Washington: Endless Deficits

The Reagan Administration has abandoned hope of a balanced budget, but has not faced the big questions about spending

THE REAGAN ADMINISTRATION, on which fortune smiled so often during the President’s first year, has faced in its second year the surest sign of political trouble. As soon as the President’s representatives proposed the heart of their domestic program, the projections for the 1983 budget, they were attacked from every side. Their assailants were groups who could agree on nothing except their opposition to this plan.

Some people on the administration’s political right pointed out that even if every one of the President’s recommendations was enacted, they would accomplish nothing more than retarding the growth of federal spending. After four years of the “Reagan revolution,” they concluded, the dead hand of the public sector would weigh even more heavily upon private enterprise than it had before the revolution began. But from the left came the judgment that these same budget recommendations were niggardly and unfair. Meanwhile, the business leaders and financiers in whose name the administration had undertaken its dramatic tax reductions issued the warning that the government’s revenues were too slight to support its spending plans.

The worst thing about these contradictory complaints was that all of them were true. This proved to be politically awkward for the administration, but it is something worse than awkward for the groups that have attempted to propose alternatives, and for the public that must live with the results.

The reason for the furor was that the budget represented two fundamental changes in modern political economy. Although both of them were logical extensions of the administration’s previous views, many politicians avoided contemplating their effects until this year’s budget was proposed. One of the changes concerns the balance between the government’s resources and its obligations; the other, the altered composition of what it uses its resources for.

The simplest way to describe the first change is to say that the administration has proposed enormous deficits. By the administration’s own estimates, the deficits in the four years from 1982 to 1985 would be the four largest in American history. But to emphasize their size is to distort their significance. What was special about these deficits was their nature. The administration was projecting deficits under circumstances different from any others in the years since World War II.

In the postwar era of big government and the welfare and national-security states, both Republican and Democratic administrations have repeatedly incurred deficits. In absolute terms, the $98.6 billion deficit expected in 1982 would be the largest ever, but as a percentage of the gross national product, it would be second to President Ford’s deficit of $66.4 billion in 1976. (That represented 4 percent of the gross national product in 1976; this year’s deficit is expected to be 3.2 percent of this year’s gross national product.) Except for John Kennedy, every American President since Dwight Eisenhower has endured at least one deficit equivalent to 2 percent or more of the gross national product, which would be about $62 billion this year. And all these figures pale by comparison with those of the early forties, when wartime deficits were as high as 31 percent of the gross national product.

But all previous deficits were—in theory, at least—self-correcting. How deficits rose and fell was well understood. In hard times, when workers were laid off and production declined, deficits would rise: the government was taking in less money through its taxes on incomes and profit, and it was paying out more through the various relief systems it had created during and after the New Deal. When the business cycle turned up, the deficits were supposed to melt away. In the early sixties, economists would have said that deficits vanished through the same process in which they appeared, but in reverse: fewer welfare recipients, more taxpayers. In the seventies, the curb on deficits came from chronic inflation, which constantly pushed taxpayers into higher brackets and effectively gave the government an automatic tax-rate increase every year.

As a measure of the (supposedly) transitory nature of their deficits, administrations used to publish what they called the “full-employment” or “high-employment” budget. Even if the real budget for a given year fell $30 billion into deficit, an administration could show that the cause was not misguided policies but rather a recession; under “high-employment” conditions, a secretary of the treasury could say, the same tax rates and spending plans would produce a balanced budget. And since every administration in modern history has, in its fouror five-year economic projections, foreseen just such a return to high employment and low inflation, Presidents have usually been able to project a balanced budget a few years away, in the hazy period known in Washington as “the outyears.” Jimmy Carter projected such a result in his “outyears” of the early eighties; President Reagan’s budget director, David Stockman, predicted a budget surplus by 1984 when he spoke for the administration early last year.

The difference in this year’s projections is that they offer virtually no hope of self-correction. The administration has made economic forecasts that strain the standards of this optimistic calling— and even so, it foresees the largest deficits in history. The concern among congressmen and financiers mounted as they turned their minds to what might happen if this administration’s forecasts, like others’ before it, do not come true.

