The deficit and the federal budget

By , Staff correspondent of the Christian Science Monitor

Federal deficits that top $200 billion: For many Americans, the gulf between what Uncle Sam takes in and what he spends every year defies comprehension. It works out to about $860 for every man, woman, and child in the United States. The prospect of continuing deficits, and their impact on the economy, is the source of much debate in Congress, at the White House, and among economists at large.

''The American people want their government to do more for them than they are willing to pay for.''

Thus Alice M. Rivlin, director of the Congressional Budget Office (CBO) for eight years, zeroes in on why the federal government's annual budget sinks into a sea of red ink.

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Lawmakers apparently agree with Dr. Rivlin's assessment of what the voters want. Otherwise, the men and women of Congress would tell their constituents that they have a choice - higher taxes, or fewer programs.

Congress, of course, has someone else to worry about. President Reagan rejects tax hikes, boosts defense outlays, and demands that Congress trim social programs.

Over the past two years Congress has done just that, slashing means-tested programs (for which only the poor are eligible) at the President's behest. ''The whole universe of means-tested programs is down 14.4 percent since 1981,'' says Robert Greenstein, director of the Center on Budget and Policy Priorities, citing CBO figures.

''It is time to give social programs a rest,'' declares Sen. Robert Dole (R) of Kansas, chairman of the Senate Finance Committee. Congress agrees. Of the additional cuts in low-income programs proposed by Mr. Reagan in his fiscal 1984 budget, almost none passed.

What, then, grows in the budget?

''Programs that are growing are very limited in number,'' says Dr. Rivlin, now director of economic studies at the Brookings Institution. She ticks off three - defense, retirement programs (mainly social security and medicare), and interest on the soaring national debt, which alone swallows 12 cents of every budget dollar.

These growth areas comprise 65 percent of the total budget, which explains why one of Reagan's prime hopes - to reduce the scope of government spending - has vanished.

When the President took office in January 1981, the federal budget absorbed 21.1 percent of the gross national product (GNP), or total output of goods and services. Reagan vowed to shrink that slice of the pie to 19.3 percent by fiscal 1984, beginning Oct. 1, 1983.

Instead, under the budget passed by the House and Senate, fiscal 1984 spending will be 24.3 percent of the GNP - the highest percentage since World War II. The average for Reagan's four budget years will be well above 24 percent , compared with 21.9 percent for President Carter's term.

Because discretionary programs - chiefly means-tested welfare programs and the like - have already been sharply cut, the government's mammoth spending can be lassoed only if major growth areas are curtailed.

As long as interest rates remain high and continuing deficits force the Treasury to finance the shortfall through additional borrowing, little can be done to shrink interest payments on the debt.

As for defense, Reagan asked for a 10 percent hike in fiscal 1984. Congress gave him 5 percent. Further cuts are unlikely, especially in the wake of the shooting down of a South Korean airliner by the Soviets.

Some progress has been made in slowing the growth rate of social security outlays and, to a lesser extent, of medicare and medicaid. But soaring hospital costs will push federal health outlays from $82.4 billion in 1983 to $90.6 billion in 1984. More than 90 percent of this spending flows through medicare and medicaid.

Social security sends monthly checks to 36 million Americans. Medicare finances health costs for 30 million elderly and disabled people. Medicaid eases the financial burden of 23 million needy persons.

Social security and medicare, as distinct from means-tested medicaid, are primarily middle-class programs, serving an ever-growing portion of the United States population. Neither Congress nor the White House shows any taste for making meaningful cuts in middle-class programs.

Expensive technology is another reason defense and medical costs are hard to control, Dr. Rivlin says.

''High technology, with its higher unit costs, impacts directly on the budget ,'' she says. ''We are not adding to the number of soldiers, but it costs more to equip them. Medical advances mean higher unit costs per treatment.''

Although Reagan missed his spending goal, he did succeed on taxes. His three-year tax-cut program will bring revenues as a percentage of GNP down to 19 percent by 1984. This remains true, although tax cuts for many Americans have largely disappeared because of higher social security taxes, plus bracket creep due to inflation.

