Bloomberg News

Bad Math Hurts Herman Cain’s Good Tax Intentions: Ramesh Ponnuru

October 17, 2011

Oct. 18 (Bloomberg) -- If you think taxes are complicated now, wait until Herman Cain simplifies them. The former chief executive officer of Godfather’s Pizza Inc., now running for the Republican presidential nomination and selling a book, has been rising in the polls partly because of the appeal of his “9-9-9” plan to reform taxes. At the Bloomberg/Washington Post debate at Dartmouth College last week, he argued that a great virtue of the plan is that it is “simple” and “transparent.”

In truth, the complexity of Cain’s proposal would impress Rube Goldberg. It has three stages. In the first, Congress would reduce the top tax rate for individuals and corporations to 25 percent, allow companies to pay favorable rates on any overseas profits they bring home, and end the capital-gains tax.

Stage Two is where 9-9-9 comes in. Cain would abolish the payroll tax and replace it with three taxes. One would be a new version of the income tax with a 9 percent rate and no personal exemption, standard deduction, mortgage deduction, earned-income tax credit or child credit. There would also be a 9 percent retail-sales tax. Companies would pay what Cain calls a corporate income tax, though it would be much closer to a European-style value-added tax. You already know the rate.

Then comes Stage Three, when Cain would throw away the new income tax and the value added tax he created and institute the Fair Tax. That’s a proposal for a retail sales tax of 30 percent that some conservatives have been promoting for years.

Poor People Lose

At last week’s debate, Cain claimed that poor people would come out ahead under his plan (Stage Two of it, that is) because they would pay a 9 percent income tax, but the standard 15.3 percent payroll levy would be eliminated. On this point he is deeply mistaken. The earned-income tax credit currently offsets some of that 15.3 percent, and he would abolish that credit. Poor people would also pay the 9 percent sales tax every time they buy groceries or get a medical bill.

And that’s not all. Cain is counting the employer share of the payroll tax in his 15.3 percent on the theory that employers pass that on to workers by cutting their wages. He is right to do so. But a good chunk of his VAT would also be passed on to workers. Today’s corporate income tax allows companies to deduct wages. The VAT doesn’t: It is designed to be, at least partly, a tax on wages -- just one that is collected from companies rather than earners. A portion of the VAT would also be passed on to consumers in the form of higher prices.

So in addition to paying new taxes on their purchases and losing the personal exemption and earned-income tax credit, people at the low end of the income scale would see their wages drop. The reduction in payroll taxes wouldn’t come close to making up for these hits. And there might be additional ones, as state and local governments raise taxes to pay for the sales taxes they would have to transfer to the federal government for their purchases. (On “Meet the Press” on Oct. 16, Cain hedged slightly. “Some people will pay more” under the plan, he admitted, “but most people will pay less.”)

Prices, Wages, Inflation

Cain claims that neither the sales tax nor the VAT will cause prices to increase. His argument is that the cost of the taxes that he would reduce or eliminate is “embedded” in the prices of goods: Reducing that cost and piling on sales taxes would be a wash. It sounds too good to be true, and it is. If taxes are embedded in the prices of goods, they are embedded in the price of labor, too. That means wages would have to fall. And if wages don’t fall, firms will fire people to avoid paying wages above the new market level.

The Federal Reserve could prevent mass unemployment by accelerating inflation to aid the transition to the 9-9-9 system, and then inflating again, even more, for the switch to the 30 percent sales tax. But Cain, who has been complaining about the Fed’s “printing money out of thin air” in recent years, may not support these steps.

Enforcement Regime

He says the plan would “end the IRS as we know it.” But even after the last stage, the federal government would still have to know people’s wages to figure out how large their Social Security checks should eventually be. And since benefits could no longer be tied to payroll taxes paid -- Cain would have abolished those taxes -- people would, for the first time, have an incentive to fool the federal government into thinking they had earned more than they actually did. Over-reporting income would get you higher Social Security benefits, without raising your tax liabilities. Cain wants to introduce personal accounts as part of a long-term change to Social Security, but during the decades of transition those accounts will be on top of some amount of traditional benefits. An enforcement regime of some kind would be needed.

The chief problem with the final stage of Cain’s plan, meanwhile, is that there’s no reason to believe it would work. Enforcing a 30 percent sales tax would be a nightmare, which is why no advanced economy relies on sales taxes to such an extent.

An Impossible Plan

Not to worry: There’s also no reason to think the federal government would ever enact Cain’s plan. Even if, per impossibile, Cain were elected president, Congress isn’t going to tell senior citizens that, after having paid taxes on income all their lives, they will now incur extra sales taxes when they spend the money. It’s not going to raise taxes on millions of poor and middle-class people.

Cain is actually right to want to move toward taxing consumption. But we could do that simply by taxing income and exempting the returns on savings -- thus avoiding many of the problems that Cain’s plan raises. Wouldn’t that be, well, simpler?

(Ramesh Ponnuru is a Bloomberg View columnist and a senior editor at National Review. The opinions expressed are his own.)

--Editors: Timothy Lavin, David Henry

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To contact the author of this column: Ramesh Ponnuru at rponnuru@bloomberg.net.

To contact the editor responsible for this column: Timothy Lavin at tlavin1@bloomberg.net.


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