Some Inconvenient Truths About the McCain and Obama Tax Plans

In Monday’s Washington Post, Sebastian Mallaby seems to have come around to realizing that tax policy is the first real test of fiscal courage for the presidential candidates and the next Administration (and the next Congress)–in his column “McCain’s Convenient Untruth.”  (Almost a month ago, Sebastian wrote a column calling for short-term stimulus to be coupled with a “medium-term plan to fix entitlements“–which inspired this post of mine.) 

Sebastian’s point yesterday:  McCain’s proposed tax policy takes a “free lunch” attitude–suggesting that we can have our tax cuts and new jobs, too–when in fact, unaffordable tax cuts inevitably harm the economy:

When it comes to fighting wars, John McCain stands up and calls for sacrifice. “We never hide from history; we make history,” he declared in his convention speech. But when it comes to taxes, McCain is unwilling to demand even a teensy bit of sacrifice. In a McCain administration, Americans would not have to surrender a dime more of their money to a cause larger than themselves.

Why this bipolar attitude toward sacrifice? Start with the answer that McCain himself provides. “My tax cuts will create jobs. His tax increases will eliminate them,” he said at the convention, offering one of the speech’s few policy contrasts between Obama’s platform and his own. In other words, McCain is not calling for tax sacrifice because he believes it would be counterproductive. On taxes, he is saying, you can selfishly avoid sacrifice — and serve the public good.

This, unfortunately, is a convenient untruth. Tax hikes taken to an extreme can indeed backfire, harming growth and job creation. But it’s a stretch to assert that Barack Obama’s tax plan would do that. And it’s downright scandalous to pretend that the economy can be strengthened in anything other than the short run by unaffordable tax cuts.

Sebastian then goes on to defend Obama’s tax policy by emphasizing that Obama’s plan would cut taxes for the vast majority of American families…

Obama is not proposing to raise taxes for most Americans. To the contrary, he would triple the earned-income tax credit for low-wage earners, increasing work incentives at the bottom. He would cut taxes on people in the middle — indeed, he would do so more aggressively than McCain would. It is only the wealthiest Americans who would face higher tax bills under Obama.

…and that even the tax increases Obama proposes on the wealthy would likely be beneficial to the economy, on net, once the effect of a reduced budget deficit is accounted for:

How might this impact jobs and the economy? Under Obama’s plan, top earners would pay a marginal federal tax rate of maybe 46.5 percent (that includes the Medicare tax and Obama’s proposed hike in Social Security taxes), considerably more than the 37.9 percent they would pay under McCain. There’s no doubt that Obama’s higher tax rates would mean weaker incentives to work, take risks and innovate; and stronger incentives to waste time and effort on avoiding the tax man.

But those bad effects must be weighed against a good one: Higher tax rates mean a lower budget deficit. According to the Tax Policy Center, over the course of a decade Obama’s plan would result in a national debt $1.2 trillion smaller than you would get under McCain’s plan. Less government borrowing ultimately means lower interest rates and more private investment. This positive effect may well outweigh the blow to growth and jobs from weaker work incentives.

But in the comparison above, the “positive effect” of a lower level of debt under Obama’s tax plan is only relative to the higher level of debt implied by McCain’s tax plan.  The “convenient untruth” in this comparison is that it’s relative to a “current tax policy extended” (i.e., “Bush tax policy extended”) baseline–which is not the real [true] baseline when it comes to legislation. 

As I’ve written many times, compared with the current-law baseline where the Bush tax cuts completely disappear after Dec. 31, 2010, both candidates are proposing to cut taxes substantially.  (The little-understood fact is that even Obama is proposing to cut taxes for essentially everyone*, even for the rich, compared with current law.)  According to the Tax Policy Center’s latest analysis (summary here) coupled with the January 2008 CBO baseline, while McCain is proposing a net tax cut of 2.5 to 3.9 percent of GDP in 2013 relative to current law, Obama is also proposing a (smaller) net tax cut of 1.6 to 1.8 percent of GDP in 2013.  (An updated CBO baseline is due to come out today (9/9); stay tuned for a revisiting of the Obama vs. McCain economic plans based on the new baseline.)

So the “convenient untruth” relates to the “inconvenient truth” that under either an Obama or a McCain Administration, the promised path of tax policy is for tax cuts that will worsen, not improve, the budget outlook, relative to current law.  The Tax Policy Center estimates that relative to current law, while McCain’s tax proposals would add between $4.2 trillion and $7.0 trillion(!) to the federal debt over ten years (2009-18), Obama’s tax proposals would still add between $2.6 trillion and $2.9 trillion to the federal debt. 

So while it’s true that McCain’s tax proposals appear much more fiscally irresponsible than Obama’s, it’s still less than crystal clear whether the (only) “relative deficit reduction” Obama’s tax plan achieves produces strong enough economic benefits to make the tradeoff with some of adverse effects of relatively higher marginal tax rates (at the very top of the income distribution) worthwhile.  And we’re not exactly going to be able to look to the spending side of the budget to find more aggressive deficit reduction from (at least candidate) Obama.  But to accentuate the positive, Obama doesn’t seem to be promising a level of deficit reduction that he cannot keep–he says he wants to keep the 2013 deficit at something less than today’s nominal deficit (of around $400 billion).

And to accentuate the positive with McCain, well, his economic proposals aren’t limited to the tax side of the budget, so the effect of his tax plans on the deficit shouldn’t be interpreted as the effects of his overall fiscal policy on the deficit.  So I’d quibble with what Sebastian sees as the “no sacrifice” position of McCain when it comes to taxes.  McCain still claims that under his Administration the budget deficit would be eliminated by 2013.  

