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WHAT SHOULD WE DO WITH THE BIG BUDGET SURPLUS?

WHAT SHOULD WE DO WITH THE BIG BUDGET SURPLUS?. John B. Taylor Stanford University Crego Lecture Vassar April 24, 2000. A multiple-choice question (from Regis Philbin’s show):. What is the best thing to do with the budget surplus? (a) Reduce the debt (b) Increase government spending

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WHAT SHOULD WE DO WITH THE BIG BUDGET SURPLUS?

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  1. WHAT SHOULD WE DO WITH THE BIG BUDGET SURPLUS? John B. Taylor Stanford University Crego Lecture Vassar April 24, 2000

  2. A multiple-choice question (from Regis Philbin’s show): • What is the best thing to do with the budget surplus? • (a) Reduce the debt • (b) Increase government spending • (c) Cut taxes • (d) All of the above

  3. The correct answer is (d), “all of the above” • If that was your answer, then the next question is: • In what proportions? • For debt reduction, for spending increase, for tax cut • 2-1-1? • 2-2-0? • 4-0-0? • Before you answer, let’s look at a few facts about the surplus.

  4. Is there really a surplus? • Look at the handout: in the columns at the right, you see many, many, negative numbers, which are deficits. • tax revenues were less than government spending. • But, starting in 1998, the minus sign disappears; there is a surplus. • tax revenues are now greater than spending.

  5. Surplus and debt • When the government runs a deficit, it increases its debt • When the government runs a surplus, it reduces its debt • surplus (‘98) = debt (end ‘97) - debt (end ‘98) • 69 = 3771 - 3720 (+ 18 in new loans) • Government borrows by issuing bonds • and retires or buys back bonds when in has a surplus

  6. What happened? • How could forecasters have been so wrong? • Tax increases? • No that was in 1993, • and was small compared to the tax cuts in the early 1980s.

  7. Income growth for upper income taxpayers was very high. • From 1994 to 1998 the percentage of taxpayers with more than $200,000 in income rose rapidly from 1.1 percent to 1.6 percent. • The percentage of all income in the United States earned by this group also increased, from 15 percent to 22 percent. • And the share of taxes paid by this group rose from 30 percent to 40 percent.

  8. Federal budget summary (billions of dollars)Fiscal year 1998 versus 1995

  9. Debt as a share of GDP • Debt/GDP can stay constant or even fall when there is a budget deficit • Example • 5% growth of GDP • then ratio stays constant if • Debt/GDP = Debt(1.05)/GDP(1.05) • thus $3.7 trillion times (.05) = $185 billion deficit • Debt/GDP ratio falls with balanced budget

  10. Ratio declining again 2000

  11. What is the forecast for the future? • Look at the bottom row of the handout. • Forecast of the budget surplus in the future—as far as the eye can see. • Note that there are two parts to this • on-budget • off-budget • Many assumptions go into this forecast.

  12. Assumptions for revenues • The strength of the economy • The extent to which people will move into higher brackets • The CBO assumptions for both are conservative. • Most likely the economy will be stronger—Blue Chip is at 4.1 versus 3.3 for CBO in 2000.

  13. Assumptions for spending • Discretionary spending depends on what Congress does, on who the next president is, etc. • CBO has three alternatives (see charts in handout): • Inflated baseline • Capped baseline • Freeze baseline • None are obviously good goals

  14. Time for an answer

  15. Debt Reduction • A bipartisan consensus has developed that we should run an overall surplus no smaller than the off-budget surplus—that is the social security surplus. • Now that is a good idea. • The important thing to notice is that even if the budget is no greater than this there is still a tremendous amount of debt reduction. • Is it enough?

  16. Spending • Proposal: Increase spending by more than the capped baseline scenario, though not as rapidly as the inflated baseline • see handout. • Would expect government to achieve some gains in productivity.

  17. Taxes • Look at handout again: • as a share of GDP, federal taxes are as high as they have been since WWII. • It certainly seems feasible to reduce them, say by about 1 percent of GDP. • Would also be helpful for the economy • would lower marginal tax rates.

  18. Conclusion and summary • We have projections of surpluses over the next 10 years of about $4 trillion. • That is based on pretty sound assumptions. • A balanced approach to these surpluses: • drawing down debt by 1/2 of that. • a spending increase for another 1/4, • tax cut that is about 1/4 • The proportions are 2-1-1, • Not 4-0-0 or 2-2-0 • So there is room for a good debate

  19. The End

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