Debt and Taxes

What's gotten into Alan Greenspan? Until recently, he
was in clear agreement with the Democrats about how to deal with the
federal budget surplus: Oppose tax cuts and use the surplus to pay off
the national debt. But on January 25--five days after the inauguration
of George W. Bush--Greenspan abandoned that position and endorsed Bush's
mammoth tax cut. The explanation he gave for his reversal was patently
phony: He said he had just realized that future surpluses would be even
larger than anticipated. Without a tax cut, Greenspan now says,
surpluses will add up to more than the national debt. This means that
the government might at some point in the future have to invest the
surplus tax revenue by purchasing private assets--and this, says
Greenspan, would create an entangling conflict of interest between the
government and private industry.

Greenspan's rationale for his turnabout is remarkably unpersuasive.
He says the situation he claims to fear would not arise for at least 10
years, yet he knows as well as anyone that forecasting 10 years ahead is
impossible. After all, barely two years ago we were still talking about
deficits stretching indefinitely into the future. What's more, he knows
that the "problem" of how to invest the government's surplus revenues
could be addressed when it arises--if, in fact, it ever does.

Thus the question becomes, What is Greenspan really up to? Is he
making nice to Bush so as to maximize his own influence over the
administration and the economy? Possibly, but a more likely (and more
charitable) explanation is that he sees a significant danger of some
very bad economic weather ahead and hopes a tax cut would give a boost
to the economy and minimize the effects of a recession. Greenspan
delicately alluded to that possibility far down in the body of his
statement on January 25. And in fact if the economy does suffer a
serious contraction, then a temporary tax cut--although not the kind
that Bush and now Greenspan are pushing--would be good policy.

Where does Greenspan's desertion leave the Democrats? In a
predicament of their own making. A vigorous Democratic Party, one whose
business in life was promoting the social and economic well-being of the
country, would never have gotten into bed with Alan Greenspan on this
issue in the first place. Whatever his talents as a steward of U.S.
monetary policy, he has a history of far-right libertarian views about
the appropriate role of government spending for social purposes. Yet
ever since the prospect of surpluses first appeared, many Democrats have
been promoting a line congenial to Greenspan's point of view. Rather
than pointing to the nation's unmet needs for health care, child care,
repair of dilapidated schools, drug treatment facilities, community
mental health facilities, and myriad other social programs, many
Democrats became as fixated as Republican-style fiscal conservatives on
paying down the debt.

How did the Democrats arrive at a position that is so grossly counter
to the party's New Deal history and to the country's current needs? Is
it really appropriate for the more progressive of the two major parties
to be espousing the policies of 1930s anti-New Deal Republicans? How did
the party of FDR arrive at this pass?

By 1994, after decades of right-wing demagoguery lambasting
government programs had helped produce the Clinton health care debacle,
Democratic politicians had become ashamed and afraid to advocate openly
for social infrastructure programs, even when the need for them was
obvious. Since then, the most a typical Democrat has dared to propose
are cautious little programs that only nibble at the edges of the huge
problems we face. But even these nibbles would be made more difficult by
tax cuts, so the Democrats' instinct is still to oppose them.

That's why, when surpluses as far as the eye could see came into
view, Bill Clinton's impulse was to fend off the inevitable Republican
tax-cut proposals. But the president had a problem. Having boldly
declared just a few years earlier that "the era of big government is
over," Clinton felt he couldn't now turn to Congress and say, "Let's
spend these funds on this long list of worthy things we haven't been
able to afford up to now." So instead of calling for expenditure on
programs he knew could help the country, Clinton proposed continuing to
run a surplus of tax revenues and applying these funds toward paying
down the national debt.

The president's most brilliant tactical ploy was to say that this
course of action would be equivalent to using the surplus to "save
Social Security first," before the money was spent on something else or
given back to citizens in the form of tax cuts. The connection (in
truth, a very loose one) between paying down the debt and balancing
future Social Security revenues and benefits was never explained, and
the media never asked. But the president's promise to save Social
Security resonated with the public, and Republican tax-cut proposals
were successfully beaten back--at the cost, however, of slipping into a
fiscal straitjacket that still constrains Democrats despite a surfeit of
tax revenues and a deficit of social programs.

