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LEADER: Tax lunacy

Financial Times; May 23, 2003

President George W. Bush declared victory yesterday in the long-running congressional wrangle over his tax proposals. "This is a Congress which is able to identify problems facing the American people and get things done," he said after House and Senate Republicans struck a deal on a $350bn tax cut over 10 years. If only that were true.

The long-run costs of financing huge US fiscal deficits, which stretch far into the future, will weigh heavily on future generations. With little of the tax cut having an immediate effect, the necessary short-run economic stimulus will be negligible.

Democrats are prone to exaggerate the culpability of the current administration in the deterioration of the US public finances from a surplus of 1.4 per cent of gross domestic product in 2000 to a projected 4.6 per cent deficit this year. The Congressional Budget Office estimates that only a third of this deterioration is due to legislative changes, the rest being either due to the cyclical downturn or excessive optimism in previous tax forecasts. The fiscal loosening over the past few years has mitigated the economic slowdown. But those caveats aside, on the management of fiscal policy, the lunatics are in now charge of the asylum.

Including "sunsetting" provisions to cut the 10-year cost of the tax measures is an insult to the intelligence of US people. Anyone who genuinely believes that in 2007 Congress will automatically reverse these tax cuts needs therapy. Much of Mr Bush's 2001 tax-cutting package was also deemed temporary, only for the measures to be made permanent later.

Long-run US fiscal forecasts are still based on unrealistic assumptions of spending restraint that have not been met, either by this administration or by its predecessor.

And the latest wheeze in Republican circles is to dismiss forecasts of fiscal deficits because they rely on "static" forecasting techniques. "Dynamic scoring" which takes account of the effect of tax cuts on economic growth would transform the picture, they insist. But the evidence is not so kind to these assertions. The 1990s, when taxes were raised, was one of the more dynamic in US history; and fiscal deficits raise the cost of capital, reducing growth.

Never mind these facts, more extreme Republicans often say, big deficits are in our interests. Proposing to slash federal spending, particularly on social programmes, is a tricky electoral proposition, but a fiscal crisis offers the tantalising prospect of forcing such cuts through the back door.

For them, undermining the multilateral international order is not enough, long-held views on income distribution also require radical revision. In response to this onslaught, there is not much the rational majority can do: reason cuts no ice; economic theory is dismissed; and contrary evidence is ignored. But watching the world's economic superpower slowly destroy perhaps the world's most enviable fiscal position is something to behold.

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