Recovery Saboteurs

Congress, n.: an organization that attempts to solve yesterday's problems by tying up tomorrow's resources.

They're at it again. Our esteemed elected representatives have worked themselves into a lather over the projected "terrifying" deficits. In response, they're gearing up to dismantle the few productive changes that have flowed from Reaganomics. The result will be the throttling of what could otherwise be an explosive economic recovery.

Lest that sound like too strong a claim, consider the economic evidence. Over the past two years interest rates have been cut in half and inflation slashed from 12 percent to below 4 percent. The percentage of GNP consumed by federal taxes has dropped, from just under 21 percent to below 19 percent. Even unemployment has begun to decline.

During the past two years businesses grew significantly leaner and more efficient. For the first time in decades, unions accepted not just pay freezes but actual pay cuts, making US labor costs more competitive. Obsolete plants have been shut down and inventories reduced to very low levels. Consumer debt has shrunk—people have been putting off large purchases until their real incomes start rising again (as they haven't done since 1978). Thus, the stage is set for a tremendous boom.

Why, then, do all the forecasters talk about weak growth and continuing deficits? The economic answer is that econometric models—which they all use—are notoriously unreliable. They tend to be extrapolations of what has been happening, rather than true explanations of what's going to happen. As Karl Brunner and Allan Meltzer point out, over a recent five-year period the average error in 13 next-quarter forecasts was between 2 percent and 3½ percent, while year-ahead forecasts erred by between 1 and 2 percent. And as Milton Friedman has noted, forecasts three to five years ahead "are not worth the paper they're printed on."

There is a political reason for the scary forecasts, also, and it is more ominous. There's a huge constituency for big government in this country. It includes big banks, much of the Fortune 500, road builders, home builders, farmers, and most of the lobbyists, law firms, and government employees in Washington. By seeking to shrink the role of government, Ronald Reagan has posed the most serious threat to that constituency in 50 years. So it is hardly surprising that this constituency—and its forecasters, consulting firms, and media house organs—is raising the specter of uncontrollable deficits. Their political purpose is to undo what remains of the Reagan experiment.

Their major target is now coming under a carefully orchestrated attack. Its name is indexing. The 1981 Reagan tax cuts reduced the marginal rates of taxation on personal income by 25 percent over 2½ years. To preserve those gains against bracket creep, the same law provides that as of 1985 tax brackets will be adjusted each year to compensate for inflation. Even after the 1982 corporate-tax and gasoline-tax increases, indexing would keep the federal government's take below 19 percent of GNP from 1985 through 1988.

Indexing of tax brackets is a matter of simple justice. Without it, every 10 percent of inflation increases government's tax take by 16.5 percent, providing a built-in engine for government growth. It was this sort of legalized theft that led to the out-of-control growth of government during the 1970s.

Canada indexed its tax brackets in 1974, and Denmark, France, and West Germany have followed suit. Since 1979, 10 states have done likewise, most recently California and Maine by vote of the people. Studies of the Canadian experience show that people with low to moderate incomes have benefited the most, primarily because tax brackets are wider in the upper ranges.

The game plan of the big-government constituency is simple. Stir up fear of huge deficits and blame them on cuts in tax rates (ignore continued growth in spending). Get indexing repealed, pump up inflation, and then use bracket creep to wipe out the deficit.

Is such a campaign under way? In recent weeks such notables as Senate Majority Leader Howard Baker, House Speaker Tip O'Neill, House Ways and Means Committee Chairman Dan Rostenkowski, and House Budget Committee Chairman James Jones have all called for repeal of indexing. O'Neill has called it a "time bomb" and Baker has stated that indexing puts tax policy "on automatic pilot and builds in economic and political distress that we are not prepared to cope with." Unprecedented rates of money supply growth over the past six months (M1 as much as 20 percent, the monetary base around 9 percent) make it clear that the Fed is already doing its part.

Can the big-government constituency's game plan be countered? A lot will depend on the rate of recovery. If the economy picks up as rapidly as Milton Friedman expects, deficits could begin dropping, forcing the forecasters to recant. (According to the Office of Management and Budget, were unemployment reduced to 6 percent, the deficit would be $175 billion less!)

Politically, however, the fear of future deficits must be countered. And the best way to do that—without choking off the recovery by raising tax rates—is to cut spending. Last November we noted a Cato Institute study that identified $107 billion in cuts by ending subsidies to business. Now the Heritage Foundation has issued a report targeting $111 billion in cuts by repealing subsidies and turning over programs to the states or the private sector.

Alternatively, there's a total freeze on spending, as suggested by Lew Uhler of the National Tax Limitation Committee. It would make everyone—including the military and Social Security recipients—share in the task of getting spending under control. A true freeze would allow revenues to catch up with spending sometime between late 1984 and mid-1985.

The point of such actions is to make sure that there is a recovery. If we aren't careful, though, the big-government constituency will soon have us back to stagflation-as-usual.