The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
NOV 6 1918
FEDERAL RESERVE BANK
OF BOST O~
BEFORE THE
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
SECOND SESSION
JULY 11, 12, 13 AND 31, 1978
Printeq for the use of the Committee on the Budget
U.S. GOVERNMENT PRINTI~G OFFICE
32--052 0
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
WASHINGTON : 1978
THE COMMITTEE ON THE BUDGET
ROBERT N. GIAIMO, Connecticut, Chairman
JIM WRIGHT, Texas
THOMAS L. ASHLEY, Ohio
ROBERT L. LEGGETT, California
PARREN J . MITCHELL, Maryland
OMAR BURLESON, Texas
LOUIS STOKES, Ohio
ELIZABETH HOLTZMAN, New York
BUTLER DERRICK, South Carolina
OTIS G. PIKE, New York
DONALD M. FRASER, Minnesota
DAVID R. OBEY, Wisconsin
WILLIAM LEHMAN, Florida
PAUL SIMON, Illinois
JOSEPH L. FISHER, Virginia
NORMAN Y. MINETA, California
JIM MATTOX, Texas
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
DELBERT L. LA TT A, Ohio
JAMES T. BROYHILL, North Carolina
BARBER B. CONABLE, JR., New York
MARJORIE S. HOLT, Maryland
JOHN H. ROUSSELOT, California
JOHN J . DUNCAN, Tennessee
CLAIR W. BURGENER, California
RALPH S. REGULA, Ohio
Executive Director
Chief Counsel
BRUCE MEREDITH , Assistant Director, Budget Priorities
NANCY TEETERS, Assistant Director, Economic Analysis
WILLIAM LILLEY III, Minority Staff Director
MACE BROIDE,
WENDELL BELEW,
(!I)
O\J
6 1918
CON
Hearings held onJuly 11, 1978 ............................................................................................................. .
July 12, 1978 ............................................................................................................. .
July 13, 1978 ............................................................................................................. .
July 31, 1978 ..................................... _...................................................................... .
Statement ofBlumenthal, Hon. W. Michael, Secretary of the Treasury ............................. .
Bolling, Hon. Richard, Chairman, Joint Economic Committee, and a Representative in Congress from the State of Missouri, accompanied by John
R. Stark, executive director, JEC; and Doug Lee, economist ..................... .
Bosworth, Barry P., Director, Council on Wage and Price Stability ............. .
Harris, Shearon, chairman; Richard Lesher, president; and Jack Carlson,
vice president and chief economist, Chamber of Commerce of the
United States ....................................................................................................... .
McIntyre, Hon. James T., Jr., Director, Office of Management and Budget,
accompanied by Bowman Cutter, Executive Associate Director for
Budget; and Carey P. Modlin, Deputy Assistant Director for Budget
Review ................................................................................................................... .
Miller, Hon. G. William, Chairman, Board of Governors, Federal Reserve
System ................................................................................................................... .
Oswald, Dr. Rudy, research director, American Federation of Labor and
Congress of Industrial Organizations, accompanied by Robert M. McGlotten, legislative representative, AFL-CIO ............................................... .
Rivlin, Dr. Alice M., DirectQr, Congressional Budget Office, accompanied by
Dr. William J. Beeman, Assistant Director, Fiscal Analysis Division; and
James L. Blum, Assistant Director, Budget Analysis Division .................. .
Schultze, Hon. Charles L., Chairman, Council of Economic Advisers .......... .
Additional information submitted for the record byBlumenthal, Hon. W. Michael:
Estimated revenues of unified budget receipts ......................................... .
Enclosed tables:
Comparison of estimated and actual unified budget receipts,
1963-68 ........................................................................................... .
Estimated revenues of unified budget receipts, 1963-68 .......... .
Prepared statement ......................................................................................... .
Bolling, Hon. Richard, table showing real GNP growth and inflation CPI in
percent ................................................................................................................... .
Bosworth, Barry P.:
Prepared statement ......................................................................................... .
Tables in statement:
Alternative measures of price inflation .................. "'···~···············
Alternative measures of employment cost ................................. .
Replies to questions by Congressman Simon ............................................. .
Chamber of Commerce of the United States, prepared statement submitted
on its behalf by Shearon Harris, chairman .................................................... .
Harris, Shearon, prepared statement submitted on behalf of the Chamber
of Commerce of the United States ................................................................... .
McIntyre, Hon. James T., Jr.:
Assessment of the First Year of Zero-Base Budgeting, from the Office
of the White House Press Secretary ........................................................ .
GeJ?-er~l ~i:vices Administration program for locating Federal facilities 1n c1t1es .................................................................................................. •·
Guidance in estimating effects of higher inflation on the budget ......... .
Prepared statement ..........................................................................................
Attached tables to statement:
Change in budget outlays, 1978 and 1979 .................................... .
Change in budget authority, 1978 and 1979 ................................ .
Proposed social security cuts ................................................................ .
Urban data task force .:.......................................................................... .
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
!III !
1
73
139
189
112
2
46
258
217
139
196
23
73
120
121
121
115
6
51
55
55
293
262
262
243
239
235
221
225
226
228
239
IV
Additional information submitted-Continued
Mattox, Hon. Jim, a Representative in Congress from the State of Texas:
"CETA: $11 Billion Boondoggle," by Ralph Kinney Bennett .................. .
Economic stability and inflation indexing of the individual income
tax .......................................................................................................... .
Miller, Hon. G. William:
Effective ways of stimulating investments ................................................ .
Evaluating cost-effectiveness of Government programs .......................... .
Prepared statement with attached charts .................................................. .
Description of charts:
·
Chart !-Current economic indicators ........................................ .
Chart 2-Measures of aggregate inflation .................................. .
Chart 3-Household borrowing ....................................... :............. .
Chart 4-Corporate finance ..........................., ............................... .
Chart 5-Interest rates ................................................................... .
Chart 6-Budget outlays as a percent of GNP .......................... .
Rivlin, Dr. Alice M.:
Prepared statement ......................................................................................... .
Tables in statement:
Ta;!~
;~~191s!~rfd79t~~~~.~~.~~.~~.~~~~.~~~.~~:.~~.~.~~
Table 2.-Federal budget totals: By fiscal years ....................... .
Full-employment budget balance (national income accounts
basis) .......................................................................... ................... .. .
Reply to question by Congressman Obey, letter dated July 18, 1978 ... .
Schultze, Hon. Charles L.:
Indexation of capital gains ............................................................................ .
President Ford's WIN program and President Carter's approach to
inflation ......................................................................................................... .
Prepared statement ......................................................................................... .
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Page
193
190
167
170
144
156
157
158
159
160
161
29
30
32
33
37
111
106
83
ECONOMIC OUTLOOK AT MID-SUMMER
TUESDAY, JULY 11, 1978
HOUSE OF REPRESENTATIVES,
COMMITTEE ON THE BUDGET,
Washington, D:C.
The committee met, pursuant to notice, at 9:45 a.m., in room 210,
Cannon House Office Building, Hon. Robert N. Giaimo, chairman
of the committee, presiding.
The CHAIRMAN. The committee will please come to order.
Today the House Budget Committee begins a series of hearings
on the economic outlook and other concerns in preparation for the
Second Budget Resolution for Fiscal Year 1979.
As you know, the second resolution will set a binding ceiling on
Federal spending and a floor on revenues. Tentatively we expect
the Budget Committee will be marking up the second resolution
early next month with consideration on the House floor expected
in the middle of August, just before the recess.
Our concern, in my view, must be the same as it was with the
First Budget Resolution for Fiscal Year 1979, which set targets for
spending and revenues. That concern is that we exercise reasonable restraint in Federal spending while providing funding for
important programs to meet human needs.
I believe that prudent spending restraints are essential if we are
to be able to reduce the Federal deficit and hold the line on
inflation.
Our witnesses today are ideally equipped to give us an information base upon which to begin fashioning the second budget resolution. They are Congressman Richard Bolling, of Missouri, chairman
of the Joint Economic Committee; Dr. Alice M. Rivlin, Director of
the Congressional Budget Office; and Barry Bosworth, Director of
the Council on Wage and Price Stability.
As for my colleague, Mr. Bolling, it is a pleasure, as always, to
have you with us. I really think that putting together this second
budget resolution at this particular time in the economic and social
history of this country is going to be something to which we are
really going to have to give our greatest efforts.
I will appreciate even more than usual your insights, your suggestions, and your advice. We know you are as concerned as we are
with the problems that confront us-high unemployment and high
inflation and high deficits and the whole matter of financing the
Federal Government. We look forward to your testimony.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(1)
2
STATEMENT OF HON. RICHARD BOLLING, CHAIRMAN, JOINT
ECONOMIC COMMITTEE, AND A REPRESENTATIVE IN CONGRESS FROM THE STATE OF MISSOURI, ACCOMPANIED BY
JOHN R. STARK, EXECUTIVE DIRECTOR, JEC; AND DOUG LEE,
ECONOMIST
Mr. BOLLING. Thank you, Mr. Chairman.
Before I begin, on my left is John Stark, the executive director of
the Joint Economic Committee; and on my right, Doug Lee, an
economist who has been most helpful to me and to the committee
in dealing with the overall problems the Joint Economic Committee confronts.
I would like to say I agree with you. I think it is going to be an
enormously difficult and interesting task for you to mark up your
second resolution.
I think we are in an extraordinarily difficult and complicated
situation economically, which impinges on the work of the Congress to a very great degree at a time when the Congress, I fear,
has not yet totally assimilated-I don't mean to suggest that is true
of this committee-but assimilated the significance of the budget
process.
We are still having a great deal of difficulty-and I don't need to
tell this to any of you-in getting some of the Members to understand what it is all about, and it is a pity that that is so, because it
makes it more difficult to do a very necessary task.
Mr. Chairman, I am pleased to be here this morning to discuss
the Second Concurrent Resolution for Fiscal Year 1979 budget.
Since the Joint Economic Committee has not completed its midyear
report, on which we are currently holding hearings, the views I
· express are my own and not necessarily those of the full committee.
First, I would like to more formally congratulate your chief
economist, Mrs. Teeters, on her nomination to the Board of Governors of the Federal Reserve System. Prior to joining your staff, she
authored or coauthored a number of papers for us, so Mrs. Teeters is
an old friend of the Joint Economic Committee, and we wish her well
in her new endeavor.
This morning, I want to direct your attention primarily to the
economic outlook. This is an area which the Joint Economic Committee monitors very closely and one where opinions seem to be
changing. As you are aware, the administration has just revised its
forecast of real growth in 1978 down from 4.7 percent, the January
forecast, to 4.1 percent, the July forecast. Similarly, the forecast for
1979 has been reduced from 4.8 to 4.3 percent.
The administration has not been alone in these downward revisions. Table 1 at the back of the presentation indicates that other
well-known forecasters have also substantially revised their predictions for both inflation and real growth.
As we think about fiscal policy for 1979, we must do so in the
context of a more pessimistic view of the outlook. Some witnesses
testifying before the Joint Economic Committee have cautioned
against the possibility of a recession or at least a "growth" recession next year. It is clear that the outlook has deteriorated in the
last 6 months.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
3
Earlier this year when the Joint Economic Committee prepared
its annual report, we noted that on a full-employment basis the
budget proposed by President Carter was relatively neutral
throughout most of 1978 and 1979. However, with the higher inflation that we have experienced, recent estimates must be revised
upward. This means that although no policy change was intended,
inflation has changed a relatively neutral policy into a mildly
restrictive one. Therefore, at the same time that the economic
outlook has been deteriorating, fiscal policy has become more restrictive. If the size of the tax cut is reduced from President Carter's original recommendation of about $25 billion to the $15 billion
now being discussed, then fiscal policy will be restraining economic
growth throughout 1979, if we are reading the tea leaves correctly.
The First Concurrent Resolution provided for outlays of $498.8
billion. With the revisions recently announced, the administration
estimates outlays at $496.6 billion. Although I am somewhat skeptical of these spending estimates because of the consistently large
downward revisions in them, I would urge you not to alter them in
any substantial way. I realize that some minor changes may be
needed for technical reasons, but I supported the general policies
outlined in the First Concurrent Resolution and continue to do so. I
do not feel that large budget reductions are appropriate at this
time. I would be doubtful that large spending increases could be
put in place in a short period of time.
The tax side of the budget is somewhat more complicated. As you
know, the First Concurrent Resolution provided for an extension of
the temporary tax reduction and a tax cut of about $15 billion to
become effective January 1, 1979. This gave a total tax cut in 1979
of about $25 billion.
Two issues have been receiving a great deal of attention both in
the press and in the congressional discussions: First, the appropriate size of the tax cut and second, the proper composition.
With respect to the size of the tax cut, I was not unhappy with
the levels set by the First Concurrent Resolution. In my judgment,
it would be a mistake to reduce the tax cut allowed by the budget
resolution Just because President Carter seems willing, or, I might
add, forced, to reduce his recommended tax cut.
If the economic situation does deteriorate next year, Congress
may need to act quickly to provide economic stimulus. In this
situation, a budget resolution that inhibited congressional action
would be very unfortunate. I recommend that the revenue levels be
maintained at roughly the same levels established in the First
Concurrent Resolution.
The second issue concerns the composition of the tax cut. The
Kemp-Roth proposal to reduce individual income taxes some 33
percent has been under discussion in recent weeks, and I have
several comments to make.
First, I think it would be a mistake to try to legislate a $98
billion tax cut 3 years in advance. It may be necessary to reduce
taxes in 1979 or 1980, but I do not feel confident enough, and I
don't really know anybody who does whose overall judgment and
track record I find first-rate, but I do not feel confident enough in
our ability to foresee the future to make this commitment today.
Even if I were sure that a tax cut would be needed, I could not
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
4
presume to know the proper amount. While I should stress the
importance of looking as far into the future as possible, the limitations of our foresight make it necessary to also maintain our flexibility.
A second comment relates to the economic response which might
be expected from such a tax cut. The authors of this bill and some
economists have claimed that the Kemp-Roth tax reductions would
produce a veritable bonanza of jobs and increased economic output.
I find this difficult to believe.
Although the Kemp-Roth proposals are frequently compared to
the Kennedy tax cuts, back in 1963-64, Walter Heller, the principal
author of those tax cuts, has told the Joint Economic Committee
that those who use the experience of 1964-65 as support for large
tax reductions today are "misreading the verdict of history." This
is the statement as Dr. Heller made it to the committee, and I am
going to supply it to the Budget Committee with some slight revisions, but I am going to read the statement that he made to us.
According to Dr. Heller:
/
Contrary to their assertion that the Kennedy-Johnson tax cut achieved its economic stimulus and consequent revenue flows "by increasing aggregate supply, by
increasing the reward to work and investment," the record is crystal clear that the
great bulk of the success of the "great tax cut" that was phased in during 1964-65
came, as expected, from its stimulus to demand, its release of some $10 billion of
consumer purchasing power and another $3 billion or so of corporate funds.
Second, the economic setting for the Kennedy tax cut was sharply different from
our setting today. The 1964 cut was injected into an economy characterized by (a)
Plenty of slack in both labor and product markets, coupled with (b) virtual price
stability-inflation averaging about 1.2 percent per year-and stable-to-falling unit
labor costs. In other words, the "aggregate supply" capacity already existed in the
form of high unemployment and low industrial operating rates, and inflation was
not a problem. So the tax cut was able to activate idle physical and human
resources without more than minimal impact on the price level.
I would like to add to that the fact that I had the opportunity to
talk to the not-yet President, but Presidential candidate Kennedy
at some length in October 1960, and while I accurately described
Dr. Heller as the principal author, because he put together the
details, the principal motivator was the President, himself.
He was far more sophisticated about economics than any President I have ever had the · privilege of dealing with. And his first
preference, interestingly enough, was for the kind of package that
President Carter offered, a package of tax reform plus tax cut.
When it became obvious that there was no way to get that through
the Congress that Saturday in 1963-64, he backed off on the tax
reform in a fashion which is not unlike the situation that we have
today.
So what I am trying to say in quoting Dr. Heller, is that we were
working then on the second choice. That tax bill was almost
worked out in 1963, and when the President was shot and Lyndon
Johnson took over, there were still a few things to deal with in the
Senate, and they were dealt with, and the tax cut that went
through was essentially the second-choice Kennedy version, and it
did have a very good effect, and I think it would have had a better
effect if it had been politically possible to put through the firstchoice Kennedy version.
Mr. DERRICK. Could I interrupt?
Mr. BOLLING. Sure.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
5
Mr. DERRICK. What was the first choice?
Mr. BOLLING. It included some tax reform, and the tax reform he
sent up I haven't looked up the details, but it would be the same
kind of things, bringing a little bit more equity to the Tax Code.
Mr. DERRICK. Thank you. Excuse me for interrupting.
Mr. BOLLING. This, of course, was not stated precisely publicly,
although there was some tax reform in the initial presentation.
Another argument used by those who support very large tax
reductions is based on the so-called Laffer curve. This is based on
the theory that the bigger the tax bite, the less incentive there is to
work, save, and invest. This lowers production, causing slower
growth, higher unemployment, and lower taxes. Those who use this
argument say that by reducing taxes, we can increase the incentive
to work and invest and thereby increase economic growth and tax
revenues.
I have not been able to find any economic evidence that supports
the Laffer curve. The Joint Economic Committee has looked for
such evidence but has not found it. Professor Laffer testified before
our committee but did not offer convincing evidence. And you may
be interested in how it came about that he testified. The committee
asked Dr. Heller, who was on a panel very recently, to comment on
Roth-Kemp, and Senator Roth is a very distinguished member of
the Joint Economic Committee. For some reason his staff did not
advise him of the circumstances that had led to that invitation,
and he talked to me and felt that he had been ill-treated, and I
said if he hadn't been advised that Dr. Heller was going to come
and comment, he was right; he hadn't been well-treated and didn't
discuss the question of whose fault it was.
He said, would it be all right if he had Laffer up, and I said it
would be fine. We had Professor Laffer up in the hearing that we
added on to one we had with Dr. Heller and a number of other
people, and Professor Laffer had every opportunity to testify.
The only hard information I have seen related to people's response to an increase in take-home pay comes from the 1960's.
Instead of working and producing more because income was higher,
people took more vacations and worked shorter hours. The evidence of history does not support the argument that taxes have
reduced economic incentive to the point that growth is inhibited.
This country still has a significantly lower tax-take, relatively
speaking, than most of the developed nations.
In summary, I have no quarrel with the overall size of the KempRoth tax cut in 1979, inasmuch as it would be about $20 billion; it
is, however, skewed in favor of individuals. But I think it would be
a mistake to try to commit future Congresses to large tax reductions, and I am skeptical of the potential benefits claimed by the
supporters of this legislation.
A final comment concerns the relationship between fiscal policy
and monetary policy. I have long been a supporter of better coordination between these two tools of economic management. Better
coordination, however, does not mean that we must compromise
our goals of economic performance. It simply means that we must
have these tools working together rather than at cross-purposes.
Recently we have seen reports that the Federal Reserve Board is
willing to exchange a somewhat smaller tax cut for a somewhat
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
6
more expansive monetary policy. Determining the policy mix is as
much a political decision as an economic one. But in the process of
making this decision, we must never forget that determining economic goals for the Nation is the business of Congress; determining
the policy mix to best reach these goals is a joint project of Congress, the administration, and the monetary authorities. In this
latter negotiating process, Congress should not be intimidated by
the positions taken by either the Federal Reserve Board or the
administration.
Let me conclude this statement by returning to the estimates
contained in the First Concurrent Resolution: Revenues of about
$448 billion, outlays of about $499 billion, and a deficit of about $51
billion. These estimates continue to appear reasonable. Given the
weaknesses which could develop in our economy next year, fiscal
policy should avoid becoming more restrictive.
Thank you for inviting me to testify. I will be delighted to try to
answer questions.
[The table referred to by Congressman Bolling follows:]
TABLE 1
[In percent]
Real GNP growth
Wharton:
Jan. 6, 1978 .................................................................................................. .
June 29, 1978 .............................................................................................. .
ORI:
Dec. 21, 1977 ............................................................................................... .
June 24, 1978 ...............................................................................................
Chase:
Jan. 20, 1978 .................................................................................................
June 22, 1978 ...............................................................................................
Administration:
Jan. 23, 1978 .................................................................................................
July 6, 1-978 ................................................................................................. .
Inflation CPI
1978
1979
1978
1979
4.9
4.2
4.9
3.7
5.4
7.2
5.6
7.9
4.5
4.0
4.1
3.4
5.8
7.0
5.5
6.3
4.3
3.7
4.2
2.8
6.1
7.0
6.1
6.4
4.7
4.8
5.9
6.1
6.4
4.1
4.3
6.8
The CHAIRMAN. Thank you very much, Congressman Bolling.
Let's talk about taxes and tax cuts and the Kemp-Roth proposal.
If I understand what you are saying, you would more or less agree
with a tax cut in the general area of about $20 billion.
Mr. BOLLING. $15 or $25 billion.
The CHAIRMAN. $15 to $20 billion?
Mr. BOLLING. $25 billion. I am going to stick with it.
The CHAIRMAN. Are we talking fiscal year or calendar year, or
doesn't it matter?
Mr. BOLLING. It does matter, in fact. But I don't think it matters
that much.
The CHAIRMAN. Let's talk fiscal year, $15 to $20 billion, with
calendar year amounts out to $20 to $25 billion. A fiscal year level
of $15 billion was recommended by this committee in its first
budget resolution. This is in the area that the Ways and Means
Committee and the Senate Finance Committee, as well as the
administration, seem to be considering.
Unfortunately, we are talking about tax cuts several months
before an election, and it is awfully difficult to address this subject
in any kind of objective fashion, but, if I understand what you are
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
7
saying, a tax cut in that range, from $15 to $20 billion, or even to
$22 billion, would not offend you very much?
Mr. BOLLING. It wouldn't offend me at all.
The CHAIRMAN. What you do object to, however, is projecting a
tax cut out into the out-years.
Mr. BOLLING. Absolutely.
The CHAIRMAN. As Kemp-Roth proposes to do and speaks of a 3year cut in the area of $90 billion?
Mr. BOLLING. We have just been through a period which proves, I
think, conclusively that we can't be that sure of what is going to
happen. It just does not make any sense to me to have a 3-year tax
cut of those proportions. I think we have to reserve our options.
The CHAIRMAN. You are right in your statement that the Fed
has been a major source in pushing for a smaller tax cut.
Can we develop a more reasonable partnership with the Fed by
trading off the size of the tax cut for a more accommodative
monetary policy by the Fed? Would that be a desirable goal? Can it
be accomplished?
Mr. BOLLING. We had Chairman Miller before the Joint Economic Committee last week, and he and I had a discussion after he
made a brief summary statement of his more formal presentation,
and we agreed on a complicated kind of interlock that is necessary
to achieve the purposes that we all adhere to with one or another
emphasis on the component parts, and his approach would essentially involve some sort of an understanding that the administration and the Congress would seek to systematically lower the deficits, that thus they would be in a position of assisting in the
problem directly of dealing with inflation, that in return for that,
but not on the basis of some kind of a hard deal, in return for that
as a conceptual approach and a gentlemen's agreement, then the
Fed would feel that it was getting help in dealing with inflation,
and it might find it reasonable to do less of the unilateral tightening up that it has the separate power to do.
Now that is a very crude representation of a rather skillfully
made presentation by a man who obviously had not only thought of
the concept but also thought of the words to express the concept.
But that is essentially what he was talking about. •
I not only think it is necessary; I not only think it is possible; I
think it is just plain flat essential. I was in on one of the old fights
that revived the Fed as a national instrument of monetary policy
coming after World War II, when it had really bowed always to
what the Treasury needed in order to finance the war, and I have
very strong feelings that the Fed should be independent, but I have
also read the books that are available, I believe, including the last
one that I know of, with regard to a very important Fed Chairman,
Marriner Eccles. It is almost an authorized biography, and it is
very clear that Chairman Eccles often disagreed with President
Roosevelt, and he often disagreed with the Congress, but he always
worked out some kind of an accommodation so that the actions of
the whole Government were coordinated so there was no conflict,
and I think that that is the kind of thing we are talking about now.
I could have just said, yes, but I think it is more complicated
than just yes.
The CHAIRMAN. Thank you very much. Mr. Mitchell.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
8
Mr. MITCHELL. Thank you very much. It is good to see you again.
Mr. BOLLING. It is good to be here.
Mr. MITCHELL. I am particularly interested in the present accommodation between the administration and the Congress and the
Federal Reserve System. I am indeed distressed by the fact that the
Feds presented the Congress with a set of targets for monetary
growth, particularly M1 and M2, and, as I recall the range was
somewhere between 4½ and 6 percent, which were subsequently
retracted.
For example, within less than 4 or 5 months after that arrangement was worked out-and, by the way, it was an arrangement
which entered into the consideration of this committee in terms of
fiscal policy, we saw the Federal Reserve beginning to exceed its
own range.
As I understand it now, the upper limit is about 8 percent of
money going out. Seemingly, this type of monetary policy directly
contravenes any fiscal policy this Congress would try to establish.
