MODERATOR: Good evening, from the Ford Centre for the Performing Arts at the University of Mississippi in Oxford, I'm Jim Lehrer of the NewsHour on PBS. And I welcome you to the first of the 2008 Presidential Debates between the Republican nominee, Senator John McCain of Arizona, and the Democratic nominee, Senator Barack Obama of Illinois. The Commission on Presidential Debates is the sponsor of this event and the three other presidential and vice-presidential debates coming in October.

Tonight's will primarily be about foreign policy and national security which, by definition, includes the global financial crisis. It will be divided roughly into nine minute segments. Direct exchanges between the candidates and moderator follow-ups are permitted after each candidate has two minutes to answer the lead question in an order determined by a coin toss. The specific subjects and questions were chosen by me. They had not been shared or cleared with anyone.

The audience here in the hall has promised to remain silent. No cheers, no applause, no noise of any kind. Except right now, as we welcome senators Obama and McCain.

[APPLAUSE]

BARACK OBAMA: Good to see you, John.

JOHN MCCAIN: Hi.

BARACK OBAMA: Pleasure to see you.

MODERATOR: Let me begin with something General Eisenhower said in his 1952 presidential campaign. Quote, "we must achieve both security and solvency. In fact, the foundation of military strength is economic strength." End quote. With that in mind, the first lead question. Gentleman, at this very moment tonight, where do you stand on the financial recovery plan?

First response to you, Senator Obama. You have two minutes.

BARACK OBAMA: Well, thank you very much, Jim. And thanks to the Commission and the University of Mississippi, Ole Miss, for hosting us tonight. I can't think of a more important time for us to talk about the future of the country.

You know, we are at a defining moment in our history. Our nation is involved in two wars. And we are going through the worst financial crisis since the Great Depression.

And although we've heard a lot about Wall Street, those of you on Main Street, I think, have been struggling for a while. And you recognise that this could have an impact on all sectors of the economy. And you're wondering how's it going to affect me?

How's it going to affect my job? How's it going to affect my house? How's it going to affect my retirement savings or my ability to send my children to college?

So we have to move swiftly. And we have to move wisely. And I've put forward a series of proposals that make sure that we protect taxpayers as we engage in this important rescue effort.

Number one, we've got to make sure that we've got oversight over this whole process. $700 billion, potentially, is a lot of money. Number two, we've got to make sure that taxpayers, when they are putting their money at risk, have the possibility of getting that money back and gains if the market, and when the market, returns.

Number three, we've got to make sure that none of that money is going to pad CEO bank accounts or to promote golden parachutes. And number four, we've got to make sure that we're helping homeowners. Because the root problem here has to do with the foreclosures that are taking place all across the country.

Now, we also have to recognise that this is a final verdict on eight years of failed economic policies promoted by George Bush, supported by Senator McCain. A theory that basically says that we can shred regulations and consumer protections and give more and more to the most and somehow prosperity will trickle down. It hasn't worked.

And I think that the fundamentals of the economy have to be measured by whether or not the middle class is getting a fair shake. That's why I'm running for president. That's what I hope we're going to be talking about tonight.

MODERATOR: Senator McCain, two minutes.

JOHN MCCAIN: Well, thank you Jim. And thanks to everybody. And I do have a sad note tonight. Senator Kennedy is in the hospital. He's a dear and beloved friend to all of us. Our thoughts and prayers go out to the Lion of the Senate. I also want to thank the University of Mississippi for hosting us tonight.

And Jim, I've been not feeling too great about a lot of things lately, so have a lot of Americans who are facing challenges. But I'm feeling a little better tonight. And I'll tell you why. Because as we are here tonight in this debate, we are seeing for the first time in a long time, Republicans and Democrats together sitting down, trying to work out a solution to this fiscal crisis that we're in and have no doubt about the magnitude of this crisis.

And we're not talking about failure of institutions on Wall Street. We're talking about failures on Main Street and people who will lose their jobs, and their credits, and their homes if we don't fix the greatest fiscal crisis, probably, certainly, in our time. And I've been around a little while.

But the point is, we have finally seen Republicans and Democrats sitting down and negotiating together and coming up with a package. This package has transparency in it. It has to have accountability and oversight. It has to have options for loans to failing businesses rather than the government taking over those loans. It has to have a package with a number of other essential elements to it.

And yes, I went back to Washington. And I met with my Republicans in the House of Representatives. And they weren't part of the negotiations. And I understand that. And it was the House Republicans that decided they would be part of the solution to this problem.

