>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.

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.

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.

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.

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 »

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 »

Barack Obama has a plan to fix Social Security. Or does he? Obama does have a vague proposal to raise payroll taxes for workers making more than $250,000. But there is a lot less to it than meets the eye, and Obama has left some hugely important questions unanswered.    more »

How will ordinary families be affected by the tax plans of John McCain and Barack Obama? To get some answers, I asked Greg Leiserson, TPC’s crack modeler, to develop some examples.

The results mostly track what we already know—that McCain would cut taxes somewhat for nearly all, and a lot for the very wealthy, and Obama would cut taxes substantially for low- and moderate-income families and raise them dramatically for those in the upper brackets. But there are also some surprises.

Before I look at how the tax cuts would work for some typical families, keep in mind that TPC allocates a share of any changes in corporate taxes to individuals. Thus, their tax liability not only includes what happens to their income taxes, but also to their share of corporate taxes. Economists do this since companies don’t actually pay tax, the people who own the companies do. (Workers pay some share too, but since no one can agree on how much, TPC allocates all the tax to capital).

With that out of the way, here is what the numbers look like:

A single mom, with one child, making $15,000-a-year (in adjusted gross income) would get a $17 tax cut from the McCain plan, but see a $500 reduction from Obama, thanks to his new work credit.

A newly-married young couple with no kids, making a combined income of $50,000, would get a $36 tax cut from McCain, but a tax reduction of about $1000 from Obama. The big difference again: Obama’s work credit.

By contrast, think about the classic suburban 1950s sitcom family, with two kids but only one wage earner, who makes $75,000. Ward and June Cleaver would do a bit better under McCain, who would cut their taxes by $800, while Obama would trim their taxes by only about $500. McCain’s increased dependent exemption for Wally and the Beave trumps Obama’s work credit.

Now, let’s look at a two-lawyer family, making $200,000, with one child. McCain would give them a tax cut of roughly $7000, while Obama would trim their taxes by about $5000. The big reason: each candidate would patch the Alternative Minimum Tax.

A married baseball player who takes home $2 million and has one child might want to go to bat for McCain, who would give him a tax cut of more than $30,000. Obama would raise his taxes by $135,000. Talk about getting one in the ear.

For seniors, the pattern is a bit more surprising, since Obama has been touting his tax cuts for the elderly. Obama would give an unmarried senior making $35,000 a tax cut of $3000, which would wipe out her tax bill. McCain would give her a tax cut of about $250.

But now let’s look at that her neighbor, who makes $75,000 from her Social Security, pension, and other income. Obama would actually raise her taxes by about $600, while McCain would give her a $600 tax cut. 

The same thing would happen to a very poor elderly couple making just $10,000. Obama would raise their taxes by $150, while McCain would cut them by about $170.

Of course, these are all averages. Some families might benefit more and others less. But this should give you a pretty good idea of the winners and losers.

Johnny, we hardly new ye.

John McCain’s ambitious plan to reform corporate taxes is disappearing faster than the Washington National's chances to win the national league pennant. What once had the makings of a provocative and potentially beneficial idea is morphing into a gimmicky mess.

Earlier his spring, McCain was talking about allowing companies to expense all their capital investments in the year they are made. This would eliminate many of the timing-related issues that make corporate taxes so complicated. It might even have become the first step towards replacing the income tax with a cash-flow levy. In such a system—a version of a Value Added Tax—companies would subtract their costs of goods from revenues and pay tax on the difference.

Back then, McCain had not yet answered one big question: What would happen to the tax deduction companies take for their interest payments? In any sensible expensing scheme, interest could no longer be tax deductible. If it were, businesses would become huge tax shelters.

Now that he’s started to answer this and other questions, his idea is getting worse. In his revised plan, which staffers have described to TPC, expensing would be limited only to short-lived property—equipment like cars and computers--now depreciated over five years or less. The proposal would be temporary, and would expire after five years. Interest payments would be taxable, but only if used to finance specific short-lived investments.