In his first few appearances before the Congress this year, David Stockman was at pains to emphasize the “realism" and “honesty” of his budget projections, in implicit contrast to those he offered the year before. Nonetheless, the economic achievement he predicted for the next few years represented merely an interruption, rather than a basic change, in the prospect of continued boom times he had set out last year. By this spring, the administration conceded that there would be a recession in 1982; Stockman said that the gross national product would probably grow by only .2 percent (in real terms) this year, as compared with the 4.2 percent growth he predicted one year earlier. But once this year has ended, rapid growth, high employment, and low inflation will, in the administration’s view, prevail. In 1983, the economy will grow by 5.2 percent; through the next three years, it will grow by between 4.4 and 5 percent every year. All of these figures are higher than the corresponding predictions made last year.

This increase in national wealth will, so the administration says, drive unemployment down, although not quite as fast as predicted last year. From 8.9 percent this year, the unemployment rate is supposed to fall to 7.1 percent two years from now and 5.8 percent two years after that. At the same time, the administration’s efforts will restrain inflation, which will be down to 5 percent in 1984 and will keep falling thereafter.

WHAT ALL THIS amounts to is a picture of steady, non-inflationary economic improvement unprecedented since the mid-sixties. When those very conditions prevailed in the sixties, they generated so much public revenue that deficits occurred only because of the attempt to pay for the War on Poverty and the war in Vietnam at the same time. But in the eighties, if every one of these predictions does come true, the government will still be left with deficits of at least $96 billion in fiscal year 1983 (which begins on October 1, 1982), $83 billion in 1984, $72 billion in 1985, and $66 billion in 1986.

Even these figures conceal the true magnitude of the problem, because they assume that the administration will have put in place a “budget-saving plan” made of vaguely specified management improvements, tax increases, and program reductions. Without these changes, but with the same rosy economic assumptions, the deficits would be far larger— at least $152 billion in 1983, $167 billion in 1984, $171 billion in 1985. (This does not include the extra $20 billion or so that is added to each year’s deficit by “off-budget” activities, such as federally guaranteed loans.)

The prospect of these deficits is, in a sense, the perfectly predictable result of the administration’s success in enacting its “supply-side” tax decreases without reducing federal spending. The reductions in individual and business taxes are generally expected to reduce the government’s receipts by some $715 billion in the next five years—a figure nearly high enough to explain the deficits by itself. By the end of that time, “indexing” of federal tax schedules will take over, which will mean that the government’s expenses are driven up by inflation but its receipts are not.

But the administration managed to assume away this logical consequence last year, through theories of a “supply-side” economic boom that, because they were untested, could not be disproved. This year, the administration returned, chastened, to admit that the plan will not work as well or as fast as had been hoped. The administration’s admissions were less damaging for what they said than for what they implied. If deficits slowly declining from $100 billion were the best that could be hoped for, what might happen if something went wrong?

THE CONGRESSIONAL BUDGET Office attempted to answer that question, and in so doing depressed spirits further still. Last year, Stockman and other spokesmen from the administration attacked the CBO whenever it released an economic projection less optimistic than their own. They called the CBO biased, saying that the very formulas in its computer programs bore the mark of Keynesian ideology, which was no longer applicable in the age of supply-side tax cuts. As it happened, the CBO came closer to predicting this year’s recession than did the administration, though even the CBO underestimated its severity. In the slippery business of economic forecasts, the CBO has compiled a better record than most; and so, its estimates of budget deficits issued this spring quickly replaced the administration’s figures in negotiations over the budget.

What the CBO did was to develop a “baseline projection” of future levels of unemployment, inflation, and economic growth. In general, it assumed that unemployment and inflation would be somewhat higher, and economic growth somewhat lower, than the administration’s forecasts. From these levels, it then calculated the corresponding deficit in each year. All its deficit estimates were higher than the administration’s, in some cases dramatically so. For fiscal year 1983, it said that the most likely deficit would be not $96 billion but $157 billion—and that deficits would rise, not fall, through the following four years. By 1987, it said, the deficit would be $248 billion. As percentages of the gross national product, these deficits would start at 4.6 percent in 1983—higher than at any time since World War II—and go above 5 percent in the next few years. Under the most optimistic assumptions, the CBO said, the deficit might be as little as $146 billion in 1987. Under the most pessimistic, it might be $367 billion.

This is why the Democrats’ attacks on the deficit were less droll than they might initially have seemed. No administration in the past had ever proposed nearly endless deficits. Republican administrations had strained toward balanced budgets; Democratic administrations had argued that deficits were in consonance with their overall economic plans (because, once again, deficits would occur only when the economy was depressed). Unlike its Republican predecessors, the Reagan Administration abandoned hope of a balanced budget; unlike the Democrats, it found its deficits at total war with the rest of its economic policy.

