Bush faces tough economic choices

By Stephen Evans BBC North America business correspondent

Can President Bush fix what's wrong with the economy?

President Bush is not a man to hold back. Why should he be?

After all, in his first term, he had no popular majority to embolden him and an election to worry about.

Now, he has no votes ahead to worry about (apart from those on Capitol Hill) and his victory at the polls in November was thumping.

As he put it himself: "I earned capital in the political campaign and I intend to spend it".

The big question is "How?".

He has already signalled he wants radical change of social security. Reforming the tax system is also high on his economic agenda. And he hopes to deal with two very serious deficits.

Pension reform

Mr Bush has already started preparing the political ground for reforming the system of pensions (social security).

The administration's initial task is to persuade law-makers that there's a crisis on the way and Something Must Be Done.

The high birth rate fifty years ago means a rise in pensioners is on the way with fewer workers to support them.

As the Bush administration puts it: "The current system is heading for an iceberg".

Risky strategy

Mr Bush wants to move from paying pensions out of taxes to one where workers save for their old age - what a leaked White House memo called "one of the most important conservative undertakings of modern times".

Slow economic growth means tough choices

The snag is that the plan also means cutting benefits by pegging them to prices rather than faster-moving wages.

As Peter Wehner, Mr Bush's director of strategic initiatives, wrote in the "not for attribution" memo: "You may know that there is a small number of conservatives who prefer to push only for investment accounts and make no effort to adjust benefits.

"In my judgment, that's a bad idea."

And the plan means big borrowing. As the memo put it: "If we borrow $1-2 trillion to cover transition costs for personal savings accounts and make no changes to wage indexing, we will have borrowed trillions and will still confront more than $10 trillion in unfunded liabilities.

"This could easily cause an economic chain-reaction: the markets go south, interest rates go up, and the economy stalls out."

Democrats are opposed to the change but so are some Republicans.

They're wary of borrowing and also recognise that an economy that "stalls out" isn't good either.

Tax reform

On taxation, Mr Bush also has radical ideas.

Some Conservatives moot the abolition of income tax but that's probably too radical.

What is more likely is a shift of taxation from incomes to spending.

Conservatives say that such a change wouldn't necessarily mean increasing the burden on the poor and easing it on the rich.

Certainly, the poor spend a higher proportion of their incomes on taxable goods but, so say the plan's defenders, other compensatory payments could be made to groups that lost out.

Democrats aren't so sure.

Dire deficits

Having dealt with taxation and social security, Mr Bush still has two elephants in the Oval Office: One, the deficit in the balance of payments - that is the excess of American imports over exports. Two, the deficit in public finances - that is the excess of government spending over income.

Both deficits are large and unavoidable, and neither can be easily moved.

Presidents, of course, are powerful - but not all-powerful, not all-powerful over currency markets, for example.

Economists are divided over whether the record deficit in the balance of payments will be rectified smoothly through the normal mechanisms of international adjustment, like orderly movements in exchange rates, or whether the change will come with a bump.

Those who advise Mr Bush assert that the balance of payments deficit is manageable and similar gaps in the past have been narrowed without turmoil and pain.

Bleaker minded sceptics retort that Americans are on a borrowing and spending binge that will lead to a hang-over when the debts come due, perhaps with a collapse in the property market.

Broadly speaking, this is the problem; foreigners produce what Americans consume and lend them the money to do so.

As Stephen Roach, the chief global economist at Morgan Stanley put it: "We outsource everything except consumption."

Tough choices

The budget deficit offers a similar problem: how to bring spending more into line with saving.

Some programmes are sacrosanct: nobody is proposing cuts in military spending, for example. And Mr Bush has not been a great pruner, much to the chagrin of some fellow Conservatives. Of course, robust economic growth would increase tax revenue and help close the gap between government income and spending.

But all the signs are that growth is not going to be robust. And slow growth means tough choices.