I know you are familiar with the fact that a few short weeks ago
the discount rates were raised again. Of course, this inevitably will
lead to an increase in interest rates. If you have been reading the
papers, you see where that increase is in excess of the primes and
it is adversely affecting the interest rates offered by our smaller
lending banking institutions.
So I agree with you that it is imperative that some sort of
arrangement be worked out by means of which we work in tandem
rather than having the Federal Reserve present a policy which it
purports to follow for a year and then because of some changes in
the economic system, it violates its own policy.
The net result of this violation, the net result of the present
increase in prime interest rates, is going to impact negatively on
the pitifully small efforts that we are now making to reduce unemployment.
That is a statement rather than a question. Now let me get to a
question, if I may.
In light of the predictions that our real growth rate over the
next 12 months will be around 4 percent or even less, what is your
assessment of this estimate on unemployment rates? Would you
assess that unemployment rates will remain at their prevailing
rates? Will they increase? Will it be a temporary increase? That is
the question.
Mr. BOLLING. I am supposed to be pretty outspoken, and I guess,
relatively speaking, I am, but after our experience with unemployment in the last few months, if the statistics turn out to be accurate, I am not sure I am brave enough to make any guess as to
what is going to happen. I don't know of anybody who predicted
this last drop from 6.1 to 5.7 percent. I don't know anybody who 6
months ago was going to predict we were going to come down from
wherever we were then, 6 or 7 months ago, going to come down to
5.7 percent.
I will be perfectly honest with you, Mr. Mitchell, I don't know,
and I am not sure anybody else does, whether there is some statistical error in that or we have an entirely new kind of economic
situation going on, because we don't have a growth rate that would
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
9
justify our being able to predict that substantial decrease in unemployment.
Nobody that I know of, no matter what point of view they
represent, predicted it 7 months ago; nobody predicted it a month
ago, for that 0.4 percent.
My guess is, and the guess of all the informed people that I have
talked to directly, is that it is going to have a bad effect on growth.
The lack of growth is going to have a bad effect on unemployment.
But with this incredible mix of an enormous increase in jobs, of a
relatively low productivity, of unemployment going down substantially when not expected-Mr. MITCHELL. If I have time, I would like to ask one additional
question. In terms of a real growth rate at 4 percent or less, would
you, or would you not, agree that such a growth rate can have
little or no impact on the structural unemployment in this country?
Mr. BOLLING. Absolutely.
Mr. MITCHELL. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Derrick.
Mr. DERRICK. Thank you, Mr. Chairman.
Mr. Bolling, if I interpret Mr. Miller, and the thrust of your
statement correctly, it seems to me that they are pretty much in
disagreement. As I understand Mr. Miller, he would like to see us
cut back considerably in spending and end up this year with
around a $35 billion deficit, next year, a $17 billion deficit, and as I
understand his program, a balanced budget in 1982.
He goes a step further, in a veiled threat, I suppose, maybe not
·too-veiled, and says if we don't do that, we are going to cut back
drastically on the money supply .
. -As I read your statement, you indicate that this is not a time to
cut back on programs, spending, and, as a matter of fact, you had
rather see us go toward a $25 billion tax cut.
Now, I would just like you to comment on that. You made the
comment just a few moments ago, from which I gathered that you
and Mr. Miller had some meeting of the minds.
Mr. BOLLING. In terms of what would be ideal. And you know,
before I comment on that, I think I should add that one of the real
problems in all of this is that Congress for a variety of reasons,
some good and some not so good, is a very nearly totally unpredictable partner in all of this process.
It is extraordinarily difficult to say what the Congress is going to
do if you look at it from the point of view of the administration or
the point of view of the Federal Reserve.
I guess that one of the things we need to do is figure out how to
make a treaty with the Senate on some of these economics, and I
don't say that with any disrespect.
Mr. DERRICK. Your name will go down in history along with
Henry Clay if you do that.
Mr. BOLLING. But, to answer your question, of course Mr. Miller
and I have slightly different perceptions of what the bottom line is.
I am closer to Mr. Mitchell's bottom line than I am to Mr. Miller's,
by a considerable degree.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
10
If you scratch me hard, you are going to find I am not prepared
to suffer a very substantial increase in unemployment without
taking some risks at the other end of the scale.
Now, Mr. Miller deals with that particular end of the scale, the
inflation end, and that is one of his prime functions, not his only
prime function, but it has become sort of traditionally one of the
prime functions.
I would deal, I think, with inflation if there were any way on
earth to get it through the Congress; I would deal with inflation
somewhat as the Joint Economic Committee has consistently recommended for some years, that we would have pre-price increase
notification.
First, we would have a piece of legislation that would regularize
and legitimatize jawboning. It would give the council that deals
with these matters more specific powers. As a matter of fact, I
think this is about the only way we are going to avoid a sudden
panic where the people of the country insist on direct wage and
price controls unless we have some kind of a technique for moving
in and cutting this ratchet effect.
Our friend, Mr. Fisher, has made some recommendations on this
that I am in the process of having my staff study. But we have got
· to break in.
Mr. DERRICK. For instance, United States Steel would be required
· to give 30 days' notification before any price increase. Is this the
sort of thing you are talking about?
Mr. BOLLING. That is the kind of thing. About 60 days probably.
People immediately come back and say why don't you intrude on
the collective bargaining process. That is why you don't, because it
is a collective bargaining process, and you have an opportunity to
see early what is going on and what is going to happen.
But if you once begin to move in the direction of doing something
about price; then you could come up with whatever the sensible
proposal was to do something about slowing down wage increases. I
don't think there is any question that we are going to have to face
that, too, as bitterly opposed as it may be under certain circumstances by the American labor movement.
I don't think we can tolerate the kind of situation we have when
you have a very, very serious deflation and a very high unemployment and prices don't come down and wages don't come down. I
just don't see how you can tolerate that and expect it to work. And
there may be ways that I haven't thought of that we have to use,
but we clearly are going to have to deal with inflation or we can't
deal on anything like a permanent basis with unemployment.
Mr. DERRICK. I am convinced that the business community
thinks that we are going to have a recession next year. They are
convinced of it, and as far as I can see, they are doing everything
they possibly can to make it happen. That is all I hear back home,
and businessmen regularly quote Mr. Miller to back up their statements. Not that Mr. Miller is saying that we are going to have a
recession, but he says we are not doing the things we must do to
prevent it.
I am delighted to hear there are substantial differences in your
opinions. I thank you very much.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
11
The CHAIRMAN. The time of the gentleman has expired. Mr.
Latta.
Mr. Latta. Mr. Bolling, I want to commend you for your statement. As per usual, we don't agree on everything. One thing you
have apparently overlooked when you are looking for ways to turn
down some of this inflation is to reduce Government spending.
Would you like to comment on why you leave this out?
Mr. BOLLING. I kind of leave it out now because I don't want to
encourage the tendency of this particular year. I don't have any
trouble saying I am for reducing Government spending. I think
there is an incredible amount of waste. As a matter of fact, I was
one of a minority that voted to cut some water projects. It is not
the first time I have done it. One of them is in my own State.
I think that the Congress makes itself look to be difficult when it
votes for meat ax cuts and then votes the other way on specifics. I
am for reducing spending, but I am for reducing the ones that I
think are the low-priority items that are really, if the truth must
be said-you said that we sometimes disagree, the ones that I think
ought to be reduced, and I think are low-priority items, are the
darlings of the conservatives of both parties. They are the pork
barrel programs, many of which are terribly important.
Mr. LATTA. Let me say I don't think they are terribly important.
I voted against the entire bill.
Mr. BOLLING. That is an easy way to go, and I can't disagree with
you. I can't fault you.
Mr. LATTA. Maybe we see eye-to-eye on that.
Mr. BOLLING. We see at least eye-to-eye on it if we particularize
it.
Mr. LATTA. On page 6 of your statement, you say, "The evidence
of history does not support the argument that taxes have reduced
economic incentive to the point that growth is inhibited." What
history are you talking about, the history of the United States, or
history generally?
Mr. BOLLING. I have never seen any hard evidence that what
goes on in this country has reduced incentives enough to make
people get out of an active engagement in making more money
unless they just prefer the alternative. I don't think people are
motivated only by the desire to make more. There are people, and I
have known a few of them, who suffered very ill effects of this
disease, who are multimillionaires, but greedy, and they always
want more.
But it is sad that people who make over $100,000 or $200,000 a
year can choose to pay taxes. There are a whole lot of people that
make substantially that or more, or have that kind of income, who
choose to pay taxes.
Mr. LATTA. You are more or less limiting, then, the history to the
American history. What I had in mind was Britain, for example. I
think most economists will agree, having taxed to the extent they
have, they have inhibited growth by their taxes. Wouldn't you
agree on that?
Mr. BOLLING. I think what I would have to do is put that in a
much larger context, because I think that charge is surely made,
but when you talk about the United Kingdom, you are talking
about what was the world power. Suddenly as a result of what it
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
12
did in two wars, having to totally change its way of living and its
economy, the whole nature of the British economy changed as a
result of a whole series of events, World War I and World War II,
and decolonization, and what I would fault the United Kingdom for
is a misguided attempt to maintain a grandeur that was gone and
an economic system that no longer existed, and I think in the
process of doing that, it got very badly out of skew, and I suspect
there were some people there who had a very much higher tax rate
than we, with a very much higher level of social service than we,
very much higher; that there was some disincentive. Maybe there
should have been some for some of the people involved.
Mr. LATTA. My third and last question deals with the fact that
you don't have any quarrel with Kemp-Roth as far as the 1979
fiscal year is concerned, but into the future . .
Don't you think that people generally ought to be able to plan
for more than 1 year ahead and Government should be planning
for more than 1 year ahead, and when we are talking about planning, we are looking at budget receipts that were just recently
revised by 0MB, which shows a tremendous increase in 1979 receipts of $47 billion, and then in 1980 we are going to have a $59
billion increase over and above that, and in 1981, a $73 billion
increase in receipts over and above that? Don't you think that
people should have the right or the opportunity to plan more than
1 year ahead; that maybe their government is going to give them a
tax cut?
Mr. BOLLING. I think it would be nice if people had an opportunity to plan, and I think it would be nice if everybody up here would
get together and decide that it is time that the biggest business in
the world, the U.S. Government, have an opportunity to do a little
planning, itself, and anytime you suggest that in legislative form,
you find automatic violent resistance, and I will say in both parties, and you are not going to be able to have tax cuts a year in
advance or 2 years in advance until there is a more effective way
for the Government to look down the track and decide how it is
going to relate what it does to what happens in the economy.
I don't think there is any question that we need more planning,
but the toughest place to find effective planning is at the Federal
level, and the greatest resistance to planning is at the Federal
level, and specifically in the Congress.
Mr. LATTA. I couldn't agree more.
Mr. MITCHELL [presiding]. Your time has expired. Mr. Lehman.
Mr. LEHMAN. Thank you. I just came back, as most of us did,
from talking to people in my district. I think if there was one
recurring theme, it was a general disillusionment with the Federal
Government's ability to solve problems people see at the local level,
with regard to employment or anything else. They bring to me
such things as the inability of CETA employees to get jobs in
private industry and ask whether the money is really doing the job.
In the youth employment programs, they tell me some summer
job programs are put in neighborhoods where the low-income youth
cannot even get to because of transportation problems. There are
all kinds of Federal programs that try to accomplish things but
have built-in roadblocks. Those are the kinds of problems that I
hear from the people as I get around in my district.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
13
In regard to the rollback in the capital gains tax rate, it was
strange to me that while I talked to a number of business people in
the $100,000-plus bracket, they didn't have any problem. They
didn't seem to want a rollback particularly, and some were even
uneasy with the tax rollback idea. The people who did want the tax
rollback were the retired people, who had acquired maybe $100,000
worth of securities. They felt they were locked into those securities
and they wanted some relief on capital gains so they could sell if
they needed to. This was a switch I didn't expect.
Some people questioned whether the official unemployment
figure is really valid or not, either at the 5.7 or 6.1 percent rate. I
saw a lot of people who wanted the Federal Government to. do
things for them, like put needed parks in areas of low-income
housing. But there was little demand for federally funded job programs unless they resulted in concrete evidence. People wanted to
see those parks, perhaps, or the enlargement of an airport facility,
or senior-citizen housing. People asked me for something they
could see or feel, not abstract programs.
Then, some of the people that you mentioned, that are already
making $100,000 or more, seemed to have stopped trying to make
more money. Instead, they were trying to drop down into what I
guess we're now calling the underground economy. I see this growing more and more apparent, people dropping out of the highincome, high-tax activities, and, say, renting little strips of individual stores where they can deal in cash and escape all or part of
their tax burden, or going into flea market operations, or just
getting into all kinds of rather bizarre vocations where they seem
to be able to make more money without being part of the mainstream of the economy.
·
I don't see them trying to move up, any more, whether they are
doctors or business people or whatever, but just trying to avoid the
taxes, the paperwork, the pressure of the mainstream economy.
People also tell me that in the small businesses they cannot hire
people except off book.
Now, just within the last 2 or 3 months, I have run into the
expression "off book." I didn't even know "off book" existed, but
it's big economy now. I think that is typical of what I see happening. An awful lot of people evidence their greed not by trying to
roll back taxes but by trying to avoid them, to get into an area that
is gray and no longer subject to the ability of this country to tax.
I am just giving my little speech, Mr. Bolling. You can react in
any way you want.
Mr. BOLLING. I think it's important to comment. There is nothing
mysterious about the underground economy. It's there and has
been growing. The last census in 1970 admits it probably missed 5
million people. I don't know, you pay your money and you take
your choice; you can decide what 5 million were missed and where.
But I think that figure is probably pretty good, and there is clearly
an underground economy. Some of it is probably just barely illegal,
off book in its nature.
Mr. LEHMAN. Would you yield? I met a man who rents the site
for just one of the flea markets in Miami, for just 1 day a week. He
pays $600,000 a year rent and collects at least that much by rent-
32-052 0 - 78 - 2
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
14
ing out the stalls to the flea market vendors. And nobody in that
flea market even collects sales taxes, much less pays income taxes.
Mr. BOLLING. I think you will find when you get at it that there
is one statistic that tends to respond to that whole question. I am
as concerned, and we are doing some work on trying to find out
about the underground economy, trying to find more facts, but
there is one very interesting factor, and that is that we have had
the most incredible increase in employment, listed employment, in
the last-I don't know what the right time period is-but the last
year or 2 years, that has ever happened.
Now, those are people who are above ground, and one of the
reasons-I don't want to grind my pet ax, but I have got to at some
point-one of the reasons that the Joint Economic Committee and
the Congress, by resolution, are undertaking a special study on
economic change is that we think there are a lot of unanswered
questions. This is not designed as a criticism of professional economists or anything else.
We just think that the economy has grown so big and has
changed so much and has so many variations, and you have just
begun to mention some of the more complex ones, the more complex ones are international. We have some changes; we have to
take a fresh look and try to figure out maybe why it is we can't do
a better job of projecting the future.
But sure, I think the kind of thing you have been seeing, I think
you saw it in a larger dose than I usually do when I am in my
district, and I don't know whether that is just a question of how or
where you happen to be going this trip, but I think we have all got
some of that, no matter how staid and conservative our districts
are.
Mr. MITCHELL. The .gentleman's time has expired.
Mr. LEHMAN. May he comment on the one thing about the lower
income people and retired people being more concerned about capital gains taxes?
Mr. MITCHELL. Mr. Obey, you are next; do you have any objection
to an extension of time?
Mr. SIMON. Mr. Chairman, if I may also suggest he insert in the
record, or someone insert in the record, the definition of ''off book,''
because I had to ask the chairman and Mr. Latta what "off book"
meant.
Mr. MITCHELL. It does not deal with parimutuels.
Mr. LEHMAN. Mr. Bolling, if you have the time, would you comment on the fact that retired people are more interested in the
capital gains rollback than business people are?
Mr. BOLLING. If I may say so, and maybe this is a little bit
unkind, I think there has been a very deliberate effort, as there
always used to be in housing and rent control, and a very successful effort to convince retired people that they are going to be the
real beneficiaries and that is not what the tables show. What the
tables show is that the very well off are the ones that are going to
be the major beneficiaries.
There is another factor involved. I think in the original recommendations of the Carter administration, at least the housing capital gains windfall was taken care of, and I understand that there is
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
15
a move afoot now to take care, specifically, in any tax bill, of that
kind of thing. But that is not the real target.
All the tables I have seen, the ones by the people who are for the
Steiger amendment and for the Jones amendment and the ones
that are against all the tables I have seen, would indicate to me
that the beneficiaries are people of high income. And the people
who incidentally get a little bit of the benefit are the people that
you describe.
But, as is always the case when an attempt is made to sell one
like this, they always send the grandmothers who are retired.
Mr. MITCHELL. The gentleman's time has expired again. Mr.
Obey.
Mr. OBEY. Mr. Bolling, I have just two questions that really don't
relate directly to the budget resolution at this point. You indicated
in response to Mr. Derrick's question that one of the things you do
on the inflation front, my concern is that given political reality we
have only two choices: Either to face the pressure of tax cuts and
larger tax cuts down the line and the pressure for reduced Federal
spending below the amount that you would recommend for this
year, or else something else, and my question is, since nothing
seems to be happening in the private end that would encourage
people on inflation, the only visible target at this point that seems
to be getting any political attention is the spending level.
In addition to what you have already suggested to Mr. Derrick,
what would you suggest by way of Government actions to attack
inflation and what would you also suggest to deal with the question
of capital formation?
Mr. BOLLING. I am involved, and I am not yet entirely successful,
in a private effort to have a real deficiency study made on how to
get better capital formation, by completely reputable people, and
the dilemma we have is we cannot get people who represent all of
the interest groups to commit themselves to participate.
They are so afraid of coming together to settle a controversy that
it takes an incredible amount of negotiation between well-intentioned people to get a real study that would have standing in the
whole community with everybody because of the participants and
funding, and so on, underway. That is a classic illustration of the
dilemma that we have.
One illustration of it is sort of a small thing, but not really
small. We have a capitalist labor movement in this country. There
is more conflict between management and labor in the United
States of America than there is in the other developed countries
where they have Socialist labor movements.
What is happening is that everybody is quarreling about getting
more for themselves, and we are not able to put together the kind
of combined effort that has always been necessary in this society
for the society to function. And we see a great deal of this in the
activity of both business and management and labor in their response to the President's plea to help on inflation.
Now, I told-and maybe you were there-I told the executive
board of the Business Round Table, when they were before the
Democratic Steering Committee, that they were going to have to
get together with the labor leaders before Government was going to
be able to come up with a program.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
16
I think everybody in the room, including the Speaker, was mystified by what I meant, and I have explained it and it is just what I
said a little bit earlier. We have to get the best minds that we have
got from all points of view to come together with a public interest
kind of approach.
Now, I think what it is going to contain is a specific involvement
of everybody in reversing the ratchet. That is implicit in what I
said earlier about the need for wages to be modified. I don't happen
to think that it's possible to do it totally fairly. I think the inflation
we have had up to date has been largely a cost-push inflation. It
may now be turning a little bit the other direction, but I think we
are going to have to have techniques of intervention which are
acceptable to a variety of interest groups and which are implemented by government by law.
Mr. OBEY. Let me ask you a question, because you mentioned it
earlier. You indicated you thought Bosworth's Council needed additional powers. When he was before us the last time, I think it was
the last time, he indicated he did not think they needed any more
formal authority than they had now.
Mr. BOLLING. Well, he is, after all-Mr. OBEY. I recognize that, but what specifically are you suggest-.
ing?
Mr. BOLLING. I think one of the things we recommended was that
they should issue reports estimating the impact of Government
activity on inflation, price supports, import restrictions, minimum
wage, take a hard look at all of that. That has not been done
effectively because some of those things are off limits. And they
should not be.
I mean, we are at a point, I can understand why he said what he
did, but I cannot believe he would resist the opportunity to have
subpena power and so on and so on. I think he has to have more
power.
Mr. OBEY. I am just asking you to lay out your laundry list.
Mr. BOLLING. I think the easy way to say it, the quick way to say
it is we are going to have to have structural tools to deal with what
is in essence a sort of structural inflation, just as we finally and
belatedly came to the notion that we had to have structural programs to deal with unemployment to complement the macropolicies. I do not think we can deal with inflation solely with macropolicies. I think there has to be a detailed range of weapons, and I
would not even presume to think of all of them, since I have not
even been able and my committee has not even been able to get
the first step, which is to give them some increased power to
function, for reasons which are obvious.
Mr. MITCHELL. The gentleman's time has expired. Mr. Burgener.
Mr. BURGENER. Thank you, Mr. Chairman. Chairman Bolling, it's
always a privilege to listen to your provocative and excellent testimony.
Mr. BOLLING. Thank you.
Mr. BURGENER. I appreciate it very much. I hope the Congress
does not wait to be hit over the head with a very blunt weapon
such as we were the recipients of in California recently. We were
collecting money at our State level literally faster than they could
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
17
spend it, believe it or not, · and they amassed a $5 billion to $7
billion surplus.
I think they wisely did not spend it. But the government out
there lives on inflation, much as it does here, and in the absence of
any restraints such as indexing, the taxes just piled up and up to
$7 billion. Now, at the same time people's property taxes doubled
and tripled, and senior citizens particularly and anybody on a fixed
income got priced out of their homes, and they were angry and
frustrated and they had to actually sell, and reduce their standard
of living in an expanding economy.
I think if we don't get the message here that people want spending cut, even modestly, and taxes cut rather substantially, we will
be missing the boat.
In all I have read about the Kennedy tax cuts and Johnson and
Heller and so on in the early 1960's, it seemed to me that the best
thing about them, and I would echo what Mr. Latta said, they were
permanent; they were not quicky, one-time rebates; they ·were permanent in nature, and I guess they are still with us in large
measure.
You argue that they didn't result in higher productivity, that
people worked fewer hours and took more vacations and so on.
Now, economists differ. Some don't like Professor Laffer because he
is new and_a bit of an upstart perhaps. Milton Friedman is certainly not an upstart. He won the Nobel Prize for economics, and he
argues, I believe I am correct, that permanent tax cuts are absolutely in the public interest.
It might restore investor confidence. Am I correct that we are
the only large industrial nation with a capital gains tax? Would
someone correct me if I am wrong about that?
Mr. BOLLING. I think that is probably true, or so I am informed. I
don't know of any other nation, but that is, I must say, and I know
you are aware of it, the missison of taxation in other nations and
ours is extraordinarily different. That is not the only difference.
Mr. BURGENER. The President has labeled the capital gains reduction as a millionaire's relief act. I would not care if it is if it
also benefited the general public. I don't care how many millionaires get help if it helps the general public as much or more. I
think a lot of people involved in capital gains are not millionaires,
by the way, and an immense amount of public investors, large and
small, would be benefited.
So I would like to try to focus in on the differences in the
economy in 1960 and today. Inflation is one. Your testimony said
inflation was very low and we had ideal plant capacity.
Mr. BOLLING. That is correct.
Mr. BURGENER. And yet if we didn't increase productivity, what
happens then to increase revenues to the Treasury? I am told $50
billion plus in the next 5 years after those permanent tax cuts.
Mr. BOLLING. My impression of the intent at the time, as I said I
had some small involvement myself, and the result as interpreted
by the people at the time was that the success of that cut was that
it added to demand, not to supply, and that the effect was there
was a multiplier, the cut was in the order of what, 13 to 15, and
you multiply it out in sort of a normal fashion because of the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
18
increase in demand which increased, in effect, production and employment.
Now, we had a much better level of productivity in those days
than we do today. One of the really weird things, and weird is a
strong word, but I think it is weird, is we have this enormous
increase in the labor force. We don't have very much sign of
economic growth, and we have got a terrible productivity compared
to earlier times. We don't really understand why.
Mr. BURGENER. One final point. Am I mistaken or is there not a
massive amount of purchasing power out there, that there is
money floating around, funny money maybe, not worth much, but
it's out there in droves, that purchasing power is more massive,
savings are higher, spending levels are higher than ever before? Or
am I wrong?
Mr. BOLLING. I suppose you can say that without being relative,
but as soon as you are relative, then your problem, I think saving
is a little bit higher than it has been, but we are not getting the
satisfactory level of investment, and that is supposed to be partly
because people cannot look ahead and feel sure, and we have not
even started to get into that because one of the fundamental reasons they cannot look ahead and be sure is we finally figured out
that what Germany and Japan do is critical.
That is why we are going to get an awful lot back; feedback from
whatever happens at this summit, which in some theories has no
meaning, but in other theories has all of the meaning. But I don't
know the answer. That is why I would like to see us be able to
study, under auspices that are impeccable and not political, with a
neutralization on interest and the politics, the problem of capital
formation, and I have been working with a variety of people
around the country, academics and businessmen, to try to get that
done. We don't know the answers, at least I sure don't.
Mr. BURGENER. Thank you. My final point, I just hope Congress
will cut spending modestly because I think it's unrealistic to cut it
heavily, but do it each year, and cut taxes substantially and of a
permanent nature.
I think it will work, but you have to have a lot of confidence in
the private sector or free market to take that route, and I am not
sure there is that much confidence. I have it. I hope it is not
misplaced. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. Mr.
Mineta.
Mr. MINETA. Thank you, Mr. Chairman, and thank you, Mr.