From the very day of Ronald Reagan’s election, the economic philosophy of his administration has been divided between the supply-siders, who place their economic hopes in tax cuts, and “monetarists,” who feel that an economy’s problems start when the supply of money expands more rapidly than the supply of goods. The supply-side part of this philosophy means that the administration is not afraid to run big deficits, since its main goal is to cut taxes. The monetarist part means that when it comes time to finance its deficit, the government wall compete against private borrowers for funds, rather than just printing more money to cover its needs. This means, in turn, that interest rates will soar. The hope of supply-siders is that their tax cuts will stimulate the creation of new wealth. The effect of the monetarists is to make interest rates so high that businesses find it hard to make a profit on new endeavors, no matter how attractive the tax breaks. In the absence of new endeavors and the new jobs and products they create, federal deficits grow larger, and the cycle begins again. It was this self-feeding cycle that people had in mind when they began using the word “depression” in referring to the effects of “Reaganomics”; it was because of this fear that congressmen spoke of reconsidering the tax cuts and re-examining the budget.

ON RE-EXAMINATION OF the budget, the second large change made by the administration becomes clear. It is a change in the inner makeup of the budget, and in this case the simplest way to describe it is also the most precise. In allocating increases and reductions in federal spending, the Reagan Administration has assigned the greatest share of the sacrifice to the poor.

Between 1955 and 1965, government spending grew at the same rate as did the overall economy. Federal spending remained at about 18 percent of the gross national product through all those years. Because they were years of plenty in the private economy, the government had steadily more resources at its disposal. It used them largely to inaugurate a number of new social programs. The most familiar of these were the Great Society programs, such as Model Cities, the Community Action Program, and Head Start, as well as such large national efforts as the Apollo program. But the most significant new undertakings, in terms of their eventual effect on the budget, fell into the government category knowm sometimes as “entitlements,” or, with a slightly different meaning, “payments to individuals.” Medicare was such a program—a new entitlement to medical care for older people. Social Security, another entitlement, was greatly liberalized; like a number of other pension programs, it was eventually equipped with an automatic cost-of-living adjustment, known as COLA, to enable beneficiaries to keep pace with inflation.

By the beginning of the 1980s, such programs had created a federal budget dramatically different from that of twenty-five years earlier. All in all, public spending represented a larger share of the gross national product—22.6 percent in 1980 versus 18 percent during the fifties and early sixties. The military, which had accounted for 58 percent of the entire federal budget in 1955, was only 23 percent in 1980. The figure for 1955 is artificially high, since Social Security payments were not officially included in the budget then. Still, since defense budgets had remained fairly constant, in real terms, while other forms of federal spending grew, the military’s share of the total continued to fall. The entitlement payments that had begun their substantial growth in the sixties made up 47 percent of the federal budget in 1980. Their rapid growth was due less to the creation of new programs—almost no “new” entitlements have been enacted in the past five years—than to increases in the number of retirees and to the cost-of-living adjustments. Another 11 percent of the budget went toward interest on the national debt in 1980, and the remaining 19 percent covered everything else.

As it began its efforts to revise the budget, the Reagan Administration was constrained by one decision of principle, one decision of practicality, and one inescapable fact.

The decision of principle was that the nation must spend more for defense. Including the revisions it made in Jimmy Carter’s last military budget, the Reagan Administration planned to increase military spending by more than 40 percent, in real terms, within five years. Between 1972 and 1980, military spending had fallen by an average of .6 percent a year; between 1980 and 1985, it was to rise by 8 percent each year. As a proportion of all federal spending, defense would rise from 23 percent in 1980 to 29 percent in fiscal year 1983, and to 36 percent in fiscal year 1987.

The decision of practicality was not to propose reductions or changes in the Social Security system, and to make only the most delicate suggestions about Medicare. In 1981, David Stockman had led the charge for revisions in Social Security benefits, but the administration’s plan was disapproved in the Senate by a vote of 96-0. Between them, Social Security and Medicare make up 80 percent of the entire federal budget, or nearly two thirds of all entitlement payments. During 1983, the cost of Social Security is expected to rise by $15.5 billion because of cost-of-living adjustments alone. Yet the administration declared this large tract of the budget off-limits for its cuts.