But I want to emphasise one point to all Americans tonight. This isn't the beginning of the end of this crisis. This is the end of the beginning if we come out with a package that will keep these institutions stable. And we've got a lot of work to do. And we got to create jobs. And one of the areas, of course, is to eliminate our dependence on foreign oil.

MODERATOR: All right. Let's go back to my question. How do you all stand on the recovery plan? And talk to each other about it. We've got five minutes. We can negotiate a deal right here. But I mean, do you favour this plan, Senator Obama? And you, Senator McCain, are you in favour of this plan?

BARACK OBAMA: We haven't seen the language yet. And I do think that there's constructive work being done out there. So for the viewers were watching, I am optimistic about the capacity of us to come together with a plan.

The question, I think, that we have to ask ourselves is how did we get into this situation in the first place? Two years ago, I warned that because of the subprime lending mess, because of the lax regulation, that we were potentially going to have a problem and tried to stop some of the abuses in mortgages that were taking place at the time. Last year I wrote to the Secretary of Treasury to make sure that he understood the magnitude of this problem and to call on him to bring all the stakeholders together to try to deal with it.

So the question, I think, that we've got to ask ourselves is, yes, we've got to solve this problem short-term. And we are going to have to intervene. There's no doubt about that. But we're also going to have to look at how is it we shredded so many regulations? We did not set up a 21st-century regulatory framework to deal with these problems. And that, in part, has to do with an economic philosophy that says that regulation is always bad.

MODERATOR: Are you going to vote for the plan, Senator McCain?

JOHN MCCAIN: I hope so. And I believe so.

MODERATOR: The United States Senate. You're going to vote for the plan?

JOHN MCCAIN: Sure. But let me point out, I also warned about Fannie Mae and Freddie Mac. And warned about corporate greed in excess and CEO pay and all that. A lot of us saw this train wreck coming.

But there's also the issue of responsibility. You've mentioned President Dwight David Eisenhower. President Eisenhower, on the night before the Normandy invasion, went into is room. And he wrote out two letters.

One of them was a letter congratulating the great members of the military and allies that had conducted and succeeded in the greatest invasion in history, still to this day and forever. And he wrote out another letter. And that was a letter of resignation from the United States Army for the failure of the landings at Normandy.

Somehow we've lost that accountability. I've been heavily criticised because I called for the resignation of the chairman of the Securities and Exchange Commission. We've got to start also holding people accountable. And we've got to reward people who succeed.

But somehow in Washington today, and I'm afraid on Wall Street, greed is rewarded, excess is rewarded, and corruption, or certainly failure to carry out our responsibility, is rewarded. As President of the United States, people are going to be held accountable in my administration. And I promise you, that'll happen.

MODERATOR: Do you have something directly to say, Senator Obama, to Senator McCain about what he just said?

BARACK OBAMA: Well, I think Senator McCain's absolutely right that we need more responsibility. But we need it not just when there's a crisis. I mean, we've had years in which the reigning economic ideology has been what's good for Wall Street but now what's good for Main Street.

And there are folks out there who had been struggling before this crisis took place. And that's why it's so important, as we solve this short-term problem, that we look at some of the underlying issues that have led to wages and incomes for ordinary Americans to go down, the health care system that is broken, energy policies that are not working. Because 10 days ago, John said that the fundamentals of the economy are sound. I do not think that they are.

MODERATOR: Say it directly to him.

BARACK OBAMA: --the economy are sound.

JOHN MCCAIN: You afraid I couldn't hear him?

[LAUGHTER]

MODERATOR: I'm just determined to get you all to talk to each other. I'm going to try.

BARACK OBAMA: And I just fundamentally disagree. And unless we are holding ourselves accountable day in day, day out, not just when there is a-- --folks who have power and influence and can hire lobbyists, but for the nurse, the teacher, the police officer. Who, frankly, at the end of each month, they've got a little financial crisis going on. They're having to take out extra debt just to make their mortgage payments. We haven't been paying attention to them. And if you look at our tax policies, it's a classic example.

MODERATOR: So Senator McCain, do you agree with what Senator Obama just said? And if you don't, tell him what you disagree with.

JOHN MCCAIN: No, we've got to fix the system. We've got fundamental problems in the system. And Main Street is paying a penalty for the excesses and greed in Washington DC and in the Wall Street.

