National Center for Policy Analysis

MONTH IN REVIEW

Federal Spending and Budget
September, 1996

FALLING DEFICIT NUMBERS

The federal budget deficit for the 1996 fiscal year ending September 30 will be lower than last year's - at $117 billion, according to a July forecast from the Office of Management and Budget. An August economic update from the Congressional Budget Office pegs the 1996 deficit at $116 billion.

The OMB forecasts that the deficit will be 1.6 percent of gross domestic product, down from 4.9 percent of GDP in 1992. However, it is not what President Clinton proposed.

In 1995, he submitted a budget that called for a $211 billion deficit in fiscal 1996 -- $94 billion higher than currently expected.
But Congress capped most low-priority domestic programs at 75 percent of last year's amount.
It also terminated more than 200 small pork programs, resulting in the first year-to-year decline in discretionary spending since 1969.

How much of the deficit reduction was due to curtailed spending rather than increased tax collections? Budget analysts say:

Cuts in projected spending increases accounted for more than half of the deficit reduction - 1.9 percent of GDP - and cuts in defense spending accounted for almost all of those cuts.
In a period of four months this year, the OMB increased its forecast for federal revenues by $26 billion.
Most of this revenue increase comes from investors who had been holding their stocks in the hope that capital gains tax rates would be lowered - then gave up and sold their stocks before April 15.

Analysts say that increasing federal tax rates hasn't helped reduce the deficit by increasing tax revenues. In 1996, for example, personal income tax revenues will take a lower share of GDP than they did in 1987, when the top rate was still 28 percent.

The 1993 tax bill increased the top marginal tax rate to 39.6 percent for taxpayers with incomes above $250,000, but their reported income grew less than people in lower tax brackets, suggesting that people respond to tax incentives by earning less. Harvard economist Martin Feldstein calculated that repealing the 1993 increase in tax rates for high-income taxpayers would raise an additional $2 billion in revenue.

Source: Ed Rubenstein, "Right Data," National Review, September 2, 1996.

LOSING OTHER PEOPLE'S MONEY

Firms which use government loans for start-up and expansion are far more likely to flop than those which don't, according to a recent study by the Federal Reserve Bank of Chicago.

A federal program allows Small Business Investment Corporations (SBICs) -- which depend on money from the federal Small Business Administration, as well as private funds -- either to invest in small firms or issue them loans.

The study looked at the economic performance of about 280 SBICs between 1986 and 1993.

Over the period, these institutions turned in a dismal return of - 0.2 percent per year to their shareholders.
These SBICs failed at a rate of 11 percent a year -- compared with a 5.5 percent failure rate among savings and loans and a 1 percent rate among commercial banks.
More than half of those tracked were liquidated or voluntarily turned in their licenses before the close of 1993.

According to the General Accounting Office, the Small Business Administration is owned nearly $500 million from failed SBICs and similar investment companies that use federal subsidies to buy stock only in minority-owned firms. Also, authorities have found many examples of improper financial dealings by SBIC managers.

And why not? After all, critics note, its only other people's money.

Source: Perspective, "Risky Business," Investor's Business Daily, September 11, 1996.

WHO PAYS WHAT WHEN DISASTERS HIT?

As those affected by Hurricane Fran begin assessing the damage, the question arises as to how much aid will come from the federal government, insurance and out-of-pocket payments by the victims.

Between 1975 and 1994, natural disasters in the U.S. cost an average of $250 million per week, according to the Natural Hazards Research Center.
During the first five years of the 1990s, 189 declared disasters cost the federal Treasury $11.6 billion.
Experts estimate that the federal government picks up about one-third of disaster costs, with insurance companies contributing 40 percent to 50 percent.
Individuals pay the rest out of pocket.

With one disaster following another in the 1990s, the trend is to build stronger and safer homes and businesses that, with luck, are out of harm's way. Loss prevention is now the goal.

Since the 1993 floods in the midwest, the federal government has committed $97 million to move 240 towns -- either whole or in part -- to higher ground.
In Florida's Dade County, homes are being built to withstand winds of up to 150 miles per hour -- reportedly at an additional cost of just 3 percent over conventional construction.
Following the 1993 epidemic of forest fires in southern California which destroyed 1,100 buildings, tile roofs and adobe or stucco walls are replacing wood siding and roofs, and roof sprinklers are in demand.

Under federal law, governors are supposed to make formal requests of a president for disaster aid. But there are reports that White House assistants call governors to prod them into making the requests. About 2,000 gubernatorial requests for federal aid have been made since 1953. More than 600 of the requests were turned down, with Presidents Carter and Reagan being the toughest to get a request past. Easiest to satisfy: Presidents Bush and Clinton.

