CBO just posted its latest budget update. The headline number is a $1.2 trillion deficit in fiscal year 2009. That’s indeed alarming—especially considering that it excludes the $750 billion or so in additional stimulus that president-elect Obama promises. But beyond the next couple of years, things don’t look that bad. The economy recovers, the Bush tax cuts expire, and by 2018, the budget deficit weighs in at a svelte $188 billion. Admittedly, this is still a big reversal from previous forecasts, which held out the promise of surpluses (not to mention the actual, real surplus on the books when President Bush took office). But a sub-$200 billion deficit doesn’t look too scary compared with the current situation.

Senator Mitch McConnell proposed over the weekend to cut the 25-percent tax bracket to 15 percent as part of the economic recovery package. This might make sense politically, but it’s a pretty dubious economic stimulus. On the positive side, the proposal wouldn’t cost much compared with the hundreds of billions bandied about by the president-elect. Total cost: $18 billion in 2009. But it’s so cheap because it would throw 5 million taxpayers onto the AMT, boosting AMT revenues by almost 80 percent. (More middle-class taxpayers fall prey to the shadow tax system because the lower tax rate pushes regular tax liability below the AMT threshold.)

Nice to see Tom Friedman on the energy tax bandwagon. As he wrote in his Dec. 27 New York Times column, “I’ve wracked my brain trying to think of ways to retool America around clean-power technologies without a price signal—i.e., a tax—and there are no effective ones.” Friedman needs to give his cranium a holiday break. Policymakers have been searching for this magic bullet for years, without success. They’ve tried government-mandated (CAFE) auto mileage standards, tax credits for the use of everything from hybrid cars to low-E windows, massive government subsidies for production of alternative fuels and sincere pep-talks from sweater-clad Presidents. Nothing has worked. Take a look at this chart from the Energy Information Agency:

I’ve been reading up on the Great Depression (never say those of us at TPC don’t know how to have fun) and am struck by one overriding thought: Even with the benefit of 80 years of hindsight, economists still can’t agree on either what went wrong or how the economy got back on track. There is an important lesson here. Famously impatient, Americans not only expect government to fix today’s economic crisis, they demand it. Barack Obama, I suspect, will have about a year to turn things around before the public turns on him. Yet, if we still don’t know what happened in 1929, how can we expect policymakers to truly understand—and correctly address—events happening in real time today?

No. The New York Times suddenly discovered a study by Fed economist, Hui Shan, which they think reveals a new cause for the housing bubble. Shan's study found that a 1997 tax change allowing capital-gains-tax-free sales of homes (up to $500,000 of gains for couples and $250,000 for singles) increased housing sales. The Times concluded that this change might have contributed to the housing bubble by increasing the demand for owner-occupied housing. They tell the story of an investor who repeatedly bought homes, lived in them for the required two years, and then sold them at a tax-free profit, and inferred from this anecdote that this was a significant part of the bubble.

George Bush just spent $13.4 billion of your money to kick the automaker mess into the Obama Administration. Funny how easily so many billions slip through our fingers these days. Seemingly unable to decide whether to let Chrysler and GM reorganize in bankruptcy or engineer a full-blown government bailout of the deeply troubled automakers, President Bush tried to split the difference. He is offering a $17.4 billion loan--$13.4 billion upfront and another $4 billion in February. The deal is filled with demands for cosmetic concessions such as limits on executive comp and corporate jets—none of which are financially meaningful in any way. The White House calls this a loan, but don’t count on a dime ever being repaid.

There may be no provision in tax law more bizarre than the estate tax. In just a year and a few days, on Jan. 1, 2010, the levy will expire and estates of any size will be passed on tax-free. A year after that, the tax will return with a vengeance. Uncle Sam will take 55 percent of assets of more than $1 million.

Is it time for the U.S. to consider a Value Added Tax? More and more tax experts think so. But the politics isn’t yet getting easier. One problem: While more specialists are joining the VAT fan club, they can’t agree on what to do with the money. TPC’s Len Burman has proposed a VAT to supplement the income tax and pay for health care. Michael Graetz, once a top tax aide to the senior George Bush, would use one to get most Americans off the income tax. At the TPC/Tax Analysts tax reform conference on Dec. 5, Pam Olson, who was a top tax aide to the today’s President Bush, endorsed the levy as a way to buy down corporate tax rates. Once the tab comes in for the trillions of dollars Washington is spending to stimulate the economy and bail out the financial markets, I am certain others will propose a VAT simply to help pay the bills.