166 February 18, 1982 THE' REAmN BUDGET SllLL TOO lTMlD INTRODUCTIO N The press, Congress, and assorted interest groups have expressed outrage at President Reagan's recently released budget cutting package. They have raised a loud chorus of complaints that the cuts are unjust, unacceptable, and inequitable. When not compl aining about the magnitude of budget cuts, they are wringing their hands over the large expected deficit. The protest however, seems to represent a vanguard without much of a following.

National opinion polls .indicate that solid majorities continue to fav or additional budget cuts and fully support further reductions in the size of government along with a massive transfer of federal welfare, education, and health programs to state and local govern ments.

There is strong evidence, moreover,_that the public may support cuts far beyond what Reagan has suggested in his recent package. In a January 1982 poll conducded for The Heritage Foundation by Sindlinger and Company, Inc. (see Appendix), over 40 percent of the respondents thought the budget had not been.cu t enough while only 19 percent thought the federal budget had been cut too much social programs, but not in the military budget in the nationwide poll, only 23 percent want to cut defense spending while 53 percent favor cuts in social programs. There also a ppears to be strong support for maintaining the military build-up plans. Over 51 percent of the public favor current defense spending even if this requires running a budget deficit The public favors additional cuts primarily in Of those sampled The public may also favor a more radical devolution of federal programs to the states and localities than even the President has recommended. Yet the President's relatively modest federalism proposal has raised a storm of protest from some of the nation's governors a nd mayors. They complain that the Presi2 dent is shirking national responsibilities and attempting to balance the federal budget on the backs of the states. The public, however, broadly supports returning social welfare programs to local governments .wher e they can have more direct control. Nearly 80 percent of the public, for instance, feel that most welfare, education, and health programs should be administered at the local or state level. Only 14 percent feel that the federal government is best capable o f providing these services. impressive 50 percent say the local government provides needed government services most efficiently 27 percent cite the state government and only 14 percent say that the federal government gives them the best value for their do l lar An The strong public support for additional budget cuts and a Is massive realignment of federal programs blunts much of the shrill criticism of the budget. this a "Reagan budget criteria set by Reagan himself at the outset of his Administration? Does i t: reduce the level of taxation to encourage work, saving, and investing in order to stimulate economic growth and productivity reduce the growth of government spending' to eliminate unneeded programs, wasteful spending, duplicative services, and programs benefiting the non-needy Yet there is one valid criticism Is this a budget that fulfills the reduce the regulatory burden on business in areas where the competitive marketplace assures quality and safety reduce inflation through a stable and de-accelerati ng money supply?

At least two more goals were implicitly set by the Administration: to determine which federal programs should be returned to local governments to provide for a military defense budget that will protect U.S. security and vital interests abroad.

Are these criteria being met?

Is this, in short, a budget document worthy of a self-proclaimed conservative administration dedicated to nothing less than the slowdown and then rever sal of the longstanding trends of greater growth of government and the precipitous decline in the nation's military capability? The answer is at best a muted lfyes.ll The budget strategy, bold as it is in some respects, fails to attack major economic prob l ems. The President has suggested some 43 billion in new budget cuts, but these merely slow down the accumulated momentum of budgetary growth. They do not, as promised, reverse the trend. And while the federalism package touches a responsive chord in the A m erican passion for local self-government it lacks theoretical coherence. 3 Perhaps in his speeches across the country, the President will develop a more coherent rationale why some programs belong at the local government level but so far the federalism in itiative is inconsistent.

While a few dozen major regulations have been repealed and many new regulations died aborning, little long-term regulatory reform has been proposed nor have there been many changes in enabling legislation governing. the purview of regulatory agencies. The problem with regulation is not its burden on the budget but its burden on the economy. All regulatory agencies combined amount to only a few billion dollars in the budget, but their burden on the economy has been estimated as hig h as $100 billion. The President has recommended a reduction in the budgets of many regulatory agencies. What is disappointing is that this Admini stration does not seem to be taking the much more important step of limiting the legislative mandate of regul atory agencies and eliminating those which have outlived their usefulness not a budgetary matter but nonetheless essential.

