www.economist.com/world/na/displayStory.cfm?story_id=2189237
It will not be easy to reverse LAST week's figures looked, at first, like vindication. He has chopped taxes in every year of his presidency, in all by as much as Ronald Reagan did in the early 1980s. It cut marginal income tax rates, gradually eliminated the estate tax and raised the child tax credit, ostensibly to make sure that the budget surplus was returned to Americans and not frittered away in Washington. See also President Bush's 66 economic policies and the 67 Congressional Budget Office. In May 2003 came another big tax plan, again sold as a stimulus, but designed mostly to shift the tax burden away from investment income by cutting taxes on dividends. The buzz in Washington is that this tax-cut strategy will continue into election year. The White House is said to be working on a new tax package for 2004, focused on dramatically expanding tax-free retirement and savings accounts. Politically, the goal is to appeal to America's large, and growing, investor class. Economically, it would shift the tax burden yet further onto wage income. In time, most Americans' savings would be shielded from tax. While Team Bush touts tax cuts, it never mentions the other hallmark of this administration's fiscal policy: soaring federal spending. For all his rhetoric about keeping Washington in check, Mr Bush, as one Republican analyst puts it, has been spending like "a drunken sailor". The ever-widening war on terror, of course, accounts for much of that. But non-military discretionary spending, (that is, spending that must be appropriated by Congress every year) has risen by 21%. Much of that increase is on homeland security, but not all. Mr Bush has merrily accepted spending bills stuffed with local pork. He also supports a huge rise in hand-outs to America's elderly. With White House backing, Congress is about to include a prescription-drug benefit in Medicare, the government health-care plan for old people, in the biggest expansion of that programme since it began in 1965. The combination of a sharp economic slowdown, tax cuts and higher spending has transformed America's budget. According to the Bush folk, this shift is unfortunate but hardly worrying. America, they claim, was hit by an unprecedented combination of economic slowdown, terrorist attacks and stockmarket collapse. But now, boosted by tax cuts,buoyant growth coupled with disciplined spending will soon stem the red ink. A poll by ABC News and the Washington Post, published on November 2nd, showed that 53% of respondents disapproved of Mr Bush's tax policy. The large cast of Democratic presidential hopefuls claim Mr Bush's tax cuts have been a giveaway to the rich, wrecking the economy and mortgaging the future for America's children. In their most recent poll, members of the National Association of Business Economists described the federal deficit as the biggest problem facing America's economy. A bipartisan coalition of three economic think-tanks--the Committee for Economic Development, the Concord Coalition and the Centre on Budget and Policy Priorities--recently declared that, without a change in course, the next decade might be the "most fiscally irresponsible" in the country's history. The stakes in this debate are high, affecting not just America's economic future, but the world's. Deciding whether to be nonchalant or nervous means answering three questions. A question of time In the short-term, America's fiscal shift has been dramatic but hardly dangerous. Growing deficits flow naturally from a sharp economic slowdown, as tax revenues fall and benefit spending rises. Part of America's fiscal deterioration over the past three years has come from a slower economy. In addition, tax revenues fell further than anyone expected after the stockmarket bubble burst. Spending increases and tax cuts have reinforced that trend, worsening the fiscal position but at the same time bolstering the economy. Few disagree that the administration's aggressive use of fiscal stimuli--along with record low interest rates--helped stave off a sharper global economic downturn. And with plenty of slack still in the economy, today's budget deficit is unlikely to squeeze out private investment. Look only at the overall deficit and at the past three years, and America's fiscal deterioration hardly seems reckless. Budget rules require Congress's number-crunchers to project the impact of tax and spending decisions over the next ten years. The cut-off is arbitrary, and leads to much accounting chicanery. But it shows, if you look carefully, what a mess America's finances are in. This figure was always mythical, largely because it assumed that much of the tax take of the bubble years would be permanent. But it captured Washington's imagination and led Alan Greenspan, chairman of the Federal Reserve, to fret publicly that the government, once it had paid off all its debt, would then have to invest in private shares. That fretting, in turn, paved the way for Mr Bush's first tax cut. But, taken at face value, the fiscal outlook is still relatively benign. America's debt/GDP ratio, currently at 37%, peaks at 40% in 2005 but is back down to 30% by 2013, far below the levels of many other rich countries. Yet these official projections, and similar ones by the White House, bear no resemblance to reality. The CBO is forced by law to make extremely implausible assumptions both about taxes and spending. The White House does so because it suits Mr Bush's political purposes. To be more realistic, the budget forecasts need adjusting in four main areas: Extending the tax cuts. To stay within Congress's budget rules, the Bush tax cuts expire at various points over the next decade. In an attempt to stop rich taxpayers avoiding tax by over-using deductions, Congress introduced the AMT in 1969. If your tax bill is higher using the AMT formula, that is what you must pay. However, the combination of Mr Bush's tax cuts (which reduce taxes under the traditional system) and the fact that the AMT is not indexed to inflation means that it will affect far more people in future: 33m in 2010 and 42m in 2014. But simply indexing AMT thresholds to inflation adds $690 billion to the ten-year deficit. And according to a CBO analysis, the Bush defence plans imply a 20% real increase in military spending by 2020. The coalition of economic think-tanks last month reckoned that, at a minimum, the ten-year figure for discretionary spending needed to be $600 billion higher. Since it is not (yet) law, the official forecasts do not include the cost of a Medicare prescription-drug benefit. Officially, this will cost $400 billion over the next decade, though most health experts reckon that rising medical costs mean it will be much more. Add these factors together, and America's budget outlook is far worse than the official forecasts suggest. Among Washington's independent budget experts, the consensus is that the official figures understate the cumulative deficit by about $5 trillion. Rather than a budget that returns to surplus by 2012, America is more likely to see deficits that average 3% of GDP over the next decade. All these projections assume a healthy average rate of real GDP growth, at 3% a year. Faster growth would improve the outlook, but would not eliminate the spectre of deficits. Contrary to the Bush team's rhetoric, America does not have a small, temporary fiscal problem. Big budget deficits reduce America's already abysmally low saving rate. As the economy's slack is worked off, Uncle Sam's demand for dollars is likely to crowd out private investment and reduce long-term economic growth. Big budget deficits will aggravate these external imbalances and so raise the risk of financial volatility, even a dollar crisis. Over the next few years, that is perhaps the biggest risk that Mr Bush's fiscal policies pose for the world economy. No Ronald Reagan Grim as it is, the medium term appears rosy compared with America's long-term fiscal outlook. The retirement of the baby-boomers, increasing life expectancy and inexorably rising medical costs mean that the cost of funding America's commitment to its old people will soar over the next few de...
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