A ‘Surplus’ We Need

William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

October 16, 1998

James K. Glassman presents a misleading case for using current and future budget surpluses for tax cuts, and a flawed interpretation of the tax policy debates of the past 20 years [“The Surplus: Cheers and Fears,” op-ed, Oct. 13]. Although significant tax cuts won’t become law this year, debates over the use of the surplus will dominate fiscal policy for years to come. So it is crucial at the outset to get the facts straight and the logic right.

The projected surpluses are substantial, roughly $1.5 trillion over the next decade. But they arise from the peculiarities of government budget accounting, which focuses on annual cash flows, not from underlying economic reality. Over the next several decades, because of the pressure that retiring baby boomers will put on Social Security and Medicare, the government faces large economic deficits, rather than surpluses. Even with no tax cuts, the accruing surpluses will not be sufficient to pay for future liabilities. Thus, attempting to save Social Security first, although sometimes used as a political gimmick, is actually sound policy.

Put differently, if the government kept its books like a business, it would show a shortfall under current circumstances, not a surplus. A respected financial adviser like Glassman should not be hoodwinked by mere accounting statements that seriously misrepresent underlying economic realities. Nevertheless, Glassman offers three reasons why surpluses should be used for tax cuts.

First, Congress will just “blow” the funds, anyway. Granted, this is a serious concern, and opinions can reasonably differ. But Social Security reform could be structured in ways that make the surplus unavailable for other purposes. For example, government purchases of stocks for the Social Security trust fund could be counted as budget outlays, and diversions of payroll taxes into private accounts would reduce revenues.

Second, tax cuts would stimulate economic growth. But Congress and the administration give little hope on this front. The 1997 tax act they approved and the 1998 bill that passed in the House demonstrate politicians’ continuing predilection for showering subsidies on favored constituencies, rather than for promoting economic efficiency and growth. Retaining the surplus, (i.e., paying off the debt) and reducing government borrowing would have a bigger impact on long-term economic growth by raising savings and investment.

A tax cut might provide a short-term stimulus, as Glassman notes. However, it would come at the expense of the longer-term budgetary outlook. And immediately cashing in the first surplus in 30 years could easily backfire by eroding investors’ confidence in long-run budget discipline and raising interest rates.

Third, Glassman raises a moral dimension, claiming that Washington is overcharging taxpayers if it does not use surplus funds for debt reduction, which he considers politicians incapable of doing. On the other hand, the morality of Congress imposing increased burdens on future generations by deliberately choosing not to raise funds to meet the future spending obligations it created also can be questioned.

Finally, Glassman reinterprets history to claim that “when Ronald Reagan and Jack Kemp said that we could grow our way out of the deficit, they were ridiculed—but they turned out to be right.” Everyone understands that economic booms will reduce deficits by reducing means-tested spending and raising revenues. The distinctive contribution of Messrs Reagan and Kemp was to claim that their tax cuts could generate enough growth to eliminate the deficit.

The evidence suggests that their claim was off by several hundred billion dollars per year. Even in 1989, after a seven-year economic expansion and after tax increases in 1982 and 1984, the 1981 tax cuts advocated so strongly by Reagan and Kemp still were creating deficits as far as the eye could see. It took George Bush’s willingness in 1990 to abandon a poorly conceived “no new taxes” pledge and Bill Clinton’s 1993 tax increases to help set the fiscal ship on the right course.

Many other factors made significant contributions as well, including sound monetary policy, budgetary restraints and a strong economy.

But nothing in the history of the past 20 years suggests that Reagan and Kemp were right about tax cuts and deficits, or that tax cuts generated the surpluses we have today.

The surplus is no minor achievement, but it is only a first step toward long-run fiscal sustainability. When Social Security and Medicare financing have been adequately resolved, Congress will have earned the right to talk seriously about tax cuts. Until then, tax cuts just make it harder to solve the real problem.