Personal Finance

The 44th president's $4 trillion headache

The candidates want to do things like reduce taxes and fix health care. But they'll have to deal with the cold realities of the federal budget.

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By Jeanne Sahadi, CNNMoney.com senior writer

three_candidates.03.jpg
The next president, no matter who wins, will face two tough fiscal realities: the Bush tax cuts and the AMT.
AMT: Cost of change
  • Repeal: $1 trillion to $2 trillion over 10 years
  • Curb reach: $500 billion and $1 trillion over 10 years
Source: Tax Policy Center
Tax cuts: Cost of extension
  • For all taxpayers: $2 trillion over 10 years
  • For middle- and low-income tax filers: $783 billion over 10 years
Source: Tax Policy Center

NEW YORK (CNNMoney.com) -- The presidential candidates all have big plans for their time in the White House. Reform health care. Reduce taxes. Close corporate loopholes. Encourage savings. The list goes on.

Like college graduates whose career choices may be limited by their student loan debt, however, the next president could be constrained by the federal budget.

According to the Congressional Budget Office (CBO), the annual budget deficit will improve during the next president's four-year term and end in a surplus of $61 billion by 2013.

But that baseline projection is based on financial assumptions that no one expects to pan out. Two of the biggest roadblocks threatening to upend budgetary nirvana: What to do about the looming expiration of tax cuts enacted in 2001 and 2003, and the growing cost of fixing - or nixing - the Alternative Minimum Tax (AMT).

Depending on how you address them, those two factors alone could add close to $4 trillion to the federal budget deficit by 2018, according to estimates by the Tax Policy Center.

Add in the costs of the wars in Iraq and Afghanistan and the growing costs of Medicare and Social Security, and you end up with something more like a budgetary nadir.

"A substantial reduction in the growth of spending, a significant increase in tax revenues relative to the size of the economy, or some combination of the two will be necessary to maintain the nation's long-term fiscal stability," the CBO warned in a recent report.

Deficit experts doubt that the candidates' plans will pare back the deficit.

"None of the candidates has any proposals that would lead us to believe they would cut the deficit," said Joshua Gordon, senior policy analyst at the Concord Coalition, a deficit watchdog group. They even may add to it, he said. "Their 'pay-fors' are much harder to do politically, and there are fewer of them."

Can they hold the line?

All of the candidates claim their proposals are fiscally responsible and, at the very least, will not add to the deficit.

Take Democratic frontrunner Barack Obama.

"Obama has committed to pay for anything he proposes in the campaign," said Austan Goolsbee, Obama's top economics adviser.

Goolsbee cited a list of revenue-generating and spending-cut measures that Obama supports. Among them: drawing down the war, letting tax cuts expire for high-income households, closing corporate loopholes and cracking down on tax havens.

"Qualitatively they may be right - but quantitatively, I don't know how they get the numbers," said Roberton Williams, principal research associate at the Tax Policy Center and the former deputy assistant director for tax analysis at the CBO.

For example, how much revenue would be generated by Obama's plan to close corporate loopholes? Until the ink dries on any final measure approved by Congress, said Williams, "you can claim any number you want, but it's totally unproveable."

Extending the tax cuts

One of the main challenges facing the next president involves whether to extend a series of tax cuts set to expire in three years.

The leading candidates of both parties want to preserve the tax cuts to some extent. The Republicans want to extend all the cuts. According to the Tax Policy Center, that would reduce federal revenue by $2 trillion over 10 years.

The Democrats want to preserve them only for lower- and middle-income households. Obama and Hillary Clinton say they would let them expire for couples who make more than $250,000, a move they say will help pay for their new proposals. The Tax Policy Center says, however, that could reduce revenue by $783 billion compared to the CBO baseline, which assumes that all the tax cuts expire.

Gene Sperling, Clinton's economic adviser, contends the baseline is more formalistic than realistic.

"A lot of people who don't like the way the Bush tax cuts were passed still believe they're in the baseline," Sperling said. Democrats think that letting all the tax cuts sunset would be "too harsh on the middle class in a time of wage stagnation," he added.

On the Republican side, John McCain sees the cure for deficits on the spending side of the ledger, not the tax side.

"Sen. McCain believes that a comprehensive effort to target discretionary spending on genuine national needs in defense and non-defense areas, as well as comprehensive reform of the entitlements, can lead to a balanced budget," said his senior economic policy adviser, Douglas Holtz-Eakin, former director of the CBO.

Even with the tax cuts and AMT relief in 2007, the government still collected a higher-than-average amount of tax revenue and it usually spends more than it takes in, Holtz-Eakin explained. "So the tax system will support the typical revenue needs of the government."

AMT changes on tap

There's another political reality that the next president won't be able to ignore: providing permanent relief to most if not all taxpayers from the AMT - something that both Democrats and Republicans in Congress have said they want to do.

McCain has pledged to eliminate the AMT. Holtz-Eakin says such a move could be paid for by another of McCain's pledges - to eliminate earmarks. Earmarks are funds for lawmakers' special projects that may benefit only their constituencies.

Holtz-Eakin noted that the cost of the latest annual budget "patch" to fix the AMT was $60 billion, roughly the same as the amount assigned annually to earmarks by the CBO. He figures eliminating earmark funding could free up $650 billion over ten years and make up for lost revenue if the AMT is eliminated.

Even if every earmark dollar were cut - an unlikely scenario, experts say - the cost of AMT repeal could still trump the savings. The Tax Policy Center estimates that revenue will be reduced by roughly $880 billion over 10 years if Congress lets all the tax cuts sunset or $1.85 trillion if they extend them.

The cost would be somewhat less if the AMT was simply structured to protect middle-class taxpayers, which both Obama and Clinton favor.

Changes to the AMT, combined with extending the tax cuts, mean the next president will need to figure out whether and how to replace up to $4 trillion in revenue.

If the lost revenue is not replaced, the government will need to slash spending, raise taxes or borrow more since projections for the federal budget assume the AMT stays on the books as is and the tax cuts expire.

The political friction over which route to take will play a big part in shaping the next president's initiatives. Gordon of the Concord Coalition said it's not hard to find ways to balance the budget mathematically. But, he said, "it's hard politically." To top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.