"The Politics of Surplus"
Jude Wanniski
May 15, 1998


Supply-Side University Economics Lesson #17

Memo To: SSU students
From: Jude Wanniski
Re: "The Politics of Surplus"

This is a Polyconomics letter we sent April 30. It was published soon thereafter by The Washington Times with its essentials picked up last Friday, May 8, by Paul Gigot in his Wall Street Journal column. A number of you who heard it quoted on the radio in various places asked if I could e-mail it to them. I decided it would be an appropriate lesson for SSU this week, as it mixes together economics and politics so directly. I'll be gone all next week, attending a conference on the world political economy in London, where I've been invited to speak on presidential politics of the year 2000. I've written the "memos on the margin" for next week, with the help of our TalkShop participants. I'll attempt to collect some illuminating thoughts from London and share them with you.

What I'd like you to get out of this lesson is the sense of how deeply competition between political institutions — Republicans and Democrats in this instance — leads them to withhold or disguise information which they believe will help the opposition. Some of this is done deliberately, some of it because people have natural blind spots because of the nature of their work. When information is withheld from one party by another in the same institution -- the USA — the family will suffer. In February 1977, Jack Kemp and I had one of our most important meetings, at the very beginning of our long relationship. It was at the Palm Restaurant in Washington, a hangout for political types who like their steaks rare and Martinis dry. It was one of the infrequent times I had dinner alone with Jack, because in those days he insisted on eating every dinner at home with Joanne, Jeff, Jennifer, Judith and Jimmy — and when I was in town — with Jude. We were at the Palm because Joanne and the kids were out of town. I had been teaching Jack supply-side economics and in February 1977 was already writing Chapter III of The Way the World Works.

Over our Steaks a la Palm, Jack told me he thought the tax-cutting ideas we had developed even at that early date were so powerful that maybe we should not talk about them until the next election, when we could use them to regain control of the White House! I told Jack that he had it exactly wrong, that he was looking at our ideas as if we were in a football game, where the objective of one side is to demolish the other. In national politics, I suggested, the objective is to produce ideas that would make life better for everyone, whatever their politics. The best thing that could possibly happen would be if he gave a speech on how to fix the economy with tax cuts and President Jimmy Carter, inaugurated a few weeks earlier, heard about it and said: "Kemp is right! Taxes are too high! If we cut them, the economy will flourish and revenues might even increase! Get Kemp on the phone and tell him I want to get started right away." Jack looked a bit mystified as to where I was headed, but I made it plain: Jack, you got into politics after a successful career in football You want to help the country get out of the fix it's in, especially the people of Buffalo who elected you. If you could get Jimmy Carter to do everything you know needs to be done, the economy would boom, and your job will have been done. You could quit politics and go back to Buffalo, and do what retired quarterbacks generally do, and open a Chevy dealership or a steakhouse.

Jack knows good advice when he hears it. He doesn't always take it, but he always knows it is good when he hears it. In this case, he not only gave the speech, but bounced over to the Democratic side of the aisle and made the speech one-on-one. He made a nuisance of himself, and became known as Johnny-one-note. Yet if it were not for Kemp, there would have been no President Reagan, no Reaganomics, no boom on Wall Street, and we'd probably still be up to our neck in the Cold War -- as it was the Reagan economic boom that finally caused Moscow to throw in its towel on the great communist experiment.

It is not always easy to find a political leader who is willing to share his best ideas with everyone who is within earshot, whatever their political affiliation. Those who do sometimes become so popular and so effective that they become targets of all those dark forces who make their living on chaos, war, death and decline. Yet these are the only kinds of leaders who can make positive strides for the nation, as opposed to narrow interests, partisan interests, vested interests, which operate in the zero-sum world where a winner requires a loser.

Bear these thoughts in mind as you read the following. I'll comment at its conclusion.


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.

Jude Wanniski

What we see here is the Republican Party as an institution trying to find its way back into minority status. In the smallest political unit, which you will remember is the "family," the seeds of destruction are planted when husband first decides to conceal important facts from his wife, or she from him. They work at an optimum when they tell each other everything that needs to be told, so in combination they can make the correct decisions on how the family will proceed. They can conceal what they know from their children, but cannot stop listening to what their children want to tell them, or that will grow into a problem that requires more resources. Here we have the Republican budget-balancers hiding budget surpluses so they won't have to share them with tax cutters or the Democratic spenders. The Democrats want to hide the surpluses as long as possible, hoping the voters will throw the Republicans out in November, and they will be able to spend more of the surplus. Kemp goes to the trouble of disclosing the giant surpluses that are emerging as the result of the Reaganaut tax cuts, the 1997 tax cuts, and the Greenspan Fed, and his fellow Republicans are silent, lest anyone pay attention to him. How awful! If we have revenues, how can we make the argument that we can't afford food stamps for the poor?!!! Chairman John Kasich of the House Budget Committee pretends there are no surpluses so he can propose cutting $150 billion out of spending programs. Chairman Pete Domenici of the Senate Budget Committee announces that he wants to REALLY, REALLY cut taxes, and he proposes to do so with the proceeds of a cigarette tax that would add $1,000 to the costs of a smoking family. Good going, Pete.

Remember Ibn Khaldun in his first of three guest lectures at SSU. He came back from the 14th century to tell us that an empire goes into decline when partisans stick with the party line long after it should be apparent the party line is leading one over a cliff. When surpluses emerge and Republicans plead poverty and promise austerity, you know they are in decline. In The Way the World Works, p. 174, I quoted the British historian Thomas Macaulay, who in the middle of the 19th century looked back on the fears of the national debt heaped up by the Napoleonic wars, which disappeared as tax rates were steadily CUT!

[After the Napoleonic War] the funded debt amounted to £800 million. It was in truth a...fabulous debt; and we can hardly wonder that the cry of despair should have been even louder than ever...Yet like Addison's valetudinarian, who contrived to whimper that he was dying of consumption till he became so fat that he was shamed into silence, she went on complaining that she was sunk in poverty till her wealth...made her complaints ridiculous. The...bankrupt society...while meeting these obligations, grew richer and richer so fast that the growth could almost be discerned by the eye.

There is a reasonable case that can be made for paying down some debt and for spending more on projects that might offer reasonable returns on the public investment, but there is no reasonable argument for federal cigarette tax increases. And there is definitely no good reason for politicians to hide the truth from each other when the national interest only can benefit from a sharing of truths. This only goes to show we ain't perfect yet.