Saving $1,756 Billion, Overnight –

By: Larry Walker, Jr. –

“There is no doubt that many provisions in the Tax Code benefit narrow groups of taxpayers, but the dirty little secret is that the largest special interests are us – the vast majority of U.S. taxpayers. Virtually all of us benefit from certain exclusions from income, deductions from income, or tax credits.” ~National Taxpayer Advocate

According to Article I, Section 7 of the United States Constitution, “All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with Amendments as on other Bills.” And, according to the 16th Amendment to the Constitution, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Thus Congress has the power to pass spending bills, and a responsibility to collect taxes on incomes; however the pair should be administered by separate agencies. Anyone with a background in accounting or auditing knows that an adequate internal control system should include proper authorization and segregation of duties. By granting the IRS the dual responsibilities of administering social welfare payments and collecting taxes, Congress has left the door wide open for ineffable fraud.

Since at least 1975, a growing portion of social welfare spending, now to the tune of $1.7 trillion over a 10 year period, is introduced by congressional tax-writing committees and administered by the Internal Revenue Service. Such manipulation has introduced government spending policy into what otherwise would be an exercise in economic measurement. Tax expenditures, by way of refundable credits, represent a deviation from the “tax base”, introduce complexity into the tax law, and impose a spending function on an agency best suited to revenue collection.

Delivering Social Benefits through the Tax System

In the 2010 Annual Report to Congress, National Taxpayer Advocate Nina E. Olson focused on the need for tax reform as the No. 1 priority in tax administration. In particular, she has focused on the problem of delivering social benefits through the tax system, which complicates the mission of the IRS, resulting in a dual mission of welfare administration as well as revenue collection. Elsewhere in the report, the National Taxpayer Advocate recommends that the IRS adopt a dual mission statement and hire personnel appropriate to the delivery of social benefits that already have been codified.

Okay, so let’s stop playing games. Nobody wants to get rid of deductions for mortgage interest, state income taxes, medical expenses, charitable contributions, employee business expenses, or ordinary and necessary business expenses. And as far as officially expanding the mission of the IRS, to social welfare appropriator, on top of being the tax collection arm of the government, we don’t even need to go there. So let’s just cut to the chase. The main problem with the income tax code, today, can be found among three refundable tax credits, at the individual level.

It is important to note that neither of the following are what their names imply: The Earned Income Credit, Child Tax Credit, and Making Work Pay Credit (now known as the 2% Payroll Tax Cut) are not tax credits at all; they are merely social welfare giveaways, administered by the IRS. For the most part, neither represents a refund of income taxes actually paid, as such refunds, when combined, are well in excess of the total amount of taxes paid, including in many cases Social Security and Medicare withholding. Common sense dictates that one cannot refund something which has never been received.

1. The Earned Income Credit (EIC) was signed into law by President Gerald Ford in 1975. The function of the EIC was to offset the burden Social Security taxes placed on low-income filers with children, and to motivate them to work. The earned income credit has grown to be one of the principal antipoverty programs in the federal budget. The only problem is that it is not a part of the federal budget. In 1975, 6.2 million families received an average credit of $201. In 2009, 27.3 million families received an average credit of $2,206.

2. The Child Tax Credit (CTC) was enacted as part of the Taxpayer Relief Act of 1997. Congress established the child tax credit to address concerns that the tax structure did not adequately reflect a family’s reduced ability to pay taxes as family size increased. Initially, for tax year 1998, families with qualifying children were allowed a credit against their federal income tax of $400 for each qualifying child. For tax years after 1998, the credit increased to $500 per qualifying child, and was refundable for families with three or more children. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) increased the credit to $1,000 per child beginning in 2003, and extended refundability to families with fewer than three children. It is one thing to want to help lower the income tax burden of families, but entirely another when the burden is reduced below zero.

3. The Making Work Pay Credit (MWP) was enacted as part of the economic stimulus act (“American Recovery and Reinvestment Act of 2009,” or ARRA). The purpose of the credit is to offset part of the Social Security taxes paid by low- and middle-income workers. MWP provided a refundable tax credit equal to 6.2 percent of earnings (the employee share of the Social Security payroll tax), up to a maximum credit of $400 for individuals ($800 for couples). Couples could claim the full $800 credit, even if only one spouse worked.

Can you say redundant? So let me get this straight – The EIC was implemented to offset the burden Social Security taxes placed on low-income filers with children, and to motivate them to work. The CTC was established to address concerns that the tax structure did not adequately reflect a family’s reduced ability to pay taxes as family size increased. And the MWP was enacted to offset part of the Social Security taxes paid by low- and middle-income workers.

If Social Security and Medicare taxes are collected from all workers, on an equal basis, in order to pay for future benefits, then shouldn’t the act of granting some citizens a premature distribution, of the same, result in a reduction of future benefits? Common sense says it should, but that’s not how this works. Under each of the above tax credits, some citizens are given back all of their Social Security and Medicare payroll contributions, and a portion of their employer’s contributions, and yet they are eligible to reap the full amount of future benefits based on the amount of their rebated contributions.

What’s wrong with this picture? Again, common sense would dictate that, if you don’t put anything into the pot, then you don’t get anything out. And if you put something into the pot, then you should have to wait until age 62, 65, or 67 to obtain a benefit, just like everyone else.

“Don’t be misled–you cannot mock the justice of God. You will always harvest what you plant.” ~Galatians 6:7

Today, the United States is reaping exactly what it has sown. We have a $15 trillion national debt, a $1.5 trillion annual budget shortfall, and social entitlement programs on the verge of bankruptcy. But instead of balancing the budget, reducing the debt, and placing money into trust funds to cover future liabilities, we are giving millions of low-income families a double benefit. First, they are given refundable credits, absolving them from any stake in the future of this nation, and then they are promised benefits in the future, benefits which will be paid for entirely at the expense of others.

If the government wants to provide public assistance benefits for low-income filers with children, and motivate them to work, it should accomplish this through one of its other redundant agencies, it doesn’t need to use the tax code. The refundable tax credits, listed above, are precisely the kind of social welfare expenditures that have no place in tax administration.

According to the Law of Nature, “You will always harvest what you plant.” But as far as the federal government’s logic goes, justice would seem to dictate that either someone else will harvest what you plant, or you will harvest what someone else plants. It’s not even clear, to most American’s, how much is actually being squandered in this seemingly everlasting war on common sense.

Free Money

According to the Joint Committee on Taxation, in 2010, the IRS gave away $55.1 billion by way of the Child Tax Credit, $56.2 billion via the Earned Income Credit, and $59.7 billion through the Making Work Pay Credit. That’s a total of $170.9 billion in a single year, $103 billion of which was refundable. Over a 10-year period, we’re talking about $1.7 trillion in tax credits, just over $1 trillion of which is refundable.

Note: Although the MWP expired at the end of 2010, it was replaced with the 2% Payroll Tax Cut beginning in 2011, as part of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The new credit allows for a 2% cut in payroll taxes for employees, which reduces the Social Security Tax from 6.2% to 4.2%, without affecting Social Security benefits. When combined with the EIC and CTC, millions of citizens will receive future benefits without having made adequate contributions. No wonder Social Security is on the verge of bankruptcy.

The federal government has thus, not only come up with a way of returning to millions of Americans the full amount of their social security contributions, but an amount well in excess, since millions of households are eligible to receive all three tax credits. Another major flaw, in all of this activity, is that eligibility for the premature distribution of Social Security benefits doesn’t disqualify or limit any of these tax filers ability to receive other Federal and State social benefits (i.e. Public Housing, Medicaid, Food Stamps, and Temporary Assistance for Needy Families).

If the federal government insists on granting relief to “qualifying” citizens through the tax code, then under no circumstances should such tax credits be refundable. As I stated in Part I, “I think it’s enough to not owe any federal income taxes at all. The concept of transferring one man’s tax payment directly to another taxpayer is most detestable, and unnecessary.”

