"When spending leads to deficit finance, it diverts scarce private-sector saving from financing investment to financing the federal debt. . . . This administration is committed to reducing the budget deficit." -- Treasury Secretary Donald T. Regan on Jan. 27, 1981.
Yesterday Regan told Congress that the large prospective deficits in President Reagan's new budget "will be manageable because of the growth in private-sector saving." New savings because of Reagan's tax cuts will provide an "extra shot in the arm of capital markets that will put downward pressure on interest rates" and will finance big deficits and a rapid build up in investment, he said.
Many economists question that. They believe the federal deficits likely in the next few years will absorb an historically high proportion of available credit, will put upward pressure on interest rates, and will likely crowd out private investment in new plants and machinery. If the federal government borrows all the money that individuals save, then there will be little left for business to use for investment.
"It would not be a terrible bet to say that if we stay on this policy course, the federal deficit will come close" to equaling the amount of personal saving in the economy, conservative economist Rudy Penner of the American Enterprise Institute said yesterday.
In any given year there is a pool of savings available for business executives to invest in new plant and equipment or for the government to borrow to finance its deficit. Most of these savings comes from individuals, who do not spend all of their income, and from business profits. Some of it can come from overseas if foreigners invest more money in the United States than American citizens invest overseas, and some of it comes from the budget surpluses usually run by state and local governments.
The more that the government takes from this savings pool, the less is available for other purposes. Last year individuals saved just over $100 billion, business saved $372 billion, and state and local governments had an overall surplus of $36.5 billion. The federal government deficit was equivalent to more than 12 percent of the total private savings of business and individuals, administration figures show.
The significance of this federal share varies depending on what is happening to the economy. During recessions, business executives generally do not want to borrow much for investment, so government borrowing is not "crowding" them out. Business profits also shrink, reducing the size of the total savings pool, and so raising the share of it that goes to government. Meanwhile, this share is also pushed up by larger federal deficits. Federal revenues fall in recession--with falling profits and slower wage increases--and federal spending rises. The administration predicts that the federal government will take nearly 20 percent of private savings this recession year.
Few economists worry about that. But they do worry about how much the federal government will be taking of total private savings by 1983 and 1984 when the economy will be recovering, and--presumably--business executives will be willing to invest again.
Regan predicts that a combination of falling deficits and rising savings will bring down the federal government's share of the available credit to about 11 1/2 percent by 1984. Tax cuts will add to the cash available to business and households, while lower marginal tax rates will encourage people to save more of their incomes, the Treasury secretary says.
Figures supplied to the Treasury by the president's Council of Economic Advisers show personal saving rising to more than $170 billion in 1983, before slipping to $163.5 billion in 1984. Business gross savings, before accounting for the wearing out of plant and equipment, rises to $479 billion in 1983 and $578 billion by 1984. Meanwhile the deficit comes down.
But other economists believe, firstly, that the economy will not grow as quickly as the administration says, so the pool of savings will not increase so much, and, secondly, that the federal deficit will be larger than Reagan predicts.
"The gross savings generated through the tax reductions and restructuring of balance sheets in the private sector will not be enough to finance the projected deficits," Allen Sinai of private forecaster Data Resources Inc. commented this week. Yesterday he said that the Reagan numbers are "internally inconsistent."
The total growth in the economy and in personal incomes that Reagan assumes is inconsistent with the tight money targets of the Federal Reserve, Sinai and other economists argue. If the economy grows less rapidly, then the federal deficit will rise and the pool of private savings will be lower than Reagan predicts.
The other inconsistency is between the administration's prediction of falling interest rates together with a large budget deficit and increased savings, Sinai said. High interest rates help to attract savings, and to discourage people from spending. If rates are falling, then the projected increase in the proportion of income that is saved is less likely, he says.
Moreover, even if people do save much more than in the past because of Reagan's tax cuts, Sinai calculates that more than half of the total of this additional savings and the extra cash for businesses and households that will come directly from the tax cut would have to be put into Treasury securities in the next three years to cover the projected deficits and the rollover of past federal debt.
Interest rates on these securities will have to be high to attract that kind of money, he warns. High interest rates will discourage business investment.