What Is a Proportional Tax?
A proportional tax is sometimes referred to as a flat tax. It is an income tax system that levies the same percentage tax to everyone regardless of income. A proportional tax is the same for low, middle, and high-income taxpayers.
In contrast, a progressive or marginal tax system adjusts tax rates progressively by income. Low-income earners are taxed at a lower rate than high-income earners.
Key Takeaways
- A proportional tax, or flat tax, assesses the same tax rate on everyone regardless of income or wealth.
- Proportional taxation is intended to create greater equality betweenmarginal tax ratesand average tax rates.
- Proponents of proportional taxes argue they encourage people to spend more and work more because there is no tax penalty for higher earnings.
Understanding Proportional Taxation
A proportional tax allows people to be taxed at the same percentage of their annual income. Supporters of a proportional tax propose that it gives taxpayers an incentive to earn more because they are not penalized with a highertax bracket. Flat tax systems make filing easier. Critics of flat taxes argue the system places an unfair burden on low-wage earners in exchange for lowering tax rates on the wealthy.
A sales tax can be considered a type of proportional tax since all consumers, regardless of earnings, must pay the same fixed rate. The sales tax rate applies to goods and services, and the income of the purchaser is not a part of the equation. Other examples include polltaxes and the capped portion of the Federal Insurance Contributions Act(FICA) payroll deductions.
Greenland imposes a 45% flat tax, one of the world’s highest rates.
Example of Proportional Taxes
The United States imposes a progressive or marginal income tax system on its taxpayers. Income is taxed on a graduated scale at rates that range from 10% to 37%.
Countries such as MongoliaandKazakhstanimpose flat taxes of 10%, andBoliviaandRussiahave a 13% flat tax rate.A citizen in Bolivia subject to a 13% flat tax rate who earns the equivalent of $50,000 per year would pay $6,500 in taxes. A person who earns the equivalent of $1 million would pay $130,000.
Although the federal government and most states in the U.S. impose a progressive tax system, 11 states levy a flat tax on wage and salary income as of 2023.
Pros and Cons ofProportional Taxes
Proportional taxes are a type of regressive taxbecause the tax rate does not increase as the amount of income subject to taxation rises, placing a higher financial burden on low-income individuals. A tax is regressive if it has an inverse association where the average taxcarries less impact on higher-income individuals or businesses.
Opponents of theproportional tax argue that higher-income earners should pay a higher percentage than taxpayers with lower incomes. They claim that a flat tax system places a more significant burden on middle-income earners to carry a large portion of government spending.While the percentage is the same, the after-tax effect on low-income earners is more burdensome than for high-income earners.
However, If a system has generous deductions, then low-income earners may be exempt from tax, thus eliminating, at least in part, the regressive aspects of the tax. Variations of the proportionaltax include allowingmortgage deductions and setting lower income levels.
Why Do Countries Impose a Marginal Tax Rate Over a Proportional Tax Rate?
Developed countries tend to use a graduated or marginal tax system where those with lower incomes pay a smaller percentage of their income in taxes. The common argument for a marginal tax system is that those who have low incomes need most to all of their income to provide for basic needs such as food and shelter.
Is Sales Tax Considered a Proportional Tax?
Sales tax is considered proportionalbecause all consumers, regardless of their income, pay the same fixed rate.
What Is the Difference Between a Progressive Tax and a Regressive Tax?
A regressive tax system is where the tax rate decreases as the taxpayer's income increases. A progressive tax system is one in which the tax rate increases as the taxpayer's income increases.
The Bottom Line
A proportional tax is commonly called a flat tax, which assesses the same tax rate on everyone regardless of income.Proponents of proportional taxes argue they encourage consumers to spend more because there is no tax penalty for higher earnings. Critics argue the system places an unfair burden on low-wage earners.
