Plumbing the Candidates' Tax Plans

Joe the plumber is on to something: If a President McCain had his way, Americans could expect to keep their tax cuts. They’d also see their household income grow more, along with jobs and the economy, than would be the case under a President Obama.

Indeed, under John McCain’s tax plan, the economy would grow by $320 billion more in 10 years (after inflation) than under Barack Obama’s tax plan. Average household income would climb by about $2,600 more.

Each candidate’s tax plan reflect the priorities he would pursue if elected president. Numerous blanks and vagaries remain, yes. But with little more than two weeks to go, the Arizona Republican and the Illinois Democrat have laid out clear proposals for American voters to consider.
Both plans involve significant changes to the federal tax system, as The Heritage Foundation’s Center for Data Analysis details in a newly posted overview and assessment of their respective economic effects.

“Senator McCain will make the Bush tax cuts permanent, with the exception of the estate tax,” the study notes. “McCain credited the Bush tax cuts with helping the economy recover after the 2001 recession.

“Senator Obama, on the other hand, will extend the Bush tax cuts only for those taxpayers who earn less than $250,000 a year — he has deemed the rest of the people ‘rich.’ Senator Obama will also enact new tax increases on these rich individuals as well as a series of targeted tax credits for lower-income individuals.”

The McCain and Obama tax plans do share an unfortunate attribute: They would add to the complexity of the tax code. In other respects, though, the McCain proposal significantly advances good tax policy by emphasizing lower rates, while the Obama plan raises tax rates.

The Obama plan also suffers by proliferating and expanding refundable tax credits, which further — and inappropriately — transforms our income tax system into an income support system.

“Senator Obama believes the current tax system is not progressive enough and that higher taxes on the rich should be used to give money to low-income individuals or those who do not work at all,” my colleagues William W. Beach, Karen Campbell, Rea S. Hederman Jr. and Guinevere Nell write in a summary of their findings.

Obama’s view apparently bothers Samuel Joseph Wurzelbacher, who dreams of taking over his boss’s plumbing business.  Joe the Plumber’s concerns got wide attention when he challenged Obama over his tax plans when the candidate stopped in Joe’s neighborhood in Holland, Ohio.  

Heritage analysts’ close look at the McCain and Obama tax proposals revealed important similarities and distinctions — and some valid causes for Joe’s concerns. Among the similarities:

Lower taxes. Both plans, on balance, reduce federal taxes, demonstrating a clear and encouraging understanding by the candidates that income taxes are too high. McCain proposes $300 million more in tax cuts over 10 years. Unfortunately, Obama proposes additional tax increases — but conveniently delays their implementation until at least two years after a hypothetical second term.

Validation of Bush tax policy. Both sets of proposals recognize the fundamental soundness of the 2001 and 2003 tax cuts. Although liberal Democrats in Congress long have criticized the Bush tax cuts, Obama would make most of the income tax cuts permanent. McCain would make all those income tax cuts permanent.

Support for cutting the death tax. Both plans recognize the harmful effects and unfairness of the estate tax. Unfortunately, both plans retain this death tax but at least would impose much lower rates and offer a larger exemption than existed in 2000.

Among the major differences, the most important is that McCain’s proposals emphasize creating jobs and raising wages.

This distinction is most apparent in the Republican nominee’s proposal to extend all the 2001 and 2003 reductions in tax rates and his proposals to cut the corporate tax rate from 35 percent — second highest in the industrialized world — to 25 percent. The distinction is also apparent in McCain’s proposal to allow immediate expensing of business investment necessary for job growth and international competitiveness.

The McCain plan includes another positive reform: It replaces the unlimited exemption for employer-sponsored health insurance with a simple tax credit available to anyone who buys health insurance. This provision corrects a terrible and unfair distortion in the tax code. The change would be a major step toward fundamental reform of health care and significantly reduce the number of uninsured in America.

Obama’s tax proposals exemplify the Democrat’s view that redistributing Americans’ income — “spreading the wealth around,” as the candidate famously told Joe the plumber  — is more important than increasing their earnings and creating jobs.

This view is apparent in Obama’s proposal to raise income taxes dramatically on individuals and small businesses earning more than $250,000. That’s about what Joe says the plumbing company he works for makes. Obama then intends to raise payroll taxes on these same taxpayers after 2018.

Obama’s preference for punitive redistributionism is also seen in his proposal to raise tax rates on capital gains and dividends. Capital formation is essential for increasing workers’ productivity and wages. Taxes on capital gains and dividends are direct and certain impediments to business investment.

While raising taxes on higher earners, Obama would cut taxes for those who already pay little or no federal income tax. He would achieve this by increasing the tax credit for child and dependent care, and making it refundable. Obama also would spread the wealth around through a new, refundable “make work pay” tax credit for low-wage workers, and by expanding the earned-income tax credit.

These distinctions between the two plans explain why Heritage’s CDA analysts expect the McCain tax proposals would be more beneficial for economic growth, jobs, and wages.   

“Jobs respond more to McCain’s plan than to Obama’s,” the CDA analysis says. “Job growth over a 10-year forecast horizon is more than twice as high. Total employment grows an average of 915,800 jobs under Obama, 2.13 million under McCain. Both plans encourage job creation each year, but McCain’s leads to significantly larger growth — and sooner.”

By 2018, McCain’s plan, which makes the Bush tax cuts permanent and lowers the rate on corporate profits, creates an additional 3.43 million jobs. Obama, in contrast, would raise taxes on many of the economy’s key investors and business owners. Job growth under his plan by 2018 is about half as much, at 1.58 million.

Policy is about choices, and choices often reflect trade-offs. A common and fundamental trade-off in economic policy is between economic growth and redistributing the income from growth, between job creation and wage growth on the one hand and economic security on the other.

Especially with its focus on lower tax rates, the McCain tax plan is more conducive to economic growth and increasing wages. The Obama plan’s higher tax rates and proliferation of refundable credits means the United States would forego a significant amount of wage growth in favor of redistributing wages and earnings.

Through the lens of sound tax policy, both plans both would leave the tax code more complicated than it is today.
Even so, McCain’s plan has important advantages because it focuses on keeping tax rates low — and lowering them further in some instances. It does so while improving incentives for investment and correcting an extremely harmful tax distortion at the heart of much of the trouble in America’s health care financing system.

In contrast, the Obama plan raises income tax rates, raises payroll taxes on a delayed basis and actively increases use of the tax system to redistribute income to those who pay little or no income tax.– helping them by spreading Joe’s and others’ wealth around, as Obama earnestly explained.

Obama would move the tax code in a decidedly inappropriate direction. On balance, the McCain plan would be markedly better for economic growth, largely because it would lower tax rates.

If a President Obama takes office in January and pushes through his tax proposals, we could expect economic output, jobs and household income to grow more slowly than would be the case if a President McCain is elected and gets his way.

Joe and other informed voters will have to decide which kind of economic change they believe in.