July 7, 2015

Why The Flat Tax Won't Work

On this week's session, I’m going to talk about the Flat Tax being proposed by some Presidential candidates. Every election season, we tend to hear more about this so I’ll address it up front as well as why it won’t work.  The flat tax is where everyone pays the same tax rate regardless of their income level. Currently, federal tax rates for individuals range from 0 to 39.6% plus from 7.65% to 8.55% in payroll taxes which go to fund social security and Medicare. Essentially, a flat tax is a tax cut to those in the upper brackets along with the elimination of all deductions and exemptions for all. Additionally, the flat tax eliminates the tax on unearned income like interest and dividends. This also amounts to an additional tax cut for the higher income brackets which are more likely to have this type of income. If the higher tax rates were lowered to accommodate a flat tax, the government would need to make the lost revenue from somewhere else to fund its operations. Cuts to budgets and programs could only get so far. Economists are projecting that it would cause over 3 trillion dollars less to come into the US treasury over the next 10 years. That's over 800 million dollars per day less than the government would have to work with. I’m all for smaller and smarter government, however, I don’t think that is possible to trim that much without drastically decreasing the quality of life or safety that we enjoy as Americans.

A study by the nonpartisan tax foundation showed that taxpayers earning between 200,000 and 500,000 would see between a 4 and 7% increase to their after-tax income. Earners making 500,000 and above would see a 10% increase to their after-tax income and earners making over a million would see a whopping increase of 27% to their after-tax income.

The Tax Foundation also found that Rick Perry’s 20% flat tax plan would increase the annual tax bill of a typical family of four earning $50,000 per year by more than $4,000.

As you can see, once these proposals are fleshed out they just don’t make any common sense. And that’s the reason why the flat tax has been proposed election after election for decades and they have never gotten any traction. The Flat tax in any form it has been proposed cannot work.

What could work to bring in more revenue is to stop taxing carried interest as capital gains and instead tax it at regular income tax rates? Carried interest is how private equity funds, venture capitalists and some hedge funds earn their income and have it taxed at a maximum of 20% instead of the top tax bracket of 39.6% It’s essentially a creative way for the rich to get richer.

Our federal government has 18 trillion dollars of debt in 2015 and it is projected to reach over 25 trillion dollars by 2019. Being an entrepreneur for 19 years and advising thousands of tax clients and tax business owners, I would never advise someone in debt to bring in less revenue. It just doesn’t make sense. And neither does the flat tax.

Have a wonderful and productive rest of the week and take care.

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