As we near the 2016 election season, you will undoubtedly hear some candidates tout their desire for a "flat tax" or a "fair tax". Being in the tax profession, I could not agree more that our current tax system is cumbersome and complicated. But, getting rid of the IRS and taking the country to a flat/fair tax is not as easy as it sounds. Following are a few reasons why.
Income
In most of the examples of the flat tax I have seen, a flat 15% is deducted from someone's paycheck, instead of Federal withholding, FICA, Medicare, etc. This sounds great, but what about people that don't get a real paycheck? What if all my income is derived from investments or partnerships / S-corps? Are interest and dividends considered earned income for the flat tax? Is the gross income from my partnership subject to the flat tax, even though I might have distributed more or less of that to myself during the year? In the end, someone will have to determine what "income" is subject to the flat tax, which will ultimately lead to the same loopholes and treatments that we have in place today.
Incentives
Our current tax code offers several incentives to businesses for purchasing capital assets and maintaining employees. For example, Section 179 and bonus depreciation allow a taxpayer to expense 50% or 100% of a qualified asset in the year it is purchased. This gives the business an immediate tax benefit for purchasing new equipment. If that goes away, businesses are likely to ride out their equipment longer, putting a strain on parts of the economy where the equipment is manufactured. If new equipment is not purchased, the manufacturing companies won't need to keep as many plants open, meaning people will ultimately lose their jobs.
Pressure
Another reason why we won't be able to easily walk away from our current tax structure is pressure - pressure to fund Social Security, Medicare, and the Affordable Care Act. If all contributions to Social Security that come from your paycheck and self-employment taxes ceased today, then Social Security benefits would probably run out next week. If revenue is not received from your paycheck and the net investment income tax to fund Medicare, then millions of people would go without health coverage ... next week. And, a function of the Affordable Care Act is for people that receive subsidies to pay them back if their income exceeds what they estimated when they applied for coverage. If those don't get paid back, then the whole Affordable Care Act will fail ... next week. I'm not saying I agree with all of these policies, but I am saying that the pressure to keep them going is stronger than the pressure to move away from our current tax system.
In closing, a flat tax sounds great on the surface. But, it can't apply universally to every situation, and it might end up doing more harm than good. Remember, we already have a flat tax built into our current tax system - it's called the Alternative Minimum Tax, which requires people in a certain income level to pay at least 26% income tax.