With Goodies For All

The budget deal erases the deficit, but only for as long as the economy booms

Only in Washington could anyone promise to balance a budget by raising spending and cutting taxes. And only in this economic cycle of strong growth and low inflation could it work.

That, in essence, is the story of the Great Balanced Budget Agreement of 1997. This is not to say the deal is fake. Indeed, not only will the budget come into balance by 2002, but the deficit could disappear as early as next year--so long as growth remains robust.

But even the buoyant U.S. economy won't solve the problems that Washington took a pass on this time around--an overhaul of Medicare, the federal health program; and Social Security. Unless Washington follows through with major reforms in these entitlements and looks for other domestic spending cuts, the budget won't stay in balance for more than a year or two.

Alas, when President Clinton and congressional Republicans announced their deal on July 29, such grim undertakings were the last things on their minds. Instead, they jubilantly dispensed tax and spending goodies to the many and called for sacrifice from the few.

Indeed, the budget deal came together so easily after years of partisan fighting only because it contained so many gifts--and ducked so many hard choices. "It's Santa Claus in July," grouses Senator Ernest F. Hollings (D-S.C.), a longtime deficit hawk. Adds David H. Resler, chief economist of Nomura Securities International Inc.: "I'd love to negotiate with these guys. Their idea of compromise is to say, `If you give me more, I'll give you more."'

QUICK TURN? The pols can be so generous only because the economy keeps outperforming expectations. If that continues and the economy grows 3% a year--about half a percentage point higher than Administration forecasts--Washington could have $100 billion in 2002 for still more tax cuts or spending. On the other hand, the economy could slip into recession during the next five years. A '98 downturn would quickly turn the 2002 balanced budget into a deficit approaching $75 billion.

That's how the overall economy will make or break the budget. But how will the budget pact affect growth? The GOP insists that slashing capital-gains tax rates and expanding individual retirement accounts will spur investment and growth. Clinton argues that education incentives will do the same. And both sides insist that fiscal balance alone will produce a big payoff.

But mainstream economists are underwhelmed. They figure that most of the interest-rate benefit of shrinking federal deficits has been priced into the markets. The deficit has been falling for five years, and this deal had been expected. Although the benchmark 30-year Treasury bond fell to 6.33% on July 30, Roger E. Brinner, chief economist at DRI/McGraw-Hill, expects rates to fall no more than another half-point.

For a longer-term impact, many economists and business leaders still look for action on entitlements. Medicare, which got trimmed by $115 billion in the deal, still needs major reform to keep it solvent once baby boomers begin retiring. And the pact didn't even touch Social Security. "These issues must be dealt with," says ConAgra Inc. Chairman Philip B. Fletcher. "If you don't find a way through in this kind of booming economy, politicians will just play their same games later."

In this deal there were some losers. Smokers and some airline travelers face higher taxes. Seniors will see faster increases in Medicare premiums, and Medicare payments to doctors and hospitals will rise more slowly.

But there are far more winners. Savers, investors, and families with children get sweet new tax breaks. Broadcasters will get billions' worth of public airwaves for free. Tobacco growers will continue to get millions in crop insurance. And colleges will get new construction subsidies. "Spending increases too much," complains Representative Matt Salmon (R-Ariz.).

In total, outlays will grow from $1.63 trillion this year to more than $1.8 trillion in 2002. Over the next five years, the government will spend $275 billion less than it would have without a deal. But 85% of those savings won't come until 2000 or later. And half will come from future cuts in domestic programs.

Taxes will be slashed by $94 billion over the next five years, partly from the capital-gains cut that delights investors and entrepreneurs with big paper gains. "It's not a trickle-down effect," says Cisco Systems CEO John T. Chambers. "It's a waterfall." But another high-tech chieftain worries about the overall size of the tax bill. "Cutting taxes now is a little short-sighted," says James H. Clark, Netscape Communications Corp.'s chief executive. In fact, over the next decade, the cuts will divert more than $250 billion from the treasury, putting more pressure on the budget just when spending on seniors is expected to take off.

Even some conservatives doubt that cutting capital gains will encourage long-term investment. They are even more skeptical about the $500 child credit and the education tax breaks. "It's stupid tax policy," says Resler. "This takes a tax code that didn't make a great deal of sense and makes it even worse."

In the end, the Administration and Hill Republicans will claim credit for budget balance--despite their tax cuts and spending deals. But the vast bulk of deficit reduction came between 1992, when the deficit hit a record $290 billion, and this year, when it could fall as low as $25 billion. The biggest single reason: the cold war's end. Defense spending fell from 6.4% of gross domestic product a decade ago to 3.4% now. Adjusted for inflation, the 1997 military budget is $100 billion less than in 1987.

The rest of the credit goes to two of the most maligned budgets in recent memory--George Bush's "Read My Lips" plan in 1990 and Clinton's 1993 fiscal blueprint. Bush pushed though a tax hike and arcane budget rules that froze most spending--except for Social Security and Medicare. Clinton followed with a tax increase of his own and continued the spending restraint. As a result, Washington has slashed cumulative deficits by $2 trillion since 1990. The new deal would cut the last $200 billion. Says Budget Director Franklin D. Raines: "We're just doing cleanup."

It's not even a messy job. Apart from Medicare, there aren't many spending cuts. Indeed, many programs will grow. House Minority Whip David E. Bonior (D-Mich.), a liberal firebrand, backs the deal because it expands the entitlement to medical care to 5 million low-income kids. "It's the largest health-care bill for children in 35 years," he brags.

TV broadcasters, who gave more than $4 million in the 1996 congressional elections, love the deal, too. They get free use of an extra channel for the next decade--a gift worth about $5 billion. Tobacco interests get a goodie to help offset a 15 cents-a-pack hike in cigarette taxes: The budget retains a crop-insurance program worth $34 million a year to tobacco farmers. "There's something in this for everybody," says Cato Institute budget analyst Steven Moore.

NEW CHANCES. But despite the pork, the news isn't bad. What really matters is that, after 20 years of fighting, Washington has managed to get a budget that balances. Michael J. Durham, CEO of Sabre Group, an information-technology unit of AMR Corp., praises the pact: "It's a very significant step in reducing uncertainty and volatility. We should applaud our politicians."

Don't count on that. For now, the deal ends Washington's obsession with the deficit. That gives lawmakers the chance to move on to new domestic policy fights: repairing Medicare and Social Security and restructuring the tax system. Those disputes will be just as contentious as the battle of the budget.

Or worse. While the strong economy made the final round of budget-cutting a breeze, the pols may not be so lucky when they get around to the entitlements. The retirement of the boomers is one problem America can't grow its way out of. The tough choices still lie ahead.

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