A flat tax refers to a tax where there is a single tax rate paid by every individual. For instance, if a country were to have a flat tax on incomes, then all employees would pay at a rate of 20 per cent on their salaries. The concept of flat tax has been present for a very a long time in several nations including the United Kingdom. Nevertheless, it was until 1994 when European nations actually adopted the flat rate tax (Hall & Rabushka 2007). The history of flat tax dates back to when Estonia began taxing corporate and personal income at the same rate of 26 per cent. Lithuania and Latvia, Baltic neighbors to Estonia, were the first to follow Estonia’s lead. Other nations that have followed Estonia’s lead include Slovakia, Russia and United Kingdom. In this regard, this paper discusses the advantages and disadvantages of the flat tax in United Kingdom.
Advantages of Flat Taxes
The first benefit of flat tax is simplicity. If everyone pays similar percentage of their income taxes, it eradicates the need to fill out various sophisticated tax forms. According to Forbes (2005), it also eliminates the demand to maintain many records for the deductions of tax. Flat tax also potentially gets rid of the thousands of pages of state tax code. Few individual ever understand these thousands of pages, perhaps no individual fully comprehends all these pages of state tax code.
Another advantage of flat tax is associated to its ease of understanding tax due. It is evident that the subject of taxes is confusing to many individuals. The findings of Heijman & van Ophem (2005) echoed these sentiments. According to the findings, about 78 per cent of the respondents agreed that the tax system was too sophisticated to be understood by them. The supporters of flat tax have claimed that the marginal tax rate results in complications in comprehending tax due. As such, the marginal tax rates act as a disincentive to effort. Ivanova, Keen & Klemm (2005) noted that the adoption of flat taxes in the UK would make it simple for individuals to comprehend their respective legal responsibility of paying tax. However, the critics of flat taxes have maintained that the cost of attaining the understanding might be very high. In the views of Neubauer (2010), direct move to flat tax is likely to cause much disturbance of the burden of taxation to attain the required level of popular acceptance.
According to Forbes (2005), flat tax is easy to collect. The easiness of the collection of tax is associated with the argument that under flat tax system, the total tax take can result. The simplicity of collections presumes that flat tax is a simple system, characterized with low tax compliance costs. Fewer tax authorities can be involved in gathering more tax whilst making fewer mistakes. According to the critics of flat tax, the evidence supporting the ease of its collection is difficult to assess. According to the UK Treasury, the debate concerning the adoption of flat tax is fierce because there is very little evidence supporting the claims of pro-flat tax.
Some authors have also cited that the adoption of flat tax results in a decrease of bureaucracy and enhances the transparency in the collection of taxes. This was supported by the Government of Romania National Commission of Economic Forecasting. The changes are undoubtedly welcomed, though it is important to note that Romania is one of the three recent transition economies in Europe, which have implemented flat taxes against internal chaos. The other two transition economies that adopted flat taxes include Ukraine and Georgia. According to Heijman & van Ophem (2005), the introduction of flat tax leads to voluntary conformity with the tax policy. In addition, flat taxes also results in the increased voluntary conformity from recovery of long-standing taxes due. In Neubauer’s (2010) study, compliance seems to have increased by approximately one third. Nevertheless, it remained uncertain whether the increase in compliance was because of the parametric tax policy.
Another advantage associated with flat taxes is decreased evasion and avoidance. According to Hall & Rabushka (2007), a straightforward tax system decreases the extent of avoiding paying taxes. Flat tax system achieves this by eliminating the thresholds, deductions and irregularities on which avoidance is based. In this regard, the adoption of flat tax in UK makes the enforcement of taxes simple and reduces the chances of unlawful evasion of tax. Additionally, reinstating a system of higher are taxes with a flat, single and low rates decreases the incentive for avoiding paying taxes.
Flat tax is associated with fairness. Various literatures have affirmed that fairness is one of the greatest virtues of flat tax (Hall & Rabushka 2007). The concept of fairness is based on the idea that all individuals should be treated similarly. Instead of giving policymakers and their interests decide who should be treated fairly, flat tax system sets a single goal standard. Regardless of the amount of money earned by an individual, the type of business, he or she is will pay taxed at the same rate as other individuals.
