Wild Card Is Tax Reform’s Effect, Experts Agree : How Times Economists See 1987: 4 Look Up, 3 Down, 1 Isn’t at All Sure

Price increases should speed up from 1986’s oil glut-induced rate of about 1.9%, but there won’t be anything close to the double-digit inflation that ravaged the economy during the late ‘70s. Interest rates should also remain in check. And the nation’s trade deficit should finally begin shrinking as a result of the roughly 25% plunge in the value of the dollar as measured against the currencies of major trading partners.

That is the consensus of the eight members of The Times’ Board of Economists, who were polled for their views on what’s in store for consumers and businesses in 1987. But that’s about as far as the consensus goes.

The Board of Economists generally pointed in widely diverging directions--lending some truth to the old saw, that if all the economists in the world were laid end to end, they wouldn’t reach a conclusion.

Pointed Upward

Four members of the board pointed up, predicting that the sluggish economic growth that characterized 1986 will continue into 1987, perhaps with a slight uptilt toward the end of the year. Three pointed down, forecasting a recession. And one assigned equal probabilities to the economy going in each of three different directions.

The fence-sitter was Don R. Conlan, president of Capital Strategy Research Inc. of Los Angeles, who said: “The economy will either speed up, stay the same or fall into a recession.” Conlan assigned a 33.3% probability to each of the three possible outcomes.

“The only difference between my projection and the others,” added Conlan, who was chief economist for the Cost of Living Council during the Nixon Administration, “is the level of feigned certainty.”

The sharply different forecasts to some extent reflect the fact that members of The Times’ Board of Economists have been selected over the years for their varying perspectives on the economy.

The board members agreed, however, that perhaps the biggest wild card in forecasting 1987 is the Tax Reform Act of 1986, which is expected to lead to sweeping changes in the nation’s economic landscape.

Cuts Tax Rates

The new law, which went into effect Jan. 1, cuts income tax rates for businesses and individuals but does away with many tax deductions, preferences and exemptions. At the same time, the law shifts $120 billion in taxes from individuals to the nation’s corporations over the next five years. This should tend to dampen business spending on plants and equipment.

“Tax reform has spawned uncertainty, and businesses and consumers tend to sit on their hands when they are uncertain,” said A. Gary Shilling, a New York-based economic consultant.

Shilling, firmly planted in the pessimists’ camp, pegged the chance of a recession in 1987 at “better than 50-50.” He based the prediction on tax reform and on his view that consumers, who have been largely driving the nation’s 50-month-old economic expansion, will be forced to retrench.

“The consumer has been borrowing to keep up a life style he can no longer afford,” contended Shilling. “And when he throws in the towel, the jolt will be severe.”

To be sure, consumers have been on a borrowing and spending binge that seemed unsustainable even before the changes in the tax code. During the first 10 months of 1986, consumer debt climbed 12.5%, far outstripping the 6.3% growth in personal income.

Phases Out Deductions

The new tax code phases out deductions on consumer interest and eliminates the sales tax deduction, leading pessimists like Shilling to conclude that “it may be curtains for consumer spending.”

But board members who see economic growth continuing into 1987 believe that tax reform will actually boost consumer spending because the lower tax rates will result in higher paychecks.

“There’s a lot of uncertainty, but people will realize quickly that they will be getting higher take-home pay, and they will spend accordingly,” predicted panel member Michael J. Boskin, professor of economics at Stanford.

Overall, said Boskin, “I am cautiously optimistic that 1987 will be a slightly better year than 1986, with the second half stronger than the first.” He said the gross national product--the nation’s total output of goods and services--would grow at a rate of 3% “or better,” compared to about 2.5% in 1986.

Like the others who pointed up, Boskin sees the economy being helped by a reduction in the nation’s trade deficit. The weaker dollar has made U.S. goods cheaper to overseas purchasers and raised the price of many imports.

Since peaking in February, 1985, the dollar has fallen about 25% when measured against a basket of 15 foreign currencies, according to Morgan Guaranty Trust Co. When measured against the currencies of such major trading partners as Japan and West Germany, the fall is even greater: 38% against the yen and 42% against the mark.

“I expect the trade deficit to fall,” said Boskin, but he added this caveat: “If it does not, there is a threat of nasty protectionist legislation that could deteriorate into a full-blown trade war. I see that as the biggest threat to the economy.”

Forecasts Expansion

Panel member George L. Perry, a senior fellow at the Brookings Institution, a Washington research group, also forecasts that the economy will expand again in 1987 “at something like a 3% rate.”

