Use a Pending Budget Surplus — Only for Major Fiscal Reforms

Committee on the Budget
United States House of Representatives

Mr. Chairman and members of the Budget Committee: I am honored for this opportunity to address a most surprising question — what should be done about a pending surplus on the unified budget? My first reaction to this question, based on the dismal fiscal record of the past 30 years, is that you should not count your surpluses until they are hatched; for most of this period, the annual budget projected a surplus in the fifth year but somehow that never happened. For this hearing, however, I will suspend my usual skepticism to address how Congress may best respond to a growing surplus on the unified budget, beginning as early as this fiscal year. You are commended for addressing this issue early but it is too early, I suggest, to commit to any specific disposition of a pending surplus. This hearing, however, provides a valuable forum for addressing the considerations that should bear on your choice among the alternative proposals for the disposition of this surplus.

My general advice on this issue is to use a pending budget surplus only to finance one or more major fiscal reforms. The flip side of this coin is that Congress must discipline itself against responding to a pending surplus in the way it responded to the O’Neill windfall — by an inchoate mishmash of small spending increases and tiny tax cuts that characterized this year’s budget deal. If Congress is not ready to address a major fiscal reform, a pending surplus should not be committed in any way other than to reduce the outstanding federal debt. My priorities, thus, place major fiscal reform ahead of debt reduction. On the other hand, I value debt reduction more than any of the new entitlements and junk tax cuts that often emerge when a surplus is in prospect.

The most valuable use of a budget surplus, I suggest, would be to help finance the necessary transition from our pay-as-you-go social security and medicare programs to advance funded individual retirement and medical insurance accounts. There should no longer be any doubt that such a transition is necessary. These two programs are on an unsustainable path, one that will not survive the retirement of the boomer generation without some combination of breaking promises to those who counted on these programs, huge increases in the payroll tax, or huge increases in the debt burden on subsequent generations. This is an issue that Congress cannot ultimately avoid, and the transition problem will be smaller the sooner it is addressed. Some part of the payroll tax revenues must be diverted to finance the individual accounts, and the magnitude of the necessary transition finance is the difference between the outlays necessary to maintain the benefits of those now retired plus those who choose to stay in the government programs and the lower payroll tax revenues. This transition finance problem eventually disappears when all future retirement benefits are prefunded.

One might hope that the projected surplus on the unified budget would be sufficient to finance this transition problem. If not, some other budget measures would also be necessary: reducing the growth of future retirement benefits (such as by gradually increasing the age for full benefits), reducing other government spending, or by increasing other taxes. The relative magnitude of these measures, of course, depends on the details and timing of the transition to fully prefunded plans and the effects on the economy. In any case, this problem would only be magnified by committing a surplus on the unified budget to selective spending increases and other tax cuts. One should recognize that a deficit on the unified budget understates the increase in the liabilities of the federal government by the amount by which the net liabilities of the several government retirement programs increase in that year. If, as now appears increasingly probable, the unified budget is balanced sometime in the next few years, the total deficit of the federal government will still be over $100 billion.

The only other major fiscal reform that merits priority over reducing the federal debt would be a major tax reform. Our federal tax system now costs the economy nearly $2 for every $1 of revenue, and any of the major tax reform proposals would substantially reduce this cost. The budget problem is that a tax reform that is revenue-neutral in the long term reduces revenues in the short term. Since a major tax reform would increase economic growth and reduce the relative debt burden, I would not hesitate to use a pending budget surplus to finance the resulting short term revenue loss. Using a budget surplus to help finance the transition to prefunded retirement plans merits higher priority only because this reform is necessary, whereas a major tax reform is only strongly desirable. But these two types of reforms need not be mutually exclusive. My preference would be to program a surplus on the unified budget surplus sufficient to finance the transition to prefunded retirement plans and to implement a major tax reform that is revenue-neutral on a static basis.

Until such time as there is sufficient consensus on one or both of these major reforms, we should welcome a surplus on the unified budget and the resulting reduction in the federal debt. Above all, don’t fritter away a growing surplus and the important reform opportunities that it would make possible by new entitlements and junk tax cuts.

Thank you for your attention.