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Budget Surpluses and Minuses

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ANNOUNCER: Think Tank is made possible by AMGEN, recipient of thePresidential National Medal of Technology. AMGEN, helping cancer patients through cellular and molecular biology. Improving livestoday and bringing hope for tomorrow. Additional funding isprovided by the John M. Olin Foundation, the Lilly Endowment, theLynde and Harry Bradley Foundation, the United States-JapanFoundation, and the Donner Canadian Foundation.

PRESIDENT CLINTON (From video): Wealth will falter if we don’ttake dramatic steps to tame this deficit, and soon.

SEN. GRAMM (From video): Warren Rudman and I wrote theGramm-Rudman law which was the only effort in a generation to dosomething about the deficit.

MR. PEROT (From video): Nobody ever told me that while they were increasing our taxes by $166 billion, they increased federal spendingby $304 billion, $.83 in new spending for every tax dollar raised. (Musical break.)

MR. WATTENBERG: Hello, I’m Ben Wattenberg. Deficits, deficits, deficits as far as the eye can see, perennial, inexorable,unrelenting, structural deficits. Poof, gone, and now surpluses,surpluses, surpluses, inexorable, structural, but not as far as theeye can see. What happened? What should America do with the unexpected surpluses? And has this dramatic economic shift taught us something new about how the world works?

Joining us to sort through the conflict and consensus are Isabel Sawhill, senior fellow at the Brookings Institution, and formerassociate director of the Office Management and Budget from 1993 to1995; Allan Meltzer, professor of political economy and publicpolicy at Carnegie-Mellon University, and a visiting scholar at theAmerican Enterprise Institute; Rudy Penner, senior fellow at the Urban Institute, and a former director of the Congressional Budget Office; and Mancur Olson, distinguished univers ity professor ofeconomics at the University of Maryland. The topic before theHouse, budget surpluses and minuses, this week on Think Tank. (Musical break.)

MR. WATTENBERG: For years it seems like all we heard about thefederal budget was bad news. We were told our economy was beingcrippled by rampant spending and a ballooning deficit. Three yearsago on this program, we discussed the gloom and doom sce nario thatmost economists were projecting.

MR. WATTENBERG (From video): According to the budget justintroduced by the Clinton Administration in 1995, the governmentwill spend $93 billion more than it will take in, and the deficitwill continue at about that level into the future.

MR. WATTENBERG: And then, two years ago on this program, more badnews.

MR. WATTENBERG (From video): There is one thing both sides agreeupon, spending is outrunning revenues, creating big deficits. Ifnothing is done, the budget deficit would be $231 billion in theyear 2002.

MR. WATTENBERG: But now this.

PRESIDENT CLINTON (From video): I can also say that the budgetthat I present to the Congress in February will be a balanced budgetfor 1999. Again, this will be the first time in 30 years we’ve hada balanced budget. And that’s good news for the Ame rican peopleand for the American economy.

MR. WATTENBERG: The recent reversal of fortune can be attributedto several factors, budget deals, a slow down in spending, and taxhikes are among the factors most often mentioned. But, the biggestpart of the story concerns hefty increases in tax re venues. From1992 to 1997, fueled by extraordinary economic performance,= revenues rose at the remarkable rate of 7.6 percent per year. This situation has triggered new debates in Washington. One of them isabout what we should do with the money.

It’s generally agreed upon that there are three basic choices for spending a budget surplus. Most economists believe that we shouldpay down the national debt, which stands at about $5 trillion. Many politicians, no surprise, have different views. Mo st Republicansargue that a cut in taxes will fuel economic growth and create evengreater revenues and surpluses. But many Democrats see the surplusas an opportunity to invest more in human capital. They think spending programs aimed at child care, e ducation, and job trainingare investments that will, in the long run, benefit Americans andthe American economy.

Lady and gentlemen, welcome to Think Tank. This is a mostdistinguished assembly of economists. Bel Sawhill was with theOffice of Management and Budget. Mancur Olson is known as thefather of social indicators. Rudy Penner was director of the Congressional Budget Office. Allan Meltzer was a member of the Council of Economic Advisors in the Reagan Administration. Very distinguished,but a simple question, how come all of you and your colleagues inthe economics profession were wrong?

