Friday, November 13, 2015

So What Does the Cruz Flat Tax Mean for America?

Talk about the nuclear option! Ted Cruz's Flat Tax Plan:
  • Collapses the personal income tax down to one rate of 10% after a $36,000 deductible
  • Eliminates the payroll taxes
  • Eliminates the Death tax
  • Eliminates the corporate income tax
  • Imposes a 16% Business Flat Tax on business revenues, less deducations
So what does it all mean?

The reduction in personal income tax rates and the elimination of the corporation income tax is good, because it takes the game of loopholes away. Politicians love high tax rates because business and wealthy individuals will pay good money to carve out exemptions and subsidies.

The elimination of the payroll tax is yuuuuge. This is a monstrous tax on labor and in particular really burdens low-wage workers and low-wage employers. That's why so many workers work off the books and burden both on-the-books employers and employees.

The big question is the Business Flat Tax, which seems to be a tax on gross revenues. Cruz's site says: "The tax will be based on revenues minus expenses such as equipment, computers, and other business investments." That makes it sound that wage expenses will not be counted.

Here is what the Tax Foundation says about Cruz's plan, which it calls a VAT.
It’s actually pretty simple: there’s profits that go to shareholders, and there’s wages, salaries, and other compensation to workers. Both get taxed at the same rate: in this case, sixteen percent.

In that sense, a subtraction-method value-added tax is actually just a simple combination of a sort of corporate income tax and an ordinary payroll tax. (Fittingly, Senator Cruz’s plan uses this VAT to eliminate the corporate income tax and the payroll tax.)
According to the Tax Foundation businesses would deduct the monies they paid to other business for business services. But they would pay a tax of 16% on profits and and a 16% tax on labor (because the revenue that ended up as wages wouldn't be subtracted from its revenue.

This is, of course, a gigantic tax. If we assumed that the GDP is equal to about the gross revenue of businesses, then it amounts to a tax of 16% of GDP. No doubt it isn't that big. But still it is huge.

But let us assume, for the sake of argument, that the total Cruz taxes after the nuclear explosion are about the same as today's federal revenue at about 18% of GDP. What then?

Well what is going to happen is similar what the Austrian economists call "the liquidation of the malivestments of the previous boom." Today's businesses are organized around today's tax system and the exploitation of their business revenue by governments high and low. Today businesses pay a bunch of federal taxes on labor, from FICA to unemployment, some of which are passed through to employees and some of which aren't. It is obvious that many businesses are going to find that their business models are severely damaged by the Cruz plan. Others will find that they really benefit from the Cruz plan. At this stage, I suggest, nobody has a clue what will happen. My guess is turmoil for a couple of years, just like the first two years of the Reagan administration, followed by a staggering boom.

Of course, all the pettifogging tax regulations on business will be lighter, and that's a good thing. But nobody should imagine that such a remarkable change will be cost free. And don't imagine that crony capitalism will go away. There will still be ways to game the system and the lobbyists and the politicians will be working hard to make it happen.

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