TPC's Katherine Lim has crunched some numbers on John McCain's proposal to temporarily cut capital gains tax rates from 15 percent 7.5 percent. In 2009, under a plan that lowers taxes on both gains and dividends, those making $1 million or more would get two-thirds of the benefit, and an average tax cut of more than $72,000. Those making less than $50,000 would get, on average, nothing.

Both Barack Obama and John McCain have rolled out new economic stimulus plans. Each is a hodgepodge of some good ideas, some not-so-good, and some potentially awful. Obama says his new ideas would cost $60 billion. McCain says his would cost about $52 billion.

Here is a quick look at what they have in mind:

The centerpiece of Obama’s proposal is a new refundable tax credit for companies that add domestic jobs. Businesses would get $3000 for every net new full-time worker they hire. Any business would be eligible, even those that pay no taxes.

Obama would offer this credit for two years—2009 and 2010. In effect, it would pick up an employer’s share of Social Security and Medicare payroll taxes for a median wage worker.

On the margin, the credit might encourage some new hires, although I imagine it will take more than $3000 per worker to get many companies hiring again. But I am not so sure about extending refundable credits to businesses. Obama already wants to do a lot of this for individual taxpayers. Now he’d start writing checks to businesses as well.

I am also terrified about this turning into yet another tax extender. I can imagine this tax subsidy never going away, especially for small business. And in a strong economy, it would become a huge boondoggle.

Speaking of which, Obama also wants to double down on what is already a terrible idea—an additional $25 billion “loan” to the auto industry, on top of the $25 billion approved by Congress just a couple of weeks ago. Sorry, Detroit, I know we are throwing money at banks and you want some too, but the domestic auto industry is simply no longer critical to the U.S. economy. Better that we use the money to retrain auto workers to do something else.

For his part, McCain has several proposals to cut taxes for mostly-wealthy investors. To start, he would trim the tax rate on capital gains from 15 percent to 7.5 percent, and allow taxpayers to deduct up to $15,000 in capital losses. For those age 60 and older, he’d also cut the tax rate to 10% on their first $50,000 in withdrawals from IRAs and 401(k)s. The 10 percent tax on withdrawals and the increased deduction for capital losses would apply in 2008 and 2009. The lower capital gains rate would kick in for 2009 and 2010.

TPC has not yet formally analyzed these proposals, but it is a good bet that high-bracket taxpayers will be by far the biggest winners. For instance, 75% of the benefit of low taxes on capital gains and dividends already go to those making $600,000 or more. Half goes to those making $2.8 million or more.

The timing of these changes is also problematic. For example, it seems that a “tax sale” on IRA withdrawals would encourage people to pull money out of their accounts right away—at a time when the last thing we need is more stock sales.

A recent TPC< analysis looked at the effect of both candidates' plans on marginal tax rates–the tax paid on an additional $1 of income. Spurred by a comment from Greg Mankiw, we also reported an alternative analysis that tilted the numbers more in Senator McCain's favor. That prompted a complaint from Obama advisors pointing out that TPC's analysis failed to consider how the McCain health plan could boost marginal effective tax rates.

Senator McCain's health care proposal would replace the existing tax exclusion for employer-sponsored health insurance (ESI) premiums with a refundable tax credit of $2,500 for individuals and $5,000 for those families who obtain qualifying health insurance. A Tax Policy Center (TPC<) analysis concludes that this plan would be much more progressive than the current system and would slightly reduce the number of people without insurance, but would also cost about $1.3 trillion over 10 years.

Two factors cause marginal rates to increase.

First, the proposal would raise the cost of purchasing more health insurance. Workers choosing to work more may want to spend some of their added compensation to buy additional coverage. For instance, they may demand more comprehensive plans from their employers. Under the current system, workers receive these extra benefits tax-free. McCain would require that added premiums come out of after-tax pay, effectively raising the marginal tax rate on labor.

