Thursday 18 January 2018

US tax attitudes dangerously out of sync with crippling debt

ARE markets sleepwalking towards disaster? There is evidence they are. The United States, with a crippling budget deficit amounting to 9pc of everything the country produces, is able to borrow on the international markets at rates of just over 3pc. Italy on the other hand, which has a budget deficit half the size of the US in proportionate terms, is facing draconian borrowing rates of 6pc.

The lack of logic of this is even more baffling when you consider that the Italians have actually got a €40bn austerity play ready for parliamentary approval, whereas the US is still unable to table an overall figure, never mind get it approved on Capitol Hill.

Clearly the US is still benefiting from what is called its "exorbitant privilege" -- it happens to produce the world's only real reserve currency and always has the ability to print a lot more of the stuff.


But even taking this into account, as the world heads towards the edge of debt cliff in early August, it seems the political risks in the US are being ludicrously discounted by the markets.

Default in the US (an event comparable to a financial tsunami) is such an awful prospect that no one is willing to predict it.

With US Treasury bonds so hardwired into the global financial system, such an event would have global, as well as local consequences. There is virtually not a single pension fund, quoted company, insurance group, bank or asset manager that doesn't have some form of US debt in its portfolio. An overnight drop in the value of such assets is likely to place huge strain on companies around the world, including in Ireland.

As a result, nobody thinks such an event could happen. But Europe and the US are very different and that is why a default in the US, in certain contexts, could be more likely than in Europe.

In Italy, Greece, the UK, Portugal, Spain and Ireland, there is broad-based political agreement -- there must be a combination of tax rises and spending reductions in order to bring down budget deficits.

Of course there is endless fighting over the balance between taxing and cutting, but virtually no mainstream political party in Europe is resisting the notion that at least some level of taxation increases must be part of the package.

But the US, almost uniquely for any OECD country, is the prisoner of a party, the Republicans, that ideologically does not accept that taxation increases always form at least some part of a deficit-reduction plan.

In fact, the Republican position is more extreme than that -- the party is actually fighting in the House of Representatives and the Senate to slash taxation, at a time when the US has a budget deficit twice the size of the eurozone's. This is politely described as burning the candle at both ends.

Presidential hopefuls like Michelle Bachmann have arrived at the conclusion that taxation can and should only ever go downward, regardless of the consequences. Now President Barack Obama is warning that based on such stubbornness retirees may not get their social security cheques in August if the US cannot get political agreement to raise the $14.3 trillion debt ceiling.

All of this would be understandable if it was just based on a sullen reluctance by ordinary Americans to give the government more money. But already the American population is barely giving its government or its states enough money to survive.

The amount of money collected by the US government comes to about 25pc of US GDP, whereas in the EU it comes to about 40pc. Nobody is suggesting the US rate should move up to meet the European rate, but efforts by Republicans to paint the US as some kind of over-taxed socialist haven are faintly ridiculous.

With the US imprisoned by such unreal political debate, come August the world's biggest headache may be emanating from Washington, not Brussels.

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