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AMERICA'S TAXES
Feb 8th 2005  

George Bush has submitted a budget that is tough on discretionary
spending for this coming year. But Iraq and Afghanistan, as well as
proposed changes to Social Security and the tax code, still leave black
clouds on the fiscal horizon

GEORGE BUSH'S supporters love to compare him with another conservative
revolutionary, Ronald Reagan. Up until now, the comparisons have been
mostly with the late president's tough talk and aggressiveness on
foreign policy. But on Monday February 7th, Mr Bush submitted a budget
for fiscal year 2006 that takes a step in Reagan's direction on home
affairs too, by proposing cuts in a slew of domestic spending
programmes. 

Headline-writers duly announced "Deep Spending Cuts" and "Sweeping
Budget Cuts". And it is true that many public-sector agencies will be
feeling the pain. Mr Bush hopes to cut "mandatory" spending, which
includes programmes such as food vouchers ("food stamps"), by $4.5
billion next year and by almost $123 billion over the next ten years.
Discretionary spending--that which can be raised or lowered each year
through political negotiation--will increase by less than the rate of
inflation, meaning a spending cut in real terms. Non-security
discretionary spending (ie, excluding defence and homeland security)
will even fall in nominal terms--the first such cut, the
administration's summary points out, since Reagan's presidency in the
1980s.

Several of the proposed cuts are surprising, others (for Mr Bush) less
so. In the surprising category is farming: the president proposes
cutting the Agriculture Department's spending by $2 billion, or 9.6%.
Much of this reduction would come by capping subsidies (much of which
go to big farms) at $250,000 per farm. This will infuriate communities
in the farming states of the south, mid-west and west, most of which
have up until now been firm supporters of Mr Bush. 

Less surprising is the president's plan to cut $3.7 billion from the
Department of Housing and Urban Development (HUD). Mr Bush said in last
week's state-of-the-union address that duplicated or ineffective
programmes would be cut. Some of HUD's programmes were deemed to be
among them. These will be transferred in a modified and reduced form to
the Commerce Department, which sees a $3.1 billion, or 49%, spike in
its budget (see chart). Other departments scheduled for cuts are
transportation, labour and justice. One notable increase is for
international aid: Mr Bush is proposing $1.5 billion in new money for
countries that meet certain measurable good-government criteria.

But Mr Bush's new-found fiscal conservatism is patchy. His current
deficits are primarily the result of a collapse in tax revenues, down
from 20.8% of GDP in 2000 to 16.8% this year, yet he intends to make
his tax cuts permanent. Security spending is also largely exempt from
his tight-fistedness. Next year, defence spending will grow by 4.8% in
nominal terms, to $419 billion; homeland-security outlays will go up by
1.2%, to $29 billion. And the budget does not include likely
"supplementals" for ongoing military operations in Iraq and
Afghanistan. Congress has already approved one such supplemental, of
$25 billion for fiscal 2005, and is preparing to consider another
$80-billion request from Mr Bush.

Indeed, none of these numbers is safe from Congress. Budget hawks fear
so-called "Washington Monument proposals": proposals to cut or close
emotive programmes or landmarks, which the public (and their
legislators) will never allow. Last year, Mr Bush's budget proposed
eliminating 65 programmes. Four were eventually cut. Thad Cochran, a
Republican senator from Mississippi, has already begun shoring up
support from farm groups to fight cuts in agricultural subsidies (and
farm states are over-represented in the Senate, where each state has
two senators regardless of population). The Democrats are, predictably,
up in arms too. Nancy Pelosi, the party's leader in the House, called
the latest budget "a hoax on the American people."

THAT WAS THE EASY PART
Mr Bush has received praise for being willing to take on discretionary
spending, the main source of power for Congress. But even doing so
successfully (which is far from given) would only be a start.
Non-security discretionary spending is less than a sixth of the total
budget. In the future, the president's efforts to restrain it will be
dwarfed by the impact of two giant entitlement programmes, Medicare and
Social Security (pensions). The budget overview acknowledges that, even
under the best-case scenario, the retirement of the baby-boom
generation in a decade or so will put new, intense pressure on
America's finances. This, the administration argues, makes the reform
of the Social Security system all the more urgent.

On current trends, Social Security will begin spending more than it
takes in through payroll taxes in 2018, and in 2042 it will deplete its
accumulated trust fund. To avoid this, Mr Bush wants to create private
accounts: workers would put some of their payroll taxes into personal
accounts that would be theirs on retirement. Though the idea holds some
long-term promise, the transition costs will be big. No one knows how
big until Mr Bush produces a detailed plan, but estimates range between
$1 trillion and $2 trillion in the first decade. None of this is
included in the budget just unveiled.

Other fiscal pain has also been put off, but cannot be avoided forever.
One headache is the Alternative Minimum Tax (AMT). Originally devised
to keep rich taxpayers from finding so many loopholes that they pay no
taxes, it will soon begin to hit middle-class Americans. Fixing this
will be expensive. Mr Bush also says he wants to flatten and simplify
the tax code. But to make it revenue-neutral, as he says he would like
to do, would require ending popular deductions, for example those on
charitable giving and mortgage interest. Public pressure might keep Mr
Bush and Congress from pulling off tax-code reform without leaving
expensive loopholes.

The budget released this week cheerily shows deficits dropping from a
peak of 3.6% of GDP in 2004 to 3.0% next year and just 1.5% in 2009.
But even assuming everything goes well for Mr Bush, several things will
make this nigh-impossible. AMT reform will have to begin well before
2009 if a middle-class revolt is to be avoided, and is not included in
the administration's calculations. Nor are future supplemental costs
for Iraq and Afghanistan. 

And after 2009 is when it gets really hard again. That is when Mr
Bush's tax cuts, if made permanent, start to get very expensive,
costing over $1 trillion between 2011 and 2016. It is also when the
transition costs of Social Security reform would kick in. None of this
shows up in Mr Bush's deficit projections because they look ahead only
five years, not the traditional ten. Perhaps he does not dare peek
ahead beyond 2010. Or, since he is leaving office in 2009, perhaps he
does not care.

Alan Greenspan, the chairman of the Federal Reserve, said recently that
"the voice of fiscal restraint, barely audible a year ago, has at least
partially regained volume." Mr Bush has said some of the right things.
But it is his deeds, not his words--as well as events in Iraq and
Afghanistan beyond his control--that will determine America's fiscal
future.

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