Keep in mind that the refundable tax expenditures above represent amounts over and above the amount of tax initially collected from the affected taxpayers. Thus, these are not income tax refunds at all, they are social welfare payments, confiscated from taxpayers, and handed over to non-taxpayers through the tax code.

Does the act of filing a tax return make one a taxpayer?

The reality is that a great number of tax returns are filed simply to receive refundable tax credits. If there were no refundable tax credits, then it is conceivable that several million tax returns would not need to be filed. And, if millions of citizens were excluded from filing income tax returns, then that would aid in reducing the size of the IRS, and thus the size of government. Isn’t this what most conservatives want?

That brings us to the following questions: How many tax returns are filed each year simply to obtain refunds in excess of taxes actually paid? And, how much money is being squandered in floating social welfare programs through the tax code?

First of all, these days we hear a lot of people whining about the tax code being too complex, so in Part I, we asked the question: How complicated is your tax return? To bring the numbers up to date, we checked the IRS 2009 Data Book (preliminary). We found that for tax year 2009, out of the 140,532,115 individual tax returns filed, only 59.7% filed the more challenging long-form 1040, while 28.4% filed the short-form 1040-A, and 12% filed a simplified form 1040-EZ (see table below). So from this we can see that 40.4% of Americans, who filed 2009 tax returns, filed fairly simple forms.

The data also shows that 65.8% of filers, 92,518,891 out of 140,532,115, utilized the basic standard deduction, while only 32.5%, or 45,640,583, itemized their deductions. It is a fact that only 74.3% of the returns filed contained taxable income, and just 61.3% resulted in an income tax liability. Meanwhile, the majority, 62.6% of filers, claimed tax credits.

With 65.8% of taxpayers claiming the standard deduction, 62.6% claiming tax credits and 40.4% filing simple tax forms, there is potential to eliminate the filing requirements for perhaps as many as 56,702,628 households (the lowest common denominator).

The following table was derived from estimates published by the Joint Committee on Taxation (JCT). You will note that the JCT data reflects the total number of returns as 156.8 million, versus the IRS report of 140.5 million. The reason for the difference is that the JCT estimate includes both filing and non-filing tax units. Non-filing tax units include individuals with income that is exempt from Federal income taxation (i.e. transfer payments, interest from tax-exempt bonds, etc…). Note: The JCT data also excludes individuals who are dependents of other taxpayers and those with negative income.

From this, we can conclude that at least 16 million persons, with positive income, are not required to file income tax returns. This is not complicated to follow. Generally speaking, if a taxpayer’s income is less than the applicable standard deduction, and personal and dependency exemptions, then they are generally not required to file a return. The only reason that a return would be filed, when one is not required, would be to obtain a refund of an overpayment of tax withheld, or to receive a refundable tax credit.

From this data we also learn that 81,458,000 out of the 156,878,000 returns, or 51.9%, were considered to be non-taxable. We can also see that 106,865,000 returns out of the total of 156,878,000, or 68.1%, did not itemize deductions.

Thus, from the perspective of the US Congress, there should be room for the elimination of additional pointless compliance. Since 16 million Americans were already eliminated from annual filing rites, what would be wrong with exempting several more million, especially those who take out of the tax system more than they put in?

The next chart (above), also from JCT data, shows the distribution of income tax liability by income class. From this, we can see that most of the returns filed, with less than $30,000 in annual income, had negative tax liabilities. In fact, only 10,071,000 returns out of 70,091,000, or 14.4% of those with income under $30,000, were taxable, while 85.6% were non-taxable.

Even more striking is that the returns in this income category had a cumulative negative tax liability of $66.9 billion. We may further infer that almost all of the $71.5 billion in taxes, paid by those who made between $40,000 and $75,000 per year was collected for the sole purpose of being redistributed to those who made less than $30,000.

I submit that the mission of the Internal Revenue Service ought to be to collect what is required to fund the federal government, not to redistribute funds received from some taxpayers directly to others. The fact that federal revenue is being spent before the funds ever hit the US Treasury’s coffers should be alarming.

What should be clear is that removing the filing requirement for approximately 60,020,000 (70,091,000 – 10,071,000) taxpayers would result in federal savings of at least $66.9 billion per year ($669 billion over 10 years). Since the tax code already eliminates the filing requirement for 16,000,000 persons, the potential exists to exclude an additional 44,000,000 (60,020,000 – 16,000,000). But that’s not the end of the story.

Exponential Growth of the EIC

The following table, derived from the IRS 2010 Data Book, shows that in the first 18 years after implementation of the Earned Income Credit, from 1975 to 1992, the IRS expended a total of $67.5 billion, $49.4 billion of which was refundable.

The next table, derived from the same data book, shows that in the subsequent 17 years, from 1993 to 2009, the IRS gave away a total of $615 billion through the EIC, $530 billion of which was refundable. So the amount of EIC spending grew nearly 10-fold in the second period.

The Earned Income Credit has thus grown from initially giving 6.2 million families an average tax credit of $201, in 1975, to granting an average credit of $2,206 to some 27.3 million families, in 2009. With the current level of spending in excess of $60 billion per year, the IRS will give away more, on the EIC, in the next 10 years, than was spent in the first 35 years of the program. Will the spending ever end?

Waste, Fraud, and Abuse

Social benefit programs add complexity to the tax code and represent a large part of tax expenditures, or government spending structured through the revenue system. To address the complexity and other implications of tax expenditures, the National Taxpayer Advocate has recommended, “adoption of a process to evaluate whether a tax expenditure presents an administrative challenge, and if so, the extent to which it achieves its intended purpose”.

I would contend that the answers to her questions are self-evident, and further evaluation is unnecessary. For had the Earned Income Credit been sufficient, then there would have been no need for the Child Tax Credit, the Making Work Pay Credit, or the 2% Payroll Tax Cut. Thus neither program has been effective. Their only accomplishment, thus far, has been to aid in the accumulation of $15 trillion in government debt, a $1.5 trillion budget deficit, and a downgrade to our national credit rating.

The IRS 2010 Data Book reveals that, in fiscal year 2010, 37% of the 1,581,394 individual returns audited by the IRS, involved the Earned Income Credit (above – click to enlarge). Among these, 556,809 returns had adjusted gross income below $25,000, and 28,393 reported adjusted gross income greater than $25,000. These EIC audits resulted in the recommendation of $2.3 billion in additional taxes.

Thus, eliminating the Earned Income Credit will not only save the federal government $60 billion per year (or $600 billion over 10 years) in tax expenditures, but it will eliminate the needless filing and processing of millions of returns, and reduce the number of audits by 37%. That’s significant in and of itself, but when we tack on elimination of the Child Tax Credit and Making Work Pay Credit (2% Payroll Tax Cut), we are talking about total savings of $855 billion over 5 years, or $1,710 billion over 10 years.

In addition, Table 28, of the 2010 Data Book (above – click to enlarge), shows that the IRS expended a total of $12.4 billion in its fiscal year 2010 operations. Thus elimination of the EIC, on its own, would allow the IRS to reduce its size by 37%, saving taxpayers an additional $4.6 billion per year ($46 billion over 10 years). Add that to the savings realized through elimination of the social welfare benefits associated with the EIC, CTC and MWP and this proposal will save the federal government $1,756 billion over the next 10 years. That’s more than three times my original goal. Problem No. 1 solved.

So what’s the bottom line? The administration of social welfare benefits through the tax code should be suspended immediately. By so doing, Congress will eliminate the unnecessary annual filing of more than 40 million tax returns, save the federal government $1,710 billion in tax expenditures, reduce the budget of the IRS by $46 billion, and will accomplish all of this without raising taxes, or eliminating critical spending programs.

References:

The Joint Committee on Taxation – Congress of the United States

IRS 2010 Data Book

National Taxpayer Advocate – 2010 Annual Report to Congress: Volume 2

Related:

Study: Michigan among states scaling back low-income tax credits

9-9-9 Plan | Prejudiced and Convoluted?

