whence the surplus

Doug Henwood dhenwood at panix.com
Fri Oct 20 10:59:22 PDT 2000


[hey Max, what do you make of this?]

New York Times - October 20, 2000

Taxes, the Market and Luck Underlie the Budget Surplus

By LOUIS UCHITELLE

In all the political debate about how to spend the rapidly emerging budget surplus, almost nothing is said about where it came from. It is a patchwork creation, hard to keep sewn together.

Taxes thrown off by the soaring stock market contributed handsomely to the surplus. So did higher tax rates on the rich, enacted just before their incomes surged ahead of other Americans' in the booming economy of the 1990's. Cutbacks in military spending after the cold war also helped significantly. Without these three windfalls, the budget would be in deficit today.

"There was a huge amount of luck involved in creating this surplus," said June O'Neill, a former director of the Congressional Budget Office, now an economics professor at Baruch College in Manhattan.

The bull market and the surge in tax revenue from the rich by themselves brought the budget out of deficit. If the market had risen more slowly in the 1990's, or income had been distributed more evenly across the work force, then the current surplus of $81 billion would instead be a deficit approaching $100 billion, according to government estimates. And if military spending had simply held steady at the 1990 level of $289.8 billion, instead of falling, then an additional $261 billion would have been subtracted over the decade from the surplus.

The nation, in sum, would have been struggling today with an annual budget deficit of more than $300 billion, about as high as the annual deficit has ever been for federal government operations other than Social Security.

The so-called unified budget surplus, including Social Security, which has its own revenue stream from payroll taxes, was $232 billion in the fiscal year that ended last month. This much larger unified budget surplus is often cited in the political debate. But without the windfalls of the 1990's, it, too, would show a deficit today, one of about $200 billion.

"We did not expect the favorable experiences that produced these surpluses," said Alan Auerbach, an economist and tax expert at the University of California. "Whether they will last is largely beyond anyone's control, including the politicians."

Vice President Al Gore and Gov. George W. Bush of Texas are counting on the good luck to last. They propose to use up - in tax cuts and new spending - nearly all of the surplus projected by the Congressional Budget Office over the next 10 years. The projections of the budget office, a nonpartisan research arm of Congress, assume that the mix of fortuitous circumstances that swung the budget from deficit to surplus will continue over the next decade, at least on the revenue side. That would happen even if the economy slowed, the budget office estimates.

"We are assuming," said Dan Crippen, director of the budget office, "that the tax revenues generated by the economy at any level of economic growth are now permanently higher than they were a few years ago."

That assumption goes unchallenged by Mr. Gore and Mr. Bush - although the recent sell-off in the stock market, if it continues, could eventually undermine tax revenue. The candidates accept the surplus projections of the budget office, although Jason Furman, a senior economist in the Gore camp, says that to be on the safe side, Mr. Gore's proposals would fall $300 billion short of spending the entire $2.2 trillion in surpluses projected by the budget office through 2010.

Mr. Bush is taking the budget office projection on faith. "What else can a politician do but rely on the best estimates?" said Ari Fleischer, a Bush spokesman.

The $2.2 trillion surplus does not include Social Security, which is expected to generate an additional surplus of $2.4 trillion by 2010. Mr. Gore would put this extra money aside to help pay retirement benefits when Social Security is projected to start running deficits in about three decades. Mr. Bush would put aside slightly more than half, but use about $1 trillion to finance individual retirement accounts.

The budget deficits began to shrink in 1993 after reaching a peak of $340.5 billion in 1992, excluding Social Security. The trend began gradually and became more rapid until a surplus of $700 million appeared in 1999. This rose to $81 billion in the fiscal year 2000, which ended on Sept. 30.

The swing was $421 billion, with much of it a result of normally rising tax revenue in a strong economy combined with caps on spending. But nearly $180 billion of that amount, or about 43 percent, according to the budget office, came from the unexpected surge in tax revenue thrown off by the soaring stock market and the rapidly rising incomes of people making more than $200,000 a year and particularly more than $1 million.

