Herman Cain Thinks You’re a Moron: A Critique of the 999 Plan
Herman Cain is a smart man. He graduated college with a major in mathematics. As a guy that took three tries to get through the second semester of high school geometry I have nothing but respect for his intellect. In addition, he completed a masters, in computer science and worked as a mathematician in ballistics for the Navy. He then went on to a successful career in business ending up as the CEO of a major corporation and the chairman of the board of directors of the Federal Reserve Bank of Kansas City. Cain is the presidential candidate with the highest IQ since Bill Clinton.
When a guy this smart, comes out with an economic plan as dumb as the 999 plan and tries to run for president on it, I can only conclude that he is a con man who thinks that the American people are morons.
Here's Cain's 999 plan taken straight from his web site:
9% Business Flat Tax
ñ Gross income less all purchases from other U.S. located businesses, all capital investment, and net exports.
ñ Empowerment Zones will offer deductions for the payroll of those employed in the zone
9% Individual Flat Tax.
ñ Gross income less charitable deductions.
ñ Empowerment Zones will offer additional deductions for those living and/or working in the zone.
9% National Sales Tax.
ñ Unlike a state sales tax, which is an add-on tax that increases the price of goods and services, this is a replacement tax. It replaces taxes that are already embedded in selling prices. By replacing higher marginal rates in the production process with lower marginal rates, marginal production costs actually decline, which will lead to prices being the same or lower, not higher.
(from www.hermancain.com/999plan)
For starters, despite Mr. Cain’s protestations to the contrary, independent evaluations of his plan have shown that the richest sixteen percent of the population would pay less in taxes and the remaining eighty four percent would pay more than at present. The CEO earning five million dollars a year and his housekeeper earning $30,000 a year would both pay income tax at the rate of nine percent. That's fair.
Now let's look at Cain's business tax. Gross income less ('purchases from other U.S. located businesses, all capital investment and net exports'). The portion giving deductions for purchases from U.S. businesses and net exports is pure unadulterated gobbledygook and would be almost impossible to administer. This guy is trying to make the tax code simpler. Right!! Now consider the main part of the business tax. This like his other taxes is supposedly a flat tax with no deductions(except for charitable contributions), and no gimmicks.
Well first of all he gives a big fat deduction for capital investment. Currently, a capital investment is not an expense. When a manufacturer spends money on new machinery he has not incurred an expense he has acquired an asset. That asset will wear out, that is, depreciate over time and the manufacturer can treat this depreciation as an expense against income. Under Cain's plan the manufacturer would be able to expense the machinery before it has a chance to wear out.
After taking his big fat deduction for capital investment the manufacturer pays a nine percent tax on gross income. Plain and simple, no gimmicks here. Cain is betting that you don't know what gross income is. Gross income or gross profit, according to High – Powered Investing All in One for Dummies (C 2008 Wiley Publishing, Inc) 'is simply the sales less the direct cost of producing the company's product or service …'
To make things simple let’s say you're in the hubris business (hubris for those of you not up on your Greek tragedies is the kind of arrogance or chutzpah the gods punish you for). You manufacture yellow, green and purple hubris in big vats in the basement and sell it to customers in your store on the first floor. You pay three guys in the basement to stir the vats and you pay three salesmen to sell the three different kinds of hubris. You pay separate rents to the landlord for the basement and the store.
So let's say in September you sold $100,000 worth of hubris. The raw materials for the hubris cost you $10,000. You paid the landlord $10,000 for the basement and $10,000 for the store. Finally, you paid each of your six employees $3,000 for the month. Your gross profit for September was $100,000 minus ($10,000 for the basement, $10,0000 for the raw materials and $9,000 for the three employees who stirred the vats) or $71,000. The $9000 you paid the salesmen and the $10,000 you paid the landlord for the store are operating expenses and do not subtract from gross income. Under the current tax system it wouldn't matter. Let's say you opened the business on 9/1/11 and closed it on 09/30/11. The business would have net income of $52,000 for tax purposes.
Under the Cain plan, businesses are supposed to be paying a flat tax on gross income with no deductions and no gimmicks. So you're supposed to pay the nine percent tax on the $71,000 in gross income. Then you remember the salesmen would go down and stir the vats when the basement guys were on their lunch breaks. That means that you can subtract the $9,000 you paid the salesmen from gross profit and only pay the nine percent on $62,0000. Cain creates a loophole that you could drive a fleet of trucks through. Cain's business tax proposal should be known as the Tax Lawyers Full Employment Act of 2013.
Now let's consider Cain's sales tax. He calls this a 'replacement tax' because it 'replaces higher marginal rates in the production process with lower marginal rates'. Cain claims his sales tax would actually lower the cost of goods and services. Businesses would be forced by competition, according to him, to lower their prices commensurate with the reductions in their taxes. Glaxo Smith Kline, the manufacturer of the Avodart, I take for my prostate would lower what it charges me for the drug because it would be paying less to the government in taxes. Wait a minute, Glaxo Smith Kline has a patent on Avodart. They don't have to lower the price on the drug because they have no competition. To give another example consider the fees banks are now charging on debit cards. Banks are charging these fees because the Federal Reserve lowered the fees banks could charge merchants when the debit card purchases are rung up. It was presumed that the merchants would in turn pass on their savings to customers in the form of lower prices. Expert opinion, at the present time, predicts that merchants will in fact pocket these savings. Many providers of goods and services operate in environments in which competition is imperfect or wholly lacking. There is no reason to believe that they would pass on their tax savings to consumers. Finally, the really wealthy can elect to spend their time and money abroad and avoid the sales tax altogether.
