Why Deficits Really Matter

By GEORGE J. CHURCH

Twenty-nine billion dollars! A mind-boggling sum. To many people, grappling with their own family budgets and worried about their own personal deficits, it is absolutely alarming that the Government proposes to spend that much more than it takes in during a single year. Yet the figure is a small fraction when compared with the total size of the U.S. economy. By the end of the budget year in September 1980, the U.S. will be producing goods and services at an annual rate of $2.6 trillion. So what does the $29 billion figure actually mean? Do deficits really matter? If so, why and how much?

That is one of the most durable and emotional questions in American political debate. As inflation has soared close to double-digit rates, with no war or speculative boom or oil shortage to blame it on, deficit spending has come to be viewed as the fiscal mortal sin leading inexorably to inflationary damnation. The legislatures of 22 states have called for a constitutional amendment that would require a balanced budget every year. Amendment or not, that would be impossible, since no Administration could predict future revenues and expenditures accurately enough. It is also undesirable. There are circumstances in which a deficit would be unavoidable, such as when a war is raising spending faster than taxes can be jacked up. There are also times when a deficit is necessary, such as when inflation is low, unemployment is high and private spending is insufficient to put people back to work.

But how does one judge whether--and how big--a deficit is appropriate? There is no simple answer, because deficits can have a variety of effects on the economy. As Arthur Burns, former Federal Reserve Board chairman, notes: "When the Government runs a budget deficit, it pumps more money into the pocketbooks of people than it takes out of their pocketbooks." That creates more demand for goods and services, which can put idle people and machines to work, or can make prices rise faster than they would if demand were lower.

All too often, alas, a deficit does both, and economists divide diametrically on which effect has predominated lately. Says Liberal Arthur Okun: "The role of the deficit in the inflation of recent years has been trivial. The only way that a deficit creates inflation is by overheating the economy, and we haven't had an overheated economy in five years." The opposing view, from Burns: "This persistence of substantial deficits in federal finances is mainly responsible for the serious inflation that got under way in our country in the mid-'60s ... and when the deficit increases at a time of economic expansion, as it has done lately, we should not be surprised to find the rate of inflation quickening."

Opinions differ so strongly largely because there are many ways of measuring the size of a deficit, and the measure that is most easily grasped--the actual number of dollars involved--is not necessarily the most important one. A great deal depends on the condition of the economy: a huge deficit may spur only a little inflation if the nation is in a severe recession, while a small deficit may be violently inflationary if demand is pushing at the limits of business's productive capacity. The Carter Administration stresses that its proposed $29 billion deficit would be only about 1 % of the gross national product, down from 4% in fiscal 1976, when the deficit was $66 billion. That is a smaller proportion than in West Germany, which has a low 2.6% inflation rate. Two reasons why Bonn gets away with it: the rising value of the deutsche mark keeps import prices down, and rapid productivity gains combined with tough domestic and foreign competition limit industrial price boosts. Democratic Economist Walter Heller insists that the size of the deficit next year is less important than the underlying trends in spending and revenues. He points out that federal spending is rising by only 8.5% a year, while tax collections are growing at 12%, putting a squeeze on demand that he considers a bit too tight.

Conservatives reply that the official budget is far from the whole story. Alan Greenspan, former chairman of the Council of Economic Advisers, calculates that when the off-budget activities of several federally sponsored lending agencies are counted, the Government will be pumping not $29 billion but at least $60 billion in cash and credit into the economy during fiscal 1980 -- altogether too much. Another problem: a big deficit tempts the Federal Reserve to create huge quantities of new money so that banks can lend that money to the Treasury to cover its bills. A rapid run-up in money supply is definitely inflationary, though the effects may not be felt for 18 months or two years.

The alternative is not much better: if the Fed does not cover the deficit by creating new money, the Treasury has to sell bonds that are paid for out of private savings.

Less capital is then left to finance business investment that is needed to increase productivity. In practice, the Government has financed its big deficits of the 1970s by a combination of both methods. From fiscal 1970 through 1979, the total deficits have amounted to $354 billion, and all that money flooding into the econ omy has surely created inflation.

The primary problem now is to brake the mo mentum that pushed prices up by 9.25% last year, and that cannot be done without a substantial reduction in the deficit. Even if liberals are correct in their contention that the present inflation is being caused not by excessive demand but by the spiral of wages chasing prices and prices chasing wages, adding more demand now would only make the spiral spin faster.

Beyond the strictly economic arguments, the psychological impact of the deficit is all-important.

How much the Government can cut the deficit has become the supreme test of how determined the Administration and Congress are to curb inflation. President Carter has no hope of per suading labor and management to obey his wage-price guide lines unless he can demonstrate that the Government is restraining its own profligacy. Foreign bankers would take any failure to chop the deficit as a signal for them to dump dollars again, in expectation of continued U.S. inflation. A renewed slide in the dollar would fan the very inflation they fear.

Then why run any deficit? Why not balance the budget next fiscal year? That cannot be done: the nation has become too addicted to the extra demand spurred by deficit spending. Cold-turkey withdrawal could well shock the economy into a deep recession. That could reduce tax revenues so much, and raise expenditures for unemployment compensation and welfare so greatly as to perversely produce a bigger deficit than ever. Even a mild recession could splash more red ink across the budget books than the $29 billion that Carter proposes.

But a determined attempt must be made to get the deficit down. The question is whether even Carter's $29 billion target is not still too high. Surely the deficit must be reduced, and then the budget brought into balance, in the years immediately ahead.

Cutting the deficit will not ensure progress against inflation. It will not by itself increase productivity or moderate wage claims or reduce costly Government regulation of business. But no real progress in any of these areas can be made without a drop in the deficit. -- George J. Church

This file is automatically generated by a robot program, so viewer discretion is required.