1999 Politics of Surplus Jude Wanniski March 26, 1999

It is hard to imagine the Republican congressional leadership climbing out of the hole they have dug for themselves, too clever by half as the British say. Picture Wile E. Coyote setting a trap for the Roadrunner, only to step into it himself, and you have a good idea of the Budget Resolution that whipped through Congress this week on straight party-line votes. With trillions of dollars of budget surpluses now projected for as far as the eyes of the Congressional Budget Office can see, the GOP only could find room for $15 billion in tax cuts in the coming year. They do have more than that amount netted out, because they finally have scored a lower capital gains tax as a revenue gainer. Wall Street also enjoyed reading about a possible phasing out of the federal estate tax as part of the GOP plan. But once again the President and congressional Democrats have outsmarted the Republicans, which is why they could vote with impunity against the resolution almost unanimously in both House and Senate. They did this by insisting Social Security be saved by putting aside the surpluses before taxes are cut. Aha! Republicans then announced they would put even more money aside than the White House suggested, to really, really save Social Security. Because all the budget surpluses for the next few years result from the payroll tax itself, any tax cut now must be “paid for” by spending cuts, which the budget resolution does not specify, but which of course will get the GOP back into the school lunch business that twice closed down the government in the 104th Congress and greased the skids for House Speaker Newt Gingrich.

That’s not all. By putting all the Social Security surplus in a “lock box,” there is no money left over to “save” Medicare. No matter that Medicare has been in deficit since FY1995 anyway, sustained by transfers from the general fund as they cash in Treasury IOUs. The President now is warming up to denounce the GOP fat cats for not putting aside funds to save it. Predictably, the NYTimes is already wringing its hands over the profligate Republicans, who once again want to cut taxes for the rich at the expense of our elderly old folks. How the GOP leaders will maneuver through this mine field that they have created for themselves is hard to imagine. The leaders themselves have no idea how to survive a White House veto later this year, when they try to make silk-purse legislation out of the sow’s-ear resolution. House Ways&Means Chairman Bill Archer says tax legislation will be drafted by August, not before. There is of course not a snowball’s chance in hell the $800 billion tax cut (over 10 years) will be enacted. If somehow a separate tax bill emerges that includes loophole closings -- which Archer and Treasury are seriously discussing -- we might see the capital gains tax cut to 15%. But there even may be confrontation over that.

The silliest part of the exercise, which almost nobody inside the Beltway seems to understand, is that the Social Security problem cannot be solved by “saving the surplus.” This is because almost every member of Congress on both sides of the aisle thinks in terms of squirrels saving nuts for the winter. It is extremely hard to get members of the banking or finance committees to understand that this ain’t squirrels and nuts. You cannot bury an IOU in a hollow tree and take it out 20 years from now to feed and house a senior citizen. If there are deficits in the system based on government promises, they can only be made up over time by increasing the efficiency of the economy. When you take out the IOU in 20 years, the economy had better be able to produce goods and services sufficient to support one retiree per two workers, or the tax rate on the two workers will break their backs. The ONLY way to make this happen is by making believe there are no surpluses -- because as promises written into accounting ledgers they are worthless unless the promises can be kept on time. Better to concentrate entirely on redesigning the tax, monetary and regulatory structure of the economy so the capital/labor ratio GRADUALLY increases by 50% during the next 20 years.

We must assume that Chairman Phil Gramm of Senate Banking understands this. He has a Ph.D. in economics! But he is not acting as if he does, taking charge of the Save-Social-Security issue by insisting on locking away the surplus in a way that blocks the needed reforms. Chairman Pete Domenici of Senate Budget has joined him in this sterile enterprise and so has the Senate GOP leadership. House Majority Leader Dick Armey also has a Ph.D. in economics and knows how phony the debate is, but feels that he has to go along with this squirrely/nut savings in order to neutralize criticisms from the White House. The narrow hope is that late this spring the CBO will come out with a new surplus projection that will give everyone more wiggle room. There is optimism in Armey’s shop that there will be so many Democrats voting for a tax bill, especially in the Senate, that the President will be ready to cut a deal to sign it. This could happen if the GOP gets behind the Coverdell-Torricelli bill, which not only is bipartisan but also distinctly middle-class in its powerful supply-side effects -- widening the brackets by $10,000 between 15% and 28%, expanding the Roth IRA to $3000 a year, exempting capital gains of $5,000 a year per family, and exempting $500 per family on interest and dividends. The President would not veto this, assuming Vice President Al Gore will not wish to go into the 2000 presidential race having helped kill Santa Claus. There is plenty of pessimism in GOP ranks on this topic, but I still think the optimists are probably right -- and so do the financial markets.