The inescapable fact was that interest payments on the national debt—essentially, the premiums paid on Treasury bills—would rise, because interest rates were so high and the deficits so large. In the mid-fifties, interest was usually about 7 percent of the budget. By the mid-seventies it had risen to 9 percent. In 1983, the administration predicts, interest payments will represent 15 percent of all federal spending.

When all these decisions are rolled together, the most important choices about a budget have already been made. Its total size is likely to grow. If all of the administration’s forecasts come true, federal spending will gradually decline from 22.6 percent of the gross national product in 1980 to 22.2 percent in 1985. If the CBO is right, federal spending will reach 23.2 percent in 1985. But that overall growth will not be able to keep pace with the growth of certain vigorous components. The quickest-growing portions, of course, are defense, Social Security, Medicare and Medicaid, and interest payments. Together, they already represent two thirds of the budget. They are expected to be three fourths next year, and four fifths by 1987. For them to grow, something else must shrink. This brings us back to the poor.

IN ITS BUDGET proposals for 1983, the administration suggested several ways to keep budget deficits from getting totally beyond control (that is, to bring the 1983 deficit from $152 billion down to $96 billion). Some involved increasing the government’s revenues, but without repeal of the major tax cuts. For example, the administration might lease oil tracts on the outer continental shelf at a faster pace, or increase the manpower of the IRS (each dollar spent on an agent’s salary is thought to bring in about eight dollars through audits), or impose “user fees,” such as a tax on aviation fuel, through which private pilots would bear more of the cost of the federal aviation-safety system.

But these steps would not be nearly enough without further cuts in federal programs. The programs being reduced fell into two general categories: those, such as food stamps, Medicaid, and other welfare programs, that had been undertaken to help the poor; and those, such as funding for education, transportation, scientific research, or natural resources, that had been advanced in the name of national welfare in general.

Of the $27 billion by which the administration proposed to reduce programs in 1983, about $10 billion would be taken from entitlement programs. But most of the reductions would come from the small portion of the entitlement payments that are “need-related,” or aimed at the poor. Eighty percent of all entitlement programs are “non-need-related.” The retirement programs, including Social Security, fall into this category, along with Medicare and certain other benefits. These payments represent, in general, transfers from tax-paying middleclass America to older versions of itself. (It is, of course, an indication of how successful Social Security and Medicare have been that the elderly can no longer be automatically classified among the impoverished, as they were before these programs.)

The only substantial reduction in these programs in the administration’s budget was a change in the Medicare reimbursement system that is supposed to save about $2 billion in 1983. Along with a slowdown in the cost-of-living increases given to federal retirees, plus a few other changes, the savings from the “middle-class” entitlements will come to about $3 billion. Since these programs total well over $300 billion, that is a reduction of less than one percent.

That leaves $7 billion to be taken out of the rest of the entitlements, the 20 percent that are intended to help the poor. These programs now total $57 billion, so in aggregate they would be reduced by 12 percent in one year. The food-stamp program would be cut by $2.2 billion in 1983, after a $1.5 billion reduction in 1982. The Aid to Families with Dependent Children program—“welfare,”in the classic sense—would fall by $1.3 billion. In a few cases, such as that of Supplemental Security Income, which is a direct cash grant to the poor, the administration’s reductions simply keep the program from growing larger. But for most entitlements, including the two largest programs, Medicaid and food stamps, the budget provides significantly fewer dollars in 1983 than in 1982 ($10.35 billion versus $11.2 billion for food stamps, $17.1 billion versus $17.9 billion for Medicaid).

To point out the reductions in these programs is not to imply that all of the programs are effective or conceptually sound. Some are not. But it is to suggest a grave imbalance in the “sacrifice” the administration has asked the nation, through this budget, to make. The Congressional Budget Office, in a report issued this spring, attempted to quantify the imbalance. It found a simple correlation. The higher a family’s income, the more it stood to gain from the administration’s tax cuts; the lower its income, the more it stood to lose as programs were reduced. According to the study, in 1983 the changes in tax rates and benefits would amount to a 1.7 percent reduction in total income for families earning less than $10,000—and a 6.7 percent increase for families earning $80,000 or more. That the tax cuts would have such an effect was understood from the beginning and defended by the administration as a necessary part of supply-side theory. Not so the pattern of reductions in benefits.

