Against the Grain, McCain Style
His economics are more Goldwater than classic GOP

Thus far, Senator John McCain's surging Presidential bid has been largely about three Ps--populism, personality, and the POW camps where the Vietnam War hero endured years of brutal treatment. Many voters just seem to like him, the way they did Ronald Reagan. But when it comes to the fourth P--policy--they'll be disappointed if they expect a replay of Reaganomics. With its mix of old-time Rotarian fiscal prudence and anti-Establishment reforms, McCain's version of economics marks a sharp departure from the supply-side dogma that has dominated the GOP for 20 years. Think Barry Goldwater, and you will be closer to where McCain ends up on economic issues.

While GOP rival George W. Bush tells voters that new 10-year-surplus projections leave plenty of room for a big tax cut, McCain wants to save any windfall to pay down the $3.4 trillion national debt and shore up Social Security. ''What do you think is more conservative,'' he asks audiences, ''a huge tax cut or saving Social Security?'' Besides, he adds, ''I'm not totally convinced there will be surpluses as far as the eye can see.'' So far, many voters seem inclined to agree.

McCain also is bucking another piece of 1990s Republican economic orthodoxy: The GOP's embrace of across-the-board tax cuts. McCain prefers to take modest steps toward tax reform rather than make broad rate cuts. He would reduce taxes for millions more Americans by expanding the 15% tax bracket to include households earning as much as $70,000. It would also eliminate $150 million in loopholes for such corporate taxpayers as oil and gas drillers, life insurance companies, publishers, and multinationals. ''He's gone the farthest of any of the candidates in talking about the things that have to be changed,'' says Joel B. Slemrod, a University of Michigan economist.

SMALL TEAM. But while smaller than Bush's, McCain's tax cuts are still quite large. And many economists worry that cutting taxes at all while the economy is booming makes little sense. ''We do not need further stimulus, particularly from the demand side,'' says Kathleen Stephansen, senior economist at the Wall Street investment firm Donaldson, Lufkin & Jenrette.

Not only did McCain come to different conclusions, he also arrived there in a very different way than his main rival for the GOP nomination. While Bush surrounds himself with an army of task forces and issues advisers, the Arizonan began only last May to pull together a small team led by Kevin A. Hassett, a 37-year-old scholar at the American Enterprise Institute and former Federal Reserve economist. McCain gave them firm marching orders: preserve Social Security and Medicare. Pay down the debt. And if any money is left, cut taxes.

Hassett and a group of relatively unknown academic economists worked out the broad details over four months. Without sophisticated computer models, the hardest part was figuring out what the schemes cost. ''It took months,'' recalls Hassett. ''I was relying on [campaign volunteers who were] English majors.''

McCain's stress on debt reduction comes straight from the heart. After all, he's a protege of the late Senator Goldwater, who in 1981 ripped Congress for cutting taxes before balancing the budget. ''It would be a disgrace if we were to pass on a legacy of debt and broken promises to our children,'' says McCain. And reducing the debt may be the best thing government can do for the economy today. Says Carol A. Stone, deputy chief economist at Nomura Securities, Inc.: ''You can always argue that fiscal prudence is good.''

But McCain's plan also reflects cold political calculation. By targeting retirement programs, McCain is lifting a campaign plank that Democrats have used successfully against Republicans in the past. First, he would set aside 62% of the operating surplus--about $500 billion over 10 years--to help pay for a transition to a beefed-up Social Security system. Like other Republicans, McCain promises that workers would be able to put aside about 20% of their payroll taxes into private accounts. But like other GOP candidates, he provides few details of how this system would coexist with the current trust fund. ''None of the candidates is really putting forward a complete proposal. But if [as McCain insists] we pay down the debt and improve the economy, this will help when the problem comes due,'' says Urban Institute economist C. Eugene Steuerle.

McCain's fiscal caution extends beyond retirement programs. He favors new spending for missile defense, along with boosts in military pay and veterans' programs. But he would try to offset part of the cost by trimming $20 billion from unneeded weapons programs and by pushing management reforms and base closings.

He takes a similar tack with tax cuts. Where Bush's are huge--at least $1.3 trillion over 10 years--McCain's are a downsized $497 billion. Where Bush has tax breaks for everyone, McCain vows to raise taxes on some corporations. And while the Texan distributes tax relief mostly to the poor and the very rich, McCain targets the middle class for the biggest help and calls his rival's plan a giveaway for wealthy backers.

CONTRADICTIONS. McCain's tax package also includes the usual GOP promises to eliminate the marriage penalty, expand medical savings accounts, and repeal the estate tax. But the most interesting aspects are his promises to shift to a flat tax-like system. He would do this in two ways: First, he would expand the current 15% tax bracket to 25 million families with incomes of $70,000 or less that now pay at the 28% rate. That would shift about 80% of all taxpayers into the lowest bracket.

McCain would also allow those same families to put aside up to $6,000 in tax-deferred savings accounts. Unlike individual retirement accounts, the money would not have to be saved for retirement. Rather, a family could defer taxes by simply holding the money for one year. Once it is withdrawn and spent, it would be treated as ordinary income. ''His ultimate goal is not that different from Steve Forbes's flat tax,'' says Brookings Institution economist William G. Gale. ''But he has a different way of getting there.'' And presumably, with Forbes's decision to quit the race, McCain may attract some of his limited support.

McCain has also proposed a permanent ban on sales taxes for goods purchased on the Internet--an idea that Governor Bush opposes. This highly controversial idea would give e-tailers a big price advantage over Main Street businesses, which would still have to collect sales taxes. But McCain sees the initiative as an incentive for tax reform on the state level, according to Hassett.

McCain recognizes that states could not sustain such a divided system, Hassett says. Instead, he figures, governors would eventually have to drop traditional sales taxes and adopt the same sort of consumption-based income tax that McCain is pushing at the federal level ''Retail sales taxes are going to have to evolve,'' Hassett says.

McCain's plan--like the man himself--isn't a model of consistency. For example, he proposes closing tax loopholes and says the tax code should not reward special interests. But at the same time, he would create a new set of tax incentives for long-term care and education. His Internet tax policy also raises contradictions. Even as he would bar states from taxing e-sales, thus taking away the potential of billions of dollars in revenues, he'd impose new demands on states for improving schools and health care.

Up to now, these details have been lost amid the din of an increasingly bitter Bush-McCain media war. The core of the Bush assault is that McCain's economic program is warmed-over Clintonism. But McCain's fiscally conservative agenda should make that a hard sell.

By Howard Gleckman in Washington

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