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The Budget’s Bottom Line

With corporate income tax virtually wiped out, Reagan offers Congress two choices: bleed the workingman or risk economic collapse

Reagan, economy, demonstration

Between 200 and 300 persons took part in a march and rally Saturday morning at East High School demonstrate the broad base of support for health and human service programs as a priority in Colorado as well as the nation. Colorado, 1981

Glen Martin/The Denver Post/Getty

Summer has begun a bit early in Washington, and it is nasty. The season promises to be unlike any other in the past forty years, for the politicians of both parties have put themselves in a vicious bind, and they know it. Behind the political filigree of grandly worded budget resolutions, just one question confronts the members of Congress the only question they must answer between now and the elections in November, no matter how you phrase it: Which citizens will be forced to make up for the enormous deficits created by Ronald Reagan’s economic policy? Who will pay for last year’s mistakes? Who are we going to screw?

It’s the same old story for legislators. What makes the summer of ’82 extraordinary is that it’s the wrong season for political pain. Normally, the even-numbered years, when federal elections are held, are when Congress pours the gravy, in the form of tax cuts, new spending programs, subsidies, special favors and redeemed promises from old campaigns. Not surprisingly, this biennial largesse makes citizens feel better about their government. It pumps up the economy and helps return faithful public servants to another term in the House and Senate.

But Congress did its big giveaway last year. The Republicans, aided by the confused “me, too”-ism of the Democrats, enacted $750 billion in tax cuts over the next five years. Everyone now understands that Reagan’s celebrated three-year tax cut for individuals was tilted in favor of the rich, but most Americans probably still do not comprehend that last year’s legislation amounts to wholesale looting of the Treasury by the Fortune 500. The corporate income tax was virtually wiped out, and business’ share in financing the federal government was shifted to individual taxpayers.

This tax giveaway, plus the hoggish feeding at the Pentagon, is what has produced the budget crisis of 1982. The beguiling magic of Reagan’s supply-side economics promised that the Treasury would be replenished by a new era of robust industrial investment—more profits, more jobs, more federal revenue. Instead, the country got a long recession, the highest unemployment since the early Forties, rising bankruptcy and fear. The recession was man-made, caused by the tight monetary controls imposed by the Federal Reserve Board with the president’s full support. The Fed was supposed to wring inflation out of the economy by holding it back, while the Reagan tax cuts were supposed to propel the economy forward with huge new incentives for real growth. That was the theory, and it didn’t work. You can’t go both directions at once. Cutting taxes simply meant less revenue, and the high interest rates created by the Federal Reserve Board blighted any prospects for new investment. If Congress doesn’t undo the fundamental miscalculations of Reaganomics, the government will be in the red by $180 billion next year and more than $300 billion in a few years.

Knowing this, congressional leaders have fastened upon a simple-minded consensus: they must raise taxes and cut spending drastically, before continuing high interest rates sink the economy. This epic bind is producing panic in the herd. Their seasonal instincts tell the politicians that it’s time to spread around the sugar before the November elections, but the outlines of economic crisis tell them they must do the opposite. Normally, citizens might derive a little sardonic pleasure from watching their men and women in Washington squirm, but this time the stakes are too scary to be amusing. No politician wants to talk about it openly, but they are driven this summer by another, even deeper, fear: if a political solution isn’t found this summer, America could be headed toward a genuine economic collapse. With a little bad luck and more bad policymaking, 1982 could become something resembling 1929. This is the unspoken subtext that compels the nasty choices Congress must make in the coming months.

No responsible economists are predicting the Big D, but for some months now, the most sober-minded analysts have identified the preconditions and envisioned the possibility. One scenario for disaster goes like this: sooner or later, the economy will finally begin to recover from recession and business will pick up again. But the combination of Reagan’s huge deficits and the Federal Reserve’s tight lid on the money supply will produce a new surge in interest rates, which will squelch the recovery. Scores of corporations, already over-extended on short-term credit from the last recession and having sold off their best assets to survive, won’t have enough time to get well. If a new recession hits later this year or early in 1983, many of these enterprises would be pushed over the brink. Then what would happen? With a few dramatic failures, nervous bankers would begin calling in loans from other shaky businesses and a cascade of industrial bankruptcies would spread panic throughout the economy, further fueled, perhaps, by more failed savings-and-loans and farmers buried in debt.