– By: Larry Walker, Jr. –

“A tax loophole is something that benefits the other guy. If it benefits you, it is tax reform.” ~Russell B. Long –

Herman Cain’s 9-9-9 Plan, which involves eliminating the 15.3% payroll tax, of which every dime is presently committed to current Social Security and Medicare payments (and then some), fails to address the main problem with modern day governing – the budget. Since it was just barely 3 months ago when our nation faced its first ever credit downgrade, any tax reform proposal which doesn’t lead to a balanced budget should be pronounced dead on the campaign trail. Replacing a 35% corporate income tax, a 35% personal income tax, and a 15.3% payroll tax, with 9-9-9, not only doesn’t balance the federal budget, but it shifts the burden of federal revenues to those who can least afford it. All that the 9-9-9 Plan really accomplishes is to disproportionately favor the well-off, while punishing the middle class, the working poor, children and the elderly.

I am well aware that some conservatives believe Herman Cain is a gifted mathematical genius, who has it all figured out. And I know that many have bought into his 9-9-9 proposal, without hardly any scrutiny. “Anything is better than what we have now”, some say. Even if it doesn’t make any sense to them, and even though many experts have disputed its claims, an element of conservatives have bought it, lock, stock, and barrel. But I’m not buying it. Herman Cain is human, and no human being is perfect. And to the chagrin of many, there isn’t any such thing as a perfect tax system. For whether a tax is progressive, flat, or regressive, each method involves tradeoffs. There are winners and losers under any policy. And besides, the concept of a flat tax turns out to be nothing more than a myth; there is simply no such thing, as we shall see.

I have never been one to settle for second best. I believe that there is an easier way to achieve the kind of tax simplification that most conservatives really want, a way which is in line with fiscally conservative objectives. And it’s something that could be achieved right now, today. I was never a proponent of taxing those who can’t afford it. The argument that 40% of taxpayers don’t pay any income tax was proffered to counter Barack Obama’s contention that he was going to give 90% of Americans a tax cut. The statistic was used in support of the common sense principle that, you can’t cut income taxes for someone who doesn’t pay income taxes. That was it, and I stand on that to this day. The 40% figure was never intended as a justification for forcing blood from turnips.

But ever since Herman Cain introduced his 9-9-9 Plan, I have heard a few conservatives argue that the poor need to pay their “fair share”. However, my only contention has been that the poor should not be receiving refunds of taxes they never paid. I think it’s enough to not owe any federal income taxes at all. The concept of transferring one man’s tax payment directly to another taxpayer is most detestable, and unnecessary. I have heard a few other conservatives’ state that they don’t care whether or not the federal government can pay its bills. They contend that if the government takes in less money under the 9-9-9 Plan, that Washington DC will be forced to spend less. But that’s not where I stand.

The federal government is already taking in $1.5 trillion less than it spends, so how would Herman Cain’s revenue reduction strategy fix this? It won’t. So the first step (Part I) towards tax simplification is to expose the shortcomings of the 9-9-9 Plan and other flat tax schemes. The second step (Part II) is to outline a plan for tax simplification which will not only eliminate unnecessary compliance, but will in the process, save the federal government $500 billion over 10 years.

Testing Cain’s 9-9-9 Plan

Cain’s main assumption is that the U.S. Tax Code is too complex and should therefore be thrown out and replaced, baby and bathwater. So in other words, he has given up on all other options of reforming the current tax code, and is advocating a radical transformation. I don’t know about you, but I’ve had about enough of fundamental transformations by radicals, on either end of the compass. We all know how Obama’s dream has worked out, but now, instead of simply taking our country back; some conservatives are exhibiting a rather disturbing desire for even more extraneous change.

Whenever a superfluous change is proffered, the first question among conservatives ought to be, “Has it ever been tried before?” And if it has been tried, then this should be followed up with, “How well or how poorly did it work?” But if said change has never been tried, then how would a conservative determine whether or not it would succeed? Well, if a proposed policy has been attempted we just need to analyze the data, and if it has not been tried, then we would simply need to locate and analyze the most similar comparables.

For example, we know that Communism has been tried before, and we know how that worked out. And we know that Universal Health Care plans have been implemented, and we know how they worked out. Real conservatives generally rely on facts and evidence rather than rhetoric. But so far, all we have heard from Herman Cain, and proponents of his 9-9-9 Plan is assertion and rhetoric, rather than analysis and evidence. When challenged, most of them simply resort to name calling and innuendo. But why is no one talking about how combination “flat / consumption tax” plans have fared elsewhere in the world? Well, lucky for us such plans have already been implemented, so there is already evidence available attesting to how well, or in this case, how poorly they have performed.

Flat Tax: Fact or Fallacy?

Most of the EU member states have “progressive” systems under which earners pay higher income tax rates on increasing levels of income. However, seven EU countries – Bulgaria, Czech Republic, Estonia, Latvia, Lithuania, Romania and Slovakia – have had “flat tax” systems in place, some for more than a decade. According to a recent study, ‘Workers’ salaries are taxed at higher rates in “Flat Tax” countries than in “progressive” systems’. This is simply a fact, based on analyzing the evidence, not mere rhetoric.

When it comes to Herman Cain’s Plan, as we have repeated three times previously, according to a study on the 9-9-9 Plan conducted by the non-partisan Tax Policy Center:

1. “The 9-9-9 Plan would cause 95 percent of people making $1 million or more to receive tax cuts averaging $487,300,” and
2. “Only 16 percent of people making between $50,000 and $75,000 a year would get a tax cut, averaging $1,959, and at least 70 percent of people in this middle-income category would see their average federal taxes rise by $4,326.”

Conservatives who dispute this claim have, thus far, failed to provide any evidence to the contrary.

It should be noted that flat taxes in the seven EU countries generally apply only to the income tax, as none of the seven have eliminated social security taxes. For example, Slovakia has an individual and corporate “flat tax” rate of 19%, but its employers pay a 35.2% contribution to social security, and in addition to the flat income tax its employees have 13.4% of their pay deducted for social security. Add to that Slovakia’s 19% Value Added Tax (VAT) and you have the full package. When you total it all up, the average worker in Slovakia pays total taxes, as a percentage of real gross income, of around 45.5%. So if tax rates are so high in Slovakia that its plan equates to a 19-35.2-19-13.4-19 Plan, then what makes proponents of the 9-9-9 Plan think that it can cover all of the obligations of the United States with such dramatically lower rates? Do they have any evidence, or just words?

In 2006, the International Monetary Fund (IMF) published a working paper by Michael Keen, Yitae Kim, and Ricardo Varsano entitled, The “Flat Tax(es)”: Principles and Evidence. The study describes the world’s most recent flat tax adoptions as, “quite radical reforms, marked more by assertion and rhetoric than by analysis and evidence.” In other words, public opinion has been swayed, more by confabulation than by a careful assessment of facts. Two of the conclusions of the study were as follows:

1. “In no case does there appear to have been a Laffer effect: these reforms have not set off effects strong enough for them to pay for themselves.”
2. And, “looking forward, the question is not so much whether more countries will adopt a flat tax, as whether those that have will move away from it.”

So the dynamic implications associated with Cain’s 9-9-9 Plan probably won’t materialize, based on available evidence. And today’s proponents of the flat tax have conveniently chosen to ignore the experiences of other countries. If countries who adopted flat tax policies in the 1990’s are on the verge of returning to “progressive” systems, then isn’t it entirely possible that our current tax framework is already the best in the world? And why wouldn’t it be? Are we not, after all, exceptional?

Tax Simplification

In terms of tax simplification, the authors of the IMF working paper concluded that, “the rate structure itself is commonly not the primary source of complexity in taxation. This comes more from exemptions and special treatment of various kinds. For example, the (limited) survey evidence for Russia does not suggest that the system was widely seen as significantly less complex after adoption of the flat tax.” Herman Cain has already modified his plan to provide exemptions for individuals and businesses associated with “empowerment zones”. He has also included a deduction of dividends for businesses, an exception for capital gains, an exclusion of charitable contributions for individuals, and others, but these are most likely just the tip of the iceberg.