MR. PENNER: Forecasters like us are usually saved by offsettingerrors. And what we’ve seen recently is the kind of reversedMurphy’s Law where all the errors have gone in the same direction. And you also have to remember that what is being forecast in thosecharts that you mentioned is the deficit, which is the differencebetween two huge numbers, which we really forecast, expenditures onthe one side at about $1.7 trillion now, revenues on the other sidealmost as high. A 1 percent error in forec asting outlays is $17billion.

MR. WATTENBERG: Is that everybody else’s apology also, that it’sjust really a little --

MR. MELTZER: No. I would say the major factor has been, for thefirst time in U.S. history we’ve had 15 years, 15 years, back toback with one mild recession. No one forecast 15 years with onemild recession. If we’d had a recession, the deficit wou ld havebeen higher.

MR. WATTENBERG: Well, but if you had 15 years of it, how come as recently as two or three years ago, everybody was still singing the blues. That was after 12 years of growth. How come nobody said,hey, this stuff is going to go away, the deficit?

MR. MELTZER: Well, as you pointed out, the big change has been intax revenues, and the big change has been the strength of theeconomy which brought those tax revenues up, and people did notforesee that.

MR. OLSON: I think that economists in general have a good recordof pointing out the unwisdom of the tax cuts and expenditurepolicies that generated these long deficits. And so therecommendation of almost all economists that we should have had aset of tax and expenditure policies that didn’t generate deficitswas good advice. There had been some tax increases. These taxincreases, along with the growth of the economy, have got us out ofthe problem temporarily. By and large, the economic advice hasbeen good.

MS. SAWHILL: In the early ’80s, when President Reagan cut taxesquite deeply, which was the start of the very large deficits thatwe’ve been dealing with ever since, most economists projected thatthere was going to be a problem out there, except for a fewpolitically-oriented types who said, oh, well, there’ll be a supply side revolution, and these tax cuts will pay for themselves, and wewon’t have a deficit.

MR. WATTENBERG: Of course.

MS. SAWHILL: And they were wrong. And the bulk of mainstream economists were right about that.

MR. OLSON: But it’s got to be pointed out --

MR. WATTENBERG: Of course, now that you bring up Reagan andpolitics, the Democrats added in their own Christmas tree tax cutsin 1982.

MS. SAWHILL: It’s true, there was some bipartisan errors made inthose years.

MR. MELTZER: I don’t think we should make a partisan issue out ofit. The fact is that the Reagan tax cuts were a good thing to do atthe time because they did help to get the economy growing. Thatthey were accompanied by big increases in defense, t hat a big partof the last three years, three to five years, has been cuts indefense spending, the rundown in the saving and loan crisis, whichreally wasn’t a major factor, and the superior growth of the economy. Those are the three big factors.

MR. PENNER: It’s got to also be pointed out that we have had somereal surprises. The growth in revenues has been even greater thanyou would expect given the growth of the economy. We don’t fullyunderstand it, but we think it’s largely capital gain s, this hugestock market surge that nobody -- nobody forecast. And on thespending side, there have been some really big surprises, too. Medicaid growth just declined rapidly. And while not a surprise, thecut in defense spending, as Allan said, has really helped.

MR. WATTENBERG: Is it possible that a much scorned group, thepeople who were saying, we can grow our way out of the deficit --and everybody said, oh, ho, ho, supply side -- is it possible thatthey turned out to be right?

MS. SAWHILL: Well, I think that you can’t forget the tough policy actions that were taken here. I mean, we did have a budget bill in1990 which was very significant under President Bush. We hadanother one in 1993, when Clinton first took office that made hugeprogress against the deficit. And then, of course, we had anothermuch smaller action this summer. I certainly don’t want to argue that the economy and the growth of the economy hasn’t been animportant part of the success we’re seeing now i n bringing thedeficit down, but there have been policy actions as well.

MR. WATTENBERG: Okay. I have tried to get some contrition fromthe economics profession. I haven’t done very well.

MR. PENNER: No surprise there.

MR. WATTENBERG: Yeah, no surprise there. Right. Now, let’s goon. What should we spend this money on?

MR. OLSON: Paying down the deficit, or paying down the debt.

MS. SAWHILL: Absolutely, pay down the debt should be our toppriority. I would point out that we are spending something like$250 billion a year just to cover the interest on our outstandingdebt. Think of what we could buy with that $250 billion if itwasn’t all being sucked up by interest.

