The Budget, Debt and Taxes: An Exclusive Interview With The Brookings Institution's William G. Gale

Every American is impacted by the federal budget yet so few understand the budget process. This is especially the case among the Black electorate. To address this problem BlackElectorate.com will be covering the budget process and the political debate which surrounds it in great detail. We feel this is especially important as the budget is nothing more than a reflection of a nation's priorities. Today we present our exclusive interview with one of America's foremost experts on the federal budget, William G. Gale, Senior Fellow for Economic Studies at the Brookings Institute.

Here is our interview with Mr. Gale:

Cedric Muhammad: Do you feel that there is anything wrong with the manner in which the current budget is constructed? How do you feel about the government's "unified" budget which in effect lumps expenses and investments together?

William Gale: The information the budget does and does not provide is not well understood and leads to poor policy choices. For example, in July, 2000, CBO released a projection that the cumulative budget surplus between 2001 and 2010 would be about $4.6 trillion. That is certainly a lot of money, but it does not tell us what we really want to know, which is how much is available for new spending and/or new tax cuts. Of the $4.6 trillion, about half was due to accruing balances in the social security trust fund, which both sides have agreed to leave off-limits for other programs. Another $800 billion was due to trust fund build ups for Medicare and government pension reserves. The same reasons why it is inappropriate to spend social security funds on other programs--namely, those funds represent obligations to future retirees--applies with equal force to the Medicare and pension reserve funds, so that $800 billion should logically not be available for new programs.

In addition, the budget assumes that real discretionary spending will be held constant over time. This would, however, reduce real spending per person by 10 percent over the next 10 years (since the population is going to grow by about 10 percent) and would reduce the share of GDP going to discretionary spending by about 30 percent. It would also set discretionary spending at its lowest level relative to GDP in more than 50 years. So it is not a very plausible assumption. a more plausible assumption--that discretionary spending would grow at the same rate as GDP--would knock another $900 billion off of the available surplus.

Finally, a number of technical tax issues need to be addressed and will cost about $200 billion. All told, that leaves about $350 billion left for new spending or new taxes, not the $4.6 trillion that the official number suggests. All of these figures apply only to the next 10 years, however. After that, looking at the long-run, the government (that is, the people of the USA) face a bigger long-term financial problem when the baby boomers retire and start putting pressure on social security and Medicare. So the question is, how would one describe best the current fiscal situation?

I would argue that we have current short-term surpluses in cash flow, but we do not have an economic surplus, in the long term, in any meaningful sense. This accounting exercise and discussion is important because it has crucial effects on policy. For example, if the surplus were reported as $350 billion over 10 years and a deficit in the long-term, politicians would not be falling over themselves proposing new tax cuts and new spending. Thus, by misrepresenting the government's real financial situation, the budget leads to inappropriate policies.

Cedric Muhammad: Do you think that deficits and debts are inherently bad? If not, under what circumstances would you consider running a deficit or enlarging the national debt to be a good thing?

William Gale: They are neither inherently bad nor inherently good. Think about a family. A family that has solid income prospects but needs a loan to make a productive investment -- a house, a car, an education, etc -- should not be afraid to borrow. Borrowing confers benefits -- the ability to consume the house, car, or education now rather than later--and the family's prospects for paying off the loan are good. On the other hand, a family with no income that is taking out loans to go on vacation is in a bad situation. They are getting nothing productive out of the loan, nor do they have the ability to pay it back. They would be borrowing to live above their means. So whether family debt is good or bad depends on how it is used and how well situated the borrower is to pay it back. The same is true for public debt. if the nation's economy is growing and fiscal funds are well spent (on health, housing, environment, education, take your pick) and there is not too much debt, then debt finance is fine.

Cedric Muhammad: Do you believe that there is a direct relationship between the size of a national debt and the interest rate levels? For example, do large national debts mean higher interest rates?

William Gale: Generally, the relation is hard to pin down in statistical terms for a number of reasons, but almost all of our theories and intuition suggest that if debt affects interest rates the effect should be positive--higher debt should raise interest rates.

Cedric Muhammad: Do you share president Clinton and Treasury Secretary Summers' opinion that paying down the national debt has the effect of a tax cut in that it reduces future interest payments?

William Gale: The fact that lower debt reduces interest payments follows as a mathematical certainty, as long as interest rates are constant. Note that if lower debt reduces interest rates then that is a second way that lower debt reduces interest payments. Whether this mechanism is "the same as a tax cut" is open to interpretation. It is the same in that it reduces the required level of government spending currently. It is not the same in that it does not reduce the ability of the government to raise money, the way a tax cut would.

Cedric Muhammad: Do you have a preference for tax cuts or increased spending with the budget surplus?

William Gale: I think the best use would be to pay down the debt right now. A well structured tax cut or spending increase would be wonderful (similar to the family above making good use of its loan) but I fear that most real spending or tax changes that can make it through Congress will end up being politically loaded and less than ideally formulated. In contrast, debt reduction is debt reduction--it is hard to politicize that in the same way that tax and spending changes can be politicized

Cedric Muhammad: In light of the fact that you believe that a debt is good or bad only in terms of how it is used and how well-situated the borrower is to pay back the loan, what is your opinion of dynamic scoring which allows the "productive" impact of tax cuts to be measured? Do you think that tax cuts should be differentiated between those that increase production and federal tax revenues and those that do not?

William Gale: I think the two questions are unrelated. Dynamic scoring is an interesting issue in principle, but it would be very difficult to trace out all of the effects of every program. Currently, many of the effects are included in revenue estimates, but these might best be described as "impact" effects and some behavioral responses.

To do dynamic scoring would require, in addition to the effects above, the effects on behavior, markets and feedback to the economy as a whole. This could very dicey. In general, my view is that it is better to have the budget depend on clear items that are less theoretically pure rather than vague items that meet some ideal standard but are difficult or impossible to implement or understand.

I think that dynamic scoring is much closer to the second concept than the first.

Cedric Muhammad: In light of the increase of capital gains tax revenue coming into government coffers over the last decade do you think the current capital gains tax rate is optimal? Is it possible that a further reduction in the capital gains tax rate could in fact lead to more tax revenue being paid to the government?

William Gale: It is hard to know what the optimal capital gains tax rate is. Having a capital gains tax rate lower than the tax rate on other capital income fuels alot of tax sheltering and complex portfolio behavior. I think it would be better to change policy in two ways (a) tax capital gains at the same rate as other forms of income and (b) use the revenue gained from that to reduce the top tax rates. I don't think that reducing the capital gains tax rate will raise the revenues the government collects in the long run for two reasons.

First, the lower rate might induce a little more realization of existing capital gains, but most of that increase (studies show) would be temporary and would come at the expense of future realizations. Second, the lower is the cg rate relative to the tax on other capital income, the more sheltering will occur, which will reduce the revenue from taxes on other capital income by more than it raises capital gains tax revenues (that is, after all, why people want to put their funds in shelters like assets that generate capital gains in the first place.)

Thursday, January 18, 2001