Flat tax best for businesses and taxpayers – easy projections

Flat taxes are meaningfully simple, however, in several ways. It is easier to forecast revenue under a flat tax, and to project the revenue effects of potential tax changes. It is easier for taxpayers to estimate their tax liability and how it would change under different income scenarios, which enhances tax transparency and potentially improves some economic decision-making. It accords better with impressions that taxpayers form of tax burdens based on headline rates, such that individuals and small businesses may be more attracted to a state with a relatively lower flat rate than one with a graduated-rate system that would yield similar liability. And it simplifies the function by which taxpayers decide whether to work or invest more on the margin, since all marginal returns to labor and investment are exposed to the same rate.

Of greater significance for taxpayers, however, is that flat-rate income taxes tend to function as a bulwark against unnecessary tax increases, and to provide greater certainty for individual and business taxpayers. Economic decisions are made on the margin; choices about investments, labor, or relocation will be made on the basis of the effect on the next dollar of income, not the prior ones. A competitive top marginal rate matters most for economic growth, and flat income taxes—given their “all-in” nature—not only mean a lower rate on that all-important margin, but tend to be harder to raise in the future, whereas highly graduated taxes are more susceptible to targeted, but often economically inefficient, tax hikes.

Taxpayers seem to sense this intuitively: it seems to have been persuasive in Illinois, for instance, where voters lopsidedly rejected a constitutional amendment permitting a graduated-rate structure even though the initially proposed tax increase would not increase tax liability for the vast majority of voters. They seemed to recognize that, once the principle was established, higher rates would be established for more and more taxpayers—even setting aside the implications for the state’s economic competitiveness.

This is one reason why states with nearly-flat taxes should consider finishing the job. In Alabama, for instance, the current three-bracket system, with the top rate kicking in at $3,000 of income, only provides $40 in tax savings compared to taxing all income at the top rate. Raising the standard deduction would easily provide the same progressive benefits while embracing the simplicity and—more importantly—the certainty and stability of a single-rate tax. Five other states likewise have top rates that kick in at or below $10,000, including Idaho and Mississippi, which are now transitioning to a flat tax, and Oklahoma, where a flat tax is under active consideration.