With the economy continuing to falter and less than a year until the next presidential election, the effect of income taxes on economic growth and the need for income tax reform have become major campaign issues. Let's take a look at three of the top Republican contenders' stated plans for the U.S. tax system. (For more on the U.S. Tax system, read Understanding The U.S. Tax Withholding System.)
TUTORIAL: Economics Basics
Herman Cain's 9-9-9 Plan
Herman Cain proposes major changes to the current tax system. His 9-9-9 plan would replace the current tax system with three flat taxes: a 9% national sales tax, a 9% business tax and a 9% individual tax. The goal of his plan is to expand GDP, create jobs, increase wages and increase business investment. He also states that his plan would end the special-interest favors in the tax code.
This plan is not as simple as it might initially seem, because it still allows for a few adjustments in taxable income. For example, businesses would pay taxes on gross income less capital investments, net exports and purchases from other U.S. businesses, and individuals could still deduct charitable contributions from their income. His plan would also provide tax incentives to businesses and employees that locate and work in inner-city areas in need of renewal, which Cain calls Empowerment Zones.
The nonprofit Tax Policy Center states that because of the way the three 9% taxes interact with each other, Cain's plan is equivalent to a 25.38% national sales tax. The Tax Policy Center also estimates that the plan would raise about the same amount of revenue that the current tax code raises.
The tax burden under Cain's system would fall differently on households with different levels of income, because it is a flat tax, not a progressive tax like we currently have. Of course, our progressive tax system has not been successful in its goal of equitable taxation. A Tax Policy Center analysis shows that the plan would mean lower taxes for taxpayers with incomes of more than $200,000 (16% of taxpayers) and higher taxes for everyone else (84% of taxpayers). For example, taxpayers with incomes of $50,000 to $75,000 would see an average tax increase of $4,326 under Cain's plan. (For more on How your taxes are calculated, read How Your Tax Rate Is Determined.)
The plan would eliminate payroll taxes, creating a simpler and less bureaucratic system for both employers and employees. It would also eliminate the estate tax and capital gains taxes, and it would not tax business profits repatriated from overseas. Ultimately, Cain's plan would repeal the 16th Amendment, which gives Congress the "power to lay and collect taxes on incomes, from whatever source derived."
Rick Perry's Optional 20% Flat Tax
Perry's "Cut, Balance and Grow" plan aims to lower and simplify taxes and reduce government spending to improve economic performance. His 20% flat tax option would phase in over eight years. During the phase-in period, Americans could choose to file their taxes under either the current system or the new system. After choosing the flat tax system once, taxpayers would have to continue using the flat tax system in subsequent years. Taxpayers could choose which system to use, meaning that no one would initially see a tax increase. However, if Perry allowed the Bush-era tax cuts to expire, taxpayers who benefited from those cuts might pay more.
Under Perry's 20% flat tax system, taxpayers earning less than $500,000 would retain the mortgage interest, charitable contribution and state and local income tax deductions, and see an increased standard deduction of $12,500 for each individual and dependent. All other deductions and credits would be eliminated. Perry says this system would make it possible for Americans to file their taxes on a postcard and would save taxpayers hundreds of billions in tax compliance costs.
Perry would also lower the corporate tax rate to 20%, with a temporary 5.25% rate to encourage the repatriation of overseas income. He would also reform the corporate tax system from a worldwide-based system that taxes income earned anywhere in the world to a territorial tax system that only taxes income in the country where it is earned. Business tax deductions would be similar to those under the current system.
Perry says the plan "phases out corporate loopholes and special-interest tax breaks." However, the mortgage interest tax deduction could be considered a special-interest tax break for the residential mortgage and construction industries. It encourages Americans to do more business with these groups than they otherwise might by lowering the cost of having a mortgage.
Perry says he will eliminate the estate tax and the taxes on qualified dividends and long-term capital gains. He also wants to privatize Social Security for younger workers. Balancing the budget by 2020 and capping federal spending at 18% of GDP are also components of Perry's plan.
The Tax Policy Center states that the Perry plan would dramatically reduce federal tax revenues. However, because Perry also intends to dramatically cut government spending, the reduced revenues wouldn't be a problem. (For more on Flat Tax, read Should The U.S. Switch To A Flat Tax?)
Mitt Romney's 10% Corporate Tax Reduction Plus Lower Taxes On Savings and Investments
Romney's tax proposals are minor, compared to Cain's and Perry's. In fact, his campaign website contains almost no mention of taxes, other than a video clip from an Iowa State Fair campaign rally where he claims that he won't raise taxes. His "Believe in America Plan for Jobs and Economic Growth," a 160-page document available at MittRomney.com, also does not provide many specifics about taxes. Though we know where he stands on most major tax issues, he hasn't provided the level of detail about his tax policy agenda that Perry and Cain have.
Romney would make the Bush tax cuts permanent and eliminate taxes on interest, capital gains and dividends for taxpayers with adjusted gross incomes below $200,000. He would also cut the corporate tax rate to 25% and give a tax holiday to repatriated corporate profits. Like Perry, he supports moving to a territorial tax system for corporations.
Like the other Republican candidates, Romney would repeal the estate tax and the Affordable Care Act taxes. Also like Perry, Romney supports a balanced budget amendment. Romney proposes capping government spending at 20% of GDP as opposed to Perry's 18%.
As stated in his Believe in America plan, Romney would keep the current marginal tax rates, but pursue a "flatter, fairer, simpler" structure for the tax system in the long term. However, he does not provide specifics about what this long-term plan would entail. He refers to it as a "conservative overhaul" with "lower and flatter rates on a broader tax base."
The Bottom Line
There are many tax-reform proposals on the table, and a national discussion about the pros and cons of various tax policies and their effect on economic growth is certainly a worthwhile pursuit. Taxes consume a large percentage of many of our incomes and current rates of government spending are unsustainable without tax increases and/or spending cuts. It will be interesting to see whether any Republican candidate's tax plan proves a deciding factor in his or her nomination, and whether those campaign promises will become reality if a Republican wins the 2012 election. (To learn how a president can affect the market, see The Market And Presidential Promises.)