Monday, July 14, 2008

The differences between the tax policies being promoted by Sens. Barack Obama and John McCain are stark, but neither candidate’s proposal tackles the nation’s worsening fiscal problems, analysts say.

If Congress fully adopts the next president’s tax policies unrelated to health care, average federal taxes in 2009 for the middle fifth of the American population would decline by $1,042 under an Obama administration and by $319 under a McCain administration, according to an analysis of their plans by the nonpartisan Tax Policy Center (TPC), a joint venture of the Urban Institute and the Brookings Institution.

Meanwhile, with congressional approval, average federal taxes for the top one-tenth of 1 percent of the population, which includes households that earn at least $2.9 million, would rise by more than $700,000 next year if Mr. Obama becomes president and would fall by nearly $270,000 if Mr. McCain wins the election.

These figures do not include Mr. McCain’s proposal to allow taxpayers to calculate their taxes under an optional alternative tax system, which would feature two rates, an increased personal exemption and a large standard deduction.

Former Sen. Phil Gramm of Texas, an economic adviser to Mr. McCain, told The Washington Times on Wednesday that the two tax rates would be 10 percent and 25 percent, which is 10 percentage points below today’s top rate.

A TPC analysis of a Republican Study Committee proposal to establish an alternative tax system with a top rate of 25 percent concluded that it “would disproportionately benefit those with very high incomes, making the tax system less progressive.”

These figures also do not include Mr. Obama’s recent proposal to apply Social Security payroll taxes to salaries above $250,000. Social Security taxes are now limited to the first $102,000 of wage and salary income.

Leonard Burman of the TPC has estimated that applying the full Social Security tax to salaries above $250,000 could increase Mr. Obama’s annual tax increase for the top one-tenth of 1 percent of income earners by an additional $400,000. The Obama campaign has not decided what Social Security rate will apply to incomes above $250,000.

Mr. Burman estimated that the top marginal tax rate, including state and local taxes, could reach 57 percent under Mr. Obama.

“A lot of high-income people can re-characterize their income to avoid paying the higher individual income-tax rates,” he said. “I’m concerned about the effect of high marginal individual and corporate income-tax rates on economic incentives and tax sheltering.”

Moreover, as long as Social Security tax revenues continue to exceed benefit payments, “the additional revenues collected by raising the Social Security income threshold would be spent on other government programs, while masking the deficit’s size,” Mr. Burman said.

The Obama tax plan in 2009 would redistribute $131 billion from the top 1 percent to all other taxpayers, said Scott Hodge of the Tax Foundation.

Mr. Hodge, citing Congressional Budget Office data, said that the top 1 percent of households paid nearly 40 percent of federal income taxes in 2005. The top 20 percent paid 86.3 percent.

“It is startling to learn how greatly the Obama plan would shift the tax burden further up the income pole,” Mr. Hodge said. “It’s the most ambitious redistribution of wealth in recent memory.”

“Income redistribution through the tax code entails less economic cost than other means of redistributing income, including limiting trade and increasing regulation,” Mr. Burman said. “Almost all the gains of the last 20 years have gone to the top 1 percent, putting enormous pressure on the political establishment to do something about it,” he said.

No help on the fiscal front

Economists generally agree on one thing: Both candidates’ tax plans would worsen the nation’s fiscal situation.

“The fiscal situation doesn’t start off very well,” said Alan Viard, a scholar at the American Enterprise Institute for Public Policy Research, noting that next year’s budget deficit is projected to exceed $400 billion. He expects “a continuation of large deficits,” regardless of who becomes president next year.

“It seems likely the deficit would be higher under Obama,” Mr. Viard said. A President Obama would be far more likely than a President McCain to persuade a Democrat-controlled Congress to pass his tax and spending proposals, Mr. Viard explained.

“Neither [candidate] seems to recognize fiscal reality,” Mr. Burman said. He calculates that each plan would increase the deficit more than permanently extending President Bush’s tax cuts.

