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The $5.7 Trillion Myth

The Democrats' fuzzy math.

Jul 21, 2008, Vol. 13, No. 42 • By STEPHEN MOORE
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This week John McCain officially released the details of his economic recovery tax plan. The howls of protest from the left were both loud and predictable. The Obama campaign ripped into the McCain plan with the mantra of "tax cuts for the rich," while leftwing special interest groups claimed that McCain would blow a supersized hole in the budget deficit.

Yes, that bogeyman issue of the budget deficit is back again. That's the issue that's never an issue except when Republicans want to cut taxes, in which case deficits are suddenly one of the four horsemen of the apocalypse. Never mind that on Nancy Pelosi's watch the budget deficit has more than doubled--to $400 billion--in 18 months. That inconvenient truth hasn't stopped a barrage of attacks from the media and union-funded groups directed at McCain's "$5.7 trillion tax cut plan."

McCain wants to retain the Bush investment tax cuts; repeal the alternative minimum tax; cut the corporate income tax rate to 25 percent from 35 percent, and offer Americans an alternative flat tax (an idea he borrowed from me, by the way). Former Clinton labor secretary Robert Reich calls the McCain tax cut "the most financially irresponsible plan I've seen in years." And even the newspaper I write for, the Wall Street Journal, joined in the charge of media skepticism with a headline that read: "McCain Tax Cuts Would Bloat Deficit or Take Huge Spending Curbs."

I'll get to the specifics of why these criticisms are misleading, but let's start with a quick comparison of Senators Obama's and McCain's records on fiscal responsibility. Obama hasn't been in Washington for very long, but in his three years he's firmly entrenched himself among the bottom ten senators on the National Taxpayers Union scorecard of fiscal responsibility. On the same rating scale, McCain ranks as the third-most hostile senator to new spending. In his campaign promises, Obama has proposed $307.2 billion of new spending a year, which is about 40 times larger than the $6.9 billion in new spending that McCain has proposed.

Yet, we're to believe that it's John McCain who's going to pile debt on the backs of our children and Barack Obama who is going to balance the budget. This makes as much sense as picking Rex Grossman over Tom Brady in a fantasy football league.

Then there is the myth that Obama would cut taxes for the middle class, while McCain would only lavish tax cuts on the rich. Bill Clinton also famously touted a middle-class tax cut, and that promise lasted until about the third week of his presidency. The Obama promise to cut taxes on the middle class is an equal farce; it utterly ignores the $1.5 trillion cap and trade energy tax--a tax that (alas) McCain has also endorsed. A study by Laffer Associates found that this would be the biggest increase in taxes on the middle class in decades, and it didn't count the 1 million jobs that would be lost. So if the economic killer cap and trade is enacted (by Obama or McCain), middle-class taxes are going way, way up, not down.

This brings us back to the hullabaloo over the "$5.7 trillion McCain tax plan." This number comes from economist Len Burman of the Brookings Institution and Urban Institute. It is made up out of whole cloth.

About $1.7 trillion of this "cost" comes from making the current tax rates permanent. McCain wants to prevent the 15 percent capital gains and dividend tax rates from rising to 20 percent and 39.6 percent after 2010. In any plain use of the English language, when tax rates go up, this is a tax increase. Certainly the 80 million or so Americans who own stock will feel their taxes going up. But the Democrats have it wedged in their heads that preserving current tax laws is a $1.7 trillion tax cut for the rich. And these are the people who accuse George Bush of fuzzy math.

Equally deceptive is the Democrats' ever-evolving position on the despised alternative minimum tax (AMT). Some 25 million, mostly middle-class Americans are scheduled to start paying an extra $2,000 a year AMT surcharge in 2009. That would be a giant middle-class wallet buster. So while Barack Obama is pledging to cut taxes on squeezed workers, his colleagues in Congress passed a budget earlier this year that assumes that 25 million middle-class Americans will pay the AMT after 2010. This is how they arrived at a "balanced" budget. Meanwhile, McCain, who has pledged to protect the middle class from a tax they were never supposed to pay, is accused of handing out a $1.5 trillion "tax cut."

This means that $3.2 trillion of the $5.7 trillion "cost" of the McCain plan is for tax cuts that are either not cuts at all, or tax cuts that Democrats say they favor themselves.

Then there's the other giant flaw in the $5.7 trillion tax cut myth. The models that come up with this number assume that there will be zero change in the economy from lower tax rates. So a roughly one-third reduction in the corporate tax rate translates into a one-third decline in corporate tax receipts. Conversely, a 33 percent increase in the capital gains tax means a 33 percent rise in capital gains receipts. This defies common sense because the reductions in the capital gains tax in 1997 under Bill Clinton and in 2003 under George W. Bush more than doubled capital gains receipts on both occasions.

The same forecasters who say that McCain's tax plan will lose $5.7 trillion also assured us five years ago that the investment tax cuts of 2003 would blow a $1 trillion hole in the budget. Oops. Instead the deficit fell in half from 2003-07 as federal revenues soared by a record $750 billion.

Do economists on the left really believe that the economy's response to a reduction in tax rates is zero? Can it be that moving the U.S. corporate tax rate from the second highest in the world to the international average won't help the competitiveness of U.S.-based firms at all? If that's the case, how does one account for Ireland, which cut its corporate tax rate from 48 percent to 12.5 percent but now has so much economic activity, its tax receipts have soared?

So we have a clash of visions on tax policy here that will be played out on center stage in the months ahead. The left wants a tax system that redistributes $130 billion of the tax burden from the rich to the poor. Good luck to them. Almost every attempt by the Democrats for the past 50 years to increase tax payments by the rich by raising their tax rates has led to the top 1 percent and top 5 percent shouldering smaller shares of overall taxes.

McCain has proposed a tax code redesigned to "increase the growth potential of the economy" by flattening tax rates and keeping taxes low on savings and investment. In the near term, the McCain tax plan will lose revenue, but it's a good bet that in the long run a tax system that increases jobs and growth and incomes will generate more revenues than Obama's priority of putting "fairness" ahead of prosperity. That usually delivers neither.

Stephen Moore is senior economics writer for the Wall Street Journal editorial page.