On January 16, President Bill Clinton transmitted to Congress his final budget blueprint for fiscal year (FY) 2002, arguing in the cover letter and commentary against reducing taxes for working Americans. According to the former President, "The favorable long-term budget results in these projections can be realized only with prudent policy--choosing continuing reductions in outstanding debt, rather than expensive tax cuts or spending increases."1 The need to reduce the debt, in President Clinton's opinion, precludes other options, particularly tax cuts. Nevertheless, the former President ignored his own warning regarding spending and recommended increasing funding for over 70 programs, which he cites as underfunded in FY 2001 despite the fact that they had received funding increases between FY 2000 and FY 2001.2
On January 25, however, Federal Reserve Board Chairman Alan Greenspan made it clear that the size of projected surpluses should no longer force a tradeoff between debt reduction and other uses of the surplus. Greenspan recommended that Congress take the opposite approach from that suggested by President Clinton's big-spending final budget. Using the same projections that the Clinton Administration included in its budget report, Greenspan testified that "[I]f long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases."3
With such conflicting economic advice emanating from Washington, it is no wonder that Americans are confused. But as Chairman Greenspan undoubtedly already knows, close examination of the budget numbers cited in the Clinton report reveals a picture very different from the one described by the former President in the cover letter and commentary accompanying his final budget submission nine days earlier. In fact, the Clinton budget report makes one of the most compelling cases thus far for substantially reducing taxes as soon as possible. Buried in the report's financial data and accompanying footnotes are details that make it clear that tax reduction is absolutely necessary to avoid severe economic disruptions as the national debt held by the public approaches zero.
The reason: Under current policies, the federal government will collect $2.9 trillion more in tax overpayments than it will be able to use to pay down national debt held by the public.4 This money must be spent by the federal government, invested in the private sector, returned to taxpayers, or some combination of all three. Regrettably, many policymakers have advocated allowing the federal government to invest these excess balances in the private sector. This would be a formula for disaster, which would threaten the economy as well as the retirement security of all Americans.5
Chairman Greenspan made this clear in 1999 when President Clinton first proposed to invest $650 billion of surplus Social Security funds in the stock market over a 15-year period. Greenspan testified before Congress then that such an investment "would arguably put at risk the efficiency of our capital markets and thus our economy."6 As he underscored on January 25, 2001,
continuing to run surpluses beyond the point at which we reach zero or near-zero federal debt brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private assets.7
Greenspan recognizes that the stakes of spending the surplus by investing it in the private sector are too great to ignore. His cautions to Congress and his support of tax cuts clearly indicate that, for Alan Greenspan, $2.9 trillion in excess cash represents too large and too dangerous a temptation for policymakers who are looking to expand government control over the private sector.
The federal government's "publicly held" debt is approximately $3.2 trillion.8 This amount represents money owed to investors from around the world who hold various federal government debt instruments, everything from short-term bills to long-term notes and bonds.
If current policies remain unchanged, the federal government will collect $27.6 trillion in revenue between 2002 and 2011 while spending $22.6 trillion.9 This will result in a surplus of $5 trillion over 10 years. And since the total federal debt held by the public is less than $3.2 trillion (according to the Clinton Administration's own estimates), the federal government will be left to decide what to do with a minimum of $1.8 trillion in excess cash on hand.