MR. WATTENBERG: Think of what we could buy with tax cuts, parentswould have more money to help their children.

MR. MELTZER: Right. Right.

MR. WATTENBERG: So, you’re in favor of tax cuts?

MR. MELTZER: I think that we have -- revenues historically neverget on average above 20 percent of GDP, so I think we’re going tohave a tax cut.

MR. PENNER: I’m on the side of paying off the debt, and the mainreason for that are the huge liabilities that we face early in thenext century as the baby-boomers retire. If it weren’t for that,I’d be on Allan’s side.

MR. WATTENBERG: But, Rudy, if you continue this kind of growth,those unfunded liabilities of Social Security and Medicare will be substantially diminished; is that correct?

MR. PENNER: Well, first of all, it’s unlikely we’ll continue this growth. Much of the growth has come from having a higher proportionof our labor force employed. We can’t keep doing that forever.

MR. WATTENBERG: Because there will be fewer people of working age coming into the labor force.

MR. PENNER: Not only that, but we have been taking down the unemployment rates, so more and more people in the labor force havebeen employed, and that’s been responsible for a very large part ofthe economic growth over the last number of years.

MR. MELTZER: What we need to do is reform the Social Securitysystem and the Medicare system. And giving the money to just reformthe present system is the wrong way to go. We need to reform thepresent system. After that, we should look to see what ’s left thatwe were unable to reform and work out, and then perhaps use some ofthe surpluses if they continue, to pay for that, but we should nottake the problem off the front-burner. We need to solve the Social Security system, and we need to do it by major reforms in bothMedicare and Social Security.

MS. SAWHILL: I agree about the need to reform both SocialSecurity and Medicare, but I want to point out that before we get toenthusiastic about cutting taxes, we should recognize that we stillhave a large deficit in the operating budget of the feder algovernment. The only reason that you’re hearing all these stories about balance and surpluses now is because the Social Security systemis taking in more in revenues than it is paying out in benefits. And that extra accumulation of money in the Soci al Security systemis masking or offsetting the deficit in the operating part of thefederal government. So, it’s a little bit misleading to say wedon’t still have a problem that we should worry about.

MR. WATTENBERG: Is that right, Mancur?

MR. OLSON: Yes. But another reason why I think we shouldn’t havetax cuts, but should pay off the debt, is that while we have a largedebt, we have each year to have a lot of taxes that are thereimposed on the population and discouraging effort and m aking theeconomy less efficient.

MR. MELTZER: But all those taxes are just used to pay back theinterest on the -- so, that’s just a wash. I mean, transferring thetransfer.

MR. OLSON: No, but it isn’t a wash. The fact that the taxesdrive a wedge between what the worker and the firm gets for itseffort and investment distorts economic activity, and makes theeconomy less efficient. When bondholders are paid back, there’ snot a corresponding gain. So, if we have --

MR. WATTENBERG: If there was a gain when the bondholders lent themoney to the government, that money was spent on things like astrong defense, which is giving the next generations a world withouta Cold War.

MR. MELTZER: Precisely.

MR. WATTENBERG: A world without totalitarianism. I mean, talkabout investments, that was probably the best investment thiscountry has ever made.

MR. MELTZER: Absolutely.

MR. OLSON: You are more enthusiastic about Communism than I thinkis justified. I think Communism was a very inefficient system andcollapsed because of its inefficiencies.

MR. WATTENBERG: Well, you do not think that there was arelationsh= ip to a strong American defense effort with its alliesover a course of 45 years that prevented a further expansion ofCommunism?

MR. OLSON: Of course I was for containment, and of course Ididn’t want any possibility for Stalinism to expand. So, yes, astrong defense was a very good thing. If you ask why Communismcollapsed when it did, it’s because it was a profoundly ineffic ientsystem. They finally saw the need for reforms. They reformed their polity before they reformed their economy, and then they fell apart.

MR. WATTENBERG: We can get off this. But just as a matter offact, they did have nuclear ballistic missiles pointed atShirlington, Virginia, which is where we are right now, just for therecord. So, I mean, it’s kind of a nice thing. Let me ask you aquestion. What we haven’t brought up yet is the view of manyDemocrats that we ought to use this surplus for increased spending. Do you go along with that?

