Washington's Coffers Are About to Overflow
By Bruce Bartlett, James Buchanan, Lawrence Kudlow, Stephen Moore, Mark Neumann, Herbert Stein
To the surprise of most economists and politicians, the U.S. government is on a course to start running substantial budget surpluses very soon. Because the natural temptation will be for Congress and the President to spend those surpluses in foolish ways to curry favor with the electorate, conservatives have begun to debate how they should respond. One of the hottest arguments on Capitol Hill this fall will be over the merits of a bill introduced by Rep. Mark Neumann (R-Wisc.), and embraced by the House Republican leadership, which would require the government to run surpluses in the future, and use most of the proceeds to pay down the national debt.
The American Enterprise recently gathered a panel of expert observers to thrash out this topic, and the discussion was quite fervent.
Mr. Stein: We are here to discuss the question: "Federal Budget Surpluses Ahead: How Should Conservatives React?" James Buchanan, could you start?
Mr. Buchanan: It’s purely imaginary to expect that today’s political structure will ever generate surpluses. We had this same argument about what to do with surpluses back in the ’60s—but they never materialized, because extra spending sopped them up. The same thing will happen again now; so it’s an imaginary game.
But let’s play the game. There are ethical questions, political questions, economic questions. First of all, the national debt. My emphasis has always been: Let’s at least stop increasing the burden. If we could get the budget in balance—and I think that’s only possible with a constitutional amendment—then we would only have to deal with the existing debt.
Should we try to retire the debt? Retiring the national debt would amount to creating capital, a good thing. On the other hand, I don’t think any particular generation of taxpayers should have the burden of paying off the accumulated debt we have eaten up in past years.
Mr. Kudlow: I believe we are entering a period of considerable budget surpluses, thanks to a smoothly functioning economy. My own estimates are that if we adhere to current law on spending, we’ll see a federal surplus this year—fiscal year 1998—and that the surpluses will rise to around $100 billion over a couple years, and to over $300 billion by the year 2002. But I also recognize that the spending restraints that exist on paper in the 1997 budget agreement may never come to pass; so I wouldn’t want to be pinned down to an exact number.
I disagree that the national debt is a big problem, at least under current economic conditions. I view debt as merely an instrument of financing. It can be a very bad instrument if it’s financing bad federal policies, but it can be a positive instrument when it’s financing good federal policies. The debt incurred in the 1980s—the focus of the controversy—financed three areas, all of them extremely positive: Number one, we used debt financing to underwrite the reduction of inflation from about 10 or 12 percent to 2 or 3 percent (which starved the government of inflated revenues). I think lower inflation is the crucial ingredient in the U.S. economic recovery.
Second, we used debt to finance the early stages of President Reagan’s income tax cuts. These cuts eventually created huge flows of revenues, but you can argue that we had to fund, say, $50 billion in the short run to finance the tax cuts in ’83 and ’84. By ’85 and beyond the tax relief was paying for itself.
And, third, we used debt to finance the build-up of military spending which was essential to America’s winning the Cold War. That was Reagan’s vision, and he succeeded. He took risks, and they’re still paying off.
So debt doesn’t worry me much. Even estimates from the Congressional Budget Office with low assumptions on future economic growth show that the size of our national debt in comparison to the whole economy will drop sharply over the next ten years, from the equivalent of about 50 percent of gdp to 30 percent. That would return us to the low debt burden of the past century. I think the absolute low was about 25 percent during the 1970s, and the high was following World War II, at over 100 percent. So we’re not currently staggering under some great debt burden.
Some argue that government borrowing crowded out private investment. Yet interest rates—the price of borrowing money to invest—have fallen as the debt has risen, so I don’t believe there is any particular link between national debt and interest rates.
I also dislike the measures being considered as a means of handling future budget surpluses. The proposal furthest along in Congress is Mark Neumann’s plan to cap growth in government spending at one percentage point below the growth in government revenues, and then use two-thirds of the resulting surplus to pay off debt. (The other third would be used for tax reduction.)