How will the government determine which areas qualify as empowerment zones? Will there eventually be a push for additional exemptions for poor people who reside outside of empowerment zones? What about allowing a deduction for charitable contributions at the corporate level? Then there will likely be an outcry for exemptions for college students, widows, widowers, the elderly, active military, and on and on. Overtime, the overly simplistic 9-9-9 Plan may become more complicated than our present system. One need only examine the Russian experiment to see how convoluted a “simple” flat / consumption tax system may become. What other exemptions will be granted, and how will those be calculated?

As pointed out in the IMF working paper, the presence of a tax-free threshold means that there are really two marginal tax rates (one of them being zero), so that problems of tax arbitrage, withholding and averaging do not disappear under flat tax regimes. There will still be complications, such as in arranging proper withholding from those with multiple jobs (to ensure that they receive the tax-free amount only once). In Cain’s 9-9-9 outline, he states that there will be exemptions for people who either live within, or work within empowerment zones. So where an individual lives outside of an empowerment zone, but works at one job within a zone, and a second job outside of the zone; or where a business owner lives outside of an empowerment zone, but owns multiple businesses located within and outside of such zones, it is possible that the 9-9-9 Plan will create more complexities, not fewer.

Public Servants and Ministers: 0-18-9

Back in the 1990’s when the United States Congress last considered the flat tax, a paper was written entitled, Flat Tax: An Overview of the Hall-Rabushka Proposal. It was written by Mr. James M. Bickley, for Members and Committees of Congress. In the paper, Mr. Bickley affirmed that, “in some instances, a flat tax can be more complicated (rather than simpler) than the tax it replaces”. For example, he points out, that employees of federal, state and local governments, and non-profits would have to add to their wage base the imputed value of their fringe benefits. “Hence, a separate individual wage tax form would be necessary for these employees.” He adds that, “The actual calculation of the imputed value of fringe benefits would be complicated.”

As I mentioned previously, since businesses are not allowed to deduct wages for tax purposes under the 9-9-9 Plan, and since government entities, and non-profits don’t pay income taxes, the simple rule of not allowing a deduction for wages would have no effect upon them. However, under our present tax system, because employers pay a matching portion of Social Security and Medicare payroll taxes, all employers are on equal ground, where they would not be under the 9-9-9 Plan. So how will this be resolved? Will government employees, ministers, and other non-profit employees be taxed at higher rates in order to make up the shortfall? Or will those who actually pay taxes under Cain’s plan unknowingly subsidize such entities? In this matter, Cain’s proposal becomes more complicated, not simpler.

To give us a better idea of the complexity surrounding non-taxable entities, as of the 3rd quarter of 2011, per Table 2.2B – Wage and Salary Disbursements by Industry, the U.S. Bureau of Economic Analysis estimated that the annualized amount of wages and salaries paid in the U.S. was $6.7 trillion. However, out of this amount, $1.2 trillion (or 18 percent) was paid by federal, state and local governments. And according to the National Center for Charitable Statistics, employees of nonprofit organizations would account for 9 percent, or roughly $670 billion of the wages paid in the U.S (2009 data). So overall, without additional rules and regulations, roughly $1.8 trillion of wages paid by governments and non-profits would escape Cain’s 9% business flat tax. Since tax exempt entities don’t pay income taxes, government workers may have to pay additional taxes on their benefits in order to be on a level playing field with private sector employees. Thus, describing the 9-9-9 Plan as “simple and fair” may be a gross overstatement.

How complicated is your tax return?

In his flat tax analysis prepared for Members and Committees of Congress, Mr. Bickley admits that the current income tax system is complex. He is sympathetic to the fact that the federal tax code and regulations are lengthy and continue to expand. He agrees that many taxpayers spend much time, money, and effort complying with the current income tax system. And that the complexity of the tax code and the fear of the Internal Revenue Service (IRS) have caused many taxpayers to pay for professional assistance. I generally concur, but let’s review the facts.

For tax year 2000, a micro-simulation model developed jointly by IBM and the IRS estimated the amount of time and money that individuals spend on federal tax compliance. The authors found that “in tax year 2000, 125.9 million individual taxpayers experienced a total compliance burden of 3.21 billion hours and $18.8 billion.” This translates into an average burden of 25.5 hours and $149 per taxpayer. These are just averages, but it doesn’t sound like that much when broken down to the individual level. For example, when compared to the 9-9-9 Plan, which would raise taxes by an average $4,326 on 70% of people making between $50,000 and $75,000, I would hardly call spending 25.5 hours or paying $149 for assistance a huge burden. The big question is – How many Americans would rather pay $4,326 more in taxes, than spend a couple of weekends preparing their own tax return, or pay less than 4% of that amount for assistance?

Furthermore, I agree with Mr. Bickley that, “the complexity of the income tax should not be overstated.” For example, in tax year 2003, only 59.4% of taxpayers (78.75 million out of 132.38) paid for the preparation of their returns. Yet for tax year 2004, the Internal Revenue Service reported that only 34.8% of tax returns (46.19 million out of 132.38 million) were filed by individuals who itemized their deductions. That means roughly 32 million, or 24% of taxpayers paid for tax preparation when they could have simply filed their own 1040-EZ, or short-form 1040-A, which are far from complex.

Are IRS Forms 1040-EZ and 1040-A so complex that 32 million Americans have to pay to have them prepared? I think not. These are after all akin to yesterdays versions of Rick Perry’s postcard sized tax return. You know as well as I do that the reason at least 24% of taxpayers pay to have their tax returns filed is not due to complexity, but rather because they want to receive a refund as quickly as possible, and with the least possible effort. In other words, for at least 24%, paying for tax assistance is a matter of convenience, not a burden. I must admit that cleaning my home and mowing my yard are not that burdensome, and I am pretty adept at either, nevertheless, I choose to pay a housekeeper and gardener. There are things I could do for myself that I would rather not. We shall revisit the 24%, and deal with the remaining 76% in Part II.

In conclusion, no matter how simple Herman Cain’s 9% business flat tax, 9% individual flat tax, and 9% national sales tax sounds, under his proposal some citizens would be covered by a pure 9-9-9 tax; while empowerment zone residents, workers, and businesses would be subject to either 9-0-9, 0-9-9, or 0-0-9 plans; and employees of governments and non-profits may be subordinated to something resembling a 0-18-9 plan. The point is that, what portends to be “fair and simple” may turn out to be “prejudiced and convoluted”, or in other words worse than our present system.

To be continued in – Tax Simplification, Part II

References:

http://www.taxpolicycenter.org/taxtopics/upload/412426-Cain-9-9-9.pdf

http://www.langlophone.com/20100526_edition/20100526_EU27_data_table_flipped.pdf

http://congressionalresearch.com/98-529/document.php?study=Flat+Tax+An+Overview+of+the+Hall-Rabushka+Proposal

http://www.imf.org/external/pubs/ft/wp/2006/wp06218.pdf

***2nd Revision***

Even our brightest may be deceived! ~Anonymous Blogger –

By: Larry Walker, Jr. –

Continued from: 3rd Concern with the 9-9-9 Plan –

Mr. Cain’s main argument against the fact that his plan redistributes wealth from the poor to the rich is that, “it does no such thing.” But what does that mean? Simply stating “it does no such thing” doesn’t satisfy the anxiety. The real concern is that since the top 1% of income earners pay 38% of all income taxes, and because the 9-9-9 Plan reduces their tax rate by 74%, while at the same time exempting empowerment zone residents, that either a greater burden of taxes will be borne by the middle class and working poor, or the United States will go down in flames in a matter of weeks instead of years.

According to a study on GOP flat tax proposals conducted by the non-partisan Tax Policy Center, the 9-9-9 Plan would cause ’95 percent of people making $1 million or more to receive tax cuts averaging $487,300′. The dilemma is that since Mr. Cain claims his plan to be revenue neutral, that is to say, the amount of total taxes collected today will be the same under his plan, then where will the money come from to make up the shortfall? You guessed it! From the same study conducted by the Tax Policy Center –

“Only 16 percent of people making between $50,000 and $75,000 a year would get a tax cut, averaging $1,959, and at least 70 percent of people in this middle-income category would see their average federal taxes rise by $4,326.”