The Administration has not mustered the political courage to begin reforming entitlement programs--Medicaid, Medicare, and Social Se curity--which have ballooned in cost while benefiting large segments of the middle- and upper-income classes. While most of the President's advisors have lobbied him to increase taxes, a truly effective remedy for the recession and eventually even the def i cit has been ignored: acceleration to the start of this year of the personal tax cut reductions scheduled for July 1. If the Administration were truly courageous, it would pare the federal budget much further, reform major entitlement programs, and accele rate the tax reductions to give supply-side economics a fair chance to stimulate production and reduce unemployment.

BREAKING THE MOLD In some areas the Reagan budget clearly breaks with the For years the defense budget has been underfunded to past finance the massive social welfare build-up of the 1970s. By calling for an 18.1 percent increase in defense expenditures in 1983, the budget clearly takes a crucial step toward ending the deterioration of the U.S. arsenal. While critics seem to blame the defici t on the defense build-up, the military budget in 1962 before the Vietnam involvement claimed a larger share of the gross national product than in any year of the projected Reagan budget. Congressmen who worry that the U.S. cannot bear its defense burden n eed to be reminded that the nation's military budget could increase at an annual rate of 24.4 percent until 1985 before it would equal 8.67 percent of GNP, the share in 19

62. The high level of defense spending in that year did not dampen economic prosperi ty. The U.S. had 7.7 percent economic growth, an unemployment rate of 5.5 percent and an annual infla- tion rate of about 1 percent. It is not defense spending that has burdened the economy and caused the budget deficit; it is the 4 burgeoning social welf a re expenditures which increased by 4.7 percent yearly after inflation from 1975 to 1981 increase in defense expenditures during the same period amounted to only 1.8 percent, while the Soviets continued their largest military build-up in peacetime history. The President wants to reverse those priorities and has proposed increasing defense expenditures an average of 7.9 percent after inflation for 1981 to 1987 and still increase entitlement programs by an annual rate of 1.5 percent after inflation. steadily r aise the national defense share of total outlays from 24.3 percent in 1981 to 29.2 percent by 1983 and 37.2 percent by 1987 The real The shift in priorities will AN'NUAL RATES OF INCREASE IN REAL FEDERAL SPENDING percent 1975 to 1981 to 1981 1987 National defense 1.8 7.9 Entitlements 4.7 1.5 Other 4.3 -7.6 Subtotal, Nondefense 4.6 -1.7 Nondefense Total 3.9 1.0 Source: Budget of the United States, Fiscal Year 1983 The President's new budget also breaks the mold and fulfills his campaign promise to reduce th e growth in government expendi- tures, although even after adjusting for inflation many social programs will continue to grow sharply. Under the President's budget, the growth of government outlays should fall from 17.4 percent in 1980 to 10.4 percent in 1 982 to 4.5 percent in 1983.

