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October 25,1985

Of Mice and Men
After months of painful deliberation, the House
and Senate on August 1 adopted S. Concurrent
Resolution 92 expressing their nominal agreement
on a budget for fiscal year (FY) 1986 and spending
targets for the following two years. If implemented, the targets ostensibly would reduce
spending over the next three years by $276 billion;
that is, aggregate outlays (as distinguished from
spending authority) would be $276 billion less
than if no cuts are made. However, the term "cuts"
is somewhat imprecise; while various individual
programs are targeted foractualreductions, total
spending (for 1986-88) at a prospective level of
about $3.1 trillion would still exceed spending during the last three years (FY 1983-85) by almost
$500 billion.
It also would be accompanied by additional
deficits totaling about $440 billion, some $50 billion less than the deficits projected for this period
by the President in his budget message last February. Nevertheless, the Congressional Budget Office
(CBO) believes the magnitude of the projected
deficits through FY 1988 has been underestimated
by about $40 billion. Moreover, following adoption
of the budget resolution, Senate Majority Leader
Robert Dole (R-Kansas) conceded that "We really
haven't cut Federal spending (and) reduced the
deficit that much... and the deficit will really be
much larger." House Budget Committee Chairman
William Gray III (D-PA) declared that "savings"
over the next three years probably would be about
$76 billion less than estimated and that an economic crisis probably would have to occur before
the Congress and the Administration would consider tax increases or cuts in Social Security.
For his part, recently resigned director of the Office
of Management and the Budget (OMB), David
Stockman, characterized the budget resolution as a
"limp rag," and, in remarkably blunt comments,
recently asserted that "we have increasingly
resorted to squaring the circle with accounting
gimmicks, evasions and half truths and downright
dishonesty in our budget numbers, debate and

This Letterreviews the changing dimensions and
structure of the budget over the last five years,
including the Administration's initial game plan and
the more recent (1983) recommendations of the
Grace Commission (The President's Private Sector
Survey on Cost Control). A future Letterwill discuss current Congressional efforts such as the
recent Senate passed and White House endorsed
Gramm-Rudman proposal to reduce the deficit-to zero by 1991.

Through the looking glass
In July, 1981, the Vice Chairman of the Congressional Joint Economic Committee issued a study
which, he noted, "demonstrates that the Reagan
(Kemp-Roth) tax cuts will produce more than
enough savings to finance any short-term increase
in the budget deficit." Notwithstanding a prospective $496 billion loss of revenues as aresult of a cut
in tax rates and other tax reductions, the new Administration's "Program for Economic Recovery"
estimated that total revenues, bolstered by an
expanding economy (real growth was estimated to
average 4.5 percent a year), even with tax cuts,
would rise by about $250 billion from FY 1981
through FY 1985, surpassing a $190 billion risein
expenditures and resulting in a budget surplus of
$7 billion in 1985. Without implementation of the
new program, total spending was projected to
reach $911 billion by FY 1985 and receipts $1,033
billion, resulting in a budget surplus of $122 billion
- a prospect which the Administration viewed as
unacceptable because of the increase which it
would entail (from 21.4 percent to 23.5 percent) in
the government's share of GNP.
But as Robert Burns noted 200 years ago (he may
have been struggling with his household accounts
at the time), "The best laid schemes 0' mice and
men gang aft a gley; an' lea'e us nought but grief
and pain for promis'd joy./I According to the recent
mid-year (August) estimates of the OMB, FY 1985
will close in October with receipts of $741 billfon,
outlays of $951 billion (24 percent of GNP) and a
deficit of $210 billion, raising the total of deficits
incurred since 1981 to $734 billion. In the process,

the outstanding debt held by the public has more
than doubled. The larger than expected net rise in
spending over the period ($320 billion) clearly has
been a significant factor contributing to the soaring
deficits. However, so has a $435 billion overall loss
in revenues from the 1981 tax cuts, even though
the net impact of the latter has been modified by
$125 billion in new funds derived from various
"revenue enhancements" enacted in 1982-1984 to
help stem the rising deficits.
In addition, as the CBO has noted, the chronic propensity to overestimate revenues and underestimate spending and deficits is attributable to
excessively optimistic assumptions about the real
growth of the economy, which the Administration
has estimated at about a steady 4 percent per

The budget resolution adopted by the Congress on
August 1, while actually fairly close to the Administration's budget in terms of its overall spending and
deficit magnitude, differs significantly from the Administration's proposals in various particulars.
White House Chief of Staff and former Treasury
Secretary Donald Regan, for example, stated that
Congress cut "too much in defense and not
enough in non-defense," and that the Administration would concentrate more in obtaining cuts in
domestic programs in the FY 1987 budget (to be
submitted next February). These programs
presumably include some twenty whose elimination the Administration recommended earlier this
year but which the Congress (except for General
Revenue Sharing - about $5 billion in FY 1985)
thus far has refused to approve. Among them are
Amtrak and Conrail subsidies, the Small Business
Administration, general revenue sharing, the Job
Corps, national employment and training programs, and urban mass transit.
On balance, the Congress' August budget resolution and spending targets contemplate about a
$20 billion (2 percent) net rise in total spending in
FY 1986 to $968 billion, and, including FY 1986, a
$127 billion (13 percent) increase to $1,073 billion
in FY 1988 - about $20 billion less than proposed
by the Administration. In setting this target, the
Congress shaved about $110 billion off the Administration's proposed level of defense spending during the three year period to $856 billion. However,
at this' level, military outlays would still exceed

