Let’s Get Real About 9-9-9

Herman Cain is now considered a front-runner in the race for the Republican nomination. Mr. Cain’s meteoric rise in the polls has been driven by his proposed 9-9-9 tax plan, which would scrap the current tax code in favor of a 9% flat tax on personal income, sales, and “business income.” Mr. Cain is to be commended for trying to drastically reform the tax code, but his plan presents an unending list of problems.

Here is a small sampling:

The Misleading Business Tax

First of all, Mr. Cain’s presentation of his plan is misleading. His “business income tax” is nothing like the current corporate tax.

Here is a simple way to prove that the two tax systems would be completely different: Currently, the corporate tax code raises about $300 billion per year with a 35% tax rate (although because of various deductions, the effective tax rate is closer to 23%). Mr. Cain estimates that his 9% business tax would raise $862 billion per year. If Mr. Cain’s plan were a corporate tax, corporate profits would have to increase by a factor of six to make these numbers line up. Clearly, Mr. Cain’s business tax is not a corporate tax as we know it.

So what is his business tax? Many others have looked at what few details exist of Mr. Cain’s plan, and they have come to the conclusion that it resembles a value-added tax, or VAT–which is essentially a sales tax. In other words, Mr. Cain’s plan would really involve a 9% personal income tax and an 18% (9% + 9%) sales tax.

Revenue Estimates

The US had a $1.3 trillion deficit this fiscal year. Affordable tax reform must at least be revenue neutral. Mr. Cain has stated that his plan meets that criterion, but this is a very dubious claim: An analysis by Bloomberg says that Mr. Cain’s plan would fall short by $200 billion per year.

But in reality, both Mr. Cain’s and Bloomberg’s analyses are unreliable because of the guesswork involved in creating these estimates. When Mr. Cain was asked why Bloomberg came up with different numbers than he did, he said it was because “they start with assumptions that we don’t make.”

This is the precisely the point.

Both Mr. Cain and Bloomberg were presumably using a dynamic model, in which they assume that the lower tax rates will increase economic growth, and thus, tax revenue. But the precise quantitative relationship between tax structure and economic growth is unknowable, especially for such a radical departure from the current tax code. By altering your starting assumptions, you could come up a broad range of revenue estimates. To put it simply, we have no idea how much Mr. Cain’s tax plan would raise.

Whittling Away at the Base

One thing that we do know is that the simple 9-9-9 plan would not stay so simple. Already, Mr. Cain’s plan will allow deductions for charitable contributions–what’s to prevent Congress from adding deductions for retirement savings, or health insurance, or any other tax benefit?

Similarly, Mr. Cain has exempted used items from the sales tax. I predict similar exemptions would be extended to food and clothing.

Mr. Cain’s plan would soon fall prey to the same lobbying that created our current convoluted tax code. In this way, the political realities of broadening the base make revenue neutrality even more difficult to achieve.

Making the poor pay

The previous problems–the misleading business tax, the unreliable revenue estimates, and inevitable hacking away of the tax base–are minor inconveniences compared with Mr. Cain’s proposed transfer of wealth from the poorest to the richest.

Right now, the United States has a (mostly) progressive tax system: in general, higher-income earners pay more in taxes than lower-income earners. By only having flat rates of 9%, Mr. Cain immediately destroys any progressivity in the tax code.

But the reality is worse than that:

Most poor and middle-class workers earn their income through wages, which would then be taxed at 9%. Wealthier people also earn a significant portion of their income as capital gains, which Mr. Cain would not tax at all. Furthermore, the poor tend to consume what they earn immediately, paying Mr. Cain’s sales and VAT taxes immediately. While the rich will eventually consume most of what they earn, some of it will be left to their estates at their death, which would, again, not be taxed.

In other words, 9-9-9 would invert the tax code. Instead of the wealthy bearing the greatest share of taxes, the poor and middle-class would have the highest tax burden.

This country needs a serious discussion about the tax code. I am thankful that Mr. Cain has initiated this discussion, but 9-9-9 is not the solution we need.