Testimony of Wendell Primus: Tax Cuts

TESTIMONY OF WENDELL PRIMUS
Director of Income Security,
Center on Budget and Policy Priorities
before the Senate Special Committee on Aging
March 4, 1999

The original testimony has been revised to reflect new CBO estimates of the projected surplus over ten years and a better methodology for separating out the emergency spending portion of the fiscal year 1999 appropriations bills.
None of the qualitative conclusions of the testimony have been affected.

I very much appreciate your invitation to testify on the subject of tax cuts. My name is Wendell Primus and I am Director of Income Security at the Center on Budget and Policy Priorities. The Center is a nonpartisan, nonprofit policy organization that conducts research and analysis on a wide range of issues affecting low- and moderate-income families. We are primarily funded by foundations and receive no federal funding.

The projected surpluses present policymakers with a once-in-a-generation choice. You can spend those surpluses by cutting taxes or raising government spending and thus boosting current consumption. Or you can save those surpluses by strengthening Social Security and Medicare, paying down the debt held by the public, and raising national saving, investment and economic growth.

The Administration projects unified budget surpluses of $4.85 trillion over the next 15 years. Under the Administration's plan, $2.87 trillion of these surpluses would be used to reduce the public debt, about $580 billion would be invested in equities and about $1.4 trillion would be spent. The interest savings alone from this proposal (as a percentage of GDP) would more than offset the increase in Social Security costs that will occur under current law over the first half of the next century.

This can best be illustrated in the following way. Over the last 10 years, the combined amount that we have spent on Social Security and net interest costs has averaged 7.7 percent of GDP. If we could eliminate our net interest costs, Social Security costs alone as a percent of GDP (and hence the burden that these expenditures will place on future generations) will not exceed the 7.7 percent level until about 2070 under the actuaries' intermediate assumptions. This proposal also would increase national saving and thus, over time, probably lead to somewhat higher levels of GDP.

In addition, the Administration has proposed setting aside 35 percent of the on-budget surpluses to strengthen Medicare and Social Security over the next 15 years. ( The President has proposed crediting the Medicare Hospital Insurance fund with 14 percent of the total surplus (and about a third of the on-budget surplus), which would result in Medicare holding $686 billion of additional Treasury securities and the public debt being paid down by that amount.) In addition, $536 billion over 15 years would be used to create Universal Savings Accounts, which would, to a substantial degree, also raise national saving. To the extent that you do not accept the President's proposal to transfer monies to Medicare or to enact universal savings accounts, that money should be transferred to Social Security and saved, rather than being used for consumption through enactment of a larger tax cut or increase spending.

My generation — those born after World War II — are entering their peak earning years, and we know there will be budgetary pressures as the baby-boom generation retires. The choice you face is whether to give my generation a tax break for the next 10 to 15 years and let some future Congresses raise taxes on my children and grandchildren to meet current Social Security and Medicare commitments. I strongly urge that you save the surplus, including a significant portion of the on-budget surplus, to strengthen Medicare and Social Security.

Plans to restore long-term Social Security and Medicare solvency may require more resources than are provided by the Social Security surplus itself; some temporary general revenue transfers from the non-Social Security surplus to the Social Security and/or Medicare trust funds may be needed if solvency legislation that can pass is to be fashioned. If the non-Social Security surplus is consumed by tax cuts before legislation restoring Social Security and Medicare solvency is approved, resources that may prove to be needed as part of solvency legislation may disappear. That could make it more difficult to secure an agreement on Social Security and Medicare legislation. (It also could mean that whatever Social Security and Medicare solvency legislation ultimately was enacted it would have to contain larger benefit reductions than might otherwise be the case, because resources that could have been used to bolster the trust funds would be gone.)

The best thing we can do for both our elderly and younger generations is keep the promise we as a society have made under the Social Security and Medicare programs. Lowering interest burdens also is one of the best things we can do for younger generations.