I have always opposed formulaic notions of fiscal policy. I don’t think they work. And I believe Neumann’s plan would actually permit higher government spending, rather than restraining it. For example, in fiscal year 1997, revenues are going to come in about 11 or 12 percent above ’96, so a one-percentage-point reduction of spending below the revenue line would permit a 10 percent jump in spending by Congress.
I would use the surpluses I’m predicting for much different purposes: for tax streamlining and a flat-tax rate reduction; to finance Social Security privatization; and I would prevent any of the surpluses from being spent. My great hope is that we can shrink the federal government and terminate a lot of agencies and programs in the next 10 years.
Mr. Moore: Let me start with three points. The first issue is, Will there be a budget surplus at all? Here I am a skeptic, as Jim Buchanan is. The politicians will want to spend this money before any surplus emerges. We already see people like Ted Kennedy and Dick Gephardt salivating over the idea of a budget surplus that would let them create national child health care programs, socialized medicine, etc. So the most important policy is to make sure surpluses are not spent.
Second, is there a case for debt retirement? I think it’s important to put this issue in historical context. We are now in a post-war period in America. As Larry Kudlow says, we had big deficits in the 1980s because we used those deficits to finance a Cold War build-up, a worthy investment of tax dollars. But now the Cold War is won, and in virtually every other era after concluding a war, the United States cut wartime taxes, moved immediately to a balanced budget, and then started retiring wartime debt. That was true after the Revolutionary War, it was true after the Civil War, after World War I, World War II, and Korea. So if we start retiring some debt as Congressman Neumann wants, it would be consistent with what we’ve done before.
Moreover, there is a political elegance to Mark Neumann’s idea. The opportunity his bill presents is to forge a coalition of supply-side tax-cutters like Larry Kudlow with the Perotians and the part of the Republican Party who say, "We have a moral obligation to reduce the debt." So I have no objection to the Neumann bill.
But is his scheme the optimal treatment of a budget surplus? Here I part company with Neumann. We care about deficits and debt because of their impact on future generations. But if that is our concern, the single most important thing we can do for future generations of Americans is to privatize Social Security.
Allowing today’s workers to rechannel their payroll taxes into individual investment accounts would produce many good effects for the economy and retirees alike. It would increase savings, and it would reduce the huge debt overhang of promised future Social Security benefits. And the easiest way to do this would be to use budget surpluses to pay the benefits due to today’s senior citizens as we make the transition from our current Social Security system to a privatized replacement. So while I am attracted to the Neumann plan, this could be an even better alternative.
Mr. Bartlett: My concern with the Neumann proposal is this: The only benefit of paying off our national debt would be to reduce our interest payments. Interest on the debt currently takes about 15 percent of our budget. So the most we could achieve via this Herculean undertaking is to cut taxes by 15 percent. That’s what Bob Dole proposed last year without having to get into debt repayment.
Meanwhile, some existing taxes are far worse than others. These levies are particularly likely to distort and drag down the economy. There is much more value in eliminating those taxes than in reducing the overall level of taxation by an amount equal to the interest we now pay on the national debt.
Unfortunately, cutting taxes has become politically difficult, which is why we’ve had only two tax cuts in the last 16 years, and one of them hardly counts. So it seems to me that if we have surpluses, it’s imperative we use the extra revenue to get rid of our worst taxes.
I’m also very sympathetic to Steve’s idea about using surpluses to make it easier to privatize Social Security—because that too would have many more positive overflow effects than just eliminating the costs of servicing the debt. Either alternative is a vastly better idea than sending cash to bond-owners who hold debt that is imposing no burden on the economy.
Rep. Neumann: We all adamantly agree that we don’t want future surplus revenues spent on new Washington programs. And we all believe we need to put something into place to prevent that from happening, as it so easily could.
