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August 27, 2001
The Outlook
The Outlook
The federal budget surplus is rapidly shrinking. That's a good thing, but you wouldn't know it from the debate in Washington, where the standard recession-fighting prescription is endangered by a newfound obsession with the Social Security surplus.

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Most economists accept that, at least in theory, the government should offset contracting private activity in downturns by reducing its tax take and by boosting spending, a policy advocated by British economist John Maynard Keynes in the 1930s. Yet after the administration said last week the surplus this year and next will be less than expected, though still among the largest in U.S. history, budget director Mitch Daniels began demanding spending cuts. Democrats responded by condemning anew the tax cut. Both agree the Social Security surplus -- the excess of Social Security receipts over benefits, estimated at $157 billion this year -- must not be touched, thus barring the government from running a deficit in the rest of its budget.

On Wall Street, where you'd think preserving surpluses would score points, instead it's considered a really bad idea. "If the economy needs help today, fiscal stimulus may well be a better bargain than mindless fealty to an accounting fiction about Social Security and Medicare trust funds," remarked Neal Soss, Credit Suisse First Boston's chief economist. Jan Hatzius of Goldman Sachs adds that President Bush's defense of the Social Security surplus "may very well stand in the way of a sensible, countercyclical fiscal policy. After all, a temporary on-budget deficit would be a price well worth paying for averting a recession."

But don't let last week's rhetoric in Washington fool you. Keynesianism is not dead. It's enjoying a revival in some of the oddest places. The International Monetary Fund, whose austerity prescriptions are often blamed for deepening the late-1990s Asian crisis, praises the U.S. tax cut as "appropriate and timely." Meanwhile, signs that Germany and France may overshoot their deficit targets have fueled talk of relaxing Europe's strict limits on deficits.

But Keynesianism's oddest standard-bearers are President Bush and the supply sider who advises him, Lawrence Lindsey. Mr. Lindsey once labeled Keynes's advocacy of countercyclical fiscal policy "utopian." But last month, he said it was only "common sense economics" not only to let the budget deteriorate in a slowdown, but to push it along with a tax cut. He compared Democratic critics of the tax cut to Herbert Hoover, who raised taxes in 1932.

President Bush is committed to preserving the Social Security surplus, Mr. Lindsey said in an interview last week, but he'd make an exception for war or recession. "I don't think his is an absolutist view here," Mr. Lindsey said. If it turns out the U.S. is in recession, "then I think he'd be willing to reconsider."

This seems to run counter to Mr. Daniels's demand for spending restraint, but then not many analysts expect the bipartisan defense of the Social Security surplus to prevail against the ingrained momentum for more spending.

As long as the economy looks sick, that's probably a good thing. Democratic and Republican economists agree that trying to rope off the Social Security surplus when the economy is sinking is bad economics. Harvard University's Martin Feldstein, who was chairman of President Reagan's Council of Economic Advisers, thinks the record on fine-tuning the economy through countercyclical fiscal policy is awful, but says, "It's hard to see why we would want to try arbitrarily fine-tuning the economy in the wrong direction."

Princeton University's Alan Blinder, who sat on Mr. Clinton's council, says from the economics angle, an even bigger short-term tax cut would have been the right policy. But this time, good politics trumps good economics. "When you look out into the future, we really need that revenue for the Social Security system. To win politically you need a symbol that would attract politicians and voters. It turns out that saving the whole Social Security surplus is a pretty good candidate for that. This isn't something that comes out of the economic textbooks, but the political textbooks," Mr. Binder says.

On this, Mr. Lindsey agrees. There's no economic significance to a balanced budget or any given level of the Social Security surplus. "But it turns out there's value in the political process to having a number that everyone agrees to." It used to be zero; now it's $157 billion.

For this fealty to balanced budgets, thank the straitjacket of deficits that since 1982 not only made Keynesian countercyclical initiatives impossible, but often led to the opposite.

In 1990, President Bush senior had to raise taxes during a recession. Three years later, with the recovery still looking fragile, President Clinton had to abandon a $30 billion stimulus package he'd hoped would reduce the sting of his own tax increase. With the help of Federal Reserve Chairman Alan Greenspan, those moves kicked off a prolonged decline in interest rates, 10 years of prosperity and, ironically, the budget surpluses that today make Keynesian-style stimulus possible.

If, as many economists think, the 2001 tax cut has come just in time to head off recession, it may give Keynesian fine-tuning its biggest jolt of credibility in decades.

-- Greg Ip

Write to Greg Ip at greg.ip@wsj.com2


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