After Congress and President Reagan spent several months haggling over deficit reductions, the stalling in Washington finally gave way to positive action in the form of the Gramm-Rudman-Hollings bill (better known to most of us as the balanced-budget amendment). In mid-December of 1985, Congress passed this historic piece of legislation in order to force the deficit reductions necessary to keep the recovery going. Hastily constructed and rushed through Congress in order to avoid a debt crisis here and a confidence crisis abroad, the Gramm-Rudman plan promises to bring the federal budget deficit to zero by 1991 — for the first time in more than 20 years. But promises were made to be broken, and Gramm-Rudman is no exception.
The Balanced-Budget Amendment: Remedy or Ruse?
Even more significant than the landmark balanced-budget amendment was the debt-ceiling bill to which the Gramm-Rudman measure was attached. The passage of this bill raised the federal debt ceiling to $2.079 trillion, which is, in effect, an admission that Congress and the traditional budget process have failed. Could it be that nobody wants responsibility for reducing the deficit that has financed our recovery, when cutting the deficit could bring on another recession?
All the stalling can hardly be blamed on those in Congress, either. Many of these deficits were born of President Reagan's incompatible priorities of increasing defense spending while slashing taxes. It was the president's belief, based on supply-side theories, that the tax cuts would stimulate enough economic growth to pay for themselves. But the stubborn deficits have refused to come down, providing mounting evidence that supply side theories may have been more fantasy than fact.
Because of President Reagan's long-held view that we would eventually grow out of the deficit, it has been Congress — and not the White House — that has taken the lead in the battle against red ink with the balanced-budget amendment. In fact, deficit-reduction attempts by members of the president's own party during the spring and summer of 1985 were thwarted by Mr. Reagan himself.
Record-high trade deficits were undoubtedly among the primary forces that finally motivated Congress to take action to reduce the budget deficit. The trade deficit is directly related to the huge federal deficit. The federal budget deficit has forced the government to do a lot of borrowing, and the competition for cash between the government and the private sector has caused real interest rates to remain rather high. Our high interest rates and apparent economic health have drawn a lot of foreign capital to the U.S., and much of this foreign investment has gone for the purchase of U.S. debt securities. This has helped us finance the deficit, but foreign demand for dollars to invest in the U.S. has driven the value of the dollar way up. Our overvalued currency has caused our exports to be more expensive overseas and also has reduced the prices of imports here. These factors have resulted in record U.S. trade deficits, which have led many American manufacturers to seek protection from foreign competition. Concern over rising protectionist sentiment and a slowing economy, also believed to have been caused primarily by the trade deficit, prompted Congress to take action.
With President Reagan's backing, the Republican-controlled Senate passed a budget resolution in May of 1985 that would have cut the current deficit in half by 1988. The resolution included skipping the Social Security cost-of-living adjustment (COLA) in 1986, but Mr. Reagan's support for the "COLA holiday" fizzled when House Democrats turned the matter into a partisan issue.
During the summer, Senate Republicans promoted a three-year, $338 billion deficit-reduction plan that included some tax boosts, but the package fell apart when Reagan refused to entertain the idea of a tax increase and threatened a veto. After this setback, Senate negotiators and their House counterparts had little left to argue about and were able to iron out remaining differences within a matter of days. The resulting budget resolution for fiscal 1986 promised to cut projected spending by $277 billion over a three-year period, with the savings divided about equally between defense and domestic programs. Not many in Congress were happy with this watered-down resolution. Everyone blamed everyone else for the general absence of will in coming to grips with the deficit, which would have topped $170 billion in 1986 even if all the savings in the August budget resolution were achieved.
As summer turned to fall, it became more and more obvious that the savings in the August budget resolution would not be attained. Failure by Congress to carry through on proposed spending cuts, and falling revenues caused by a more sluggish economy than the administration had projected, led to speculation that the deficit in fiscal 1986 could top $200 billion. There was even some speculation that the 1986 deficit could match the record $212 billion 1985 deficit.
Concern over the ballooning deficit induced the Senate to mount another attack. Senators Phil Gramm and Warren Rudman drafted a bill requiring the president to submit budgets that would take the deficit to zero in even steps by 1990. In this proposal, the president would have had to come up with across-the-board cuts in all programs — including defense and Society Security — if Congress was unable to meet the deficit target by the beginning of the fiscal year. The president's cuts would then have gone into effect if Congress remained unable to recommend cuts of its own.