So I guess Mr. Cain better hope that the middle class, who are busy working everyday and taxed enough already, aren’t paying too much attention to his claims. But I don’t think that’s the case. Perhaps Mr. Cain needs to go back to the drawing board. So here’s what the Obamas actual 2009 tax return would look like against the 9-9-9 Plan.

When you remove a 15.3% payroll tax, a 35% corporate tax, and a 35% individual tax and replace them with 9-9-9, it doesn’t measure up. In order for the Obamas to make up the shortfall they would have to spend $14,755,022 on items subject to the 9% national sales tax (take the tax cut of $1,327,952 and divide it by 9%). That’s almost 3 times their current gross income. So unless the Obamas run out and buy a new house, or otherwise figure out how to spend 3 times more than they make, on items subject to the sales tax, that revenue will never come back from them. The government will either go broke, or the middle class – 70% of those making $50,000 to $75,000 – will really end up paying $4,326 more in taxes, just like the Tax Policy Center said.

As you know (or maybe not), like many others, not all of the Obamas income is from wages paid by an employer. Actually all $374,460 of his wages were paid by US taxpayers. The other 9% tax on his self-employed business income is already included in the table. Obama’s business didn’t really have any expenses, so no sales tax would be collected there. So did taxing the Obamas self-employed business income the other 9% make up the shortfall? No. So will the 9-9-9 Plan tax the federal government for the other 9% on Obama’s wages in addition? No.

Does the federal, or do state and local governments even pay income taxes? No. So under the 9-9-9 Plan, what tax return will government entities not be allowed to deduct wages from? When it comes to government workers, their employers will not be paying the other 9%, because their employers don’t pay income taxes. You can add other tax exempt organizations to that list as well. And when it comes to the self-employed, and small business owners, some will benefit and some won’t. Those who make more than $330K will clearly benefit more under 9-9-9, while most everyone else will pay higher taxes. That’s why this dog won’t hunt.

By proof, policies have consequences – The 999-Plan will create a host of unintended social problems which naturally occur on the other end of Laffer’s curve. Giving average tax cuts of $487,300 to 95% of people making over $1 million per year, and increasing the tax burden on the working poor and middle-class, solves nothing. Yes I am a conservative, and if you don’t believe it then read the rest of my blog. I’m not too sure how to classify Mr. Cain’s 9-9-9 Plan, but from my point of view, 9-9-9 is not a conservative plan, and not something that conservatives should even be considering. Had Mr. Cain not risked his entire campaign upon this flimsy reed; he might have had my support. But if Herman Cain is somehow able to win the Republican Party nomination, I’ll be casting my vote for the first viable 3rd party candidate.

Source:

http://www.whitehouse.gov/sites/default/files/president-obama-2010-complete-return.pdf

Conservatives vs. 999ers –

By: Larry Walker, Jr. –

Under the 9-9-9 Plan, “95 percent of people making $1 million or more would get a tax cut that averaged $487,300.” ~Tax Policy Center –

At a Michigan website entitled, North Star Writers Group, Herman Cain attempted to address some of the criticism to his 9-9-9 Plan. The article, dated October 16, 2011, is entitled, “9 responses to 9 false attacks on the 9-9-9 plan”. But somehow Mr. Cain has confused what is merely constructive criticism with “attacks”. I mean it’s as if when one asks Mr. Cain a valid question these days, he either gets it wrong the first time, or he simply pulls the ‘assault card’. Yet, after I criticized Mr. Cain’s plan (not him personally), when I wrote an article entitled, “Herman Cain’s 9-9-9 Sham”, I was personally labeled as a Marxist, Communist, as naïve, an idiot, and a left-wing shill. And all of that came from fellow, so called, conservatives. So has Mr. Cain’s plan really been “attacked”, or are perhaps the 9 concerns, which he deems to be false attacks, simply valid points?

Personally, I think that when conservatives start calling fellow conservative’s naïve, Communist, Marxist, idiots, and left-wing shills somebody’s got a problem. To contrast, the article I wrote immediately prior to my critique of Mr. Cain’s tax plan was entitled, “Obamacare’s Deadweight Loss”, and with that I was practically branded as a conservative champion, by way of private commentary. But apparently, sometime between October 12th and October 23rd, I either lost my mind, or I unwittingly signed on with the Communist Party USA. I’ll let you decide. Okay, so today I’m not going to list all 9 of the concerns that many have with the 9-9-9 Plan, but just the 3rd, and Mr. Cain’s response.

Claim 3: The plan redistributes wealth from the poor to the rich.

Response: “It does no such thing. It is fair and neutral, taxing everything once and nothing twice. What’s more, we are getting ready to propose empowerment zones for economically struggling areas in which the rates will be even lower. That will allow the poor to benefit even more from the plan than they already would.”

Mr. Cain’s main argument against the fact that his plan redistributes wealth from the poor to the rich is that, “it does no such thing.” But what does that mean? Simply stating “it does no such thing” doesn’t satisfy the anxiety. The real concern is that since the top 1% of income earners pay 38% of all income taxes, and because the 9-9-9 Plan reduces their tax rate by 74%, while at the same time exempting empowerment zone residents, that either a greater burden of taxes will be borne by the middle class and working poor, or the United States will go down in flames in a matter of weeks instead of years.

Also, according to Mr. Cain, “it is fair and neutral, taxing everything once and not twice”. But this is simply not true. As proof, since the 9-9-9 Plan doesn’t allow businesses to deduct wages in determining taxable income, it in effect imposes a 9% tax on wages at the corporate level, and then taxes wages again at the individual level. So how is this not taxing something twice? And further, when the same wages are spent into the economy, they are hit again by a 9% national sales tax. So wages are not only taxed once or twice under Mr. Cain’s plan, but at least three times. Following are two hypothetical examples of what the 9-9-9 Plan will accomplish when it moves from Cain’s chalkboard to the real economy.

Example 1

For example, in the table below, a couple has wages of $1,000,000 and only claims the standard deduction and personal exemption(s). Under the current tax code they would pay federal taxes of $334,043, and only $90,000 under the 9-9-9 Plan. Thus, under Mr. Cain’s plan, this couple would receive a tax cut of $244,035. And in order to make up for the shortfall in revenue, by way of his national sales tax, the couple would need to spend $2,711,500 (244,035 / .09) on items subject to the 9% sales tax, or almost three times the amount of their earned income.

Example 2

Since under the current tax code, the taxpayer’s in the first example are already in a 35% marginal tax bracket, if they earned an additional $1,000,000, they would pay federal taxes of $698,543 under the current tax code, versus $180,000 under the 9-9-9 Plan. So under Mr. Cain’s plan, this couple would receive a tax cut of $518,543 (see table below). And in order to make up for the shortfall in revenue, by way of the national sales tax, the couple would need to spend $5,761,588 (518,543 / .09) on items subject to the 9% sales tax, or almost three times the amount of their earned income.

According to a study on GOP flat tax proposals conducted by the Tax Policy Center, the 9-9-9 Plan would cause ’95 percent of people making $1 million or more to receive tax cuts averaging $487,300′. The dilemma is that since Mr. Cain claims his plan to be revenue neutral, that is to say, the amount of total taxes collected today will be the same under his plan, then where will the money come from to make up the shortfall? You guessed it! From the same study conducted by the Tax Policy Center –

“Only 16 percent of people making between $50,000 and $75,000 a year would get a tax cut, averaging $1,959, and at least 70 percent of people in this middle-income category would see their average federal taxes rise by $4,326.”

So I guess Mr. Cain better hope that the middle class, who are busy working everyday and taxed enough already, aren’t paying too much attention to his claims. But I don’t think that’s the case. Perhaps Mr. Cain needs to go back to the drawing board.

