An Unhappy Anniversary

By WALTER ISAACSON

Amid economic woes, the President calls for a New Federalism

"We've made an impressive start. We've laid the foundations for economic recovery and national renewal. Inflation and interest rates are down. A program that will mean more jobs and more opportunity for all Americans is now in place."

Ronald Reagan's first-anniversary pep talk to 2,000 federal employees gathered in a Commerce Department auditorium was one of the rare glimmers of optimism emerging from the gloom of Washington last week. Indeed, the very victories that Reagan was exalting--his stunning political success in enacting deep cuts in spending and taxes--made the stagnation of the economy all the more worrisome to those in his Administration. For intruding into the President's vision of success is a devastating 8.9% unemployment rate and a deep recession reflected by a 5.2% annual drop in the gross national product for the past quarter.

Yes, inflation has been reined in; according to figures released last week, consumer prices in 1981 rose only 8.9%, the lowest increase since 1977. But the main cause of the moderation was the current recession, rather than the hoped for increases in productivity and growth. Yes, interest rates are somewhat lower, but they remain at investment-strangling levels and could easily thwart the midyear recovery that economists have predicted. And looming over the program of the man who for years rode the rubber chicken circuit decrying unbalanced budgets are projected record deficits--the total for the next three years exceeds a shocking $300 billion.

As the economic battles of 1981 were being fought and won, a spirit of unity and purpose infused the Administration. This has now been replaced by a sense of drift and uncertainty, marked by fissures in the troika of top presidential advisers, internecine foreign policy disputes, and ill-conceived actions that are raising questions about the Administration's sensitivity to issues of fairness and racial justice. The President compounded the uneasiness by projecting, with amiable vacuity, an unsteady hand on the tiller of state at his seventh press conference last week. He displayed a disconcerting lode of misinformation (see box), and a dubious grasp of the details of his own programs. The performance raised new questions about Reagan's control of the presidency, which were being asked even by some of the far rightists who helped elect him. At a meeting of conservatives organized by New Right Leaders Richard Viguerie and Paul Weyrich, Reagan last week was criticized for his neglect of social issues like abortion and his fecklessness on foreign policy.

Recovering from this trough of troubles and deflecting debate over the budget are what the State of the Union message this week is designed to do. The speech will place more emphasis on the states than the union. Its cornerstone is a sweeping proposal for a "New Federalism," which goes far beyond concern over budget and tax levels and aims to transfer important government functions from Washington to state capitals, beginning in fiscal 1984.

The potential ramifications of this proposed shift of responsibilities may be even more radical than the cutting and slashing of 1981. The Federal Government will make a $25 billion swap of programs: the states will be expected to assume all of the costs of Aid to Families with Dependent Children and food stamps, while Washington will assume all of the costs of Medicaid. The Federal Government now pays slightly more than half of the money for these programs. This would reverse the trend, which began with the New Deal (see SPECIAL SECTION), of making "income maintenance" programs for the needy a national responsibility.

In addition, the Federal Government will, under Reagan's plan, turn back to the states as much as $20 billion worth of other programs, including education, highway construction and mass transportation. To help the states finance these new responsibilities, Reagan plans to set up a trust fund of revenues. This fund would include receipts from certain designated excise taxes as well as the money now allocated for revenue-sharing and other block grants that go directly from Washington to local governments.

Amid a flurry of leaks from his anxious staff, Reagan has been wondering whether he should recommend additional federal excise taxes. The revenue, some of which would be used to finance the trust fund for the states, would help dent the menacing deficits. Many of the President's top aides believe that the increased taxes are integral to making the New Federalism a significant and credible program. Says one ranking member of the White House staff: "I'm not sure the Federalism package will be able to command much attention without the excise tax increases to fund it."

