The Clinton blueprint misses the target

National Review, April 19, 1999 by Lawrence B. Lindsey

Mr. Lindsey, a former governor of the Federal Reserve, is a scholar at the American Enterprise Institute and the author of Economic Puppetmasters: Lessons from the Halls of Power (AEI Press).

As Congress and the White House prepare for another bitter budget fight, President Clinton takes the field with a budget that is, in a word, Clintonesque. The same administration that two years ago claimed the FY 2000 budget would see a deficit of $87.1 billion now claims a surplus of $117.3 billion, a swing of $200 billion. The Social Security system, which just months ago was in such bad shape that we had to "save the surplus" for years to come, now features trillions of dollars for all sorts of other spending.

A closer look at the Clinton budget-the assumptions behind it and the economic conditions that form its context-shows the desirability, indeed the prudence, of an entirely different policy route: an across-the-board personal income tax cut.

Fact Number 1: We have no idea what the budget deficit or surplus will be over the next 15 years. Clinton has treated the $4.5 trillion as money in the bank, there to be "spent." But it appeared by changing some assumptions and can disappear just as easily. Over the last three years, the average change in the deficit forecast for only the three years ahead has been $66 billion per year.

This does not mean that budgetary scoring is useless. We can tell with reasonable degrees of certainty what will happen if programmatic changes are enacted. For example, we know that the current Medicare system is horribly underfunded, with costs consistently rising faster than revenues. Clinton has proposed lowering the age of Medicare eligibility from 65 to 55 on a voluntary basis. It does not take much insight into human nature to realize that those who stand to gain the most from joining Medicare early will do so. Therefore, the underfunding problem of Medicare will grow steadily worse if we adopt the president's suggestion. And we also know with relative certainty that if this proposal is enacted it will be very difficult, if not impossible, to rescind.

The Clinton budget arithmetic is emblematic of the man himself. Give the focus group what it wants tonight. Tomorrow is another day. Congress should avoid expanding existing programs and enacting new programs that will no longer look so affordable in an economic downturn. The projected surpluses are money that may materialize, but only if we follow sensible policies, and have good luck.

Fact Number 2: To the extent we have a budget surplus now, it is because the American people are overtaxed. In the past few years the federal tax share of GDP has risen sharply, from 20.0 percent in 1995 to 21.8 percent in 1998. This rise is roughly three times as important as extra economic growth in producing the unanticipated surge in revenue since 1995. Between 1995 and 1998, GDP rose by $1,213 billion, or 16.7 percent. Federal revenue, in contrast, rose by $390 billion, or 26.9 percent. In other words, extra federal taxes took 32 percent of the total growth in GDP between 1995 and 1998.

A close examination of the data reveals that this rise in tax collections has been concentrated on the individual income tax. Corporate income taxes and social insurance taxes have risen at about the same rate as GDP, while other taxes, such as excises, have been relatively static. But personal income taxes have increased 43 percent in the last three years, two and one half times as fast as GDP. Personal income tax collections exceeded all expectations, including those of the Clinton administration. When it hiked personal tax rates in 1993, it projected personal taxes would take only 8.6 percent of GDP. In fact, they now take 10 percent.

This surge in assumed personal tax receipts is the real reason behind Clinton's sudden discovery of a $4.5 trillion budget surplus. What the surplus really means is that government will collect $4.5 trillion more in taxes from Americans than it now needs to cover spending.

Fact Number 3: It is nonsense to assume that "paying down the deficit" is a smarter use of this revenue surge than returning it to the taxpayer. Unfortunately, many conservatives have let their instincts overrule their logic on this issue. Instinctively conservatives (including me) loathe large debts, including large government debts. It is staggering that the U.S. government has outstanding debt of some $5.6 trillion.

But here is the real question: Let's assume that the government is really run by taxpayers (forgetting for a minute that if you leave the tax revenue with Washington, the government will spend it rather than use it to pay down the debt). Who will do a better job investing the funds for the taxpayer's benefit: the government or the taxpayer himself?

Right now the cost of government borrowing is about 4.8 percent. So, leaving the money with Uncle Sam to "pay down the debt" saves taxpayers this cost and thus can be said to create a 4.8 percent rate of return. But in today's economy there are myriad ways to get a higher rate of return than that (have you checked your mutual fund lately?). So it would make sense for individuals to borrow at that 4.8 percent rate, invest the borrowed funds, and pocket the proceeds from any returns over 4.8 percent.