But I also believe our generation has a strong moral responsibility to pay the bills we have run up over the last two decades. I know there was debt before 1980, but it totaled less than $1 trillion, so $4 trillion of today’s total debt has been run up from 1980 forward. I think we as a generation have a responsibility to pay these bills, rather than pass them on to future Americans.
Under my proposal we can fulfill this moral responsibility and also reduce taxes. As Larry Kudlow mentioned, my plan caps spending at one percent below revenues, with one-third of the resulting surplus dedicated to tax reduction. Two-thirds would be dedicated to repayment of debt. And under reasonable projections, my bill would allow our national debt to be entirely repaid by 2026.
Many in Washington question whether the one-third/two-thirds ratio between tax reduction and debt repayment is right. Let me just say I’m listening. Whether we devote one-third of surpluses to tax reduction, or one-half, or whatever, can be debated in the appropriate bodies here in Washington. I agree with arguments about the benefits of tax reductions. And I note that this is the only bill currently under consideration that guarantees additional tax cuts in each and every year as we look forward.
This bill doesn’t say we can’t have further tax cuts. It only says that we’re going to make sure we have at least this much tax relief and repay the debt, whose interest currently eats up close to one out of every six dollars of federal spending.
Buchanan: How are you going to lock in future Congresses?
Neumann: You can’t lock in future Congresses.
Buchanan: That’s my point.
Bartlett: We passed a law to balance the budget some years ago, if you remember, the Byrd amendment.
Stein: Then we had Gramm-Rudman.
Neumann: I’m glad you brought that up. The Gramm-Rudman Act was passed by a Democratic Congress in 1985, but the promises it made to the American people were not kept, and then in ’93 they raised taxes to get out of the hole.
By contrast, in 1995 when the Republicans took control of the House and Senate, we laid out a plan to balance the federal budget, and we are not only on track, we are three years ahead of schedule. It’s the people’s responsibility to make sure their elected representatives continue this in the future. There is no other way in the United States of America.
Kudlow: Gramm-Rudman probably had some mild positive effect the first year. Then Congress figured out how to get around it, and it broke down. That failure should be an instructive warning against relying on formulaic budget plans.
Moore: But there’s an important point that you’re missing in his formulaic approach. The Neumann bill would create a constituency to keep spending down and have a surplus in the first place. We can tell people, "Look, we’re going to use that money to cut your taxes and reduce the debt." That creates political momentum for getting our hands on the money before the Left does.
Kudlow: Having worked at the Office of Management and Budget, I just don’t believe that fiscal policy can be put on autopilot. Mark, I think your formula will ultimately encourage additional spending rather than discouraging it.
Neumann: How is that?
Kudlow: Federal revenue growth this year exceeds 10 percent. Permitting spending at one percentage point below that would provide a tremendous increase in spending.
Neumann: Our bill says spending must grow at least one percentage point below the level of revenue growth. That doesn’t mean that when revenue grows by 10 percent spending must automatically grow by 9 percent.
Kudlow: But it can. If the economy performs as well as I expect, your plan could provide cover for a lot of new spending.
Moore: Look at Gramm-Rudman. During the four or five years Gramm-Rudman was in effect, no, it didn’t reach its deficit targets—but we did have spending growing less than inflation because of those rules we put into place. So I think rules are better than no rules, even though the rules can be broken.
Bartlett: But even if we use 100 percent of any future surplus to cut taxes, the national debt will still fall substantially. So as long as we keep a balanced budget to avoid adding more to it, the debt will become less and less significant in comparison to a steadily increasing economy. Plus, no one is predicting zero inflation any time soon, and even if you assume just two percent inflation, the declining value of the dollar "eliminates" $100 billion worth of the debt every year without doing anything. What’s more, the Federal Reserve buys up government bonds every year, converting them into money. For all intents and purposes that debt is extinguished. So the debt will automatically shrivel even if we give all surplus revenues back to taxpayers, as I think we should.
