Oct. 20 (Bloomberg) -- Republican presidential candidate Herman Cain has risen in the polls thanks, in large part, to his 9-9-9 plan, which would replace most of the U.S. federal tax system with a 9 percent personal-income tax, a 9 percent retail-sales tax and a 9 percent value-added tax.
Cain’s supporters love 9-9-9’s simplicity and transparency and think it would do wonders for the economy. His detractors say it’s horribly regressive. As New York Times columnist Timothy Egan put it: “Cain is proposing the largest shift in tax burden from the wealthy to the poor and middle class in the nation’s history.”
Neither side is completely right. It’s not as bad as its detractors say, but it could be a lot better. To be clear, I don’t support Cain, and I find some of his remarks outrageous, particularly the disparaging ones about Occupy Wall Street. But we’re not going to find common ground in this country if the left and the right distort each other’s proposals.
Evaluating Cain’s plan is difficult, even for a trained economist. To understand how different income groups would fare under 9-9-9, one must recognize that tax reforms affect households over people’s entire remaining lives, and do so differently at different ages. To that end, I used financial-planning software to compute households’ taxes for each future year and determine their sustainable living standards -- the amounts they can spend annually without running out of money.
The result: Commentators are mistaken when it comes to 9-9-9’s treatment of those with lots of wealth and little or no labor income, but they are correct in saying that it is highly regressive with respect to working Americans.
Consider four 45-year-old married couples, who all live in Texas and have two young children each. One is super-rich, one is upper income, one is middle income, and one is very poor.
We’ll start with the Riches. They have $7.5 million in investments on which they earn 3 percentage points above inflation on average. They own two $2 million homes with significant mortgages. Neither spouse works. Under today’s tax system, the couple can spend $128,422 each year, measured in today’s dollars, after meeting their housing costs, child care and taxes. Under 9-9-9, the Riches would get to consume $103,071, which is 20 percent less.
Why? Commentators miss the fact that rich folk spend money, too. Indeed, any well-trained public-finance economist knows that taxing spending is equivalent to taxing what’s used to pay for consumption -- current wealth as well as current and future wages. Hence, the 9 percent retail-sales tax and the 9 percent value-added tax add up to an 18 percent tax on wealth.
As a result, instead of paying only 15 percent on the dividends and capital gains they get from their investments, the Riches will pay a 9 percent tax on their investment income (excluding capital gains) and 18 percent on their spending. Moreover, the Riches can’t escape the tax by leaving their money to their children. Whatever the kids inherit will have 18 percent less purchasing power.
Now for the Uppers. Each spouse earns $250,000, each has $750,000 in a 401(k) retirement account, each contributes $10,000 annually to the 401(k), enjoys a $10,000 employer match, and has a $25,000 checking account. Their $2 million house is mortgaged to the tune of $1 million. Under the current system, the Uppers can spend $180,711 per year. Under 9-9-9, their consumption rises to $204,040. That’s a 13 percent improvement.
Each of the Middles earns $40,000, has $100,000 in a 401(k) account and contributes $1,500 annually, receives a $1,500 match, and has a $5,000 checking account. They owe $100,000 on their $200,000 house. Today, the Middles can spend $42,074 per year. Under 9-9-9, that falls by 5 percent to $40,031.
Finally, the Poors earn $15,000 each. They have no retirement or checking accounts, and pay $700 a month in rent. Their sustainable discretionary expenditure is $12,387 a year. Under 9-9-9, it’s $9,197. That’s 26 percent less.
In sum, 9-9-9 is highly progressive in some ways and highly regressive in others. There are various ways Cain can revise his proposal to remedy its flaws. Alternatively, he could simply ditch 9-9-9 and adopt a proposal I have advanced, known as the Purple Tax Plan. It replaces the corporate-income, personal-income, and estate and gift taxes with progressive levies on payrolls, consumption and inheritances. The effective rate for all three taxes is 15 percent.
The plan lowers the Riches’ living standard by 24 percent, while raising the living standards of the Uppers and Middles by 5 percent and the Poors by 11 percent. It is designed to help working Americans, make those with wealth pay more, improve incentives to work and eliminate disincentives to save. Best yet, it makes April 15 just another day, since neither households nor firms need to file annual tax returns.
The Purple Tax Plan is simple, transparent, progressive and efficient. My advice: Forget 9-9-9 and adopt 15-15-15, which will really get everybody on board and the economy moving.
(Laurence J. Kotlikoff, a professor of economics at Boston University, is a Bloomberg View columnist. The opinions expressed are his own.)
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