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R e s e a r c h B ejpo2r& m erc& May 17,1974 Continued heavy spending by state and local governments has helped give the economy a lift during the recent business slowdown. These governments purchased $185 bil lion (annual rate) of goods and ser vices in the first quarter of the year, and thus kept their spending in step with the 13-percent increase re corded in 1973. At the same time, states and municipalities as a group remained in the strongest fiscal po sition of the past generation, al though many large cities continued in difficult financial straits. This sit uation has helped make it possible for many states, for the second straight year, to reduce taxes instead of increasing them. State-local spending almost tripled over the past decade— far exceeding the growth rate of the national economy, which showed a doubling of current-dollar CNP over the same time-span. Most of the differential was due to the much faster increase of employment at the state houses and city halls, which rose 65 percent over the decade to 11.3 million, or almost double the pace of the over all economy. In further contrast, Federal employment increased only 11 percent during this period, and most of that occurred prior to 1967. This ten-year record of growth has not been costless. It has been built upon heavy borrowings in the credit markets, plus very large tax in creases— on a per capita basis, a tripling of income taxes and a dou bling of sales and property taxes within the decade. This has led to1 1 Digitized for FR A SE R mounting demands for relief on the part of hard-pressed taxpayers, especially in fast-growing areas of the country, which suggests that part of the widespread anti-growth sentiment may reflect a disillusion ment with the popular belief that economic growth, by broadening the tax base, will make possible a reduction in taxes. Strong fiscal position In recent years, the fiscal position of most states and municipalities has improved considerably, making it possible in many cases to respond favorably to pleas for tax relief. After a quarter-century of very small surpluses and deficits— rarely ex ceeding $1.5 billion— the aggregate state-local surplus soared to $13.1 billion in 1972 and $10.5 billion in 1973. Much, but not all, of this im provement was due to the introduc tion of the Federal revenue-sharing program. The largest surpluses coin cided with the receipt of revenue sharing funds, but the improvement had already started, as can be seen from the fact that the state-local sector recorded a $7.0-billion sur plus (annual rate) in the pre-grant period of 1971-72. Federal grants-in-aid in the aggre gate quadrupled over the past dec ade, reaching $40.9 billion in 1973, or more than one-fifth of total state-local government receipts. Most of the growth occurred in the early 1970's, with heavy Federal funding for revenue sharing, at the expense of direct support for a number of separate Federally(continued on page 2) F e d e r a l R e s e r v e Raiak © ^ IF Sam Frameke® Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. directed programs. Altogether, Con gress appropriated some $30 billion for general revenue sharing for the 1972-76 period, and about $11 bil lion of the total had been distributed as of last January. (Under the law, states receive one-third of the funds and local governments receive the rest). To date, state recipients have utilized about two-thirds of their grant money for educational pur poses, while municipal governments have allocated a like proportion of thejr funds for public safety. The improvement in public finances which occurred in the pre-revenueshe(ring period was due in part to the substantial tax increases im posed during the fiscal crisis of the 1960's. Another cause for improve ment was the deceleration in spend ing: for the largest and (until recently) fastest-growing govern mental activity, public education. The postwar baby boom has by now worked its way out of school and into the labor force, and the need for new teachers and expensive fa cilities consequently has tapered off. Inflation and other forces Inflation itself has helped boost gov ernmental revenues, reflecting the increasing state-local reliance on2 2 Digitized for FR A SE R sales taxes and (in particular) pro gressive income taxes. (Income taxes now account for about 30 per cent of all state-local tax revenues.) As prices and nominal incomes rise and income recipients move into higher tax brackets, the flow of tax revenues into public coffers rises disproportionately. Still, inflation is a two-edged sword, since it has also pushed up the cost of the goods and services purchased by all types of government. The recent business slowdown has begun to affect state-local financing, helping to account for the reduction in their combined