Adithya
Introduction
It is a well-known fact that India follows a progressive tax rate system, where the rate of taxation increases with a rise in the income of the taxpayer. In comparison, a flat tax rate system follows a simplified structure wherein a uniform rate applies to all taxpayers irrespective of the income slabs. It is often argued to be a regressive tax system, making it more burdensome on people with low-income levels, as they have to shell out more returns on their income than those with significantly higher levels of income.
The concept of flat tax finds its genesis in the minds of Robert Hall and Alvin Rabushka’s comprehensive tax reform proposal in the early 1980s. The 2025 Budget has been doing rounds in the media about a potential simplification of taxes and rationalizing exemptions inter alia, making it simpler for a layperson to comprehend the laws and act accordingly. Although much remains to be seen about the possibility of tax reforms in the form of an Income Tax Bill, said to be modeled on the Direct Tax Code, it would be apt to draw a comparison with the flat tax rate systems adopted in various countries and examine the viability of such a taxation structure in India, given its socio-economic climate.
Flat Tax System in Central and Eastern Europe
A flat tax system is based on the principle of applying a single tax rate to all taxpayers, regardless of their income levels. This approach eliminates deductions and exemptions, thereby creating a simplified and transparent tax structure. While proponents highlight its efficiency, critics caution that it disproportionately burdens lower-income individuals, who would have to pay a greater share of their earnings in taxes compared to wealthier taxpayers.
A critical aspect of evaluating the flat tax system in India is understanding its fiscal feasibility and the steps necessary for its implementation. Given that India’s direct tax-to-GDP ratio hovers around 6-7% (as of 2022), a sudden transition to a flat tax system could pose a variety of challenges.
It would now be appropriate to refer to countries that have adopted the flat tax system. Empirically, the adoption of a flat tax regime occurred in two waves: The first wave saw the Baltic States set marginal rates at their highest pre-reform levels, while the second wave, including Russia and several Eastern European nations, introduced lower rates. Notably, Russia abandoned its flat tax regime in 2021 for a progressive five-tier structure. While all flat tax systems share a single marginal labor income tax rate, they vary in corporate tax rates, dividend policies, and VAT structures. Optimal tax theory suggests that a non-linear tax system maximizes efficiency and equity, but proponents of the flat tax argue that it offers simplicity and administrative efficiency. Increasing tax-free thresholds helps low-income earners, whereas reducing marginal rates for high earners can lead to decreased progressivity. Studies on Russia and Slovakia reveal mixed results in this regard. The effects on labor supply remain uncertain—lower marginal rates may incentivize work, but lower average rates could reduce motivation. Compliance can improve due to reduced complexity, as seen in Russia’s 2001 reform, though enforcement improvements might have also played a role. If structured properly, flat taxes can maintain stabilizing effects through broad tax bases and adequate exemptions. Although such reforms are often introduced by market-friendly governments, the uncertainty regarding long-term sustainability, as seen in Slovakia loom writ large. The impact of a flat tax varies by country, influencing revenue collection, compliance levels, work incentives, and equity outcomes differently. Political considerations heavily influence tax adoption and longevity, therefore emphasizing the need for further empirical research, especially in lesser-studied flat tax jurisdictions.
Flat tax in the USA
There is a growing trend in the U.S.A, with a number of states transitioning from progressive income tax systems to flat tax structures. Between 2021 and 2022, Arizona, Iowa, Mississippi, Georgia, and Idaho enacted legislation implementing single-rate tax systems, reflecting an effort to simplify tax codes and enhance economic competitiveness. The motivation behind these reforms includes making tax structures more predictable, reducing compliance costs, and potentially encouraging economic growth by lowering rates for higher earners. Despite these advantages, concerns remain regarding revenue stability and equity. Critics argue that flat taxes may disproportionately benefit higher-income groups while placing a greater burden on lower-income earners. Additionally, states that rely heavily on income tax revenue may face fiscal challenges, particularly during economic downturns.
Ultimately, the shift toward flat taxes represents a broader trend in U.S. tax policy, emphasizing simplicity and economic incentives. Ongoing talks about the abolition of income tax in the USA under the rule of President Trump further shed light on the consumerist policies said to be adopted by the US administration. However, states must carefully consider the long-term implications, including revenue sustainability and potential effects on income inequality, when implementing such reforms.
Oversimplification or need of the hour?
An analysis of the tax structures in the said countries reveals a common pattern in respect of certain economic characteristics that facilitated their success—smaller populations, relatively low-income disparities, and efficient governance. India, however, presents a far more complex landscape.
