That Monster Deficit

By Charles P. Alexander

COVER STORY

Because of it, the President's men feud, and the recovery may be stunted

During the reign of France's Louis XVI, Marie Antoinette supposedly once asked the Royal Finance Minister, "What will you do about the deficit, Monsieur le Ministre?" His reply: "Nothing, Madame. It is too serious."

In many ways, the President of the U.S. could not ask for a better election-year economy. Unemployment is falling, sales and profits are surging, investment is perking, inflation seems under control. After presiding over a deep recession, Ronald Reagan can now boast of having engineered one of the most stunning economic turnarounds in U.S. history.

But if the economy is going up, why do so many people feel so down about it? Why is the stock market sliding? Why is Federal Reserve Chairman Paul Volcker warning of a "clear and present danger"? Why is Congress in an uproar over the President's economic policy? Why, after little more than a year of recovery, is the dread word recession even being occasionally heard from the President's economic advisers?

The answer to all the above: the federal deficit. In this fiscal year, the U.S. Government is expected to shell out $183.7 billion more than it takes in through taxes and other revenues. By the Reagan Administration's own projections, which private and congressional economists consider to be unrealistically optimistic, the cumulative budget shortfall from 1984 through 1989 will amount to about $1 trillion. Sums up Thomas Johnson, president of Chemical New York, the bank holding company: "Everybody wants to feel good because we've just come through three years of really excruciating difficulties. But we are working on borrowed money and borrowed time."

At the very least, Government deficits of such unprecedented magnitude threaten to boost interest rates, reignite inflation, discourage capital investment and hinder growth. At worst, the budget imbalance could stop the recovery cold. Warns Volcker: "If left unattended, the deficits will accumulate until they undercut all that has been achieved with so much effort and so much pain."

At the moment, the budget gap is indeed being left unattended. Though Rea gan in his State of the Union address called for a budget-reduction "down payment" of $100 billion over three years, negotiators from the White House and Congress have had only three halfhearted and inconclusive meetings on where to begin. Last week the President and the Democrats were pointing fingers at each other over who was really to blame for the huge deficits. Said Reagan in a press conference: "I am a little struck by these born-again budget balancers, who for 40 out of the last 44 years have controlled both houses of Congress and who have rel-giously had a policy of deficit spending and never raised their voices about il." Fumed House Speaker Tip O'Neill: "On the campaign trail, the President condemns deficits. Here in Washington, lie defends them."

Not exactly. Said Reagan last week:

"I'm as determined as they are to get deficits down. But I'm not going to get then down the way they want them down." The President opposes tax increases or substantial cuts in his military budget, while the Democrats are unwilling to reduce only social programs without triraming defense and raising revenues. The Democrats will be harping about the Republican deficits in the presidential campaign, but it will be a hard case to make. Congressional Democrats have moved slowly to reduce spending, and polls show that the public holds Congress even more responsible than the President for all the red ink.

American businessmen are concerned about the deficit. Says Chrysler Chairman Lee lacocca:

"It is a scandal. I don't know what It's wacko time." The public is likewise worried. "We've got to do something," says Leon Kaplan, a Los Angeles auto mechanic.

"Sooner or later, these deficits are going to catch up with us. I'm not worried about me. I've lived half my life now, own a house, drive a couple of nice cars. But I worry about my children." A survey of 1,000 registered voters conducted for TIME by Yankelovich, Skelly & White found that 64% consider the deficit a major issue, and 23% regard it as the most serious problem facing the U.S.

The budget gap alarms Wall Street. Says Robert Farrell, chief market analyst for Merrill Lynch: "In just a few weeks, the investany other to call public attention to the def icit dilemma is a member of the Reagan Administration. As chairman of the Presi dent's .Council of Economic Advisers (CEA), Martin Feldstein has been a combi nation of gadfly, maverick and doomsayer, a Cassandra amid a passel of Pollyannas, an adviser who insists on proffering un wanted advice. He has warned repeatedly that the deficit will stunt economic growth and that taxes may have to be raised.

Those are tocsins that the Administration does not want tolled at all, much less publicly, repeatedly and in the midst of an election campaign. Yet Feldstein has gone right on making unpleasant noises. While the President has promised to move force fully against the deficit after the election, Feldstein argues that it would be a big gam ble to delay taking action. "The longer the deficits are allowed to persist," he says, "the greater are the risks to our economy."

