Dose Of Reality

By Richard Lacayo

For once the overworked phrase was apt: an era ended last week. Almost 10 years to the day after Ronald Reagan won the Presidency by promising to simultaneously cut taxes, expand defense spending, balance the federal budget and foster a new prosperity, Congress passed and sent to the White House a deficit-reduction plan that made no pretense of trying to accomplish those mutually exclusive goals. Capping more than five months of partisan wrangling, finger pointing and evasion, a new reality had forced itself upon a reluctant Washington: there is no way for the U.S. to get its fiscal house in order without demanding some sacrifice from nearly all citizens.

The unwillingness of both the Democrat-controlled Congress and the Republican Administration to face that harsh but inescapable truth had made the battle over the budget a prolonged and ugly struggle. It had a harsh edge to the very end. Late Friday night the House chamber rang with boos and shouts as members postured and debated before finally voting 228-200 to approve the plan. On Saturday afternoon, Senators converged on the Capitol for an extraordinary session and quickly okayed the package, 54-45.

But while both sides pronounced that the deal was the best that could be achieved in the current political climate, it was nothing to brag about. The compromise will slow but not arrest the tide of red ink that is washing over the nation. Even after the accord goes into effect, the deficit for the fiscal year that began on Oct. 1 is expected to soar to $254 billion, not counting the estimated $1 billion a month the government is spending on its military forces in the Persian Gulf. Every citizen's share of the $3 trillion national debt will rise by $2,600 over the next 12 months. In the words of an Arab saying, "The mountains labored greatly and produced a mouse."

Given the threat of recession, a mouse is all that could have been hoped for. Any attempt to cut the deficit to $64 billion, as the Gramm-Rudman- Hollings law requires, would have sent the economy into a tailspin. The $40 billion in deficit reduction the plan is supposed to achieve this year -- half from spending cuts and half from tax increases -- amounts to 0.5% of the nation's total output of goods and services. Once the costs of the S&L bailout and the Persian Gulf mission are factored in, the real reduction for 1991 will probably be closer to $30 billion. Says Rudolph Penner, former director of the Congressional Budget Office: "In an economy of this size that's just noise."

It is not even clear that the package is ambitious enough to accomplish one of its main goals: encouraging the Federal Reserve to lower interest rates. With the threat of recession more and more apparent, Fed Chairman Alan Greenspan has indicated that he would ease credit once a plan was adopted. But financial experts expect no more than a quarter-point decline in interest rates, far less than the 1.5% drop the Administration has been hoping for. "This agreement will give the Fed a degree of maneuvering room, but not much," says Lyle Gramley, a former Fed governor.

That was only one of the deal's shortcomings. In fashioning its package of cuts, Congress shied away from major reforms in the two largest areas of government spending: defense and programs for the elderly. Not a single weapons system -- including some the Pentagon has long wanted to scrap -- was entirely eliminated. While $100 billion in growth in domestic spending programs such as farm subsidies and veterans benefits will be slashed over the next five years, the lawmakers refrained from any adjustment of the automatic cost-of-living increases for Social Security payments. They trimmed Medicare by a modest 6%. Both programs benefit virtually all senior citizens, including many who can easily afford private coverage, but there was no serious discussion of limiting them to those who are truly in need.

On the tax side, for all the boasts about soaking the rich, the standoff between House Democrats and the White House was settled by a compromise that will give the wealthy no more than a sprinkle. The top tax rate for couples earning more than $200,000 will rise from 28% to 31%. Personal exemptions for couples with taxable income between $150,000 and $275,000 and individuals between $100,000 and $225,000 will be phased out. The plan would also limit itemized deductions for upper-income taxpayers. To soften the blow, Democrats agreed to drop from 33% to 31% the rate paid by upper-middle-income taxpayers in the so-called bubble.

All told, higher income taxes and revenue from increased excise taxes on tobacco, alcoholic beverages and expensive airplanes, yachts and furs are supposed to bring in $134 billion over the next five years. That makes the package the largest deficit-reduction plan Congress has ever adopted. Though it marks a welcome shift toward fiscal realism, the plan is still only a first step in what will be years of fiscal bloodletting before the deficit is reduced to manageable proportions.

In no area did Congress show less courage than on gasoline levies. The new deal will raise the present 9 cents-per-gal. tax by a nickel, costing the average driver a mere $34 a year. The plan rejected four weeks ago by the ; House had proposed a 10 cents hike. Even that was only half the amount economists say is needed to significantly encourage fuel conservation.

