Down with the Deficits

By GEORGE J. CHURCH

Reagan begins to ease his stance on taxes and arms cuts

If Hollywood were to make a movie of the budget drama now being enacted inside the White House, it might well be titled Reagan Faces Reality. Reluctantly, imperfectly and very belatedly, to be sure. Nonetheless, the key decisions taken last week in an eleventh-hour overhaul of the budget that goes to Congress on Jan. 31 seem likely to meet a modest but all-important goal: enabling Ronald Reagan to present a set of deficit projections for fiscal 1984 and later years that will serve as a starting point for a serious effort to stem the tide of red ink before it drowns prospects for a lasting economic recovery.

To accomplish even that much, the President had to back away from some of his most cherished beliefs about military spending and taxes. He denied stoutly that he was doing any such thing and, in fact, seemed to be largely unaware of the economic and political stakes. Nettled by charges in the press that his Administration was "in disarray" and losing its direction, Reagan charged at his Friday meeting with newsmen that the disarray was in the minds of reporters who were printing tentative budget proposals as hard-and-fast decisions. He added, "I do not believe that, philosophically, I have changed at all."

But it was difficult to read any other meaning into last week's three major decisions. They were:

1) To reduce planned military spending by $8 billion in fiscal 1984, lowering it to $239 billion. About half the cut would result from a decline in inflation, especially an expected continuing drop in the cost of buying fuel for ships, tanks and planes. The rest would come from cancellation of a 7.6% pay increase for 2.1 million soldiers, sailors and airmen that had been scheduled for Oct. 1 and miscellaneous "program changes," probably including such items as less steaming time for Navy vessels and postponements in building of military housing.

The military cuts pleased no one. Congressmen and Senators stormed that the reductions would be both too small (military outlays would still rise by more than 14% above the current fiscal year) and wrongly focused. Hawks and doves joined in the worry that scrapping the pay increase would endanger the ability of the military forces to persuade skilled people to reenlist. They contended that the Administration might do better to cancel or delay some expensive weapons-buying programs. Even the Joint Chiefs of Staff, who were not consulted on the reductions, took that line. Air Force Chief of Staff General Charles Gabriel grumbled to reporters that the Chiefs would prefer to buy fewer weapons rather than cancel the pay boost.

The decision marked a sharp turn in White House thinking. Though Reagan had always insisted that military spending must be exempt from budgetary restraints, he is now proposing a reduction for the sole purpose of shrinking the deficit. Secretary of Defense Caspar Weinberger, who fought against the cuts and lost, made that reasoning explicit. Ashen-faced and biting off his words, Weinberger declared, "If it were not for the deficit, we would not have any suggestion that we not carry out the full program."

2) To propose a freeze on many types of nonmilitary spending. The President is almost sure to recommend holding unchanged the salaries of 2 million federal civilian employees, who were expecting a 4% raise next October. In addition, he is likely to propose delaying for at least six months, and possibly for as long as a year, cost of living increases that would otherwise be triggered automatically in a wide range of federal "entitlement" programs. Some samples, besides Social Security, might be pensions for veterans, federal civilian employees and railroad workers. While this proposal is fully compatible with the Reagan philosophy, it constitutes an admission that the President cannot narrow the deficit sufficiently by more reductions for such targeted social programs as food stamps and welfare, but must take more drastic action.

3) To ask Congress to enact huge standby tax increases to go into effect in 1986 if, and only if, deficits by then still seemed likely to exceed $100 billion a year or so. Current thinking is to propose new taxes calculated to take in approximately $100 billion over a three-year period. One would be a $7-per-bbl. tax on imported oil; a much more direct levy would be an income-tax surcharge of perhaps 8%. That is, every taxpayer would add up his or her bill under the rate schedules now written into law, then pay another 2% or 3%.

This proposal marks the sharpest break of all from Reaganite philosophy. The President does not see it that way; in his mind, he would only be proposing tax increases that would probably never take effect. But one of his bedrock principles has been that taxes must be steadily reduced as a proportion of national income. Now some of his subordinates are openly declaring that goal to be not only unattainable but undesirable. Treasury Secretary Donald Regan went so far last week as to insist that tax collections must increase from the current 18% of gross national product to 20% by 1986 if deficits are ever to be tamed.

Even with all these plans, the deficit would remain frighteningly large. The military-spending reductions and partial freeze on civilian programs, in combination with social-spending cuts that Reagan still hopes to wring out of Congress, would whack about $40 billion out of expenditures in the next fiscal year. But that would still mean spending roughly $175 billion more than the Government could hope to collect in taxes. That deficit would be barely below the $180 billion to $185 billion now expected in fiscal 1983.

Hardly anyone in Washington entertains the illusion that Congress will be satisfied with so minor a reduction. The legislators are certain to ax far more than $8 billion from military outlays and to demand that arms purchases share in the slashes. Almost everyone on Capitol Hill seems to have a hit list of costly weapons that could be dumped without injuring national security.