So there's no doubt that we have a long way to go. And obviously, stricter interpretation and consolidation of the various regulatory agencies that weren't doing their job that has brought on this crisis. But I have a fundamental belief in the goodness and strength of the American worker. And the American worker is the most productive, most innovative. America is still the greatest producer, exporter, and importer.

But we've got to get through these times. But I have a fundamental belief in the United States of America. And I still believe under the right leadership our best days are ahead of us.

MODERATOR: All right. Let's go to the next lead question, which is essentially following up on this same subject. And you get two minutes to begin with, Senator McCain. And using your word, fundamental, are there fundamental differences between your approach and Senator Obama's approach to what you would do as president to lead this country out of the financial crisis?

JOHN MCCAIN: Well, the first thing we have to do is get spending under control in Washington. It's completely out of control. And we have now presided over the largest increase in the size of government since the Great Society.

We Republicans came to power to change government. And government changed us. And the worst symptom of this disease is what my friend Tom Coburn calls earmarking as a gateway drug. Because it's a gateway. It's a gateway to out-of-control spending and corruption. And we have former members of Congress now residing in federal prison because of the evils of this earmarking and pork barrel spending.

You know, we spent $3 million to study the DNA of bears in Montana. I don't know if that was a criminal issue or a paternal issue. But the fact is that it was $3 million of our taxpayers' money. And it has got to be brought under control.

As President of the United the States, I want to assure you, I've got a pen-- this one's kind of old. I've got a pen and I'm going to veto every single spending bill that comes across my desk. I will make them famous that you will know their names.

Now Senator Obama, you wanted to know one of the differences. He has asked for $932 million of earmarked, pork barrel spending. Nearly a million dollars for every day that he's been in the United States Senate.

I suggested that people go up on the website of Citizens Against Government Waste. And they'll look at those projects. That kind of thing is not the way to rein in runaway spending in Washington DC. That's one of the fundamental differences that Senator Obama and I have.

MODERATOR: Senator Obama, two minutes.

BARACK OBAMA: Well, Senator McCain is absolutely right that the earmarks process has been abused. Which is why I suspended any requests for my home state, whether it was for senior centres, or what have you, until we cleaned it up. And he's also right that oftentimes lobbyists and special interests are the ones that are introducing these kinds of requests. Although that wasn't the case with me.

But let's be clear. Earmarks account for $18 billion in last year's budget. Senator McCain is proposing, and this is a fundamental difference between us, $300 billion in tax cuts to some of the wealthiest corporations and individuals in the country-- $300 billion. Now, $18 billion is important. $300 billion is really important.

And in his tax plan, you would have CEOs of Fortune 500 companies getting an average of $700,000 in reduced taxes, while leaving 100 million Americans out. So my attitude is, we've got to grow the economy from the bottom up. What I've called for is a tax cuts for 95% of working families-- 95%.

And that means that the ordinary American out there who is collecting a paycheck every day, they've got a little extra money to be able to buy a computer for their kid, to fill up on this gas that is killing them. And over time that, I think, is going to be a better recipe for economic growth than the policies of President Bush that John McCain wants to follow.

MODERATOR: Senator McCain.

JOHN MCCAIN: Well, again, I don't mean to go back and forth.

MODERATOR: No, that's fine.

JOHN MCCAIN: But Senator Obama suspended those requests for pork barrel projects after he was running for President of the United States. He didn't happen to see that light during the first three years as a member of the United States Senate. $932 million in requests maybe, to Senator Obama, is not a lot of money.

But the point is that, you see, I hear this all the time. It's only $18 billion. Do you that it's tripled in the last five years? Do you know that it's gone completely out of control to the point where it corrupts people? It corrupts people.

That's why we have, as I said, people under federal indictment and charges. It's a system that's got to be cleaned up. I have fought against it. My career, I have fought against it.

I was called the Sheriff by one of the senior members of the Appropriations Committee. I didn't win Miss Congeniality in the United States Senate. Now, Senator Obama didn't mention that along with his tax cuts, he is also proposing something $800 billion in new spendings on new programmes.

Now that's a fundamental difference between myself and Senator Obama. I want to cut spending. I want to keep taxes low. The worst thing we could do in this economic climate is to raise people's taxes.

BARACK OBAMA: I don't where John's getting his figures. Let's just be clear. What I do is I close corporate loopholes, stop providing tax cuts to corporations that are shipping jobs overseas, so that we're giving tax breaks to companies that are investing here in the United States.

