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Presidential Campaign 2016: Is There A Flat Tax In Your Future?

by
Lee Reams, BSME, EA
on
8/10/2015
Presidential Campaign 2016: Is There A Flat Tax In Your Future?

As the presidential election campaign heats up, you will surely hear some candidates talk about a flat tax, and the flat tax rates usually mentioned range from 12 to 15% or even higher. Before you get too excited about the prospect of being in a lower tax bracket than you presently are or a complication-free tax system, maybe you should compare the flat tax to our current graduated system.

A flat tax would be a percentage of your total income. So let's say your total income was $60,000. If the flat tax rate were 15%, your tax liability for the year would be $9,000. On the other hand, under our current graduated system of taxation, you are able to reduce your income by deductions (either a standard amount or itemized deductions) and the personal exemptions for the filer, spouse and dependents. If a married couple earned $60,000, they would be able to reduce their income by the $12,600 standard deduction for married individuals plus two exemption amounts of $4,000 each to arrive at a taxable income of $39,400. Using the tax rate schedule for 2015, we arrive at a tax of $4,988, or $4,012 less than the 15% flat tax. Hmmm… not the result you expected, right? On the other hand, if the flat tax is designed to also include the couple's FICA contribution toward Social Security and Medicare, and their $60,000 of income is all from wages, then the flat tax method would result in $1,778 less total tax, based on the employee's Social Security and Medicare tax currently withheld via payroll.

The income tax under the current system of taxation depends upon filing status and the number of dependents claimed by the taxpayer(s). There are other variables as well, such as adjustments to income and credits, so the actual difference between the flat tax and the current system can vary significantly based on those factors.

A true flat tax would work out great for the really well-to-do. For example, once a married couple's income is in the neighborhood of $150,000, the flat tax actually becomes less than the income tax figured by the current system. But you can be pretty well assured that Congress wouldn't let that happen since the taxpayers with the top 10% of incomes actually pay most of the income taxes.

Homeowners would be big losers if our tax system switched to a pure flat tax, primarily since they are able to deduct home mortgage interest and property taxes under the current system, which they would be unable to do under most flat tax plans. This could make waves in the housing market since many homeowners count on tax breaks to be able to afford their mortgages and property tax payments.

Charitable contributions are also included as itemized deductions, which would go away with a flat tax. What impact would that have on the nation's charitable organizations? Although many individuals would continue to support their favorite charities, many make contributions for the tax breaks, and without those breaks they might reduce or eliminate their contributions.

One of the biggest obstacles facing the flat tax reform proposals is their revenue implications. A recent Tax Policy Center review of Rick Perry's 20% flat tax proposal showed that federal revenues would be reduced dramatically. When comparing the proposal to the current progressive tax system, the TPC estimated the Perry plan would lower federal tax liability by $995 billion in calendar year 2015 compared with current law, roughly a 27% cut in total projected revenue. If the tax rate were 15%, the projected shortfall would be even larger. How Washington, D.C., would make up for this loss of income through other tax increases would be hotly debated. But even the Perry plan is not a true flat tax, as it allows income reductions for home mortgage interest and property tax, state income tax and charitable deductions plus a standard exemption of $12,500 for each filer and dependents. It also excludes long-term capital gains and Social Security benefits from taxation.

Don't lose too much sleep over a flat tax since it has been proposed many times before, only to be rejected. Instead, every time we end up with a more complicated tax system. Congress uses the tax system to further its social agenda, and a flat tax does not lend itself to that.

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Lee Reams, BSME, EA

Lee Reams, BSME, EA

Editor-in-Chief

Besides his role at CountingWorks as an educator and speaker to thousands of accountants nationwide, Lee manages a technical research service for a large group of tax accountants which sharpens his technical skills. Lee served on the Board of Blackline Systems, is a former Board of Director for the California Tax Education Council, is a Past President of the San Fernando Valley Chapter of Enrolled Agents, Member and Past Director for the California Society of Enrolled Agents.

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