A Q&A With McCain Adviser Douglas Holtz-Eakin

The presidential candidate's top economic guru talks taxes, spending, and energy policy.

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Douglas Holtz-Eakin is the director of economic policy for Sen. John McCain's presidential campaign. He's also a former director of the Congressional Budget Office. I recently caught up with Holtz-Eakin at McCain campaign headquarters and chatted with him a bit about taxes, the size of government, and energy policy. (To get his take on Clintonomics and the 1990s, see this.) Here are some excerpts:

Are we headed toward bigger government?

Senator McCain's position is that there is a role for government, and the primary thing is that you identify government's role and make sure that it does it well. The striking thing that has come out of the campaign is the degree to which the American people have lost trust in their government to pursue genuine national priorities, and there are three instances in which this gets voiced pretty clearly; probably the most vivid is the immigration debate, where people simply did not believe that the federal government [would secure the borders]...so Senator McCain made it his commitment that he will secure the border and have the governors of the border states certify that it is secure before any other steps on immigration are taken.... And earmarks have led to the undeniable perception that Congress is interested in taking care of their friends and not the nation, and [earmarks] have led to political corruption and in some cases criminal corruption. And the third is trade...where the perception is that trade deals are no better than earmarks, and that is really troubling and you have to fix that before you do anything else as far as getting the government's role in the economy correct. [People] want it to work, they really do. Financial regulation would seem to be one area where government needs to work better.

I don't think there is any sensible observer of our regulatory system that says this is how you would do it if you drew it up from scratch.... Neither is there a sensible observer who would say, "Look, there is no role for regulation." So that debate is an artificial one. The real question is what will be effective regulation of financial markets going forward.... Senator McCain is a very practical person and he likes to get things done, and so his approach, for example, on the mortgage crisis has been fundamentally pragmatic: Let's target the assistance.... You don't want to have some poor American taxpayer reach into their pocket and help someone who was just flipping houses in California.... And when we do this, let's do it in a way that helps us not return here again. And both lenders and borrowers should have to give up a little bit to get some taxpayer help.... I like to think that the debate has come where he is. People are saying "no broad bailouts." He said that a long time ago. How does the state of the budget look to you?

If you look at the last full fiscal year, close the books on 2007, we raised 18.8 percent of GDP in [tax revenue] and spent a bit more than that, and we ran a modest deficit by postwar standards.... You roll the clock forward and you see the spending part of the budget explode, real pressures, and there is no way you can tax enough to meet those pressures—and if you tried, you would do such harm to the economy that it would ultimately fail. So the right approach is to take a comprehensive look at the spending commitments, undertake reforms in healthcare to slow the growth of Medicare, commit to solving the Social Security [solvency problem], which is a political problem more than anything else, deal with nondefense discretionary spending. That's the recipe.... Let's commit to getting the economy growing, and the revenue will be there. This is not a revenue problem; this is a spending problem. How will you balance spending and the tax cuts Sen ator McCain has proposed?

It's not that complicated.... He wants to repeal the [alternative minimum tax]. That's about $60 billion in additional revenue losses. Fine. We have $60 billion in discretionary spending that was sourced to earmarks. He believes that should go away.... The one that is going to be getting attention is if we cut the corporate income tax from 35 percent to 25 percent—which is a competitiveness must—you, in some static sense, lose $100 billion a year ballpark. That's real. But you can broaden the base. There are $30 billion a year in rifle shots that you should go after. You can count on some economic feedback, some 30 percent. So that gets you to $60 billion. So the net loss is $40 billion, and we think we can get 40 more in spending. How would a President McCain make Social Security solvent?

He believes it can be fixed without raising taxes.... If you just do [indexing benefits to prices rather than wages] you can fix it over the long haul, and he is perfectly willing to have personal accounts be part of this as long as they are not a substitute for fixing the basic challenges facing the system. When he becomes president, he will ask Congress to do it. He will send them a bill, up-or-down vote, let's go. What would his approach to tax reform be?

Look at our current tax code, and the striking number is the one that came out of the president's tax reform panel. Take a comprehensive measure of the costs of administration, compliance, and economic distortions—it's $140 billion a year. That is a seriously large number, just wasteful. So the first step is, the current tax code is a disaster. And what we want to do is keep taxes low because we are raising enough revenue, and they have to be fairer and simpler. So, we said, let's get rid of the AMT because it's starting to hit the middle class.... And let's make sure it is pro-growth and competitive.... In 2000, he ran on a march to a flat tax, from the bottom up, and that signals how simple he would like things to be if he could get there. Why is getting rid of budgetary earmarks important?

The earmarks are not about the numbers; they are about the message you are sending to the American people. You cannot go to the American people and [cut spending] when they believe someone else is getting theirs on the side. If you want to deal with entitlements and the broader spending problems, you need to get the high ground. Hillary Clinton says she can manage the economy better than McCain. Can any president really manage our $13 trillion economy?

No one should try. It's a bit of a cheap shot, but I can't bring myself to not say it: The last ones who tried this were the Russians. You don't manage economies. You just don't because you can't. The key is to have some principle, to have a rudder that says, "This is something the private sector does, and here is the framework in which they should do it. Go...." But the government has to do defense, the government has to take care of poor people, it has to step in during emergencies and have an effective response—those are places where we belong, and we have to be able to manage that because it sends confidence that we can then go get the other stuff right. What is the key to dealing with healthcare?

The fundamental problem with healthcare is rising costs. The focus on the Democratic side is covering everybody. That's a laudable goal, but the reality is even if you were to snap your fingers and cover everybody who was uninsured ... and in exchange for their insurance you had them pony up $3,000 apiece, you would raise $150 billion, which is a lot of money, and now everyone would be in the system and given 6 to 8 percent cost growth a year, you would chew up that $150 billion within a year, and now everybody is in and it's getting more and more expensive every year and that is why companies drop insurance and people can't buy insurance. The Democratic formulation solves the wrong priority first. McCain favors a cap-and-trade system to deal with carbon emissions rather than a carbon tax. Former Bush economist Greg Mankiw says a carbon tax would be far simpler and transparent. Any thoughts on this?

The carbon tax is never going to look like anything that Greg Mankiw draws up in his blog. It will be a real-world carbon tax, which will have the same complexities and issues that a cap-and-trade system does. So the issue is which real-world policy, which will never look as clean as it does on a blackboard, will be effective. The senator is quite convinced that to bring the broad environmental community on board, cap-and-trade is the most effective way.... And there is international experience with it, which is important since this is fundamentally a global problem. So the realities dictate that cap-and-trade is probably the most fruitful approach. But point No. 2 is that you have to do something. We can't spend $400 billion a year on imported oil and finance Hugo Chávez...so let's get serious. And the most serious way to do something is to in fact innovate, but the only way we innovate is if there are market incentives to innovate, and that is exactly what cap-and-trade produces.