Before the plan became legislation, some changes were made. It was proposed that Social Security be taken off the budget and made a freestanding trust fund, and a provision which would have given the president more flexibility in budget cutting was omitted. By the time all the changes were finished, a large percentage of all federal spending remained exempt from the plan, including Social Security, interest on the debt, long-term procurement contracts for military and domestic purchases, and some entitlement programs. The Senate passed the measure, and President Reagan gave it his blessing.
The House then adopted its own Democratic version of a plan to revamp the budget process. That plan put more pressure on Senate Republicans to tighten their deficit targets. The original Senate target of $192.6 billion for 1986 was much higher than the $161 billion deficit target endorsed by the House. The strong 249-180 vote in the House made it harder for the Senate to hold out for the higher deficit ceilings favored by the Reagan administration.
The White House looked on with a growing sense of unease as the House and Senate worked out a compromise on the balanced-budget bill. As it became increasingly evident that defense programs would be hit with the largest share of the cuts if the mandatory reductions were ever triggered, top officials at the Pentagon urged all-out opposition to the plan. Caspar Weinberger stressed the possible devastation of defense programs and urged the president to resist the measure, but President Reagan's hands were tied. He had already endorsed Gramm-Rudman. Even so, a veto threat did materialize during the week preceding the president's trip to Geneva, on the grounds that Congress couldn't expect the president to accept a big cut in defense right before his meeting with Soviet leader Mikhail Gorbachev. In response, Congress approved a debt-limit extension to assure that no action would have to be taken on the debt-ceiling bill and the Gramm-Rudman amendment until the president's return. So it was that in mid-December Gramm-Rudman became the nation's new program for limiting the federal budget deficit.
The version of Gramm-Rudman that finally passed contains the following deficit targets: $172 billion for fiscal 1986, $144 billion for 1987, $108 billion for 1988, $72 billion for 1989, $36 billion for 1990, and zero in 1991. If the president and Congress now fail to meet those goals, an automatic procedure will be set in motion to force across-the-board spending reductions. The cuts will be split equally between defense and domestic spending. Social Security, veterans' compensation, interest on the national debt, and several poverty programs — such as Medicaid, food stamps, and Aid to Families with Dependent Children — will be exempt from reductions. Some health programs — Medicare, for example — will be subject to limited cuts of no more than 1% this year and 2% in future years.
Meeting the $172 billion deficit target for fiscal 1986 will require an additional $11.7 billion in spending reductions for the year already in progress. If the automatic cuts are triggered, half the spending reductions will come from defense. Certain provisions give the Pentagon flexibility in distributing its share of the cuts in fiscal 1986. In future years the reductions will fall automatically, affecting each line of the defense budget proportionately. Gramm-Rudman casts a shadow of doubt over the Pentagon's current budget plans, which call for after-inflation growth of 3% for the next two fiscal years.
The truth is that the federal deficit has grown so monstrous that even if all government spending were halted — except for defense, for meeting automatic payments for entitlement programs like Social Security, and for paying interest on the national debt — the budget would still be in the red. However, as much as 58% of the annual budget remains protected from the automatic cuts. The largest cuts would fall on that portion of the budget, including defense spending, which has no special protection. As the deficit is reduced, then, it will be all but impossible to maintain defense spending even at current levels without a tax hike.
In an ironic twist of fate, Congress used the president's own balanced-budget rhetoric to compel acceptance of the Gramm-Rudman program, which many experts believe will force the president to slash defense spending, raise taxes, or both. It all looks like a giant step backward from the supply-side theories the president has for so long espoused. However, there is a provision in the balanced-budget scheme that may save Mr. Reagan from such an embarrassment. And this same provision has also led some of us to question whether Washington really intends to balance the budget by 1991. You see, Gramm-Rudman contains a loophole that would allow the automatic cuts to be suspended during a national emergency or a recession!
Furthermore, many economists were predicting a recession for 1987 or 1988 before the Gramm-Rudman plan was drafted, and many now feel that the likelihood of such a recession increases as the government cuts the deficit spending that's been fueling the recovery. As Washington spends less with private businesses, an economic slowdown is very likely to result. And as the government reduces spending because of the mandatory cuts, it puts fewer dollars into consumers' pockets. This would adversely affect consumer spending and deepen the recession. It might also be interesting to note that since less government spending means less money for consumers, tax receipts would fall. This could cause the deficit to rise somewhat, making it difficult for Washington to hit the deficit targets.