Bolling, for your very fine statement. On the second page of your
testimony you refer to the number of witnesses who have appeared
before the Joint Economic Committee cautioning against the possibility of a recession or at least "a growth recession." What is your
definition of a growth recession?
Mr. BOLLING. In effect, it means we would have a moderate
amount of growth, but still have an increase in unemployment.
Mr. MINETA. Also on page 2, and I appreciate your comments on
the Kemp-Roth proposal because we do have all kinds of cure-all
panaceas these days. Kemp-Roth is based on the so-called Laffer
curve and, in fact, someone described the Laffer curve as being in
the shape of half a potato, but it was half-baked.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
19
Rather than exaggerated promises, Congress should be working
on carefully crafted policies in this whole area you have mentioned. My colleage from California has very accurately, I think,
portrayed what happened in California in terms of an inflation
situation that brought more tax revenues to the State government.
I am wondering whether or not you feel that inflation-induced tax
increases are serious, and whether or not we should be considering
indexing the Tax Code to automatically offset the effects of inflation. What problems might we encounter if we were to do that?
Mr. BOLLING. We have an economist who has done a lot of work
on that. I have a little trouble with any kind of index. I voted for it
a couple of times, but I am coming to the conclusion that as a
fundamental rule of thumb it is better to leave flexibility and
demand on the wisdom of Congress and the administration rather
than indexing. I am not very firm on that conclusion. I vacillate on
it. But I have not seen enough to convince me that indexing is the
way to go. I rather take a position that it's terribly unpopular in
Congress, in fact, so unpopular that people say it will never
happen.
I would rather give to any administration, and as I look back on
it I don't think there is an exception to this, I would _rather give to
any administration the right to raise and lower taxes neutrally by
a certain percentage, to get the flexibility in.
Now, that is not fine tuning, it's sort of gross tuning, but the
more I have watched Congress perform and I am pretty well committed to the idea that the House is important and the Senate is
important, the mor~ I watch us perform the more I am convinced
that we are incapable because of the nature of the society, not the
nature of the Congress, that we are incapable of dealing quickly
with tax changes, and I think that would solve much of the problem that you are confronting when you recognize that inflation
forces people into higher brackets and that there should be some
kind of I suppose reverse indexing to compensate for that.
I would rather see the President have the right to pop them out
of those higher brackets just by having the right to maybe 5
percent, 6 percent up or down. Down, obviously, to pop them out of
the higher brackets. I think that makes more sense.
Now, you might have a veto on that, a congressional veto, but
you have to be able to do it relatively quickly if you want to have
some reasonable economic effect. I am not sure that makes sense
either, but it's the best I have come up with.
Mr. MINETA. On this other issue that we continue to face, the
area of capital investment, it seems to me part of the problem is
that we are drying up the sources of capital investment and equipment and plant, partly due to the fact that people are getting out
of the stock market, out of the equity market and into real estate
speculation where the returns are greater. At least we are experiencing that in California. I was wondering if you had any comments on that kind of a shift.
Mr. BOLLING. That I think is based on people trying to find some
safe place where their money will be protected somewhat from
inflation, and I think what has happened is we had an enormously
successful 20 years from 1946 to 1966 and the interesting thing
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
20
about that is that it was through all different kinds of administrations.
Some of the best years, although there were more recessions in
them than I liked, were in the Eisenhower years. So you had
conservative Presidents and more liberal Presidents and you have
a long period of fantastic and unbelievable economic growth, and a
whole variety of things happened from 1966 through 1973, and a
few things have happened since, but everything has turned upside
down.
I think virtually every professional economist who is old enough
to know the whole period or to have looked at the whole period or
experience the whole period would agree. And we have not yet
arrived at the synthesis of the new factors.
I don't think we know the details of the new factors. Thirty years
ago what Germany thought or did was not very important. The
same is true of Japan. Today they are absolute keys in the health
of the American economy. The smaller countries still have great
power, economic power, and great influence on what happens.
France and England, for example, are trying to invent new techniques to protect their own manufacturing. All kinds of strange
things are happening, but we don't even know the facts, the facts
on our labor force. We are trying to dig out and find out what
really has happened in the American labor force. Its character has
changed absolutely, from my point of view, incredibly.
Mr. MINETA. If we are to try and deal with these issues, instead
of gross tuning, as you referred to it, we ought to be doing some
fine tuning, it seems to me; we ought to be coming back with some
carefully crafted policy.
Mr. BOLLING. I think first we have to get the facts, Mr. Mineta,
and we are always involved in dealing with the next crisis or the
next political problem and that again, I have to come to one of my
pet projects, that is why we have, and you voted for it, and so did I,
I guess most people in the room, we have a special study on
economic change going on which is going very slowly and trying to
be very careful about bringing everybody into it.
We started out with demography, and we are going to move from
there on into the more conventional kinds of things. But in the
process of conflicts over what is the score on the labor force is just
unbelievable. We don't know.
Mr. MINETA. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Ohio.
Mr. REGULA. Thank you, Mr. Chairman. First of all, Mr. Bolling,
I think your idea on the flexibility on the tax structure for the
executive branch has more merit than giving the executive branch
flexibility on the outlay side, and I suspect it would be a healthier
technique for stimulus in periods of slight recession. I am intrigued
with the idea.
First, have you reached any conclusion as to what percentage is
the magic figure in terms of total tax take? We hear the idea that
if it gets above 33 or above 35 it begins to have a regressive impact.
Would you have an opinion on that?
Mr. BOLLING. I have sort of reluctantly come not to believe any
magic figures exist, even 4-percent unemployment.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
21
Mr. REGULA. Fair enough. The second question is does the idea of
deferring tax on capital gains until it is actually used as an expenditure for personal purposes, in other words, the idea of allowing an individual to roll over from one security to another security
such as we do on a residence now for those that are actually living,
or it's their principal place of business and also allowing a factoring in of the inflation during the period of the investment and then
taxing the ultimate money that is going to be expended as income
after having factored out the impact of inflation at the standard
rate, have any appeal to you?
Mr. BOLLING. I would like to run it through some specifics to see
what the specific effect would be. What you are trying to reach is
some kind of more equitable and more inflation-proof approach to
capital gains. Obviously, I agree with the purpose and I just simply
don't know what the impact would be. But it's an interesting
thought, and I will be glad to pursue it a little.
Mr. REGULA. My next question is, I note in the table on the back
of your statement that it seems without exception that Wharton,
Chase, and the others agree we are going to have from 0.2 percent
to 0.6 percent lower real growth than the administration forecasts.
Does this concern you and do you think that we should be concerned about this happening in terms of policies that are effectuated by this Congress?
Mr. BOLLING. Yes. That is one of the reasons, a good part of the
basis for the fundamental thrust of the statement, which is that we
need a substantial tax cut.
Mr. REGULA. As a stimulus to growth?
Mr. BOLLING. That is correct. I am very much concerned about it.
I have a hard time facing my friend, Mr. Mitchell, when he talks
about unemployment, because I know exactly what he is talking
about. We have this substantial reduction in unemployment across
the board, and where we have minority youth at 37.5- percent,
which is absolutely incredibly destructive, I cannot say it strongly
enough, because you are wiping out that generation.
Mr. REGULA. That is true. Do you think that the deficit has a
substantial or moderate or very little impact on inflation, and I am
talking about the deficit as we face it in fiscal years 1978 and 1979?
Mr. BOLLING. I used to think it has less impact than I think .now,
and the reason I think now it has more impact than I used to is I
have watched it used as a device, and I want to be careful about
this because this has not, in my opinion, been done by a party,
although it may be in the end. It has been a device used very
cleverly by some organized groups to try to pursue their desire to
cut down the amount of Federal spending.
Now, I am sure it has been done consciously by some of the
people that are involved in the outside in it because I know them
well. And the reason for that is a highly uncomplicated one. With
all its flaws and particularly leaving out social security, which is a
peculiar kind of tax, the Federal tax take, in my opinion, is much
fairer than the State or local tax takes. It's much more progressive.
Therefore, those who want to protect as much as they can higher
incomes always want to take the spending away from the Federal
level and put it into the State and county and the city, because
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
22
their tax takes are much less progressive, much less based on
ability to pay.
I think a monumental amount of the maneuvering seen over a
relatively long career has been based on that one simple factor,
and I am sure there are a great many people who advocate proposals that stem from that approach who are not even conscious that
that is really what the approach is all about.·
Mr. REGULA. The last question. Do you agree or disagree that we
are forcing the Federal Reserve to substitute monetary policy for
fiscal policy in view of the fact that we apparently are unwilling or
unable to restrain the deficits?
Mr. BOLLING. I think that is a fair question, and it's very difficult
for me to answer it. I think that is true up to a point. My impression is, and somebody can correct me, I suddenly realize I am not
sure on this, but my impression is that the Chairman voted against
the last increase in the funds, in the Federal funds percent. There
was some flurry in the paper. I happen to have considerable admiration for Mr. Miller, and I happen to be somebody who has pretty
consistently supported the concept of an independent Fed.
I think there are times when we put too much of a burden on
them and force them as they see their duty to go pretty hard. Now,
sometimes I think they go too hard, and I think they may be at
that point now. I am not prepared to say on a quarter of a percent
basis I know for sure.
Mr. REGULA. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. We want
to thank you very much, Mr. Bolling, for spending the time with us
on a very important subject, and we appreciate the help, and the
suggestions, and the inputs.
Mr. BOLLING. Thank you very much. I enjoyed it as always.
The CHAIRMAN. Thank you very much. Our next witness this
morning is Dr. Alice M. Rivlin, who is well known to us, of course,
on this committee, Director of the Congressional Budget Office. Dr.
Rivlin, we welcome you to the committee.
We are interested in hearing your views as to the future course
of the economy and your recommendations as to the size and type
of tax cut that should be included in the second resolution. We
would also like your assessment of the outlook for inflation and
unemployment over the next 18 months.
I understand that the CBO is currently analyzing the "MidSession Review of the 1979 Budget" released July 6 by the Office of
Management and Budget. Those reestimates predict a "shortfall"
of $10.7 billion for fiscal year 1978 below the January estimate. Do
you have an explanation as to why the overestimates of expenditures are continuing?
Also, the Congressional Budget Office completed a study last
week for the committee on the impact of passage of Proposition 13
in California which reduced property taxes. Would you briefly summarize your findings?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
23
STATEMENT OF DR. ALICE M. RIVLIN, DIRECTOR, CONGRESSIONAL BUDGET OFFICE, ACCOMPANIED BY DR. WILLIAM J.
BEEMAN, ASSISTANT DIRECTOR, FISCAL ANALYSIS DIVISION;
AND JAMES L. BLUM, ASSISTANT DIRECTOR, BUDGET ANALYSIS DIVISION
Dr. RIVLIN. It is a large order, Mr. Chairman. I think most of
these points, except Proposition 13, are covered in the statement. I
will read part of it and summarize the rest.
The statement covers four topics: The economic outlook as projected by CBO; the budget estimates included in the mid-session
report on the fiscal year 1979 budget recently released by the
administration; fiscal policy options for fiscal year 1979 now receiving attention in Congress; and the need for closer coordination of
monetary and fiscal policies and/ or structural approaches to controlling inflation.
THE ECONOMIC OUTLOOK
This committee begins its consideration of the Second Concurrent Resolution on the Budget for Fiscal Year 1979 at what I
believe to be the most difficult moment for economic policymakers
since the beginning of the budget process and possibly longer.
Inflation is accelerating just at the moment that the economic
recovery is showing signs of running out of steam. Despite last
month's drop, unemployment remains high by postwar standards.
Most forecasters project little improvement in the jobless rate in
the months ahead and some foresee deterioration. As a result,
policymakers face a most troubling dilemma. On the one hand, the
standard remedies for inflation may weaken economic growth and
perhaps trigger a new recession. On the other hand, actions designed to sustain the recovery run the risk of aggravating the
already rapid increase of prices.
It is also a particulary difficult time to forecast the behavior of
the economy. The contours of any economic projection depend critically on the resolution of this policy dilemma, and that final outcome is still very much in doubt. For the purposes of this forecast,
we have made the following policy assumptions: As is customary,
we have taken as given the fiscal policies included in the First
Concurrent Resolution. With respect to monetary policy, we have
assumed that short-term interest rates will not rise much further
and that credit conditions will not become so restrictive as to abort
the expansion.
Based on these assumptions, CBO expects economic activity to
grow at a 3.5 to 4.5 percent rate during 1978, slowing by about onehalf of 1 percentage point during 1979. As shown in table 1, the
unemployment rate is forecast to range between 5.2 and 6 percent
by the end of 1979, that is to say, about where it is right now.
[The tables referred to may be found in the prepared statement.]
Dr. RIVLIN. The most unpleasant side of this scenario is the
outlook for prices. While inflation is likely to moderate from the
double-digit rates during the first half of 1978, the increase in the
Consumer Price Index-CPI-for the entire year is expected to be
in the range of 6.8 to 7.8 percent, substantially above the 6.6
percent rise during 1977. Prices are projected to continue to rise at
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
24
a rapid rate in 1979, although, in the absence of any unanticipated
shocks, they will probably decelerate somewhat from this year's
pace.
There are at least three aspects of this projection that deserve
some further examination. First, in a period of relatively high
unemployement, why has the outlook for inflation deteriorated so
badly? Second, given the assumption of an accommodating monetary policy, why have we forecast a slowdown in the growth of
economic activity? Third, if there is a slowdown, why won't it turn
in to a recession?
OUTLOOK FOR INFLATION
Inflation has accelerated sharply since the beginning of the year.
The rate of increase of consumer prices between December and
May was about twice the rate during the second half of last year.
This upsurge did not reflect widespread shortages of labor and
capital, but rather was associated with the simultaneous occurrence of three events: A rapid increase in food prices resulting
from the harsh winter and the beginning of a cattle cycle, the
depreciation of the dollar, and the January increases in payroll
taxes and the minimum wage.
Although the CBO forecast assumes that no comparable food and
depreciation shocks will occur next year, the rate of price increase
is projected to moderate only slightly from this year's pace. The
principal impetus to this continued high level is expected to be
rising labor costs. If past behavior holds true, the recent jump in
the CPI will cause a lagged acceleration of wage gains and a
corresonding markup of prices late this year and in 1979.
Past performance unfortunately also indicates that restrictive
macroeconomic policies would have only a small effect on inflation
during the first few years. Like the special factors that induced the
price acceleration earlier this year, subsequent wage catchup, once
there has been a price increase, has proved to be relatively insensitive to variations in total demand. Under such circumstances, it
takes many years of high unemployment to reduce inflation significantly.
REASONS FOR THE SLOWDOWN
The foreign trade and State and local government sectors are
expected to provide moderate stimulus to the economy during the
next year and a half. Thus, the outlook for slower growth through
1979 rests largely on the behavior of three sectors of the economy:
Housing, consumption, and business fixed investment.
Spending on residential construction provided significant impetus to the rise in real GNP last year. Such strength, however,
probably will not continue through the projection period; this
year's rapid tightening of credit markets has already limited the
availability of funds for home mortgages. Savings and loan institutions have experienced a significant deceleration in deposit inflows
and by May commitments outstanding for future mortgage lending
had fallen for 5 consecutive months.
The prospects for consumer spending also appear less bright.
Personal debt has risen sharply relative to income, and tighter
mortgage conditions will reduce opportunities to convert real estate
equity to cash, a practice that apparently helped sustain consump-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
25
tion throughout the expansion. Furthermore, consumer attitude
surveys indicate that the recent surge in retail sales may be based
in part on the attempt to avoid expected future price increases.
Such buy-in-advance behavior would reduce consumer spending in
the remainder of this year and perhaps in 1979.
The growth of housing and consumer spending typically slows as
an expansion ages, but such slowing is usually somewhat offset by
increased outlays for plant and equipment. According to the Commerce Department's survey of business anticipations, constant
dollar business fixed investment is again likely to increase faster
than overall growth, but less rapidly this year than last. Moreover,
a slowdown in the overall pace of economic activity means less
pressure on capacity utilization throughout the forecast period. As
long as existing productive capacity remains underutilized, there is
little likelihood of an investment boom.
REASONS FOR NO RECESSION
Most forecasters agree that growth will slow, although many go
further than the CBO projection and predict a recession within the
next year and a half. This is admittedly a difficult call, but, given
our policy assumptions-particularly our monetary policy assumptions, CBO does not believe that current economic trends point to a
recession. This assessment is based on a number of factors:
The tax cut included in the First Concurrent Resolution more
than offsets the effects of rising payroll taxes and fiscal drag on
disposable personal income and should help sustain consumer
spending. In addition, the tax package should stimulat~ business
fixed investment.
The impact of higher interest rates on housing activity may be
softened somewhat by the new option available to lending institutions to pay market interest rates on deposits of $10,000 or more.
The recent depreciation of the dollar is expected to boost net exports.
Perhaps most importantly, there is little evidence of the kind of
imbalances between production and final sales that typically characterize a period preceding a recession. Throughout the current
expansion, businesses have pursued a cautious inventory policy,
keeping stocks closely alined with sales.
These reasons, however, do not touch on the principal differences
between the CBO projection and those who foresee a near-term
recession; that is, the future course of monetary policy.
As I noted earlier, CBO has assumed no significant further tightening of credit markets. By contrast, many forecasters anticipate a
recession brought about by a credit crunch, as the Federal Reserve
responds to the recent acceleration of inflation and rapid growth in
the basic money supply.
EVALUATION OF 0MB JULY BUDGET ESTIMATES
In its Mid-Session Review of the Fiscal Year 1979 Budget released last week, the Office of Management and Budget-OMBlowered its estimates of the budget deficits by over $10 billion for
both fiscal years 1978 and 1979, as compared with its January
estimates. The reduction in the 1978 deficit estimate is almost
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
26
entirely caused by lower outlay estimates as a result of the continuing shortfall in expenditures. For 1979, the deficit reduction
results partly from lower spending estimates, but mostly from
changes in the administration's tax reduction proposals. Table 2
compares the latest 0MB estimates for the budget totals with the
1978 Second Concurrent Budget Resolution limits and the 1979
First Concurrent Resolution targets.
Mr. Chairman, we are now reviewing the new 0MB estimates,
and will submit the results of this review to the Budget Committees within the next 10 days. Let me just summarize by saying that
at the moment we don't see any distinct reasons to disagree with
the 0MB, that we expect this review will roughly confirm the
estimates they have given.
Let me skip, in the interest of time, to the top of page 11 on
policy options.
POLICY OPTIONS
Recognizing the need for stimulus to sustain economic growth,
the Congress enacted a First Concurrent Resolution last spring
with several new initiatives, including a sizable tax cut. With these
measures, the deficit is expected to be about $50 billion in fiscal
year 1979, about the same as in the current year. The full-employment budget deficit, one measure of fiscal stimulus, would increase
slightly from fiscal year 1978 to 1979, as you can see in the table in
my prepared statement.
The Congress now has an opportunity to review that earlier
decision in the light of changing economic conditions. Recent economic developments are mixed. Inflation is considerably worse
than expected, while the unemployment rate has declined more
rapidly than anticipated. At the same time, however, most forecasters believe the outlook for economic growth has not improved, if
anything, it has worsened. Hence, the policy dilemma: Measures
aimed at reducing inflation could slow growth and risk a new
recession, while policies designed to sustain economic growth could
accelerate inflation.
RESTRICTIVE FISCAL POLICY OPTIONS
If the Congress feels that continuing the current fiscal policy
provides too much stimulus at this stage of the economic expansion-particularly in light of the persistence of inflation-it can
take steps to reduce the fiscal year 1979 deficit. Perhaps the easiest
way to achieve a more restrictive budget at this time would be to
forgo all or part of the $15 billion tax cut for fiscal year 1979-$20
billion annual rate-that was included in the first resolution to
take effect in January 1979.
The CBO forecast described earlier includes this tax cut, assumed
to be $11.4 billion in personal and $3.6 billion in corporate taxes.
What would the outlook be without the tax cut? CBO's guess is
that the effect on our forecast by the end of 1979 would be to
reduce real growth by about three-fourths of 1 percentage point
and to raise the unemployment rate by about two-tenths. A policy
of no tax cut would not reach its maximum restrictive effects on
real economic activity until the end of 1980, however, when .the
impact would be somewhat larger. In terms of inflation, prices
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
27
might be 0.2 percent lower by the end of 1980. Inflation reacts to
stabilization policies more slowly than unemployment.
A significant restrictive economic effect could also be attained by
cutting expenditures. For example, the House of Representatives
has voted to reduce spending by 2 percent in a number of fiscal
year 1979 appropriation bills. If such a reduction were applied to
the First Concurrent Resolution outlay target for 1979, total outlays would be lowered by about $10 billion,• to $489 billion. The
CBO economic forecast already assumes a shortfall of about $4
billion from the First Concurrent Resolution. To achieve further
reductions, however, would require difficult actions, such as forgoing, or requiring full absorption of, the October pay raise for Federal employees, and forgoing or reducing sharply the planned new
spending initiatives for defense, agriculture, urban aid, veterans'
benefits, and other programs that have not yet been acted.
Alternatively, savings could be sought in existing programs to
achieve the spending reduction and still provide for some needed
new spending initiatives. One way of achieving this would be an
across-the-board cut in budget authority provided in all 1979 appropriation bills for nonmandatory payments under existing law. Assuming that the Congress could achieve a cut in spending of, say,
$10 billion beyond the estimated shortfall, the effect on economic
activity would be roughly similar to that described above for eliminating the tax cut, depending on the composition of the reductions.
If the Congress were to forgo the tax cut or take comparable
action on the spending side, fiscal policy would be more restrictive
in 1979 than in 1978. To the extent that the economy is approaching full employment, such a reduction in fiscal stimulus could
reduce the risk of generating excess demand inflation. But we must
recognize that real growth appears to be slowing, and there is a
substantial danger that monetary and fiscal policies will become
restrictive simultaneously, a shift that in the past has generally
been followed by recession.
EXPANSIVE FISCAL POLICY OPTIONS
In contrast to these various restrictive measures, the Congress
has before it a proposal for substantial tax reductions. H.R. 8333the Kemp-Roth Tax Reduction Act-proposes large tax cuts over a
period of 3 years without comparable red~ctions in spending. Conventional economic analysis indicates that, as a result of such a
policy, the budget deficit would rise sharply. With the economy
likely to reach full employment during this period, a large stimulus
of this kind would be highly inflationary.
Some of the proponents of this policy option, however, argue that
the conventional view is incorrect. They contend that large tax
cuts increase incentives to work, save, and invest to such an extent
that the cuts would pay for themselves in the first or second year
and, therefore, would not be inflationary.
CBO does not know of any empirical evidence for the view that
the supply side effects of tax cuts are so large and so quick. The
evidence available to us supports the conventional view that the
stimulative effects of most types of tax cuts occur primarily
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
28
through increased aggregate demand and that these effects are not
large enough for tax cuts to be self-financing.
THE COORDINATION OF STABILIZATION POLICIES AND STRUCTURAL
MEASURES
Past experience suggests that some incidences of poor performance by the economy have resulted from excessive shifts of monetary and fiscal policies in the same direction. The fiscal and monetary authorities each assumed that the other would not take apprO:
priate action in response to current economic trends; together they
overreacted. Such an overreaction appears to be possible at this
time. If monetary and fiscal policies are both used to reduce inflationary pressures, the chances for a recession are great.
Closer coordination of monetary and fiscal policies might result
in a more desirable mix of policies. For example, the longrun
performance of the economy might be improved by a tighter fiscal
policy and an easier monetary policy. That policy mix might:
Reduce Federal deficits and, perhaps, decrease the size of the Federal sector as well; and encourage investment spending, with the
resulting growth in capacity reducing inflationary pressures.
At present, however, adequate arrangements for choosing specific economic goals and implementing a coordinated policy simply do
not exist. Although attempts at closer coordination of fiscal and
monetary policies are not without their risks, the benefits in terms
of stabilization could be substantial. Hence, this seems to me to be
an appropriate time to examine mechanisms for improving coordination of monetary and fiscal policies, such as requiring the Federal Reserve to: Clearly specify its money and credit targets for the
ongoing and upcoming fiscal year before enactment of the budget
resolutions; reveal its estimates of the level of unemployment, production, and prices for the end of the fiscal years that go with
those policies; and explain periodic revisions of its objectives and
plans.
Finally, the dilemma facing policymakers today could be made
less acute by improving the tradeoff between inflation and unemployment-as this committee has discussed many times in the
past-through the use of structural programs, including: Skill
training, public service employment, reform of Government regulations, more vigorous enforcement of antitrust legislation, reducing
the minimum wage for youth, incomes policies, such as TIP-taxbased incomes policies-and reductions in payroll taxes.
But even with structural improvements and better coordination,
however, simultaneous inflation and unemployment will continue
to present difficult choices for macroeconomic policy. Measures to
deal with one of these problems may well worsen the other. Ultimately, the resolution of this dilemma will depend on whether the
Congress gives greater emphasis to inflation or to sustaining economic growth.
[Testimony resumes on p. 34.]
[The prepared statement of Dr. Rivlin follows:]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
29
PREPARED STATEMENT OF DR. ALICE
M.
