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Economists Support Budget Surplus

By John M. Berry
Washington Post Staff Writer
Sunday, October 5 1997; Page A07

More than $1 out of every $7 the federal government spent in the last year went to pay interest on the $3.8 trillion national debt, which has doubled in less than a dozen years.

Now that President Clinton and Congress have agreed to balance the federal budget, some economic analysts say they should consider running budget surpluses to pay down the debt – the accumulated total of past annual deficits – and to reduce the government's interest bill, which reached $245 billion in fiscal 1997, which ended Tuesday.

The mounting interest payments compounded the difficulty Clinton and Congress had in reaching an agreement to balance the budget, forcing them to squeeze other popular programs harder than they would have had to otherwise.

Meanwhile, for a variety of reasons, federal spending, other than for interest, has dropped to 17.2 percent of the gross domestic product – the total value of the nation's output of goods and services. That is the lowest level since 1966.

One compelling reason for paying down part of the federal debt is that it would lead to lower interest rates for consumers, businesses and the government, some economists argue. Running a surplus in coming years equal to about 1 percent of GDP could trim long-term interest rates by anywhere from a third to three-quarters of a percentage point, according to estimates by different experts. That, in turn, would lower the government's interest payments on the debt by billions of dollars each year.

It's like a family struggling with its monthly payments on a home mortgage, car loan and burgeoning credit card balances. First, the family has to cut back on current spending to keep from going even deeper into debt and paying out even more in interest charges. Once that happens, if some extra income can be found, it can be used to pay down the debts, reducing the size of interest costs. That makes getting out of debt steadily easier.

If the president and Congress "stick to their guns and hold spending down, [economic growth] will generate a surplus that will last into the first decade of the next century," said economist Roger Brinner of DRI/McGraw-Hill, a forecasting firm. "You get a virtuous cycle instead of a vicious one."

How fast the debt could be paid down would depend on how large a surplus was achieved and whether the economy remains solid or falls into a recession somewhere along the way. However, with a surplus of perhaps 1 percent of GDP, "in an average recession you still wouldn't have a deficit," said economist John Taylor of Stanford University. In that case, the debt wouldn't go up again but its reduction would be delayed.

Taylor expressed great skepticism that a substantial surplus would be allowed to develop, given the powerful political incentives to increase spending or cut taxes. But, he said, if there were one, it would "have a positive effect" on economic growth by boosting the very low level of national saving. That in turn should mean lower real interest rates, which "would be the inducement to more investment" and raise the economy's long-term potential to grow, he said.

A number of lawmakers of both parties are already proposing to use any potential surplus either to increase spending or cut taxes.

But suppose a surplus equal to 1 percent of GDP could be achieved. That would be equal about $80 billion, a large number but only about two-thirds the size of the reduction in the deficit from fiscal 1996 to fiscal 1997. Further suppose the surplus were achieved over a two-year period and stayed roughly at the 1-percent-of-GDP level indefinitely, with long-term interest rates falling by half a percentage point from what they otherwise would have been. And finally suppose there were no recessions in the next 10 years.

At the end of that decade, roughly $1 trillion worth of debt could be paid off and the ratio of the debt to the overall economy, as measured by GDP, would be at its lowest level since before World War II. A smaller surplus or a recession would mean a smaller payoff in debt reduction and interest payments, but the payoff could still be significant.

The ratio is considered important because the lower it is, the more resources the government has, for a given level of taxation, to meet other needs.

Economist Rudy Penner, a former head of the Congressional Budget Office and one of those who would like to see the government run a surplus, said that the most important long-run budget issue facing the United States is how to pay for the retirement of the baby-boom generation.

"It would be very nice to enter that era with the lowest possible debt to GDP ratio," said Penner.

Penner said that until recently he had expected the ratio, now just under 50 percent, to reach 60 percent, which would have meant higher interest payments. If the budget is just balanced, as opposed to having a consistent surplus, that ratio still could fall to 40 percent because of economic growth before the first boomers begin to retire in 10 or 15 years, he said.

"All this is very good news indeed."

Former Federal Reserve governor Lawrence B. Lindsey, now at the American Enterprise Institute, has doubts that the surge in income tax receipts that has played a major role in reducing the deficit will continue in future years. Part of that surge is the result of big capital gains from a booming stock market and large increases in the pay of corporate executives, both of which could taper off.

Criticizing Clinton and Congress for only aiming at budget balance, Lindsey said, "The prudent thing to do when you enjoy a windfall from some good luck is to save it; you might need the cushion in bad times."

© Copyright 1997 The Washington Post Company

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