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Flat Taxes and Gold: A Few Thoughts on Ted Cruz’s Economic Plan
U.S. Senator Ted Cruz, Republican of Texas, speaks at the First in the Nation Leadership Summit in Nashua, NH, April 18, 2015. Andrew Cline / Shutterstock.com
Full disclosure: I have written critically of the flat tax and gold standard as appropriate policy choices for the modern US economy. Frequently, in fact.
So there goes Ted Cruz in Wednesday’s debate endorsing both policies (kind of regarding the gold standard): “If you want a 10 percent flat tax where the numbers add up, I rolled out my tax plan today. … And I think the Fed should get out of the business of trying to juice our economy and simply be focused on sound money and monetary stability, ideally tied to gold.”
Some thoughts:
1) Cruz has momentum in the betting/prediction markets. Now that may have mostly, if not entirely, to do with his sharp attack on the media. But I can see how his economic plan would score well with many GOP primary voters who (a) think the tax code is hopelessly broken and (b) fret that the Fed’s “money printing” will lead to surging inflation or financial crisis.
2) To be fair, Cruz didn’t specifically say “gold standard.” I suppose you could just make Fed policy more dependent on what gold is signaling about inflation without returning to late 19th, early 20th century monetary system.
That said, here is the great free-market economist Milton Friedman on the gold standard (thanks to economist Roger Farmer for the pointer) in Capitalism and Freedom:
Even during the so-called great days of the gold standard in the nineteenth century, when the Bank of England was supposedly running the gold standard skillfully, the monetary system was far from a fully automatic gold standard. Even then it was a highly managed standard. And certainly the situation is now more extreme as a result of the adoption by country after country of the view that government has responsibility for ‘full employment.’ [A gold standard] is not desirable because it would involve a large cost in the form of resources used to produce the monetary commodity. It is not feasible because the mythology and beliefs required to make it effective do not exist. This conclusion is supported not only by the general historical evidence referred to but also by the specific experience of the United States.
Again, I think the consensus GOP take on monetary policy is misguided.
3) My AEI colleague Alan Viard wrote a must-read post yesterday on the Cruz tax plan, which combines a low flat income tax with a value-added tax — though Cruz doesn’t use that term. A key bit from Viard:
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 .A VAT can be split into a business cash flow tax and a wage tax, with the wage tax collected as an employee payroll tax that shows up on workers’ pay stubs. Or, the total VAT collected from businesses along the production chain can be listed as a separate line item on the final customer’s receipt, the way state and local retail sales taxes are listed. But, the Paul and Cruz plans would collect the VAT from businesses without listing it on customer receipts, ensuring that neither workers nor consumers would ever see the tax.
It’s a politically clever plan that allows Cruz to offer a super-low flat income tax at a rate not seen for a century. But it doesn’t lose the sort of revenue one might think because of the VAT. The Donald Trump plan, for instance, would lose $12 trillion ($10 trillion on a dynamic basis), according to the Tax Foundation, with a progressive tax code and 25 percent top rate. The Cruz plan would lose just $3.6 trillion statically, $800 billion dynamically. (Not that those revenue losses aren’t still pretty big.)
As the Tax Foundation’s Alan Cole explains:
It’s a powerful tax that captures pretty much all of the income in the country. … Ted Cruz has proposed combining the corporate income tax, the payroll tax, and some of the income tax into a single, larger, broader tax assessed on businesses. … The Cruz plan would give us a rate of equivalent to 19 percent, by the invoice credit method. Furthermore, if you counted sales taxes levied at the state and local level, this plan would put our consumption tax rate at around 26 percent, tax-exclusive. That is actually towards the high end of the range of ordinary OECD countries. For example, in Denmark and Sweden, the overall consumption tax rates are in the mid to high twenties. In Australia, the rate is ten percent, and in Japan and Switzerland, the rate is in the single digits. With this high VAT revenue (and much lower government spending than other OECD countries) the U.S. could sustain low income tax rates, such as the ten percent proposed by Senator Cruz.
4) Indeed, if one assumes the future US tax burden will need to rise for demographic reasons, the VAT provides an efficient mechanism for raising taxes in a less economically harmful way. Some Democrats talked about a VAT after President Obama’s 2008 election to pay for healthcare reform.
I would guess Cruz’s primary opponents will attack his VAT as enabling bigger government, especially given its “hidden” nature. But it does have some big economic merits, deficits aside.
Published in Economics
It lowers taxes and encourages long-term growth.
