Voters weighing Obama, McCain tax plans

With both John McCain and Barack Obama offering tax cuts, the 2008 election promises a boost for the typical family budget. But it could also strain the much larger budget of the US government.

Already America is in a deep financial hole. The nation has made big promises to future generations without a clear plan on how to pay. Will the next president keep digging that hole?

That’s just one of the fiscal questions that voters across America are weighing.

In Tulsa, Okla., photographer Chris Humphrey wants to see a plan that will spur economic growth. As Boston schoolteacher Berta Berriz considers what’s fair, she argues for higher taxes on the wealthiest.

In polls, nearly 3 in 4 voters see taxes and budget deficits as “extremely” or “very” important – a ranking not far behind energy, healthcare, and the war in Iraq. Tax policy experts say Americans are right to feel concerned.

“We’re eventually going to face this enormous problem, and huge measures are going to have to be taken,” says Alan Auerbach, an economist at the University of California, Berkeley. “It would certainly be better to have a smoother transition to a sustainable system.”

Yet in these next four years, Dr. Auerbach says, it’s possible that even a self-proclaimed “agent of change” in the White House will leave the thorniest fiscal problems unresolved.

Certainly, the campaigns themselves are talking much more about near-term tax relief than about tough choices for the long haul. And they are doing it in distinctly different ways.

Republican candidate John McCain calls for broad tax reductions for businesses and the very rich.

Barack Obama, the Democratic nominee, has a more targeted plan aimed at low-income workers and the middle class. But if Senator Obama offers slightly smaller tax cuts, he offsets it on the other side of the fiscal ledger with significant new spending plans.

Neither candidate denies America’s long-run challenge: that the government will have a hard time supporting spending programs – notably for healthcare – that are projected to rise faster than tax revenues.

But they are relatively vague on how to solve the problem, even as they urge very specific measures that seem likely to deepen the fiscal hole.

Politicians often pitch tax cuts as a stimulant to economic growth. But it’s vital to consider, too, the economic consequences of government borrowing, say fiscal policy analysts.

“If the tax cuts substantially raise the national debt, the increase in borrowing by the federal government could crowd out private investment and consumers’ purchases of homes and durable goods, which could slow the economy,” warns a report by the Tax Policy Center, a Washington research group that strives for neutral analysis of the candidate plans.

The report concludes that both Obama and McCain appear set to follow President Bush in this respect: increasing the national debt.

Americans want balance

Surveys of public opinion suggest Americans want balance – not as in “balanced budget” but in a blending of goals.

Most see the income tax they pay currently as fair. But in January, an NBC/Wall Street Journal poll found the public split over whether those tax cuts have been “worth it,” since economic gains were offset by a rising federal deficit. And an April Gallup poll found strong support for tax hikes on upper-income Americans.

Jere Smith, who owns a Kansas City auto-repair business along with her husband, reflects some of America’s mixed feelings.

“You’ve paid student loans and worked hard,” she says. “Any tax that’s going to penalize us because we make more money than someone who didn’t has always kind of bothered me.”

At the same time, she complains that big corporations “have gotten way out of hand” and don’t deserve the additional tax cut that McCain is urging.

Economists, for their part, offer no clear consensus on where tax policy should head. They note that there’s no magic rule saying that governments should balance their budgets. But on one big point a consensus exists: It’s bad if the national debt grows too large – and if it keeps growing faster than the gross domestic product (GDP). That’s exactly what looms ahead, though not immediately.

McCain takes supply-side approach

McCain approaches fiscal policy squarely from the supply-side tradition: Cut taxes to encourage more economic activity, more supply of goods and services.

He wants to maintain the Bush tax cuts largely as they exist. Instead of repealing the estate tax, he would reduce it to 15 percent. The deduction taxpayers get for each dependent in the household (currently $3,500) would gradually double. He would cut the corporate tax rate from 35 to 25 percent, with the goal of bringing the US into line with other developed nations.

McCain says he’ll reduce spending below current forecasts with a tough review of all budget items and the elimination of earmarks that lone lawmakers insert into spending bills.

