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ARTICLES |
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| "The
New Budget Outlook: Policymakers Respond to
the Surplus," Economic & Financial
Review, Second Quarter 1999 (Text
or PDF)
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| "The
Federal Budget Surplus: Pleasant Surprises
and New Choices," In Depth,
January 1999 (PDF)
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U.S. Economy
The
Federal Budget Surplus Surprise
Dallas
Fed Senior Economist Alan Viard discusses the sources of the federal
budget surplus that took legislators by surprise.
The federal
budget landscape has changed dramatically during the last six years.
After a steady decline in the deficit from 1993 to 1996, a budget
“surprise” unexpectedly brought the budget close to balance
in 1997 and moved it into surplus in 1998 for the first time in
29 years. The deficit decline and the move into surplus resulted
from a combination of factors, including a surge in individual income
tax receipts, slower growth of medical costs, lower interest rates,
economic growth and the 1990 and 1993 deficit-reduction laws.
These events,
combined with legislation adopted in 1997, have produced a new budget
outlook. If current policies are maintained, surpluses are expected
to continue for 20 years, completely retiring the outstanding federal
debt. However, deficits are expected to reappear after 2020 due
to rising Social Security and medical spending.
The steady deficit
decline from 1993 to 1996 was followed by a surprise that moved
the budget close to balance in 1997 and into surplus in 1998. To
appreciate the magnitude of this budget surplus surprise, it is
necessary to understand what forecasters expected in 1996.
 Although
the deficit had declined for four consecutive years, forecasters
expected it to begin rising again. Figure 1 charts budget projections
for fiscal years 1997–99 made at various dates by the Congressional
Budget Office (CBO). (The projections assumed there would be no
changes in tax and entitlement laws and that discretionary spending
would equal the Budget Enforcement Act cap until it expired.) In
May 1996, CBO projected deficits of about $200 billion for 1997–99.
Although there were no major relevant policy changes, persistent
good news repeatedly forced CBO to alter its forecasts. Fiscal 1997
ended with a deficit of only $22 billion and 1998 with a surplus
of $69 billion; CBO now projects a $107 billion surplus in 1999.
The magnitude of these forecast deviations is unprecedented.
Analysts are
still trying to fully explain the budget surplus surprise, but several
factors emerge from a comparison of the actual fiscal 1998 budget
outcome with the May 1996 CBO projection. One-third of the forecast
deviation was caused by an overestimate of outlays. Almost half
of the outlay overestimate was in Medicare and Medicaid, reflecting
the continued slower growth of medical costs. Interest outlays also
were lower than predicted, reflecting both lower debt and lower
nominal interest rates.
 Two-thirds
of the deviation was caused by an underestimate of receipts, primarily
reflecting an unexpected surge in individual income tax receipts.
Income tax receipts were boosted by strong economic growth and by
several other factors, as discussed by CBO. Income from partnerships
and S corporations rose sharply, and wages and salaries grew most
rapidly in the highest tax brackets. One important factor was the
rapid rise of net capital gains realizations, which largely reflected
the recent stock market boom. The stock market’s continued
strength suggests that realizations remained high in 1998, boosting
fiscal 1999 receipts.
The budget surplus
surprise, combined with new legislation adopted on August 5, 1997,
has profoundly altered the budget outlook. In 1996, CBO’s 10-year
forecast projected large and growing deficits. Now, the 10-year
forecast predicts large and growing surpluses if current policies
are maintained, as shown in Figure 2. CBO’s longer term projections
predict that surpluses will continue for an additional decade after
2009 but that deficits will reemerge after 2020.
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