Serving Up a Bitter Pill

By GEORGE J. CHURCH

Mondale hopes to score on candor with his deficit-cutting plan

Half the population would pay higher taxes, but by law none of the money could be returned to them in the form of increased Government benefits or services. Indeed, there would be new limits on federal spending to assist farmers and the elderly sick. And all this for the sake of averting a disaster--runaway deficits--that to many citizens seems no more than a vague cloud on a far horizon.

It sounds like an odd way to attract votes. But for Walter Mondale, this is no time for caution; if he is to win the presidency, he must come from further behind (13 to 16 points, according to three newly released national polls) than any non-incumbent ever has been able to at this stage of a campaign. So the Democratic nominee last week took the big risk of proposing tax boosts that by fiscal 1989 would raise an extra $85 billion a year from many corporations and all families earning more than $25,000 a year. He also outlined plans, regrettably much less specific and based on some rather iffy assumptions, to reduce federal spending in fiscal 1989 by $105 billion below the total now expected. His goal is to slash the federal deficit in fiscal 1989 to $86 billion, roughly a third of what the nonpartisan Congressional Budget Office now projects.

As difficult as it was to popularize this austere program, Mondale's efforts were hampered by a series of petty campaign blunders, the distracting debate over religious issues and the lingering doubts about his running mate's financial affairs. The House Ethics Committee announced that it would investigate whether Geraldine Ferraro, as a Congresswoman, had improperly claimed an exemption from disclosing the finances of her husband John Zaccaro. The committee had no choice politically except to proceed with a probe, once the conservative Washington Legal Foundation had formally challenged Ferraro's right to the exemption. Its investigation, which probably will not be completed before Congress adjourns Oct. 4, does not necessarily mean Ferraro did anything wrong. But it is at least a jarring reminder of the furor that bogged down the Democratic campaign so badly in August.

Nonetheless, Mondale has found a central domestic theme for his campaign, which he is hammering at relentlessly in every stump appearance and in TV spots. Like a majority of non-Government experts, including TIME'S Board of Economists, he contends that in the long run the U.S. simply cannot tolerate uncontrolled deficits. He now has a "tough" plan for curbing them, Mondale insists, while Reagan has no plan at all--or anyway none that the President dares disclose to the voters. In a fiery speech in St. Louis, Mondale denounced Reagan's "happytalk campaign . . . He's not telling you where he's going to go. He's running around with cameo performances, photo opportunities." (The candidates, though, were near an agreement last week to hold two debates, one on domestic issues Oct. 7 and the other on foreign affairs Oct. 21, with a panel of journalists posing questions. Arrangements were being made for a single debate between the vice-presidential candidates on Oct. 11.)

At a press conference in Washington, Reagan blandly asserted that the specifics of his cost-cutting plans could be found in the four budgets he has submitted to Congress (which in fact projected red ink at levels that dismayed many of his supporters). Holding his fingers close together to symbolize a narrowing gap, the President asserted that spending cuts such as those he has proposed but Congress has refused to enact, combined with rapid economic growth that would raise revenues without any increase in tax rates, could eventually reduce the deficit sharply or even eliminate it. While most professional economists, including some prominent Republicans, consider that contention highly dubious, it is attractive to voters, who often regard deficits as a vague abstraction.

To Reagan, indeed, Mondale appeared to be leading with his chin, and the President gleefully swung some roundhouse rights at it. Campaigning at a high school in upstate Endicott, N.Y., he drew a big laugh by asserting, "The American people aren't undertaxed. The Government in Washington is overfed. The main difference between ourselves and the other side is: we see an America where every day is the Fourth of July. They see an America where every day is April 15."

Mondale's plans are open to more sophisticated criticism, partly because in many respects it seems questionable whether they would yield the results that he expects. For his tax program Mondale chose $25,000 in annual income as the breakpoint because the Census Bureau calculates that roughly half of all families earned less than that in 1983 and half earned more. Taxes in the upper half would be raised in three ways: the indexing formula that goes into effect next year would be made less generous, and thus would offset less of the effect of inflation in raising tax liabilities; rates would be increased on incomes above $60,000 a year and a 10% surcharge applied to incomes of more than $100,000 (see box). Statistically, people who would be affected by the latter two steps are well-off; Treasury estimates indicate that less than 5% of all tax returns list adjusted gross incomes of $60,000 or more. But many taxpayers in this category do not regard themselves as exactly rich, nor do they seem so to their neighbors. Mondale's advisers figure that the dollar increases for a family of four would range from $95 a year if its income were $30,000, to $2,613 if it earned $100,000.

Such increases, however, would raise only $46 billion a year by 1989. Mondale would get the rest of his $85 billion by such methods as closing tax loopholes, presumably those enjoyed by corporations and wealthy individuals, and enacting a 15% minimum tax on the earnings of the 90,000 profitable corporations that he contends now pay nothing to the federal Treasury because of excessive Reagan tax breaks. Together, he asserts, these steps would raise $25 billion. Maybe, but the effects of loophole closing are notoriously difficult to estimate, and some tax experts say they would not know how to write a workable minimum tax on corporate profits. Still more doubtful is Mondale's claim that he could raise $10 billion a year by "toughened tax-compliance measures."