Despite a quiet, unassertive manner and a round, cherubic countenance that --has been compared with a Cabbage Patch doll's, Feldstein has -- become one of the most celebrated and controversial chairmen in the 38-year history of the CEA.

While past chairmen may have disagreed with the White House, they have generally kept their differences private. The job, of course, is to advise the President, at whose pleasure the adviser is assumed to work. But Feldstein, who just 18 months ago was a little-known economics professor at Harvard, has become the Administration's chief whistle blower.

In that role, he has had almost continuous confrontations with Treasury Secretary Donald Regan, who is the President's chief economic cheerleader. Rarely, if ever, has an Administration had two top officials who so publicly and so flatly contradicted each other. Feldstein has maintained that deficits "push up interest rates. Regan has said that they do not.

Feldstein contends that the budget shortfall causes the dollar to be overvalued, inflicting severe damage on American export industries. Regan counters that the dollar is not overvalued and that its vigor is merely a reflection of the strength of the U.S. economy.

In testimony before Congress, the Treasury Secretary, once the chairman of Merrill Lynch, ridiculed Feldstein as an ivory-tower professor who has spent too much time in the library. Regan has often dismissed Feldstein's fears about the deficits. "I wish those economists would sit back and relax," he said on one occasion. "This will be one of the greatest recoveries in history."

Where Regan is concerned, Feldstein holds his fire in public, but privately he can be condescending--and worse--toward the Treasury Secretary. Aides say that Feldstein speaks of Regan as a slow, recalcitrant student who must be patiently tutored and humored. He does an imitation of how the Treasury Secretary loses his temper, pounds on the table and utters a stream of expletives.

While Feldstein has infuriated Regan, he has aroused equally intense ire at the White House. Not since Budget Director David Stockman was taken to the woodshed for revealing doubts about Reaganomics in the Atlantic Monthly in 1981 has the Administration been so embarrassed, and harassed, by one of its economic gurus. The President's aides accuse the economist of being disloyal and giving ammunition to the opposition during an election campaign. Says one staffer: "He's made the CEA a four-letter word around here." On several occasions, the White House has censored advance texts of Feldstein's speeches and ordered him to cancel television interviews. The President has become so annoyed that he never consults Feldstein one-on-one, and the CEA chairman is often excluded even from small strategy meetings.

Atop policymaker who is one of Feldstein's handful of Administration allies thinks that many White House aides have become unreasonable and downright unfair to the economist: "They're saying he wants to get his national name recognition up to 40% and that he's determined to go down in the history books as the man who tried to stop those deficits. It's pretty nasty stuff. It's not really justified."

Over at the Treasury, Regan's staff professes to be amazed that Feldstein has lasted this long. Says one official: "He's incredibly arrogant. We can't understand why he hasn't been fired." He almost was last fall, but Administration campaign strategists fear that sacking Feldstein, who long ago announced plans to return to Harvard in September, would be politically more hazardous than keeping him on a while longer. The President has said that he does not want to make a "martyr" of the economist. Feldstein may be pushing his luck, though. Says one White House aide: "Sometimes it seems as if he's testing us to see just how far he can go. We don't know if he wants to be fired or not. Sometimes it seems like he does."

If the words have been hot and the tempers short, the importance of the issue justifies the emotions. "The deficit is the crucial economic problem." says Jerry Jasinowski, chief economist of the National Association of Manufacturers. "It is the central obstacle to a continued healthy economy."

The sheer size of the budget gap is al most beyond comprehension. In its weekly newspaper, the American Bankers Association tried to put a $180 billion deficit into perspective by calculating that in order to spend a billion dollars, a shopper would have to use up $100 a minute for 19 years. The. President has used a similar metaphor. In a speech unveiling his economic program soon after he took office, Reagan dramatized his concern about the national debt, then approaching $1 trillion, by noting that it would take a stack of $1,000 bills 67 miles high to equal that total. When he brought out his new budget this month, Reagan failed to mention that his deficits would push the debt to $ 1.8 trillion by next year and raise his stack of $ 1,000 bills to more than 120 miles.