So (as I first pointed out in July) his tax proposal does identify (even if it doesn’t “spell out”) the sacrifice required–and that’s the spending cuts needed to get the budget to balance given his proposed tax cuts.  The 16.0 to 17.4% of GDP in revenues under McCain’s tax plan in 2013, combined with his claimed zero budget deficit in 2013, imply that 2013 outlays under a McCain Administration would be held to the same 16 - 17 1/2% of GDP.  That’s a 2 to 3 1/2% of GDP cut in federal spending compared with CBO baseline outlays, but a 3 to 4 1/2% of GDP cut in federal spending compared with a more realistic path of spending (according to CBO Table 1-5).

So the sacrifice McCain is calling for is sacrifice not from current taxpayers, however rich, but from two possible groups of people, depending on what we believe about his balanced budget pledge:  (i) if the pledge is genuine, the sacrifice will be made by those who benefit from current federal spending programs (which he is wisely and ”conveniently” choosing to leave unidentified); or (ii) if the pledge is just campaign talk, the price will be paid instead by future generations who will bear the burden of the added debt–in eventually many-fold larger tax increases or spending cuts. 

______________ 

*footnote:  As the Tax Policy Center’s longer analysis explains (page 28), in 2012 (when the Bush tax cuts would otherwise be completely expired under current law), “the Obama plan would provide an average tax cut to the top quintile of 2.0 percent of income or $4,285. Only about two-fifths of taxpayers in the top 1 percent of the population would face a tax hike.”

Comments

[Steven Hansen:]

since when did a president establish a tax rate, and what was the last time a congress took any recommendation from a president and implemented it.

all a president can do is try to control congress with vetos, and get us into war.

it is time that every incumbent congressman is voted out of office - no matter the party. if america wants change we cannot leave the people who have given us the last 8 years of destruction in office.

2008 Sep 09 05:21 AM

[misterbillusa:]

When are you going to recognize the fact that we don't have a tax problem - we have a spending problem. Why do so many people and journalists not understand that tax receipts for the federal government are WAY UP since they Bush tax cuts?

2008 Sep 09 10:12 AM

[LouieK:]

Rogers quoted:

"There’s no doubt that Obama’s higher tax rates would mean weaker incentives to work, take risks and innovate; and stronger incentives to waste time and effort on avoiding the tax man.

But those bad effects must be weighed against a good one: Higher tax rates mean a lower budget deficit."

The Democrats' reputation for tax and spend is to tax and then take the taxes and spend it on special interests such as unions, government bureaucracy, welfare, Leftist ideas such as the environmental lobby, etc.

I think historically, the Democrats have been the party of tax and spend, and the Republicans the party of tax and spend, but the difference is the Republicans tilt toward less tax and spend and more encouragement of private, business investment (via lower tax rates on the rich, small business and corporations). Spin all you want, but you are not correct. Give either party more tax money and they will spend it, largely, foolishly, not necessarily decrease the budget. The truth is that the Democrats are the party that has created (and threatens to continue) the policy of winning elections based on promises intended to buy the electorate. The Republicans find the need to follow suit to keep up with the Democrat inspired largesse.

2008 Sep 09 10:21 AM

[mediapro:]

OK. Everyone's had their ideological moment. Let's look at the spend side of the equation.

Where is the largest drain on the federal budget? Most will say "entitlements" in Health and Human Services. If one defines "entitlements" as Social Security, Medicare/Medicaid, and Unemployment, one is correct. If one asks the logical question, how come those are entitlements, since we all pay this tax on wages that contribute to these systems. We invest in our somewhat pitiful guarantees under these programs as a stop-gap from poverty. I would also add, who decided the rather arbitrary cap on these taxes at $90,000/year? Is the money earned above that amount somehow different?

The next logical question is: Where is the largest drain on the federal discretionary budget? The answer: tada -- Defense, at now more than 1/3 of federal discretionary spending. The Iraq War alone is draining more money each month than the much-ballyhooed "earmarks" target spoken by McCain.

When will we decide that our defense spending is the problem, not the solution to our security in the world?

If the next President can lead us through the inevitable morass of the barriers erected by the military-industrial-Co... complex, we might not be talking about "sacrfice" by millionaires while the rest of us see our own form of deficit spending each month as prices rise and bank accounts fall. We might actually learn that investing in America's infrastructure instead of destroying and spending ungodly sums restoring the country that we unecessarily invaded and annihalated, we might be better off at home and abroad.

2008 Sep 09 03:56 PM

[Birdfan:]

I would rather have the president concentrate on controlling spending. Then maybe congress could consider tax cuts. Tax cuts are irresponsible when spending is out of control and we are running a deficit and borrowing from the Chinese. If McCain wants my vote, he needs to tell me (and more importantly congress) how he will veto any spending bills that add to the debt.

2008 Sep 10 10:15 AM

[johnthebear:]

LIBERALS THINK THEY ARE G O D !

THEY CAN SOLVE ALL PROBLEMS!

THEY EVEN COMPARE THEMSELVES TO JESUS!


FORTUNATELY THEY ARE GOING TO LOSE


AND HOPEFULLY THEY WILL LOSE BOTH THE HOUSE AND SENATE


SO WE CAN DRILL, DRILL, DRILL INCLUDING ALASKA


OBAMA WAS NOT DISAPPOINTED WITH $4/GAL

HE WAS ONLY DISAPPOINTED THAT IT HAPPENED BEFORE HE WAS PRESIDENT!


OBAMA WANTS $5/GAL GAS TO SPUR CONSERVATION, (AIR IN TIRES ETC)


OBAMA'S ONLY ANSWER TO OPEC OTHER THAN HIGHER TAXES

2008 Sep 11 01:06 PM