India’s current tax system is characterized by progressive income taxation, indirect taxes like GST, and various exemptions and deductions. Considering its socio-economic diversity, adopting a flat tax system raises important questions about equity, efficiency, and revenue implications. The existing system in India, as noted earlier, follows a progressive personal income tax system with multiple slabs ranging from 5% to 30% as of the 2025 Budget. The corporate tax rate ranges from 15% to 35% approx. excluding surtax and cess. depending on factors like residence, place of effective management, turnover, etc. The Goods and Services Tax (GST) has simplified indirect taxation but remains complex due to multiple rates, various exemptions, deductions, and subsidies cater to different income groups, making the tax system intricate but tailored to India’s economic disparities.
Given India’s fiscal deficit and welfare expenditures, transitioning to a flat tax may require compensatory measures like indirect tax hikes or expenditure cuts. The viability of a flat tax in India is significantly limited due to its distinct socio-economic conditions, which differ from those in the U.S., Central, and Eastern Europe. In India, implementing a flat tax system would face significant challenges due to the country’s vast income disparity. The socio-economic landscape is marked by a high percentage of low-income earners who rely on progressive taxation for relief. A system with reduced subsidies and simplified tax laws may not function effectively in India, as it could create loopholes that enable widespread tax evasion. Additionally, India’s complex economic structure necessitates targeted policies that address sector-specific needs, which a flat tax may fail to accommodate.
The U.S. states adopting flat taxes benefit from a strong institutional framework, a more formalized labour market, and limited reliance on direct taxation as a primary revenue source. Additionally, the presence of decentralized governance allows states to experiment with different tax structures while relying on federal transfers to mitigate revenue volatility. Central and Eastern European countries that adopted flat taxes in the 1990s and early 2000s did so in a bid to attract foreign investment, simplify tax administration, and encourage compliance in transitioning economies. However, Russia’s decision to abandon its flat tax regime in 2021 highlights the long-term sustainability challenges of such a system.
India, by contrast, faces a large informal economy, substantial income inequality, and high dependency on direct and indirect tax revenues to finance welfare programs. Unlike the U.S., where safety nets and federal programs exist to cushion lower-income groups, India’s fiscal structure necessitates progressive taxation to fund essential social programs, including subsidies, healthcare, and education. Furthermore, a reduction in tax progressivity could exacerbate inequality, limiting economic mobility for lower-income populations. Additionally, India’s tax administration is already complex, and introducing a flat tax could lead to unintended consequences such as increased evasion and revenue losses.
While tax simplification and rationalization remain crucial for economic growth, a blanket flat tax system is not a feasible solution for India. Instead, a hybrid model that retains progressivity while streamlining exemptions and deductions would be a more sustainable approach. Empirical evidence from past reforms in the U.S. and Europe indicates the need for country-specific solutions rather than a one-size-fits-all model. Given these considerations, India’s tax policies should focus on enhancing compliance, and maintaining a fair and progressive tax structure to support its diverse economic landscape.
Policymakers must, therefore, tread cautiously, ensuring that tax reforms cater to the unique needs of the Indian economy while maintaining fiscal sustainability. By incorporating elements of a flat tax system while retaining necessary safeguards, India can explore a tax model that simplifies compliance, enhances revenue collection, and fosters economic growth.
Conclusion
The debate around the implementation of a flat tax system in India inevitably intersects with the country’s unique socio-economic structure, where significant income disparity and a large informal economy require a more nuanced approach. Unlike the U.S. and Central and Eastern European nations, India’s government adheres to socialist principles enshrined in its Constitution, with a strong emphasis on social welfare and reducing inequality. This is reflected in progressive taxation systems that fund essential services like healthcare, education, and subsidies for marginalized groups. The capitalist sentiment driving tax reforms in the U.S. and some Eastern European countries emphasizes simplicity, economic incentives, and growth. However, these reforms thrive in contexts where institutions are strong, income disparities are relatively lower, and welfare systems are robust. In contrast, India’s progressive tax model is designed to address its vast socio-economic divide, focusing on equitable wealth distribution and poverty alleviation. Such a system would also likely lead to an overwhelming surge in tax litigation, further straining the judiciary. Moreover, it would conflict with the constitutional principles that mandate state intervention to uplift the economically weaker sections of society.
Therefore, an unfiltered flat tax system, would be unsuitable for India. While tax simplification and rationalization are essential, India must adopt a model that respects its socialist constitutional framework, fosters equity, and enhances administrative efficiency. A hybrid tax model—one that retains progressivity while simplifying the system—would be a more pragmatic and constitutionally sound path forward.
