Perry Tax, Flat Tax, Fair Tax, VAT (Tax): What's the Difference?

By Derek Thompson

Keeping straight the competing tax plans from Rick Perry, Herman Cain, flat-tax conservatives, and skeptical economists615 rick perry reuters.jpgREUTERS

We got our first glimpse of Rick Perry's tax proposal today, one week after fellow Republican presidential candidate Herman Cain amended his own famous 9-9-9 plan. Perry's plan is modeled after Steve Forbes' "Flat Tax." Cain's is an intermediate step toward the Fair Tax. Both have been described as a value-added tax.

That's a lot of taxes to keep straight!  Let's break it down:

THE FLAT TAX

Today, we tax income with all sorts of rates depending on where it comes from and how much there is of it. If you make a little money, you pay a low rate. If you make lots of money, you pay a higher rate on income above a certain level. Your wages get a Social Security tax. Your investment income gets a different treatment. (And I'm not even touching implicit marginal rates.) The upside of this confusion is that it allows us to create a progressive tax system that focuses its money-sucking energy on the rich. The downside is that it is really confusing and inefficient.

Steve Forbes proposed replacing our tax code with a Flat Tax. Under his plan, a family would pay no taxes on their first $36,000. After that, they would pay 17 percent of every dollar they earn. That's it. No tax on Social Security, or savings, or capital gains taxes. This would do three things, in theory. It would lower taxes for the vast majority of households, and especially the rich. It would increase deficits and reduce Washington's ability to pay for social welfare. And it would unleash pent up investment to grow the economy.

THE PERRY TAX

Rick Perry's tax proposal is considered a kind of flat tax. (Forbes has endorsed Perry's candidacy.) Families would pay one rate on their income, 20 percent, with a handful of deductions. The flat rate is higher than Forbes' plan, but it also keeps special preferences for charitable donations, health care, mortgages, and children.

Perry offers a choice. If you prefer the current tax system, you can keep it. One in two households pay no federal income tax. One out of six households receive benefits that offset both federal income and payroll taxes. Many of those families make less than $30,000 a year. They would stay with the current plan.

On the other hand, Perry keeps the mortgage interest deduction for upper-middle class homeowners and eliminates the tax on investment income, which benefits wealthy households. Therefore, you'd expect the richest ten percent to flee to Perry's plan.

You can guess where this gets us. Half of the country continuing to pay no federal income taxes plus lots of rich people paying fewer overall federal taxes means much less money for government. On the one hand, that's the point. On the other hand, it would lead to huge deficits or dramatic cutting.

THE 9-9-9 PLAN

Herman Cain's plan replaces the current law with a three-digit proposal: a 9 percent tax on personal income; a 9 percent tax on business income; and a 9 percent tax on consumption. Last week, he announced that he would have special exemptions for poor families and impoverished districts. It's a work under construction.

Unlike the Flat Tax and the Perry Tax, Cain's proposal might have a shot at raising about as much money as the government does today. What would change dramatically is the distribution of the tax burden. The middle class would see its tax rates go up by as much as 10 percent. The rich would get a huge tax breaks, due to low rates on earned income and no rates on investment income. As it stands, for a family making between $40,000 and $50,000, Cain's plan would raise their tax bill by $4,000. For the group of Americans earning more than $1 million a year, it would lower their tax bill by an average of $580,000.

THE FAIR TAX

Cain has said that his 9-9-9 tax is an intermediate step toward the Fair Tax. You can think of the Fair Tax as a flat tax on consumption: a 23-percent (or is it 30 percent?) sales tax imposed on all retail sales of new goods and services. This levy would replace the entire federal tax code.

A 30 percent tax rate on families in poverty isn't fair. So there is a "prebate" that spares the lowest-income households on the first $15,000 of their income. That might still raise effective tax rates on the poor. But more concerning is that, according to a Treasury Department analysis of the Fair Tax, taxes would certainly go up on non-poverty families earning up to $200,000. Overall government revenue would decline.

There are also enforcement problems. With today's tax evasion rates, the fair tax would have to be greater than 50 percent for Washington to make as much money as with today's system, according to the Brookings Institution's Bill Gale. (Of course, this is somewhat the point. Find me a Fair Tax advocate who wants to increase government revenue, and I will find a trillion-dollar coin to pay you for your time.)

THE VAT

The first thing to know about the value-added tax is that it's bit like professional soccer. It's popular in just about every country except the United States.

But maybe that's changing. (The VAT, I mean. American soccer is doomed.) Some economists rightly point out that the flat tax and the Cain tax work quite a lot like value-added taxes, because they're taxing the difference between what businesses and families earn and spend.

Last year I wrote a long explainer on the VAT that I'll excerpt here: VAT is a consumption tax on the "value added" at each stage of production. Imagine a $1 loaf of bread you buy from the supermarket with a VAT of 10%. You've got a farmer, a baker, and a supermarket in the production chain. The farmer grows the wheat and sells it to the baker. The baker makes a loaf, sells it to the supermarket. The supermarket sells the loaf to me. Each link on the production chain pays the government 10% of the price of its product minus 10% of the price it paid for the goods to make that product. Ultimately, the government collects a total of 10 cents on the $1 loaf. At the supermarket, I pay the bread price plus the VAT: $1.10. Maybe that sounds complicated. But it's actually much easier to collect VAT than a national retail sales tax because there is a counterparty to every transaction. The production chain helps to police itself.

***

Making the tax plan simple isn't so simple.

There are lots of benefits to a VAT if it's joined by other progressive taxes. In fact, there are lots of benefits to simple taxes and low rates in general, so long as they preserve a progressive system that raises enough money to pay for stuff Americans like, such as Social Security, health insurance, and an army. But most of these plans make the tax code less progressive, reduce revenue, or both. That's one reason why I continue to be a fan of the Simpson-Bowles Commission's tax plan, which simplified the tax code, lowered rates, raised revenue, and increased progressivity.

This article available online at:

http://www.theatlantic.com/business/archive/2011/10/perry-tax-flat-tax-fair-tax-vat-tax-whats-the-difference/247333/