That Monster Deficit

(5 of 11)
and balance the budget at the same time grew out of his fascination with supply-side economic theory, a doctrine that puts great faith in the power of tax cuts to spur growth. Reagan's supply-side enthusiasts, who were concentrated in the Treasury Department under the leadership of Secretary Regan, realized that tax cuts might open up a big deficit temporarily, but they believed that a spurt of growth in the economy would make up for part of the shortfall: more income and profits would mean more taxes for the Treasury. Cuts in Government spending, they thought, could close the rest of the deficit.

But the supply-siders underestimated how difficult it would be to bring down the 12.4% inflation level of 1980. To tame prices and restore the badly shaken confidence of the financial community, the Federal Reserve had to slow the growth of the U.S. money supply. Instead of expanding briskly, the economy dipped into a severe recession that lasted from the summer of 1981 through November 1982. As a result, the deficit exploded.

Murray Weidenbaum, a mainstream conservative economist who served as the first chairman of Reagan's Council of Economic Advisers, was never comfortable with the rosy claims made by the Administration's supply-siders, and resigned in the summer of 1982. To replace Weidenbaum and shore up the sagging credibility of Reaganomics, the White House turned to Feldstein, another conservative with strong credentials (see box).

At first, Feldstein was influential in policymaking. He argued that the deficit would hinder the economic recovery and insisted that the Administration project G.N.P. growth for 1983 at a cautious 3%, a forecast in line with what private economists were saying. When the White House was preparing its budget message early last year, Feldstein and Stockman helped persuade the President, over objections from the supply-siders, to propose a contingency tax designed to boost revenues in 1985 if the deficits were still too high. Feldstein's austere outlook and recommendations earned him the nickname "Dr. Gloom."

The recovery turned out to be much more robust than Feldstein and most other economists expected. Last year's growth rate was 6.1%, or double Feldstein's forecast. That miscalculation hurt his standing in the Administration and encouraged the supply-siders.

Meanwhile, Feldstein kept calling for tax hikes. That irritated the White House, which had quietly abandoned its contingency-tax proposal. Spokesman Larry Speakes telegraphed the displeasure by telling reporters at a briefing that Feldstein was talking "too often and too much." Stooping to heavyhanded ridicule, Speakes alternately pronounced the economist's name "Feldsteen" (incorrectly) and "Feldstine" (correctly).

Showdown time for the feuding economic advisers came during the White House deliberations on this year's budget message. Feldstein and his ally Stockman urged the President to propose new taxes. Regan held out against them. Faced with conflicting recommendations, the President followed his instincts: no new taxes. Reagan has always felt, with plenty of justification, that giving Congress more revenues would merely encourage more spending.

The President's decision did not put an end, however, to the confusion within the Administration over economic policy.