Stein: I’d like to take a somewhat longer view for a moment. As we look ahead 20 years or so, we see a period in which, as things are now set up, we are going to have, not federal surpluses, but enormous deficits, this time because of an aging population’s increased drain on Social Security and Medicare. How do we account for these large deficits beyond the year 2020 or so?
Moore: Economist Larry Kotlikoff of Boston University calculates that if we go beyond current cash flow and also factor in the unfunded future liabilities of our Social Security system, we actually have about a $400 billion budget deficit today. This is a strong argument for either privatizing the Social Security system to wipe out some of those future liabilities, or else running surpluses now so that we can clear the books for those large obligations in the future.
Buchanan: Privatizing Social Security is in fact paying off debt, retiring that implicit debt.
Bartlett: Privatizing would do that well. But beware of the alternate idea of building up a surplus within the current Social Security system for use down the road. Remember the lesson of the 1983 Social Security fix. The politicians at that time consciously created a surplus in the Social Security trust fund, supposedly to prepare for the future baby-boomer retirements we’re now worried about. But no overall budget surplus occurred, because the Social Security surpluses were just raided to fuel additional government spending in other parts of the budget.
Kudlow: I am a strong supporter of Social Security privatization. I think it kills many birds with one stone. It helps growth, it lowers debt by reducing liability in the future, provides a tremendous amount of self-government and personal responsibility, adds to the savings rate, and so forth.
But I agree with what Bruce said: The debt will fall of its own accord if our other economic policies are good. If we keep growing this economy, then the scope of the national debt will have fallen to 20 percent or 15 percent of gdp by the time the boomers start drawing retirement checks.
Stein: Larry, you must agree that your forecast is subject to a certain degree of uncertainty, and the question is how to deal with these uncertainties. Is it more prudent to operate on less optimistic assumptions and initiate debt-reduction while we’re waiting to see if your high growth actually happens, in which case you can then cut taxes? Or do we neglect this opportunity to reduce the debt now and risk entering a period of large deficits with a debt that’s already quite large?
Neumann: I think that’s a very important question, and I rely on my business-world experience to respond. I owned a home-building company that built 50 percent of its houses on speculation, which means we borrowed large sums of money. But when times were good, we paid down our debt. That’s how we dealt with future uncertainties in the home-building business, which is much closer to real life than your projections.
I think the prudent course of action today is to reduce our debt with the anticipation that at some point in the future we’re going to be very happy we made that decision.
Moore: The very best way to bring our debt down, though, is to reform entitlement policies, which will also facilitate faster growth. Because even if we have your program in place, Mark, if the economy tanks there will be no budget surpluses to squirrel away. So there is something to be said for moving aggressively toward lower tax rates, particularly a flat tax that will make the economy grow and in turn create the budget surpluses you want to work with.
But it does matter what type of tax cut we’re talking about. If the choice is just to do another stupid tax cut like this year’s, I’d rather retire debt. On the other hand, if we could lower rates, then it might be better to have a tax cut than to retire debt. All tax cuts are not created equal.
Bartlett: I object to making current economic policy on the basis of what the nation may or may not need a whole generation from now. If we are to have formulas and rules, one rule I have always thought might be useful to follow, and it is consistent with paying off debt, is simply to stipulate that Congress cannot spend more this year than it raised in revenue last year. With some rule like that, spending would almost always lag revenues and you’d automatically provide for a surplus.
Moore: Could I ask Jim Buchanan a question drawing on his academic expertise in how public choices are made? Many of the people who oppose Mark Neumann’s bill fear that if the Left is proposing new spending, and Republicans counter with a proposal to reduce the debt instead, the Left will out-bid the Republicans and seduce the public into new spending programs. How do you see that playing out?
