Sen. John McCain is viewed as a maverick. Most of his colleagues in Congress have lined up behind George W. Bush, the establishment’s man. So why is it that on the biggest domestic-policy question of the day—what to do with the budget surplus—congressional Republicans are siding with McCain? Maybe it’s because on this issue, the bold challenge to the Washington consensus is coming from Bush.
The surplus has two parts: the payroll-tax revenues that are left after Social Security checks have been sent out, and the surplus from all the other operations of the government. (It’s slightly more complicated than that, but trust me, you don’t want to hear about it.) About the Social Security portion of the surplus—projected to be $147 billion next year, and $2 trillion over the next ten years—there is little political disagreement: That money is going to be "saved" in the Social Security trust fund.
The trust fund is a fiction of accounting; since the federal government is a debtor, it can’t actually save money for the future. What will really happen is that the feds will use the Social Security surplus to pay off some debt. Social Security will get some IOUs, owed by the government to the government. Whether this maneuver actually does anything for Social Security is questionable, but nobody in Washington is questioning it.
The Bush–McCain dispute concerns the non–Social Security surplus, projected (like the Social Security surplus) to be $2 trillion over the next decade. Bush wants to return much of this surplus to taxpayers. His campaign estimates that his tax-cut plan would reduce federal revenues by $483 billion over five years (assuming it doesn’t increase economic growth, which would add back some revenue). McCain describes this as "fiscally irresponsible." He wants a smaller, $237 billion tax cut, partially offset by tax increases on corporations. But he wants to spend 5 percent of the non–Social Security surplus to reduce the national debt, and to save 62 percent of it for Social Security. Since the saving has to be done through debt reduction, McCain’s policy amounts to using two-thirds of the non–Social Security surplus to reduce the debt.
Why 62 percent? McCain says he’s making good on President Clin ton’s 1999 promise to devote 62 percent of the sur plus to Social Security. Actually, McCain’s going much further than Clin ton: The president was referring to 62 percent of the total surplus of $4 trillion. McCain’s talking about using the entire $2 tril lion Social Security surplus, plus 62 percent of the $2 trillion non–Social Se curity surplus: a whopping $760 billion difference.
Clinton’s promise was widely seen as a ploy to block tax cuts, and House Republicans might be expected to side with Bush rather than Clinton or McCain—with tax cuts rather than debt reduction. Yet in early January, House Speaker Denny Hastert announced that paying down the debt would be a priority for Republicans this year. He also made a long-term commitment: "We are putting together a plan to pay off all of our nation’s debt so that our children will inherit a debt-free country." Only small tax cuts—relief from the marriage penalty and expanded educational savings accounts—are on the agenda.
Totally eliminating the national debt would be fraught with danger. It would make it harder for the Federal Reserve to make monetary policy. The Fed manages the money supply by buying and selling Treasury securities. But what if the government stopped offering securities? The Fed could buy corporate bonds instead—but which ones, and with what adjustments for risk? The potential for politicization is obvious.
Though reducing the national debt is widely supposed to bring down interest rates, that is unlikely. Economist Stephen Entin points out that with $100 trillion in financial instruments around the world, even a major change in the national debt "isn’t going to do anything substantial." But eliminating the debt, or coming close, could raise interest rates. That’s because the dollar is a "reserve currency." Foreign governments use Treasury securities to back their own currencies. If they had to switch to something else—the euro, gold, whatever—the demand for the dollar would fall. Either the value of the dollar would decline, or the Fed would have to raise interest rates.
Merely reducing the debt, as opposed to eliminating it, wouldn’t have disastrous effects. But it wouldn’t do much good either. It wouldn’t save Social Security, whose unfunded liabilities are in the tens of trillions thanks to rising life expectancies. Pretending otherwise would, if anything, make it harder to enact the free-market reforms to the program that McCain also advocates. On the campaign trail, Gary Bauer has been arguing against privatization of the program on the utterly specious grounds that there wouldn’t be a problem if "the politicians" hadn’t stolen money from the trust fund.
Republicans on the Hill think that using money to pay down the debt will keep surpluses from being spent on government programs. They’re right that paying down debt is a better use of the money than most new spending. (On the other hand, a stronger de fense would be worth a little debt.) But debt reduction would reduce the government’s interest payments, too, and that would free up money to be spent. The extra money, of course, could be used to finance new tax cuts—but spending would be more likely. Besides, why not cut taxes today instead of tomorrow?
The supply-side case for cutting tax rates, after all, is that it improves incentives to work, save, and invest, and thereby makes more wealth available tomorrow. McCain doesn’t appear to understand this point. He has been arguing that if Bush’s tax cut is adopted, the government won’t be able to finance Social Security and will therefore raise payroll taxes. But if the tax cut stimulates growth, financing the program will be a little easier. Clinton, McCain, and Congress are taking a government-centered approach to savings.
Whatever the policy merits of debt repayment, it’s reasonable to ask whether it’s a realistic political option in the first place. Republicans have been able to block some spending by saying it would dip into the (again, mythical) Social Security trust fund. Paying down debt for its own sake, rather than to protect the trust fund, will be a much more abstract proposition for voters. Debt repayment polls well, but will it be more compelling than liberal proposals to subsidize prescription drugs for the elderly, or to bail out farmers, or to spend money for some other popular cause? Says Republican strategist Ed Gillespie, "I just don’t believe that reducing the debt is a man-the-ramparts rallying cry for the party."
That’s why Gov. Bush argues that the money has to be kept out of Washington in the first place: If it’s there, it will be spent. It’s a serious argument—far more so than the argument of McCain spokesmen that Bush is cutting taxes to curry favor with his rich campaign contributors.
In his fear of cutting taxes for the rich, though, McCain is in the mainstream of congressional Republicans. Like him, they have not challenged Clinton’s 1993 tax hike. Like him, they have acquiesced in Clinton’s use of debt reduction to block sweeping tax cuts. Like him, they have essentially taken the Clinton line on what to do next about Social Se curity. McCain and the congressional GOP are in a defensive crouch.
Debt reduction also fits with a McCain pattern of obsessing over problems that aren’t particularly important. He inveighs against pork-barrel spending (a minuscule portion of the federal budget) and soft money. If McCain ultimately loses to Bush, one reason will be that Republican voters decided that they’re still more concerned about high taxes—as well they should be.