How to Cut the Budget: Third of a Series LET'S GET STINGY WITH BUSINESS AND CITY HALL The federal government can cut the deficit--and promote commerce more effectively--if it stops giving billions to business and local governments for economic development. The savings in 1986: $26 billion.
By Thomas Moore RESEARCH ASSOCIATE Kate Ballen

(FORTUNE Magazine) – IN THE THICK undergrowth of federal spending, subsidies to business and state and local governments are some of the hardiest forms of plant life--and the most in need of weeding. They will have climbed from virtually nothing in 1930 to over $65 billion this year, not counting major government disbursements to the farm, defense, and health care industries. Yet the federal government simply does not have the charter, the savvy, or the money to bolster and protect all these parochial interests. Evidence continues to mount that free-market forces nurture economic development far better than the good intentions of the federal government, and that the most effective way for the government to carry out its constitutional mandate to promote commerce--as opposed to special commercial interests--is to pursue economic policies that improve the business climate. FORTUNE believes direct subsidies should be rooted out of the budget and that indirect subsidies resulting from the provision of various essential government services should be paid for by user fees. FORTUNE's overall plan for cutting the federal deficit, spelled out in this series of articles, calls for holding government spending constant in inflation-adjusted terms. If that were accomplished, the budget would move into balance in six years or so without a tax increase. FORTUNE calculates that eliminating subsidies to business and state and local governments would save $26 billion in 1986 and $154 billion through 1990. The President sounds awfully tough on subsidies in his 1986 budget, but Ron's bark is often worse than his bite. The Administration proposed cutting many of the same subsidies in past budgets and then backed away as soon as the special interests started hollering. Senate Majority Leader Robert Dole sees ominous signs in Reagan's recent harping on themes such as tax reform rather than on spending cuts. ''My biggest difficulty in getting significant cuts this year,'' Dole told FORTUNE, ''is convincing the President that the deficit is a real problem.'' Halfhearted pruners won't make much headway against such hardy perennials as the Small Business Administration and the Export-Import Bank. The SBA makes loans to small companies that ostensibly are too risky to attract venture capital or borrow from commercial banks. In practice, however, many of the loans go to mainstream businesses that have access to conventional credit. Some 77% of the SBA's borrowers in the first half of 1983 were what the Office of Management and Budget calls ''economic straphangers''--weak but ''government-wise'' businesses that come back repeatedly for more money. Small business would hardly suffer without the aid. Less than 0.2% of the more than 14 million U.S. companies that qualify as ''small'' under the SBA's convoluted industry formulas--and less than 2% of the start-up operations--got SBA help in 1983. The lending program is also one of the least cost-effective in government because of high defaults and heavy overhead (4,900 employees and 119 field offices). Killing the SBA, as the Administration proposes, would save $1.5 billion in 1986 and about $8.6 billion over the next five years. The Eximbank helps U.S. business compete internationally by extending credit on terms designed to match the export supports granted by foreign governments. Most of the money goes to foreign customers buying aircraft, locomotives, and other big-ticket items from Boeing, General Electric, General Motors, and a handful of other large companies. Benefits to the country as a whole are hard to pin down. As the Administration points out, ''The availability of subsidized credit is a negligible factor in determining the U.S. trade balance.'' Reagan wants to eliminate the agency's direct-loan program, which would save $393 million in 1986 and $8.8 billion over the next five years. The Administration would create an ''interest-matching program'' under which the Eximbank would subsidize interest rates on export loans from commercial lenders rather than make loans itself. But why offer any export subsidies at all if the only noticeable effect is on the bottom lines of a bunch of big companies? Forgoing the interest subsidies would save about $100 million in fiscal 1986.

$ Many business subsidies began as programs to ease the pain of temporary dislocations in certain industries or regions, but lived on after their reason for being had disappeared. The Rural Electrification Administration was created in 1935, when only 12% of farms had electricity. To this day it makes loans at interest rates of just 2% and 5% to hundreds of utilities, though more than 99% of farms have electricity. The REA began subsidizing telephone service to rural areas in 1949, when only 36% of farms had phones. Today 95% do. In the past ten years the interest subsidies to electric and telephone utilities have cost more than $41 billion. Many areas the utilities serve, such as five suburban Atlanta counties, have become affluent and distinctly nonrural since the Depression. THE GOVERNMENT started subsidizing training programs in the health professions in the mid-Sixties to alleviate a shortage of doctors and other health specialists. Today the problem is a glut (see Selling). By 1990, according to a study by a government advisory panel on medical education, the U.S. will have 90% more neurosurgeons than it needs, 50% more surgeons, 25% more pathologists, and 5% more family doctors. The subsidy amounts to a sort of income distribution in reverse: taxes levied on the middle class are used to subsidize the training of entrepreneurs whose incomes will put them in the upper class. The government has spent over $460 million since 1978 subsidizing airline service to small cities that might have been abandoned when the airlines were deregulated. The program gives the carriers a profit as a percentage of operating expenses, leaving them little incentive to hold down costs. In some cases the subsidy is all that keeps the airline in business. In 1983 the government paid Desert Sun Airlines $1,096 per passenger to fly the 360-mile round trip from Blythe, California, to Los Angeles. For that sum, according to the OMB, a passenger could have taken a taxi from Blythe to Las Vegas, dropped $500 at blackjack, and taken a taxi home with cash to spare.

