Deficit Under Control, Most Analysts Believe : They See Little Danger That It Will Soar Above $200 Billion Again if There Is No Recession

As he has presided over the Senate Budget Committee for the last six years, Sen. Pete V. Domenici (R-N.M.) developed a well-deserved reputation as the political leader who worried, fretted and nagged the most about the nation’s soaring budget deficits.

So it came as something of a shock when he insisted at a conference in New York last month that the federal government finally had wrestled the deficit under control.

“Almost nobody realizes it,” Domenici said, “but the simple truth is that the budget deficits in this country are coming down.”

Over the last two years, practically unnoticed amid the sound and fury of Capitol Hill bickering, the federal government has undergone a quiet fiscal revolution. Battered by a whirlwind of conflicting political forces, Congress has halted the defense spending splurge and maintained a firm rein on domestic spending. And it forced President Reagan to grudgingly accept a series of tax increases after the enormous 1981 tax cut.

At the same time, interest rates have fallen, substantially reducing the government’s payments on the national debt.

A Dramatic Plunge

So when Reagan submits his fiscal 1988 budget to Congress today, it will show the federal deficit declining to an estimated $173 billion this year and falling to about $150 billion next year, even without further spending cuts or revenue-raising measures--a dramatic plunge from the record $221-billion deficit for the fiscal year ended Sept. 30, 1986.

The turnaround represents an even more startling contrast from the projection offered only 16 months ago by the nonpartisan Congressional Budget Office. As recently as August, 1985, the CBO estimated that the deficit would rise steadily to $285 billion by 199807433582Its most recent forecast, however, showed the deficit falling as low as $134 billion by 1990 and $85 billion in 1992 under current budget policies.

Reagan’s spending plan will propose further cuts for 1988 aimed at pushing the deficit under the $108-billion target called for by Gramm-Rudman, the budget-balancing law that remains technically in effect despite a ruling by the Supreme Court that its key enforcement mechanism is unconstitutional.

Congress is almost certain to reject most of Reagan’s reduction proposals and few economists expect the federal government to come even close to the goal of a balanced budget by 1991.

But most independent analysts now acknowledge that the government has at least turned the corner on the budget deficit. As long as the economy does not plunge into a recession, there is little danger that deficits will soar above $200 billion again. More important, the deficit is no longer growing faster than the nation’s gross national product, and interest payments on the national debt no longer appear to be absorbing an ever growing share of the nation’s economic output.

“You can never stop worrying entirely,” said Rudolph G. Penner, director of the Congressional Budget Office, “but there is much less danger now that the debt burden will spiral out of control. We can see, so to speak, the light at the end of the tunnel.”

The public, of course, has heard that line before. And as Penner acknowledged, his Vietnam-era metaphor ironically suggests the hidden danger in the improved deficit outlook. Once the fear of the deficit’s escalating out of sight fades, so may the determination among lawmakers to maintain the policies necessary to keep it under control.

Keeping the Lid On

“The pressure is off,” said James R. Capra, an economist with Shearson Lehman Bros. in New York and a former CBO budget analyst. “Congress deserves the credit for braking the growth in the deficit but, now that the danger of a runaway deficit is gone, you have to wonder whether they can keep the lid on.

“All it would take is for the government to let down its guard on Medicare,” Capra added, “and you’re off to the races again.”

Under the scenario now expected by congressional budget analysts, federal spending would grow barely faster than inflation, allowing economic growth to gradually dissolve the deficits. While that would be a marked improvement over the previous situation, it would still mean living with deficits well above the level experienced before the Reagan era.

The forecast released Friday by the CBO, for instance, projects the deficit’s falling close to $100 billion by 1991. Before 1982, though, the deficit never exceeded $66 billion, and the only times it ever reached as high as $50 billion was in the wake of an economic recession.

Two Looming Uncertainties

“We may no longer be talking about $200-billion-plus deficits, but I don’t think what they are projecting is sustainable,” said Lawrence A. Kudlow, a former chief economist for the Office of Management and Budget who is now at Bear Stearns & Co., an investment firm in New York. “If you say a $150-billion deficit is OK, before long you might be willing to accept, say, $175 billion. Where does it stop?”

There are two looming uncertainties hanging over the budget outlook.

For one, there is the question of whether the federal government can live for the foreseeable future within the constraints it has been willing to accept during the last two years. President Reagan, for instance, is still proposing to boost the defense budget by at least 3% more than the inflation rate every year--despite congressional expectations that military spending will grow no faster than the rise in prices. Moreover, the budget outlook leaves no room for new spending programs unless Congress is willing to reduce an existing domestic program by an equal amount to make room for new priorities.

