Windfall In, Windfall Out: What Could Shrink The Surplus

In his most recent congressional testimony, Alan Greenspan emphasized one of his core economic beliefs--namely, that federal budget surpluses have boosted investment and economic growth by keeping real interest rates lower than they would have been otherwise. This has also been a guiding principle of budgetary policies championed by the Clinton Administration. Indeed, during the January announcement of his nomination for a third term as Federal Reserve chairman, Greenspan said the Administration's commitment to fiscal discipline was instrumental in achieving the longest economic expansion in the nation's history.

Unfortunately, dramatic upward revisions in projected budget surpluses have made pre-election economic promises that much easier to toss about. A careful look at the numbers, however, indicates that the budgetary windfall may end up being considerably smaller than first meets the eye--and captures the political imagination.

Let's begin with the distinction between projected surpluses in Social Security and in the remainder of the federal budget. Congress has embraced President Clinton's proposal to save the substantial difference between payroll-tax revenues and Social Security expenditures during the next decade to cover shortfalls that will develop when the baby boom generation retires. This "lockbox" approach means that such surpluses, estimated at about $2 trillion over the next 10 years, would be dedicated to debt reduction and would no longer be available to finance either tax cuts or spending programs.

Breaking with this lockbox consensus, Republican Presidential candidate George W. Bush has proposed diverting about $1 trillion from projected Social Security surpluses into private retirement accounts. As I have explained in this column (BW--June 26), this would hasten the projected date of insolvency for Social Security unless benefits were cut dramatically. And even under optimistic assumptions about the stock market over the next 30 years, the projected returns from private accounts would fail to compensate for cuts in Social Security benefits, so overall retirement benefits would decline.

In a recent paper, Martin Feldstein, one of Bush's economic advisers, acknowledges that such a privatization scheme would require a substantial infusion of general revenues from the rest of the government budget to safeguard overall benefits levels. Feldstein's analysis confirms that there is no such thing as a free lunch.

According to the most recent estimates, the 10-year surplus in the non-Social Security portion of the federal budget will amount to about $1.9 trillion, double the estimate of just five months ago. This projection is based on the assumption that the economy will grow at an average rate of 2.9% a year over the next decade. That assumption seems reasonable by the standards of the past five years but was considered wildly optimistic when I served as President Clinton's economic adviser. Indeed, a heated disagreement between congressional Republicans and the Administration over whether a multiyear budget deal should be based on an economic growth assumption of 2% or 2.2% was a major reason behind the two government shutdowns in 1995.

PAINFUL CHOICE. Yet even if current economic assumptions prove correct, there will be far less than $1.9 trillion available for tax cuts and new spending initiatives over the next decade. Vice-President Al Gore has proposed that the projected 10-year surplus of $400 billion in Medicare's Part A program be saved, or "locked up," to extend its solvency date through 2030, and both houses of Congress have passed legislation to that effect. According to the Center on Budget & Policy Priorities, an additional $400 billion is required simply to maintain current spending levels on existing discretionary programs, adjusting for inflation and population growth, and to extend expiring tax credits that are routinely approved by Congress. That leaves slightly more than $1 trillion for all other purposes, including tax cuts, increases in spending on existing programs, and funding for new initiatives.

Both the tax cuts proposed by Republican leaders in Congress, with a 10-year price tag of $1.8 trillion, and those proposed by Bush, with a 10-year price tag of $1.7 trillion, including interest costs, significantly exceed this amount. If such cuts were to become law--an almost certain outcome if the Republican Party retains control of Congress and wins the Presidency--there would be no money left to address other priorities such as reducing the ranks of the uninsured, adding a prescription drug benefit to Medicare, addressing environmental dangers, strengthening national defense, and "leaving no child behind."

The country would quickly find itself confronted with a painful choice between sacrificing these priorities and running federal budget deficits to finance them, thereby undermining the fiscal discipline that has served as the foundation of the unprecedented expansion. We've seen this trade-off before, and we know what happened. Haven't we learned from the past?