A Project of The Annenberg Public Policy Center

The Budget According to McCain: Part II

The new McCain loves tax cuts. But many of his claims about them are off.


Summary

In our last installment we looked at McCain's pronouncements on spending cuts to help balance the budget. In Part II, we examine what he's said on a subject that might be more pleasing to many Americans: lowering taxes. We found exaggerations and distortions here, as well. 

  • McCain says that eliminating the Alternative Minimum Tax will save "more than 25 million middle-class families more than $2,000 every year." But McCain's "middle class" includes families making up to $200,000 per year, and the $2,000 figure is an average. Those earning more money will see the lion's share of the savings. McCain also leaves out the fact that the proposal could cost as much as $1.6 trillion over 10 years.
  • By the measure most economists prefer, McCain is wrong in his claim that Sens. Clinton and Obama want to implement "the single largest tax increase since the Second World War;" it would be the fifth largest. At a more basic level, it's misleading to tag Clinton and Obama for something that was scheduled during the Bush administration – the expiration of the 2001 and 2003 Bush tax cuts, which by law will occur at the end of 2010.
  • McCain also repeats the mantra that cutting the capital gains tax rate will increase government receipts. In fact, rate cuts produce a spike in revenue, but it's only temporary. McCain also falsely claims that higher capital gains tax rates will affect 401(k) plans.
  • McCain was the first to announce the now widely discredited proposal to suspend federal gas taxes. The proposal wouldn't lower prices at the pump and would result in (effectively) an $8.5 billion windfall to oil companies.

Analysis

In an April 15 speech, McCain unveiled a set of proposals that he says would reduce spending, lower taxes and still leave the government with enough money to balance the budget. We've already tackled McCain's pledge to cut discretionary spending by $100 billion. In this second part, we examine his plan to lower your taxes.

Alternative Middle-Class Cuts
 

McCain says his plan to eliminate the Alternative Minimum Tax (AMT) would be a "middle-class tax cut." That depends on what your definition of "middle class" is.

McCain (April 15): “I will also send to the Congress a middle-class tax cut – a complete phase-out of the Alternative Minimum Tax to save more than 25 million middle-class families more than 2,000 dollars every year.”

Douglas Holtz-Eakin, McCain's economic adviser, confirms that the senator is referring to taxpayers making up to $200,000 a year. According to projections by the Tax Policy Center (TPC), 26.6 million of those paying the tax in 2010 will make up to $200k, while 5.8 million will make more than that. TPC figures also show that the majority (64 percent, or 20.9 million) of AMT taxpayers in 2010 will earn more than $100,000 a year. The AMT was originally devised in 1969 after 155 taxpayers with incomes over $200,000 escaped paying any federal income taxes. But because the tax isn't indexed to inflation, it has been affecting a greater percentage of taxpayers in most income classifications each year; that $200,000 threshold would be worth $1.2 million in today's dollars. Bush's tax cuts have caused the AMT to affect more people than it otherwise would: Taxpayers are subject to the AMT when the amount they owe under the "regular" tax system dips below the amount they would pay under the AMT, so cuts in the regular tax rate can actually increase the number of people who must pay the AMT. In fact, the estimated percentage of taxpayers subject to the AMT will have more than doubled in 2010 because of the Bush tax cuts.

Holtz-Eakin also told FactCheck.org that the families to which McCain refers would save an average of $2,000 a year. That means some would save more and some would save less. Those in higher income groups pay much more of AMT taxes than do those with lower earnings, and they would reap more of the benefits of repealing the tax as well. About 90 percent of the tax benefits of doing away with the AMT in 2007, for instance, would have gone to households in the $100k and above group; 55 percent would have gone to households earning more than $200k. We've charted the Tax Policy Center's data on who will pay the AMT in 2010 and how much of the AMT tax burden they'll bear:

 

The TPC projects that 32.4 million taxpayers will pay the AMT in 2010. As the chart shows, 46.6 percent of them will earn between $100,000 and $200,000 that year. Those with higher incomes pay more of the tax. For instance, nearly 22 percent of AMT taxpayers in 2010 will make between $75,000 and $100,000, but they'll pay 7.7 percent of AMT taxes. Those making $200k to $500k represent just 15 percent of all AMT taxpayers, but they pay nearly 40 percent of all AMT taxes.