After having reached 23 percent of the GNP in 1981, federal expenditures will represent 22.1 percent in 1983 and 20.9 percent in 1985 if the Reagan program is enacted. however, is not the result of expenditure cuts but of sharp increases in the estimates of future GNP cuts, in fact, only amounts to about 5 percent of the 1983 budget and only reduces the year-to-year growth in government expenditures by about half. The President is attacked for allegedly shredding the social safe t y net programs. Yet major health, welfare, and retirement programs have increased sharply since Reagan took office. Even accounting for the EY 1983 proposals, medical care outlays have increased by over 13 percent a year since Reagan took office, Social S e curity is up by 12 percent a year, unemploy Most of this decline The President's seemingly drastic 43 billion in budget 5 ment compensation outlays are increasing by 7 percent yearly, and housing assistance is up 13. percent a year. While some specific so c ial welfare programs are being cut, the entire entitlement budget is increasing over 5 percent in 1983 to a yearly total of $341.5 billion. That social Droarams will increase at all after growing by a stagyering rate bf &most 15 percent yearly since 1973 i s potent evidence that the Reagan budget knife is still too dull THE GROWTH IN BUDGET OUTLAYS, 1973-1981 In billions of current dollars 1973 1981 Budget component National defense Entitlements Social Security Medicare and Medicaid Other Subtotal, Entitlem e nts Net Interest Other nondefense Education, training, employment, and social services Energy Transportation Community and regional development All other Subtotal, other nondefense Total budget 74.5 159.8 48.2 138.0 14.1 59.3 32.2 94.8 94.6 292.0 17.3 68. 7 12.7 29.1 1.2 10.3 9.0 23.1 4.6 9.4 31.7 64.7 59.2 136.7 245.6 657.2 Source: Budget of the United States. Fiscal Year 1983 Average rate of growth 9.7 13.6 19.0 14.0 14.6 18.2 10.6 30 O 12.1 9.1 9.0 10.7 12.7 Food stamps, Medicaid, Medicare, AFDC and othe r social welfare programs all have undergone scrutiny in this budget and are being trimmed to exclude some recipients who do not require sustenance from the taxpayers But the Administration has yet to articulate a long-term strategy aimed at reform of the w elfare system. the needed fundamental changes in the outmoded and initiative- numbing anti-poverty efforts, nor will it achieve permanent reductions in the social welfare budget. Eventually, the federal government could return tax sources to the states to finance programs for the needy, leaving Washington to supplement state welfare budgets only in cases of severe fiscal need Nibbling at the growth of a few programs will not achieve 6 All levels of government now combine to spend over $200 billion on welfa r e for the poor. With 25 million Americans below the poverty line to some degree or another, each theoretically could receive $8,000 or about $32,000 per family of four ly, much of the social welfare money never gets to the poor but ends up supporting an e n ormous professional bureaucracy of social workers, caseworkers, administrators and other interest groups charged with "taking care" of the poor. tives do not fundamentally revise the system that allows such a 'large share of each welfare dollar to go to t h e welfare industry Obvious Reagan's budget initia The 1983 budget initiatives also envision dissolution of the Cabinet level departments of education and energy. the Department of Energy budget by one-third and calling for its reorganization, the Administ ration is on the right track, but it needs to go much further.

It should eliminate energy commerciali- zation projects in which even industry has little or no interest, such as the 232 million Clinch River Breeder Reactor, where industry's support has neve r been more than 9 percent. The reactor's design has long been eclipsed by the French, who are looking forward to selling their technology. should curtail research where the product obj'ective, completion date, and foreseeable benefits are vague at best s u ch as magnetic fusions projects 444 million) or the high energy and nuclear physics programs 601 million). The 1983 budget increases expendrtures for these questionable projects at a time when the U.S. should rely on private competition to meet energy nee d s By cutting The budget also THE PROBUN OF RED INK Although the budget deficits are slated to decline both absolutely and as a percentage of GNP after 1982, business leaders and economists are worried that government borrowing could increase interest rate s , ,divert capital from expanding business needs cause the Federal Reserve to increase the money supply, and perhaps abort the economic recovery expected in the spring Even with the planned budget cuts and revenue-raisers, the deficit will go from 98.6 bil l ion in 1982, or 3.2 percent of the GNP, to 91.5 billion in 1983; 2.7 percent of GNP, to $82.9 billion in 1984, 2.2 percent of GNP, and to $71.9 billion, or 1.7 percent of the GNP in 1985 The'solution to the gushing red ink, however, is not to raise taxes, especially in the current recession. Tax hikes crowd out private sector growth as much, if not more, than does government borrowing to finance the deficit. The relevant measure of the government burden on the economy is the level of government spending. W h ether spending is financed by explicit taxes, government borrowing, or inflationary increases in the money supply to finance government debt, all are 'Itaxesll on productive activity. Of course, the kind of tax imposed makes important differences to produ ctivity, saving, and work effort.

