Bye-bye black ink, hello feud

The suddenly shrinking federal surplus is threatening to undermine the long-term prospects of George Bush's tax cut and future spending on everything from highways to fighter planes.

While Republicans and Democrats smugly blame each other for its disappearance, the lack of a financial cushion is already changing the political calculus in Washington and will force tough decisions on funding priorities that, even just a few months ago, lawmakers thought they wouldn't have to make.

True, the announcement yesterday by the White House Office of Management and Budget that the surplus will be $123 billion less than predicted doesn't necessarily have deep immediate impact. The nation is, after all, still in the black rather than running the monster budget deficits of the 1980s.

Yet the estimate that the federal surplus now stands at $158 billion - within $1 billion of breaking into the Social Security surpluses that both the White House and Congress said they would not spend - will affect how quickly and how much of the national debt is paid down.

It is giving Democrats ammunition to argue that President Bush's 10-year, $1.3 trillion tax cut was something the country can't afford - and will undoubtedly lead to efforts to rescind parts of it. More immediately, the debate on Capitol Hill will sharpen over preserving Social Security and Medicare, and how to set funding priorities for defense, education, and healthcare.

"The biggest problem is long term," says Stanley Collender, a budget expert at Fleishman-Hillard, a communications firm. "If the newest numbers are correct, then all the promised debt reduction we were told was going to happen, isn't going to happen."

More bad news is likely to come next week. The Congressional Budget Office is expected to release projections showing the budget surplus is even lower than the White House estimates.

"The news is an 'I told you so' for people who oppose the Bush tax cut, because they said from the beginning it was too big and it would have been more prudent to do a smaller tax cut," says Joel Friedman, a senior fellow at the Center on Budget and Policy Priorities in Washington. "They seem to be proven true even earlier than they had anticipated."

But the reasons go beyond the tax cut. In recent months, an economic downturn has begun to eat away at federal tax revenues.

Also, by agreeing to consider the Social Security surplus as being in a "lockbox," both parties have voluntarily limited the money pool available for federal spending.

That sets up a big fight when Congress returns next month over appropriations bills. The Senate version of the education bill includes more than $300 billion in new spending over the next 10 years, not currently provided for in the budget resolution. Democrats say they won't let the bill out of conference without it.

The White House request for $198 billion in new defense spending will also draw fire from Democrats. The routine emergency spending - for things like hurricane relief - could add anywhere from $50 to $90 billion to the budget over the next 10 years.

In addition, Congress and the White House are still $113 billion apart on the cost of a new prescription-drug benefit, even with the additional $37 billion the White House added to its budget estimate yesterday.

In one sense, the coming battles over spending are unnecessary. The lockbox is a piece of fancy accounting, not an iron safe under the Capitol Rotunda.

Today's federal budget is in far better shape than in the deficit-ridden 1980s, when Washington spent all of the Social Security surplus and then some. Well into the 1990s, the CBO was still predicting big deficits into 21st century. And most politicians couldn't remember a time when government didn't borrow to pay its bills.

By 1999, however, the economy helped the nation run its first on-budget surplus since 1960 (that is, a surplus that does not count money paid into the Social Security Trust Fund). In 2000, the on-budget surplus jumped to $87 billion.

The key political battle will be how the shrinking surplus will be understood by the public. The White House blames the $50 billion Congress and President Clinton added to this year's budget at the end of last year's budget negotiations.

Democrats hope the new numbers sow doubts about the big tax cuts that are scheduled to kick in later in the decade.

"The $38 billion tax cut that went out in rebate checks for 2001 is not the problem. I and many Democrats supported that. Bush had plenty of room to do a stimulus in 2001," says Gene Sperling, a former economic adviser to President Clinton. But long term, the tax cut will "generally drain funds that should have been going to be saved for Medicare and Social Security."

In a speech Tuesday, Bush defended his tax cut as a bulwark against possible recession.

"The slowdown is serious, folks. Make no mistake about it," he told an audience in Independence, Mo. "You will hear people say that tax relief is going to make it hard to meet the budget. But the reality is, tax relief is important to make sure our economy grows."

The notion that Social Security and Medicare trust funds should not be spent has become an article of faith for both Republicans and Democrats.

In February, the House approved the Social Security and Medicare Lockbox Act of 2001 by a vote of 407-2. It requires that surpluses in these accounts be used to pay down debt, so that the nation is in a better shape to pay benefits when baby boomers start to retire.

"The lock box is a theoretical concept," says Robert Cuomo, principal economist at DRI-WEFA, an economic consulting group in Lexington, Mass. "People feel comfortable when they hear that a fund has been set away for a problem. But in the end, it will go up and down depending on revenues."

The White House estimates that US economic growth this year will be 1.7 percent, down from 2.4 percent in April, and that growth will average 3.2 percent for the rest of the decade.

"The president and his advisers are quite optimistic. The consensus of commercial forecasters is not as positive as the administration numbers appear to be. They're being optimistic to make the surpluses look a little larger," says Alice Rivlin, former CBO director under Clinton.

But OMB director Mitch Daniels says that even if growth turns out to be less than half of White House forecasts, there will still be a surplus next year of well over $100 billion.

"The size of future surpluses, as well as continued strong growth of Social Security and Medicare trust funds, all depend on a return to sustained economic growth," Mr. Daniels said in a press conference yesterday.

"The key to everything is growth," he says, "and the key to growth is a tax cut."

But the new budget realities are already squeezing some Republican hopes. Business groups, for example, worry that the new budget projections will dash their hopes for new tax breaks in this session of Congress.

The White House says its top priority, repeal of the capital-gains tax, is no longer a prospect this year.

Staff writer Francine Kiefer in Washington contributed to this report.