Deficit numbers better, but how bad were they in the first place?

CONTRARY to many pessimistic predictions, the United States budget deficit in fiscal 1988 is running about the same as last year. For the first 10 months of the year ending Sept. 30, the deficit totals $142 billion, compared with $142.9 billion for the same period in 1987. Considering that the volume of capital-gains taxes collected last year was exceptionally high because of a change in the tax laws, the nation continues to make some progress in reducing the deficit.

But to Boston University economist Laurence Kotlikoff, this deficit number is ``garbage.''

Some other economists diminish the economic importance of the deficit by noting offsetting factors. For example, state and local governments together enjoy budget surpluses - perhaps $40 billion or $50 billion. Inflation trims the real value of outstanding debt held by the public by about $90 billion a year. Some government spending adds to the capital assets owned by the nation, rather than to consumption.

Professor Kotlikoff takes an even more uncommon view by arguing that the deficit is an inherently arbitrary accounting construct that has led the nation to completely misread its true fiscal policy. He believes the deficit should be measured by a form of reckoning that takes regard for the budget's intergenerational impact. In other words, does it financially help or hurt us, our children, or our grandchildren?

Looking at the accounting issue, when government takes money from the private sector, it can label those receipts as ``taxes'' or ``borrowing.'' Taxes won't be repaid. Loans and interest are to be repaid in the future.

Taxes reduce the deficit. Loans are part of the deficit. Both currently come from the public's pocket.

The labeling problem becomes clearer in the case of social security taxes. These are now classified as taxes. But they could just as easily be called borrowing, because the government promises to pay the employee back in the future with specific benefits, mainly a pension.

Kotlikoff suggests that if, in return for their taxes, the government had given employees a piece of paper, a ``social security bond,'' whose principal and interest would be repaid according to a certain formula on retirement, the government would have racked up deficits as large as $600 billion in the 1970s. That was a time when Congress was passing more substantial social security benefits.

Congress eventually realized that its generosity would one day bankrupt the system. Thus in 1983 it reversed direction and cut the benefits of future retirees. Soon after the year 2000, full benefits will not be granted until an individual reaches 67. By then, most retirees will also be paying taxes on their social security benefits.

As a result, says Kotlikoff, the government really enjoyed a roughly $1 trillion surplus in 1983 - a sum about equal to the debts built up during the Reagan years under current deficit accounting, in which government ``spending'' less ``taxes'' equals the deficit.

Kotlikoff sometimes offers economic advice to Democratic presidential nominee Michael Dukakis. His conclusions on the deficit, however, should in theory please the Republicans.

For example, Democrats often charge that the Reagan administration has left to our grandchildren the obligation to repay our debts. Kotlikoff calculates that when several other tax factors are taken into account, Reagan policy has been ``fairly neutral'' in its impact on the present generation.

But he doesn't believe the Republicans can take credit for this. ``The Reagan administration doesn't know what they are doing most of the time in economics,'' he says.

In the case of the younger generation, the Reagan tax cuts are of great benefit. But the 1983 social security change trimmed their benefits by about 20 percent, if measured in terms of the loss in what economists term ``present value.'' The two changes roughly cancel each other out.

Older Americans weren't much hurt by the social security changes and did benefit from the tax cuts. But a shift in the tax burden away from income toward consumption in 1981 (through an accelerated cost recovery system that affects stock values) did do some damage.

Because of such complications, Kotlikoff believes the present calculation of the budget deficit should be scrapped in favor of a system that squares with neoclassical economics. The new system should take account of what each generation will pay to and receive from the government over its lifetime.

Of course, that isn't going to happen anytime soon. It took decades for Washington to adapt (in theory) to the Keynesian economic concept that the budget should be balanced over a business cycle with surpluses in an expansion and deficits in a recession. In fact, deficits have become a permanent phenomenon.

So trying to balance the budget impact on generations would probably be beyond the ability of government. But perhaps the ``generational impact'' of budgetary changes could be examined.