A consumption-based tax, for example, is much less harmful to the economy than progressive income taxes; and each tax affects groups in society differently. economy is not lessened by raising one tax say excise taxes in or der to lower the implicit taxes of government borrowing or inflation. sound approach to reducing the budget deficit But the relative burden on the The Reagan budget cuts represent the economically The White House has been less than consistent on this poin t In the 1983 budget, the Administration has trotted out many of the same proposals to eliminate tax loopholes suggested by the Carter Administration. minimum corporate tax and user fees which are estimated to 'raise nearly $9.7 billion in 19

83. If past p olitical history is any clue, these tax increases have little chance of enactment. That's just as well. The tax increases are too small to appreci- ably reduce the deficit, but large enough to discourage already over-taxed businesses and groups of workers and professionals. The Administration risks losing valuable political capital by fighting for these nuisance tax increases; a battle would only blur Reagan's popular and economically sound tax-cutting image. Are these measures included in the budget to pr o ve the Administra- tion's toughness to business and wealthy individuals? they surely will fail to convert the opponents of economic growth and will send conflicting signals to business The proposed tax revisions include 'a If so NEW FEDERALISM The most in n ovative aspect of the new budget is President Reagan's New Federalism. more than forty programs as well as food stamps and Aid to Families With Dependent Children to state and local control. In return, Washington will take over Medicaid expenses and estab - lish a $28 billion trust fund financed by federal excise taxes to compensate states for net increases in costs due to the swap. What vitally distinguishes this plan from past schemes, like revenue sharing and grants-in-aid, is that the states and locali- ties will resume responsibility for financing the programs in 1988 as the federal trust fund and federal excise taxes are phased out. The proposal forces taxes to be raised for programs by the same level of government that runs the programs. This will cau s e taxpayers to associate taxes with services and make decisions more rationally about the appropriate level of govern- ment services The President has proposed to transfer While the Reagan federalism initiative generally provides a good blueprint for rest r ucturing the federal government, the Administration seems unsure of the principles motivating it. The swap of AFDC and food stamps for Medicaid may please the big city mayors by removing the health program from their budgets, but it saddles the federal go v ernment with the complete cost of one of the budget's fastest growing programs. Federal health programs grew an astounding average of 19 percent between 1973 and 1981 and in 1981 alone soared 21 percent. The federalized Medicaid 8 program is expected to r ise 83 percent by 19

87. Yet the total funding level- for programs arned back to the s,ates, AE'DC and food stamps is projected to decrease slightly'from $26.5 billion in 1981 to $24.5 billion in 1987.

After 1987 when the states begin to finance the turnb ack programs, the federal government will assume over $25. billion in state Medicaid costs and will give to the states less than $18 billion in federal welfare programs. The swap, moreover, central- izes government further. The Administration has also sug gested a turnback of some $31 billion in other programs to'the states by 19

87. Even if this additional turnback is approved by Congress, the Medicaid program will offset over 50 percent of the expendi- ture turnbacks. In sum, the federalism initiative so far is only a step a welcome step, to be sure toward decentralizing government. Federalizing health care programs, however, is a qiant step towards the liberal goal of universal national health insurance.

What concept of federalism, it can be asked, justifies the return of the major poverty programs to the states, but not the major health program for the poor? Such an arbitrary distinction between federal and state responsibilities creates the impression t h at the Administration is confused in its theory of federalism. Yet the Administration should-not have trouble developing a convincing and coherent theory of federalism. purpose of federalism is to establish local control of government programs. The Americ a n constitutional system was founded on the idea that a digpersal of power among states presents much less danger to liberty and representative government than concentration of power in one national government. At the local level, indivi- duals also exert m ost influence over their own government. National opinion polls find large majorities of Americans believ- ing that local and state governments are less wasteful of tax dollars, less corrupt, and more- likely to reflect local wishes Some critics contend t h at states cannot afford additional responsibilities and that inequities will result since some states have fewer.resources than others. If there is a "fiscal mismatch,lt however, it favors the states. State and local revenue has risen 345 percent in const a nt dollars since World War 11 while federal revenue has risen only 151 percent over the same time. Reqional wealth differences have also declined by 40 percent since 1960, and will continue to narrow rapidly in the future. The federal government, however, does enjoy one major advantage over the states--the Bureau of Engraving and Printing. By running the printing presses, the federal government can pay for just about any program. The states, of course, cannot print money and thus must live within their mea ns The underlying than the federal government I In the process, it triggers inflation.