RIVLIN
Mr. Chairman, my statement this morning will cover four topics: The economic
outlook as projected by CBO; the budget estimates included in the midsession report
on the fiscal year 1979 budget recently released by the administration; fiscal policy
options for fiscal year 1979 now receiving attention in Congress; and the need for
closer coordination of monetary and fiscal policies and/ or structural approaches to
controlling inflation.
THE ECONOMIC OUTLOOK
This committee begins its consideration of the Second Concurrent Resolution on
the Budget for Fiscal Year 1979 at what I believe to be the most difficult moment
for economic policymakers since the beginning of the budget process. Inflation is
accelerating just at the moment that the economic recovery is showing signs of
running out of steam. Despite last month's drop, unemployment remains high by
postwar standards. Most forecasters project little improvement in the jobless rate in
the months ahead and some foresee deterioration. As a result, policymakers face a
most troubling dilemma. On the one hand, the standard remedies for inflation may
weaken economic growth-and, perhaps, trigger a new recession. On the other,
actions designed to sustain the recovery run the risk of aggravating the already
rapid increase of prices.
It is also a particularly difficult time to forecast the behavior of the economy. The
contours of any economic projection depend critically on the resolution of this policy
dilemma, and that final outcome is still very much in doubt. For the purposes of
this forecast, we have made the following policy assumptions: As is customary, we
have taken as given the fiscal policies included in the First Concurrent Resolution.
With respect to monetary policy, we have assumed that short-term interest rates
will not rise much further and that credit conditions will not become so restrictive
as to abort the expansion.
Based on these assumptions, CBO expects economic activity to grow at a 3.5- to
4.5-percent rate during 1978, slowing by about one-half a percentage point during
1979. As shown in table 1, the unemployment rate is forecast to range between 5.2
and 6.0 percent by the end of 1979. The most unpleasant side of this scenario is the
outlook for prices. While inflation is likely to moderate from the double-digit rates
during the first half of 1978, the increase in the Consumer Price Index (CPI) for the
entire year is expected to be in the range of 6.8 to 7.8 percent, substantially above
the 6.6-percent rise during 1977. Prices are projected to continue to rise at a rapid
rate in 1979, although, in the absence of any unanticipated shocks, they will probably decelerate somewhat from this year's pace.
32-052 0 - 7 8 - 3
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
TABLE !.-ECONOMIC PROJECTIONS BASED ON CURRENT POLICY, CALENDAR YEARS 1978 AND 1979
Rates of change {percent)
Levels
Economic variable
*:
1977:4
1978:4
$1,962
$1,360
144
185
6.6
$2,160-$2,202
$1,408-$1,421
153-155
198-200
5.5-6.1
{actual)
11
~~~iot~11~!n;u~e~~1~ ~~~1trsr·:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
General price index {GNP Deflator, 1972 = 100) ...................................................................... .
Consumer Price Index (1967=100) ..........................................................................................
Unemployment rate {percent) ................................................................................................... .
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1979:4
1976:41977:4
(actual)
1977:41978:4
1978:41979:4
9.0-11.6
10.1-12.2
11.8
$2,354- $2,457
2.7- 4.2
3.5- 4.5
5.7
$1,446-$1,481
6.1- 7.1
6.4- 7.4
5.8
163-166
6.2- 7.2
6.8- 7.8
6.6
210-214
5.2-6.0............................................................. ······································
31
There are at least three aspects of this projection that deserve some further
examination. First, in a period of relatively high unemployment, why has the
outlook for inflation deteriorated so badly? Second, given the assumption of an
accommodating monetary policy, why have we forecast a slowdown in the growth of
economic activity? Third, if there is a slowdown, why won't it turn into a recession.
OUTLOOK FOR INFLATION
Inflation has accelerated sharply since the beginning of the year. The rate of
increase of consumer prices between December and May was about twice the rate
during the second half of last year. This upsurge did not reflect widespread shortages of labor and capital, but rather was associated with the simultaneous occurrence of three events: A rapid increase in food prices resulting from the harsh
winter and the beginning of a cattle cycle, the depreciation of the dollar, and the
January increases in payroll taxes and the minimum wage.
Although the CBO forecast assumes that no comparable food and depreciation
shocks will occur next year, the rate of price increase is projected to moderate only
slightly from this year's pace. The principal impetus to this continued high level is
expected to be rising labor costs. If past behavior holds true, the recent jump in the
CPI will cause a lagged acceleration of wage gains and a corresponding markup of
prices late this year and in 1979. Past performance also indicates that restrictive
macroeconomic policies would have only a small effect on inflation during the first
few years. Like the special factors that induced the price acceleration earlier this
year, subsequent wage catchup has proved to be relatively insensitive to variations
in total demand. Under such circumstances, it takes many years of high unemployment to reduce inflation significantly.
REASONS FOR THE SLOWDOWN
The foreign trade and State and local government sectors are expected to provide
moderate stimulus to the economy during the next year and a half. Thus, the
outlook for slower growth through 1979 rests largely on the behavior of three
sectors of the economy: Housing, consumption, and business fixed investment.
Spending on residential construction provided significant impetus to the rise in
real GNP last year. Such strength, however, probably will not continue through the
projection period; this year's rapid tightening of credit markets has already limited
the availability of funds for home mortgages. Savings and loan institutions have
experienced a significant deceleration in deposit inflows, and, by May, commitments
outstanding for future mortgage lending had fallen for 5 consecutive months.
The prospects for consumer spending also appear less bright. Personal debt has
risen sharply relative to income, and tighter mortgage conditions will reduce opportunities to convert real estate equity to cash-a practice that apparently helped
sustain consumption throughout expansion. Furthermore, consumer attitude surveys indicate that the recent surge in retail sales may be based in part on the
attempt to avoid expected future price increases. Such buy-in-advance behavior
would reduce consumer spending in the remainder of this year, and, perhaps, in
1979.
The growth of housing and consumer spending typically slows as an expansion
ages, but such slowing is usually somewhat offset by increased outlays for plant and
equipment. According to the Commerce Department's survey of business anticipations, constant dollar business fixed investment is again likely to increase faster
than overall growth, but less rapidly this year than last. Moreover, a slowdown in
the overall pace of economic activity means less pressure on capacity utilization
throughout the forecast period. As long as existing productive capacity remains
underutilized, there is little likelihood of an investment boom.
REASONS FOR NO RECESSION
Most forecasts agree that growth will slow, although many go further than the
CBO projection and predict a recession within the next year and a half. This is
admittedly a difficult call, but-given out policy assumptions-CBO does not believe
that current economic trends point to a recession. This assessment is based on a
number of factors:
The tax cut included in the First Concurrent Resolution more than offsets the
effects of rising payroll taxes and fiscal drag on disposable personal income and
should help sustain consumer spending.
In addition, the tax package should stimulate business fixed investment.
The impact of higher interest rates on housing activity may be softened somewhat
by the new option available to lending institutions to pay market interest rates on
deposits of $10,000 or more.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
32
The recent depreciation of the dollar is expected to boost net exports.
Perhaps most importantly, there is little evidence of the kind of imbalances
between production and final sales that typically characterize a period preceding a
recession. Throughout the current expansion, businesses have pursued a cautious
inventory policy, keeping stocks closely alined with sales.
These reasons, however, do not touch on the principal difference between the CBO
projection and those who foresee a near-term recession: The future course of monetary policy. As I noted earlier, CBO has assumed no significant further tightening of
credit markets. By contrast, many forecasters anticipate a recession brought about
by a credit crunch, as the Federal Reserve responds to the recent acceleration of
inflation and rapid growth in the basic money supply.
EVALUATION OF 0MB JULY BUDGET ESTIMATES
In its Mid-Session Review of the Fiscal Year 1979 Budget released last week, the
Office of Management and Budget (0MB) lowered its estimates of the budget deficits
by over $10 billion for bot}:i fiscal years 1978 and 1979, as compared with its January
estimates. The reduction in the 1978 deficit estimate is almost entirely caused by
lower outlay estimates as a result of the continuing shortfall in expenditures. For
1979, the deficit reduction results partly from lower spending estimates, but mostly
from changes in the administration's tax reduction proposals. Table 2 compares the
latest 0MB estimates for the budget totals with the 1978 Second Concurrent Budget
Resolution limits and the 1979 First Concurrent Resolution targets.
TABLE 2.-FEDERAL BUDGET TOTALS: BY FISCAL YEARS, IN BILLIONS OF DOLLARS
1978
Revenues .................................................................. .
~Il~t:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
~~~,it:i~~~~~.:: ::: :::::::::::::::::::::::::::::::: :::::::::::::::
1979
Second
Resolution
limits
0MB
July 6
estimates 1
First
Resolution
targets
0MB
July 6
estimates
397.0
458.25
61.25
500.1
775.45
400.3
451.4
51.1
502.9
768.3
447.9
498.8
50.9
568.85
849.1
448.2
496.6
48.5
571.4
847.8
1
The 0MB.July 6 estima~es have been adjusted to treat the earned in~me credit payments as income tax refunds, as was done for
the Second Budget Resolution for 1978. The First Concurrent Resolution for 1979 and the 0MB July 6 estimates classify these
payments in excess of an individual's tax liability as outlays and budget authority.
We are now reviewing the new 0MB estimates, and will submit the results of this
review to the Budget Committees within the next 10 days. The review will also
incorporate our new assumptions about the economic outlook, an analysis of actual
outlay and receipt patterns in recent months, and other relevant programmatic
information provided by the administration. At this time, I can only provide a
preliminary assessment of the budget totals.
On the spending side, the July 0MB estimates of total outlays for both 1978 and.
1979 appear to be realistic in terms of our analysis of spending patterns. For our
latest economic forecast, we assumed that total outlays in fiscal year 1978 would be
$451 billion, almost precisely the same level as the latest 0MB estimate, adjusted
for the treatment of earned income credit payments. For 1979, we assumed that
budget outlays would total $495 billion, only slightly less than the 0MB midsession
review estimate.
OMB's cJownward reestimates of $4.5 billion for fiscal year 1979 about matches
the outlay figures incorporated in the First Concurrent Resolution. Based on the
new 0MB information and other factors, I expect that we will propose some further
downward adjustments in 1979 outlay estimates in the range of $2 to $4 billion.
For fiscal year 1978, the administration revenue estimates remain virtually unchanged from the January budget, but slightly above the CBO figures. CBO now
estimates 1978 receipts at $397.7 billion, compared with $400.3 billion for 0MB. Of
the $2.6 billion difference, about $1.5 billion is because of higher wage assumptions
by the administration, and about $1.0 billion is attributable to differences in estimating techniques.
0MB has revised its fiscal year 1979 receipts estimates upward from its January
estimates. Changed legislative assumptions increase revenues by about $10 billion,
but revised economic assumptions and technical estimating adjustments reduce
revenues by over $2 billion, leaving a net increase of about $8 billion. While CBO
has not yet completed its revenue estimates for the Second Concurrent Resolution,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
33
our preliminary work suggests that the adjustment 0MB has made for economic
assumptions and estimating revisions is not out of line. CBO's revenue estimates
will be ready for the committee's markup of the Second Concurrent Resolution.
POLICY OPTIONS
Recognizing the need for stimulus to sustain economic growth, the Congress
enacted a First Concurrent Resolution last spring with several new initiatives,
including a sizable tax cut. With these measures, the deficit is expected to be about
$50 billion in fiscal year 1979, about the same as in the current year. The fullemployment budget deficit, one measure of fiscal stimulus would increase slightly
from fiscal year 1978 to 1979:
Full-Employment Budget Balance
(National Income Accounts Basis)
Fiscal year:
1977 ................................................................................................................. .
1978 ................................................................................................................. .
1979 ................................................................................................................. .
Billions
of dollars
-14.5
-17.9
-20.7
The Congress now has an opportunity to review that earlier decision in the light
of changing economic conditions. Recent economic developments are mixed. Inflation is considerably worse than expected, while the unemployment rate .has declined
more rapidly than anticipated. At the same time, however, most forecasters believe
the outlook for economic growth has not improved; if anything, it has worsened.
Hence, the policy dilemma: Measures aimed at reducing inflation could slow growth
and risk a new recession, while policies designed to sustain economic growth could
accelerate inflation.
RESTRICTIVE FISCAL POLICY OPTIONS
If the Congress feels that continuing the current fiscal policy provides too much
stimulus at this stage of the economic expansion-particularly in light of the
persistence of inflation-it can take steps to reduce the fiscal year 1979 deficit.
Perhaps the easiest way to achieve a more restrictive budget at this time would be
to forgo all or part of the $15 billion tax cut for fiscal year 1979 ($20 billion annual
rate) that was included in the first resolution to take effect in January 1979.
The CBO forecast described earlier includes this tax cut (assumed to be :f,11.4 in
personal and $3.6 billion in corporate taxes). What would the outlook be without the
tax cut? CBO's guess is that the effect on our forecast by the end of 1979 would be to
reduce real growth by about three-fourths of 1 percentage point and to raise the
unemployment rate by about two-tenths. A policy of no tax cut would not reach its
maximum restrictive effects on real economic activity until the end of 1980, however, when the impact would be somewhat larger. In terms of inflation, prices might
be 0.2 percent lower by the end of 1980. Inflation reacts to stabilization policies
more slowly than unemployment.
A significant restrictive economic effect could also be attained by cutting expenditures. For example, the House of Representatives has voted to reduce spending by 2
percent in a number of fiscal year 1979 appropriation bills. If such a reduction were
applied to the First Concurrent Resolution outlay target for 1979, total outlays
would be lowered by about $10 billion, to $489 billion. The CBO economic forecast
already assumes a shortfall of almost $4 billion from the First Concurrent Resolution. To achieve further reductions, however, would require difficult actions, such as
forgoing, or requiring full absorption of, the October pay raise for Federal employees, and forgoing or reducing sharply the planned new spending initiatives for
defense, agriculture, urban aid, veterans' benefits, and other programs that have
not yet been enacted.
Alternatively, savings could be sought in existing programs to achieve the spending reduction and still provide for some needed new spending initiatives. One way of
achieving this would be an across-the-board cut in budget authority provided in all
1979 appropriation bills for nonmandatory payments under existing law. Assuming
that the Congress could achieve a cut in spending of, say, $10 billion beyond the
estimated shortfall, the effect on economic activity would be roughly similar to that
described above for eliminating the tax cut, depending on the composition of the
reductions.
If the Congress were to forgo the tax cut or take comparable action on the
spending side, fiscal policy would be more restrictive in 1979 than in 1978. To the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
34
extent that the economy is approaching full employment, such a reduction in fiscal
stimulus could reduce the risk of generating excess demand inflation. But we must
recognize that real growth appears to be slowing, and there is a substantial danger
that monetary and fiscal policies will become restrictive simultaneously, a shift that
in the past has generally been followed by recession.
,,.
EXPANSIVE FISCAL POLICY OPTIONS
In contrast to these various restrictive measures, the Congress has before it a
proposal for substantial tax reductions. H.R. 8333 (the Kemp-Roth Tax Reduction
Act) proposes large tax cuts over a period of 3 years without comparable reductions
in spending. Conventional economic analysis indicates that, as a result of such a
policy, the budget deficit would rise sharply. With the economy likely to reach full
employment during this period, a large stimulus of this kind would be highly
inflationary.
Some of the proponents of this policy option, however, argue that the conventional view is incorrect. They contend that large tax cuts increase incentives to work,
save, and invest to such an extent that the cuts would pay for themselves in the
first or second year and, therefore, would not be inflationary.
CBO does not know of any empirical evidence for the view that the supply-side
effects of tax cuts are so large and so quick. The evidence available to us supports
the conventional view that the stimulative effects of most types of tax cuts occur
primarily through increased aggregate demand and that these effects are not large
enough for tax cuts to be self-financing.
THE COORDINATION OF STABILIZATION POLICIES AND STRUCTURAL MEASURES
Past experience suggests that some incidences of poor performance by the economy have resulted from excessive shifts of monetary and fiscal policies in the same
direction. The fiscal and monetary authorities each assumed that the other would
not take appropriate action in response to current economic trends; together they
overreacted. Such an overreaction appears to be possible at this time. If monetary
and fiscal policies are both used to reduce inflationary pressures, the chances for a
recession are great.
Closer coordination of monetary and fiscal policies might result in a more desirable mix of policies. For example, the longrun performance of the economy might be
improved by a tighter fiscal policy and an easier monetary policy. That policy mix
might:
Reduce Federal deficits and, perhaps, decrease the size of the Federal sector as
well;and
Encourage investment spending, with the resulting growth in capacity reducing
inflationary pressures.
At present, adequate arrangements for choosing specific economic goals and implementing a coordinated policy do not exist. Although attempts at closer coordination of fiscal and monetary policies are not without their risks, the benefits in terms
of stabilization could be substantial. Hence, this is an appropriate time to examine
mechanisms for improving coordination of monetary and fiscal policies, such as
requiring the Federal Reserve to:
Clearly specify its money and credit targets for the ongoing and upcoming fiscal
year before enactment of the budget resolutions;
Reveal its estimates of the level of unemployment, production, and prices for the
end of the fiscal years; and
Explain periodic r~visions of its objectives and plans.
In addition, the dilemma facing policymakers today could be made less acute by
improving the tradeoff between inflation and unemployment through the use of
structural programs, including: Skill training, public service employment, reform of
Government regulations, more vigorous enforcement of antitrust legislation, reducing the minimum wage for youth, incomes policies such as TIP (tax-based incomes
policies), and reductions in payroll taxes.
Even with structural improvements and better coordination, however, simultaneous inflation and unemployment will continue to present difficult choices for
macroeconomic policy. Measures to deal with one of these problems may well
worsen the other. Ultimately, the resolution of this dilemma will depend on whether the Congress gives greater emphasis to inflation or to sustaining economic
growth.
The
CHAIRMAN.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Thank you very much, Dr. Rivlin.
35
Dr. RIVLIN. I have said nothing about Proposition 13, Mr. Chairman. I wonder if you would like to have me enter the report, or its
summary, in the record?
The CHAIRMAN. Well, I don't think we need it in the record. We
have it as a committee paper.
Dr. RIVLIN. Fine.
The CHAIRMAN. Would you like to comment on it, briefly?
Dr. RIVLIN. I could comment on it very briefly. We were asked to
look at the impact of the recent decision in California on the
national economy and on the Federal budget. We estimate the
impact on the national economy to be minimal. At first the effect
will be some marginal reduction in the general level of economic
activity; further in the future it will cause a marginal stimulus as
the tax reduction effects begin to dominate the expenditure reduction effects. As a result of this impact in California alone, there
will be some drop in the inflation rate although, of course, it is
marginal.
The effect on the budget will be, in the first instance, some
increase in Federal revenues, largely stemming from the fact that
Californians will no longer be deducting so much property tax from
their Federal tax. The effect on Federal expenditures, we think,
could go either way. There may be some increases and some decreases, and we have detailed some of those possibilities in the
report.
The CHAIRMAN. Thank you very much. You note that passage of
the Kemp-Roth tax proposal would be highly inflationary. Have
you made any specific estimates of how much it would add to
existing inflationary pressures?
Dr. RIVLIN. No, I don't believe we have. That estimate would be
based on going out beyond the first-year effects, which would be
not very different from the other tax cut proposals before the
Congress.
The CHAIRMAN. That is the point I am trying to get at. Are you
saying that the inflationary characteristics of Kemp-Roth would be
because of its projection out into the second and third year, rather
than in the first year where it is similar to the tax cut that the
President has recommended and that the Budget Committee and
Ways and Means Committee seem to be considering, one in the $15
billion and $20 billion area?
Dr. RIVLIN. Yes, we are saying that, Mr. Chairman. The tax cut
in the Kemp-Roth bill would be somewhat larger than the tax cut
assumed in the First Concurrent Resolution, but not enough larger
to make a lot of difference in the first year. It is in the second and
third years, in which additional tax cuts are proposed as the economy approaches full employment, that one would worry seriously
about the inflationary impact.
The CHAIRMAN. Let's talk about a tax cut that we are recommending. In the first budget resolution we were recommending a
fiscal year tax cut of about $15 billion. Is that inflationary, given
the present state of the economy?
Dr. RIVLIN. No, I don't think so, if bi that you mean would
inflation be significantly less if you didn t pass a tax cut. If you
didn't pass any tax cut at all, we have estimated that by 1980 you
might lower the inflation rate by 0.2 percent.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
36
The CHAIRMAN. Let's back up to 1978 and 1979. We are going to
recommend in the Congress and probably pass a tax cut somewhere
between $15 billion and $20 billion. Isn't that going to contribute to
an already high and unacceptable inflation rate? Isn't it bad economics to have a tax cut in a period of high inflation?
DI,: RIVLIN. That depends on what causes the inflation, and I
thi:r1R the answer is that the tax cut would not significantly contribute to the inflation rate at this moment. As I said in the
statement, the acceleration of inflation that we have seen recently
seems to be caused by an acceleration in food prices, the depreciation of the dollar, and other factors, such as the increase in the
minimum wage, that are not reflections of high aggregate demand.
Those factors will be passed on probably, if the past is any guide
to the future, in wage increases next year, which will mean that
we will have continued high inflation. But we will have continued
high inflation anyway. You wouldn't significantly affect that by
forgoing the tax cut.
The CHAIRMAN. Thank you very much. Mr. Obey.
Mr. OBEY. I would like to pursue the chairman's line of questioning on Kemp-Roth. You say that Kemp-Roth would down the line
be highly inflationary, but you haven't measured what degree of
inflationary pressure that would create.
If I am back home talking to my Rotary Clubs, trying to explain
to them what I mean by highly inflationary, quoting you, what do I
tell them?
Dr. RIVLIN. I am not sure we can give you a number at this
moment for two reasons: First, because to look at, say, the third
year goes into an area of great uncertainty in economic projections;
second, with the economy so close to full employment, nobody is
quite sure at what moment that additional stimulus through tax
cuts will be highly inflationary. But we are certainly now moving
close to that critical time.
Mr. OBEY. My point is when you say highly inflationary, what do
you mean by the word "highly"? What is your range? Otherwise,
frankly, that statement to me is meaningless.
Dr. RIVLIN. I think it means that the inflation rate, instead of
being 7 percent, could take off into the double-digit range again.
We have had that experience in the last few years, and we could
have it again, with a rapid stimulus to the economy at a time when
it was approaching full employment.
Mr. OBEY. You think that would be possible within 3 years?
Dr. RIVLIN. Yes, I do, within 3 years of the tax cut.
Mr. OBEY. On page 4, you are talking about the causes of inflation, and you mention three: Increase in food prices, depreciation of
the dollar, and the January increases in payroll taxes and the
minimum wage. Approximately what degree of inflation, what
amount, would you attribute to each one of those factors?
Dr. RIVLIN. Let me see if Dr. Beeman would like to have a try at
that one.
Dr. BEEMAN. Each one of these alone probably had a pretty
modest effect. It is when you add them up that you get some
appreciable increase in the Consumer Price Index. Some have estimated that the depreciation of the dollar will increase the CPI this
year by one-half of 1 percentage point. I think, the effect of the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
37
minimum wage is usually estimated to be quite a bit smaller than
that. The point is, however-Mr. OBEY. Like about what?
Dr. BEEMAN. I can't recall offhand what the estimates are,
maybe two-tenths, something like that.
Mr. OBEY. What about payroll taxes?
Dr. BEEMAN. I am trying to recall the exact number for the
payroll tax but again it is probably something like two-tenths or
three-tenths-the point being that you add them up and you can
come up with a considerable amount. Of course, the other aspect of
it is that it results in some acceleration in future years, as the
increases in the CPI cause increases in wages later on.
Mr. OBEY. What about food prices?
Dr. BEEMAN. The recent increase in food prices?
Mr. OBEY. You have given me the figures for 'the other three
items.
Dr. BEEMAN. It depends on which period you look at. In the last 6
months, the acceleration in food prices has been about double-digit
figures and that has made a large contribution to the acceleration
in the CPI. Almost all the acceleration in consumer prices can be
attributed to these three factors.
Mr. OBEY. Again, I am simply trying to get-Dr. BEEMAN. Comparing 1978 with the previous year, it probably
adds one-half of 1 percent. I will supply you with more information
on that.
[The following information was received for the record:]
CoNGRF.SSIONAL BUDGET OFFICE,
July 18, 1978.
Hon. David R. Obey,
U.S. House of Representatives,
Washington, D.C. 20515.
DEAR CoNGRF.SSMAN OBEY: At the Budget Committee hearings on July 11, you
asked how much of the acceleration of inflation so far this year had to do with
rising food prices, the dollar depreciation, and the January increases in payroll
taxes and the minimum wage. The following presents the relevant data:
1. The acceleration in the rate of increase of the Consumer Price Index has been
great; from December 1977 to May 1978, the CPI rose at a 10 percent annual rate,
compared to a 4.7 percent rate during the second half of last year.
2. It is straightforward to calculate the contribution of food inflation to this
acceleration, since we have separate food price data; nearly half (45 percent) of the
overall acceleration resulted from rapidly rising food prices, especially for meats.
