>If Barack Obama gets elected President, the first thing he should do is hire Doug Holtz-Eakin to be his budget director. A highly-respected non-partisan budget wonk, who is leaning Obama’s way in the election, threw out this seemingly crazy idea at lunch the other day. And the more I thought about it, the more sense it made.

Why would Obama want to hire John McCain’s chief policy advisor to run his OMB, perhaps the most critical policy shop in the Administration?

To start, Obama often talks about a post-partisan Presidency. This would be a way for him to show he means it.

Second, Holtz-Eakin would enjoy fiscal credibility in the financial markets. The bond vigilantes have not cared about deficits for years, but they tend to get interested when Democrats run the government. Just ask Bill Clinton. Today, they see Obama as little more than a big-government liberal with a good speech. This might show them he is more complex than that.

Most important, though, Holtz Eakin would help lower the stratospheric expectations the left has of Obama. The candidate has already made trillions of dollars in promises he cannot possibly keep, and liberals will demand hundreds of billions more if he and a Democratic Congress are swept into office in November. Of course, McCain has his own problems with super-sized promises, but that’s for another day.

How can Obama lower these expectations? He needs a Dr. No—someone who can bring some reality into the political debate. And who better than Holtz-Eakin, who even many liberals like and respect? They’d detest Obama’s decision to pick him, but someone has to play the heavy.

I don’t know if Holz-Eakin would take the budget job in a McCain Administration, much less in Obama’s. And I can’t imagine he’d get the offer. Besides, with the election still nearly 12 weeks away, the whole thing is more than a bit premature. Still, it is an idea worth musing about in the heat of a Washington August day. Just a thought.

Right after the housing bill was signed, I opened up my personal e-mail to find this:

Dear friends,

Great News!! President Bush just signed into law the Housing and Economic Recovery Act of 2008. This is a major victory for REALTORS®, consumers, and our nation!

Homebuyers will soon have access to more affordable financing, and first-time homebuyers (those who have not owned a home for three years) will receive a tax-credit to help them enter the market. For more details on all of the provisions in the new law, please use the link below.

How a realtor in Milpitas got my e-mail address, I don’t know, but she sure is convinced that the new law will bring buyers back into the market. But is the first-time homebuyers’ credit really a good deal for consumers and our nation?

Unlike other credits, the new one is really a 15 year interest-free loan. Qualifying buyers will get a refundable credit of the smaller of 10 percent of their purchase price or $7,500 for homes bought between April 2008 and June 30, 2009. Because they don’t get the credit until they file a tax return—and not when they buy the house—it’s unclear how much the cash windfall will help with down payments—which presumably was the whole idea. And interest-free doesn’t mean free: they must pay the money back to the government over 15 years.

You can see why real estate agents and homebuilders love it. It fairly screams: Buy now and get $7500 off! But you must act fast! Assuming we are no longer in a world with no-money-down home purchases, what would the new credit really do?

For people who have the money to buy a house but have been waiting to enter the market, the credit could encourage them to buy now rather than later. If home prices fall by another few percentage points, the tax break will help cushion the blow of falling home prices.

But what about the person who is on the edge of being able to afford to buy at all—the one who needs the money for the down payment? Assuming there will be ways of accessing the money quickly they face lower upfront costs but higher future expenses. Isn’t this a lot like the financing game that got us into the housing mess in the first place? It would be a shame if the government ends up effectively setting up the next generation of defaulting home-owners.

At least the current credit is an improvement over an earlier tax break proposed for people buying foreclosed property. Still, adding yet another credit to the hundreds of billions in tax breaks we already lavish on homeowners makes me wonder whether we should step back and rethink whether owning is truly the answer for everyone.

Liberal bloggers have taken to ganging up on the Blue Dogs—conservative Democrats who tend to go their own way on fiscal and foreign policy issues. Smelling victory in November, some on the left would like to find a way to take out these lawmakers, who mostly represent southern and midwestern swing districts.

The left’s biggest objection seems to be the Dogs’ support of both the Iraq War and the Bush Administration’s aggressive “war on terror,” including its curbs on domestic civil liberties. I’m not going there. After all, this is a tax blog. But when Ezra Klein charged in a post the other day that the Dogs were also pro- tax-cut sell-outs in thrall to business lobbyists, that was a bit too much.

I’ll take Ezra’s word for it that these pols take lobby money. They are, after all, congressmen. But they are hardly knee-jerk tax cutters.

