Curb Your Enthusiasm

Earlier this year, the Congressional Budget Office (CBO) estimated that the fiscal 2001 surplus, including the Social Security and Medicare trust funds, would come in at a stunning $280 billion. But last week, reacting to the stagnant economy and the newly enacted tax rebates, the CBO sharply revised that figure down to a not-as-impressive $153 billion. This move suggested that the government would have to draw down about $9 billion of the Social Security surplus to fund this year's operations.

The events have inspired acts of bipartisan hypocrisy. Democrats, whose Congressional forebears for years heedlessly tapped the Social Security surplus to fund their spending plans, are now railing against President Bush for dipping into that same cookie jar. Republicans, who last year repeatedly swore that the Social Security surplus should be off limits, are now engaging in Clintonesque parsing and hemming.

The problem -- for both sides -- is that budget makers have been relying on short-term projections of economic growth (and the amount of taxes that should flow into federal coffers) that turned out to be way too optimistic.

Getting it wrong

Back in January, economists polled by the Blue Chip Economic Indicators projected 2001 growth of 2.6 percent. The Bush Administration in April estimated the economy would grow at a 2.4 percent rate in 2001. But with the economy having grown at an annual rate of less than one percent in the first six months of 2001, those numbers turned out to have the shelf life of skim milk. Today, most professional economists, and the Bush administration, believe the economy will grow at about 1.7 percent this year. I'd be willing to bet these estimates, too, will also turn out to be too rosy.

After all, economists at the CBO, the White House Office of Management Budget (OMB), and on Wall Street seem to have a knack for getting things wrong. Throughout the 1990s, when economic conditions were favorable, they continually underestimated the performance of the economy and the amounts of surpluses it would generate. In 1998 the CBO said that the surplus for 1999 would come in at about $2 billion. Instead, the number turned out to be a whopping $125 billion. Alan Reynolds of the Cato Institute pointed out in the Wall Street Journal last week that in mid-1996 the CBO said the economy would grow 2.1 percent in 1996 and 1.9 percent in 1997. The real numbers came in at 3.6 percent and 4.4 percent, respectively!

Appearance vs. Reality

Bad economics? Yes. But these pessimistic prognostications turned out to be great politics. The gloomy estimates forced Washington budgeters continually to rein in spending. And as results came in better than expected, funds magically became available for new initiatives and tax cuts, like the 1997 capital gains tax cut. The series of pleasant "upside surprises" boosted the popularity of incumbents -- of both parties -- and made them look like responsible fiscal stewards.

Savvy companies have been playing the same sort of expectations game for years. They guide Wall Street analysts to suggest certain figures on earnings and revenues, and then contrive to beat the expectations. When they do so, even if only by a small margin, investors are thrilled. Executives who consistently bring in earnings ahead of expectation are regarded as geniuses, while those who consistently fail to meet expectations are marked as hopeless laggards with tenuous job security.

Which brings us back to politics.

More Pessimism, Please

As compared with the 1990s, the current situation -- a declining stock market, rising unemployment, sparse growth -- actually seems to warrant more pessimism. But the Bush administration is stubbornly sticking to its estimates for growth, which strike me as too optimistic by half. To achieve the projected growth of 1.7 percent for 2001, the U.S. economy will have to grow at a 2.65 percent annual rate in the second half. Given the activity thus far in the third quarter, that doesn't seem likely. As for next year, Team Bush insists that the economy will grew by 3.2 percent -- a figure that is significantly above the Blue Chip estimate of 2.8 percent.

The slowing economy has put the Bush economic team in a bind. Taking down the numbers further would inevitably lead to further negative implications for the federal balance sheet and provide Democrats with an opening. But sticking to overly optimistic forecasts is an even more dangerous gambit. If the economy continues to meander along for another few quarters, it will not only throw into question Bush's management competency, it will blow up the economic assumptions on which the future phase-in of the tax cuts rests. In the process, it could hamstring his party's attempts to take back the Senate in 2002.

Tax Repeal Unlikely

On the other hand, if the Bush Office of Management and Budget would predict even lower -- and perhaps more realistic -- growth expectations for this year and next, it would really put Congressional Democrats in a bind. Facing an eroding fiscal situation, the alternatives would be to reduce spending, or to increase taxes. While many Democrats opposed the Bush tax plan, few would risk moving for a politically unpopular repeal. Meanwhile, the fiscal strains would forestall Democratic efforts to push through popular, expensive measures like a prescription drug benefit for Medicare. By standing up for fiscal discipline and beating the drum for the continued roll-out of the tax cut, Bush could occupy the high ground.

Of course, there's a fine line a president has to walk between being a cheerleader and a party-pooper. If Franklin Delano Roosevelt had used "Brother Can You Spare a Dime" as a campaign song instead of "Happy Days Are Here Again," he probably would never have been elected.

Like his similarly well-born predecessor, President Bush is naturally optimistic. That's an admirable quality. But when it comes to the economy, there are times when a little pessimism may be the best political strategy.