Use a Pending Budget Surplus — Only for Major Fiscal Reforms

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Mr. Chairman and members of the Budget Committee: I am honoredfor this opportunity to address a most surprising question -- whatshould be done about a pending surplus on the unified budget? Myfirst reaction to this question, based on the dismal fiscal recordof the past 30 years, is that you should not count your surplusesuntil they are hatched; for most of this period, the annual budgetprojected a surplus in the fifth year but somehow that neverhappened. For this hearing, however, I will suspend my usualskepticism to address how Congress may best respond to a growingsurplus on the unified budget, beginning as early as this fiscalyear. You are commended for addressing this issue early but it istoo early, I suggest, to commit to any specific disposition of apending surplus. This hearing, however, provides a valuable forumfor addressing the considerations that should bear on your choiceamong the alternative proposals for the disposition of thissurplus.

My general advice on this issue is to use a pending budgetsurplus only to finance one or more major fiscal reforms. The flipside of this coin is that Congress must discipline itselfagainst responding to a pending surplus in the way itresponded to the O'Neill windfall -- by an inchoate mishmash ofsmall spending increases and tiny tax cuts that characterized thisyear's budget deal. If Congress is not ready to address a majorfiscal reform, a pending surplus should not be committed in any wayother than to reduce the outstanding federal debt. My priorities,thus, place major fiscal reform ahead of debt reduction. On theother hand, I value debt reduction more than any of the newentitlements and junk tax cuts that often emerge when a surplus isin prospect.

The most valuable use of a budget surplus, I suggest, would beto help finance the necessary transition from our pay-as-you-gosocial security and medicare programs to advance funded individualretirement and medical insurance accounts. There should no longerbe any doubt that such a transition is necessary. These twoprograms are on an unsustainable path, one that will not survivethe retirement of the boomer generation without some combination ofbreaking promises to those who counted on these programs, hugeincreases in the payroll tax, or huge increases in the debt burdenon subsequent generations. This is an issue that Congress cannotultimately avoid, and the transition problem will be smaller thesooner it is addressed. Some part of the payroll tax revenues mustbe diverted to finance the individual accounts, and the magnitudeof the necessary transition finance is the difference between theoutlays necessary to maintain the benefits of those now retiredplus those who choose to stay in the government programs and thelower payroll tax revenues. This transition finance problemeventually disappears when all future retirement benefits areprefunded.

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

The only other major fiscal reform that merits priority overreducing the federal debt would be a major tax reform. Our federaltax system now costs the economy nearly $2 for every $1 of revenue,and any of the major tax reform proposals would substantiallyreduce this cost. The budget problem is that a tax reform that isrevenue-neutral in the long term reduces revenues in the shortterm. Since a major tax reform would increase economic growth andreduce the relative debt burden, I would not hesitate to use apending budget surplus to finance the resulting short term revenueloss. Using a budget surplus to help finance the transition toprefunded retirement plans merits higher priority only because thisreform is necessary, whereas a major tax reform is onlystrongly desirable. But these two types of reforms need not bemutually exclusive. My preference would be to program a surplus onthe unified budget surplus sufficient to finance the transition toprefunded retirement plans and to implement a major taxreform that is revenue-neutral on a static basis.

Until such time as there is sufficient consensus on one or bothof these major reforms, we should welcome a surplus on the unifiedbudget and the resulting reduction in the federal debt. Above all,don't fritter away a growing surplus and the important reformopportunities that it would make possible by new entitlements andjunk tax cuts.

Thank you for your attention.