I make sure that we have a health care system that allows for everyone to have basic coverage. I think those are pretty important priorities. And I pay for every dime of it.

But let's go back to the original point. John, nobody is denying that $18 billion is important. And absolutely, we need earmark reform. And when I'm president, I will go line by line to make sure that we are not spending money unwisely.

But the fact is that eliminating earmarks alone is not a recipe for how we're going to get the middle class back on track. And when you look at your tax policies that are directed primarily at those who are doing well and you are neglecting people who are really struggling right now, I think that is a continuation of the last eight years. And we can't afford another four.

MODERATOR: Respond directly to Senator Obama about that. He's made it twice now, about your policies about tax cuts.

JOHN MCCAIN: Well, let me give you an example of what Senator Obama finds objectionable. The business tax. Right now, the United States of America business pays the second highest business taxes in the world, 35%. Ireland pays 11%.

Now, if you're a business person and you can locate any place in the world. Then obviously if you go to the country where it's 11% tax versus 35%, you're going to be able to create jobs, increase your business, make more investment, et cetera. I want to cut that business tax. I want to cut it so that businesses will remain in the United States of America and create jobs.

But again, I want to return. It's a lot more than $18 billion in pork barrel spending. I can tell you, it's rife. It's throughout.

The United States Senate will take up a continuing resolution tomorrow or the next day, sometime next week, with 2,000-- 2,000. Look at them, my friends. Look at them. You'll be appalled. And Senator Obama is a recent convert after requesting $932 million worth of pork barrel spending projects.

So the point is, I want people to have tax cuts. I want every family to have a $5,000 refundable tax credit so they can go out and purchase their own health care. I want to double the dividend from $3,500 to $7,000 for every dependent child in America. I know that the worst thing we could possibly do is to raise taxes on anybody. And a lot of people might be interested in Senator Obama's definition of rich.

MODERATOR: Senator Obama, do you a question for Senator McCain on that?

BARACK OBAMA: Well, let me just make a couple of points. Here's what I can tell the American people. 95% of you will get a tax cut. And if you make less than $250,000, less than a quarter million dollars a year, then you will not see one dime's worth of tax increase. Now, John mentioned the fact that business taxes on paper are high in this country. And he's absolutely right.

Here's the problem. There are so many loopholes that have been written into the tax code, oftentimes with support of Senator McCain, that we actually see our businesses pay, effectively, one of the lowest tax rates in the world. And what that means, then, is that there are people out there who are working every day, who are not getting a tax cut. And you want to give them more.

It's not like you want to close the loopholes. You just want to add an additional tax cut over the loopholes. And that's a problem.

Just one last point I want to make. Senator McCain talked about providing a $5,000 health credit. Now what he doesn't tell you is that he intends to, for the first time in history, tax health benefits. So you may end up getting a $5,000 tax credit. Here's the only problem, your employer now has to pay taxes on the health care that you're getting from your employer. And if you end up losing your health care from your employer, you've got to go out on the open market and try to buy it.

It is not a good deal for the American people. But it's an example of this notion that the market can always solve everything. and that the less regulation we have, the better off we're going to be.

JOHN MCCAIN: Well, let me just--

MODERATOR: We've got to go to another lead question.

JOHN MCCAIN: I know we have to. But this is a classic example of walking the walk and talking the talk. We had an energy bill before the United States Senate.

It was festooned with Christmas tree ornaments. It had all kinds of breaks for the oil companies. I mean, billions of dollars worth. I voted against it. Senator Obama voted for it.

BARACK OBAMA: John, you want to give oil companies another affordability.

JOHN MCCAIN: You've got to look at our records. That's the important thing. Who fought against wasteful and earmark spending? Who has been the person who has tried to keep spending under control?

Who is the person who has believed that the best thing for America is to have a tax system that is fundamentally fair? And I've fought to simplify it. And I have proposals to simplify it.

Let's give every American a choice. Two tax brackets, generous dividends, and let Americans choose whether they want the existing tax code or they want a new tax code. And so again, look at the record, particularly the energy bill.

But again, Senator Obama has shifted on a number of occasions. He has voted in the United States Senate to increase taxes on people who make as low as $42,000 a year.

BARACK OBAMA: That's not true, John. That's not true.

JOHN MCCAIN: And that's just a fact. Again, you can look it up.

BARACK OBAMA: Look, it's just not true. And if we want to talk about oil company profits, under your tax plan, John-- this is undeniable-- oil companies would get an additional $4 billion in tax breaks.

