Rolling In Dough

The turnaround has been so staggering as to defy belief. For as far back as anyone can remember--since 1969, in fact--the Federal Government has been spending money and every year leaving behind a prodigious pile of ious. As recently as 1992, the government spent a record $290 billion more than it took in, and the deficit would have been much larger without a big Social Security surplus. That was before the 1997 budget deal that began winding down the deficit, however. Now the payoff is here. In the fiscal year just ended, Uncle Sam rolled up a $123 billion surplus, by far the biggest in the nation's history. Even the non-Social Security part of the government about broke even. Suddenly, Capitol Hill is expecting to be awash in cash

Wait, though. That's only the beginning. Estimates are that with no change in current policy Washington over the next 10 years will collect a mind-boggling $2.9 trillion more than it spends--$1.9 trillion in the Social Security trust fund, and $1 trillion as an excess of tax collections over spending for everything else the Feds do. The $1 trillion overage is the size of the entire federal budget in 1987 and, paradoxically, creates a problem for politicians that they have never faced before: How best to channel that torrent of cash?

Maybe better to say potential torrent. Past budget forecasts have been wildly off-target. As recently as 1996, the Clinton Administration predicted deficits of $200 billion or more each year as far as the eye could see. So, can today's great expectations be trusted? Absolutely, said a majority of members at a special session of TIME's Board of Economists, which met recently in Washington to debate the budgetary outlook. For this occasion the board included some of the country's most important public officials as well as economists. They split along party lines on what to do with the money. But most had little doubt that the money would be there.

"The numbers add up," said Ohio Republican John Kasich, chairman of the House Budget Committee. Moreover, he asserted, they will continue to add up because of conservative assumptions used to create them. His Senate counterpart, New Mexico Republican Pete Domenici, pointed out that those estimates factor in two mild recessions sometime during the next 10 years and include assumptions that "do not contemplate the kind of growth that is actually going to occur." That would imply surpluses even greater than projected--a prospect confirmed by Allen Sinai, chief global economist for Primark Decision Economics, a forecasting firm. Sinai's "baseline" forecast, assuming no changes in taxes or spending patterns, is for a non-Social Security surplus of $1.3 trillion, or 30% above the official guess for the next decade.

Not everyone at the meeting agreed. Alicia Munnell, a former member of Clinton's Council of Economic Advisers, now a professor at Boston College School of Management, voiced distrust of the surplus estimate, arguing that caps on federal spending budgeted for the next three fiscal years are wildly unrealistic and will--in fact, should--be exceeded. Already the government is evading spending caps by sticking an "emergency" label on all sorts of additional outlays. That, said Munnell, "makes a mockery of the whole process." Also, she noted, revenues are getting a huge boost from soaring stock prices, which inflate capital-gains-tax collections. Given the market's volatile ups and downs, who can be certain this windfall will continue?

Tart-tongued South Carolina Democrat Fritz Hollings, one of Domenici's predecessors as chairman of the Senate Budget Committee, decried all talk of surpluses as "a circus act if I've ever seen one." Said he: "Instead of the deficit and debt going down, they're going up." His point: while the government is no longer borrowing from Social Security, it is still borrowing heavily from trust funds for Medicare, pensions for military and civilian government employees, highway building and other things. Without those nonpublic borrowings, he contended, the government ran a deficit of $127.8 billion last fiscal year, and the debt, including amounts owed by one part of the government to another, is still rising from $5.6 trillion. Other board members conceded that Hollings' numbers were correct but strongly quarreled with his interpretations. Kasich, Munnell and Secretary of the Treasury Lawrence Summers all insisted that internal-transfer payments do not burden the government as a whole; it is the $3.5 trillion borrowed from the public that must be repaid or refinanced.

Which introduced one of the revolutionary implications of the surpluses that the board majority agreed really are in prospect. At TIME's meeting, Summers indicated that the $3.5 trillion public debt would be wiped out completely if all the Social Security surpluses and part of the non-Social Security surpluses projected to emerge over the next 15 years were used to pay it off. That would create a host of new challenges for economists and currency traders. What kind of security, for example, could replace the 30-year Treasury bond as the bellwether of bond trading and as a particular magnet for foreigners who accumulate dollars in trade with the U.S. and want to invest the bucks in something both high-yielding and safe? "This is my definition of a high-class problem," Summers wryly remarked. But no one at the meeting expected nearly every penny of budget surpluses to be used to pay off debt.