Source: J. Taylor Buckley, "Aid and Insurance Help, But the Victims Pay a Lot," USA Today, September 6, 1996.

OPIC IS CORPORATE WELFARE

Unless Congress reauthorizes it by the end of this month, the Overseas Private Investment Corporation (OPIC) will have to shut its doors. Free market economists and others say that is a consummation devoutly to be wished.

OPIC, created 25 years ago, insures U.S. investments against the risk of nationalization finances the projects and guarantees loans to U.S. firms pursuing private profits in developing economies.

A bill which just failed in Congress would have cost taxpayers $45 billion for a huge expansion of OPIC's authority to issue insurance and loan guarantees.
Political risk insurance rose last year to $8.6 billion, project finance ate up $1.8 billion and investment funding cost $1.4 billion.

OPIC's supporters argue that he agency should be kept because it pays for itself. But if OPIC's "profits" really come from the economic merits of the projects it takes on, critics contend, then it should stop crowding out private insurance and investment companies from that line of business. In fact, critics argue, OPIC's profits are simply the result of its power to coerce taxpayer dollars.

The risks to American capital are substantially greater in countries with poor economic policies and resistance to reform. Critics assert that funneling money into such areas is not only risky business, but poor international politics -- allowing these countries to coast along without making efforts to reform.

Source: Perspective, "Bailing Out Risk-Takers," Investor's Business Daily, September 16, 1996.

FEMA PLOWS AHEAD

The Federal Emergency Management Agency is in the news again, due to a series of natural disasters. But the agency is not the godsend it pretends to be, according to some observers. They say it is more like a check-writing machine.

A FEMA Inspector General report last year concluded that its Disaster Relief Fund could not be audited "because the systems, records and lack of controls made the Fund unauditable."
The report went on to note that "many accountants and analysts did not know what their jobs entailed, and questioned their own value to the operation."

Critics cite the fact that snowfalls have now become "major disasters." The Agency's director told the Senate that "disasters are very political events as well." So far this year, President Clinton has sent federal aid to 16 states hit by snow -- implying that state and local governments are inherently incapable of plowing the streets.

The effect of aid can be perverse. One Connecticut town lowered its snow removal budget for next winter on the assumption the federal government would help it shovel its snow.

Since early 1993, the White House has delivered over $25 billion in disaster aid, over $7 billion of it from FEMA.

Source: James Bovard (Competitive Enterprise Institute), "The FEMA Snow Job," Investor's Business Daily, September 17, 1996.

CORPORATE WELFARE NOT DEAD YET

Although the House last week rejected doubling the funding authority of the Overseas Private Investment Corporation, its supporters are pleading for another $32 million to keep it going.

OPIC insures multimillion dollar U.S. corporations against the risks of overseas investments and provides project financing and loans to companies investing in poor countries. Critics categorize them as loans that shouldn't be made in the first place -- loans that can't meet the test of the market.

The agency's projects have included $6 million to insure a Mongolian camel-hair processing plant and $200 million for a coal-fired electric plant in Indonesia.
It insures Citibank for losses up to $200 million in its Brazil operations, and Union Carbide for $200 million in Kuwait.
Its funding authority totaled $23 billion last year.

Critics say that many countries OPIC ventures into have such shoddy and risky economic histories that local investors can't get their own money out of the country fast enough. OPIC's investment funds commit American taxpayers to projects private risk insurers wouldn't even touch.

Source: Editorial, "Trim Overseas Corporate Pork," Investor's Business Daily, September 20, 1996.
NEW BUDGET LAW NEEDED

The Gramm-Rudman act passed in 1985 required Congress to balance the budget by 1991. It set targets for reducing the budget deficit and set up automatic spending cuts, called sequestration, to reduce the deficit to mandated levels if Congress overspent.

Critics charge that the act was a dismal failure because Congress kept exceeding the deficit reduction targets by an average of about $30 billion per year. But some budget experts say it was repealed by pro-spending forces because it was working too well.

Compared to 1985 Congressional Budget Office estimates of future deficits without the budget law, the actual 1989 federal budget deficit was about $100 billion less than expected.
The deficit fell from 6 percent of gross domestic product to 3 percent under Gramm-Rudman.
The deficit fell because the growth of federal spending was trimmed from an annual growth rate of 8.7 percent in the five years before the act to only 3.2 percent in the five years the act was in effect.
Even entitlement spending was curtailed under Gramm-Rudman to a 5 percent annual growth rate.