Now look, we all would love to lower taxes on everybody. But here's the problem. If we are giving them to oil companies, then that means that there are those who are not going to be getting them.

JOHN MCCAIN: In all due respect, you already gave them to the oil companies.

BARACK OBAMA: But John, the fact of matter is, is that I was opposed to those tax breaks, tried to strip them out. We've got an energy bill on the Senate floor right now that contains some good stuff, some stuff you want, including drilling off shore. But you're opposed to it because it will strip away those tax breaks that have gone to oil companies.

MODERATOR: All right. Speaking of things that both of you want, another lead question. It has to do with the financial rescue thing that I started asking about. And the first answer is to you, Senator Obama.

As President, as a result of whatever financial rescue plan that comes about and the $700 billion, whatever it is it's going to cost, what are you going to have to give up in terms of the priorities that you would bring as President of the United States as a result of having to pay for the financial rescue plan?

BARACK OBAMA: Well, there are a range of things that are probably going to have to be delayed. We don't yet know what our tax revenues are going to be. The economy is slowing down. So it's hard to anticipate right now what the budget is going to look like next year.

But there's no doubt that we're not going to be able to do everything that I think needs to be done. There are some things that I think have to be done. We have to have energy independence.

So I've put forward a plan to make sure that in 10 years time we have freed ourselves from dependence on Middle Eastern oil by increasing production at home. But most importantly, by starting to invest in alternative energy, solar, wind, biodiesel. Making sure that we're developing the fuel efficient cars of the future right here in the United States, in Ohio and Michigan instead of Japan and South Korea.

We have to fix our health care system, which is putting an enormous burden on families. A report just came out to that the average deductible went up 30% on American families. They are getting crushed. And many of them are going bankrupt as a consequence of health care. I'm meeting folks all over the country. We have to do that now because it will actually make our businesses and our families better off.

The third thing we have to do is we've got to make sure that we're competing in education. We've got to invest in science and technology. China had a space launch and a space walk. We've got to make sure that our children are keeping pace in math and in science. And one of the things that I think we have to do is make sure that college is affordable for every young person in America.

And I also think that we're going to have to rebuild our infrastructure, which is falling behind. Our roads, our bridges, but also broadband lines that reach into rural communities. Also making sure that we have a new electricity grid to get the alternative energy to population centres that are using them.

So there are some things that we've got to do structurally to make sure that we can compete in this global economy. We can't short change those things. We've got to eliminate programmes that don't work. And we've got to make sure that the programmes that we do have are more efficient and cost less.

MODERATOR: What priorities would you adjust as president, Senator McCain, because of the financial bailout cost?

JOHN MCCAIN: Look, no matter what, we've got to cut spending. As I said, we've let government get completely out of control. Senator Obama has the most liberal voting record in the United States Senate.

It's hard to reach across the aisle from that far to the left.

BARACK OBAMA: [LAUGHS].

JOHN MCCAIN: The point is, we need to examine every agency of government. First of all, by the way, I had to eliminate ethanol subsidies. I oppose ethanol subsidies.

I think that we have to return, particularly in defence spending, which is the largest part of our appropriations. We have to do away with cost plus contracts. We now have defence systems that the costs are completely out of control.

We tried to build a little ship called the littoral combat ship that was supposed to cost $140 million. It ended up costing $400 million. And we still haven't done it.

So we need to have fixed cost contracts. We need, very badly, to understand that defence spending is very important and vital, particularly in the new challenges we face in the world. But we have to get a lot of the cost overruns under control.

I know how to do that. I saved the taxpayers $6.8 billion by fighting a contract that was negotiated between Boeing and the DOD that was completely wrong. And we fixed it. And we killed it. And people ended up in federal prison. So I know how to do this, because I've been involved in these issues for many, many years.

But I think that we have to examine every agency of government and find out those that are doing their job and keep them. And find out those that aren't and eliminate them. And we'll have to scrub every agency of government.

MODERATOR: But if I hear the two of you correctly, neither one of you is suggesting any major changes in what you want to do as president as a result of the financial bailout? Is that what you're saying?

BARACK OBAMA: As I said before, Jim, there are going to be things that end up having to be much deferred and delayed?

MODERATOR: Like what?

BARACK OBAMA: Well look, I want to make sure that we are investing in energy in order to free ourselves from dependence on foreign oil. Now that is a big project. That is a multi-year project.

