Opening salvo - Taxes

Rubio opens a new front against Cruz: Taxes

By Danny Vinik

On Monday, Sen. Marco Rubio (R-Fla.) lobbed an opening salvo in what’s likely to become a new front of disagreement in the GOP primary race: taxes.

“Believe it or not, multiple Republican candidates for president support new taxes on the American people,” Rubio said at an economic town hall in Sarasota, Florida. “Some even support imposing a new tax that generations of conservatives have fought against, called a Value Added Tax.”

He didn’t name names, but for anyone who’s been following the tax argument, “some Republicans” means most prominently Sen. Ted Cruz (R-Tex.).

As Republicans seemingly compete over who can lower tax rates the most and make them the flattest, a few differences are starting to emerge. Cruz’s plan, released in October, trashes both the payroll tax and the corporate tax, replacing them with a tax on all business revenues minus capital investments at a 16 percent rate. Cruz has gone to great lengths to avoid calling this idea a value-added tax, or VAT—which has suspiciously European connotations—instead terming it a crisply Republican-sounding “business flat tax.” But economists widely agree it’s a VAT.

Cruz, whose campaign did not immediately return a request for comment, has taken heat among conservative tax wonks for his plan, with many on the right critical of him for refusing to call it a VAT and for describing it in misleading terms in the fourth GOP debate. In November, a minor kerfuffle broke out in conservative tax circles over Cruz’s proposal after economist Stephen Moore defended the plan (and also another similar proposal from Sen. Rand Paul). That provoked strong responses from National Review’s Ramesh Ponnuru and the Cato Institute’s Daniel Mitchell.

It sounds like a quibble over naming, but it’s actually part of a broader tax argument ongoing among conservatives. Moore and influential supply-side economist Art Laffer both like Cruz’s “business flat tax,” arguing that consumption-based taxes will boost economic growth better than the current tax system that levies significant taxes on capital. Opponents of VATs like Cruz’s say that because VATs are more obscured from public view, they’ll make it easy for politicians to raise more revenue and expand government without most Americans noticing.

The idea is to tax consumption by targeting moments that value is added to a product. So for example, a wheat farmer would pay a tax on the sales of wheat to a baker; the baker, in turn, pays tax on the sale of bread to a customer, less any taxes paid by the farmer. This way, the system only taxes the value added by the baker. Economists typically believe that the baker will then pass on the tax to the consumer through higher prices—in essence the VAT is equivalent to a national sales tax.

Though adding taxes seems anathema to conservatives—and it doesn’t help that value-added taxes in general have found far more support across Europe than in the United States—there’s a lot about the VAT for tax reformers to like. It can bring in huge sums of money even with a fairly low rate because it has a very broad base—while corporations pay taxes only on their profits under the current system, for instance, a VAT effectively applies to all business cash flows, which includes wages. Cruz’s “business flat tax” of 16 percent—and, properly measured, the rate is actually 19 percent—would bring in more than $25 trillion over 10 years, more money than the Congressional Budget Office projects the corporate and income taxes to bring in over the next decade. That’s a big reason why Cruz’s tax plan would take a smaller bite out of the overall budget over the next decade than would Rubio’s plan.

Most European countries have adopted a VAT to fund their governments, but the idea has never found significant support in the U.S. Democrats have at times flirted with it—as Rubio noted in Monday’s speech, President Barack Obama called it “novel” in 2010—but conservatives have generally opposed it, arguing that it is a hidden tax increase on Americans that could pave the way for much larger government. Rubio revived those criticisms as he took aim at Cruz Monday.

“[The VAT] falls squarely on profits and wages,” he said. “That means it punishes businesses for earning money, and it punishes your boss for giving you a raise.” He added, “It’s 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.”

Alan Viard, an economist at the American Enterprise Institute who has written frequently about VATs, said that Rubio’s description of a VAT was slightly off, since the tax falls on business cash flow, not profits. But Viard commended Rubio for making the VAT debate part of the national conversation.

The issue has been on a simmer since it emerged over the fall—but as Cruz and Rubio move higher in the polls, they’re likely to find themselves facing off in the months to come. The two have already sparred over immigration. Tax plans may not be far behind.