The most frightening aspect of the deficits and the national debt is that they may be snowballing out of control. The President's budget predicts that the deficit will remain in the $180 billion range through fiscal 1987, but then will fall to $123.4 billion in 1989. That forecast, however, rests on the shaky assumption that the interest rate the Government must pay on three-month Treasury bills will drop, from an average of 8.6% last year to 5% by 1989. Feldstein has argued that if budget deficits are not reduced in the next few years, interest rates may not fall significantly. The President's budget projections are thus internally inconsistent.

Using a more realistic forecast that interest rates will drop only slightly, the Congressional Budget Office (CBO) calculated last week that the shortfall might reach $248 billion in 1989. even if all the deficit-cutting measures proposed in the Reagan budget are adopted. That gigantic number is also optimistic: the CBO assumed no new recession for the rest of the decade. Charles Schultze. chief 'economic adviser for Jimmy Carand now a senior fellow at Washington's Brookings Institution, estimates that if another downturn occurs and nothing has been done in the meantime to close the budget gap, the deficit could top $350 billion by the late 1980s.

In general, economists think that the budget deficit in a healthy economy should amount to no more than 2% of the gross national product.

As recently as the 1970s, the shortfall generally stayed at about that level. But unless something is done, deficits are now bound to total about 5% of the G.N.R until 1990. Interest on the national debt ($149.5 billion this year) is already the third largest single budget item after defense and Social Security.

It is ironic that such a specter has arisen during the Administration of Ronald Reagan, who as a candidate talked of balancing the budget by 1984. If Reagan serves a second term, even his optimistic budget projections show that he will run up a higher deficit total ($1.3 trillion) than all past Presidents combined (about $766 billion), although inflation accounts for some of the difference.

Reagan has tried to blame the current deficits on a legacy of freewheeling Government spending that he inherited from past Administrations. But an analysis by the CBO challenges that contention. If no laws had been changed during the Reagan years, says the CBO, the budget would be headed toward an $11 billion surplus by 1989. The rise in the deficit results mainly from the 23% personal income tax cut that Reagan pushed through Congress in 1981 and his large military buildup. By 1989 increases in defense spending will almost completely offset the cuts Reagan and Congress have made in domestic programs.

The President's belief early in his term that he could slash taxes, restore American military might 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.

In budget briefings with reporters, Feldstein suggested that the Administration would eventually have to compromise with Congress and agree to reduce defense spending and raise taxes. Grumbled a top White House aide: "There was Feldstein, in public, emphasizing that the budget as presented was a bad job and that, of course, defense will have to be cut and, of course, the Treasury needs more revenue. The Democrats will feel emboldened to stick to their guns all the more stubbornly." That same week the Administration released the Economic Report of the President, which was prepared under Feldstein's supervision and contained a stern new warning about deficits. An angry Regan advised members of the Senate Budget Committee that they could "throw away" Feldstein's report.

The squabbling among his advisers reinforced the President's deep distrust of economists. In a January radio address, he described economic forecasting as "far from a perfect science" and called economists "naysayers" and "doom criers." Though Rea gan was never a doctrinaire supply-sider who believed that deficits were nothing to get too concerned about, the President apparently refuses to believe that the budget gap will be as big and as harmful as Feldstein thinks.

To a large extent, Reagan has become his own economist. At a meeting last fall, Feldstein, Regan and Stockman presented forecasts showing that the deficit would rise to well over $200 billion in the last half of the decade. The President studied the figures and noticed that inflation, as measured by a broad index known as the G.N.P. deflator, which includes prices paid by both businesses and consumers, was expected to hover around 5%. "Why can't we continue to make progress?" the President demanded. "We can't just declare victory at 5%."

Having no ready answer, the economic troika went back to the calculators and produced a downward-sloping curve that showed inflation falling from 5% this year to 3.6% in 1989. Since interest rates are related to the level of inflation, the advisers trimmed their estimate of the 1989 rate on three-month Treasury bills from the 7%-8% range to 5%. By that statistical legerdemain, the projected 1989 budget deficit shrank from more than $200 billion to $123 billion.

