A flat tax is a tax that charges one rate across the whole of its taxable base, so the rate reaching the last dollar of the base is the rate that reached the first. The same two words also name a whole system design, a single-rate tax that replaces a graduated rate schedule, and the version that name is most commonly associated with, the Hall and Rabushka proposal, sits on a consumption base rather than an income base. Which sense is in play changes what the words claim, because a system built on one rate can still take a rising share of a taxpayer’s income.
A Flat Rate on One Charge, or a Flat Tax System
Proportional describes what a single charge’s rate does on its own base, a reading worked through in proportional tax alongside the progressive and regressive cases. Flat tax names either that same single-rate property or an entire system design. The two senses diverge as soon as a system exempts an amount before its rate applies, because the exemption moves the share of income the tax takes while the rate itself stays put.
Why One Rate Does Not Fix the Average Rate
The exempt amount does the work the rate does not. In the standard design, individuals are generally responsible for paying taxes on the wages that had been deducted by businesses, in excess of an exemption level (CRS Report R44342, Consumption Taxes: An Overview, updated January 24, 2023).
A fixed exempt amount is a shrinking share of a growing income, so the average rate climbs toward the single marginal rate without ever reaching it. What is flat is the rate, not the share of income the system collects.
Say a single-rate system charges one stated rate on wages above a stated exemption. The figures below run three wage levels through it.
single rate 20%
exempt amount 20,000
wages 40,000
taxable (40,000 less 20,000) 20,000
tax at the single rate 4,000
average rate on wages 10.0%
wages 100,000
taxable (100,000 less 20,000) 80,000
tax at the single rate 16,000
average rate on wages 16.0%
wages 200,000
taxable (200,000 less 20,000) 180,000
tax at the single rate 36,000
average rate on wages 18.0%The rate on the next dollar is the same at all three levels and the average rate on wages is not, and it rises at every step without ever arriving at the stated rate. Reading that gap off a real return is set out in how to calculate effective tax rate.
The Flat Tax as a Whole System
The flat tax is commonly associated with systems based on a proposal originally formulated by Robert E. Hall and Alvin Rabushka, and it has two components, a wage tax and a cash-flow tax on businesses taxed at a single flat rate. Businesses would generally pay cash-flow taxes on their sales minus deductions for wages, pensions, material costs and capital investments, individuals would pay on the wages the businesses deducted above an exemption level, and the resulting system is essentially a modified value added tax (CRS Report R44342).
The Congressional Research Service groups the flat tax with the value added tax and a national sales tax as common consumption tax designs, so the base is spending even though a household meets the charge on its wages (CRS Report R44342). The spending base is set out in consumption tax, and the stage-by-stage mechanism the business side resembles is in value added tax.
Where a Single Rate Sits in US Law Today
The federal individual income tax is not a single-rate charge. Its rate schedules are graduated, in the original tables and in the tables substituted for taxable years beginning after 2017 (26 U.S.C. 1(a) and 1(j)(2)).
The federal corporate income tax comes closer. Subsection (a) imposes the tax on the taxable income of every corporation, and subsection (b) sets that tax at 21 percent. Subsection (c) then lifts the charge off corporations taxed under regimes of their own, which covers mutual savings banks conducting life insurance business under section 594, insurance companies under subchapter L, and regulated investment companies and real estate investment trusts under subchapter M. Subsection (d) reaches a foreign corporation only as section 882 provides (26 U.S.C. 11).
Section 11 is not the whole federal corporate charge either. For an applicable corporation, section 55 works out a tentative minimum tax, meaning 15 percent of adjusted financial statement income as determined under section 56A, reduced by the corporate alternative minimum tax foreign tax credit. What section 55 then charges is the amount by which that tentative minimum tax exceeds the corporation’s regular tax plus the tax section 59A imposes (26 U.S.C. 55(a) and 55(b)(2)).
A number of states charge one rate on individual income. Illinois is a worked case, where the individual income tax is 4.95 percent of net income, effective July 1, 2017 (Illinois Department of Revenue, Income Tax Rates).
Flat Rate Versus Flat Dollar Amount
The standard deduction is a flat dollar amount, not a flat tax. The statute defines it as the sum of the basic standard deduction and the additional standard deduction, both carried as dollar figures and adjusted for inflation (26 U.S.C. 63(c)). It comes off income before any rate applies, so it changes the base, while a flat rate changes what the base is multiplied by. The deduction itself is worked through in standard deduction.
What a Single-Rate State Changes for a Firm
Less than the name suggests. One rate removes the bracket arithmetic from the rate line and nothing else. Nexus, residency and the credit for taxes paid to other states work the way they did, and a multistate business still divides its income by formula before any rate touches it, which is the exercise in apportionment. A flat-rate state return is a shorter calculation, not a simpler engagement.
Common Questions
One rate on everything the tax reaches. However big or small the base turns out to be, the same percentage applies to all of it.
Not for individuals at the federal level, where the rate tables are graduated (26 U.S.C. 1(j)(2)). Single rates do sit elsewhere in US law, in the corporate charge under section 11(b), subject to that section’s own exceptions, and in a number of states’ individual income taxes (26 U.S.C. 11).
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