MODERATOR: But you're not willing to give that up.

BARACK OBAMA: Well, I'm not willing to give up the need to do it. But there may be individual components of it that we can't do. But John's right that we've got to make some cuts.

We right now give $15 billion every year as subsidies to private insurers under the Medicare system. It doesn't work any better through these private insurers. They just skim off $15 billion. That was a giveaway.

And part of the reason is because lobbyists are able to shape how Medicare works. They did it on the prescription drug bill. They've done with respect to Medicare. And we are going to have to change the culture.

John mentioned me being wildly liberal. Mostly, that's just me opposing George Bush's wrongheaded policies since I've been in Congress. But I think that it is also important to recognise that I worked with Tom Coburn, one of the most conservative Republicans who John already mentioned, to set up what we call a Google for government. Which says that we are going to list every dollar of federal spending to make sure that the taxpayer can take a look and see who, in fact, is promoting some of these spending projects that John's been railing about.

MODERATOR: What I'm trying to get at is this. Excuse me, if I may, Senator. I'm trying to get at that one of you is going to be the President of the United States come January in the middle of a huge financial crisis that is yet to be resolved. And what I'm trying to get at is how this is going to affect you not in small ways, but in major ways. And the approach you would take as to the presidency.

JOHN MCCAIN: Well, how about a spending freeze on everything but defence, Veteran Affairs, and entitlement pro--

MODERATOR: Spending freeze?

JOHN MCCAIN: I think we ought to seriously consider, with the exceptions of caring for our veterans, national defence, and several other vital issues.

MODERATOR: Would you go for that?

BARACK OBAMA: Well, the problem with a spending freeze is you're using a hatchet where you need a scalpel. There are some programmes that are very important that are currently underfunded. I want to increase early childhood education. And the notion that we should freeze that when there may be, for example, this Medicare subsidy, I think doesn't make sense.

Let me tell you another place where I'd like to look for some savings. We're currently spending $10 billion a month in Iraq when they have a $79 billion dollar surplus. It seems to me that if we're going to be strong at home as well as strong abroad that we've got to look at bringing that war to a close.

JOHN MCCAIN: But we're sending $700 billion a year overseas to countries that don't like us very much. Some of that money ends up in the hands of terrorist organisations. We have to have wind, tide, solar, natural gas, flex fuel cars, and all that. But we also have to have offshore drilling. And we also have to have nuclear power.

Senator Obama opposes both storing and re-processing of spent nuclear fuel. You can't get there from here. And the fact is that we can create 700,000 jobs by building, constructing 45 new nuclear power plants by the year 2030.

Nuclear power is not only important as far as eliminating our dependence on foreign oil. But it's also important as part as climate change is concerned, an issue that I have been involved in for many, many years. And I'm proud of the work that I've done there along with Senator Clinton.

MODERATOR: Before we go to another lead question, let me see if I can figure out a way to ask the same question in a slightly different way here. Are you willing to acknowledge, both of you, that this financial crisis is going to affect the way you rule the country as President of the United States beyond the kinds of things that you've already said? I mean, is it a major move? Is it going to have a major affect?

BARACK OBAMA: There is no doubt that it's going to affect our budgets. There is no doubt about it. Even if we get all $700 billion back. Let's assume the markets recover. We're holding assets long enough that eventually taxpayers get it back.

And that happened during the Great Depression, when Roosevelt purchased a whole bunch of homes. Over time, home values went back up. And in fact, government made a profit.

If we're lucky and we do it right, that could potentially happen. But in the short term, there's an outlay. And we may not see that money for a while. And because the economy is slowing down, I think we can also expect less tax revenue.

So there's no doubt that, as president, I'm going to have to make some tough decisions. The only point I want to make is this. That in order to make those tough decisions, we've got to know what our values are, and who we're fighting for, and what our priorities are. And if we are spending $300 billion on tax cuts for people who don't need them and weren't even asking for them, and we are leaving out health care, which is crushing on people all across the country, then I think we have made a bad decision. And I want to make sure we're not short-changing our long-term priorities.

JOHN MCCAIN: Well, I want to make sure that we're not handing the health care system over to the federal government, which is basically what would ultimately happen with Senator Obama's health care plan. I want the families to make the decisions between themselves and their doctors, not the federal government.

Look, we have to, obviously, cut spending. I have fought to cut spending. Senator Obama has $800 billion in new spending programmes. I would suggest he start by cancelling some of those new spending programmes that he has.