MS. SAWHILL: Not as a first use, no. I think that we need somemore spending in certain areas, but I would try to achieve it byreallocating what we’re spending now rather than by using thesurplus for that reason.

MR. WATTENBERG: Right.

MS. SAWHILL: My first priority is to use the surplus to reducethe debt. I am not in favor of tax cuts.

MR. WATTENBERG: A tax cut is not --

MR. MELTZER: It’s not giving anything back, it’s just taking ourmoney -- giving us our money, leaving it with us. And this is theage of state and local government. This is going to be the age ofstate and local government. The growth of the federa l governmenthas been an anomaly of the Cold War and the Depression. We’re goingback to the age of state and local government, where state and locallocalities are going to decide these problems on their own, in theirown way. I welcome that trend. I think that’s going to be a greatmovement for us. And what we ought to do is get the federalgovernment out of a lot of the businesses that it’s in.

MR. WATTENBERG: You are a devolutionary, not a revolutionary.

MR. MELTZER: Absolutely, devolutionary.

MR. PENNER: I’d be much more favorable to be inclined towards taxcuts if I thought the Congress would do it in a comprehensive mannerand use the money to make the tax system a lot simpler, a lot lesscomplicated, more efficient, more conducive to sav ing andinvesting. What they did last year was just a horror in terms of its complexity. What I’m afraid that they would do this year --

MR. WATTENBERG: Bel, I agree with that, too. Would you take atax cut if it had Rudy’s conditions on it?

MS. SAWHILL: No, I don’t think I would, although I’d be willingto look at it. I think it’s worth pointing out that in terms of thepart of the budget that is devoted to everything from job trainingto food and drug safety, and all of the other things that thegovernment does that don’t count defense and don’t count these largeentitlements for the elderly, the amount that we’re spending as a proportion of our national income is back where it was in about 1960.

MR. WATTENBERG: The Congressional Budget Office projections, and,Rudy, you’ve been the head of CBO, in their recent projections areactually showing for the next few years very tiny deficits, and thena moderate increase. But they did those projectio ns on the basisof an increase of tax revenues of 3.5 percent per year, and we havebeen growing at 7.5 percent per year. Even if you split the difference and say, well, it will be 5.5 percent a year, whichthere’s a certain logic to it, those surpluses will be huge. Imean, people are talking about a couple of hundred billion dollarsof surpluses. Is it possible, you know the politics of that place,that those projections are sort of purposefully overcautious?

MR. PENNER: I think that’s right, the part about them being very conservative assumptions is right.

MR. WATTENBERG: And, Bel, you were at OMB, same thing there. They’re going to be -- everybody is afraid of the rosy scenario now.

MS. SAWHILL: Well, I would call them judicious rather than conservative. As Rudy pointed out a little while ago, we have been climbing out of a recession, pushing the unemployment rate down tolevels that we haven’t seen in 24 years, maintained low in flationalthough that may be because that’s been masked by some other thingswe could talk about, I’m not sure that that’s sustainable.

MR. WATTENBERG: Your thought, Rudy, is -- I mean, obviously, wedon’t know, but the odds are that that surplus is going to be morethan CBO said; is that fair?

MR. PENNER: I think so. It depends on two things. CBO assumes abig slowdown in the economy to get down to more normal -- what wemight call normal unemployment rates in the longer run. And,secondly, they assume that some of this great surge in rev enue thatwe’ve seen in recent years that we can’t really explain, that that’sgoing to disappear.

MR. WATTENBERG: The conventional wisdom, driven in part but not entirely by economists, is that we are sort of living in a world of governmental scarcity in the United States, certainly in the European countries, everybody is saying they overspent. An d that everybodyhas been sort of pessimistic and pinch-faced about the welfarestate, about government, about how much we can produce, we can’t grow too fast. There’s a Phillips curve if we grow, if we growfaster it will cause inflation. Has this dev elopment -- I don’twant to put it out of perspective, I want to put it in perspective,has this development changed the way we see the world?

MR. PENNER: There are two possible new paradigms. One is some attitudes towards government, and one is whether somethingfundamental has changed in the economy. I think clearly attitudestoward government have changed since the late 1970s.

MR. WATTENBERG: Less trust in the efficacy of government.

