The tax for which the rate of taxation increases with increase in the base amount, is termed as progressive tax. On the other hand, the tax for which the rate of taxation is universal and does not increase with increase in base amount, is flat tax. Progressive tax is based on the principle that higher the income of the individual or bigger the business, the higher is the ability to pay tax. Thus, in economies that have progressive tax, it is the wealthier people of the society who are made to pay bigger amounts as tax, while the low-income group is practically exempted from the payment of taxes. When it comes to flat tax, however, the underlying principle is that everyone should be treated equally and there should be no discrimination, whatsoever, when it comes to payment of taxes. So, in countries like Bulgaria, Romania and Russia that follow a flat tax system, the government decides on a particular rate of interest for tax deduction that is applicable for all, and does not allow for any exemptions. Both these methods of taxation come with their own pros and cons. However, the progressive tax vs flat tax debate has continued ever since the two methods of taxation came into existence.
How is Progressive Tax Different from Flat Tax
Here we have illustrated the major differences between progressive tax and flat tax. In order that you have a clearer understanding of the points discussed hereafter, let us take a look at a small example. Say, there are three individuals, A, B and C. Consider that A is earning $6000 per month, B is managing $2000 while the monthly income of C is $20,000. Now say, the place where these people live, has a progressive taxation policy, which states that income below $5000 is exempted from tax, income between $5000 to $10,000 will be taxed at 10% and income above $10,000 will be taxed at 12%. So, how much do these people end up paying every month? Yes, you're right! A pays $600, B enjoys total exemption from tax payment and C has to pay $2400. However, if the same people had to pay taxes under a flat tax policy of, say,10%, A, B and C had to pay $600, $200 and $2000 respectively. So, we can see that in the second scenario, B ends up paying tax unlike earlier, while C ends up paying less tax. Now, isn't it unfair that even a person earning less has to pay tax? This is what sparked up the flat tax vs progressive tax debate. So, what's your point of view? Read on as you try to figure it out!
The following table enlists the pros and cons of both progressive tax as well as flat tax. Just have a look!
|Progressive Tax||Flat Tax|
|Capitalist or Socialist||Some economists believe that progressive taxation borrows from the socialist ideology that aims at equal distribution of wealth, which means taking away wealth from the rich and distributing it to the poor.||On the other hand, flat tax is pro capitalism as it seems to encourage ownership of capital, the basic principle of capitalism. This is because the rich are not forced to pay more taxes.|
|Marginal Utility of Wealth||Economists believe that progressive taxation is based on the principle of declining marginal utility of wealth, which means that with every next dollar, the utility of dollar declines for the rich. However, for the poor, with every extra dollar earned, its utility increases. This is why the rich should be able to pay more money in taxes.||Flat Taxation is not based on the principle of declining marginal utility of wealth.|
|Benefits for the Poor||Many experts believe that progressive taxation is beneficial for the poor as it relieves the burden of taxation from the people who earn the least, and are not capable of paying taxes.||However, flat taxation policy does not take into consideration the paying capacity of low-income groups as everyone is bound to pay a certain percentage of their income as taxes. This, economists believe, leaves an unnecessary burden on the poorest of the working poor.|
|Equal Distribution of Wealth||Progressive taxation is a step to bridge the huge gap between the rich class and the poor. Increasing tax rate with increase in income, means that the rich pay more taxes and this revenue generated can be used for the benefit of the poor.||Equal distribution of wealth is certainly not one of the objectives of the flat taxation policy as it forces even the poorest of the working poor to pay taxes, and makes no provisions for tax exemptions.|
|Benefits to the Economy||More and more economists believe that progressive taxation policy is beneficial to the economy. Even the famous economist Adam Smith in his book, The Wealth of Nations, mentions that progressive taxation helps in overall economic growth.||Although no method of taxation is ideal, almost 80% of economists in the U.S. are of the view that it is progressive tax that is beneficial to the economy, as opposed to the flat tax.|
|Effects on Employment Opportunities||It has been observed that there are better employment opportunities, and a higher employment rate, in an economy that follows progressive taxation. Also, in case of loss of employment due to factors such as recession, it is easier for people to recover due to less or no tax burden.||Economists are of the opinion that, in general, a flat taxation policy is not friendly to rate of employment and creation of employment opportunities.|
|Simplicity of Tax Filing Process||Due to the various groups into which the earning class is divided in progressive taxation, the entire process becomes too lengthy and complicated.||When it comes to simplicity of the tax filing process, it is the flat tax that wins hands down. This is because the particulars are so brief that they say it can be done using a postcard sized form as well!|
|Revenue to the State||The revenue earned by the state in the form of taxes is less in case of existence of a progressive taxation policy.||However, if the policy of flat taxation prevails, then the revenue earned by the state automatically increases due to the absence of loopholes in the taxation process, and due to the fact that every working citizen is paying taxes.|
Another factor is that while flat tax promotes the principle of equality according to which all citizens are equal before the law, progressive taxation policy discriminates between the rich and poor sections of the society. In spite of the pros and cons of flat tax, major economies across the world, including the U.S., follow a progressive taxation policy. Even the common man, in general, seems to be happy with the system of progressive tax as they feel that it is not unjust to collect tax from people who can afford to pay a little more.
So, that was about the differences between progressive tax and flat tax. You can yourself analyze the points discussed above and come to the logical conclusion regarding which taxation policy is better.