Nine percent is a teaser rate. The real rate is much higher.
So what about Herman Cain’s 999 tax plan? Turns out it has some very good aspects — and some others, not so good. I’d give it two rousing cheers and one bronx cheer.
The plan is called ‘9, 9, 9’ because it would replace today’s complicated and economically burdensome federal tax code with a simple, three-part system, consisting of a 9% flat tax on individuals, a 9% flat tax on businesses, and a 9% national retail sales tax.* That’s it.**
The plan thus has three major virtues: It’s bold, it’s simple, and it’s fair. And by proposing it, Cain is showing some political courage and imagination. Grassroots voters are hungry for just those things. No wonder this plan is fueling Cain’s strong standing in the GOP presidential race.
But there are some flaws.
So let’s consider the proposal—the good, the bad, and the ugly.
The Good
Here are the Cain plan’s good qualities:
- It ends nearly all deductions and special interest favors.
- It ends all payroll taxes.
- It ends the death tax.
- It eliminates the double taxation of dividends.
- It eliminates the taxation of capital gains and repatriated profits.
- It allows immediate expensing of business investments.
- It shifts the burden of taxation from production to consumption.
- It increases capital formation, which will fuel productivity and wage growth.
In short, Cain’s plan would be more fair, neutral, transparent, efficient, and pro-growth than today’s system. Good stuff!
But wait. There’s more. Cain says this is just Step One. Step Two would be to repeal the personal income tax altogether. Wow!
The Bad
But here we come to a problem.
Cain doesn’t get rid of the income tax. Instead, he reforms it. And then he adds a new levy — a national retail sales tax — on top of it.
Why? Why doesn’t he just get rid of the income tax at the start? The answer, most likely, is that if he proposed to eliminate the income tax in one fell swoop, while trying to raise the same amount of revenue as we do today, he would have to set the rate for the sales tax so high—well above 9%—that voters would balk. My guess is a national sales tax would have to be set at something closer to 25%, to raise the same amount we currently raise with the existing income and payroll taxes.***
Now, ask yourself: If you could be relieved of paying income and payroll taxes, would you be willing to pay a roughly 25% sales tax on everything you buy? Well, presumably that would depend on whether you’d be better or worse off, financially, right? The key here is how much you pay in income taxes under the current system.
- If you’re one of the minority of people—the top 10% of the population—who pay 70% of the income tax revenues, you might see the change as a good deal.
- But if you’re lower down the income scale, and especially if you’re one of the 50% of Americans who don’t pay any income taxes, then you might not see it as such a good trade.
- And if you’re poor, you might really hate it.
And that, I suspect, is why the so-called FairTax (the proposal to replace income and payroll taxes with a national retail sales tax) has never taken off as an idea. When people hear about that 25% rate, they experience a kind of sticker shock. They imagine, quite reasonably, that they could be worse off than under the current system.****
No wonder Mr. Cain has fallen back to a two-step strategy: 9 percent is a teaser rate!
The Ugly
The second problem with Cain’s plan is more serious than the first. It puts in place the infrastructure for a VAT, a Value Added Tax. That’s bad.
No, that’s very bad.
A VAT is a form of national sales tax that is collected at every stage of the process from the initial sale of raw materials to a manufacturer to the final sale of a finished product to an end-consumer. It’s the most insidious of all taxes, because it is built into the price of everything and consumers can’t see how much of the price is due to the tax. When taxes rise, prices rise, but consumers mistakenly assume that’s just market forces at work. Politicians love a VAT: it lets them take a lot more money out of our wallets. And VATs usually exist side by side with income taxes, not in lieu of them. Taxpayers should hate VATs for the same reasons politicians love them.
European countries have VATs; we do not. European countries collect a lot more in taxes than we do. These two facts are related.
Total receipts of the US Government since World War II have averaged about 18 percent of GDP and have never exceeded 20.9 percent (the peak, in 1944). By comparison, as the graph shows, the original European Union member countries’ total tax receipts since the mid-1960s, when VATs started appearing, have not been less than 30 percent of GDP and today average a little over 40 percent. In short, thanks to VATs, European tax collections are twice as high as in the U.S.!
Clearly, if you want to raise taxes, support a VAT. If you want to make government permanently gargantuan, support a VAT. If you want to burden your economy and destroy jobs, support a VAT.
