Monday, October 17, 2011

Why 9-9-9 is headed for the deep six

I watched analysts battle over the positives and negatives of Herman Cain's 9-9-9 tax plan this weekend. After hearing their arguments and using my own CPA noggin, I'm coming down on the side that it's a great slogan but falls down in two key ways.

So we're on the same page, here are the main points from Cain's website. The 9-9-9 plan would eject the current tax code and replace it with a 9% tax on personal income, a 9% tax on corporate income, and a 9% federal sales tax. The only deduction for personal income tax returns would be charitable donations. Deductions from gross income for businesses would be purchases from other U.S. located businesses, capital investments, and net exports. The federal sales tax would be on new goods, but I haven't been able to determine if services would be taxed. In fact, other than the vague bullet points on Cain's election website, I haven't been able to locate the actual 9-9-9 plan. Although a tax code that can be printed on a note card seems appealing, it's doubtful that one that short could actually be implemented.

Here's why 9-9-9 is destined for failure:

1) It scraps the long accepted graduated tax system for one that favors people with discretionary income. A person making $50,000 in wages and who has no charitable deductions would pay $4,500 (9%) in federal income tax. An additional 9% in federal sales tax would be assessed on expenditures. Because there's no actual 9-9-9 plan to read yet, I'm not sure if spending on car and house payments would be taxed or if services would be taxed. Are utilities considered new goods or services? Let's assume that this person spends $25,000 on federally taxable stuff. That would amount to an additional $2,250 for a total of $6,750, or 13.5% of the $50,000 wage.

Now let's consider someone who makes $1,000,000 in salary and spends $250,000 of it to support a nice lifestyle. Assume again that half of the $250,000 is spent on federally taxable items. Federal income tax would be $90,000; sales tax would be $11,250. That totals to $101,250, or 10.125% of the $1 million salary.

How does that compare to the current tax code? A single person earning $50,000 with no itemized deductions pays $6,350. A married couple earning $50,000, again with no itemized deductions, pays $3,061. A single person earning $1 million would certainly be able to itemize deductions, so it's not realistic to assume a standard deduction for such a person, but for laughs, let's do just that. A single person earning $1 million would pay $324,371. A married couple would pay $313,763.

Therein lies the political challenge for 9-9-9. Lower paid folks would pay a higher percentage of their earnings in taxes than people who earn more than they spend. Secondly, compared with the current system, 9-9-9 provides a significant reduction in actual dollars paid in federal income taxes for high earners, while the opposite is true for lower earners. Some people may like this idea, but it won't fly at the ballot box.

2) The introduction of a federal sales tax is just too tempting as a new revenue source for Congress. The Fair Tax Act, as formulated by Neal Boortz and John Linder, calls for a national sales tax but marries the idea with the repeal of the 16th Amendment, which would abolish the federal income tax.

Herman Cain's 9-9-9 plan, according to his campaign website, is step one of a two-step process, with step two being adoption of the Fair Tax Act. The problem I see is that, in the unlikely event that Cain is elected and 9-9-9 becomes law, Congress would start dreaming about how great a 12-12-12 plan would be, or a 20-20-20 plan. Income taxes would remain on the table and the easy way to avoid spending cuts would be to crank up the national sales tax. More tools in the tax hike toolbox is a recipe for disaster.

Tax reform is needed, but I believe we will have to whittle away at the tax code we've got. Eliminating loopholes and tax preferences will result in a fairer tax system without cutting the safety net we have in place for our less fortunate citizens. Anyone who thinks they'll win the presidency on a tax policy that goes after lower wage earners to benefit high wage earners is just not tuning into the national debate.

9 comments:

  1. All I know is whatever happens that it is me who constantly gets screwed. I pay pay pay and the government takes takes takes. For myself, I will not follow this rediculous Presidential campaign nor will I ever vote for any of those running reguardless of party. My message is simply that I have given up.

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  2. No mention of imbedded taxes.

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  3. I am well aware that Cain is trying to defend 9-9-9 by talking about imbedded taxes. He is correct on that point, which is one of the fundamental selling points of the Fair Tax Plan, but the fact that goods might hold their prices or even go down with the national tax in place (due to the elimination of imbedded taxes) is enjoyed by everyone who purchases those goods; rich and poor alike.

    Therefore, my two points are unaffected by this positive aspect of 9-9-9. The poor still would pay a higher rate and Congress would have a free-for-all with a new tax.

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  4. Please explain imbedded taxes?

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  5. The taxes that are imbedded in this instance are corporate income taxes paid by suppliers, and suppliers to suppliers, etc. Each company in the supply chain must make a profit after paying their income taxes, so the theory is that the cost of goods at each stage is inflated by the income taxes paid. By going to a 9% flat corporate tax rate, which is significantly less than the tax rate under the current system, there should be room to adjust prices downward while still maintaining the same level of profitability.

    Why would a company lower its prices when it pays less income taxes? Competition. Some other company sees an opportunity to edge you out of some business by lowering prices. You have to lower your own prices to stay competitive. It actually does work this way in a competitive market. Herman Cain is saying that this competition under a system with lower income taxes will result in prices of goods that remain the same or drop some even with the 9% federal sales tax added in.

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  6. Carl Johansen would state

    Randy here is my vesion of 9 9 9

    Nine seconds, thinking how we can make a change of the tax code.

    Nine hours attempting to sell it.

    Nine minuts before every one realizes
    it is a joke

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  7. http://www.boortz.com/weblogs/nealz-nuze/2011/oct/21/recording-video-today/

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  8. It is a very dangerous situation when you have a large segment of income earners who are not paying any income tax. Nearly half of U.S. households are not paying any Federal income tax. The bottom 40% on average, make a profit from the federal income tax, meaning they get more money in tax credits than they would otherwise owe in taxes. It is a dangerous and unfair situation when you have nearly 50% of society with no skin in the game coupled with politicians who have no shame in pandering for votes with free stuff for those who aren’t paying taxes at the expense of the other 50%.
    I strongly disagree with your concept of “whittling away at the tax code we've got.” Good luck with whittling away at a 9,097,000 word tax code. The whole tax code should be scrapped for the reasons in this link. http://www.freedomworks.org/scrapthecode/topten.php

    Nearly half of US households escape fed income tax.
    http://finance.yahoo.com/news/Nearly-half-of-US-households-apf-1105567323.html?x=0

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  9. Paul, I completely agree with you on all of your points. My commentary was relative to whether the 9-9-9 plan is a winning presidential election strategy. You see now that Cain is allowing a poverty level exemption in his plan: "For those people it's a 9-0-9 plan," he says. Because there is no actual plan, Cain's interpretation of it will continue to evolve to attempt to deflect criticism of it.

    As a CPA, I would ask whether this poverty exemption is available for everyone. As an example, if you earn $1 more than the federal poverty ($22,350 for a family of four), do you pay 9% on all of your taxable income? That doesn't seem fair. But does someone with a family of four and $250,000 of taxable income get an exemption of $22,350? Some would say that's not fair. So is there a phase out for the poverty level exemption?

    You see, even the simplest exception to the rule generates questions of fairness and complicates the 9-9-9 plan. The whole idea of Cain pushing his plan before he's thought it through is a real problem for him.

    Most of the Republican candidates appear to be more concerned with pushing ideology than they are about winning a presidential election. Lee Atwater, Bush 41's campaign strategist understood that winning is everything. You cannot implement tax reform or anything else on your list of to-do's if you don't win. Carl Rove, a student of Atwater, learned the same lesson.

    In this field, Mitt Romney is the only candidate, in my opinion, who has the combination of factors to win in a general election.

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