Senator Ted Cruz has confounded his critics’ expectations in rising as far in the presidential polls as he has, and is now drawing the attacks that go with it. The most substantive of the criticisms concern his tax plan. There is a lot to be said for that tax plan, but the critics are pointing to a real flaw in it that the senator can and should correct.
Cruz’s plan would cut tax rates, especially on saving and investment, while avoiding the large reductions in revenue that many of the other Republican candidates’ plans would entail. The plan scores well, then, with respect to both economic growth and fiscal responsibility (although it would need to be paired with some spending cuts).
Ben Carson and Senator Marco Rubio are criticizing a key feature of Cruz’s plan: its reliance on a value-added tax. Cruz’s plan dispenses with the payroll tax and the existing corporate income tax, and brings income-tax rates down to 10 percent. To make up for most of the lost revenue, he institutes a new business tax. Unlike today’s corporate tax, the new business tax would not let companies deduct the cost of wages. So the new business tax would fall on labor income as well as corporate cash flow. The wage earner would pay the tax through either lower wages or higher prices or both (relative to what they would be without this new tax).
Senator Cruz does not emphasize on the stump this element of his plan. (Neither does Senator Rand Paul, who has a very similar plan.) But the attractive elements that he understandably emphasizes have to be understood in light of it. The effective tax on labor income would be much higher than the headline 10 percent rate. And while families of four making less than $36,000 a year would not pay income taxes under the plan, they would pay through either forgone wages or higher prices.
It is the hidden nature of the tax that has traditionally worried conservatives. Most people would not know what their wages would have bought them if this tax were lower, or if it did not exist. Even if receipts for every purchase they made included a line that disclosed the tax bill, few people would have a sense of how much they were paying cumulatively. And so it might prove much easier for politicians— say, a liberal successor to President Cruz — to raise this tax over time than it is for them to raise income or property taxes. The fact that European countries use this tax to finance their swollen welfare states reinforces this fear.
Luckily, there is a way for Cruz to retain the economic and fiscal advantages of his proposal while eliminating this danger. (This road lies open for Senator Paul, too.) The main step would be to collect taxes on labor income from workers instead of collecting it indirectly from their bosses. In other words, let businesses deduct wages when they pay their taxes and use the income tax to make up for it. This modification would keep the effective rate of taxes on labor income the same; it would just make it transparent. And this more direct approach is fully compatible with the reduction in taxes on capital investment that Cruz seeks.
Most important, it would make it a little less likely that over time government would grow larger and larger and taxes climb higher and higher — something that we are confident in asserting that Senator Cruz does not want either.