Buchanan: The real question is, what is the constituency for debt retirement? I agree with most of what Congressman Neumann says about the moral responsibility of debt-reduction, and he implied that there is a considerable body of public support out there for debt retirement, which is possible.
But it is quite possible that pressure for spending increases or tax cuts will overwhelm other options. After all, paying off debt is equivalent to creating capital for the nation, which is a very good overall policy in a certain sense, but when have we ever done that? We’ve more often done just the opposite by running deficits, which is equivalent to destroying capital. So if a Neumann-like effort could create a public constituency for retiring debt as a kind of moral obligation, that could be beneficial, but it may not be an easy sell.
Kudlow: The right budget question to ask at all times is not, "Does the budget balance?" but rather, "What are the consequences for growth versus recession?" That’s also the right question to raise before the public in assessing various ways of handling surpluses.
Bartlett: We’ve dwelled on the 1980s, but if you go back to the prosperous 1950s, debt was relatively high as a share of gdp. And in the mid-1970s, debt as a share of gdp reached its lowest level in the century, I think—and yet it was a dismal period economically.
Kudlow: The reality is that the increase in debt over the last 15 years has been accompanied by an extremely prosperous economy.
Neumann: The economy has been booming because we’ve been spending our children’s money. When I talk to people outside of Washington, do you know what they tell me? "Don’t do tax cuts if it means we can’t balance the budget." They are willing to forego their own income today because they do not want to pass on to their children the debt that’s been run up over the last 15 or 20 years. I believe strongly that the people of this country will see the moral imperative to do this, so that it will outweigh any other argument.
Moore: Larry made an important point earlier that debt is a financing technique and much depends on how you use that debt. I get tired of these Generation Xers who say, "You people ran up this debt for your own comfort." Actually, there are good reasons why our children and grandchildren should help pay off today’s debt, because they are the beneficiaries of what much of that debt was spent on over the last 15 years—namely eliminating the Soviet threat by re-arming, and kicking off a high-growth, low-inflation era with tax relief.
But I do think that now that there is no Soviet menace, now that debt has reached a fairly high level, it might be a good time to pay some of it down like a sensible business.
Kudlow: Businesses don’t necessarily pay their debts down in good times. It’s a question of comparing rates of return on different possible uses of their free capital. It’s a financing issue, not a moral issue.
Buchanan: It is a moral issue. And an economic issue. You’re mixing up two sides of the account. Sure, investing in productive things is better than investing in non-productive things. But that has nothing to do with the taxing side, how the revenue is raised.
If you tax people to make an investment, you are paying for it now. But if you make an investment by borrowing, the people who are paying for whatever it is you’re getting are the taxpayers of the future. And they may or may not benefit from what you get. There is no way you can get around that very simple law.
Kudlow: I will say this for publication—I miss the deficits, because they were a very effective restraint on federal spending. We are going to have more trouble in the next ten years restraining spending in the absence of deficits than with them.
Bartlett: Pat Moynihan always said Reagan’s deficits were a conspiracy.
Kudlow: He was partly right, and we knew exactly what we were doing, from Reagan on down. But tax cuts—and I include Social Security privatization under that heading—can offer a compensating restraint on the size of the federal government. Debt-reduction, on the other hand, is not a clear restraint on the power of government.
Moore: The value of a debt-reduction crusade that you’re missing, Larry, is that liberals are already out there with lots of new spending plans, and we need some kind of goalie to slap their proposals away.
Bartlett: Take away their allowance.
Kudlow: What you’re missing is that in the next 12 months, and the ’98 congressional elections, Democrats will embrace debt-reduction. Why? Because they’ll figure out that Mark Neumann’s formula will still permit spending to rise plenty. Always and everywhere, the place where the rubber meets the road in shrinking government is tax reduction. You show me a tax-cutting regime, I’ll show you a government-shrinking regime. You show me debt-reduction, I’ll say the record is all over the place—there’s no clear link to the size of government. Mark can reduce debt and still grow spending by 8 percent a year, by his own formula.
