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Thursday, May 05, 2005

The Relationship Between Greenspan’s 2001 Testimony and Current Fiscal Imbalance

Greenspan’s January 2001 testimony before the U.S. Senate and its relationship to the current fiscal imbalance is examined followed by a general discussion of how the Social Security Trust Fund has been treated in Federal Budget accounts in a second post.

Greenspan's January 2001 testimony before the senate marks a turning point in fiscal policy. In a previous post I examined the extent to which Greenspan ought to be held accountable for the budget situation we are in today and some of that is repeated below. But the focus here is on a different aspect of the testimony, his views on how a projected surplus ought to be managed, in particular his concerns with the federal government holding private sector assets, and how that was used as political cover to lower taxes.

Greenspan’s January 2001 testimony before the U.S. Senate is linked and excerpted below. In these remarks, there are several things to note. First, his remarks and recommendations are based upon projected surpluses. He is concerned with how to manage a surplus and he is careful to qualify his remarks in that regard. Second, given that there are projected surpluses he is concerned with the federal government holding private sector assets. He does not want government intervening in the private sector to the degree implied by the forecasted accumulation of private sector assets in government hands. Third, to avoid holding private sector assets centrally he proposes creating private accounts as a means of storing the government wealth safe from the greedy hands of congress. Fourth, he does not believe the government will be able to completely avoid holding private sector assets so the question becomes how to manage the assets. In that case, he proposes locking the private sector assets up in the Social Security Trust Fund where they cannot be used to increase spending by congress who, in his view, cannot restrain themselves. Fifth, if privatization of the surplus is not possible, and he is not sure it will be, or if the accumulation of assets is greater than needed to fund social programs and the general fund, then he prefers a tax cut to an increase a cut in spending.

Here are portions of Greenspan’s remarks:

Outlook for the federal budget and implications for fiscal policy, Testimony of Chairman Alan Greenspan Before the Committee on the Budget, U.S. Senate, January 25, 2001

… The challenges you face both in shaping a budget for the coming year and in designing a longer-run strategy for fiscal policy were brought into sharp focus by the release last week of the Clinton Administration's final budget projections, which showed further upward revisions of on-budget surpluses for the next decade. The Congressional Budget Office also is expected to again raise its projections when it issues its report next week.    

… The most recent projections from the OMB indicate that, if current policies remain in place, the total unified surplus will reach $800 billion in fiscal year 2011, including an on-budget surplus of $500 billion. The CBO reportedly will be showing even larger surpluses. Moreover, the admittedly quite uncertain long-term budget exercises released by the CBO last October maintain an implicit on-budget surplus under baseline assumptions well past 2030 despite the budgetary pressures from the aging of the baby-boom generation, especially on the major health programs. …    

But continuing to run surpluses beyond the point at which we reach zero or near-zero federal debt brings to center stage the critical longer-term fiscal policy issue of whether the federal government should accumulate large quantities of private (more technically nonfederal) assets. At zero debt, the continuing unified budget surpluses currently projected imply a major accumulation of private assets by the federal government. This development should factor materially into the policies you and the Administration choose to pursue.    

I believe, as I have noted in the past, that the federal government should eschew private asset accumulation because it would be exceptionally difficult to insulate the government's investment decisions from political pressures. Thus, over time, having the federal government hold significant amounts of private assets would risk sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise.    

Short of an extraordinarily rapid and highly undesirable short-term dissipation of unified surpluses or a transferring of assets to individual privatized accounts, it appears difficult to avoid at least some accumulation of private assets by the government.    

… Decisions about what type of private assets to acquire and to which federal accounts they should be directed must be made well before the policy is actually implemented, which could occur in as little as five to seven years from now. These choices have important implications for the balance of saving and, hence, investment in our economy. For example, transferring government saving to individual private accounts as a means of avoiding the accumulation of private assets in the government accounts could significantly affect how social security will be funded in the future.    

