That Long-Awaited Budget Surplus? Don’t Count On It
Unless they can predict the stock market, politicians shouldn’t make plans to spend the newfound surplus in the federal budget. That’s because the surplus is due largely to tax revenues from capital gains and stock-option income related to the surging stock market--and there’s no guarantee that stocks will continue to rise so strongly this year and beyond.
A modest rise in stock prices in 1998--or a market decline--could eliminate whatever surplus exists and upset President Clinton’s projections for a balanced budget in fiscal 1999, which begins Oct. 1, analysts say.
In fact, the surpluses could vanish if stock price gains are only a moderate 5% to 6%, even with continued growth in the economy, contends economist Saul Hymans, director of the University of Michigan’s Seminar on Quantitative Economics.
Stocks as measured by the Dow Jones industrial average have risen at least 20% a year for the last three years, an unprecedented climb that many analysts consider unlikely to be repeated this year, particularly with the Asian economic crisis threatening to cut U.S. corporate profits.
But such a bull market was the critical factor in producing huge surges in capital-gains tax revenue that reduced the federal deficit from $200 billion three years ago to what is believed to be a surplus now--far sooner than anyone had projected a few years ago.
No one expected the stock market--and thus stock-related tax revenue--to do so well and produce such largess. Government forecasters were able to predict most of the $1.5 trillion in tax receipts the U.S. Treasury took in last year from corporate profits and employee wages in a strong economy. Based on those projections, the budget was expected to reach a surplus in 2002, and budget officers planned government expenditures accordingly.
But no one foresaw the unprecedented numbers of taxpayers in recent years who have sold stocks and mutual funds and exercised stock options at substantial gains. As taxes were paid on those gains, the federal government has enjoyed an unprecedented rush of tax receipts: $40 billion extra in the latest fiscal year, by one estimate.
That has produced an unusual period of government solvency and confidence. The Treasury even announced in December that the federal budget had run a $2-billion surplus--in a $1.7-trillion budget--over the previous 12 months.
And that confidence has given rise to spending proposals that cheer politicians and worry economists.
“The budget surplus won’t last long. Congress will find ways to spend it,” says Ted Gibson, chief economist for the California Department of Finance, which itself saw a $1-billion rush of capital-gains tax receipts in April, helping to create a surplus in the state’s budget.
The stronger-than-expected stock market is not the only surprise factor that has contributed to the budget surplus.
Government forecasters also did not fully anticipate the surge in growth in the entrepreneurial U.S. economy, where more people are self-employed or work for companies that pay partly in stock options. Such activity, which is particularly pronounced in places like Southern California and the Silicon Valley, has produced surging tax revenue, although there are debates in government circles as to how much revenue there really is from the entrepreneurial economy, because so much of it is not easily categorized.
The debates remain inconclusive because hard data are unavailable until detailed reports from the Treasury Department are released more than a year from now.
Nonetheless, the value of the entrepreneurial economy is recognized by the Paris-based Organization for Economic Cooperation and Development, which noted in a recent study that the U.S. economy is at once more turbulent, with businesses starting up and failing more frequently than in other countries, but also innovating more often and creating more jobs.
Another unexpected factor contributing to the budget surplus has been Medicare and Medicaid expenditures that have been lower than projected by the Office of Management and Budget. This is due partly to the rise in more people joining health maintenance organizations, which reduce the cost of medical insurance to the government.
Also, Congress and the White House have held the line on federal expenditures in recent years, partly by reducing what they transferred to the states in block grants. State governments haven’t complained because they too were enjoying an increased flow of taxes from stock options and investment gains.
The budget is in surplus also because of the illusory effect of an $80-billion surplus in the Social Security Trust Fund for this fiscal year, notes economist Barry Bosworth of Washington’s Brookings Institution. If reserves being held for future generations of retirees were not included in the calculation, the federal budget would still be in deficit by $80 billion to $100 billion.
The Social Security reserves exist today because more employment tax revenues are coming into the trust fund from active workers than benefits are being paid out to retirees. That situation will continue until 2010 or so, when benefits paid to baby boomer retirees begin to outweigh taxes coming in from active workers.
The government’s real challenge in the interim, economists say, is to keep the budget in as much balance as possible and to encourage national saving so 2010 doesn’t produce a serious budget crisis. That means, according to economist Hymans, that the current surpluses--based partly on unpredictable stock market gains as they are--can’t be given out in tax cuts or expanded government expenditures.
