Who Needs a Tax Cut?

By John Greenwald

Can a trillion-dollar windfall really be a problem? For nearly two decades, the U.S. wrestled with huge budget deficits that burdened the economy. But now that Washington projects a $1 trillion budget surplus over the next 10 years, the delightful news has mainly become a cause for pitched partisan wrangling.

Or so it would seem from the shrieking produced last week as the Republican-run House rammed through a measure to chop taxes by $792 billion over the next decade. President Clinton called that irresponsible behavior, fiscally speaking, and espoused a much smaller, $250 billion tax cut. Then he angrily vowed to veto the huge reduction.

Absent politics, which is to say, in purely economic terms, the debate focuses on two issues: Should the surplus be returned to taxpayers, who put up the money in the first place? Or should it be used to pay down the $5.6 trillion national debt and shore up wobbly Medicare and Social Security funds? "This is a wonderful problem for the U.S. to have," says Allen Sinai, chief global economist for Primark Decision Economics.

For starters, many economists doubt that huge tax cuts make sense at a time when the U.S. economy is running flat out after nearly nine years of expansion. Slashing taxes now "seems a little odd," says Cynthia Latta, principal U.S. economist for Standard & Poor's DRI. "Its support comes from the assumption that if [the surplus] is not handed back to taxpayers, the government will just use it for more programs." Latta's fellow critics include Federal Reserve Chairman Alan Greenspan, who warned last week that "the timing is not right" for the House measure, which calls for a 10% across-the-brackets cut in income taxes and a reduction of the 20% rate on capital gains to 15%. Translation: the proposals could overheat a strong economy and ignite inflation. Says Greenspan: "The first priority, in my judgment, should be getting the debt down."

But champions of tax cuts argue that the surplus rightly belongs to citizens whose Form 1040s gave rise to it and who now deserve their money back--to do with as they see fit. As a Wall Street Journal editorial-page headline framed the issue last week, WHOSE SURPLUS IS IT, ANYWAY? Indeed, Americans now pay an amount in taxes equal to 20.7% of gdp, a post-World War II high that is up from just over 18% 10 years ago. Nor are many economists bummed by the fact that most of the benefits that would flow from the G.O.P. cuts would accrue to upper-bracket taxpayers, since they have been the hardest hit by tax increases during the past decade.

Clinton wants tax relief too, but his more modest plan focuses on the lower end of the scale. The White House wants to funnel tax breaks into new Universal Savings Accounts, which would serve as government-subsidized iras for low-income earners. The heart of the Administration plan is devoted to paying off the national debt and ensuring the solvency of Social Security and Medicare. Clinton would set aside a third of the projected surplus--or $374 billion--for replenishing Medicare funds that could otherwise expire by 2015. And he would put the interest savings that result from debt reduction into Social Security trust funds, which otherwise will run out by 2034. Moreover, sopping up red ink would ease the need for federal borrowing and pave the way for lower interest rates throughout the economy.

Although the national debt has always loomed like a monster, especially to Republicans, there are arguments not to kill it off entirely. If there were no debt to finance, for instance, the government wouldn't need to sell Treasury securities. Then the Federal Reserve could have a tough time managing liquidity, since its principal method of doing so involves buying and selling those securities.

Of course, debating how to use the surplus could be like haggling over the division of water in a mirage. Yet even if the estimates are a bit optimistic, the nation will still be faced with the problem of having too much money. "If we use the surplus wisely, we could cement our wealth for another couple of decades," says Sinai, who is worried that big tax cuts now would be premature. "The task for our society," he adds, "is to make sure we don't blow it."

--Reported by Jay Branegan and Adam Zagorin/Washington

With reporting by Jay Branegan and Adam Zagorin/Washington