This is not crazy talk from professional merchants of doom. Albert M. Wojnilower, chief economist and managing director of First Boston, a leading investment banking house, warned what might happen if the government doesn’t change policies. “Just when the business community is heaving a collective sigh of relief that interest rates may be ebbing a bit, they would shoot up again,” he said. “In that event, it is odds-on that a serious credit crunch and a wave of industrial bankruptcy would be precipitated, engulfing the prudent and imprudent with little distinction.”

Henry Kaufman, the Wall Street guru from Salomon Brothers, phrases his fears more opaquely, but his message is the same. “The American economy,” he said last month, “is still in a very precarious position. I believe that position is more precarious than it was a year or so ago…. The financial fabric of our economic system has been significantly weakened.” This is not just another recession, Kaufman emphasized: “We are not in a typical cyclical period. We’re in a period in which our financial system has become more fragile … and therefore we must do things that are extraordinary, that are different, that to some extent are painful.”

James K. Galbraith, the young executive director of the Joint Economic Committee of Congress, described the risk: “The cracks are visible in the wall. As an engineering question, you can’t predict when the wall will crumble.”

***

Most congressional leaders, listening to this somber talk, have accepted the unavoidable question: who must feel the pain so that America can get well? Senate Republicans have drawn up a list of victims endorsed by the president, and it looks very much like their list from last year: Poor people on welfare. College students with government-backed loans. The elderly. Public schools and community health services. Construction workers whose jobs depend upon government highway projects. Federal employees—including soldiers, sailors and airmen—who will not get a pay raise next year. Veterans and other pensioners who won’t get their regular cost-of-living increases. People like that.

Old folks, in particular, have been singled out for virtuous suffering. The Republican budget proposal calls for trimming about $300 billion over the next three years (not counting some fanciful predictions about lower interest rates on the national debt), and more than a fifth of that money will come from the elderly. Social security, Medicare, Medicaid, veterans’ pensions—cuts from these programs will save about $65 billion. Roughly speaking, the golden agers are going to pick up the tab for the increased spending at the Pentagon.

Reagan hoped they wouldn’t notice. The budget resolutions Congress would enact in early summer would speak in generalized terms, and the specific legislation later in the year would define exactly who’d lose blood. The administration planned to wait until after the fall elections before taking a transfusion from social-security recipients, but the Republicans in the House, normally sheeplike in their obedience, rebelled. You see, all of them face reelection this fall, and their elderly constituencies had noticed and were not pleased. Reagan’s social-security cuts were thus “shelved,” but one can confidently predict that these cuts will reappear after the old folks have cast their ballots in November.

The Republicans also intend to raise taxes, but they are being coy about whose taxes. The Senate finance chairman, Senator Bob Dole (R-Kansas), is pushing a minimum corporate tax to perfume the stench left by the business tax cuts he approved last year. The majority leader, Senator Howard Baker of Tennessee, was talking up a surtax on rich folks in the upper-income brackets, but he couldn’t sell the idea to the true believers in his own party. Taken as a whole, the Republican tax proposals will not distress the well-to-do, for the pain is artfully distributed among everyone else. In fact, the increases are designed to conceal the fact that the average American, not the rich, will be paying more taxes if the Republicans have their way. It goes like this:

  • If you drive a car or truck, you may be paying twelve cents a gallon more for gasoline. This is known euphemistically as an “energy tax,” which will discourage profligate Americans from wasting gas. Actually, it is an import fee on foreign oil that will help the domestic oil industry by propping up its sagging prices.
  • Excise taxes may also add a few pennies each to the price of cigarettes, beer, whiskey, wine and telephone calls.
  • When they file their income taxes, wage earners may find that the Republicans have closed a few loopholes. Not the big ones for corporate returns, but nickel-and-dime deductions for average folks, such as those for state and local sales taxes, interest payments on consumer credit and the minimum deduction of $150 for health insurance.
  • For those who are out of work, the administration proposes adding insult to injury by taxing all unemployment benefits as income. The justification is perverse this would make laggards go out and find a job.

