Budget Reality Still Proving Elusive

Financial markets in January reacted favorably to the early evidence on President Bush’s economic plans. His appointees, especially Richard Darman at the Office of Management and Budget, were widely regarded as politically experienced, pragmatic and competent. The immediate attention given to the crisis in the savings and loan industry suggested that the new Administration would deal swiftly with the glaring economic problems it had inherited.

This impression even carried over to the budget deficit as spokesmen for the new Administration confirmed that they would meet declining deficit targets without violating the Bush pledge of no new taxes. And, as expected, the President formally put forward a budget for fiscal year 1990 with a deficit under $100 billion, some $60 billion to $70 billion lower than the deficit now expected for fiscal year 1989.

If these early impressions truly presaged what would happen, they would indeed be good news for financial markets. A major reduction of the budget deficit would point to lower interest rates ahead, and that would justify higher prices for both bonds and stocks.

In many areas of economic and budget policy, one should have confidence that the new Administration will be a big improvement over its predecessor. The attack on the savings and loan problem is a first, important step in that direction. But on the big picture of the overall budget deficit, believe nothing coming out of the Administration for now.

The budget deficits are supposed to be limited by the Gramm-Rudman law. Since they were introduced a few years ago, the law’s targets have upset the budgeting process. Whether they have had much impact on eventual budget outcomes is debatable.

The important change in the trend of the deficit occurred not with Gramm-Rudman but with the rejection by Congress in 1985 of the future defense increases scheduled by the Reagan Administration. In subsequent years, Administration budget requests for defense were considered “dead on arrival” and were routinely disregarded on Capitol Hill, where Congress substituted a virtual freeze on real defense spending.

At bottom, Gramm-Rudman has been ineffective because it in no way addresses the real problem of how to cut the federal deficit. It holds out the threat of sequestration--arbitrarily cutting defense and a limited, unprotected part of non-defense spending--if the projected deficit for an upcoming fiscal year exceeds the specified target. But since neither the Administration nor Congress has believed that such arbitrary cuts are appropriate, they have always found a way to avoid sequestration.

The budget for the current fiscal year illustrates two ways this has been done in the past. Today, the deficit target for fiscal 1989 is $136 billion. A couple of years ago, it was $72 billion. When the original targets looked unachievable because of the refusal of the Reagan Administration to raise revenue and the refusal of the Senate and House to cut Social Security and other spending enough, the targets were simply revised up.

So revising the targets has been the first way. The second has been to make unrealistic estimates. In October each year, the Administration, through its Office of Management and Budget, must certify that the deficit for the fiscal year just starting is within $10 billion of the target. This past fall, OMB estimated that this year’s deficit would be $146 billion. In January, only months later, it estimated that it would be $161 billion. But the original estimate avoided sequestration, and now the deficit could finally end up at $180 billion, or any other level, without any consequences from Gramm-Rudman.

The law, in short, has severe consequences for planning to exceed its targets, but it has no consequences for actually doing so. OMB has exploited this feature fully, and Congress has not complained. Neither has wanted sequestration, and together they have not been able to compromise on steps that would actually meet the deficit targets.

Will the future--with a new, more attentive President--be any different? Not from the way it is starting out. The Congressional Budget Office, which has been a far more objective and accurate analyst of the budget than has OMB, now estimates the current services budget deficit for fiscal 1990 as $146 billion. Bush has presented a budget with a deficit estimate of under $100 billion. Not surprisingly, $100 billion is the Gramm-Rudman target for fiscal 1990.

If the Bush budget offered spending cuts and revenue increases in some combination that would cut some $50 billion from the current services budget, that budget proposal could be debated by Congress and could provide a vehicle for negotiation and compromise with the Administration. In fact, Bush proposes new tax breaks and spending initiatives, which would add to the deficit, and says nothing about where specifically where he would cut spending to reach his totals. The deficit projected under the Bush budget is as unrealistic as anything his predecessor put forward.

You might think that Congress would blow the whistle. But it, too, wants to get on with the real business of budgeting without being hamstrung by a deficit target that cannot be met without major concessions on matters such as taxes, Social Security and defense. One hope is that a compromise on these matters might be reached with the President by summer or fall. But with Bush boxed in by his own promises of no new taxes, that may not happen, at least not this year.

It would not be catastrophic to the economy if Gramm-Rudman targets were once again not met. Our excessive deficits thus far represent a chronic problem of shortsighted priorities and undersaving, rather than the acute economic crisis that some observers have been predicting.

But an important question is whether financial markets, here and abroad, would react very badly to the realization that another year is passing with little, if any, further progress on the deficit. Maybe they have adjusted to the prospect of little progress.

The deficit is, after all, considerably smaller than it was back in 1985-86. But if financial markets are assuming that the President is putting forward a realistic program of deficit reductions, they could be in for some bumpy times as budget reality sets in.