Like a sacred cow to the slaughter

You heard it here second. A tax increase is coming in America - and Republicans will be among those who preside over that increase.

The first place you might have heard about it was, of all places, Reaganite web chat rooms. There, economists have been muttering for a good six months about the prospect of Republican-supervised tax increases. Especially clear has been Bruce Bartlett of the National Center for Policy Analysis, a think-tank in President Bush's own Texas.

It is not that the less-government types desire tax increases. Far from it. It is just that they totted up the numbers. Taken together, the nation's new Medicare programme and Social Security, its old unreformed pension system, make a tax increase just about inevitable.

Since tax increases are to Republican voters as Sars is to tourism, you have to wonder how Republicans got themselves into this position. Here's the short version.

Back in the 1970s and 1980s, free-market thinkers in the UK and the US decided good fiscal policy was about one thing: providing incentives for growth or, put another way, reducing disincentives to it. Taxes were high, so Margaret Thatcher and Ronald Reagan slashed rates. In this philosophy, also known as supply-side economics, deficits and budgets mattered less. If you made your economy competitive through tax cuts, your deficits would, eventually, narrow. If you look at the 1980s and 1990s together, you can see that this worked.

Sometimes, tax cuts paid for themselves through increased growth and revenue. Cutting spending, a traditional conservative goal, was less important. The philosophy allowed Republicans to distinguish themselves from their conservative forerunners. No Scrooges they.

Sidelined in the 1990s, the Republicans watched as President Bill Clinton put a second philosophy into action: "triangulation". The idea was to marginalise your opponent by stealing his ideas. This lesson stuck as well.

By Mr Bush's inauguration, the old supply-side theory had shifted a bit. What had been matters of emphasis became absolutes. Tax cuts always paid for themselves. They always offset spending. And generous spending was necessary, so that the Republicans might "triangulate" and snatch the mantle of compassion from the Democrats.

The new administration applied those lessons. It encouraged growth by cutting taxes and staying out of the way of business; this administration gets an A minus when it comes to growth.

The administration and its Congressional friends, however, also spent like crazy. There was defence spending after September 11 2001, of course. And Social Security went unchanged. But there were also the outlays of triangulation, "compassionate conservatism". The biggest such commitment was the Medicare drug programme for senior citizens. This new entitlement will cost billions. It would be hard for lower tax rates alone to offset it.

With the winter have come some second thoughts. In December, the Congressional Budget Office, warned that "unless taxation reaches levels that are unprecedented in the US, current spending policies will probably be financially unsustainable over the next 50 years". The report went on to note that "an ever-growing burden of federal debt held by the public would have a corrosive and potentially contractionary effect on the economy".

So much for not playing Scrooge. You have to wonder what Douglas Holtz-Eakin, director of the CBO, felt as he signed off these words. After all, Mr Holtz-Eakin is an incentive-oriented sort of person, known best as the co-author of the famous Holtz-Eakin/Rosen study showing that low income- tax rates invigorate small business.

But as the CBO points out, you do not need a new law to widen the government's tax take. Wages are increasing, pushing citizens into higher brackets. A quirk in the system, the Alternative Minimum Tax, will force many households to pay extra taxes. Some Bush tax cuts are scheduled to be phased out.

What now? If you ask the various Democratic candidates, Washington must undo some or all of the Bush income tax and capital gains tax cuts. There is also talk - although mostly from think-tanks - of raising Social Security taxes. Currently, the amount of income subject to Social Security is capped at under $100,000. Some Democratic thinkers would eliminate that cap. This would amount to a wicked marginal tax rate increase.

What about the Republicans? The Office of Management and Budget is already wildly promising budget cuts for 2005. President Bush will call for making rate cuts permanent in his State of the Union address. But there needs to be more to avoid increases. He can use the campaign year to expand the small free-market components of the Medicare law into something significant. He can put forward a social security privatisation plan that would dwarf Mr Clinton's "ending welfare as we know it". He can start looking at government spending as a share of gross domestic product, instead of looking at the deficit-GDP ratio. This change in methodology would force him to confront his spending plan.

In short, Republicans can turn themselves back into the party of small government, however untriangulating that sounds. But if the campaign is all balloons and compassionate conservatism, the tax increase will come. It is only a matter of when.

© Copyright 2004 Financial Times

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