March 13, 1998

Would Using the Budget Surplus for Tax Cuts or Entitlement Expansions Affect Long-Term Social Security Solvency?
by Kilolo Kijakazi and Wendell Primus

President Clinton announced during his State of the Union address that until comprehensive legislation is enacted restoring Social Security to a sound, long-term footing, the projected surplus in the unified budget should not be used for any purpose other than helping Social Security. The President's statement has raised questions and debate about the projected surplus and its potential relationship to shoring up Social Security.

Many economists and fiscal policy analysts believe that the use of the surplus that would best serve both Social Security and the U.S. economy is to shrink the national debt. They argue that Congress and the Administration should pay for any tax cuts or program initiatives with offsetting savings measures, rather than financing such measures by dipping into the projected surplus.

The argument for using projected surpluses to shrink the debt is related to concerns about both the nation's fiscal health when the baby boom generation retires in large numbers and the need to restore long-term solvency to the Social Security system. Congressional Budget Office projections indicate that deficits will reappear shortly after 2015 and eventually grow to levels unprecedented for periods other than recessions or wars. The projections in the Social Security trustees' report indicate that in 2029, the the Social Security trust funds will not have sufficient resources to cover the full cost of providing Social Security benefits for all of those who qualify for them.

The presence of these long-term financial challenges has important implications for what should be done in the years ahead with the projected budget surpluses. It also means that the decisions today's policymakers make on this issue will have a bearing many years from now both on the nation's fiscal health and on the long-term financial condition of Social Security.



Old Age, Survivors, and Disability Insurance (OASDI), more commonly known as Social Security, is funded through payroll taxes from current employees and their employers, as required by the Federal Insurance Contribution Act, or FICA. The employee and employer each contribute 6.2 percent of payroll, for a total of 12.4 percent, on earnings up to $68,400.(1)

The method of using current payroll taxes to pay current benefits is referred to as a "pay-as-you-go" approach. An alternative financing approach, under which funds are accumulated in advance to pay for future benefit costs, is known as advance funding or pre-funding. Following enactment of Social Security legislation in 1977 and 1983, the Social Security system began to move from being essentially a pure pay-as-you-go system to being a system that also includes some advance funding. Annual Social Security payroll tax collections began consistently to exceed annual Social Security benefit costs by sizeable amounts in 1985, resulting in the accumulation of a surplus, or reserve, in the Social Security trust funds.(2) The surplus is enabling Social Security to pay current benefits while also providing some advanced funding of the hefty future benefit costs that will be incurred when the baby boomers begin to retire in substantial numbers.

Social Security revenue is deposited with the Treasury and credited to the two Social Security trust funds — the Old Age and Survivors Insurance trust fund and the Disability Insurance trust fund — through the issuance to the trust funds of interest-bearing Treasury bonds. In turn, the Treasury pays Social Security benefits and adjusts the amounts in the trust funds accordingly.

When the Social Security payroll taxes collected exceed the benefit payments made, the surplus revenue is reflected as additional holdings of the trust funds, with these balances earning interest at the same rate as other Treasury securities. This interest is credited to the trust funds. No actual cash is held in the trust funds, as the funds hold Treasury securities instead.(3)

The trust funds operate somewhat like checking accounts. They are credited with the deposits made and debited for checks written. When a deposit is made in an individual's checking account, the bank that holds the account uses the money for other purposes (such as loans for mortgages) until the funds are needed to cover a check the individual writes. Similarly, when the Treasury receives payroll tax deposits, it issues bonds to the Social Security trust funds while placing the cash in the same pool of funds as other federal revenue, and there is no legal restriction preventing the Treasury from using these borrowed funds to help finance other government costs. As Social Security benefit payments are needed, the Treasury makes funds available to redeem the bonds. If the Treasury does not otherwise have enough cash available to redeem these securities (or to meet other, non-Social Security obligations), it borrows money from the private sector.