In fact, conservatives regularly rage against the Dogs for opposing the Bush tax cuts. Last year, the National Taxpayers Union gave them a collective grade of D for their lack of featly to its agenda. Rep. Jim Cooper (D-Tenn) got an average NTU rating of 26 out of 100 over the past five sessions of Congress. Nick Lampson (D-Tex) averaged an 18, not much better than Barack Obama, who scored a9. Earl Pomeroy (D-ND), averages about a 20 from Grover Norquist’s Americans for Tax Reform.

These ratings can sometimes be silly, but the message is clear: In the eyes of the anti-tax crowd, the Dogs are far from reliable friends. Andthey have made some very tough votes along the way.

I wish they were tougher on spending. Not surprisingly, since many of the Dogs represent rural districts, they have not been keen to cut farm subsidies. And they have been disappointingly soft on other efforts to trim spending. Still, they are better than most.

Finally, there is the politics of all this. Despite the fervent wishes of the left, a 2009 spending spree, which would generate either more borrowing, higher taxes, or both, is neither good for Democrats nor the country. Having a few Blue Dogs around to provide cover for a bit of fiscal prudence may not be such a bad thing. Besides, why would any Democratic partisan want to replace a conservative Democrat with an even more conservative Republican, which would be the inevitable result of such a purge.

As any politician can tell you, kicking a Dog is never a good idea.

For a brief 48 hours, it looked as if John McCain was courageous enough to say something sensible about tax policy—and as a result was immediately attacked by both the right and the left.

Today’s Wall Street Journal reported disapprovingly that McCain would consider payroll taxes as a way to bolster Social Security’s finances.“Mr. Stephanopoulos [on ABC’s This Week] pressed, ‘So that means payroll tax increases are on the table, as well?’ Here came the words that have caused the McCain campaign well deserved grief: ‘There is nothing that's off the table. I have my positions, and I'll articulate them. But nothing's off the table.’”

The Journal also reported that the Democrats were preparing attack ads accusing McCain of flip-flopping and hypocrisy on taxes since he’d earlier vowed to never raise taxes and had criticized Senator Obama for saying he would.

This was a good flip-flop, though—like Obama’s grudging acceptance that the surge in Iraq, which he’d initially opposed, seems to be working.We should cheer when candidates recognize reality, however late in the game. I don’t know if higher payroll taxes should be part of the solution to Social Security’s long-term ills, but why rule them out before negotiations even begin?It is simple arithmetic that any sensible solution requires cuts in benefits, higher taxes, or some combination of the two.Ruling out options 2 and 3 would wreck any reform effort.

More fundamentally, the enormous demands placed on government by the retirement of baby boomers and rising health care costs will, at some point, require additional revenues.Slowing the growth of spending, especially for the big entitlement programs—Social Security, Medicare, and Medicaid—is necessary too, but almost nobody believes that will be the whole solution.

But, alas, today it was back to read my lips: “I want to look you in the eye: I will not raise your taxes nor support a tax increase,” he said … at a town-hall-style meeting at the Wagner Company, a Caterpillar dealer. “I will not do it.”

Sigh...

To paraphrase the oily Captain Renault of Casablanca fame, we in Washington are shocked, shocked to find that deficits are going on here. To listen to the cries of outrage and dismay, one might think the Bush Administration’s latest projection of nearly $400 billion in red ink for the fiscal year ending on Sept. 30, and almost $500 billion for next year was unexpected.

After all, if we happily run significant budget shortfalls when the economy is flush, why should we surprised that they grow when it is soft?

The Bush math is very simple, really. Based on the White House projections, from the time the President came into office in 2001 until he leaves in fiscal 2009, Medicare spending will nearly double from $214 billion to $417 billion, fueled in large part by his new Part D drug benefit. Military spending will more than double. Officially, OMB says defense costs will rise from the ’01 level of $334 billion to $675 billion, but that assumes only $70 billion for the wars in Iraq and Afghanistan in 2009—far below the real price, which is likely to hit $200 billion.

While this big ticket spending explodes, income tax receipts will be less than one-third higher, or about $500 billion more, in ’09 than in ’01. And medium-term revenues are likely to be lower than projected since Bush assumes no fix for the Alternative Minimum Tax after 2009, an item which will cost more than $70 billion. Ironically, while John McCain and Barack Obama want us to assume a budget baseline where the costs of the war and an AMT patch go on forever, Bush does not.

As Budget Director Jim Nussle said yesterday, in a bit of uncharacteristic understatement, “This is going to be a challenge.”