Second, adding ESI premiums to taxable compensation will push some taxpayers into higher tax brackets, further raising the marginal cost of additional work. For example, a single taxpayer with taxable income of $75,000 and $7,000 in ESI premiums is in the 25 percent bracket. McCain's plan would raise her taxable income to $82,000 and push her into the 28 percent bracket.

McCain's plan might also change workers' employment decisions. Since he would reward taxpayers for obtaining health coverage, regardless of whether they get it through an employer, some workers may switch from a position that offers health benefits to one that doesn't, or they might switch from full-time to part-time if they do not need to work 40 hours to get tax-subsidized health insurance. Some might elect to not work at all.

There is no formal estimate of the effect of the plan on marginal tax rates but a Congressional Budget Office analysis of a somewhat different plan suggests that a plan like McCain's could raise marginal tax rates by perhaps 1.5 to 2 percentage points above the estimated 31 percent current rate.

In a sense, these effects are by design – one of the strengths of McCain's proposal is that it reduces the incentives for taxpayers to buy overly comprehensive insurance. The downside is that he raises the after-tax price of purchasing additional insurance. We may have to raise the cost of coverage to limit the increase in health costs, but we should not ignore the accompanying impact on labor supply.

The most interesting thing I heard in last night's debate between John McCain and Barack Obama (in fact, the only interesting thing I heard) was McCain's call for a new federal effort to directly refinance residential mortgages into new low-interest loans. The plan got me thinking about a provocative way to pay for it—eliminate the mortgage interest deduction for these new loans.

The idea of government-subsidized refis isn't new. The bailout bill signed into law last week seems to permit them. Hillary Clinton suggested a similar plan during the Democratic primaries. Obama now says he thought of it first. And the scheme is based on the Depression-era Homeowners Loan Corporation. McCain's version seems to follow a plan designed by former top Bush economic aide Glenn Hubbard and Chris Mayer, both at the Columbia Business School.

But this homeowner bailout would cost taxpayers a ton. The McCain campaign says about $300 billion. Hubbard and Mayer say negative equity on owner-occupied houses is nearly $600 billion.

McCain doesn't say how he'd pay for it. This is a presidential campaign, after all. But there are a few ideas worth thinking about. Hubbard and Mayer suggest the government could take an equity stake in any refinanced homes. Thus, it would receive a share of any profits when the home is eventually sold. I think that isn't such a bad idea, although my colleague Len Burman is more skeptical. He argues that people would sell homes quicker than usual rather than share profits with the government.

Another possibility, heretical as it sounds, would be to make a deal with these bailed-out homeowners: The government will cut your interest rate, but you must agree to forego tax deductions on your new low-rate mortgage.

The current deduction doesn't mean very much for low-bracket taxpayers in any event. And even without the tax break, such a taxpayer would still be better off cutting, say, a 7% loan to 5.25%. Upper-income homeowners would not do as well, but do they really need two government subsidies—low mortgage rates and the tax break?

Trading off the tax deduction would help recover some of the expense of yet another bailout. But it is also important for fairness reasons. McCain's plan would reward many who irresponsibly took out mortgages they could not afford. But its cost would be borne by all taxpayers, including both those who played by the rules and borrowed responsibly and those who never purchased homes at all.

The idea of government refis is worth thinking about. But responsibly financing them ought to be an important part of the discussion.

With Barack Obama and John McCain arguing about who is going to cut taxes more, I though it would be interesting to find out what investors think is going to happen to their tax bills in the coming years.

So, in a totally unscientific survey, I asked four money managers what their clients think. The results were striking: Every one said their clients overwhelmingly believed their taxes would rise in the coming four years, no matter who is president. As you watch tonight's debate, keep in mind both candidates are desparately pitching tax cuts to voters who don't believe either will deliver.

The managers were in metropolitan Washington, D.C., Boston, Seattle, and Boca Raton, FL. Their clients were generally 50 or older. Many were retirees, although a significant number still worked. Some had clients with assets in the $250,000 to $3 million range. Others ran money for people of significantly greater wealth. But, according to the managers, none of that mattered.