‘But wait, Clancy,’ you say. ‘Cain’s national sales tax isn’t a VAT. It’s a retail sales tax, collected at the cash register. That’s a big difference.’
So it is. But guess what. Cash-register sales taxes have a habit of evolving into VATs. That’s what happened in Europe. And that’s undoubtedly what will happen here, if we adopt Cain’s plan.
People are willing to pay a sales tax when the rate is low, but when the rate rises, they start finding ways to evade it. And sales taxes are easily evaded. So when people evade a rising sales tax, politicians respond by morphing it into a VAT.
Conclusion
Mr. Cain’s 999 plan is on the right track with its goal of a lower, flatter, simpler, fairer, more transparent tax system. Nine percent would be a wonderful top rate for the income tax, compared to today’s 35% top rate. And let’s face it, abolishing the payroll tax and the death tax would simply be awesome.
But adding a national retail sales tax on top of the federal income tax (even a flat tax) is a bad idea, because it creates the infrastructure for a federal-level, European-style VAT.
And if Cain’s 9% personal flat tax failed to remain flat (as happened with Ronald Reagan’s promising but ultimately failed 1986 tax reform), we would end up with the worst of both worlds: a confiscatory income tax and a job-crushing VAT.
Paradoxically, then, if you want higher taxes and permanently bigger government, one way to get there would be to support Herman Cain’s 999 plan!
Two rousing cheers, for boldness and imagination. And one bronx cheer, for a dangerous lack of foresight.
Dean Clancy is FreedomWorks’ Legislative Counsel and Vice President, Health Care Policy
* The 9% Individual Flat Tax would define ‘income’ as gross income less charitable deductions. The 9% Business Flat Tax would define ‘income’ as gross income less all investments, all purchases from other businesses and all dividends paid to shareholders. It appears the 9% National Sales Tax would be applied to all goods and services sold in the economy, though Congress could and presumably would exempt certain ‘vital’ goods and services (such as food, medicines, health care, education).
** Cain’s plan would also include subsidies for Empowerment Zones, politically defined areas designated by Washington for special tax favors. This would detract from his goal of ending distortions and complexity in the tax code.
*** This discussion assumes we only want to raise the amount currently raised, and not the amount currently spent. The feds currently spend 40% more than they take in. If we tried to fully fund the government solely with Mr. Cain’s national retail sales tax, we’d need a sales tax rate in the vicinity of 40%.
**** In the ‘FairTax’ plan that Mr. Cain wants to get to, every citizen and permanent resident alien would receive a monthly cash ‘prebate’ check from the government. This is intended to effectively exempt ‘essentials’ like food and medicines from the tax with minimal hassle and paperwork at the cash register.
ADDENDUM: Some may read this post as a brief for a Flat Tax and against the so-called FairTax. That’s not my position. I personally support, very enthusiastically, Cain’s idea of eliminating both the income and payroll taxes. (And both is important — I would want both to go, not just one or the other.) But absent constitutional amendments, the Flat Tax won’t stay flat and the FairTax will become a VAT.
Instead of replacing the income and payroll taxes with a national retail sales tax, I believe we should replace them with a system of effectively self-limiting imposts and duties, such as we had before 1913. Unlike Cain’s 999 plan, the traditional, pre-1913 approach would avoid the danger of a VAT, and wouldn’t necessitate constitutional amendments (though, to be sure, it would be nice to have an amendment preventing the return of an income tax).
To put this another way, I don’t oppose a national retail sales tax in principle, but I do strongly oppose it as a practical matter under current conditions, because of its high likelihood of morphing into a VAT. I could support ‘999,’ therefore, only after or contingent upon ratification of a constitutional amendment outlawing a VAT. Rep. John Linder’s proposal to sunset the FairTax automatically after 8 years, should the 16th Amendment remain in place, is not a serious way to address the concern. The constitutional amendment needs to be ratified first, before the FairTax takes effect.
Unfortunately, if revived today, the traditional, pre-1913 tax system would face the same practical problem as Cain’s proposed sales tax, to wit: If we want to raise as much revenue as we currently do — let’s not even talk about trying to raise as much as we currently spend — the rates would have to be set so high as to be politically and economically untenable. The real reason fundamental tax reform goes nowhere is that today’s federal government is simply too big. The true ‘Step One’ of fundamental tax reform is a massive downsizing of government.
[Originally posted at freedomworks.org, October 6, 2011. @FreedomWorks. Republished at deanclancy.com.]