Even this understates the true size of the projected tax overpayments and accumulated cash balances. Many retirees, pension funds, and institutional investors who hold federal Treasury notes are simply not anxious to redeem them. As Chairman Greenspan reports:
As of January 1, for example, there was in excess of three quarters of a trillion dollars in outstanding nonmarketable securities, such as savings bonds and state and local series issues, and marketable securities (excluding those held by the Federal Reserve) that do not mature and could not be called before 2011. Some holders of long-term Treasury securities may be reluctant to give them up, especially those who highly value the risk-free status of those issues. Inducing such holders, including foreign holders, to willingly offer to sell their securities prior to maturity could require paying premiums that far exceed any realistic value of retiring the debt before maturity.10
The amount of unified budget surplus available to repay debt held by the public is estimated to be greater than the amount of debt that is available to be redeemed in 2006 and subsequent years. The difference is assumed to be held as "excess balances" and to earn interest at a Treasury rate.11
These "excess balances" would start at $289 billion in 2006 and exceed $2.9 trillion by 2011. Whether the accumulated excess cash is on-budget or off-budget,12 generated by payroll or income taxes, or deposited in trust funds or the general fund is unimportant. Excess cash is excess cash, regardless of how accountants record it on the government's balance sheets. Under current policy, these balances would continue to grow after 2011 by more than $800 billion per year until at least 2015, by which time the federal government's excess cash balances could exceed $6 trillion.13
In other words, even after making the best possible effort to pay off the debt held by the public, policymakers will still have a huge amount of excess tax revenue on their hands. So what should politicians do with all this extra money? Some argue that it should be set aside, "saved" in a "lockbox" to help finance Social Security's long-term deficit or for some other purpose. But this does not mean the government would put the money in big cookie jars and bury it under the White House lawn. What this really means is that politicians would be able to seize control of a large share of the U.S. economy. According to an op-ed by Kevin Hassett and R. Glenn Hubbard:
Investing that much public money would likely mean the government purchase of stocks, because only equity markets are large enough to absorb such inflows and still remain liquid. Assuming the Treasury begins to invest surpluses in the stock market as soon as it has retired all the debt that it can, and that these investments earn a 10% annual return, our government will be sitting on a stock-market portfolio worth $20 trillion by 2020. To put that in perspective, the current market value of all equities in the U.S. is about $17 trillion, according to the Federal Reserve. Projecting forward, the U.S. government could own about one-fifth of all domestic equities by 2020.14
But as Chairman Greenspan has cautioned, returning money to taxpayers would be far more beneficial to the country's long-term economic stability than would allowing the federal government to invest heavily in the private sector.
Some politicians who oppose tax cuts continue to reject Chairman Greenspan's endorsement of tax reduction on the grounds that surplus projections are unreliable. These policymakers commonly assert that current economic growth levels (which determine the tax base and therefore tax collections) are unsustainable or that Congress will increase spending to absorb future revenues. Both demographic analysis and historical review, however, indicate that neither of these assertions is valid.
Several demographic trends converged in the 1990s, resulting in unexpectedly strong economic growth. These trends should continue to have a positive effect on the national economy for at least another decade, possibly much longer.
The baby-boom generation has entered middle age, and as one analysis explains, "Household income peaks in the 45-54 age group.... Fully 16 percent of householders aged 45-54--or one in six--have incomes of $100,000 or more."15 Moreover, they are paying more in taxes.
The labor force participation rate among women almost doubled between 1960 and 2000. Consequently, women's income and tax payments are also rising.16
Educational attainment, one of the prime determinants of taxable income, rose sharply between 1960 and 1998. The percentage of the population graduating from high school doubled from 41.1 percent in 1960 to 82.8 percent in 1998. The percentage completing college more than tripled from 7.7 percent in 1960 to 24.4 percent in 1998.17
More people are earning higher incomes. While the percentage of households earning less than $35,000 per year (in inflation-adjusted 1997 dollars) fell from 56.2 percent of the population to 47.3 percent in 1997, the percentage earning over $75,000 rose from 7.1 percent to 18.4 percent over the same period.18 Consequently, more people are paying higher taxes.
It is also unlikely that politicians will spend all of these revenues. For instance, even though lawmakers have dramatically increased the growth rate of federal spending in the past three years, budget surpluses have continued to grow. In short, money has been pouring into the Treasury's coffers faster than politicians can come up with new ways to spend it.
Barring any significant new entitlement programs, this pattern is likely to continue; and while there likely will be "horse trading" between liberals and conservatives that results in increased discretionary spending for both domestic and national security accounts, it is unlikely that this would consume more than one-third--and possibly as little as 10 percent--of the projected surplus.
Policymakers may find themselves under pressure to invest the accumulated excess balances in private-sector financial markets, but the sheer size of the excess balances to be invested would raise serious questions of government control of the private sector. As former Office of Management and Budget (OMB) Director Alice Rivlin observed in 1992, "No good would come of making the government a big shareholder in private companies or the principal owner of state and local bonds."19
Under current policies and the Clinton's plan, the federal government's private-sector investments could exceed $2.9 trillion by 2011 and reach $6 trillion by 2015. Even with the best of intentions, it would be difficult to manage investments of this size without displacing private-sector investors, including pension plans and mutual funds. For this reason, Greenspan was right to say back in 1999 that such federal investment in the private sector "would arguably put at risk the efficiency of our capital markets and thus our economy."20
There are four major dangers involved in having the federal government invest in the private
- "Politically correct" decisions at the expense of taxpayers, with politicians foregoing sound investments in unpopular industries and investing instead in feel-good causes that could lose money.
