THE FEDERAL government faces serious deficit problems, but not the ones you've been worrying about. The real problem is that our budget calculations are so misleading that our budget-balancing efforts can bring disaster.
If we begin to measure the federal budget accurately to take account of the effects of inflation, we will realize a disturbing fact: The balanced budget contemplated by the Gramm-Rudman-Hollings deficit-reduction act will, with a 4 percent annual rate of inflation, produce sizable real budget surpluses during the 1990s. These surpluses will sap purchasing power and plunge the economy into a depression.
Let me offer a modest counter-proposal: We can immmediately ease our budget crisis by changing our accounting methods to reflect the effects of inflation and capital spending. The latter would bring the federal government toward the accounting procedures used by all major corporations and nearly all state and local governments. Both would help to demystify the deficit problem itself, so that we can distinguish the real economic effects of deficits from scare talk about them.
There has always been a certain amount of hysteria surrounding the federal debt and deficits. For most of the American public, debt and deficits are like sin: morally wrong, difficult to avoid, but not easy to keep track of.
Consider the case of the Carter administration. Faced with seemingly explosive inflation, Carter reacted sharply to the then supposedly large federal deficits believed responsible. He allowed taxes to rise, limited spending and encouraged tight money. Carter thus weakened a sluggish economy and contributed to his own demise.
Those Carter policies were based on false intelligence, misread by friend and foe alike. They were unnecessary and misguided. The official numbers showed a total deficit of $153 billion over the Carter years. In fact, we did not have real federal budget deficits from 1977 to 1980. If we measure the effect of inflation in shrinking the real value of the federal debt, the Carter budgets added up to a real budget surplus of $72 billion.
The new Reagan administration in 1981, in the name of combating inflation, at first continued the Carter policies. But it did so with sufficient dedication and efficiency to bring on the worst recession since the Great Depression. Business investment and profits plummeted, and unemployment rose to a post-World War II record. And then came an economic miracle. We began to run really huge budget deficits, and the economy recovered sharply. A new "Reaganomics" and hitherto-unheralded preachers of a "supply- side" gospel claimed credit.
The real story is that federal budget deficits can have great consequences for the economy. And startling as this may seem, these may be good, as well as bad. But we cannot begin to know the consequences of deficits until we measure them correctly. Because we have not measured deficits correctly, we have confused economic analysts, turned economic theory on its head, and committed grievous errors in economic policy. If we continue to act this way, we court future disaster.
As World War II brought us an early bout with inflation, a popular song had it that "A dollar ain't a dollar any more." The refrain in recent years could be that "A deficit ain't a deficit any more."
Why? Because of inflation itself. As inflation wipes out the value of money, it also wipes out the value of debt. As it does so, it profoundly alters the significance of conventional measures of the deficit. Accordingly, meaningful correction for inflation can cause a dramatic shift in understanding. Deficits that have appeared to be enormous can turn out to be moderate. Moderate deficits are converted to surpluses!
The reason is that the federal deficit is the increase in how much the federal government owes from year to year. But inflation skews our sense of what a real increase -- or deficit -- is. Suppose, for example, the national debt of $2,000 billion were to go up by 4 percent in 1986 because of a deficit of $80 billion. But if prices -- inflation -- in 1986 also rise at 4 percent, the national debt in "real" dollars -- reflecting constant purchasing power over time -- would not change. In real terms, then, measured as the increase in the real value -- or real cost -- of the debt, the $80 billion "deficit" disappears.
In a high and rising inflation year like 1978, this means that the federal government calculated it had a $29.5 billion deficit, when in fact, adjusted for inflation, it was running a $32.9 billion surplus.
Inflation is not the only source of our confusions on the deficit. The federal government has a strange accounting system. It differs not only from that of private business, but also from that of state and local governments.
Every large corporation, just like the state of California under Ronald Reagan, distinguishes between current and capital expenditures. Every individual sensibly managing his own finances must make the same distinction. Our official measures of the federal deficit do not.
Businesses and individuals recognize that not all debts are the same. Gambling debts aren't the same as a mortgage on a new home. Business investment is applauded as contributing to economic growth.
But by federal government accounting practice, AT&T, General Motors, IBM and many other companies would be guilty of "deficit-financing." And so, indeed, would be most of our state and local governments, which by their own accounting generally show balanced budgets or tidy surpluses.
If the federal government adopted a capital budgeting system, the deficit would shrink sharply. The Office of Management and Budget provides estimates of "federal investment-type outlays." These include spending for such things as the building of post offices, highways, B1 bombers, filling up the strategic petroleum reserve, and research on space and health. For fiscal 1986, these estimates came to $215 billion -- roughly equal to the deficit.
Application of private accounting principles would not eliminate all of the deficit. While we would exclude most of the current capital expenditures of $215 billion and another $4 billion of loans to farmers, students and small businessmen, we would have to add in perhaps $120 billion in depreciation of government assets. But we would still cut the reported deficit by half.