The president, naturally, has excluded himself as much as possible from these distasteful propositions. In fact, if you listen to White House rhetoric, Reagan is against raising anyone’s taxes. He only went along reluctantly with the nervous Republicans in the Senate. Strangely enough, this is probably the truth.

To understand the president’s utter calm in the midst of general panic, you have to appreciate that Reagan has already accomplished most of what he came to Washington to do. He has launched a massive buildup of armaments. He’s bamboozled Congress into enacting lopsided tax cuts that favor folks at the top end of the income scale. He’s given oil and other industries everything they wanted. The deficits frighten others, but they don’t bother Reagan because he sees them as a club, driving the congressional herd where he wants to go: toward a smaller federal government.

It’s not even clear how distressed the president is by the ruinous economic conditions. Last month, when the latest unemployment numbers were announced, the president was on the South Lawn, dressed in that ridiculous riding outfit that makes him look like a Hollywood director from the Twenties. Reporters asked how he felt about 9.4 percent unemployment; the Gipper said he felt bad. He blamed the Democrats. Then, with a wave and a smile, he went horseback riding.

Reagan keeps proclaiming his faith that supply-side prosperity is just around the corner. But he also quarrels with unemployment figures, as though bad statistics were to blame. His handlers keep posing him for media photos in earnest conversation with poor people. But he does seem awfully happy with himself.

Indeed, perhaps Reagan has wrought exactly what he wanted. And he is pleased. Back in the spring of 1978, when he was still a presidential candidate and before his rhetoric of economic recovery had been fully developed, Reagan had an unguarded conversation with reporters. They were discussing the economy and what was needed to make things right. “Frankly,” said Reagan, “I’m afraid this country is just going to have to suffer two, three years of hard times to pay for the binge we’ve been on.”

In those days, Reagan used to preach that the country must endure a big “bellyache” before it could get well. Pain is good for you. His advisers persuaded him to drop the bellyache from his speeches.

***

The Democrats are immobilized by their own confusion. They can’t describe the future convincingly, and they seem to have forgotten their own past. Groping to understand, many of them became fearful that maybe Reagan’s conservativism is the future. Since the cowboy blew them out with his 1980 landslide, the party of the bleeding hearts has been taking lessons from the party of the bottom line. Last year, the Democrats learned about capital investment. Their version of corporate-tax giveaways was nearly as obscene as the Republican bill that was enacted. This year, the liberals discovered deficits. They pronounced themselves appalled.

Now the Democrats are pulling frantically in different directions, unable to exploit the Republican disaster because they’ve really become three parties in one. The oldest and largest contingent is composed of aging “red-hots,” who came to Congress when liberalism was in flower, mostly from big-city, working-class districts or rural backwaters of poverty. They know what they believe in, and it is not smaller government. Their ranks are dwindling. In the middle are the “boy scouts,” bland and earnest and anxious to sound more responsible than the red-hots. They want business as a pal. They talk up high-tech as the big solution to every social ill (columnist Mark Shields calls them “Atari Democrats”), and they would like to believe that the old class differences of poverty and race are passé. On the Democratic right wing are the “porkers,” mostly from the South and West, sometimes known as “boll weevils.” Behind a veneer of conservative rhetoric, they practice old-fashioned pork-barrel politics — taking care of oil, the defense industry, sugar, cotton, peanuts. They do pretty well, too, because they are willing to take their votes wherever they smell the bacon cooking.

This melange has produced its own conflicting lists of who should pay for the deficits, but none is especially comforting. For one thing, the Democrats propose a three-year freeze on domestic spending that’s only slightly less restrictive than the Republicans’. It is sugared with a few million here and there to create the appearance that the Democrats aren’t hurting the same folks, though of course they are. The Democrats admittedly would take a much bigger bite out of the defense budget, which the Republicans barely nicked. The Democrats are also rallying around the old folks, promising to protect them from the Republican barbarians. This is smart politics for November, but the promise isn’t worth much in the long run.The social-security system does face insolvency next year, just as the Republicans say. Sooner or later, somebody will have to pay for that, too—either the elderly who get the checks or the young wage earners who pay the taxes.

