Barack Obama says John McCain would raise people's taxes by changing the way the IRS looks at health insurance. McCain says he wouldn't.

Who's right?

Quite possibly McCain. But only because he's decided to slash Medicare and Medicaid instead.

Laura Meckler, who is one of the sharpest and most reliable policy reporters around, has the full story in today's Wall Street Journal.

To review: The essence of McCain's health care plan is to change the tax treatment of health benefits they get from employers. Instead of having people deduct the cost of group insurance premiums from their taxes, as they do now, McCain would offer everybody a tax credit--worth $2,500 to indivdiuals and $5,000 to families--that they could apply towards the purchase of health insurance. The credit would be valid whether people buy insurance through their employers or on their own.

It sounds simple enough. But you have to pay attention to the math.

Giving everybody that big new tax credit costs a lot of money. To pay for it, you'd have to get rid of the entire deduction as it now exists. That means people could no longer write off the cost of health insurance from their personal income taxes or from their payroll taxes. As Meckler explains:

If Sen. McCain were to apply both of these [deductions] to the value of health benefits, he could fully pay for his new tax credits. That is what aides have in the past suggested he would do.

In April, when Sen. McCain gave a major speech about his health plan, Mr. Holtz-Eakin, the senior policy adviser, said the tax provisions alone were budget neutral -- meaning that health benefits would have to be subject to both income and payroll taxes.

In my inteviews with McCain staff, I got the same impression.

But the trouble with making this shift is that it would substantially alter people's tax liabilities. Some people would see taxes fall, while others would see taxes rise. And that last part is the opening Obama has seized recently, claiming that McCain wants to raise people's taxes.

As I've written, Obama's attacks aren't ideal from a policy standpoint; properly done, as part of a broader reform package, the kind of change McCain has described might work. But, strictly speaking, Obama's argument is correct.

Or, at least, it was. A few months ago, the McCain campaign began telling people that it wouldn't get rid of both deductions after all. It would eliminate the deduction on income taxes but it would keep the deduction on payroll taxes.

That meant only a few people would see their taxes go up. The rest would see their taxes decline--since, after all, they were keeping part of their old deduction and getting McCain's new credit.

But that also changed the math. Instead of being revenue neutral, the McCain health plan would cost the government money. A lot of money. According to the non-partisan Tax Policy Center, it would add $1.3 trillion to the deficit over ten years.  

Last week, though, a new wrinkle appeared. During the vice presidential debate, Sarah Palin announced that McCain's health plan was "revenue neutral."

I wrote that this was dishonest, but apparently I was wrong. The McCain campaign has now decided to introduce one more change. They're going to help pay for the new tax credit with cuts to Medicare and Medicaid. Again, here's Meckler, explaining this latest sequence:

Mr. Holtz-Eakin said the campaign never intended to apply the payroll tax to health benefits. That means that most people would see a net tax cut, contrary to Sen. Obama's assertions. Only those with very rich benefits packages are likely to see a net increase in taxes. But it also means that Sen. McCain must fill a huge budget hole -- which the campaign says will come from cuts to Medicare and Medicaid.

...

Mr. Holtz-Eakin said the plan is accurately described as budget neutral because it assumes enough savings in Medicare and Medicaid spending to make up the difference. He said the savings would come from eliminating Medicare fraud and by reforming payment policies to lower the overall cost of care. He said the new tax credits will help some low-income people avoid joining Medicaid. The campaign also proposes increasing Medicare premiums for wealthier seniors.

So, just to review...

First McCain said he would elimine the entire tax deduction for health insurance, in order to pay for his new tax credit. This would have paid for itself, but it would have done so by raising taxes on a lot of people.

Then McCain decided he was keeping part of the deduction after all. While he would be raising taxes on a very few people, he'd be lowering them for most. Of course, that would also have meant running much bigger deficits.

Now McCain is saying, no, no, he's not going to increase the deficit with his health care plan. Instead, he's going to pay for it by cutting Medicare and Medicaid--which, at the levels he's discussing, might seriously weaken the program.

I can't wait to see what they come up with next.

--Jonathan Cohn