Since Cruz is proposing these as part of his income tax proposal, he’s specially treating income generally with his deductions.
How do you think a deduction for this or that is not a special treatment?
Eric Hines
Fascinating comment thread, especially given the gravitas of the participants.
I’ve not read Cruz’s plan other than bullet points.
I received a call today about the Cruz plan from a very like minded, far right gentleman who, like me, tends to support Cruz on most things. He is a very astute money manager (billion(s) AMU with books both written by and about him) and economist. He knows my general support of Cruz.
The nicest statement he made regarding the plan is “this is the worst thing I’ve ever read”. We discussed Jeb!, Trump, and Jindal’s plan also and again he reiterated points, some similar, to those here about how awful he considers the Cruz plan. We didn’t discuss Cruz’s comment about a pseudo gold standard.
Reading the OP and the comments, combined with this afternoon’s discussion and now I am dreading reading his plan.
Was he against the VAT or anything specific? If so what are his problems with a VAT?
Thanks, John I’d forgotten about that aspect of a VAT (should have remembered since my brother and Parents in Singapore do this with the Singapore GST all the time).
I am not sure how raising the deficit, cutting income taxes, hiding a 10% VAT, opening up a new avenue for taxation, and begging to have the income tax increased from only 10%, will necessarily lead to growth in the long run.
This is a card game. You might win, but the odds favor the house.
VAT countries, where the VAT is up front and public, typically experience much higher and increasing taxation.
VAT is a good thing, if you can control it. Like fusion.
My confusion is fundamentally tied to this: we have the mother of all deficits, it is going to get worse, entitlements are growing and we are going to cut taxes and grow our way into credit-worthiness? The dynamic scoring never shows this. And, if you follow the scoring models closely, you will see that a minor error, assumption or change can lead to very different outcomes (see Obamacare over 4 years).
If our economists were aiming a man at the moon, he would have a 2% chance of making it. Someone earlier mentioned the millions of decision-making parts of the economy. Indeed. None are predictable.
And what is the stuff about the gold… something. That is pure economic slight of hand. Full employment goals contaminate monetary policy. Gold standards tend to choke it.
I like the concept of a VAT in that it seems to take a lot of power from government and gives it back to the people. It is also largely fairer than most systems — I take fair to mean having similar proportional impact on everyone, not the progressive version of fair which seems based on rich people suck. Fair, if some mechanism can be put in place to soften the impact on truly low-income folks.
The problem is adding a VAT to existing taxes; if they don’t repeal the income tax when implementing a VAT then they’ll still have the power and an additional source of revenue. As much as I like Ted Cruz I do not like this idea.
If taxes remain at Cruz’s specified level it would lead to growth. I share your concern that the VAT leads to ever larger taxation, if this were a stand alone proposal I’d vote against it. In Cruz’s estimation the best way to reign in spending is to starve government revenues while keeping monetary policy tight, which is why he nodded to the gold standard as part of his tax plan. Personally, I think Cruz has it backwards, but there is an internal consistency to his plan that would reduce taxation and promote long-term growth. Only when you look at external factors like the pernicious consistency of the federal government misusing the levers of power, to which Cruz proposes to add 1 more, does the plan fall apart.
I read the plan on Cruz’s website.
The personal portion is better than what we have, but no better than Trump or Jeb! In other words poor. I think it disingenuous to call it a flat tax with all of the deductions and EIT junk still in the plan. It is a single rate plan, but not what I consider a traditional flat tax.
I am not reading the corporate portion as a VAT. The website description reads like a 16% corporate profit tax. I didn’t see anything about changes to partnership vs. c-Corp election so assume that remains the same.
My first reaction about claims eliminating the IRS is BS and reads like campaign propaganda not grounded in reality. We will be publishing a plan to eliminate the IRS next month.
Reading his plan on the website is very disappointing. I concur on many of my friend’s points and think there is good commentary here.
Jamie a combination of VAT and convoluted income tax were his primary objections. We discussed a host of other issues, but those were in contrast to other projects we are working on together.
I have no interest in debating hard money, but an absolute recipe for imminent disaster (as in sooner than our current mess) is doing a sort of central bank with a fiat currency or having a central bank and a sort of gold standard.
I don’t follow at all. Some forms of spending are privileged, but I don’t see any income that is privileged, unless you mean in the sense that income under $14k is not taxed, but above that you may have to start paying.