The Administration had tentatively decided, early last week, on a $15 billion package of 1983 tax increases, including additional excises on cigarettes, liquor, wine and luxury items. But after a White House breakfast meeting with leaders of the U.S. Chamber of Commerce on Thursday, Reagan had second thoughts about imposing any tax hikes at all. The business leaders urged him to cut the budget further and to give his supply-side theories more time to work before supporting new levies. Responded Reagan: "I can assure you this advice won't roll off my shoulders. I've taken it to heart." Did the businessmen get to Reagan? "No," says a top aide, "I believe Ronald Reagan got to Reagan." He decided to rethink the issue over the weekend at Camp David.

Although Reagan has long advocated a shift of programs back to the states, politics has a lot to do with his New Federalism proposal. Among other things, it is a move designed to dominate the 1982 economic debate and buy time for the supply-side program of tax cuts to work its magic. Says a Reagan aide: "The whole idea is to come up with something that does not require us just to respond and defend the economic program. So we're changing the subject."

A draft of the State of the Union message outlining the New Federalism proposals--which will be made whether or not Reagan decides on additional tax hikes--was shown to Republican House Leader Robert Michel and his Senate counterpart Howard Baker last week. "Grand and heroic," pronounced Baker. But some Republicans on the Hill were annoyed that the leaders had not been asked for their opinions as the plan was developed. This was not done, Reagan's aides say, largely because the White House wanted to retain an element of surprise. But members of both parties fear the White House approach indicates a belief that the Republicans can be taken for granted and the Democrats bulldozed again this year. Says Republican Senator Slade Gorton of Washington: "Reagan's tactics will have to be different. He'll have to meet us halfway." One big difference about 1982 is that it is an election year. Scaling back federal responsibilities and imposing excise taxes will be politically difficult, no matter how sensible such moves might be.

Even if most Republicans, and some Democrats, embrace the idea of transferring Government power to the states it is unlikely that they will forget their concern over the huge 1983 and 1984 deficits that seem inevitable, with or without the Federalism initiatives. Republican Congressman Richard Cheney of Wyoming warned Reagan not to expect party support in the House for a badly unbalanced budget. "We've got to show declining deficits," he said. Senate Republican leaders, led by Robert Dole of Kansas and Pete Domenici of New Mexico, have been urging that the red ink be diluted by reducing somewhat the proposed boosts in defense spending and by cutting into some entitlement programs, as well as by raising taxes, if necessary. The Chamber of Commerce leaders also urged the President last week to take a harder look at Pentagon spending. Paul Thayer, chairman of the LTV Corp., told the President: "I've been in defense contracting for over 30 years, and I can tell you that 40% of the cost of the planes I sell is attributable to red tape, bureaucracy and duplicative expenditures."

Although Republicans are concerned about the deficits, many are reluctant to support higher excises to raise revenue. Supply-side true believers, such as House Republican Leaders Jack Kemp of New York and Trent Lott of Mississippi, argue that increasing taxes now would be to abandon Reaganomics before it has had a chance to work. Kemp has pressed on the President a fervent faith that the economy will soon spurt forward as a result of the tax cuts passed last year. But many economists now fear that the recovery, when it comes, will be weaker than the Administration predicts.

Any plan to raise excises would also be militantly challenged by Democrats. Dan Rostenkowski, chairman of the Ways and Means Committee, has labeled the levies "consumer taxes" that put a regressive burden on "the little guy." The Democrats have already focused their criticism on what they say is the unfairness of Reagan's program to the poor and the working class. A film prepared by Democrats as their televised rebuttal to the State of the Union message features average Americans as well as party leaders arguing that the pain of sacrifice is not being distributed equally.

The President's decision to press forward with the New Federalism, rather than concentrate on reducing the deficit, reflects his optimism that Reaganomics will eventually bear fruit. If a significant economic recovery does begin by midsummer, as the White House predicts, the proposed radical shifts in America's federal system could become the next legacy of a man whose political savvy is constantly being underestimated. If not, the New Federalism may remembered as nothing but a wishful ploy that merely deferred the day of reckoning for an economic approach that failed.

--By Walter Isaacson. Reported by Douglas Brew and Neil MacNeil/Washington

With reporting by Douglas Brew, Neil MacNeil

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