A year ago, we economists who insisted that every economy has both a demand side and a supply side were pronounced old-fashioned by Washington's new breed. For awhile, I thought of changing my name to Edsel.
Now I'm glad I didn't. The pipe dreams that were passed off for policy in the hazy days of summer were revealed to be delusions by the time the snow fell. The radical supply siders, I hope you will remember, claimed that we could reduce inflation without recession; that we could combine tight money with easy fiscal policy and still bring down interest rates; that we could cut taxes to the bone, throw money on the Pentagon and still balance the budget.
To serious economists, these claims were always Lafferable. And now the American people seem to be waking up to the fact that we've been had. We have the lower inflation, all right, but we also have a serious recession, triple-digit budget deficits as far as the eye can see and the prospect of continuously high real interest rates.
What to do? Having dug ourselves this hole, how can we get out? This question brings to mind the old quip: you can't get there from here. Given the economic constraints that the medicine men of voodoo economics chose to ignore, and the political constraints that the president has imposed on us, there really seems to be no way to put things right any time soon.
The critical need right now is to stop the credit strangulation of our economy by trading a tighter fiscal policy for a looser monetary policy. But the two easiest routes from here to there have been sealed off by the president: he has declared that he will not rescind the scheduled 10 percent tax cut in 1983 and will not stop bathing the Pentagon in dollars.
Let's look at the numbers, taking fiscal year 1984 as an example. The administration, which was promising us a balanced budget only a few short months ago, is now projecting an $82 billion deficit. But this number is about as trustworthy as a Trojan horse. It is based on incredibly optimistic projections of economic performance and on congressional acquiescence in putting the social safety net through the office paper shredder. A more realistic estimate of the FY84 deficit toward which current policies are heading is $150-$200 billion.
A sensible target for FY 84, given where we are now, is a deficit of perhaps $75 billion But this time around we must get there from here by hook, not by crook. Can we do it? I'll suggest three items which together can shave about $100 billion off the FY 84 deficit.
First, we should rescind the 1983 installment of the Kemp-Roth tax cuts. (We need the 1982 installment to help end the recession). According to the Congressional Budget Office, this would produce about $37 billion in added revenue. However, the president has already declared that he will not balance the budget on the backs of the taxpayers.
Second, we should sharply curtail the projected real growth of defense spending. Notice that I am not suggesting cutting defense spending, nor even questioning the idea that the Pentagon's budget should grow faster than inflation. Just cutting the growth of real defense spending to about 3 percent per annum would shave $25-$30 billion from the FY 84 budget, and leave me sleeping just as soundly as before. However, the president does not want to balance the budget on the back of the Pentagon. Whose backs are left? The administration seems to have in mind the backs of the poor. I think this is a shame, and would like to nominate a different and far more muscular candidate. If we can't use the backs of the taxpayers, lets use the backs of the tax avoiders by closing tax loopholes.
The arithmetic makes it very believable that we might find $30-$40 billion of additional revenue for FY84 in this area. After all, the CBO's September 1981 report on tax expenditures listed over 100 tax preference items with a total estimated revenue loss of $287 billion for FY84. Thus, eliminating only 12 percent of these loopholes--which would permit us to concentrate on only the most glaring ones-- would produce $35 billion in new revenue.
Paring tax expenditures seems to be both an efficient and an equitable way to shrink the gaping budget deficits. For one thing, the beneficiaries of these expenditures are generally quite well off and have just been given sizable tax cuts. They have much stronger backs than the people who bore the brunt of the FY82 budget cuts. For another, cutting tax expenditures would reduce some important tax distortions and promote economic efficiency; it's good "supply-side economics."
As we learned in the Atlantic Monthly article, David Stockman compiled a list of target tax expenditures in his "Chapter II" of budget cuts. I do not know what was on his list, so here are a few candidates of my own, indicating in each case the CBO estimate of the amount of revenue that could be raised in FY84:
* Eliminate the preferential treatment of capital gains--$24 billion.
* Eliminate special tax breaks for the oil and gas industries (mainly, percentage depletion and expensing of intangible drilling costs) --$10 billion.
* Eliminate the deductibility of consumer interest payments (other than on mortgages, business and investment loans)--$8 billion.
* Limit the deduction for home mortgage interest to $5,000 per year--$5.5 billion.
There. I'm almost up to $50 billion and I've hardly warmed up. This list is not meant to be definitive. Others will have their own favorite targets. It is meant to illustrate that there is lots of money to be found in tax expenditures.
>So here is the proposed deal. A fiscal package to reduce the FY 84 deficit by about $100 billion in return for the Federal Reserve loosening up enough on monetary policy to bring real interest rates down 1 or 2 percentage points. Now all we need is to get Reagan and Volcker to agree! As I said, you can't get there from here.