StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

McCain's Pro-Today Tax Agenda

21 Apr 2008
Posted by Andrew Samwick

Last week, while campaigning in Pennsylvania in anticipation of Tuesday's primaries, John McCain unveiled his economic plan with this as the objective:

Today In Pennsylvania, John McCain Outlined A Pro-Growth, Pro-Jobs Strategy To Get Our Economy Back On Track. John McCain's strategy includes taking the near-term actions needed to provide immediate help to American families while also taking the longer-term steps necessary to secure America's economic prosperity and leadership in the world.

The strategy excludes any mention of fiscal responsibility per se, confirming our earlier suspicions that is is not a top line priority. For this transgression, Pete and Stan will have a lot to say in their posts.

My task is to consider the economics of the plan. Presidents don't have a magic wand that creates a growing economy out of thin air with a simple wave. In truth, the best anyone can hope for is to improve the economic environment a bit at a time through sensible changes to policy. The frustrating part of that task is that it takes time for good policies to have an impact. And my conclusion is that time is not on McCain's side.

I'll follow the plan as the McCain campaign laid it out:

1) The High and Rising Cost of Living

The McCain plan proposes three reforms. A summer gas tax holiday, a hiatus in filling the Strategic Petroleum Reserve, and ending ethanol subsidies and other barriers to trade.

a) The summer gas tax holiday is ridiculous. As others have noted, prices are likely to rise in order to make up the difference given the way the oil industry runs at full tilt over the summer months. Besides, in order for this to work as a campaign pledge, McCain would have to win in November and then go back in time to May to remove the tax.

b) If you think you've heard this argument about the SPR before, you have. Then as now, you could file it under "every little bit helps," but by only a little bit at most.

c) I'm not in favor of ethanol subsidies or tariffs or sugar quotas either. These existing policies do not improve the economic environment for growth. They restrict trade or distort it in favor of particular technologies that are themselves unproven. I view just about every departure from free trade as patronage to politically influential domestic interest groups.

2) Housing and Student Loans

There are two elements here. The first is the "HOME Plan," in which mortgage borrowers with a particular combination of characteristics (e.g., non-conventional loan, primary residence, after 2005, in or soon to be in arrears) can switch to a new 30-year fixed rate mortgage. The second is a task force at the Justice Department to investigate abuse by lenders.

I think that the first principle of a bailout--where laws are changed after the fact to ease someone's burden at someone else's expense--should be that the entity being bailed out has all of its equity wiped out. This is to avoid the moral hazard problem in dealing with other borrowers later on in this crisis or the next one. This is why I like Dean Baker's Own-to-Rent plan.

McCain's plan is typical of what Presidential candidates propose: a set of fairly complicated conditions for eligibility and then a limited amount of relief for those who are eligible and apply. It doesn't seem big enough to do much harm or offer much help. Judging this plan versus others requires immersion in the details, which is something of a pointless exercise considering that most of the remaining fallout from the crisis will occur during the 9 months between now and the date it could first be signed into law.

I'm all for investigating bad lending practices, and there were many in this environment.

There is also a statement in the plan about calling on student loan providers and the states that backstop them to anticipate and overcome disrputions to the program in the fall semester. I have often said that if young people voted, student loans would be the third rail of American politics. This is another policy that would require a time machine to work as a campaign proposal.

3) The "Pro-Growth, Pro-Jobs" Tax Agenda

I'll leave most of the heavy lifting on the details of this to Pete. There's a cornucopia of reductions in the tax burden across the economy: AMT relief, personal exemptions, capital expenditures, capital income, corporations, the internet, cell phones, R&D, and Medicare premiums. Suffice it to say that there is absolutely no suggestion that anyone in the economy is going to be taxed at a higher rate.

Stan will point out that this blows an enormous hole in the deficit for years to come. So the question left for me is simply, "Are any of these objectives so important that we should burden taxpayers of the future to pay for them?" In general, my answer is "no." Just about all of these tax reductions are attempts to giver more resources to groups of the population of taxpayers today. Those that do have an impact at the margin (like expensing equipment investment) are not targeted to meet an identified need. If the deficits were for repair of critical infrastructure, then I would be more inclined to support them.

In its particulars, this is a Pro-Today Tax Agenda, not a Pro-Tomorrow Tax Agenda.

There are two other elements of the Tax agenda worthy of comment. First, the proposal to require a 3/5 majority vote in Congress to raise taxes would be better applied to a 3/5 majority vote in Congress to deviate from a responsible budget policy. Second, the notion about tax simplification--that taxpayers should be able to opt into a very simplified tax code--would be okay under the proviso that almost everyone would pay more under the simple code than the current code.

4) Trade and Competitiveness

There is some good stuff here, if like me you are most receptive to the Milton Friedman view of microeconomics.

First, there is a pledge to open up international trade, with the goal of lowering the cost of living for American families. That's the right goal to have. If it can stand up to interest group pressure, that will be a great improvement.

