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Congress' New Temptation

Economic Trends


What to do with a budget windfall

It's remarkable what a robust economy, a roaring stock market, and a little time can do for a government's fiscal woes. At the start of the year Congress was looking down the barrel of a projected $124 billion federal deficit in fiscal 1997 and focusing on measures to balance the budget by 2002. By the time the fiscal year ended in October, the current budget deficit had melted away to a trivial $23 billion, and legislators were considering ways to spend an unexpectedly strong inflow of revenues.

"With next year a Congressional election year, it would be an act of extraordinary discipline if Congress resisted the temptation to curry favor with voters via new tax cuts or spending programs," says economist Mitchell Held of Smith Barney Inc.

Among the ideas already being floated are eliminating the income-tax marriage penalty, shortening the holding period for capital gains, and boosting educational outlays. The urge to splurge will be even greater if, as Smith Barney is projecting, fiscal 1998 produces an actual surplus approaching $20 billion---a possibility enhanced by the hefty capital-gains tax revenues generated by Wall Street's recent turmoil.

The temptation extends beyond Washington. Revenues of state and local governments have been growing so fast that surplus cash is piling up even though many have been cutting taxes. The upshot is that the total government budgetary position--reflecting all levels of government--is running its largest surplus as a percent of gross domestic product in nearly 20 years.

All of this bodes well for the bond market over the next few months, says economist L. Douglas Lee of HSBC Washington Analysis, because the government as a whole will be adding to the economy's aggregate savings. A year from now, however, governments will be operating in fiscal 1999 and implementing budgetary decisions made by legislators in the first half of next year. "The chief risk," says economist Mark Zandi of Regional Financial Associates Inc. in West Chester, Pa., "is that federal and state governments will assume that the revenue surge is permanent and will be too aggressive in cutting taxes and raising spending."

If that happens, a stock market slump or a recession, which isn't envisioned in the recent budget agreement, would make a balanced budget virtually unattainable for the foreseeable future. And it would become even more difficult to solve the massive fiscal problems that will confront the nation when the baby boomers start to retire after the turn of the century.

Meanwhile, Smith Barney's Held warns that excessive legislative generosity could actually threaten the expansion itself. "The longer the economy stays close to full employment," he says, "the greater the chances that the stimulative effects of another round of tax cuts would impel the Fed to step down hard on the monetary brakes."BY GENE KORETZReturn to top

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So far, state cuts favor the rich

As states with bulging coffers consider new tax cuts to dole out surplus revenues, they might consider the effects on different income groups. According to a new study from the liberal Center on Budget & Policy Priorities, state tax systems in the U.S. have become increasingly regressive in the 1990s--taking a larger proportion of income from low- and middle-income taxpayers than from higher-income groups.

In the early 1990s, reports the research group, states faced with recession-induced revenue shortfalls boosted income taxes, which fall most heavily on high-income households, by some $8.2 billion. At the same time, they raised sales and excise taxes, which hit low- and moderate-income groups the hardest, by $11.7 billion.

More recently, however, cash-rich states have been easing tax burdens. The problem is that almost all of the relief has gone to higher-income groups. In the past four years, the states have cut personal income taxes by $9.8 billion, often by trimming only the top rates. But they have cut sales and excise taxes by a mere $200 million. Indeed, the number of states with a general sales tax rate of 6% or higher has grown from 10 in 1989 to 17 today.

In light of the heavy impact of sales and excise taxes on the working poor--and the implicit goal of recent welfare reform to increase work incentives---the study's authors think states might do well to direct more of future tax relief to lower-income groups.BY GENE KORETZReturn to top

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