As discussed in this chapter, personal income taxes in most developed countries are progressive, meaning that the rate of taxation increases at higher income levels. However, in several countries a flat (or, proportional) tax is used. In its basic form, a flat tax requires that a fixed percentage of income (for individuals) or profit (for corporations) be paid as tax. It is simple, and said to be fairer for everyone, as well as more lucrative for governments. Following the fall of communism, Russia and most of the former communist Eastern European countries instituted flat tax regimes. These countries have since had strong economic growth, and many economists credit the flat tax as an important factor in this growth. Other countries that have flat tax include Hong Kong, Saudi Arabia, Nigeria, Uruguay, and the Bahamas. For individuals, a flat tax is very easy to manage. For most workers, no tax return is required since deductions made by employers on their behalf complete their tax compliance. Also there is usually a minimum income before any tax is payable, so that low income earners are protected. There are several important consequences of a flat tax on businesses. One is that in most implementations profit is taxed only once, as opposed to some countries in which it is taxed at the company level, and then again at the taxpayer level when profits are distributed as dividends or capital gains. Another important consequence for most implementations of a flat tax is that all capital purchases for a company are expensed in the year of purchase. Flat taxes also reduce the administration costs for companies, individuals and governments.

Discussion:

The concept of flat taxes has generated heated debate in some developed countries. The simplicity and efficiency of flat taxes make them attractive alternatives to bloated tax bureaucracies, massively complex tax rules, and frustrating reporting requirements that are the norm. Also, there is evidence that flat taxes promote compliance and generate more tax revenue than progressive taxes. However, there are those who would be adversely affected by a change to a flat tax, and there is considerable resistance generated whenever a serious effort to institute flat tax is made. This is why the only major countries to move to a flat tax in recent years are ones like Russia and the Eastern European countries who are newly instituting income taxes, and consequently are not threatening entrenched interests.

Questions:

1. Which of the following groups would likely welcome a flat tax? Which would resist it?

(a) Accountants

(b) Small business owners

(c) Individuals with investments in the stock market

(d) Government tax department workers

(e) Low-wage earners

(f) Rich people

(g) Capital equipment manufacturers

(h) Leasing companies

(i) Welfare recipients

(j) You

2.

If a country changed from a tax regime in which corporate profits are taxed twice to a regime in which they are taxed only once, what would likelv be the effect on the stock market?

3.

In the long run, would the ability to expense capital equipment fully in the year of purchase dramatically affect a company's investment decisions? If so, do you think society is better off as a consequence of these effects, or worse off?

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