Flat Tax - an unfair system of taxation?

Table of Contents:

1 Introduction

2 Justice in taxation

3 The Flat Rate Tax

4 Conclusion

1 Introduction

Some European countries, especially in Eastern Europe, for example the Czech Republic and Slovakia, recently introduced a ‘flat tax’ system.¹ Furthermore in other European countries like Germany and Switzerland there are controversial discussions about introducing a flat rate tax system. A flat rate tax is a system with a constant tax rate this means that each tax payer has to deduct the same proportional amount of his income and earnings subject to taxation to the fiscal office. With respect to income taxation, it usually comprises a tax exemption for income below a certain level. As the following figure shows the marginal rates of taxation stay the same however the average tax rate increases with rising income due to the more and more negligible effect of the tax exemption.

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Flat rate tax

Especially with respect to income tax the flat rate tax system is often contrasted with a progressive tax rate system. A progressive tax is characterised by rising marginal and average rates of taxation, which in contrast to a proportional tax emphasizes more strongly the effect that the relative tax burden increases with rising income.

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Progressive tax

As a progressive tax system places a higher tax burden on earners of a high income, it is often considered to be more just and fair than a proportional tax system as it achieves redistribution from wealthy people to the poor in a society. Moreover this redistribution seems also to be justified considering the decreasing marginal utility of income. A progressive tax indeed places a disproportional higher tax burden on high income earners but due to the decreasing marginal utility of income this does not necessarily lead to a comparable higher sacrifice of utility. A progressive tax aims at equalizing the utility sacrifice of all tax payers and helps to flatten the income gap up to a certain degree. In contrast a proportional tax would impose a comparable heavier sacrifice to poor people than to rich people. Additionally it is possible that high income earners benefit disproportionally high from government services (financed through taxation) like the protection of property rights, as they simply have more income and property to protect and to lose. This again would justify a comparable higher tax burden for rich people The aim of this essay is to analyse a flat rate tax system and to try to figure out if a flat rate tax system is indeed inferior to a progressive tax rate system with respect to justice in taxation. I will compare the effects of a flat rate tax to those of a progressive tax in this essay. In the end I will draw the conclusion that from the point of justice a flat tax rate is not inferior to a progressive one.

2 Justice in taxation

Comparing two different tax rate systems with respect to justice demands first of all to define which goals justice in taxation should achieve. A fair system of taxation should pay attention to the following three criteria:

- Ability to pay
- Horizontal equity
- Vertical equity²

The fundamental requirement of a just system of taxation is to obey the principle of ability to pay.³ The tax system should be sensitive to the fact that due to different levels of economic capability like the income and wealth it would not be fair to demand the same tax burden from everyone like, for example, a head tax would request. Each tax payer should contribute to the public welfare according to his ability, therefore those who are more fortunate in a society and who can spare parts of their income more easily will have to pay more taxes than those who are less well off. However it could be argued that not only economic capabilities, like income or capital gains should be considered when determining the tax burden but also factors like the endowment, defined as the ability a person has to earn an income or to accumulate wealth should be considered.⁴ A system of taxation that pays attention to the ability to pay of the tax payer might also ask that no taxes have to be paid on a basic income, as the subsistence minimum should be tax free.

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¹ Zipfel (2008), p. 1

² Suttmnann (2007), p. 42 f.

³ Suttmann (2007), p. 43

⁴ Murphy, Nagel (2002), p. 20