Budget deficits may force Bush to make hard choices

America is a country living beyond its means. That simple truth places a giant question mark on the radical agenda George Bush has set out for his second term.

It features the part privatisation of social security, major changes in the US tax code, and moves to make permanent the massive "temporary" tax cuts of his first term. The only problem is that the US is in no position to pay for them.

The measure that would define the Bush domestic legacy would be an overhaul of a social security system whose origins go back to Franklin Roosevelt. Mr Bush wants to allow workers to invest part of the contribution that now goes to the government into new tax-free accounts.This would cost the system between $1trn and $2trn.

Few would argue there is a pressing need for an overhaul of the US tax system which is grossly overcomplicated and riddled with special interest loopholes.A simplification, however, would be part of Mr Bush's wider agenda of lowering taxes for the well-paid. The President wants to move towards what critics say is a more regressive system, shifting the tax burden from income to spending.

The third item on the agenda sounds innocuous enough - a removal of the "sunset clauses" which have imposed theoretical time limits on some of the $2trn of tax cutssince Mr Bush took office in 2001. This accounting device has enabled the administration to claim that the federal budget deficit will decline later in the decade. With this measure, that will no longer be possible. One way or another, the federal budget deficit will increase, if nothing is done.

The US is saddled with a record budget deficit of $413bn (£223bn) and a trade deficit running at $600bn (£326bn). On one thing the experts agree. This cannot go on for ever.

The Bush administration has cut taxes but has boosted spending at the fastest rate since Lyndon Johnson's "Great Society" era. The President has yet to veto a single spending bill sent him by Congress.

Thus far he, and the US, have got away with it. A combination of surging productivity, low commodity prices and cheap imports has kept inflation and interest rates low. Taxes have been falling and, thanks to low interest rates, debt has been cheap. As a result, the American consumer has kept spending. The result has been a solid recovery from the 2000/2001 recession, and a respectable growth rate of 3.5 per cent or more. But the recovery is financed by borrowing, mostly from abroad, and the bills may be about to come in. Productivity is slowing, the price of oil is soaring and other commodity prices are also climbing.

The US gets away with both deficits thanks to the willingness of foreigners to hold dollars despite low interest rates. The nightmare of the Federal Reserve is that foreign investors and central banks will stop buying US stocks and government securities.

If that happened - and there even are signs the process may have started - the Fed would be forced to raise interest rates more quickly, pushing up the cost of consumer borrowing and mortgages. The US property bubble might burst. Growth would then stall, and unemployment would rise.

And there is an even deeper structural problem. In a few years, the first baby-boomers will retire, placing a huge strain on pensions, welfare and the like - paid out of social security.

If the the system is to stay solvent, even without privatisation, either taxes must rise or benefits be cut. This is the sort of choice that Mr Bush or any other politician hates to make.