surplus. Receipts from sales taxes (a major revenue source) have proven vulnerable to the decline in consumer purchases of durable goods and the slowdown in other consumer purchases. Rising unemployment, while modest to date, has meanwhile necessitated larger governmental disburse ments for unemployment compensation. Another reason for a declining sur plus is the current emphasis on tax reduction at the state level. State governments as a group initiated a statutory reduction of roughly $500 million annually in 1973, and a sim ilar revenue effect may develop from this year's legislative deliber ations. The early-1974 tax-cut mood seemed to reflect continuing opti- mism regarding state finances, rein forced perhaps by the political popularity of tax reductions in an election year. This year as last, most proposals have concentrated on tax relief for individuals, notably in the form of reductions in general sales taxes and income taxes— for exam ple, by exempting food and other essentials from sales taxation. Heavy borrowing Despite their strong fiscal position, state and local governments relied heavily on borrowing during the early 1970's. From an already high 1970 level, the borrowing pace jumped 38 percent in 1971 to a rec ord $25.0 billion, and has remained near that level ever since. Munic ipal-bond activity in the past year or so has been concentrated in housing and utility issues, while educational and highway bond issues have fallen considerably. Nonetheless, state-local financial planning may suffer this year from the recent weakness in the munibond market, which in the past two months has led to a rise in yields (and fall in prices) approaching the record levels of four years ago. One major cause of the slump has been the lack of commercial-bank buying support for the market. The banks, which for more than a decade were the heaviest purchasers of munic ipals, have largely withdrawn from 3 Digitized for FR A SE R the market because of their need for funds to meet surging business-loan demand. Casualty-insurance firms and other yield-conscious traders also have been putting fewer dollars than usual into bond purchases. If state and local governments should again encounter difficulties in meeting their financial needs, we may see renewed interest in support for this sector through such entities as a National Development Bank. The Bank would guarantee as well as purchase municipal obligations, with funds obtained either through Congressional appropriations or through the sale of its own obliga tions to the Treasury or the general public. This approach would be de signed to help smaller governmental units enjoy the same market stand ing as larger states and cities. Critics of this proposal point out that Development Bank openmarket borrowings in support of state-local projects would only tend to push interest rates upward. In addition, they claim that such bor rowings would only reallocate— not increase—the total supply of loan able funds, and thereby reduce the amount of funds available for other potential borrowers. Verle Johnston uojSuiqseyw • qein • uoSdJO • epeA^N • oi|ep| iieMEH • eiujojjje:) • euozuy • e>|$e|V (D osootsm ones ’ p w m | p g jR © p © t j[ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Loans (gross) adjusted and investments* Loans gross adjusted— Securities loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other Securities Deposits (less cash items)— total* Demand deposits adjusted U.S. Government deposits Time deposits— total* Savings Other time I.P.C. State and political subdivisions (Large negotiable CD's) Weekly Averages of Daily Figures Amount Outstanding 5 /1 /7 4 Change from year ago Dollar Percent + + + + + + + 4+ + + + 82,809 64,240 1,130 23,344 18,939 9,224 5,422 13,147 78,532 21,456 1,395 54,444 17,858 26,427 7,476 13,528 Change from 4 /2 4 /7 4 + 9,511 + 8,889 - 165 + 3,068 + 2,999 + 963 - 946 + 1,568 + 7,210 + 982 + 37 + 6,381 242 + 6,972 - 441 + 4,829 - 404 707 84 189 43 35 344 41 307 515 731 2 58 49 53 7 + + + + + + + + + + + + 12.98 16.06 12.74 15.13 18.81 11.66 14.86 13.54 10.11 4.80 2.72 13.28 1.34 35.84 5.57 55.51 Week ended Week ended 5/1/74 4/24/74 Comparable year-ago period 37 134 97 45 379 334 65 296 -231 + 2,152 + 433 125 + 57 Member Bank Reserve Position Excess Reserves Borrowings Net free ( + ) / Net borrowed ( - ) - - Federal Funds— Seven Large Banks Interbank Federal funds transactions Net purchases ( + ) / Net sales ( - ) Transactions: U.S. securities dealers Net loans ( + ) / Net borrowings ( —) + 1,341 + 207 + * Includes items not shown separately. Information on this and other publications can be obtained by calling or writing the Administrative Services Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, California 94120. Phone (415) 397-1137. Digitized for FR A SE R
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