3. The effects of depreciation and the cost-raising programs are more difficult to
derive, because they have widespread impacts on the CPI components. The CBO,
however, has estimated these effects, and the results are briefly summarized in the
following:
a. A trade-weighted dollar depreciation of 6 percent-the actual change between
October 1977 and April 1978-has in the past been associated with a 1 ¼ percent
rise in the CPI; if one-half of this effect on consumer prices occurred since · last
December (a reasonable estimate), then the depreciation induced more than a quarter (27 percent) of the overall acceleration in the CPI.
b. The impact on inflation of the January increases in the minimum wage and
payroll taxes has been estimated to be ½ to ¾ percentage points; assuming some
lag before the full effect of these cost-raising measures occurs, they may have
caused one-fifth of the recent CPI acceleration.
4. Given the above estimates, more than 90 percent of the recent acceleration in
consumer price inflation resulted from rising food prices, the depreciation of the
dollar, and the January cost-raising legislation.
Sincerely yours,
ALICE M. RIVLIN, Director.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
38
Mr. OBEY. OK. On page 6, you say, "As long as existing productive capacity remains underutilized, there is little likelihood of an
investment boom." As you know, there is an increasing number of
people who are suggesting that perhaps we have been measuring
that productive capacity under old terms; we haven't taken into
account the inflationary costs sufficiently as we reach that productive capacity.
What is your judgment on that? Do you think that percentage
figure has really changed any in the last year or two, given the
tremendous increase that we have had in energy prices and things
like that?
Dr. RIVLIN. There are certainly some problems with measuring
capacity, and the statistics we have are anything but optimum.
They do show very little change in capacity utilization over the last
year and a half.
If it is true that capacity utilization is higher than the numbers
show, then it is surprising that it hasn't shown up in more investment. It is alleged that some of this capacity may be obsolete
because of energy price increases or other causes, but this would be
an argument, or a factor, that would tend to increase investment,
and we haven't seen that in this recovery. For perhaps any number
of reasons, investment has lagged behind what one would have
expected in a recovery at this stage.
Mr. OBEY. So your answer is that you don't think the character
of that has changed very much?
Dr. RIVLIN. I don't see any evidence of it in what has happened.
Mr. OBEY. On page 12, you are talking about, in the second
paragraph, the effect of your forecast by the end of 1979 would be
to reduce real growth by about three-quarters of 1 percent and
raise unemployment by about two-tenths. How many people is
that?
Dr. RIVLIN. It is 200,000.
Mr. OBEY. That is all, Mr. Chairman.
The CHAIRMAN. Mr. Lehman.
Mr. LEHMAN. Thank you. I have some problems with trying to
understand inflation.
Dr. RIVLIN. You are not alone.
Mr. LEHMAN. I just wonder whether we are really measuring it
right. Despite claims that increases in the prices of essentials is
eating up people's income, people seem to have more disposable
money these days to spend on extra items.
I met with some people in Florida who control a large portion of
the moderate-priced motel rooms in the State. They told me they
just can't accommodate all the middle-income Americans that are
coming into Florida. Recreational vehicle people I talked to say
there is a new explosion in the sale of recreational vehicles.
I go to restaurants fairly often in Miami and Washington. The
last six times, at all different levels, not just luxury, I had to stand
in line. I had a terrible time trying to get back to Washington on
the airplane. I also talked to people building condominiums in
Florida, and was told that a well-located two-bedroom condominium that sells for $85,000 in Florida is likely to be bought for
investment purposes by someone from overseas, because nowhere
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
39
else in the world can you buy a new condominium, they tell me,
two bedrooms in a good location, for $85,000.
One other thing that happened; my son built a row. of 21 little
shops, a minishopping center and every single shop was rented to a
nonnecessary type of tenant. There were boutiques and beauty
parlors and pastry shops, and none of them is selling essentials.
They all cater to disposable income. If we have all this inflation,
where is all the disposable income coming from?
Dr. RIVLIN. You are picking up two factors operating at the same
time, I think. One is that we have had inflation at the same time
that the economy was recovering from a quite severe recession. It
is true that disposable income has increased, employment has gone
up, unemployment has gone down, and, on the average, people are
better off, a lot better Qff than they were in, say, 1974.
You are also picking up the relative improvement in the socalled Sun Belt, which has been a high-growth area relative to
much of the rest of the country.
Mr. LEHMAN. One other question, if I have time. You stated to
the Congressional Clearinghouse on the Future when you were
there the last time that you think prices for scarce material and
energy resources should be allowed to rise to their replacement
cost. I think I am quoting you, more or less. If that happened, how
would it affect inflation?
Dr. RIVLIN. It is clear that it would aggravate inflation in the
short run, but that again is one of those difficult weighing decisions. If we want to induce economizing of scarce materials, particularly of oil, it may be worth paying the price in inflation.
Mr. LEHMAN. One other question: One of the problems with our
tax system is that taxes are so visible. We see what we are paying
in withholding and social security taxes and property taxes. Many
other Western industrial nations kind of hide it in their value
added taxes. Do you think the tax resistance we are seeing today
might force us to shift our sources of revenue to things that are
less apparent to the people, that we are going to have to reduce the
painful visibility of our taxes?
Dr. RIVLIN. I think that is possible. You are already seeing a bit
of that in California, where local jurisdictions are switching to fees
and various other devices to make up the difference.
The CHAIRMAN. Mr. Burgener.
Mr. BURGENER. Thank you. If they switch to very many fees,
they are going to find themselves in a new occupation, I predict,
but that is an aside.
Dr. Rivlin, on page 16 of your excellent testimony, you outlined
some options about the tradeoff between inflation and unemployment. One is reducing the minimum wage for youth, and many of
us, but not a majority, or it would be law, favor this.
I really think many of us believe that this youth differential
would result in positive effects, less unemployment, more money
earned, and more self-pride, and so on. But there are people who
honestly disagree. You feel this should at least be considered?
Dr. RIVLIN. Yes. This is a list of structural options to remind the
committee there are other possible changes in microeconomic
policy you should be thinking about that might reduce inflation.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
40
Clearly a youth differential in the minimum wage is one possibility.
Mr. BURGENER. Is it a fair statement to say we are in a period of
economic uncertainty?
Dr. RIVLIN. Yes.
Mr. BURGENER. We have agreed on that. It seems to me that
many businessmen, particularly of the less sophisticated variety,
which most of us are, small business people who still constitute a
big part of our economy, which I think is a very positive thing, I
think they understand what deficits are, and they read about them
and react psychologically, in a period of uncertainty particularly.
I am not sure they ever heard of a shortfall or know what that
means, and I am not sure I do. I think it means either the inability
or the unwillingness to spend money we haye appropriated. Is that
correct?
Dr. RIVLIN. It means that the actual expenditures come in lower
than the estimates.
Mr. BURGENER. Is it inability to spend or unwillingness, or a
combination of both?
Dr. RIVLIN. It may be either of those, but I think it is more likely
to be that the estimates themselves were unrealistically high to
begin with. There is a tendency to overestimate the amount that
can be spent, a tendency on the part of Federal bureaucrats to say ·
they expect to spend more than they realistically can.
Mr. BURGENER. It would seem to me that overestimating, as a
habit, would tend to result in inflation, or more spending than
underestimating, as a habit. Or am I wrong? If we habitually
underestimated?
Dr. RIVLIN. If you are a bureaucrat, the penalties for underestimating are considerable. Then you run out of funds. If you overestimate and don't spend quite as much as you thought you were
going to, you are in less trouble.
Mr. BURGENER. Your statement indicates, or does it, about $4
billion for fiscal year 1979 current projection shortfall?
Dr. RIVLIN. Yes, it depends on where you start from.
Mr. BURGENER. OK, what would be the best guess for fiscal year
1978, the current year we are in?
Dr. RIVLIN. Let me ask Mr. Blum to speak to that. It depends on
where you start from.
Mr. BLUM. We believe at least $7 billion, and it could be as much
as $9 to $10 billion. I am using the second resolution level of $458
billion as the estimate from which the shortfall could occur.
Mr. BURGENER. Based on that, I find that encouraging, not discouraging, somewhere between $7 and $10 billion, and we project
$4 billion for next yea:r; why wouldn't it be good psychologically to
reduce authorizations and appropriations by at least $4 to $5 billion in anticipation of that? Might that not appear to be fiscal
restraints without hurting any program, without really taking any
dollars out of the spending stream, so to speak?
Dr. RIVLIN. I wouldn't want to guess on the psychological effects.
It might have that effect.
Mr. BURGENER. There are dollars indeed not spent, I take it.
What happens to those dollars?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
41
Now the fiscal year is going to end on September 30, and take a
figure, let's assume it turns out to be $7 billion in shortfall. What
happens to that $7 billion?
Dr. RIVLIN. It just doesn't get spent. When we were first dealing
with the shortfall phenomenon, it was thought that money that
wasn't spent in one fiscal year would create a bulge in the next,
but we haven't found that. We have found that the shortfall phenomenon has been consistent over several years, although it is
getting less. The 0MB and the CBO, I think, are getting better at
estimating what the actual expenditures will be, and the shortfall,
as a percentage of the total has been reduced.
Mr. BURGENER. A final question: It appears we have at the
moment high employment; it depends on your point of view, but
compared-Dr. RIVLIN. Certainly higher than it was.
Mr. BURGENER. The cost of hiring more people, the labor costs
are still less, are they not, than building new plants and equipment, and is this an important factor in holding back investment
incentives? Is it cheaper for employers to put on more people
rather than increase in plant and equipment?
Dr. RIVLIN. I don't think there is a general answer to that. It
depends on what kind of business one is in, but we have not
seen-Mr. BURGENER. I mean to increase productivity?
Dr. RIVLIN. We have certainly not seen any dramatic increase in
productivity recently. Productivity has been in a rather dismal
state, which certainly partially accounts for the unusual decrease
in the unemployment rate, relative to the growth rate. One
wouldn't have expected that much drop in the unemployment rate
if productivity increases were holding up, but they haven't been.
Mr. BURGENER. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. Mr.
Mineta.
Mr. MINETA. Thank you, Mr. Chairman. Dr. Rivlin, on page 2,
you explain your table on economic projections and state that you
assume that, "Short-term interest rates will not rise much further,
that credit conditions will not become so restrictive as to abort the
expansion." Could you give us a little more detail about what that
means? Do you think the Federal Reserve Board is going to adopt
such a policy? Would you characterize that policy as expansionary
or restrictive?
Dr. RIVLIN. First, we are not venturing a prediction of what the
Federal Reserve Board will do. We are not good predictors of
that-I don't know that anybody is-but in order to make a projection we have to assume something about monetary policy.
Interest rates have already risen quite rapidly in the last several
months, enough to affect the mortgage markets somewhat, and we
are simply assuming for the purposes of projection that they will
not rise much more. If they did, it would affect our forecast in a
negative direction. If they rose substantially more, then we would
have to go with the forecasters who are predicting a possible recession in 1979.
Mr. MINETA. In your discussion of inflation, you also point out,
"Wage catchup has proved to be relatively insensitive to variations
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
42
in total demand." In this regard, I have noted recently that economists are increasingly talking about wages and prices being "inflexible downward."
I would see this as being as much a social and political development as an economic one. I am wondering if you might comment
on that and what structural changes in the past 10 years would
you say have contributed to this inflexibility.
Dr. RIVLIN. I think wages and prices have been inflexible downward for quite a long time, partly because of the degree of unionization and collective bargaining and long-term contracts that keep
wages from falling, and partly for psychological reasons.
We are dealing now with a situation not of downward inflexibility but with the persistence of upward movements, even in the face
of considerable unemployment which is a step further.
Mr. MINETA. Momentum inflation?
Dr. RIVLIN. Momentum inflation is a way to characterize it. The
not surprising fact that once an increase in the Consumer Price
Index has occurred, then it tends to be reflected within a few
months in wage settlements and continues over the next several
years. There is not very much that seems to be possible to do about
it-it is our estimate that, even if unemployment rose considerably,
this lagged effect of past price increases would not be mitigated
very much.
Mr. MINETA. You project a slowdown in the business investment-a change from your January projection. Of course, here in
the Congress we are struggling over this whole question of how to
stimulate investment in plant and equipment. Would you give us
your thoughts on the desirability of changing the capital gains tax
rate as opposed to increasing the investment tax credit, and are
there any other specific steps that you would recommend that the
Congress might consider?
Dr. RIVLIN. I think everybody has agreed that increasing investments would be good for the economy, both in the short run and in
the long run for the economy. It's very difficult to know how to do
it because investment has such psychological overtones. I think the
evidence is stronger that using a specific tax change, like an investment tax credit, is more effective than changing a general tax rate,
whether it be the corporate income tax or even the capital gains
tax.
Mr. MINETA. When you mention this question about unemployment going down, it seems to me that a great deal of employers
have taken advantage of the $4,200 employee tax credit that was
granted in last year's tax reduction act. Have you looked at that to
see whether or not that has been an impact on it?
Dr. RIVLIN. I don't believe we have. It phased in slowly, but let
me turn to Dr. Beeman on that.
Dr. BEEMAN. At this moment I don't think we have the data to
analyze its effect. It has not been in effect long enough, but we
hope to be able to do so in the future.
Mr. MINETA. I know in our area where we have an expanding job
market because of the electronics and semiconductor business that
the numbers, just a slug of them, we have over probably 50 companies involved in that whole semiconductor business with about
60,000 employees, but I know a lot of them have just taken advan-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
43
tage of that, and I just wondered whether or not it has not had
that kind of salutary effect in terms of impacting on the employment rate.
Dr. RIVLIN. It may well have.
Mr. MINETA. Thank you, Mr. Chairman. Thank you, Dr. Rivlin.
The CHAIRMAN. The gentleman from Ohio.
Mr. REGULA. Thank you, Mr. Chairman. Dr. Rivlin, I note in
your statement on page 5 you say, "Under such circumstances it
takes many years of high unemployment to reduce inflation significantly." That is sort of a depressing thought.
What I would wonder is, how do you explain the fact that in the
Eisenhower-Kennedy years that we had relatively low inflation,
and relatively low unemployment. What was magic in that time we
cannot duplicate now?
Dr. RIVLIN. I don't think anybody knows for sure. But certainly
we are in a situation in which outside shocks to the economy have
produced inflation, and they didn't have that then. I think what we
are experiencing now is that once you have inflation, it's awfully
hard to get rid of.
Mr. REUGLA. What do you mean outside shocks?
Dr. RIVLIN. A whole complex of things, beginning with the oil
price increase, depreciation of the dollar.
Mr. REGULA. Guns and butter.
Dr. RIVLIN. Food, guns, and butter. Food price increases and all
kinds of other events happened in conjunction with each other and
that got inflation started. Conceivably, it depends on how far back
you want to go; certainly the high budget deficits in the face of full
employment in the late 1960's were a contributing factor. Monetary policy in 1973-74 has been faulted. But however inflation got
started, it did get started, and we have not been able to wind it
down.
Mr. REGULA. Would you, if you were running the show, be able
to recommend a scenario that we could dampen inflation without
tremendously penalizing the unemployment situation?
Dr. RIVLIN. Not quickly. I really think there isn't any easy
answer to this, and the only thing to do is to push on all frontssome of the structural options listed in the statement, cautious
monetary and fiscal policy, and be prepared to have to fight this
battle over a long time.
Mr. REGULA. What would you recommend to stimulate real
growth? I note in Mr. Bolling's statement that the statistics indicate a depressing reduction in real GNP growth rates which obviously has a lot of implications. What would you recommend, if
anything, that we could do?
Dr. RIVLIN. This again, I think, is a difficult question to answer,
and nobody really knows. The investment stimulating strategies,
with much uncertainty about what works, clearly have to be tried.
Mr. REGULA. I was interested-you say we must recognize that
real growth appears to be slowing, and there is substantial danger
monetary and fiscal policies will become restrictive simultaneously.
Don't you think that the Federal Reserve could respond rather
quickly if we had a little bit of fiscal responsibility on the Hill to
not having a similar move on monetary policy? Aren't they flexible
enough to avoid that scenario?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
44
Dr. RIVLIN. There have been times · in the past when they were
not.
Mr. REGULA. But doesn't the potential exist? Maybe they weren't,
but could not they be much more responsive than we are in fiscal
policy in a short time?
Dr. RIVLIN. They do have in many ways a more flexible set of
instruments to adjust policies more quickly. Dr. Beeman, do you
want to say something on that?
Dr. BEEMAN. One of the problems is that monetary policy does
affect the economy with considerable lags.
Mr. REGULA. I understand.
Dr. BEEMAN. It's very difficult now to tell what the current
tightening is going to do in the next year.
Mr. REGULA. Don't you think they are reacting to the absence of
a fiscal responsible policy on the Hill or in the administration
both?
Dr. RIVLIN. I would not want to second guess Chairman Miller on
that. You had better ask him.
Mr. REGULA. Reading from page 15: "Closer coordination of monetary and fiscal policies might result in a more desirable mix of
policies. For example, longrun performance of the economy might
be improved by tighter fiscal policy and an easier monetary
policy," and you point out some of the advantages.
I think you are absolutely correct. Although I note that on page
16 you seem to put the burden on the Federal Reserve system to do
the coordinating. Don't you think there is some responsibility that
rests up here always?
Dr. RIVLIN. Yes, and I didn't mean to imply that. I think the
main point there is that, if you want to experiment with the mix of
fiscal and monetary policies, you do not now have a mechanism for
doing that. Certainly this committee does not have. And it suggests
not that the burden be on the Federal Reserve, but that the Con-_
gress work with the Federal Reserve to find a mechanism for
coordinating.
Mr. REGULA. What would you recommend as a mechanism?
Dr. RIVLIN. I think perhaps the most obvious first step is to ask
the Chairman to come in and tell you what he is doing, what are·
his goals for the economy, what does he expect to happen, and
what unemployment rate and price assumptions go with the actions that he expects to take.
Mr. REGULA. Mr. Chairman, is it possible that we could get
Chairman Miller?
'
The CHAIRMAN. He is scheduled to come in Thursday.
Mr. REGULA. That is a first step, then. Thank you.
The CHAIRMAN. Thank you. Dr. Rivlin, on the shortfall, why are
the overestimates of expenditures continuing at such a high rate?
Dr. RIVLIN. I don't think we really know. They are diminishing.
as I said. The difference in fiscal year 1977 estimates between the
beginning and the end was as much as 4 percent. For next year we
expect it will be only around 1 percent. But I think there is this
psychological factor involved. If you are a Federal bureaucrat and
you are asked in advance how much you expect to spend, you
protect yourself by estimating on the high side, and that tendency
may continue.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
45
0MB and CBO and perhaps the top management in the major
agencies like Defense are getting a little bit more sophisticated,
however, in dealing with those estimates and scaling them down
sooner.
The CHAIRMAN. Thank you.
Mr. MINETA. Mr. Chairman, could I follow up?
The CHAIRMAN. Yes.
Mr. MINETA. Isn't that what zero-base budgeting is supposed to
be doing, and 0MB supposedly says they are using a zero-base
budget approach in trying to put together as they did in the 1979
budget for the first time and more thoroughly hopefully in the 1980
budget?
Dr. RIVLIN. No. I don't see a direct connection between zero-base
budgeting, which is a mechanism for arriving at budget proposal
priorities, and shortfall phenomenon which has to do with how fast
will that money spend out after the budget authority estimates
have been made.
Mr. MINETA. But then if they cannot apply zero-base budgeting
to try and eliminate programs that are not working or that are
unnecessary in 1978, then it seems to me without a question that
the legislature, the Congress, is going to have to impose sunset.
Dr. RIVLIN. That is possible, but I think it's a different question
from the shortfall question. Certainly some form of sunset legislation would enable the Congress periodically to look carefully at
how programs are working and eliminate or change those that are
not working well.
Mr. MINETA. Isn't the shortfall also coming from the lack of
oversight then on.the part of Congress?
Dr. RIVLIN. No; I don't think so. The shortfall is coming from a
very real difficulty in estimating how fast you can spend money
once you have decided to spend it. If you have decided to build an
aircraft carrier, it's hard to know how fast the money is going to
spend out on building it. You may have a strike; you may have all
kinds of problems. There is genuine uncertainty there.
Mr. MINETA. Those add to costs; they don't add to the shortfall.
Dr. RIVLIN. No, they affect the timing. The money may just not
spend out as quickly as you thought it would.
Mr. BURGENER. Would the gentleman yield?
Mr. MINETA. Surely.
Mr. BURGENER. They always overestimate. I never heard of anybody underestimating around here. Or am I wrong?
Dr. RIVLIN. I am a veteran of the Johnson administration. We
used to underestimate all of the time. We didn't have any idea
what medicare was going to cost.
Mr. MINETA. Thank you, Mr. Chairman.
Mr. BURGENER. It gets farther and farther back, doesn't ·it?
Thank you.
The CHAIRMAN. Thank you very much, Dr. Rivlin, for your very
helpful testimony.
Dr. RIVLIN. Thank you, Mr. Chairman.
The CHAIRMAN. The committee will be in recess until 2 o'clock.
32-052 0 - 78 - 4
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
46
AFTERNOON SESSION
The CHAIRMAN. The committee will please come to order. Our
witness this afternoon is Barry Bosworth, Director of the Council
on Wage and Price Stability.
It is a pleasure to welcome you once again to the Budget Committee. As you know, we are holding hearings in anticipation of
developing the Second Concurrent Resolution on the Budget for
Fiscal Year 1979.
The committee is interested in your forecast on inflation for the
next 12 to 18 months. We are extremely interested in your assessment of the success of the voluntary program of wage and price
restraint. Are you obtaining agreements from businesses to moderate their price behavior? What sort of cooperation are you receiving from organized labor? The effort you are making is of prime
concern, not only to this committee, but to the Nation as a whQle.
We understand that there are only a few major labor settlements
remaining in calendar year 1978, but that there will be a larger
number of settlements in calendar year 1979. Hopefully you can
tell the committee what groups are involved in the settlements and
how you expect them to go.
STATEMENT OF BARRY P. BOSWORTH, DIRECTOR, COUNCIL ON
WAGE AND PRICE STABILITY
Mr. BoswoRTH. Mr. Chairman, I have a prepared statement,
which I thought I would submit for the record.
The CHAIRMAN. Fine. Without objection, we will include it in the
record.
Mr. BOSWORTH. In my opening remarks I will try not to filibuster
but summarize. In terms of examining where we are, I'd like to
take the committee through a couple of tables attached to the end
of my testimony and try to summarize the inflation situation at
present.
The first table looks at alternative measures of price inflation
and what has been happening. And through the first 5 months of
this year, the rate of increase of consumer prices has now hit a full
10 percent annual rate of inflation.
But while that is extremely discouraging, and obviously in the
opposite direction from where we want to go, there are some special factors about it that should be taken into account.
First, the annual rate of increase in food prices has been 19
percent. As best as we can determine, but realizing the tremendous
uncertainty associated with any forecast of food prices, we believe
that nearly all of the food price inflation for this year should be
behind us. We may see a fairly significant increase in June, but the
second half of the year many sectors of the food industry give hope
of price declines.
The next category, energy, has been rising at about 7½ percent
annual rate. Compared to earlier periods, energy prices have not
been a major source of accelerating inflation in the first 6 months
of this year. But there are a couple of other items that have
contributed heavily to the apparent acceleration of the inflation,
and yet are somewhat unrelated to the basic underlying economy.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
47
First, in the housing area there has been an enormous acceleration for home financing, insurance, and taxes on new homes; it's
rising at almost 20 percent annual rate of increase, even higher
than food prices.
Second, another component of consumer prices, is used-car
prices, which have historically fluctuated widely from month to
month and can sometimes distort the underlying trends.
If we exclude those four somewhat special items and focus on
what is happening in the industrial sector of the ~conomy, it is
apparent that the Consumer Price Index for other items shows an
acceleration of the rate of inflation of about 6¾ percent through
the first 5 months of the year. So there has been a worsening of the
inflation, but not quite of the magnitude suggested by the 10 percent annual rate of increase.
In addition, we put into the table for your information some of
the sectors where price increases have been particularly dramatic.
The housing sector shows over a 10 percent annual rate of price
increase in the first 5 months. Medical care prices have continued
to run high, although they have slowed slightly in the rate of
increase compared to last year. The private sector is attempting to
establish a voluntary cost containment program for hospitals.
There seems to have been some progress and some results from
that program at present, at least in the sense that the rate of
medical care inflation has leveled out and has not accelerated to
the same extent that other components have.
Another interesting thing about the food price inflation this year
is that last year we had a very rapid rate of food price increase as
well, 8 percent. But that 8 percent inflation last year was heavily
composed of imported food items, beverages, coffee, and tea. This
year, imported food item prices are declining, and they have been a
major source of stability for overall consumer prices. Unfortunately, the prices of domestically produced farm products have accelerated enormously, so overall prices are up about 19 percent. The
retail value of domestically produced farm products is rising at 23
percent of the annual rate of inflation. That is comparable to the
rates of increase in 1972 at the same time.
If you look at the farm value of those same commodities, with
the same weights that are used in the Consumer Price Index, you
see that at the farm level those prices are rising at an annual rate
of 50 percent. Obviously, we do not expect that rate of inflation to
continue, nor do we believe it can possibly continue. We believe
that farm prices will level out over the remainder of the year
despite all the talk about rising food margins and the middlemen.
