A simple and effective tax system that is fair and does not put excessive brakes on wealth creation. This is the idea behind the flat tax, which has been adopted by many countries around the world, and recently adopted by four states in America: Iowa, Mississippi, Georgia and Arizona.
The proposal is associated with the figure of businessman and politician Steve Forbes. Forbes made the unique marginal guy his main and almost only electoral trump card. It was never enough to win the Republican nomination for president, but it popularized the proposal, and today four states have already adopted it.
A fiscal revolution
Jonathan Williams and Nick Stark even say that "a revolution of the single marginal kind is underway." Indeed, the conclusion that Williams and Stark arrive at for the National Review does not seem exaggerated. For example, the authors show that last year Arizona passed a $1.9 billion income tax cut. The measure included a plan to flatten the tax, with a maximum rate of 4.5%. Beginning in 2024, Arizona will have a single rate of 2.5%.
In early April, the Georgia Congress passed a law that provides for the income tax to be flattened in the coming years, to a range of 4.99 to 5.75%. In the same month, Mississippi has approved a plan based on two principles: lowering rates and making them flatter. It lowers the maximum rate from 5% to 4%, and eliminates the two lowest rates. Georgians will save $1 billion, and Mississippians $525 million.
The boldest reform is Iowa's. The hawk-eyed state passed a reform that involves eliminating all marginal income tax rates, which means reducing the top rate from 8.53% to 3.9%. Iowans save $2 billion.
And they are not alone. Two states, Utah and North Carolina, have had unique marginal rates for a decade and a half. These two states lead the index economic performance index Rich States, Poor States developed by Arthur Laffer, Stephen Moore and Jonathan Williams
The context for these tax reforms is one of post-pandemic economic recovery, increased tax revenues and, in many states, sometimes very large fiscal surpluses.
What a flat tax looks like
Income tax has always been progressive. Whoever is able to produce the most income pays the most. To make the tax more progressive, it is normal to divide it by brackets, with each new "step" having a higher marginal rate than the previous one. Thus, the federal income tax is divided into seven brackets. The first $9,950 pays 10%. From 9,951 to 40,525, a rate of 12% applies. So as income increases, the last dollars enter new tranches with higher rates. The maximum federal rate is 37% starting at dollar 523.601.
This would not happen with a single marginal rate. Above a certain amount, a single rate would tax the same proportion of income. In principle, it is a more proportional tax, and therefore less progressive, than if it has numerous brackets that go up. But it doesn't have to be that way.
In the case of the Americas, the first dollar of income generated is taxed directly. However, an initial exempt amount can be fixed. Thus, for lower incomes, the minimum exemption will be proportionally higher and the average effective rate will be lower. That average effective rate will grow as income grows. Greenland, for example, has a marginal rate of 44%, but with an exempt minimum of SEK 58,000 (about $8,000).
There are several countries that have unique rates for their income taxes, ranging from autocracies such as Russia to established democracies such as Lithuania or Hungary. Other countries where it is imposed are Mongolia, Georgia, Romania, Kazakhstan or Bolivia.
Advantages and disadvantages
Critics of the flat income tax rate point out that it is not very progressive. In fact, it can be made as progressive as you want, simply by raising the minimum exemption and taxing a very high marginal rate thereafter.
But it has several advantages. One of them is its simplicity; many tax advisors may lose their jobs. Another is that it may be the same tax for companies and individuals. And the third is that it can be an effective means of limiting the greed of politicians over the income of citizens.
In any case, six states believe that it is a good way to compete fiscally with the rest, and this is a trend to which, for the time being, there is no end in sight.