United States

• Author: Paula R. De Masi
• Pages: 8-9

Page 8

During most of the 1990s, the unified federal fiscal balance improved more consistently and rapidly than expected. Leidy (1998) shows that the improvement in the cyclically adjusted budget deficit was largely the result of legislated tax increases that raised the structural revenue-to-GDP ratio (by about 2 percentage points) and, to a lesser extent, cuts in discretionary spending. ¹ Also contributing to the rise in revenues were shifts in the distribution of income toward higher income groups and a shift in the composition of total income to more of the types that tend to be taxed at higher rates (e.g. wages and salaries).

The fiscal surpluses in FY 1998 reduced the level of federal government debt. The shrinking supply of treasury securities-which play a role in monetary policy operations and serve as benchmarks in financial markets-raised a number of important technical issues. Arora and Luzio (2001) discuss how the Federal Reserve could adapt its operations by broadening the range of financial instruments used in conducting monetary policy. ² Schinasi, Kramer, and Smith (2001) consider the implications for financial markets where treasury securities serve as benchmarks for pricing fixed-income securities, instruments for hedging market risk, and safe-haven assets. ³ If government surpluses were to continue and cumulatively exceed the level of redeemable debt, then these funds could be saved to pay for the future liabilities of the Social Security and Medicare programs. Arora and Dunaway (2001) explore the challenges of trying to ensure that such investments are insulated from political pressures and do not have adverse effects on economic efficiency and long-term growth prospects. ⁴

With regard to longer-term fiscal issues, a number of studies have addressed various options for reforming Medicare and Social Security as well as the tax system. ⁵ Leidy and Tokarick (1999) evaluate recent reform proposals and raise concerns about suggestions to transfer general revenues to the Social Security Trust Fund. While most Social Security reform proposals are assessed in terms of the effect on the economy's output, national saving, or the present value of expected benefits relative to contributions, Valdivia (1997) takes into account the value of the Social Security insurance against poverty among the elderly. His analysis illustrates that risk pooling provides welfare gains despite the adverse effects Social Security may have on aggregate saving, employment, and output. ⁶ Altig, Auerbach, Kotlikoff, Smetters, and Walliser (2001) simulate the impacts of various tax reform proposals and conclude that, while some reforms could offer significant long-run gains in output and welfare, these gains might come at the expense of certain economic groups.

Since the mid-1990s, labor productivity growth has risen to an average annual rate of about 2 !/4 percent, up from about 1 !/2 percent over the period 1973-95. Whether productivity growth remains strong will be...