Second, there are pledges to enable parents to have more choice in where they send their children to school. (More from McCain here.) Unfortunately, the federal government has little direct role to play here, since primary and secondary education is the province of state and local governments. If McCain were looking for a better way to make an impact using tools at the disposal of the federal government, he'd make private school tuitions tax-deductible, just like the state and local taxes that fund public schools (or make available a tax credit). More from me on this here.

5) Reforming the Unemployment Insurance System

There is some good stuff here, too. The McCain plan recognizes that the current system of assistance for displaced workers is a patchwork that suffers from both gaps and redundancies. It also borrows the very good idea from some work about a decade ago by Martin Feldstein and Dan Altman about unemployment insurance accounts. The basic idea is to get displaced workers to economize on the time spent unemployed by letting them keep some of the foregone benefits if they find a job sooner rather than later.

6) The Big Omissions

Big Omission #1: In the "plan," health care reform receives only a scant mention at the end. There's more here. In the more detailed version, there is an acknowledgement that health insurance should be portable across jobs. Health security should be decoupled from job security. A candidate who proposed constructive changes in that regard, but almost only in that regard, would get my support.

Big Omission #2: In the "plan," energy reform also receives only a scant mention at the end. That mention does acknowledge the need for reducing consumption, which is a positive sign.

Big Omission #3: In the "plan," there is no mention of immigration reform. McCain lays out his views here. I summarize mine here.

So what can we make of all this? There are some parts of the McCain economic plan that are silly or irrelevant. There are some good points on microeconomics and international trade. But I would be surprised if these got any attention at all, given the enormous fiscal burden that this plan shifts to future generations. Since they cannot vote, I'll turn the blog over to Stan and Pete for their expert commentary.

Andrew, Re: "First, the


Re: "First, the proposal to require a 3/5 majority vote in Congress to raise taxes would be better applied to a 3/5 majority vote in Congress to deviate from a responsible budget policy."

Absolutely! Make fiscal irresponsiblity of any sort more difficult.

Re: "the question left for me is simply, "Are any of these objectives so important that we should burden taxpayers of the future to pay for them?""

I agree, but that's because I agree with your implicit premise that it is not realistic to think that we can solve our long-term fiscal imbalance entirely on the spending side. In other words, tax increases are inevitable, and even greater tax increases would be inevitable if we cut taxes today.

But there are some who reject this premise. Who think that it IS realistic to think that we can hold the line on taxes forever and just cut enough from projected spending to solve the problem. If that argument is invalid, as I believe it to be, it should be refuted explicitly and with a stronger argument from a more authoritative source than me, which is why I've requested that you gents do so.

Another argument is, of course, the extreme "starve the beast" argument: that spending will adjust, dollar for dollar (or more) with changes in revenues, and therefore tax cuts won't exacerbate deficits and tax increases won't mitigate them. And I know you guys have discussed that argument, and I hope you will again sometime.

Can It All Be Done on the Spending Side?

I think Stan has taken up this issue in his posts. The total discretionary budget, including defense, is in the $1.2 trillion range. Cuts of the magnitude required would cripple those programs, including many essential government services. You are right--something more compelling than "Do the Math" is required for an audience that has refused to do the math on its own.

Andrew,Stan,Pete: Spending Side POLITICAL question

Andrew, Stan, Pete,

It's true that many folks who think we can solve the long-term fiscal imbalance solely on the spending side have not thought through how severe the cuts would have to be, and they would not favor such a scenario if they were better-informed.

But there are some at the extreme economic conservative/libertarian end who would LIKE to see entitlements and many other progams eliminated or almost eliminated. My question to you, Stan, and Pete, therefore, is this:

Leaving aside what would be desirable, is it realistic POLITICALLY to think that we could solve the long-term fiscal imbalance problem solely on the spending side (i.e., without ANY tax increases at any point)?

For questions of politics

It is even less feasible politically than it is economically.

Stan and Pete: Concur with Andrew?

Stan and Pete,

Do you concur with Andrew?

(Andrew, thanks for your reply)

Just the Spending Side

Theoretically it's possible to balance the budget with just federal spending cuts, but as a matter of practical politics and practical economics, I doubt we'll ever see budget balance achieved that way. I've been involved on Capitol Hill in many deficit reduction efforts, and the only ones that succeeded in any real sense, particularly in early 1990 and in 1993, combined equal amounts of spending cuts and tax increases. We quickly learned that equally shared pain was the only policy that worked politically. Having said that, our health care system is badly broken and wastes hundreds of billions of dollars of taxpayer money each year, not to mention the far larger private sector costs. No other country in the world operates its health care like we do. This is the main driver of our deficit. The war is a close second. Turning those two issues around, which will take many years each, would go a long way toward balancing the federal budget. Some revenue increases would have to accompany those spending cuts or else social liberals wouldn't go along with the health spending cuts. It takes a grand compromise, and it will probably take several rounds of legislation over the next decade to get to budget balance. Hopefully, the next president can cut through our fiscal impasse without becoming a one-term president because of it.

