[front page]
The Outlook
The federal budget surplus is rapidly shrinking. That's a good thing, but you wouldn't know it from the debate in Washington, where the standard recession-fighting prescription is endangered by a newfound obsession with the Social Security surplus. Amid a softening economy, how important is preserving the federal budget surplus? Participate in the Question of the Day.
Most economists accept that, at least in theory, the government should offset contracting private activity in downturns by reducing its tax take and by boosting spending, a policy advocated by British economist John Maynard Keynes in the 1930s. Yet after the administration said last week the surplus this year and next will be less than expected, though still among the largest in U.S. history, budget director Mitch Daniels began demanding spending cuts. Democrats responded by condemning anew the tax cut. Both agree the Social Security surplus -- the excess of Social Security receipts over benefits, estimated at $157 billion this year -- must not be touched, thus barring the government from running a deficit in the rest of its budget.
On Wall Street, where you'd think preserving surpluses would score points, instead it's considered a really bad idea. "If the economy needs help today, fiscal stimulus may well be a better bargain than mindless fealty to an accounting fiction about Social Security and Medicare trust funds," remarked Neal Soss, Credit Suisse First Boston's chief economist. Jan Hatzius of Goldman Sachs adds that President Bush's defense of the Social Security surplus "may very well stand in the way of a sensible, countercyclical fiscal policy. After all, a temporary on-budget deficit would be a price well worth paying for averting a recession."
But don't let last week's rhetoric in Washington fool you. Keynesianism is not dead. It's enjoying a revival in some of the oddest places. The International Monetary Fund, whose austerity prescriptions are often blamed for deepening the late-1990s Asian crisis, praises the U.S. tax cut as "appropriate and timely." Meanwhile, signs that Germany and France may overshoot their deficit targets have fueled talk of relaxing Europe's strict limits on deficits.
But Keynesianism's oddest standard-bearers are President Bush and the supply sider who advises him, Lawrence Lindsey. Mr. Lindsey once labeled Keynes's advocacy of countercyclical fiscal policy "utopian." But last month, he said it was only "common sense economics" not only to let the budget deteriorate in a slowdown, but to push it along with a tax cut. He compared Democratic critics of the tax cut to Herbert Hoover, who raised taxes in 1932.
President Bush is committed to preserving the Social Security surplus, Mr. Lindsey said in an interview last week, but he'd make an exception for war or recession. "I don't think his is an absolutist view here," Mr. Lindsey said. If it turns out the U.S. is in recession, "then I think he'd be willing to reconsider."
This seems to run counter to Mr. Daniels's demand for spending restraint, but then not many analysts expect the bipartisan defense of the Social Security surplus to prevail against the ingrained momentum for more spending.
As long as the economy looks sick, that's probably a good thing. Democratic and Republican economists agree that trying to rope off the Social Security surplus when the economy is sinking is bad economics. Harvard University's Martin Feldstein, who was chairman of President Reagan's Council of Economic Advisers, thinks the record on fine-tuning the economy through countercyclical fiscal policy is awful, but says, "It's hard to see why we would want to try arbitrarily fine-tuning the economy in the wrong direction."
Princeton University's Alan Blinder, who sat on Mr. Clinton's council, says from the economics angle, an even bigger short-term tax cut would have been the right policy. But this time, good politics trumps good economics. "When you look out into the future, we really need that revenue for the Social Security system. To win politically you need a symbol that would attract politicians and voters. It turns out that saving the whole Social Security surplus is a pretty good candidate for that. This isn't something that comes out of the economic textbooks, but the political textbooks," Mr. Binder says.
On this, Mr. Lindsey agrees. There's no economic significance to a balanced budget or any given level of the Social Security surplus. "But it turns out there's value in the political process to having a number that everyone agrees to." It used to be zero; now it's $157 billion.
For this fealty to balanced budgets, thank the straitjacket of deficits that since 1982 not only made Keynesian countercyclical initiatives impossible, but often led to the opposite.
In 1990, President Bush senior had to raise taxes during a recession. Three years later, with the recovery still looking fragile, President Clinton had to abandon a $30 billion stimulus package he'd hoped would reduce the sting of his own tax increase. With the help of Federal Reserve Chairman Alan Greenspan, those moves kicked off a prolonged decline in interest rates, 10 years of prosperity and, ironically, the budget surpluses that today make Keynesian-style stimulus possible.
If, as many economists think, the 2001 tax cut has come just in time to head off recession, it may give Keynesian fine-tuning its biggest jolt of credibility in decades.
-- Greg Ip
---------------------
[editpage]
Debating Cockamamie Economics
By ROBERT L. BARTLEY
As the economy limps out of a quarter of zero growth, our solons are engaged in a great debate over their $160 billion budget surplus. Democrats contend it's too small; Republicans that it's just right.