Despite the plan's defects, it was remarkable that any budget accord was reached at all. As late as last Tuesday, Texas Democrat Lloyd Bentsen, chairman of the Senate Finance Committee, was convinced that there would be no deal before January. Though weary Senate Democrats were in a mood to compromise, their colleagues in the House were unwilling to budge from their insistence that a 10% income tax surcharge be imposed on those with taxable incomes over $1 million a year. The President was equally firm in his opposition to that idea. "I fear we are close to cratering out," Bentsen proclaimed. In the end, the House leadership had to struggle for the votes it needed to prevent another humiliating loss.

But Bush was no less concerned that his opposition to the surtax had him looking once more like the billionaire's best friend. Searching for a way out of the impasse, he huddled at the White House on Wednesday with his closest advisers, including Secretary of State James Baker, Commerce Secretary Robert Mosbacher and Treasury Secretary Nicholas Brady. Baker's advice: "Get out of this as quickly as possible."

The Democrats knew they had extracted the maximum political advantage from their stand on higher taxes for the rich when they saw a gloomy Bush on television Tuesday night, suffering through a New England campaign swing during which G.O.P. candidates distanced themselves from his positions. The next day, top congressional Democrats arrived for their daily 8 a.m. meeting in majority leader Richard Gephardt's office. All agreed that pushing for another victory over the President would be counterproductive. "We didn't win everything, but we got most of what we wanted," says Congressman Charles Schumer of New York, who had been among the group that most strongly urged for a steeply progressive tax plan. "It's like poker -- you have to know when to hold 'em, know when to fold 'em."

With that decided, Gephardt placed a phone call to Budget Director Richard Darman, who was still the White House point man in the negotiations, though he and chief of staff John Sununu had both been cast in messenger roles because their aggressive arm bending in support of the budget summit's package had alienated many Republicans and most of the Democrats. Gephardt told Darman that the Democrats would give up the surtax in exchange for a tax-rate increase for the rich and a phaseout of their personal exemptions, along with a 5 cents gas tax hike and a new capital gains top rate of 28%. Speaker Thomas Foley followed up later with a call to the President, who accepted the plan. As both conservative Southern Democrats and House liberals began signaling their approval, Foley was confident that the new plan would not meet the fate of the budget-summit package that was voted down in the House three weeks earlier.

Republican lawmakers were not so easy to deliver. Many were furious that the President was forcing them to defend an unpopular tax hike with the midterm election only two weeks away. Some suspected Bush of going along with higher taxes to head off an even worse deficit that could endanger his own re- election in 1992.

Those suspicions are not unfounded. A senior White House official suggested last week that the Administration was trying to encourage the widespread throw-the-bums-out attitude toward congressional incumbents -- the vast majority of them Democrats -- to boost the chances of Republican challengers. Asked if the anti-incumbent fever might not topple some G.O.P. members of Congress, the official confidently predicted, "I think they feel strong enough to withstand it." Many Republican strategists are not so sanguine. They fear that in next week's voting the Republicans may lose more than 10 House seats, the average for the party that holds the White House in a midterm elections.

Now that the deal has been cut, Bush is left with the difficult task of trying to explain why he agreed to a program that most Republicans loathe. Before leaving Washington on a campaign swing to California, Hawaii and Oklahoma, he predictably began blaming Democrats. Expressing support for the pact while holding it at arm's length, he insisted that a Republican- controlled Congress would have blocked the $140 billion in tax increases the Democrats favored. "We believe, and always have, that people aren't taxed too little; government is spending too much," Bush said. He claimed that the Democratic plan for higher taxes on the rich was merely a disguised means of eventually raising taxes on everyone. But before the plan was adopted in Congress, a number of House Republicans asked for a separate vote on the surtax proposal so that they could go on record as supporting it.

It is no surprise that the President has reverted to themes that have served him -- and his predecessor in the White House -- in past campaigns. Nor is it shocking that Democrats, sensing an opportunity to regain the offensive, have pretended that the middle class could be spared the pain of deficit reduction by shifting the burden to the rich.

But for either side to persist in these charades flies in the face of reality. The unbalanced tax cuts of the 1980s, which sharply favored the rich, made the current deficits inevitable. They were passed with Democratic votes. Congress's failure to make spending cuts that will anger voters is a bipartisan affliction: many Republicans are no more ready to cut Social Security or Medicare entitlements than many Democrats are to close B-2 assembly lines. For all its foolish and squalid moments, the budget circus of the past five months has brought home to Washington the emptiness of the myth that the U.S. can spend and spend without paying. The test of political leadership now will be the willingness to bring that message to voters.

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Joe Lertola

CAPTION: BEARING THE BURDEN

Percent change in federal income taxes

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Joe Lertola

CAPTION: MOVING THE BUBBLE

Marginal tax rates for a couple filing jointly with two children

With reporting by Michael Duffy and Nancy Traver/Washington