As part of Reagan's tax package, bracket creep will end beginning Jan. 1, 1985, when income taxes are scheduled to be indexed to inflation. This will benefit taxpayers but will also reduce the flow of revenue to the US Treasury, which traditionally has counted on inflation to boost tax payments.

Ironically, the President's very success on taxes contributes mightily to the budget dilemma. The growing disparity between what the government takes in and what it spends creates the structural element of the budget deficit - the part of the shortfall that economic recovery alone cannot erase.

During a recession, the government collects less money in taxes and spends more for unemployment compensation and related costs. Each 1 percent rise in unemployment costs the Treasury roughly $25 billion in lost taxes and additional outlays. This part of the deficit is called cyclical.

A sustained economic recovery will reduce unemployment from the current 9.5 percent to perhaps 6.5 percent, thereby increasing tax revenues and trimming recessionary outlays. But the structural part of the deficit will persist, so long as spending growth outstrips the amount of taxes that can be collected under current law.

''The simple fact is that if we don't cut our spending, or raise taxes, or both, we will have escalating deficits of staggering proportions over the next several years,'' says Dr. Rivlin.

Growth areas of the budget, as we have seen, are unlikely to be trimmed anytime soon. What, then, about tax hikes, the only other way to close the budget gap?

''There is no way that we can grow our way out of this budget problem,'' says Rudolph G. Penner, new director of the CBO. ''The overwhelming message is that we need tax increases, beginning now.''

Most experts agree with Dr. Penner. But, says John E. Chapoton, the Treasury's chief tax official, tax hikes are ''dead for this year'' and any major increases are unlikely before 1985 - that is, after the 1984 elections.

This means, according to a CBO analysis, that the budget deficit - now 6 percent of GNP - is likely to hover at the $200 billion level for several years to come.

Mr. Reagan did not foresee things turning out this way when he pledged that the budget shortfall would evaporate by fiscal 1984. He operated on so-called supply-side theory, which holds that massive tax cuts would generate so much growth that fresh tax revenues would pour into the Treasury. What went wrong?

''The unique feature of Reaganomics - the big tax cuts - did not achieve the expected goal: an increase in savings and investment,'' says economist Herbert Stein of the American Enterprise Institute.

''The administration,'' he says, ''made the mistake of trying to do too many things at once'' - huge tax cuts, coupled with mammoth boosts in defense spending, and no real effort to curb outlays for social security and medicare.

If the President's economic program had fostered a dramatic increase in net savings - that portion of income saved or invested by individuals and corporations - the huge deficits could more easily have been financed without upward pressure on interest rates. But the US savings rate, if anything, has declined during the Reagan years.

''The historical savings rate of the private sector is 16 percent, of which 5 -6 percent is individual, 10-11 percent corporate. To finance a deficit that is even 2 percent of GNP, you would need about a 40 percent increase in the savings rate,'' says Stein, who has served as an adviser to Republican presidents.

Instead, the deficit runs at 6 percent of GNP and the savings rate failed to grow. With what result? The Treasury swallows up the bulk of private-sector savings by borrowing to pay government bills.

''Rarely in the past has the deficit amounted to more than 20 percent of net savings,'' Penner says. Through 1985, without radical shifts in spending and tax policies, the deficit will equal 80 percent or more of the nation's annual savings pool.

What looms ahead is collision, as the Treasury and a resurgent private sector compete for capital. The Treasury will win, but the public will lose, through higher interest rates.

''The pool of savings is sufficient this year to prevent the crowding out of the private sector,'' says Treasury Secretary Donald T. Regan. ''But if we have high deficits year after year, we will get crowding out. The markets cannot stand the Treasury going in for $180 billion to $200 billion in new borrowings (each year), plus the rollover of the existing $1 trillion debt.''

''When the government takes 4 to 5 percent of GNP in borrowing in a nation where the (individual) savings rate is 7 percent,'' says Martin S. Feldstein, chairman of the Council of Economic Advisers, ''the effect inevitably is to raise long-term interest rates.''