If such a recession occurs, unemployment will rise, tax revenues will fall dramatically, and the deficit will get bigger, not smaller. The automatic cuts in Gramm-Rudman would further reduce the deficit spending on which the economy has become so dependent and thereby further aggravate the recession, unless the mandatory cuts are suspended. Suspension of the deficit cuts during a recession would allow the deficit to balloon by $100 billion or more, possibly up to $300 billion. This scenario makes the prospect of balancing the budget by 1991 seem remote at best. In our zeal to curb runaway inflation, we now find ourselves faced with the grim specter of runaway debt.
Whether or not all this comes to pass, and just how serious the recession may become, now depends to a large extent on the Federal Reserve. The Fed has recently allowed phenomenal growth in the money supply to ease the credit shortage caused by the deficit and to take some of the strength out of the dollar. This may be evidence that the Fed is shifting away from the tight monetary policy of the early 1980s to a more liberal policy. If this is the case, the Fed may try to head off the impending recession with a hefty dose of more created money. The implications of this are fairly obvious: We'd be avoiding a serious recession at the expense of renewed inflation. Should the Fed decide to keep the recovery going with created money, we will have once again entered into another economic era. For this would signify a shift away from fiscal stimulation of the economy (deficit spending) back to a reliance on monetary stimulation. However, if we're "lucky," a return to monetary stimulation might just allow us to balance the budget — at the cost of renewed inflation.
Aside from fears that Gramm-Rudman may eventually bring on recession or renewed inflation, there are several flaws in the plan that may themselves undermine its original goals. One major problem with the balanced-budget program is that the first cut is so minor that it will do relatively little to reduce interest rates and bring down the overvalued dollar. To make matters worse, renewed foreign confidence could further slow the dollar's decline and may even put upward pressure on our currency as we give foreigners the impression that we're putting our fiscal house in order. And the longer it takes for the dollar to decline significantly, the longer U.S. manufacturers and farmers hurt by the strong dollar will continue to suffer.
However, there is also hope. If those hit hardest by our overvalued dollar can hang on for a while, things should get better once Gramm-Rudman forces Washington to put a sizable dent in the deficit. Unfortunately, as noted above, by the time this happens, we could find ourselves in the midst of a painful recession.
Gramm-Rudman also has a serious flaw in that its primary aim is to reduce projected deficits, not government spending. There are just too many factors that can affect economic performance over the course of a year. If the government is overoptimistic and the actual deficit turns out to be larger than the projected deficit, the spending cuts may not achieve their goal. This is precisely what happened in 1985, which is primarily why Gramm-Rudman was created to begin with.
There is something implied by Gramm-Rudman, too, that is very disturbing. Those who represent us in Washington were elected in the hopes that they would be responsible in acting on our behalf, showing good judgment and exercising their wisdom. Gramm-Rudman threatens to replace good judgment and wisdom with the inflexible routine of a mechanistic device, and a crude one at that. Congress may well have solved its deficit dilemma by inventing the ultimate contrivance for passing the buck. There is hardly any part of the U.S. budget that doesn't have a constituency. As certain programs get cut, the folks in the House and Senate can now avoid the flak simply by shrugging their shoulders and muttering the words "Gramm-Rudman." The plan allows the members of Congress to escape their responsibility to come to grips with the deficit, a feature which could prove especially handy as we approach the 1986 congressional elections.
On the other hand, Congress does deserve some credit for taking action now, instead of waiting for the deficit to plunge us into a crisis. If the deficit had been allowed to remain at around $200 billion, a recession would have quickly made it impossible for us to get all our dept back under control (a scenario that could, in fact, still come to pass).
The stock market rally in late 1985 reflected a growing sense of optimism fueled by Washington's apparent resolve to get the deficit under control. But we're hardly out of the woods yet. Although the balanced-budget scheme should solve some of our short-term problems by boosting confidence at home and abroad, it will almost certainly create more problems for us in the not-too-distant future. In short, Gramm-Rudman could turn out to be more of a placebo than a remedy.