Cain's 'Simple' Tax Plan Misunderstood by Fans: The Ticker

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By Ramesh Ponnuru

Herman Cain says his tax-reform plan is “simple” and “transparent.” Then why do so many of his fans not seem to grasp its basic features? Those fans were out in force in response to my Bloomberg View column on the plan,  berating me both in comments and emails. Leaving aside the personal attacks, a few questions emerged that deserve responses.

1. Why do I say that what Cain calls a corporate income tax would actually “be much closer to a European-style value-added tax”?

There is a lot of confusion about this point. In a Wall Street Journal op-ed defending the plan this week, Arthur Laffer called this part of Cain’s plan a tax on “net business profits.” So let’s look at what Cain’s own website says: The tax will apply to businesses’ “[g]ross income less all purchases from other U.S. located businesses, all capital investment, and net exports.” (This is, incidentally, slightly different from the site's portrayal of the tax two weeks ago.)

Today's U.S. corporate-income tax lets companies deduct wages as a cost of doing business, and that’s what a tax on “net business profits” would do too. Cain’s business tax includes no such deduction, but it does let companies deduct the cost of purchases from other businesses. That’s what a value-added tax does. Perhaps that’s why the scoring report commissioned by the Cain campaign, and available on the campaign website, refers to the tax as a “subtraction method value added tax.”

There are reasonable arguments for a VAT, although I don’t happen to find them persuasive. But a candidate proposing one should call it what it is.

2. Why do I say that the last stage of Cain’s plan is a 30 percent sales tax? Again, look at Cain’s website. It says that after replacing today’s income, payroll, and corporate taxes with his 9-9-9 plan, “the next step” will be “the Fair Tax.” That’s a specific proposal long championed by Americans for Fair Taxation, former presidential candidate Mike Huckabee, and many others.

Knowledgeable supporters and opponents of the Fair Tax agree on this point: If a consumer buys a product for $130, including the tax, the seller will get $100 and the federal government will get $30. Supporters of the Fair Tax usually say that we should say that it is a 23 percent tax rate, since 30 is 23 percent of 130. And for some purposes, that is the right rate to quote. If you want to compare the sales tax rate to an income tax rate, for example, you should use this percentage. Your income tax rate is your tax liability divided by your income, including that liability. That’s how Americans for Fair Taxation justifies using the 23 percent figure. I used the 30 percent figure to make the national sales tax Cain supports comparable to the sales taxes most people think about and pay.

3. Why do I claim that if the abolition of existing taxes brings prices down, it also has to bring wages down?

Proponents of both 9-9-9 and the Fair Tax—Cain very much included—say that the sales taxes involved will not raise the prices of consumer goods. Their theory is that the cost of income taxes and payroll taxes are embedded  in these prices, and that Cain-style reforms will lower those costs. The net effect on prices will be a wash. But wages are a price as well—the price of labor—and if firms sell at a mark-up in order to reach a desired after-tax price, then the same must hold true of workers.

Look at it another way. Cain says his tax reform raises as much money as the current system, even if it has no effect on economic growth. If prices aren’t going up and wages aren’t going down, where does all this revenue come from? There’s no reason to expect all or even most of it to come out of business profits. Cain and supporters of his plan make it sound as though his reform is even better than a free lunch: Nobody pays anything extra or gets anything less than he currently gets, but people get to pay less in income and payroll taxes. That can’t be right.

The Fed will determine to what extent new sales taxes will raise prices or cut wages, but some combination of these effects is bound to happen.

4. Doesn’t Cain’s plan keep poor people from paying any taxes?

Okay, this one didn’t come from my reader mail or comments; it comes from Arthur Laffer’s op-ed. Laffer claims that “the [9-9-9] plan exempts from any tax people below the poverty line.” Cain hasn’t said any such thing, even in responding to criticisms of the plan's effect on poor people. The page on his website describing the plan says only that people living in “empowerment zones” would receive some unspecified tax relief.

To my knowledge, the only element of the Fair Tax that Cain has ever criticized is its “prebate”: a check from the federal government to everyone to cover the cost of paying taxes on the necessities of life.

5. Why do you hate Herman Cain?

Actually, I like him. I even blurbed one of his books. But there are a lot of people I like who wouldn’t make good presidents. Cain’s far-out claims about his plan make me think he’s one of them.

(Ramesh Ponnuru is a Bloomberg View columnist.)

-0- Oct/21/2011 15:18 GMT