The tax plans from Rick Perry and Herman Cain would make millionaires vastly richer while raising taxes on the middle class. It's voodoo economics gift-wrapped for rich voters.
Republican presidential candidates are falling over themselves promising to cut your taxes. Well, probably not your taxes. Somebody else's taxes. Somebody rich.
First there was Herman Cain's 9-9-9 plan, which would replace all of our current taxes with a 9 percent national sales tax, a 9 percent "business tax" and a 9 percent tax on income. Now Rick Perry says that his 20 percent "flat tax" is even better. Meanwhile, Michele Bachmann says Perry stole her idea. But let's be clear: These are massive tax cuts for the rich, not for most of us.
The Cain 9-9-9 plan is breathtaking. The poorest Americans would see their effective tax rate increase from about 5 percent to 18 percent. The typical household would pay $4,000 more than today. But the top 0.1 percent would get an average tax cut of $1.4 million and would pay an effective tax rate of 18 percent--lower than any other income group. That a plan so insane could be proposed by a leading presidential candidate just shows how crazy our political system has become. Although Perry's flat tax preserves the tax code for most families, he offers a special tax cut for the rich. A retired couple making $700,000 would be $75,000 richer under his plan. (To see a very tall graphical representation of Perry and Cain's tax plans, see Derek Thompson's charts.)
Poll after poll says that most Americans want to raise taxes on the rich. In one recent survey, more than two-thirds of respondents -- and even a majority of Republicans! -- favored higher taxes on households making more than $250,000 per year. Why are people who want to be elected president proposing the exact opposite of what the people want?
The most charitable answer is that they think lower taxes are good for the country. Reducing taxes on the rich would make them work harder, save more, and promote economic growth. This is the theory George H.W. Bush once called "voodoo economics," and 30 years later, it's still voodoo.
TAXES AND GROWTH: THE NON-RELATIONSHIP
There is no historical relationship between marginal income tax rates and economic growth. In the 40 years after World War II ended, the top rate ranged from 50 percent to 91 percent. Meanwhile, the economy averaged 3.5 percent growth. In the last 20 years, when the top rate ranged from 28 percent to 44 percent, GDP growth averaged 2.6 percent. Even after excluding the recent recession, growth averaged 3.0 percent.
This shouldn't be surprising. Marginal tax rates do not impact people's propensity to work that much. Empirical studies show that, for most workers, the effect of income tax rates on labor supply is small or nil. Lower taxes do seem to increase workforce participation for married women--but that effect is unlikely to apply to the super-rich favored by Cain and Perry. Higher income tax rates do produce modest decreases in taxable income, but mainly because higher-income taxpayers work harder to avoid taxes, which is welfare-destroying. (See Saez, Slemrod, and Giertz 2010, forthcoming in the JEL.)
What about taxes on investment income, which George W. Bush reduced to 15 percent and Cain and Perry want to reduce to zero? Again, it's not clear these taxes have any impact on economic growth. Since 1947, GDP growth has averaged 3.0 percent in high-tax years (top capital gains rate over 25 percent) and 2.7 percent in low-tax years (top capital gains below 25 percent).
This shouldn't be surprising, either. In theory, lower capital gains taxes encourage people to save more. More savings means more capital available for businesses to invest. In practice, though, cutting taxes on investment income just increases the federal budget deficit, which means the government is saving less, and reduced government saving more than cancels out any increase in private saving. As a result, total national saving--the only thing that matters--goes down.
Cain and Perry's claim that huge tax breaks drive economic growth has been disproved by just about every aspect of recent history. Then again, Cain and Perry aren't looking for history to endorse them. They're looking for deep pockets.
A TAX PLAN FOR WHOM?
There are other possible explanations for their tax plans.
One is that Cain and Perry are not stupid, but they just think voters are. The 9-9-9 plan is basically a 27 percent consumption tax.* Maybe Herman Cain doesn't think that most people will realize that 27 percent is a lot higher than their current effective tax rates.
Another is that the Republican tax revolt led by Grover Norquist has become so successful that the only thing that matters for winning the presidential nomination is being as extreme as possible on taxes. (Or, slightly more plausibly, the only way to become the "conservative" alternative to Mitt Romney is to be as extreme as possible on taxes.)
The final, and to me the most realistic, possibility is that Cain and Perry are simply pandering to the rich because the rich are their most important constituents. Given the way campaign finance works these days, they have no chance of matching President Obama's war chest without the backing of Super PACs that face no limits on campaign contributions. Super PAC money comes from the richest Americans and corporations. The easiest way to go after that money is to have a race to see who can propose the more incredible tax cuts for the super-rich and for corporations.
Perry's plan even includes a totally gratuitous, one-time reduction in the corporate tax rate to 5.25 percent--a goody that corporations have been lobbying for to allow them to "repatriate" profits parked overseas. The last time this happened, it was under George W. Bush, and most of that money was promptly paid out to shareholders as dividends. There's little chance that the typical Iowa caucus-goer cares about the problems of international taxation or wants to give corporations a huge tax break. That provision is more evidence that Perry's tax plan, like Cain's, was never intended to be a document for tax policy wonks. It's just another campaign advertisement for people with lots of money. If you're running for president, votes matter. But money matters first.
*The details are here, but basically an exemption for all investment income is equivalent to only taxing consumption. For everything that's sold, looking at the tax-exclusive price (the way we usually think about sales taxes here), 10 percent goes to the "sales tax," 10 percent goes to the "business tax," and a little over 7 percent goes to the "income tax."
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