Said Perry: “The ingredients needed for a recession don’t seem to be there.” With a continuing accommodative stance by the Federal Reserve Board, inventories under control and the prospect of an improving trade balance, he continued, “the negatives just aren’t very great.”

Perry predicted that the swing in the balance of trade could add $40 billion to the nation’s gross national product next year. “That’s the main positive thing I foresee,” he said.

Still, he cautioned that economic growth in the United States is dependent on growth overseas. “If the rest of the world were to tumble, we’d probably get pulled down, too.”

Rounding out the camp of optimists were Irwin L. Kellner, chief economist at Manufacturers Hanover bank in New York, and Lawrence R. Klein, professor of economics at the University of Pennsylvania’s Wharton School of Business and a Nobel laureate.

Kellner predicted economic growth of between 2.5% and 3% for 1987. “Superficially, it will look very similar to 1986,” Kellner said. In fact, however, 1987 will be a better year because more of the demand for U.S. output will come from overseas, due to the narrowing trade deficit.

Goods Sector Stronger

“This implies that the goods-producing segment of the economy will be relatively stronger than the service sector,” he said, and that bodes well for corporate profits. Kellner said pretax corporate profits will rise 17% in 1987, versus an 8% gain in 1986.

Klein, too, was bullish. “I expect that 1987 will be better than 1986,” he said, predicting gross national product growth of between 3% and 4%.

“Inventories are lean, the falling dollar is beginning to have its desired effect . . . and inflation remains under control,” Klein said.

Against this healthy scenario, he said, “consumers will hold their own.” He added, however, that “the biggest stimulus to the economy will come from the turnaround in the trade situation.”

While economists are almost unanimously predicting an improvement in the nation’s trade deficit and statistics occasionally have been promising, an improved trade picture remains largely elusive. The monthly merchandise trade deficit averaged $12.8 billion during the third quarter, compared to $12.1 billion in the second quarter and $12 billion in the first quarter, said Howard Murad, chief of the Commerce Department’s merchandise trade branch. And the trade deficit soared to a record $19.2 billion in November, assuring that 1986 would be the worst ever.

Pessimists on the Board of Economists--who include Shilling; David M. Gordon, professor of economics at the New School for Social Research in New York, and Robert Lekachman, professor of economics at Lehman College of City University of New York--think that even if there is improvement in the trade balance, it will be outweighed by a sluggish domestic economy. Moreover, they say that the current economic expansion, which is entering its 50th month, is getting old.

The average post-World War II economic expansion lasted 45 months, but that number is skewed by the 106-month boom that included the Vietnam War.

“The best possibility for next year is that the current rate of growth will get even more sluggish and that unemployment will rise” from its current level of 7%, Lekachman said. More likely, “the economy will slide into a recession that will be longer and deeper than what we have been used to in the post-World War II period.”

‘Dangerously High’

He based his forecast on “dangerously high” levels of debt--consumer, corporate, business and foreign. Lekachman believes that fiscal and monetary weapons traditionally used to fight recession have grown relatively impotent.

Should the economy falter, Lekachman said, the huge federal budget deficit will limit the government’s ability to provide fiscal stimulus. Meanwhile, monetary stimulus might be counterproductive as investors, scared off by the prospect of resurgent inflation, bid down the price of long-term bonds and drive up interest rates.

With the consumer nearing “exhaustion,” Lekachman said, “it is very easy to think that this economy will go very sour--not just slightly sour.”

“The Teflon has worn off the Reagan presidency in foreign affairs, and I see the same thing happening next year with the domestic economy,” he added.

Gordon at the New School for Social Research is also decidedly bearish. “There are reasonable grounds for expecting either a real recession or a period of economic stagnation,” he said.

The so-called Reagan Revolution, he said, “hasn’t done a thing to revive investment, spur productivity or help the nation’s competitive position in world trade.”

“We are living in an economy that, by the standards of the 1950s and 1960s, is limp, inertial, sluggish and imposing a lot of suffering on a lot of people,” Gordon said, and few mainstream economists or politicians are proposing remedies to the problem.

So far at least, the optimists on the Times Board of Economists have the most company among their economics colleagues and in the Reagan Administration. The Administration has forecast economic growth of 3.2% for 1987.

And Blue Chip Economic Indicators, a Sedona, Ariz., consulting company that surveys 50 economists and averages their predictions, in December released its relatively optimistic consensus forecast: The economy will grow at a rate of 2.5% in 1987, unemployment will edge downward to an average of 6.9% and inflation will climb to 3.2% as measured by the consumer price index.

Noted Manufacturers Hanover’s Kellner: “Our forecast is smack in the middle of the consensus, which is a safe place to be. If we’re wrong, we can say that everybody else was wrong, too.”