My post a week or so ago considering (and ultimately rejecting) the hypothesis that the 2004 election might be a good one for the Democrats to lose raised plenty of eyebrows, but the ensuing debate helped to sharpen up my thinking on the underlying issue, that of the unsustainability of current US fiscal policy and the appropriate Democrat response.

In the original post drew the conclusion that the only campaign strategy that would give a Democrat, once elected, any real chance of prevailing over a Republican congress, was that (supported by Dean, Gephardt, Kucinich and Sharpton) of repealing the entire Bush tax cut and starting from scratch. To the extent that primary voters considered this issue, they didn’t see it this way. With the possible exception of Lieberman, Kerry was the candidate most supportive of the tax cuts.

Like Bush, Kerry promises to cut the deficit in half over four years. He proposes to scrap the cuts for those earning more than $200 000, but to expand them for ‘middle-class families’, a group normally taken to include about 95 per cent of the population[1]. When other spending proposals are taken into account, the Tax Policy Center (a joint venture of the Urban Institute and Brookings Institution) estimates that Kerry’s proposals will yield a net increase in the deficit of $165 billion over four years , or $40 billion a year. (Of course, Bush will almost certainly spend more once the unbudgeted costs of higher defense spending and even more tax cuts are factored in). As I show below, this is relative to a baseline of around $550 billion.

I think it’s safe to say this won’t happen. The problem for Kerry, then, is when to discover the deficit. There are three basic options:

fn1. It’s evidence of the startling lopsidedness of the Bush tax cuts, and the explosion of income inequality over the past two decades, that there is, nonetheless, a substantial revenue gain from repealing the cuts for the rich and ultra-rich. About half the benefits of the Bush tax cuts go to those on incomes over $200 000 per year.

UpdateBrad de Long points to Kerry’s appointment of Roger Altman as his budget priorities advise as evidence that Kerry will choose Option 1. Kevin Drum is underwhelmed. He supports Option 2 and expects Opinion 3.

1. Discover it now, dump the current fiscal policy and campaign on full repeal of the Bush cuts. As I argued in my previous post, this would give a newly-elected Kerry the mandate to push the policy through Congress. This strategy would incur a fair bit of short-term political pain, but Kerry’s early and overwhelming win in the primaries gives him some time and political credit to spend.

2. Discover it immediately after the election. This is the strategy usually adopted by newly-elected Australian governments who want to dump their campaign promises. The idea is that on Day 1, you appoint a Commission of Audit. In a month or two, the Commission reports back with the shocking news that the previous government’s figures, on which you naively relied, were a massive exercise in book-cooking. You then introduce an emergency Budget. This strategy works well in a Parliamentary system where the government has a majority in the Lower House where budgets are determined. To make it work in the US system, you’d need to win well enough to get a Democrat majority or at least a workable majority with moderate Republicans. As I understand things, however, a Democrat majority is unlikely and moderate Republicans are an extinct species.

3. Discover it slowly over time. The key point in favour of this strategy is that the Bush tax cuts expire automatically (in 2006 I think). But this is the strategy most likely to lead to deadlock, for which the President will probably take most of the blame, and which will produce the most painful economic adjustment

If you accept my summary of the options, I think it’s pretty clear that Option 1 is the way to go.

h5. Notes

To get an idea of the scale of the problem, go to the Congressional Budget Office and add up from Table 1-1 and Table 1-3
1. The baseline budget deficit projection for 2008 ($278 billion)
2. The effect of extending the Bush tax cuts ($125 billion including debt service)
3. Alternative Minimum Tax relief ($43 billion including debt service)
4. Discretionary appropriations growing in line with nominal GDP ($102 billion including debt service)
for a total starting point deficit of $548 billion, assuming no adverse economic shocks or spending requirements.

Kerry’s partial repeal would save only about $50 billion

For completeness, here’s the section of Kerry’s economic policy headed Restore fiscal discipline to Washington

By borrowing from future generations to give tax relief to those who need help the least, George W. Bush’s economic policies have, for the first time in history, forced the federal government to spend $1 billion more EACH DAY than it takes in. John Kerry believes that we need a smaller and smarter government that wastes less money. He has put forward a sensible plan that will at least cut the deficit in half in his first term, while investing in economic growth and investing in workers. To restore fiscal discipline and strengthen our economy, Kerry will repeal Bush’s special tax breaks for Americans who make more than $200,000. He will cut excesses in government and reign in out of control spending. And he will implement the McCain-Kerry commission on corporate welfare to undermine the special interest groups that make it hard to cut tax loopholes and pork barrel spending projects.