June 22, 2000

June 22, 2000 | News Releases on Federal Budget

Ex-CBO Director: More Tax Money, Less Spending Brought Surpluses

WASHINGTON, June 22, 2000-With the federal budget going ever deeper into the black-the latest estimate has the surplus hitting $750 billion over the next decade-the question naturally arises: What led to this abundance of revenue?

Some credit the budget caps Congress adopted in the early 1990s, which triggered a significant decline in government spending. Others point to the fact that taxable income jumped between 1994-1998. Still others attribute the surplus to congressional gridlock or say it's just plain luck. But according to June O'Neill, director of the Congressional Budget Office from 1995 to 1999, the correct answer is: all of the above.

"Unfortunately, there is no DNA test for determining the real father of the economic successes of the past five years," she writes in the latest issue of Policy Review. "Many people and things, known and unknown, planned and accidental, were players in the outcome."

There's no question the budget caps played a part, O'Neill says, as federal outlays fell from 21.2 percent of GDP in 1989 to 18.7 percent last year, a level not seen since 1974. "In my view, having observed Congress struggling with a constant stream of requests and temptations to spend more, the caps provided an important reason to say no," she adds. The end of the Cold War helped as well, with deep defense cuts causing a huge drop in government spending.

But the revenue side of the ledger-unexpectedly large tax receipts-also led to big surpluses, O'Neill says. Between 1994 and 1999, taxable personal income shot up, along with capital gains and retirement income such as 401(k) plans. Those taxed at the highest rate saw their incomes rise sharply as well, with the income received by taxpayers making more than $200,000 a year increasing from 15 percent to 22 percent.

Congress can also be thanked, though more for what it didn't do, she says. The lack of legislation that would have adversely affected the budget-such as President Clinton's overhaul of the nation's health-care system-kept the economy humming. Consider the infamous government shutdown of 1996, which helped bring federal spending in at $13 billion below the budget ceiling. "Gridlock seems to be good medicine for the economy," she notes.

And let's not forget a certain degree of luck, O'Neill adds. Many post-1992 surprises, including the enormous growth of the stock market, declining Medicaid costs (due in part to the switch to managed care), and the fact that the Asian financial crisis provided Americans with cheap imports, improved both the revenue and outlay side of the ledger.

One other factor shouldn't be overlooked, O'Neill says: the pessimistic budget forecasts of the early 1990s. As recently as 1995, the CBO was predicting deficits of 3 percent of GDP at least for the rest of the decade. "The large actual deficits, and projections of more of the same, put tremendous pressure on legislators to find ways to reduce federal spending," she writes.

Which prompts another question: Could projections of surpluses, paradoxically enough, put future surpluses in jeopardy? Unfortunately, yes. Congressional spending has grown since surpluses were predicted, and budget gimmicks such as specious "emergencies" are becoming more frequent. "The combination of a potentially large surplus and the coming election may prove too tempting to resist this year, and belts may be further loosened to allow for a great deal more spending than we have seen for the past few years," O'Neill writes.

A tax cut would be preferable to more spending, she says, for three reasons. For one, effective tax rates will otherwise continue to climb along with real income. For another, many of the current spending proposals, such as more federal funds for education, are more appropriately handled at the state and local level. And a tax cut would be more effective at stimulating growth than debt reduction.

"But in the short run-certainly for this budget season-I see little downside to waiting and allowing the surplus to reduce the debt further," O'Neill writes. "It would give us more time to gauge whether we have really reached a new 'plateau of prosperity'-in the immortally mistaken words of Irving Fisher in 1929."

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