Financial Status of Social Security

Although Social Security payroll tax revenues currently exceed benefit payments and the trust funds consequently are accumulating credits (i.e., are in surplus), demographic changes that lie ahead will result in substantial increases in benefit payments in coming decades and create an actuarial imbalance in the program over the long term. The baby-boom generation is aging and will begin retiring in large numbers after 2010. By 2025, most of this group will be 65 or older.(4)

Moreover, rising life expectancy will further increase the number and proportion of the population that is elderly. The Social Security actuaries' projections, reported by the Social Security trustees, show the number of people age 65 and older will nearly double from 34 million in 1995 to 61 million in 2025.(5) During that period, the proportion of the total population that is elderly will grow from 12.5 percent to 18.2 percent. There also will be a decline in the rate of growth of the working-age population. As a result of these various changes, the ratio of workers to Social Security beneficiaries will decrease from just over three-to-one today to two-to-one in 2030, and remain at approximately this level through 2075, the last year of the actuaries' projections.(6) At that point, the elderly will comprise 22.7 percent of the total population.

The Social Security actuaries project that Social Security benefit payments will begin to exceed payroll tax revenues in 2012. Total trust fund income — which includes interest earnings that the trust funds receive on the Treasury bonds they hold, as well as income from payroll taxes — will continue to exceed benefit payments until 2019. In 2019, the combination of payroll tax revenues and interest earnings will no longer be sufficient to cover all benefit costs, and the trust funds have to begin redeeming the bonds they hold to raise the additional funds needed. The actuaries project that the trust funds will cash in these bonds fully in 2029. At that point, the Social Security surplus now building up will be exhausted.(7)

After 2029, the trust funds will be dependent entirely on payroll tax collections for income. From that time on, Social Security will be insolvent because it will not have sufficient annual income to make the full benefit payments to which its beneficiaries are entitled by law. This does not mean Social Security will collapse at that time and have no funds to pay any benefits; to the contrary, the problem is that after 2029, incoming payroll taxes are projected to be sufficient to cover about 75 percent of the benefit payments, rather than 100 percent of these costs.(8)

Policymakers need to make policy changes that eliminate this shortfall. The 1994-1996 Advisory Council on Social Security examined this issue but could reach no overall consensus on how to address it. The Council split into three factions when making recommendations on the steps that should be taken. Nevertheless, the Council members were unanimous in some of their recommendations; the recommendations on which all of them agreed would close an estimated 32 percent of the long-term financing gap.(9) Assuming policymakers can embrace the Council's unanimous recommendations, the challenge is to close the remaining gap.

As the next two sections of this paper explain, the degree of difficulty that policymakers will face in accomplishing this task will be affected by the ability of the federal government to contribute to national saving. And that, in turn, will be affected by the use made of the projected budget surpluses in the years ahead.


Treatment of Social Security Within the Federal Budget

The current surpluses in the Social Security trust funds are offsetting virtually all of the deficit in the remainder of the federal budget. Soon the surplus in the Social Security trust funds will be larger than the deficit in the rest of the budget; at that time, the "unified budget" will be in surplus. The Congressional Budget Office has forecast that a very small surplus will appear starting in fiscal year 1998, the current fiscal year.

Legislation enacted in 1985 requires the Administration and Congress to present budget totals that exclude Social Security benefits and revenues.(10) The Administration and Congress also are free to provide budget presentations including Social Security — i.e., presentations of the unified budget. Budget documents typically present the budget under both approaches. Sponsors of the 1985 provision sought both to prevent the Social Security surplus from masking the size of the deficit in the rest of the budget and to forestall possible efforts to reduce the deficit by cutting Social Security. Their thinking was that if members of Congress and the executive branch focused on the non-Social Security budget, they would adjust their decisions on taxation and spending to reduce the deficit in that part of the budget.