Sen. Phil Gramm (R-Texas) and House Majority Leader Dick Armey (R-Texas) have introduced legislation to restore many of the features of Gramm-Rudman repealed by past Congresses, including deficit reduction targets that, if missed, would trigger automatic across-the-board spending cuts.

Such a new budget law would make it possible to achieve a balanced budget by 2002, as outlined in the House Budget Resolution last year.

Source: Stephen Moore, "Seven Reforms to Balance the Budget," Cato Policy Report, July/August 1996, Cato Institute, 1000 Massachusetts Avenue, NW, Washington, DC 20001, (202) 842-0200.

DEFENSE SPENDING TUG-OF-WAR

Capitol Hill observers say the Clinton administration is sending conflicting signals on defense expenditures. While it has sought to cut $3 billion from Defense appropriations, it is committing military forces to costly programs and ventures.

Defense Secretary William Perry has proposed a new $300 million dollar program to protect American forces abroad from terrorism -- an amount he predicts will grow into the billions.
U.S. military initiatives in Iraq are adding between $200 million and $250 million in short-term operating costs.
The Pentagon is reported to be short by at least $2.5 billion for fiscal year 1996-97 operations in Bosnia.

On top of this, the General Accounting Office estimates that the administration would need to add some $30 billion per year just to fund a force that is too small to carry out the stated National Security Strategy of fighting and winning two regional wars at the same time.

While the military has shrunk by some 40 percent since the end of the Cold War, overseas troop deployment requirements for the average soldier and airman have increased by an estimated 300 percent to 400 percent -- leading to personnel "burnout." Re-enlistment rates are down. Divorce rates are up.

Noting that funding for new and replacement weapon systems has declined by some 70 percent in the last ten years, the service chiefs asked Congress this spring to add $20 billion to the White House's procurement requests.

Source: John Hillen (Heritage Foundation), "Having It Both Ways on Defense," Investor's Business Daily, September 25, 1996.

DEFENSE SPENDING TUG-OF-WAR

Capitol Hill observers say the Clinton administration is sending conflicting signals on defense expenditures. While it has sought to cut $3 billion from Defense appropriations, it is committing military forces to costly programs and ventures.

Defense Secretary William Perry has proposed a new $300 million dollar program to protect American forces abroad from terrorism -- an amount he predicts will grow into the billions.
U.S. military initiatives in Iraq are adding between $200 million and $250 million in short-term operating costs.
The Pentagon is reported to be short by at least $2.5 billion for fiscal year 1996-97 operations in Bosnia.

On top of this, the General Accounting Office estimates that the administration would need to add some $30 billion per year just to fund a force that is too small to carry out the stated National Security Strategy of fighting and winning two regional wars at the same time.

While the military has shrunk by some 40 percent since the end of the Cold War, overseas troop deployment requirements for the average soldier and airman have increased by an estimated 300 percent to 400 percent -- leading to personnel "burnout." Re-enlistment rates are down. Divorce rates are up.

Noting that funding for new and replacement weapon systems has declined by some 70 percent in the last ten years, the service chiefs asked Congress this spring to add $20 billion to the White House's procurement requests.

Source: John Hillen (Heritage Foundation), "Having It Both Ways on Defense," Investor's Business Daily, September 25, 1996.

PILING ON DEBT AT THE SBA

The Small Business Administration's loan-guarantee programs are once again facing heavy losses.

The default rate on the main guarantee program, called 7(a) is expected to be 17 percent in the fiscal year ending September 30, 1997, according to an SBA review.
This program is expected to back $8 billion in lending next year, as part of the SBA's overall $10 billion loan guarantee programs.
Estimated program losses over the past four years exceeded the reserves established to cover them -- which triggered an automatic congressional appropriation of more than $250 million earlier this year.
Losses in fiscal 1997 are expected to require an additional appropriation of more than $84 million and lead to higher fees for lenders and borrowers.

One study found that SBA takes an average of 18 months to foreclose on borrowers who have stopped repaying their loans.

A recent notice to bankers served by the SBA's Los Angeles office said, "All lenders are reminded that meeting minority lending goals is one of the several important factors" in retaining certification as an SBA lender. Critics, however, note that minority lending is not a requirement to participate in the 7(a) program.

Source: Michael Selz, "SBA Load-Guarantee Programs Again Face Big Losses," Wall Street Journal, September 24, 1996.

DRUG STUDY CRITISIZES CLINTON POLICIES

Some drug policy specialists charge a Pentagon-funded drug study showing interdiction cuts down usage is being suppressed by Clinton administration officials because it is at variance with the President's policies. Clinton prefers funding addict treatment, rather than trying to cut down on the flow of illegal drugs into the country.

