Prepare for tax hikes. The current size of the US budget deficit and the prospect for its increase are forcing the administration and Congress to consider more intently some form of tax increases.
''The general atmosphere,'' says Herbert Stein, who was chairman of President Nixon's Council of Economic Advisers, ''is getting too hysterical about the budget deficits.''
He's concerned that this will lead to what he regards as unwarranted cuts in defense spending. In a telephone interview, he said he'd rather send a signal to the Kremlin about United States defense preparedness than a signal to Wall Street that the deficit would be smaller.
By contrast, Alan Greenspan, who was President Ford's top economic adviser, would like to see the defense program stretched out, though not cut in its goals. He's more concerned about the impact of budget deficits on the economy. ''One critical aspect of national security is the state of the economy,'' he noted in a telephone interview. ''A considerable part of our ability to be advanced technologically relative to the Soviet Union is the structure of our private economy.''
Both economists, though, would like the federal deficit trimmed. Dr. Stein suggests cutting it to $100 billion, 2 percent of gross national product (GNP), the nation's output of goods and services - in five years. He wants it done by cutting entitlements and boosting taxes, not defense.
Whatever, it isn't going to be easy to knock down the deficit by budget cuts alone.
George Brown, an economist with Data Resources Inc., an economic-consulting firm in Lexington, Mass., says that if the growth in real defense spending, after removing inflation, were reduced from the presently projected 7 percent down to 3 percent a year, it would save $250 billion in defense spending over the next five years. But it would trim the budget deficit only $120 billion over that time span, or about one-eighth of the deficit anticipated in that period. That's because the cut in defense spending would also reduce tax revenues and slow the economy somewhat.
Similarly, Mr. Brown continued, if nondefense spending were slashed $250 billion, it would also only knock down the deficit by about one-eighth. But he added that he has seen no proposals in Congress for cutting civilian spending by more than $30 billion a year - or substantially less than $250 billion.
''Spending cuts, even if you go out with a meat axe, are not going to solve the deficit problem,'' he concluded.
Mr. Brown's calculations are based on a modest recovery, with real GNP rising something over 2 percent this year and 3 percent in following years.
Some are more hopeful.
''I am expecting a somewhat stronger recovery than all my cautious economist friends predict,'' says Richard D. Hill, chairman of the executive committee of First National Bank of Boston. Citibank officials also hold that administration economists and others are ''poor-mouthing the upturn.''
Even if the economy does rise more rapidly than many anticipate, the increase in resulting government revenues is not going to completely close the budget gap between revenues and expenditures.
Dr. Stein, now with the American Enterprise Institute in Washington, suggests that one deficit-reducing technique would be for Congress to brace itself and tackle the problem of social security. He would not index payments against the ravages of inflation so thoroughly. He would bring federal workers into the program. He would stretch out the normal retirement date gradually. And he would make half of the benefits taxable, since the recipients of those benefits have not paid taxes on that half when the money was earned. Moreover, such taxation would not hurt poor recipients, he said.
Further, Dr. Stein would raise taxes. He says he's not fussy about how, but did mention such ideas as a tax on value added; a boost in excise taxes, including imposing one on imported oil; and removing some tax loopholes, such as interest on home mortgages. (The latter, of course, would not be politically popular in Washington.)
''We have a big tax base out there,'' he noted.
One aim of any tax changes should be to go further in encouraging savings, he added.
Dr. Greenspan wants a freeze on all federal cost-of-living increases, including those for social security benefits. And if necessary, he would ''not be against'' the creation of a tax on value added in the future.
President Reagan had hoped that his supply-side tax cuts would so stimulate production that government revenues would rise rapidly and reduce the deficit. Considering the impact of inflation, average tax cuts have actually not been large in real terms. Nonetheless, marginal tax cuts for the well-to-do have been sizable - but the impact on revenues has not so far been large.
Messrs. Stein and Brown both say the economy should not determine the size of the defense budget. Defense-budget decisions should be based on national-security needs, Mr. Brown said. Dr. Stein added that the American economy will remain far stronger than that of the Soviet Union, no matter what is decided on the defense budget.
But if defense spending is not paid for out of tax revenues, its financing in the capital markets will tend to drive up interest rates, assuming the Federal Reserve system holds the monetary line. This, Dr. Stein said, would weaken interest-sensitive industries such as autos and housing. Data Resources also sees damage from high interest rates to business-fixed-capital formation. The defense industries, naturally, would be doing well.
Data Resources calculates that this crowding out of investment takes a long time. But by 1988, potential GNP is reduced by 0.9 percent. And the damage gets worse in subsequent years.
''This loss of potential GNP growth reduces the country's ability to meet its needs, whether for rising living standards, increased capital formation to maintain our competitive place in the world, or even to meet future defense bills,'' Mr. Brown and his boss, Otto Eckstein, told Congress in written testimony. ''The failure to pay for defense can thus be seen to be a very damaging economic policy.''
That's why administration officials have been trying to persuade the President to agree to a budget that somehow reduces the deficit in the years ahead. And that would include tax increases.