Overflowing Government Coffers Should Purchase Fresh Thinking

The federal budget is piling up surpluses after decades of deficits. President Clinton said last week that the accumulated budget surpluses over the coming decade will total more than $4 trillion because government coffers are overflowing even more than anticipated.

The outlook in Washington seems to be that there will be money for everything--for tax cuts, for prescription drug benefits for the elderly, for Social Security and Medicare, for defense and for many other programs.

That may not be true, however. Forecasts of surpluses are not exactly money in the bank. A recession or even a slowdown in the economy during the decade would throw the budget into deficit again.

As to Social Security, today’s surpluses are no guarantee that it will be able to deal with its problems, which will come to a head in the next decade when baby boomer retirees hit the system.

But even continued surpluses won’t mean money for everything. What the new environment really offers the U.S. is time to deal with major issues. It can be a decade of opportunity to make decisions about Medicare and other important matters.

How did these budget surpluses happen? What do they mean for the economy and for Social Security, Medicare and the positions of the candidates in the presidential election? Last but not least, what does the outlook say about the stock market and investments?

Answers are both obvious and surprising.

The surpluses are surging today because the flow of personal income taxes to the federal government is greater than anticipated. In 1999, the government’s income tax receipts rose by 8%, faster than the economy grew.

An economy driven by the production and use of new technologies, and featuring stock options and 401(k)-type investment plans, is largely responsible. Capital gains taxes on stock market winnings have swelled income taxes in recent years. And rising incomes have pushed more people into the highest brackets, reports June E. O’Neill, former director of the Congressional Budget Office and now professor of economics at Baruch College of the City University of New York.

Social Security taxes, at a time when there are many more taxpaying workers than benefit-receiving retirees, are adding to the surpluses, and that will continue through the decade. According to Office of Management and Budget projections, Social Security taxes in 2010 will total more than $1 trillion, but benefit payouts will be only $685 billion.

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The pattern reverses--benefit payments outrun tax receipts--starting in 2015, when mounting numbers of baby boomer retirees enter the system.

Meanwhile, today’s Social Security taxes are being used, in effect, to pay down the national debt. That’s an emotionally appealing pursuit--the United States has paid off its debt three times in history. And lowering the $3.5-trillion debt, which represents government borrowing through Treasury bonds and bills, will tend to lower interest rates.

The surplus is an issue in the election too. Democratic candidates favor keeping surpluses in the government to pay down the debt, while Republican candidates favor major tax cuts to spur economic growth.

But neither the debt nor taxes are the most important issues that the country needs to grapple with, now that a good economy offers the opportunity.

The biggest issue is Medicare reform.

Unlike Social Security, Medicare is in deficit. It is also in a shambles, with hospital and medical groups refusing to take Medicare patients because payments are too low. Sens. John Breaux (D-La.) and Bill Frist (R-Tenn.) have put forth ideas for giving Medicare recipients choices of health plans and for changing the system of financing. Debate is needed on such fresh thinking.

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And decisions are needed on ways to ensure greater equality of opportunity in America. That largely comes down to improving education, by experimenting with new solutions, not simply spending more money.

Fortunately, it’s a good time to try fresh thinking on those thorny subjects because U.S. productivity is rising thanks to advances in technology. And the years ahead promise many more technological advances--broadband Internet communications and genetic medicine, to mention two.

So what does all that suggest for investing? Simple: Look for businesses that will answer basic needs and that will benefit from technological advances and a financially easier environment thanks to government budget surpluses.

The pharmaceutical industry qualifies on many counts. New drugs are being developed with great rapidity because of advances in biological and computer science. Eli Lilly Co., which made headlines last week by announcing that it was near to bringing out a cure for septic shock, is a prime example of such breakthroughs.

The demand for such drugs is strong, which is why programs for prescription drug benefits are being debated in the election campaign. And it’s fairly certain that some kind of program will be drawn up.

“A well-crafted Medicare drug program will be a positive for the industry, and the current boom times give a little more room” for the government to develop one, says Viren Mehta, head of Mehta Partners, a New York firm that specializes in research and investments in the pharmaceutical industry worldwide.

Both traditional drug companies and biotechnology firms will benefit. “I think the way we discover and define new drugs is going to change so that traditional labels won’t apply anymore,” Mehta says.

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In education, the major opportunities will be for companies that can deliver education to students of all ages in corporate settings, homes and traditional schools. Learning over the Internet will become a commercial reality in the coming decade.

But it isn’t much of an industry yet. The problem is that, in contrast to every other information industry, education has failed to bring down costs in all its years of hand-wringing about improvement. That situation will change within the next years, financier Michael Milken said last week at his foundation’s education conference in Los Angeles. “We see great opportunity,” said Milken, who owns a number of private companies in the education field.

A lot is new this Fourth of July--the dawning of a new century, new technologies, surpluses in government budgets. It could be a decade of opportunity.

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Surplus Scenarios

The White House says surpluses in the federal budget will mount each year to 2010. Congress concurs. But projections, like weather forecasts, can reflect optimism or pessimism and can be changed by reality. White House and congressional predictions are based on assumptions about economic growth. If growth were to slow even to 2% a year-a faster pace than in most previous decades-the budget would soon go into deficit again.

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Sources: Congressional Budget Office; June E. O’Neill, Baruch College, former director of the Congressional Budget Office

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James Flanigan can be reached at jim.flanigan@latimes.com.