I would also like to point out that the marketing margins of the
farm retail price spread is rising at about 7½ percent a year,
almost exactly in line with the overall rate of inflation. That has
been true for the last 10 years; the comment that the source of the
rising food price inflation in this country is a very rapid increase in
food margins is misleading. The farmer's share of the consumer
food dollar has been absolutely constant over the last two or three
decades. Of course, if you go back to a period like 1973, the farmers
share went up because farm prices went up so dramatically. But
the long-term trend will find that the farm value of food prices
rises in step with the general rate of inflation, as do the marketing
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
48
margins, and the distribution between marketing margins and
farm prices has been almost constant.
The recent food price acceleration can be traced to farm prices,
and not acceleration of the middlemen margins.
The Wholesale Price Index over the first 6 months of this year
tells us about the same story. The overall rate of inflation is near
10 percent, but if you look at the prices in the industrial sector, the
rate of inflation shows obvious acceleration from the 6-percent
average of the last 2 years but not quite of the magnitude that
would be suggested by 10 percent; it's a range of about a percentage rate of acceleration. If we project this forward, trying to be
optimistic about a substantial moderation of food prices, it is possible to hold the rate of overall consumer price increases for the year
to about 7 percent. But it is obvious that if you just count up the
magnitude of the changes, if you average 10 percent for the first
half of the year and want to get to 7 percent for the year as a
whole, you have to have very low rates of price increase for the
second half of the year.
While I think it is possible, because food prices have contributed
so much to the first half of the year, it is still optimistic and it will
not be easy to realize. It certainly implies more voluntary support
and effort than we have had so far.
The second table looks at employment costs in the economy.
There you will find that basically the same trend is occurring; we
are getting a gradual acceleration in the first half of the year.
About the best short-term measure we have of wage trends in the
economy is the average hourly earnings index. While those wage
increases have been in the magnitude of about 7 percent a year, in
the first 6 months of this year they have accelerated to an annual
rate of wage increase of about 8 percent.
If we add on social security tax increases and increases in private
fringe benefits, for the first half of the year you would get rates of
increase in employment cost between 9 and 10 percent. So there
has been a worsening of the inflation situation on the wage side as
well as on the price side.
One interesting statistic, which I am not too sure of how to
interpret, shows that if you look at the average hourly earnings
since January, after the minimum wage increase, the rate of wage
increase has been only 6½ percent; this is a major moderation of
the rate of wage inflation in this country. It is surprising to me,
because I can't readily explain why the numbers show a big deceleration. It appears to be mainly in the services sector-Mr. FRASER. Could you go over that once more?
Mr. BoswoRTH. Yes; in January, there was an 18-percent increase in the minimum wage. Instead of taking the change shown
in the table between December and June, at an annual rate which
was 8.3 percent, if we instead take the rate of wage change since
January, after the minimum wage increase, the average rate of
wage inflation has been only about 6½ percent. That is sharply
below the average of the last 2 years.
If you try to explain why, by looking at the individual sectors of
the economy, you find that almost all of that wage deceleration is
concentrated in the service sector of the economy. There has been
no major moderation, for example, in manufacturing, contract con-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
49
struction, and mining. All show substantial acceleration in the rate
of wage increase.
I am not sure why the service sector numbers show up that way.
I think one cautionary factor is that this is one area where the
Government data is very bad. So I am not sure I believe it. But if it
is true, it is a very optimistic sign.
You would be more impressed with the aggregate number if it
were reflected in more sectors. The difficulty is that it is mainly in
services, and therefore I am doubtful that it represents a lasting
trend for the rest of the year.
So I continue to believe that for the economy as a whole, the best
data we have suggests that there has been an acceleration of the
rate of wage increase. Certainly there has been acceleration of the
rate of wage increase in the basic industrial sector of manufacturing, contract construction, and mining.
If you look at what has actually happened this year, both on the
wage side and on the price side, you will see that we have made
absolutely no progress in beginning to moderate inflation. Moreover, it appears to be worsening; at least for 2 years before we had
held inflation to 6 percent, it had stabilized, and we hoped to work
it down. Mainly because of the destructive effects of the food price
inflation, the economy is now headed in the opposite direction. The
best outcome for the year as a whole would appear to be 7 percent.
We have to admit that inflation is worsening, not improving.
There are three parts to the anti-inflation program that the
administration has proposed to try to deal with, and I will summarize briefly where I think it stands.
First I think we have to admit and identify Government actions
as a major inflationary factor in the economy. In 1978 we had the
social security tax increase, the minimum wage increase, and the
increase in unemployment insurance tax rate. These increases
themselves added about three-quarters of 1 percent to the inflation
rate. Our own less reliable estimates indicate that in terms of the
measured rate of price inflation, Federal regulatory activities are
adding about another three-quarters of 1 percentage point.
Since April there has been a major change both on the part of
the administration and the Congress in taking a much harder line
toward some of the individual proposals that would have an inflationary impact. The farm bill did not go through as proposed. The
modified version of it had orily a very modest impact on inflation.
The President's action to increase meat imports has at least broken
the speculative boom that had gotten going in meat prices and has
stabilized them a little bit.
Several actions have been taken by the administration and the
Congress which .indicates that the Government is finally beginning
to face up to and take a stronger stance against its own inflationary actions. Because of that, we are encouraged in terms of the
inflation outlook in the next year or two.
· In 1979, even if one assumes there is an oil import tax or a crude
oil tax of one form or another, Government contributions to inflation will be less than they were in 1978. In the regulatory area, we
have made some progress in getting the regulatory agencies to
begin to review the economic impact of their regulations, to realize
that although many of these regulations are desirable, they are not
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
50
free. There is a cost associated with them, and there is a limited
amount of resources to spend on them. There is now a requirement
that every regulatory agency must do an economic analysis of its
regulations, and I think that has been helpful. Within the administration there is a regulatory review group to assure that those
regulatory analyses are reflected in actual regulations and get
incorporated into the decisionmaking.
The general deceleration objective for business prices is that an
individual, industry-by-industry basis we have asked them to try to
limit their price increases significantly below the average of the
last 2 years. Business has given us general verbal support. In terms
of actual results, however, if you look at the first half of the year,
you see that the trend of prices is not consistent with that voiced
support.
We have talked to many individual firms about the outlook for
prices in their industries, and they all tell us the second half of the
year will be much better than the first half. We certainly wanted
to get out of the nickel-and-dime business, where businesses used to
come in with separate price increases and say they wanted 6, and
we said too much, and we compromised on 5. So we have gone to
the year as a whole and have not yet been able to comment very
effectively on price increases to date.
As the last half of the year goes on, we will have to emphasize
more strongly to the individual firms the importance of achieving
the deceleration objective. So, in the last half of the year, I would
expect that the Council will become more actively involved in
prices in individual situations.
But, as I said earlier, we have not seen any evidence of a deceleration of the rate of price increases in the first half of the year. If it
is going to occur, it will occur in the second half.
I think it is fair to characterize our progress so far on the labor
side as zero, at least in terms of trying to get acceptance for a
general concept of what is meant by noninflationary wage behavior. We haven't yet been able to propose a way to deal with wages
and to hapdle labor contracts that has received any support from
organized labor. I think that remains the biggest difficulty of the
anti-inflation program.
It is almost impossible, for example, to talk about moderation of
the average worker's wage increases, who has been receiving 7 to 8
percent, when he can look about him and see some very prominent
and public unions whose workers have been and are continuing to
receive 10 percent annual rates of wage increase.
It is absolutely necessary to have labor's cooperation if we are
going to slow down inflation.
Therefore, that program first has to be made credible; the people
who have been getting the largest increases must begin to come
down back in line with the rest of the economy. So far, we have
made no progress in trying to achieve that. That is evident with
respect to the coal settlement, and I think it will be evident with
respect to the railroad settlement.
I understand the difficulties there. They have 3-year labor contracts. They are being asked to put faith in an anti-inflation program they have no confidence in, to believe that, in fact, prices will
decelerate. I however, also remind you that the major contracts we
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
51
are dealing with contain cost-of-living escalator provisions. It is not
true that workers are being asked to exercise wage restraint with
no assurances that prices will come down in step. They will get
wage increases in line with the price increases over the next 3
years of the contracts by the automatic provision of the cost-ofliving escalators. But we continue to search for some formula or
approach on the labor side that could be effective.
As I said earlier, on the business side, there has been acceptance
in a verbal sense. We've heard a lot of words and a lot of pledges.
It will remain to be seen over the last half of the year whether, in
fact, those words will be translated into any effective actions.
Therefore, I think we have to report that the inflation situation
is not as bad as it appears by just looking at the first 5 months. It
is way too early to give up on the voluntary program and say there
isn't a way to try to induce people voluntarily to cooperate and
decelerate. The administration has only pursued it vigorously for
the last couple of months. At the same time, the present trends
don't give you a great deal of optimism.
Thank you, Mr. Chairman.
[Testimony resumes on p. 56.]
[The prepared statement of Mr. Bosworth follows:]
PREPARED STATEMENT OF BARRY P. BOSWORTH
Mr. Chairman and members of the committee, it is a pleasure to appear before
you today. I do indeed wish I had some good news to offer. Unhappily, this is not the
case. The latest inflation indices speak for themselves. I have attached some tables
indicative of recent inflation trends.
I do think, however, that the picture is not quite as bleak as the cold figures
indicate. They show inflation running at an annual rate of about 10 percent. I
believe when the year ends it will be at a rate of about 7 percent. That certainly is
not something that gladdens the heart. But neither is it cause for panic. We are not
heading pellmell into double-digit inflation rates.
Most of the increases we have been experiencing during the past few months have
come from food. We expect those prices to moderate sharply in the next few months.
We already are seeing a decline in fresh vegetable prices after the effects of the
bitter winter and record rains in California; and the large increases in meat prices
are behind us, with a more stable level of prices for the remainder of the year. Food
price inflation should slow sharply in the second half of the year.
Beyond the second half of this year the outlook is far less certain. Much depends
on the effectiveness of our efforts to reduce the rate of inflation.
We do have an anti-inflation program in place with stated objectives for each
major sector of the economy. I know there is criticism that it has not so far
produced any tangible results and that there remains a good deal of skepticism
about its voluntary nature. But let me be perfectly candid. We did not expect the
decelertion program to produce immediate improvement in a situation that has
worsened for more than a decade. We have not sought a quick fix. The objective is
to get a gradual but sustained improvement over the next few years. The multiyear
nature of many of our wage and price contracts does not make it feasible for a
voluntary program to achieve dramatic results in a short time period. I will grant
you that in recent months the rate of inflation has worsened when we hoped it
would improve.
But I believe it is too early to conclude that this Nation cannot solve its inflation
problems through cooperative efforts or that we must again resort to fighting
inflation by throwing people out of work. The President announced the concept of
the deceleration effort last January and then further implemented it with a number
of positive steps of which you are all aware in April.
Our first priority was to explain to business, labor and various branches of the
Federal Government what it is we are trying to do and then convince these groups
that the program is a credible one that requires their support. It is true that there
are still a good number of skeptics. It is up to us to convince them that the program
is both equitable and vital if we are to avoid sinking into a recession.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
52
The Council on Wage and Price Stability for the past several months has been
meeting regularly with individual groups to review inflationary conditions in their
industries and solicit their support. A number of industries and individual firms
believe that they can achieve the deceleration objective of holding their 1978 price
increases below the average of the last 2 years. A number have committed themselves as well to hold down executive compensation. I will readily admit that none
of this has been translated into a slower rate of inflation. But I do believe that we
are beginning to achieve the first steps of an effective national effort to reduce
inflation.
There has been considerable criticism about the voluntary approach to reducing
the rate of inflation. Some of that criticism is well founded. But let's look at the
options available.
A lot of people say if you balance the budget it would end inflation. Others argue
that we could end this inflation by reducing the rate of money supply growth.
The advocates of both these positions are absolutely correct. You could reduce the
amount of fiscal stimulus to the point that inflation would end. You could hold
down the money supply growth to achieve the very same result. But let's be honest
about what we are talking about. Since no businessman sets prices by the size of the
budget deficit and no one demands wage increases because they feel the money
supply is rising too fast, what we really mean is cut Government spending, cut
production, throw a few million more people out of work and maybe they will quit
asking for wage increases.
I agree that we could end inflation by this old-fashioned demand restraint. But
let's not fool ourselves. The price, in terms of human costs, would be enormously
high. The best economic estimates are that it would take an additional 1 million
unemployed for 2 years just to bring down the rate of inflation 1 percentage point.
In my opinion, that is an unacceptable price tag. We do not have an inflation by
excess demand and it cannot be halted by creating an even larger pool of the
unemployed.
There was a time when just a little aggregate demand restraint applied through
fiscal or monetary policy achieved results. But this is no longer true. We have
undergone a number of structural changes in our economy-such as the reduction
of competition both in labor and in pricing markets and the growth of Government
involvement-that have markedly altered our options. The use of the fear of unemployment and lost sales as incentives to hold down wage and price increases has
become relatively ineffective for several major sectors of the economy.
At the other extreme, of course, we have wage and price controls. But they are
simply not applicable to the kind of inflation we have today. Controls are short-term
solutions to emergency situations. This is not what we have. Inflation has been a
problem for us and all other industrial democratic nations for several decades. The
use of controls or a sustained basis would cause distortions and inequities and would
not address the fundamental structural problems. The administration has said
repeatedly and emphatically that it rejects this approach. One very basic reason is
that we just don't know how to operate controls. There are millions of prices in this
country and when you try to set them from Washington, you inevitably make
serious mistakes that ultimately lead to bottlenecks and distortions. And when you
try ~o set wage rates in Washington I think you run the risk of creating basic
changes in our political structure. The political activity of labor and business would
concentrate primarily on persuading the Government to approve their higher wages
and prices.
In between these two extremes there is very little left. We have been looking at
some new incentive ideas that are loosely lumped together as Tax Incentive Plans. I
believe that these options should be fully explored because they appear to address
the problem of insufficient incentives for the individual firm and worker to exercise
restraint in their wage and price decisions. But, there are serious administrative
problems. The idea certainly is well worth exploring. Significant progress has been
made in identifying and solving these problems; but, we do not yet have a version of
such an incentive approach that is a viable option.
At present we have identified the major areas in which our anti-inflation efforts
will need to concentrate and we have tried to develop for both business and labor
reasonable guidelines for noninflationary wage and price decisions.
The program has four major parts. First, the administration recognizes that the
Federal Government itself is an important contributor to inflation.
The administration is committed to working with Congress to maintain a responsible longrun budgetary policy that balances concern for sustained economic growth
with a determination to avoid excessive surges in aggregate demand relative to
supply. The President has reduced the size of the proposed tax cut to avoid excessive
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
53
demand stimulation and has indicatd that he will veto budget bills that exceed his
requested levels.
In other areas the President has strengthened the review and analysis of the
Government regulatory process in an attempt to simplify regulations and assure
that their objectives are achieved in the most cost-effective manner. It is reliably
estimated that Government regulations add about three-quarters of 1 percent annually to the rate of inflation.
The President as well has frozen the salaries of the White House senior staff and
has recommended a 5.5-percent ceiling on this year's Federal white collar pay raise.
He has ordered the executive branch to reduce where possible the purchases of
goods and services where prices are rising rapidly.
·
But while the Federal Government must do its share, it alone cannot solve the
problem. Cooperation of the private sector is vitally needed.
The anti-inflation program is based on the premise that deceleration must be
achieved in every market. To achieve this goal individual industries are being asked
to limit price increases to less than the average over the last 2 years. The objective,
as well, is to assure that there is no widening to profit margins. Several individual
firms already have pledged to meet this deceleration target and we are continuing a
full schedule of meetings to persuade others to do the same. In this effort I am
working closely with Robert Strauss, the President's special counselor for inflation.
We adopted a guideline for price behavior that refers to the cumulative magnitude of price increases for the year 1978 as a whole in order to avoid encouraging a
multitude of small price increases for which we did not have resources for analysis,
and to encourage firms to be responsible for their own cost increases rather than
accepting a passthrough of costs as adequate justification for price increases.
One consequence of that policy has been that we have not had a basis on which to
comment with respect to many pricing actions in the first half of the year. During
the next 6 months, however, many industries will be approaching the deceleration
target that we expect them to meet. I anticipate that we will need to expand the
Council's activities in that area over the next few months. On the basis of price
developments through June, for example, we have begun a process of contacting
these firms in industries with price increases approaching the deceleration objective
to inquire as to what actions they contemplate taking during the remainder of the
year in order to achieve the objective. If they cannot do so, we would like to obtain a
detailed explanation of the factors responsible for accelerating inflation in this
industry.
The third part of the program involves gaining labor support. a moderation of
prices can only be sustained if there is an equal reduction in the magnitude of
average wage increases.
Quite candidly we have not succeeded in obtaining the full support of groups.
Realistically a lot of the blame for this should probably fall on my shoulders.
Perhaps I did not explain the labor side of the program well enough and did not
address myself adequately to some special problems labor has with a voluntary
program.
It is a lot easier for business to make a price commitment than it is for labor to
make a wage commitment. If inflation fails to moderate, businessmen can simply
pull out any time and raise prices. But labor contracts are in effect for 2 or 3 years.
So there has to be an understanding that the workingman will be protected if the
cost of living continues to rise.
But, I think there are equitable means of handling this problem. Many major
labor agreements contain cost of living escalator provisions alternatively, they could
choose to negotiate shorter term contracts or to inclµde provisions for annual wage
reopeners. But our problem has been that, in the name of protection against
inflation, some labor groups have obtained wage increases far in excess of the
average American worker. These increases also exceed productivity gains plus increases in the cost of living. We cannot continue this trend toward a dual labor
market where the wages of one group rise far more rapidly than those of the
average worker. Nor can we ask the average worker to participate in the antiinflation effort by restraining his wage increases when the gains of others are so
much greater.
Both on the labor side and the price side the voluntary deceleration program
provides for flexibility to meet specific problems and situations. This is what distinguishes it from a rigid guidepost approach. The program expects more from those
industries and those workers who have done very well in recent years. And it
understands that it will have to accept less from those who have done poorly.
We recognize, for instance, that firms that lowered their price-cost margins
during the recession will experience a rise in those margins as demand strengthens.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
54
The program is not designed to penalize those firms who have in the past varied
prices in response to market conditions. By the same token there should be flexibility to allow for uncontrollable mandated costs from Government programs such as
payroll tax increases, regulatory actions, tax changes and imported raw materials.
On the other side, it is indeed true that the average American worker has not
fared well because of inflation. This does not apply, however, to those workers in
the central industrial core of our society. They have been receiving gains of about 10
percent annually. If we are really going to do anything about inflation, these groups
must begin to moderate their gains and bring them back in line with the 7-percent
average of the rest of the economy.
The final part of the program deals with those sections of the economy that
present special inflation problems. These include medical care, food, transportation,
and housing. In general the rate of price increases in these sectors has consistently
exceeded the economywide average.
There is before Congress a hospital cost containment bill that was designed to
provide significant relief in this area. Congress has not acted on it. Recently the
Council on Wage and Price Stability met with representatives from the American
Medical Association in an effort to persuade individual doctors to hold down their
rate of fee increase, which has been accelerating much faster than the general rate
of inflation.
I think it is equally essential that we defeat proposed legislation that would
sharply raise the raw U.S. sugar price. Anything more than what the administration has proposed is simply unnecessary to protect domestic producers.
In recent months a significant number of actions have been taken to moderate
inflationary pressures. These include the expansion of meat imports and directing
Federal procurement programs to avoid the purchase of goods and services whose
prices are rising rapidly, and limiting the automatic escalation of procurement
contracts.
The administration will continue to search for ways to reduce the Government's
contribution to inflation.
But in the final analysis it is up to business and labor, working with the Government, to find ways to reduce the rate of both wage and price increases.
No one is asking for any great sacrifice. But, realistically, an effective effort will
require that everyone give a little.
But if we fail to begin this downward process, the consequences seem quite
apparent. The Federal Reserve will refuse to continue to finance the economic
expansion. We will find ourselves again in a recession-and with very little likelihood that it will significantly ease the pains of inflation.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
55
ALTERNATIVE MEASURES OF PRICE INFLATION
Dec. 1977
Annual changes 1
relative
importance - - - - - - - Percent change
(percentage)
1977 year to date 2
1976
Consumer Price Index: 3
All items ........................................................................................ .
Food ...................................................................................... .
Energy ................................................................................... .
Home finance, insurance, and taxes ..................................... .
Used cars ...............................................................................
Other items .....................................................................................
High inflation components:
~:~~f care·:::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::::
100.0
17.7
8.6
9.2
3.0
61.5
.6
6.9
1.6
19.0
6.1
6.8
8.0
7.2
11.2
-4.1
6.2
10.0
18.7
7.4
19.3
14.0
6.7
43.9
5.0
17.7
5.4
10.1
.6
7.6
8.8
8.0
10.8
8.7
18.7
6.1
-.9
8.0
8.0
11.6
22.1
-3.2
-10.6
2.1
15.9
5.1
4.3
5.6
25.7
23.0
50.9
7.5
3.3
6.4
2.1
4.9
6.4
13.5
6.6
7.2
6.4
6.1
6.4
11.4
10.5
8.3
11.1
7.9
7.7
14.0
4.8
Food ............................................................................................... .
Consumer food:
Prices:
Away from home ................................................................. ..
5.5
At home ................................................................................ .
12.2
Domestically produced farm food: •
Retail value .............................................................................................................
Farm value ..............................................................................................................
Farm-retail margin ................................................................................................ .
Imported food ..................................................................................................................
Wholesale Price Index:
Finished goods .................................,..............................................
41.2
Producer ................................................................................
12.2
Consumer ...............................................................................
29.0
Consumer less food ................................................................
18.7
Intermediate less food .....................................................................
45.5
Crude less food ...............................................................................
4.0
N.A.
December over December of prior year.
CPI figures show December to May changes, WPI figures show December to June changes. All figures are seasonally adjusted at
annual rates.
3
CPI for all urban consumers.
• Domestically produced farm food comprises 100 percent of consumer food at home. Relative importance of the components of this
group are: Retail food (100 percent) , farm value (41 percent) , and farm-retail margin (59 percent) .
Source: U.S. Department of Labor and U.S. Department of Agriculture.
1
2
ALTERNATIVE MEASURES OF EMPLOYMENT COST
Average annual
percentage change
Private nonfarm sector:
Average hourly earnings ...................................
Hourly earnings index ......................................
1967-77
1976-77 1
December 1977June 1978 2
June 1977June 1978
6.9
7.1
7.6
7.2
9.4
8.3
8.4
8.2
1967-77
1976-77 I
1977: IV1978: 12
1977: I1978: I
7.7
1.6
6.0
8.9
3.0
5.7
13.2
-3.3
17.0
9.1
.9
8.2
.8
.3
2.9
2.2
.0
-11.9
1.4
1.9
Average annual
percentage change
Hourly Compensation (all persons) .......................... .
Labor productivity .................................................... .
Unit labor costs ...................................................... ..
Real wages:
Average hourly earnings .................................. .
Real spendable earnings 3 ••••••• ••••••••••••••••• ••• ••••
Average annual percentage change 1975: IV to 1977: IV.
Seasonally adjusted at annual rates.
Real spendable weekly earnings of a worker with 3 dependents.
Source: Bureau of Labor Statistics.
1
2
3
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
56
The CHAIRMAN. Why do food prices go up during the first half of
the year and seem to go down during the second, and what is the
impact of the farm bill that we passed last year on higher food
prices?
·
Mr. BoswoRTH. The major reason is that we have seen extremely
bad winters in the last 2 years.
The CHAIRMAN. Is that a phenomenon of just the last 2 years?
Mr. BoswoRTH. Yes, the weather has been a lot worse than
usual, which triggered some price increases. There has also been a
speculative element in a lot of the agricultural commodity markets,
and once something like that gets started, there is a tendency for it
to get exaggerated. We saw that in the meat market, when pork
production was less than expected during the winter months, prices
went up. That touched off a general movement within the meat
markets and prices soared for a period of time.
Then last month, they finally broke. Beef prices in particular fell
dramatically, and in the last couple of weeks have been edging
their way up again. We had, and still have, an agricultural situation we are only gradually working our way out of.
There were no grain reserves available, so everything depended
on the weather. The moment someone heard a rumor of a bad
storm in the West, they said, "Grain shortage" and prices skyrocketed. Whereas in the 1960's, no one cared, because we had a large
grain reserve to stabilize the market.
We are now rebuilding that grain reserve, but it is still at a
marginal level. We could take 1 year's crop failure, but it would
put us in pretty desperate straits. Over the next couple of years, if
we continue a policy of building up the grain reserves and providing more protection against the severe weather, I think that
market will begin to stabilize.
As important as food prices are, it is a little silly, in my view, to
run an economy as we have, and leave food prices to be determined
by the weather, when it is completely unnecessary. If you have
grain reserves you can smooth the fluctuations out.
The CHAIRMAN. That holds true for grains. What percentage of
the total food picture would that be?
