The Surplus: It's Up. It's Down. It's Up...

Weighty decisions are being based on some sketchy numbers

It's Washington's equivalent of finding a paper bag stuffed with $100 bills on the sidewalk. The Congressional Budget Office estimated on July 15 that the Treasury will boast a $1.6 trillion surplus by 2008--up an astonishing $932 billion from the CBO's estimate just four months ago. It took about a nanosecond for a gleeful House Speaker Newt Gingrich (R-Ga.) to draft plans for tax cuts. The White House insists on using the windfall to bolster Social Security.

These are weighty policy decisions. Yet they're based on forecasts that are pure guesswork about the next 10 years. Could Asia's woes or the Year 2000 glitch trigger a U.S. recession? Might the bull market turn bearish? "There's a Murphy's law of budgeting--you can't anticipate everything," concedes Rudolph G. Penner, CBO director from 1983 to 1987. "There's a 50% chance that the bottom line in 2003 will be $200 billion higher or lower" than the current forecast of a $136 billion surplus, he adds.

WHOOPS. Indeed, the only forecast that seems solid now is the one for the fiscal year ending Sept. 30--and even that has been sharply revised. In January, the CBO figured the budget would end up $5 billion in the red. But an unexpected flood of tax revenues now seems likely to create a $63 billion surplus. That's only if you include payroll taxes to finance Social Security, which is running a $104 billion annual surplus this year. Exclude the retirement system, and the government will be a tad in the red through 2008, the CBO says.

Even including Social Security, how realistic is the CBO's estimate? The agency conservatively assumed growth will average 2.2% a year through 2008, down from the 2.5% rate of the past 10 years and the 3% rate since 1994.

Pro-growth Republicans gripe that those estimates are low. They note that CBO forecasts have consistently understated the economy's growth over the past four years. "The errors have been enormous," acknowledges Alicia H. Munnell, a former member of President Clinton's Council of Economic Advisers. If the Republicans are right, the impact would be huge. Raise the growth forecast by 0.5%, and the accumulated surplus in 2008 would swell to $2.5 trillion. That's enough to fortify Social Security, pay down some of the national debt, and even provide some tax relief.

What about an error in the opposite direction? In the '80s, the CBO repeatedly understated the ballooning budget deficits. It could happen again. Suppose the U.S. has a mild recession in 1999 that lowers the gross domestic product by 0.8%. "The projected surplus would vanish, and you'd have a $100 billion deficit in 2000," says Penner.

When such small economic changes have so profound an effect, politicians need to proceed with caution. Making long-term commitments based on flaky estimates is a risky business.