Herman Cain's "999 Plan": The Good, the Bad, and the Ugly

By Dean Clancy, 10/07/11

So what about Herman Cain's 999 tax plan? 

Turns out it has some very good aspects -- and some others, not so good. 

I'd give it two rousing cheers and one bronx cheer. 

The plan is called "9, 9, 9" because it would replace today's complicated and economically burdensome federal tax system with a simple, three-part system, consisting of a 9% flat tax on individuals, a 9% flat tax on businesses, and a 9% national retail sales tax.* That's it.**

The plan thus has three major virtues: It's bold, it's simple, and it's fair. And by proposing it, Cain is showing some political courage and imagination. Grassroots voters are hungry for just those things. No wonder this plan is fueling Cain's strong standing in the GOP presidential race.  

But there are some flaws.

So let's consider this proposal -- the good, the bad, and the ugly. 

The Good 

What are the Cain plan's good parts? 

  • It ends nearly all deductions and special interest favors. 
  • It ends all payroll taxes. 
  • It ends the death tax. 
  • It eliminates the double taxation of dividends. 
  • It eliminates the taxation of capital gains and repatriated profits. 
  • It allows immediate expensing of business investments. 
  • It shifts the burden of taxation from production to consumption. 
  • It Increases capital formation, which will fuel productivity and wage growth.

In short, Cain's plan would be more fair, neutral, transparent, efficient, and pro-growth than today's system. Good stuff! 

But wait. There's more.

Cain says this is just Step 1. Step 2 would be to repeal the personal income tax. Wow. 

The Bad

But here we come to the problem. 

Cain doesn't get rid of the income tax. He adds a new levy -- a national retail sales tax -- on top of the income tax. 

Why does he proceed in stages?

If he wants to get rid of the income tax, why doesn't he just get rid of it? 

The answer, most likely, is that he realizes that if he proposed to eliminate the income tax in one fell swoop, while trying to raise the same amount of revenue, he would have to set the rate for the sales tax well above 9% -- and voters would balk.

My guess is a national sales tax would have to be set at, not 9%, but closer to 25%, to raise something like the amount of money currently raised by the income tax.

And actually, the rate might have to be set at twice that amount -- 50% -- if we also eliminated the payroll tax, as Cain proposes to do. 

A 50% sales tax? Are you serious? 

Okay. Take a breath. For present purposes, let's be charitable. Let's set aside the payroll tax piece of the equation. Let's assume Cain's sales tax rate will only be 25%.

Now, ask yourself: If you could be relieved of paying income taxes, would you be willing to pay 25% more for everything you buy?

Well, presumably that would depend on whether you'd be better or worse off, financially. 

If you're one of the minority of people -- the top 10% of the population -- who pay 70% of the income tax revenues, you might see the change as a good deal. But if you're lower down the income scale, and especially if you're one of the 50% of Americans who don't pay any income taxes, then you might not see it as such a good trade. And if you're poor, you might really hate it. 

And that, I suspect, is why the so-called FAIR tax (the idea of replacing the income tax with a national retail sales tax) has never taken off as an idea. When people hear that 25% rate, they quite reasonably imagine that they could be worse off than under the current system.***

No wonder he has fallen back to a two-step strategy: 9% is a teaser rate! 

The Ugly

The second problem with Cain's plan is more serious than the first. It puts in place the infrastructure for a VAT, a Value Added Tax. That's bad.

No, that's very bad. 

A VAT is a form of national sales tax that is collected at every stage of the process from the initial sale of raw materials to a manufacturer to the final sale of a finished product to an end-consumer. It is the most insidious of all taxes, because it is built into the price of everything and consumers can't see how much of the price is due to the tax. When taxes rise, prices rise, but consumers mistakenly assume it's just market forces at work. Politicians love this about a VAT: they can take a lot more money out of our wallets. Taxpayers should hate it for the very same reason.

European countries have much higher overall tax takes than does the United States, primarily because the Europeans all have VATs, and we do not.

VAT - Europe vs USA

Total receipts of the US Government since World War II have averaged about 18 percent of GDP and have never exceeded 20.9 percent (the peak, in 1944). By comparison, the original European Union member countries' total receipts since the mid-1960s, when VATs started appearing, have not been less than 30 percent of GDP and today average a little over 40 percent -- twice as high as in the US!

If you want to raise taxes, support a VAT. If you want to make government permanently gargantuan, support a VAT. If you want to burden your economy and destroy jobs, support a VAT. 

"But wait, Clancy. Cain's national sales tax isn't a VAT. It's a retail sales tax, collected at the cash register. That's a big difference."

So it is. But guess what. Cash-register sales taxes have a habit of evolving into VATs. That's what happened in Europe. And that's undoubtedly what will happen here, if we adopt Cain's plan.

People are willing to pay a sales tax when the rate is low, but when the rate rises, they tend to evade it. And when people evade a sales tax, politicians respond by morphing it into a VAT. 

In short, if you want a VAT, higher taxes, and bigger government, support Herman Cain's 999 plan. 

Conclusion

To repeat, Mr. Cain's plan has some very good elements. He's on the right track with his goal of a lower, flatter, simpler, fairer, more transparent tax system.

Nine percent would be a wonderful top rate for the income tax, compared to today's 35% top rate.

And let's face it, abolishing the payroll tax and the death tax would simply be awesome. 

But adding a national retail sales tax on top of an income tax is a bad idea, because it creates the infrastructure for a VAT. 

We would likely end up with the worst of both worlds: a confiscatory income tax and a job-crushing VAT.

Dean Clancy is FreedomWorks Legislative Counsel and Vice President, Health Care Policy

 

* The 9% Individual Flat Tax would define "income" as gross income less charitable deductions. The 9% Business Flat Tax would define "income" as gross income less all investments, all purchases from other businesses and all dividends paid to shareholders.  The 9% National Sales Tax would presumably be applied to all goods and services sold in the economy, though Congress could and presumably would exempt certain "vital" goods and services (such as food, medicines, health care, education). 

** Cain's plan would also include subsidies for Empowerment Zones, politically defined areas designated by Washington for special tax favors. This would detract from his goal of ending distortions and complexity in the tax code. 

*** In the "FAIR Tax" plan that Mr. Cain wants to get to, lower-income folks would be made eligible for tax rebates to relieve them of the burden of the high sales tax rate. This would necessitate people's having to report their income to the IRS, just as they do today, and would thus defeat the FAIR Tax's main selling point, that it would "abolish the IRS."

**I personally support, and very enthusiastically, Cain's idea of eliminating both the income and payroll taxes. I don't want the IRS to need to know how much money I have or make. I also don't want politicians having a tool -- the tax code -- with which to engineer or manipulate my behavior. But instead of a national retail sales tax, I'd replace the income and payroll taxes with a system of duties, imposts, and excises, such as we had in the 19th century. Unlike Cain's 999 plan, the traditional, pre-1913 approach would avoid the danger of a VAT. But if undertaken today, it would share with Cain's plan one important problem: we would have to set the rates high, if we wanted to raise as much revenue as we currently do. And that would be bad, economically. And so here we come to the real problem with current proposals for fundamental tax reform: today's federal government is simply too big. (Not to mention, it currently only raises about 60% of the amount it spends.) Trying to pay for all the government we currently have makes serious tax reform politically impossible.  What we need to do first is shrink the government dramatically. The real Step 1 of Tax Reform is deep spending cuts.