The Institute for Defense Analysis study concludes that interdiction -- seizing and destroying illegal drugs before they make it into the U.S. -- "is a cost-effective operational strategy for increasing cocaine prices, and thereby reducing cocaine use in the United States."
It estimates that "the cost of effecting a 1 percent reduction in demand via source zone production denial in 1995 was roughly $8 million per year."
This finding differs widely from figures developed in two earlier studies conducted by the Rand Corporation, which found the cost of a 1 percent drop to be $780 million.
Clinton used the Rand studies to support a "controlled shift" of anti-drug money and manpower from drug interdiction to treatment.

As part of this policy:

Clinton cut the drug office staff by more than 80 percent.
Military resources for stopping traffickers in transit were cut almost in half by 1995 from $504.5 million in fiscal 1992.
Coast Guard interdiction funding dropped almost one-third from $443.9 million in 1992.
Meanwhile, Clinton increased treatment spending by 21.5 percent.

The General Accounting Office warned the administration earlier of the need to restore assets to the interdiction effort, recommending a return to 1992-93 levels of effort. The GAO said that due to the decline in interdiction efforts, the Caribbean is becoming a major transit zone for cocaine again.

Clinton's drug czar, Barry McCaffrey, is under fire for withholding the politically embarrassing study. Only one dozen, control-numbered copies are in circulation.

Source: Matthew Robinson, "The Drug Study You'll Never See," Investor's Business Daily, September 27, 1996.

LINKING TAX RATES WITH GOVERNMENT SPENDING

With polls showing that voters want smaller government as well as tax relief, some Republican political strategists are advising presidential candidate Bob dole to link tax cuts to reduced federal spending. They argue that the cuts themselves will force government downsizing.

When President Reagan lowered the top personal tax rate from 70 percent to 50 percent in 1982, and then to 28 percent in 1988-89, federal spending slowed markedly.
During this period, entitlement programs expanded by a mere 2 percent at an inflation-adjusted annual rate, and their share of gross domestic product declined from 11.6 percent to 9.8 percent.
Nondefense discretionary spending increased at a paltry 0.5 percent real annual rate, while its GDP share dropped from 4 percent to 3.1 percent.
Strong 4 percent per year economic growth reduced the demand for federal programs.

So tax cuts successfully pressured government to curb spending.

By contrast, two major tax increases under Presidents Bush (1990) and Clinton (1993) financed significantly higher domestic spending.

Since 1990, entitlement spending has grown at a 5.7 percent inflation-adjusted annual rate, rising from 10 percent to 12 percent of GDP.
Domestic discretionary spending has accelerated at a 4.2 percent annual rate of increase, rising from 3.1 percent to 3.5 percent of GDP.
A sluggish 2 percent annual growth rate has increased economic anxiety and increased the demand for federal assistance.

The President's 1997 budget contains 193 new programs that are estimated to cost $180 billion more by 2002 -- necessitating tax increases. A recent Money magazine interview revealed Mr. Clinton's preference for expanded government: income redistribution, opposition to Social Security privatization and opposition to tax reform.

Source: Lawrence Kudlow (Laffer, Canto & Associates), "Cut Taxes, Starve the Beast," Wall Street Journal, September 30, 1996.

REINVENTING GOVERNMENT JOB CUTS

One of the chief goals of Vice President Al Gore's National Performance Review, begun in 1993, was to "cut 252,000 government jobs -- especially administrative jobs that do not serve people directly -- in five years." Federal employment has been reduced by nearly 200,000 jobs; but some analysts question whether this the result of "reinventing government?"

Not counting the U.S. Postal Service, the Office of Management and Budget says that:

Federal executive branch civilian employment (in full-time equivalents) in fiscal year 1992 was 2,169,000 and in 1995 it was 1,970,000 -- showing that 199,000 jobs have been cut.
But most of the cuts were made in civilian employment at the Defense Department , which fell from 973,000 in fiscal year 1992 to 822,000 in 1995 -- for a total of 151,000 jobs.
Also included in the reduction total are 9,500 positions eliminated when the Resolution Trust Corporation went out of business at the end of 1995.

Critics point out that the downsizing of the Defense Department is a result of the end of the Cold War and reduction in military expenditures -- not more efficient civilian programs. The RTC went out of business when it finished bailing out financial institutions. Thus, if all the remaining reduction in federal employment is credited to the National Performance Review, the actual net effect has been a cut of about 38,500 employees.

Source: Benjamin Zycher, "'Reinventing Government' and Federal Employment," Jobs & Capital, Spring 1996, Milkin Institute for Job & Capital Formation, 1250 Fourth Street, Second Floor, Santa Monica, CA 90401, (310) 998-2600.