Short of some privatization, it would be preferable in my judgment to allocate the required private assets to the social security trust funds, rather than to on-budget accounts. To be sure, such trust fund investments are subject to the same concerns about political pressures as on-budget investments would be. The expectation that the retirement of the baby-boom generation will eventually require a drawdown of these fund balances does, however, provide some mitigation of these concerns.    

… Certainly, we should make sure that social security surpluses are large enough to meet our long-term needs and seriously consider explicit mechanisms that will help ensure that outcome. Special care must be taken not to conclude that wraps on fiscal discipline are no longer necessary. …    

In general, as I have testified previously, if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases. The flurry of increases in outlays that occurred near the conclusion of last fall's budget deliberations is troubling because it makes the previous year's lack of discipline less likely to have been an aberration. …    

Lately there has been much discussion of cutting taxes to confront the evident pronounced weakening in recent economic performance. Such tax initiatives, however, historically have proved difficult to implement in the time frame in which recessions have developed and ended. ... In today's context, where tax reduction appears required in any event over the next several years to assist in forestalling the accumulation of private assets, starting that process sooner rather than later likely would help smooth the transition to longer-term fiscal balance. And should current economic weakness spread beyond what now appears likely, having a tax cut in place may, in fact, do noticeable good.    

As for tax policy over the longer run, most economists believe that it should be directed at setting rates at the levels required to meet spending commitments, while doing so in a manner that minimizes distortions, increases efficiency, and enhances incentives for saving, investment, and work. …    

The reason for caution, of course, rests on the tentativeness of our projections. … Indeed, the current economic weakness may reveal a less favorable relationship between tax receipts, income, and asset prices than has been assumed in recent projections. Until we receive full detail on the distribution by income of individual tax liabilities for 1999, 2000, and perhaps 2001, we are making little more than informed guesses of certain key relationships between income and tax receipts. …    

… let me end on a cautionary note. With today's euphoria surrounding the surpluses, it is not difficult to imagine the hard-earned fiscal restraint developed in recent years rapidly dissipating. We need to resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake.    

I believe Greenspan's motivation for calling for tax cuts has been misinterpreted by some. His primary worry was government’s participation in the private sector as he believed that it would “…risk sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living than would be achieved otherwise.” He is offering tax cuts as one means of avoiding this problem, but he is careful to say that adjustments must be made if projected surpluses do not materialize. His first choice for getting rid of the surplus appears to be the creation of individual private accounts for the reasons discussed above. If this cannot be accomplished, then he prefers tax cuts to spending increases. He is also careful to note that tax cuts are not generally a very useful countercyclical policy tool and he cautions on their use in that regard. So tax cuts were not his primary goal. His primary concern was the participation of government in the private sector and tax cuts were one of a menu of options for avoiding that outcome.    

As I’ve noted in the post linked above, where I fault Greenspan is in not sounding the alarm when the projected surpluses did not materialize and the tax cuts, privatization, etc. were pursued anyway. He understood the consequences for the budget and for the Social Security Trust Fund and I do not believe he made whatever concerns he might have had clear. Had he chosen to do so, he could have brought considerable political pressure from the public on congress to bring the general fund back into balance, but I don’t recall hearing a strong voice from him in his public statements. Even today, the cautions and prescriptions are far more muted than I would like to hear. Whatever his personal philosophy, the public should be informed as to the effects of all options the government has, cutting spending, rolling back tax cuts, continuing on the present course, and so on, but I don’t feel that has happened.    

Congress is, of course, not immune from criticism either. Had they listened to his advice to “resist those policies that could readily resurrect the deficits of the past and the fiscal imbalances that followed in their wake” rather than using the message to justify their actions and provide political cover for tax cuts and other policies, the budget picture today would be much different today.    

Finally, as I’ve noted elsewhere also, we should not let ourselves off the hook either. If the public does not hold politicians accountable, if the press does not report the state of the budget accurately, if experts do not bother to speak up and inform both the press and the public, then politicians will have no incentive to make the difficult decisions required to preserve long-run fiscal vitality.

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