From surplus to deficit in one painful lesson

May 15, 2002|By Jay Hancock

TOP BOSSES and major shareholders at the late, lame Global Crossing contributed at least $300 million in taxes to the federal budget surplus in 2000, one can deduce from stock-sale disclosures and an awareness of the capital-gains tax rate.

Honchos at Internet auctioneer eBay probably paid at least $100 million in capital gains taxes that year. And, all by himself, Microsoft's Bill Gates paid in the neighborhood of $1 billion in stock-sale-related taxes in 2000.

Many things about the economy in recent years were not normal. This is one. People do not usually have eight- or 10-figure incomes, let alone tax bills that size.

It has become shockingly clear that the budget surpluses from 1998 through last year were generated largely by a relatively few taxpayers cashing in unusually enormous stock gains. As such, the surpluses are turning out to have been a tax bubble, as fleeting as Enron profits or the Nasdaq stock index at 5,000.

The results of the April 15 tax filings have presumably prompted embarrassment across Washington. The Congressional Budget Office disclosed last week that tax collections have fallen $75 billion behind its projections. The deficit this fiscal year could approach $150 billion, a depth of red ink not seen since 1995.

One reason for the hole, certainly, is the second installment of President Bush's tax cut. Others are antiterrorism costs, rising defense spending and a sluggish economy.

But behind the immediate cause of the trauma is an amazing failure of fiscal analysis and political dialogue.

It was only a year ago that the government projected a cumulative budget surplus of $3 trillion over the next decade, and that was after putting $2.6 trillion aside for Social Security.

Federal Reserve Chairman Alan Greenspan became so addled from political keister-kissing and "New Economy" stardust that he worried publicly about whether the U.S. Treasury would have too much money and start buying corporate stocks and bonds. That was his rationale for supporting Bush's tax cut and softening his insistence on paying off the national debt.

Listen to Treasury Secretary Paul O'Neill in March 2001, testifying to the Senate Budget Committee and predicting there would be $1.4 trillion available for debt reduction even after the tax cut.

"I think there is no doubt - at least I have not heard anyone express doubt - that the structure of our current tax system is going to produce a remarkable level of surpluses over the next 10 years," O'Neill said.

Was it bad faith or bad analysis? Of course Republicans, pushing for tax cuts, daubed extra-bright colors on the tax-glut fantasy. But even they have been stunned by the recent shortfall in Treasury receipts.

After all, the economy grew by a not-terrible 1.2 percent last year and at a booming 5.8 percent annual rate in this year's first quarter. How far would tax collections fall in a real recession?

Greenspan, it turns out, warned more than a year ago that the surplus might be vagabond. But he did so only in passing, more as a way of buying political insurance than sounding a fiscal alarm.

The future "may reveal a less favorable relationship between tax receipts, income and asset prices than has been assumed in recent projections," the Fed chairman said in January 2001 and repeated five weeks later. This is Greenspanish for worrying that budget surpluses were generated not by a structural, sustainable growth in the tax base, but rather by a 100-year flood in stock windfalls.

Which is what seems to have happened.

As the stock market hit new heights in the late 1990s, peaked in early 2000 and then went south, selling by insiders and other long-term holders apparently accelerated and then exploded.

Paper profit reaped over a two-decade bull market was finally cashed in. The government took a fifth of each long-term capital gain. Of course, taxes ballooned.

Much of the capital grown in the 1990s - Microsoft and eBay - remains solid and will produce taxes in the future. But much of it - Enron, Global Crossing, Webvan - will not.

Fourth-grade math might have tipped off Washington that something weird was going on. From 1995 through 2000, the dollars produced by the economy (in gross domestic product unadjusted for inflation) grew by a third. But during the same period, without any big increase in tax rates, the dollars flowing into the Treasury swelled by half.

How long, exactly, did the government think this sort of thing could continue?

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