The Washington-area adviser seemed surprised I'd even ask the question. "It goes without saying," she told me. "My clients have been preparing themselves for this for months."

Another said recent news made the nearly-inevitable even more likely. "Even before the (financial market) bailout, my clients expected their taxes would go up. Now, they think it is a certainty."

Interestingly, the outcome of the election doesn't seem to matter much to these investors, at least when it comes to their tax bills. Many with relatively small nest eggs (for this group, at least) expect their taxes will rise even if Obama is elected. Despite the fact that many earn well below $250,000 annually—the income level below which Obama vows to cut taxes—these clients simply don't believe it, their advisers say. Similarly, high net worth individuals doubt McCain would keep their taxes as low as they have been in recent years.

The Boston adviser told me, "Of course, my clients were happy to see the Bush rates—especially on capital gains and dividends—but they never thought they'd last. They know what McCain has promised. But they also know he'll be working with a Democratic Congress."

Is the likelihood of high taxes changing their clients' investment strategies? Unfortunately, the past few days were probably not the best time to ask that question. Said the Florida adviser, "My clients are hanging on for dear life right now. 2010 capital gains rates are the last thing on their minds."

My sources at the Federal Reserve and in the financial markets increasingly expect that Washington is going to have to put up hundreds of billions of dollars more to directly recapitalize troubled banks.

Such a step would be in addition to the $700 billion authorized by Congress last week and could require new congressional appropriations. It would put even greater pressure on the short-term budget deficit and add to uncertainty over the total cost of cleaning up the financial system mess. It could also require new federal legislation, setting up yet another bruising battle on Capitol Hill.

The timing of such a direct cash infusion, which would come through the Fed, is unknown. Fed officials had hoped it would not be necessary at all, or at least not until after a new President is sworn in next January. However, the market’s negative reaction to last week’s bailout could accelerate the next step. Normally, the Fed could manage such a cash infusion through its own reserves. And today it announced modest efforts to get funds to financial institutions by paying interest on bank reserves. However, the magnitude of the crisis may require far more capital than the Fed has and require additional federal borrowing.

What’s the solution to the short term credit problems of California? A federal loan, of course. According to a story by  Randal Archibold in the New York Times Governor Schwarzenegger sent a letter to Secretary Paulson asking for a $7 billion loan. If it works for AIG, why not states? Though maybe Treasury should demand the Golden Gate Bridge as collateral.

After close to three months of debate, California finally passed its $103.4 billion general fund budget last week. While other outrageous fiscal events trump the state’s fiasco, it is worth noting that no one in California actually thinks the state’s budget problems are solved. Rather, they’ve plastered over a mess that will worsen with economic conditions next year and make it even tougher to balance the budget after that.

The new budget has cost savings and spending cuts, all right, but they have dubious long-term value. For instance, the budget includes $500 million in general fund spending vetoes. It also reflects $340 million in budget savings from the budgeting delay slowing or halting many government activities. That’s a terrible budgeting method that the state should never repeat.

The revenue raisers are even more problematic: tax receipts rise this year and next but offset by givebacks in later years that will cause declines in the long run. The budget slaps bigger penalties on high-income corporate filers who have under-withheld and accelerates other tax payments by changing date rules. And net operating loss deductions have been suspended for two years. On the other hand, corporations can now extend carry-back losses for two years starting in 2011, which lowers future revenues and, more important, lets firms cut their tax bills in the next recession even more. Similarly, tax credits are limited for 2008 and 2009 but then revert back to the current values (which can cut taxes to an $800 minimum). And, starting in 2010, businesses may share credits with other entities in the same organization. A change in the “yacht tax” offers the only clean source of new revenue: starting this fiscal year California residents who purchase planes, vehicles and boats will have to pay taxes on them if they were moved into the state within a year of purchase rather than three months after purchase.

