Obama vs. McCain: Taxing and Spending

They've parried over gas taxes (BusinessWeek.com, 4/15/08) and fixes for the housing crisis. Now, as the general election campaign kicks off, Senators Barack Obama and John McCain have begun to hammer away at each other's tax and spending programs.

Obama, who has begun a two-week tour around the country to highlight his views on the economy, derides McCain's plans to extend the Bush Administration's tax cuts, eliminate the Alternative Minimum Tax, and slash corporate taxes. Campaigning in St. Louis on June 10, Obama called the current Administration "the most fiscally irresponsible in our history" and argued that McCain would be even worse. "I've said John McCain is running to serve out a third term, but when it comes to taxes, that's not being fair to George Bush. Senator McCain wants to add $300 billion more in tax breaks and loopholes for big corporations and the wealthiest Americans," Obama said.

As McCain revs up his campaign, he has wasted no time in trying to paint Obama as a typical tax-and-spend liberal. He argues that if the Senator from Illinois is elected, America is in store for the biggest tax increase since World War II. "Under Senator Obama's tax plan, Americans of every background would see their taxes rise—seniors, parents, small business owners, and just about everyone who has even a modest investment in the market," McCain said in a speech to the National Small Business Summit in Washington, also on June 10.

First Round to Obama

So where does the reality lie? According to a new analysis by the nonpartisan Tax Policy Center, a joint venture between the Urban Institute and the Brookings Institution, two Washington think tanks, this round goes to Obama. The TPC took a look at the various tax proposals put forth by the two candidates and estimated that Obama's plan would lead to a boost in aftertax income for all but the highest earners, while taking a smaller bite out of government tax revenues than would McCain's plans.

Len Burman, a former Treasury tax official who is now a senior fellow at the Urban Institute, says if Obama's proposals—which include plans to rescind the Bush tax cuts on couples making more than $250,000, close corporate tax loopholes, and tax private equity earnings known as "carried interest" as ordinary income—were adopted in 2009, for example, married couples with earnings in the lowest quintile of the population would see their aftertax income rise 5.8%. Those in the next quintile would see an increase of 4%. Those breaks would be paid for by those with high incomes: the top 1% of taxpayers would see aftertax income fall 8.4%.

Under McCain's proposals, by contrast—including an extension of the Bush tax cuts for all taxpayers, a corporate tax cut, and a larger reduction in estate taxes than Obama would support—far more of the benefits would go to the top. If his plans went into effect in 2009, married couples in the bottom fifth of the population would see aftertax income go up just 0.2%, while those in the next quintile would see a 0.7% hike. But those in the top quintile would see a bump up in aftertax income of 2.7%.

"It's just flat wrong" to say people would do worse under Obama, says Burman. "Most lower- and middle-class people would pay less taxes under Obama than they would under the proposals being put forth by McCain."

Doug Holtz-Eakin, McCain's top economics advisor, argues that the study doesn't take into account which policies might prove better for jobs and the economy, or how companies or individuals might behave in reaction to changing tax rates. Cutting the corporate tax rate, for example, is intended to keep jobs in America, he says.

"It says a great deal about the state of affairs in Washington when the analysis of proposed economic policy rejects the real outcomes that can be achieved by reshaping federal bureaucracies, and protecting taxpayers' money," Holtz-Eakin says.

But Jason Furman, the newly named economic policy director for the Obama campaign, disputes that view. He argues that the study demonstrates that McCain's tax plans would drive the tax code in a far more regressive direction. "Some 23% of the tax cuts they are proposing would go to households making more than $2.8 million under the McCain plan," he says. "That's a phenomenally large benefit for the super rich, beyond anything George Bush has proposed."

All Depends How You Figure It

The two candidates' tax plans would change overall government tax revenues in vastly different ways. But by how much? That depends on how the impact is measured. Under current tax law, the Bush tax cuts are supposed to expire for all taxpayers at the end of 2010, so the current estimates by the Congressional Budget Office for tax revenues beyond those years assume that rates go back to the levels in effect before the tax cuts took effect. The top income tax rate, for example, is assumed to rise from today's 35% to the old top rate of 39.6%.

Using that assumption as a baseline, the Tax Policy Center looked at the impact of all the changes in tax law that each of the candidates has proposed. If McCain's proposed tax changes were put into effect, the Treasury would lose $3.7 trillion in revenue for the 10-year period between 2009 and 2018, compared with what it would take in under current law. If all of Barack Obama's tax plans were put into effect, the loss to the Treasury would be $2.7 trillion in revenues.

However, no one in Washington believes all the Bush tax cuts will be rescinded. Even under a Democratic Congress and Administration, the Bush tax cuts are likely to be kept in place for most taxpayers. So economic advisers to both campaigns argue it is more realistic to judge the impact of their campaign proposals against the tax policies and rates currently in effect.

Under that scenario, the numbers for both candidates look far better, although Obama still comes out well ahead. Indeed, when compared with current tax policy, his proposals would actually increase revenues coming into government coffers. Although he has promised tax cuts to many middle- and working-class families, along with the elderly, the TPC concludes that those cuts would be offset by his plans to increase taxes on high-income families and to close corporate tax loopholes. Together, those moves would bring an estimated additional $734 billion to the Treasury over 10 years, according to the Tax Policy Center study.

Leaving the Treasury Short

By contrast, even using the more favorable comparison, McCain's proposed tax changes would still leave the Treasury coming up short. According to the study, McCain's combined proposals would slash tax revenues by an estimated $253 billion over the 10-year period compared with what would come in under current tax policy.

Burman points out that the estimates assume the plans put forth by either candidate would be adopted exactly as proposed, which is unlikely. Both the McCain and Obama plans will probably evolve and become more specific as the campaign progresses; Congress, too, will want to have its say, no matter who is elected.

There's another highly questionable factor built into these calculations: Each campaign assumes it will get hundreds of millions in new revenues by closing tax loopholes, eliminating excessive spending on earmarks, and other maneuvers. To come up with its estimates, the Tax Policy Center takes those figures at face value, though many can't be verified or are unlikely to materialize. Spending, after all, is rarely cut—or loopholes as easily closed—as much as pledged during a campaign. Instead, says Burman, the analysis provides a snapshot of what would be feasible "if they could become President without a Congress, and without the need to run for reelection."

Nevertheless, he says, the estimates provide the closest idea possible of what the candidates intend. "It gives us some sense of their view," says Burman.