The rest of the administration’s reductions come from the “non-defense discretionary programs.” These include scientific research and energy-development projects, housing assistance, grants for mass-transit systems or for water and sewer projects, operation of the national parks, and just about everything else the government does besides paying for pensions, interest, and the military. As a category, these programs reflect a desire to add to the stock of “public goods”— the underpinnings of the nation’s productivity, from its highway system to its trained labor force. Proportionately, they are being more severely cut than anything else in the budget. They are to be reduced by $14.2 billion in 1983, through such steps as “zeroing out” nearly all employment-training projects, and by a further $61 billion in the following two years, in ways the administration declined to specify.

THE REAGAN BUDGET, then, amounted to this: a government that would serve as armorer and as pension agent, and would honor its debt—but a government that could do little else, and would nonetheless see its spending outstrip its resources by growing amounts each year. It was this implicit vision of America’s future that created much of the outcry about the budget. But is there really an alternative?

The economists have concentrated on “retuning” the fiscal and monetary system of the government, so that interest rates and federal deficits do not chase each other up and up. This is no simple step, since it involves the clash of ideologies and the workings of such vast and complex organisms as the national banking system and the Congress of the United States. But it is probably a simpler exercise than two others that must be performed if the budget is not to continue further in the direction indicated by the 1983 proposals. One is to think more carefully about the connection between military spending and military strength; the other, to confront the growth of “middle-class” entitlements.

The Reagan Administration’s proposals for the military are even more profligate than is generally perceived. As presented by Caspar Weinberger, the secretary of defense, in his annual report to the Congress, the budget is propelled by purchasing decisions rather than by strategy and has no obvious theme or emphasis other than “more.” The annual report itself was indicative; these documents, informally known as “posture statements,” usually contain several hundred pages, traditionally divided fifty-fifty between a strategic rationale and a list of proposed purchases. This time, the buy-list was three and a half times as long as the rationale, and the rationale itself consisted of highly dubious comparisons between Soviet and American spending. For example, the NATO alliance as a whole outspends the Warsaw Pact, but the report discounts this advantage, saying that the greater diversity of the NATO nations means that their forces are only “60 per cent additive to U.S. efforts, while Soviet satellite efforts are 90 per cent additive to Soviet efforts.” There is no indication of where these numbers came from, or of how “additive” the Polish army might be to the Soviet, or of whether a diverse force might actually have great tactical advantages over a more homogeneous adversary.

The true danger of this budget is what it threatens to do to American forces in the next few years. In the month and a half before it was presented, the 1983 military budget suddenly swelled by some $15 billion. The “total obligational authority” in the budget—the military’s authority to let contracts—had been expected to be around $245 billion, but when the final budget submissions came back from the printers, the TOA was nearly $260 billion. Not all of this money, and very little of the extra $15 billion, will actually be spent in 1983. Two new nuclear-powered aircraft carriers, for example, will eventually cost some $7 billion, but only $200 million of that would be spent—for planning—in 1983. Some congressmen and others rose to this bait. They concluded that it was hardly worth scrutinizing such far-off purchases, since you couldn’t save any money on them this year. But if they are not scrutinized this year, they determine the shape of the military budget for a half-dozen years to come. By reducing the flexibility of future budgets (much as entitlements do in the domestic budget), they also increase the odds that when squeezes on the military budget come, planners will be left no option but to rob the accounts that pay for fuel, readiness, and training. Such a pattern is the sad story of the last generation of military management; Secretary Weinberger’s budget would ensure that this story continues unchanged.

The “middle-class” entitlements are as challenging an issue intellectually as the military—and vastly more difficult as a political proposition. “Middle-class” tax breaks, such as the home-mortgage deduction, have made this a nation of homeowners; Social Security and Medicare have accomplished their purposes as effectively as any public programs ever devised. Yet the price that must be paid for these benefits is rising fast. By the beginning of the next century, there could be only half as many tax-paying workers per retired beneficiary as there are now. It is not too soon to ask whether we can afford to offer Social Security and Medicare benefits to everyone, regardless of need. Will there be enough for people who truly need help if the help is extended to all? Should our government aspire to any non-military function other than the payment of pensions and debt?

In avoiding such questions, and their counterparts about military spending, the administration was driven to its 1983 budget. Until they are faced, that budget is the shape of the American future.

—James Fallows