It is apparent that the adoption of flat taxes results in significant increases in revenues from some form of taxes (Hall & Rabushka 2007). For instance, in Romania value added tax (VAT) increased by about 36 per cent, while social security increased by about 18.7 per cent due to the adoption of flat taxes (Heijman & van Ophem 2005). Tax on income revenues fell by about 5.3 per cent, whereas profit taxes rose by less than 1 per cent in Romania. However, the proof that flat taxes increase revenues from taxes by themselves seems to be extremely hard to find in various nations that have adopted the system. However, the evidence indicates that efficient good tax collection administrations that lead to increased revenues from tax.
Disadvantages of Flat Taxes
While flat tax system seems to be interestingly simple, the practical details beneath its adoption are often more sophisticated. Every time flat taxes are adopted, they are frequently adopted in conjunction with more sophisticated system. This adds only another layer of directives. There are some hidden limitations associated with the adoption of flat taxes. According to Forbes (2005), these limitations can only be seen after critical and deep assessment of the flat tax system.
The first disadvantage is that flat taxes are intrinsically regressive. This implies that the poor citizens proportionately pay more than the rich do. As such, the flat tax system undermines the principle of social democracy that states that the rich should help the poor individuals for public goods. This disparity is acknowledged and disliked. According to Forbes (2005), flat tax has an association with social policy. Since the World War II, the United Kingdom has been using the progressive tax system as a key aspect of its social policy. Progressive tax system ensures that the taxes paid by an individual increases as his or her income increases. On the other hand, regressive tax system reverses the situation. According to Forbes (2005), this shows that tax is unfair to the poor and individuals who earn low incomes.
According to Neubauer (2010), there are no reliefs or allowances under the speculative flat tax. However, there is an exception for income from abroad. This implies that a source of income, which could finance consumption, is not taxed. As such, no individual can determine if the tax is progressive in relation to consumption. This is because consumption might be financed by other non-taxed income.
The critics of flat tax have pointed out that the system is extremely simple, and therefore it loses the required flexibility (Heijman & van Ophem 2005). It is apparent that services and goods differ. As such, it is not appropriate to tax luxury goods at similar rates as economic goods. For instance, goods used by children should not be taxed at similar rates as goods used by adults. By contrast, income taxes might promote more labor to compensate for any short fall, whereas tax credits offered to low income earners can guarantee that marginal rates are below 100 per cent.
Neubauer (2010) pointed out that shifting to a new flat tax system could be a complex and expensive process. As such, the transition might result in a period of confusion. The capacity to determine new ways of evading tax will frequently be available, particularly during the transition. Flat tax is also rigid, unlike income taxes where ‘fiscal boost’ and ‘fiscal drag’ serve as involuntary stabilizers in bust and boom periods respectively.
According to Forbes (2005), shifting the costs of administration on to business will not assist. The experience of Australia has indicated that the shit to indirect or flat taxes negatively affects small business. An excessively straightforward system does not timely allow additional motivation to prospective investors. As such, the system causes a significant loss of international competitive to the United Kingdom.
The paper has discussed the various disadvantages and advantages of flat tax in the United Kingdom. In general, proper implementation of flat taxes results in fairness, revenues and dynamic economies. The first biggest benefit of flat tax is simplicity. If everyone pays similar percentage of their income taxes, it eradicates the need to fill out various sophisticated tax forms. It is apparent that the adoption of flat taxes results in significant increases in revenues from some form of taxes. Flat taxes are intrinsically regressive, which implies that the poor citizens proportionately more than the rich. The critics of flat tax have pointed out that the system is extremely simple, and therefore it loses the required flexibility.
Forbes, S 2005, The flat tax revolution: using a postcard to abolish the IRS, Regnery Publishing, New York.
Hall, R & Rabushka, A 2007, The flat tax: updated revised edition, 2nd edn, Hoover Press, London.
Heijman, W & van Ophem, J 2005, ‘Willingness to Pay Tax: The Laffer Curve Revisited for 12 OECD countries’, The Journal of Socio-Economics, vol 34, p. 714–23.
Ivanova, A, Keen, M & Klemm, A 2005, ‘The Russian ‘flat tax’ reform’, Economic Policy, vol 34, p. 397–444.
Neubauer, B 2010, Flat tax – an unfair system of taxation?, GRIN Verlag, London.