Have you read the Tax Foundation’s account? I thought that it was helpful. Explaining “tax inclusive” (the reason it’s more like 19 than 16) was particularly helpful, but explaining that it was a tax on revenues rather than just profits was helpful, too. One difference from many VATs is that it appears to cover services as well as goods, which I think is probably an improvement (it reduces distortion). It appears that Cruz agrees with the analysis.
Edit: I can’t believe that the one time I find myself defending Cruz, Brent doesn’t show up until late and then it turns out I’m still wrong.
James, I’ve not read their account, but my associate did and came to a conclusion similar to yours.
Tim Worstal has a nice piece on the comparative deadweight costs of various tax schemes today in Forbes. A consumption tax is less harmful than an income tax. Substituting it for the corporate heads you where you want to go without the problem of the Fair Tax (which is that I, for one, will cheat like hell on a 30% sales tax). Sadly, the Land Use Tax–the wisest–is out of bounds in the US because so many states tax property. Possibly why the Single Tax Party had to change its name in 1924.
Regards the OP, I don’t get why a VAT is any more opaque than the current corporate income tax: how many of us know who actually pays corporate taxes? On Viard’s investment comment, the VAT is friendlier to investment because it eliminates the double taxation on dividends.
I think I heard Ted say “rule-based” system (also a Milton Friedman desiderata), ideally based on gold. Such a system can also be mismanaged. The Fed did this in its early days (and still on a gold standard) touching off a hellacious and unnecessary inflation during WWI into the early 1920s. Any pegged currency needs an effective currency board in order not to go KABLOOEY (technical term) every now and again. Serious gold standard advocates seem to be aware of this. And that effective currency boards do, in fact, exist.
James, I am not insinuating you are wrong. My apologies if you think I’ve done so. We don’t always agree, but I hold you in high regard.
I’ve only read the announcement on his web site using an iPad. It seemed much more detailed re the personal portion and limited in discussing the corporate portion.
Starve government revenues, tighten money, drive up interest rates, increase deficits that crowd private borrowers out, … is this a formula for a Depression? Andrew Mellon and Herbert Hoover tried this first.
V-P, I understand the theory. What I don’t understand is a plan that dynamically leads to a higher deficit being authored by a guy who won’t vote for the Debt Limit unless there is a dollar for dollar decrease in spending. The whole thought is inconsistent.
As for the idea that a dynamic economic model generates a $3.6 trillion higher deficit with the Cruz plan, unless that growth curve is really headed upward at a rapid rate of climb at the end of 10 years, this is probably an aborted take off.
Frankly, it seems to be about the following:
It just seems a bit too gimmicky. Will the Tea Party and Freedom Caucus support this? Cutting taxes only widens deficits unless you cut Social Security, Medicare, Defense or the big spender, the Dept. of the Interior.
Axing is what is required. Tax shifting is just shuffle board.
It is easy to make the VAT explicit. The beauty of a uniform across the board no good excluded VAT is that it makes collection simple and automatic, reduces distortions, increases investment and savings, and it is difficult to increase if it is across the board and hits everyone. EU and many other countries tax different goods differently. This not only corrupts the system, it creates incentives to tax luxury goods and reduce taxes on necessities. Not only is this wrong headed, the inputs into a crib or a yacht are similar, this invites demagoguery, log rolling and cheating. Across the board works, uniform works; see New Zealand’s reform of the early 80s. The VAT should be joined at the hip with the flat tax so that it is difficult to raise one without raising the other. This means the rates should be equivalent, perhaps a few years with the vat at a higher rate with a sunset. That it doesn’t close the deficit in the short term is really beside the point. If savings increase, and they will as we tax consumption more and savings and investment much less, the Federal deficit will impact less on the external debt. However, spending is the true cost and it must be cut. We must cut spending and reduce regulations to solve the problem but in the short term financing the excess spending by market conforming interest rates is superior to taxes on productive activities.
It doesn’t take power from government; it’s government imposing the tax, in whatever form. It’s also not particularly similarly proportional. We all have necessary expenses, on which we must spend our income–food, rent, that sort of thing. The poor, though, spend a far higher proportion of their money on those necessities than the rest of us. Adding a VAT on top of that hurts them disproportionately. And it’s a tax they have to pay, whether they have any income, or not. A flat tax hits them, too, but if the tax is low enough, not as badly.
James Of England: I don’t follow at all. Some forms of spending are privileged, but I don’t see any income that is privileged, unless you mean in the sense that income under $14k is not taxed, but above that you may have to start paying.