Some Members of Congress and others now are calling for using some of the projected surplus in the unified budget to finance tax cuts or increases in spending on items such as highways, thereby enlarging the deficit in the non-Social Security part of the budget. As noted, Congressional Budget Office projections show that under current policy, the unified budget will be in surplus starting this year. CBO projects that under current policy, the cumulative surplus between now and 2008 will total $679 billion.(11)

When these unified budget numbers are separated into Social Security and non-Social Security components, however, it becomes evident that all of the projected surplus throughout this period is attributable to Social Security. The remainder of the budget will remain in deficit throughout the next decade.(12)

Table 1 and Figure 1 illustrate this point, using the CBO projections. As Table 1 shows, CBO projects that the unified budget will show a surplus of $8 billion in 1998. But when Social Security revenue and outlays are removed, the remaining budget is projected to run a $92 billion deficit. CBO projects that from fiscal years 1998 through 2008, the deficit in the non-Social Security budget will total $966 billion.

Table 1: CBO Projections
(in billions of dollars)




Surplus in Social Security $100 $1,645
Deficit in Rest of Budget $-92 $-966
Unified Budget Surplus $8 $679

Figure 1 makes a similar point. It shows that the unified budget, represented by the middle line in the Figure, moves from deficit to surplus in the next few years as a result of steadily mounting Social Security surpluses.(13)

Figure 1

313ss-f1.gif (13545 bytes)

Source: Congressional Budget Office. Revised Baseline Budget Projections for Fiscal Years 1999-2008, March 3, 1998.

CBO also projects that although the unified budget will be in surplus for a period beyond 2008, deficits eventually will reemerge. CBO director June O'Neill testified on January 28, 1998 that CBO expects deficits in the unified budget to return after 2015.(14)

Their return will be due primarily to mounting costs for government health care programs; as the population ages and medical advances continue to prolong life, health care costs are projected to rise significantly. Average health care costs are much higher for elderly people than for the non-elderly. The health costs of the very old, a group expected to become much more numerous in coming decades, are especially high.

Given these forecasts, what should be done now with the projected surpluses in the unified budget, which stem entirely from the current surpluses in the Social Security trust funds? Should these unified-budget surpluses be saved now in preparation for future fiscal and demographic demands? Or should they be used to finance tax cuts or program initiatives?

"Saving the surplus," rather than using it for tax cuts or program expansions, means applying it to reduce the national debt. When the government runs a surplus in the unified budget, the debt automatically shrinks. As explained below, reducing the debt increases national saving, and that in turn makes more capital available for private investment, which should promote economic growth. Stronger growth would ease, although certainly not eliminate, the problems that lie ahead for Social Security and for the federal budget generally. The relationship between the surplus, national saving, economic growth, and Social Security solvency is discussed in the next two sections of this paper.


The Need for National Saving

National saving consists both of private savings from individuals and businesses and of government saving, which can be either positive or negative depending on whether the government is running surpluses or deficits. When the government runs a deficit and spends more than it takes in, it pays for the shortfall by borrowing money from the private sector. This borrowing consumes a portion of private savings and thus lowers "net national saving." When the government runs a deficit, it is said to "dissave."

For example, between 1959 and 1980, the private saving rate averaged 9.6 percent of national income. During the same period, government deficits averaged 1.4 percent of national income. Hence, net national savings during that period averaged 8.2 percent of national income (9.6 percent minus 1.4 percent).(15)

By 1989-1990, private saving had declined to 6.6 percent of national income, while government deficits had increased to 3.6 percent of national income. That reduced net national saving to three percent of national income.

An increase in net national saving should lead to an increase in private-sector investment. If the government reduces the amount it borrows from the public and net national saving increases, a larger share of private saving is available for businesses to borrow and invest in new or modernized plants and equipment. More modern plants and equipment, in turn, should increase the productivity of the workforce (i.e., the output per hour worked). Increased productivity leads to greater economic growth and higher national income.

This has implications for Social Security. As the size of the economy and the level of national income climb, payroll tax revenues also should rise, which in turn would provide more resources for the Social Security trust funds.(16)

In addition, if national income is higher, the nation will more easily be able to absorb the benefit reductions and/or revenue increases needed to close the long-term gap between Social Security revenues and Social Security benefit payments. By bolstering economic growth, increased national saving thus helps stabilize Social Security over the long term.

