As Herman Cain’s 9-9-9 plan continues to draw attention, a key component of it remains misunderstood. Cain’s plan would replace the individual and corporate income taxes, estate and gift tax, and payroll and self-employment taxes with three new levies. As is well-known, one levy is a 9 percent retail sales tax and another is a 9 percent income tax.
The misunderstanding concerns the third component. Most media reports, taking the lead from Cain’s own terminology, continue to describe it as a business or corporate tax or even as a tax on corporate profits. Yet, the tax is actually a value added tax (VAT), a fact confirmed by the economic analysis circulated by Cain’s campaign.
A VAT and a retail sales tax are conceptually equivalent consumption taxes, apart from administrative and compliance issues. The plan is therefore better described as featuring a 9 percent income tax and an 18 percent consumption tax, with half of the latter collected using the VAT methodology and the other half collected using the retail sales tax methodology.
One concern about the Cain plan has been overstated. Analysts who thought that the third tax was a tax on business profits or cash flow (in other words, a tax that allowed firms to deduct wage payments) complained that the plan would raise revenue far short of current levels. The fact that the tax is actually imposed on value added (so that firms cannot deduct wage payments) means that it would raise considerably more revenue than those analyses had indicated. Although the 9 percent rate is not quite revenue neutral, a rate around 10 to 11 percent might work, if no deductions or tax preferences are added to the plan.
If the plan was adopted at a revenue-neutral tax rate, it would increase long-run economic growth by largely eliminating the tax penalties on saving and investment. But, it would also cause a massive shift in tax liabilities towards moderate-income households, a disturbing outcome and one that is likely to make the plan politically unviable.
But, the biggest issue is one of truth in labeling. Mr. Cain should level with the voters by explaining that he’s proposing a VAT and allow them to weigh the advantages and disadvantages of this approach.