Moore: But there is not a conservative majority in Congress to enact the kinds of tax reduction you and I want. The elegance of the Neumann plan is that it puts the debt-reduction coalition together with the tax-cutting coalition and achieves a majority that can serve as a strong traffic cop to stop those who will want to spend future surpluses.
Kudlow: There is no debt-reduction constituency.
Moore: There are a lot of Americans who agree entirely with what Mark Neumann said about the moral obligation to reduce the debt.
Stein: I can see why Larry has so little interest in the future. He smokes. [laughter]
Moore: But, Larry, you don’t have the votes in Congress to do what you want to do. Mark Neumann has—
Bartlett: He doesn’t have the votes either. There’s not one supporter of his legislation in the Senate.
Stein: The question is whether we should make tax reductions—which will primarily go to increase consumption—or debt-reductions, which will primarily go to freeing up funds for private investment.
Kudlow: That was the argument given to us again and again in the ’80s: "If you cut taxes, people will spend the money." The fact is, we have had an investment boom for 15 years because we improved investment returns in the United States. We increased incentives to supply more labor and more investment.
Moore: But Herb gets to the point I was making earlier. How much good you do depends a lot on how you cut taxes. There are cuts that would go almost entirely to consumption.
Kudlow: I agree. I want tax rate cuts.
Stein: But then you don’t have a proposition which is especially salable to the public, which likes the idea of everybody getting $500.
Moore: I think that if the Republicans went out and said, "We want to make a transition to a simpler, flat-rate, consumption-based tax system, but it is going to cost $100 billion in the transition," that’s a very salable thing. That’s a very populist issue with Americans. You could sell Social Security privatization in the same way—as a long-term good with a short-term price tag.
Bartlett: One problem with the Neumann plan is that because it demonizes debt, it could hurt the chances for Social Security privatization. Everybody studying the privatization of Social Security agrees that in any transition from today’s system to private accounts there will have to be a big increase in on-budget debt. That’s not a real increase in debt, because it will be balanced by the elimination of implicit debt currently hidden from view in the form of promised future old-age benefits. But the shift will be highly visible. By stirring up moral fervor against visible debt, Congressman Neumann could make it easier for opponents to demagogue the privatization of Social Security.
Kudlow: Which would be a real irony, and tragedy, because privatizing Social Security would both reduce debt (in the form of promised future benefits) and buoy national growth through large new investments of individual retirement accounts in the stock market. In this sense, privatizing Social Security is the only "debt-reduction" I really like.
Moore: That’s optimum.
Kudlow: I could accept using, say, 80 percent of future surpluses for tax and Social Security relief, and 20 percent for debt-reduction, something of that magnitude. But it’s not a headline issue in my mind. I believe a successful political coalition has to emphasize economic growth, tax relief, and consumer choice in the areas of retirement, health care, education. Those are coalition builders. Debt-reduction is going to fail to be a political rallying cry.
Stein: But you mustn’t confuse the politics of debt-reduction with the economics of debt-reduction. The economic desirability of debt-reduction, I think, is not contestable.
Buchanan: If I borrow money, I have to pay it back tomorrow. It’s just that simple.
Kudlow: Yes, but if you borrow money and put it to work and create an asset, you will be able to pay it back.
Buchanan: But it makes a difference if I create my assets by borrowing, or by paying for it today.
Bruce Bartlett served in the U.S. Department of the Treasury during the Reagan and Bush administrations. James Buchanan teaches at George Mason University and was awarded the Nobel Prize in Economics in 1986. Lawrence Kudlow is an economist who served in President Reagan’s Office of Management and Budget. Stephen Moore is director of fiscal policy studies at Washington, D.C.’s Cato Institute. Mark Neumann is a second-term Republican Congressman from Wisconsin. Herbert Stein of the American Enterprise Institute was a chief economic advisor to Presidents Nixon and Ford.