“Senator McCain’s economic policies were all designed and set up for one reason – to create jobs” in the private sector, says Taylor Griffin, a campaign spokesman on the economy. Lower taxes won’t “pay for” the tax cuts, but a positive “feedback” on the economy should cause federal revenues to come in better than traditional models forecast, the McCain camp believes.

On spending, “there’s a lot of fat to cut,” Mr. Griffin says. McCain promises to balance the budget by 2013. But his campaign has not specified the needed spending cuts.
Obama would also maintain Bush income-tax rates on the vast majority of the population. For households making $250,000 or more, the marginal tax rate would return to late 1990s levels – as high as 39.6 percent. The estate tax would stay at its current rate of 45 percent, with a lower exemption amount than under McCain. The capital gains tax would rise to 20 percent for many investors.

Obama targets significant tax breaks to modest- and lower-income taxpayers: About $500 cash back for workers on the first $8,100 in job income, eliminating taxes on seniors with $50,000 or less in income, a mortgage credit for people who don’t currently reap an interest credit by itemizing deductions, an expanded saver’s credit, and expansion of a childcare credit. To raise some offsetting revenue, Obama plans to close off more corporate tax breaks than McCain. His campaign makes no pledge to balance the budget.

Obama stresses equity

“The Obama tax plan is to be preferred not only on grounds of equity, but (because it is more fiscally responsible) it is also likely to lead to better economic performance,” says Lawrence Summers, an Obama adviser and former Treasury secretary.

But definitions of what’s fair and what will boost the economy differ.

Berta Berriz, a Cuban-born American who arrived in the US as a girl in 1958, doesn’t see evidence that lower tax rates in recent years have improved economic growth.

“This whole idea of trickle down ... I haven’t seen it rain,” says Ms. Berriz, who teaches fifth graders in Boston.

And neither McCain nor Obama promise a big tax windfall directly for her or her husband, Ty dePass, who’s currently earning little as a freelance writer.

But for them, fairness means that society’s best off should pay more in taxes.

“My [students] are brilliant children with a lot of potential and the will to make it,” she says. But they are also children of immigrants who often work two or three low-wage jobs.

“I would pay more taxes to have children well fed and children out of poverty,” Berriz says. She says that, even though her own budget is tight. Her heating oil bill has doubled to $500 a month. She intends to vote for Obama.

Chris Humphrey sees a different picture of how the economy works.

Like Berriz, he’s far from rich, but he’s a successful wedding photographer near Tulsa, Okla., and is leaning toward a McCain vote.

For him, the ideal system is what proponents call the FairTax, replacing the income tax with a simpler tax on personal spending.

Short of that, he says the best path is the one that tinkers least with the economy’s job-creating machinery. On that score, Obama worries Mr. Humphrey, because of the plan to raise tax rates on people with high incomes – many of whom run businesses.
“For me personally, taxes are a huge factor, and I don’t think that a majority of Americans get how taxes really move the economy,” he says.

It’s not just what candidates say but what they might actually do that he’s thinking about as he considers future opportunities for himself, his wife, and their two young boys.
Many business owners around the country share Humphrey’s concern.

Impact on small businesses

Most small businesses don’t have net income as high as $250,000. But many successful ones do, and they’re often organized so that the income flows onto the personal tax return of the owner. These businesses are effectively taxed at the personal tax rate, not the corporate tax rate.

While not endorsing one candidate or another, Boston-area accountant Larry Nannis describes the implications for many of his clients.

“If you’re paying more in taxes,” he says, “then you have less money to do other things, be it grow a business, buy a yacht, or ... [fund] a child’s education.”

That doesn’t mean that every top-bracket taxpayer is backing McCain.

Ted Almon, owner and chief executive of a medical-supply distribution company based in Warwick, R.I., says he leans more toward Obama than McCain, despite the prospect of a hit to his wealth in the short run.

His reasoning is that America’s interest, and his own long-run self-interest, lies in finding a middle ground on the political spectrum.

“I feel strongly that there is a balancing point somewhere between the far left, or social activists, and the far right, or fiscal conservatives, where the economy clicks at its best, which is to everyone’s benefit,” Mr. Almon says.

In recent years, a rightward tilt of economic policy has gone too far, he argues. “The middle class and working class are losing their ability to consume.”

