BUDGET DIRECTOR DARMAN & A FEDERAL CASE OF BUDGET FRAUD

Sunday's column reviewed warnings that filled this space from July to December, 1990, concerning how the bipartisan Washington Establishment mishandled the federal budget and the nation's economy. In the following article, Dr. Paul Craig Roberts relates how White House Budget Director Dick Darman, principal architect of the Budget Summit fiasco, went about his work in a manner that would have landed him in jail had he worked for private industry.

Fraud: Washington's Budget Summit Agreement of 1991

If Exxon can be criminally indicted for an accidental oil spill that cost the company and its shareholders a large fortune, and if financier Michael Milken can be sentenced to 10 years on dubious charges, then surely the signatories to last autumn's budget agreement can be indicted, for no greater fraud has ever been perpetrated on the American people.

Last fall the people were told that President George "read-my-lips" Bush had broken his "no new taxes" pledge in order to save the economy from the deficit. As the story went, President Bush purchased $500 billion in deficit reduction by signing onto a $165 billion tax increase. Reagan Republicans were told to stop carping and to be glad that something was finally being done about "their" deficits.

Deficits are exploding

Nine months later the Office of Management and Budget has released its midseason review of the budget. Far from a five-year deficit reduction of $500 billion, the cumulative deficit forecast for 1991-95 has doubled to $1.087 trillion. Syndicated columnist Warren Brookes has slammed Budget Director Richard Darman for "the worst fiscal mismanagement in U.S. history." But Mr. Brookes's charge of incompetence shields the government from the far more serious charge of fraud.

Before the budget agreement was reached, the government knew that its claims for deficit reduction would not be achieved. It withheld revised economic assumptions that showed the recession would eat up the projected revenues from the tax increase, together with 20 percent of the claimed outlay reductions.

However, instead of facing outrage for blatant fraud, Mr. Bush was widely congratulated for his "realism" in rejecting the myth that economic growth could reduce the deficit. The fraudulent deficit-reduction bandwagon rolled on, growing in outrageousness.

To make the budget agreement look even more palatable, Mr. Darman commingled the one-time affair of acquiring and disposing of S&L assets with the taxing and spending operations of the government. In the short run this unconventional accounting practice inflated the deficit as the assets came into the government's hands, but the subsequent sale of the assets counted as negative spending in later years. By distorting expenditures this way, Mr. Darman was able to project federal outlays in 1994 $50 billion below the 1992 level, thus giving the appearance of expenditure reduction.

Mr. Darman has managed to produce a larger deficit with a tax increase and a defense build-down than Mr. Reagan achieved with a tax cut and a defense buildup. The Bush administration now forecasts a 1992 deficit of $348 billion, much larger than the Reagan administration's record of $221 billion in 1986. Moreover, unlike the Reagan deficits, the Bush deficit is not offset by the state and local surpluses that were part of the long Reagan expansion. Throughout the 1980s statistics from the Organization for Economic Cooperation and Development (OECD) comparing general government deficits (including federal, state and local entities) showed that the U.S. deficit as a share of Gross National Product (GNP) was often below the OECD average for other western nations.

This respectable performance has radically changed. If Mr. Darman's accounting is used, today only Italy among major industrial countries has a larger general budget deficit as a share of GNP than the U.S.

More bad news

Moreover, the growth in the federal budget deficit may be far from over. States and localities are generally prohibited from consistently running deficits, and so to pare their deficits, they are likely to increase income and property taxes, which are federally deductible. Thus, as these taxes rise, federal tax revenues grow less rapidly with income which itself grows less rapidly as taxes rise.

The deficit reduction agreement projected in the budget agreement assumes the sale of assets from the government's inventory of S&L properties. If these assets are not sold at the assumed rate and price, the projected deficit reduction will not occur. Moreover, if continuing policy mismanagement leads to a comparable bailout of commercial banks, the deficit will escalate.

As the true magnitude of the budget fraud comes to light, those responsible are beginning to run for cover. Mr. Darman blamed the revenue shortfall on a mathematical goof by Treasury revenue estimators. Such public fingerpointing by one administration department on another suggests that more shoes are due to fall.

Indeed, an even bigger deficit may be on the way. Government officials are speaking of a "January surprise" when the budget is presented. They are worried because of the discovery that the tax-base share of GNP appears to be shrinking.

Part of the explanation reflects the supply-side principle that income expands fastest when taxed least, and data seem to show that earnings above the Social Security tax cap are growing more rapidly than those below. Consequently, the payroll tax brings in proportionally less revenue as income grows. Another part of the explanation is the growth in deductible state and local taxes. The "January surprise" could lead to higher taxes, as Washington responds by raising the Social Security cap and curtailing the deductibility of state and local taxes.

As disincentives flow back into the economy from taxes, regulation and mandated health benefits, domestic income growth will slow as more production is shifted to lower cost foreign locations. The deficit will grow, and unlike the Reagan deficits, which reflected an unexpected collapse of inflation, the growing deficit will reflect a dying economy. Paul Craig Roberts, Ph.D.

Dr. Paul Craig Roberts served in the Treasury Department under President Reagan in 1981-82. He is currently chairman of the Institute for Political Economy in Washington, D.C.