Taylor’s correct that the massive tax increases necessary to fund these deficits and programs shouldn’t happen, but it’s not clear to me that they won't. A Democratic Congress is talking about adopting John McCain's plan to tax health-care benefits. While this would be a tax on the middle class (read: everyone) that Obama said he wouldn’t impose, he’s clearly willing to sign a bill that has such a tax.

The administration is starting to float trial balloons about a new value-added tax (VAT). Many of my non-US readers will be familiar with VAT taxes, especially in Europe. A combination of a VAT and the taxing of health-care benefits would raise enough to get us to a deficit of "only" a few hundred billion. Take away the Iraq war and you get even closer. You can make an economic case that a VAT tax would be preferable to an income tax.

However, the administration isn’t talking about a substitute, but an additional tax. There’s momentum in the heavily Democrat-controlled Congress for large new health-care programs. While there’s resistance to large deficits on the part of a few moderate Democrats, there’s a chance they could be brought aboard with a tax (or a series of new taxes) that would offer the potential to pay for the new programs. (Even though everyone knows the cost overruns on new health-care benefits will be much larger than estimated.)

As much as it grieves me to say it, a tax on health-care benefits, or a VAT tax large enough to hold the proposed deficits to something under 3% of GDP, would be preferable to running decade-long trillion-dollar deficits - which would destroy the US economy and the dollar, and do severe damage to the world economy. (For the record, I’m assuming the Bush tax cuts are history.)

But while a large tax increase would keep the economy from crisis and collapse, it’s not without grave consequences: It will put a serious crimp in economic growth. It will lock in European growth rates and European-like unemployment rates. And we’ll be using those tax increases to fund new spending, though we won’t have solved future problems with Social Security and Medicare - both of which will require massive increases in spending in another 5-7 years. This means that either a cut in benefits or another round of growth-crippling tax hikes is down the pike.

A third path would be to simply raise taxes on the rich, say no to increased spending on programs until we can afford them, hold the line on any new spending, and see if we can reintroduce the gradual budget control that was the result of the stand-off (and to some extent, cooperation) between Gingrich and Clinton.

I put about a 5% probability on the third scenario happening. Better than the chances of a snowball in hell, but not much. The first disaster scenario is about a 35% probability, which is quite scary. If we do choose such a path, short the dollar, buy gold, and invest abroad. It will be a very tricky and difficult environment.