South-Western College Publishing - Economics  

Policy Debate: How should the U.S. budget surplus be used?

Issues and Background

Saving Social Security, Medicare, creating USA accounts -- this is the right way to use the surplus. If we do so... we will still have resources to meet critical needs in education and defense. And I want to point out that this proposal is fiscally sound. Listen to this: If we set aside 60 percent of the surplus for Social Security and 16 percent for Medicare, over the next 15 years, that saving will achieve the lowest level of publicly-held debt since right before World War I, in 1917.
~ President Bill Clinton, 1999 State of the Union Address
If by some miracle a federal budget surplus does materialize, under no circumstances should the president and Congress be allowed to use it to buy more goodies for favored constituencies. Rather, it should be used in only two ways: to cut taxes or to finance a transition to a privatized Social Security system, or both.
~Edward H. Crane, "Making Better Use of the Budget Surplus," Cato Institute, January 28, 1998

After three decades of federal budget deficits, a budget surplus was realized in 1998. Economic forecasts at the time suggested that the budget surplus was likely to continue for the next several years (in the absence of a major recession or substantial revisions in fiscal policy). In the past, much of the discussion of the federal budget has dealt with the possibly adverse consequences of a federal deficit. At the end of the 1990s, the discussion temporarily shifted to examine what, if anything, should be done with the federal budget surplus.

One of the costs associated with a federal deficit is a possible "crowding-out effect" in which more government borrowing leads to higher interest rates and less private investment and consumption spending. Economists note that a federal budget surplus, on the other hand, can result in lower interest rates, increased investment and consumption spending, and a higher rate of economic growth (unless the Fed takes actions to offset this effect due to concern about inflationary pressures). While many economists would like to see the surplus used to reduce the federal debt, concern is usually expressed that such a policy is unlikely in the long run because the surplus provides a convenient political justification for either a tax reduction or increased government expenditures.

During his 1999 State of the Union address, President Clinton presented the framework of a plan to use most of the federal budget surplus to build the trust funds for Social Security and Medicare to levels that are required to provide benefits to the large baby-boom generation as it reaches retirement age. (The problems facing Social Security are addressed in greater detail in the online debate entitled: "Will Social Security survive into the 21st century?.") As part of this plan, Clinton proposed to invest some of the surplus in government managed retirement accounts that invest funds in the stock market. He proposed that the rest of the surplus be used to fund new initiatives in education, health care, national defense, and pollution abatement.

Many conservatives, on the other hand, argue that the economy would operate more efficiently with less government intervention. They believe that a federal budget surplus is unlikely to be saved or used to reduce the national debt since there will always be pressure to use the funds to satisfy requests from special interest groups that are engaged in rent-seeking behavior. Many of these conservatives believe that the federal budget surplus provides an historic opportunity to reduce the size of government by providing tax cuts. These tax cuts, in their view, would transfer funds that would ultimately have been used for government spending back to private consumption and investment alternatives.

In the summer of 2001, the Bush administration successfully sponsored tax cut legislation that, combined with the aftereffects of the attack on the World Trade Center and the recession beginning in 2001, have eliminated the budget surplus. Since economic growth had been sluggish early in 2001, this move was applauded by many who were concerned about the possibility of a recession. Opponents, however, argued that the preservation of Social Security and other social programs would have been a more desirable use of the budget surplus. More recent proposals for further tax cuts have met with similar debate. While the surplus has at least temporarily disappeared, the issues presented in this document remain as sources of political debate.

One of the main areas of contention is the size of the deficit or surplus. As the government deficit or surplus is currently measured, Social Security revenues and expenditures are included in the "unified budget." The recent budget surplus, however, was primarily due to a surplus in the Social Security account. Under current legislation, the Social Security surplus is supposed to remain in the Social Security trust fund to provide for future deficits in the Social Security program. The use of this surplus to provide tax cuts and fund other programs has eliminated some of the savings that were supposed to be set aside to cover future shortfalls in the Social Security account.


Primary Resources and Data

  • Office of Management and Budget
    The Office of Management and Budget formulates budget plans for the Executive branch of government. This web site contains information on current and proposed budgets, and an extensive collection of studies, testimony, and other information dealing with budget-related issues. Budget forecasts may be found in the online copy of "Economic and Budget Outlook: Fiscal Years 2007-2016." Chapter 2 of this document deals with the federal budget outlook.

