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Tic . . . Tic . . . Tic . . .

Before Hurricane Rita slammed into the Texas/Louisiana coast and re-flooded parts of New Orleans, U.S. Treasury Secretary John Snow had concurred that recovery costs associated with Hurricane Katrina could go as high as $200b.  As if to reassure deficit watchers, he stated that in the short term the country can afford the costs; adding that higher taxes would not create opportunity nor encourage recovery.  He might also have been defending those tax cuts that Congress legislated in 2001 to boost the economy but were also expected to cost the federal government some $1.7t over the next decade.

As Rita wound down, President George Bush issued disaster declarations for Texas and Louisiana.  Stung by critics who complained about the government's slow response time to Katrina, Bush's timelier declarations pave the way for financial assistance from the federal government.  But can the government afford the clean-up costs of both hurricanes?

Al Hubbard, director of Bush's National Economic council, doesn't think so.  After surveying the damage wrought by Katrina, he said that of course the American taxpayer will foot the bill.  Given that the deficit was $331b on 15 August, Mr Hubbard joins those who maintain that the government cannot continue footing the bills of natural disasters, an unpopular foreign war and economic recovery.  The specter of precipitating chaos in currency markets as a consequence of further undermining of the American dollar could  cause Congress to blink.

For now the combined punches of Katrina and Rita have knocked out nearly all energy production in the offshore oil fields of the Gulf of Mexico, which affects 30% of U.S. refining.  It is expected that the paralysis, however short-lived, will push gasoline prices well over $3.00 a gallon ($.80/litre) and cause spot shortages.  Heating oil prices will rise and so will every other commodity dependent upon transportation.  For the American working class obliged to repay some $2t in consumer debt, these added living costs will not allow much wiggle room for a tax increase.  So what will the government do?

Back in 1916 when Congress enacted a tax on the transfer of a decedent's estate, the Committee on Ways and Means felt that the "consumption (or income) tax" was not equitable.  An estate tax would shift the burden of taxation to those who had accumulated wealth and most benefited from the government's protection.  The tax has been a major source of revenue for the treasury of the United States since then.

But in June 2001 as part of his tax cutting package passed by Congress, President Bush signed into law the phase-out of the nation's estate tax.  This phase-out means that expats are increasingly exempted from taxation by the federal government.  In 2010 Congress must then act to repeal the estate tax; otherwise the tax will revert to rules in effect in May 2001.

If the estate tax is not repealed, the government stands to gain some $800b in added revenues in the decade of the 2010s.  Moreover, intergenerational transfers of wealth amounting to as much as $100t are likely to occur in the next half-century, giving rise to further significant revenues.  So in the face of mounting pressures on the deficit, what will Congress do?  Or not do?  Tick . . . tick . . . tick . . .