We can, I think, adjust spending around to take care of the very much needed programmes, including taken care of our veterans. But I also want to say, again, a healthy economy with low taxes with not raising anyone's taxes is probably the best recipe for eventually having our economy recover. And spending restraint has got to be a vital part of that.

And one of the major reasons why we're in the difficulties we're in today is because spending got out of control. We owe China $500 billion. And spending, I know, can be brought under control because I have fought against excessive spending my entire career. And I've got plans to reduce and eliminate unnecessary and wasteful spending. And if there's anybody here who thinks there aren't agencies of government where spending can be cut and their budgets slashed, they have not spent a lot of time in election.

BARACK OBAMA: But I just have to make this point, Jim. John, it's been your president, who said you agreed with 90% of the time, who presided over this increase in spending, this orgy of spending, and enormous deficits. And you voted for almost all of his budgets. So to stand here after eight years and say that you're going to lead on controlling spending and balancing our tax cuts so that they help middle class families when over the last eight years that hasn't happened, I think it just is kind of hard to swallow.

MODERATOR: Quick response to Senator Obama.

JOHN MCCAIN: It's well known that I have not been elected Miss Congeniality in the United States Senate nor with the administration. I have opposed the president on spending, on climate change, on torture of prisoners, on Guantanamo Bay, on the way that the Iraq War was conducted. I have a long record. And the American people know me very well. And that is an independent and a maverick of the Senate. And I'm happy to say that I've got a partner that's a good maverick along with me now.

MODERATOR: All right. Let's go to another subject. Lead question, two minutes to you, Senator McCain. Much has been said about the lessons of Vietnam. What do you see as the lessons of Iraq?

JOHN MCCAIN: I think the lessons of Iraq are very clear. That you cannot have a failed strategy that will then cause you to nearly lose a conflict. Our initial military success, we went into Baghdad and everybody celebrated. And then the war was very badly mishandled.

I went to Iraq in 2003 and came back and said, we've got to change this strategy. This strategy requires additional troops. It requires a fundamental change in strategy. And I fought for it.

And finally, we came up with a great General on a strategy that has succeeded. This strategy has succeeded. And we are winning in Iraq.

And we will come home with victory and with honour. And that withdrawal is a result of every counter insurgency that succeeds. And I want to tell you that now that we will succeed and our troops will come home, and not in defeat, that we will see a stable ally in the region and a fledgling democracy.

The consequences of defeat would have been increased Iranian influence. It would have been increase in sectarian violence. It would have been a wider war, which the United States of America might have had to come back. So there was a lot at stake there.

And thanks to this great General David Petraeus and the troops who serve under him, they have succeeded. And we are winning in Iraq. And we will come home. And we will come home as we have when we have won other wars and not in defeat.

BARACK OBAMA: Two minutes for how you see the lessons of Iraq, Senator Obama. Well, this is an area where Senator McCain and I have a fundamental difference. Because I think the first question is whether we should have gone into the war in the first place.

Six years ago, I stood up and opposed this war at a time when it was politically risky to do so. Because I said that not only did we not know how much it was going to cost, what our exit strategy might be, how it would affect our relationships around the world, and whether our intelligence was sound, but also because we hadn't finished the job in Afghanistan.

We hadn't caught bin Laden. We hadn't put al-Qaeda to rest. And as a consequence, I thought that it was going to be a distraction.

Now, Senator McCain and President Bush had a very different judgement . And I wish I had been wrong for the sake of the country and they had been right. But that's not the case.

We've spent over $600 billion so far, soon to be a trillion. We have lost over 4,000 lives. We have seen 30,000 wounded. And most importantly, from a strategic national security perspective, al-Qaeda is resurgent, stronger now that at any time since 2001. We took our eye off the ball.

And not to mention that we are still spending $10 billion a month, when they have a $79 billion surplus, at a time when we are in great distress here at home. And we just talked about the fact that our budget is way overstretched. And we are borrowing money from overseas to try to finance just some of the basic functions of our government.

So I think the lesson to be drawn is that we should never hesitate to use military force. And I will not, as president, in order to keep the American people safe. But we have to use our military wisely. And we did not use our military wisely in Iraq.

MODERATOR: Senator, do you agree with that lesson of Iraq?

JOHN MCCAIN: The next president of the United States is not going to have to address the issue as to whether we went into Iraq or not. The next president of the United States is going to have to decide how we leave, when we leave, and what we leave behind. That's the decision of the next president of the United States.

