Bush Tax Cuts Are Centerpiece of McCain Tax Policy

Third in a Series: The economy “is far and away the most important issue” of the presidential campaign, according to leading independent pollster John Zogby. About 60 percent of those polled in a recent survey cited it as their top concern, compared with Iraq, the second-most important issue, cited by about 20 percent of respondents.

“Voters don’t like bad behavior on the part of CEOs, but economic populism really doesn’t work” as a campaign strategy, Zogby says. “And both guys have to show leadership on the economy.”

The presumptive Republican and Democratic candidates for president get the message. In recent days, the debate between Democrat Barack Obama and Republican John McCain has increasingly focused on the economy. When it comes to such discussions, tax policy is where the rubber meets the road. And it is one of the key areas where the candidates are offering dramatically different approaches.

Last week, I outlined Barack Obama’s proposals, which would tilt the tax code toward those making less than $250,000 a year and raise taxes on the richest Americans. But McCain argues that his proposals would do far more to encourage economic growth. Most of the data is contained in a new report by the Tax Policy Center of the Urban Institute and the Brookings Institution.

At the center of the debate are the Bush administration tax cuts from 2001 and 2003. All are set to expire in 2010. Without any action, that means the 10 percent tax bracket will disappear and the 28, 33, and 35 percent tax rates will increase to 31, 36, and 39.6 percent, respectively. In addition, the capital gains rates will increase from 0 and 15 percent to 8 or 10 and 18 or 20 percent (the lower rate applies to long-held assets).

The child credit will shrink to $500 per child and be nonrefundable for most taxpayers; the top of the 15 percent bracket and the standard deduction for married couples will no longer be set to double the amounts for single filers; the top estate tax rate will increase to 55 percent and the exemption will decline to $1 million; and numerous other provisions will revert to their previous form or expire.

The effect is important to note because the centerpiece of McCain’s tax policy is to make all of the 2001 and 2003 tax cuts permanent. Here are other highlights of his tax proposals.

Estate Taxes: Current law reduces the estate tax in 2009 and eliminates it entirely in 2010, but only for that one year. Expiration of the 2001 tax cuts in 2011 will return the estate tax exemption to $1 million and the top estate tax rate to 55 percent. McCain has called for permanent reduction of the tax in 2010 by increasing the estate tax exemption from its scheduled 2009 level of $3.5 million to $5 million and reducing the tax rate from 45 percent to 15 percent.

Corporate Income Taxes: Corporations currently pay tax at rates of 15, 25, 34, and 35 percent and are also subject to 3 and 5 percent surtaxes in certain income ranges. McCain proposes to cut the maximum corporate income tax rate from 35 to 25 percent. McCain’s plan would eliminate the 35 percent bracket immediately; and phase down the 34 percent rate to 30 percent in 2010, 28 percent in 2012, 26 percent in 2014, and 25 percent thereafter. The surtaxes would also be eliminated immediately.

Depreciation Allowances: McCain proposes to allow businesses to immediately expense the full cost of three- and five-year business equipment purchased between 2009 and 2013. After 2013, businesses would again have to depreciate equipment over time. To prevent tax sheltering, the proposal would disallow the interest deduction for expensed equipment.

R&D Tax Credits: Under current law, companies may claim a tax credit of 20 percent for certain research and experimentation expenditures above a base amount. The effective rate of subsidy on all expenditures has been estimated at between 3 and 5 percent. McCain would make the research credit permanent and equal to 10 percent of all wages spent on research and development.

Oil Companies: Several provisions benefiting oil companies would be repealed, including expensing of exploration and development costs, the 15-percent tax credit for enhanced oil recovery costs for tertiary wells, the exception to uniform capitalization rules for intangible drilling costs, and the special depreciable lifetimes for select oil company assets.

Corporate Tax Base: McCain would broaden the corporate income tax base to raise $30 billion per year. Specific proposals to achieve this objective have not been specified.

Tax Subsidies for Health Insurance: The current exclusion from income tax for health insurance provided by an employer would be replaced with a refundable tax credit of $2,500 for singles and $5,000 for family coverage. Unlike the current exclusion, the credit would be available for both privately purchased and employer-provided insurance. The plan would count the health care employees get from their employer as if it were taxable cash income.

Dependent Exemption: The dependent exemption — but not the personal exemption for taxpayers themselves — would increase by $500 each year beginning in 2010 until it reaches $7,000 in 2016, after which it would again be indexed for inflation. Because current law indexes the exemption for inflation, the proposed $7,000 exemption in 2016 will not be twice the level under current law but only two-thirds higher, because current law would raise the exemption to around $4,600 to account for inflation.

Married couples filing a joint return reporting adjusted gross income of $50,000 or less would be eligible for the $7,000 exemption immediately (in 2009). The higher exemption phases out at a rate of $100 for each $1,000 (or fraction thereof) in excess of $50,000, but not below the level set by the unrestricted phase in available for all taxpayers. For married couples, the $7,000 threshold would be indexed for inflation in 2017.

Overall, in 2009, the fully-phased-in McCain tax plan would, on average, provide a tax cut equal to 2.0 percent of after-tax income, or $1,195, but the distribution would be skewed to upper-bracket households. The bottom fifth of all households would receive an average tax cut of just 0.2 percent ($19) and those in the middle fifth would receive an average cut equal to 0.7 percent of income ($319), according to the report.

Households in the top fifth would get an average tax cut of 3.0 percent of income ($6,264). Within that group, taxpayers in the top 1 percent of the population would see their taxes fall by an average of 3.4 percent or more than $40,000 and the richest 1 in 1,000 would see an average tax cut of almost $270,000 or 4.4 percent of income.

After 2012, the fully phased-in McCain plan would cut taxes for those in the bottom fifth of households by 0.9 percent, or about $100. Households in the middle would receive an average tax cut of 3.1 percent of income, or $1,444. The top fifth would receive an increase in after-tax income of 6.4 percent or $13,858. The top 1 percent would receive cuts averaging 9.5 percent of income ($126,951) while the richest 1 in 1,000 would see their after-tax incomes rise by 11.6 percent, or about $680,000.

Next week’s column, the fourth and final part of the series, will examine reaction to the tax proposals.