The bull market delivered more than $70 billion of the nearly $180 billion in extra tax revenue, not only from a surge in capital gains taxes on the sale of stocks, but also from taxes on stock options cashed in and market-related bonuses, as well as taxes on withdrawals from pension accounts fattened in the soaring market. Some of the rise in taxes on pension withdrawals was simply taxes deferred on contributions to retirement accounts like the 401(k). Most of these accounts have existed only since the mid-1970's and are just now being drawn down in significant amounts.

The surging economy and rising employment added another $40 billion in unexpected revenue from taxes on individual incomes, the budget office estimates. And labor productivity played a role. It surged over the last five years as workers increased their output for each hour on the job. This extra revenue from rising efficiency showed up as taxable individual income or as taxable company profits. Whether the unanticipated surge in productivity growth will last through the decade is still an open question among economists.

The surge in taxes paid by the wealthy has been the biggest single source of the surplus, accounting for roughly $72 billion of the $421 billion swing over eight years. That has pushed total income tax collections from all Americans to nearly $900 billion annually, or about 10 percent of the gross domestic product, up from 7 percent to 8.5 percent, for most of the years since the early 1960's.

The budget office's projections on the surplus assume that taxes on individual incomes will keep this revenue above 10 percent of the gross domestic product each year of this decade. That optimistic assumption is challenged by some economists.

"If we plunge into a recession, the surplus projections are going to be way off," said William Gale, a senior fellow at the Brookings Institution, a research group.

In explaining the projections, the budget office, in a July report, attributed the unanticipated rise in individual income tax revenue in part to the increase in capital gains taxes from "surges in stock prices and growth in stock market volume." Tax receipts from the wealthy, whose incomes rose far more rapidly in the 1990's than those of most other Americans, got equal billing.

"The average effective tax rate climbed because of a swift rise in income among people in the highest tax brackets," the report said. It concluded that the stock market and the tax revenue from the wealthy "explain many of the recent changes to both actual revenues and the projections of revenues over the next few years."

Congress set the stage a decade ago for the budget surpluses appearing today. Tax rates rose for the wealthiest Americans as a result of legislation in 1990, when Governor Bush's father was president, and in 1993, under President Clinton. A 1997 law undid some of the 1993 tax rate increases, but tax rates on wealthy Americans were still sharply higher when the economy suddenly roared ahead in 1996. The boom lifted nearly everyone's taxable income, but a far larger share of the gain - in the form of stock options and bonuses as well as higher pay - went to people with taxable incomes above $200,000.

So-called bracket creep, when rising incomes put people into higher tax brackets, accounted for a significant share of the surge in tax revenue. But equally significant was the flow of income to people already paying the highest rate: up to 39 percent vs. 28 percent a decade ago.

That was particularly the case for people reporting $1 million or more in taxable income. Their taxable income rose to $508 billion in 1998 from $171 billion in 1993, an increase of nearly 200 percent, according to Citizens for Tax Justice in Washington.

"Not since the 1920's has income been so concentrated at the top," Mr. Gale said.

But if tax revenue has grown faster than the economy itself and well above historical trends, in the view of the Congressional Budget Office, spending certainly has not. The spending restraint also fattened the surplus, but now seems in conflict with some of the stated plans of Mr. Gore and Mr. Bush.

Both have spoken, for example, of maintaining a strong military. But a budget office report this month estimates that an additional $50 billion a year will have to be spent on the military to maintain the armed forces at their present level. That includes the cost of overhauling or replacing aging equipment. The $50 billion is well beyond the annual increases in military spending used by the budget office to calculate the budget surpluses over the decade.

Federal spending on education has also declined since 1992 as a share of the gross domestic product, although both candidates call for a stepped up federal role in education. Generally, the mild spending increases for education, the military, research and other discretionary spending are a result of the spending caps imposed in the 1990's tax laws.

"If Congress and the next administration are not going to increase these spending caps," said Robert Pollin, an economist at the University of Massachusetts, "then any growth in the economy or surge in the stock market is naturally going to translate into more tax revenue and a surplus."



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