A `no tears' prediction on how budget deficit could evaporate by '95

ECONOMIST Michael W. Keran doubts that Congress will raise taxes next year. In fact, he predicts the federal budget deficit will disappear by 1995 as long as Washington does nothing new in the tax and revenue area. Now that kind of forecast takes guts.

In Washington, economists and others in the think-tank and trade-association establishment are pretty unified in their view that the new president - no matter what he said about the ``dreaded T-word'' during his campaign - must make a reduction in the deficit his first priority.

Otherwise, the standard argument goes, foreign central bankers, who financed the deficit in 1987 and so far this year, will withdraw from that role. Foreign private institutions will also be reluctant to put more money in the United States. Then, these analysts continue, the US economy will face a hard landing. The exchange rate of the dollar will plunge, interest rates will rise, and the nation will suffer simultaneous inflation and recession.

But Dr. Keran, chief economist at the Prudential Insurance Company of America, doubts that foreigners will dump dollars so grandly. And he doesn't mind being out of step. Last year, when most economists predicted slow growth or recession in the first half of this year, Keran forecast a robust economy. He proved correct. The economy grew at about a 4 percent annual rate.

As for the budget, Keran now projects a deficit for the fiscal year ending Sept. 30 of about $150 billion. That's about the same as it was in fiscal 1987. The deficit for the first three quarters of fiscal 1988, published Friday, shows he is not far off. The deficit was running about $2.36 billion below what it was for the first nine months of fiscal 1987.

Because he expects approximately zero growth - perhaps even a modest recession - in the first half of next year, Keran figures the deficit in fiscal 1989 will grow to $165 billion.

From a political standpoint, a recession early in a presidential term is ideal timing. It weakens any inflationary tendencies. And most voters will have forgotten the economic damage by the next election. That expected slump, though, will make it difficult for the new government to raise taxes, lest this might worsen conditions, Keran notes.

Then, assuming Congress keeps defense spending flat in real terms and does not permit an acceleration in civilian expenditures, the deficit will drop to $95 billion in fiscal 1990 as the economy snaps back. The deficit will gradually shrink to zero by 1995.

This progress, he explains, will result partly from a growing surplus in the social security trust fund trimming the unified budget deficit. Also, he says, the Tax Reform Act of 1986 has proved to be a modest ``revenue enhancer.'' The tax cuts have tended to boost economic activity.

As investors become aware of the better budget picture, interest rates on bonds will start to drop about half a percent per year, he predicts.

``Things will look pretty good,'' says Keran.

Wall Street economist Sam Nakagama sees another favorable development for the deficit. He expects Soviet leader Mikhail Gorbachev to push aggressively for mutual reductions in conventional forces, especially in Central Europe. Since the US spends about $150 billion a year on its NATO forces, this should make it easier to meet deficit-reduction goals beginning next year.

``In effect,'' he says, ``we could get deficit reduction without tears or big tax hikes.''