Why Their Economic Plans Don't Add Up

A rocky economy means the gap between campaign promises and governing realities may be larger than ever this year

As he crisscrosses the country in his quest for the Presidency, Senator John McCain frequently repeats his vow to keep today's low income tax rates in place, take a further whack at the estate tax, and ease the tax burden on business. "I want to look you in the eye," he said at a July 30 town hall meeting at a local Caterpillar (CAT) dealer in Aurora, Colo. "I will not raise your taxes nor support a tax increase. I will not do it."

Yet how much faith should voters put in the Arizona Republican's proposals? Or for that matter in Senator Barack Obama's bold plans to spend hundreds of billions on national health care, infrastructure, education, and energy? Put another way, how likely is it that the plans now being spelled out on the campaign trail will actually come to pass? In two words, not very.

Politics, the weak economy, and the reality of the ballooning federal budget will all limit the next President's room for maneuver. McCain's low-tax strategy could well be chewed up in a Congress that is likely to be even more Democratic than it is today. Obama's lofty plans could be undone by the hefty costs of his health-care plan and other programs. Even some Democrats may not stomach the huge expense and vast complexity of Obama's proposals.

In every election there is a big gap between what the candidates promise and what they can actually deliver. Think of Bill Clinton campaigning on middle-class tax cuts, universal health care, and infrastructure development. He spent much of his Administration cutting the deficit, not implementing big new programs. Or George W. Bush, who said he would trim greenhouse gas emissions in a move to buff his eco-credentials when facing off against Al Gore. Bush quickly abandoned that idea once the race was won.

This year that gap between promise and reality may be even larger than usual. "Whoever wins will face a big wake-up call as soon as the election is over," says Daniel Clifton, head of Washington policy research for investment group Strategas Research Partners. "Many campaign promises will need to be scuttled."

The 2009 economy will offer tough conditions for a President set on bold new policies. The next Administration will face anemic growth, sluggish employment, a housing downturn expected to continue at least through much of next year, and continued tight credit markets as the shakeout works its way through the financial sector.

And in part because of last spring's $168 billion stimulus, the federal deficit will rise to nearly $500 billion next year, almost three times fiscal 2007 levels. There's a growing sense in Washington, particularly among Democrats, that another round of stimulus or further moves to bail out the housing or financial markets could be needed. Such spending could add tens if not hundreds of billions to the deficit. In the face of that tab, the question will be whether McCain or Obama can find the money to fund many of their tax cuts and spending proposals.

Some economists think the next President will have more room to maneuver than those deficit estimates suggest. A $500 billion deficit would be about 3.6% of gross domestic product, still well below the 6% high reached in 1983. Many economists also think heavy deficit spending is the right move in a slowdown. But sustained continued deficits do still matter, especially given the looming costs of Medicare and Social Security—it's the trajectory that counts, says James Poterba, the head of the economics department at Massachusetts Institute of Technology. And "there is no question that the proposals of either candidate would dramatically worsen the fiscal situation," adds Maya MacGuineas, president of the bipartisan Committee for a Responsible Federal Budget, a project of the New America Foundation, a think tank.

Start with McCain, who believes tax cuts create growth and jobs. Along with making the Bush tax cuts permanent on income, capital gains, and dividends, he would whittle back the much disliked Alternative Minimum Tax, reduce the estate tax from its planned 2009 rate of 45% to 15%, and double deductions that can be taken for children and other dependents, from $3,500 to $7,000. He'd also trim the corporate tax rate—one of the world's highest—from 35% to 25%.

Doing anything close to that could lead to a big hole in the Federal budget, however. Because all of the Bush tax cuts are set to expire by 2011, the official budget and deficit estimates include the big rise in tax revenues that would result from rates returning to earlier levels. Those estimates also assume that the AMT is fully collected, even though Congress "temporarily" adjusts it every year to keep many middle-class taxpayers from being hit.

So all the tax changes McCain calls for would be costly. According to estimates by the nonpartisan Tax Policy Center (TPC), extending most of the Bush tax cuts now set to expire in 2011 would cost an average of $170 billion a year in lost revenue between 2009 and 2018. Indexing the AMT so that it nabs fewer middle-class folk would nip $120 billion more from Uncle Sam's purse. McCain's proposed reductions in the corporate tax rate would lop off $73 billion annually on average. All told, estimates the TPC, McCain's tax proposals would reduce estimated tax revenues over the next decade by some $4.2 trillion.

What does the McCain camp say? Douglas J. Holtz-Eakin, McCain's top economics policy adviser, argues that McCain's proposals should be judged against the tax policies in effect today, since no one in Washington thinks it realistic that all the Bush tax cuts will snap back. Seen in that light, the McCain plan would cut tax revenues by $600 billion over the decade. By either measure, Holtz-Eakin argues that the TPC numbers don't take account of the economic expansion that would be stoked by reducing taxes.

Roberton Williams, a Congressional Budget Office veteran now at the Tax Policy Center, points out there would be a sizable shortfall in revenue if McCain got his tax cuts. Current federal spending accounts for about 20% of GDP. The TPC says McCain's proposals would cut projected tax revenues to just 17.6% of GDP. "You'd need an awful lot of growth—or some awfully large spending cuts—to close that gap," says Williams.

That breach shows how tough it will be for McCain to meet his pledge to balance the federal budget by the end of his first term. He says he can cut $100 billion a year from the budget by going after earmarks and other wasteful programs in the military, in farm subsidies, and in health care. Holtz-Eakin adds that McCain would push Congress to limit government spending to a 2.4% annual increase. That's well under the 4.3% rise projected by the Congressional Budget Office, and cutting pork-barrel spending or popular government programs is one of the hardest political tasks going. Every candidate promises to cut waste. Few have ever delivered.

