Some thoughts on Herman Cain’s 9-9-9 Plan
October 19, 2011
The existing U.S. federal tax code is a monstrosity. According to the IRS, Americans spend more than 3% of GDP on compliance costs each year. The deductions and exemptions in the existing code favor some industries over others and some behaviors over others. Why should Google and GE pay only a few percent of their profits in taxes when Wal-Mart has to pay nearly 40%? Why should a financier pay a lower tax rate than a doctor?
Unsurprisingly, many people have called for replacing the tax code with something simpler and more fair. One alternative that has recently been featured in the news is the 9-9-9 plan devised by Republican presidential candidate Herman Cain.
How does it compare to the current system? What are its assumptions? Are the criticisms justified? Would it accomplish its objectives?
Cain’s plan replaces the existing code with a 9% flat tax on all gross income less charitable deductions, a 9% sales tax, and a 9% value-added tax (business revenues less expenses paid to other U.S. businesses).
The best way to understand this plan is to look at it from the perspective of internal devaluation, where taxes on labor are cut and taxes on goods are raised. In fact, the Cain campaign says that one of the main advantages of his plan is that it will remove the existing biases in the tax code that encourage outsourcing and trade deficits:
In keeping with the basic value-added structure, the tax is treated as border adjustable. That is, the tax is on a territorial basis and applies only to sales in the U.S. rather than the worldwide treatment under the current tax system. This approach exempts exports while subjecting imports to the tax.
A retail sales tax would impose a transactions tax on the sale of goods and services used for consumption. Purchases by businesses would be exempt. Instead of individuals and businesses paying taxes via returns, revenue would be collected at the cash register. This means that goods produced for export will not appear in the base and imported goods will be added.
Considering that the trade deficit sucks about $600 billion out of the economy each year and that the imbalances created by excessive personal consumption helped cause the current crisis, these reforms seem like a welcome step in the right direction.
How would the tax burden shift? The Tax Policy Center (run by the Brookings Institution and the Urban Institute) claims that Cain’s plan would increase taxes on the vast majority of Americans (particularly the poor) and lower the tax burden on those in the upper quintile of the income distribution. Their methodology is misleading, however:
We assume that the national sales tax and business flat tax are imposed independently on businesses so they sum to sales tax rate of 18 percent. The individual flat tax, however, is applied to real wages that have been reduced by 18 percent by the other two taxes. The 9 percent individual tax thus applies to only 82 percent of tax-inclusive consumption, making its effective rate 7.38 percent of all consumption. Therefore, the three taxes combined are equivalent to a 25.38 percent national sales tax.
The problem is that this analysis does not compare Cain’s plan to the existing patchwork of taxes on income and payroll taxes, which could also be translated into a national sales tax. I will.
Consider a single earner who makes $60,000, claims the basic deductions, and spends exactly what he earns. After federal income and payroll taxes, he only receives $47,860. But this ignores effects of a tax that is hidden from him: the employer’s share of the payroll tax, which is currently 7.65%. His employer spends $64,590 for his labor yet he only gets $47,860. Thus, his real effective tax rate is higher than the headline figure of about 20%.
Using the methodology of the Tax Policy Center, this means that the tax regime he currently experiences is equivalent to a national sales tax of about 35%, because anyone who is paid $64,590 but can only buy $47,860 worth of goods is paying a premium of just under 35% on what he purchases in taxes.
From this perspective, Herman Cain’s plan cuts the tax burden of our hypothetical middle-income American by nearly one-third. The rich benefit more because the tax rates are flat rather than “progressive” and because the wealthy are less likely to spend everything they earn.
Does Cain’s plan raise taxes on the very poor, as the TPC argues? No. This is what Cain’s advisors wrote in their long-form summary of the plan:
Relief for lower income taxpayers will inevitably be part of any tax reform. To illustrate the effect that progressivity could have on tax rates, we will later derive the rates needed to allow a refundable exemption equal to the poverty level of income. This is the same as a refundable credit equal to the tax rate times the poverty level of income…The poverty grant is the sum of the threshold times the number of families for each family size group. For example, the average family would receive an exemption of $14,764 in 2008, reducing the tax base of each proposal by $2.0 trillion.
Curiously, the TPC does not mention this.
Finally, both Cain and the critics agree that his plan is revenue-neutral relative to the current system. [UPDATE: Not clear how this could work if it cuts taxes or keeps them the same for the vast majority of Americans]
Cain’s reform plan might be overly ambitious. It provides bigger tax cuts to the highest-earners than it does to the middle class. It is less elegant than some other proposals, such the continuous progressive income tax or the APT Tax (my favorite). It will not collect nearly enough revenue to balance the budget without cutting annual government spending by more than $1 trillion, if you care about that sort of thing. These are flaws. However, when compared to the existing tax code, it is a significant improvement and ought to be treated more seriously than it has been so far.