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Economy, Spending Could Soak Up Surplus

The Budget
By George Hager
Washington Post Staff Writer
Thursday, October 29, 1998; Page C1

Politicians got one more chance to celebrate the first federal budget surplus in a generation yesterday when the Treasury Department made the fiscal 1998 number official: $70 billion in black ink for the 12 months that ended Sept. 30.

But even as President Clinton announced from the Rose Garden, again, the end of 29 dark years of seemingly intractable deficits, some experts worried that the pot of money may not last long.

Already, politicians from both parties are girding for renewed fighting next year over whether to spend the coming surpluses on tax cuts, defense programs, other domestic spending or reduction of the national debt.

Some economists warn that a slowing economy could also trim back projected future surpluses.

And a serious slowdown would likely trigger calls for stimulating the economy to prevent a recession, either through tax cuts or spending increases particularly during the two years running up to the presidential election in 2000.

Barry Anderson, who served until this year as assistant director for budget at the White House's Office of Management and Budget, said pressure for extra spending from both parties has badly strained last year's balanced-budget deal. "I don't see it as the death knell," he said, "but the vultures are beginning to circle."

Economists are divided over how the slowing economy will affect the surplus, especially in the short run. Some see little change right away. Michael Montgomery, a senior associate at Standard and Poor's DRI, said the forecasting firm still projects a healthy $68 billion surplus in the current fiscal year, even though it simultaneously projects a "substantial" slowdown in economic growth from a 3.5 percent pace this year to 1.9 percent in 1999.

The surplus will survive, Montgomery said, because while the economy has cooled, it "is still growing and [federal] spending is being controlled."

But other economists are gloomier. Nicholas Perna, chief economist for Boston's Fleet Bank, projects economic growth slowing to 1.5 percent next year and the surplus dropping to just $25 billion.

"The surplus gets an awful lot smaller with some risk on the downside that it could become a deficit," Perna said.

Perna said his pessimism stems from a conviction that a lot of the force behind the sudden switch from deficits to surpluses came from the stock market, which minted new millionaires for the last two years and threw off enormous tax revenues. With the Dow Jones industrial average nearly 1,000 points below its mid-July peak and stockbrokers fretting about sharply diminished year-end bonuses, market-driven revenues are likely to contract sharply, he said.

Perna is also worried about what Congress and the president might do in the way of new spending or tax cuts next year, both of which could cut into any surplus.

If a serious slowdown raises the prospect of a recession, that could provoke demands for policymakers to forget about deficits and instead pump up the economy.

At the same time, some economists warn that the nation's recent experience casts doubt on whether traditional fiscal stimulus would work to spur growth. Some say the economy has expanded steadily for close to eight years in part because efforts to cut the federal budget deficit sparked a drop in interest rates, which boosted growth.

And with the Federal Reserve poised to counteract the inflationary impact of extra spending or tax cuts, "the basic notion that smaller deficits mean less expansion . . . is not a theory that is well suited to the way the economy operates today," said Treasury Deputy Treasury Secretary Lawrence H. Summers during a meeting with Washington Post reporters and editors yesterday.

Meanwhile, the White House and Congress have already started nibbling into the current year's surplus.

According to preliminary estimates, emergency spending in the "omnibus" spending bill enacted last week will carve some $13 billion to $14 billion out of the surplus. That is barely a rounding error in the $1.7 trillion federal budget, but it is a significant chunk of the $80 billion surplus the Congressional Budget Office projects for Fiscal 1999..

And plans are already afoot to sharply escalate both spending increases and tax cuts in next year's budget process. Republicans demanded and got an agreement in the just-ended budget talks that every added dollar of domestic emergency spending in the omnibus bill would be matched by a dollar of defense spending, a deal that helped add nearly $10 billion in Pentagon money to the measure.

That could be just the beginning. Sen. John McCain (R-Ariz.) sent a letter to his Senate colleagues warning that the Joint Chiefs of Staff told him they may need up to $27.5 billion a year in additional funding to restore military readiness.

And on the tax side, House Budget Committee Chairman John Kasich (R-Ohio) laid down the first marker for next year's tax debate just as Congress adjourned, calling for a 10 percent, across-the-board tax cut that would cost some $330 billion over the next five years.

The administration has signaled that it will treat any GOP tax-cut requests next year the same way it did this year, by opposing significant cuts until Congress and the White House work out a deal to ensure the long-term solvency of Social Security, which is facing bankruptcy in the next century.

Summers said yesterday it would be "irresponsible" to increase spending or cut taxes "until the Social Security issue has been resolved."

The argument enraged Republicans this year, killing their plans for a tax cut and subjecting them to attacks that they were out to cut Social Security. They were particularly inflamed that while he was insisting on saving the budget surplus for Social Security, President Clinton was working to use part of it for his emergency spending proposals.

Budget analysts pointed out, however, that both sides worked to increase the size of the emergency spending package. "The big difference is that the Republicans really got on board this year," said former OMB senior aide Anderson,

who is now vice president of the consulting group Jefferson Solutions. While politicians celebrated the formal advent of surpluses yesterday, deficit hawks pointed out again that there would be no surplus at all if it were not for counting the excess payroll taxes being collected for Social Security money that is theoretically being saved to pay baby-boomer retirement benefits in the next century.


© Copyright 1998 The Washington Post Company

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