Mondale would put all the additional money raised by his tax changes into a trust fund that by law could be used only to reduce deficits, not to finance higher spending. The difference would turn out to be more semantic than real, if, for example, the Government used the money in the trust fund to retire old debts but simultaneously increased borrowing to be repaid in the future.

On the spending side, the Democratic nominee proposes to reduce military outlays in fiscal 1989 by $25 billion below Reagan's projections, in part by canceling the MX missile, the B-1 bomber and the Star Wars antimissile system, all of which Mondale considers both costly and ineffective. Defense expenditures would still increase, but by only 3% to 4% a year above the rate of inflation, vs. 1% under Reagan's plans. Domestically, Mondale would set limits on federal outlays for Medicare, leaving states to figure out what cost-cutting steps would enable them to squeeze under those ceilings. Whether he could save the $12 billion a year he projects for 1989 without reducing or at least freezing benefits seems questionable, as does his plan to take $4 billion out of the farm price-support program, largely by "better management." In any case, Mondale also intends to increase federal spending $30 billion a year by 1989 for a variety of social programs that were cut sharply by Reagan, especially education and jobs. He resisted pleas for much higher spending by various party groups, notably blacks who wanted an additional $30 billion for job programs alone.

Even so, the success of Mondale's program depends heavily on a rather wishful scenario: as the tax increases and other measures begin to reduce the deficit, the pressure of federal borrowing on capital markets eases and the independent Federal Reserve Board figures it can funnel more money into those markets without increasing the danger of inflation. That combination pushes down the interest rate on federal borrowings from about 10% now to 7.5% in 1989. Paying lower rates on less borrowing, the Government saves $51 billion in interest costs on the federal debt five years from now, by far the biggest "spending cut" in Mondale's package. Further, lower interest rates spur consumer spending and business investment, making possible economic growth of 3.5% in 1989, vs. 3% now estimated by the Congressional Budget Office. The faster growth raises federal revenues $17 billion more than could be expected from tax increases alone. The $68 billion from these two sources constitutes more than a third of the entire deficit reduction Mondale hopes to accomplish.

That scenario certainly seems plausible, but it could go awry. A member of TIME'S Board of Economists, Rimmer de Vries, chief international economist at Morgan Guaranty Trust, warns that if the Federal Reserve for whatever reason holds to a stringent monetary policy, the combined shock of Mondale's tax increases and tight money could tip the economy into a new recession. Charles Schultze, chief economic adviser during the Carter Administration, thinks Mondale's program would work but would prefer a "more radical" plan: sweeping tax reform and a one-year freeze on federal spending. Nonetheless, said Schultze, "Mondale has offered a specific and consistent plan to deal with the deficit, and that is vastly preferable to the do-nothing alternative his opponent is offering."

The Democratic nominee's efforts to persuade the voters to make the same choice floundered badly early last week. A three-city televised conference with four families supposedly hurt by Reagan's economic policies was notable chiefly for the antics of a five-year-old with the improbable name of Madonna Putz. She kicked, yawned and tried to squirm into the lap of her mother Jennifer as Joan Mondale attempted an interview in Chicago while her husband watched from Philadelphia. The nominee later addressed the International Machine Tool Manufacturers' Association from a Chicago stage decorated to bear a disconcerting resemblance to a funeral parlor, and at the Green Bay, Wis., plant of Procter & Gamble was presented by a worker with a sample of the factory's product: Charmin toilet paper. "You want me to test the quality of it?" asked Mondale before giving the paper a squeeze.

By midweek, however, Mondale was campaigning with unaccustomed vigor. His voice shaking with real passion, he accused Reagan of secretly planning to cut deficits by gutting such programs as Social Security and Medicare, or by sponsoring after the election a national sales or value-added tax (VAT). His advisers even calculated how much extra taxes might be paid during a second Reagan Administration by families that would not be affected by Mondale's plan: $370 a year on an income of $15,000; $440 extra on a $20,000 income. The figures assume that Reagan also tries to raise an additional $85 billion a year by 1989, but does it by a sales tax or VAT.

That, of course, is partisan guesswork. The real economic danger of a Reagan re-election might turn out to be something quite different. Though the President has reluctantly conceded that tax increases might be needed "as a last resort," he has been taking a very different line on the campaign trail, vehemently assailing any talk of tax boosts and even speaking of still lower rates. He might become so enamored of his own rhetoric as to oppose any tax changes that would raise Government revenues, even as part of a broad reform and simplification that would also lower some taxes. Such a stand would hamstring the effort to craft an effective deficit-cutting program that the great majority of thoughtful leaders in both parties agree must be a top domestic priority for whoever is elected in November. --By George J. Church. Reported by Laurence I. Barrett with the President and Jack E. White with Mondale

With reporting by Laurence I. Barrett, Jack E. White