SYNOPSIS:

JANE CLAYSON, co-host: In April, Bush administration officials projected a $281 billion budget surplus for the current fiscal year. But last week, the White House acknowledged that $123 billion of that surplus has already evaporated. To tell us what's behind the numbers, let me welcome in San Francisco, John Fund, an editor for The Wall Street Journal; and here in New York, Paul Krugman, a columnist for The New York Times and the author of "Fuzzy Math." Gentlemen, good morning to both of you.

Mr. John Fund (Editorial Board, The Wall Street Journal): Thank you. Mr. PAUL KRUGMAN (Author, "Fuzzy Math"): Good morning.

CLAYSON: Mr. Krugman, let me start with you first, $123 billion. Where'd the money go?

Mr. KRUGMAN: Fifty billion is the recession, 70 billion is the tax cut. And it gets worse. If--three years from now we'll be in deficit still and it'll be all tax cut.

CLAYSON: Perhaps more importantly than--than where did the money go, why is it such a surprise to so many people?

Mr. KRUGMAN: I think basically because the administration lied. You know, they low-balled the cost of their own spending proposals. They low-balled the revenue that was going to be lost because of the tax cut. They presented this happy picture to get the bill through Congress, and now the truth hits.

CLAYSON: Mr. Fund, it may be a surprise, but is it a problem?

Mr. FUND: I don't think so. And I think rather than playing a blame game, I think your audience is going to be interested in whether or not they're going to be able to keep their jobs and what kind of things we can do to get out of this minor problem. Look, this is a bipartisan problem. A quarter of the Democrats in the Senate voted for that tax cut, and Max Baucus, who is the Democratic chairman of the Senate Finance Committee, says no Monday morning quarterbacking could have predicted this. It is an economic slowdown that is causing this. And he says it's not the tax cut and he's the Democratic chairman of the tax committee.

CLAYSON: So the tax cuts had no effect on the shrinking surplus?

Mr. FUND: They had--they clearly had some. But this is a cyclical problem with an economic slowdown that no one would have anticipated back in April, private or public forecasters.

Mr. KRUGMAN: Let me just break in. It's--it's the projections. The congressional projections and basically the administration projections say it doesn't go away. This is still going to be a problem in the year 2004 when everybody thinks the economy will have recovered. So it's not cyclical.

Mr. FUND: Professor Krugman--Professor Krugman, the congressional budget office has a 30-year record of overestimating deficits and underestimating surpluses. I have the data in front of me. They have a poor track record in predicting those thing.

Mr. KRUGMAN: It's--it...

CLAYSON: Mr. Krugman, you don't support the Bush tax cuts, but--but you supported the recent tax rebate; however, you called it a rebate and switch. What did you mean by that?

Mr. KRUGMAN: The tax cut is two parts. There's the rebate this year, which is a good thing, which was a Democratic proposal that the administration adopted reluctantly at the price of getting the real tax cut, which is the huge tax cuts, mostly at the top end of the income scale, that don't come for five years, which do nothing for today's economy, but are the reason why this deficit won't go away, why we are now looking at deficits as far as the eye can see.

CLAYSON: Mr. Fund?

Mr. FUND: This is ridiculous. We have the second largest surplus in American history right now, even with this slowdown. It's $160 billion. We would have been loving for the surplus a few years ago. This is good news. it's not nearly as good news as we had a few months ago, which is why I'm glad this tax cut is in line. We should have further tax cuts, including a capital gains tax cut to stimulate this economy to make sure that your audience continues to get better jobs.

CLAYSON: Let me read to you a quote, both of you, from the 2000 Republican Party Platform. It says, "The Social Security Surplus is off limits, off budget, and will not be touched." However, on Friday, the president did say he would dip into the Social Security surplus for emergencies, like war and economic recession. Given the state of our economy, are we about to see a promise broken?

Mr. KRUGMAN: It wouldn't matter if it was going to be broken this year. Although that was a pretty firm promise, there was no--there's no wiggle room in that. The point is that it's not looking like it's going to go away. So, the prob--yeah, the promise is going to be broken. They always intended to break the promise, but it wasn't supposed to happen quite this soon.

CLAYSON: Mr. Fund, Time magazine quotes a Bush economic adviser as saying that there is no economic consequence to dipping into the surplus, but what about political consequences, do you see them?

Mr. FUND: Jane, sadly, there is no Social Security surplus. It's a pay as you go system, none of the money is set aside. And that's why young people today believe that there's more of a chance they're going to see UFOs than get their Social Security benefits. Robert Reich, who was Bill Clinton's secretary of labor, says the Social Security surplus is an accounting fiction. I wish both political parties wouldn't have talked about Social Security the way they did last year, the lockbox was a fiction, and it really confused and I think deceived people.

Mr. KRUGMAN: Look, the president made a promise. He said I am going to--what he really said--what he said was that, 'I'm going to set this money aside. I'm going to keep this money. We're going to use it to pay down the debt and therefore we won't have this debt when you retire, and we'll be able to pay your benefits.' And, in fact, now, the money is not being used to pay the debt, it's being used to cover the revenue loss because of the tax cut.

Mr. FUND: Professor, when Bill Clinton's own labor secretary says the Social Security surplus is an accounting fiction, you should have to recognize that as well. It doesn't exist.

Mr. KRUGMAN: I--look--Robert Reich...

Mr. FUND: You have to admit that.

Mr. KRUGMAN: ...proposed all of the good things that the Clinton administration did. I'm--I'm a Democrat in the line of, you know, of Bob Rubin, who produced the surplus that has now just been squandered.

Mr. FUND: You've acknowledged there is no Social Security surplus?

Mr. KRUGMAN: No, I believe it's entirely real.

Mr. FUND: Trust fund.

Mr. KRUGMAN: It's money that's being saved so that our children don't have to bear an enormous burden to pay our benefits.

CLAYSON: All right. I've got about 20 seconds left for each of you. Very short--very briefly, predictions for the surplus, long and short term. Mr. Krugman, you first.

Mr. KRUGMAN: Social Security surplus is gone. We're going to be in deficit properly counted for the rest of the decade. Promises, prescription drug insurance, gone. The military's not going to get what it thinks. We're in deep trouble.

CLAYSON: All right, Mr. Fund.

Mr. FUND: The same congressional budget experts he quotes have been wrong consistently over the last 30 years. I think we have a short-term slowdown and I think we have to have more tax cuts and we have to hope that the economy gets better soon. And I think the tax cuts will help.

CLAYSON: John Fund and Professor Paul Krugman. A lively debate. Thank you, gentlemen, very much. Seven thirty-six now.

Originally broadcast, 8.31.01