As noted, net national saving rises when the federal government reduces the amount it borrows from the private sector. This occurs not only when a budget deficit is reduced but also when the government uses budget surpluses to shrink — or "pay down" — the national debt. When surpluses are used to reduce the debt, the government redeems securities it previously issued to pay for deficit spending; this reduces the amount of money invested in government securities and frees up more money for investment in the private sector. (To buy down the debt, the government does not have to "call in" securities. It can simply issue fewer new Treasury bonds and notes as current bonds and notes come due and are redeemed by the investors who hold them.)

Actions to increase net national saving are important, since the saving rate has fallen sharply in recent decades. In the 1990s, net national saving equaled about 12.5 percent of the Net National Product, which is a basic measure of the size of the economy;(17) today, the national saving rate is only a little more than half that. A sharp decline in the private saving rate is responsible for this decline.(18)

In a recent article in Business Economics, Van Doorn Ooms, senior vice president and director of research for the Committee for Economic Development, cites data linking the decline in investment since the 1960s to this drop in saving. Ooms argues that running a surplus in the unified budget would partially compensate for the decline in the private saving rate. By so doing, he writes, a surplus could help raise overall national saving toward the levels needed to generate sufficient private investment so the economy can increase its levels of growth and future output and thereby provide more adequately for the baby boomers' retirement.(19)

Many economists would note that public investment also can generate economic growth.(20) Federal, state, and local government investment in areas such as education can contribute to worker productivity and ultimately to stronger economic growth. As another example, investment in research can lead to development of new technologies that enhance productivity. But the principal proposals now being discussed to use the surplus for purposes other than shrinking the national debt — primarily proposals to use it for sizeable tax cuts — would do little to promote investment. Instead, they would largely promote consumption by making more funds available for current purchases, while keeping the national debt higher than it otherwise would be and thereby reducing the resources available for private investment. The total amount of investment thus should be greater if the surplus is used to pay down the debt than if it is used to finance a raft of tax cuts.

Economist Herbert Stein, former chair of the Council of Economic Advisors under President Nixon and a fellow of the American Enterprise Institute, recently spoke to this issue. Writing in the Wall Street Journal, Stein observed: "Consider the effect of cutting taxes. Doing so will increase private consumption by putting more income in private hands. It will also reduce private saving available for private investment, unless the tax cut is of a kind that strongly encourages saving. If the tax cut increases the deficit, the government will absorb more of the private saving that could have been invested. If the tax cut reduces a surplus, the government will add less to the supply of private saving that can be invested. And if the saving available for private investment is reduced, the rate of growth of future national income will be reduced — and that will be true whether the budget is initially in deficit or in surplus."

Stein added: "...the question of what to do with the surplus now in prospect pits the consumption of the present generation against the income of future generations.... Those who now want to eliminate or substantially reduce our prospective small surpluses should admit that in so doing they are impairing the incomes of our children and grandchildren. They should not act as if there was some excess income that could be given away without hurting anyone...."(21)


The Implications of Using the Surplus for Tax Cuts or Spending Increases

As just noted, if a portion of the surplus is used to cut taxes or increase government expenditures rather than to pay down the debt, some of the projected surpluses in the unified budget will be used for current consumption rather than for investment that can boost growth and income. In addition, the national debt will be larger if surpluses are used for tax cuts or spending increases than for paying down the debt. The larger the debt, the greater the proportion of future budgets that will have to be devoted to interest payments on the debt. Larger interest payments in turn will reduce the budgetary resources available to meet other needs.

How Can the Budget Surplus Be Used to Shore Up Social Security?

Since the State of the Union address, there has been some confusion over how projected budget surpluses can be used to shore up Social Security and just what President Clinton has proposed. The Administration has sought to clarify that its position is that none of the surplus should be used for tax cuts or spending increases at least until comprehensive legislation is enacted that addresses Social Security financing needs on a long-term basis.