“Both plans would worsen, not improve, the fiscal position of the nation,” which is facing a gigantic long-term fiscal gap, said Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget. “Both plans would dramatically enlarge the deficit.”

Measured against the “current-law” base line, which assumes the Bush tax cuts expire at the end of 2010 and the alternative minimum tax (AMT) is permitted to affect tens of millions of additional families, the McCain tax policies would reduce revenues by $3.6 trillion over 10 years, the TPC study found. The Obama tax plan would lower revenues by $2.7 trillion.

Measured against the preferred standard of both candidates, the so-called “current-policy” base line, which assumes the Bush tax cuts are extended and the AMT is permanently patched, Mr. McCain’s plans would reduce taxes by more than $600 billion over 10 years. Mr. Obama’s tax policies would increase taxes by nearly $300 billion.

In terms of the long-term fiscal impact, “it doesn’t matter what base line is used,” Ms. MacGuineas said. The candidates prefer to measure their policy recommendations against the “current-policy” base line because “its deficit projections are hundreds of billions of dollars per year higher” than the “current-law” base line. As a result, she said, the fiscal impact of each candidate’s tax policies doesn’t seem as drastic as it really is.

What the candidates propose

Mr. McCain of Arizona, who was one of only two Republican senators to vote against both the 2001 and 2003 Bush tax cuts, would permanently extend nearly all of them beyond their expiration at the end of 2010. The major exception is the estate tax, which is scheduled to expire in 2010. Mr. McCain would apply a 15 percent tax rate to estates worth more than $5 million.

Mr. Obama of Illinois would extend the Bush tax cuts for all households earning less than $250,000 per year, including the 15 percent rate that applies to capital gains and dividends. He would increase the top income tax rate from 35 percent to 39.6 percent. (In 1993, President Clinton and a Democratic Congress raised the top income tax rate from 31 percent to 39.6 percent.)

Under an Obama administration, the dividend tax rate, which declined from 39.6 percent in 2000 to 15 percent in 2003, would increase for households earning more than $250,000. The top capital gains rate, which fell from 20 percent to 15 percent in 2003, would increase to a level between 20 percent and 28 percent, which was the top rate after President Reagan’s 1986 tax reforms. (The TPC study assumed a maximum tax rate of 25 percent for capital gains and dividends.) Estates above $3.5 million would be taxed at 45 percent, which is three times the rate Mr. McCain proposes.

Both candidates would permanently patch the AMT to prevent it from affecting more households. Mr. McCain has said he wants to permanently repeal the AMT, which now applies to mostly upper-income households.

Mr. McCain would reduce the top corporate income tax rate from 35 percent to 25 percent. Over the 2009-13 period, Mr. McCain would permit firms to fully deduct in the first year the cost of business equipment expected to last between three and five years. That provision would expire after 2013.

Mr. Obama has said he would eliminate the capital-gains rate for startups and small businesses.

Both candidates would make the research and development tax credit permanent. Both candidates also would eliminate tax preferences for the oil and gas industry, but Mr. Obama would impose a windfall-profits tax on oil. Mr. McCain had proposed suspending the 18.4-cents-per-gallon federal gas tax during the summer, but the idea, which Mr. Obama called “a gimmick,” went nowhere.

Mr. Obama’s plan includes additional revenue raisers totaling nearly $1 trillion over 10 years, while Mr. McCain’s plan pledges to eliminate nearly $400 billion in corporate welfare over the same period. The TPC characterized both figures as “unverifiable campaign-provided revenue estimates.”

Beyond permanently extending the Bush tax cuts and patching the AMT, the major middle-class item in the McCain plan is a proposal to phase in a doubling of the personal exemption for dependents from $3,500 to $7,000.

Mr. Obama offers a slew of mostly refundable tax credits, which are aimed at low- and middle-income workers and phased out for high-income households. Refundable credits are available regardless of income-tax liability.

