William Niskanen of the White House Council of Economic Advisors said last week that President Reagan's economic aides are ""puzzled and confused" about the persistence of high interest rates. It was thought that the president's budget and tax programs would trigger a burst of confidence in the financial markets leading to lower inflationary expectations and lower interest rates. There is no question that President Reagan has obtained a dramatic breakthrough on the economic front. In six months, he has cut some $37 billion in spending -- a feat thought impossible in January. But the Reagan strategy doesn't seem to be working. Why? Because of three significant misconceptions.
The first misconception is that we have had decades of irresponsible government and that one responsible administration could quickly balance the budget and boost public confidence. That fact is that, until the last decade, the federal government has been responsible. The cumulative deficit for the period 1951-1960 amounted to only $17.7 billion. For the next 10-year period, 1961-170, it went to $57 billion. So for those 20 years, we had a cumulative deficit of $74.7 billion. But for the last 10 years, the cumulative deficit exceeds $400 billion. With this kind of surge in red ink, the cost of interest on the national debt is running at an annual rate of $90 billion. No president coming to office at the height of this surge could turn it around in a year. Economically, it should't be done in a year's time because this would result in a deep recession, high unemployment and further revenue losses. But it can be done in three years, and, properly phased-in, the Reagan program can work. For now, the good news of a $37 billion cut in spending is offset by the $37 billion increase for defense and other programs. Economists looking at the bottom line don't consider this part of the Reagan program much of a change.
The second misconception is that Washington makes money from inflation. The administration's perception of Congress' meeting gleefully each year to distribute a huge pile of additional tax revenues collected by inflation is erroneous. True, taxpayers are ratcheted into higher brackets by inflation. True, the government will receive a windfall of $70 billion in tax revenues this year. But federal programs are indexed for inflation. So Social Security, Civil Service retirement, veterans, defense costs, interest costs, etc., will soar by $83.1 billion. To keep programs levelly funded, we have been cutting back either the program or the benefits. Last year's reconciliation bill amounted to an $8 billion reduction in the deficit. Even with $8 billion and $37 billion in savings, inflation will call next year for another cut -- or a large deficit. Congress is caught up -- inflation, causing deficits, causing inflation, causing deficits. . . .
The third misconception is that a tax cut always amounts to a tax cut. Not necessarily. We had a balanced budget and surplus for fiscal 1969. But since that time there have been seven tax cuts amounting to tax reductions, or a loss in revenue of $731 billion. These continuous deficits require the government to be constantly in the financial market borrowing money to pay for the deficit -- thereby increasing inflation and increasing the rate of interest. Accordingly, a fiscal policy of deficit spending causes sustained inflation throughout the economy: wage and price increases; persons being ratcheted up into higher tax brackets; and millions coming into the income-tax system for the first time. In reality, this kind of tax cut results in a tax increase for millions.
When the president recommends a tax cut, Wall Street and the business community see it as more of the same. A cross-section of the best financial and economic minds recently met in Washington. Looking at the $150 billion tax cut for the next three years, observing that only $30 billion was for investment and savings but $120 billion was on the demand-inflationary side and studying the increases and decreases in spending, they projected roughly a $60 billion deficit for 1982, a $60 billion deficit for 1983 and a $60 billion deficit for 1984. As economists see it, Republicans and Democrats are submitting the same old program of large deficits for the next three years. Both parties favor the spending cuts (Democrats, on two occasions, voted in the Senate for the cuts by almost 2-to-1). Both parties call for an approximate $40 billion tax cut for two or three years. Some differ with respect to how the cut is kiltered, but it amounts to the same loss in revenue. Neither approach addresses the problem of big dificits, high inflation and high interest rates. So the judgment flowing back to the business and investment houses of the nation is that we will continue to have high interest rates. White House aides shouldn't be "confused."
The first order of business is to stop deficit spending. We can do this and at the same time stimulate investment, savings and productivity -- do it exactly the way President Kennedy did it in 1962, when he first gave a tax cut solely to business. Then in 1964, it was followed with across-the-board individual income tax cuts. If we can restrict the tax cut for '82 solely to business and savings, we can stimulate plant modernization and make our industry competitive with the West Germans and the Japanese. The Finance Committee's provisions on depreciatiuon allowance, capital gains, overseas earnings, the marriage tax penalty, and a savings certificate should be passed immediately at a cost of $12 billion -- rather than the $40 billion cut. Across-the-board individual income tax cuts should be withheld until January 1983. Then we can give a 10 percent cut in 1983 and subsequent years. We would have a $35 billion deficit, rather than $60 billion in 1982. And rather than $60 billion deficit, we would have a balanced budget by 1984. In this way, we can bring interest rates down to size.
Adlai Stevenson, asked whether he was conservative or liberal, said that was not the important question. The important question is: Am I headed in the right direction? This is the need of the hour: to head America in the right direction. Most of the President's program can be accpted with a proper phase-in. But under the present proposal, huge deficits and high interest rates are guaranteed for the next three years.