Laffer’s Folly

In a second article written in the same venue entitled, “Arthur Laffer brings reality to 9-9-9 discussion”, Mr. Cain states that, “Contrary to some of what you hear in current conversation, the theory of the Laffer Curve was proven correct when Ronald Reagan cut marginal tax rates across the board in 1981, and federal revenues soared. So did deficits, of course, and that’s the part you usually hear about. But that’s because federal spending soared even more. Excessive spending, not insufficiently high tax rates, was the problem then and it’s still the problem today.”

Notice how Mr. Cain implies that it was “not insufficiently high tax rates” that was the problem back then, or today. That’s a double negative, but doesn’t Mr. Cain’s statement refute his own plan? If tax rates are not the problem today, but rather excessive government spending, then why are we even talking about a 9-9-9 Plan? A few month’s ago, conservatives were in unity behind a platform of not raising the Bush tax rates, and reducing government spending. Yesterday it was, “We don’t have a revenue problem; we have a spending problem.” But now, suddenly, it seems that many conservatives believe that all of our problems can be solved through Mr. Cain’s proposed wealth displacement. So does Mr. Cain’s plan balance the federal budget? Will it fix Social Security and Medicare’s solvency issues? If the answer is no, then what is the point?

Laffer’s curve – In the 1981 Act, Reagan cut the top tax rate from 70% to 50%, and closed many loopholes. He didn’t propose cutting the top rate to 9% and adding a 9% national sales tax. Reagan later raised the bottom rate from 0% to 15%, and cut the top rate down to 28%. But his plan was reasonable, while Cain’s proposition is extreme. On its own merits, the 9-9-9 Plan is extreme enough to fall off the other end of Laffer’s curve. Laffer defined a sweet spot somewhere in the middle – as when tax rates are too high, tax revenues decrease, and when tax rates are too low, tax revenues decrease, but when tax rates are just right, revenues will increase. But I believe that Cain’s plan overshoots the sweet spot by a long shot. In other words, if Reagan Era tax rates were the mark, and I believe that they were, then why not just bring them back?

Policies have consequences – The 999-Plan will create a host of unintended social problems which naturally occur on the other end of Laffer’s curve. Giving average tax cuts of $487,300 to 95% of people making over $1 million per year, and increasing the tax burden on the working poor and middle-class, solves nothing. Yes I am a conservative, and if you don’t believe it then read the rest of my blog. I’m not too sure how to classify Mr. Cain’s 9-9-9 Plan, but from my point of view, 9-9-9 is not a conservative plan, and not something that conservatives should even be considering. Had Mr. Cain not risked his entire campaign upon this flimsy reed; he might have had my support. But even if Herman Cain is somehow able to win the Republican Party nomination, I’ll be casting my vote for the first viable 3rd party candidate.

Related:

Herman Cain’s 9-9-9 Sham

More Questions than Answers –

By: Larry Walker, Jr. –

Herman Cain argues that the reason we need his 999-Plan is because the tax law is too complicated. But is it really? I’ve worked with the tax law for 30 years, and I don’t think it’s all that complicated. It may have some complex calculations, mainly related to a few special write-offs and credits, but the basic bedrock of the Internal Revenue Code isn’t at all complex. Following Cain’s logic, if the tax law is so complicated that it needs to be “thrown out” and replaced, then isn’t our entire legal system similarly complex? If you answered yes, then why not just throw out the entire United States Code, shut down all courts including the U.S. Supreme Court, and just substitute the 10-Commandments. Would that work for you? If not, then why would you be in favor of Herman’s Cain’s overly simplistic 9-9-9 Tax Gimmick?

Business Taxes

Under present tax law, business expenses that are ordinary and necessary for the production of income are deductible for income tax purposes. The reason such expenses are deductible is because they represent taxable income to the recipient. There’s nothing really complicated about this. Expenses such as wages, advertising, office supplies, vehicle expenses, postage, legal and professional fees, commissions, rental payments, utilities, uniforms, travel, meals and entertainment, telephone usage, insurance, licenses, interest expense, benefits costs, retirement plan contributions and others, which are incurred for the production of income, are deductible for federal tax purposes. Although state and local governments are exempt from federal income tax, a deduction for state and local taxes is also allowed, under the theory that taxpayers should not be taxed at the federal level on taxes paid locally. All such expenses are likewise deductible in determining an entity’s profitability under general accounting principles. Where the law gets complicated, as far as business taxes are concerned, is when it comes to accelerated depreciation and general business credits.

Accelerated Depreciation

The reason fixed assets are depreciable is that each has a limited useful life, so the cost is spread over the life of the asset. For example, a computer has a useful life of 3 years, such that at the end of three years it generally needs to be replaced, so a business is allowed to write-off the cost over a three-year period. However, special gimmicks have been instituted over the years to accelerate the write-off of assets, such as the Section 179 deduction, and 50% or 100% bonus depreciation, whereby at least half or the entire cost may be written off in the year of purchase. If society wants to get rid of the accelerated depreciation loophole, then all that’s required is for the legislature to change the law back to regular straight-line depreciation. It doesn’t take a genius to figure that out, nor does it require throwing out the entire tax code.

General Business Credits

The other place that the law departs from reality is when it comes to tax credits. General business credits are special privileges which allow a company to receive direct tax credits over-and-above the normal deduction. For example, under the new Small Business Health Care Credit, where a business would normally be able to deduct the costs incurred for its portion of employee’s health insurance, a tax credit may now be taken over and above the regular deduction. Where it gets complicated is in determining which businesses qualify for the credit. In order to qualify a business can have no more than 24 full-time equivalent employees, and the average amount of wages paid per employee cannot exceed $49,999 per year. To obtain the maximum credit, a business can have no more than 10 full-time equivalent employees who are paid an average of less than $25,000 per year.

To determine whether one qualifies for the Health Care Credit, a business must be able to calculate the number of full-time equivalent employees and the average amount of wages paid based on complex formulas. Further complicating matters, the business must include and exclude certain types of employees and certain wages. Finally, if the business does qualify, it must subtract the amount of the tax credit from the amount of the normal deduction. For more on this, see Obamacare’s Effect on Small Business. If Americans wish to get rid of the smorgasbord of general business tax credits, it could be accomplished through legislation. It doesn’t take an Occupy Wall Street protest, or a 999-Plan to make this change. All that’s required is leadership.

Getting rid of accelerated depreciation and general business credits would go a long way toward tax simplification. Once accomplished, tax rates may be reduced to more tolerable levels. It doesn’t take a genius or a 999-Plan to accomplish this.

Problems with Cain’s 9% Business Flat Tax

The most egregious problem with Herman Cain’s plan involves wages. Under current tax theory, when a business pays wages, the employee bears the tax responsibility, not the business. But under Cain’s upside-down theory, businesses will not be allowed to deduct wages from gross income, unless they reside in empowerment zones. So in effect businesses will bear a 9% tax burden on the wages and salaries that they pay, and in addition employees will incur a 9% tax on the same. The double taxation of wages in the 999-Plan represents not only a huge departure from basic income tax theory, but from common sense.

Interest expense is currently deductible for income tax purposes as it represents taxable income to the recipient. But under Cain’s theory, interest will no longer be deductible by the borrower, yet it remains taxable to the lender. This is also an extreme departure from common sense. Under Cain’s theory, a corporate officer who loans money to a majority owned company would be taxed on the interest income received, while his company would incur a 9% tax on the same. Who wants to pay a 9% tax on the interest paid to banks and other lenders? It’s not personal, it’s the principle…

Contributions to employee retirement plans are currently deductible for income tax purposes, because they represent future taxable income to the recipient. But under Cain’s plan, company contributions to retirement plans are apparently not deductible for tax purposes. In effect businesses will bear a 9% tax on such contributions and the recipient will bear another 9% tax upon the withdrawal. Again, this form of double taxation represents an extreme departure from basic income tax theory.