Spending is just the obverse of income. Take the mortgage interest deduction. It favors a form of income for the lender, and it favors the borrower’s income spent on housing. In both cases, it’s a tax used for social engineering.
Eric Hines
In spades. The simpler the tax code we can create, the smaller the IRS we’ll need to collect it, but as long as we have a tax, we’ll need an IRS to enforce it and to collect it.
Eric Hines
I was mostly joking, but I appreciate the genuine response. I think I agree with you that this is a tax plan that is excellent for making promises from (if you say that you’ve found a way to cut taxes to 10%, you get a lot of heads turning, and a depressingly small number of people find “and my plan will cost less than a trillion dollars when you cost it dynamically” to be a terrifying statement) rather than a serious effort at reform.
Because this increases the deficit, you couldn’t do it with reconciliation, so it’d have to change a lot to become Democrat compatible (or get a supermajority, in which case it’d still have to change somewhat to become deficit hawk compatible), and I don’t get the impression that the plan is intrinsically awful in concept.
It’s basically making the tax system a lot like the UK’s or Germany’s or Denmark’s, with some improvements and some adjustments that would still need to be made (like, 10% is clearly not enough, even with the VAT). That’ll be fun to note that to Bernie fans in the future (You want to be like Denmark? I assume you’re voting for Cruz in the Republican primary now that the Democratic contest is over?)
For tax policy purposes, spending is very different indeed from income. People don’t spend the moment they get income, and they don’t always wait for the income to spend. Since the subject is a reform to shift tax from income to consumption, using the same word for both things is unlikely to improve clarity.
It’s not possible to reform tax code–with or without a VAT–without also dealing with spending. You can continue the misconception of the two’s independence from each other; I choose not to.
Eric Hines
Is this word association? Earlier you were talking about taxpayer spending. Now you appear to be talking about government spending. Also, you appear to be wrong about the latter. If you reform the tax code without changing the amount of revenue raised, you do not necessarily alter the need to address spending.
I wasn’t saying that income and spending aren’t linked. I was just saying that they’re not the same thing, and that the difference is important for tax policy, and particularly for discussing a shift from taxing one to taxing the other.
He’s very big on the “I will cut taxes” bit and light on the “I will introduce a massive new tax” bit? Surely not!
Agree on Bernie and Denmark. If you want Denmark you need to be a supply-sider. (Switzerland, of course, should be the goal.) But why are 10% and 16% clearly not enough?
On another subject, Paul Krugman wrote a fine essay (go ahead, faint; have a glass of water; take your time) that took a well-deserved stick to unctuous policy charlatans like Robert Reich. From it I gather that actual economists are rightly suspicious of ideas that don’t have a model. This makes sense: if Milton Friedman says MV=PT you know what he’s trying to say and at least in heaven you can say “tell me again why you ever thought V was roughly constant?” Presumably they laugh at you at economist gatherings if you show up without some mathematics. Why then do economists always say things to the public like we should know what the hell they’re talking about? Like “a VAT isn’t transparent but it’s friendlier to investment?”
We are in agreement.
This is grounded in reality.
I want the IRS gone tomorrow and forever. Once again I get a letter from those morons saying I under-reported income by $26,000+ and owe an additional $7K+ in taxes and penalties. I didn’t and I don’t. Once again I must pay my accountant to sort it out and fill out the necessary paperwork explaining why the IRS is screwed up. Eventually, I get a letter from them saying OK, you were right but I get no compensation for having to correct their boo boo. Evidently, the IRS makes this mistake a lot and most don’t bother to correct it if the amount is small. Since it generates extra income with no penalty on their part, the IRS has little incentive to fix the software.
Even though the income didn’t exist (just shifted the chairs on the deck of the Titanic), had it existed, the tax penalty would have been steep. I have worked hard and saved and for that I have to pay big bucks to advisers and accountants to preserve as much of my earnings as possible for retirement years and correct government mistakes. No wonder so many people save so little — they have more material things than I and fewer headaches.
Because when your selling point is “my plan would cost less than a trillion dollars”, your plan is too expensive. If Cruz says that his plan would create a massive deficit, I believe him.
Reworded: The people who pay a VAT don’t see that they’re paying it (assuming you think that consumers pay it; tax incidence is a really complicated topic). It’s not a direct tax on investment, though, so it’s likely to make investment more competitive. To put it another way, it shifts business taxes from businesses to consumers, which is neat from a business owner’s perspective.