those of the last three years by $165 billion. By
1988, when defense spending will reach a $304
billion annual rate, it would account for 28 percent
of total budget outlays. In "real" terms, that is, after
allowance for inflation (estimated by the Administration at about 121/2 percent over the period),
defense spending would register a net increase of
8 percent.
In the area of health and income support (Social
Security, Medicare, food and nutrition, housing
assistance, unemployment compensation and
general retirement and disability programs) total
spending is targeted to rise by about $61 billion
(15 percent) to a $479 billion annual rate in
FY 1988, about $10 billion higher than proposed
by the Administration and representing 44 percent
of total budget outlays. In real terms, spending
would increase by a nominal 2 percent. Interest
outlays in support of servicing the rising debt are
projected to rise by as much as $20 billion (to $150
billion) by 1988, and all other expenditures (net of
offsetting receipts) to decline by about $10 billion
to $140 billion in 1988.
This "residual" category of programs runs the
gamut from international affairs to science, energy,
transportation, agriculture, natural resources and
the environment, education, training, employment
and social services, community and regional
development, and community and housing credit.
In recent years, they have been a major focus of
spending cuts - including actual reductiqns as
compared with just reduced rates of increase. Between 1980 and the current fiscal year, for example, aggregate outlays for those programs rose very
slightly in current dollars (from $143 billion to $149
billion), but due to a 30 percent increase in the
price level (as measured by the GNP deflator),
registered a decline of 20 percent in real terms. In
real terms, the proposed level of aggregate spending on these programs in FY 1988 would entail a
further reduction of almost 20 percent.
However, as noted previously, the Congress
refused to terminate completely several programs
whose phase-out has been recommended by the
Administration. Fot example, agricultural price supports, targeted by the Administration for a reduction from about $20 billion this year to $8 billion
by FY 1988 (and subsequent elimination), have
been tentatively set by the Congress at $14 billion
in 1988. Partly because of its potential assistance

to American farmers, the Congress also refused to
terminate funding for the Export-Import Bank.

Grace for today?
In the face of these developments many observers
have wondered: "Whatever happened to the
recommendations of the Grace Commission?" The
Commission was established by President Reagan
in 1982 and headed by J. Peter Grace to determine
ways of reducing the costs of running the federal
government. It advanced some 2,498 proposals
aimed at reducing waste, improving management
and rectifying "structure failures" in government
programs. These recommendations, according to
its estimates, would involve savings of $424 billion
over a three-year period when finally implemented.
(In some cases, such as suggested changes and
potential savings of $58 billion in military retirement programs, full implementation would not
occur until 2001-03). A considerable number of
the recommendations, including the elimination of
various programs, already have been incorporated
into the Administration's budget proposals.
However, early in 1984, the General Accounting
Office (GAO) together with the CBO did a lengthy
analysis of some 396 of the Commission's proposals, which together account for 90 percent
($380 billion) of the Commission's estimateasavings. The report was highly laudatory of the Commission's efforts and noted that two-thirds of the
proposals it analyzed "have some merit" (including
150 which previously had been advanced by the
CBO itself, and 50 of which were in the process of
implementation). But the report also concluded
that, on balance, potential savings would be
"much smaller" than estimated by the Commission
- perhaps only one third as much.
It also noted that the bulk of estimated savings
involve recommendations that would require "sig_
nificant changes in current laws" and that the estimated savings are "much too large" to be
attributed to waste and inefficiency. The analysis
also identified a number of cases that involved
double counting, and several key recommendations that, if implemented, actually would result in
added costs. For example, making federal pay

"comparable" to that ofthe private sector could
result in a net increase in federal salary costs of
about $2 billion rather than the $11 billion in savings claimed by the Commission, inasmuch as the
differential in favor of federal pay scales which
existed in 1976, and which apparently was
assumed by the Grace Commission still to exist, no
longer prevails.
In summary, the CBO/GAO concluded that the
Commission had not found an easy solution to
resolve the problem of soaring costs and budget
deficits. Moreover, it concluded, it is questionable
whether the Commission's recommendations
could be achieved, as the Commission contends,
"without raising taxes, without weakening
America's defense buildup and without harming in
any way necessary social welfare programs."
(However, to those appalled at documented
revelations of overcharging in military procurement
programs, for example, the Commission's "assumption" that 5-71/2 percent of procurement costs san
be reduced a priori appears entirely credible.) .
On balance, the spending targets for the next three
years, embraced in Concurrent Resolution 92
adopted last August, envision an increase in total
spending in current dollars of about 12 percent,
but an increase in "real" terms of only about one
percent. In the Resolution, there is roughly an 8
percent "real" increase in defense spending and a 2
percent increase in health and income support that
are largely offset by a further substantial (20 percent) decline in outlays for a gamut of social
infrastructure programs.
In the face of prospective continued large deficits
and what many observers increasingly have
viewed as a potential crisis, the Senate, by a sybstantial majority early in October, adopted the
Gramm-Rudman proposal to reduce deficits to
zero by 1991. Together with proposals to amend
the Constitution to require a balanced budget, the
proposal, including its implications for monetary
policy, will be the subject of a future Letter.

Verle B. Johnston

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.




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~uaw~Jodaa LpJOaSa~
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities 2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances 4
Total Non-Transaction Balances6
Money Market Deposit

Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures



Change from 10/3/84












- 1,818


Period ended

Period ended




Reserve Position, All Reporting Banks
Excess Reserves (+ )jDeficiency (-)
Net free reserves (+ )jNet borrowed( -)



1 Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
3 Excludes U.s. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change