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Wednesday, October 26, 2011

FLAT TAX FEVER

Republican presidential candidate Herman Cain has generated much attention with his
"9-9-9" plan to reinvigorate the economy, as well as his campaign.  The plan starts with eliminating the current multi-bracket federal individual tax system and replacing it with a single bracket; a "flat tax" of just 9%.  It would also reduce the corporate tax rate to 9%.  The obvious loss of federal tax revenue by such a change would be partially made up by eliminating most tax deductions.  Cain also sought to enhance revenue sufficient to eliminate federal deficits and reduce the federal debt by the imposition of a federal sales tax of 9%.

Cain claimed that his plan is "bold" and indeed it is, and he was rewarded, at least temporarily, by a jump in his poll numbers, actually leading former front runner Mitt Romney by a small percentage, with both around 25%. 

This is not a new idea.  A "flat tax" has been discussed among conservative politicians and economists for years.  In the current campaign, candidate New Gingrich has been one of those and has recently offered a more detailed description of his own.

Now comes Texas Governor Rick Perry who is attempting to recharge his flagging popularity with his "own" flat tax plan.  While Gingrich still has a bigger popularity deficit than Perry to overcome, Perry's sudden enthusiasm for "bold" tax and spending plans is clearly driven by his fall from poll numbers in September of around 30-35% to his current 8-11.5%.  Indeed, all of these plans are primarily intended to generate support among Republican conservatives, Tea Party identifiers and others as well, in the nomination contest.  Because of the realities of the two party legislative process and special interest influence, none would emerge from Congress in the same form as proposed, if at all.

Nonetheless, with three such plans on the electoral table it is worth taking a look at the concept from an economic and political point of view.

Essentially, the plans are very similar in structure with the major differences being the flat tax rate proposed.  Cain’s plan stipulates a 9% individual and corporate rate:  Gingrich’s plan has an individual “flat” rate of 15% “or less” and a corporate rate of 12.5%:  Perry proposes an individual and corporate rate of 20%. The current maximum corporate rate is 35%.

The differences in impact on federal revenues, individual and corporate tax obligations and benefits will require a detailed analysis by a credible financial institution similar to  the Office of Management and Budget (OMB) which doesn’t look at campaign proposals but would analyze any similar legislative proposal.  What is clear however is that Cain’s plan for income taxes taken alone, would benefit individual and corporate tax payers more than Gingrich’s or Perry’s simply based on the lower rate.  All three would eliminate the estate tax, the capital gains tax, and the taxes on dividends.  In political terms, liberals thus claim that flat taxes provide disproportionate benefits to corporations and wealthy individuals, the implication being that this is “unfair” to middle and lower class tax payers.

The important differences in the plans start with Cain’s third “9”.  This is revenue enhancement by imposition of a national sales tax of 9% which, according to Cain allows the otherwise unrealistically low tax rates of 9%.  A second difference is that of allowable deductions.  The tax simplification part of all three plans is based more on the removal of the vast number of so called “tax expenditures”, or allowable deductions which complicate the tax code and are seen by critics to primarily benefit corporations and the “rich” . All three would continue to allow business deductions for capital expenditures, and Gingrich and Perry would allow the standard deduction for individuals of $10-12,000 and $12,500 respectively. Mixed in with these politically inspired tax breaks however are a couple of additional “sacred cows” which the politically sensitive Gingrich and Perry have stepped around.  Both would allow the current mortgage interest deduction on primary residences as well as the deduction for charitable contributions.  Cain’s plan would allow the charitable deductions but is silent on the mortgage interest deduction which in the context of today’s housing crisis has become even more like the free wandering bovines of Calcutta.

Thus the major criticism of the three flat tax plans will be that at the outset they would all create major federal revenue shortfalls and thus continue to increase annual deficits and the cumulative federal debt.  Cain will point to his national sales tax as the remedy for this but a new sales tax on top of the average state sales taxes of 9.6%, (although much lower in many states), will be condemned as “regressive” by liberals and send shudders through the “any new tax” averse conservatives.  In any case, all three rely on hypothetical levels of economic growth generated by the plans to make up federal revenues and provide new jobs.