  • Congressional Budget Office
    The Congressional Budget Office web site provides information about current and projected government budgets. Studies, reports, and testimony dealing with budget-related issues are available on this web site.

  • Bureau of the Public Debt
    The Bureau of the Public Debt web site provides information on the size of the federal debt. Annual public debt data from 1791-2005 and daily data from 1993 to the present day is available on this site.

  • The Concord Coalition
    The Concord Coalition is a nonprofit organization that supports a balanced budget and the preservation of Social Security, Medicare, and Medicaid. This web site contains numerous studies, press releases, and other information related to these budget-related issues.

  • Office of Management and Budget, "A Citizen's Guide to the Federal Budget"
    This online document provides a discussion of the U.S. budget and the budget formulation process. Problems associated with budget deficits and the national debt are also examined in this publication.

  • Brian W. Cashell, "The Economics of the Federal Budget Surplus"
    Brian Cashell is the author of this March 30, 2001 Congressional Research Service Report to Congress. This report provides a useful overview of the components of the federal budget surplus. It also examines the short-run and long-run macroeconomic effects of alternative fiscal policies.

  • Washington Post, "What to do With a Budget Surplus?"
    In this March 17, 1998 article, Clay Chandler and John M. Berry examine the economic arguments concerning alternative uses of the federal budget surplus. This article provides a good summary of the major arguments surrounding this issue.


Different Perspectives in the Debate

  • President Bill Clinton, "1999 State of the Union Address"
    In this speech, President Clinton stated his plan for dealing with the U.S. federal budget surplus. This plan involves using the budget surplus to build the Social Security and Medicare trust funds and to fund new education, health care, national defense, and environmental programs.

  • President Bill Clinton, "2000 State of the Union Address"
    President Clinton discussed his plans for expanded health care and education initiatives while reducing the federal debt in the 2000 State of the Union address.

  • The Clinton-Gore Administration FY2001 Budget
    The Fiscal Year 2001 budget proposal contains detailed information on the administration's plan on how to use the surplus to support initiatives in health care and education while preserving a social security surplus and paying down the national debt.

  • President George W. Bush, "A Blueprint For New Beginnings"
    This February 2001 document summarizes President's Bush's economic plan for the next 10 years. He proposes to use some of the surplus to cut taxes while also raising spending on education and reducing the debt. This document contains a reasonably detailed statement of this plan.

  • The Bush Administration FY 2003 Budget
    While this budget message focuses on the antiterrorist campaign and homeland security, it also discusses a plan to restore a balanced budget by 2005.

  • The Bush Administration FY 2004 Budget
    This budget message continues a focus on the antiterrorist campaign and homeland security. Projections of a balanced budget in the short term are no longer present.

  • The Bush Administration FY 2005 Budget
    This budget message continues an emphasis on national defense and homeland security. Issues of economic security are also addressed. A goal of cutting the deficit in half within 5 years is stated in the President's budget message.

  • The Bush Administration FY 2006 Budget
    This budget message suggests that the deficit will continue to decline in response to economic growth.

  • The Bush Administration FY 2007 Budget
    This budget message suggests again that the deficit is again expected to continue to decline in response to economic growth.

  • Max B. Sawicki and Robert Denk, "How Do You Spell Relief?"
    In this March 12-26, 2001 American Prospect article, Max B. Sawicki and Robert Denk examine alternative tax cut proposals. hey critique the Bush plan by noting that it primaily effects the income tax and this has little impact on low- and moderate-income workers. Sawicki and Denk argue that low- and middle-income households would receive more benefits from a payroll tax cut, since a larger share of these taxes are paid for by lower-income households. They observe that the Bush tax cut plan provides approximately 43% of the tax cut to the wealthiest 1% of households.

  • Robert B. Reich, "Use the Budget Surplus for Universal Health Care "
    In this April 9, 2001 article appearing in the Los Angeles Times, Robert B. Reich, former U.S. Secretary of Labor, argues that some of the budget surplus should be used to provide health care benefits to those who cannot afford them. He notes that a growing number of U.S. citizens do not have health insurance. Reich also notes that medical insurance costs are very large share of income for low-income households. He believes that there would be broad public support for a system of universal health care coverage.