Under the Administration's plan, any surpluses in the unified budget would be used to reduce the national debt until Social Security legislation is enacted. As this paper explains, such a course would help Social Security.

Social Security legislation may itself ultimately address the question of whether and how to use the surplus to bolster Social Security. For example, the federal government could take the surpluses in the unified budget and appropriate them to an entity with the independence of the Federal Reserve Board, which in turn could invest these funds in the private market and subsequently redeem the investment instruments on an as-needed basis to provide resources to the Social Security trust funds. A recent Washington Post article cites former CBO director Robert Reischauer as mentioning such an option.

Alternatively, a decision could be made and reflected in Social Security legislation that any surpluses in the unified budget that are attributable to surpluses in the Social Security trust funds are to be walled off from use for tax cuts or program increases and applied solely to shrinking the national debt. Or policymakers could decide that once Social Security legislation is enacted, other uses of unified budget surpluses are acceptable. The Administration is proposing that no use be made of the projected surpluses until this decision can be made in the context of Social Security legislation or after such legislation becomes law.

Some individuals have asked how any use of the surpluses can make a dent in Social Security's long-term financing problems, since these problems are so massive that Social Security will be insolvent after 2029. Such statements reflect a common misunderstanding of Social Security's long-term financing situation. When the Social Security actuaries project the program will become insolvent in 2029, they do not mean the program will be completely broke and unable to make any payments. What the actuaries project is that after 2029, the payroll taxes that Social Security collects each year will be sufficient to finance only about 75 percent of the Social Security benefits to which beneficiaries will be entitled, rather than 100 percent of the costs of these benefits. The surpluses that Social Security is now building will have been exhausted at that point, and there will be a shortfall equal to about one-fourth of the benefit payments due each year.

Putting Social Security back on a sound long-term footing entails closing this 25-percent gap. Although that will not be an easy task, the financing gap is not equal to 100 percent of future benefit requirements, as some who have heard the term "insolvency" used to describe Social Security's condition after 2029 have mistakenly assumed.

This also means the assumption that Social Security will go "belly up" after 2029 and "not be there" for those who retire after that date is incorrect. The issue is not that Social Security is threatened with collapse but that its income and benefit payment obligations will be out of balance because the income will be insufficient to make the full amount of benefit payments required under current law.

Furthermore, if the surplus is used for permanent tax cuts or entitlement expansions, deficits will return sooner and climb to higher levels (unless deeper cuts in basic government programs or steeper tax increases are instituted down the road to avoid budget deficits so large as to be economically injurious). In addition, if the federal government needs to borrow in the future to meet pressing needs during the decades when the baby boomers are retired in large numbers, it may be in a weaker economic position to do so if the national debt is larger at that point as a result of the surpluses now in prospect having been dissipated on tax cuts or spending increases. These issues are discussed below.

Lower National Saving and Less-Rapid Growth

As noted earlier, the national saving rate has declined substantially. A higher saving rate would be advantageous to promoting a higher rate of economic growth. It would result in more capital being available for productivity-enhancing investments in new plants and equipment.

If the projected surpluses in the unified budget are used to shrink the debt, national saving and investment should rise and give us a somewhat larger economy over time; a larger economy would bring in more Social Security payroll tax revenue without raising the payroll tax rate. A bigger economy also would enable us better to afford modifications in the Social Security benefit and/or revenue structure needed to restore the system to long-term balance. By contrast, if the projected budget surpluses are used for tax cuts or spending increases — and resources consequently are used primarily for current consumption rather than for investments that can boost productivity— economic growth is likely to be somewhat slower. That would likely make the steps needed to restore long-term Social Security solvency somewhat more painful.

Higher Interest Payments

To the degree the surplus is used to reduce the national debt, interest payments on the debt will be smaller. Over time, the effects of such a policy on interest payments would be substantial.