The President's seat-of-the-pants forecasting and his refusal to listen to his chief economic adviser have raised serious questions: Is there any basis for Reagan's optimism? Is Feldstein right about the perils of deficits? Does a growing budget gap produce high interest rates?

Followers of supply-side theory have compiled a growing list of studies purporting to show that deficits do not raise interest rates. One was done by Manuel Johnson, an Assistant Treasury Secretary. Two other outspoken advocates of the supply-side view are Alan Reynolds, an economic consultant with Polyconomics in Morristown, N.J., and Paul Craig Roberts, a former Assistant Treasury Secretary in the Reagan Administration who is now a professor at Georgetown University. Supply-siders contend that the main factor propping up interest rates is the Federal Reserve's tight money policy. They argue that it was the Reserve Board that caused the recession and that if the 'Fed would loosen up, interest rates would come down and growth would stay strong.

The supply-side movement, however, has had very little impact on the thinking of mainstream economists ranging from liberals like Barry Bosworth of the Brookings Institution to conservatives like Alan Greenspan, who served as President Ford's chief economic adviser. Traditional economists admit that many factors influence interest rates and that the stance of the Federal Reserve is perhaps the most important. But most would argue that if all other factors are held constant, the higher deficits go, the higher interest rates will ultimately be. The proposition is as simple as the law of supply and demand: if the Government sharply increases its demands for credit because it is running larger deficits, then the price of credit tends to rise.

To most economists, the question is not whether a credit squeeze will occur, but how soon it will hit and how severe it will be. Says John Wilson, chief economist of San Francisco's Bank of America: "The danger is that if interest rates go up from their current high levels, it won't take much to squeeze out private spending and drive the U.S. back into a recession in 1985." A survey released last week by the National Association of Business Economists found that 69% of the 237 members polled were worried that the deficits could bring on a downturn next year.

Whether or not that happens depends in large part on what the Federal Reserve Board does. The deficits force the seven governors on the board to choose between two extremely unpleasant choices: 1) they can hold down money growth, let interest rates rise and risk a recession; 2) they can expand the money supply enough to accommodate the deficits and possibly rekindle inflationary pressures. Chairman Volcker and several other board members have signaled their determination not to give up the progress that has been made against rising prices. Says one governor: "The Fed is going to stick it out." But another governor thinks that the board would have to back down in a crunch. Says he: "If a crisis develops that would cause a serious downturn in the economy, we should do what is necessary to remedy this. But you have to realize that the cost of such action can be renewed inflation." A jump in food costs brought on by bad weather caused the consumer price index to jump .6% in January, its steepest gain in nine months, but most economists remain hopeful that inflation will stay moderate this year.

Even if interest rates do not rise enough to spark a recession, they could discourage the capital spending that companies need to modernize and expand their capacity. Investment has begun to revive during the recovery, but much of the money has gone for computers and automation devices, rather than for the heavy machinery and new factories needed for long-term growth. Spending for construction of industrial plants fell 24% last year, and is expected to be flat in 1984. Businessmen seem to be reluctant to make investments that will not return a sure profit within a short time. Explains Robert Ortner, chief economist of the U.S. Commerce Department: "There is a fear that deficits will strangle the economy, which creates uncertainty. And uncertainty is always detrimental to long-term business decisions."

The Gang of Three against deficits--Feldstein, Volcker and Stockman--argue that the red ink damages the international competitiveness of American industry.

By keeping interest rates high in the U.S.

in comparison with what they are in other countries, the budget gap spurs foreigners to put money into American bank deposits, bonds, Treasury bills and other investments. First, though, they must convert marks, pounds or francs into dollars. That raises the value of the U.S. currency on exchange markets. The Council of Economic Advisers reports that since 1980 the dollar has risen 52% against an average often major currencies. As the dollar goes up, American products become more expensive abroad, while foreign goods become cheaper in the U.S.

This has made life difficult for American companies that sell overseas and for those facing foreign competition in the U.S. American exports of manufactured goods fell 5.2% last year, while imports increased 13.5%. Even the healthiest U.S.

industries were hit. Exports of computers and office machines rose 15%, but imports surged 58%. Feldstein predicts that the U.S. merchandise trade deficit will reach a record $110 billion this year.