The coup de grace is issuing debt against future lottery funds. Besides the small problem of needing voter approval - always questionable in the birthplace of the tax revolt—selling off future revenues for today’s spending is never a good budget practice.

Even with all this kicking the can down the road to 2010, analysts already project a deficit for next year’s budget.

In an effort to avoid repeating today’s mistakes, the governor is proposing changes in budget rules—basically strengthening the fixes put in place in the last budget crisis. These reforms might help but there are more fundamental problems: passing a budget requires a 2/3 legislative majority and some politicians simply won’t consider any tax increases, regardless of the consequences.

California lawmakers seem unable to compromise or tell their voters hard truths. Sound familiar? The national financial crisis also involves politicians who refuse to compromise across party lines for fear their constituents will abandon them.

The final irony? The budget delay has left California right in the path of the country’s credit tsunami. While financial markets are frozen, it may be unable to float the short-term debt needed for its day-to-day operations. In the end, the cost of delaying on tough decisions may spell even higher costs and more bad news for both California and the nation.

Let it be written: If the Senate-passed financial services bailout bill turns out to save us from the next Great Depression, we will owe a deep debt of gratitude to… chicken poop. If not, we can simply say the entire proposition turned out to be little more than, well, you know.

After the House walked away from the bailout on Monday, thanks to a curious coalition of hard core conservative Republicans and liberal Democrats, the Senate leapt into the fray and passed the measure with uncharacteristic swiftness last night. And it did so in a time-honored way, by buying votes one at a time. And what better way than to tack on a shameless collection of tax extenders, which were not only a motley collection of special interest give-aways, but were also entirely funded with borrowed money. The House backed the same provisions, but at least had the decency to pay for some of them with offsetting tax hikes.

Not the Senate, which for years has steadfastly refused to pay for any of these tax breaks. So, it has added a cool $100 billion dollars in unfunded tax give-aways to $700 billion in bailout money. Just imagine: We are going to fix a credit crunch driven by massive leverage by, of all things, borrowing more money. We are going to replace hundreds of billions of dollars of private debt with a hundreds of billions of public debt. Wall Street may have temporarily forgotten how to borrow money, but Washington surely has not. These second rate investment bankers have now turned to the real dukes of debt, the true rajas of red ink—Congress and the President-- to show them the real road to long-term financial ruin.

The madness only got worse over the past few weeks. First, in an effort to get through the short-term financial crisis, regulators encouraged a handful of mega-banks to acquire failing financial institutions such as Washington Mutual and Wachovia. These arranged marriages look a bit like the shotgun wedding of two high school dropouts. It may make the relatives feel better, but the long-term prospects are dicey at best.

In this case, though, Uncle Sugar will take care of everything. If Citigroup and Bank of America were too big to fail before, imagine what they are like today. Anybody think Citi/Wachovia or Merrill Lynch/Bank of America/Countrywide would ever be allowed to go down? Then, the Senate compounded the mess by increasing the government’s liability for bank failures from $100,000 per account to $250,000. I’m sorry. I thought the House initially rejected the bailout because taxpayer obligations were too big. Didn’t we just make them bigger?

What does all of this have to do with chicken poop? Thought you’d never ask. It turns out the hundreds of pages of tax breaks the Senate tacked on to help assure the bailout’s passage includes one of my favorites—a tax credit for turning biomass (aka chicken waste, garbage and, apparently even algae) into jet fuel. Now, I have nothing against alternative energy. But more tax credits? Did we learn nothing from the ethanol debacle?

If you think I’m kidding, you could look it up on page 184 of the now 451 page bill (by the way, didn’t this whole enterprise start off with a bill that was 3 pages long)?

Are we a great country, or what?

Typically, TPC measures the impact of tax laws and proposals in terms of average tax rates. This gives a good measure of how taxes affect our pocketbooks, but economists also like to examine how taxes affect economic incentives. For that purpose, the effective marginal tax rate is most apt. That is, how much tax do we pay on an additional dollar of income. This is important because marginal rates affect the incentive to work that extra hour or to engage in tax avoidance.

