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Whatever your opinion of the Bush tax cuts, it is indisputable that they made our tax base more progressive:  the rich and very rich now pay a higher percentage of the total tax take than they did before Bush took office.  That has dire implications for the budget for the next few years.

Especially in recent years, the income of the wealthy has become more volatile than the income of the middle class and below.  In good years, their earnings soar, and Uncle Sam reaps more revenue than expected.  In bad years--particularly bad years on Wall Street, since most of that money comes in the form of some sort of security, rather than cash--tax revenues nosedive.  Incidentally, the more we focus on taxing the rich, the worse this problem will get.

The Bush administration is already projecting record deficits next year.  And unlike with their previous dire predictions, we're highly unlikely to get a happy surprise come the mid-year budget review.  If I had to guess, I'd bet on revenues being even lower than currently projected.

Meanwhile, of course, the bailout is going to cost us.  How much?  No idea.  Not, as some economically illiterate commentators are saying, the full amount of the loans--most of that money will probably be paid back.  It's not unlikely that the Fed will actually make money in the long run.  In the short run, however, we'll probably need to put more money into fixing this mess, particularly at Fannie and Freddie.

And though the rush of investors currently seeking a safe haven for their money has temporarily driven the interest on treasury debt down to practically nothing, I wouldn't bet that this will last.  Depending on how spooked investors, particularly foreign investors, get about the future of the US economy, we may be paying more for our debt in the near future than we have in the past.

What does that mean for the grand plans of our two presidential candidates?

  • McCain will probably not be able to make the Bush tax cuts permanent.  It's possible that tax revenues will recover by 2010, though frankly I think the magnitude of the cuts on Wall Street will take years for the tax base to digest.  But we won't know that until early 2011, after the tax cuts have already expired. He'll likely have to push this through with the grim memory of a plummeting 2009 revenue line fresh on everyone's minds.  But Democrats shouldn't smile too much, because this also means
  • Barack Obama will not get his middle class tax cut.  Raising taxes on the rich will not raise all that much revenue in the next year or so.  He'll need the stable middle-class base just to sort of cover current expenses.  Plus,
  • Barack Obama will probably have to radically trim back his spending plans.  Unlike John McCain, he can't just wait a year or so and see if Wall Street bonuses rebound.  He needs the political momentum that he will presumably derive from election to get a big package like his health care plan through. Given the budget problems, unless he's willing to spend money like  a drunken sailor, those programs will come attached to a hefty tax increase that will need to fall, at least in part, on middle-class voters.  Otherwise,
  • The Democrats will have to abandon Paygo.  It's not clear how much good this will do them, however.  The price of money after the fallout settles may make this pretty unattractive--if not to Democrats, then to their constituents.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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