Ten years ago, when I would tell audiences that by the end of the century the political fights in Washington will be over how to spend the budget surpluses, I could hear the snickers and titters. As we went through the eye of the deficit storm created by the break from gold in 1971, it was generally assumed that the problem never could be solved. Now, we are headed into surpluses in the federal budget that are beginning to resemble tidal waves. And the politics of surplus have begun, with Republicans and Democrats afraid to tell the electorate the dimensions of the waves. A team of budget experts pulled together by Jack Kemp at Empower America now estimates that on the current trend line the surplus this year will exceed $50 billion, exceed $120 billion in FY 1999, and reach $410 billion in 2003. If there are no changes in tax or spending projections, the total surplus for the five-year planning period will be $1.34 trillion. As Wall Street is getting wind of these numbers and the likelihood there will be tax cuts to spend some or all of the surpluses in advance -- which of course would produce faster growth and more surpluses -- the exuberance we see is entirely rational.
These numbers are not built on rosy scenarios, but on a growth path of 4% nominal GDP over the period and a 6.3% annual growth in revenue. The 6.3% number is consistent with revenue growth since 1981 and is so clearly defensible that some of the experts on Kemp’s team argued for a 7% annual revenue growth over the period. Only two weeks after tax day, Treasury is now realizing their daily receipts are surpassing all expectations as taxpayers send in huge payments on their capital gains and rising real incomes. The beancounters at both Treasury and the Congressional Budget Office cannot believe this will keep going, which is why they are cooking the books to a crisp to minimize future projections. This is the second annual “April Surprise,” which the budget nerds and politicians of both parties have conspired to hide from the electorate out of fear that there will be demands that it be returned in the form of tax cuts. Which is exactly what Kemp is now recommending to the GOP legislative leaders in the Senate and House.
Because so much of the $1.34 trillion is accumulating in the Social Security accounts, Kemp is recommending that two percentage points be knocked off the payroll tax. Remember, when the Moynihan-Greenspan Commission “fixed” Social Security in 1983, they projected low growth and high inflation as far as the eye could see. This is why young workers have been burdened with high payroll taxes as we worked our way through the inflation bubble with faster growth and now zero inflation. The two points would use perhaps as much as $400 billion of the $1.34 trillion. Kemp would use another $200 billion of that to restore the tax rates that obtained in the last year of the Reagan administration, before Presidents Bush and Clinton passed their totally unnecessary tax increases, which only slowed the process by which we now arrive at these huge surpluses. The top rate would again be 28%. The Alternative Minimum Tax, one of the most iniquitous artifacts of the deficit storm, would either be fixed by doubling the amount and indexing it, which would cost $15 billion over five years, or better yet, says Kemp, eliminate it entirely at a “cost” of $30 billion. Treasury beancounters know well enough that taxpayers have been expending enormous energy and resources to avoid the AMT by shifting income around, and it is a dreadful thing for the IRS to administer.
The remaining amount, something more than $600 billion, Kemp would use by spreading the distance between the new 15% and 28% brackets and by increasing the minimum standard deduction for those frozen at the 15% bracket. The capital gains holding period would be cut to 12 months from 18 and the 20% rate would be replaced by a 50% exclusion. Kemp also would eliminate the income caps on the new Roth IRA accounts -- replacing them with a higher maximum annual contribution, to $5,000 from $2,000. Kemp’s team also suggested that if the two points would be cut from the payroll tax for public pensions, the savings would be directed to private pensions via the Roth IRA accounts. The twist of increasing the maximum amount and throwing out the income caps eliminates the class warfare argument that would be raised by Democrats if Kemp were simply to suggest raising the income caps. In other words, Bill Gates would still only be able to put $5,000 a year into a Roth IRA. The idea, incidentally, was privately suggested by a Democrat who would love to see the Roth IRA expanded.
Is this simply happy talk? Can any of this really happen? Kemp -- with the assistance of the most experienced Reaganauts in the budget field -- is firing a broadside at the budget balancers in the GOP who are trying to avoid tax cutting in order to pay down the national debt. If these mossbacks have their way, there really would have to be slower growth projected forward and an austerity solution to the Social Security and Medicare problems. The Democratic Party would of course prefer to hide the revenues as long as possible or force the GOP into “compromises” that would chew up the $1.34 trillion in social spending and a disguised version of Hillary health care. The difference between Kemp and the rest of his party is evident when we observe that the most aggressive tax cutter in either House or Senate at the moment is Rep. John Kasich [R-OH], chairman of the House Budget Committee and a putative candidate for the GOP presidential nomination in 2000. Kasich proposes to spend a mere $150 billion in tax cuts over the next five years, but not one penny of that would come out of the $1.34 trillion which the Kemp team foresees!!! Instead, Kasich proposes to cut an average of $30 billion a year from projected spending in order to “pay for” the tax cuts and to quietly watch the $1.34 trillion go to buying back government bonds. Big whoop!
What’s going on here? It is the “Pay-Go” rule, an outgrowth of the 1974 Budget Act and all the austerity mechanisms built into government during the years of the budget deficit storm. It requires that before tax rates can be cut, spending must be cut in the amount of revenue that the tax cuts would cost the Treasury. It is a laughable artifact of those dark years -- along with its admirers in the Concord Coalition -- but the GOP Hooverites and the Democratic spenders cling to it because it now technically prevents this flood of taxpayer cash from being returned to the American people. The Pay-Go rule was to have expired last year, but in the dark of night, the GOP leaders, egged on by the Budget Committee chairmen, extended it through next year. Kemp intends to force both parties to ‘fess up to the tidal wave of tax revenues and admit they will continue as far as the eye can see -- unless the Federal Reserve strangles the economy single-handedly (which it won’t).
The Pay-Go rule now seems to stand as a bulwark against Kemp’s cornucopia of tax cuts, but he and his team believe it could not stand up against a $1.34 trillion tidal wave. For one thing, I think Kemp would waltz into the GOP presidential nomination in 2000 if the other 26 contenders, Kasich among them, insist that “rules are rules,” and the American people ain’t gonna get that money back. The congressional leaders of both parties and the White House will soon have to huddle on how to deal with Kemp’s broadside. His old friend House Speaker Newt Gingrich, who in 1995 asked Kemp to head up the Dole/Gingrich Tax Commission, now has to deal with the fact that Kemp has the standing, the weight and the only major league budget team in either party. My hipshot guess is that Newt will see in this an issue to take to the voters in November and secure his hold on the Speaker’s chair in the 106th Congress -- while he joins what will become the Kemp Bandwagon. Senate Majority Leader Trent Lott, I suspect, will be an enthusiastic supporter when possible, always recognizing he is constrained by the budget-balancers in his ranks. Don’t let anyone tell you otherwise: These numbers are what the market is learning in dribs and drabs and is discounting into the continuing boom on Wall Street.