Robert J. Stonebraker, Winthrop University
The Joy of
Economics: Making Sense out of Life
Robert J. Stonebraker, Winthrop
University
Surpluses and Saliva
Annual income twenty pounds, annual expenditure nineteen nineteen six, result
happiness. Annual income twenty pounds, annual expenditure twenty pounds ought
and six, result misery.
...Charles
Dickens
October 1998 provided American citizens with two remarkable events. First, Mark McGwire stunned sport fans by smashing a then-record 70 home runs. Second, a besieged Clinton Administration stunned the political pundits by finishing the fiscal year with the first federal budget surplus since 1969.
What happened?
Yes. A surplus. After running up $3.5 trillion in deficits since 1969, Washington eked out a $69 billion surplus in fiscal 1998. Even more amazing, the surpluses continued for three more years: $126 billion in 1999, $236 billion in 2000, and $127 billion in 2001. Was it some miraculous feat of political will? Not really. An unexpectedly robust economy helped. Unexpectedly strong economic activity pours unexpectedly high tax revenues into the public coffers. The baby boomers did the rest. At the peak of their earning years, boomers dumped more taxes into the social security system than current retirees pulled out -- a mix that soon will reverse when boomers storm the retirement beaches in force.
With the bottom line wallowing in the black, we might have expected budget rhetoric to cool. It did not. Never underestimate the creativity of demagogues. Partisan squabbles over budget surpluses proved every bit as contentious and ill informed as those waged over soaring deficits. As usual, the rhetoric was largely cosmetic; lots of bluster, but little substance.
When the surplus developed, President Clinton pushed for saving it to protect social security. Impossible. The surplus cannot be saved for the future in any meaningful way. In fact, it is already gone. In the normal course of a month, billions of dollars worth of outstanding government bonds mature. The Department of Treasury routinely issues new bonds to raise the funds needed to repay those that are maturing. With an initial $69 billion surplus, the Treasury simply issues $69 billion less in new bonds. The result? A $69 billion drop in the value of outstanding government bonds; a $69 billion drop in the National Debt.
Congress faced three basic choices:
1. Keep 'em coming: Stay the course. Let the surpluses roll in and whittle down the National Debt.
2. Go shopping: Break out the checkbook. Spend the would-be surplus funds on new government projects. Whose pet projects should be expanded? Everyone has the same answer...."mine."
3. Give it back: Wipe out future surpluses with a tax cut. Which taxes should be cut? Everyone has the same answer...."mine."
Surpluses and economic growth
Which option would have been the best? It depends. If long-run growth is your goal, the keep 'em coming option looks attractive. Growth is driven by investments in technology and new capital goods; investments that enhance labor productivity and drive up output per person. But savings are a prerequisite for investment. If we do not save, we have no funds to lend firms trying to borrow and invest. Saving drives investment, and investment drives growth.
Alas, personal saving in the U.S. has been a disaster. Never very high by Japanese or European standards, personal saving rates in the U.S. have been in a steady decline ever since the early 1980's. In 1980, Americans were saving about eight percent of their disposable income. By 1990, the rate had fallen to five percent and has now plunged below two percent. Wall Street's remarkable run in the 1990’s was partly to blame. Soaring stock prices fattened financial balances. When portfolio values swell to record levels, consumers see less need to save. Booming home prices offer another possible explanation. Many U.S. families have most of their wealth tied up in housing. As long as home prices are rising, these families may feel financially secure and choose not to save.
If personal saving dries up, where will we get the funds needed for new investment? There are two other potential sources. The first is foreign funds. We can import savings -- and have been doing so since the early Reagan years. However, many Americans are uncomfortable with the notion of foreign investors taking ownership of U.S. corporations and assets.
The second alternative is a government budget surplus. Yes. A federal budget surplus has the same impact as personal saving. When the government runs a deficit, it finances the deficit by selling bonds. Deficits make the federal government a net demander of funds in financial markets. They draw monies out of the market that could have gone to finance private borrowing. Surpluses reverse the process. Federal surpluses turn the government into a net supplier of funds. With a $69 billion surplus, the Treasury will pay off $69 billion more in maturing debt than it will issue in new debt. That's a net increase of $69 billion available to fund investments in new capital and technologies. More federal budget surpluses mean more funds for growth-enhancing investment.
Go Shopping
Some politicians favored another option....the go shopping option. After all, they argued, economic growth requires public as well as private investments. Growth requires a well-educated and well-trained labor force; it requires a solid infrastructure of modernized highways, bridges, ports, and dams; it requires cities in which people are unafraid to walk and work. In short, it requires more government spending: more spending on basic scientific research, more spending on education, more spending on highways, more spending on improving the quality of life in general.
Are they correct? It depends. Where are the social rates of return higher? Will an extra billion dollars invested in education and highways create more long-run growth than an extra billion dollars invested in a new machine tool factory? Political liberals are likely to say: "yes." Political conservatives, convinced that all non-defense government spending falls into a black hole, answer, "no." I do not know the answer. But, I do know it is something about which intelligent, well-meaning people can disagree.
Give it back
What about the final option...the give it back option? Tax cuts always offer a political boon and many politicians salivate at the thought. But, be careful. We have slipped on that saliva before. Permanent tax cuts typically are not saved, they are spent. When the Reagan administration slashed tax rates in the early 1980's, recipients launched an almost unprecedented spending spree. Consumption rates soared, but savings rates fell. A boom in consumption is fun in the short run, but wreaks havoc in the long run. In terms of long-run growth, tax cuts are the least attractive option.
Does it matter? Politicians are focused notoriously on the short run. After all, the long run occurs after the election, and voters who enjoy the long-run benefits of past budget surpluses cannot easily reward politicians who no longer are in office. Are representatives more likely to follow their sense, or follow their saliva?
Saliva won the day. The Bush Administration campaigned on the promise of tax cuts and delivered once voted into office. Three successive tax cuts were enacted in George W’s first three years. Unfortunately, these cuts, coupled with a slowing economy and increased defense spending after 9/11quickly drove the federal budget back into red ink. The $127 billion budget surplus of 2001 collapsed into a $158 billion deficit for 2002, a $374 billion deficit for 2003, and a $413 deficit in 2004 -- the largest in U.S. history. Current projections forecast additional deficits as far the eye can see.
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Testing Yourself
To test your understanding of the major concepts in this reading, try answering the following:
1. Explain what caused the budget surpluses during the late 1990’s.
2. Identify the three basic options politicians had in dealing with budget surpluses.
3. Explain why budget surpluses might help spur economic growth.
4. Explain why the budget surpluses projected earlier have become budget deficits.