The remaining question, which is likely to dominate public debate--not just during the 2000 elections but for years after that--is what to do with all the money rolling in. Board members discussed the issue with much more cordiality than might be expected in Washington's currently polarized climate. They voiced glowing bipartisan self-congratulations for the success of the 1997 budget-balancing agreement. Kasich went so far as to say that "there is nothing wrong with sending some kudos down Pennsylvania Avenue" to the President for that agreement. Summers enumerated several points on which he saw "wide areas of agreement"--notably that "Social Security surpluses should not be used for any other purpose than paying down debt."

But the debate over what to do with non-Social Security surpluses, while courteous, was sharp. Republicans Domenici and Kasich stoutly defended their party's proposal--which they did much to draft-- for a 10-year, $792 billion tax cut. Vetoed by Clinton and dead for this year, that scheme is sure to be revived in some form.

Domenici asserted that the tax cut would be small in the beginning, totaling only $6 billion in the first two years, but would grow in future years as the anticipated surpluses increased. Said he: "I think that there is more of a danger we will use up the surplus for more spending than there is that we will use it up for extravagant tax cuts. We will see if there is any surplus left for anyone after we hear the presidential candidates talk about what they're going to do when they get in and have all this money to spend."

Kasich put the same argument in more extreme, Reaganesque terms. The main thing is to "get the surplus out of town before we spend it." And if polls show that the public is cool to big tax cuts? That, said Kasich, is because "they don't trust politicians to deliver a tax cut; secondly, they think that if there are tax cuts, they're going to be puny" rather than the massive ones the Republicans want.

Summers noted that the Administration has been shrinking government. Federal civilian employment, for example, has gone down by 270,000 over the past six years. "But we believe in smart shrinkage," he added. He feared a G.O.P.-size tax cut would "lock in" the government to reductions of about a third to a half in all its nondefense programs, a figure Republicans strongly dispute. Summers noted that the Administration has proposed some tax cuts of its own, generally estimated at $250 billion, about a third as large as the Republican package. The prudent course, he insisted, is to increase spending a bit for such needs as education and environmental protection, to provide a modest tax cut and to build a Medicare reserve, while focusing on paying down debt without drawing on Social Security surpluses. Munnell argued further that "if we give away money now" through big tax cuts, "we are going to have large deficits in the future" when baby boomers retire and claim Social Security and Medicare benefits.

Sinai pointed out that the Republican and Democratic plans of today have not been spelled out in full detail and may not be totally accepted by the presidential candidates who are nominated. Nonetheless, he attempted a summary of their likely economic effects. The Republican plan, he thought, would prompt slightly more economic growth, though only in the first five years, largely by spurring more consumer demand than a fully employed economy might need. Inflation would therefore be a bit higher in the first three years than under the Democratic plan, and interest rates could be significantly higher. On the other hand, the Republican plan includes a capital-gains tax cut of about $35 billion, a reduction that would yield a "quite significant bang for the buck," in Sinai's phrase, in spurring investment and entrepreneurial incentive. The Democrats propose a tax cut that is really a savings incentive--in Sinai's opinion, a good idea. They would increase government spending on the military and through transfers for education and other social purposes and reduce debt much more than would the Republicans--although the Republican reduction of $257 billion over 10 years from non-Social Security surpluses is scarcely a pittance. The Democratic spending proposals, in Sinai's view, "are targeted for things that will be productive and not the old welfare-state, liberal way of wasting money at the government level."

In sum, the Republican plan is heavily oriented toward consumption and growth, the Democrats' toward savings and debt reduction--not quite what one would expect from the past history of the parties.

In any case, the plans cannot be judged purely on economic grounds. They embed highly controversial political and social judgments. Just how much government do the people want, and what do they think it should do? Are the pending surpluses a heaven-sent opportunity to spend more on high priorities like education while still reducing debt? Or is the money likely just to be wasted, whereas if put into the pockets of citizens through tax cuts, it would be spent productively? The President and Congress elected next year will of course not pass either plan in toto. Whatever initial deal they strike can only be a compromise that may well intensify rather than end the debate. Ah, but what a refreshingly first-class debate to have. --With reporting by Bernard Baumohl/Washington

Rolling In Dough

After decades of deficits, the Federal Government is starting to generate mountains of surplus cash. So what do we do with it?

By GEORGE J. CHURCH

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Cover Date: November 29, 1999