Always Tax Cuts for the Rich?

by Tom Bozzo

The ‘McCain Resurgence Plan’ surges on (h/t Creative Destruction):

Current rules mandate that investors must begin to sell off their IRAs and 401Ks when they reach age 70 and one half years old. Those rules should be suspended to spare senior citizens from being forced to sell their stock just as the market is hurting the most. Under the emergency measure I propose, we will also cut the tax rate for withdrawals from tax-preferred retirement accounts to ten percent…

Fine, but this affects a small slice of the public and not necessarily those who are going to be hurt by the recession.

“Small slice of the public” may be an understatement for the retirement plan changes. Last time I checked, there was a 10 percent regular income tax bracket, and for 2008 a married couple has to have $16,050 in taxable income to clear it. The top of the 15% bracket is $65,100. So lower-income seniors get nothing except the right to defer tax-deferred plan withdrawals that they arguably cannot afford not to take, and most seniors get no more than 5 percent of their withdrawals. The main beneficiaries are owners of tax-deferred retirement accounts that are so large that they can replace an income in roughly the top 25% (or better).

McCain goes on

It is essential that we avoid an exodus of capital from the market. Senator Obama yesterday offered up a proposal that would have the effect of encouraging early withdrawal of funds from 401(k) accounts, by suspending penalties through 2009. This is an invitation to capital flight, and therefore to continued instability in the market, at a moment when exactly the opposite is needed. Any family that takes part in this will not see the benefits of the market recovery that smart policy can help bring about. In my administration, we will instead revive the market by attracting new investment. I will cut in half the capital gains tax on stocks purchased and held for more than a year — from a rate of 15 to 7.5 percent.

These provisions do not make exactly make Team McCain look in-touch.

First, people are raiding their 401(k)’s because defined contribution plan balances are often the only significant “savings” they have. “Joe Sixpack,” as a certain vice-presidential candidate likes to say, doesn’t have appreciable amounts of money in assets that are potentially subject to capital gains tax. (See, e.g., the Survey of Consumer Finances. In 2004, the median holdings for working families owning stocks and investment funds were $10,000 and $25,000, respectively. But only 15 percent of all families owned stocks directly and 40 percent owned mutual funds, so majorities had nada.) Eating one’s retirement capital is already a desperation measure, and Obama’s plan arguably relieves an injury following insults that are done deals. Plus, Obama would keep in place the loss-of-income-tax-deferral disincentive and limit penalty-free withdrawals, so we aren’t talking carte blanche here.

Meanwhile, there is a fairness issue here, in that the “rich” — i.e. those with substantial financial asset holdings outside of retirement accounts — can dump their assets at will and McCain will if anything make the terms of such transactions more favorable. It’s just us chumps with defined contribution plans who are tasked with riding out the crisis in McCain world.

Second, it’s not at all obvious what McCain could substantively mean by “capital flight.” This, I suppose, is part of what has Brad DeLong scratching his head. Asset sales have to have two parties — the upshot is that someone exchanges money for an asset. These transactions aren’t counted as savings in the NIPAs since all that happens is a change in ownership, and the macro statistics don’t care exactly who holds what. Capital can’t be “fleeing” the market since someone has to buy in to complete the transaction, and desperate 401(k) raiders likely are not trying to invest their proceeds in foreign assets. (That would be the rich dumping assets to stuff cash in tax havens.)

Third, if the stated policy aim is to keep people from selling assets, how on earth will reductions in taxes on asset sales — note that another part of the McCain plan is to increase capital losses that can be counted against income — do that? The naive incentives of the plan make it a bit easier to sell, unless McCain is offering something other than the long-term capital gains rate cut that he seems to be selling. Rich people who are sitting on long-term gains see their tax rate go, as Maynard of Creative Destruction puts it, from minuscule to infinitesimal. So maybe that gun is set to run out of ammo anyway. But when the case is made for capital gains tax cuts raising, or at least not losing, much revenue, the argument always seems to involve an element of capital gains realization timing: people time their asset sales to take advantage of the more favorable tax terms.

In any event, it is maybe not so surprising that a campaign of millionaires and lobbyists can’t put together a plan that isn’t a giveaway to themselves. So the clown show at a train wreck goes on…