I did this using Igor Drukov's Ultimate Fire Script (which you can find in the editors depot). I just bunged in the script to my mission folder and had in the initilisation box of the flag:
this setflagtexture "usa_vlajka.pac"; [this,[0,0,2],2] exec "UltimateFire.sqs"
This will cause the flag to look like it is burning. You can fiddle around with the numbers, they must control the position of the flames or something. If you want the flag nearer the ground so a mob can reach it use the setpos command on the flag.