McCain also fails to mention that repealing the AMT costs the government a lot of money in lost revenues. According to the TPC, nixing the AMT would cost more than $850 billion over 10 years, if the Bush tax cuts expire as scheduled. If the tax cuts are extended, eliminating the AMT would cost $1.6 trillion over 10 years.

Doing away with the AMT would certainly be a tax cut for wealthy individuals – and others affected by the tax. As for whether it rightly can be called a "middle-class tax cut," as McCain says, we'll let you be the judge. We’ve written before about how the majority of Americans consider themselves to be middle class.

Speaking of Those Bush Tax Cuts…
 

The senator also repeated his opposition to letting Bush's tax cuts expire, a reversal of his previous position on the cuts:

McCain (April 15): By allowing many of the current low tax rates to expire, [Democrats] would impose – overnight – the single largest tax increase since the Second World War. Among supporters of a tax increase are Senators Obama and Clinton. Both promise big "change." And a trillion dollars in new taxes over the next decade would certainly fit that description.

Actually, there’s nothing "new" about most of these taxes. As we’ve noted before, Bush’s major 2001 and 2003 tax cuts are set to expire at the end of 2010. It’s a bit misleading to say that not changing the current law would be enacting a tax hike.

Both Sens. Obama and Clinton have said they would extend some of the Bush tax cuts but allow those that apply to people making more than $250,000 a year to expire. (Just 2 percent of U.S. households are projected to earn more than $250,000 next year, according to the TPC.) While there’s some guesswork about how their policy pronouncements would play out, the TPC has calculated that under a scenario like the one the Democratic contenders have suggested, Americans would pay $1.1 trillion more in income and estate taxes over 10 years than they would if all 2001-2006 tax cuts were extended and the estate tax was repealed permanently. Put another way, that means that extending all of the reductions and eliminating the estate tax would lower government revenues by about $1.1 trillion more than the Democratic proposal. To be fair, McCain has said he wouldn't eliminate the estate tax, but raise the exemption and cut the rate.

McCain also calls the Democratic plan to let some of the Bush cuts expire "the single largest tax increase since the Second World War." That’s true when measured in inflation-adjusted dollars, a comparison that a U.S. Treasury study calls "the second best measure." Since McCain said the increase would happen "overnight," we looked at the effect in the first year of the tax changes. The TPC found that taxpayers would pay an additional $103.3 billion in 2011, the first year a Democratic plan would be implemented. In inflation-adjusted dollars, that would be the largest single-year tax increase since WWII.

But most economists prefer to measure tax changes as a percentage of gross domestic product, which takes into account changes in the size of the overall U.S. economy. The Congressional Budget Office projects the GDP will be $16.7 trillion in 2011, which means the tax change would be six-tenths of 1 percent of GDP. By that measure, this plan would be the fifth-largest increase enacted since 1943. Looking at the effect of tax increases as an average of the first two years, this one would be the third largest since 1968.

McCain’s Supply-Side Myth

McCain says that not all of his tax cuts will cost the government money. He continues to repeat the suspect claim that cutting the capital gains tax rate will actually increase government revenue.

McCain (April 20): Sen. Obama says that he doesn’t want to raise taxes on anybody over – making over $200,000 a year, yet he wants to nearly double the capital gains tax. Nearly double it, which 100 million Americans have investments in – mutual funds, 401(k)s – policemen, firemen, nurses. He wants to increase their taxes. And he [Obama] obviously doesn’t understand the economy, because history shows every time you have cut capital gains taxes, revenues have increased, going back to Jack Kennedy.

Obama doesn't understand the economy? What about the giant blunder of clearly implying that 401(k) funds are subject to capital gains taxes? That's simply not the case: Those retirement funds are taxed as income when they are drawn down. (If the money is withdrawn before the plan participant is 59 1/2 years old, a penalty must also be paid unless the money is used for certain purposes.)

Also, Obama hasn't quite said he "wants to nearly double the capital gains tax" rate. What he said, in a CNBC interview, was this:

Obama (March 27): And I certainly would not go above what existed under Bill Clinton, which was the 28 percent. I would – and my guess would be it would be significantly lower than that.

