Who Swiped The Surplus?

By ADAM COHEN

It seems like only a few months ago that the federal budget surplus was unfurling like a vast, star-spangled security blanket, a cushion of cash that stretched farther than the eye could see. Wait. It was only a few months ago. In April the White House projected a surplus of $281 billion for this fiscal year and $3.4 trillion for the next 10 years--enough to fund Bush's tax cuts and Congress's spending programs, missile defense and school reform, private Social Security investment accounts and a prescription-drug benefit for seniors, with a ton of money left over to pay down the national debt.

Too good to be true? You bet. Last week the White House conceded that $123 billion of this year's surplus had somehow evaporated. The $158 billion left over is almost entirely made up of Social Security tax receipts--which Bush and congressional leaders have vowed not to touch. And this week the Congressional Budget Office is expected to release even more pessimistic figures, showing the government will tap those funds before the year ends. Cue up the attack ads--the ones in which each side accuses the other of endangering the retirement security of elderly Americans.

Who killed the surplus? Not I, said the President. When George W. Bush gave his big budget speech last week--arguing that his tax cut was jump-starting the economy and that big-spending Democrats were squandering the surplus--he delivered it in Harry S Truman's hometown of Independence, Mo. At Harry S Truman High School. Under a portrait of Harry S Truman. The not-so-subliminal message: like Truman, the first President to push for health coverage for seniors, Bush would give 'em hell on behalf of older Americans.

Who killed the surplus? Don't look at us, said the Democrats, who were quick to blame Bush and cue up a few Truman visuals of their own. They rushed out a TV ad that aired in Washington, D.C., Missouri and Texas and featured Harry S at the desk with his famed THE BUCK STOPS HERE sign on it. "George W. Bush is in Harry Truman's hometown explaining his budget, and he's got a lot of explaining to do," the ad retorted. "Because the Bush budget violates one of Harry Truman's basic principles--protecting our seniors."

With that familiar scare tactic being trotted out yet again (no, the shrinking surplus doesn't imperil current Social Security recipients), it's tempting to turn off the whole sorry show and head back to the beach. But the dwindling surplus will have a real impact on ordinary Americans. To avoid cutting into the Social Security trust fund, Congress may have to slash farm subsidies, tax credits for the working poor and other social programs. A lack of surplus dollars to pay down the national debt helps keep mortgage and credit-card rates higher than they should be. And all those great-sounding programs Bush and Al Gore argued about last year--giving a drug benefit to seniors, letting people invest Social Security money in the stock market--just got pushed further into the future.

On the most basic level, the surplus matters because anyone who has ever tried to run a household or a small business understands the core issue: being disciplined enough to keep spending in line with income. "I run a business on a budget," says Jay Fox, 42, executive director of the Arkansas State Golf Association. "If our surplus was disappearing, it would be of concern to me."

Bush aides insist the surplus shrank mainly because of the slowing economy--a weakness the Office of Management and Budget, in a report last week, was careful to trace to the stock-market slide that started in March 2000. (Translation: Bill Clinton did it.) In truth, the lack of $46 billion of the missing $123 billion is attributable to lower general tax revenues because of the slowdown. "It's remarkable we have a surplus at all, given the yearlong slowdown," argues OMB director Mitch Daniels. The rest of the shortfall can be traced to Bush's military pay raise, the tax rebate and corporate-tax receipts that Bush delayed to make next year's figures rosier.

The Administration insists there is help on the way--those tax-rebate checks. "This was a perfectly timed tax cut," says Larry Lindsey, director of the President's National Economic Council, that "stopped a very precipitous fall." As the rebate stimulates consumer spending, he argues, it will increase the government's tax haul. The upshot: the surplus should come roaring back.

In the meantime, Bush says, Congress must exercise restraint on the 13 major spending bills being considered before the new fiscal year starts on Oct. 1. "Don't overspend," Bush cautioned Congress during a press conference near his Texas ranch last Friday. "One of my jobs as President is to make sure we keep fiscal sanity in the budget." But Democrats argue that it was Bush who started the insanity--with the same tax cut he is hailing as a cure-all. "He claimed we could afford his massive tax cut, a major defense buildup, more money for education, while paying down the debt and protecting Social Security and Medicare," Senate Budget Committee chairman Kent Conrad said last week. "He was wrong."

Another thing the Democrats say Bush had wrong: his math. They charge that the White House made some convenient assumptions--including an unlikely 3.2% growth rate for 2002--to pad its budget by a few extra billion. They say the Administration's projection that its tax cut will cost $1.35 trillion is a wild understatement. A new study by the International Monetary Fund buttresses their argument. It puts the cost of the tax cuts at closer to $2.5 trillion. Which means that, with honest accounting, Bush's budget would already be nibbling at the Social Security trust fund.

But the budget-surplus battle is more about politics than economics. In a $10 trillion economy, it doesn't much matter if the government has to dip into Social Security for a few spare billion. But with both parties committed to a lockbox, budget makers are forced to look for savings in less sacrosanct areas, which means that, depending on where the budget ax lands, you may be about to lose a popular program.

The lost surplus may also be hurting the economy--and hitting Americans in the wallet. Despite Federal Reserve Board Chairman Alan Greenspan's seven short-term interest-rate cuts, long-term rates--the ones that govern home mortgages--have hardly budged. The reason: those rates are set not by the Fed but by bond traders, many of whom are clearly spooked by economic uncertainty and anticipate more government borrowing in the future. Mortgage rates, though fairly low, could be lower--and if they were, even more Americans would be refinancing their mortgages and getting back hundreds of dollars a month to spend or save. Home-equity and small-business loans are similarly affected. All of which means that the economy isn't getting the huge boost it could be getting, because someone swiped the surplus.

Bush's greatest political peril will come if he and the Congress eat up great hunks of the Social Security trust fund (they are already raiding Medicare, something the OMB report went to great pains to say didn't matter) to meet general operating expenses. The $158 billion Social Security surplus is as tempting to Democrats as it is to Bush, who vowed again last week to increase defense and education spending. But there's a compelling reason to hold the line. Neither party wants to be at the wrong end of attack commercials next fall saying it sold out seniors. Bush adviser Lindsey argued to Time that "there's no economic consequence" to crossing the line and dipping into the Social Security surplus. But there's a political consequence, as he and Bush well know.

As the battle over the lost surplus rages in the months ahead, look for both sides to tie the issue to emotionally resonant problems. That's just what Maryland Congressman Steny Hoyer did last week at an Arthritis Foundation meeting in Edgewater, Md. Hoyer tried earlier this year to increase federal research on chronic diseases by $350 million, but the White House pared it down to $175 million. He had hoped to restore the cut, but with the surplus gone, he told the seniors, it now seems unlikely. In Missouri, Bush had used his favorite tax-cut line: "It's your money." Hoyer gave the seniors the Democrats' response: "It's also our money, and we need to spend it responsibly."

These are the kind of real-world budget arguments that could pack a punch at the polls a year from now--which is something Harry Truman could appreciate. He understood that the presidency isn't just where the buck stops. It's also--for vital federal programs, paying down the debt and keeping the economy strong--where the bucks start.

--Reported by James Carney, Douglas Waller and Adam Zagorin/Washington and Steve Barnes/Little Rock

With reporting by James Carney, Douglas Waller and Adam Zagorin/ Washington and Steve Barnes/Little Rock