The Agenda

Art Laffer Spouting Nonsense on 9-9-9

I guess somebody had to try to defend Herman Cain’s 9-9-9 plan. Art Laffer does so in today’s Wall Street Journal, but his defense is really embarrassing.

First, Laffer describes the business tax component of 9-9-9 as a 9 percent tax on “net business profits.” This is false. Cain’s business tax, as described by his campaign, applies to “Gross income less all purchases from other U.S. located businesses, all capital investment, and net exports.” Because wages and salaries are not deductible, this is a tax on much more than just business profits.

Consider the example of a company that makes $1,000 in sales. It pays $400 for components of the goods it makes and $400 in wages, leaving $200 in profit. Under Cain’s plan, the company would pay tax on sales less cost of goods sold, or $600, meaning its tax bill would be $54. In the case of this company, that amounts to 27 percent of net profits.

In fact, the business tax isn’t a profits tax at all; as I will say until I am blue in the face, it is a value-added tax. But you don’t have to take it from me. You can look at page seven of the scoring report commissioned by Cain’s own campaign, which calls this tax a “subtraction method value-added tax.”

This undermines a second point in Laffer’s op-ed, where he says this: “With lower marginal tax rates (and boy will marginal tax rates be lower with the 9-9-9 plan), both the demand for and the supply of labor and capital will increase.” For many taxpayers, marginal tax rates would be lower under 9-9-9. But for some, marginal rates would go up—because the marginal tax rate under 9-9-9 is not 9 percent.

If you take a tax and split it up into a few parts, still requiring people to pay each part, you haven’t cut the marginal rate. And 9-9-9 consists of three taxes on more or less the same base: consumption. As the Tax Policy Center puts it: “The bases of all three taxes are essentially the same as the base of a national sales tax… the three taxes combined are equivalent to a 25.38 percent national sales tax.” (Because of interaction between the taxes, the rate does not sum to 27 percent, but it gets close.)

25.38 percent is lower than the marginal income and payroll tax rate that many American taxpayers face today (though, for most middle-class taxpayers, it wouldn’t be lower by much). And because 9-9-9 would not tax returns to capital, it would encourage investment. But most of the apparent “reduction” in marginal rates from 9-9-9 comes from splitting one tax up into several components, not from real reductions in rates.

Then, Laffer says this: “this 9-9-9 plan has made certain that even on static terms those below the poverty line will be better off—period.” It’s hard to see how that could be true, but the Cain campaign’s description of 9-9-9 has been so haphazard that we can’t know for sure.

Some of the scoring charts for 9-9-9 make provision for something called a “poverty grant,” which appears to be a refundable tax credit equal to the tax liability of a taxpayer at the poverty line. But this is not listed in his campaign’s literature about the plan. In last night’s debate, Cain mentioned something about helping the poor by reducing tax burdens in “empowerment zones,” but again there is no detail. (And what if you don’t live in an empowerment zone and don’t want to move to one?)

More damningly, responding in writing to questions about how his plan would affect the poor, Cain not only fails to mention the poverty grant, he attacks the similar “pre-bate” provision of FairTax as “another federal entitlement” which is “the last thing we need.” If Herman Cain’s plan includes a similar entitlement, has anybody told Herman Cain about it?

Without a poverty grant, 9-9-9 leads to a huge tax increase on the poor. The Tax Policy Center (which notes that it could not score the empowerment zone proposal due to lack of information on it) found that 9-9-9 would take the average federal tax rate on households in the bottom quintile from 1.9 percent to 20.2 percent, an increase of $1,854 per household.

This finding isn’t surprising. Today, a typical working poor household would pay payroll tax, and see much of that liability wiped out by the Earned Income Tax Credit. Now, that household would pay a 9 percent flat income tax, plus a 9 percent sales tax and a 9 percent VAT on everything it buys—including purchases made with non-taxable income sources, like food stamps.

If Cain’s plan really does include a “poverty grant” provision that makes TPC’s analysis wrong and Laffer’s claim about poverty-line families true, then Cain’s campaign should explain what that provision is and how it works. (Incidentally, if there is any phaseout of the poverty grant, it will raise marginal tax rates above 25.3 percent.)

More broadly, 9-9-9 supporters invariably hide the ball when they talk about the plan’s distributional effects. I don’t think anybody disputes that high income taxpayers would get a very large tax cut under 9-9-9. Yet, the plan is supposed to be close to revenue neutral even on a static basis. That means if somebody is paying less, somebody else must be paying more. And if the people paying less are the wealthiest people who pay a disproportionate share of tax, they will have to be offset by a lot more people paying more.

TPC confirms this: they find that under 9-9-9, 84 percent of filers pay more, including most of those at the bottom of the distribution. You could tweak the plan to avoid soaking the poor, by introducing a “poverty grant,” but the only way to avoid soaking the middle class would be to introduce graduated tax rates.

But 9-9-9’s backers go to great pains to avoid admitting this. Instead of leveling with the public about the fact that he’s proposing a middle-class tax increase, Cain prattles on about how his tax only hits you hard if you buy a lot of “new goods.” This is idiotic for two reasons. One is that the tax capitalizes into the value of durable goods (it will be paid on a new car, and then become a factor of the price in subsequent sales of that car.) The other, bigger reason is that you can’t buy used food or used medical care.

The only people Laffer mentions in his op-ed as paying more tax under 9-9-9 are (1) people who start working more because the economy is stronger, and (2) rich people who start spending less time on tax avoidance because tax rates are lower. On the subject of the middle class, crickets.

Cain has an excuse: he doesn’t know much about anything. (To the extent that can be an excuse when you’re running for president.) But Laffer ought to know better.

Josh Barro — Mr. Barro is the Walter B. Wriston fellow at the Manhattan Institute. His research is focused on state and local fiscal policy.


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