Effectiveness of Flat Tax Over the Current Tax Policy Term Paper

Pages: 16 (4659 words)  ·  Bibliography Sources: 15  ·  File: .docx  ·  Level: Master's  ·  Topic: Economics

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S. lawmakers considering switching to flat tax policy to remove complication associated with the current tax system in order to improve economic efficiency and growth as well as removing double taxation associated with a progressive taxation. The flat tax system arguable will attract capital investment in the country as well as improving business climate. Under a flax tax option, the government will tax all incomes at the same rate after tax authorities apply all personal allowances.

Many known politician have already advocated for a flat tax policy in their campaign. Steve Forbes advocated for a tax option in his campaign during the Republican presidential nomination. Senator Richard Shelby and Representative Dick Armey have already proposed the Fairness and Freedom Restoration Act that proposes a flat tax rate of 17% and personal allowance of:

$11,350 for an individual, TO BE REVISED

$14,850 for a single household, $22,700 for a married couple

$5,300 for each dependent. TO BE REVISED

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Opponents of flat tax option claim that the new system will impose a considerate burden on the lower income earners because the tax rate will eliminate the "Earned Income Tax Credit." They further argue that the flat tax rate will benefit the wealthy people and higher income earners because it will abolish the personal income tax on dividends, interests, and capital. However, supporters of a flat tax policy view all these taxes as double taxation because the capital gains are taxed at business level. Since flat tax system will abolish inheritance tax, the opponents claim that flat tax will increase national debt and federal deficits.

Term Paper on Effectiveness of Flat Tax Over the Current Tax Policy Assignment

Despite the claims of the opponents of flat tax system, this paper argues that the current tax option is too complicated for ordinary taxpayers. Ordinary taxpayers cannot file the tax returns by themselves because they find the current tax system too complicated to understand. Moreover, the current tax policy does not encourage marginal propensity to invest which consequently discourage economic growth. (Martinez-Vazque, & Timofee, 2011).

Effectiveness of Flat Tax System over the Current System

The economic theory provides ten principles of good taxation and they are as follows:

1. Equity and fairness,

2. Certainty,

3. Convenience of payment,

4. Economy in collection,

5. Simplicity & Understandable,

6. Neutrality,

7. Efficient and Economic growth

8. Visibility and Transparency

9. Minimum tax gap,

10. Appropriate government revenues. (Nellen, 2006).

The analysis of the current tax policy reveals that it is not simple for ordinary tax payer to understand. Moreover, the current tax policy increases as there is an increase in income, which does not follow the minimum tax gap. Moreover, the current tax policy does not follow economy in collection because costs of collection are enormous. The IRS uses billion of dollars yearly to collect taxes from taxpayers. (AICPA, 2001).

The flat tax will remove the complexity of filing tax returns by individual and corporations. The flat tax system will rest on simpler administrative principles where corporate and individual income should be taxed once. Typically, current tax policy violates principle of taxation because capita gains and dividends are taxed twice.

More importantly, the flat tax is very simple to adopt unlike the current tax laws that are so complex to understand. Typically, the current tax system encourages tax cheating and avoidance. Moreover, the current tax policy costs the government billions of dollars to administer. Moreover, it costs taxpayers time spent that worth billion of dollars to fill the tax form and other form of compliance. Moreover, the current tax system costs the economy billion of dollars in term of lost output in form of goods and services because the time wasted for the tax purpose would have been used for investment purposes. The flat tax policy will remove complicated depreciation deduction and replace it with a favorable capital formation, revealing an immediate write off investment spending by 100%. Typically, the system is a value added approach leading to the consumption taxation. Under current tax policy, the fringe benefits make no sense.

Under the flat tax system, each corporation will file a simple tax form. Even larger business such Microsoft Corporation will file a simple tax form and every line will in the form will compose of well-defined number that will be obtained directly from business accounting record. The simple individual tax form and business tax form are presented below.