In 1980, in response to the fuel shortages of the previous decade, the government set up the U.S. Synthetic Fuels Corp. to subsidize efforts by private companies to develop alternative energy sources. The oil glut has eliminated the last pretext for this hastily conceived boondoggle, which so far has committed $720 million to two projects. Last year the Administration worked out a deal with Congress to rescind $7.4 billion of the $14.9 billion originally authorized for Synfuels. Budget Director David Stockman, who considers the entire program a waste, says he left Synfuels alone this year only to stick to last year's deal. Phasing out the REA loans over five years, eliminating the health training and air carrier subsidies, and rescinding the unspent funds authorized for Synfuels could save $8.2 billion in 1986 and $14.3 billion over five years. GOVERNMENT functions that serve both national and special interests are a fertile area for savings. Various arms of government dredge waterways, tow boats in distress, and do research on shipbuilding that basically benefit the shipping and shipbuilding industries. The Administration has proposed, for the fifth time, to recover some of those costs by billing the beneficiaries. Other services that the government should start charging for are meat and poultry inspections, information services provided by the Geological Survey and the Bureau of Mines, NASA's research on behalf of civilian aviation, and the Department of Energy's commercial research programs. User fees that recovered the full cost of these commercial subsidies would save the government an estimated $1.9 billion in 1986 and $11 billion over five years. Ending the Postal Service's subsidy to charities, educational institutions, publishers, and direct-mail advertisers would save $981 million. More than two-thirds of the savings would come from making the nonprofits pay their way. However, the Administration has suggested keeping rates low for charities and loading the cost of their subsidy on other postal customers. The Great Society made the federal government a great revenue source for state and local governments. The Administration wants to save $3.6 billion in 1986 by killing or cutting back a bevy of programs--including Urban Development Action Grants, the Economic Development Administration, the Appalachian Regional Commission, the Farmers Home Administration's rural development programs, sewage treatment grants, and general revenue sharing. The proposed cuts have brought screams from governors and mayors, but the hard fact is that the federal government is in no position to play sugar daddy to anyone. Moreover, a lot of the money is used to finance competition among state and local governments to attract business and industry, with no net national gain. ''Much of what the government does in the name of regional economic development is really paying county X to steal jobs from county Y,'' says Donald Moran, executive associate director of the OMB. Case in point: in 1982 the Department of Housing and Urban Development agreed to give Jersey City a $40-million Urban Development Action Grant to help build a major commercial complex. Some of the private developers, who put up $160 million of their own, quite naturally started soliciting tenants across the river in Manhattan. After HUD approved a second grant for another office complex in Jersey City, New York City sued the agency. HUD froze the money and then Jersey City sued HUD. In the meantime, New York pocketed $41 million in grants for similar commercial developments. While the Administration is after wholesale cuts in most subsidies to state and local governments, it hasn't asked Congress to halt the Community Development Block Grant program, which spends much of its funds resuscitating rundown housing and stores. Instead, it wants to consolidate the program with remaining odds and ends from others and prune the overall funding 10%, to $3.1 billion. But the block grants are no different from any other local development aid and are subject to precisely the same abuses and inefficiencies. FORTUNE believes they should be eliminated as soon as projects already under way are complete. The Environmental Protection Agency has committed over $44 billion since 1972 to build or modernize sewage treatment plants. The federal assistance enticed some small communities into building bigger facilities than they could afford to maintain. Affluent areas tapped the U.S. Treasury to finance state-of-the- art treatment plants that they could and probably would have built on their own. The federal government may pump $4 billion into mass transit in 1986, but it's hard to see why. Studies by the Congressional Budget Office and economist Yale Brozen of the University of Chicago have shown that most of the operating subsidies have gone to fatten the paychecks of transit workers instead of improving service. Moreover, the availability of federal money has led, or misled, some cities to build transit systems they don't need. Decisions on mass transit--and the costs--would be better left to the cities and regions that benefit from them. THE CONGRESSIONAL Budget Office calculates that the federal government could save around $11 billion through 1990 if the Department of Transportation limited its highway construction to interstate routes of national significance and abandoned such debatable proj- ects as the controversial Westway in Manhattan (cost to taxpayers: $2 billion). DOT could save another $11 billion by letting state governments maintain highways and bridges that aren't part of the interstate system. The federal government also provides handsome subsidies to lucky regions of the country in the form of cheap electricity. Five power-marketing administrations within the Department of Energy sell power generated at 123 federal dams. Monthly bills for electric space-heating in January 1984 averaged $166 nationwide, but customers of the Bonneville Power Administration in Washington State paid as little as $35. The Administration wants to trim the losses of the power-marketing administrations by tightening the terms on loans the government makes to keep them running. The Grace Commission on government waste recommended raising their electric rates to the levels charged by other utilities. Jacking them up to normal rates would cut the deficit by $1.5 billion a year. Subsidies to business and local governments will be exceedingly difficult to purge--and probably impossible unless the President has the stomach for the fight. As Moran of OMB puts it: ''One man's cost is another man's income.'' But the air of crisis over the deficit presents Congress with the best opportunity in years. It shouldn't be lightly thrown away.