What Do You Do With A Cool Trillion?
Funny how $1 trillion focuses the mind. Until recently, Washington was locked in an endless debate over the role of government in an era of deficits. Even in 1998, when surpluses first appeared, pols still were playing the same old game: What Democratic spending programs would have to be cut to fund which GOP tax cuts? How should Social Security be trimmed to assure its solvency?
But thanks to the massive tax receipts being generated by the New Economy boom, the debate is changing. On June 28, the Office of Management & Budget issued new estimates showing that stronger growth--2.5% vs. the previously predicted 2.3%--could boost the surplus by $1 trillion over 15 years.
The startling possibility--and it remains only that--of surpluses as far as the eye can see may transform economic policy, opening new options both this year and beyond. "We've moved into a different era," says Urban Institute economist C. Eugene Steuerle. "This is going to have extraordinary implications for both fiscal and monetary policy."
Suddenly, Washington seems ready to shift trillions in general revenue dollars to Social Security and Medicare, ensuring paper solvency well into the next century. And both President Clinton and the GOP are backing a dramatic buydown of the public debt. Money may be available to shore up Social Security and Medicare without painful benefit cuts. And the Administration even hopes to add prescription-drug coverage to Medicare, to be funded partly by the new abundance. The huge surplus may even bring the Administration and the GOP together on a tax-cut deal later this year, President Clinton told BUSINESS WEEK on June 29.
Although long-range budget forecasts are notoriously shaky, there's no question that the economy's surprising surge has created a new engine for future surpluses. Just three years ago, budgeters thought revenues for fiscal 1999 would be $1.68 trillion. Now, with growth hitting 4.3%, they figure they'll be $100 billion higher. Over the next 15 years, according to the Administration, cumulative surpluses will near $6 trillion--$1 trillion more than predicted just five months ago.
The President used the release of the new estimate to float a series of proposals that would define the federal budget for years to come. He wants to use the surpluses now building up in Social Security to wipe out the $3 trillion public debt over the next 15 years. Buying back Treasury securities would save the government $100 billion a year in interest costs. All those savings would be used to shore up Social Security later on.
BOOMER BONUS. Clinton also proposes creating a special category of spending for education and children's programs that, like Social Security and Medicare, would be treated separately from ordinary budget items. Over 15 years, the Administration would allocate $156 billion for such programs, while increasing defense and environmental protection a bit and cutting taxes by $250 billion.
But Clinton reserves the bulk of his New Economy bonus for baby-boomer retirement needs. Some $790 billion would be pumped into Medicare, while $600 billion would be shifted to Social Security.
There are, of course, other options for reordering spending priorities, given the new outlook. Republicans favor diverting some of the newfound money from the Federal coffers in the first place by cutting income taxes by close to $1 trillion over 10 years. "Republicans think if you give this money back to the people who earned it, they would have better use for it," says Lawrence B. Lindsey, a top economic adviser to Texas Governor George W. Bush. Like the Administration, Republicans would spend more on defense and on some domestic programs, pay down the debt, and protect Social Security by stopping "borrowing" payroll taxes for general government spending.
It's not hard to see a compromise here. If Clinton accepts a bigger tax cut, Republicans might buy into a limited Medicare drug benefit and modest hikes in domestic spending. Both sides could use clever accounting to paper over Social Security and Medicare solvency.
BOND BIND. But would a grand October compromise result in fiscal policy that fits the New Economy? After all, keeping the expansion going is the key to the virtuous cycle that brought the U.S. to the Promised Land of surpluses.
On the plus side, most economists think the single biggest element of both camps' plans--shrinking the debt--will benefit the economy. It "will lower real interest rates, encourage investment, reduce borrowing from abroad, and increase living standards," says Harvard University economist Benjamin M. Friedman.
But there are problems with retiring the debt entirely. Without government borrowing, there would be no Treasury bond market and the Federal Reserve would lose a vital monetary tool: buying and selling Treasuries to adjust liquidity.
In addition, the single-minded focus on debt repayment means "a very tight fiscal policy," notes an adviser to Presidential hopeful George W. Bush. "Clinton is talking about a surplus that would be close to 3% of gross domestic product." Democrats agree. "This will constrain policymaking," says former Congressional Budget Office Director Robert Reischauer.
Liberals are furious. They insist that debt elimination should not take precedence over education, training, and other human-capital investments. That's how states have used their surpluses in recent years. Jeff Faux, president of the Economic Policy Institute, a labor-funded think tank, says the government should spend up to $100 billion a year more on such programs because they boost productivity and help the poor benefit from growth. "In '93, Clinton told us that while public investment was important, we had to get the deficit down. Then we were told we had to balance the budget. Then we had to run surpluses to take care of Social Security. Now, we have to get the debt to zero before we can get poor kids into Head Start. This is crazy."
Another consequence of the Clinton and GOP plans would be to cut off debate over Medicare and Social Security reform. With surplus money to keep the programs operating as they do now, politicians are disinclined to revisit touchy subjects such as shifting some Social Security funds into marketable securities or trimming benefits.
That, warn critics, leaves the retirement of 76 million baby boomers a potential time bomb for the 21st century. Without structural changes in Social Security, and with an added drug benefit for Medicare, Washington will be spending nearly 80% of its resources on aging baby boomers by 2040. "There's almost nothing left for anything else," says Steuerle.
The sudden appearance of a Second Peace Dividend--this one generated by technological innovation, strong productivity growth, and globalization--has Washington giddy. When the delirium wears off, though, policymakers may take the time to consider more imaginative ways to use the windfall--and ponder whether it will materialize on schedule.