Tuesday, September 16, 2008

Obamanomics Vs. McCain

Did this for NGLCC BIZ -- a comparison between the two candidates' policies on four internal issues: taxes, health, energy and foreign trade. Broken into four parts, below is the first installment, on taxes.


While comparing both the candidates’ economic agendas, one thing is quickly made clear – both have retained the basic economic thrust of their parties. That said, both claim to have tinkered where they can to add their own touches.

Obama, for instance, has admitted to being more accommodating of free market principles than many of his fellow democrats are, even publicly appreciating some of Reagan-era policies. His idea of solving an economic crisis may be setting up a government program to address a market failure, but then he’d also like to exploit market dynamics to drive that program in long-term. Also, in an interview with The New York Times, he proposes what he calls a more ‘moral’ capitalism. The best example of this ideology would be his proposal for a windfall profits tax on oil companies. It defies everything that free market economics teaches, and yet, according to his campaign, makes up for the unjustifiable tax breaks the energy industry has received in the past.

McCain on the other hand has tried to reaffirm his reputation as a reformer, by declaring an ambitious agenda to combat federal corruption and discourage corporate lobbying for incentives and tax breaks. Simultaneously, his plan has also retained the traditional republican thrust on cutting taxes and providing the largest investors the largest incentives, promoting the same economic trickle down formula made popular by Reagan – where the effects of reducing taxes on corporate investors are expected to trickle down to the entire economy and fund the budget deficit.

In this series of articles, I've looked at certain elements of the candidates’ economic policy from a business perspective – taxes, health care, energy and trade. This is the first installment, on their tax policies.

Taxes - Reading Between the Lines

Income Tax

Obama seeks to propose a tax-cut program that is friendlier to the lower-income families, but not so much to the wealthier class making more than $250,000 a year. Interestingly, despite not cutting taxes for the entire population like McCain will, Obama’s tax plan will produce annual net savings of $900 for the population on average, as compared to McCain’s $200. Research by the non-partisan Tax Policy Center (TPC) shows how traditional big tax breaks given by Republican governments in the past haven’t always benefited lower and middle families. A major reason for this is the fact that for lower and middle-income families, it is the payroll tax – and not the income tax – which takes the most away from them. Obama’s other major cut is a $500 credit applied toward income taxes based on payroll taxes already paid.

Although unsympathetic to the top income earners when put in context with McCain’s plan, whose biggest tax reduction is for those with incomes above $2.87 million, Obama’s tax increases don’t overburden the segment. They do take away Bush’s tax cuts, but still do not entirely reverse the huge pre-tax gains made by the top 1 per cent earners whose incomes have nearly doubled in the past decade.

McCain’s campaign has promised to permanently extend the 2001 and 2003 tax cuts, increase deductions for taxpayers supporting dependents, reduce the corporate income tax rate, and allow immediate deductions for investments in certain capital equipment. His greatest tax cuts – nearly 5% - are for those making above $2.87 million. His remaining tax cuts range from 1 to 3 per cent, applicable to those making between $66,000 and $227,000.

Corporate Income Tax

One of the key emphases of McCain’s tax policy has been how it benefits the business sector. McCain has promised to cut the corporate income tax rate from 35 percent to 25 percent, which will indeed result in a significant tax break for the C Corporations. For the small business sector though, this may not be as beneficial as a majority of small corporations are S Corporations, partnerships, limited liability corporations (LLCs), or sole proprietorships, none of which pay taxes at the corporate rate. In fact, the tax rate applicable to them is the owner’s individual tax rate.

Capital Gains Tax

Obama plans to raise the tax rate on dividends to 20 percent from the current 15% for those making over $250,000. McCain supports maintaining the current rate, set by Bush, and argues that higher capital gains taxes affect millions of middle-income Americans.

For small business owners, again, it is first important to consider that as all S Corporations and LLCs are prohibited from paying dividends, a business would have to have investment income or be a "C" corporation to be affected. That way only the very high-income taxpayers who report the most capital gains will benefit. Many more Americans make capital gains on corporate shares they hold within tax-deferred employer-sponsored retirement plans, on which they don’t need to pay capital gains taxes. Accruals within those accounts are tax free until distributed and then are taxed as ordinary income. Hence it is likely that the 5 per cent tax hike will not affect a majority of small business owners.

The Estate Tax

Both candidates have proposed to increase the estate tax exemption and reduce the estate tax rate compared with current law in 2011 and beyond. But McCain has shown a greater opposition for the estate tax, and would cut the tax much more than Obama. Under Senator McCain’s proposal, just about 4,000 estates would be subject to tax in 2011 - less than 0.2 percent of the 2.5 million adult decedents. Under Senator Obama’s proposal for estate taxes, about 8,000 estates would be taxable in 2011.

A near repeal of the tax revenue as suggested in the McCain proposal will primarily benefit a very small group of extremely affluent families, which is a less progressive tax structure. Also, it is undecided though just how much the estate tax affects the economy, as its effects on working and saving are not clear. TPC reports that where the tax may discourage some wealthy people from saving or working by reducing the size of their after-tax bequests, it may influence others who have a fixed target amount of wealth they want to transfer to save more, in order to make up for the expected tax liability. The tax may also encourage some potential heirs to work and save more because they are less able to live well off the proceeds of their inherited estate. Statistics show though that reducing the tax doesn’t greatly influence the overall economic activity.

Tax Cuts and the Budget Deficit

Economists have stated that both candidates’ tax plans will cause huge budget deficits. Both have promised to offset the deficit with spending cuts. For instance McCain emphasizes cutting down on earmarks and federal corruption; Obama wants to cut down on war spending and call the troops home. But both candidates sorely lack key details about all the measures they will take to stop the federal deficit from ballooning in the next five years.

TPC has found that Obama's tax-reduction plan would increase the national debt by $3.5 trillion by 2018. McCain’s plan to leave existing tax cuts in place rather than let them expire would add $5 trillion to the debt.

The non-partisan Congressional Budget Office (CBO) also offers a dismal forecast, projecting a record deficit of $438 billion in the coming year due to the slowing economy, which would decrease tax receipts to the Treasury. CBO has said that the deficit is a result of decrease in tax revenues and increase in federal spending in the past years. How do the candidates then plan to sustain the huge tax cuts each has promised?

The reason for their elusiveness, apart from election politics, may be that every action they take with regards to tax credits or other spending ultimately depends on the actual budget realities they inherit once they come into office.

Lastly, it is also important to consider that each candidate’s plan stand much greater chance of implementation if the candidate’s party controls part (or all) of congress – an advantage that Obama clearly has over McCain at this point.