The Tax Foundation, which Cruz cited in the debate, spells out the terms: “Senator Cruz’s (R-TX) tax plan would enact a 10 percent flat tax on individual income and replace the corporate income tax and all payroll taxes with a 16 percent ‘Business Transfer Tax,’ or subtraction method value-added tax. In addition, his plan would repeal a number of complex features of the current tax code.” The plan repeals the estate and gift tax and the payroll tax. The income tax cut is substantial ($3.6 trillion) with a static model but all but $786B is made up in a dynamic scoring which also includes what in effect is a VAT tax. (Cruz does not specify spending cuts to make up the difference.) The income tax is not a pure flat tax since it retains a number of deductions and credits (home mortgage and charitable deduction, child tax credit, etc.) and familiar exclusions from income (e.g. employer provided healthcare insurance).
A Cruz adviser explains, “The plan exempts a large amount of initial income for low- and middle-income taxpayers, with a $10,000 standard deduction and $4,000 personal exemption. A family of four will pay no taxes on the first $36,000 of income. It also keeps the Child Tax Credit and expands the Earned Income Tax Credit. The analysis by the Tax Foundation shows double-digit increases in the after-tax incomes for low-income groups — and for that matter for all income groups.” He cites a number of respected conservatives who support a concept of a VAT.
On the plus side, the plan would generate roughly a 14 percent increase in GDP over time and overall after-tax incomes would rise roughly the same amount. But the problems are significant from a policy and a political standpoint.
For starters, the Tax Foundation analysis makes clear the income tax part is easily characterized as a boon to the rich:
Taxpayers in the bottom decile would see a 4.3 percent increase in after-tax income due to the expansion of the Earned Income Tax Credit, which more than offsets the impact of the new value-added tax. The next six deciles (the 10th through 70th percentiles) would see increases in after-tax adjusted gross income (AGI) of between 1.2 and 2.4 percent. High income taxpayers that fall in the highest income class (the 90-100 percent decile) would see an increase in after-tax income of 17.4 percent. The top 1 percent of all taxpayers would see a 29.6 percent increase in after-tax income.
It is a big break for the richest Americans, almost nothing for the middle and very little for poorer Americans. Moreover with the personal and business tax systems still in effect Cruz’s plan sacrifices simplification and would still necessitate a substantial taxing authority to police all this (rather than “abolish the IRS” as Cruz likes to say).
Cruz’s team points to the populist appeal in getting all companies to pay the new business tax. Actually, the new “business tax” is not a tax on businesses at all. It is hardly a populist-friendly idea and is unlikely to counterbalance the regressive nature of the personal income tax plan. Dan Mitchell of the Cato Institute praises the pro-growth aspects of the income tax part of the plan, but explains: “He says he wants a ‘business flat tax,’ but what he’s really proposing is a value-added tax. . . . His proposal is a VAT because wages are nondeductible. And that basically means a 16 percent withholding tax on the wages and salaries of all American workers (for tax geeks, this part of Cruz’s plan is technically a subtraction-method VAT).” In short, the corporate tax may vanish but the new business tax is in essence a tax on individuals. (Sen. Rand Paul (R-Ky.) also has both a personal income and VAT-type plan, so many criticisms of the latter apply to both plans.)
The American Enterprise Institute’s Alan Viard is concerned about many of the same elements:
Scaling back the income tax system and instituting a VAT would have advantages and disadvantages. Thanks to their VAT revenue, the Paul and Cruz plans achieve deeper income tax cuts, with smaller revenue losses, than other Republican presidential candidates’ tax plans. A VAT is much more growth-friendly than the income tax because it does not penalize saving and investment. However, it places more of the tax burden on those who are less well off. And, giving the government another major revenue source might make it harder to restrain entitlement spending growth.The concern about spending growth is heightened because Paul’s and Cruz’s proposed VATs would be hidden from public view – their plans do not include either of the two steps that can be taken to make VATs visible to the public. . . .If the United States is to have a VAT, it should be adopted in the light of day, not snuck through as a “business tax.” And, once adopted, its tax burden should be made visible to the American people, who have a right to know the full cost that they’re paying for their government.
Mitchell is likewise concerned that giving the federal government two revenue streams sets up Republicans for trouble. “So what happens 10 years from now or 25 years from now if statists control both ends of Pennsylvania Avenue and they decide to reinstate the bad features of the income tax while retaining the VAT? They now have a relatively simple way of getting more revenue to finance European-style big government. And also don’t forget that it would be relatively simple to reinstate the bad features of the corporate income tax by tweaking Cruz’s business flat tax/VAT.” There is a reason many anti-tax advocates including Grover Norquist’s Americans for Tax Reform have strenuously opposed adding a VAT while the income tax remains. A conservative economist with whom I spoke wisecracked that he’d only favor Cruz’s VAT if the 16th Amendment were repealed.
In sum, Cruz’s plan is concrete and detailed. His aim, properly so in our view, is to increase growth. He does recognize that a pure flat tax is not not going to fly. Still, his plan includes many of the same maladies we cited in other GOP contenders’ plans (lost revenue, big breaks for the rich) and it adds some news ones with the VAT. (That said, it is certainly more sophisticated than Dr. Ben Carson’s tithing-like scheme.)
The plan underscores the dilemma Cruz faces. Attacking fellow Republicans, engaging in no-win fights, and deploying high-voltage rhetoric have turned off a large swath of GOP voters. He cannot win the nomination with simply his hardcore base. (As we have discussed, moderate and somewhat conservative Republicans make up as much as 70 percent of primary voters.) He therefore broaden his reach and show he could govern responsibly, especially with Speaker Paul Ryan in office and hopes running high for conservative governance.
Unfortunately for Cruz, his insurgent role so overshadows everything else that he will have a steep uphill climb convincing voters outside his base. His tax plan — with pluses but considerable weaknesses and virtually no chance of getting through Congress — is not likely to win over very many of his skeptics.
Can he offer more viable proposals, win over new supporters and keep his base? It will be extremely hard given how seriously he has alienated a good deal of the party. That is why a candidate like Sen. Marco Rubio (R-Fla.), who appeals to many types of Republicans, has an easier path to the nomination. Nevertheless, if the tax plan is a sign of Cruz’s maturation as a lawmaker and candidate, Republicans should commend the effort.