Surpluses As Far As The Eye Can See?

Volume III, Number 12 August 11, 1997

Everybody is debating a grand new question about our fiscal future: what to do with the vast budget surpluses Washington will soon be piling up. This question isn't occasioned by the revised deficit numbers announced by President Clinton last week. The official projections still foresee at best a brief period of minor surpluses lasting a few years beyond 2002. Rather, it is being posed by a new school of surplus optimists who claim that the CBO and other official agencies are drastically underestimating the future budget balance. These optimists say we're headed for large and growing surpluses as far as the eye can see -- and have touched off squabbles over what to do with the fiscal windfall.

Missing from the debate is a critical assessment of the underlying premise -- namely, that CBO is unduly pessimistic about America's long-term fiscal future. It isn't.

Hang on a Minute

What's behind the surplus school's optimism? On the spending side, they often extrapolate the near-term outlay growth spelled out in the recent budget deal -- and wonder why the CBO doesn't regard this low growth path as a long-term baseline. Here are two obvious reasons. First, the budget deal calls for a pace of real-dollar cuts in certain programs, including defense, that would eventually zero them out as a source for further savings. Second, the CBO has long recognized what so many commissions, agencies, and think tanks have described and quantified in detail: the explosive impact of the coming age wave on entitlement spending beyond the year 2010. Optimism is one thing, denial another.

On the tax side, the optimists argue that the CBO revenue projections are too low relative to the historical trend. At first glance, this objection seems plausible. From now to 2030, the CBO projects that revenues will grow at about 4.3 percent annually -- versus 6.2 percent since 1981 or 6.9 percent since 1991.

But hang on a minute. There are good reasons why historical rates are higher than what the CBO is projecting. For starters, take inflation, which was higher in the past than anyone expects it to be in the future. Next take tax rates, which have been raised repeatedly in recent decades. Then take the business cycle, which clearly makes the post-1991 rate unsustainable, since it only reflects expansion years. Remember: Long-term projections must average in recession years, when revenues fall off.

Most important, the lower future rate directly reflects a dramatic slowdown in labor-force growth, as vast numbers of Boomers retire, a relatively smaller crop of young workers comes on line, and the share of women who work stops rising. During the 1980s, total work hours in the U.S. grew at 1.6 percent annually; thus far in the 1990s, they have grown at 0.9 percent. From now to 2030, the CBO (in keeping with the consensus forecast of most demographers, public and private) projects that this growth will be only 0.2 percent.

There's another way to look at all this. Start with the proposition that, absent policy changes, revenues in the long run tend to grow at the same rate as GDP. This means that the 4.3 percent rate CBO projects for future revenue growth also applies to future GDP growth. The GDP growth rate, in turn, is the sum of a 2.6 percent average inflation rate, a 0.2 percent labor-force growth rate, and a 1.5 percent productivity growth rate. Where is the CBO too pessimistic? The only debatable issue is productivity. But here the CBO figure is considerably more optimistic than what the Social Security Trustees assume -- and, for that matter, better than the actual record of the U.S. economy over the past quarter century.

A Surplus Worth Talking About

The current economic expansion won't correct our long-term fiscal imbalance. But amidst Dow Jones euphoria and all the hype about "long booms," the surplus optimists have gotten an uncritical media reception. Their predictions are no more likely to pan out than similar predictions at the height of the Reagan Boom that Social Security would soon be buying back the national debt. The danger is that the public will believe them -- and that this will get in the way of enacting reforms that might lead to a surplus worth talking about.


The Concord Coalition web pages were designed by Marla Parker and Krista Reymann. These pages are now maintained by Craig Cheslog. . Last updated: 12 Aug 1997