Indeed. Especially if, like Obama and McCain, you hope to govern the country after Bush moseys on back to Texas. Yet, while the budget hole deepens in front of their eyes, the candidates keep making implausible promises.

McCain insists he’d balance the budget by 2013 but proposes a tax plan that would increase the national debt by $5 trillion over the next decade, even as he offers no credible way to slash spending by close to that much.

Obama economic adviser Austan Goolsbee told TPC last week that the campaign is aiming for a deficit no larger than this year’s $400 billion by 2013. Yet even meeting that low bar won’t be easy in the face of his tax plan, which would increase the debt by $3.4 trillion by 2018, and his ambitious new spending plans for health care, the environment, and education, which would add billions more.

Bush’s new budget estimates are a reality check on both candidates. They tell us that there is no way McCain can cut taxes by as much as he promises and there is no way that Obama will cut taxes and boost spending by as much as he wants.

That is, I suppose, comforting in some inside the Beltway way.

A questioner at our forum on the candidates’ tax plans asked about the portion of Senator Obama’s tax proposals that would go to households with no tax liability. I did not have the answer then, but Jeff Rohaly has since crunched the numbers. He estimates that the refundable portion of tax credits (other than for healthcare) would increase by $648 billion over ten years in the Obama plan. The new credits would also increase the percentage of households that do not owe income tax in 2009 from 38 percent under current law to 48 percent in the proposal, although that percentage will decline over time as real incomes grow.

By budget scorekeeping convention, the refundable portions of tax credits are treated as outlays—that is, the same as direct spending—rather than as tax reductions. Under current law, outlays on the earned income tax credit and the child tax credit (and several much smaller refundable credits) will total $406 billion from 2009 to 2018; Senator Obama’s proposals would increase the total to $1,054, or almost 160 percent.

There’s an interesting debate about refundable tax credits. On the one hand, some critics argue that “tax cuts are for taxpayers,” meaning that refundable tax credits should not be part of the tax cut agenda. The Wall Street Journal editorial page once famously opined that people with incomes too low to owe income tax were “lucky duckies,” undeserving of tax relief.

On the other hand, a lot of what we call tax cuts are really spending programs in disguise. Does it really make sense to provide subsidies for health care, homeownership, saving, education, etc., in such a way that the people who most need assistance—those with low incomes—are automatically disqualified? For that reason, Lily Batchelder, Fred Goldberg, and Peter Orszag have argued that all tax subsidy programs should be converted to refundable credits.

While this debate rages, there seems to be general agreement that refundable credits are the way to go to expand health insurance coverage. President Bush proposed refundable credits several times before switching to his standard deduction for health insurance. Senator McCain’s proposal is basically the president’s, but provided as a refundable tax credit instead of a deduction. This is likely to be much more effective in targeting assistance to those who need help affording insurance. And Senator Obama’s subsidy scheme is also fully refundable, and even more targeted at those with low incomes.

I’ll post an estimate of the refundable portion of the health tax credits for both proposals next week.

Barack Obama’s fiscal policy can be summarized pretty simply: Cut taxes for low- and middle-class Americans, boost spending for education, health care, and alternative energy, and pay for much of it raising taxes on the rich. That’s not the only way he’d finance his ambitious plans, of course—he’d also have to borrow $3 trillion and get some money from ending the war in Iraq—but he hopes to generate nearly $300 billion over the next decade just from rolling back the Bush tax rate cuts on high-bracket taxpayers.

The numbers are quite striking, according to a new TPC analysis of the Obama plan: Middle-income families would see their taxes cut by about $1000 annually or 5 percent, while those in the top 1 percent (with incomes in excess of $600,000), would pay $130,000, or about 2.7% more. And that does not include the likely impact of Obama’s still-vague plan to boost payroll taxes on those earning more than $250,000. That proposal alone could increase taxes on those high earners by an additional $400 billion over 10 years.

Taxing the rich may be a political winner, but it runs the risk of creating some big economic problems. TPC figures Obama could boost the top effective marginal income tax rate to 46 percent, assuming a 2 percent payroll tax increase. In a high-tax jurisdiction such as New York, the combined state, city, and federal rate would top 50 percent. If high-earners have to pay the full Social Security payroll tax, their rates could approach 60 percent.

We’ve seen those rates before—they have been as high as 90 percent-- and we’ve got a pretty good idea what happens. When labor is taxed that much, wealthy people will find a way to turn ordinary income into capital gains and dividends, or to defer income. The result: At these levels, rising rates generate tax avoidance, not more revenue.

