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A Bogus Budget Surplus?

Economic Trends


Federal trust funds skew the tally

Call it the amazing shrinking federal deficit. A year ago it was projected to hit $124 billion in fiscal 1997. Now, the final number has been revised down below $22 billion. And for the 12 months ended in November, the federal budget is reported to have actually been in surplus to the tune of $2.4 billion.

Predictably, politicians are already taking credit for the good news and calling for new tax cuts to share the benefits with voters. On the table are proposals to do away with the income tax marriage penalty, boost defense spending, and provide new tax credits for child care and education.

While he doesn't criticize Washington's self-congratulatory mood, economist Daniel E. Laufenberg of American Express Financial Advisors Inc. points out that the deficit picture isn't as bright as it seems to be. That's because the official "unified" budget reflects not only the shrinking gap between regular government revenues and outlays but also the money piling up in federal trust funds--which really represents Washington's future obligations.

Government trust funds--mainly Social Security, Medicare, and federal civil service and military retirement funds--are made up of taxes and other receipts earmarked by law for specific purposes, and any funds they accumulate are invested in Treasury securities until they are spent. Thus, as long as trust fund balances are growing, they act to reduce the unified deficit.

The catch, of course, is that the Treasury debt securities held by the trust funds--currently over $1.5 trillion--will have to be redeemed in the future. Indeed, they're counted as part of the national debt even though they mitigate the federal deficit. And when these securities are cashed in, the government must come up with the money to redeem them--via new taxes, more borrowing, or other expenditure cuts. Laufenberg notes that this is already happening to the Medicare hospital insurance trust fund and will start happening to the Social Security funds in a dozen years.

Many economists regard the trust funds as an accounting fiction with little current relevance to the real economy. What matters is not what the government borrows from itself but what it borrows from the credit markets. When trust funds grow, as they did by $151 billion in fiscal 1997, the government's borrowing needs decline and interest rates tend to fall.

But Laufenberg isn't so sure. Noting that real long-term interest rates are, at nearly 4%, unusually high, he thinks they partly reflect fears of future surges in borrowing to redeem the huge pileup of Treasury securities in the trust funds. "The public may think the budget is close to balance," he says, "but the financial markets know better."BY GENE KORETZReturn to top

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Factory output charges ahead

Rising capacity utilization across Europe suggests that industrial output is picking up steam. Based on preliminary data, economist J. Paul Horne of Salomon Smith Barney reports that the manufacturing operating rate in the European Union rose to 83.3% in the fourth quarter, its highest level in years and far above its 1993 recession low.

Horne notes that factory operating rates in Austria, Belgium, Denmark, Finland, and Sweden are close to or above previous cyclical peaks, while Germany and Britain boast rates of 86% and 85% (vs. prior cyclical peaks of 89.5% and 86.4%).

Despite these trends, Horne warns that Europe's economic recovery could still falter in 1998--particularly if Asian slowdowns seriously hurt its export growth.BY GENE KORETZReturn to top

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