Just How Big Is That Surplus?

The ifs and maybes behind the CBO's $5.6 trillion estimate

Tax-cutters are on a roll. Federal Reserve Chairman Alan Greenspan blessed their efforts on Jan. 25. Even better, on Jan. 31 the Congressional Budget Office announced that the federal surplus over the next decade would reach a stunning $5.6 trillion. That's $1 trillion more than CBO figured just six months ago--and more than enough money for Bush's $1.6 trillion tax cut.

More than enough, that is, if the forecast turns out to be right. So the $5.6 trillion question is: Will such numbers really materialize? To answer that, it helps to ask two other questions. First, do the CBO's economic assumptions make sense? And second, is the agency realistically accounting for billions of dollars in popular programs and tax breaks?

First, the economics. CBO assumes the slowing economy will grow at about 2.4% for the current fiscal year but hum along at an average of 3.1% over the decade. It gets there mostly by figuring that labor productivity will keep rising at an annual rate of about 2.3%, a number most mainstream economists accept. Says Alan Blinder, former economic adviser to Bill Clinton and Al Gore: "The long-term growth projection is very reasonable. You could easily argue for it being a bit higher."

"TOTAL CRAPSHOOT." Still, forecasters have had little luck getting 10-year budget projections right. Calling turns in the business cycle is hard enough. Massive structural changes in the economy--like the improved productivity of recent years--make the task tougher. "Ten-year projections are a total crapshoot," scoffs top Senate Budget Committee Democrat Kent Conrad (D-N.D.).

Predicting revenues is toughest of all. But that's key: A gusher of tax dollars was the major reason for the booming surpluses of recent years. Thanks to the bull market, capital-gains revenues ballooned from $40 billion in 1994 to $118 billion in 2000, about 6% of total tax receipts. And taxes from exercised stock options jumped from $2 billion to as much as $30 billion over the same period, according to government estimates.

Some worry that a sagging market could cut deeply into tax revenues, endangering future surpluses. But unless the market really tanks, that probably won't be the case. In the short run, the market slump of late 2000 may actually boost capital-gains taxes, since many investors were cashing in years of paper profits. Longer term, a lingering bear market might slash the cumulative surplus by about $250 billion over the next decade. That's no small change, but it isn't devastating when stacked up against $5 trillion. Still, even Greenspan has his doubts about economists' ability to accurately forecast revenues. "We are making little more than informed guesses of certain key relationships between income and tax receipts," he told Congress.

Truth is, there are many informed but conflicting guesses swirling around. The CBO assumes that the stock market will return to its historic annual growth rates of 6% to 8% and that capital-gains taxes will settle at just over $100 billion per year. But Mark Zandi, who runs Economy.com Inc., a West Chester (Pa.) consulting firm, figures if the market stagnates for a couple of years, capital-gains levies would sag to $76 billion by fiscal 2002, and to $68 billion by 2003 before turning back up. "Over the long run," says Zandi, "you're getting much slower revenue growth."

VANISHING ACT. Another wild card is the extent to which stock options contribute to tax receipts. A sagging market will mean fewer exercised options. It may even mean they could decline as a form of compensation. That would further reduce taxes on options, but nobody knows by how much.

Revenues are only half the budget story. There are also serious squabbles about how to account for existing tax and spending policy. Of the CBO's $5.6 trillion surplus, about $2.5 trillion is earmarked for Social Security. And there is broad bipartisan support for other costly programs. Some examples: $400 billion to support the current Medicare program, $300 billion for a new prescription drug program for seniors, $100 billion for new Pentagon spending, $100 billion to extend popular tax credits, and $100 billion for farm subsidies. Add it up, and a cool $1 trillion disappears from the projected surplus. As a result, CBO's projections of future spending are almost surely low.

Still, that leaves about $2 trillion for policymakers to play with. Will it materialize? Truthfully, nobody knows. But the numbers do offer a pretty enticing look at what a healthy economy can mean for the federal budget.

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