The Power to Tax, Power to Destroy : Latest deficit-reduction proposal is a lulu

Is two or three weeks enough time for Washington’s leaders to deal with a $170- billion budget deficit that threatens to eat the U.S. economy alive? Not if limiting the amount of state and local taxes that can be deducted on federal tax forms is the best idea they can produce. And not if Congress, which starts its August vacation Friday, can’t tear itself away from raw politics and focus on negotiating a deficit package.

In recent weeks, political leaders have grudgingly agreed that at least $50 billion a year must be carved from the deficit to give the economy room to breathe and that the difference should be split between higher revenue and lower spending. President Bush started the ball rolling, retreating from his pledge on taxes because of low growth and high interest rates.

But since then, it has been mostly politics as usual. Last week’s episode, for example, started with a proposal that was tentatively approved at a meeting between White House staff and top congressional Republicans. It would put a limit of $10,000 on the amount of state and local taxes that could count in reducing federal taxable income.

Word of the meeting leaked. Democrats promptly decided to wait--perhaps until after Labor Day--to put forward their own tax ideas, leaving Republicans all alone on the firing range.

The President’s advisers let him down on this one. Because a limit on state tax deductions affects a relatively small number of high-income taxpayers, the advisers may have figured it would produce the fewest complaints. Obviously, they did not expect both Republican and Democratic governors to attack it.

Then, too, the idea would produce just $3 billion the first year, short of a decent down payment on $25 billion in new money Washington needs to match budget cuts. Even with some $7 billion from raising the tax on beer, wine and spirits to 25 cents an ounce of pure alcohol, negotiators need another $15 billion.

The idea also ignores the reality that cities and states are near the breaking point. After paying for drug treatment, better schools, health care and other crying social demands, local government needs help at least as badly as Washington. The proposal would have a chilling effect on states that are trying to raise enough money to finance their own programs.

These arguments are based not on ideology but on hard-headed assessments of the nation’s future. Felix Rohatyn, the well-known New York investment banker, argues that helping the states is an essential part of getting the United States into shape to compete in the marketplace with other big powers. David Aschauer, senior economist at the Federal Reserve in Chicago, thinks that the biggest single factor holding back productivity in the country is the sorry state of so many highways, water and sewer systems and other elements of the support base for producing and moving goods.

It’s true that, more than anything, the nation needs a budget that at least moves its government toward living within its means so that interest rates can come down. Next in importance is doing it right.