Flat tax is a term used to describe any proposal that would flatten tax rates and eliminate most tax exemptions. The term was first used to describe a proposal to reform and simplify the United States income tax. The original proposal was made by Stanford University economists Robert E. Hall and Alvin Rabushka in their book The Flat Tax (1985).
Hall and Rabushka’s flat-tax plan would create a basic exemption (amount of income excluded from taxation) for each household. It would eliminate all deductions for personal expenditures, such as mortgage interest and charitable contributions. It would tax the labor income (wages, salaries, and pensions) of individuals and the tax base (difference between taxable receipts and deductible expenses) of businesses at a single (“flat”) rate. This rate would be approximately 20 percent—about half the highest current rates.
Other changes would include revised rules regarding capital, interest, and dividends. Under the flat tax, businesses could deduct the entire expense of capital investments (purchases of physical assets, such as buildings or machinery) immediately. Currently, U.S. businesses may deduct only depreciation (loss in value) over the life of an asset. The immediate deduction of an asset’s entire purchase price would be simpler, and flat-tax supporters say it would encourage saving, investment, and economic growth. Also under the flat tax, interest, dividends, and capital gains (profits from the sale of assets) would be exempt from taxation, and interest would not be a deductible business expense. Exemption of capital gains, and other capital income, and the elimination of deductions, would greatly simplify the tax returns of many individuals.
Opponents of the flat tax argue that the plan would shift tax burdens dramatically from the wealthy to the middle class. They also point out that current tax exemptions serve useful purposes, such as encouraging home ownership and charitable contributions. In addition, such a fundamental change in tax policy would raise complex questions about how to treat current investments and debt.
See also Income tax.