If the government uses the projected surplus for tax cuts or program increases, the debt will be $523 billion higher in 2008 — and interest payments on the debt will be approximately $30 billion larger — than if the surplus is used to shrink the debt.(22) The smaller the debt, the less the amount of principal on which interest payments must be made.

By using the surplus to reduce the debt and drive down interest payments, policymakers would be placing us in a stronger position to meet future fiscal policy challenges. If interest payments eat up a larger share of the federal budget, there will be less room to meet other needs when the baby boomers are retired. The result could be greater pressure on Social Security benefits, Medicare, or other parts of the budget at that time.

Effects on Budget Deficits in the Future

CBO projects that if we consume the surplus, deficits in the unified budget will return sooner and subsequently grow at a significant clip. CBO director June O'Neill recently testified that if we were to devote the projected surpluses to tax cuts or spending increases, deficits in the unified budget would return before 2015 and begin to mount.(23)

The long-term fiscal forecast already is rather daunting; it indicates that under current policy, deficits will eventually rise to a level of GDP unprecedented for a period when the nation is not in a recession or at war. O'Neill's testimony points out that under current policy, the deficit could rise to about five percent of the Gross Domestic Product by 2030 and a stunning 20 percent of GDP by 2050. The federal debt would exceed GDP in the 2040s and reach 200 percent of GDP by 2050. This long-term forecast assumes we use the surplus to shrink the debt, rather than for tax cuts or spending increases. If the surplus is consumed instead — and particularly if it is used for permanent tax cuts or entitlement expansions — the long-term forecast becomes significantly more adverse. The federal debt would exceed GDP in the 2030s rather than the 2040s.

If the nation ultimately is faced with deficits of a large magnitude, one or a combination of several scenarios must unfold. If we run deficits so large over an extended period of time that the national debt eventually rises sharply as a percentage of the Gross Domestic Product, economic growth will eventually be impaired, and the economy could ultimately begin to contract. If that occurs, we will be less able to afford Social Security, as well as other basic components of government. If we ultimately avert dangerously high deficits by cutting programs sharply, either programs such as Social Security will be reduced more than would otherwise be needed or other elements of government — such as education, programs for the poor, national defense, or other areas — could be squeezed hard. Similarly, if we eventually raise taxes substantially to hold deficits to manageable proportions, tax burdens on future generations could be raised to substantially higher levels than would otherwise be necessary.

The specter of large future tax increases is another reason that using the projected surpluses to cut taxes now would be imprudent. Doing so would cause deficits to return sooner and rise to higher levels. That in turn could lead policymakers eventually to raise taxes to much higher levels than would be needed if the surplus had been used to pay down the debt and future deficits and interest payments had been kept to lower levels.

Effects on the Government's Ability to Borrow Safely in the Future

Because of the aging of the population and the continued rise in health care costs as medical technology advances, as well as other factors that cannot be foreseen at this time, the federal government may need to engage in significant borrowing when the baby boom generation retires in large numbers. To what extent the government can do so safely will be affected both by the magnitude of the amounts to be borrowed (i.e., the size of the deficit in those years) and the dimensions of the national debt at that time.

Currently, the debt equals 45 percent of the Gross Domestic Product. CBO forecasts show that if the surplus is used to bring down the debt rather than being spent on tax cuts or program increases, the debt will shrink to 25 percent of GDP by 2008. Extrapolating from the CBO forecast and the intermediate projections of the Social Security trustees, we estimate the debt would decline to just 17 percent of GDP by 2012 under such a policy.

Looked at in dollar terms, the debt held by the public now stands at $3.8 trillion.(24) If the surplus is used to shrink the debt, the debt in 2012 will be an estimated $2.1 trillion (in 1998 dollars). The reduction in debt would be $1.7 trillion.

Shrinking the national debt in this fashion will give us more room to borrow in the future when the baby boom generation retires if that should prove necessary to meet needs for Social Security and Medicare and address other problems without sacrificing other needs too heavily or raising taxes too high.