For him, it’s a balancing act partly because he sees tough choices in all directions.

The budget demands fiscal discipline, but society also shouldn’t “be faced with dismantling the safety net,” Almon says. And if taxes went through the roof, it would squeeze out private-sector growth – “the goose that lays the golden egg.”

He echoes a tension felt by many Americans, who are leery of big tax hikes but also of big cuts in government services.

As they struggle to win voter hearts and minds, the candidates are selling their plans in connection to the immediate challenges many Americans face. A housing downturn and a historic rise in energy prices have dragged the pace of economic growth well below normal.

During the Republican National Convention last week, McCain criticized Obama for advocating higher taxes. It is true, according to the Tax Policy Center analysis, that Obama’s plan would raise $600 billion more tax revenue, over 10 years, than if the Bush tax cuts were all extended.

Still, the economy might recover before any new tax plan is enacted.

And for the long term, both candidates are seeking to appeal as politicians who can break the traditional mold – including on the looming fiscal crunch.

Whether solutions are forged by Obama, McCain, or someone else, they will require mold-breaking leadership.

The key to the fiscal challenge is healthcare (an issue that will be addressed in detail later in this series). Even assuming some slowdown in medical inflation, spending on Medicare and Medicaid appears likely to grow three times as fast as Gross Domestic Product (GDP) over the next quarter century, for example.

The aging of America’s demographic profile also puts pressure, to a lesser extent, on Social Security. And to the degree that all these expenses add to the national debt, interest payments could soar.

How big is the problem?

At present, the federal debt is not unusually large as a share of GDP.

But if current fiscal trends continue unchecked, America might see federal spending nearly double, as a share of GDP, over the next three decades, according to the nonpartisan Government Accountability Office.

That’s a wide “fiscal gap” between promises (like Medicare) and current tax payments.
Economists generally say this gap is too big to simply “grow our way out,” although figuring out ways to boost economic growth would certainly help.

Bond rating a factor

One danger: If lenders someday stop viewing US Treasury bonds as “Triple-A” quality, the government would have to pay higher interest when it borrows in the future.
Solutions are within reach, but they may involve both more taxes and new spending controls. Delay makes the economy’s fiscal burden larger, and it would spread the cost less evenly.

“It’s an issue of distributing the burdens and benefits fairly among generations,” says Mr. Auerbach at the University of California. “Something pretty significant has to be done with respect to these entitlement programs. Some combination of taxes and spending changes.”

Part of the fix might be tax reform that balances or blends public goals: simplicity, economic efficiency, and fairness.

Another is to devise creative new ways to curb spending.

The alternative looks grim: Rising deficits could erode the pool of capital the economy needs for investing in things such as research, education, and new businesses.

“The general public understands the basic math problem,” says Diane Lim Rogers, an economist at the Concord Coalition in Washington, which promotes fiscal sustainability.
Without action, she says, “our children and grandchildren are going to face higher taxes or lower services.”

Reality check

The candidates have their proposals, but what will actually get done? Probably some of their tax cuts but not all.

Both major candidates want to maintain Bush-era income-tax rates on most Americans. With those rates set to expire at the end of 2010, a failure to do this could tar the next president and Congress as imposers of a mammoth tax increase.

But worry about federal deficits may impose some limits on tax cuts.

For one thing, remember the way an economic slump in 2001 caused the budget deficit to widen to unexpected proportions as dotcom-era tax revenue evaporated.

Moreover, campaign pledges to curb government spending alongside tax cuts have a way of going awry.

“I’m not sure anybody is going to make substantial reductions in spending. It looks to me like all the pressure is going in the other direction,” says one veteran watcher of budget matters, Stan Collender, a managing director at Qovis Communications in Washington.

“For anyone earning over about $150,000 a year, taxes are almost certainly going up regardless of who gets elected,” Mr. Collender predicts.

He says the top income-tax rate won’t go higher than where it stood when Bush took office – 39.6 percent.

Pollsters anticipate a more Democratic Congress, but many of them “are relatively fiscally conservative,” Collender says. And Senate Republicans may retain enough seats to use filibuster leverage against measures they oppose.