Tuesday, June 17, 2008

The Candidates get a Fiscal Exam

The Tax Policy Center has made a preliminary analysis (with slight revisions) of McCain and Obama's tax plans. Under current law, most of the tax cuts passed in 2001 and 2003 are scheduled to expire after 2010 - i.e., if nothing is done, there will be a significant tax increase in 2011 (returning us to the higher tax rates we had back in the Clinton years, when the economy was growing faster, unemployment was lower, and the federal budget was in surplus...). Relative to this, both candidate's plans would reduce revenue - McCain by $3.6 trillion and Obama by $2.7 trillion over 10 years (or, compared to keeping the current tax code in place, Obama would raise revenue by $262 billion while McCain would reduce it by $615 billion). Federal tax revenue was 18.8% of GDP in 2007 - under McCain's plan it is projected to be 17.9% of GDP over 2009-2018, versus 18.4% under Obama's.

Both candidates' proposals are multifaceted; highlights include:

McCain would extend almost all of the 2001-03 tax cuts (except that a 15% tax would remain in place on estates over $5 million), increase the tax exemption for dependents and reduce the maximum corporate tax rate from 35% to 25%.

Obama would extend the portions of the tax cuts affecting lower- and middle- income households, but allow the top tax rates to revert to their 2000 levels (e.g. the top income tax rate would return to 39.6% from its current 35%) and raise capital gains and dividend taxes. Lower and middle-income families would also be the beneficiaries of more tax credits: he would add a $500 "Making Work Pay" tax credit, expand the Earned Income Tax Credit (EITC) and the child and dependent care tax credits.

The distributional effects of the two plans are very different: Obama's plan would raise the average federal tax rate in 2009 for the highest-income quintile (i.e. the top 20%), and lower it for the remaining 80%. The cut would be 5.3 percentage points for the bottom quintile and 2 pts for the middle quintile, while the top 20% would see a 1.5 pt increase (and the top 1% would see their tax rate increase by 6.1 pts). Under McCain's plan, the average federal tax rate for all groups, but the decrease for the bottom quintile (0.2 pts) and middle (0.6 pts) are small compared to the change at the top (2.2 pts for the top quintile).

The study has a number of caveats. The center had to make some assumptions because proposals are vague - the report says "no one - not even inside the campaigns - knows exactly what the proposals are. Stump speeches and campaign white papers are often short on the technical details needed to analyze the proposals fully." Also, the analysis did not tackle the candidates' plans regarding health care, which will also affect the tax code (the TPC promises a separate study on this).

EconomistMom examined the distributional consequences; here's her answer to the Telly Savalas question ("who loves ya, baby"):
So in aggregate, at least in terms of tax cuts, McCain loves taxpayers (even) more than Bush loves taxpayers, and Bush loves taxpayers more than Obama loves taxpayers. All of them are not so fond of our children and grandchildren though, because they’re all willing to have our children and grandchildren (aka future taxpayers) pay for all that love they’re willing to give to us current taxpayers.

But how much the candidates love you, in particular, depends a great deal on how “rich”, or not, you are. With his tax cuts, Senator Obama loves those who are not so rich a lot more than he loves those who are. Senator McCain, on the other hand, really loves the really rich. In fact, with his tax cuts, Senator McCain loves the really rich even more than President Bush has loved them.

And Paul Krugman says:

The key point, again: because of all those middle-class tax cuts in the Obama plan, he collects only 0.4% of GDP more in taxes than McCain. The tax collection comes from different people: lower and middle-income Americans would be substantially better off under the Obama plan. But where is the money for health care reform?
Krugman also wrote a column on the subject (his numbers are slightly different because they are prior to the TPC's revision of its estimates), and Clive Crook did too.

The TPC's analysis does not include Obama's proposal - which is still lacking specifics (maybe we should call it a "gambit" for now) - to apply the social security payroll tax to higher-income owners (currently, income above $102,000 is not subject to social security contributions). Back in November, this came up in a debate between Clinton and Obama (see this post for a discussion). Obama says that the tax would kick back in for incomes above $250,ooo (i.e. there would be a 'donut hole'). While the problems of social security are often exaggerated, this would make the tax code more progressive (and the top marginal rate would be getting pretty high, for those who worry about such things) and reduce the amount the government needs to borrow from the "public" (or, really, China), because the social security trust fund would buy some of the Treasury bonds that would otherwise have to be sold to finance the deficit. That should be a plus for investment (less "crowding out") and the current account. The TPC says:

Senator Obama not been clear about what rate would apply, when the tax would take effect, or even what the tax base would be. (See our follow-up blog post.) Assuming that the proposal would apply the full 6.2 percent OASDI (old age survivors and disability insurance) tax, paid by both employers and employees, to earnings above the threshold, TPC estimates that the proposal would raise $629 billion, or about 0.4 percent of GDP, over the ten-year budget period.

For a good analysis of the donut, see this post from EconomistMom.

Update (6/19): The Times' David Leonhardt has three questions for McCain.

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