The issue is.not whether states have sufficient wealth to provide for the needs of thei.r citizens. If the federal govern9 ment did not drain 22 percent of the nation's resources, states would have enough of an economic base to support)services. The federal government could always provide emergency aid to needy states, but such intervention should be rare. The federal govern- ment now provides not only emergency aid, but funds for pothole repairs, sewers, milk for pregnant mothers and hundreds of other programs. It is not the federal government's role to equalize wealth between states or finance services which states can-but prefer not to--provide themselves.

The Presiden t should broaden his New Federalism to include regulatory agencies. The federal government should be regulating only when a national effort is required.to remedy market imperfec- tions and when the initiative cannot be undertaken by the states individuall y.

FAT ENTITLEMENTS The Administration's 1983 budget fails to confront Social Security reform, even though Social Security consumes about one-fourth of the budget and has been rising at nearly 14 percent a year since 19

73. Over the next five years Social Security outlays will climb an average of 8.5 percent yearly at a time when the budget as a whole (excluding Social Security) will increase only 5.5 percent. While any mention of Social Security change is politically explosive, major reform must be consi d ered iE budgetary growth is to be limited and a secure retirement provided for today's young Americans. Eventually, the Administra- tion will have to consider restructuring Social Security into a true insurance program in which the retiree's pension is ba sed on his contributions during working years plus accumulated interest.

The Administration's budget-cutting strategy is running into an inevitable dilemma. Apart from defense, Social Security, Medicare and Medicaid, very few areas of the budget can be cut substantially. These four areas represent 56.5 percent of the FY 1982 budget. Under the current round of cuts, the programs will claim almost 72 percent of the budget by 19

87. If the President .is to achieve sizable additional cuts, the fat entitlement pro- grams=-long sacrosanct--will have to come under the axe. Reform of basic entitlement programs is nearly impossible to avoid in the next few years if budget growth is to be restrained signifi- cantly. Yet the current Reagan budget for 1983 contemplate s no substantial reform of Social Security, Medicare or Medicaid THE SUPPLY-SIDE PRESCRIPTION Caught in the midst of a chilling recession that is not his doing, Ronald Reagan has fashioned a budget that must take account of rising unemployment and idle ind u stry. Reagan's integrity that he has not capitulated to his unrelenting critics. He has not, in short, abandoned the supply-side prescrip It is a tribute to 10 tion for economic vitality. full supply-side dosage. of the supply-siders. now scheduled for Ju l y, he 'should accelerate it by six months, making it retroactive to January 1 Yet he hesitates to administer the Thus, rather than delay the 10 percent cut Now is the moment to test the promises THE GROWTH IN BUDGET OUTLAYS 1982-1987 In billions of curren t dollars 1982 1983 1984 1985 1986 1987 Outlays National defense Social Security Medicare and Medicaid All other entitlements Net interest Other nondefense Total budget outlays Growth rate (percent) and Medicare.

Defense, Social Security, Medicare All othe r To tal budget Share of' budget (percent Defense, Social Security, Medicare All other and Medicaid 187.5 221.1 253.0 292.1 331.7 364.2 154.6 173.5 188.5 202.3 216.5 232.0 67.4 72.4 79.8 88.8 97.8 107.4 102.9 95.6' 93.7 95.3 96.6 98.5 83.0 96.k 98.7 100.8 99.3 93.2 129:9 98.7 92.3 89.2 85.2 83.5 725.3 757.6 805;9 868.5 927.0 978.9 14.7 14.0 11.6 11.9 10.8 8.9 5.2 -8.0 -2..1 0.2 -1.5 -2.1 10.4 4.5 6.4 7.8 6.7 5.6 56.5 61.6 64.7 67.1 69.7 71.9 43.5 38.4 35.3 32.9 30.3 28.1 Source: Budget of the United States , Fiscal Year 1983 This speed up, contend supply-siders, could quicken economic recovery and enhance the incentives for the saving, investing, and working essential for increasing productivity and employment. Supply-siders also urge immediate indexing of i n dividual income taxes to halt inflation-induced tax bracket creep. Since economic growth powerfully reduces budget deficits, the supply-side remedies also should reduce and eventually eliminate the budget deficit. A 1.2 percent higher real GNP growth rate and an inflation rate 1.2 percent lower than the Administration's own scenario, for example, would cut the defict in half over 1982019