Yuck. Speeding up a deduction that you could take in a couple of years anyway is not much of a tax break. Making the proposal temporary just creates messy new timing issues—and would threaten to become yet another tax “extender” that is part of the annual Washington theater. And tying the interest deduction to the purchase of specific property will surely create endless opportunities to game the system. This will bring joy to the hearts of investment bankers and tax lawyers, but not to the rest of us.

The best that can be said about McCain's latest version is that perhaps it is an effort to shove the tip of the camel’s nose under the proverbial tent: Start with this and get more ambitious later. But that's a reach. Don’t get me wrong, McCain’s initial proposal had its problems, but it was intriguing, potentially far-reaching, and worthy of debate in a presidential campaign. This version will fall into the dust-heap of forgotten ideas. There was a brief moment when I thought we were going to have a serious tax reform debate in this campaign. I should have known better.

Barack Obama’s tax plan will either raise $262 billion over the next 10 years or increase the national debt by $2.7 trillion. John McCain would add either $615 billion or $3.6 trillion to the debt.

What’s going on? Don’t everyone turn your computer off at once, but we need to talk about budget baselines.

There is nothing more esoteric, but Obama and McCain have made them hugely important. Trillions of dollars important. In fact, the only way either candidate can establish even a nanobit of fiscal credibility is by dramatically reframing the deficit discussion.

Both want to convince us that the Bush tax cuts will go on forever, even though they are due to expire in 2010, and that the Alternative Minimum Tax mess has already been fixed, although a permanent solution is nowhere in sight. With these helpful assumptions, their trillions of dollars in tax cuts look modest. Both candidates can make it appear as if they are merely moving around a bit of loose change, rather than massively increasing their grandchildren’s debt.

This is nothing more than a fiscal parlor trick. McCain, at least, can argue that he has supported the Bush tax cuts—well, he supported them after he opposed them. Obama has voted time and again against extending them and calls them irresponsible. What is likely to be a strongly Democratic Congress will never vote to sustain them as is. Yet, both Obama and McCain would like us to believe these tax cuts are cast in stone—the fiscal Ten Commandments, if you will—even as they propose to change them.

Neither seems to have noticed that Washington routinely overhauls the tax law every decade or so. When it comes to taxes, change is the status quo.

There is an easy way to cut through this palaver. Forget the baseline. Just think about three numbers: How much would either candidate collect in taxes as a share of the Gross Domestic Product? How much is government likely to spend? And, how much would they have to cut that spending to keep the national debt from ballooning.

TPC estimates that in 2013, Obama would collect revenues of 18.2 percent of GDP. McCain would bring in about 17.8 percent. Spending that year would be about 19.5 percent, according to the Congressional Budget Office, assuming the Iraq war will be winding down.

Thus, Obama would have to cut spending by 1.3% of GDP or $230 billion, to balance the budget in 2013. McCain must find 1.7% of GDP, roughly $300 billion. For context, Bush and the Congress have been battling for years over budget cuts one-tenth that size.

I await word on the candidates’ additional spending cuts. Obama has embraced costly new initiatives for infrastructure, education, health care, and energy, but said little about exactly where he’d cut spending. McCain vows to cut pork, which might get him 5% of what he needs. On the other hand, he is not likely to end the war any time soon.

We've heard from the Obama campaign about our blog post on Senator Obama's Social Security tax increase on people earning more than $250,000. The campaign clarified that the threshold would be $250,000, but Senator Obama has not specified what the rate would be, when it would take effect, whether it would apply to employers, employees, or both, or what the tax base would be.   more »

In preparing our analysis of the candidates’ tax plans, we sent descriptions to each campaign for comment/clarification/correction. Senator Obama’s staff asked us not to include his reported support for a Social Security tax on earnings above $200,000 or $250,000, saying that there was no specific proposal. So we left the Social Security proposal out of our core analysis. We also left out Senator McCain’s proposal for an optional alternative tax system on similar grounds. We did discuss these non-proposals in two sidebars in our analysis.   more »