A flat tax (also called proportional tax) is a tax structure in which the tax rate stays constant regardless of the level of income. It means the rich and the poor pay the same or nearly same proportion of their total income as taxes.
Under a flat tax regime, the rich tax payers pay a higher amount of tax. However, as he moves up the tax slab structure, the tax rate applicable neither increases nor decreases. Such a tax structure results in constant effective tax rate.
A flat tax regime needs simple legislation; is more efficient because less resources are expended in assessing tax payable; and relatively more equitable than regressive tax regime. However, it does not help raise as much revenue as a progressive tax regime.
A flat tax is either (a) true flat tax or (b) marginal flat tax. In a true flat tax, no deductions are allowed; while in marginal flat tax, some deductions are allowed such as on account of charitable donations, etc. A marginal flat tax is progressive at lower level of income and turns flat as income increases.
Iris Frasheri lives in Tirana, Albania and works as a graduate assistant in University of Tirana and earns ALL 85,000. Sabina Boza works as a professor in the same university and earns ALL 500,000.
Albania charges a flat 10% rate on personal income in tax rate 20Y3 and we are assuming no deductions are applicable.
Iris's tax liability for the year is ALL 8,500 (10% of ALL 85,000), while Sabina's tax liability is ALL 50,000 (10% of ALL 500,000).
Sabina has higher income and she pays higher amount of tax as compared to Iris. However, both pay same proportion (i.e. 10%) as tax regardless of their total income. This is flat tax regime.
Written by Obaidullah Jan, ACA, CFA and last revised on