Flattening Tax Rates

To date, five Republican presidential candidates have announced tax proposals that have at least one thing in common – simplifying the current tax code.

In its most basic form, a flat tax taxes all income once, at the source, at the same rate. While Senators Cruz and Rubio have suggested one 10% and 15% rate respectively (Senator Rubio’s plan does have a second tier of 25%), Jeb Bush’s and Donald Trump’s plans outline a system with only three to four tax brackets as opposed to the current seven income tax brackets. Although the method of simplification varies, many of the candidates are leaning towards a flat – or flatter – tax.

Why a flat tax?  Let’s consider the hypothetical case of Sarah, a dental assistant. Under the current income tax system Sarah pays a top marginal rate of 15% since her taxable income (after deductions and exemptions) is $37,450 annually. Under a tax system similar to Sen. Cruz’s flat tax, Sarah would pay a flat 10% income tax rate.  Calculating under the current tax law Sarah would pay $5,156 but only $3,750 under the flat tax.

Lower taxes are always nice, but to take flaws in the current system one step further let‘s say that Sarah has the opportunity to earn additional income from a weekend job, adding $5,000 annually to her salary. This extra income in the current system bumps Sarah up an income bracket and she now is required to pay the 25% income tax rate, or a total of $7,156 annually.  However, under a flat rate of 10%, her tax burden would only be $4,250.  The point here is not necessarily the rate as much as it is the fact that under the current system, a worker is penalized for working more, even among moderate income levels.

Proponents of the flat tax use examples like Sarah to highlight the disincentives to work that exist under the current U.S. income tax laws. In addition to requiring Sarah to pay more if she jumps an income bracket, the current tax system also financially encourages Sarah not to get married.

Sarah and Joshua have been dating for two years and would like to get married. However if they do, their tax burden will significantly increase.  Joshua is working part-time since he is also finishing up his Bachelor’s degree and reports $12,000 in taxable income, paying a 15% marginal tax rate.  If they married, Sarah’s income would be added to Joshua’s, moving them to the higher bracket and requiring them to jointly pay 25% or $9,956 annually.

While unmarried, Joshua only pays $1,200 and Sarah pays $5,156 annually in income taxes.  Under the current tax system, why should they get married and pay $3,600 more in income tax?

A flat tax would remove the marriage burden and increase the incentive to work by charging a single flat rate. No wonder 2016 Republican presidential candidates are leaning towards the flat tax.

Comments (2)

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  1. Steve says:

    Your examples assume that the tax rates apply to the first dollar of income, without taking into account any exemptions or itemized deductions. You better consult the tax code before writing any more on the subject.

  2. Stevi Knight says:

    Thank you for your concern! Certainly a tax example that does not include exemptions or deductions would be unrealistic (To improve clarity the blog post was edited). However, for the purposes of demonstrating marginal vs. flat tax rates, we are assuming that this is income subject to taxes after deductions and exemptions (also assuming a non-itemizing individual who takes a standard deduction). We are not looking at average effective tax rates, but the disincentives associated with marginal tax rates. These disincentives exist regardless of the amount of a deduction or exemption.

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