Thoughts & Further Thoughts on Herman Cain's 999 Plan

The Independent Institute
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Herman Cain’s 999 Plan

By Randall Holcombe

I’ve been asked a few times about Herman Cain’s 999 Plan, so here are some initial thoughts. I haven’t seen the details, and perhaps the specifics haven’t been hammered out at this point, but my information about the 999 plan comes from Cain’s website. Essentially, the plan is to replace the current federal tax system with a 9% Business Flat Tax, a 9% Individual Flat Tax, and a 9% National Sales Tax.

One criticism I’ve heard of the plan is that while it would be a tax cut for the rich, most people will pay higher taxes under Cain’s plan. This is unlikely to be true for people who are working, and spending less than their incomes. Those people would pay at most 9% of their incomes in income tax and 9% of their incomes in sales tax if they spent all of their incomes on sales-taxable items, for a total of 18% in personal taxes. But the employee and employer shares of the current Social Security Payroll tax is more than 15%, which is pretty close to the 18% in the 999 Plan. If people don’t consume their entire incomes, and don’t pay the whole 9% income tax (Cain deducts charitable contributions from taxable incomes, and would have additional deductions for those in “empowerment zones”) they would pay less than 18%, and today anybody who pays federal taxes beyond the Social Security tax already pays more than 15%. That criticism only appears to hold water for people who are consuming more than they are earning.

Another criticism I’ve heard is that the 999 Plan would generate less revenue for the federal government. Of course, some people (especially people who tend to read this blog) would not consider that to be a criticism. Let’s see how that holds up with a back-of-the-envelope calculation. Consumption is about 70% of GDP, and if that is what is taxed by the National Sales Tax it would raise 6.3% of GDP in revenue. Corporate profits are about 5% of GDP, and if that is what is taxed by the Business Flat Tax it would raise 0.45% of GDP. Labor income is about 75% of GDP and if that is what is taxed by the Individual Flat Tax it would raise about 6.75% of GDP. Add them together and the 999 plan would raise about 13.5% of GDP in taxes.

Federal tax revenues as a share of GDP are 14.4% for 2011, so even with revenues depressed as a result of the recession it appears Cain’s 999 plan would not raise as much in revenues as the current tax system. Perhaps my back-of-the-envelope calculation underestimates some revenue, and in particular the Business Flat Tax might raise more. But even if it raised twice what I estimated, that would put 999 revenues at around 14% of GDP. So, the criticism that the 999 plan would generate less in federal tax revenues appears to hold up.

The biggest issue I have with the 999 plan is that it would introduce a new national sales tax, and it is easy to envision the tax rate starting at 9% and doubling or more (which would still leave it below the Value Added Tax rates in most of the EU). Cain’s longer-term plan is to phase out the business and personal income taxes and replace it with a larger National Sales Tax. But one could easily imagine the larger sales tax along with rising rates on incomes when spending continues to be so much larger than revenues. My reservations on the 999 Plan would be mitigated if it were implemented as a result of a Constitutional amendment that would mandate that the rates not rise.

Further Thoughts on Herman Cain’s 999 Plan

By Randall Holcombe

Yesterday I passed along some thoughts on Herman Cain’s 999 plan, and on thinking about it some more, I probably underestimated the amount that would be paid through the Business Flat Tax. I estimated it assuming the tax base would be corporate profits, but it appears the tax base, which is gross revenues minus purchases from other companies, capital investment, and net exports, includes wages paid to the firm’s employees. That adds up to about one-third of GDP, so a 9% tax on it would add another 3% to my earlier estimate that the 999 plan would raise revenues of about 13.5% of GDP. I’ll revise that to 16.5%.

This is a rough “back-of-the-envelope” estimate, and I conjecture it overstates what the plan would really raise because I assumed all labor income would be taxed and all consumption purchases would be taxed. No income tax in the real world, and no consumption tax in the real world, comes close to taxing all of its tax base.

If I had my way, federal spending would be far less than 16.5% of GDP — or 13.5% of GDP for that matter — and the 999 plan would raise more than enough revenue for the federal government. President Reagan’s experience shows it is easier to cut taxes than it is to cut federal spending. So even with this higher estimate of revenues under the 999 plan, it wouldn’t balance the budget.

One commenter on my earlier post said that economic growth would increase under the 999 plan, increasing GDP and government revenues, and I think that is true. High marginal tax rates impede economic growth, and Cain’s plan proposes to keep the marginal rate on all federal taxes below 10%. But as I stated yesterday, I do fear that with a national sales tax in place, we would see rising tax rates in all those taxes without a constitutional amendment preventing it. Deficit spending could easily turn the 999 plan into the 15-15-15 plan, or worse.

I like Herman Cain’s bold thinking, the 999 plan has much to recommend it, and I don’t mean to criticize Cain’s plan with my comments yesterday and today. Taking a realistic look at the likely implications of the plan isn’t a criticism. Should Cain win the presidency, we know that the president’s plans are rarely implemented without modification. It does appear that Cain is pushing in the right direction here.