Negotiating Who Will Pay the Price : Next President Will Face Grim Job of Cutting Debt

Whoever wins the election in November will face a daunting task. To manage the U.S. economy successfully, the next President must learn to “just say no.”

Unlike President Reagan, neither George Bush nor Michael S. Dukakis will enjoy the luxury of jacking up the federal budget deficit to pay for his spending and tax policies. Instead, the next President will face the thankless chore of negotiating with Congress over which groups will pay the price for reining in the nation’s accumulated debts.

“As a nation, it’s as if we’ve enjoyed a visit from the family’s favorite uncle for the past eight years,” says Ted Van Dyk, a Democratic political and economic consultant. “By relying on the family’s credit card, Ronald Reagan has helped us buy a new car, enjoy a few vacations, even remodel the house. But now our lovable but errant uncle is leaving, and it turns out he’s used our credit line to the limit. The next President will have to be a much sterner uncle.”

Dukakis and Bush are in no hurry to sign up for the role. As candidates, both are doing their best to avoid addressing any specific strategy for narrowing the budget gap while sustaining economic growth.

As Dukakis, the Democrat, campaigns around the country, he rarely goes beyond talking about the need for “tough decisions and tough choices.”

Bush, the Republican, has done little more than vow never to raise taxes. “Read my lips,” he often tells his crowds. “No new taxes.”

Despite the rhetoric, however, some important differences on economic policy are apparent between the two candidates.

Dukakis represents the party that emphasizes deficit reduction as the key to maintaining the economy on a sound footing. With unemployment at a 14-year low, many Democrats warn that a continuing string of gigantic deficits threatens to overheat the economy and reignite inflation.

Republican economists, by contrast, generally worry that overzealous deficit reduction would bring Reagan’s six-year economic expansion to a grinding halt. Inflation, they believe, can be kept in check as long as the Federal Reserve maintains tight reins on the growth of the money supply.

In practical terms, the issue of who should pay what in taxes probably remains the single biggest economic issue dividing the Democrats from the Republicans.

Bush not only promises to resist tax hikes but also advocates a variety of new tax breaks--restoring the benefit for capital gains on investments, providing tax incentives for child care expenses, exempting some personal interest income from taxes, giving new tax breaks to domestic oil firms. He would reduce the top tax rate on capital gains for most taxpayers from 28% to 15%.

“The focus of a Bush Administration would be on trying to keep taxes low and providing incentives that empower private individuals to help themselves,” says Robert Zoellick, issues director for the Bush campaign. “In general, he wants to limit bureaucratic interference and restrictions.”

Behind that thinking is the “supply-side” argument that lower tax rates, particularly on risky business ventures, foster greater individual initiative and promote entrepreneurship. It does not matter if most of the tax benefits flow to the wealthy, it is contended, because the ultimate outcome will be greater prosperity for all.

“Some people may condemn that as free-market thinking, but we believe the truth is that a rising tide lifts all boats,” says Zoellick. He points out that Americans at all income levels, when divided into five equal groups, have gained ground in the 1980s. By contrast, all income groups failed to keep up with inflation during the previous five years.

Dukakis attacks Bush’s approach on taxes as little more than a giveaway to the rich and a handful of favored industries such as the oil and gas business, which is heavily concentrated in Bush’s adopted home state of Texas.

“Listen to the vice president very carefully,” Dukakis said during the Sept. 25 debate after Bush offered his capital gains tax proposal. “What he’s proposing . . . is a tax cut for the wealthiest 1% of the people in this country. An average of about $30,000 that we’re going to give to people making (more than) $200,000 a year.”

Dukakis instead favors making the tax system fairer across the board. The “only principle” for raising taxes, Dukakis once said during his campaign for the Democratic nomination, is “on the basis of ability to pay. . . . Every tax is an income tax. The question is--Who pays?”

While Dukakis has studiously promised to consider tax increases “only as a last resort,” his position clearly leaves open the door to a boost in income tax rates for high-income families.

At the same time, he supports further efforts to curb tax breaks and accuses Bush of trying to undermine the sweeping tax revision package that was the centerpiece of Reagan’s second-term domestic policy.

Mimicking Bush’s pledge not to raise taxes, Lawrence Summers, a Harvard economist who is Dukakis’ principal economic spokesman, told a recent Washington seminar: “Read my lips. Under President Dukakis, it will be no new tax loopholes.”