The Democrats propose to raise taxes even more than the Republicans, and they are even less precise about naming the victims. Their fundamental confusion has led many boy scouts, such as Representative Jim Jones of Tulsa, chairman of the House Budget Committee, to propose a repeal of Reagan’s third-year tax cuts for individuals, the final ten percent due on July 1st, 1983. This would save the government big bucks, but it would also hurt the very people Democrats are supposedly representing: striving middle-class families, including those blue-collar union families who used to vote Democratic. It would set the Democrats up for Reagan’s accusation that they are the party of big spenders who tried to raise the workingman’s taxes. Maybe the Democrats will rediscover old principles this season, but it doesn’t seem likely.

***

The obvious target that Democrats seem unwilling to go after is the lost revenue from the wholesale tax reductions for business. The business tax cut was last summer’s scandal. This summer’s scandal is that neither party has mustered the courage to reopen the subject of corporate taxes and restore some of the lost revenue, not to mention a semblance of justice. Consider the numbers: business tax cuts will total $250 billion over the next five years and $500 billion by 1990—plenty of loose change to help curb deficits. The corporate share of federal revenue will decline drastically, from 12.4 percent in 1980 to 7.1 percent in 1987 (back in the flush times of 1965, it was 21.8 percent). And it’s individual taxpayers who’ll be picking up the slack: they provided 74.6 percent of the revenue in 1980, and by 1987, they will be paying 85.2 percent of it.

As everyone knows, the new “incentives” for business have not produced the anticipated surge in investment, but they did yield a crazy quilt of windfall dollars on corporate tax returns. General Electric not only owed no taxes on its 1981 profits of $2.6 billion, it actually collected a $100 million refund from the government on previous years’ returns. Occidental Petroleum, being a resourceful oil company, hasn’t paid federal taxes for four years; finding that it couldn’t apply its tax breaks to its own 1981 return (since it didn’t owe anything), the company sold its windfall for $25 million. The choicest bonbon was a new provision called “leasing,” which allows companies to sell their surplus tax breaks to other companies for use as write-offs. To underscore the Democrats’ confusion about all this, consider that Charles Manatt, the Los Angeles businessman who is Democratic national chairman, is actually campaigning with corporate tax lobbyists against the repeal of leasing.

The new depreciation rules, coupled with the investment tax credit, have actually created negative tax rates on new investments. Roberr S. McIntyre, director of federal tax policy for Citizens for Tax Justice, a labor-consumer group, explained what a negative rate means: “If you earn one dollar on a new investment before taxes, you earn two dollars after taxes. The new deductions are so generous that they will not only shelter income from new assets but also other income from a company’s regular operations.”

This reality is artfully disguised in the Council of Economic Advisers’ 1982 report, which nevertheless acknowledges that investments in construction machinery, general industrial equipment, and trucks and trailers all now enjoy negative tax rates. By 1986, if a company earns a 2.6 percent return on its new machinery, the federal government will make sure its after-tax profit is four percent.

While theoretically every business can benefit, the tax lobbyists who drafted the new code stacked it in favor of their employers, the largest corporations in America—specifically, the oil, mining, railroad, auto and steel industries. Some of these didn’t need help from Uncle Sam, and some of them can’t get well even with the help. Oil and gas interests, by McIntyre’s estimate, will save at least $60 billion from depreciation over the decade, plus $33 billion from the reduced windfall-profits tax also lobbied through Congress.

But these tax breaks contain another element that is perhaps more damaging—a bias against jobs. If you run down the list of which industrial sectors enjoy negative-incometax status with the government, the bias is revealed: the capital-intensive industries (oil, chemicals, mining) were the big winners, and labor-intensive enterprises like building construction suffered. The tax bonuses available to a company that buys a new machine instead of hiring a worker are going to tilt every decision made by corporate planners in the obvious direction. A company would be foolish not to buy a machine, even if hiring a worker is more economical.

