Plunging into the Red Ink

By George J. Church.

Reagan's budgetmakers find it easier to leak than to cut

Medicaid, veterans' benefits, farm price supports. Civil service pensions, aid to mass transit, student loans. Plus . . . well, not defense or Social Security. But name almost any other federal spending program, and somebody in Washington was telling reporters last week that it might be cut deeply in the budget that Ronald Reagan will send to Congress early next year.

The rumors reflected the frustration of budgetmakers who have been handed an almost impossible assignment. Briefly put, a sharper than expected slowdown in the U.S. economy has made the task of reducing federal deficits more urgent than ever. Nonetheless, for reasons of ideology, politics or both, President Reagan at least for the moment has ruled out all the most obvious methods of stemming the red ink, and the economic slowdown has narrowed the only remaining escape hatch.

During the campaign, Reagan repeatedly predicted that growth in production and incomes would raise federal revenues enough to shrink deficits painlessly. Figures released last week, however, made it clear that right now the exact opposite is happening. The Government recalculated the third-quarter increase in the gross national product, or total output of goods and services, at a mere 1.9%, vs. 7.1 % in the previous three months. It reported a 7.3% drop in after-tax corporate profits during the third quarter. Moreover, October reports disclosed a slight but unexpected decline in consumer spending, and much bigger falloffs in housing starts (9.8%) and factory orders for durable goods (4.1%).

Some economists fear that the U.S. might be headed for, or perhaps is already in, a "growth recession." That is a situation in which production rises too slowly to create jobs for growing numbers of people looking for work. So civilian unemployment, now at 7.4%, goes up too. The majority opinion, however, is that growth will speed up again early in 1985. Some reasons: consumers' incomes are still rising faster than prices, which increased at a comfortably modest annual rate of 4.2% in October, and interest rates are shading lower. The Federal Reserve tried last week to nudge that trend along by reducing the discount rate it charges on loans to member banks by a half point, to 8.5%.

Meanwhile, though, the slowdown is causing deficits to shoot up again. Budget Director David Stockman now estimates that, if nothing is done, the shortfall will rise from $175 billion in fiscal 1984, which ended Sept. 30, to $210 billion in the current financial year and only slightly less in 1986. And these calculations assume renewed growth in the economy that the deficits themselves could all too easily retard. For example, a major cause of the current slowdown is the excess of U.S. imports over exports, estimated at a gargantuan $130 billion this year; this trade deficit is aggravated by the budget deficit, which keeps U.S. interest rates and the value of the dollar artificially high.

So something has to be done--but what? Though Treasury Secretary Donald Regan's aides reportedly have completed work on a tax-reform plan to be presented to Reagan, the President has declared that it will be turned into a disguised tax increase only "over my dead body." That leaves drastic cuts in future spending, which Reagan has directed his budget team to prepare. Simultaneously, though, the President told them to keep hands off Social Security and military outlays. Add some truly uncontrollable items such as interest on the national debt, says Washington Economist Michael Evans, and in effect "70% of the budget is off limits to cuts before you even start."

Reagan left Washington to spend Thanksgiving at his ranch in California without giving his budgeteers any clear idea of what cuts he might accept in the remaining 30%. In his absence, aides filled the press with speculation, seeking to test congressional and public--and no doubt White House--reaction to recommendations they might make when Reagan returns this week. Some were obviously prompted by a sweeping study prepared by the Heritage Foundation, a conservative think tank that takes credit for many of the initiatives launched in Reagan's first term (see box). Among the programs getting the most scrutiny from budget cutters:

Medicaid. Federal grants to states under this program, which helps the poor pay hospital and doctor bills, totaled $20 billion in fiscal 1984 and are expected to rise to $25 billion in 1986. The Heritage Foundation recommended a number of changes, and Administration officials let on that they are seriously considering at least one: reducing grants to states in which health-care costs are rising especially rapidly, presumably because those states are making inadequate efforts to hold them down.

Veterans' Benefits. Outlays are expected to increase from $25.9 billion in 1984 to $27.5 billion in 1986. They could well explode in a few more years, as millions of World War II veterans turn 65 and qualify for free treatment in Veterans Administration hospitals. Budget planners are considering various ways of holding down the cost, perhaps by instituting a means test or limiting care to veterans with service-connected ailments (a mere third of those now being treated in V.A. hospitals, according to one estimate).

Farm Subsidies. Price-support loans and direct subsidies will cost Washington about $12 billion in 1985, down from a record $20 billion two years ago but nearly four times the outlay in the last year of the Carter Administration. Reaganauts grumble that the subsidies are distorting the farm economy. They complain, for example, that some processors are turning out cheese in 7-lb. blocks suitable primarily for storage by the Government. Administration officials talk rather vaguely of shifting to lower supports over a three-to-five-year transition period.

Civil Service Pensions. Employees who were added to the federal payroll after last Jan. 1 are covered by Social Security, but some 2.8 million who were hired earlier as well as 1.9 million retirees or their beneficiaries enjoy a more generous plan. For example, after 30 years of service, they can retire on full pension at 55. The total cost of civil service pensions in fiscal 1984 was $21.9 billion. Reagan's budgeteers have outlined a fairly detailed plan to increase employee contributions to the program, reduce future cost of living increases in the pensions, and raise the age for retiring at full pension to 62 or 65.

Budget planners are talking up such recommendations as a new attempt to slash or eliminate federal operating subsidies for mass-transit systems, enact new restrictions on Government-subsidized student loans, consolidate and reduce many federal grants to localities, and perhaps abolish the Department of Education. But they are pointedly not discussing any further slashes in programs such as food stamps and welfare that make up the so-called social safety net. Vows one planner: "There will be virtually nothing in this budget that can be construed as an attack on the poor."

Until the President indicates what cuts he might choose, only two predictions seem safe: 1) whatever reductions he recommends will arouse bitter resistance from some of the best-entrenched lobbies in Washington (one senior Administration official comments wryly, "The starting presumption is that every one of the options will be politically impossible"); and 2) even if all the cuts now rumored could be enacted, they probably would not accomplish the Administration's goal of cutting the deficit roughly in half, to about $100 billion, by fiscal 1988 (planners no longer even talk about achieving a balanced budget during the Reagan presidency).

Some White House aides muse that an across-the-board freeze in domestic spending would save more money and stir less passionate opposition than cuts in specific programs. But that approach would present problems too: Congress might demand that military outlays be included, while Reagan would insist that they be exempted.

One uncertainty should begin to clear up this week. The Republican Senate majority will elect a new leadership Wednesday, so the White House will at least know with whom it will have to negotiate in the upper chamber. The Democrats controlling the House, however, may take a bit longer to select a Budget Committee chairman. In any case, though Congress has the final budgetary say, it will wait for a lead from Reagan -- just as his own Administration is now doing. At budget-cutting time, it gets lonely at the top.

-- By George J. Church. Reported by Neil MacNeil and Christopher Redman/ Washington

With reporting by Neil MacNeil and Christopher Redman/ Washington