Contrast these suggestions to some of the approaches being considered in Congress. I have serious reservations about approaches that would use on-budget surpluses to provide tax cuts and use a large portion of the Social Security surpluses to establish individual accounts. These plans will not reduce the publicly held debt very much, forcing Americans to pay higher interest bills than under a plan that largely reduces or eliminates the publicly held debt.

For example, the Feldstein approach would increase our retirement-income promises to the elderly, since it guarantees all of the elderly's Social Security benefits plus a portion of the retirement income they would receive from government-funded individual accounts. Under this plan, government funds would have to be deposited in individual accounts on an ongoing basis, not just for 15 years. Yet federal interest costs would not have been appreciably reduced to help make room for these costs. The fiscal burden on future generations would increase. While we should, to the best of our ability, fund the promises we have made to the baby-boom and succeeding generations, the last thing we should do is to increase those cash retirement promises, particularly to the more affluent elderly, as the Feldstein plan does. To be sure, there is a need to improve benefits for widows, as the President has suggested, but the cost of such improvements should be offset with other Social Security reforms.

SOCIAL SECURITY SURPLUSES SHOULD BE WALLED OFF AND NOT USED FOR TAX CUTS OR SPENDING INCREASES

It is extremely important that all of the Social Security surpluses be walled off in a manner that precludes their being used for tax reductions or spending increases. These surpluses should be used solely for Social Security solvency. In addition, the pay-as-you-go rule should continue to apply until Social Security is solvent for 75 years. After that, the pay-as-you-go rule should be modified so on-budget surpluses that remain after any transfers to Social Security and Medicare are made may be used for spending increases and revenue reductions. This rule should be enforced with both a sequester and a 60-vote point of order.

In fiscal year 1998, the federal government as a whole ran its first surplus in decades. CBO expects that without new tax cuts or program expansions, these surpluses will continue and grow over the course of the next ten years. Further, CBO projections indicate that starting in fiscal year 2002— three fiscal years from now — the federal government will be running on-budget surpluses (i.e., non- Social Security).. Excluding Social Security, CBO projects a net surplus over the next ten years of $824 billion.

The forecast of this sizable surplus in the non-Social Security budget has led many policymakers to believe there will be substantial amounts of money available to the federal government even after they have enacted a plan to fix Social Security's long-term funding problems. The President and many Members of Congress have put forward proposals to use the part of the surplus not used for Social Security reform to pay for tax cuts or increased spending on programs.

The CBO projections, however, assume that policymakers will keep spending within the discretionary caps.⁽¹⁾ The bill the Senate has just passed on military pay and pensions increases both discretionary spending and entitlement costs. According to CBO, the legislation increases discretionary spending by $40.8 billion over the next 10 years, with the costs rising each year. The costs reach $6.5 billion a year by 2009 and would continue to rise for a number of years after that. This requires Congress and the President to agree to make even deeper cuts in other discretionary programs (possibly including other defense programs). Including entitlements and revenues, the bill's total cost is $55 billion over 10 years. The reality is the discretionary caps will be increased; the only question is when Congress will adjust the caps.

In fact, if discretionary spending is allowed to grow just enough to preserve the same inflation-adjusted amount of resources available to discretionary programs as is available to them this year, not including the emergency spending in fiscal year 1999 — that is, if discretionary spending is allowed to grow just enough to counteract the effects of inflation, without expanding any program — discretionary spending would be $580 billion higher over the next ten years than assumed in the CBO baseline projections. That would use up $580 billion — or 70 percent — of the non-Social Security surplus.⁽²⁾

In addition, by using up part of the surplus that would otherwise pay down some of the federal government's debt, this additional discretionary spending would make federal debt somewhat higher than CBO's projections assume. As a result, the amount of interest on the debt the government would need to pay out each year would also be somewhat higher than CBO assumes. Over the next ten years, the extra spending on interest payments that would occur if discretionary spending were allowed to grow by just enough to counteract the effects of inflation would total $146 billion.

