A surplus of taxes.

THERE is good news and bad news on the budget front. The good news: this year will be the first time since Lyndon Johnson's Presidency that the fiscal year has ended in the black. When the Republicans took over Congress in 1994, they inherited $200-billion deficits for as far as the eye could see. Their promise to balance the budget in seven years was widely regarded as unrealistic. As it happened, they helped produce a $50-billion surplus in three. Newt Gingrich and Trent Lott, take a bow.

The bad news: the budget is being balanced not by federal retrenchment but by higher taxes. The latest Treasury Department report indicates that for the first six months of fiscal year 1998, tax receipts are up 10 per cent over last year. (As proponents predicted, capital-gains tax cuts are contributing to increased revenues.) From 1998 to 2002, tax collections will now be roughly $500 billion higher than projected in last year's budget agreement. Yet this new tax windfall has not emboldened GOP tax cutters. Last month the Senate considered a tax cut so microscopic that, as Sen. John Ashcroft (R., Mo.) calculates it, the typical family would be able to afford a Big Mac with each month's $1.87 savings.

Big spenders in both parties have shown no such timidity. Their plans for new health-care programs, federal day- care subsidies, federalization of the schools, and highway pork projects in every district can be fended off only by taking the money out of their hands. Congress should return at least half the windfall -- $250 billion over five years -- to the taxpayers who produced it.

There is no shortage of possible tax cuts on offer. Simplifying the capital-gains tax, making the cost of medical insurance deductible for individuals as it now is only for companies, expanding the 15 per cent tax bracket, and eliminating the marriage penalty are all options. Any of them would be preferable to the status quo, but some have strategic advantages over others.

A major factor driving the Federal Government's current growth is real-income bracket creep. Because of the steep progressivity of the income tax, economic expansion pushes more and more American families into higher brackets each year. Over the past three years revenues have been climbing nearly twice as fast as wages and income. Moving most middle-income workers from the 28 per cent to the 15 per cent tax bracket, as proposed by Lawrence Kudlow and Stephen Moore in these pages, would roll back these unlegislated tax increases. (It would also reduce the marriage penalty.) Such increases should be blocked in the future as well, as Milton Friedman suggests, by indexing tax brackets for real income growth in addition to inflation.

These moves should be combined with measures to promote investment, thus expanding the constituency for further market-based reforms. Sen. Paul Coverdell's bill for educational savings accounts has already passed the Senate. Rep. Bill Archer (R., Tex.) is considering similar tax breaks for health care, and Sen. Phil Gramm (R., Tex.) and Rep. John Porter (R., Ill.) have proposed private investment options for Social Security. Republicans should do as much along these lines as possible as early as possible, to get the ball rolling.

But before they get to the details, they must resolve to cut taxes in the first place. It's why they were put on this earth. If President Clinton wants to veto tax cuts, let him do so -- and hand the GOP a neatly gift-wrapped campaign issue for the fall.