Originally published in THE BOSTON GLOBE
Tuesday, April 27, 1999
Reform should include adding to individual investments
Social Security's surplus
Martin and Kathleen Feldstein
"This is the first time in thirty years the budget debates will occur in the context of an expected surplus"
THE OUTLINE OF THE FEDERAL BUDGET for fiscal year 2000 is now beginning to take shape in Washington. The President made his opening bid in the budget submitted to Congress at the time of the State of the Union message. Just before the spring recess the Republican Congress made its initial response in a budget resolution. As this process continues over the spring and summer, the key measures to watch are the projected budget surplus and its use.
When the government runs a surplus, it automatically buys back outstanding debt held by the public. That allows the holders of the debt to direct their funds to more productive uses. Instead of financing government borrowing, those funds will finance additions to business plants and equipment and to housing. These, in turn, add to overall economic growth and well-being.
If current spending rules are followed for the next fiscal year, federal government receipts would now be expected to exceed federal government outlays by more than $100 billion. The Congressional Budget Office now estimates there will be annual surpluses for more than twenty years.
But will the budget surpluses continue as projected? Or will they be dissipated by hikes in government spending or by tax cuts that finance more private consumption?
This is the first time in 30 years that the budget debates will occur in the context of an expected surplus. While the current fiscal year should turn out to be the second year in a row of federal budget surplus, both 1998 and 1999 were expected to show a deficit when each budget was passed.
The projected budget surpluses were not the intended results of past policy decisions, but were the fortuitous effect of three factors. It's important to recognize the factors that got us to this unexpected state of surplus in order to assess the likelihood that the surpluses will continue. First Medicare spending has dropped much more sharply than was intended in the Balanced Budget Act of 1997. Second, interest rates have fallen more than the CBO or the administration predicted. That has brought down the cost of interest payments on the national debt. And finally, tax receipts have exceeded previous expectations because of strong growth in the economy and the stock market.
In making projections of continued budget surpluses, both the White House and the CBO are conservative in their economic predictions, but they do assume continued growth and stable interest rates. As the economic expansion continues into its ninth year, there is necessarily considerable uncertainty about both the level of interest rates and overall economic growth.
The continuing surplus projected by the CBO is also based on the assumptions that there are no changes in taxes, no changes in entitlement rules that increase benefits and that the growth in all other spending is limited to the rise in the price level. Under these heroic assumptions, the publicly held national debt will also fall from over 40 percent of gross domestic product to less than 10 percent over the next 10 years, sharply reducing the government's current interest bill of more than $230 billion a year.
In reality, we are more likely to see spending increases and tax reductions. The national debt will therefore fall more slowly, if at all, leaving the interest burden larger than projected by the CBO.
A critical piece of this will be the treatment of the surpluses in the Social Security program. Ever since 1983, the annual receipts of Social Security have exceeded the benefits. But although the resulting Social Security surpluses have been duly recorded in the trust fund, deficits in other parts of the federal budget have more than offset Social Security surpluses until 1998. The result has been a deficit in the overall federal budget and a lower level of national saving.
President Clinton gives the impression he is committed to saving future Social Security surpluses and not using them to finance other spending or tax cuts. But his actual five-year budget does the opposite. Over the next five years for which the President has submitted an explicit budget he proposes to divert more than $30 billion of Social Security surpluses to finance a variety of other forms of government spending. His claim that this will be made up sometime after those five years is not backed by details. That's one reason why we favor a Social Security reform that would transfer some of these surpluses into individual investment accounts. Although using budget surpluses to build up such accounts would not buy back government debt explicitly, they would add directly to national saving just as they would if they remained in the Social Security trust fund. And by taking the funds away from the government and putting them into individual accounts, the government's temptation and the ability to spend those funds would be eliminated.
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen. also an economist, write frequently together on economics.