Wall Street sees Congress tempering Reagan tax cut

Wall Street is no great fan of supply-side economics. That view may be one of the reasons behind the excitement in the stock market Tuesday.

Investors love the efforts by the Reagan administration to cut federal spending. But many in the financial community are worried by the 10 percent per year cut in income taxes for three years pushed by President Reagan. They doubt it will stimulate output as much as imagined by the supply-side theorists in the government.

So, they figure, if the Reagan proposals had gone through Congress untouched, it would enlarge the federal deficit, worsen Wall Street's burden of financing national debt, and possibly add to inflation.

Comments Sam I. Nakagama, Kidder, Peabody & Co.'s top economist: "Although the Reagan administration was aiming for a 100-day 'blitzkrieg' victory on the budget-policy front, such a triumph is moving rapidly out of reach. This is probably not a bad thing for the country nor for President Reagan himself."

He continues: "As our favorite saying from George Bernard Shaw has it, 'the only thing worse than not getting what you want is to get it.' And if President Reagan were able to get what he says he wants, the results might be very unhealthy for the Republicans by 1982."

Mr. Nakagama argues that complete success for President Reagan's program would so discomfit the American people that the electorate would punish the Republicans by sweeping the Democrats back to office in 1982 and 1984.

Whatever, one encouragement for the stock market in recent days has been signs that the administration will not get all it wants in the way of tax reduction. Jay N. Woodworth, chief economist at Bankers Trust Company and a former Treasury economist, suspects that any tax cuts will not be effective until Oct. 1 at the earliest, and possibly not until Jan. 1, 1982. Moreover, he thinks Congress will not be so generous as Mr. Reagan would like. A one-shot tax cut similar to those drafted by the Senate Finance Committee last year of about $40 billion -- half on personal income taxes and half on the business side -- is more likely to emerge from the legislature, he figures.

"The heyday of the supply-siders on Capitol Hill has faded a bit," he says.

However, the President may have a surprisingly high batting average on its tax-cut proposals, Mr. Woodworth predicts.

Wall Street has not been happy about the increasing indications that the federal budget deficit will be larger than originally thought. Mr. Woodworth speaks of $70 billion to $75 billion in fiscal 1981 and doubts that the administration will reach its target for reducing the deficit in fiscal 1982 starting next October.

What people like Mr. Woodworth would prefer is the policy advocated by the chairman of the Federal Reserve Board, Paul A. Volcker. He suggests that tax cuts follow and depend on the size of spending reductions. Mr. Volcker told the House Ways and Means Committee earlier this month: "The amount of tax reduction that can be prudently undertaken is dependent on cutting back the inexorable rise in federal spending, on and off budget. The larger the spending cuts, the greater the prospects for reducing the strains in financial markets and for turning back inflation. . . ."

He continued: "Even the specific cuts proposed by the administration, large as they are, are only a kind of progress payment toward what needs to be done to bring the budget into balance in reasonably prosperous economic conditions."

Mr. Volcker's enthusiasm for tax cuts, like that of Wall Street, was much more restrained. This is "puritan economics" -- a demand for a firm monetary policy and better balance in the federal budget.

Monetarist economists support wholeheartedly the need for restraint in creating new money. One group of such economists, the Shadow Open Market Committee, last week held that the monetary policies urged by the Reagan administration might bring inflation down to a 3 percent annual rate by 1985 if the Federal Reserve System adheres to such a firm monetary strategy.

These monetarist economists get less excited about fiscal policy. However, they do believe better balance in the budget might reduce inflationary expectations and thus help bring down the rise in wages and prices and thus inflation.

Kidder, Peabody's Mr. Nakagama, who is not the Reagan administration's favorite economist, sees another problem in the proposed tax cuts. He says "it is simply not conceivable that this country can simultaneously afford a massive rearmament program and a massive tax-cut program for individuals, particularly at a time when the inflation rate is in the double-digit range."

He points out that the tax cuts won by President Kennedy in the mid-1960s were made possible by the fact that defense spending fell from 9.2 percent of gross national product in the first quarter of 1962 to 7.1 percent in the first three quarters of 1965. By the first quarter of 1967, the defense share had risen to 8.9 percent of GNP -- an increase of 1.8 percentage points.

If President Reagan has his way on arms, defense spending will rise even faster. It has already climbed from 4.8 percent of GNP in the fourth quarter of 1979 to 5.2 percent in the fourth quarter of 1980. Mr. Nakagama estimates it could climb to about 7 percent of GNP by the fourth quarter of 1984. That, he figures, could be as inflationary as the Vietnam escalation.

He concludes: "Against this background, a 27 percent individual tax cut seems like a pretty wild idea. It's not only a question of guns and butter but meat on the table and gas in the car."

As this idea sinks in, Congress may well moderate the President's rearmament program as well as his tax proposals.