The Big Risk of Tinkering With Success

With the economy cooking nicely, the last thing we need is to turn up the flame and scorch it. The tight budgets of the 1990s have avoided fiscal overheating and permitted interest rates to stay down. But in essentially party-line votes, the GOP-led Congress has voted to reverse all this. It rejects the proven strategy of low interest rates to keep the economy moving. It rejects the historically sound pattern of jump-starting the economy only when it falters. Instead, Congress wants a highly stimulative $800-billion, 10-year tax cut.

This is foolish, because it raises the one risk to continued U.S. prosperity: economic overheating, which leads to inflation and high interest rates. That is how every postwar expansion has come to an end. It is also why the stock market always wobbles at the mere hint of a return to this negative syndrome. Unfortunately, Congress wants to use the politically juicy budget surpluses to take us back there.

Running the risk of reigniting inflation is dumb economics and bad policy. It is bad budgeting because it overestimates the surpluses and then commits the entire inflated amounts to tax cuts. It is bad tax policy because it would cut the capital-gains tax and eliminate the estate tax, changes that aren’t needed now. It is probably even bad politics because the American public doesn’t much want it. President Bill Clinton is right to promise a veto. Instead, we should use the budget surpluses to pay down the national debt.

Let’s start with the bad economics. The stimulus of a big tax cut makes no sense in an already strong economy. Indeed, it could trigger that one set of events that could end this remarkable period of strong growth and low rates of inflation, unemployment and interest: a sudden burst of unsustainable growth. This would cause higher interest rates that, as always, would crimp investment and consumer spending and weaken the overall economy.

As Alan Greenspan, chairman of the Federal Reserve Board and a mainstream conservative, said to Congress last month, “We will need a cut in marginal rates when the economy falters,” but “the timing is not right, [and] the business cycle is not dead,” In other words, if you run the overheating risk, you’re stupid.

Second, such a big tax cut is bad budget policy. It could send us back into the deficit morass from which, after 35 years, Americans have finally escaped. Republican leaders contend the cut would be relatively small when measured against the anticipated budget surpluses. But that contention doesn’t hold up.

The size of the tax cut is estimated by the Congressional Budget Office at just above $800 billion over the next 10 years. Additional interest expense, compared with maintaining the surplus, would take the total cost up to $1 trillion. While there are no official estimates of costs beyond the 10-year point, it is widely believed that the size of these cuts would double, reaching nearly $2 trillion, during years 10 to 20.

Turning to the surplus, the cumulative 10-year amount is now officially estimated at $3 trillion. GOP leaders point to this as evidence that we can easily afford $1 trillion of tax cuts and interest expense. But the Clinton administration and the Republican congressional leadership have already agreed that two-thirds of the surpluses must go to shore up the Social Security and Medicare trust funds. Indeed, they propose to “lock away” this $2 trillion to make it untouchable. This would then leave a $1 trillion net surplus, which would be wiped out by the congressional tax cut.

In any case, the net surplus will be nowhere near $1 trillion. The reason? Surplus projections assume draconian cuts in discretionary domestic (other than entitlements) spending. Believe it or not, the CBO projects that, if defense is funded at the president’s requested level, all other domestic discretionary spending (inflation adjusted) must be cut by approximately 35% over the 10-year period. Yes, this would be the requirement under current budget law.

Such reductions would emasculate education, health care, scientific research and agriculture. Cuts of this magnitude will find no support, and everyone in Washington knows it. The budget law will be changed and total spending will actually be $300 billion to $400 billion higher. The real surplus will be that much smaller.

The other reason is that the economic projections underneath the budget surpluses look overly optimistic. The CBO calculates annual U.S. growth at 2.4% for the next 10 years. This is virtually equivalent to the rate of the ‘90s, but expecting these golden times to continue unabated is Panglossian. As Greenspan says, there will be a downturn at some point, though the surplus estimates don’t include it. So if the overestimated surplus is committed now to a tax cut, we’ll see deficits again.

The third argument against the congressional proposal is that it represents bad tax policy. With the stock market still at stratospheric levels, we do not need a cut in the capital-gains tax rate. Moreover, the proposed $75-billion elimination of the estate tax would benefit so few Americans that it can’t be justified. These are just the two most obvious lemons.

The fourth point is simply that tax cuts are not a priority for Americans today. Surveys show that education, health care and morality are higher priorities. Maybe giant tax cuts will play well in GOP primaries. But the legendary common sense of the American people is invariably greater than that of their politicians. We are seeing that again.

So what should be done with those non-Social Security and non-Medicare surpluses that do materialize? The main answer is to pay down the national debt, as the Treasury has started to do. By reducing the supply of U.S. debt, interest rates will fall. This would be the equivalent of reducing the costs of mortgages, car loans and all other borrowing for consumers, the economic equivalent of a tax cut for the middle class. It also would reduce business-borrowing costs and spur investment. Politically, it should appeal to moderates and conservatives as well, because this strategy would return the surpluses to the American people.

Paying down the national debt represents a more flexible fiscal strategy than tax cuts. We can pay it down as surpluses actually accumulate, instead of overcommitting them up front as tax cuts. This would continue the conservative budget policy that has contributed so much to U.S. prosperity during the 1990s. With economic expansion now breaking records for longevity, only a fool would change the winning formula.*