As the world awaits with bated breath the revised Congressional Budget Office projections for the federal budget deficit in 2009, 2010 and beyond, one thing must remain perfectly clear. There is no way that the capital markets will put up with sustained US budget deficits over 10% of Gross Domestic Product. Since the current political class is incapable of cutting spending (indeed it appears to want to spend still more, in yet another “stimulus plan”) taxes will go up, no question. The interesting question is: which?

I wrote last week about one tax that could usefully be imposed which would actually do some economic good: a Tobin tax, by which transactions in stocks, bonds, commodities and foreign exchange would be subject to a very small transactions tax on each deal carried out. The purpose of this would be to limit “high velocity trading,” computerized trading with millisecond lead-times by which Wall Street sucks value out of the economy while destabilizing prices and making markets more dangerous and unstable for long-term investors. The yield of such a tax would be only a few billion, but every little helps, and it would assist in re-diverting economic activity from Wall Street rent-seeking into something useful.

If I believed in global warming, I would regard a carbon tax as another such economically beneficial impost. By taxing carbon emissions, it would divert energy usage into less carbon-dependent forms and encourage conservation, therefore preventing the dangerous long-term warming of the planet. The problem is, the evidence does not appear to me to justify belief in global warming; certainly the effect is dwarfed by decades-long natural fluctuations, which have caused global temperatures in the last few years to be significantly below 1998’s peak.

Imposing heavy government regulations because of an unproven but hysterically maintained popular fad is disgraceful. However a moderate carbon tax would be no more economically harmful than any other tax and might be worth imposing on the “precautionary principle” that every now and then, hysterically maintained popular enthusiasms turn out to have a modicum of truth behind them. Currently, I don’t see it, but you never know.

A carbon tax would meet with enthusiasm among the chattering classes and do little harm. There are other taxes which would also do little economic harm, possibly even some good, but would be met with huge opposition from “opinion formers.” Two of these were proposed by the Obama administration in its budget, but were declared “dead on arrival” in Congress.

One was a reduction in the tax deduction for home mortgages for those with incomes above $250,000. The US political penchant for subsidizing housing, including the fearsomely expensive rescues of Fannie Mae and Freddie Mac, has been hugely damaging in the last decade and promises to continue being so going forward. It diverts resources from productive investment to building and buying houses that are both larger and more dispersed than is economically optimal.

When Tim Geithner, a career bureaucrat whose earnings have rarely if ever exceeded his current Treasury Secretary’s salary of $191,300, has difficulty in selling his $1.6 million house in Larchmont NY, you know that even the smartest of the US middle classes have got their spending and investment priorities impossibly skewed. Removing the home mortgage interest deduction, or at least capping it at $10,000, would reverse this distortion. Running silver stakes through the hearts of Fannie and Freddie would help too, of course. Needless to say the Ginnie Mae direct government guarantee program, supposedly responsible for $1 trillion of mortgages in 2009, is another accident waiting to inflict itself on taxpayers.

Another noble but doomed effort by the Obama administration was the attempt to cap the tax deduction on charitable donations. The ability to deduct such donations is an enormous and unjustified loophole in the US tax code, protected by sentimental affection for everybody’s favorite charitable cause. In reality it has spawned a gigantic nexus of political agitation organizations, which have stretched the definition of “charity” beyond all meaning in order to attain favorable tax status. These unpleasant outfits are also granted other favors, such as exemption from the “do not call” regulations protecting citizens from telephone harassment.

Many of these tax-advantaged organizations are hostile not only to the free market but to the kind of sustained middle class values that are essential for a society to prosper, both economically and socially. Far from deserving special favors from the taxman these groups, both domestic charities and international NGOs, would in a well-run society be tightly regulated and prevented from diverting public resources to value-destroying activities. Both US society and the unfortunate developing world would thereby be greatly enriched.

The above discussion has I hope illuminated the options for raising necessary revenue without doing significant economic damage. If the revenue thus raised proves insufficient, other revenue sources are possible, but they are likely to prove economically damaging. Some of them however are more damaging than others.

The most tempting source of revenue to lovers of big government is a value added tax. It is tempting because, falling as it does on sales transactions and being incorporated into sale prices, it is much less visible to voters than an income tax. It also has the virtue of being largely self-enforcing, since every business organization, including retailers, has the incentive to report every penny of VAT “inputs” they incur, and to charge VAT on their outputs, so evasion becomes very difficult. Political conservatives groan that VAT is especially burdensome on informally run small businesses; this is because most other taxes are easily evaded by them.

VAT also has the virtue of taxing consumption, not income, thereby encouraging production and saving. In the US economy, devoted as it has been to excessive borrowing and consumption, this is no bad thing. Its main disadvantage is that, added to an income tax, it allows government to increase spending to French or Swedish levels, with consequent corrupting and debilitating effects on the economy and society.

Tariffs are universally despised by economists, but the economists are wrong. Government must raise revenue somehow and there is no obvious reason why modest taxes on imports are more damaging than income taxes, rather the reverse. Certainly a great deal of economic and societal damage was done by the “unilateral disarmament” of British economic policy between 1846 and 1932, in which tariffs were abolished without regard to the fact that foreign countries still had them. By that foolish policy, British agriculture and its rural-dominated society was almost wiped out, while the hollowing out of British industry, barred from its natural Imperial markets by tariff-protected foreign competition, was only a few decades delayed.

Nevertheless, there are real global benefits from “comparative advantage” by which goods are produced in the most efficient market. Moreover the political temptations are irresistible for governments to raise tariffs in economic downturns, producing the kind of economic death-spiral caused by the 1930 Smoot-Hawley Tariff and fortunately avoided this time around. International mechanisms for preventing unilateral tariff increases, like the World Trade Organization, are thus beneficial. In an ideal world, such organizations would allow uniform modest tariffs, by which revenues could be raised without huge distortion of “comparative advantage.” In the real world, raising tariffs is probably too dangerous.

Finally, we come to income taxes and social security taxes. These have two principal problems. First, high marginal rates, significantly above 50%, have a large disincentive effect and almost certainly yield no net revenue or even reduce revenue and damage the economy in general. The 90% rates common in Britain before 1979 were thus both counterproductive in terms of revenue and hugely damaging to economic growth; they were a product of pure political spite and envy. An economically competent Conservative government after 1951 would have reversed them forthwith, thus preventing thirty years of relative economic decline. This adverse effect happens for rich an poor alike; high marginal rates from phase-out of negative income taxes (the “Earned Income Tax Credit”) and social security contributions is just as damaging as high marginal rates on millionaires.

Second, if as in the United States today, less than half the population pays effectively all the income tax, political incentives can become distorted. Even if social security taxes and sales taxes are paid by the great majority of people, an income tax levied at high rates on a minority is subject to incessant agitation by the majority for unjustified increases.

Hence an increase in income tax rates significantly beyond their present levels (the marginal rate of which including state taxes and social security rises above 50% at several points in the income scale) would be economically unproductive. Sadly, politics being what it is, it will almost certainly be the first resort of politicians when further borrowing becomes difficult. As discussed above, there are many superior alternatives if revenue must be raised.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)