On the spending side of the budget, there are fewer meaningful differences between Dukakis and Bush.

Bush advocates a “flexible freeze” to hold down government spending--a vague plan that would continue a modest defense buildup and leave Social Security intact but dig deeply into a host of unspecified government programs by preventing overall federal spending from growing any faster than inflation.

Dukakis, also recognizing the constraints imposed by the deficit, has hit upon another way to expand social programs for the middle class. He would put most of the costs on businesses rather than the federal government.

At the same time, he favors a shift in resources away from the military to domestic programs that Democrats believe were neglected during Reagan’s tenure.

“Dukakis is bound to have more new programs and initiatives than Bush, if only because the Democrats have been out of the White House so long,” says Carol Cox, director of the Committee for a Responsible Federal Budget. “His problem is finding a way to pay for them.”

Neither candidate would be able to pursue his agenda unimpeded. In dealing with Congress, the next President is likely to have to abandon his own most fervent backers in order to compromise with the opposition.

“It’s the Nixon-goes-to-China story,” says Michael Barker, a Democratic economic strategist. “Just as only a committed anti-Communist could open the door to Communist China, in the end, it would probably be Bush who would be more successful in keeping down defense spending and Dukakis who would be able to bring down benefit programs.”

For Dukakis, that suggests he might be forced “to produce a package more Republican than a Republican President would,” says Cox.

And for Bush, who almost certainly would have to deal with a Democratic-controlled Congress, it means that any deficit package inevitably must include some tax increases.

“To get what he wants, Bush will have to deal with Congress,” says Rudy Penner, a former Congressional Budget Office director who is now an analyst at the Urban Institute. “Sooner or later, that means some kind of tax increase.”

Privately, some of Bush’s policy advisers have talked about forging a “deal of the century” with Congress if Bush becomes President. The new Administration would accept some higher taxes, mostly on consumption, in exchange for an agreement from congressional Democrats to reduce such benefit programs as Social Security and Medicare.

At its heart, the conflict between Dukakis and Bush over taxes and spending reflects significantly different approaches to managing the economy.

Most Democratic economists would rely on a tight fiscal policy--reductions in the budget deficit through a combination of higher taxes and lower spending--to maintain steady growth and prevent the economy from overheating and regenerating inflation.

“It is close to an ideal time for deficit reduction,” says Summers, Dukakis’ economic adviser. “The goal should be to craft an agreement within the first few months of the new Administration that puts the deficit on a downward trajectory toward close to balance by 1993.”

The classic danger of a tight fiscal policy is that it tends to depress the economy by leaving people with less money to spend. But under current circumstances, most mainstream economists contend, the Federal Reserve could offset any drag from fiscal policy by adopting a looser monetary policy--lower interest rates and faster growth for the money supply.

“Any President who does something serious about the deficit would automatically give the Fed more leeway to expand money and credit to keep the economy on a stable growth path,” says Alan Blinder of Princeton, a leading Democratic economist. “But if little is done about closing the deficit, the danger is that the Fed would feel compelled to tighten up after the election to prevent the economy from growing at an excessive rate.”

While many of Bush’s economic advisers share the conviction that deficit reduction is a high priority for the next President, they are not convinced that it is so easy to offset the consequences of a tighter fiscal policy by adopting a looser monetary policy.

“Sure, you could reduce the deficit by simply raising taxes, but you would undermine the incentives to work and invest,” says Michael Boskin, a Stanford economist who is one of Bush’s principal economic advisers. “Unless we get spending under control, you won’t be able to ease monetary policy at all.”

Other conservative economists contend that Dukakis, if elected, would be likely to run into economic problems similar to those that plagued President Jimmy Carter in the late 1970s.

“It may seem esoteric, but the real issue is the policy mix,” says Alan Reynolds, a supply-side economist at Polyconomics Inc. in Morristown, N.J. “What Dukakis is promising is higher tax rates and a weaker dollar through easy money. Just like Carter, they are likely to find if they try it that they will end up with the worst of both worlds--stagflation.”

Dukakis’ economic advisers reject the comparison. The conservative approach of relying primarily on monetary policy to control inflation, they argue, threatens to set off another rise in the value of the dollar that would undermine the current export-led recovery in American manufacturing.