Program for New Federalism

By GEORGE J. CHURCH

A package of cuts and taxes to stem all that red ink

The buildup to Ronald Reagan's State of the Union address has been a kind of will-he or won't-he suspense serial that has been running for almost two months. But when he steps before a joint session of Congress and the TV cameras next week, the President will finally provide the answer: yes, he will ask for higher taxes, perhaps $40 billion to $60 billion over the next two fiscal years. If enacted--a very large if--they could extract more money from everyone who buys a beer or a pack of cigarettes or drives a car, possibly also from people who have sizable medical expenses or run up charge-account bills.

The payoff for this pain: a forecast that budget deficits will drop from around $100 billion this fiscal year to a range of $60 billion to $80 billion in fiscal 1983, and $40 billion to $60 billion by 1984. Earlier projections of a 1983 deficit of more than $150 billion had frightened not only Washington but Wall Street and the nation as well.

There will, of course, be much more to the speech than that. Reagan will stress one way to advance the "new federalism": turning over to the states a portion of the revenues from increased federal taxes to help them carry on programs for which Washington has reduced funding. The President will also propose further deep slashes in federal social spending, totaling about $31 billion, most of which are already known.

Reagan will expectably defend his economic program, contending that the second-stage income tax cut of 10%, which takes effect July 1, will fuel a strong recovery from the current recession. During that recovery, he will doubtless predict, inflation and interest rates will continue to decline and unemployment will markedly turn down too.

The President gave a preview of his argument last week in a speech to civic and business leaders in New York City. "Yes, we are in a recession," Reagan said. "Our Administration is cleanup crew for those who went on a nonstop [spending] binge and left the tab for us to pick up."

Presidential Aide Michael Deaver began collecting ideas for the State of the Union speech in November, and the President took a preliminary draft to California on his end-of-year vacation. Reagan and his aides have been extensively rewriting ever since. As of last week, the draft contained blank spaces for new bud-jet figures and proposals. Nonetheless, Reagan took 33 min. to deliver it in a preliminary run-through and told advisers: 'I want to sweat it down some more." He is aiming at 25 to 28 min. Thus the speech will probably contain only bottom-line numbers and broad outlines for many proposals.

The toughest problem that the White House faced in shaping the speech was to produce a forecast of dwindling deficits and a believable strategy for bringing them down. For months, the President's economic advisers have been locked in a dispute over those subjects that was a mixture of charade and reality. It did no harm to publicize predictions of a raging tide of red ink if nothing were done about spending and taxes. "We're dealing with perceptions here," explained one White House aide, "and the perception is that Reagan is bringing the deficit down after it was in danger of being wildly out of control." Nor did it hurt to have leak after leak portray the President as stubbornly resisting the tax increases being urged by his advisers.

At the same time, the fear in the White House of spiraling deficits was quite real, and the agonizing over tax increases entirely genuine. In fact, TIME has learned that Paul Craig Roberts, the most hard-line opponent of tax boosts in the Administration, will resign this week as an Assistant Treasury Secretary to become a professor of economics at Georgetown University. Roberts thinks that the President's program has been subverted by advisers who do not really believe in supply-side economics.

Reagan has ruled out any delay or reduction in the income tax cuts he won from Congress last year, since they are the heart of the supply-side program. Instead, the Administration will propose what one aide calls "consumption taxes that do not do violence to supply-side theory."

The most likely proposal is a doubling of federal excise taxes on alcohol and cigarettes, which currently are $1.66 on a .75-liter bottle of whisky and 8-c- on a pack of smokes, and a boost in the 4-c--per-gal. federal tax on gasoline, perhaps to 9-c-. Doubling the 2% federal tax on interstate telephone calls might be included as well. A portion of the added revenue, estimated at $9.2 billion, would be turned over to the states, but the size of their share is still uncertain.

The Administration is also considering a lid of $120 a month on the tax-deductible health-insurance premiums that an employer can pay for each worker, and perhaps letting individual taxpayers deduct only medical expenses that exceed 10% of annual income, vs. 3% now. That proposal is politically explosive, since it would raise the tax bills of people who are hard-pressed by illness. The rationale: medical inflation is being fanned because the underwriting of bills by private insurers or the Government gives neither hospitals, doctors nor patients any incentive to hold down costs. Another possible proposal: eliminating the deductions that taxpayers can claim for interest paid on clothes, furniture or just about anything bought on credit (interest paid on home mortgages and auto loans would remain deductible).

In addition, Reagan will resubmit the $22 billion, three-year package of loophole-closing measures that he first proposed in September. Among its provisions were ending some tax credits granted to businesses that conserve energy and requiring faster payment of taxes on profits earned by defense contractors. The President definitely will not propose a windfall-profits tax on natural gas producers, but aides hint broadly that he will not fight a move by Congress to tack the tax onto a repeal of the remaining price controls on natural gas. Such a tax might bring in $10 billion to $20 billion a year.

As to spending, Reagan will probably propose severe reductions in job-training programs and federal aid to public schools, along with additional slashes in food stamps, Medicare and Medicaid. Construction of subsidized housing would be all but abolished; Reagan will recommend starting only 10,000 units in fiscal 1983, vs. 153,000 this fiscal year.

Outlining the program is one thing; selling it is something very different. Though the President won every important legislative battle in 1981, one senior adviser concedes that "we are going to lose some" this year. Congress may well balk at further sharp cuts in social spending unless Reagan agrees to significant reductions in defense-spending plans as well. And no legislator will be eager to vote for higher taxes in an election year.

The severity of the recession is greatly compounding Reagan's problems. Some Administration economists now expect the unemployment rate to peak at 9.5% in March or April; that would be a post-World War II record. Many other economists fear that the figure could reach 10%. If it does, and if unemployment stays high, the President's figures would be skewed. Every percentage point of unemployment adds $20 billion to the deficit in transfer payments (like jobless compensation) and revenue loss. One little noticed fact: although the number of jobless jumped to nearly 9.5 million in December from 7.8 million a year earlier, the number receiving unemployment compensation actually fell, to just under 4 million, from 4.2 million. One reason is that last year's budget cuts tightened the rules concerning who could qualify.

If the Administration is right in contending that the jobless rate will start falling in the spring, toward a year-end total of around 7.5%, Reagan may escape severe political damage. But if the rate rises into double digits by summer, the President's program will come under severe attack during a congressional session certain to be dominated by jockeying for partisan advantage in the November elections. --By George J. Church. Reported by David Beckwlth and Douglas Brew/Washington

With reporting by David Beckwith, Douglas Brew/Washington

This file is automatically generated by a robot program, so viewer discretion is required.