retained, households will be able to deduct interest payments, even though they would not have to pay taxes on interest income.
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Personal Finance. Your Practice. Popular Courses. Taxes Income Tax. Table of Contents Expand. What is a Flat Tax? Working Proof. The Bottom Line. Key Takeaways A flat tax is a system where everyone pays the same tax rate, regardless of their income. While countries such as Estonia have seen their economies grow since implementing a flax tax rate, there's no actual proof that the tax system is the reason behind the growth.
Some drawbacks of a flat tax rate system include lack of wealth redistribution, added burden on middle and lower-income families, and tax rate wars with neighboring countries. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Investopedia does not include all offers available in the marketplace. Related Articles. Tax Law. Partner Links. A flat tax system applies the same tax rate to every taxpayer regardless of their income bracket. Discover more about the flat tax system here. Understanding Taxes A mandatory contribution levied on corporations or individuals by a level of government to finance government activities and public services. In practice, flatter tax rates are the best proxy for that ideal.
By contrast, the progressive overlay is at its core unconcerned with providing public services but is instead chiefly aimed at achieving redistribution from rich to poor. Some progressivity may be tolerable, or even desirable, where it corrects for regressivity elsewhere in the tax system.
Outsiders who flock to Illinois as taxes become more progressive are anticipated net gainers from the tax reform and subsequent expenditures. On the flip side, higher earners will tend to flee the state because they have little appetite to provide these benefits to others. This happened in Maryland over a decade ago, when its sharp income tax increase led to a 30 percent decline in millionaire filers and a 22 percent decline in tax revenues from that same group.
Illinois is already subject to just these economic pressures and more. For example, its population declined from Low-tax states like Texas and Florida saw population surges during the same period. But the paper takes the sunny position that the progressive tax increases will raise revenue and increase funding for much-needed services, such as high-quality education.
This argument is doubly wrong-headed. The bulk of the tax revenues were quickly diverted to new spending programs. Two simple explanations account for why both Pritzker and the Times have gone astray. First, they implicitly assume that the major impact of any tax increase is distributional. In their fairy-tale version of the world, productive activities will remain just as they were before; the size of the economy will remain constant even as the tax rate increases.
But changes in taxes alter the incentives for both public officials and private parties alike. The former will use the additional funds to curry favor with their preferred constituents in exchange for political votes.
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