The flood of foreign capital into the U.S., some $46 billion in the first nine months of 1983, has, of course--, had a beneficial side effect. Without that inflow, U.S. interest rates would have been an estimated 1 to 3 percentage points higher. But it has also raised the almost shocking possibility that the U.S. will soon become a debtor nation for the first time since 1917.

At the end of 1982, Americans had investments abroad totaling $834 billion, while foreign holdings in the U.S. amounted to $665.5 billion. Projections of present trends indicate that some time in 1985 the U.S. may owe foreign countries more than they owe America.

Another concern is that the U.S. appetite for foreign money has made the country vulnerable to a sudden flight of capital. If investors abroad were to lose confidence in the U.S. economy, the value of the dollar could decline, perhaps dive. Many foreign investment advisers are now counseling their clients to be wary. Says Economist Richard O'Brien of the Amex Bank in London: "The dollar is like a long rubber band. The longer it stretches, the harder it snaps back on you."

The dollar is already showing a bit of weakness. In the past month it has fallen 7% against the West German mark and 5% against the British pound. American economists expect the dollar to drift downward, by perhaps 10% this year. Moreover, experts do not rule out a precipitous dollar plunge. If that happened, it could drive up American interest rates and fuel inflation in the U.S.

The most serious damage caused by the large deficits is a slow corrosion of the American economy. In many ways, the deficits are creating a false sense of prosperity. They are putting spending money in consumers' pockets, but they are draining funds from badly needed investment. By consuming too much and building too little now, the U.S. is damaging its future industrial capacity. "The real harm done by deficits," says Congressional Budget Office Director Rudolph Penner, "is the negative impacts on long-run growth and future living standards. The process is gradual, with no easily identifiable, traumatic event that clearly illustrates the effects of deficits."

In trying to cut the budget, Congress and the Administration face the fact that more than two-thirds of Government spending goes for only four items: defense, Social Security, Medicare and interest on the national debt. The rest of the budget has already been trimmed considerably.

Nonetheless, there are numerous ways that spending, much of which goes to support America's middle class, can be reduced. The CBO has a list of 98 possibilities for trimming outlays. Example: limiting cost of living adjustments for Social Security recipients and railroad retirees to two-thirds of the increase in the consumer price index, instead of the present 100% raise, would save the Government 543.6 billion over the next five years.

The Bipartisan Budget Appeal, founded by former Commerce Secretary Peter Peterson and former Treasury Secretaries W. Michael Blumenthal, John Connally, C. Douglas Dillon, Henry Fowler and William Simon, calls for $85 billion in spending cuts by 1986. About $36 billion of that, the group suggests, could come from freezing for two years the cost of living adjustments in numerous federal benefits, including Social Security, civil service and military pensions. The group would carve another $10 billion out of Medicare.

The President's Private Sector Survey on Cost Control, headed by Peter Grace of W.R. Grace & Co., made 2,478 recommendations for cutting the budget, claiming that $424.4 billion could be saved over three years. The steps include revising civil service retirement to make it no more generous than private pension plans (a three-year savings of $30 billion) and repealing the Davis-Bacon Act, which generally requires the Government to pay high union wages on construction projects (a $5 billion savings).

A consensus is forming that the U.S. cannot afford as swift and sweeping a military buildup as Reagan proposes: a 13% increase in defense spending, after adjustment for inflation, in 1985 alone. Though Pentagon critics have long urged that such costly weapons systems as the B-1B bomber ($5.6 billion this year) and the MX missile ($2 billion) be scrapped, Congress is reluctant to abandon programs already started. But the Democrats say that development timetables for most military procurement programs could be stretched out. If the money scheduled to be spent during the next five years were spread over six years instead, they suggest, the cumulative federal deficit from 1985 through 1987 would be $100 billion lower. The Grace commission contends that $7.3 billion could be saved in a three-year span if the Pentagon encouraged more competitive bidding among suppliers of ordinary military parts. Grace said, for example, that the Pentagon was paying $91 each for a type of screw that should have cost 30.

Many economists and congressional leaders are convinced that tax hikes must be added to spending reductions. Privately, several officials besides Feldstein concede the point. Says one top Administration policymaker: "There are some spending hits to be made. The farm program is a fertile area. It has to be made cheaper, and soon. Medicare is an obvious place to look. But you'd be lucky to assemble a package of $25 billion in domestic cuts and $20 billion out of defense during three years. We would still need $100 billion in new taxes."