Senator Obama said the surge could not work, said it would increase sectarian violence, said it was doomed to failure. Recently on a television programme, he said it exceeded our wildest expectations. But yet, after conceding that, he still says that he would oppose the surge if he had to decide that again today.

Incredibly-- incredibly-- Senator Obama didn't go to Iraq for 900 days and never ask for a meeting with General Petraeus.

MODERATOR: Well, let's go at some of these things--

JOHN MCCAIN: Senator Obama is the chairperson of a committee that oversights NATO that's in Afghanistan. To this day, he's never had a hearing.

MODERATOR: What about that point?

JOHN MCCAIN: I mean, it's remarkable.

MODERATOR: All right. What about that?

BARACK OBAMA: Which point? He raised a whole bunch of them

MODERATOR: I know. All right, let's go to the latter point. And we'll back up. The point about you're not having been--

BARACK OBAMA: Look, I'm very proud of my vice-presidential selection, Joe Biden, who's the Chairman of the Senate Foreign Relations Committee. And as he explains, and as John well knows, the issues of Afghanistan, the issues of Iraq, critical issues like that, don't go through my subcommittee. Because they're done as a committee as a whole. But that's Senate inside baseball.

But let's get back to the core issue here. Senator McCain is absolutely right that the violence has been reduced as a consequence of the extraordinary sacrifice of our troops and our military families. They have done a brilliant job. And General Petraeus has done a brilliant job.

But understand, that was a tactic designed to contain the damage of the previous four years of mismanagement of this war. And John, you like to pretend like the war started in 2007. You talk about the surge. The war started in 2003.

And at the time when the war started, you said it was going to be quick and easy. You said we knew where the weapons of mass destruction were. You were wrong.

You said that we were going to be greeted as liberators. You were wrong. You said that there was no history of violence between Shia and Sunni. And you were wrong.

[INTERPOSING VOICES]

BARACK OBAMA: If the question is who is best equipped as the next president to make good decisions about how we use our military, how we make sure that we are prepared and ready for the next conflict, then I think we can take a look at our judgement .

MODERATOR: We have a lot on the plate here.

JOHN MCCAIN: I'm afraid Senator Obama doesn't understand the difference between a tactic and a strategy. But I'd like to tell you two 4ths of July ago, I was in Baghdad. General Petraeus invited Senator Lindsey Graham and me to attend a ceremony where 688 brave young Americans whose enlistment had expired were reenlisting to stay and fight for Iraqi freedom and American freedom. I was honoured to be there. I was honoured to speak to those troops.

And afterwards, we spend a lot of time with them. And you know what they said to us? They said, let us win. They said, let us win.

We don't want our kids coming back here. And this strategy and this general, they are winning. Senator Obama refuses to acknowledge that we are winning in Iraq. They just passed an election law just in the last few days. There is social, economic progress.

And a strategy-- a strategy-- of going into an area clearing, and holding, and the people of the country then become alive with you. They inform on the bad guys. And peace comes to the country and prosperity. That's what's happening in Iraq.

And it wasn't a tactic. It was a strategy. And that same strategy will be employed in Afghanistan by this great general. Jim

And Senator Obama who, after promising not to vote to cut off funds for the troops, did the incredible thing of voting to cut off the funds for the troops in Iraq and Afghanistan.

BARACK OBAMA: Jim, there are a whole bunch of things we've got to answer. First of all, let's talk about this troop funding issues. Because John always brings this up.

Senator McCain opposed funding for troops in legislation that had a timetable, because he didn't believe in a timetable. I opposed funding a mission that had no timetable and was open-ended, giving a blank check to George Bush. We had a difference on the timetable. We didn't have a difference on whether or not we were going to be funding troops. We had a legitimate difference.

And I absolutely understand the difference between tactics and strategy. And the strategic question that the president has to ask is not whether or not we are employing a particular approach in the country once we have made the decision to be there. The question is, was this wise?

We have seen Afghanistan worsen, deteriorate. We need more troops there. We need more resources there.

Senator McCain, in the rush to go into Iraq said, you know what? We've been successful in Afghanistan. There is nobody can pose a threat to us there. This is a time when bin Laden was still out.

And now they've reconstituted themselves. Secretary of Defence Robert Gates himself acknowledges the war on terrorism started in Afghanistan. And it needs to end there. But we can't do it if we are not willing to give Iraq back its country.