There are other changes we should make in the way we think about deficits. For example, you'd think that as the federal government runs deficits, it would increase its debt. In fact, why else worry about deficits? But suppose the federal government ran a balance sheet like businesses do -- with debts on one side and assets on the other. We would find in it some possible surprises. For example, from 1946 through 1980, federal budget deficits totaled some $450 billion. Yet, over that period, the government's net worth has moved from red to black. That's because its assets -- everything it owns, from federal land with its oil, gas and coal, to gold reserves to official limousines to its entire stock of M16 rifles -- are now worth more than those liabilities.
The market or replacement value of reproducible assets alone -- structures, equipment and inventories -- increased by $469 billion, from $179 billion to $648 billion, according to data from the Bureau of Economic Analysis. By very conservative measure, the value of federal land, exclusive of mineral rights, had increased another $166 billion.
Despite the very large federal deficits of the last four years, the total gross federal debt of roughly $2 trillion as of now is far more than matched by about $2 trillion in real assets and another trillion in gold, government securities, mortgages, other loans and cash held by the Treasury, the Federal Reserve, credit agencies and trust funds.
This is not to suggest that we should sell all the federal government's assets to make the national debt disappear. That would be as bizarre as suggesting that a family sell its $100,000 home to make its $50,000 mortgage disappear.
The federal government's assets are creating wealth for the nation. When the government builds an airport, for example, it is creating wealth for the airlines and the passengers who use the airport to do business. That is not bad for the country. Nor is it necessarily bad for the government's bookkeeping. If the government chooses, it could and usually does collect some of that wealth by taxing the airlines more.
Nonetheless, the Reagan administration has already proposed to solve deficit problems by selling off government loan portfolios, federal petroleum reserves and the Bonneville Dam. It can be argued that the federal government should not, for example, be in the power business. But selling these assets to solve the deficit problem makes no more sense than raising money by selling our M1 tanks to defense contractors and renting them back.
Despite all the talk about new deficits, the general trend of real federal debt -- the debt adjusted for inflation -- has been downward. Subtracting financial assets from liabilities and adjusting for inflation, we find that from 1945 to 1980, the real net debt of the federal government fell by 58 percent. The real net debt per capita declined from $4,017 in 1972 dollars at the end of 1945 to $1,032 at the end of 1980, a drop of almost three quarters. By the end of 1984, it was up to $2,183 and is now several hundred dollars higher. But it remains far below its post-World War II peak.
And that's important because the significance of deficits, after all, is that they add to debt. But with inflation, that is simply not necessarily so. You can run a "deficit" while the real value of it debt declines.
The government, in fact, has been paying off its debt in a sneaky way thanks to inflation, all these years. You could call it an "inflation tax." This means that the government has reduced how much it owes in real terms, because the people who hold government bonds have seen the real values of their securities -- how much they could buy with them -- eroded. Year after year, during periods of high and rising inflation, the bonds were decreasing in worth by even more than the bonds were supposed to be paying in interest.
When we adjust conventionally measured budget deficits for this "inflation tax" on government bondholders -- as real in its effects as any other tax, we get some startling results. Again, nominal deficits are even converted to real surpluses! As we noted earlier, the Carter deficits of $153 billion -- then considered very large -- turn into total surpluses of $72 billion.
This should properly lead to a quite revised view of recent history. We did not have large deficits contributing to inflation during the Carter years, 1977 to 1980. We rather had inflation -- propelled chiefly by huge increases in prices of oil and agricultural products -- converting presumably large deficits into real surpluses.
The deficits should have been expected to be sufficient to stimulate the economy and reduce unemployment. With the economy rather turning sluggish, many were led to question the Keynesian analysis which had come to dominate economic thinking over almost half a century.
But if budgets were not really in deficit but in surplus the picture is entirely different. The Federal Reserve was no longer the "only game in town" to slow down the economy. The government itself -- by taking in more money in total taxes, including the inflation tax, than it was spending -- contributed mightly to the 1981-82 recession, the sharpest and deepest economic downturn since 1930s, with unemployment by December of 1982 reaching 10.8 percent
This approach explains not only the sharp recession of 1981-82 but the subsequent recovery. For the Reagan administration had actually persisted in the Carter tight-money, tight-fiscal policies well into 1982. But, looking at the inflation-adjusted, high-employment budget beginning in the latter half of 1982, the combination of the cuts in both legislated taxes and the inflation tax brought the biggest swing from surplus to deficit on record. As should have been predicted, the economy recovered smartly.
The future is a somewhat different matter. Even adjusting for inflation, prospective deficits are still large. They should be reduced to restore a proper balance between fiscal and monetary policy. Recognizing, though, that lowering the deficit in itself would tend to reduce spending and purchasing power and increase unemployment, deficit reduction should be matched by increased stimulus from easier money.
But the true deficit is the one adjusted for the inflation tax. A "balanced budget," which would eliminate the official, nominal deficit, would create a very substantial surplus.
Whatever else may be right or wrong about the current Gramm-Rudman-Hollings hot potato, meeting its target of an officially balanced budget by 1990 would create a huge real budget surplus. For with inflation even at a modest 4 percent, the inflation tax then would come to some $100 billion. Such a surplus could go far to precipitate a new economic downturn that would make our recession of a few years ago look minor.