John McCain argues that these high rates will hurt small business most, but that claim is shaky. Fewer than 2 percent of taxpayers with business income are in the top bracket. These entrepreneurs may aspire to millionaire-hood, but most will never get there.

Still, Obama’s effort to make the highest income Americans pay for more of government through higher tax rates will not come without a price.

TPC sponsored a fascinating debate today between John McCain’s top policy adviser, Doug Holtz-Eakin, and Barack Obama’s senior economic adviser, Austan Goolsbee. More than anything, I was struck by how much time each spent criticizing the other guy’s fiscal plan rather than promoting their own.

The discussion coincided with TPC’s release of an updated analysis of the candidates’ tax plans. The new report concludes that both will significantly increase the deficit over the next decade. Including interest costs, Obama would do so by $3.4 trillion, while McCain would raise the deficit by $5 trillion. The Obama plan would cut taxes for most people, but raise levies significantly on the very wealthy. McCain, but contrast, would cut taxes for nearly everyone, but provide by far the biggest reductions for those making the most money.

McCain’s primary policy goal is economic growth, Obama’s is progressivity. These are big and interesting contrasts, and it would have been nice to learn more about what drives their bosses’ agendas. But, instead, I mostly heard why the other candidate’s plan is so awful.

Goolsbee talked a lot about McCain’s “budget shammery.” It is a nice turn of phrase, but neither candidate gets high marks for transparency. Both prefer to use a budget baseline that assumes the Bush tax cuts will go on forever and that the Alternative Minimum Tax will be permanently “patched.” I understand why, since that appears to give them more money to pay for campaign promises. But, in truth, both candidates are hiding a lot of fiscal irresponsibility behind these wonky arguments over baselines.

Holtz-Eakin gets credit for giving a straight answer to a very important question; How much tax revenue is right? In the short term, he said about 18 percent of Gross Domestic Product. Since he also said McCain wants to balance the budget by 2013, he is suggesting that spending also ought to be about 18 percent of GDP. That implies some pretty tough cuts in current government programs, which cost more than 20 percent of GDP.

There are serious questions about whether McCain could get there, and what kinds of spending cuts it would take, but at least I came away with some idea of where he is headed. Goolsbee, by contrast, ducked the question at least twice. The closest he came to an answer was to concede that Obama’s 2013 deficit would be lower than this year's, which will exceed $400 billion. Not exactly a high fiscal bar.

In response to my blog the other day about economists endorsing John McCain’s proposal to create an alternative individual income tax, Winghunter asked a perfectly reasonable question: What would such a scheme do for the economy?

Winghunter was asking about a version proposed earlier this year by Fred Thompson, a plan which mimics one first put out by the House Republican Study Committee. But the idea is essentially the same: Individuals would figure their liability under both the regular income tax and a simplified lower-rate alternative and pay whichever is less.

TPC has concluded that such a Thompson-like tax system would reduce federal tax revenues by an eye-popping $7 trillion over 10 years. But, getting back to Winghunter’s question: What would that do for the economy?

The short answer is nothing good. A conventional lower-rate structure would boost growth, but only if it is financed, either by spending reductions or tax increases. It happens that CBO has just released a report that looks at the economic effects of a much more modest plan—permanently indexing the Alternative Minimum Tax and extending the 2001 and 2003 tax cuts. It estimated that unless these tax cuts are paid for, deficits would reach 5 percent of GDP by mid-century and 18 percent by 2082. Eighteen percent of GDP happens to be about what we collect in total tax revenues each year. Hello Argentina.

In this study, CBO director Peter Orszag says the economic consequences of such a flow of red ink are literally unimaginable. As he put it, “projected deficits would grow to levels well beyond the range for which economic models have been developed.” Diane Rogers over at economistmom.com has a nice take on this.

Of course, some on the Right may try to dismiss Orszag’s analysis since he used to work in the Clinton Administration and at The Brookings Institution—a think tank Winghunter dismisses as “liberal.”

Trouble is, Orszag’s analysis is essentially identical to what CBO was saying 5 years ago, when its director was Doug Holtz-Eakin, a highly-respected conservative economist who is now John McCain’s chief economic adviser. This is what he said about the impact of tax cuts that are not financed:

“Sustained and rising budget deficits would affect the economy by absorbing funds from the nation’s pool of saving and reducing investment in both the domestic capital stock and foreign assets… As a result, the growth of workers’ productivity would gradually slow, real wages would begin to stagnate, and economic growth would tend to taper off. If that situation continued long enough, rising deficits could actually lead to a sustained contraction of the economy.”