Obama has been more specific than McCain in detailing the tax hikes and spending cuts that would allow his Administration to pay its way. His thesis is that the squeeze on working- and middle-class families lies at the core of the economy's problems. "It's time to restore balance and fairness to our economy so it works for all Americans," he told a town hall meeting in Springfield, Mo., on July 30.

To address these imbalances, Obama backs $50 billion in near-term stimulus. Longer-term, he would spend $65 billion a year on a broad-based health insurance program to cover the uninsured, plus $150 billion on green energy technologies and $60 billion on infrastructure over the next decade. Some $18 billion annually would go into early childhood education, while college students would get $4,000 in tuition tax credits. Then there's a $1,000 rebate for families hit by high energy costs.

Who will pay for this largesse? For families bringing in more than $250,000, Obama would raise the top two income tax brackets back to the 36% and 39.6% rates in effect in the Clinton years. He would also boost taxes on capital gains and dividends for high earners from today's 15% to between 20% and 25%. The TPC estimates those moves could bring in an average of $28 billion a year. Obama also proposes to raise taxes on oil and gas companies, tax the gains of private equity partners as regular income rather than at the lower capital gains rate they now pay, and target overseas tax havens and income earned overseas. These moves could bring in some $92 billion a year.

Still, because of host of other tax breaks he has proposed—indexing the AMT for inflation, further cuts for seniors and working families, and an extension of the Bush tax cuts for families making under $250,000—the TPC estimates Obama's plan would cut tax revenues over the next decade by some $2.8 trillion. Overall, says Williams, the Democrats' plans would bring in tax revenues of 18.3% of GDP—more than McCain's plan, but still below the estimates of expected federal spending.

Like Holtz-Eakin, Obama's top economic adviser, Jason Furman, argues that Obama's plan should be measured against current tax rates, rather than having to add back the full cost of ending the Bush tax cuts. By that measure, Obama would raise $778 billion over the next decade and help whittle down the current deficit. Those numbers, however, don't take into account many of Obama's plans to boost spending in areas like health care and green energy.

Furman argues that the Obama camp will also bring down spending in other ways that aren't in the TPC tally. Using more technology, better managing chronic illnesses, and reducing drug prices would drive down health-care costs for everyone and fund the expense of adding the uninsured to the rolls. Money would be freed up by redirecting much of the $10 billion a month now being spent on Iraq. Funding for green technology would come from establishing a market-based "cap and trade" system to control the harmful carbon emissions that cause global warming. Auctioning off the rights to emit such carbon to oil refiners, coal-fired power plants, and others would bring in more than the $150 billion Obama wants to pour into alternative energy development. "With each policy, we've laid out what we'll do and how we'll pay for it," says Austan Goolsbee, another top economic adviser. "Our budget adds up."

It would add up—but only if all those projected new revenues come in. That's an aggressive assumption, say budget experts. Even if the decision to leave Iraq were made tomorrow, the costs of drawing down the troops and refurbishing the military's equipment will continue to eat up much of that sum for several years.

Alan Viard, a tax policy expert at the American Enterprise Institute, also points out that closing corporate loopholes is a perennially popular idea, "but it's a lot harder to do when you get down to specifics." Private equity firms already defeated one congressional attempt to boost their tax rates last year, thanks to heavy lobbying. Obtaining big savings through better management of the health-care system will also be a big challenge. "The truth is, no one really knows how much cost savings such moves can generate," says MacGuineas of New America's budget committee.

Money won't be the only constraint on the candidates. Tom Gallagher, the head of Washington research for financial services firm ISI Group, argues that much will also depend on where Congress stands. That simple truth could spell big difficulties for McCain's Presidency. If current trends hold, the Democrats look likely to strengthen their majorities in both houses. Much of what McCain is now promising to voters could be very difficult to get past Congress.

Take McCain's pledge to maintain all of the Bush tax cuts, even for the affluent. There is little Democratic support for maintaining today's lower rates for top-end taxpayers on income, capital gains, or dividends. "Those rates are gone for taxpayers making over $250,000 come 2011—unless Congress restores them, and Congress is simply not going to do that," says the AEI's Viard. As for McCain's plan to slash corporate rates? Viard and others say don't count on those either.

Obama may not have an easy path himself. A strained budget could force him to dial back on his health-care plans or drop some of his proposed tax cuts. Obama's attempts to fund his $150 billion alternative energy plans could run into especially strong headwinds. He wants to auction off carbon emission rights to the utilities, oil refiners, and others who are largely responsible for such pollution. But auctioning those rights off rather than initially giving many of them away—as McCain and others have advocated—could put a bigger financial strain on the companies involved.

A less stringent emissions plan than Obama supports has already foundered in the Senate. "A bill that's less business-friendly than the one that stalled in June would be even less viable," says Vicki Arroyo, the director of policy analysis for the Pew Center on Global Climate Change.

Furman says the Obama campaign has been conservative in estimating the savings and revenues it can count on to fund its proposals. As for the politics, Obama's willingness to push for such changes and show how he'd pay for them will make the difference to Congress. "Having Presidential support will change the dynamic completely," Furman says. On that, if little else, Furman and Holtz-Eakin agree. If McCain is elected on a platform of low taxes and contained spending, he'll have a mandate the Democrats will have to heed. "Congress can't ignore the evidence," says Holtz-Eakin.

Come January, the next President will have to take a much clearer stand as to where his priorities truly lie. The problem for voters is that it is impossible now to tell which of many competing goals Obama or McCain will back when the time comes to move from campaigning to governing. In either case, Americans will likely get much less than what's being offered in the heat of the campaign.

Business Exchange related topics:U.S. EconomyEconomy and the Election2008 Election

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