One Last Hand of Budget Poker

By WALTER ISAACSON

Reagan and O'Neill get ready to call each other's bluff

The urgent negotiations between Administration officials and congressional leaders were carried out in uncommon secrecy. Twice the group met at 7 a.m. at George Bush's house; each time the Vice President had already left for work, to throw sniffing journalists off the scent. There were dawn breakfasts at the homes of top White House Aide James Baker and House Budget Committee Chairman Jim Jones. The impressive result: tentative agreement on a sweeping plan to reduce the projected 1983 deficit by billions through spending cuts, adjustments to the Social Security program and new taxes. If approved, the compromise would bring the deficit below $100 billion and possibly jolt wary financial markets into lowering the high interest rates that have been strangling hopes for an economic recovery. Only two officials have yet to approve the bipartisan package. Two very important officials: House Speaker Tip O'Neill and President Ronald Reagan.

Will the crusty Democratic leader accept a plan that not only preserves the 10% tax cut scheduled for 1983 (the final installment of Reagan's three-year program to reduce personal income taxes by 25%), but also shrinks future increases in Social Security payments? Will the doctrinaire quarterback in the Oval Office agree to scale back his sacrosanct defense budget and raise new tax revenues? In public last week the President once again dug in his heels on the tax-reduction plan passed last August. "Tampering with the third year of the tax cut should set off alarm bells in your heads and send shivers up your spines," he told a construction trade union conference in Washington. O'Neill responded with similar obstinacy: "I am as firm on Social Security as the President is on the tax cut. In no way are we going to balance the budget on the backs of senior citizens." Says one observer: "There are four Irish feet stuck in concrete. We've got to get them out."

Behind the scenes, representatives of both sides were much more flexible, although Baker insisted the tax-cut plan was not up for discussion. The group--consisting of top White House aides led by Baker, Republican Senate chairmen led by New Mexico's Pete Domenici, and House Democratic chairmen led by Oklahoma's Jim Jones--agreed to use the economic assumptions of the Congressional Budget Office rather than the rosier Administration numbers. According to the CBO, the deficit for fiscal 1983, which begins Oct. 1, could reach $180 billion if Congress does not pass any of the spending cuts proposed by Reagan. The Administration's formal budget proposal, based on the dubious assumption that Congress will accept the radical changes in domestic programs that are part of Reagan's budget, projected a $91.5 billion deficit when submitted in February. Last week the White House revised that figure up to $101.9 billion. But even presidential aides admit this is too optimistic.

To avoid tampering with Reagan's tax cut, Administration officials agreed to consider alternative ways to raise new revenues. Among them: a $5 per-bbl, oil import fee, a 5-c- per-gal. gasoline tax, a hike in excise taxes on cigarettes and liquor, a 4% tax surcharge on individuals with incomes above $40,000, and curbs on the new, much criticized provision that allows businesses with more tax deductions than they need to sell them to companies facing big tax bills. These steps could raise $30 billion in new revenues. The Administration bargainers also indicated that the President's proposed 11% increase in military spending might be reduced to a 7% hike after inflation, saving $10 billion.

In return, the Democrats have shown a willingness, despite O'Neill's rhetoric, to consider cuts in Social Security payments. One plan tentatively accepted by both Domenici and Jones is to postpone for three months the cost of living adjustments scheduled for next July and then peg future COLAs at 2 or 3 percentage points below the consumer price index. All told, the entire bipartisan package would slash $80 billion off the CBO's projected $180 billion shortfall, enough to reassure the financial markets.

The maneuverings took place against a backdrop of rising economic worries. The level of new claims for unemployment benefits has been rising since February, leading to fears that the current 9% jobless rate may go even higher. Commerce Secretary Malcolm Baldrige predicts that one or two major corporations may fail before the current recession ends. The only good news was the second consecutive monthly decline in the producer price index, a measure of inflation.

Even those who support the Reagan program are becoming impatient with the budget process. Says Itek Corp. Chairman Robert Henderson, whose high-tech optical company anticipates "significant" first-quarter losses: "I didn't expect that we would knock out the deficit overnight, but I would like to see some indication that we are really working on it."

The bipartisan bargainers hope to get O'Neill and Reagan together over breakfast soon to seal what is seen as the last chance for an economy-salvaging solution to the budget dilemma. Baker has been briefing his boss almost daily, and the President has shown signs that he is open to a compromise with Congress. "I look forward to progress being made as soon as they come back from the Easter recess," Reagan said last week, adding that he would not object to a "summit" with Democratic leaders. The Speaker will go along with the budget compromise, his aides say, as long as Reagan takes the lead: "Only the President can persuade the American people to swallow the medicine."

Such delicate duets have dissolved into disharmony in the past, and could do so again if a debate breaks out over taxes and Social Security. But a Republican who has been involved in the negotiations shared the week's optimism. Said he: "Believe it or not, everyone involved seems to be putting the economic stakes above politics for the moment. A lot of us would be surprised if the President jerked the rug out from underneath Jim Baker at this point." Should a compromise fall through, there is little hope of controlling the burgeoning deficits, and the November elections will be dominated by finger-pointing and political posturing over who is to blame for the continued stagnation of the economy.

--By Walter Isaacson.

--Reported by Douglas Brew and Evan Thomas/Washington

With reporting by Douglas Brew, Evan Thomas

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