Mr. Obama’s Make Work Pay Credit of 6.2 percent would apply to the first $8,100 of a worker’s earnings, yielding a maximum credit of $500 per worker. He would expand the Earned Income Tax Credit. His Universal Mortgage Credit would allow non-itemizing homeowners to claim a 10 percent credit up to $800 against mortgage interest. He would eliminate income taxes for seniors earning less than $50,000. His American Opportunity Tax Credit is a fully refundable credit applicable to the first $4,000 spent for qualifying higher-education expenses during the first two years.

“The long list of Obama’s targeted tax breaks gives me heartburn,” Mr. Burman said, “and some of his specific proposals, like the exemption for most seniors, seem especially ill-advised.” Why, he asked, should seniors earning $50,000 pay no income taxes at the expense of younger families, whose needs were probably greater?

What the economic advisers say

Douglas Holtz-Eakin, Mr. McCain’s chief economic adviser, said the McCain plan “is all about creating jobs in the U.S. by keeping taxes low and not raising taxes on small businesses, many of which pay their taxes through the individual income tax system.” Tax relief for corporations “will make sure workers have the finest equipment,” he said.

Mr. Holtz-Eakin called Mr. Obama’s plan “a scattershot of tax policies with no coherence whatsoever.” Mr. Obama’s tax increases are “a bad idea in a weak economy. They have small business in the cross hairs,” he said, “and they will end up hurting people who are not rich.”

He dismissed Mr. Obama’s plan to eliminate capital gains taxes on startups and small businesses as “a full-employment act for tax lawyers.”

“The Obama plan promises tax cuts for 95 percent of American workers and spends well over a trillion dollars over 10 years on health, infrastructure, foreclosures and green-energy policies,” Mr. Holtz-Eakin said. “I would love to see him make the numbers add up in public.”

Jason Furman, a top economic adviser of the Obama campaign, sees things differently.

“The debate isn’t whether to cut taxes. It is about who gets the tax cuts,” Mr. Furman said. “McCain cuts taxes for corporations, and Obama cuts taxes for the middle class.”

Mr. Furman also argued that the TPC study seriously underestimated the cost of Mr. McCain’s corporate tax cut, which he said was “closer to $1.5 trillion,” more than double TPC’s estimate. In addition, Mr. Furman said, the Obama tax plan would bring in $500 billion more over 10 years than TPC estimated.

Mr. Furman ridiculed Mr. McCain’s proposal to create a revenue-neutral optional alternative tax system.

“You can’t have an elective tax system that is revenue-neutral,” he said. People will select the system that allows them to pay lower taxes, he explained.

Mr. Burman of the Tax Policy Center agreed. Moreover, an earlier TPC study of the Republican Study Committee’s optional alternative tax proposal, whose top tax rate was 25 percent (the same top rate that Mr. Gramm said would apply to Mr. McCain’s alternative tax system), concluded that it would have reduced revenues as much as $7 trillion over 10 years, based on current law.

Mr. Furman also accused the McCain campaign of “using the same set of budget tricks from the Bush tool kit, including phase-ins, delayed implementation and sunsets” in order to mask the ultimate cost of his tax cuts.

James Horney of the Center on Budget and Policy Priorities was skeptical of Mr. McCain’s plan to end the full expensing of capital equipment after 2013. Noting that Mr. McCain favors permanently extending the Bush tax cuts that he opposed, Mr. Horney said the capital-equipment sunset “violates Mr. McCain’s belief that once a tax cut is in effect, you should be able to extend it without paying for it.”

Mr. Burman, who was a Treasury official during the Clinton administration, acknowledged his “strong preference [for a] 1986-style tax reform - eliminating many preferences and lowering marginal tax rates while preserving revenues and progressivity.”

Lamenting the state of affairs, Mr. Burman told The Times: “I understand why politicians would not want to talk about scaling back popular tax breaks during an election campaign, but I wish that they would at least acknowledge that the current system is deeply flawed and commit themselves to meaningful tax reform after they’re elected.

“McCain 2000 was actually pretty good on this, but he, like Obama, has been in full pander mode during this campaign.”

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