Maverick McCainomics Could Alter Our Fiscal Future

Cutting entitlement spending increases could free trillions for tax cuts and investment.

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Uncle Sam has plenty of dough. That's the core belief at the center of McCainomics. Or maybe we should call it "maverick economics," since John McCain's approach toward taxes and government spending has the potential to change the rules of the Washington budget game. Actually, it has the potential to change the game itself and perhaps create a long-term solution to America's fiscal problem—with trillions left over. See, that's what the Wall Street Journal didn't seem to understand when one of its reporters wrote the following last week:

Sen. John McCain is proposing tax cuts that would either cause the federal deficit to explode or would require unprecedented spending cuts equal to one-third of federal spending on domestic programs.

The skeptical, if not incredulous, tone of the article led McCain economic adviser Douglas Holtz-Eakin to write a response over at National Review Online:

Nowhere in the article does [Laura Meckler, the WSJ reporter] mention that John McCain has explicitly addressed entitlement spending and the need for action to cut spending today.... By addressing entitlements now, John McCain can reduce federal spending today and prevent Meckler's doomsday scenario.

The fiscal knot that a President McCain would have to untie to meet his promise to extend the Bush tax cuts, cut corporate taxes, eliminate the alternative minimum tax, and create an optional two-rate income tax system—while also getting America's fiscal house in order—may seem like one of Gordian difficulty.

1) The Congressional Budget Office will treat all McCain's tax cuts as pure revenue losers—an argument the media will completely buy into. And even the McCain campaign isn't making the argument that his tax cuts would come close to fully paying for themselves through the increased revenue that comes from higher economic growth. (A good thing since Team McCain doesn't believe much in supply-side effects.) With the corporate tax rate cut, for instance, the campaign thinks it can recoup $30 billion of the $100 billion in lost revenue. So in isolation, McCain's tax cut proposals would increase the budget deficit, which may be half a trillion bucks or more in 2009.

2) Assuming he isn't going to slash the Pentagon's budget, McCain realistically can't cut nondefense discretionary spending enough to pay for his tax cuts. In 2007, nondefense discretionary spending was $458 billion, or 3.3 percent of gross domestic product. If McCain was able to cut the $160 billion or so in excess spending he says he could find in the budget—whether through eliminating earmarks or other reductions—that would cut spending on education, border security, technology investment, and other discretionary items to around $300 billion, or 2.1 percent of GDP. Now the low point for the past four decades was 3 percent GDP in 1999.

Yet even that skimpy amount of spending would still leave a huge budget gap. Just extending the Bush tax cuts, for instance, would add an average of $280 billion a year to the budget deficit from 2011 to 2018, according to the old-fashioned, static analysis of the CBO. So using the campaign's own economic logic, McCain would pretty much have to eliminate all nondefense discretionary spending to pay for his tax cuts.

So where is the money going to come from? Just as Holtz-Eakin said: from entitlement programs. Total government revenues, about 18.8 percent of GDP, are well within historical norms. Last year, the government took in $2.6 trillion, including $1.2 trillion in income taxes (vs. $794 billion in 2003 before the economic recovery and second round of tax cuts kicked into gear). What America needs to decide is how much money it wants to spend on entitlements—and it is that critical debate that McCain seems intent on pushing.

Let's focus just on Social Security, since the fixes there are pretty straightforward. Two of the most common solutions to the program's long-term solvency problem are extending the retirement age and indexing benefits to inflation rather than to wages. Implementing those two solutions would actually result in more money going into Social Security than is needed to fund scheduled benefits. There would be money left over to help reduce taxes or increase spending on education or energy or whatever.

As Andrew Biggs of the American Enterprise Institute explains it, Social Security has a $5 trillion deficit over the coming 75 years: "This amount is a present value, which means that if you had $5 trillion today—earning interest at the government bond rate—you could draw it down over time to pay full benefits for 75 years." Now if you did a combination of price indexing starting in 2015 and extended the retirement age to 70 by 2050, that $5 trillion deficit turns into a $2.87 trillion surplus.

Of course, Medicare is an even bigger problem than Social Security. But look at it this way: The current projected 10-year annual growth rate for all mandatory spending is 5.7 percent. If that amount were reduced to 4.7 percent, notes Chris Edwards of the Cato Institute, we would save $253 billion in 2018 alone.

Now McCain and his advisers have not said specifically how they want to reform Social Security. And certainly a Congress controlled by Democrats would have other ideas. Plus, there is a good chance that the McCain campaign is actually underestimating the economic impact of its tax cut ideas—if they went into effect—and the revenue they might produce. (Don't forget that the budget was on a glide path toward being balanced until the housing implosion and credit crunch dramatically slowed the economy.)

The state of the economy and the budget, and the political makeup of Congress, would also determine the direction of McCainomics. But there is at least a direction that leads to a result where taxes are kept low and America's social insurance system is kept solvent.

McCain, John
2008 presidential election
federal budget

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