Before I get too much into Herman Cain’s tax flat tax plan let me point out, once again, just because someone calls a tax plan a “flat tax” doesn’t mean that you’ll be paying less in taxes or that the tax code will be simpler. I think that candidates use the term “flat tax” to denote that their plan is less complicated and that you’ll pay less in taxes, but I don’t think those are safe assumptions to make.
After blogging about Gov. Perry’s flat tax proposal, I thought I might spend a little time looking at Herman Cain’s 9-9-9 tax proposal. According to a September 15, 2011 article by Mr. Cain in the Wall Street Journal, he outlined his plan as follows:
“The plan begins with restructuring the tax code to include the broadest possible base at the lowest possible rate. The elements are:
- A 9% corporate flat tax. Businesses would deduct purchases from other businesses and all capital investment. The resulting gross income is taxed at 9%.
- A 9% personal flat tax. Individuals would deduct charitable contributions, then pay 9% on the rest of their income. Capital gains are excluded.
- A 9% national sales tax. This levy would be placed on the consumption of all new goods. Used goods purchased would be excluded.
My plan would also permanently eliminate taxes on repatriated profits, as well as payroll taxes and the estate tax.”
Corporate flat tax. Mr. Cain’s first proposal of a 9% corporate flat tax would certainly be broadening the corporate tax base by the way he is defining taxable income. Mr. Cain’s proposed corporate taxable income definition sounds eerily familiar to the way the state of Texas defines taxable income (see my blog dated October 25, 2011).
Under the Cain proposal, corporate taxable income would be calculated as follows:
Sales – Purchases – Capital investment = Taxable income
I’m assuming all purchases would be deductible, which would include things from raw materials to paper clips and everything in between. Corporate taxpayers would then deduct capital investments (i.e., purchases of machinery and equipment). So it sounds like any machinery or equipment placed in service during the year would be deductible in calculating taxable income. Would this deduction also include the cost of a new building placed in service during the tax year as well? I don’t know the answer to this question. I think it’s important to note that there would be no deduction for wages paid to employees under this plan.
Under the Cain plan for calculating taxable income does a company get to carryforward a loss? It doesn’t sound like it. If a company purchased a building one year and created a tax loss for that year it doesn’t appear that that loss would carryforward to the next year to offset taxable income based on the proposed tax plan. The Cain plan kind of looks like a cash basis method of accounting for expenses – you spend the money, you get a deduction.
Individual flat tax. As with most tax proposals out there, politicians love to talk about the tax rate, but no one ever defines taxable income. As I’ve mentioned before, the tax rate is the easy part of figuring the amount of tax due, the difficult part comes in figuring out what taxable income is. I think politicians assume that everyone gets paid a W-2 wage and so that person’s taxable income is what the W-2 says it is. What about those that are self-employed who don’t work for someone else and don’t get paid on a W-2? What about owners of partnerships, LLC’s, or S corporations who generally don’t get paid via a W-2 (or a full W-2 wage), how do we define their taxable income? In order to take a tax plan seriously I think these questions must be addressed.
Now that I’m down off my soap box, let’s look at Mr. Cain’s plan assuming everyone earns their living the same way and gets paid on a W-2 (it’s nice when we all live in such a simple society). So under his plan I would take my W-2 wage, subtract out charitable contributions, multiply that by 9% and that would be my tax that I would owe. Seems simple enough, especially for those that are use to paying taxes.
However this not good news for all of those that haven’t been paying taxes. The last statistic I saw was that over half of the people who filed income tax returns did not owe any income tax. In fact, many of those same people got refunds of the taxes they did pay and many also got refunds, via the earned income credit, of taxes they did not pay.
The 9% individual income tax would certainly broaden the tax base. The proposal could also provide a tax cut to those who have been paying taxes under the current system of progressive tax rates, but it would also cause those who have not been paying taxes to start paying taxes. So while Mr. Cain is presenting his plan as a tax cut, millions of Americans who have not been paying income taxes will start paying income taxes. For higher income earners, this plan will most likely be a tax cut.
National sales tax. Under the national sales tax plan, the purchase of all goods would be subject to the national sales tax. This would include things we are accustomed to paying sales tax on such as food, TV’s, clothes, cars, etc., but there would also be the national sales tax on homes and probably other goods that we are not used to paying sales tax on.
The 9% national sales tax would tend to affect lower to moderate income families more that higher income families. Lower to moderate income families tend to spend more of their income on purchases (even purchases of necessities) than higher income families do. Those who are able to save some of their earnings will not have these earnings taxed until they decide to spend these savings. However those that have to spend what they earn will have these earnings taxed immediately. The national sales tax seems to be a regressive tax.
In summary, this 9-9-9 tax plan would tend to hit those with the least the hardest. There would be some that are currently paying 0% in taxes that would start paying at least 18% in new taxes (i.e., 9% income tax plus 9% sales tax). Those in brackets above 18% would see a decrease in their taxes. Those who generate their income through investments and capital gains would have an even bigger tax cut because their capital gain income would not be subject to tax under the Cain plan (Mr. Buffet ought to love this, see my blog dated October 3, 2011).
Even though this plan is touted as a tax cut plan, it does seem to be a very regressive tax plan by placing more of a burden on lower to moderate income families and giving higher income earners a tax break. I’m not opining on if this is good or fair tax policy, but I did want to point out that this plan is only a tax cut plan if you are already paying taxes in excess of 18%. If you’re not paying more than 18% in taxes then this is a tax increase plan – even if this plan touted as a “flat tax”. Based on the latest data I saw from the IRS I would have to assume that for more than half of the US taxpayers the Cain plan would be a tax increase plan and most likely a tax cut for the other half.
Based on my understanding of Cain’s tax plan, I’m not sure if the above consequences are his real intent or not with his 9-9-9 tax plan. However before anyone jumps on the “flat tax” bandwagon I think one needs to understand more than just the tax rate portion of any tax plan.