My colleagues, Katie Lim and Jeff Rohaly, just released a fascinating analysis of how the presidential candidates' tax plans would affect marginal effective income tax rates on earnings. Katie and Jeff found that, on average, Obama's plan would leave marginal tax rates pretty much where they are now while McCain would cut them modestly. Although Obama would cut effective marginal rates for many more tax units than McCain (61 percent in 2009 vs. 20 percent), he'd also raise them on more taxpayers (15 percent vs. just 1 percent). Not surprisingly, the most dramatic difference is among those in the top brackets. On average, in 2009, Obama would raise effective tax rates on millionaires by almost 6 percentage points while McCain would leave them unchanged.

[Warning: The following gets a little technical. For non-economists, the upshot is that if we calculate marginal rates a different way, as suggested by Greg Mankiw, a Harvard prof who used to be President Bush's top economist, the comparison is more favorable to McCain. Caveats follow.]

When Greg Mankiw saw our study, he observed on his blog that average effective tax rates might not be the best way to measure the impact of taxes on economic welfare:

The Mankiw measure shows about a 1-percentage point increase in rates in 2009 under the Obama proposal and a 1-percentage point decline under McCain. As Greg conjectured, the difference between the two plans is somewhat larger under this metric than the traditional measure (2.4 percent vs.1.5 percent).

There's a question about how to treat negative effective tax rates—as apply to low-income households eligible for refundable tax credits that phase in with earnings (such as the EITC, the child tax credit, or Senator Obama's proposed working families tax credit). The negative rates are subsidies, not taxes, but a squared -10 percent rate would look just like a squared +10 percent rate. This is the right answer if the concern is the distortion in the choice between labor and leisure. However, if there are good policy reasons to favor work over leisure, it might be misleading. For that reason, we also show the average rates setting negative marginal tax rates to zero. This modification doesn't change the qualitative conclusions, but both McCain's and Obama's effective rates are slightly smaller by this measure.

Here's the caveat. McCain's and Obama's plans raise different amounts of revenue. The long-term economic effect of the two plans depends on their impacts on the deficits (and, implicitly, future tax rates). For example, if you believe that Senator McCain will do a better job at controlling spending than Senator Obama, then the lower tax rates under his plan are likely to be more durable. If, as the Obama campaign claims, McCain would spend more because of his policies in Iraq and elsewhere, then Obama's plan might be better for the economy over the long run.

Thus, a calculation of the long-term economic effects depends critically on what happens to spending. The Tax Policy Center will be examining this very question in a forum on Friday at the Urban Institute. Click this link to register.

Whatever its ultimate fate, the $700 billion financial market bailout has me thinking about how events of the past few months have fundamentally changed the nature of economic risk in the U.S. And, that, in turn, raises some interesting questions about capital gains taxes.

For years, we've heard that one big reason for lower tax rates on capital is the need to encourage innovation. We all know the argument: Entrepreneurs and others won't make the chancy investments that drive a vibrant economy without the benefit of lower taxes.

There is plenty of doubt about whether the premise is even correct. But, for the sake of argument, let's assume it is. Let's say that investors will be less likely to risk their money on new businesses and new ideas without government incentives.

Well, the Bush Administration has just promised to put $700 billion in taxpayer money on the table to encourage investment. It has, in fact, put a floor beneath the hazards of investing—at least for a large segment of the financial world—by saying if you bet wrong, government will ride to your rescue. Once we make it through the current mess, this decision to socialize a chunk of financial risk will have some interesting consequences. It should encourage more people to put up their money, which, in turn, should drive down the cost of capital. That, after all, is the whole point of the bailout.

So, if we are now explicitly using Treasury assets to stimulate investment, do we need the tax code to further encourage risk taking? Didn't the mix of cheap money, tax incentives, and lax regulation help enable this mess in the first place?

