McCain's econ brain

Former Senator Phil Gramm is McCain's economic adviser - and perhaps his closest political friend.

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NEW YORK (Fortune) -- Now that the faltering economy has replaced national security as the overriding issue in the presidential campaign, John McCain is portraying himself as a budget-shrinking, flat-tax-embracing, healthcare-privatizing champion of free markets. But is this Reaganesque zealot the real John McCain?

The big question is whether McCain's radical agenda is simply designed to rally the Republican base, or would prove a blueprint for a McCain presidency. Given the Arizona Senator's maverick record, voters have every reason to distrust the new McCain. He twice opposed the Bush tax cuts and keeps dropping disturbing lines like, "I don't know as much about the economy as I should."

But economic conservatives should take heart. McCain's chief economic adviser - and perhaps his closest political friend - is the ultimate pure play in free market faith, former Texas Senator Phil Gramm. If McCain follows Gramm's counsel, and most of his current positions are vintage Gramm indeed, his policies as president would represent not just a sharp departure from the Bush years, but an assault on government growth that Republicans have boasted about, but failed to achieve, for decades.

Since retiring from the Senate in 2002, Gramm - a former economics professor at Texas A&M - has been circling the globe as an investment banker at UBS (UBS). In July, McCain called on his old friend to salvage his floundering campaign.

"The campaign was structured on the belief that McCain would be the prohibitive front-runner, so he'd have no problem raising money," Gramm told Fortune. But McCain's support among voters and contributors collapsed when the "surge" in Iraq, which McCain championed, got off to a shaky start.

"Suddenly it was 'McCain's war,'" says Gramm. With the campaign strapped for cash, Gramm swooped down on McCain headquarters in Arlington, Virginia, and spent a marathon session combing through the books. He helped McCain dramatically shrink the staff and budget. In the fall, McCain re-emerged following the Gramm strategy, as a scrappy insurgent underdog, running on a puny budget.

On the economy, McCain's most daring manifesto is his healthcare plan. Not surprisingly, it bears the Gramm imprint. In fact, McCain has been heeding Gramm's "power-to-the-consumer" approach for more than a decade. The two senators bonded when they linked arms to fight Hillary Clinton's ill-fated healthcare program in 1993. "We couldn't get any press coverage in Washington, DC, so we traveled all over the country, to the regional media markets," says Gramm. In 150 meetings at hospitals and clinics, McCain and Gramm relentlessly pounded the Clinton plan, helping fire the voter outrage that killed the plan in 1994.

Today, McCain is advocating a plan that's radically different from those of Clinton and Barack Obama, and - if he goes all the way by following Gramm - could revolutionize America's healthcare system. For McCain and Gramm, the problem with our healthcare system - and the reason why over 47 million Americans are uninsured - is that it's excessively, scandalously expensive. The solution, they say, is to let Americans shop for healthcare with their own money. McCain advocates giving tax rebates of $2500 per individual or $5000 per family. With that money, families could purchase policies on their own. What's truly radical about the plan is that it eliminates the tax exclusion for healthcare benefits offered by companies to their employees, and replaces it with the $2500 to $5000 rebates.

Consumers could then use that cash to buy their own insurance in what Gramm foresees as a vibrant, consumer-driven marketplace for healthcare packages.

By contrast, Clinton and Obama want to leave the employer-based system in place; Clinton would make big companies either fund gold-plated packages for workers, or pay a stiff tax to support a new Medicare-like system. The Democrats wouldn't allow insurers to charge lower rates for young workers who cost far less than older Americans. McCain favors allowing insurers to charge rates based on actual cost. Gramm adamantly supports that policy allowing insurers to tailor their premiums, and their packages, to their customers. Says Gramm: "Most people without coverage are young and healthy. We shouldn't penalize them by forcing them to pay for someone else's coverage."

What about taxes? McCain now advocates extending the Bush tax cuts that he twice voted against. For Gramm, McCain's strength is that, unlike Bush, he will be a relentless hawk on spending. "McCain's main objection when Congress passed the tax cuts was that we didn't have spending controls," says Gramm. "If we'd had them, we could cut taxes again and not make do with some temporary stimulus."

McCain pledges to balance the budget by 2012, not by increasing taxes, but by vetoing all pork barrel spending, and curbing outlays for Social Security and Medicare. That would accomplish the seemingly impossible, reducing federal spending as a portion of GDP, a holy grail for conservatives. Could Gramm be the Treasury Secretary who spearheads the McCain plan? He says he'd be reluctant to return to public life, but doesn't rule it out. Indeed, he says that he and McCain talk every day. Gramm even quotes Rudyard Kipling to salute his friend's grit in political combat.

McCain is a hero to Gramm but not to free-marketers. Conservatives are hoping that by embracing their hero, McCain will become one himself.