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David Ignatius

Exit Strategy For a Fiscal Impasse

By David Ignatius
Tuesday, November 9, 2004; Page A27

President Bush won an impressive election victory, but he didn't repeal the laws of arithmetic. And the cold-hearted actuaries of doom, the bond and currency markets, were signaling last week their judgment that the president's economic numbers don't add up. The United States is running huge budget and trade deficits, but Bush showed no sign during the campaign that he had a serious plan to deal with them.

That's why I'm encouraged by Bush's new, post-election talk of a radical overhaul of the tax system. It's hard to see how tinkering with revenue and spending will get us out of our current mess. The only workable solution will have to be a bold one, and this is one area where the president's bullheaded "I'm prepared to lead" style is genuinely welcome.

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About David Ignatius

The current fiscal impasse reminds me of the old joke about the traveler who asks a flinty Maine woodsman how to get back to Boston. The Maine man considers a number of possible routes, each of which he rejects before finally advising the traveler: "You can't get there from here." He might have been talking about reducing the budget deficit. If you can't cut defense or social entitlement programs and you can't raise taxes, then truly, you can't get there from here.

The budget squeeze is so bad that even the Kerry campaign, in its most ebullient pre-election moments, despaired of finding an easy solution. John Kerry had a plan on paper for cutting the budget deficit to half of this year's roughly $450 billion by 2008. But when Kerry's transition planners began discussing what they would do if Kerry should win, they realized that in addition to the paper plan, they needed a "Hastert Plan," for what was actually doable in a Republican-controlled Congress led by House Speaker Dennis Hastert. The Kerry team talked about "micro-steps" that would help build support for its paper plan. But some Kerry advisers concluded that what was needed was a radical alternative approach -- which they wouldn't discuss for the record.

This sense of no exit explains the post-election behavior of the bond and currency markets. By Friday the dollar had fallen to an all-time low against the euro, with traders worrying about a coming dollar crisis caused by the huge and unsustainable trade deficit. And bond prices fell because of traders' fears that the second Bush administration wouldn't take the budget deficit any more seriously than the first one did.

What's the way out of this fiscal dead end? The only answer may be to carve a new road -- one that provides a simpler, more stable source of revenue than the current loophole-ridden system of income taxation. Attempts to tinker at the margins haven't worked; it's too tempting to give interest groups and ordinary folks more of the breaks they want.

Bush has been vague about what he's after, beyond naming a commission to study fundamental changes in the tax system. But I hope the president and his commissioners will put a consumption tax at the top of their list. The more you look at America's underlying economic problems -- which begin with a propensity to consume more than we produce and save less than we need -- the more a consumption tax makes sense.

The most interesting plan I've seen comes from Michael J. Graetz, a Yale law professor who wrote an article last year titled "A Fresh Start for the U.S. Tax System." Graetz urges a national value-added tax similar to those adopted by 120 countries. It would be like a sales tax, except that it would be collected at each stage of production along the way to retail sale. Graetz calculates that a 14 percent VAT, which is a little less than the average European rate, would raise about $800 billion annually -- enough to abolish federal income taxes for any family making less than $100,000.

Graetz deals with the usual criticism of consumption taxes -- that they affect the poor disproportionately -- by providing that families making more than $100,000 would still have to pay income tax. But he proposes a flat rate of 25 percent, with deductions for home mortgages and charitable giving. Graetz would cut corporate taxes to 25 percent, too, and apply that same rate to transfers of wealth in place of estate taxation.

A consumption tax of the sort proposed by Graetz would be simple and fair. Bush wants any tax change to be revenue neutral, but over time a U.S. VAT could add the revenue needed to balance the budget. If Bush could pull off this sort of big, bold reform and start the long track back to fiscal responsibility, he would deserve cheers even from the bluest of Blue America.


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