Then there's the matter of whether capital gains tax cuts trigger revenue increases. We’ve addressed this distortion before, most recently when ABC News moderator Charles Gibson made a similar claim during a Democratic debate. Like Gibson, McCain is partly right. Revenues do tend to increase immediately following a cut in the capital gains tax rate. Because capital gains (or earnings on gains in stocks or real estate) are taxed only when the asset is sold, many investors will hold on to their assets until lower tax rates take effect, then rush to the "sell" window. But the spike in income to the federal government is temporary. A 2002 Congressional Budget Office study found that the effect wears off after a year or two. The report concluded that cuts to the capital gains tax rate "may not be enough to produce additional receipts over a long period" but "may do so over a few years."

For the record, Obama has said he doesn't want to raise taxes for anyone making less than around $200,000 per year; McCain appears to have made a verbal typo when he said "over $200,000."

The Gas Tax Pander
 

McCain also pledged to temporarily lift the 18.4 cents per gallon federal tax on gasoline (24.4 cents on diesel).

McCain (April 15): I propose that the federal government suspend all taxes on gasoline now paid by the American people – from Memorial Day to Labor Day of this year. The effect will be an immediate economic stimulus – taking a few dollars off the price of a tank of gas every time a family, a farmer, or trucker stops to fill up.

We've written about this one before. In fact, no economist thinks that McCain's gas tax holiday – or the very similar one proposed by Hillary Clinton days after McCain announced his promise – will save consumers money. Price cuts would spur greater demand for gasoline, but because the summer gas supply is already fixed, consumers would end up bidding gas back up to its old price. So motorists would pay just as much for each gallon, but 18.4 cents of each of those gallons would go to oil companies instead of the federal government. The tax currently goes directly to the Highway Trust Fund, and the American Society of Civil Engineers estimates that the holiday could siphon $8.5 billion from the fund. McCain promises to use general revenues to shore up the Highway Trust Fund, but that of course means increasing the deficit by another $8.5 billion. (Clinton would try to retrieve that money by slapping a windfall profits tax on oil companies.)

In McCain's world, everyone gets a pony: tax cuts for the middle class, higher revenue to continue all the popular government programs and the elimination of all those earmarks that no one (except their very specific beneficiaries) really likes anyway.

Unfortunately, in the world of fiscal reality, it's not so easy to dole out such generous gifts.

– by Lori Robertson, Viveca Novak and Joe Miller

Sources

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Congressional Budget Office. "Capital Gains Taxes and Federal Revenues." 9 October 2002. Congressional Budget Office. 1 May 2008.

Internal Revenue Service. "401(k) Resource Guide – Plan Participants – General Distribution Rules." 1 May 2008. United States Department of the Treasury: Internal Revenue Service. 1 May 2008.

Obama, Barack. First on CNBC Interview: CNBC's Maria Bartiromo Speaks with Senator Barack Obama on CNBC's "Closing Bell" Maria Bartiromo. 27 March 2008.

Tempalski, Jerry. "Revenue Effects of Major Tax Bills." Office of Tax Analysis, U.S. Department of the Treasury, Sept. 2006.

Tax Policy Center. "AMT Participation Rate (percent) by Individual Characteristics." 29 January 2008. Tax Policy Center. 1 May 2008.

Tax Policy Center. "Distribution of AMT and Regular Income Tax by Cash Income, Current Law." 29 January 2008. Tax Policy Center. 1 May 2008.

Tax Policy Center. "Options to Limit the Extension of the 2001-06 Tax Cuts Above $250,000, Static Impact on Individual Income and Estate Tax Liability and Revenue ($ billions), 2009-18." 11 February 2008. Tax Policy Center. 1 May 2008.

Tax Policy Center. "Repealing the AMT: Costly and Regressive." 5 January 2007. Tax Policy Center. 1 May 2008.

Tax Policy Center. "AMT Revenue per AMT Taxpayer." 29 Jan. 2008. Tax Policy Center. 1 May 2008.

Burman, Len and Julianna Koch and Greg Leiserson. "The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections." Tax Policy Center. 1 Dec. 2006. 1 May 2008.

Weisman, Jonathan. "Falling Into Alternative Minimum Trouble." 7 March 2007. The Washington Post. 1 May 2008.

Congressional Budget Office. "Backup Data for CBO's Year-by-Year Forecast and Projections for Calendar Years 2008 to 2018." 14 May 2008.

ABC News transcript. "Obama and Clinton Debate." 16 April 2008. ABC News Web site. 14 May 2008.