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Flat Tax

An income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets.

Single-Rate “Flat” Income Taxes

A flat tax, where a single rate is applied to all taxable income, is an appealing income tax system due to its relative simplicity, transparency, neutrality, and stability. Flat taxes are relatively transparent and simple in that they make it easier for taxpayers to estimate their tax liability and for revenue forecasters and state policymakers to estimate how a rate cut or increase would impact revenue.

Importantly, flat taxes avoid impacting individuals’ and businesses’ marginal decisions, or what they will do with their next dollar of income. Whereas graduated-rate income taxes reduce the payoff to work and investment on the margin by imposing higher tax rates on higher levels of marginal income, flat taxes treat all taxable income neutrally and are less likely to discourage additional work, investment, and other activities that contribute to economic growth.

Because all income taxpayers are subject to the same tax rate under a flat tax system, single-rate taxes are generally more difficult to increase than graduated-rate taxes. This provides predictability to taxpayers and helps protect against unnecessary tax rate increases.

While economists would describe a perfectly flat income tax as one that does not distinguish between types of income, does not double-tax consumption, does not introduce time-based distortions, and does not include deductions or credits that would alter the effective tax rate, in practice, no state has a perfectly flat income tax. Every state makes certain distinctions between types of income and offers various credits and deductions, and most state income taxes are levied in addition to sales taxes, double-taxing consumption.

Flat Taxes in Practice

Most states that levy an income tax have graduated-rate tax systems similar to the federal income tax, but nine states levy a flat tax on wage and salary income.

States with a flat individual income tax:

  • Colorado
  • Illinois
  • Indiana
  • Kentucky
  • Massachusetts
  • Michigan
  • North Carolina
  • Pennsylvania
  • Utah

Of the nine states that already have flat taxes, five enshrine that status in their state constitution, locking in the benefit and making it harder for lawmakers to raise taxes by switching to a graduated-rate tax structure.

In the first 109 years of state income taxation, only four states ever transitioned from a graduated-rate to a flat income tax: Colorado, Utah, North Carolina, and Kentucky. In 2022 alone, however, four additional states enacted laws or received judicial clearance to shift to a flat tax: Arizona, Georgia, Iowa, and Mississippi.

Graduated-Rate “Progressive” Income Taxes

Unlike single-rate or “flat” income taxes, graduated-rate or “progressive” taxes impose higher marginal tax rates on higher levels of marginal income. This reduces the payoff to additional work and investment on the margin and acts as a negative incentive on working more. As a result, compared to single-rate taxes, graduated-rate taxes are usually more harmful to economic growth, especially when the variation among rates is large and the top rate is high.

The U.S. federal individual income tax has a graduated-rate structure with seven tax brackets and rates ranging from 10 to 37 percent. For single filers in 2022, the first $10,275 in taxable income is taxed at a rate of 10 percent, the next $31,500 is taxed at a rate of 12 percent, the next $47,300 is taxed at a rate of 22 percent, and so on.

2023 Federal Income Tax Brackets and Rates for Single Filers, Married Couples Filing Jointly, and Heads of Households
Tax Rate For Single Filers For Married Individuals Filing Joint Returns For Heads of Households
10% $0 to $11,000 $0 to $22,000 $0 to $15,700
12% $11,000 to $44,725 $22,000 to $89,450 $15,700 to $59,850
22% $44,725 to $95,375 $89,450 to $190,750 $59,850 to $95,350
24% $95,375 to $182,100 $190,750 to $364,200 $95,350 to $182,100
32% $182,100 to $231,250 $364,200 to $462,500 $182,100 to $231,250
35% $231,250 to $578,125 $462,500 to $693,750 $231,250 to $578,100
37% $578,125 or more $693,750 or more $578,100 or more
Source: Internal Revenue Service

As an example of how marginal tax rates affect decision-making, take an individual earning $41,775 in taxable income, meaning much of their income is taxed at the 12 percent rate. If this individual wants to work extra hours or take a second job, they would end up facing the 22 percent rate on their additional earnings. At that higher tax rate, they will bring home less take-home pay from their second job or additional hours of work, meaning the benefit they receive from working additional hours or taking a second job is reduced. This may influence the individual to decide not to take a second job or to work fewer hours than they may have chosen to otherwise because the benefit they receive from working more is reduced.

Similarly, high marginal tax rates can influence businesses to make investment decisions that minimize tax liability even if those decisions might not otherwise make the most sense from an economic or business standpoint.

Proponents of graduated-rate tax structures like the perceived fairness that comes from higher income earners paying higher rates than lower income earners, but this can also encourage economically inefficient decision-making, reduce labor force participation, and weaken long-term economic growth.

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