Hardly anyone wants to increase personal income tax rates. Boosting rates tends to undermine incentives for Americans to work hard, save and invest. As a result, some economists have come to favor so-called consumption taxes. A 5% federal tax on all forms of energy consumption, for example, would raise $82.9 billion over five years. Another possibility is a value-added tax (VAT), a form of national sales levy that is used in most West European nations. Even if housing, food and medical care were exempted, a 5% VAT would yield $60 billion a year. Such taxes, of course, would take money from consumers' pockets and be a drag on growth.

As the rich range of options shows, closing the budget gap is not an economic or technical problem. It is a political problem. Voters, being human, want more benefits and fewer taxes, and politicians, being politicians, respond to the voters. Says the CBO's Penner: "All spending does some good for someone, and all taxes do some harm to someone. So there is never a good spending cut or tax increase in the eyes of the entire electorate."

Congress is just as much to blame for the budget gridlock as the White House, if not more. "Senators and Congressmen have made great speeches on how to reduce the deficit," says Republican Senator Jake Garn of Utah. "Yet it is because of their voting records that we have these deficits." Too many lawmakers denounce the bloated budget but are unwilling to choose a specific course of action. Their rhetoric is reminiscent of the legendary Congressman who declared a half-century ago, "I oppose inflation. I oppose deflation. I'm for flation."

Several influential Congressmen, however, are beginning to look for ways to bring the deficit under control. In the Senate, this group includes Republicans Robert Dole of Kansas, chairman of the Finance Committee, and Pete Domenici of New Mexico, chairman of the Budget Committee. Dole's committee voted last week to set a $100 billion three-year deficit-cutting goal. Dole can count on support from such leading Democratic Senators as Russell Long of Louisiana and Presidential Candidate Fritz Rollings of South Carolina.

On the House side, such Democrats as Oklahoma's Jim Jones, chairman of the Budget Committee, and Ways and Means Chairman Dan Rostenkowski of Illinois are eager to attack the deficit. Rostenkowski said that his committee would begin work this week on a $51.2 billion revenue-raising bill.

At the moment, these leaders are having trouble achieving a breakthrough, partly because of the uncompromising attitudes of Speaker O'Neill and President Reagan. O'Neill fears that the President's call for a "down payment" toward reducing the deficit is a ploy to force the Democrats into sharing election-year blame for the huge shortfall. Late last week, however, the Speaker declared for the first time that he would consider trimming cost of living increases in social benefits, if the President would give ground on the tax and defense issues.

An Administration delegation led by White House Chief of Staff James Baker met twice last week with congressional leaders. The two sides had their frankest exchanges yet on defense. Republican Domenici stunned Administration negotiators with a proposal that the 1985 military spending increase be held to 5%, instead of the 13% the President wants. House Majority Leader Jim Wright of Texas demanded that the White House provide a list of Pentagon programs ranked according to how vital they are to national security. The Administration had no immediate response, and Wright complained that Defense Secretary Caspar Weinberger "considers everything in his budget absolutely indispensable."

Democratic Senator Daniel Inouye of Hawaii said that if Administration officials did not provide more specific suggestions/Congress might take budget-cutting action on its own.

The deficit dilemma facing the U.S. is a problem inherent in free societies. Democratic governments around the world have found it easy to give out favors and almost impossible to take them back. Writes Samuel Brittan, a British economic commentator, in his new book The Role and Limits of Government: "Each of us wants the benefit of services while transferring the cost to some other group; we evade the problem of deciding who should be the loser."

That predicament is complicated in the U.S. by the rapid-fire pace of elections.

Voting day is never more than two years away for 468 of the 535 U.S. lawmakers.

Unfortunately, the business cycle has no respect for the political cycle. If Congress and the White House insist on avoiding until 1985 the difficult measures needed to control the deficit, the chance to keep the recovery going and assure the future health of the U.S. economy may slip irretrievably away. --By Charles P. Alexander. Reported by David Beckwith, Gisela Bolte and Neil MacNeil/Washington

With reporting by David Beckwith, Gisela Bolte, Neil MacNeil