This is absurd. Worse, feckless, since the fortunes of 275 million Americans are involved. For decades if not centuries, economists of all stripes have taught that in a recession a deficit is appropriate. The Keynesians (where have they gone?) argued that the deficit itself was the key to stimulating the economy. Classicists and supply-siders look for stimulus in tax cuts to improve incentives, and recognize that overcoming an economic pause justifies some borrowing. Just when the economy needs some help, the political class has been seized by cockamamie economics.
"In the Congress -- both houses, both parties -- we reached a consensus," says Rep. John Spratt, the Democratic point man on the issue. The consensus, he explained on the PBS "NewsHour," was to pay down the federal debt by an amount equivalent to the bookkeeping entries in the Social Security and Medicare trust funds. "We felt that if we did this religiously for the next 10 to 12 years, we could pay off all the debt held by the public, about $3.4 trillion."
What matters here, note well, is achieving a "consensus" among 535 politicians. Success is defined as having most of the 535 believe the same nonsense, or at least mouth it. "Consensus" takes precedence over prosperity, jobs and anything else of concern on the other side of the Beltway.
Now, Rep. Spratt and other members dress up their debt mania with arguments that it will help the economy by lowering interest rates, and that lower public debt will make it easier to fund Social Security. But these feeble arguments are merely window dressing for the truth: that debt repayment is the default that results when Republicans block Democratic spending and Democrats block Republican tax cuts.
In fact, the current promises of the Social Security system dwarf any reserve that could be accumulated; if funded through borrowing they would create a debt dwarfing anything within our experience. The long-term health of the system depends first of all on reform: restraining the pay-as-you go commitments with some bona fide savings and investment -- the fundamentalthrust of proposals for partial private accounts. (Once the open-ended commitments were under control, some borrowing for transition costs might indeed be prudent.)
Second, the health of Social Security depends on the growth of the economy to provide a larger pie to share with future retirees, which is to say today's taxpayers and voters. We need to use the current surplus in a way that helps the economy to grow faster between now and tomorrow.
The notion that growth comes from paying down the debt to lower interest rates used to be confined to cranks and bond traders, until bond trader Robert Rubin arrived at the Treasury and used it as an excuse for the Clinton tax hikes. In fact, interest rates went up while these taxes passed, and started down with the election of a GOP Congress in 1994. Unhappily and against warnings from me and others, Speaker Newt Gingrich put budget balance as the first plank in his Contract with America, stoking the deficit/debt fires.
This combination morphed into a whole mythical world of "out-year" projections, lockboxes, static analysis, "trust fund" bookkeeping and other creatures resembling nothing so much as the inhabitants of Dungeons and Dragons. As both candidate and president, George Bush felt he had to contort his tax proposals to fit this Procrustean bed. Thus the economy is getting scant help from the fiscal side, monetary policy is either behind the lag or drawing a blank, and we have arrived at the current nonsensical debate.
As for the debt, it's plunging. The OMB midsession review predicts that by 2011 it will be 6.1% of GDP, the lowest level since 1917. Government debt can be worrisome at a high enough figure -- more than 100% of economic output at the end of World War II or in Japan today. But at current levels it's a mere curiosity. Letting it displace growth as the centerpiece of economic policy is eccentric and potentially destructive.
The Bush administration almost certainly understands this, to judge by the tenor of its arguments in the current debate. Its spokesmen explain that the Social Security trust fund stays the same whether or not you pay down debt, that today's surplus is the second largest in history, that some of the debt is practically impossible to retire. On PBS, OMB Director Mitch Daniels concluded, "I return to the thought that restoring economic growth is the most important thing we can do."
However, the administration also remains committed to paying down debt commensurate with the bookkeeping entries for Social Security. The best its spokesmen can do is treat this as the arbitrary political commitment it is. The president said during the campaign he would not touch the "Social Security surplus," and this president keeps his campaign promises.
It is indeed uplifting to see a politician take his promises seriously, and a budding reputation for doing so has served the president well. Still, Bush 43 may have learned too well the lesson of Bush 41 and "read my lips." George W. made the campaign pledge on the "Social Security surplus" back when the economy was booming; similarly, he sent campaign tax proposals up essentially unchanged even after the slowdown became apparent.
We can hope the administration will get lucky with its prediction of an economic bounce to 3.2% growth next year. The Fed easings may gain some traction after a 12-month lag, and even the phased-in cuts in marginal tax rates may help a little. But in a real recession, the federal debt should not stand in the way of real stimulus -- for example, advancing all the marginal rate cuts into 2002. For my money, the same would apply to the grudging recovery we are likely to face. At least the president opened the door a crack in his Friday press conference by suggesting his pledge did not apply "in case of an economic recession or war."
With the Democrats blaming the "vanishing surplus" on the Bush tax cuts, it would be even more refreshing to have the president go further. He could say: During a recession you don't raise taxes, dummy, you cut them and worry later about debt. This would point not only to the right medicine for current problems, but also to a restoration of economic sanity.