Originally Published in THE BOSTON GLOBE
Tuesday, October 13, 1998
"There's enough income for tax cuts -- and Social Security"
"It is clear the surplus will be large enough to make some
permanent improvements in the federal budget"
Put budget surplus to use
Martin and Kathleen Feldstein
In a year of surprises, the unexpected surplus in the federal budget is certainly one of the most welcome. And it is even better news that this surplus will continue to grow for several years. Congress and the administration should not miss the opportunity to use this surprise bonus to improve the tax structure and reduce the tax burden, as well as save Social Security.
At the Sept. 30 close of the 1998 fiscal year, the surplus was a whopping $70 billion. And using the quite conservative forecasts of the Congressional Budget Office, the annual surplus is predicted to grow to more than $250 billion for the fiscal year 2008. This budget surplus adds directly to our pool of national savings and is particularly welcome at a time when the rate of private saving has sunk to a historically low level. It means we can put resources that would otherwise have been used to fund the deficit into productive uses that will improve our country's overall standard of living. And it means that we are less dependent on foreign capital to finance our investments.
While the strong economic growth of the last several years has created a surge in tax revenues, it is still something of a mystery how such a very large surplus came about. As recently as January of this year, the Congressional Budget Office was anticipating a small deficit for this year and did not expect a surplus until 2001.
It is likely that much of the unpredicted additional revenue in FY 1998 is a result of the strong stock market of the last few years. Investors have sold stock and realized capital gains that have just been a lot larger than before. Further, the growing assets invested in mutual funds that turn over their stock holdings have meant periodic distributions of capital gains to investors on a new scale. Finally, the stock market boom has created unexpectedly large incomes for executives who cashed in existing stock options. Until detailed information from tax returns can be analyzed, the exact sources of the increased revenue will remain uncertain. One tentative conclusion is that the extra tax revenue has not come from just the highest income earners but has been spread across many income groups.
Reduced budget outlays have also contributed to the positive bottom line, though on a much smaller scale. Lower unemployment and interest rates than originally projected have slowed the growth of mandatory spending. While low inflation has also held down spending, it has not been a factor in the surprise surplus, since it lowers revenues more than it lowers spending.
Looking ahead, the CBO expects the higher path of tax revenue to continue. A cautious reader may have doubts. If budget analysts can't tell how we got to this large surplus, how can they be sure the surplus will really continue? What if there is a recession in the next 18 months, as looks increasingly possible?
Tax receipts would certainly decline if there is a recession, as indeed they should in order to help support a weakened economy. But unless the level of unemployment rises permanently or productivity falls, the reduction in tax receipts would be temporary. Mindful of economic cycles, the CBO continues to be quite conservative in projecting revenues and outlays. In making its projections for government receipts over the next decade, the CBO aims for a medium path that incorporates the likelihood of both recession and expansion. For example, the CBO is forecasting an average growth rate of only 2.3 percent a year, below the average growth rate of the last decade, which included a short recession.
It is clear to us that the surplus will be large enough to make some permanent improvements in the federal budget. President Clinton has said that the surplus should be used to shore up Social Security, and we agree that reforming Social Security should be the highest priority for the next session of Congress. When the president first made his suggestion, the accumulated five-year surplus was expected to be $132 billion. That surplus for those years is now expected to be more than $500 billion. So there is room to do more. We like the House Republican proposal to set aside 90 percent of the surplus over the next 10 years until a plan for Social Security has been agreed. The remaining 10 percent would go back to taxpayers in the form of a selected group of low cost tax cuts. One version of this proposal, with a cumulative cost of $80 billion over 5 years, would reduce the current penalty on married taxpayers by increasing the standard deduction for couples. The tax plan also includes an incentive for households that don't currently save or own corporate stock to do so by excluding small amounts of dividend and interest income from taxation.
Moreover in thinking about the merits of a tax cut, it is worth remembering that the government is collecting tens of billions of dollars more in tax revenue yearly than it had planned to collect. If the government didn't mean to take so much of our money, why not give some of that extra revenue back? The budget surplus is real, is likely to last, and should give the administration and Congress something good to agree upon.
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.