Fortune issue: March 20, 2000
Candidates Need Clues, Not Tax Plans
By N. Gregory Mankiw
What a long, strange trip it's been. Eight years ago the federal government faced tremendous, mounting deficits, and not even candidate Bill Clinton had the temerity to promise that he would balance the budget. Today the budget is in surplus, and a major campaign issue facing George W. Bush, John McCain, and Al Gore is what to do with all that extra cash. Assuming, of course, the surplus actually materializes. Despite all the talk, we may never actually see it.
To examine the possible scenarios, it's important to understand how we got to this happy state. Clinton tries to take credit by saying he's reduced the size of government. There is, surprisingly, some truth to the claim. Federal outlays as a percentage of GDP have fallen from 21.5% in 1993 to 18.7% in 1999, the lowest level since 1974. This fall of 2.8 points of GDP compares with a drop of only 1.0 point during the eight years of the so-called Reagan revolution. Perhaps we've learned an important lesson: A Democratic President with a Republican Congress may be more fiscally conservative than the opposite combination.
Of course, tax revenue is on the other side of the ledger, and the story there is simple: Federal taxes are now at a historic high as a percent of GDP. This is partly because the elder George Bush broke his campaign promise of no new taxes, and partly because Bill Clinton kept his campaign promise of even more new taxes. But some of the revenue increase is due to forces beyond any policymaker's control. The booming stock market, for instance, has raised revenue from capital gains taxes. The growing gap between rich and poor, while decried by everyone in Washington, D.C., has also added to government coffers by pushing more income into higher tax brackets.
Because of all these changes, the next President will take office with something his recent predecessors never imagined--more revenue than needed to cover current spending. The Congressional Budget Office estimates that the surplus over the next decade will total about $2 trillion. (An additional $2 billion surplus is accruing in the Social Security system, which is now off budget.) With this projection, presidential candidates can promise tax cuts with a credibility impossible in previous campaigns. Paying off much of the national debt, now $3.6 trillion, is more than an election-year fantasy.
But the $2 trillion surplus is not exactly money in the bank. Like all budget projections, it is based on a host of murky answers to key questions. Will Congress stick to the spending caps it has imposed on itself? Will the low unemployment, rapid growth, record-breaking expansion, and booming stock market of the past few years prove sustainable? CBO's $2 trillion projection is based on reasonable guesses by some of the best, and least partisan, minds in Washington. But they are guesses nonetheless.
Consider how much the budget changes if you alter a few assumptions. According to an optimistic scenario, Congress lives within the spending caps and the economy continues to boom, resulting in a ten-year budget surplus of more than $5 trillion. In a pessimistic scenario, Congress abandons the caps, and the economy reverts to slower growth. In this case, the surplus quickly dissipates and turns into a ten-year budget deficit of $3 trillion. It's easy to imagine an even more pessimistic scenario in which--believe it or not--the U.S. economy actually experiences a recession once again, together with the usual adverse effects on the budget. (For more on the recession outlook, see Fortune Investor.)
So should the next President aim to enact a tax cut, and if so, what size? This question will dominate the presidential campaign. But it's not a very relevant one. More vital than choosing a President with the right tax plan is electing a President with the political courage to change course when events demand it. If we have learned anything from the past decade of fiscal history, it's that we shouldn't look too hard into any budget forecaster's crystal ball.
N. GREGORY MANKIW is an economics professor at Harvard and the author of Principles of Economics.