Tuesday, October 11, 2011

Herman Cain's 9-9-9 tax plan

When Cain surged to a more prominent place in the Republican field and discussion of his "9-9-9" tax plan began surfacing, I, along with various others in my field, started getting phone calls from the press about it.

To be honest, I found it hard to focus seriously on the plan. With finite time available, a book I am trying to write, etcetera, I am often reluctant to spend a lot of time learning the details of tax proposals - not just by temporarily high-flying candidates, but also by presidential administrations and Congressional leaders - when I suspect, as frequently and with good justification I do, that they are neither well-designed enough to be of any intellectual interest nor likely enough to be enacted to have any real practical interest.

Nonetheless, I suppose a mea culpa is in order on this score, given that those of us in the tax policy biz have professional responsibilities to communicate with the public when issues in our domain reach the front burner. Thus, I am grateful to Ed Kleinbard for thoroughly analyzing the 9-9-9 plan here, and to Bruce Bartlett for doing so here.

One thing I hope I can contribute here, however, is a more succinct version of some of their key conclusions - Kleinbard's in particular, as Bartlett focuses much of his attention on Cain's apparent long-term plan to replace "9-9-9" with a national sales tax, a proposal that Bartlett has done an excellent job critiquing, such as here.

The really comical thing about Cain's 9-9-9 plan is how much it is a product of silly optics. As Kleinbard shows, it essentially amounts to a 27 percent flat tax on wages that is reduced to 18 percent for owner-employees who have enough liquidity not to need to pay themselves an explicit and observable arm's length wage.

There often is debate about whether, if we went the national consumption tax route, a value-added tax (VAT) or retail sales tax (RST) would be better. I regard the two taxes as in principle identical except that a VAT has better enforcement potential. Cain, however, has both in his plan. The business tax, his second "9," is in the main a VAT, apart from a few odd features such as its making dividends deductible. And Cain's third "9" is explicitly an RST.

Why on earth would you have both a VAT and an RST? I think the reason is that 9-9 sounds better than 18. You get the illusion that the taxes are more different than they actually are. Moreover, each, considered in isolation, seems low.

Along these lines, I have a great idea to eliminate the 35 percent individual income tax rate without losing progressivity or revenue. Here's the plan: replace the 35 percent annual income tax with a 3-3-3-3-3-3-3-3-3-3-3-3 monthly tax on annual income. After all, who's counting if the 12 monthly taxes actually add up to 36 percent annually?

Cain's first "9," of course, is the wage tax on individuals. Again, this is only for people who have to take their labor income in the form of wages because they are not owner-employees who can simply omit the step of paying a wage from their left pocket (the business) to their right pocket (the self-employed worker) - an omission that presumably requires sufficient liquidity to pay one's consumer bills with cash already on hand. But since (as Kleinbard shows) a wage tax is in the long run equivalent to a consumption tax apart from the undermeasurement of owner-employees' true economic wages, we end up with what is really a 27 percent / 18 percent consumption or wage tax, with the lower rate going to the self-employed, but, again, only insofar as they have the liquidity not to need to extract from their businesses the full economic wage. And this is not merely deferral, since in the long run you can simply sell the business and derive capital gain that the 9-9-9 plan would exempt.

As Kleinbard notes, Cain would impose a huge tax increase on lower-income and middle-class Americans, who would lose the benefit of lower income tax rate brackets, including the effective zero bracket that results from personal exemptions and the standard deduction. (To be sure, the payroll tax is first-dollar, but its rate is well below 27 percent even if one counts all of the employer / employee and Social Security / Medicare pieces.) So on the bottom end Cain's plan is shockingly regressive. Even his beau ideal the FAIR tax generally has a universal "prebate" in the amount of estimated poverty-level consumption expenditures.

As for imposing a lower tax rate on highly liquid owner-employees than on those whose work situation requires the payment of an observable arm's length wage, this in practice means that we don't even have a flat rate system, but one in which the rich will frequently pay a lower rate than anyone else. Although the high-end lower rate may in part reflect mere confusion and inadvertence, I am reminded of the gabelle - that is, the salt tax in pre-French Revolutionary France from which nobles and the clergy were exempted.


Invisible Hand said...

Doesn't a 9% VAT and 9% RST lead to a ~19% tax? (1.09**2 = 18.81)

Most assuredly it's a technicality, but if people are going bonkers over any tax increase ...

martvol said...

3% of $1000 income is $30. For a year that would be an income of $12,000. If I paid my 3% a month of $30, at the end of the year I would have paid $360. $360 is 3% of $12,000. Not 36% as you elude to in your story.

Mr T in Phoenix said...

On the 10-11-11 post, I think there might be some fuzzy math regarding the 3% monthly tax. While 3 times 12 does equal 36, 3% monthly for 12 months does not add up to 36%. It adds up to 3%.

Say you make $100,000.00 per year. 36% of that is $36,000.00. But, if you break down the $100,000.00 by 12 months it comes out to $8333.33 per month. Multiplied by 3%, equals $249,99 or say $250.00 per month. $250.00 per month times 12 months equals $3000.00 which is exactly 3% of $100,000.00.

Were you just trying to be funny (i.e. "After all, who's counting if the 12 monthly taxes actually add up to 36 percent annually?") or did you truely not understand?

Ginger said...

He stated in the post,"3% monthly tax on annual income"

A 3% monthly tax on ANNUAL income would indeed add up to 36%.

$100k * 3% = $3k paid monthly

$3k * 12 months = $36k paid over a year

$100k * 36% = $36k

Yes, the math does work.

Daniel Shaviro said...

Thanks, Ginger. That is why I said a 3% monthly tax on annual income. Note that, in 9-9-9, it would appear that your full income (if you consume it all) is hit by each of the 3 taxes, leaving aside some details, such as the fact that you won't face VAT and RST on the part of your income that you lose to the personal income tax and thus don't get to spend.