Increasing national saving by using the surplus in the unified budget to pay down the debt should lead to somewhat stronger economic growth— and both to greater Social Security revenues and a greater ability for the nation to absorb the changes needed to restore long-term Social Security solvency. This would place the government in a stronger position to honor its promises of Social Security benefits to retirees and workers who have contributed in good faith. Decisions that Congress and the White House make now about taxes and spending consequently will affect how well prepared the country is to meet future needs in Social Security, as well as in Medicare, and to help provide for the nation's elderly and disabled citizens while still meeting other essential national requirements in the decades ahead.

End Notes

1. The employer's contribution can be deducted from income tax as a business expense. The self-employed are covered by the Self-Employment Contributions Act (SECA) and pay the full 12.4 percent. They may, however, deduct 6.2 percent from their net earnings before computing their contribution. Additionally, they may deduct half of their contribution from their income tax as a business expense.

2. Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1999-2008, January 1998, Table E-4.

3. David Koitz, "Social Security Taxes: Where Do Surplus Taxes Go and How are They Used?," CRS Report for Congress, 94-593 EPW, Updated May 1, 1997.

4. 1996 Green Book: Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means, WMCP 104-14, November 4, 1996.

5. 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, April 24, 1997, Table II.H1 and Table II.F19.

6. Robert Ball, member of the 1994-1996 Advisory Council on Social Security and Commissioner of the Social Security Administration from 1962-1973, makes the point that while the ratio of workers to Social Security beneficiaries is declining, the ratio of workers to all dependents will be almost the same in 2075 as it was in the decade from 1960 to 1970. Total dependents include children as well as elderly. The ratio of people ages 20 through 64 to people either under 20 or over 64 was nearly one-to-one from 1960 to 1970 and will be about the same in 2075. While the elderly population will be larger in 2075 than it was in the 1960s, the proportion of children will be lower. See: A Commentary on the Current Social Security Debate, January 1998.

7. 1997 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, April 24, 1997.

8. Ibid. These projections are based on the actuaries set of intermediate assumptions about the demographic and economic factors affecting Social Security costs.

9. Report of the 1994-1996 Advisory Council on Social Security, Volume I: Findings and Recommendations, January 1997. There was unanimous support by members of the Advisory Council on recommendations to extend Social Security coverage to all state and local government employees hired after 1997, to adopt the Bureau of Labor Statistics' revised methodology that would more accurately reflect true price changes in the Consumer Price Index and result in a 0.21 percent reduction in the cost of living adjustment, and to phase out the low-income threshold for income tax on Social Security benefits. (Thirty percent of low-income beneficiaries would still be excluded from taxation based on normal income tax rules.)

10. This requirement was established by the Balanced Budget and Emergency Deficit Control Act of 1985 (P.L. 99-177, also known as the Gramm-Rudman-Hollings law) and reaffirmed in the Budget Enforcement Act of 1990 (P.L. 101-508).

11. Congressional Budget Office, "Revised Baseline Budget Projections for Fiscal Years 1999-2008, March 3, 1998, Table 2.

12. The Office of Management and Budget and CBO forecasts differ somewhat on these projections. The President's budget projects a surplus in the non-Social Security part of the budget beginning in 2007 and projects that under the Administration's budget request, the projected unified budget surplus will total $1.1 trillion through 2008. See: Office of Management and Budget, Budget of the United States Government: Fiscal Year 1999, 1998.

13. The President's budget projects Social Security surpluses at a level similar to CBO's estimates, while its projections for the non-Social Security budget are more optimistic.

14. The Administration's long-term budget forecast is decidedly more optimistic than CBO's. It shows that under current services assumptions, the budget will remain in balance until about 2054. The

Administration's long-term forecast appears too rosy for three reasons. First, it adopts the intermediate long-term forecast of the Medicare trustees, which assumes Medicare per capita growth will, over the next 25 years, slow down so that it rises no faster than the GDP growth rate. There is no historical basis for assuming such a substantial slowdown in the Medicare growth rate under current law; Medicare costs have consistently risen faster than GDP and are likely to continue doing so indefinitely, especially as medical technology continues to advance and prolong life, at considerable cost.

