Taxes (again)

A while ago, I wrote a post on taxes, and mentioned that the non-partisan Tax Policy Center had performed an analysis of both Obama’s and McCain’s tax policies. I also said that after I had read it, I would provide you with additional information regarding both candidates’ tax plans. Well, I have read it, but I am too busy to write more about it. So here is the Tax Policy Center's introduction and summary of the candidates tax plans.

Tax and fiscal policy will loom large in the next president’s domestic policy agenda. Nearly all of the tax cuts enacted since 2001 expire at the end of 2010. The individual alternative minimum tax (AMT) threatens to ensnare tens of millions of Americans in a web of pointless complexity and higher taxes, but a permanent fix palatable to both political parties has proven elusive. In the past year, the federal budget deficit has ballooned, and, more worrisome, large projected increases in spending on Social Security, Medicare, and Medicaid will put unprecedented demands on federal government revenue sources in the coming decades.

Fundamental reform of our tax system is one way to resolve these problems, but, at least in part because reform creates both winners and losers, the leading presidential candidates have not addressed it seriously. Nonetheless, both candidates have proposed major changes to the nation’s tax laws. Senator McCain would permanently extend the 2001 and 2003 tax cuts, increase deductions for taxpayers supporting dependents, reduce the corporate income tax rate, and allow immediate deductions for investments in certain capital equipment. Senator Obama would permanently extend certain provisions of the 2001 and 2003 tax cuts primarily affecting taxpayers with incomes under $250,000 but repeal the cuts in the top two marginal income tax rates ahead of their scheduled expiration in 2010; increase the maximum rate on capital gains; raise the top tax rate on qualified dividends from its current level (but keep it below pre-2001 levels); and enact new and expanded targeted tax breaks for workers, retirees, homeowners, savers, students, and new farmers. Senator McCain proposes to extend permanently and increase the AMT “patch” that has prevented most individuals and families with incomes below $200,000 from being affected by the tax and lowered the tax for others, and in our interpretation of his proposal, Senator Obama would also extend the patch. Each candidate would also increase the estate tax exemption and reduce the estate tax rate compared with current law in 2011 and beyond, although Senator McCain would cut the tax much more than Senator Obama. Finally, each candidate promises to broaden the tax base and reduce corporate loopholes. McCain lists eight breaks for oil companies as targets but, other than that, is short on details for his pledge to eliminate “corporate welfare.” Obama identifies a variety of steps, including basis reporting for capital gains, taxing carried interest as ordinary income, and enacting sanctions on international tax havens that don’t cooperate with enforcement efforts, but he would also need additional as-yet-unspecified policies to achieve his revenue target for base broadening.

Although both candidates have at times stressed fiscal responsibility, their specific non-health tax proposals would reduce tax revenues by an estimated $4.2 trillion (McCain) and $2.8 trillion (Obama) over the next 10 years. Both candidates argue that their proposals should be scored against a “current policy” baseline instead of current law. Such a baseline assumes that the 2001 and 2003 tax cuts would be extended and the AMT patch made permanent. Against current policy, Senator Obama’s proposals would raise $800 billion and Senator McCain’s proposals lose $600 billion.

The two candidates’ tax plans would have sharply different distributional effects. Senator McCain’s tax cuts would primarily benefit those with very high incomes, almost all of whom would receive large tax cuts that would, on average, raise their after-tax incomes by more than twice the average for all households. Many fewer households at the bottom of the income distribution would get tax cuts and those tax cuts would be small as a share of after-tax income. In marked contrast, Senator Obama offers much larger tax breaks to low- and middle-income taxpayers and would increase taxes on high-income taxpayers. The largest tax cuts, as a share of income, would go to those at the bottom of the income distribution, while taxpayers with the highest income would see their taxes rise significantly.

The impact of the tax code on economic activity under each candidate’s policies would differ in several important ways. Under Senator McCain’s proposed policies, the top marginal rates (35 percent on individual income and 25 percent on corporate income) would be significantly lower than under Senator Obama’s plan (39.6 and 35 percent, respectively). McCain’s reduced individual and corporate rates could improve economic efficiency and increase domestic investment, but the larger future deficits would reduce and might completely negate any positive effect. In contrast, Senator Obama’s proposed new tax credits could encourage desirable behavior, particularly if the childless EITC and payroll tax rebate encourage additional labor supply among childless low-income individuals. However, he would also direct new subsidies at an already favored group—seniors —and an already favored activity—homeownership—which could probably be better directed elsewhere.

As I have stated before, I like that Obama's plan will make permanent the tax breaks for individuals making less than $250,000. I also like that his plan will bring in more revenue than McCain's plan, although both are relying on fiscal responsibility to reduce spending and help balance the budget. With the current size of the US deficit, I think that we need to start taking several corrective actions to reduce our addiction to borrowing money from countries like China.