Deep Divisions Seen on Splitting Peace Dividend : Economy: Divvying up defense funds is expected to dominate budget debate. Big money will be at stake.

The emerging consensus that billions of dollars should be shifted from defense to domestic needs is triggering a titanic struggle over the federal budget that will dominate the 1992 political campaign and that could determine who occupies the White House as well.

After years of federal budgets so tight that Congress and the White House had little room to maneuver, there will be big money at stake in this year’s budget debate.

And the question of how to divvy it up--whether for tax cuts, deficit reductions, health care or a combination of things--is politically critical because a recession-racked electorate increasingly looks to the “peace dividend” for relief.

“The question of who gets to spend the peace dividend is going to dominate this year,” said Steve Bell, a former Senate Budget Committee staffer and now a Washington lobbyist. “That fight could become very chaotic.”

While many options will be debated, the bulk of the money will almost certainly go for tax cuts. Both Republicans and Democrats see them as the most attractive approach for voters and potentially the quickest way to stimulate the economy.

On the question of what kinds of tax cuts, however, how big and for whom, there is no agreement.

The battle officially begins Jan. 28, when President Bush stands before a joint session of Congress to unveil his long-awaited economic growth package in the annual State of the Union address. But the skirmishing already has begun and the battle will rumble on throughout the year.

The intensity of the struggle reflects the confluence of extraordinary national and world events--including the longest recession in post-war history and the collapse of the Soviet empire--with the intense politics of a presidential election year thrown in for good measure.

In fact, 1992 is shaping up as the first time since 1980 that bad economic times have come in the midst of a presidential election year, and 1980 was the year that incumbent Jimmy Carter was swept out of office by Ronald Reagan.

For Bush, the ability to respond effectively to the recession, and to demonstrate that he can master domestic crises as well as international conflicts, is shaping up as the most crucial element in his reelection bid.

“I think the most important thing for the President will be for him to get back on the offensive on the leadership issue,” one Administration official noted.

So far, voters do not seem to see Bush’s performance as meeting the test. A New York Times-CBS News national poll released Friday showed that 67% of those surveyed disapprove of Bush’s handling of the economy, while 18% said they believe Bush cares about the needs and problems of average Americans.

Against such a backdrop, the economic growth package that Bush will outline in two weeks is expected to contain the core of his election year manifesto, one that will include provisions designed to reach out to the middle class while maintaining his base among the affluent.

The White House package is likely to have a split personality.

It will call for both a middle-class tax cut--probably a tax credit for families with children--and a capital gains tax reduction designed to help wealthy investors and businesses. In addition, Bush will likely propose a series of investment tax credits for business, a tax credit to pay for health insurance for uninsured Americans, and an expansion of the benefits of individual retirement accounts.

The demise of the Soviet Union seems to have given him an opportunity to pay for many of his domestic proposals without running up the federal deficit. Democratic and Republican sources say Bush is likely to call for new defense cuts of between 4% and 5% over the next five years, amounting to roughly $15 billion a year in reductions over and above what he has already announced.

That marks a sharp reversal from last year, when Bush dismissed talk of a peace dividend, arguing in his budget proposal that money-grubbing wrangles over slicing up the defense budget “trivialized” a “great historical shift” in the Soviet Union. Today, facing an economic crisis just as the Soviet Union has literally become history, Bush has changed his tune.

Democrats are changing too. Battered in past election campaigns by GOP charges that they were weak on defense, congressional Democrats had become gun-shy about insisting on drastic cuts in the Pentagon budget. In the landmark budget agreement of 1990 that controlled last year’s budget decisions, they agreed that the Pentagon budget could not be raided to finance domestic programs.

The proviso remains in effect, but with the Soviet threat evaporating, both parties are signaling that they are ready to relax the rule and permit money to be shifted out of defense to finance tax cuts or other measures.

Democrats are now watching with glee as Bush struggles to regain the initiative on the economy by adopting many of the broad policy principles--tax cuts for the middle class and lower defense spending--that Democrats have advocated for years.

“Bush is sounding like Milli Vanilli, lip-synching Democratic proposals on middle-class tax cuts,” said one senior House Democratic staffer.