Mr. BOSWORTH. Grains would be a small element on consumer
prices, but as an underlying foundation, they build producer expectations in the meat and dairy sectors of the industry. They are very
important. When the beef, pork, and chicken producers never know
what feed grain prices are going to be from one day to the next,
they are not about to expand production.
I think, for example, that one of the explanations for the pork
situation, where supplies have not expanded even though we expected them to, is not the weather; it was the continual debate in
the Congress last fall about raising or not raising corn support
prices. That created a lot of uncertainty among pork producers.
They didn't know what was going to happen to the prices; so they
held back production.
We kept telling them that now it is a profitable situation, which
is true, but it wouldn't be if corn prices went up. The uncertainty
for many months surrounding that debate did contribute to some
increases in prices.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
57
However, I think the fundamental problem has been beef prices,
and that was the price you were going to pay. It has a legacy going
back to 1973 and 1974, when those grain prices first went up,
getting the whole production cycle out of phase. They have been
slaughtering off the herds ever since. Sooner or later, that had to
end, and when it did, a reduced amount of meat would come to the
market while they rebuilt the herd.
In the first part of this year that appears to have happened.
Second, for reasons we don't fully understand, there was a strong
growth in consumer demand for meat products in the early part of
this year and the last part of last year.
Now the meat demand seems to have leveled out; at least it is
not rising as dramatically. But I do think the long-term solution is
grain reserves. They are fundamental reasons that food prices fluctuate in the short run on the basis of random events. If you had
that grain reserve, these little developments wouldn't affect anything. They wouldn't change people's expectations. But it is now a
market very dependent on people's expectations, both on the part
of the producers and on the part of the purchasers.
Outside that area, the rest of it is weather. It was a bad
winter in California, and the fruit and vegetable crop was cut
significantly.
The CHAIRMAN. The increases that you mentioned in housing,
real estate, how significant a role do they play in the inflationary
increases,. and what can we do in that area to bring them under
some sort of control or restriction?
Mr. BoswoRTH. People have identified food, housing, and medical
care as the three particular problem areas. Of those, housing is the
largest. It has the largest weight in the Consumer Price Index.
Medical care is a problem, but in terms of overall inflation it has a
small weight, perhaps 4 percent of the overall Consumer Price
Index.
There are just a multitude of problems in the housing area.
There are difficulties at almost every stage of the process you can
look at. First, take the level of raw materials. We continually use
monetary policy to put the brakes on or take them off of the
overall economy. The brunt of that policy falls on the housing
industry, and it looks like a roller coaster over the last decade.
Every time we have a monetary crunch, we destroy capacity in the
basic materials part of the housing industry, and then we turn
around and want easy monetary policy and expansion and overstimulate and run out of the raw material prices, and they soar.
That is what happened last year.
This year, as the year goes on, you will find a dramatic drop in
raw material prices. There are exceptions to that, of course. In
timber, for example, we have run i'.nto a lot of environmental
difficulties. We do not want to cut the national forest because of
the environmental concerns. At the same time, we say we want
cheap and affordable housing for Americans.
The price of lumber is one of the largest elements in the cost of
building a home, and it has been increasing at tremendous rates.
That's because we can't resolve those public policy issues. How are
we going to tradeoff what we want in increased timber for houses
and environmental concerns? Is there a better way of balancing it?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
58
So, in that one instance anyway, I think environmental concerns
have been a problem.
The brick industry and the glass industry were both heavily
disrupted by the fuel crisis of 1974. When you turn to the rest of
the housing industry, you find that labor costs have not been a
problem. There have been moderate rates of increase in labor costs,
but it is a declining portion of the cost of the house.
One problem that remains is financing charges, which are going
up enormously. That is happening mainly because of the overall
inflation and the fact that the Federal Reserve uses monetary
policy as a way to fight that inflation, which drives up interest
rates. To stay competitive, mortgage rates are driven up.
For decades prior to the 1970's we were able to offset increases in
mortgage interest rates by a gradual easing of the terms of mortgage contracts. We lengthened out the time period over which you
paid it. We allowed a bigger proportion to be lent. Those tended to
offset increases in interest rates, and so financing costs for a home
declined as the industry evolved.
Now we have gone about as far as we can go. We have mortgages
up to about 90 percent of the value of a house. The term of the
loan is out there as far as it can be. If you look at people's first 2 or
3 years' payment for a mortgage, 99 percent of it is interest. There
is not much more you can do about liberalizing and postponing the
day you pay off the principal. You can't have interest payments
that are 110 percent of the monthly payment. It won't work. You
would have a rising mortgage value over time. So, because of
inflation and because monetary policy has been the primary
weapon against it, mortgage interest rates have gone up dramatically.
The third problem area is site costs. There has been an explosion
in the cost of a site for a home. There are many reasons for that.
Local zoning practices are probably the biggest contributor to it. A
couple of decades ago, people used to build their home only, not
paying for streets, sidewalks, sewers, or street lights. All that
would be paid for by the community out of general taxes. The city
put them in and your deal was they paid for yours, and in future
years you paid for somebody else's out of your taxes.
Nowadays, we don't finance housing that way. Those of us who
owned the houses said, "Enough of that. I don't like that any
more," and we have forced new home buyers to put all their money
up front. Now they have to have the street, their sidewalk and
sewer before they can build their house. So the rest of us bought
houses years ago and benefited from the old deal, and then we
canceled it. We have thus piled up those costs of site development
in the price of the house. The developer has to do it now, and he
puts the cost up front erecisely when most people are ill prepared
to pay for it. They don t have a lot of money at the time they buy
the house. That made the purchase price go up rapidly.
In many cases, Washington, D.C., for example, communities don't
want low-income groups in, so they require very large-sized lots.
They don't let mobile homes in. By eliminating the cheaper form of
housing, we forced an upgrading of housing, creating shortages of
the lower cost, more affordable housing that the average American
could buy. A lot of that is associated with local zoning law changes
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
59
and what we required. Some were for environmental reasons, but
other ones because we wanted to maintain a certain type of community. And it has become much more costly than it was before.
Behind that there is also a sewer moratorium in many parts of
the country which creates shortages of housing. One of the interesting things about it is that the housing price problem is, in a
sense, a regional problem. When you look around the country as a
whole, you find many regions that have very modest rates of housing inflation. The rates of price increase are not dramatic in the
Midwest or in the South. They are less than the overall Consumer
Price Index.
The problem with housing lies in the major metropolitan areas
like Washington, D.C., and Los Angeles. There has been enormous
speculative increases, and that affects the national average that
goes in the Consumer Price Index.
But the notion of expensive housing, in a sense, depends on
where you live. Some parts of the country have not had this
difficulty. Where land has not become a short commodity, home
price increases have been less than the rate of overall inflation.
The CHAIRMAN. Under the administration's policy of voluntary
action against inflation, what do you propose in this area, real
estate and housing?
Mr. BoswoRTH. The Department of Housing and Urban Development just completed recommendations that tried to identify what
were the factors responsible for housing price inflation. This task
force was made up of Government builders, consumers, and others.
They identified, as I recall, over 100 items, some of them minor,
some major.
They are now trying to see how many of those they can implement. One example of things that you could do is to put forth a
model national building code. That is a local issue, but if the
Federal Government proposed the outline of what one should look
like, maybe more local communities would adopt it. Building codes
can make substantial cost savings possible.
The same thing is true of zoning ordinances. At the financing
level, however there is not a great deal you can do without subsidizing housing, and subsidies have not worked very effectively in
the past.
There the problem is to solve the overall inflation. Their interest
rates would come down and housing costs wouldn't go up as rapidly. In commodities and materials we have largely been unsuccessful. I am afraid there will be another crunch in the housing industry over the next year and production will again go down, and that
will postpone the expansion that is needed in the supply side of the
industry. For example the cement industry has finally gotten back
to a profitable situation, a situation where normally we begin to
look for some expansion of capacity. Well, already an economic
downturn has begun, and you wonder if that will keep going.
We tried to do something about a Federal timber policy. That
was too complicated an area with too many conflicts of interest,
and I don't think we are going to produce anything that is very
effective.
The CHAIRMAN. Thank you. Mr. Fraser.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
60
Mr. FRASER. I was struck by ,the candid nature of your remarks.
You suggested we would be lucky if we ended up with 7 percent.
Mr. BoswoRTH. I have learned to be a little pessimistic on the 6
months.
Mr. FRASER. On the whole, things aren't working very well. That
is what I get from your statement. You pose two choices in your
statement. You said that on the one hand we can go back to the, I
hope, discredited policy of throwing people out of work as a means
of reducing demand and bringing down inflationary pressures. On
the other, you said we can go to wage/price controls and all the
difficulties of Washington making the price and wage decisions.
You talked about TIP, but said so far there isn't a feasible
formulation at this time. How bad does inflation have to get before
we do something more than we are doing now?
Mr. BoswoRTH. Well, I hope it doesn't have to get a lot worse.
One answer is to look at Great Britain. There is a point where you
can push a country; the inflation situation deteriorates so far that
finally people look over the edge; they don't like what they see, and
they are willing to pull back.
They have done it largely with a voluntary program. They have
been enormously successful. They had a 25-percent rate of inflation, and now it is lower than ours. They did it in about a 2-year
period. In this country the general public attitude is one of upset,
but I don't think we are past the point of poking fingers at each
other. We still continue to look for a villain, for the simple answer,
like balancing the budget, or something like that.
I will tell you what the correlation between inflation and the
budget deficit is-zero. There isn't any. You look back over the
post-war period, and see that they don't balance out at all.
In our efforts to try to get a voluntary program going, we still
haven't gotten to that stage of looking over the edge. We still have
problems, and labor is symptomatic of them. They don't believe
others are going to go along, and we continue to look for a formula
or means by which we can try to convince them other people will
cooperate. It is a problem of getting momentum going. If you
started to show success, people would have a little more faith, and
it would tend to build on itself. But how do you get it started?
Mr. FRASER. Do you have a responsibility for developing a feasible TIP program?
Mr. BoswoRTH. Yes. We have spent a lot of time over the last
year looking at different types of approaches and trying to see
what could be done. There are two problems at present that we are
stuck on. One is the administrative problem. If you try to run a
TIP program, which is an incentive, you are going to give a tax cut,
and that suggests you have to give it to everybody. You can't
exclude people from the program.
But in order to measure people's wage change, you need the
same administrative machinery as you had for controls. And administratively it is very complicated. You are going to give money
away on the basis of determining people's wage increase, so you
have to figure it out. It is not easy to measure people's wage
increases on an individual basis.
I think we have determined that it is impossible to do on the
price side. The problems of trying to construct price indexes for
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
61
little individual companies are just too much. Look at the corner
grocery store. There are a couple of thousand items in one man's
operation. It just is not feasible on the price side. If we were to
limit it to just a few companies where the administrative problems
were more solvable, we would have to exclude a lot of people.
The only way I know how to do that is make it a penalty system.
Nobody wants to be included in a penalty system if they don't have
to, so it would be easy to get people to volunteer to keep out of it.
You could focus on the major industries or something like that.
The difficulty there is if they don't respond to the tax incentive,
if it doesn't lead them to reduce the magnitude of the wage increases, for example, then it simply adds to the inflation. They give
the same wage increase as before, we fax them, and that is just
another cost increase on top of that wage increase, and they would
pass it through.
In other words, if the system did not work, it could make things
worse. There have been a lot of administrative problems. We have
found some ways to minimize those, about how to define employee
groups and the like, and so within the voluntary program we are
getting close to having a version whose administrative problems
look resolvable.
The next question that comes up is if anybody would really pay
any attention to it. I may be wrong, but I think the first test of
really doing something on the wage side in this country is to get
the major, very large increases back in line. By this I mean the
basic industrial core, the teamsters, auto, and steel workers, whose
wages have been far above average.
I am afraid if we had a TIP program, they would ignore it. They
would get the same wage increases as before. They wouldn't pay
any attention to it, and therefore we would go through the work of
proposing this program, finally getting the Congress to pass it, and
then they wouldn't cooperate.
Mrs. HOLT. Will the gentleman yield at that point? I want to ask
why-would you yield?
Mr. FRASER. Yes.
Mrs. HOLT. Why are they reluctant to join in an anti-inflation
program? It seems to me that it is obvious to everybody that would
be a good place to start.
Mr. BoswoRTH. To be fair to the industrial core of the economy,
the large companies and the large unions, they have learned to live
with inflation quite well. It is not hurting them. They get labor
contracts with a cost-of-living escalator. If the cost of living goes
up, the wages go up. The companies pass it through without any
particular difficulty. They are not suffering particularly from inflation.
The people who are suffering from inflation are the minority
groups, the people in retail trade, and the people on the fringes.
They get hurt by unemployment and by inflation.
The industrial core people are being asked to give up a sure
thing. They negotiate their own contract. They have learned how
to take care of themselves. If you come in with a little tax gimmick
proposal and say, "I will give you a tax cut instead," they could
say, "Why bother; I will take a sure thing."
32 -052 0 - 78 - 5
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
62
Mr. FRASER. I have one last question. It has been frequently
suggested that a selected intervention might work. This approach
would focus on the 1,500 largest corporations, or pick out certain
basic sectors and establish mandatory guidelines for them on the
theory that competition will restrain prices if you can affect this
core group. Is that feasible? Clearly it reduces the administrative
problem.
Mr. BoswoRTH. Clearly it is a way of reducing the administrative
problem. Also, I myself agree with the thesis that the basic inflationary problem we face is in this highly concentrated segment of
the economy, where the labor market tends to be highly unionized,
and the private markets are dominated by a few companies. You
really don't have a problem in retail trade and in some other
segments.
Yet even in 1,500 firms, with an enormous incentive to avoid
controls, the accounting is very complex. There is also the question
whether or not politically, people are willing to accept controls,
knowing what happened last time around. The last time we did not
have general controls; we only really controlled tier 1 firms. They
are much like that 1,500 you spoke of. And that program wasn't
very successful.
The CHAIRMAN. Could we interrupt you here? There are a lot of
questions we would like to ask you. I have just taken a little poll
here of the members. We have about 8 minutes to vote on an
amendment. Could you wait until we come back?
Mr. BoswoRTH. Certainly.
The CHAIRMAN. Good, and would you all please go over and vote
and come right back?
[After recess.]
The CHAIRMAN. The committee will please come to order. Mr.
Bosworth, have you evaluated the inflationary impact of Federal
environmental requirements?
For example, you know the Aircraft Noise Revenue and Credit
Act will divert more than $3 billion over 5 years from the Airport
and Airways Trust Fund to private airlines to assist them in meeting Federal noise regulations. Is the improved noise environment
and many of the other improvements to the environment worth the
inflationary impact of higher fares which result as a result of this
type of legislation?
I think you alluded to the role of regulation in the field of
housing, additional zoning requirements, site development costs, all
of which are increasing prices. Would you give us your thoughts in
general on the question of regulation at all levels of Government?
Mr. BoswoRTH. I don't think you can make a general statement
that the benefits have necessarily been worth the costs in aggregate, because the value you put on it is in the eye of the beholder.
However, the problem is not that the benefits that we are trying to
achieve in the environmental area, health and safety area, or any
other areas are unrealistic. The problem is not the establishment
of the goals or targets, it's the means that are used to get there.
What bothers us the most is not that the benefits are unimportant,
but that in regulation after regulation there is an alternative
method that could be followed where economic costs would be
much, much lower. Therefore, that the regulations are inefficient
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
63
in the sense that there are less costly means, without ever challenging the question of whether or not-The CHAIRMAN. Can you give us an example of that?
Mr. BoswoRTH. That was the argument recently over cotton dust.
We just filed on another, which is a relatively little issue, but it
illustrated some principles and it's going to .become a big issue, and
that is noise regulation.
One example of this was motorcycles. That is a little thing, and
you say why do you care? Because the proposed EPA regulation
calls for the manufacturer to completely restructure and rebuild
the motorcycle to meet a lower noise standard, which is very costly.
There is some argument about whether the major American
motorcycle firm will, in fact, do it or whether it will go out of
business because of the economic effects.
This is going on despite the fact that all of the studies indicate
that the problem with motorcycle noise is not with the manufacturer. It's with the owner, who buys the motorcycle and then modifies
it by putting a new muffler back on the system. Now, the logical
way to try to deal with that, in my mind, is better enforcement of
the existing noise regulations by the motorcycle users, by placing
some burden on them.
For example, many motorcycle mufflers exists that do not meet
the present noise standards. So if you take the existing muffler off
and put a new one on, it's noisy. People like noisy motorcycles, the
people who own them, not the people who have to listen to them.
In that area, there is a much less costly means of achieving
exactly the same targets. I think we should reduce motorcycle
noise; the question is, how do we do it?
If we went through all the existing muffler manufacturers, for
example, and required that motorcycles be evaluated and carry a
label on them that says what their noise level is, then when
somebody stops a motorcycle on the street because of its noise, all
they have to do is look at the label on the motorcycle. This either
meets the standard or does not meet the standard, so you have a
lobbying requirement on mufflers and better logical enforcement.
But it seems to me that in regulation we never want to do
anything that makes the cost very evident to a consumer. The
difficulty with this approach is that EPA would have to tell city
governments to spend more money on police and motorcycle inspection. That will make the cities mad at you, so you can't go that
route.
You go the manufacturer route, even though the cost to society
as a whole is a lot higher. I think it is a question of whether or not
we are going to tell somebody this is where we want to get to, and
we don't care how you get there, just do it. If you don't you will be
penalized very heavily. This approach favors firm standards, absolutely firm, and if you don't meet them you are going to pay. But
how you do it, that is your business. The alternative approach of
design standards, where we will tell you in great detail exactly how
to build the machines that are supposed to attain a certain objective, is a very costly way. In my view no Federal bureaucrat can
ever know how to run a business firm very efficiently. We are
meddling in a business that is none of our concern. So our argument is that the method itself is overly costly, not the goal.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
64
The same sort of thing came up with respect to cotton dust and
others. In general, we worry that regulatory agencies place far too
little reliance on economic incentives; they don't make it in the
manufacturer's interest to want to meet the standards because it
would save him money to do so.
Instead we do it the other way around. Under the present
system, maximum available technology is required. If a firm discovered a new way to reduce pollution, it would be in its own interest
to keep it a secret. Otherwise, if EPA finds out about it then EPA
is going to order it and everybody else in the industry to use it.
Thus, any research and development it does just ends up costing it
money; it imposes a tighter standard on it without any incentives
for it to find cheaper and more effective ways to reduce pollution.
The way the economy operated in the past, we made it in the
interest of the firms to cut their costs, and thus had enormous
productivity growth. They didn't like paying a lot' of labor costs, so
they found ways of using labor more effectively.
I argue the same thing. If pollution costs firms money, they will
find ways to reduce its costs by avoiding that pollution, but we
don't use that incentive mechanism anymore. Therefore, at the
risk of angering the environmentalists, I am afraid in many areas
that the Federal regulations are a mess.
We don't have the foggiest notion any more of what we are doing
in environmental regulation. I don't believe there is anybody in the
country that can tell you what the economic impact of the Clean
Air Act and its amendments is going to be.
We have been working on it for months and we cannot figure it
out. If we ask the regulatory agencies, they say, well, we haven't
got the time to figure that out, we have to get the regulations out.
We just simply don't know anymore what we are doing to the
regional patterns of economic development and incentives that operate in this country.
Businesses are moving away from our major population centers
because those are the heavily polluted ones and they can't get
plant permits. It's so difficult that I don't even understand the
terminology. For our own purposes we are now writing a dictionary
of environmental regulatory terms because we cannot remember
what the definition of them is from one day to the next.
The CHAIRMAN. I agree with you. Mrs. Holt.
Mrs. HOLT. Thank you, Mr. Chairman. Thank you for your very
candid, interesting testimony. You have said we need to solve the
overall inflation we have built in this cost-of-living syndrome and
that we need some way to start the downward trend.
Economist Gary Shilling says that 2 to 3 percentage points of our
current inflation is being generated by just the things you were
talking about there, the budget deficits, the price supports, import
controls, regulation.
Wouldn't that be the place to start for the administration? We
pass all of these beautiful laws over here and we turn it over to the
executive branch and then they impose the regulations.
Wouldn't that be the place for the administration to really bear
down if it could? You said yourself it accounted for 1 ½ percentage
points, I think, three-quarters in one, and three-quarters in the
other.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
65
Couldn't we make more of an effort there to try to start this
downward trend by limiting the growth to a smaller amount, or
trying to take steps in that direction?
Mr. BoswoRTH. In several respects I agree. First, we have to
recognize we are all part of the inflation problem. Except for
maybe a few retired people in this country, there is really no one
who is not part of the inflation problem. I am absolutely convinced
there is nothing that can be done within the framework of doing
business as usual to solve it. Unfortunately most people want to
continue somehow to do business pretty much as usual with perhaps some minor modifications, hoping that will stop inflation.
We are going to have to disrupt almost everything else we are
trying to do until we can get inflation under control. Logically
when you say that sort of a sacrifice and risk has to be made, it is
the obligation of the public sector to start those risks and sacrifices.
But then I think you have to be very careful about what sort of
public sector you are talking about. I am not in favor of lumping
into the Government-the Government budget deficit-and using
the panacea of balancing the budget. Certainly balancing the
budget will stop inflation, but you had better be very clear about
the economic consequences of those types of Government actions.
There is no way a budget deficit reduction can have an impact
on inflation except by throwing people out of work. It has to be a
policy of demand restraint and cutting Government expenditures.
That worries me, because, in fact, in the past we had a combination
of monetary restraints and fiscal restraints to stop inflation. The
cost of that approach is putting people out of work.
Just looking back at the last three or four recessions, we estimate that to get 1 percent off the inflation rate, you will have to
put 1 million people out of work for at least 2 years. And that just
strikes me as too costly.
Mrs. HOLT. This is not the point I was trying to make. If you
slow the growth rate, that is what some of us have tried to do here,
to offer a slowdown in the rate of increase in Government-don't
you agree that that would start the downward trend and then the
cost of living increases would be less and less, and if we could
restrain ourselves then we would be setting an example that I
think maybe would filter over into the private sector.
Mr. BOSWORTH. Yes, I agree that there are things that the Government does that directly has impact on prices and wages, and it
would be helpful if we tried to have a moratorium on those, especially these special interest kinds of legislation that raises a price
someplace or puts a trade restriction in place for somebody else.
I understand as well the demonstration effects for the rest of the
economy in slowing the rate of growth of Government expenditures. My concern is not with the size of Government, but rather
the balance. I think the demonstration effects are a good idea. The
approach of falling back again on saying that somehow there is a
solution to inflation by having another recession and less fiscal
stimulus is not the way that will work.
I am very much in favor of the other methods you mention. I
think that the public sector should show more leadership. But it's
tough. Whatever are you going to do with the sugar bill that is still
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
66
up here before Congress? You have to vote one way or another.
Farm bills will continue to come along, and others. It's not easy,
given the other concerns, to just say no to every one of those bills,
but I think that is about what it takes.
Mrs. HOLT. It's not so tough.
Mr. BoswoRTH. Wait until you get one that affects one of your
constituent groups.
Mrs. HoLT. Impact aid.
Mr. BoswoRTH. It's tough.
Mrs. HOLT. Given the low increase in labor productivity we are
seeing, should we not be encouraging the administration, to support efforts to encourage capital formation such as the Steiger
proposal to decrease capital gains taxes?
Mr. BoswoRTH. I have tried to stay out of that controversy if I
could. But let me try to outline my feeling.
First it is very clear, particularly over the next couple of years,
that if we are going to keep the economy expanding there is a
great need for expanding capital formation. The question is what
you ought to do about that.
Realistically, looking at the pattern of both savings and investment in this country, the problem is not a shortage of savings. If
there were a shortage of savings you would not have a Federal
Government deficit soaking up $55 billion of it because there is too
much of it around.
Our problem now in this economy in the savings-investment area
is that savings are about in line with historical trends, people are
saving the same proportion of GNP they always were. However,
there are no incentives to invest it in a very physical sense by
American corporations, and it's the lack of those incentives that's
exacerbating the problem. Now, how do you try to address those?
One, business has no confidence that the economic expansion will
be continued. Why build a plant if you are going to have a recession in the future and you won't need it? That is the first point.
You have to follow a policy more like the 1960's, of a sustained
economic expansion they can count on instead of this roller coaster
of the last decade.
Two, they are worried about the implications of being able to
sustain that expansion with inflation.
Three, they just don't have any idea what sort of regulations
their new plants are going to be subject to, since they change every
couple of days.
Four, there are the tax questions. Now, I think there are some
very real, demonstrated ways to stimulate business fixed investment in plants and equipment, and that is the investment tax
credit, a reduction in the corporate profits tax rate, and accelerated
depreciation.
To the extent that it does anything, capital gains is mainly a way
to stimulate savings. It's in the financial markets, and its impact
on savings is even open to question.
If there were, on the other hand, a way to stimulate venture
capital, I think that would probably be a good idea. Unfortunately,
if you look at what capital gains are claimed on, that is not what
capital gains are used for. Capital gains are used for land specula-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
67
tion. I think the big effect of the program would be increased
urban land speculation in ghetto housing and other areas like that.
