Untamed Monster

By WALTER ISAACSON

Washington shrinks from dealing with the deficit

When the first signs of recovery began to break through the deep recession last winter, economists and politicians alike added apocalyptic warnings to their expressions of cautious optimism. Uncontrolled federal deficits, they declared, could drown the economy in red ink. Yet when Ronald Reagan, formerly the ardent apostle of balanced budgets, submitted a plan for fiscal 1984 with a shortfall that approached $200 billion, political paralysis seemed to set in. The enormity of the deficit monster eventually led to a feeling of futility. In addition, encouraging economic signs, such as a record bull run on Wall Street and continued moderation of inflation, raised hopes that the economy would continue its upward climb despite the deficits, at least until the 1984 elections.

This complacency was shaken last week when disputes over deficits rived the once solid unity of Senate Republicans and threatened to destroy the budget process that provides Congress with its chief source of fiscal discipline. As it became apparent that the Administration and Congress were unable, or unwilling, to deal with the budget, there was renewed concern about the danger that this presented for the still tentative recovery.

Reagan came into office professing horror at the $1 trillion national debt accumulated over two centuries, which he vividly depicted as "a stack of $1,000 bills 67 miles high." Yet his economic program could produce a string of record deficits that would increase the debt to more than $1.6 trillion during his term. The future interest payments on this additional debt alone could run higher than $60 billion a year. In contrast to the frenetic maneuvering a year ago to keep his 1983 projected deficit from breaking the $100 billion barrier (the final figure is likely to be $210 billion by the time fiscal 1983 ends in September), the President adopted a sanguine attitude about this year's shortfall. In January, he proposed a stand-by tax that would take effect in 1985 on the contingency that deficits remained high, but when it became clear that this contingency was inevitable, he abandoned the fight for the tax. Moreover, he resisted pressure to scale back his 10% real defense increase or the tax cuts passed in 1981.

Reagan's recalcitrance provoked the Republican-led Senate Budget Committee, headed by Pete Domenici of New Mexico, to send to the floor last month a budget bill written by Democrats based on a plan already passed by the House. It would reduce the projected 1984 deficit to $162 billion by trimming the real increase in defense spending to 5% and raising $30 billion in new tax revenues. Faced with this prospect, Reagan reluctantly relented two weeks ago and gave his tacit support to a compromise fashioned by Domenici and the Senate Republican leadership. It called for a 7.5% rise in defense spending.

But Reagan still refused to support significant new taxes. That prompted a revolt by a quintet of Republican moderates, led by John Chafee of Rhode Island. They proposed to alleviate future deficits by a moderate increase in taxes and a trim of the defense budget's growth to 6%. Although most Senate Democrats joined forces with the Republican moderates, no budget plan could garner a majority.

Senate leaders hope that the Budget Committee can come up with a new plan this week for a budget resolution acceptable to the House and Senate. The congressional budget process, which was instituted in 1974, requires that members pass such a resolution, putting spending ceilings on government programs and setting overall tax levels. A breakdown of this system could lead to uncontrolled spending, with each appropriations subcommittee voting to spend whatever it wanted. Democratic Senator Lawton Chiles of Florida said that if the budget process breaks down, "I think that we shall have chaos."

Reagan effectively used the budget process in 1981 and 1982 as a club to win his way in Congress. But many advisers, most notably Defense Secretary Caspar Weinberger, feel that Reagan might be better off this year without a budget resolution. He could then try to influence each appropriations bill separately, and veto those he disapproved of. The veto threat, however, would be ineffective in tackling the most important spending problem, that of burgeoning entitlements such as Medicaid and federal pensions. These can be cut only if Congress passes new laws to change eligibility. Aside from defense spending, less than one-fifth of the budget is governed by appropriations that can be vetoed.