So, no problem. All we need to do is find a way to cut $700 billion-a-year from the $3 trillion federal budget. Until we do, it is pretty clear that tax cuts of this magnitude are nothing but bad for growth.

It wasn’t exactly So You Think You Can Dance, but watching Congress and President Bush boogie their way through the final song of the recent Medicare prom was still a hoot.

In the end, Hill Democrats stomped Bush and, despite his veto, easily passed a Medicare bill that delayed, yet again, mandated cuts in physician payments. The Dems did so while insisting they were for both true competition and fiscal responsibility. Bush, trying to claim those same virtues for himself, had unsuccessfully tried to block the bill, insisting it would hurt beneficiaries by curbing their access to managed care plans.

Even by Washington standards, Bush wins a chutzpah award for attempting to justify a 13 percent subsidy to private managed care companies in the name of market competition. Medicare managed care, done properly, might improve patient outcomes and save money. But we have never seen it done right, despite at least three tries over the past two decades, in part because insurers built their business models around these unsustainable subsidies, then cut and ran when the largess dried up.

Congress shares the chutzpah award, however, for trying to wrap itself in the cloak of free markets while trashing efforts to require competitive bidding for both private lab services and durable medical equipment such as wheelchairs. When it comes to slashing subsidies for insurance companies, Congress loves markets. When it comes to ending high-cost sweetheart deals for a handful of equipment companies, not so much.

Then, there is the doctor fix, which set off this whole hullaballoo. Last century, Medpac, an independent body that advises Congress on Medicare, recommended that physician reimbursement rates be trimmed. Each year or so, Congress dutifully bows to pressure from the doctor lobby and effectively freezes, rather than cuts, physician payments. This year, the reduction was supposed to be 10.6 percent, mostly because prior cuts had been repeatedly put off. When this comes up again in 2010, the docs will be in line for a 20 percent cut in payments. Care to guess how that will come out?

This fracas shows just how hard it is to do anything to control Medicare costs. These ballooning expenses are the biggest single risk to the nation’s long-term fiscal sustainability and, thus, a critical driver of tax policy over the next decades. Yet, Washington is not willing to reduce payments, or even encourage a tiny bit of price competition, for providers. And it took a huge battle to trim subsidies for Medicare managed care, which has become a honey pot for private insurers, especially the four companies that dominate the market.

And remember, all of this blood was spilled over payments to docs, equipment suppliers, and insurance companies, not patients. Just imagine what will happen when Washington tries, as it inevitably must, to tell seniors that Medicare will no longer pay for tests and treatments they want but which have no proven medical benefits. That, I promise you, will be no dance contest.

I turned in my PhD dissertation just in time. I can’t believe I’m going to be a doctor of public finance. My paper: An Alternative Tax System in the McCain Administration. It is a detailed description and macroeconomic analysis of John McCain’s plan to give taxpayers a choice of paying under the current system or through a much simpler and more efficient option.    more »

John Endean raised an intriguing idea the other day in response to my blog on whether business executives would be willing to give up targeted tax breaks in return for a lower corporate rate, as John McCain has suggested.    more »

My blog on “How the Budget Baseline Favors Spending” stimulated numerous thoughtful comments. Some implied that my proposal would reward those who wish to make the Bush tax cuts permanent and ignore the fact that dubious accounting was used to get them passed in the first place. Those arguing this point did not pay sufficient attention to my last paragraph which implied that baseline reform would have to await the disposition of the Bush cuts. Further, I alluded to the possibility that whatever portions of the Bush policy are extended, the extension will again be temporary, thus making it difficult to finally settle the point.   more »

Unlike many bloggers, I am not going to bash John McCain’s renewed interest in balancing the budget. It is nice to see his on-and-off love affair with fiscal responsibility heating up again. There is just one problem with his vow to balance the budget by 2013. He can’t do it. Or, to be more precise, he can’t do it while extending the Bush tax cuts, cutting other taxes of his own, and maintaining a costly military presence in Iraq.    more »

The Wall Street Journal editorial page ran one of its favorite tables the other day, purporting to show how uncompetitive the U.S. corporate tax regime is with the rest of the developed world. The chart shows that, at nearly 40%, combined state and federal statutory rates here are far higher than the average of the countries in the OECD.    more »