As any student of introductory economics knows, the government's budget surplus is part of our nation's savings. And far from being a problem, saving is necessary to finance investment in productive capacity that increases future living standards. So, with the private saving rate at record lows, it should be good news that the government is projected to run large budget surpluses over the next decade. Why, then, is Federal Reserve Chairman Alan Greenspan, an outstanding student of economics, concerned about "looming surpluses" and calling for "surplus-lowering policy initiatives?" It's not because the nation is saving too much. The record current-account deficit, which measures how much foreigners are lending to us, is a sobering reminder that we are in fact saving far too little.
So what is the real source of Greenspan's latest anxiety? His analysis isn't economic; it's political. He isn't worried about the amount of government savings per se. Greenspan is worried that once the government's outstanding debt has been paid off, any additional government savings will be invested in private assets. The government's investment decisions will then fall prey to political pressures, "risking suboptimal performance" and "diminished economic efficiency," according to Greenspan. To counter these risks, he proposes curtailing government saving. And, as an advocate of minimal government, he prefers tax reductions to spending increases to realize this goal.
POLITICAL MEDDLING. Greenspan's arguments can be challenged on several grounds. First, as he himself notes, projections of future surpluses are "necessarily subject to a relatively wide range of error." That's why he warns that any long-term tax cut should be phased in and conditioned on the realization of targets for the budget surplus and federal debt. So far, President Bush has conveniently chosen to overlook this warning as he urges Congress to pass his plan for large across-the-board tax cuts. Perhaps unwittingly, the chairman's admonition to reduce future surpluses has unleashed a feeding frenzy of tax-cutting plans threatening to dissipate the hard-earned fiscal restraint of recent years.
Second, he argues that tax cuts are only one way to reduce government surpluses. Polls reveal that most Americans actually prefer the equally effective alternative of additional spending on education, health insurance, Medicare, and Social Security.
Third, there are ways to insulate the investment of government surpluses in private assets from political influence. For example, the government could invest its holdings in an index fund tied to a total market benchmark, or it could contract out benchmark returns, allowing independent money managers to choose their own portfolios to achieve them. It simply isn't necessary to sacrifice the actual benefits of government saving to avoid the hypothetical risks of political meddling in the allocation of such saving.
BOOSTING SOCIAL SECURITY. Fourth, instead of reducing government savings, why not transform it into additional retirement savings? Indeed, Greenspan himself has suggested transferring some of the government's saving to private accounts and committing some to ensuring that Social Security is adequate to meet our long-term needs. One way to do this would be to use part of the on-budget surplus, which doesn't count the social security surplus, to fund the creation of new private accounts to complement existing Social Security benefits. Although President Bush refuses to admit it, the partial privatization of Social Security, one of his campaign favorites, would require a substantial infusion of additional revenues into Social Security to cover the cost of the new accounts while paying promised benefits.
Another approach, described in a recent paper by Massachusetts Institute of Technology economist and Nobel laureate Franco Modigliani, would be to use part of the on-budget surplus to finance the conversion of Social Security from a pay-as-you-go system to a fully funded pension system. In the latter, the benefits of retirees are covered by the returns on accumulated contributions during their working lives, not by the contributions of current workers. Compared with a pay-as-you-go system, a fully funded system requires smaller contributions--that is, lower payroll taxes--for a given level of benefits because the return on accumulated savings helps defray the cost. A fully funded system also safeguards the principle of defined benefits, while a privatization approach exposes retirees to uncertain benefits based on their investment savvy and luck. Finally, a fully funded system fosters higher levels of national saving, productive investment, and living standards. This is most important for a savings-starved nation like the U.S.
The U.S. suffers from a shortage of savings--not a surfeit of surpluses. Let's not allow political shibboleths to distort sensible economic policy. Let's save some of the temporary surpluses for our future rather than squander them on tax cuts we don't need.