The chain of events works like this:

Sometime next year, as the financial markets see it, the Treasury's huge borrowings will shoulder aside the capital needs of the private sector. This will force the Federal Reserve to choose between two policy alternatives:

* The Fed can ensure that there is enough capital to go around by allowing the money supply to mushroom. Down this road lies inflation.

* To prevent inflation, the Federal Open Market Committee - the policy-setting arm of the Fed - could tighten credit. Interest rates would climb , slowing the recovery or, in the extreme, halting it.

The lending community, meanwhile, is certain of only one thing: that neither Congress nor the President will cut the deficit meaningfully before the 1984 election. What lenders do not know is how the Federal Reserve will respond to the deficit threat.

This breeds uncertainty, impelling bankers who lend out their own and other people's money to pump up interest rates protectively. During the late spring and summer of this year, interest rates rose about 1.5 percent.

Secretary Regan says that there is nothing on the inflation front to prompt such a rise. With inflation now running at less than 4 percent, he says, rising interest rates are ''an act of levitation,'' defying logic.

Regan argues that large budget deficits do not cause high interest rates. He cites a Treasury study to back him up. Rather, he says, banks and other financial institutions are charging an unconscionably large ''spread'' to borrowers.

''Spread'' measures the real interest rate - the difference between inflation (4 percent) and the nominal rate of interest charged (11 to 13 percent at present, even higher on home mortgages). This produces a spread of 7 to 10 percent.

Bankers respond that their spread is nowhere near that large, because in order to get money to lend they have to pay high interest rates themselves, either to depositors or to other lenders.

Be that as it may, agreement is widespread (except for Regan) that deficits do cause interest rates to hang high, because of the perception that down the road lies either inflation or a credit squeeze.

''Of course there is a correlation between huge deficits and interest rates, '' says Brookings Institution economist Barry P. Bosworth. ''The (Regan) argument to the contrary is specious. Deficits in the past usually have been associated with a depressed US economy, when private-sector borrowing was low. Now the White House anticipates huge deficits in an expanding economy, when private borrowing will be brisk and will collide with Treasury borrowing.''

''The primary cause of high real-interest rates,'' says Jack Carlson, executive vice-president of the National Association of Realtors, ''is the prospect of federal budget deficits of $200 billion or more for several years. Current and future deficits are adding 3 to 4 percentage points to long-term interest rates.''

In its June 23, 1983, budget resolution for fiscal 1984, Congress included $ 12 billion in spending cuts and $73 billion in tax increases, to be spread over three years. The effect of these measures would be to drop the budget deficit from $210 billion in fiscal 1983 to $145 billion in 1986. As a percentage of GNP , according to the CBO, the deficit would shrink from an estimated 6.4 percent in 1983 to about 3.5 percent in 1986.

Back from its summer recess, however, Congress shows little sign of implementing either tax hikes or spending cuts, despite discussions among some leading Senate Republicans who advocate narrowing tax loopholes to yield $12 billion to $13 billion in additional revenue over three years. Democrats, says House Speaker Thomas P. O'Neill (D) of Massachusetts, will initiate no tax boosts on their own. Impulse must come from the President, and he remains adamant against higher taxes.

That being the case, the budget deficit annually will cast a $200 billion shadow across the economy for some time to come. One result will be high interest rates, at least as high as they now are.

Interest rates, in fact, are perhaps the best way for average citizens to grasp how the budget shortfall affects them. To most people, a figure of $200 billion is incomprehensible. A 1 percent hike in mortgage interest rates, on the other hand, or the rate required to buy a car on time, applies directly to family pocketbooks.

Many thousands of Americans in export industries have lost their jobs, because an overvalued dollar shrinks overseas markets for US goods. US interest rates higher than rates abroad boost the value of the dollar.

The US Treasury, meanwhile, cannot escape from paying its debts by declaring bankruptcy, as individuals and corporations can. Buyers of Treasury certificates expect their principal back, along with interest.

The word of the US Treasury, experts agree, is the globe's last resort in a troubled financial world. To keep its word, the Treasury borrows more and more, because neither Congress nor the White House requires the federal government to pay its way.

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