Given all this, it seems strange that the party that presumes to speak for the little guy isn’t raising a righteous fury. A few Democrats — like Representative Jim Shannon of Massachusetts — are, but most politicians from both parties fervently wish to ignore this great source of potential revenue. If one asks why, the whispered answer around Capitol Hill is simple: the PACs. American business and its network of Political Action Committees scare Congress, especially the Democrats. In 1976, the business PACs poured $7 million into congressional elections, and by 1980, the business money had increased almost fivefold to $30 million in campaign contributions. If $30 million sounds like a lot, the return on this investment was $250 billion in tax reductions.

“The business interests are really powerful,” Shannon explained. “You get exposed on two levels if you question these business tax cuts. First, they say you aren’t allowing them to work. Then you get exposed on a more personal level — because the business lobby that put these things together has a hell of a lot of money to throw around.”

Democrats are anxious to get campaign money from business, but liberal Democrats are even more fearful of being targeted as antibusiness by the U.S. Chamber of Commerce, the Business Roundtable and the National Association of Manufacturers—organizations that coordinate the flow of money from corporate PACs. A PAC can dump a million dollars into an obscure congressional district and buy a lot of TV time for an unknown Republican challenger. Even righteous liberals think twice about stirring up that kind of opposition. In the old days, they’d have called it blackmail.

“The PAC money plays a big role,” Shannon said darkly. “Nobody wants to admit it. But you have to think about that. Nobody wants to get targeted.”

***

If by summer’s end Congress is still stalemated over the budget crisis, and if the national economy is truly on the brink of catastrophe, the political debate will turn swiftly to another solution. The elected representatives, regardless of party and ideology, will rediscover an old and simple rule: the way to control high interest rates is to control high interest rates. That means, in addition to any congressional action on the budget, the Federal Reserve Board must relent in its tight money policy and force interest rates down to a bearable level.

For several years, the Fed and its imposing chairman, Paul Volcker, have had the politicians spooked. The Fed’s slow growth in the money supply was the mysterious “inflation fighter” and, as long as inflation was the main aggravation, none dared challenge this approach. After all, it was working: inflation was declining dramatically. The Reagan administration fully embraced Volcker’s approach and shared in the glory of lowered inflation rates.

But now the politicians are beginning to attack. When Volcker started his policy in October 1979, the United States was in the fifty-fifth month of the longest peacetime expansion in history. Unemployment was below six percent. Industrial production was rising. Since then, the country has gone through two recessions and interest rates have climbed to a level that, in the old days, would have been called by its honest name — usury. Even if the recession ends this summer, the brightest hope for 1983 is that industrial production might return to the high point it reached in 1979 before Volcker introduced his magic.

Liberal Democrats have been flailing at Volcker and his crippling interest rates for some months. Representative Henry Gonzalez of San Antonio even introduced a resolution of impeachment. Now the Democrats are being joined by congressional Republicans. Both House and Senate budget resolutions include exhortations to the central bank, demanding that it ease up on the tight money. So far, Volcker has ignored these commandments and offered no comforting hints that he intends to change course. If it comes to that, Congress can force Volcker to lower interest rates, but this is the kind of institutional confrontation Washington abhors. Without relief from the Fed, however, there is absolutely no guarantee that whittling down the deficit will actually produce the lower interest rates and economic recovery the politicians long for.

Volcker’s policy has, in fact, squeezed harder than intended. The figures from 1981 demonstrate that the Fed held back the growth of money even more than its own guidelines prescribed. That in itself gives Congress a strong argument for forcing relaxation by the Federal Reserve, but Congress is now in a double bind. If Congress forces Volcker to relent without taking convincing action of its own on the budget deficits, a burst of hyperinflation and high interest rates would surely follow—probably worse than anything we have seen before. If it comes to a choice between catastrophe and the return of double-digit inflation, the politicians will doubltlessly choose inflation, but someone has to suffer to get out of this mess.

How much pain can America take? Even if things work out, even if Congress acts and the Fed relents and a full-scale collapse is averted, analysts like Henry Kaufman are not exactly bouyant about the years ahead.

“If we can muddle along without weakening the fabric of our system over the next couple of years,” Kaufman allowed, “then perhaps by the time we get into the latter half of this decade, we will be on sounder footing. But the intervening period will be a very difficult one for us.”

In This Article: Coverwall, Economy

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