In recent speeches and on his website, presidential candidate Marco Rubio has criticized rival Ted Cruz’s tax plan for its business flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. . As we have explained in our more detailed piece explaining the business flat tax, it is designed as a subtraction-method value-added taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. (VAT.)
A clear articulation of his critique came in a speech delivered in Sarasota, Florida:
Some even support imposing a new tax that generations of conservatives have fought against, called a Value Added Tax – also known as a VAT. The VAT being proposed in this election works by taxing businesses at each stage of the production process. It falls squarely on profits and wages. That means it punishes businesses for earning money, and it punishes your boss for giving you a raise.
The VAT is also intentionally sneaky. It attempts to trick people into believing their taxes are being lowered, when in reality they’re simply being shifted to employers – meaning everyday Americans would feel its impact through higher prices and lower wages. This would be especially harmful to the poor and senior citizens with fixed incomes.
The VAT makes for a dangerous expansion of Washington’s power, especially when stacked on top of an income tax. In most European countries where a VAT has been implemented, government has grown in size. It’s no wonder that fans of the VAT include Nancy Pelosi and Barack Obama, who called it a “novel” idea.
This particular criticism of the VAT is not new or unique to the Rubio campaign. In fact, it is the main reason that some tax policy experts who prefer lower tax burdens are against the VAT. Because voters often do not perceive the tax as taking away a percentage of their income (though, as Rubio notes, it does) they might not be as resistant to raising it.
Obviously, it is fair to assume Senator Cruz—whose plan cuts taxes by about $3.7 trillion—is not interested in increasing Americans’ tax burdens. But the claim is a little bit more complex than that—it is that another more tax-happy president, sometime in the future, will begin raising Senator Cruz’s VAT rate from the proposed 16 percent to some higher number, and be able to hit Americans with a higher tax burden because of the “sneaky” nature of the tax.
I am not a much of a political soothsayer, and I can’t really tell you whether VATs ultimately result in a higher-tax political equilibrium. The theory rests on a number of untestable but potentially-reasonable assumptions. For example, it is certainly fair to say that an individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. (as Rubio proposes) is much more obvious and transparent to voters than the business flat tax would be. And it is also fair to say that the U.S. has a generally lower tax burden than that of most developed countries with VATs. So there is at least circumstantial evidence for the theory.
On the other hand, one should note that Cruz’s plan eliminates a number of existing taxes that are not very transparent, such as the employer-side payroll tax and the corporate income tax, which are in effect folded into the business transfer tax.
In fact, consider this: the business transfer tax under Cruz’s plan includes corporate revenues minus business inputs and capital expenses. The corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. under Rubio’s plan consists of corporate revenues minus business inputs, capital expenses, and payroll. The employer-side payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. under Rubio’s plan (which is unchanged from current law) also taxes payroll. So if you put together two taxes from Rubio’s plan (and fiddle with the rates), you can actually synthetically construct the business flat tax from Cruz’s plan!
This comparison gets to the heart of the matter. Both senators ultimately believe that U.S. taxes should be broadly based on national income net of new investment, a good base for sound tax policy. Their plans are in many ways more similar than different.
I’m not here to take a side in this dispute: both senators use Tax Foundation analysis in their policy work, and both sometimes come to Tax Foundation with questions about policy. Tax Foundation does not endorse particular plans or candidates.
But the bottom line is this: these two plans have similar economic incidence. That is, ultimately both plans tax the same basic economic activities, like worker’s pay, and corporate profits net of expenses. But they differ somewhat in terms of legal incidence. That is, they differ in terms of who writes the check. Both contain some transparent taxes (such as the individual income tax) and some that are less transparent (such as the business transfer tax, the corporate income tax, or the employer-side payroll tax.) Ultimately the Cruz plan leans somewhat more on the less-transparent taxes, and it is fair for Rubio to point this out. But most differences between these two pro-growth tax plans are subtle distinctions, not stark contrasts.
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