Thus, continuing to provide discretionary programs with merely enough resources to maintain their current levels of service would cost the federal government $726 billion over ten years — $580 billion in discretionary spending and $146 billion in interest payments. That eliminates almost all (88 percent to be precise) of the $820 billion in non-Social Security surpluses expected over the next ten years. In other words, if policymakers prove unable to make the tough decisions as to what areas of discretionary spending to cut — even if they don't expand any particular discretionary program — there will be little non-Social Security surplus for other purposes.

You should also bear in mind that government spending as a share of the economy is now at its lowest level in recent decades and would continue to decline under the Clinton budget.

It would be prudent to address discretionary program needs (in both defense and non-defense areas), strengthen Medicare and Social Security and reduce our public debt for the next several years and then consider tax cuts.

In its annual report estimating outlays, revenues and budget surpluses, CBO devotes an entire chapter to a discussion of the uncertainty in these budget projections. Its projections represent CBO's best estimate of the most likely path of the economy and the budget in light of past and current trends and assuming current policies are not changed. CBO states "that considerable uncertainty surrounds these estimates, however, because the U.S. economy and the federal budget are highly complex and are affected by many economic and technical factors that are difficult to predict."

There are many factors which affect these budget estimates: GDP, income, employment, and inflation, to name a few. In addition, there are many other technical factors such as the distribution of income among tax payers, realization of capital gains, and medical technology and its impact on Medicare expenditures.

CBO compared actual surpluses for 1988 to 1998 with the first projection of the surplus 5 years earlier. The average deviation was 13 percent which implies that the projected outlays in 2004 would produce an increase or a decrease in the surplus of about $250 billion.

This again suggests that the prudent path is to wait and see if significant on-budget surpluses materialize before enacting huge tax cuts.

A growing economy, Federal Reserve policy, and the budget deals of 1990 and 1993 are all contributed to changing the budget deficit as far as the eye can see to budget surpluses as far as we can project. Despite the gloomy forecasts from supply siders when tax rates were increased, there is no evidence that tax revenues, which as a percent of GDP are now at their highest level over the last 35 years, are hindering economic growth. From a macro-economic standpoint, there is little reason to lower taxes, especially at a time where the economy certainly does not need stimulus.

Some who argue for a tax cut would have you believe that tax burdens on the average wage earner are rising. This is simply not true.

Any bipartisan solution that would restore solvency to Social Security over the next 75 years and Medicare solvency for at least 25 years is likely to involve increased revenues to the system and benefit reductions. The current payroll tax that finances Social Security and Medicare is a fixed rate for the entire 75 year period. In light of increasing longevity, the increasing percentage of the population that is over age 65, the decreasing amount of total compensation received as cash wages, and rising medical cost, it is unrealistic to expect the amount of payroll tax revenues to finance Social Security and Medicare over this entire period should decline as a percentage of GDP. But that is exactly what occurs under current law — there will be about a 0.9 percentage point decline. That decline would be worth about $78 billion a year in today's dollars. This fact must also be kept in mind as you consider Medicare and Social Security reforms.

Mr. Chairman, with the foregoing discussion in mind, it is important to proceed with the needs of the country at hand — strengthening Social Security, enhancing Medicare, and lowering the public debt. Congress should proceed with extreme caution before sizable tax cuts are enacted.

1. More precisely, the CBO projections assume that discretionary spending will fit within the caps for as long as they are in place. After 2002, when the caps are no longer in place, the projections assume that discretionary spending will grow with inflation.

2. These figures assume that the funding designated for emergency purposes in fiscal year 1999 is not repeated in subsequent years. If the emergency funding is repeated in subsequent years and if all discretionary spending is allowed to grow by enough to counteract the effects of inflation, discretionary spending over the next ten years would be $744 billion higher than if it fit within the caps. This would use up 90 percent of the surplus.