Policy-Testing Time

By Christopher Byron

Administration advisers squabble, and the recession may be deepening

Even as he basked in the glory of his unexpected victory in the AWACS vote in the Senate last week, President Reagan received still more bad news about the state of the American economy. Not only has the U.S., by the President's own admission, dropped into its second recession in 15 months, but the business dip may be both deeper and longer than Reagan predicted. The Government's index of leading economic indicators, which is supposed to portend future business trends, showed a sharp 2.7% drop in September, the biggest decline in 17 months. And, to make the situation worse, the Administration's top economic advisers have begun to quarrel among themselves over who is to blame for a policy that seems to go more wrong by the week.

The Administration's immediate problem is the hemorrhaging federal deficit. Though he took office on a pledge to balance the budget by 1984, the President last week found himself confronting the humiliating prospect of having to preside over what might become the biggest four-year run-up in the public debt since World War II. Instead of the predicted $43.1 billion deficit in spending for the fiscal 1982 year that began last month, the Administration now is girding for perhaps as much as $59.1 billion in red ink in the year ahead.

Forecasts by experts outside the Administration are even more disquieting. Last week Alice Rivlin, director of the Congressional Budget Office, warned a House banking subcommittee that the deficit could reach $100 billion in fiscal 1984, even if the economy performs well. A deficit of that magnitude would make a mockery of the fiscal conservatism that Reagan promised would be a hallmark of his Administration. One of the most alarming projections of all came from Chase Econometrics, an economic consulting firm, which forecast that without future changes in the law to reduce spending, the deficit will be $144 billion in 1983 and $168 billion in 1984.

The size of deficits will largely be determined by the level of economic activity in 1982 and after. Experts estimate that every one percentage point decline in annual gross national product translates into approximately $8 billion to $10 billion in additional deficit spending because tax receipts fall off and unemployment insurance payments rise. The Administration's Council of Economic Advisers had been expected to come up with a firm forecast of economic activity for 1982 three weeks ago, as part of the process of preparing the fiscal 1983 budget that Reagan will submit to Congress in January. But the report is still incomplete because of the inability of top Administration economists to agree on the depth of the recession.

Another reason for the economic woes is high interest rates, although there were signs last week that the cost of borrowing money may be coming down. Henry Kaufman, the influential Wall Street economist, predicted that the Federal Reserve would soon ease credit restraints, which would lower interest rates. That statement helped to give the stock market its biggest one-day boost in seven months, lifting the Dow Jones industrial average on Friday by more than 19 points, to close the week at 852.55.

But the cost of borrowing remains extremely high for both business and government. The Treasury last week released its federal financing calendar for the remainder of 1981, which calls for raising $18 billion in the coming eight weeks, a sum that will continue to apply upward pressure on interest rates.

As the news from the economic front worsens, the Administration's economic advisers have been growing daily more divided over what to do about their troubles. The travails have brought to the surface an ideological struggle within the Administration ranks between supply-side economists and monetarists on the one hand, and budget-cutters on the other.

Proponents of supply-side economics, led by Under Secretary of the Treasury Norman Ture and Assistant Treasury Secretary Paul Craig Roberts, argue that an excessive drive to balance the budget is wrecking the President's bold economic experiment. Their views are now endorsed by the Administration's monetarists, including Jerry Jordan, a member of the Council of Economic Advisers, and Beryl Sprinkel, Under Secretary of the Treasury for Monetary Affairs, who not so long ago emphasized fiscal austerity as a vital component of a successful policy.

Earlier this autumn, Treasury Secretary Donald Regan repeatedly insisted that towering interest rates were undermining the effects of the large tax cuts passed in August, but now even he has begun to move toward stressing the dangers of being too preoccupied with the deficit.

On the other hand, the Administration's budget-cutters, headed by David Stockman, the director of the Office of Management and Budget, maintain that it is essential to cut the size of the deficit, even if that can be done only by raising taxes. Since January, Stockman has sliced $38.7 billion from the fiscal 1981 and 1982 spending packages that Reagan inherited from Jimmy Carter. But the 1981 budget that ended Sept. 30 still overshot the President's $55.6 billion forecast by more than $2 billion.