  • William G. Gale and Alan Auerbach, "Does the Budget Surplus Justify a Large-Scale Tax Cut?"
    In this March 22, 1999 Brookings Institute article, William G. Gale and Alan Auerbach argue against using the budget surplus to reduce taxes. They note that most of the surplus is the result of a surplus in the social security trust fund. Since this is a short-term phenomena that will disappear as the baby-boom generation retires, it is argued that this portion of the surplus should not be used to justify tax reductions. They note that most of the "on-budget" surplus is the result of accumulations in government pension funds and, for similar reasons, should not serve as a justification for tax cuts. Furthermore, Gale and Auerbach observe that projected future surpluses are only expected to be short-term phenomena. Deficits are projected for the next several decades as the baby-boom generation reaches retirement age. These deficits will materialize earlier if the economy does not maintain the relatively high growth rate that has been experienced in the past few years.

  • David Alan Aschauer, "How Should the Surpluses Be Spent?"
    In this 1998 Jerome Levy Economic Institute policy note, David Alan Aschauer argues that the budget surplus should be used to engage in public investment projects that would encourage economic growth. (The Adobe Acrobat viewer plugin is required to view this document. You may download this viewer by clicking here.)

  • House Budget Committee (Republican page)
    This page provides information about the Republican viewpoint on the President's budget proposals.

  • House Budget Committee (Democratic page)
    On this page, you will find a Democratic perspective on the budget.

  • House Budget Committee Democrats, "Fuzzy Budget Math and the Facts"
    The House Budget Committee Democrats argue that the Bush tax cut has eliminated the surplus in the federal budget and is cutting into the social security and Medicare Trust Funds. They believe that such a policy is not desirable and contradicts early claims by the Bush administration that only a portion of the surplus would be used to fund tax cuts.

  • Senate Budget Committee (Republican page)
    This page contains information that generally supports Republican plans for tax cuts.

  • Edward H. Crane, "Making Better Use of the Budget Surplus"
    Edward H. Crane, president of the Cato Institute, argues that the budget surplus should be used to either provide tax cuts or to finance the transition to a privatized social security system. He argues that if the budget surplus is not used for one of these purposes, Congress and the President will use the surplus to fund new government programs.

  • William Niskanen, October 23, 1997 Testimony to the House Budget Committee, "Use a Pending Budget Surplus Only for Major Fiscal Reforms"
    William Niskanen, the chairman of the Cato Institute, argues that the federal budget surplus should be used to finance one or more major fiscal reforms. He recommends using the surplus to switch from "pay-as-you-go social security and medicare programs to advance funded individual retirement and medical insurance accounts." His alternative proposal is to use the surplus to finance the transition process associated with major tax reform designed to encourage economic growth.

  • Kilolo Kijakazi and Wendell Primus, "Would Using the Budget Surplus for Tax Cuts or Entitlement Expansions Affect Long-Term Social Security Solvency?
    In this Center on Budget and Policy Priorities study, Kilolo Kijakazi and Wendell Primus argue that the budget surplus should be used to pay down the national debt. They suggest that this would lead "to greater Social Security revenues and a greater ability for the nation to absorb the changes needed to restore long-term Social Security solvency." Kijakazi and Primus oppose tax cuts or new entitlement programs since neither of these uses of the surplus are likely to lead to substantial economic growth.

  • Alan Greenspan, January 29, 1998 Testimony Before the U.S. Senate Committee on Budget
    Alan Greenspan, the Chair of the Federal Reserve Board of Governors, argues that the government should use the federal budget surplus to retire government debt as a means of preparing for future shortfalls in the social security and medicare trust funds. He argues that reductions in the national debt would result in lower interest rates, increased investment spending, and a faster rate of economic growth.

  • Alan Greenspan, January 28, 1999 Testimony Before the U.S. Senate Committee on Budget
    Alan Greenspan focuses on the use of the budget surplus to preserve social security in this testimony. He argues that President Clinton's plan to invest a portion of the social security trust fund in the stock market is ill devised since he believes that political pressure will be used to invest these funds in alternatives that are not the most productive use of these funds. As supporting evidence, Greenspan notes that public pension plans have generally realized lower rates of return than private pension plans. He suggests that the focus of the debate should be on mechanisms designed to increase saving and investment.

  • Hayden G. Bryan, "Managing Anticipated Budget Surpluses"
    In this November 1997 Joint Economic Committee Study, Hayden G. Bryan argues that the budget surplus should not be used to alter market outcomes. He suggests that many past policies have resulted in substantial harm because of their interference with market processes. Bryan believes that alternative proposals for the use of the surplus should be evaluated in terms of their impact on economic growth.

©2006  South-Western College Publishing.  All Rights Reserved  |   DISCLAIMER