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An Updated Analysis of the 2008 Presidential Candidates' Tax Plans: Updated September 12, 2008
This revision of our analysis incorporates updated budget projections from the Congressional Budget Office , corrects some typos, and includes editorial changes. It does not update our revenue estimates to take account of CBO's latest economic projections.
The text below is an excerpt from the complete document. Read the full analysis in PDF format.
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.
An Updated Analysis of the 2008 Presidential Candidates' Tax Plans
Tax and fiscal policy will loom large in the next president's domestic policy agenda. Nearly all of the tax cuts enacted since 2001 expire at the end of 2010. The individual alternative minimum tax (AMT) threatens to ensnare tens of millions of Americans in a web of pointless complexity and higher taxes, but a permanent fix palatable to both political parties has proven elusive. In the past year, the federal budget deficit has ballooned, and, more worrisome, large projected increases in spending on Social Security, Medicare, and Medicaid will put unprecedented demands on federal government revenue sources in the coming decades.
Fundamental reform of our tax system is one way to resolve these problems, but, at least in part because reform creates both winners and losers, the leading presidential candidates have not addressed it seriously. Nonetheless, both candidates have proposed major changes to the nation's tax laws. Senator McCain would permanently extend the 2001 and 2003 tax cuts, increase deductions for taxpayers supporting dependents, reduce the corporate income tax rate, and allow immediate deductions for investments in certain capital equipment. Senator Obama would permanently extend certain provisions of the 2001 and 2003 tax cuts primarily affecting taxpayers with incomes under $250,000 but repeal the cuts in the top two marginal income tax rates ahead of their scheduled expiration in 2010; increase the maximum rate on capital gains; raise the top tax rate on qualified dividends from its current level (but keep it below pre-2001 levels); and enact new and expanded targeted tax breaks for workers, retirees, homeowners, savers, students, and new farmers. Senator McCain proposes to extend permanently and increase the AMT "patch" that has prevented most individuals and families with incomes below $200,000 from being affected by the tax and lowered the tax for others, and in our interpretation of his proposal, Senator Obama would also extend the patch. Each candidate would also increase the estate tax exemption and reduce the estate tax rate compared with current law in 2011 and beyond, although Senator McCain would cut the tax much more than Senator Obama. Finally, each candidate promises to broaden the tax base and reduce corporate loopholes. McCain lists eight breaks for oil companies as targets but, other than that, is short on details for his pledge to eliminate "corporate welfare." Obama identifies a variety of steps, including basis reporting for capital gains, taxing carried interest as ordinary income, and enacting sanctions on international tax havens that don't cooperate with enforcement efforts, but he would also need additional as-yet-unspecified policies to achieve his revenue target for base broadening.
Although both candidates have at times stressed fiscal responsibility, their specific non-health tax proposals would reduce tax revenues by an estimated $4.2 trillion (McCain) and $2.9 trillion (Obama) over the next 10 years. Both candidates argue that their proposals should be scored against a "current policy" baseline instead of current law. Such a baseline assumes that the 2001 and 2003 tax cuts would be extended and the AMT patch made permanent. Against current policy, Senator Obama's proposals would raise $600 billion and Senator McCain's proposals lose a similar amount.
The two candidates' tax plans would have sharply different distributional effects. Senator McCain's tax cuts would primarily benefit those with very high incomes, almost all of whom would receive large tax cuts that would, on average, raise their after-tax incomes by more than twice the average for all households. Many fewer households at the bottom of the income distribution would get tax cuts and those tax cuts would be small as a share of after-tax income. In marked contrast, Senator Obama offers much larger tax breaks to low- and middle-income taxpayers and would increase taxes on high-income taxpayers. The largest tax cuts, as a share of income, would go to those at the bottom of the income distribution, while taxpayers with the highest income would see their taxes rise significantly.
The impact of the tax code on economic activity under each candidate's policies would differ in several important ways. Under Senator McCain's proposed policies, the top marginal rates (35 percent on individual income and 25 percent on corporate income) would be significantly lower than under Senator Obama's plan (39.6 and 35 percent, respectively). McCain's reduced individual and corporate rates could improve economic efficiency and increase domestic investment, but the larger future deficits would reduce and might completely negate any positive effect. In contrast, Senator Obama's proposed new tax credits could encourage desirable behavior, particularly if the childless EITC and payroll tax rebate encourage additional labor supply among childless low-income individuals. However, he would also direct new subsidies at an already favored group-seniors -and an already favored activity-homeownership-which could probably be better directed elsewhere.
In several important ways, the candidates' speeches and web sites differ from the plans as we've outlined them above, and, in several cases, descriptions of proposals provided by campaign advisors strike us as implausible. Senator McCain has said repeatedly that he would repeal the individual AMT, allow businesses to expense all investments in equipment immediately, double the deduction for dependents, and give individuals the option to pay tax under a simplified alternative tax system. The campaign advisers say that the AMT will be patched but not eliminated except under the simplified alternative system, that only short-lived investments (for which expensing is not worth much) would qualify for immediate deduction, that the larger deduction for dependents would phase in slowly (and never equal twice the current-law deduction), and that the simplified alternative tax system would be revenue neutral. The last assertion is particularly questionable: few taxpayers will choose to pay an alternative tax if it does not reduce their tax bill, so an optional alternative is only revenue neutral if almost nobody elects it, which is probably not what the candidate has in mind. We estimated the cost of Senator McCain's plan as described on the stump, assuming that all the provisions are fully effective immediately and that the optional alternative tax system is similar to the one proposed by the Republican Study Committee. Under those assumptions, the revenue loss attributable to the Senator's plan increases to almost $7 trillion over the 10-year budget window.
Senator Obama says he would subject high-income taxpayers to additional taxes "in the range of 2 to 4 percentage points more in total (combined employer and employee)" starting "a decade or more from now" to help shore up Social Security. Nonetheless, his campaign advisers insist that there is no specific proposal. We estimated the cost of Senator Obama's proposals assuming that the Social Security proposal would impose a 2 percent income tax surtax on adjusted gross incomes over $250,000 and a 2 percent payroll tax paid by employers on employees' earnings above that threshold and that all of the provisions-including the higher payroll tax-are fully effective immediately. Under those assumptions, the Senator's proposals would reduce revenues by $2.6 trillion over 10 years, or about $390 billion less than the proposals as described by his campaign advisers.
(End of excerpt. The entire analysis is available in PDF format.)
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