October 17, 2008

McCain Vs. Obama: The Story on Taxes

By Sandra Block

In his acceptance speech at the 1984 Democratic convention, Walter Mondale promised to reduce the budget deficit by raising taxes. He later went on to lose every state but his home state of Minnesota and Washington, D.C.

It's not surprising, then, that despite a ballooning budget deficit and a recently enacted $700 billion financial bailout, John McCain and Barack Obama have pledged to lower taxes for millions of Americans.

McCain wants to extend the Bush administration's 2001 tax cuts, double the personal exemption taxpayers can claim, and lower corporate tax rates.

Obama wants to roll back some of the tax cuts for the wealthiest Americans and increase corporate tax rates, while reducing taxes for low- and middle-income families.

This week, both candidates proposed temporary tax cuts designed to help Americans cope with the financial crisis, which has sharply reduced the value of their retirement savings (see box, next page). McCain wants to cut the capital gains rate in half, reduce the tax on withdrawals from retirement savings to 10%, and waive a rule that requires seniors to start taking withdrawals from tax-deferred retirement savings at age 70 1/2. Obama would permit savers to take penalty-free hardship withdrawals of up to $10,000 from their 401(k) plans and individual retirement accounts in 2008 and 2009. Both candidates have proposed suspending taxes on unemployment benefits.

But whoever takes office on Jan. 20 will confront a brutal fiscal reality. The Congressional Budget Office estimates that the nation's debt will swell to $2.3 trillion by 2018. The non-partisan Tax Policy Center estimates that Obama's tax package would add $3.5 trillion to the total, while McCain's proposals would add $5 trillion.

Douglas Holtz-Eakin, McCain's senior policy adviser, says McCain's tax cuts would create more jobs. "The centerpiece of Sen. McCain's approach to deficit reduction is to get the economy going," he says.

Brian Deese, Obama's deputy economic policy director, says Obama has "put together a package of pro-growth tax cuts aimed to help middle-class families who are struggling the most in the current economy."

McCain has pledged to eliminate earmarks and wasteful spending, while Obama has targeted tax loopholes. But neither candidate has offered a realistic plan to pay for their tax proposals, says Leonard Burman, director of the Tax Policy Center.

In addition, reducing domestic spending is a lot harder than it sounds, says Clint Stretch, managing principal for tax policy for Deloitte Tax. "Things like aid to higher education, air-traffic controllers, roads, bridges, are not easily cut," he says.

Burman says whoever wins the election will soon confront the "overwhelming realities" of the national debt. For now, though, "Both campaigns have made a political calculation that they want to talk about happy things."

Individual tax rates

Unless Congress acts, tax cuts enacted by President Bush in 2001 and 2003 will expire at the end of 2010. McCain has proposed making the tax cuts permanent. He has also proposed increasing the exemption for dependents by $500 each year, starting in 2010. The increase would continue until the exemption totaled $7,000 in 2016. After that, it would be indexed for inflation.

Obama has also proposed making the 10%, 15%, 25% and 28% tax brackets permanent, but would boost the top two tax rates to 36% and 39.6%, their pre-tax-cut levels. Currently, the top tax rate for individual taxpayers is 35%. The increase would raise taxes for Americans who earn more than $250,000 a year.

Obama has also proposed new tax breaks for low- and middle-income taxpayers, including a tax credit of up to $500 for individuals and $1,000 for married couples. He would expand the earned income tax credit, a tax break that benefits the working poor. And seniors with income of $50,000 or less would pay no federal income tax.

The alternative minimum tax

Everybody hates the alternative minimum tax, but nobody knows what to do about it. And that appears to include the presidential candidates.

The AMT was originally designed to prevent the super-rich from avoiding taxes. But because the tax was never indexed to inflation, the number of taxpayers who must pay the tax has gradually increased. An estimated 4 million taxpayers paid the AMT in 2007. Taxpayers who are subject to the AMT are barred from claiming several popular tax deductions, including deductions for state property taxes.

While the AMT is wildly unpopular, scrapping it would cost the government billions in tax revenue. For that reason, Congress can't eliminate the AMT without making broad changes in the tax code, something lawmakers haven't had the time or inclination to do.