One lesson we might learn from the recent unpleasantness is that there can be too much risk taking. Remember, innovation is not always productive. Just as pharmaceutical companies have used the research tax credit to develop drugs that save lives, so too have they produced products that ended up killing people. Similarly, while Wall Street has found new ways to make investment more efficient, the flood of money encouraged in part by low taxes has also made it possible for investment firms to peddle the derivatives that are now strangling the financial markets.

To the degree that low capital gains rates encouraged overly leveraged investments in grossly overpriced paper, it may be time to rethink the tax. And if this bailout will cut the cost of capital, do we need a low tax rate too?

I understand there may be other reasons to keep capital gains taxes low, such as ameliorating the impact of inflation on investment returns. But the political argument for low taxes on gains has usually centered on encouraging risk-taking and innovation. And risk just ain't what it used to be. So, is it time to reconsider the preferential tax treatment enjoyed by capital gains, and, if so, how? Let us know what you think.

On Friday morning, I am going to moderate what promises to be an enlightening discussion of the spending plans of the major Presidential candidates. Panelists will be Rudy Penner of The Urban Institute, Jim Horney of the Center on Budget and Policy Priorities, Maya MacGuineas of the Committee for a Responsible Federal Budget, and Bill Hoagland of CIGNA (and formerly the top budget guru for ex-Senate Republican Leader Bill Frist).

This group of budget veterans will discuss where John McCain and Barack Obama propose to increase spending and where they say they will make cuts. I hope this session will be a useful addition to TPC's analysis of the candidates' tax agendas. If you'd like to attend or get more info, link here.

We had fun ridiculing the idea of suspending the gasoline tax for the summer, but the gas tax holiday was minor mischief compared with the newest idea for dealing with the financial market meltdown: a two year holiday on capital gains taxes.

Lower capital gains tax rates have always held iconic significance for the far right. Advocates think that lower rates would stimulate saving and risk-taking and turbo-charge the economy. There's not a shred of credible evidence to support this position. In fact, lower tax rates probably do as much harm as good because they fuel all sorts of unproductive tax shelters.

But even if gains tax cuts were a panacea, a temporary tax holiday would be a disaster in the current circumstances. A temporary tax exemption would stimulate a flood of asset sales. Virtually all directly held corporate stock with gains would be up for sale as would a lot of long-held real estate and many businesses. Prices could free fall.

While it's true that sellers would have enough money to buy back everything on the market, many would use this as an opportunity to rearrange their portfolios. Unless policymakers fix the problems in the real estate market and financial sectors, that almost surely means a flight of capital away from those troubled sectors.

There are other problems with this idea too. For one, most investment dollars aren't affected by individual capital gains taxes. They're held by pension funds, insurers, and foreign investors. The big players would only be affected indirectly to the extent that they could buy the purged assets at fire sale prices. (On the positive side, the dominance of institutional investors in the market limits the damage that could arise from the fire sale.)

And it would give company CEOs an incentive to try to generate short term profits to make their shareholders happy, since extra profits would be tax free for two years. That kind of short-term profit manipulation was a contributor to our current woes. It shouldn't be encouraged.

Most galling, while doing nothing to address the fundamental market problems, it would drain hundreds of billions from Treasury coffers that might otherwise be used for a real solution.

Finally, here's a surprise. 70 percent of the benefits of this dandy proposal would go to taxpayers making over $1 million.

This holiday is a vacation from reality.  The financial crisis, in contrast, is real. Let's get serious!

PS, I forgot to mention the stupidest part of all, from the Curious Capitalist blog:

".. the toxic mortgage securities clogging up bank balance sheets are worth less now than when they were acquired. Meaning that no capital gains tax would be owed on them anyway. If you repealed the tax, banks would have even less incentive to sell them because they wouldn't be able use the losses to offset capital gains elsewhere."

Earlier this week, both the House and Senate passed measures establishing generous tax credits for electric plug-in cars. The Senate plan gives consumers a credit of up to $7,500 for the purchase of a plug-in car, while the House plan offers consumers a credit of up to $5,000. Under both plans, the value of the credit increases with the battery capacity of the vehicle, meaning that more efficient cars receive larger tax credits.