One of the major appeals of any “flat tax” scheme is that is simplifies the complex tax code which employs a whole industry of tax lawyers and accountants and which all three flat tax candidates claim costs about $435 billion a year in preparation, litigation and enforcement.  But both Gingrich and Perry, hoping to deflect the inevitable criticism from tax code deduction losers and class warriors, have made their flat tax codes “optional”; that is, tax payers, both individual and corporate could choose to compute their taxes based on the new flat tax model or the old, existing model with its progressive rates and deductions.  This is clearly a political dodge and campaign tactic which undermines the “simplification” argument, costs, incentives for economic growth, and any “reform” arguments related to deductions. 

For any of these plans to survive analysis they would have to be combined with major spending cuts.  All three candidates support such cuts in general with talk about balanced budgets, entitlement reform and spending caps and even eliminating whole cabinet departments but cuts in specific programs, which all have organized interests ready to defend them and voters to be angered,  have not been identified. 

All three candidates have claimed that their plans, which include the aforementioned major cuts in federal spending, would eventually balance the budget.  Politically, this has great appeal to the conservative primary electorate and many in the nation-wide independent cohort, but flat tax reform plans themselves are clearly an exercise in primary campaigning.  It's the "I have ideas.  I understand economics.  I'm a leader." strategy.  Politically, such reforms have minimum medium term futures.  Gingrich’s and Perry’s “either or” tax code makes little sense, would be impossible to analyze and project, and Cain’s required flat tax would result in major resistance from the myriad of special interests who benefit from their deductions, as well as consumers who get around to calculating the cost of living with a 9% add on federal sales tax. 

Cain refutes the implications of this by saying that the sales tax is not an “add on” because the “embedded” corporate taxes in the cost of products will be reduced by the lower corporate income tax which implies the base product cost to the consumer will be reduced as well.  That is not likely to happen as the cost of finished products will continue to be primarily based on the cost of raw materials, labor, equipment, transportation, distribution and marketing.  Additionally, the fear of “rate creep” once a national sales tax is established and politicians find a new revenue source, is a concern on both the Left and the Right.

So what will be the impact of these proposed “reforms” on the Republican primary?  All three plans contain elements that make sense, especially when combined with their associated budget balancing and spending cuts, but whether the Republican primary electorate has the patience or interest to understand them and make them priorities in their choice of candidates is not certain.  Nonetheless, the short term, pre-substantive, analysis has already been felt in Herman Cain’s surge.  Governor Perry is clearly attempting to jump start his campaign by gaining back his appeal to conservatives, and like Cain, will probably see some sort of bounce in the polls just from the media attention if nothing else.

 The sustainability of any Perry bounce and Cain’s surge however is in question.  Cain has come under attack for seemingly wandering slightly away from anti-abortion purism and a joke about electrifying the border fence with Mexico.  Recently in Iowa, Perry and Bachmann and Cain were all still focusing on their personal religiosity and opposition to abortion and gay marriage, issues on which the president has little practical influence and ones far a field from flat tax considerations. Perry has been criticized as politically inept and "unpresidential" in the debates which led to his fall from grace, but has apparently sought to get far Right attention by his recent flippant reintroduction of the issue of President Obama’s birth certificate.  The fact that such issues are still crowding the public discourse and the debates, reflect a lack of seriousness on the part of voters and the tendency for policy positions to be secondary in importance to issues of style, personality, ideological conformity and substance.

Meanwhile, while Perry, Gingrich, Paul and Bachmann compete for the evangelical and Tea Party vote in Iowa,  Mitt Romney remains the front runner in New Hampshire by a wide margin.  His strategy so far has been to campaign against Obama and for the votes of the more moderate national electorate and let the more conservative candidates fight against each other and divide that vote.  Romney has introduced his own 59 point economic plan which is focused on national economic growth to produce jobs.  He offers a lower corporate tax rate of 25% and lower individual rates over time.  He also proposes eliminating the capital gains tax, which is an incentive for investment, but unlike the three flat tax candidates he would only exempt investors who earn $200,000 or less per year.  He would also cap federal spending at 20% of GDP from its current 26%.

 Cain still lacks a credible campaign organization.  Perry still must climb out of near single digit approval where he is joined by Gingrich.  Flat tax fever may help but fevers subside and 80 percent of likely Republican voters say it’s too early to make up their minds.





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