Is there any valid economic rationale for reserving most or all of
the budget surplus for debt reduction? Not much of one. During the
recent election campaign, when economists came out to argue the Clinton
line in support of Al Gore, the best they could do was trot out the
dubious theory of "crowding out." According to that theory, when Uncle
Sam sells bonds to cover a deficit, every private dollar that goes to
the Treasury to pay for the bonds is a dollar no longer available for
business purchases of new plants and equipment. If there is a budget
surplus rather than a deficit, the process supposedly works in reverse:
When the Treasury buys back its bonds rather than selling them, the
money it pays for them is added to the funds available in the economy
for business investment. In short, paying down the debt is supposed to
result in extra investment by corporate America in productive equipment,
which in turn makes the economy grow faster.

Like many economic theories, the "crowding out" theory of investment
owes more to unverified scenarios hatched in economics professors'
offices than to observations of the actual behavior of businesspeople.
And like many things the New Democrats have advocated, the theory has a
right-wing provenance. After beginning life as a jab against FDR and the
New Deal, the "crowding out" theory flourished and ultimately grew to
become a standard argument against Keynesian strategies of running
deficits to prevent or counter recessions, and against government
activism generally.

But there's a problem with the "crowding out" theory. It assumes that
investment by the private sector passively adjusts to whatever funds are
left over in the capital markets after government bond sales or
purchases take place--a premise that ignores how investment really
works: It is motivated by the perception that there might be big profits
to be made. When investment promises big profits, money to finance it
comes pouring in from many sources, such as retained business earnings
and capital from overseas. The flow of money available to finance
business investment waxes and wanes as the prospects for profits wax and

Of course, the state of the economy has a big influence on the
perception of opportunities for business profits. And the business
climate can be affected by running a surplus: Taxation that isn't
matched by government spending is likely to reduce the demand for goods
and services. Sometimes that reduction in demand is needed to stabilize
an economy that is overheating. But at other times, running a surplus
can push the economy into recession. When that happens, business
investment decreases rather than increases. That may well be what is
happening right now.

But even if one were to accept the "crowding out" theory of
investment as gospel, it does not follow that paying down the debt
is necessarily a good idea. The public programs we could finance with
the surplus would produce a healthier and more productive labor
force--and would thereby do far more to improve the nation's future
economic condition than any increase in our capacity to produce still
more consumer goodies for the well-off. Suppose further that we were to
use the surplus not for government programs that could be classed as
investments but for initiatives that simply made life better right now
for some of our citizens--say, for the working poor and their children.
Isn't there an argument to be made that relieving their hardship is
worth more to the country than a future increase in the capacity to
produce sport utility vehicles?

Unfortunately, it now appears that Democrats who don't stick with the
pay-down-the-debt line will cave in and vote for Bush's tax cut. But
there is a better alternative: A temporary cut in the now-excessive
payroll tax, which all wage earners pay, would be far more fair than
Bush's cut that heavily favors the wealthy. It would increase the
paychecks of people whose income is so low that they don't pay income
tax. Moreover, low-income families are more likely than rich ones to
spend the tax-cut money that accrues to them; therefore a payroll-tax
cut would surely boost the economy more than an income-tax cut that
primarily benefits the rich. A payroll-tax cut would by no means
endanger Social Security, a program whose future depends--contrary to
what most people think--not on a collection of bond certificates in the
vaults of the Social Security Administration but rather on the continued
willingness of the American public to support the elderly through a
public program. The Republicans, of course, want to send those same
payroll-tax dollars to Wall Street so that billions in fees can be
skimmed off by private investment firms as part of their scheme to
privatize Social Security. A temporary cut in the payroll tax would have
the additional benefit of making it harder for Republicans to carry out
that plan.

Since at least the mid-1990s, the Democrats, through their craven
reluctance to rebut the antigovernment line Bill Clinton came to
embrace, have been in the wrong camp on spending policy. Whether or not
recession is on the way (or is already here), Democrats need leaders who
are willing to buck the debt reduction canard and to champion sensible
policies of taxing and spending. Alice Rivlin, a founding director of
the Congressional Budget Office and former member of the Federal Reserve
Board, has led the way by using the op-ed page of The New York
to advocate more spending on social programs. But so far, she
seems to be a lone voice in the wilderness. Aren't there any other
Democrats who might step to the fore on this issue?