[T]he federal government should eschew private asset accumulation because it would be exceptionally difficult to insulate the government's investment decisions from political pressures. Thus, over time, having the federal government hold significant amounts of private assets would risk sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise....22
In the end, given the sheer size of the projected surplus over the next 10 years, the only responsible course of action for the federal government is to return the surplus tax revenues to the taxpayers who paid them in the first place.
First, lawmakers should establish a system of personal retirement accounts (PRAs). With these accounts, each taxpayer would dedicate a portion of his payroll tax payments to a portfolio of investments similar to those in a 401(k) account or the federal government's Thrift Savings Plan. While these accounts would be mandatory, the use of PRAs would not concentrate economic power in the hands of government bureaucrats because investment decisions would be spread among millions of workers and their professional fund managers.23
Second, President Bush and Congress should implement significant tax reductions and comprehensive reform of the income tax code. The best way to return income tax overpayments is to reduce tax rates at all levels. Tax cuts and fundamental tax reform would substantially increase incentives to work, save, invest, and take risks. Tax rate reduction is simple, fair, and rewards all taxpayers according to the level of financial burden they have borne. Moreover, because there is so much excess tax revenue available, lawmakers would be able to address other tax code inequities, including marriage penalty relief and death tax repeal.
Regardless of the precise combination of personal retirement accounts and tax-rate reduction chosen by the President and Congress, the important goal should be to strengthen and secure the economy's long-term performance. As Chairman Greenspan and others have cautioned, reducing excess cash balances that policymakers may otherwise be tempted to invest in the private sector is critical to achieving this goal.
Indeed, it is quite likely that the policies outlined above will spur the economy, which in turn will lead to even more tax revenue. If that is the case, policymakers may want to consider further income tax rate reductions and a faster transition to a private Social Security system.
Ironically, President Clinton's final budget report articulates the need for significant tax cuts. It states that "Policy decisions will be required on the use of the surpluses that are accumulated as excess balances."24 Since the national debt held by the public is not large enough to absorb the entire surplus, and since there are limits to how fast the debt can be paid down, the real choice for policymakers is whether to spend the surplus or return it to the taxpayers.
The best decision, insofar as long-term economic growth is concerned, is to reduce taxes, reform the tax code, facilitate Social Security reform, and thereby avoid the investment of cash balances in the private sector. These policies will boost the economy's long-term performance and--in the case of Social Security reform--reduce the huge potential debt facing future generations of Americans.
Peter B. Sperry is Grover M. Hermann Fellow in Federal Budgetary Affairs at The Heritage Foundation.
3. Alan Greenspan, testimony before Committee on the Budget, U.S. Senate, 107th Cong., 1st Sess., January 25, 2001, available at http://www.federalreserve.gov/BoardDocs/Testimony/2001/209010125.htm.
4. National debt held by the public, currently about $3.2 trillion, consists of debt instruments sold to anyone other than a federal trust fund. Most of this debt is owned by state and local governments, pension plans, mutual funds, and individual retirement portfolios. Most investors are strongly motivated to hold federal debt instruments until maturity--up to 30 years in the case of T-bills. Many institutional investors, particularly pension funds, are required to maintain a certain portion of their portfolio in cash equivalents, and they depend on the federal government to issue new debt when their old investments mature and are redeemed.
5. Daniel J. Mitchell, "Why Government-Controlled Investment Would Undermine Retirement Security," Heritage Foundation Backgrounder No. 1248, February 5, 1999.
8. The "gross" federal debt, which includes money the Treasury Department owes to other parts of the federal government, is about $5.6 trillion. This additional debt is routinely ignored because it simply represents intra-governmental bookkeeping and has no real-world economic impact.
12. On-budget revenue, generated primarily by income taxes, is deposited in the general fund and appropriated by Congress. "Off-budget" revenue, generated primarily by Social Security and fuel taxes, is deposited in trust funds and spent according to predetermined formulas.
13. Social Security is projected to run short of funds in 2015. Absent reform, the program's deficits will quickly reach very large levels, and the budget surpluses will disappear and be replaced by huge deficits.
23. For a more complete description of PRAs, see David John, "Structuring and Regulating Individual Social Security Accounts," Heritage Foundation Backgrounder No. 1342, January 21, 2000.