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Proportional taxation, often referred to as the flat tax rate system, is a distinct approach to taxation that stands in contrast to the progressive tax system. In a proportional tax system, every individual and entity pays taxes at the same rate, regardless of their annual income or financial status. This uniform tax rate is a defining characteristic of proportional taxation, simplifying the tax code considerably. In this guide, we will understand what is proportional tax, provide proportional tax examples, and explore the merits and demerits associated with this approach to taxation.
Unlike a progressive system of taxation, where the rate of tax keeps increasing with an increase in income, a proportional taxation system is one in which all individuals and entities have to pay the tax at the same rate irrespective of their annual income financial status. In other words, the tax rate at which one has to pay tax remains the same for everyone, irrespective of an individual’s income. The proportional tax system is also known as the flat tax rate system.
For example, Mr. A earns Rs.2,00,000 per annum, and Mr.B earns Rs.20,00,000 per annum. The flat tax rate is 10% of the income. The tax calculation will be done as follows -
Mr.A = Rs.2,00,000 x 10% = Rs.20,000
Mr.B = Rs.20,00,000 x 10% = Rs.2,00,000.
Let us understand this with the help of an example. Sunil and Anil went to purchase the same model of bike. While Sunil had a simple accounts job and had worked very hard to save for the bike, Anil was a very rich businessman. Paying 2 lakhs for a bike was a big deal for Sunil, while it was a very small matter for Anil. Sunil had planned to take the bike on EMI.
Now let’s compare the cost of the bike for both -
| Sunil | Anil | |
|---|---|---|
| Ex showroom | 1,79,700 | 1,79,700 |
| Loan taken on EMI (90%) | 1,61,730 | |
| Initial Payment | 17,970 | 1,79,700 |
| Loan processing fee | 3882 | |
| Lifetime vehicle tax | 32,346 | 32,346 |
| First EMI | 5177 | |
| Total Initial outflow | 59,375 | 2,12,046 |
| GST @18% | 27412 | 27412 |
| Lifetime tax | 32,346 | 32,346 |
| Total tax paid | 59,758 | 59,758 |
| Income per annum | 6,00,000 | 60,00,000 |
| Tax as % of income | 9.96% | 0.996% |
The above example shows how the proportional system of taxation affects individuals and the amount of tax they have to pay. The person having a lower income has to pay 10% of his income as tax, and a rich person has to pay less than 1% as tax.
Having a proportional tax system can have various advantages. Below are a few of them -
While there are certain advantages of having a proportional taxation system, it also comes with its fair share of disadvantages. Given below are a few disadvantages of proportional taxation -
The middle class feels cheated: The major disadvantage of proportional taxation is that the middle class feels cheated as they have to pay a higher portion of their total income as tax, while the richer people can get away with paying very little tax. This can result in frustration and anger as a majority of India’s population belongs to the lower and middle classes.
Huge disparity between rich and poor: A proportional tax system can widen the gap between the rich and the poor in society. This can lead to less purchasing power in the hands of the poor and more purchasing power in the hands of the rich, leading to widespread resentment. This can also result in slow economic growth of the country.
Less Tax Collection: Since both low-income people and high-income people have to pay taxes at the same rate, the total tax collection of the government is less than in the case of other taxation systems. The wealthy people have to pay very little tax, thus resulting in lower revenue collection by the government.
The concept of proportional taxation, or the flat tax rate system, offers both advantages and disadvantages. On the positive side, it promotes clarity, simplicity and reduces the incentive for tax evasion among higher-income individuals. However, it also comes with notable drawbacks, such as potential disparities in tax burden between the middle class and the wealthy, as well as the possibility of increasing income inequality. Moreover, proportional taxation can result in reduced tax collection for the government, which can impact public services and infrastructure development.
While in a regressive taxation system, the people earning lower income pay higher taxes than the people having higher income, in a proportional taxation system, the rate of tax remains the same for lower-income, middle-income, and high-income classes.
India follows both progressive system of taxation and a proportional system of taxation. While direct taxes, like the income tax, follow a progressive taxation system, indirect taxes, like GST, follow a proportional system.
The high-income class individuals pay a higher income tax in the progressive system. However, the middle-income and lower-income groups have to pay lesser taxes.