Employer paid health insurance premiums are currently deductible for income tax purposes, and not counted as income to employees, although theoretically it should be taxable to employees. But under the Cain plan, employer paid health insurance premiums will apparently not be deductible. In effect, employers will pay a 9% tax on top of the amount paid towards employee’s health insurance benefits. So an employer will be taxed whether or not it provides health benefits. Since there won’t be any incentive for providing health care coverage under the 999-Plan, what will occur? Will companies continue to pay for health benefits plus 9%, or will they just keep the money and pay the 9%? Absent any other requirements, what would you do?

9% Business Flat Tax

“Gross income less all purchases from other U.S. located businesses, all capital investment, and net exports.”

Since Cain doesn’t define the term, “purchases”, what exactly does the above statement mean? Volumes could be written to define this simple statement. For example, does the term “purchases” include services or is it limited to products? If a company buys supplies such as paper and toner, from other U.S. based businesses, are these items deductible, or does deductibility only apply to purchases of goods for resale? If a company employs the services of another business, are such services deductible as purchases? I only ask because if that’s all there is to the proposed tax code, then it’s not clear whether this statement applies to the purchase of services, goods at retail, goods at wholesale or all of the above.

Retail businesses presently buy goods at wholesale, paying no sales tax upon the purchase, but then charge sales tax upon resale. However, service companies buy their supplies at retail; as such products are for internal use and not for resale. Services are not subject to sales tax at the State level, but will they be under the 999-Plan? Will both retailers and service businesses have to pay the 9% national sales tax on U.S. purchases, or are retailers exempt, or are both exempt? If both types of businesses have to pay the national sales tax, then even if such purchases are deductible for income tax purposes, they will have already been subject to a 9% national sales tax upon purchase. The point is that the first half-sentence of Cain’s proposal, by itself, necessitates a myriad of rules, regulations and definitions.

“For if the trumpet gives an uncertain sound, who shall prepare himself for the battle?” ~1 Corinthians 14:8

Next, according to Cain, the amounts spent on capital investments will be deductible under his 999-plan. But Cain doesn’t define what he means by the term, “capital investments”. Although he has publicly referred to this passage as meaning the purchase of equipment, he hasn’t defined any limitations. Does this apply to new or used equipment, or both? Capital assets include all tangible property which cannot easily be converted into cash and which is usually held for a long period, including real estate, equipment, etc. Under current law, buildings and other commercial real estate are generally depreciable over a 39 year lifespan, while land is never depreciable. But since Cain doesn’t go into detail, and because he wants to “throw out” the current tax code, we have to ask, will a business be able to write-off the purchase of real estate including land, in full, in the year of purchase? Are there no limitations? Here are some more questions:

• If the purchase of capital equipment causes a company to have a net operating loss, can the loss be carried backwards and forward like under current law?

• Is the purchase of stock in another business considered to be a tax deductible capital investment under the 999-Plan? The purchase of stock would be treated as an asset and not as a deductible expense under current law, but would it be treated simply as a deductible expense under the Cain plan? He doesn’t say.

• Will there even be such a thing as a balance sheet under the new 999-plan, or will businesses simply need to account for gross income, purchases from U.S. businesses, capital investments, imports and exports?

• Under the 999-Plan, purchases from non-U.S. located businesses are discouraged. So does the term “purchases” include the purchase of capital equipment? If capital assets are purchased from overseas companies, will they be deductible because they are capital investments, or will they not be deductible due to the “purchases from other U.S. located businesses” clause? Again, it’s not clear.

Net exports are also excluded from the proposed 9% business tax. So it would follow that a U.S. based business, which sells more of its goods overseas than in the U.S., would be exempt from taxes. Thus businesses are encouraged to export their goods and services, which might be beneficial to large manufacturers or retailers, but not to small service based businesses which make up the bulk of the American economy. Does a U.S. company have to be based in the U.S., where it would employ American workers, in order to receive the exemption, or can it open an operation in Mexico, sell its goods there and escape the 9% tax? Cain doesn’t provide any details on the exemption for net exporters either.

“Empowerment Zones will offer deductions for the payroll of those employed in the zone”

Under the 999-Plan, labor intensive companies would not receive a deduction for wages, unless located in empowerment zones. With wages being the bulk of gross income for many service sector businesses, under Cain’s 999-Plan it is possible for a business to have zero or negative income, according to generally accepted accounting principles, and still owe taxes. Also, in spite of the proposed repeal of Social Security, Medicare, and (I guess) Federal Unemployment, since these taxes were previously deductible for income tax purposes, the full effect of their elimination is somewhat mitigated. In other words a business can breakeven, and still wind up having to borrow money at the end of the year in order to pay a tax bill. So will more businesses simply relocate to empowerment zones under Cain’s plan, or will some just get the short end of the stick while others receive a big fat special interest type government subsidy?

“That dog won’t hunt.” ~Herman Cain

Non-Deductible Business Expenses under the 999-Plan

• Wages paid outside of empowerment zones
• State and local taxes
• Federal and State and Local Licenses
• Purchases from foreign based companies
• Mortgage Interest Expense?
• Business Interest Expense?
• Retirement Plan Contributions?
• Health Insurance Premiums?

Example 1

The following small business corporation has a single-owner, is labor intensive, and is not located within an empowerment zone. As you can see, in the example below, the company has net income of -0- under current law, and net income of 8,088.50 under the 999-Plan. This is attributable to the elimination of payroll taxes which were also deductible for income tax purposes. The company has taxable income of -0- under current law, but would have taxable income of $128,318 under the 999-Plan. This is attributable to its deductions being limited to capital investments and purchases from other businesses, versus all ordinary and necessary expenses.

Thus, where Federal, State, and National Sales taxes are all -0- under current law, they would be $21,199.08 (11,548.62 + 7,999.08 + 1,951.38) under the 999-Plan. When the total business taxes are subtracted from net income, after-tax income is -0- under current law, but would be negative (-13,110.58) under the 999-Plan. So the owner will either need to borrow money to pay the taxes, or add money from personal accounts to shore up the company. Let’s hope that the 9% Individual Flat Tax leaves the owner with enough to cover the company’s shortfall.

9% Individual Flat Tax

“Gross income less charitable deductions”

Most of us know what the term “gross income” means, but what does it mean under the 999-Plan. If an individual has a sole proprietorship, will they be taxed on gross income and not be allowed to deduct ordinary and necessary business expenses? Will those who own rental properties pay a 9% tax on gross rental income without the benefit of deductions for mortgage interest, real estate taxes, insurance, repairs and depreciation? Will employees who incur substantial unreimbursed employee expenses be denied the benefit of deducting such costs?

• Since there won’t be a deduction for state and local taxes, including real estate taxes, one will in effect pay a 9% tax on the amount of State taxes paid.

• Since there will no longer be a deduction for mortgage interest, there won’t be any incentive to payoff an existing mortgage. Homeowners will in effect be paying a 9% tax on the amount of mortgage interest paid. Won’t this cause more families to simply abandon their houses for rentals? Will the plan push us from a private ownership to a public or corporate ownership society?

• Since there is no deduction for the amount of national sales taxes paid, taxpayers will in effect pay a 9% tax on the 9% national sales tax as well.

• Since there is no deduction for retirement plan contributions, taxpayers will pay a 9% tax on contributions and another 9% on the same money when the funds are withdrawn. If one currently owns a ROTH retirement plan will they receive an exclusion from the 9% tax when the funds are withdrawn?

• Will life and disability insurance proceeds, which are currently exempt, be subject to the new tax?

• Since the 9% Individual Flat Tax doesn’t distinguish between being married, single, widow, widower, or having one child or ten, what will our society look like after this plan is implemented? Will the population decline, as the cost of raising children is penalized? Will there be fewer marriages?

“Empowerment Zones will offer additional deductions for those living and/or working in the zone”

In other words, it’s not a flat tax after all; it’s a flat tax with exceptions for certain special interest groups. If businesses and citizens race to occupy today’s empowerment zones, will they eventually cease to be empowerment zones? And if no one takes the bait, and the masses instead flee from empowerment zones, what then? Will the government start issuing refundable tax credits, like it does today? Will the plan then become known as the +9, -9, +9, +9 Plan? That’s a 9% flat business tax, a 9% refundable tax credit, a 9% flat individual tax, and a 9% national sales tax.

