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June 7, 2006

What Paulson needs to do

By

Assuming no unexpected surprises on the road to confirmation, Henry M. Paulson Jr. of Goldman Sachs will soon be America's next Treasury secretary. Some observers wonder why Paulson agreed to leave a prestigious Wall Street position to serve in the last couple of years of a lame-duck administration, but many big policy decisions have yet to be made.

A strong Treasury secretary can wield enormous influence. What remains to be seen, though, is whether Paulson decides to get involved and fight on the right side. Some key battles include:

Extending supply-side tax cuts. Paulson already has a good track record on tax policy. He has favorably commented on the pro-growth impact of the 2003 tax cut, particularly the reduction in the double-taxation of dividends and capital gains. With luck, this is a sign that he will vigorously push to make these cuts permanent. In a competitive global economy, it's crucial that America avoid mistakes that would increase the tax burden on work, saving and investment.

Implementing dynamic scoring. It is difficult to implement good tax policy in Washington in part because the revenue-estimating process deliberately assumes that taxation doesn't affect economic performance. This is preposterous, as America's strong growth after the 2003 tax-rate reductions proves. Economists have long urged that the revenue-estimating process be modernized to reflect the fact that lower tax rates on productive behavior yield some revenue feedback. This doesn't mean tax cuts necessarily "pay for themselves," but it does mean that the revenue consequences of pro-growth tax cuts can be much less than currently estimated.

Protecting the dollar. Paulson has made some unwise statements suggesting that he doesn't believe in a strong dollar. Indeed, this may be why financial markets didn't react positively to his nomination. No nation has ever increased its long-run prosperity by debasing its currency. Some protectionists say a weaker dollar would reduce the trade deficit, but this foolishly assumes that a trade deficit - which largely exists because America is growing faster and has more income than our major trading partners - is a bad thing.

Restoring fiscal sanity. The Treasury secretary normally handles the tax side of the fiscal equation. While that is more than enough to keep anyone busy, there is a desperate need to get spending under control. The budget has ballooned by 45 percent since George W. Bush became president, and most of the increase has gone for domestic programs and departments that should be abolished, not expanded. Putting the brakes on spending - and figuring out reforms that will protect taxpayers from giant increases in entitlement spending once the baby boomers retire - are critical challenges. These decisions also have a big impact on tax policy, since there's no way America can have a pro-growth tax system if we eventually wind up with a French-size welfare state.

Steering international bureaucracies in the right direction. One of the Treasury secretary's less visible roles is to be the U.S. government point man in dealing with bureaucracies such as the World Bank and International Monetary Fund. These institutions are supposed to promote global growth, but they generally use their influence to encourage statist policies in the developing world. At a minimum, Paulson could insist that these bureaucracies concentrate on policies - such as lower tax rates, deregulation and spending reductions - that lower the burden of government.

Avoiding senseless regulation. The Treasury Department has substantial regulatory authority. Sometimes this power is used wisely, such as the current effort to rein in scandal-plagued government-favored entities such as Fannie Mae and Freddie Mac. In other cases, Treasury imposes heavy costs. Anti-money laundering rules are a good example. They cost the economy $7 billion annually and make it more difficult for poor people to access the banking system. Yet Treasury continuously makes these regulations more onerous even though there's no evidence that they hinder crime in general or terrorism in particular. Paulson lacks a track record on these issues, but his association with some left-leaning environmental organizations leads some to worry that he may not understand the valuable role of cost-benefit analysis.

Henry Paulson can be a caretaker Treasury secretary if he wants to. But one certainly hopes that a man with his resume has much bigger goals. Being Treasury secretary for the world's most powerful nation is a unique opportunity to create a lasting legacy for America. From tax policy to entitlement reform, Paulson can play a critical role in making the United States more competitive and prosperous.

Daniel J. Mitchell is the McKenna senior fellow in Political Economy at The Heritage Foundation.

First appeared in the  Philadelphia Inquirer

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