Administration Assumption: Economy Will Keep Growing

The Reagan Administration’s approach to reining in the nation’s massive budget deficits depends on a highly optimistic assumption: that economic growth without inflation will continue unbroken for the rest of the decade.

However, a number of independent economists, while cautioning that the state of the U.S. economy remains disturbingly precarious, agree that the broad outlines of the economic outlook contained in President Reagan’s new budget are still within the realm of possibility--at least in the short term.

Emboldened by an impressive record of economic performance in 1984, Administration analysts are predicting more of the same through the rest of the decade: steady economic growth of 4% a year through 1988, inflation only a fraction more than 4% in each of those years, unemployment down to 5.7% by 1989 and short-term interest rates of 5%--barely half their current levels--by the end of the decade.

Cheery Assumptions

Even with such cheery assumptions, the Administration is projecting budget deficits that would have been unprecedented in any peacetime year before Reagan’s first term: $222 billion in the current fiscal year, falling gradually to $144 billion in fiscal 1988.

And Administration economists agree that a deteriorating economy would send deficits still higher.

Rudolph G. Penner, director of the Congressional Budget Office, said the Administration’s projections of declining deficits and a healthy economy “sound reasonable--if you assume their projections include implementation of the policies they propose.”

The CBO will soon issue a forecast that says annual deficits will rise to nearly $300 billion by the end of the decade if Congress takes no action to reduce spending or raise taxes. But Penner conceded that the Administration’s outlook for the nation’s economic and budgetary future is “well in the range of historical expectations.”

‘Rose-Colored Glasses’

Walter W. Heller, chief economic adviser for Presidents John F. Kennedy and Lyndon B. Johnson and now an economist at the University of Minnesota, said the Administration’s economic forecast for 1985 is reasonable.

But “to project that we can hold real growth and inflation growth at 4% for the rest of the decade--that’s really using rose-colored glasses,” he said. “If you are have a perfectly honed and executed policy, it is conceivable we could grow that long at those rates. But everything has to be perfectly modulated--no plunge of the dollar, no normal business cycle.”

James R. Barth, an economist at George Washington University, said that in light of the vigorous economy of the last two years, “it’s not surprising the Administration turned up with optimistic numbers, and they’re not outrageously optimistic.”

Barth added, however, “these numbers don’t reflect the probability that there will be a downturn in the economy before 1989--or even sooner. Having the kind of stability they project is improbable. And if you have a downturn, then deficits will inevitably increase as a share of GNP”--gross national product, the nation’s total economic output.

Not Surprised

Barth said he was not surprised that the Administration put together a combination of budget proposals and economic assumptions that show the deficit declining as a share of GNP. “If they didn’t do that,” he said, “the whole budget process is not to be taken seriously because what is frightening is the prospect of deficits’ increasing as a percentage of GNP: that suggests deficits out of control.”

In the Administration’s projections, deficits would decline from 5.7% of GNP in the current year to about 2% by 1989. Even so, the accumulated national debt, which had mounted to 38% of the nation’s annual GNP at the end of fiscal 1984, would grow to nearly 41% by the end of 1987 before beginning to diminish slowly.

Reagan’s proposed budget for fiscal 1986, which begins Oct. 1, estimates that if the economy grows by only 3% instead of 4% for the rest of the decade, that would add $179 billion to the total national debt by the end of 1990. Interest payments would rise by $17 billion to $20 billion a year for each percentage point by which interest rates exceeded the Administration’s projections.

A Serious New Menace

And the new budget’s section on economic assumptions acknowledges that soaring deficits represent a serious menace.

In 1980, it notes, total federal debt accounted for 6.2% of the total wealth in private hands in the United States. But by 1984, that figure had risen to 9.4%--and without reductions in the annual budget deficit, that trend would continue to the point where private investment would be squeezed.

“Thus far in the recovery,” the report says, “in spite of the growth of federal debt relative to private wealth, domestic investment has not been crowded out. This has occurred partly because of the large net inflow of foreign savings. However, the long-term prospect of continued healthy growth . . . remains threatened unless the measures proposed in this budget to reduce the growth in the federal debt are enacted.”

Inflow of Foreign Money

The budget document recognizes that nearly $100 billion in foreign investment poured into the country during 1984, blunting the negative impact of massive government borrowing on private investment in the United States--the key engine of future growth. But thanks to this massive inflow of foreign money, the budget says, “some time this year recorded foreign assets in the U.S. will exceed our assets abroad, making us a net debtor nation.”

As a result, the nation will soon be sending more money abroad in the form of dividends and interest than it earns abroad. And in the longer run there will be a danger of higher inflation, higher interest rates and slower growth if foreign investors begin to lose confidence in U.S. economic performance or economic policies and put their money elsewhere.

With higher interest, higher inflation and lower growth, the ability of the economy to reduce federal deficits would diminish even if the Administration’s proposed budget policies are enacted.

MAJOR BUDGET CUTS FOR THE NEXT THREE YEARS Proposed savings in billions of dollars for 1986-1988 from what the Administration calculates spending would be without budget cutbacks.

PROGRAM ELIMINATIONS $31.8 Revenue sharing 12.5 SBA 5.3 Mass transit 4.2 Eximbank direct loans 3.9 Amtrak 2.2 Job Corps 1.3 Rural development 0.7 Appalachian Commission 0.6 Health training 0.5 Urban development grants 0.4 Air carrier subsidies 0.2 REDUCTIONS $146.8 Farm subsidies 26.9 Medicare 18.6 Public housing moratorium 13.8 5% civilian pay cut 10.1 Medicaid 6.3 Strategic petroleum reserve 5.2 Civil Service pensions 4.1 Student aid 4.0 Western power marketing 2.8 Postal Service 2.8 Child nutrition aid 2.6 VA medical care 2.5 10% cut in overhead 2.4 Rural utilities 1.8 Conservation programs 1.4 Federal lands receipts 1.2 AFDC and welfare 0.9 EPA sewage grants 0.2 All others 39.2

Source: Office of Management and Budget