Herman Cain: How about 15-15-15?

Chris Edwards Director of Tax Policy Studies, Cato Institute
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Presidential candidate Herman Cain has made a splash with his 9-9-9 tax reform plan. I love his 9 percent income tax, but the skunk at the tax reform picnic is his 9 percent retail sales tax. Mr. Cain is an articulate advocate of free enterprise and I wish him well in the contest, but he should ditch the sales tax.

Adding a retail sales tax to the federal government’s powerful tax armada would be a terrible idea from a small-government perspective. Democrats are desperate to find ways to fund soaring entitlement costs, so it’s dangerous to give them conservative political cover to add a new federal funding source.

Cain’s 9 percent business tax is also a problem. It is similar to a value-added tax (VAT) because would it disallow a business deduction for wages, which would make the base much broader than the corporate income tax base. And like a VAT, Cain’s business tax would apparently be imposed on all businesses, not just those currently paying the corporate income tax.

The result would be that American businesses would be collecting a large tax on workers’ wages — but workers wouldn’t see this major government grab. One caveat is that the Cain business tax would allow a deduction for dividends paid, which would narrow the base compared to the standard VAT.

In sum, two of Cain’s three 9’s are bad ideas. His advocacy of lower marginal rates and reduced taxes on savings and investment are great, but he should drop the 9-9-9 plan.

Instead, Cain and other candidates should consider a 15-15-15 plan. At first blush, that doesn’t sound very appealing because the rates are higher than Cain’s. But the business tax base would be much smaller than Cain’s, and the plan would make existing revenue sources more visible and efficient. Here’s the 15-15-15 plan:

  • 15 Percent Payroll Tax. Cain would abolish the current 15.3 percent payroll tax that funds Social Security and Medicare. That’s odd because Cain — to his credit — is proposing a Chilean-style Social Security system with personal accounts. I’d keep the current payroll tax, but move to a Chilean-style system by allowing workers to put 6 percentage points or more of the tax into a personal account. That would feel like a tax cut for workers because they would retain ownership of the money. I would also require that all 15.3 percent of the tax be listed on employee pay stubs so that the burden is highly visible. Currently, workers only see half of the payroll tax, and thus might be unaware of the high cost of these retirement programs.
  • 15 Percent Personal Income Tax. Like Cain, I’d get rid of just about all deductions and other breaks under the income tax, except pro-savings features such as the 401(k) rules. It’s also reasonable to retain a substantial basic exemption for low-income filers, as under the Dick Armey/Steve Forbes “flat tax” plans. The Armey/Forbes plans had rates in the range of 17 to 20 percent, but they only taxed labor income at the individual level, not capital income. Technically, that is the right way to go under a flat tax, but as a bow to today’s political realities, we might want to tax wages, dividends, interest and capital gains all at 15 percent.
  • 15 Percent Corporate Income Tax. We should cut the 35 percent corporate income tax rate to 15 percent. People say we should trade a rate cut for loophole closing, but loophole closing is not worth the effort. Corporate loopholes are far smaller than loopholes in the individual code, and trying to scrap them just creates a blockade of business opposition to reform. Also, if we dropped the rate to 15 percent, the base would automatically broaden as businesses reduced their tax avoidance and evasion. Corporate profits parked offshore would flood back into the United States, and capital investment would get a huge boost. In the long-run, policymakers should consider switching to the simpler cash-flow business base under the Armey/Forbes flat tax, but if we cut the rate to 15 percent, the distortions caused by the current base would be greatly reduced anyway.

How much revenue would 15-15-15 raise? You could probably make it revenue-neutral by adjusting the basic exemption amount under the individual income tax. Dick Armey’s flat tax exemption was huge at about $35,000 for a family of four. A lower exemption amount makes more sense, but this is a variable that could be fine-tuned.

Of course, tax reform would be much easier if it created an overall tax cut. And that would be much easier to achieve if Congress cut spending. So I’d encourage Mr. Cain and the other candidates to role up their sleeves and give us their detailed spending-cut plans. As a modest first step, how about a 9-9-9-9-9-9-9-9 plan to slice 9 percent off the budget of every federal agency?

Chris Edwards is editor of Cato Institute’s www.DownsizingGovernment.org.