Congress also is sure to insist on a quicker and surer shoring up of the revenue base than standby tax increases. There is strong sentiment among the Democrats, who control the House, to reduce, delay or even scrap the third stage of the tax cuts that Reagan pushed through Congress in 1981: a 10% drop in income tax rates that takes effect this July 1. And even some of Reagan's staunchest allies in the Republican-controlled Senate want to repeal the "indexing" provision of the 1981 tax law. Under indexing, tax brackets will be tied to the rate of inflation; beginning in October 1984, no taxpayer will be pushed into a higher bracket unless his income rises faster than prices do.

Whatever its shortcomings, the outlook is a vast improvement over the chaos that threatened if Reagan had persisted in his original plan to send Congress a budget that contained no reductions in military spending, no changes in tax plans and estimates of spiraling deficits far into the future. Such a budget, says one House Republican, "would self-destruct in an hour." Congress would have rejected it out of hand and proceeded to write its own budget. Interminable wrangling would have further frightened the financial markets, probably causing interest rates to go up again, further delaying any recovery from the debilitating recession. Reagan would have forfeited all chance of exercising strong leadership through the second half of his term.

The problem for the White House staff, which foresaw that course of events, was to make the President see it. The staff put on a brilliantly orchestrated performance that nudged Reagan into changing his mind while still insisting that he was holding to his basic philosophy.

The first break came shortly after Reagan returned from a New Year's vacation in California. The chairman of the Council of Economic Advisers, Martin Feldstein, greeted the President with a gloomy economic forecast. In its first two years, the Reagan Administration had made what turned out to be wildly optimistic predictions of economic growth. This time Feldstein was determined to err on the side of caution. He predicted a rise of a puny 1.4% in total national output between the end of 1982 and the fourth quarter of this year, an even more anemic recovery from recession than most private economists had anticipated.

Feldstein and Budget Director David Stockman had carefully worked out the consequences in advance. They were shocking: a deficit of $215 billion or more in fiscal 1984, increasing to $288 billion in 1988. Reagan earlier had taken a not-to-worry attitude toward deficits, believing firmly that a robust economic recovery would shrink them. But when he heard the $288 billion figure, one aide recalls, he replied by saying, "We can't go to Congress with that."

The second step began two weeks ago, when Reagan loyalists in the newly elected Congress called on the President. White House Legislative Aide Kenneth Duberstein had learned their views in advance and worked out a coordinated presentation. Basically, the Representatives and Senators told Reagan that he must propose a reduction in military spending and some kind of tax changes in order to present a budget that Congress would even consider seriously. Nevada Senator Paul Laxalt, Reagan's closest friend on Capitol Hill, made the deepest impression on the President. Laxalt advocated a standby tax increase and some kind of spending hold-down that, he warned Reagan, would have to include reductions in planned military outlays.

The G.O.P. legislators' advice reinforced what Reagan was hearing from his staff and Cabinet. Advocates such as White House Chief of Staff James Baker and Deputy Chief of Staff Michael Deaver, who had earlier proposed deficit-reducing steps and been rebuffed by the President, sat back and let others do the talking. Presidential Counsellor Edwin Meese for the first time argued strongly for slower increases in military spending. Secretary of State George Shultz, a newcomer to budget councils, whose advice as a professional economist Reagan highly respects, artfully mused about ways in which military outlays could be reduced if only Weinberger agreed that they would not damage national security.

Weinberger indeed was the key: if he continued to hold out for the full scheduled increase in military spending, the whole package, including a partial civilian-spending freeze and standby tax increases, would have fallen apart. Reagan, who maintained an essentially passive attitude through the whole affair, never directly ordered Weinberger to look for savings in defense outlays. But the Secretary of Defense saw how Reagan's consensus was shaping up, and volunteered to look for some savings. He reported back with some last week, but continued to argue for a military pay raise of at least 4%.

By then, however, Reagan had already decided on a pay freeze for nonuniformed federal employees. He told Weinberger, "Look, we can't go up there and cut everybody else's increases without cutting military pay." Even at that last moment, the President gave no orders. Instead, as silence fell over the group, Stockman penciled the prospective savings from a military pay freeze into a draft budget document and, said one White House aide, "that was the end of it."

Well, not quite. There is still some fear among Reagan's staff that the President will have second thoughts this week, the final deadline for decision if the budget message is to be printed on schedule. But the majority opinion within the White House is that the Administration has pulled off a hairbreadth escape from calamity. Says one aide: "We are in the game. Now we have a package that sets the agenda." Maybe, and if so, just barely.

--By George J. Church.

Reported by Douglas Brew and John F. Stacks/Washington

With reporting by Douglas Brew, John F. Stacks/Washington This file is automatically generated by a robot program, so viewer discretion is required.