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A Preliminary Analysis of the 2008 Presidential Candidates' Tax Plans (Full Report)
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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 and the individual alternative minimum tax (AMT) threatens to ensnare tens of millions of Americans. While a permanent fix palatable to both political parties has proven elusive, both candidates have proposed major tax changes. This report describes how we performed our modeling and analysis, outlines the major tax proposals, and discusses the implications of their policies for the revenue raised, taxpayer economic activity, and the distribution of the tax burden.
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. And 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 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 the cost of certain short-lived capital equipment. Senator Obama would permanently extend certain provisions of the 2001 and 2003 tax cuts primarily affecting taxpayers with incomes under $250,000; increase the maximum rate on capital gains and qualified dividends; and enact new and expanded targeted tax breaks for workers, retirees, homeowners, savers, students, and new farmers. Senator McCain proposes to extend and expand permanently the AMT "patch" that has prevented most individuals and families with incomes below $200,000 from being affected by the tax, 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 $3.6 trillion (McCain) and $2.7 trillion (Obama) over the next 10 years, or approximately 10 and 7 percent of the revenues scheduled for collection under current law, respectively. Furthermore, as in the case of President Bush's tax cuts, the true cost of McCain's policies may be masked by phase-ins and sunsets (scheduled expiration dates) that reduce the estimated revenue costs. If his policies were fully phased in and permanent, the ten-year cost would rise to $4.0 trillion, or about 11 percent of total revenues.
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 $300 billion, an increase of 2 percent, and Senator McCain's proposals lose $1.0 trillion (if fully phased-in and permanent), a decrease of roughly 2 percent. Senator McCain has stressed that deficits should be closed by spending cuts, but policies he identifies, such as limiting earmarks, would offset only part of the revenue losses attributable to his tax plan. As noted, both candidates may be overoptimistic in their revenue targets for closing tax loopholes-Obama probably more than McCain.
The two candidates' 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 whose taxes fall would, on average, see their after-tax income rise much less. 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.
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 could completely offset 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-borrowing for housing-which could probably be better directed elsewhere.
Both candidates have proposed to change the tax treatment of health insurance in important ways. This analysis does not address those proposals, but we expect to evaluate both plans soon.
Section I of the report describes how we obtained information about the candidates' tax plans and how we performed our modeling and analysis. In section II, we outline the major tax proposals put forth, and in section III, we discuss their implications for the revenue raised and taxpayer economic activity. Section IV looks at their effect on the distribution of the tax burden.
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