At last night’s debate, Major Garrett asked Senator Cruz whether his proposal to create a value-added tax would facilitate the growth of government. In response, Cruz denied that his “business flat tax” is a value-added tax, or VAT. The semantic question is unimportant. Conservatives have generally objected to value-added taxes for two related reasons: They are hidden taxes on labor, and could therefore prove easy to raise. And those objections apply to Cruz’s “business flat tax” as much as they do to a VAT.
The rest of Cruz’s answer illustrated how his “business flat tax” is a hidden tax. Cruz went on to say that families of four making less than $36,000 would pay no federal taxes under his plan. “No income taxes. No payroll taxes. No nothing. [Above the threshold for paying income taxes] everyone pays the same simple flat 10% income rate.” That family of four, though, would indirectly be paying a lot of taxes. That’s because Cruz’s “business flat tax,” unlike today’s corporate-income tax, does not allow businesses to deduct wages. Wages will be lower if businesses can’t deduct them than if they can. That family of four may not ever have to write a check to the federal government, but that’s because they will be paying taxes in the form of wages they never see.
Cruz’s plan has other features that offset this tax hit. He would get rid of the payroll tax, which is itself partly hidden. (The “employer side” of the payroll tax comes out of wages too.) But when Cruz says that families making less than $36,000 would pay no federal taxes, he’s ignoring the impact of his business flat tax on them. When he says that everyone above that income would pay a 10 percent rate, he’s ignoring its impact on those people too: Add in the impact of the business flat tax, and the effective tax rate on labor income is a flat 24.4 percent.
Cruz’s plan is pro-growth, and more fiscally responsible than the plans of the other Republicans. But he should scrap this hidden tax.