Recent government estimates indicate that revenues will exceed spending by 2001. The projected budget surplus will climb to more than $100 billion by 2006. A three-way debate has developed over how best to use this surplus revenue. Some would like to use it for new government programs, others to reduce the national debt. A third group would prefer returning the money to U.S. taxpayers.
Before making any decisions, policymakers first should ask themselves how to get the "most bang for the buck." Economic research continues to show that tax cuts, particularly reducing marginal tax rates on work, savings, and investment, would generate large returns. Debt reduction also would have positive returns, but the benefit would be modest because the government's inflation-adjusted borrowing costs are relatively low. Higher spending is the least desirable way to dispose of surplus revenues because most government programs have negative returns.
Federal taxes are expected to consume 19.9 percent of economic output in 1998, a peacetime record. Since Bill Clinton became president in 1993, the tax burden as a percent of gross domestic product has climbed by 2.1 percent. This may not sound like a large amount, but 2.1 percent of an $8.461 trillion economy is $177.7 billion. Just reducing taxes to their level when Clinton took office would mean that the average family of four would receive more than $2,500 in annual tax relief
Lower tax rates increase incentives to work, save, and invest. To maximize increases in family income and improvements in standards of living, tax reductions should be designed to move the tax code toward a single rate consumption-based tax such as the flat tax. Tax cuts also could facilitate the transition to a private Social Security system to boost retirement income, increase national savings, and reduce the current system's unfunded liabilities.
Inflation-adjusted interest on the national debt over the past 30 years has averaged only 1.57 percent. A $100 billion reduction in the national debt next year would reduce interest payments by less than $6.6 billion. That same $100 billion of surplus tax revenues would be more than enough to abolish capital gains taxes, the death tax, and the alternative minimum tax, and have enough left over to cut income tax rates across the board. Lawmakers also could use a $100 billion surplus to reduce the Social Security payroll tax by about 3 percent while requiring taxpayers to place that money in private retirement accounts.
Two decades of budget battles have created a bipartisan myth that balancing the budget is the most important goal of fiscal policy. But budget deficits are neither good nor bad. They simply measure the extent to which government is financed through borrowing instead of taxes. Issues like the size of government and the burden of the tax system are far more important.
Daniel J. Mitchell is the McKenna Senior Fellow in Political Economy at The Heritage Foundation.