When he proposed his dramatic economic package shortly after taking office, Reagan said that it would produce a budget surplus by fiscal 1984. Instead, it helped create a fundamental disparity between revenues and expenditures. Even assuming sustained growth, revenues will remain at about 19% of the gross national product. And even if the further reductions in domestic expenditures requested by Reagan are passed by Congress, outlays will not fall below 23% of the G.N.P. Unless the budget process can be used to force deep cuts in entitlement programs, Budget Director David Stockman warned the Cabinet last month, the country faces deficits of more than $200 billion "as far as the eye can see."

As a result, some Administration officials have been trying to play down the danger of deficits. "I will offer a prize to anyone who can show me the connection between high rates of interest and high deficits," Treasury Secretary Donald Regan said two weeks ago in Manila. Yet he seemed to enter his own contest last week, when he told foreign finance ministers meeting in Paris that the U.S. was sensitive to the problems its high interest rates created for other nations (see ECONOMY & BUSINESS). Said Regan: "I do guarantee we will make visible progress in removing the specter which arose from the January budget: record deficits as far as the eye could see." Britain's Chancellor of the Exchequer, Sir Geoffrey Howe, also made the connection, saying that the prime cause of high interest rates is the borrowing requirements of the U.S. Government. This is likely to be a source of friction when Western leaders meet later this month at an economic summit in Williamsburg, Va.

The problems posed by continued high deficits are depressingly apparent to economists. Says Martin Feldstein, the chairman of Reagan's Council of Economic Advisers: "For the past two decades, total net private savings have averaged only about 7% of the G.N.P. A budget deficit of 6% [which is what $200 billion represents] would absorb an amount equal to nearly all of those savings." The Government's growing borrowing needs could cause what Citicorp's senior domestic economist, Peter Crawford, calls "painful conflicts between the Treasury and private borrowers." This "crowding out" of private borrowers is part of an economic Catch-22. Explains Wall Street Analyst Sam Nakagama: "If the Federal Reserve tries to keep interest rates down in the face of a big deficit, it would have to permit explosive growth of the money supply and another cycle of high inflation. On the other hand, if the Fed pursues a slow-money-growth policy with the aim of fighting inflation, a large deficit causes such high interest rates that private business activity is devastated."

At both ends of Pennsylvania Avenue, however, political considerations are taking precedence. Reagan and most Republicans will simply not consider new revenue measures, even though the underlying deficit cannot be closed without them. The Democrats have been willing to propose new tax measures, but balk at placing the restraints Reagan wants on entitlements. Congressmen of both parties, and in particular the Democrats, would like to scale back defense spending, but on this they have met resistance from the White House. The fecklessness of both parties when it comes to making either tough revenue or spending decisions was illustrated last week when more than 300 House members, following the lead of their Senate counterparts, caved in to the banking industry and signed a petition supporting repeal of a measure to withhold taxes from interest and dividend income. The withholding provision, which will be reconsidered by the full House this week, would have cut down on tax cheating and produced $ 13 billion in revenues over the next three years.

At the end of his 1980 campaign, Reagan charged in a television address: "Mr. Carter is acting as if he hadn't been in charge for the past 3 1/2 years; as if someone else ran up nearly $200 billion in red ink; as if someone else was responsible for the largest deficit in American history; and as if someone else was predicting a budget deficit for this fiscal year of $30 billion or more." Those words will no doubt be thrown back at Reagan, with the added fire that his deficit in one year is about as high as Carter's was in four. House Speaker Tip O'Neill opened the barrage last week, saying, "Acting more like political muggers than legislators, the Republicans have failed to come up with a program to deal with the staggering deficits." Tough talk, but that, of course, will do little to resolve the current impasse. Unfortunately, the principal players now seem to feel that pointing the finger of blame will be more helpful to their political interests than agreeing to any effective deficit-reduction measures. So the only safe bet, it seems, is on the monster.

--By Walter Isaacson. Reported by David Beckwith and Neil MacNeil/ Washington

With reporting by David Beckwith, Neil MacNeil This file is automatically generated by a robot program, so viewer discretion is required.