Economic cooling adds another facet to decisions ahead on US deficit and taxes
President Reagan returned from Thanksgiving vacation to face a week of tough choices on tax reform and budget deficits. Those choices have been complicated by a marked slowdown in economic growth.
Reacting to the cooling economy, the Federal Reserve Board last week cut its discount rate, the fee it charges member banks for loans. The Fed's move and a decline in other market interest rates prompted New York's Citibank Monday to lead a few large banks in cutting their prime, or benchmark, lending rate from 11.75 to 11.50 percent.
Taxes were the first of the tough economic issues on the President's plate. Treasury Secretary Donald T. Regan briefed Mr. Reagan and other top administration officials Monday afternoon on the Treasury's year-long study of tax-simplication options.
The President had requested a redesign of the tax system that would make the federal tax code easier for individuals and businesses to deal with but did not raise additional revenue.
Administration sources said it was unlikely Reagan would immediately decide which, if any, of the tax-reform options to send to Congress. All of the approaches would be unappealing to some portion of the population. And reaction on Capitol Hill to the idea of a sweeping rewrite of the tax code has been decidedly cool.
The Treasury secretary, however, is known to favor a modified flat tax. In such a plan, many deductions would be eliminated. The resulting increase in revenue would be used to lower overall tax rates. Under the modified flat-tax plan outlined to the President Monday, the maximum tax rate for individuals would be cut from about 50 percent to about 35 percent. Also, the number of individual tax brackets - or income categories carrying their own tax rate - would be slashed to three, from the current system's 16.
The element of the modified flat-tax plan that has stirred the most immediate controversy is the administration's plan to reduce - but not eliminate - the rapid-depreciation provisions of the 1981 tax law. These provisions have saved American business billions in taxes.
Tomorrow, Reagan will move to an equally touchy topic when he meets with members of his budget working group to map ways to trim the $206 billion deficit now projected for fiscal year 1986. The President is expected to receive a number of options for cutting the budget and then provide guidance on which ones he favors.
Reagan has already ruled out cuts in defense and social security. Together with interest on the debt, these items account for roughly two-thirds of total federal spending.
By placing so much of the budget off limits, reaching the administration's informal goal of cutting the deficit to between $100 billion and $150 billion by budget year 1988 ''means very drastic cuts in the rest'' of the budget, says Alice Rivlin, former director of the Congressional Budget Office and now director of economic studies at the Brookings Institution. She spoke at a breakfast with reporters.
Slowing economic growth could add to the budget deficit by cutting into the government's tax receipts while forcing up spending on social programs like unemployment benefits.
Mrs. Rivlin, however, said the economy was not dropping into a recession, but instead was ''in transition to slower growth'' next year. She expects economic growth next year in the 3 to 4 percent range. That ''is not a disaster scenario, '' she said.
While a recession is possible, she said, ''there are absolutely no signs of that in the numbers I know of.'' She said the economy was not showing signs of the labor shortages or other imbalances that precede a recession.
At the White House, presidential spokesman Larry Speakes said Monday that the drop in the prime rate, along with the Fed's move to cut the discount rate, would ''restore moderate growth rates in future quarters.''
But Rivlin noted that economic growth in the range she expects would mean that the United States ''would have trouble bringing unemployment down'' much below the 7.4 to 7.5 percent level, where it has been stuck for the past six months.
While a pause in economic growth would basically be good, Rivlin said, the risk is that it would lead people into thinking that ''this is the wrong moment for action on the deficit.'' The political pressure for action on the deficit has been lowered, she noted, by the recent decline in interest rates. ''I am more pessimistic about action being taken than I was when rates were rising,'' she said.
She conceded that the deficit is a long-range problem whose symptoms can be ignored by many. ''There is no reason to think we would be in terrible trouble by 1986,'' if action were not taken. But in the long run, she said, ''we are in deep trouble'' if action is not taken.
The deficit's most costly effect, she says, is its contribution to high real interest rates. Real rates are those that have been adjusted for the expected inflation rate.
To cope with the deficit, she favors a freeze in federal domestic spending, except for certain programs that help the poor. She also favors selected cuts in the purchase of military hardware.
Federal spending could be cut without pushing the nation into a recession if the move was coordinated with the Federal Reserve, so it could move to stimulate the economy with lower interest rates at the same time the deficit is cut.