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CBO's Penner warns deficits will lower living standards

``By running up large federal budget deficits, the current generation is lowering the potential living standards of its children and grandchildren,'' Congressional Budget Office (CBO) director Rudolph G. Penner warned the Senate Budget Committee. The CBO's annual economic forecast, which was released Wednesday, is upbeat, but it is not as rosy as the Reagan administration's scenario for the economy.

The CBO expects slightly lower economic growth and slightly higher interest rates over the next two years than does the administration. The two branches of government are in rough agreement on the outlook for inflation.

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Despite slightly different economic scenarios, the CBO and the Reagan administration's Office of Management and Budget (OMB) see deficits growing to the $250 billion range by 1988 without futher trimming efforts.

But that assumes economic growth continues, as CBO and OMB expect. Mr. Penner warned that if a recession hits in 1987, the deficit could balloon to $425 billion by 1990. Even without a recession, the CBO's generally positive economic assessment is clouded by persistent large federal deficits.

Because the combination of massive deficits and economic prosperity ``is without precedent in peacetime history,'' the CBO's upbeat forecast ``must be put forward with considerable uncertainty,'' Penner said.

``Just like a household, a country can live pretty well on borrowed money,'' Penner explained. However, adding roughly $200 billion a year to government's pile of IOUs is causing the interest costs on the debt to soar, the report noted. The CBO figures that the government's debt will nearly double from $1.5 trillion this fiscal year to $2.8 trillion in 1990 unless new deficit-reduction action takes place.

``The living standards of future generations of Americans will be lowered compared to what they could be if fiscal policy were more prudent,'' Pennerargued. ``The problem is nobody notices.''

There are several ways current federal fiscal policies could affect our children, the CBO report notes.

Over time, growing federal debt would chew up more of investors' spare cash. That would leave less money available for investment in private industry. Over time that would diminish the supply of new machines and other capital equipment. That could cut the rate of growth in the amount a typical worker can turn out in an hour. As a result, ``the income of future generations would be smaller,'' Penner said.

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If foreign citizens bought some of this government debt, that might keep US companies from being crowded out of the credit markets. But US foreign debt would grow, so ``US residents would enjoy a shrinking proportion of the production generated here because of rising interest and dividend payments abroad,'' Penner said.

Growing debts also mean a larger share of the federal budget would go to interest payments, squeezing other portions of the budget. If program cuts or tax increases needed to offset the interest burden were not politically feasible, pressure might grow on the Federal Reserve to buy more of the government's debt, thus exploding the supply of money and triggering rapid inflation.

The CBO currently attaches a very small probablity to this hyperinflation scenario. Penner argues that for the time being ``the traditional goal of a balanced budget seems out of reach in the short run.''

Instead he suggests the goal of stablizing the ratio of government debt to gross national product, or economic output. To do that by the end of budget year 1988 would require budget cuts of $30 billion in 1986, $55 billion in '87, and $90 billion in '88.

The CBO and OMB economic predictions and deficit projections diverge more sharply in the period 1987-90. The CBO and the administration warn that their numbers for the longer term are projections of what might happen rather than forecasts of what will happen.

Still there is a sharp divergence over the outlook for the longer term. The administration is slightly more upbeat than the CBO on growth and inflation and substantially more optimistic on interest rates.

Such differences may seem academic, but they have a major impact on the expected size of the deficit and the need for remedial action.

The CBO says the deficit will be $296 billion in 1990 without action, whereas OMB projects $225 billion in red ink. In the 1985-87 period OMB is more pessimistic about the deficit because it assumes higher defense spending than the CBO.

Penner quickly acknowledged that ``the economy's performance could easily turn out to be much better or much worse than CBO's projections indicate.'' The major uncertainties are the size of busness inventories and the outlook for oil prices and interest rates.

Even small changes in individual economic variables can have a major impact on the deficit outlook, the CBO report noted. For example, if inflation-adjusted economic growth in 1985 is one percentage point stronger than the 3.5 percent rate the CBO expects, that would trim the deficit by $19 billion in fiscal '86 and $128 billion by 1990. Chart: Two Views of the Economy Congressional Budget Office vs. Office of Management and Budget

(Data for calendar years)

1984 '85 '86 '87 '88 '89 '90 Deficit without action (billions of dollars)

CBO $185 $214 $215 $233 $249 $272 $296

OMB $185 $224 $231 $248 $250 $233 $225

Inflation-adjusted GNP growth rate

CBO 6.8% 3.5% 3.2% 3.3% 3.4% 3.4% 3.4%

OMB 6.8% 3.9% 4.0% 4.0% 4.0% 3.9% 3.6%

Inflation rate (GNP implicit price deflator)

CBO 3.7% 3.6% 4.6% 4.4% 4.2% 4.2% 4.2%

OMB 3.7% 3.8% 4.4% 4.2% 3.9% 3.6% 3.3%

Interest rates (91-day Treasury bills, annual average)

CBO 9.5% 8.3% 8.7% 8.2% 8.2% 8.2% 8.2%

OMB 9.6% 8.1% 7.9% 7.2% 5.9% 5.1% 5.0% NOTE: 1984 data are actual, '85 and '86 are forecasts, '87 and beyond are projections. Source: Congressional Budget Office; Office of Management and Budget -- 30 --

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