Form 1

Individual Wage Tax

Your first name and initial (if filing for joint return, give spouse's name and initial) Last name

Your social security number

Present your home address (number and street, apartment number)

Spouse's social security number

City, town, state, and ZIP code

Your occupation

Spouse's occupation

1

Wages and salary

1

2

Pension and retirement benefit

2

3

Total compensation

3

4

Personal allowance

a) $16,500 for married couple filing jointly 4(a)

(b) $9,500 for single 4(b)

(c) $14,000 for single head of an household…. 4(c)

4a

4b

4c

5

Number of dependents, this is not including spouse

5

6

Personal allowances for family dependents (line 5 multiplied by the $4,500)

6

7

Total personal allowances

(line 4 plus line 6)

7

8

Taxable compensation

(line 3 if less go to line 7, and if positive; otherwise zero)

8

9

Tax (17% of line 8)

9

10

Tax withheld by employer

10

11

Tax due (line 9 less line 10, if positive)

11

12

Refund due (line 10 if less and line 9, if positive)

12

Form 1

Business Tax

Business name

EIN (Employer identification number)

Street address

County

City, state, and ZIP code

Principal product

1

Gross revenue from sales

1

2

Allowable costs

(a) Purchases of goods, and services, and materials

(b) Wages, pensions and salaries,

(c) Purchases of equipment, capital structures, and land

2

3

Total allowable costs (sum of the lines

2(a), 2(b), 2(c)

3a

3b

3c

4

Taxable income (line 1if less line 3

4

5

Tax (17% of line 4)

5

6

Carry-forward from 2013

6

7

Interest to be carry-forward (6% of line 6)

7

8

Carry-forward into 2013 (line 6 plus line 7)

8

9

Tax due

(line 5 if less line 8, if positive)

9

10

Carry-forward to 2013

(line 8 if less line 5, if positive)

10

Current economic recession that has led to the rise of national debt and budget crisis has made increasing number of Americans to call for a new tax reform for both corporate organizations and individuals. Bressler, et al. (2010) argue that U.S. corporate tax rates is the among the highest in the industrial world. The major shortcoming of the progressive tax rate is that it discourages incentive to invest. The negative impact of the current tax rate makes the flat tax policy to gain increasing attention. The flat tax will boost incentive to invest because the business will be able to enjoy immediately tax deduction for investment in equipment ad plant over the course of many years. Moreover, the flat tax regime will eliminate double taxation associated with progressive taxation currently paid on capital gains and dividends.

Typically, current economic climate provides impetus for economic reform. There is argument among tax theorists and economist that the best tax system is one that will strike optimum between equity and economic efficiency. (Hagopian, 2011). An efficiency tax system should not distort the country allocation of resources. It should also not alter investors' behaviors. Arguably, the flax tax is simple because it eliminates most tax deductions, preference, and credits. Typically, flat tax policy simplifies tax code because it reduces cost of compliances. The flat tax will influence the growth of American economy and improve incentives to work. Moreover, the flat tax rate policy will encourage entrepreneurial activity as well as capital formation, which will substantially increase people's standard of living. Although, there are group who against the flat tax policy because they suspect that the system will give away to the rich by levying equal tax redistribution. However, Seldom, (?1996) argues that the flat tax rate of 17% will stimulate economic growth because everybody will be encouraged to work which will enhance performances of the U.S. economy. Improved incentive to work will enhance take home wages of an individual, and the system will stimulate work effort which will eventually stimulate investments into most productive channels in the country.

Moreover, flat tax rate will enhance critical inputs into the economy. Since there is only one tax levied on corporate organization and individual, the flat tax will remove distortions associated with the current tax system. Typically, the current tax policy allows distortion in the economy that consequently discourages capital inputs. Under the current tax system, varying tax treatment and different marginal tax rates make the government to tax capital and other inputs differently from industry to industry. For example, average effective tax rate in the U.S. economy is 36.4% however, average tax rate on tobacco and food industry is 46%, manufacturing sector pays 40% tax rate, tax rate on agricultural crops industry is 26% while financial sector pays average tax of 32%. ( KPMG, 2014).… [END OF PREVIEW] . . . READ MORE

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