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Herman Cain has been gaining much traction with his
9-9-9 Plan, a bold proposal to replace our dysfunctional tax code with what
could be a simpler, less invasive, and more economically stimulative
alternative. While I don't agree with the full spectrum of Mr. Cain's policy
choices, I applaud his courage on the tax front. Judging by his rising poll
numbers, this appreciation is widely shared. However, the plan has deep
flaws, the most glaring of which is its creation of a hidden payroll tax
which represents a fourth "nine." This serious pitfall has been
unmentioned by Mr. Cain and overlooked by those who have analyzed his plan.
Cain would replace the current system of income and
payroll taxes with a 9% flat-rate personal income tax, a 9% corporate tax,
and a 9% national sales tax. Great idea. Such a system would unburden
businesses, provide a tax cut for most Americans, and shift taxation to
consumption and away from income generation. This is exactly what our economy
needs. But unlike our current corporate tax system, the plan eliminates the
deductibility of wages and salaries from corporate income. The net effect is
the creation of a brand new 9% tax on wages. When this fourth 9 falls from
Cain's sleeve, many of his opponents will likely accuse him of cheating.
Much of the plan's virtue lies in its elimination of
Social Security and Medicare taxes (payroll taxes) that fall heaviest on
lower income workers. This includes the 6.2% Social Security tax and the 1.5%
Medicare tax paid directly by the worker. But it also includes the 6.2% and
1.5% portions paid indirectly by workers through their employers. Payroll
taxes are, in reality, a cost of employment. From the employer's perspective
these costs are part of the wage package. Absent these taxes, employers could
raise wages by an equivalent amount without raising labor costs. Inclusive of
this portion, payroll taxes currently cost workers 15.4% of their wages.
The Cain plan scraps this tax. But the elimination of
wage deductibility from corporate taxes replaces it with a 9% payroll tax.
Therefore a more honest name for Cain's proposal is the 9-9-9-9 plan. The
forth nine changes everything.
Cain admits that the 9% sales tax would fall heaviest
on the poor, but he claims that the elimination of the payroll tax would more
than compensate. But when the hidden 9% payroll tax is factored in, more than
50% of workers who currently pay an average income tax rate of just 3% would
see a huge tax hike, from 18.4% (former payroll tax plus income tax) to 27%:
9% payroll tax, 9% income tax and 9% consumption tax (poorer worker generally
spend all income).
On the other hand, high income tax payers get a huge
break. Not counting the consumption tax, the 9-9-9 plan reduces the highest
marginal tax rate from 38% (35% income tax and 3% payroll tax - on income
over $105,000) to just 18% (9% income tax plus 9% payroll). For the
self-employed, who can transform their wages into dividends (that are
deductible business expenses under the 9-9-9 plan), the rate would fall to
just 9% (all income tax, no payroll or business tax). Of course, in either
case, the 9% sales tax will apply to spending, but even if 100% of earnings
are spent (which is generally not true of high earners) the top rate would
still top out at only 27% for the highest salaried employees and just 18% for
the self-employed. In essence, tax cuts for the rich are paid for with tax
hikes on the poor and middle class. If these aspects were widely known the
plan would become a political dead letter.
Even with its flaws, the 9-9-9-9 plan would create an
economic windfall by lowering the top corporate rate to 9% from 50% (35% at
the corporate level and 15% on dividends taxed at the individual level), and
simplifying the tax code to reduce unnecessary compliance costs and the
economically inefficient behavior that is created by perverse tax incentives.
These changes alone will make America far more globally competitive. Also by
taxing individuals based more on what they spend rather than on what they
earn, the plan will encourage more savings (which is a key ingredient for
economic growth). As a result, the economy will grow faster, generate greater
output of goods and services, and create more jobs.
The problem for Herman Cain is that unless he slashes
government expenditures, his pro-growth tax structure will inevitably shift
more of the tax burden to low and moderate-income people. The only way to
combine tax reform with tax reductions for most taxpayers is to shrink
government to a more manageable scale.
The size of the tax increases required to keep Cain's
9-9-9-9 plan revenue neutral demonstrates just how high a percentage of our
current taxes are being paid by affluent taxpayers. Couples making more than
$250,000 and individuals making more than $125,000 only constitute about 3%
of taxpayers but pay almost half of all taxes. Any policy that cuts their
taxes will inflict a disproportional hit on government revenue.
Contrary to the rhetoric emanating from the American
left, the "rich" are currently paying a lot more than "their
fair share." It is only a handful of mega-rich, those whose entire
incomes are derived from dividends and capital gains, rather than salaries or
business profits, who have the ability to pay lower tax rates than some
members of the middle class. The left knows this but continues to build their
"free loading millionaire" straw man because it makes good
politics.
In the final analysis, if Cain really wants a 9-9-9
plan that doesn't raise taxes he needs to remove the hidden 9% payroll tax.
However, the only way this could be done, without blowing an even bigger hole
in the federal deficit, is to combine his plan with significant spending
cuts. If he can pull that off, three nines may be a winning hand after all.
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