“Congress has put itself on a long-term diet,” said Barry Bosworth, a leading Democratic economist at the Brookings Institution in Washington. “But it hasn’t really made the tough decisions necessary to bring its weight under control.”

‘A Real Crunch Is Coming’

As Bosworth and others pointed out, the overwhelming reason the deficit gap is no longer expected to keep widening is because Congress has decided to rein in Pentagon spending. But instead of eliminating any major weapons program, lawmakers avoided making tough choices by simply agreeing to stretch out the timetable for acquiring existing weapons. And the Pentagon is still buying weapons on the assumption that it will get real spending increases of 3% for the immediate future.

“Only a handful realize it, but a real crunch is coming in defense spending,” Bosworth said. “I don’t think Congress can ram a different defense posture down (the Administration’s) throat, but unless some big changes are made, the Pentagon is going to have a lot of new equipment on its hands and no money to maintain it. That would be a disaster for everybody.”

The other unknown in the equation is the outlook for economic growth. If the economy falls into even a modest recession, the deficit would balloon overnight as revenues faltered and expenses soared to meet such costs as higher unemployment payments and greater farm subsidies. Even if there is no recession but the economy fails to keep pace with the long-run 3% annual growth rate expected by budget forecasters, deficits would also begin to creep above the levels currently projected.

‘Much Can Go Wrong’

“I always get depressed around this time of the year; there’s so much that can go wrong,” said John Cogan, a former top official at the OMB under David A. Stockman, who is currently a resident scholar at the conservative Hoover Institute in Palo Alto, Calif.

“If one believes the official forecasts, it looks like we have reached a peak for the deficit,” Cogan said. “But the situation always seems to be improving when everything is on the drawing boards. The problem is that the deficit is so sensitive to economic assumptions that it only takes a small mistake in the forecast to throw everything off track.”

Whatever happens, though, there is little doubt that the fiscal landscape has been dramatically reshaped in the six years since Reagan has taken office. Although the White House by now is mostly recycling its previous ideas for cutting domestic programs rather than proposing anything fundamentally new in budget policy, Reagan nonetheless has accomplished a major overhaul of federal spending and tax policies that is likely to last well after he has left office.

‘Pulling the Revenue Plug’

“The system needed a shock and President Reagan provided it,” argued Jack A. Meyer, of the American Enterprise Institute, in the recent book “Perspectives on the Reagan Years.”

By “pulling the revenue plug” in the 1981 tax cut, Meyer contended, “the government has brought pressure to bear on total outlays. . . . Whether this process turns out to be successful depends upon whether President Reagan and his successors can continue some recent progress toward tightening assistance to middle- and upper-income beneficiaries of federal social programs.”

One major challenge that remains is the burden of more than $1 trillion of additional debt accumulated during Reagan’s presidency. To pay the interest on that sum, the nation must continue to allocate a much larger share of the nation’s resources than it once did, which many believe could have an adverse long-term effect on the economy.

When Reagan entered office, the public’s national debt represented about 27.5% of the total output of the economy. When he leaves office, the debt level will be more than 40% of the nation’s GNP. “The real danger is that everyone will assume that the deficit has not done any real damage to the nation because it never precipitated the crisis so many people warned about,” said Bosworth.

Capital Drained Away

“But the truth is that we have been paying the price all along in weaker economic growth,” he added. “That’s because the deficit has drained capital away from private investment that otherwise would have generated future growth. And we will keep paying the price for many, many years.”

Reagan, in effect, has already handed the problem of lowering the debt burden to his successor.

By promising to veto any substantive tax increase and refusing to reopen the debate over Social Security, the White House has left the new Democratic-controlled Congress with almost no room for further maneuvering.

“Both the Administration and Congress have tacitly acknowledged that they are playing a waiting game on the deficit,” said Kudlow of Bear Stearns. “The idea is to live with shrinking, but still large, deficits for as long as they can” before the economy suffers.

Stark Dilemmas

The dilemmas facing lawmakers in the future will remain stark. If there are to be major revenue increases, the middle class will have to bear most of the cost.

By conditioning the public to expect tax relief, many analysts contend, Reagan has made it more difficult politically for a future President to propose a substantive tax hike as part of the cost of erasing the deficit to cut into the debt burden.

And if there are to be further major spending cuts, they will have to fall on the elderly, a political force of fearsome proportions. As it stands today, nearly every corner of the domestic budget has been pared substantially except for the big spending programs for the aged, such as Social Security and Medicare. “Within the domestic budget, the share of expenditures on the elderly has risen dramatically,” said Cogan, the former budget official. “That is the only area of the budget that was left practically untouched.”