Flat tax, an unknown issue

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These days much is heard about flat tax, or flat tax. As an Institute, we have already dealt with the subject for some time (Eurispes, flat tax: measures to achieve a concrete reform – Eurispes), and so we here try to examine this topic with a simplified approach, highlighting its practical effects, in both numerical and legal terms.

There is often some sort of confusion as to what exactly this type of measure means or what are its possible versions. Moreover, if, on the one hand, applying a flat tax means paying taxes at a lower rate than those currently paid, on the other hand, as taxpayers, who could disagree with such a measure?

The problem with the introduction of such a measure does not seem, after all, to be the protection of progressivity. This issue is actually rather limited today since there are several types of income already undergoing fixed rates in our legal system, where substitute regimes are now almost more the rule than the exception, from rents to financial income, etc. Generally speaking, today, it is indeed workers who are the ones who are really submitted to rate progressivity. In contrast, among the different sources of wealth creation, that arising from labour should, if anything, be the most protected. Then, as far as business income is concerned, the objective of the flat tax (where, as we know, a flat rate already exists in this case) should instead aim to exclusively target the profits deriving from entrepreneurial activity by granting a set of deductions relating to salaries paid to workers, the cost of goods and services necessary for production, expenses for real estate in which the business is carried out, etc., all factors that already suffer their own taxation.

The issue related to the introduction of the flat tax is then, if anything, that of financial coverage. However, in order to have a clear legal and accounting framework of reference (and against which also to assess the concept of progressivity), it is necessary to look at the numbers declared by taxpayers. The average amount declared in Italy is, in fact, about 20,000 euros. Yet we are talking about gross. Therefore, if it is true that 45% of Italian taxpayers declare less than 15,000 euros per year (paying, however, only 4.5% of the total IRPEF, with a rate of 23%), the application of a flat tax ‘at regime’, for example at 23%, would concern (and benefit) the remaining 55% of taxpayers, who currently pay much higher rates. The problem (or the advantage, depending on one’s point of view) is that 55%, in terms of tax revenue, is worth 95% of the Irpef. Therefore, the resources to be covered (in terms of lower revenue) would be considerable.

However, one does not need a great intuitive insight to understand that the numbers declared in Italy do not appear so accurate or at least do not correspond to those of the country’s consumption. And so, the flat tax goal would be to effectively counter tax evasion, which is currently estimated at (at least) EUR 100 billion in our Country. Considering the enormous tax evasion that afflicts our country, and considering that those who today declare incomes above 28,000 euro (gross), which the flat tax would immediately benefit from, are subject to objectively very high tax rates (between 38% and 43%), it is then clear that these taxpayers pay a very high tax burden precisely to compensate for the lack of income of those who do not declare it properly. Indeed, it seems at the very least unlikely that half of the Italian population, based on what they declare, receives a monthly income of around 1,000 euros gross).

One of the basic motivations behind the introduction of the flat tax is then precisely based on the assumption of considerable evasion, and the application of a lower tax rate would encourage those taxpayers who today declare unrealistic amounts to emerge spontaneously.

However, when talking about public financial balances, betting on the possible scenarios (the spontaneous emersion of those who today do not declare) is always rather risky. And so the flat tax, out of budgetary cautiousness, at least in the first phase (necessary to arrive, in a second phase, at a general revision of the system of rates), could be applied only to that part of income that Italians, given the new taxation, would be convinced (effectively) to declare, more than in the past (not so much with respect to the previous year, but with respect to a multi-year reference period, to avoid possible circumvention), also, perhaps with the guarantee, even under the law, that the IRS would not run to assess them for previous years. This is what incremental flat tax is all about. Yet, it would also address another critical issue in our current tax system. VAT holders operating under the flat-rate regime (i.e. individual entrepreneurs and professionals with incomes not exceeding EUR 65,000 per year) already enjoy a 15% rate on a taxable income determined according to the ATECO Code (and this is regardless of the 5% rate on new activities). The generalised introduction of an incremental flat tax could then also solve a further technical problem linked to this current legislation: that of the so-called ‘step’, where, if the ceiling (the step, in fact) of 65,000 euro is exceeded, the tax benefits, granted to those who fall under the flat-rate regime, are lost. Those earning EUR 65,000 a year would then have no convenience in collecting an additional EUR 10,000 because they would be forced to pay thousands more in taxes, thus effectively wiping out the higher income obtained. In the worst case, then, someone might be tempted to stay below the threshold, even by hiding part of the turnover. Even in that case, then, an incremental flat tax system would protect the commitment to higher productivity.

Of course, in order to implement such a reform in an effective and structured way, its introduction should be anticipated by data simulations on tax returns, analysis of data from the ‘Report on the Unobserved Economy and Tax and Tax Evasion’, and data on Italian household consumption. Further information should then be acquired, such as, for example, the composition of Italian ‘tax’ households by income levels; data on tax evasion broken down by sectors; income of dividends from capital companies for qualified and unqualified shareholders; data on other income subject to withholding tax, substitute tax or separate taxation. The adoption of the flat tax should then be matched by an effective and effective regulatory simplification and a strengthening of the legal and tax justice system, making, in practice, everyone pay everything they owe. In addition, to maintain an adequate tax revenue threshold, at least part of the current deductions should be abolished. The analysis should, finally, be extended to all other income currently subject to withholding tax at the source, or to substitute tax, or separate taxation. And to assess the impact of the change in taxation on these incomes, we would need data on total income and the relative total tax, divided by the different types of income (for example bank interest on current accounts not related to business activity; interest on BOTs and those on listed bonds; severance pay, capital gains due to the onerous sale or liquidation of companies owned for more than five years; prizes and winnings, etc.).

Whichever flat tax idea one intends to espouse, the path must, in any case, be progressive, since, as always for tax measures, all proposals must be analysed in a concrete and pragmatic way, highlighting (sometimes also in a long-term perspective) the pros and cons and the effects on taxpayers and the public budget. Then the decision is up to the politicians.

 

A note by Lawyer Giovambattista Palumbo, Director of the Eurispes Observatory on Fiscal Policies.

 

This content is also available in: Italian

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