What If the Flat Tax Makes a Comeback?

One of the possibilities missing from 2024 financial services universe predictions may be the return of the flat tax debate.

Some states have flat, or flattish, state income taxes. Even Massachusetts has a rate that’s a flat 5% from $8,000 in income up to $1 million.

Steve Forbes has long been famous for calling for Congress to convert the federal government to a flat tax system. Now he’s making news for proposing that Donald Trump put a 17% flat income tax rate in his platform.

What could the return of the flat tax proposal mean, other than the possibility that 1980s shoulder pads could be about to explode out of the walls?

Here are seven ideas for agents and advisors to consider.

1. Rep. Michael Burgess could tell everyone he told us so.

The Texas Republican has introduced a flat tax bill every Congress since he’s been in office.

When he can slot it in as H.R. 1040 — a nod to the tax form — he does that, and that’s what it is in the current Congress.

2. A federal flat tax could wipe out some favorite retirement planning tools.

Many of retirement planners’ favorite retirement tax incentives cost the federal government a lot of tax revenue.

The latest house White House Office of Management and Budget Analytical Perspectives report shows, for example, that 401(k) plans will create a $152 billion “tax expenditure” this year.

Defined benefit employer pension plans will cost $69 million, self-employed plans will cost $44 billion and individual retirement accounts will cost $33 billion.

Economists who strongly oppose federal government use of tax incentives to influence behavior contend that everyone would be better off if the government simply let people keep the $298 billion that will go toward major retirement tax incentives this year.

Economists who are worried about income inequality contend that too much of the incentive value goes to relatively high-income people who don’t need it.

3. Just how a flat tax would affect retirement income would depend on the details.

The current version of H.R. 1040, for example, would put “retirement distributions which are includible in gross income for such taxable year” in “taxable income.”

The Burgess retirement distribution total would include payments from 403(a) or 403(b) annuity plans, IRA distributions, individual retirement annuity distributions, 457 plan payments and governmental plan benefits.

But Burgess would allow for a deduction for employers’ contributions to retirement benefit plans.

4. A flat tax could help save people’s time.

“A flatter, fairer tax structure would be simple and tax returns could be done on a single page,” Burgess said in a 2016 video address discussing his flat tax bills.

5. A flat tax could be great for high-income clients.

A Congressional Budget Office analysis created in 1992 found that a flat tax would increase the after-tax income of people in the top fifth in terms of annual income by 6.8%, while sharply decreasing the after-tax income of people in the bottom two-fifths in terms of income.

6. A flat tax could reverse the extra income taxes heaped on high earners in recent years.

Molly Sherlock, a Congressional Research Service analyst, found that, in 2018, taxpayers in the top 1% in terms of adjusted gross income paid 40% of federal income taxes.

If federal tax revenue stayed the same and everyone paid taxes at the same rate, they would pay just 21% of all income taxes, she said.

Her chart suggests that a flat tax could cut the average tax rate they pay on all income to about 13%, from about 25% in 2018.

7. A flat tax could help annuities compete harder against life insurance.

The Burgess bill does not say what would happen to life insurance death benefits. Congress seems highly unlikely to change those rules significantly.

The tax exclusion for life insurance death benefits will cost the federal government $16 billion this year.

If the tax code did treat life insurance death benefits and annuity benefits the same way, life insurance-based retirement planning strategies could become somewhat less attractive and annuity-based strategies could become somewhat more attractive.

Credit: Shutterstock