McCain's Tax Plan Would Block a Democrat Katrina

June 25 (Bloomberg) — At about the time the river rose above its banks in Cedar Rapids, Iowa, people in Washington began talking about how John McCain was going to put the whole country underwater with his tax plan.

Suggesting that McCain = Disaster is weird. The fiscal program of the presumptive Republican nominee for president is hardly disastrous. Or, to put it all in diluvial terms, McCain's levies are like levees. They may look expensive on paper. But they'll provide a valuable infrastructure that will shore up the American house in ways that will prove more than worth it later.

Consider corporate taxes. Here the U.S. is perilously out of balance with the rest of the world. At 35 percent, our top rate is the second-highest among developed countries, behind only Japan. Everyday, we forgo business because of that 35 percent figure. Executives spend hundreds of hours and hundreds of millions of dollars shifting activity abroad just to get around it. McCain would cut the top rate to 25 percent.

The critics claim that supply-siders overrate the value of tax cuts. Sometimes they are right. When you cut an already low tax a little bit, you're not going to get the kind of change in behavior that a cut from a very high rate can yield.

But McCain's corporate change falls into the latter class. A 10-percentage-point rate cut may not pay for itself directly. But overall growth will more than compensate for nominal revenue loss. Domestic businesses could stay home, and foreign businesses would come.

Unkept Promises

Social Security? Here McCain is likewise sound. He acknowledges the entitlement's structural vulnerability: "Benefits promises cannot be kept." Currently, Social Security pensions increase not merely to compensate for inflation but add a bonus on top of that — a younger brother gets a better pension than an older one, even if the men followed the same job path.

McCain would alter the formula to adjust payouts for inflation — but not more. In addition, he would pull an "Alan Greenspan" and increase the retirement age. These changes would improve the budget numbers — and voters' sense of faith in their government.

Then there is the income tax. McCain would abolish the alternative minimum tax, a levy originally aimed at rich Americans that is increasingly ensnaring the middle class because it wasn't indexed for inflation. This is a brave proposal since the AMT might as well be called the ATM, so well does it serve as a cash machine for Washington.

What McCain has discerned is that the AMT imposes not only a dollar tax but also a civic burden on citizens. Like a booby trap, the tax often surprises them by revealing they owe more than they thought. McCain also would like to keep President George W. Bush's tax cuts, rather than allow them to expire.

Irresponsible Democrats

Here again, solid proposals. People talk about the expense — getting rid of the AMT costs $50 billion or so now per year and will cost yet more in the future. But that is only on paper. And Democratic programs such as income credits for lower earners cost more. No one blames the credits for fiscal disasters.

Democrats, the same ones who depict McCain as irresponsible, have their own plans to limit the AMT. In other words, we have something close to political consensus on AMT reform.

My own view is that AMT abolition would re-ground the country. The certainty of a simpler and more permanent rate structure will do its part to contribute to that crucial competitiveness as well.

Barack Obama's proposed tax increases, by contrast, would slow the economy's growth, and taxes will make up a greater share of gross domestic product, as in Germany — or even France. In the long run, McCain's plans make fiscal sense, too.

Open to Hyperbole

One reason the Democrats are getting away with their hyperbole is that people want to hear it. With gas prices pushing above $4 a gallon, no one is in the mood to listen to any Republican, regardless of where unemployment stands. But McCain's plans here also make sense — his pro-drilling policy would increase supply. His program for new nuclear power plants would brighten the national energy future.

Notice that one of the big charges against Republicans is that they "tilt the code toward the rich." Such a line comes out of a philosophy as old as the income tax — progressivity. That higher earners should pay higher tax rates has been a given for a century by politicians. Making the code more progressive is just something those politicians do, over and again. So many times that today the bottom half of earners pay almost no income tax at all.

There's plenty of evidence, however, that most Americans don't even understand the progressivity principle. In the 1950s, a pair of University of Chicago professors, Walter J. Blum and Harry Kalven Jr., published a study called "The Uneasy Case for Progressive Taxation." The scholars found that many Americans' understanding of the tax schedule was hazy, that they confused their average tax rate with their top rate.

Tilting Less

Most of us instinctively define "more" as proportionally more. A progressive tax increase is, however, by its very nature disproportionate — the higher earner pays not merely a greater amount, but also a greater percentage.

So when people claim that McCain's tax cuts "tilt to favor the rich," they ignore that in a progressive system any wide rate reduction favors the rich. "Untilt" or "tilt less, to make more stable" would be a better description of what McCain seeks with the tax system.

Recalibrating the jargon matters as much as any math when it comes to building a tax edifice that can weather the storms ahead.

(Amity Shlaes, a senior fellow in economic history at the Council on Foreign Relations, is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2008 Bloomberg

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