Pete,Andrew,Stan: Follow-up re: taxes

Thanks for your answer, Pete.

So you and Andrew (and I) agree that it is unrealistic in terms of political feasibility to expect that our long-term fiscal imbalance will be solved entirely on the spending side, and that tax increases will inevitably be part of the solution.

My understanding from previous comments on this site is that you guys also don't believe in a dollar-for-dollar "starve the beast" dynamic (which would mean that every dollar in additional revenue causes at least one incremental dollar in spending, and each dollar reduction in revenue causes at least one dollar less in spending). Please confirm that I'm understanding your view re: "starve the beast" correctly.

Given the above, if we don't increase taxes NOW, doesn't that mean that we are only deferring tax increasing, moving them to the future, and adding cost in the process (due to additional interest expense)?

And due to the added cost, isn't this a negative NPV proposition -- i.e., a bad financial plan for the nation?

Pete, Andrew, Stan

To put all this a bit differently, here's where I'm coming from:

I have a friend who does not want any tax increases. He insists that (1) if we increase taxes, all the additional revenue will just end up as incremental spending, thereby not improving the deficit at all, and (2) it is politically feasible that we can solve our long-term fiscal imbalance problem entirely on the spending side (and even if this meant eliminating entitlements entirely or almost entirely, he would consider that a good thing from his philisophical perspective regarding what government should and should not do).

Leaving aside my disagreement with him on whether or not such large spending cuts would be preferable to a combination of tax increases and spending cuts (such that the spending cuts would not have to be as severe), I have argued that (1) it is not true that every dollar of incremental revenue would necessarily lead to one dollar of incremental spending, and (2) it is unrealistic (in political terms) to think that we would end up solving the fiscal imbalance solely on the spending side rather than via a compromise involving a combination of tax increases and spending cuts.

Who is right re: the above? And is it a close call or is one of us clearly right?

I've also asserted that even if, arguendo, lower revenues acts as a constraint on spending to SOME degree, and even if higher revenues might lead to SOME incremental spending, that effect is not so great as to make raising revenues a bad financial deal vs. allowing our debt to mount and our debt-to-GDP ratio to worsen as entitlements costs grow. In other words, we'll be better off raising taxes now than waiting to do so later. The ideal would be a deal including both tax increases AND spending cuts, but failing that, we'd be better off raising taxes (at any given level of spending) than not doing so (except of course, for the lost opportunity to use the prospect of tax increases to negotiate spending cuts).

Do you agree?

The only tool the Republicans have

is saying they will cut or won't raise taxes.

That's pretty much it. McCain can't end the Iraq war (20-30 billion a month and possibly a trillion or more in future spending overall -- this will be a point the Dems will use over and over again), he can't say he'll cut social security or Medicare drug benefits (that would lose the coveted senior vote), can't say he'll cut transportation or other infrastructure (already lagging behind on those). He can't say he'll raise taxes on the rich, because they are a big part of the Republican campaign funding machine and base.

But this is what wins elections.

But if McCain is elected, and wants to continue spending on the Iraq war,he'll be forced to do a Bush Senior and raise taxes anyway. Read my lips: The next president will raise taxes.

Responding to Andrew

I like your idea of a private school tax credit. I imagine that it would increase competition somewhat, but it does so primarily by helping the wealthy. Vouchers seem much preferable because they would do more for competition and would help the poor so much more. Do you agree?

Second, the notion about tax simplification--that taxpayers should be able to opt into a very simplified tax code--would be okay under the proviso that almost everyone would pay more under the simple code than the current code.

Why do you feel tax simplification must incur a higher tax to be justified. Wouldn't a revenue neutral tax simplification be preferred?

Responding to Brooks

Starve the Beast may not reduce the federal outlay dollar for dollar, but I feel it is likely to create some reduction. I have noticed a tendency for taxpayers/voters to be shortsighted and undisciplined in their desires. I fear, apparently like your friend, that this will lead to inevitiably larger government. I do not know of any period in our government's history where it became smaller in absolute size. I imagine that the ratio of government to GDP has also grown for most of our country's short history.

My hypothesis is something like this. I imagine that it takes real pain to stop the growth of government (and therefore taxes). By stopping the tax growth early, we can achieve the pain necessary to temporarily halt the growth in government. I'd count a win as any case where growth in GDP exceeds growth of government.

Your NPV analysis technique may need to be modified to properly determine the impact of federal budget deficits/debt. For example, in the current situation, with China sucking in and holding much of our debt, shouldn't the depreciation of the dollar factor into the NPV analysis. It seems to me that there is some combination of interest, dollar deprication & inflation levels that makes the NPV of the dollars we owe less than the cost. I even think it is possible that the trade imbalance is a good deal for both sides, such that the NPV for each trading partner is higher. We get goods (government services) cheap on an NPV basis, and China gets GDP growth that outstrips its NPV losses from its dollar "investments."

At some level, isn't this is the bet that both countries are making?

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