Second, the Administration forecast assumes that discretionary spending after 2002 will keep pace only with inflation and fall to just 2.8 percent of GDP by 2050. It is more likely that this category of spending will rise with GDP or at least with inflation and population; otherwise such spending will fall substantially over time not only as a share of GDP, but also in purchasing power on a per capita basis. Discretionary spending has been declining as a share of GDP for most of the past 30 years (and most sharply since 1986), but there is likely to be a limit as to how much farther such spending can be cut as a share of GDP.

Third, in part because of its optimistic assumptions on the two matters just mentioned, the Administration's forecast shows the national debt being fully paid off by 2020. It assumes that federal budget surpluses after that point will be used to purchase securities in the private market, which then will earn interest that helps keep the budget in balance for a number of additional years. The political system, however, is unlikely to run surpluses after the national debt is paid off. Decisions to use revenues to purchase substantial amounts of securities in private financial markets rather than increase outlays or provide tax cuts would be unlikely.

Long-term projections by analysts at the Center on Budget and Policy Priorities, based on CBO's detailed estimates through 2008 and the long-term intermediate estimates of the Social Security trustees, suggest a return of deficits in approximately 2017. This is consistent with recent testimony of CBO director June O'Neill that deficits will return after 2015.

15. Charles L. Schultze, Memos to the President: A Guide through Macroeconomics for the Busy Policymaker, Washington, D.C.: The Brookings Institution, 1992, Memorandum 4.

16. If wages climb due to stronger economic growth, the average Social Security benefit levels to which retirees are entitled also will climb over time, since the benefit levels paid to retirees are tied to the amounts they earned during their working years. The increase in payroll tax revenue from stronger economic growth, however, would exceed the increase in benefit payments, with the net effect being to reduce imbalances in the trust funds.

17. The Net National Product is a Commerce Department measure that equals the Gross National Product reduced by an allowance for depreciation of fixed capital assets.

18. Van Doorn Ooms, "Economic Growth, Budgetary Balance, and 1997 Fiscal Policy, Business Economics, October 1997.

19. Ibid. Ooms notes that deficit reduction and increases in budget surpluses do not translate fully into increased domestic investment. He observes that a portion of the increase in government saving from reducing a deficit or enlarging a budget surplus would be offset by reduced private saving and by increased investment abroad. Ooms argues that the budget surplus should be large enough to boost domestic investment sufficiently after these partially offsetting factors are taken into account.

20. For example, see Robert Eisner, The Great Deficit Scares: The Federal Budget, Trade and Social Security, New York, The Century Foundation, 1997.

21. Herbert Stein, "Budget Nirvana Hasn't Arrived Yet," The Wall Street Journal, January 12, 1998. Stein also wrote: "There are some people who deny the need for such a choice. We are told that cutting taxes will so energize the growth of the economy that deficits will not rise and future tax increases will not be needed. But I suppose that after almost 20 years of disappointing experience, that siren song has lost its allure."

22. Congressional Budget Office, Revised Baseline Budget Projections for Fiscal Years 1999-2008, March 3, 1998. The value for interest is an approximation based on the CBO January 1998 projection of $32 million. CBO had not recalculated this value using the March 3, 1998 projections at the time this paper was completed.

23. Statement of June E. O'Neill, Director Congressional Budget Office, on The Economic and Budget Outlook: Fiscal Yeas 1999-2008, before the Committee on the Budget, United States Senate, January 28, 1998.

24. Sometimes, the national debt is referred to as being approximately $5.5 trillion. That figure refers to the "gross federal debt" and is not especially meaningful for macroeconomic considerations. The gross federal debt is not a particularly useful measure for economic purposes because it includes more than $1.7 trillion owed by the Treasury to other parts of the federal government. The more meaningful figure is the amount the federal government owes to individuals and entities outside the federal government; that figure — called "debt held by the public" — now stands at $3.8 trillion. Paying down the debt entails reducing the debt held by the public.

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