With Bush in trouble, congressional leaders say they want to force him to make the first move on economic policy, making it clear to the public that the recession is the President’s responsibility. As a result, they will wait until they see what Bush proposes in his State of the Union address before campaigning further for their own plans.

“The Democratic strategy is clear, and that is to make this the George Bush economy, to make this seem like a Hoover-type economy” agreed one senior Bush Administration official.

When they do fight back, it will become clear that despite Bush’s new willingness to cut defense outlays, deep divisions remain between the Administration and the Democrats over tax and budget priorities, congressional leaders say.

“The devil is in the details,” notes congressional Budget Director Robert Reischauer. And the key details are sure to be just how big the peace dividend should be, and exactly how to divide it up.

Leading Democrats still want far deeper defense cuts than Bush seems willing to propose. Some also want to make the wealthy pay higher income taxes so they can offer middle Americans larger tax cuts than Bush seems ready to offer.

The two most important Democratic alternatives to Bush’s package are likely to be those already proposed by Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.) and House Ways and Means Committee Chairman Dan Rostenkowski (D-Ill.). Rostenkowski’s plan calls for higher taxes on the very affluent in order to ease the burden on the middle class, while Bentsen instead wants to finance tax credits for families with children with a large cut in defense spending.

Congressional Democrats are also certain to oppose Bush’s renewed efforts to obtain a capital gains tax cut, although they may offer their support for it in return for Bush’s support for higher income taxes on the rich--a trade-off he has refused in the past.

Yet the Democrats are still divided themselves, and so far have been unable to present a united front against Bush on economic policy.

Frustrated Democratic leaders are now trying to come together on economic policy. Senate Budget Committee Chairman Jim Sasser (D-Tenn.) said in an interview Friday that the Democratic leaders of both the Senate and House have begun holding talks over the past few days to see if they can develop a unified recovery plan with which to counter Bush’s package.

“I think you will see an economic package with the imprimatur of the Democratic leadership,” said Sasser.

The President’s economic package also is likely to include his first efforts to deal with the nation’s health care crisis, an issue which now seems second only to the recession in the minds of many politicians and voters. Yet it is an area in which Republicans and Democrats appear to have even less in common than how to fight the recession.

In addition to his proposal to provide people with tax credits to buy health insurance, Bush also is likely to call for higher Medicare premiums for the affluent elderly, and the taxation of health benefits for some upper income workers.

The Administration also is expected to propose malpractice law reform to reduce “defensive medicine” by doctors, which critics say drives up the cost of medical care as physicians perform more tests and procedures to protect themselves against lawsuits.

The Democrats, by contrast, are likely to promote more sweeping and more costly programs, such as requiring businesses to provide coverage to all workers or else pay a new tax into a special fund for the uninsured. Some liberals want to go even further, and create a national health insurance program paid for by broad new taxes.

There is widespread agreement that the proposals unveiled by Bush on Jan. 28 will set into motion an intense debate on economic and health policy that will spill over into the presidential campaign.

Still, Democrats in Congress, rather than those on the presidential trail, seem certain to determine Democratic strategy as the debate unfolds in Washington. That’s partly because few of the candidates have a strong national standing on economic policy. So far, only two Democratic candidates, Arkansas Gov. Bill Clinton and former Massachusetts Sen. Paul E. Tsongas, have developed detailed economic policy proposals.

If Congress and the White House delay action on an anti-recessionary plan until next summer, then the new Democratic presidential nominee will help set the agenda. But if Washington acts this winter, the presidential candidates may be left on the sidelines, many congressional leaders believe.

“I don’t think the presidential candidates will play a role,” says House Budget Committee Chairman Leon E. Panetta (D-Carmel Valley). “When you try to do things in a presidential election year, it always raises the issue of how you confront the President, but do you obstruct action in order to help your presidential candidates? I don’t think it works that way, because with the economy so bad, people in Congress are worried about themselves and their own elections.”

* TROOP CUT PLAN: The Pentagon is preparing a plan to cut troop levels beyond those previously deemed necessary for national defense. A4