MR. PENNER: Less trust in the efficacy of government, a strongmove toward shrinking it. I’m less convinced that somethingfundamental has changed in the economy. I think it’s harder to findevidence of that. As I said, much of the growth of recent times,much of the reason for the better budget, is taking down the unemployment rate, and --

MR. WATTENBERG: Well, but taking down the unemployment rate is a premier --

MR. PENNER: Is wonderful.

MR. WATTENBERG: -- symbol of realistic optimism, I mean that wecan do this without triggering inflation.

MR. PENNER: I’m not saying it isn’t wonderful.

MR. MELTZER: What I believe has changed politically is, if youwere born in the 1930s, it was commonplace to believe that thesystem had failed, that it hadn’t worked. If you were born in the1950s or the 1960s, or the 1980s, you have a very different view ofthe role of government. And, as the voters who live with the 1930sexperience disappear, and the ones who grew with the 1950s, ’60s, and ’80s become more prominent, the view about government is changingin the society.

MR. WATTENBERG: But you guys are doing my job. You are giving mea political analysis. I don’t want that. I want to know aboutreality. Would it be proper, given the facts on the ground, for usto say, this indicates that we had the nature of the w orld wrong?

MR. MELTZER: Deregulation has changed the nature of the American economy, that’s right. We don’t see it in the productivity numbers,and that’s because the productivity numbers don’t tell us very muchto begin.

MR. WATTENBERG: And the world is beginning to go toward that deregulated American model.

MR. MELTZER: Correct.

MR. WATTENBERG: And we’re not just talking about America.

MR. MELTZER: Correct. And the great strength in the U.S. economyis in the deregulated industries.

MR. OLSON: I agree to that and I think that’s very important, andwe need, however, and Allan I think needs, to realize there’s onekind of regulation that’s very harmful to the economy, and that’swhen the government borrows needlessly, and thereby ch anges onevery important price in the economy, the interest rate, raising it. So, what I’d -- my key to Allan would be that he should be a real free market economist and not come up for tax cuts all the time, and bigger deficits, which lead to a higher interventionist government--

MR. MELTZER: Oh, I’m quite willing to have expenditure cuts, andthat’s the tax cuts.

MR. WATTENBERG: Mancur, if our children are going to be muchwealthier than we are, which seems to be a correct analysis, what isso terrible about laying off some of these expenditures, many ofwhich help them. I mean, if you build a new road, if you build anew bridge, if you defeat the Evil Empire, they are getting the benefit of that. What is so terrible about those rich young people paying some of it off?

MS. SAWHILL: Well, we have to go back to the Social Security and Medicare problem that we talked about. I mean, these surpluses arehere for maybe 10-plus years, and then they quickly vanish, and wego very heavily in the other direction. Now, if we are willing andthe public is willing to give up Social Security, to give upMedicare as we have known them in a serious way, then you’re right, it’s a whole new world. So, when we talk about public attitudestowards government, I agree there’s a lot mo re distrust, a lack ofconfidence, and Europe is beginning to imitate us and so forth. ButI don’t hear a lot of people saying they don’t want their SocialSecurity and their Medicare check.

MR. WATTENBERG: No, I understand. Hold on, we’re running out oftime, and I want to go around the room once quickly, starting withyou, Allan, and I want a very short answer, a sentence or twomaximum, on this question: Looking ahead, are you an opti mist, ora pessimist, or somewhere in-between, and why?

MR. MELTZER: I’m always an optimist, but I’m an optimist whobelieves that the worst has not yet happened.

MR. WATTENBERG: Thank you so much. Right.

MR. PENNER: I’m also an optimist, but maybe not as optimistic asAllan.

MR. WATTENBERG: Okay.

MR. OLSON: And I’m -- there are two kinds of economists, thosewho know they don’t know the future, and those who don’t know theydon’t know the future, and I’m the former kind. I just don’t knowthe future, and neither does anyone else.

MS. SAWHILL: I’d like to think I’m a realist, and that if you’rea realist, you have to combine a little bit of both, and that’s whatI see in the future. This is good news, this wonderful economy andthis surplus that seems to be emerging, but we’d b etter use itwisely.

MR. WATTENBERG: Okay. I would just point out that if you lookthrough American history, the realists have been the optimists.

Thank you very much, Isabel Sawhill, Allan Meltzer, Mancur Olson,and Rudy Penner. And thank you. For Think Tank, I’m BenWattenberg.

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