Alan Greenspan last week okayed a tax cut on the grounds that the surplus might otherwise become so big for so long that the government would be forced to buy up the U.S. stock market.

Wrong again, Alan! There are a number of good reasons for a tax cut, albeit preferably a few quarters down the road, but absorbing the surplus isn’t one of them. By fiscal year 2002, possibly even in FY 2001, ending Sept. 30 this year, there ain’t gonna be no surplus.

The great surpluses of 1998 to 2000 were caused by the surge in capital gains taxes, on the stock market profits of investing Americans. Net individual capital gains in tax year 1998 totaled $448 billion, up 25 percent on the previous year, while in FY 2000, as far as can be determined, capital gains tax revenues represented about half of the $236 billion surplus. Indeed, the surplus was highly concentrated; the surplus in April 2000 alone was $159.5 billion, representing mostly capital gains tax payments on 1999’s stock market gains; this compared with the surplus in April 1995, covering 1994, the last year before the stock market took off, of only $49.7 billion.

Since 2000 was a mainly flat stock market year, capital gains tax payments this year can be expected to be much lower. Thus the first sign that the fiscal virtuous circle has ended will come in May, when April 2001’s monthly surplus is announced. This can be expected to be well below $100 billion — thus in one month knocking $60 billion plus off the Clinton budget’s projected FY2001 surplus of $256 billion.

An alternative way to look at what may happen to the surplus is to examine the budget effect of previous recessions. Typically, at the onset of recession, the federal budget swings sharply towards deficit. This is not because recession leads politicians to be fiscally irresponsible; indeed, few past congresses have been as fiscally irresponsible as last year’s session of the 106th Congress, which added $50 billion to its original spending projections at a time of raging boom.

Recession does however have an automatic dampening effect on receipts (of which capital gains tax receipts are only one element) and a corresponding expansive effect on outlays, as unemployment and poverty rise.

Since 1947, the United States has been involved in eight recessions, defined as two successive quarters of declining gross domestic product: in 1949, 1953 to 1954, 1957 to 1958,1969 to 1970,1974 to 1975, 1980, 1981 to 1982, and 1990 to 1991.

The average decline in GDP growth, from the four quarters prior to recession to the four quarters following the onset of recession was from 3.1 percent to minus 2.1 percent, a swing of 5.2 percent.

The average change in the government budget balance was from plus 0.4 percent of GDP to minus 1.7 percent of GDP, a swing of 2.1 percent of GDP.

In the four quarters to September 2000, GDP growth averaged 5.2 percent, and the budget surplus for that year, at $236 billion, was 2.5 percent of GDP.

Thus if growth slackens to zero, the surplus can be also be expected to decline to a figure near zero. However, since capital gains revenues represented an exceptionally high portion of the surplus in 2000, and are likely to be far less in FY 2001, if growth slackens to an average zero in the four quarters to September 2001, the budget can be expected to show a significant deficit in FY 2001.

Of even more significance is the budgetary effect of the two major post-war recessions, in 1974 to 1975 and 1980 to 1982. In the first of these, the fiscal balance swung from plus 0.4 percent of GDP to minus 4.3 percent (in quarters 4 to 7 after the official onset of recession), in the second it swung from minus 0.2 percent to minus 5.5 percent (in quarters 11 to 14 from the onset of that severe “double dip” recession.)

Such a swing, which might well be caused by a recession of even moderate depth following such a high and prolonged growth rate, would lead to a budget deficit of around $350 to 400 billion in FY 2002.

This is not a “worst case” scenario. The above estimates, based on historical data, do not take account of the negative wealth effect of a reversal in most of the 1995 to 1999 run-up in the stock market.

So far, the stock market decline has been modest, except in Nasdaq where the run-up was fleeting. The excellent “Corporate Finance” survey in this week’s Economist outlines the earnings-distorting effects of stock options, and suggests that as such effects become properly recognized by investors, a substantial decline in the major stock market indices from present levels may take place.

In our view, based on historic valuation norms, a further such decline of at least 50 to 60 percent is indicated. In such a case, the recession-prolonging effect of consumers fighting to get their personal finances back in shape is likely to be prolonged. Then, even if the recession is not itself a deep one, the public sector deficit can be expected to balloon to hitherto-unseen levels, perhaps in the $500-600 billion range.

These projections depend on any recession having “started” in the fourth quarter of 2000. The first estimate of GDP growth for that quarter is due to be announced on Wednesday. We forecast in mid-December that that figure would show negative growth. It looks as though we will be either just correct or just wrong; if growth in the fourth quarter was marginally positive then the recession’s effects, based on past trends, can be expected to show up three months later than outlined above.

But our base-case forecast, of a speedy return to balance or a modest deficit in the federal budget, does not depend on an official recession. It depends only on a period of slow growth that is accompanied by a cooling of the stock and asset price market. That, we think, is in the bag.

The arguments for a tax cut, however, remain good. The analysis above has shown that budget deficits are caused largely by recessions, with only modest effects from surges in fiscal irresponsibility. Conversely, surpluses are caused by long expansions, particularly if they are accompanied by stock market booms.

It therefore follows that, even if the 1990 and 1993 tax increases had not been put into effect, the budget would still be in balance today, given the spending restraint of the 1994 to 1998 Gingrich congresses.

Thus the 1990 tax increase, in particular, which was passed going into a minor recession and resulted in exacerbating it and losing George Bush the 1992 election, was wholly unnecessary.

Alan Greenspan — insisting on an uncalled-for degree of fiscal discipline in 1991 and 1992 and being relaxed about today’s surplus — has been guilty of gross inconsistency, taking no account of the normal effect of the business cycle.

Our view is that the forthcoming recession will be a deep one, and that a year from now, if the stock market has dropped substantially further as we expect, then in spite of the budget deficit that will by then have manifest itself, a degree of fiscal stimulus will be essential in order to reverse the “drag” of the inverse wealth effect.

The fairest tax cut would be to repeal all tax legislation of the 1990’s, returning to the 1986 tax code, in our view the apogee of tax simplicity and fairness in our lifetime. No doubt, however, we will just get the usual Christmas tree of special gimmicks and lobby-driven complexity.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.