The fiscal consequences of the Bush administration

By Clive Crook
Financial Times
Published: April 13 2008

Competition for “most damaging legacy of the Bush administration” is lively. Iraq is the front-runner, of course, but bear in mind the wreckage of fiscal policy – although to use that term is to imply that the US even has a fiscal policy, when it does not. It would be more accurate to talk of fiscal consequences or fiscal footprint (an apt metaphor) than to imply anything as deliberate as “policy”.

All three presidential contenders criticise the administration on this, but none is offering much improvement. The Democrats remind the country that in the late 1990s the Clinton administration ran a budget surplus. With ill-designed tax cuts and reeling indiscipline on spending (partly, but not only, because of the war) the Bush administration turned this into a deficit. Barack Obama’s answer is the same as Hillary Clinton’s: undo the tax cuts and then raise spending by even more. John McCain, the Republican nominee and supposed fiscal conservative, is against raising taxes and promises to get spending down instead – but will not say how to do it.

The whole debate rings hollow anyway, because most Americans think it has nothing to do with them. The Democrats are promising to raise taxes only on the rich: the country’s vast middle class expects to be unaffected. And as long as Mr McCain declines to explain exactly how he will curb spending (aside from attacking earmarks, the special interest spending projects which in the larger scheme of things are trivial), voters will be equally blithe about that side of the calculation too. Everyone can deplore the fiscal incontinence of the Bush administration and hardly anyone need worry about what restoring fiscal control might require. In this, as in other areas, the thinking boils down to: “After George W. Bush, everything will be fine.”

On taxes and spending – as on Iraq – it will not. The point has become dulled through repetition, but the fact remains that the US faces, from a position of fiscal weakness, new and mounting pressures on public finance. In dealing with the larger problem, muddling through is unlikely to succeed. The country will have to change how it confronts fiscal questions.

If it proves incapable of changing its politics in that way – and it probably will – the outlook is a gradual, indefinite and growth-sapping rise in taxes and spending. At the moment, for good or ill, the US is still an outlier among rich countries, certainly as compared with Europe, in having a small state and relatively low taxes. This gap is already shrinking, however, and in the foreseeable future it will close further.

The biggest fiscal pressure comes through healthcare – with or without the universal or near-universal provision the Democrats are promising. Public spending per head on health is already higher in the US than in Britain, notwithstanding the National Health Service. Medicaid (for the poor) and especially Medicare (for the elderly) are enormous programmes and the cost of Medicare is rapidly rising as the baby-boomers retire.

Even with a fixed eligible population, US public spending on health tends to grow faster than the economy. New technologies push costs up and Medicare, like Social Security, is an entitlement programme, so higher spending comes through automatically, with no real oversight. By 2035, according to estimates by the Congressional Budget Office, the cost of Medicare and Medicaid will more than double, to nearly 10 per cent of gross domestic product. Now add universal access.

You might reasonably say, if the US wants European levels of social provision, it will have to have European levels of taxation – and what is wrong with that? Aside from the obvious, which is that people prefer low taxes and economies grow faster that way, the US is unprepared for any such fiscal transition. Because of the way Medicare and other entitlements are budgeted, control of outlays is weak. And on the revenue side, the tax base is much narrower than in most European countries. Close-to-European levels of revenue collected through anything resembling the current US tax code would require far higher income tax rates than the electorate or the economy can stand.

Even now, income tax rates in the US are not that low by international standards and the gap will get smaller still if the Bush tax cuts are allowed to expire as the Democrats propose. Yet the system raises far less revenue than you would expect because of tax expenditures – deductions for employer-provided healthcare, mortgage interest and much else besides. The revenue cost of these allowances is already in the neighbourhood of $750 bn a year. Also, of course, the US has no value-added tax, which provides a large and growing share of government revenues in Europe. The narrow base of the US tax system is incapable of bearing the strains of projected future growth in spending.

Mr Bush has done the cause of fiscal moderation grave harm. He presided over an unwarranted surge in spending and he pushed for tax cuts that were so politically ill-conceived that, in the view of many Americans, merely undoing them is all the tax reform the country needs. The issue is not so much that he moved the structural budget balance from surplus to deficit – though he did and that was a great pity – but that he spared the country until further notice the effort of examining its priorities and mending its failing fiscal machinery. In this election year, control of entitlements and far-reaching reform of the tax system are not even being discussed. Before too long, both will be unavoidable fiscal necessities. Cancelling Mr Bush is not enough.