Economists tend to scoff at the idea of offering tax credits for alternative fuel vehicles, instead advocating for reforms that incorporate the societal costs from energy consumption (e.g. pollution) into the price paid by consumers. For example, several economists, from Greg Mankiw to Robert Frank, have supported an increase in the gas tax. The problem with raising the gas tax is that it's not realistic; not in this political environment at least, with politicians proposing to cut gas taxes, not raise them. In the long-run, a higher gas tax might serve to stimulate demand for electric cars; in the short run, a higher gas tax is simply a political impossibility.

Given political constraints on raising energy prices, tax credits for plug-ins are a worthy policy to help reduce our nation's oil consumption. Prior studies indicate that tax incentives can be an effective means of stimulating demand for alternative fuel vehicles. One recent study examined the effect of state tax incentives on the demand for hybrid cars and found that the existence of an income tax credit raised sales by 13 percent. Another study of the federal hybrid tax credit found that most of the value of the hybrid tax credit was passed-on to consumers, indicating that the credit is not just a windfall tax break for carmakers.

Still, the plans passed by the House and Senate are imperfect, repeating some of the mistakes incorporated in the design of the existing tax credit for hybrid vehicles. Under both plans, the credit is non-refundable, meaning that millions of taxpayers won't be able to take full advantage of the credit. Also, the credit phase-out in the House bill—which disqualifies cars produced by a certain manufacturer after the manufacturer has sold 60,000 units—means that the most popular (and likely most fuel efficient) cars will quickly be ineligible for tax credits.

Electric plug-in cars are coming, perhaps as soon as 2010. Let's hope there's a tax credit waiting when they roll off the assembly line.

In a previous post, Len Burman reported that a substantial portion of Senator Obama’s non-health tax proposals would be provided as net refunds, over and above income tax liability.  This is a key difference from Senator McCain, whose proposals would mostly benefit taxpayers (and mostly those with high incomes).

However, the net benefits of Senator Obama’s and Senator McCain’s health proposals would both be provided almost entirely in the form of refundable tax credits—totaling $1.3 trillion over the 2009-2018 budget window for McCain and $1.6 trillion for Obama.  (See table.) 

That is the short answer.  The long answer is a little mind-numbing, but here it is.

We re-estimated the cost of each plan assuming that the tax credits were nonrefundable and no change in behavior to isolate the refundable portion of the cost estimates (the rows labeled “without refundability” in the table).  Virtually all of the $1.3 trillion total cost of Senator McCain’s health proposal over the 2009-18 budget window is attributable to the refundability of his new tax credit.  The revenue loss would be only $23 billion dollars if his credit were non-refundable. Similarly, if Senator Obama’s proposed new tax credits were not refundable, it would increase revenues by $151 billion dollars.  That is, more than 100 percent of the cost is attributable to refundable credits.
 
Households with little or no income tax liability benefit most from Senator Obama’s refundable credit and so replacing it with a non-refundable credit would dramatically reduce the revenue cost of the credits. Moreover, the proposed “pay or play” taxes on firms that do not offer insurance would, by our estimates, more than offset the revenue loss attributable to the nonrefundable portion of the tax credit.

Senator McCain’s refundable credit accounts for almost all of his plan’s net cost for two reasons:  (1) repeal of the income tax exclusion on employer sponsored health insurance; and (2) indexing the credits to general price inflation. In the short term, most of the revenue loss attributable to the nonrefundable portion of the tax credit would be offset by revenue gains from repealing the income tax exclusion. The net revenue loss would decrease over time because the credit declines in value relative to the tax exclusion, since medical expenditure costs (and the value of the exclusion) grow much faster than the tax credit. By 2014, the non-refundable portion of the credit is worth less than the tax exclusion and, by 2018, income taxpayers pay $62 billion more in tax in the aggregate (although many middle-income taxpayers still come out ahead under the proposal).