Agreement May Uncork Dilemma of the Deficit

This year marks an anniversary at which no one will drink champagne. Ten years have passed since the huge federal deficit became a national nightmare. The deficit is now larger than ever--an estimated $300 billion in fiscal year 1991.

Paradoxically, however, there is now more solid hope for its reduction than ever before--provided the President and Congress continue to stick to the tough agreement they hammered out last fall.

The deficit has caused a lot of political finger-pointing over the last decade. In fact, the culprits are legion. The blame must be shared by two presidents, six congresses and the public that elected them all.

The original sin was that when the major income tax rate cuts passed in 1981 they were not accompanied by comparable spending cuts. This big fiscal mistake was at least unofficially recognized by almost everyone in Washington as early as 1982, but elected officials were unwilling to take the political heat for the painful measures--tax increases or spending cuts--needed to correct the error.

While the Federal Reserve managed to control inflation with tight money and high real interest rates, persistent deficits absorbed a large fraction of America’s inadequate supply of saving. Americans became dependent on foreigners for capital, ran up large debts to the rest of the world and failed to make long-run investments in future growth.

Deficit reduction efforts have absorbed horrendous amounts of Washington’s time and energy over the decade.

In the first phase, President Reagan and the Congress used the existing budget process to hammer out compromises on deficit reduction. Despite repeated bitter arguments, they increased some taxes, slowed the growth in defense spending and reformed the Social Security system so that it began to produce surpluses. These actions helped.

In the second phase, Congress and the President used a procedural gimmick they hoped would force faster progress. The Gramm-Rudman-Hollings bill, passed into law in 1985, set deficit targets for future years and prescribed automatic across-the-board reductions in spending--to fall equally on defense and domestic programs--if the projected deficit for the next year exceeded the target.

This automatic procedure, known as sequestration, was admittedly a mindless way to reduce spending. The hope was that the threat of sequestration would impel the two branches of government to agree on a more sensible way of bringing the deficit down.

But Gramm-Rudman focused attention entirely on appearing to meet next year’s deficit target. This goal could be achieved by making rosy forecasts about the economy (high growth and low interest rates) and by sleight of hand, such as moving desired spending into the current year. There were no sanctions for exceeding the current year’s deficit. When the opportunity for finagling ran out, the deficit targets were raised.

After five years of this charade, the deficit was still stuck at about $150 billion and the country was losing patience. President Bush decided it was worth abandoning his “no new taxes” pledge to get faster deficit reduction. He began the third phase by calling a “budget summit” to negotiate a compromise that would lock the deficit on a downward track.

The fall of 1990 was an inauspicious moment for serious deficit reduction. The economy was sliding into a recession that was sure to increase the red ink, the country was preparing for a war whose costs were unknown and might be huge, and the bailout of the savings and loan industry was being handled in a way that escalated the deficit in the short-run, but should reduce it later as the government sold off assets of failed thrifts.

Those at the summit wisely decided to set aside these temporary effects on the deficit. They concentrated instead on reducing the underlying difference between government spending and revenues that would remain after the economy recovered, the war ended and the savings and loan bailout creaked into history.

The summit resulted in an agreement both on immediate tax and spending changes and on a new way to constrain future budget actions. Abandoning the unsuccessful attempt to enforce deficit targets, it focused instead on spending limits. Caps on appropriations were spelled out for five years. Pay-as-you-go rules were adopted for taxes and entitlements; any bill that increases entitlements or reduces revenue has to contain off-sets to neutralize its deficit effect.

The agreement is now in its second year and so far both the caps and the pay-as-you-go rules are holding. Congress has made tough trade-offs to keep spending within the limits. Unfortunately, this political restraint has gone largely unrecognized because the temporary forces, as predicted, are still pushing the deficit up. The recession has cut tax revenues, and the thrift bailout has necessitated more borrowing, although the war (because it was short and heavily financed by allied contributions) has had little deficit impact.

If the politicians do not lose their nerve, however, the deficit may actually start moving down fairly rapidly in 1993. They should be encouraged to hang tough. When the deficit is on its way to oblivion there will be time for champagne.