Herman Cain’s 9-9-9 plan includes a personal income tax, a business tax, and a sales tax, all at flat rates of nine percent. Bruce Bartlett critiques the plan in the New York Times today, and he flags a fact about the business tax that I hadn’t been aware of:

The business tax in the Cain plan bears no resemblance to the present corporate income tax. The tax would apply to gross sales less dividends paid and all purchases from other companies, including investment goods. Thus, there would be no deduction for wages.

This is far more similar to a value-added tax than to a corporate income tax. And indeed, the description on Cain’s website matches Bartlett’s, saying the business tax would apply to “Gross income less all investments, all purchases from other businesses and all dividends paid to shareholders.” One question is what Cain means by “gross income,” but I think he has to mean something like gross revenue–anything that looks like a profits concept would already exclude “purchases from other businesses” and so they would not be there to deduct.

This has a few upshots.

1. Cain is proposing both a lightly-modified VAT and a separate retail sales tax. This is certainly an unusual idea. I also think it’s not the popular understanding of the plan–I think people tend to assume, as I did, that it includes a corporate income tax and a sales tax.
2. I’d been mystified by Cain’s claims that his plan would not sharply reduce tax revenues, despite repealing payroll taxes, which raise nearly $1 trillion per year in revenue. But a 9 percent VAT could raise around $600 billion a year, three to six times the amount that a 9 percent corporate income tax could be expected to raise.*
3. Allowing a deduction for dividends paid before calculating VAT is strange. Cain says that “Dividend deductibility will help retirees, improve accounting, and moderate stock-option driven executive compensation.” Certainly, this policy would encourage companies to pay more dividends, and therefore help people who receive dividends. But it would also introduce new distortions into the tax code. Currently, our tax structure favors debt finance of corporations over equity finance, because corporations can deduct interest expense from their taxable income, but not dividends paid. Cain’s plan would reverse that, allowing deduction of dividends paid but not interest expense, and therefore creating undue incentives for corporations to finance themselves with equity instead of debt. (Ideally, a tax reform should equalize the treatment of corporate debt and equity.)

I’m not firmly anti-VAT, though I think the better path to a consumption tax base is with a tax structure that retains income tax returns but doesn’t tax investment. The X-Tax is a good example. I do think that it makes little sense to enact both a VAT and a separate national retail sales tax.

*Originally, this post stated that a 9 percent VAT would raise about $900 billion a year. I was relying on a faulty rule of thumb that implies an effective VAT base of two-thirds of GDP, and Bruce Bartlett points out by email that most VATs have a base closer to one-third to one-half of GDP. The Tax Policy Center score of the Ryan Roadmap estimated that that plan’s VAT would have an effective base of 50 percent of GDP. (Many European VATs have a narrower effective base because they tax food and other items at a reduced rate, which Cain is not proposing.) A 9 percent VAT that hits 50 percent of GDP would raise nearly $700 billion, but that revenue would be somewhat reduced by the exemption for dividends.