87. In turn, this would bring down the high interest rates plaguing the economy 11 CONCLUSION The federal, state, and lo cal governments combined currently dispose over 40 percent of our national income half a century ever increasing amounts of power and tax dollars have flowed to Washington, along with the interest groups prepared is hardly possible for Ronald Reagan to re v erse that trend in the short time since his presidency began. Taken together with the budget cuts enacted last year, however, the 1983 budget represents an impressive achievement and a clear break with past policies that have brought our nation close to e c onomic ruin It is now within the grasp of Congress to reassert control over poorly conceived government programs, to begin reform of the major entitlement programs which have long been financially out of control, and to restrict many social welfare progra m s which shower benefits on the non-needy. Just as important, the Reagan initiative makes a start at returning many programs to local governments which Americans most often cite as the most effi cient, least corrupt system, and most in accord with their ow n wishes. With all the faults and oversights of the Reagan 1983 budget it is still the only game in town. Congress can use the document as a foundation to launch a broader attack on many other programs which deserve closer scrutiny. Congress, for its own p a rt, is getting off to a bad start by seriously considering proposals to increase taxes and reduce the defense budget, but mostly the Congressmen are wringing their hands over deficits and criticizing the only person who has formulated a viable budget Rona l d Reagan ends, Congress will tackle the unfinished task before it and begin reining in the rapidly expanding public sector For more than to defend their government-sponsored benefits and positions. It One hopes that when all the political carping Thomas M . Humbert Walker Fellow in Economics APPENDIX Sindlinger and Company, Inc. for The Heritage Foimdation Special Study Interview Dates: January 7, 1982 through January 26, 1982 Before the State of.the Union Address QUESTION 1 What should the Reagan Administr a tion's defense budgetary policy be 1. Increase defense spending 2. Decrease defense spending 3. Leave defense spending intact 4. Don't Know/Not Sure QUESTION 2 While President Reagan has stated that he can no longer balance the Federal budget by 1984, he is still committed to even tually ending the deficit that we now face.

Given these alternatives, what should the primary means for achieving this be 1. Cut Social Programs 2. Cut Defense Spending 3. Increase Taxes 4. Don't Know/Not Sure QUESTION 3 Are you in favor or opposed to budget cuts as a means for reducing the Federal deficit 1. Favor Budget Cuts 2. Oppose Budget Cuts 3. Don't Know/Not Sure Total 27.4 19.3 40.2 13.0 52.6 22.6 17.8 7 .O 79.0 10.8 10.2 QUESTION 4 A-2 If it were possible to balance the budget policy would you favor only by decreasing defense spending, which 1. Balance the budget/Decrease defense spending 2. Run a deficit/Maintain defense spending 3. Don't Know/Not Sure QUESTION 5 Do you think that the Federal budget has been cut too muc h too little about the right amount or what do you think 1. Too Much 2. Too Little 3. About the Right Amount 4. Don't Know/Not Sure QUESTION 6 Which level of Government delivers needed Government services most efficiently 1. Federal 2. State 3. Local 4. Do n 't Know/Not Sure QUESTION 7 Should most welfare, education and health programs be administered at the Federal level state level local level or what'do you think 1. Federal Level 2. State Level 3 Local Level 4. Don't Know/Not Sure Total 38.4 51.5 10.1 19.2 40.1 27.9 12.9 13.7 26.7 49.9 9.7 14.3 24.0 54.8 6.9 A-3 QUESTION 8 I President Reagan is attempting to combine many programs in health, education and social services into block grants to the states is to give each state a portion of the Federal funds and let the states decide what the best uses. for the funds are What is your opinign of this concept The concept of block grants 1 2 3 4 5 6 Strongly Agree.

Moderately Agree Neutral Moderately Disagree Strongly Disagree Don t Know/No t. Sure QUESTION 9 A majo r premise of the proponents of block grants is that each state has individual problems that can be handled more efficiently by states and municipa lities than by the Federal Government Do you agree or disagree with this statement 1. Agree 2. Disagree 3. D on't Know/Not Sure Total 43.4 34.3 6.2 2.6 4.3 9.2 78.8 8.1 13.1