Instead, they've prevented the problem from getting worse by approving stopgap measures that limit the AMT's growth. The financial rescue bill signed by President Bush extends the temporary fix through 2008, protecting more than 20 million taxpayers from the AMT.

Both presidential candidates would continue that strategy, says Mel Schwarz, partner with Grant Thornton's national tax office in Washington, D.C. Extending the temporary fix "seems to be the default for both McCain and Obama until they come up with a way to solve the problem."

Holtz-Eakin, McCain's adviser, says McCain wants to get rid of the AMT, "but the fiscal reality is that it will take time."

Deese says Obama's plan to extend the existing AMT patch will ensure that "no additional middle-class families are hit with a tax increase."

Estate taxes

For 2008, the top estate tax rate is 45% for estates that exceed $2 million. The exemption is scheduled to rise to $3.5 million in 2009. Unless Congress acts, the estate tax will disappear in 2010, then rise from the grave in 2011 with a $1 million exemption and a top tax rate of 55%. That has prompted a lot of gallows humor about the financial benefits of dispatching a wealthy relative before Jan. 1, 2011.

Neither presidential candidate intends to let that happen. Obama has proposed exempting $3.5 million from estate taxes, and would impose a tax rate of 45% on estates that exceed that amount. Under McCain, wealthy families would pay much less. He has proposed a $5 million exemption, and a 15% tax rate on assets that exceed that amount.

Taxes on investments

Under the Bush tax cuts, tax rates for long-term capital gains and qualified dividends are 15% for taxpayers in the top four tax brackets. Taxpayers in the 10% and 15% brackets pay no taxes on long-term capital gains. McCain would make those rates permanent.

Obama would raise the capital gains rate to 20% for single taxpayers with income of more than $200,000, or married couples who earn more than $250,000.

Critics of Obama's plan say it would encourage investors to sell securities before the new rates take effect, inflicting further damage on the volatile stock market. Burman, who wrote a book on taxation of capital gains, says there's little economic evidence that low capital-gains rates help market performance. The biggest players in the market, such as 401(k) plans, pensions and non-profits, aren't affected by individual capital gains tax rates, he says.

Still, "With financial markets so fragile, it might be a good idea to put it off for a year or two," Burman says. "There might be some psychological effect of raising tax rates, even though the real effect is probably very small."

Deese, Obama's deputy economic policy director, says 98% of Americans would be unaffected by the proposed increase in tax rates for capital gains and dividends. For the remaining 2%, he adds, the new rates would still be lower than they were in the 1990s, a period of strong economic growth.

Corporate tax rates

McCain wants to lower the maximum corporate tax rate to 25% from the current 35%. The reduction would be phased in through 2013. Lower tax rates would encourage more companies to locate in the U.S., says Holtz-Eakin. "We're currently at a disadvantage in the competition for the location of firms," he says.

Obama has also proposed reducing corporate tax rates, although he hasn't said by how much. But he would tie corporate tax relief to specific actions, such as providing health care benefits to employees, says Schwarz.

In addition, Obama's proposals to close business tax loopholes and shut down corporate tax shelters "would mean raising the total burden on corporate taxpayers quite dramatically," says Stretch at Deloitte Tax.

Deese says Obama has proposed eliminating tax breaks for companies that move jobs and production overseas, while providing incentives for companies that create jobs in the U.S.

Tax credits

Obama has proposed expanding tax credits for child care and retirement savings. He has also proposed a $4,000 tax credit to offset the cost of college tuition, and wants to allow homeowners who don't itemize to claim a credit equal to 10% of their mortgage interest, up to $800. Currently, mortgage interest is deductible only for borrowers who itemize on their tax returns.

McCain, meanwhile, has proposed a tax credit of $2,500 ($5,000 for families) for everyone who purchases health insurance. At the same time, workers who get insurance through their jobs would be taxed on the value of those benefits. The proposal would benefit taxpayers who buy their own insurance because their employers don't provide it. But critics of the proposal say it would encourage companies to drop coverage for their workers.

Here's what Obama, McCain are talking about (c) Copyright 2008 USA TODAY, a division of Gannett Co. Inc. <>