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Tax-Cutting Frenzy

The Congressional Budget Office’s recent estimate of a 10-year, $1.6 trillion budget surplus has put would-be tax-cutters in a frenzy. House Speaker Newt Gingrich (R) of Georgia, notes that, even if $600 billion is allocated to Social Security, $1 trillion still remains for tax cuts. House Budget Chair John Kasich (R) of Ohio proposes a $500 billion cut. Ways and Means Chair Bill Archer (R) of Texas has circulated a list of possible tax cuts totaling $3 trillion over the next five years.

Tax cuts on this scale, however, would be unjustified, counterproductive, and irresponsible. The first problem is that about $300 billion or more of the 10-year surplus represents reduction in interest payments and thus is not available to be used for tax cuts or program spending. Here’s why: Surpluses now reduce federal debt, which reduces future net interest payments on the debt. But if current surpluses are used to cut taxes, the decline in debt won’t occur, so future interest payments won’t fall, either.

The bigger problem, though, is that the emerging federal surplus is largely an accounting artifact, not a reflection of long-term fiscal soundness. The situation is similar in nature to that of a college student who perceives a surplus because summer earnings exceed living expenses, neglecting to factor in September’s large tuition bill. Like the student, politicians who would cut taxes have a short time horizon, and would live it up today at the expense of the future.

Over the next several decades, the government faces a large fiscal deficit, primarily because the baby boomers’ retirement will place large demands on Social Security and Medicare. To address this problem, we currently run surpluses in anticipation of increased future liabilities. The surplus has taken the form of increasing the Social Security trust fund, which has led to distracting debates about whether the trust fund is “real.” The relevant point, however, is that surpluses in any form reduce government debt, allowing more funds to finance private investment and economic growth, and making it easier to meet future Social Security and Medicare obligations.

The current approach is prudent, but – even if it received the entire surplus – Social Security would still face a long-term shortfall. Any resolution of this problem, even if it involves privatization, must in some way cut benefits or raise taxes. In contrast, large-scale tax cuts work in exactly the opposite direction and would exacerbate the shortfall.

Other than Social Security, the rest of the budget is in deficit now and will be for several years. Significant surpluses here are not expected until 2006. These surpluses, however, may be temporary, because Medicare is expected to run out of funds shortly thereafter. And they may not even materialize, because the budget forecast allows for no future recessions.

Tax-cutters claim that government will squander any surplus funds that are left in Washington. However, many of the proposed solutions to Social Security – including government-provided personal accounts, fully private accounts, or government investment in trust funds – would effectively remove the money from the risk of discretionary spending.


Advocates also claim that tax cuts stimulate economic growth, but the economy is already at full employment. According to Federal Reserve Chairman Alan Greenspan’s recent remarks, inflation is a bigger threat than an economic slowdown. Thus, a stimulus is not needed and would likely be offset by monetary policy, anyway. In addition, any tax cut would probably look similar to the 1997 tax act. Rather than encouraging growth last year, Congress added a host of new tax subsidies for favored constituencies. Reducing the national debt via budget surpluses would do more for long-term economic prospects than would targeted tax cuts.

The responsible course of action would apply the surplus to repairing Social Security and Medicare. If and when those obligations are met, and an additional surplus arises, there will be plenty of time to debate whether to retire debt, raise spending, or cut taxes.

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