Personal Finance—Check the Math Before You Buy Candidates’ Tax Plans

One of the superior talents of politicians is their capacity for giving away money that does not exist. In this, Al Gore and George W. Bush clearly qualify, with George W. the more ambitious. George W. has weighed in with a 10-year, $1.3 trillion tax cut offer while Mr. Gore has offered a paltry $500 billion over the same period. In fact, we can’t afford either. You can understand why by examining an important basic document, the “Analysis of the President’s Mid-Session Review of the Budget for Fiscal Year 2001” by the Congressional Budget Office. Alternatively, you can think of this column as your Cliff’s Notes. For several decades now, our government has used a “unified” budget concept in which the ongoing operations of government (the “on-budget”) are combined with Social Security and a number of other trust funds (the “off-budget”) to make a single monster budget. When you examine projections for that budget, both the administration and the Congressional Budget Office review of the same budget are pretty close, if you cut them a little slack for looking ahead 10 years. The administration projects revenues of $25,256 billion, outlays of $21,844 billion, and a total surplus of $3,412 billion over the next 10 years. The CBO estimates $25,508 billion in revenue (a $252 billion increase) and $21,761 billion in expenditures (an $83 billion decrease). Put the higher revenue and lower expenses together and the CBO shows a surplus that is $335 billion higher than the administration figure. This is an important clue. Without any radical assumption changes, the two institutions are $335 billion apart, and there is either $549 billion of on-budget surplus or there is $849 billion of on-budget surplus, a difference of $300 billion. At best, Al Gore is committing the entire on-budget surplus, give or take a tiny margin of error. George W. Bush is spending a paycheck that isn’t scheduled to arrive. The Congressional Budget Office, however, has its own budget with 10-year projections. Its budget shows an on-budget surplus of $2,173 billion over the period. That’s more than enough to cover the Bush tax cuts. Whether the projected surplus is $549 billion, $839 billion or $2,173 billion, all of it could be an illusion. If the current federal surplus appeared in a few years, it can disappear even faster. Less than one election ago the Congressional Budget Office was projecting annual deficits to 2007 and beyond. Worse, the deficits grew every year, rising from $171 billion for 2000 to $278 billion for 2007. The difference between the deficits the CBO projected in January 1997 and the surpluses projected in September 2000 starts at $403 billion for fiscal 2000 and rises to $793 billion for fiscal 2007. Over the eight-year period, the total difference between the two sets of projections is a whopping $4,657 billion. The surplus could be “easy come, easy go.” Now let’s talk about where real money is, the off-budget or Social Security surplus. This surplus was created quite deliberately nearly 20 years ago by increasing employment tax rates to start building a Social Security trust fund “cushion.” The idea was to smooth the future retirement of baby boomers. In every year since 1982, our government has spent the growing Social Security surplus, filling the Social Security trust fund with IOUs from the Treasury Department. As a consequence, the Treasury didn’t have to borrow as much from foreigners, institutions and individuals because it had billions from the off-budget surplus to finance the on-budget deficit. In 1998 the unified budget had a surplus for the first time since 1969. Why? The Social Security surplus was larger than the on-budget deficit. This year, both the on-budget and the off-budget are in surplus. Even so, the off-budget surplus, at $172 billion for fiscal 2000, is more than four times larger than the on-budget surplus. The easy, and appropriate, thing to do is to use the off-budget (read Social Security) surplus to replace publicly held Treasury debt, driving it down to zero. This will have the effect of creating a future line of credit to borrow against when the baby boomers retire and Social Security starts to redeem the IOUs it holds. But what about cutting income taxes? “Fugeddaboudit.” Dividing the wealth Question: In a recent column you wrote about a man having $600,000 and dividing it up with $200,000 in a life annuity, and $200,000 in bonds, and the last $200,000 in equities. I think he would have been much better served by placing $200,000 in equities and putting the remainder, $400,000, into a money market or an interest-bearing account at a bank. In the same newspaper there was an advertisement soliciting money market investors to invest at 7.75 percent for three years, 7.5 percent for two years and 6.17 percent for one year. To me, the main problem in purchasing an annuity is that you lose control of your money in the distribution phase. If I were an investment counselor, I would have to recommend to my clients that they be smart enough to control their own money, rather than give it to an insurance company. The insurance company will eventually get the total $200,000 mentioned above. The client would be much better served at his death by giving his beneficiaries the remaining cash, than by leaving it to the insurance company. I could never find any advantage to the 10- and 20-year certain benefit offered by the insurance companies. The annuity costs certainly exceed the benefits. To me the annuity is a guaranteed loss. C.D., Bandera, Texas Answer: Generally, I am reluctant to suggest life annuities for precisely the reasons you mention loss of control and loss of principal. Part of the loss you fear, however, can be illusory because of the time value of money if you purchase your life annuity carefully. Let me explain. In a bond we receive the vast majority of the value of the bond in interest coupons long before we get our original principal back. The present value of the original principal of a $1,000 bond at 6 percent for 36 years, for instance, is only $125. The remainder is the value of the interest coupons over the 36 years. When we annuitize principal, we get a higher monthly payment at the cost of giving up the principal at the end. The present value of life annuity may repeat MAY be higher than the present value of, say, a 30-year bond earning 6 percent. It all depends on how long the annuitant lives and the payment provided by the insurance company. Questions about personal finance and investments may be sent to Scott Burns, The Dallas Morning News, P.O. Box 655237, Dallas, TX 75265, or by fax (214) 977-8776; or by e-mail: [email protected]. Check the Web site: www.scottburns.com. Questions of general interest will be answered in future columns.