What is the flat tax and how does it affect businesses?
Critics of the U.S. tax code claim it is far too complex and that it creates disincentives to save and invest, and even penalizes people for working. The flat tax is offered as a solution that would drastically simplify the tax system and that would enhance economic incentives. A flat tax, as it is most often described, would tax all individual income and all businesses at the same rate. At the same time, a flat tax would eliminate tax deductions and tax credits. That would result in more people paying taxes which would offset the income lost from taxing everyone at the same rate.
Changes for businesses
The term flat tax has been in and out of the news since at least 1910, and part of the original income tax code adopted in 1913 included a flat tax on corporations. It was during the 1980s that flat tax news references increased dramatically, and the topic has been holding public interest consistently since that decade. According to John E. Golob, author of “How Would a Flat Tax Affect Small Businesses?,” certain features of flat tax proposals that deal directly with businesses include:
- Flat rate, same as individuals
- Single taxation on business income
- Elimination of dividend and capital gains taxes
- Immediate deductions for plant and equipment investments
- No interest income tax
- Fringe benefits provided to employees cannot be deducted by a business
- No more deductions and credits
Small business
According to Golob, small business would benefit the most from a flat tax. Different types of small business would benefit more than others. For example, businesses that depend heavily on tax deductions and tax credits would benefit less, while those in growth industries — where investments in business assets are heavy — would benefit greatly.
Small businesses spend more on tax compliance, proportionately, than large businesses. Therefore they would benefit from the simplification of the tax code. Small business owners pay business taxes based on their individual returns and will get a break because of their individual exemptions. A flat tax would stimulate lower interest rates so small businesses wouldn’t feel the pinch from losing the interest deductions. A person operating a small business can gain a deeper understanding of tax theory and how it applies to real world business scenarios by attending a business management program.
Large business
A principal advantage for large businesses under a flat tax system is the removal of double taxation. Since most large businesses are corporations, the corporation is taxed on its profits, while the owner/shareholders are taxed on their incomes, resulting in double taxation. Large businesses, however, would lose a wide assortment of deductions and credits. Fringe benefits form a cornerstone of tax strategy for many large businesses. The employee is not taxed on fringe benefits and the corporation gets to take them as deductions. A flat tax would eliminate that rather large deduction for businesses. Depreciation deductions would go away, drying up that particular advantage of past investments. However, if a business had more new investments than it had depreciation deductions, then it would benefit under a flat tax. Otherwise, the flat tax would penalize it. Large corporations have also spent considerable money persuading Congress to offer them tax breaks, and many of these breaks are industry-specific. Not only would large corporations lose their investments in forging public policy, but they would also lose any current and future tax breaks.
Overall, it would be small businesses that would benefit most from a flat tax, but ultimately, how beneficial a flat tax would be to any business would depend upon its particular tax situation when the new tax code was implemented.