Example 2

In the example below, individual income taxes are calculated on the owner of the small business corporation in Example 1. The owner is married with two dependents and the only income is wages paid by the company. The taxpayer pays mortgage interest, real estate taxes, state income taxes, and makes charitable contributions as shown in the table below. Under current law, taxable income is $59,355 versus $94,500 under the 999-Plan. That’s because the only item deductible for tax purposes under the 999-Plan is charitable contributions. Thus Federal income tax under current law would be $6,053.10 (8,053.10 minus a child tax credit of 2,000), and $8,505 with the 999-Plan. Although the taxpayer saves $8,032.50 under the 999-Plan by not having to pay Social Security and Medicare taxes, State income taxes would be higher, unless all states with an income tax rewrite their revenue codes, simultaneously.

Thus, after-tax income would be $60,446.65 under current law, and $64,270.00 under the 999-Plan, but that’s before paying the 9% national sales tax. If we subtract out 15% of after-tax income as savings and principal repayments on loans, that leaves the taxpayer with disposable income of $51,379.65 under current law, and $54,629.50 under the 999-Plan. Disposable income is the amount that a taxpayer will spend on items subject to the 9% national sales tax. After allowing for the national sales tax of $5,784.30, the taxpayer will wind up paying $1,960.95 more in taxes under the 999-Plan than under current law. So unfortunately, this small business taxpayer will not save enough on personal taxes under the 999-Plan to compensate for the businesses shortfall of $13,110.58. But how many people own small businesses anyway? More than you can imagine. Does it get better for companies with more than one employee? No. It would only get better if the business and its owner relocated to an empowerment zone.

9% National Sales Tax

“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.”

Once again, volumes could be written to define this overly simplistic statement. Cain has stated publicly that the national sales tax will be levied on the purchase of new houses, cars and other goods, but not on used items. When we were discussing this, someone in my office fired off, “So should I just start buying my clothes from Goodwill?” Why would anyone want to buy a new house if it will cost 9% more? A new $200,000 home would cost $218,000 under Cain’s plan. On face value, that doesn’t mesh with prices “being the same or lower” to me. This means that where a 10% down payment is required, that instead of looking at $20,000, a buyer will now have to come up with $21,800. And since the interest expense will no longer be deductible, what’s the point anyway? One wonders if there will even be any homebuilders left if this plan were to somehow pass.

A brand new $40,000 vehicle would cost $43,600 under Cain’s law, and that’s not including state and local tax, tag, and title. Most Americans can’t afford the former, so why would the latter be an improvement? So even if underlying prices remain the same under the 999-Plan, prices will, at the minimum, rise by 9%. The 999-Plan would only lead to an increase in used car sales, and a decline in automobile production.

Marginal production costs might decline for businesses that are not labor intensive, make all their purchases from U.S. suppliers, or are located in empowermnet zones; but what about labor intensive businesses, those dependent on foreign suppliers, and those located outside of empowerment zones? Under the 999-Plan, it is possible for a business to have a net loss and still owe taxes. As shown in Example 1, if a business spends 70% of its gross income on wages, and the rest on tax deductible expenses, even though it has no profit, it would still owe a 9% tax on the amount of wages paid. Thus where a business would have owed no taxes under present law, it may owe under the 999-Plan, which will drive up, not lower its production costs.

Eliminates double taxation of dividends –

If I heard Cain correctly, corporations would be able to deduct the amount of dividends paid, before computing taxes, so that dividends are only taxed once at the individual level. That’s a good thing, but if the current tax code is simply “thrown out”, and the IRS is shut down, what’s to prevent corporate officer’s from taking all, or most, of their compensation in the form of dividends instead of wages? Since wages won’t be deductible at the corporate level and dividends will, you can bank on this loophole being blown wide open.

Features zero tax on capital gains and repatriated profits –

No tax on capital gains? That reminds me of that old Better Business Bureau film entitled, “Too good to be true.” Yeah, if it sounds too good to be true, it probably is. Just like with dividends, if there is no longer an IRS, and if the current tax code is “thrown out”, what’s to prevent corporate officers and employees from being paid in stock, rather than wages, and then cashing in on tax-free capital gains later?

Also, since charitable contributions are the only deduction allowed under the 9% Individual Flat Tax, what happens with capital losses? Will capital losses be deductible against ordinary income, only against capital gains, or not deductible at all? He doesn’t say. So when Cain “throws out” the current tax code, and shuts down the IRS, who will write the new code? Will there be some kind of 999 Super Committee, charged with coming up with new tax theories, while barred from referencing the previous code?

Not taxing repatriated profits sounds good, but it also provides an incentive for companies to relocate overseas. So it’s either Mexico, or an empowerment zone, eh? Flip a coin. Although some have advocated for such a measure in lieu of another stimulus, no one was saying that it should be a permanent pillar of U.S. tax policy. Cain has merely picked up on a popular topic and wrapped it into what I would call basically a sham.

“Let’s get real.” ~Herman Cain

Okay, let’s get real. Cain is light on specifics, so one is resigned more to asking questions than analyzing data. It all sounds good on television, but the plan appears to be constructed mainly out of neat little sound bites designed to appeal to weak-kneed conservatives, rather than out of substance. Yes I am an accountant, and I am for simplifying the tax code, but I can’t go along with a plan that lacks common sense. In my opinion, we shouldn’t throw out our current tax code in favor of a poorly constructed plan, instigated by someone who knows nothing about income taxes. Herman Cain may know how to turnaround a pizza parlor, and he was a great local talk show host, but an accountant or economist he’s not.

Anyone serious about simplifying the tax code should be talking about the following:

1. Eliminating accelerated depreciation
2. Eliminating general business tax credits
3. Eliminating personal tax credits
4. Eliminating the alternative minimum tax
5. Lowering marginal income tax rates

That would be a good start. If you don’t think that eliminating the above and lowering tax rates would greatly simplify the income tax code, then you don’t know anything about income taxes.

If the 999-Plan were to somehow miraculously survive a left-wing insurrection, how would the 43 States that have an income tax calculate their taxes? Since most of the States begin with federal adjusted gross income and allow federal itemized deductions, and since under the 999-Plan federal adjusted gross income is simply gross income, and itemized deductions are limited to charitable contributions, then won’t all States have to rewrite their tax codes as well? States will have to decide whether they want to allow deductions for mortgage interest, property taxes, and other expenses which are currently deductible, and if they don’t, then the burden of State taxes will rise, further diminishing the effect of the 999-Plan.

Finally, since the 999-Plan interferes with or supplants other federal laws, it will necessitate repeal of the Federal Insurance Contributions Act, and involve drastic changes to how Social Security and Medicare benefits are calculated. Will Social Security benefits be based on gross income, whether earned or unearned? Will future benefits simply come out of the general fund? If so, then will paying social insurance benefits out of the general fund put a strain on the rest of the federal budget, leading to tax hikes in the future? Will the Federal Unemployment Act also be repealed, since it is part of the payroll taxes employers pay?

There’s more to 9-9-9 than 9-9-9. As far as I’m concerned, the 999-Plan is a total sham, and because Herman Cain has staked his entire campaign on it, he’s not fit to be President of the United States. What America lacks is leadership. Offering to lead the nation down an unproven, untested, and unsound path is no different than what we have today. What most of us want to hear from prospective presidential candidates is what will replace Obamacare, which regulations will be repealed, how the size of government will be reduced, and how the federal budget will be balanced. Herman Cain’s 999-Plan is nothing more than a diversion, designed to win a primary and lose an election. If you want four more years of Obama, then vote for Cain.

“WHEN THE FOLLOWERS ARE READY, THE LEADER WILL APPEAR.”

References:

http://www.hermancain.com/docs/999-for-web-10-12.pdf