Question & Answer: Now suppose the United States were to convert its tax system from an income tax to a flat…..

Now suppose the United States were to convert its tax system from an income tax to a flat tax. For individuals, there would be no itemized deductions allowed, instead they would have a high standard exemption (taxpayers below the exemption would not have to file). Tax exemptions would be in place for dividends and interest income. Businesses could deduct all expenditures on salaries and immediately expense asset acquisition costs.

The student discussion will focus on what effect if any such a tax system would eliminate incentives to shift activities:

From one period to the next?

From one type to another?

From one pocket to another pocket?

Why or why not?

Do you believe a flat tax with no itemized deductions is politically feasible for the United States? Why or why not? m

Expert Answer


Income tax is not considered as a regressive tax, it is always considered as an progressive tax. The higher the income of the individual, the more taxes needs to be paid.
if we shift to flat rate of tax, then it becomes a regressive tax, as each individual will pay same percentage of tax on its income.
At present there are so many incentives which are given on capital expenditures, one can claim normal depreciation, bonus depreciation etc.
This leads to business planning their activities in order to take maximum advantages by paying less taxes in current year or deferment of taxes.
If all asset acquisition cost are allowed to be expensed in the current year, it will have a major impact on the business profitability, as asset acquisition costs are very huge, it will result in unequal amount of profit for the tax purposes each year. will lead to deferred tax liability in the books of accounts as this are not allowed as per USGAAP and IFRS.
If will eliminate the incentive to shift activities from one period to another, as all expenditure where revenue or capital, are allowed as deductions, so businesses will not think too much before incurring capital expenditures.
As all expenditures will be allowed in the current year, business houses will not try to shift expenditure from one form to another, they will show, the expenses as incurred and will try to maximize their advantages from tax. This will lead to situation in which there will be uneven income tax liability as capital expenditures are not incurred in huge volume each year.
This system will simply the tax system, as simply claim what ever expenditure has been incurred, but will create wide disparity with the accounting standards, as those will be completely different.
I don’t think , that a flat tax with no itemized deductions is politically feasible for the United States, as it will create a back lash, opposition accusing the government of saving the rich at the cost of poor. As rich people with more income will pay less taxes, and poor people will pay more taxes. it will become a political tool, as the government will be accused of favoring the businesses, as they will mostly pay less taxes, due to full deduction in capital expenditure, and plan accordingly.
The government will be accused of favoring rich and business for political gains, as they will vote for them, as they will pay less taxes.
The collections of taxes for the government will fall in the year it will be implemented as all will try to tax maximum advantages of this change, and there are always uncertainty as how the things can change with the government.
The government will also lose face in the world , as they will say, that all decision are politically motivated, so as to earn more votes and remain in power, without thinking of doing any constructive thing for the people.
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