I wrote about Rand Paul’s new tax-reform plan today at Bloomberg View. I like it much more than his old flat-tax plan, which raised taxes on a lot of middle-class people, especially parents. The new plan avoids large tax increases on them, so far as I can tell, but does not cut their taxes either.
The plan may look as though it cuts middle-class taxes because he would not apply his flat tax to families of four making less than $50,000 and he abolishes the payroll tax. But the plan taxes everyone by imposing a European-style Value-Added Tax, although he does not say it explicitly. He has a 14.5 percent tax on business activity without the deduction for wages that today’s corporate tax includes. That means wages have to fall. Alternatively, the Fed could inflate by the requisite amount — 6 to 8 percent should do it — and wages could stay flat while prices rise. In other words, real wages would fall while nominal wages stayed constant.
Paul is more committed than any other candidate to low inflation. He has just named a new adviser with hard-money views. The combination of his tax and monetary policy views, though, creates a potential problem. Economists generally think that wages are “rigid downward”: They don’t fall easily in nominal terms, although they can fall in real terms if there is inflation. If real wages cannot fall because nominal wages are rigid downward and there is no inflation, then unemployment has to rise. The only way employers will have left to bring their total wage costs down as needed is layoffs.
So the choices under Paul’s tax reform would be either mass unemployment or way more inflation than most people, and especially Paul, want.