To sum up Herman Cain's nine percent income tax is a scam, his nine percent business tax is a scam and his nine percent sales tax is a scam. Herman Cain thinks you’re a moron and if you embrace his 999 plan you are one.
So if you’re with me up to this point you’re not a moron and you’re ready for a real tax reform plan. First of all the current federal tax system works fine with respect to wages, self-employment, pensions and annuities and doesn’t work well with respect to unearned income other than pensions and annuities, and corporations. The latter categories have too many loopholes and opportunities to cheat. Now, in saying that the current system works well for wages, self-employment, pensions and annuities I realize that I have skirted over the issue of how flat or how progressive the income tax system ought to be.
The argument against progressive taxation, is that while people who make more ought to pay more, it is fundamentally unfair for some people to pay a higher percentage of their income in taxes than other people. Frederich Hayek, the conservative economist and Noble Prize winner gave a good argument against progressive taxation, in his book, The Constitution of Liberty. In this same book he also states that some degree of progressive taxation can be justified ‘to compensate for the tendency of many indirect taxes to place a proportionally heavier burden on the smaller incomes’ (Constitution of the Liberty, page 307, copyright 1960 University of Chicago). Based on the above I believe that our current level of tax progressivity is justifiable and appropriate and that calls for a flat tax are indefensible even from a conservative viewpoint.
So how should we tax unearned income other than pensions and annuities and how should we tax corporations? Before I get to my actual proposal I want to address one aspect of the current tax system that drives me crazy. I am referring to the preference (lower tax rate) given to long term capital gains. Let’s assume for the moment that this preference can be justified in the case of individuals who actually contribute capital to businesses. I fail to understand why the same break should be given to long term investors in the stock market . I buy 100 shares of IBM at $100 per share and sell my shares two years later at $150 a share for a profit of $5000. I didn’t contribute any capital to IBM. I bought the stock from a prior shareholder and sold it to a new shareholder. Why shouldn’t I pay taxes at the same rate as the poor schmuck who earned $5000 in wages?
I’ll address taxation of unearned income first then discuss taxation of corporations. What is it we’re talking about when say unearned income with the exception of pensions and annuities. We’re talking about income that is generated based on the ownership of assets. Capital gains, bond interest, dividends, bank interest and passive rental income are all based on ownership of an asset. More than one hundred years of taxation history has demonstrated that unearned income cannot be taxed fairly. Lobbyists and legislators carve out exceptions and preferences and you end up with a tax system that is both unfair and overly complex. So stop taxing unearned income.
Before I get into my replacement for taxes on unearned income I need to make a very important point. Since taxes on unearned income do not take inflation into account these taxes are actually taxes on the assets themselves. Suppose your bank is paying you 2% on a two CD and inflation is running at 3%. You’re actually losing money but yet you have to pay tax on the 2%. So both inflation and the government our feasting on your wealth.
So since a tax on unearned income is already a tax on wealth you directly impose a tax on wealth but you impose the tax in a very conservative manner. I’m going to throw out some numbers here but it’s important to realize that these numbers are not written in stone. So here goes.
1) Compute the taxpayers net worth (includes securities, home, cars etc)
2) Exclude $100,000 for personal possessions.
3) Exclude the next $1000,0000
4) Compute the average rate for a ten year treasury note for the taxable period.
5) Multiply the result in #3 by the result in #4. The resultant deemed unearned income is what the taxpayer would add to adjusted gross income.
Example
A taxpayer has a net worth of $2000,000. $100,000 is excluded for personal possessions. A further $1000,000 is also excluded. The balance is then $900,000. The average rate for a ten year treasury note is computed to be 2%. $900,000 times 2% or $18,000 of deemed unearned income is therefore added to the taxpayers adjusted gross income. If the taxpayer decorates his home with vintage guitars he has deemed unearned income of $18,000 and if he makes $180,000 in the market he also has deemed unearned income of $18,000. We don’t penalize people for being successful investors and we in effect do penalize people for conspicuous consumption.
Similarly, over 100 years of taxation history has shown that our system of corporate taxation is both unfair and overly complex. A nominal maximum rate of 30% is contrasted with profitable fortune five hundred companies able to game the system to such an extent that they are able to reduce their corporate taxes to zero.
Again the solution is to scrap the current corporate income tax and replace it with a tax based on corporations’ net assets. Multiply the corporation’s net assets by the average rate of ten year treasuries and impose a corporate tax based on the result. Again we don’t penalize the successful and if a corporation can’t earn the return on a ten year treasury note it ought to liquidate and pay off its shareholders.
The result of implementation of my two proposals would be a tax system that is harder to game, easier to administer and one that is a great deal fairer than the current system.