With that kind of a three-ring policy circus performing in public, the Reagan Administration often looks confused or inept, or both. The Administration's economic advisers in recent weeks have turned more and more to intrigues and attempts to outflank each other and seize the policy initiative. One White House official last week griped bitterly in private to Washington journalists about the low quality of economic advice being given to the President by Murray Weidenbaum, chairman of the Council of Economic Advisers, and Treasury Secretary Donald Regan. Meanwhile, Treasury officials issued broadsides of their own. Among the more startling was a byline article in FORTUNE by Assistant Treasury Secretary Roberts, who leveled a deftly worded attack on Stockman for endangering the President's program by overemphasizing the importance of a balanced budget.

Administration supply-siders and monetarists are particularly incensed at Stockman's efforts to push through a package of indirect taxes on such items as tobacco, alcohol and gasoline. Lawrence Kudlow, the chief economist at OMB, has given such tax increases the woolly euphemism of "revenue enhancers." Supply-siders say that increasing taxes would repeat the mistake made in 1979 by Britain's Margaret Thatcher, when she tried to reduce a revenue shortfall brought on by sharp income tax cuts by raising the value-added taxes on consumer goods. Many economists now believe that the Thatcher taxes seriously aggravated Britain's economic slump by further curtailing purchasing power when the economy was already slipping sharply.

Last week Treasury Secretary Regan also went after Stockman. Said he: "I feel as if I am being pushed and pulled. I am going to have to start running this operation from my gut." After a midweek strategy session with aides, Regan decided to picture the Budget Director as pursuing a flawed policy that is playing into the hands of the Democrats. Regan's argument is that by allowing the Congress to consider tax increases as an alternative to further budget cuts, Stockman is actually putting the Administration's entire program in jeopardy.

With the economy now slumping, Congress seems in no mood this year to give Reagan either the $13 billion in supplementary budget cuts or the $3 billion in new taxes that he proposed in September. Last week, for example, the Republican-controlled Senate, by a 87-to-8 vote, approved a fiscal 1982 Interior Department appropriations bill giving 19 separate departmental agencies and bureaus close to $17 billion in total spending power for the year, or $1.6 billion more than Reagan himself had proposed.

Congressional Democrats are not ready to help Reagan by accepting his new budget cuts or tax increases. House Democrat Dan Rostenkowski of Illinois, the chairman of the Ways and Means Committee, is thirsting for revenge after the humiliating defeat he suffered last summer when the Reagan machine rolled over the Democratic tax-cut program and passed its own. Rostenkowski has already warned the Administration that his committee will not take up new "consumer taxes" this session. Speaker of the House Thomas P. ("Tip") O'Neill Jr. of Massachusetts last week endorsed the tough stand, saying that Democrats would not help the Administration out of its budget bind until the President admitted that his program was a failure.

For their part, House Republicans are not anxious to consider new tax increases of any sort. Said Michigan Congressman Guy Vander Jagt, a ranking member of the House Ways and Means Committee: "I personally believe that it would be a disaster to open that can of worms."

Liberal economists are relishing the Administration's plight. Says Walter Heller, onetime chief economic adviser to John F. Kennedy: "You really had to be an ostrich not to see this thing coming. It is not just the inherent contradictions within the program but the bitter rivalries between the monetarists, supply-siders and budget-balancers within the Administration, who are all out to influence policy."

Business leaders around the U.S. generally still support the Administration program, although more and more of them are calling for some minor changes, especially more spending cuts. Says Leland S. Prussia, chairman of California's Bank of America: "The overall program is out of balance and that suggests significant further adjustments, which imply high interest rates and a worse recession." Leif H. Olsen, chairman of the economic policy committee at New York's Citi bank, says flatly that there must be "additional budget cuts to reduce inflation." Willard G. Hedrick, who runs a small construction contracting firm in St. Louis, remains confident about the long-term goals of the Reagan plan. Says he: "It'll take an other two or four years to work, and this has set me back ten years financially. But I think it has to be done." Hedrick's confidence, and that of many supporters of Reaganomics, is likely to be tested severely during the coming economic down swing.

With reporting by David Beckwith, Neil MacNeil

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