It also goes into cattle ranching; it goes into all sorts of rather
strange investments. If you knew it was going to go into venture
capital, into physical investment that contributes to productivity,
you would be for it. However, the evidence is that that tax credit is
used for a lot of different things that are not particularly productive in the social sense.
So if you want to stimulate capital formation, I would opt instead
for investment tax credits, accelerated depreciation, not a lower
corporate tax rate. I think this would be far more immediate and
would have a bigger bang for the dollar than playing around with
capital gains taxes.
Mrs. HOLT. What if we abolished all regulations, if we just one
morning said, we are not going to have any more regulations on
anybody. Would that cause tremendous unemployment?
Mr. BoswoRTH. No, you would have a lower rate of inflation,
expanded output, more cancer, and a dirty environment.
You cannot ignore the fact that in a modern economy there are
very real problems. If a businessman can produce any chemical he
wants to, the fact that it causes cancer is none of his business. He
is only out to produce that product and sell it in the marketplace.
It is an externality that has to be regulated somehow.
We have to have these regulations. There is just too much evidence that many of these chemicals cause cancer. There is too
much evidence of the damage that we are doing to the environment with unrestrained pollution.
The issue should not be put that way. The issue should be, is
there a better way to regulate? A way that is far less costly and
makes more use of economic incentives that contributed in the past
to productivity improvements? I think the answer to that is, yes,
and one of the answers is to get the business out of the hands of
lawyers and back into the hands of people who know something
about how the economic system operates.
It has been run too much by administrators and lawyers who are
always thinking of a court case instead of thinking about how the
economy operates effectively.
Mrs. HOLT. Thank you. Thank you, Mr. Chairman.
The CHAIRMAN. Would the gentleman from South Carolina like
to be recognized?
Mr. DERRICK. I guess so. I had thought that the administration
had gotten off the lawyer kick. That didn't help its ratings so I
thought maybe they would get onto something else.
Mr. BoswoRTH. I have nothing personal against lawyers.
Mr. DERRICK. Or Congressmen, either, I hope. Let me make just a
couple of observations and then ask you a question or two.
I notice that when the administration was pushing the minimum
wage we were told that it was not inflationary, and now I hear that
it is part of the inflation picture.
I was interested in what you had to say about the speculation in
the area of the agricultural middle man. When we were talking
about the 100-percent parity bill, as I recall the administration
argued that the middle man really didn't have much to do with it,
but my farmers keep telling me that they did. Apparently, accord
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
68
ing to your testimony, there is some validity to my farmers observations.
On this matter of a balanced budget; you are not telling me that
the fact we are borrowing at the projected rate for fiscal year 1979,
around $50 billion, that this does not exert substantial upward
pressure on interest rates that causes an inflationary situation in
the housing area?
One other thing: I was rather interested in your comments on
regulation and that we would have better legislation if we just told
industries they ought to clean up their act or they are going to be
penalized and let the individual industries do it and not have the
Federal Government tell each industry how to do its business.
That sounds great, and I agree with you. I think that is the way
we handled the automobile industry; I don't recall that we told
them specifically how they had to do it, we just told them they had
to do it. And we have seen the price of automobiles rise substantially, not entirely because of the pollution devices, but a substantial part of it. If you would care to comment on any of that then I
have a couple more questions for you.
Mr. BOSWORTH. Let me see if I remember the two in order. Does
budget borrowing, add to raise interest rates?
Mr. DERRICK. By the way, let me say this, on the matter of
lawyers, I am very serious about it because I go back home and I
defend my President because I think he is a great man and he is
the President of the country, I am a lawyer and I think that this
country would not be enjoying the freedoms and the democratic
form of government that we have today were it not for the contributions that were made by the legal profession over the last several hundred years, and I do resent it.
Mr. BoswoRTH. The remarks I made, though, were about the
structure of the regulations, not as an attack or nonattack on
lawyers. The question is whether or not-Mr. DERRICK. I was not directing those remarks to you; I was
asking you to carry that message back.
Mr. BoswoRTH. I will carry the message back. In this case my
concern is that the regulations are structured in a way that does
not take economic incentives into account but are too legal in
structure. Economic incentives are not reflected enough in the
regulatory process; it's more what can be proven or not proven in
court.
But, to your other, more fundamental questions about budget
borrowing and its impact, I think the key thing about budget
borrowing is that the Federal Government would cut back on its
expenditures and wouldn't borrow money. One possible outcome is
that the reduction in borrowing could lower interest rates, and
could lead to further investment by others in response to that.
Mr. DERRICK. Basically the question of what will happen with
interest rates depends upon the Federal Reserve. If they accommodate the borrowing by the Federal Government, then there would
not be an increase in interest rates, and the difficulties in the past
have been that even without an increase in interest rates, and you
know interest rates did not go up in 1975, the Federal Government's deficit dramatically increased from 1975.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
69
Mr. BoswORTH. That is exactly the point. There was not a corresponding demand during 1975. It depends on what the demand is.
Mr. DERRICK. We were not meeting the needs of housing at that
time, either.
Mr. BoswoRTH. Because interest rates were high in 1974. Starting in 1975 things turned around, and the housing industry picked
up. So if demand is very high in the private sector and if at the
same time the Federal Government tries to borrow those resources
that the private sector wants to use for investment, then, yes, it's
inflationary because they will drive them back out of the market
through the mechanism of high interest rates.
If, on the other hand, there are lots of resources out there, and
that is not the constraining influence on it, lots of savings available-Mr. DERRICK. I understand all of that, that is all very elementary. What I am talking about is that you cannot sustain the
deficit borrowing and support the need in the housing industry at
the same time.
Mr. BoswoRTH. It depends on how strong the other sectors of the
economy are. Suppose I told you that consumers decided that instead of the historical 5 percent or 6 percent of their income they
have been saving that all of a sudden they decided to start saving
10 percent of their income. This happened in 1975. Now, that
provides additional savings at that time to do both, if you wanted
to. It depends upon the total demand for resources.
Mr. DERRICK. That is fine, but we live in a world of reality, and
10-percent savings rate is not reality over the long run. We cannot
support deficit borrowing and, at the same time, meet the needs for
housing over the long period of time.
So my point was there is no correlation between the deficits and
inflation. I wanted you to address that issue.
Mr. BoswoRTH. No, if you are saying that over a very long period
of time, over the business cycles, year after year you run a very
large deficit of public borrowing, yes, then that does come out of
things like housing. That has not been the historical situation.
Mr. DERRICK. And those deficits would be inflationary.
Mr. BoswoRTH. Yes. The historical situation, however, has been
that the deficit has swollen and shrunk over the business cycle in a
way that there has been no historical correlation between inflation
and changes in the budget deficit. Now the questions you _have to
ask each time are: Is there a shortage of resources? Do we have too
much employment in this country?
Mr. DERRICK. We do have a shortage of resources when you have
the excessive borrowing on the Federal level which causes the
interest rates to go up, and then you go back into the same cycle
that we ran into in 1973 and 1974, and it's all the same thing over
again. Anyway, I think we understand each other on that. What
about the automobile industry?
Mr. BoswoRTH. With respect to the regulations in the automobile
industry, one problem is that you should never think regulation is
free. You want regulation to improve the environment, and the
increase in automobile prices is just a measure of that environmental cost. We are now spending about $200 to $300, per automobile,
as I remember, for environmental purposes.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
70
I would prefer a regulatory system that says this is where I want
you to go, I can't be too sure when the technology will be invented
for you to do it, but here it is. If you don't meet the standard you
will have to pay a tax penalty or some other penalty. However,
that is not what we did.
We tried to guess how soon technology could be made available
in the auto industry. In looking at the legislative history of those
acts, what happened is the auto industry will come in and say, "I
think it will take about 7 years to do it." You reply, "Oh, all those
guys always lie a little bit, I bet they can do it faster than that,
and you say 4 years instead." It turns out in 4 years they cannot do
it, even though you tried to guess what technology is.
You are trying to guess what things are going to happen in the
future. The alternative would have been to have had a system
saying this is the environmental pollution level we wish to achieve.
For every increment you are over that you are going to pay a tax.
If they cannot do it, they will pay. But as soon as they can do it,
they will, because they will then avoid the tax.
Mr. DERRICK. What is some other major area of regulation we
have operated correctly and has resulted in tremendous savings?
My time has expired.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Illinois.
Mr. SIMON. If you will get your pencil out, I have a series of
questions and we are not going to have time for you to answer
them, but I would like to get them in writing if I could.
One: In the whole tax reduction area, I am interested in what
the impact on inflation is of a $20 billion tax reduction versus $15
billion, versus the Vanick-Pickle proposal for no additional tax
reduction. Or, also in theory just the theoretical question whether
it is wiser to have a general tax reduction that stimulates the
economy generally or to put a specific amount into a Government
program where you aim it at structural unemployment.
Two: In view of your comments on the agricultural situation, I
am interested in the set-aside and what impact that has, and if this
is wise, taking a look at inflation.
Three: In connection with agriculture, whether we should not be
much more reliant on target prices and in the process lower the
price of food.
I have suggested the possibility of the Congressional Budget
Office having an inflation impact statement with every bill that
emerges from a committee of the House. I would be interested in
your reaction to that.
You mentioned regulations. I just had some correspondence
which amazed me that shows that the environmental impact statement has increased the length of the time it takes to authorize
bridge construction from 1 year to about 5 years.
I would be interested in, and I have made notes for Allen Cissell
of my staff to find out whether any bridge anywhere was ever
turned down for environmental impact reasons.
My guess is every bridge gets approved, but we put an automatic
inflation factor in there and there are probably a lot of other
structures like that.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
71
I think I am correct in saying Italy and the United States are
the only nations that do not have either standby wage and price
controls or some type of wage and price controls. Does it in theory
make sense to have some standby wage and price controls and, if
not, Richard Bolling this morning before this committee talked
about some advanced notice on price increases. Does something like
that make sense?
Finally, do you have any impression of the impact or the desirability of having off-budget agencies with their expenditures without congressional control, and the off-budget guaranteed loans?
Maybe you can send me a one page letter with all of the answers to
those.
Mr. BoswoRTH. I'd be happy to.
[Replies to questions by Mr. Simon may be found on page 293.]
The CHAIRMAN. Thank you very much.
Mr. SIMON. Thank you.
The CHAIRMAN. We may have some questions also for you from
Mr. Obey. If so, we will get them to you and if you can respond for
the record that will be helpful.
Mr. BoswoRTH. Sure.
The CHAIRMAN. We thank you very much. It has been a most
helpful afternoon, Mr. Bosworth, and come back again. The committee will stand adjourned.
[Whereupon, at 3:55 p.m., the committee adjourned until Tuesday, July 12, 1978, at 10:30 a.m.]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
ECONOMIC OUTLOOK AT MID-SUMMER
WEDNESDAY, JULY 12, 1978
HOUSE OF REPRESENTATIVES,
COMMITTEE ON THE BUDGET,
Washington, D.C.
The committee met, pursuant to notice, at 10:30 a.m., in room
210, Cannon House Office Building, Hon. Robert N. Giaimo, chairman of the committee, presiding.
The CHAIRMAN. The committee will please come to order.
Our witness this morning is Charles L. Schultze, Chairman of
the Council of Economic Advisers. Mr. Schultze, it is a pleasure to
have you appear once again before this Budget Committee. As you
know, we are conducting hearings in anticipation of developing the
Second Concurrent Resolution on the Budget for Fiscal Year 1979.
The committee is particularly interested in your forecast of economic developments over the next 12 to 18 months and your recommendation as to the size and composition of the tax cut that should
be included in the Second Concurrent Resolution. We would also be
interested in your assessment of current monetary policy. In addition, we would like your assessment of the progress toward reducing inflationary pressures under the voluntary program of wage
and price control, and if that isn't enough, we want your evaluation of the impact on the economy and on Federal receipts of the
Kemp-Roth and Steiger tax proposals.
We again welcome you to the committee, as always, and you may
proceed as you wish.
STATEMENT OF HON. CHARLES L. SCHULTZE, CHAIRMAN,
COUNCIL OF ECONOMIC ADVISERS
Mr. SCHULTZE. Thank you, Mr. Chairman. I appreciate the relatively easy assignments you have asked me to cover this morning. I
trust I shall at least cover them both succinctly and to the point.
As you know, Mr. Chairman, more than 3 years have gone by
since our economy touched the bottom of the worst recession of this
post-war period. During those 3 years, the economy has indeed
staged a notable recovery.
Let me interject, Mr. Chairman, that I will read part of my
statement and submit the whole thing for the record to save some
time.
The Nation's output of goods and services has increased by 16
percent over this recovery. We have made major progress against
unemployment. In May 1975, 9.1 percent of the civilian labor force
was out of work. In December 1976, the rate was still 7.8 percent.
By last month, the rate of unemployment had fallen to 5.7 percent.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(73)
74
We are now in the fourth year of economic recovery. While the
pace of recovery will, and indeed should, moderate, there is no
fundamental reason it cannot continue-if we pursue the appropriate budgetary and economic policies · in the months and years
ahead.
Unfortunately, in the battle with inflation, the record of the past
3 years is not so good. During the first half of 1975, the rate of
inflation came down quickly from the double-digit pace of 197 4 to a
range of 6 to 6½ percent. Since then, however, there has been no
fundamental improvement in the inflation situation. And since late
last year, prices have been moving up at a disconcertingly rapid
pace.
The challenge that confronts us is to deal with inflation in ways
that do not undo our progress in promoting economic growth and
reducing unemployment. Specifically with respect to the overall
fiscal policies that concern this committee, we must act with prudence and caution, pursuing a budgetary course that promotes a
moderate pace of economic growth. To seek a rate of economic
growth substantially greater than the growth of the Nation's potential would, under current conditions, seriously court the danger
of heating up inflation. But to adopt policies that severely depress
the rate of economic growth would be equally unwise.
The record of the past 10 years, Mr. Chairman, demonstrates
that an overheated economy will indeed accelerate inflation, but
that a sluggish economy will not cure it except very, very slowly
and at very great cost. Unemployment is still very high among the
young, the poor, and minorities. Trying to "wring-out" inflation
with economic slack would set back for years progress in bringing
those individuals into the mainstream of the economy. It would
also reduce business profits and sales, and discourage business
firms from investing-worsening the outlook for productivity
growth and so contributing to inflationary problems in the longer
term future.
Let me turn specifically to the administration's recommended
goals and policies for the remainder of 1978 and 1979 on page 4 of
my statement.
In the January budget, the administration set as its objective
real growth of our gross national product of 4.5 to 5 percent in 1978
and in 1979. In the. intervening months, unemployment has declined far more rapidly than we had anticipated, while inflation
has worsened. Under these circumstances, economic growth at the
pace projected very early this year would probably cause the rate
of unemployment to drop substantially below our current estimates, and put strong upward pressure on wage rates. Inflationary
pressures in the economy might be aggravated.
We have therefore set more modest growth objectives for the
period ahead. We are aiming for an overall growth rate in the
economy of about 4 percent per year in 1978 and 1979. That is
slightly above the longrun growth rate of the Nation's productive
potential. That productive potential grows at something like 3½
percent a year.
We still can and should make gradual further progress against
unemployment, but we must design our economic policies to main-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
75
tain rates of economic growth that do not add an element of excess
demand to the inflation problem.
In cooperation with the Congress and the Budget Committees,
the administration has adjusted its fiscal policy recommendations
to reflect recent changes in the economic situation. We have reduced the size of the recommended tax cut by $5 billion and postponed the effective date that we recommended to January 1, 1979.
This has trimmed $10 billion from the magnitude of tax reduction
in fiscal year 1979.
Budget outlays, and the budget deficit, in the current fiscal year
are expected to be about $11 billion lower than projected in the
January budget. Outlay projections for fiscal year 1979 have also
been lowered by $4½ billion, and together with the smaller tax cut,
this will reduce the projected deficit in fiscal year 1979 by $12
billion.
In order to achieve this result, and this lower deficit, we urge the
Congress, in its authorization and appropriation actions, to stay
within the limits proposed by the President. On its part, the administration will continue to seek economies and efficiencies in the
operation of Federal programs, so as to carry out the programs
enacted by the Congress at the lowest possible cost to the American
taxpayer.
Final decisions on the President's recommendations for the fiscal
year 1980 budget will not, of course, be made until the end of the
year, and will take into account economic developments over the
intervening period. The prospect today indicates quite clearly that
keeping economic growth along the desired path, not too much and
not too little, will require that the budget deficit in 1980 will be
significantly below that for 1979. To that end, the President has
instructed Federal agencies, in planning their 1980 budget submissions, to reduce outlays substantially below those currently projected in the Mid-Session Budget Review, which was sent to the committees a short time ago.
Let me turn to the economic outlook for the remainder of 1978
and for 1979.
The course of fiscal policy we are now recommending to the
Congress is, in our view, consistent with an economic growth rate
of about 4 percent in 1978 and again in 1979. Since January,
several developments besides the change in budgetary policy have
been working to reduce the outlook for economic growth. The rate
of inflation increased in the first half of this year. That increase
was due in substantial measure to sharply rising food prices and
the effects on prices of imports and the depreciation of the exchange value of the dollar. These sources of higher inflation absorb
purchasing power of the majority of consumers, who must spend
. more of their incomes to buy food and imported goods, and who
therefore have less to spend on other goods and services. So, the
outlook for real personal consumption expenditures has dimmed.
The sharp rise in interest rates has also had a direct dampening
effect on economic expansion by raising the cost of buying a home
or making a business investment. Interest rates have risen in
response to the increased credit demands that have accompanied
continued growth and more rapidly rising prices, combined with
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
76
actions by the Federal Reserve to tighten credit in an effort to hold
down the growth in the monetary aggregates.
Our forecast for the rest of 1978 and for 1979 takes account of
these developments. It is based on three key assumptions about
economic policy:
First, that the Congress, in its actions on tax and expenditure
legislation, pursues the overall fiscal policies recommended in the
Mid-Session Budget Review.
Second, that conditions in the money and credit markets do not
lead to a significant rise in interest rates.
Third, that the high rate of inflation in the first half of the
year-which was fed by a number of special factors-eases during
the second half, and that the underlying rate of inflation does not
accelerate in 1979. For the second half of this year we expect
economic growth to be in the 3½- to 4-percent range. Growth
would weaken in 1979 in the absence of the $20 billion tax cut
proposed by the administration and incorporated in the First Concurrent Budget Resolution. With it, however, growth in personal
consumption and investment should be strengthened enough to
maintain a growth rate of close to 4 percent again in 1979. To say
that another way, Mr. Chairman, we don't have the numbers in yet
for the second quarter of the year, but for the first half this year's
growth should be in the neighborhood of, say, 4½ percent. Growth
in the second half should be somewhat below 4 percent, perhaps
3½, 3¾ percent. With the tax cut in effect, growth would then go
up a bit again in 1979, so that between putting all this together,
you would have about 4-percent growth in both years with the kind
of economic policies we are recommending to the Congress.
The CHAIRMAN. How do we know that is going to happen in the
second year, that we are going to get a reduction which will then
contribute toward bringing down the inflation rate?
Mr. SCHULTZE. Let me start by saying, Mr. Chairman, of course,
that all of this is based on our best efforts to peer into the future.
The CHAIRMAN. I know.
Mr. SCHULTZE. As I indicate further on in my testimony, we have
an economy-maybe I can make two characterizations of it. We are
going into the fourth year of economic recovery. We have not,
during this recovery, built up the kind of major distortions that in
the past have often turned recovery into recession, excessive inventories, heavy speculation in raw materials, tight liquidity for business firms so they can't move. None of that has really happened.
So we do have, on the one hand, the prospects for continued growth
in the sense there are not any key distortions that are going to
turn us off.
On the other hand, we are going into the fourth year of recovery;
the unemployment rate has dropped substantially. We have got, on
the one hand, to keep economic growth going, but we can't keep it
growing at the same rate we had in prior years; it would just
overdo it. If you put those two together, it seems to us that: (a) it is
possible to continue this recovery, and (b) we need a set of fiscal
policies that will help continue it, but at the relatively moderate
pace.
Next, with respect to the tax cut, we are not in a world in which,
barring a tax cut, tax rates would stay constant. We know there
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
77
are increases in tax rates facing the American taxpayer, social
security taxes, the impact of inflation on the tax system, and we
need to offset at least a good chunk of that.
Now, you put all of this together, and it does suggest that moderation is the right course and that our economic circumstances are
such as to make moderation possible-neither too much nor too
little. It is admittedly a difficult line to walk, but presumably that
is what we are here for, to try to put in place policies that do that.
In a way, I have covered in fairly general terms some of the
specific points of the economic outlook that appear on pages 7, 8, 9,
and 10 of my testimony. Let me turn, if I might, to page 11 of my
testimony, where I specifically talk about unemployment and then
turn to prices.
Growth of about 4 percent a year, this year and in 1979, will
probably mean a gradual further reduction in the rate of unemployment. But forecasting the future course of unemployment is
more difficult than usual. During the past year, even before taking
into account the dramatic fall in unemployment in June, unemployment declined much further, given the growth of economic
activity, than past relationships would have suggested. We do not
yet know the extent to which this is a temporary phenomenon that
may be reversed, or symptomatic of a more persistent new relationship. The very sharp additional decline in June simply adds to this
puzzle. It is possible-although there is no hard evidence-that
part of the very large decline in unemployment in June reflects a
statistical aberration. Given these uncertainties, our best estimate
is that the rate of unemployment will stay close to its current level
for the remainder of 1978, and then drift slowly downward next
year, although, admittedly, as I indicated, forecasting the unemployment rate is more difficult than usual.
Let me turn to prices. The rate of inflation began to move up
late in 1977 and has accelerated further this year. From December
to May, consumer prices rose at an annual rate of 10 percent and
prices of producers' finished goods at a IO-percent rate in the first 6
months of the year.
The acceleration in inflation early this year is reminiscent of the
experience in 1977, when rapidly rising food prices pushed up the
CPI at a 9-percent annual rate in the first 6 months of the year.
The increase in food prices moderated during the second half of
1977, and the overall rate of inflation therefore declined substantially. Although the sources of the latest inflationary surge are
somewhat different, there is good reason to expect a repeat of last
year's pattern. While any slowdown in inflation later this year
would, of course, be welcome, the longer term rate of inflation will
remain too high, and the risks that it will accelerate are too great
to ignore. Inflation is our most serious economic problem, and
dealing with it must receive top priority.
The worsening of inflation early this year stemmed to an important degree from a very rapid increase in food prices, as I indicated. From December to May, food prices at the consumer level rose
at an 18½ percent annual rate.
Other special factors made modest contributions to the higher
inflation rate, such as the increase in the minimum wage in Janu32-052 0 - 78 - 6
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
78
ary and the effect on prices of imported items of the 7½-percent
devaluation of the dollar which occurred in the past year.
As in 1977, the outlook for the second half of 1978 is for considerable improvement in the rate of inflation. The rise of food prices
should slow substantially. Cattle prices are below their earlier peak
levels. The strong production of poultry and increased output of
pork in the second half are expected to moderate the rate of meat
price increase for the remainder of 1978. Vegetable supplies should
increase significantly as the summer crops are harvested, and
prices of some of them should decline.
The contribution to inflation from other special factors should
also be less in the second half of this year and in 1979. A more
stable dollar in foreign exchange markets should contribute less to
inflation. And, the increase in Government-mandated payroll costs
will be less in 1979 than in 1978.
In stressing the role of special factors that have aggravated the
rate of inflation this year, I do not mean, Mr. Chairman, to minimize the seriousness of the inflation problem. Even after all of
these special factors are allowed for, some worsening in the course
of inflation remains. The chief problem lies in the fact that pressures on costs of production have mounted somewhat.
The longer term trend rate of growth in unit production costs is
a fundamental determinant of the underlying rate of inflation.
How much the underlying rate has increased over the past year is
difficult to judge, but it may have crept up from the 6- to 6½percent range to the neighborhood of 7 percent.
Moreover, this upcreep could continue if wages and fringe benefits received by small unions and by nonunion workers rose still
more rapidly in an effort to close the gap which opened up earlier
between settlements won by large unions and the wages and benefits earned by others.
If an acceleration of inflation is to be avoided, it is essential that
the remaining gap be closed by a significant deceleration in the
rate of increase in major union contracts in the new round of
collective bargaining that begins in 1979.
Let me now turn, Mr. Chairman, to the kinds of policies we must
pursue to combat the serious inflation problem that confronts us.
Monetary and fiscal restraint have an important role to play in
this endeavor. Past experience indicates that an overheated economy leads to an acceleration of inflation, then tends to become built
into the economic system.
·
We must therefore follow a course of policy that avoids the
emergence of excess demand, which would cause prices to rise even
faster than they have recently. As I indicated earlier, the degree of
fiscal stimulus has been cut back for just that reason. At the
present time, we are aiming for a rate of economic expansion near
the growth of our longrun potential so that economic overheating
will be avoided.
. You may ask why, in light of the seriousness of our inflation
problem, we should not slam on the fiscal and monetary brakes
hard in an effort to make even greater progress in reducing inflation. But experience clearly demonstrates that this would be an
ineffective route to follow.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
79
Slowing economic growth still more, to a pace well below the
economy's potential, would have some effect on the rate of wage
and price increase, but only a small one. Over the past two decades, the rate of wage and price increase has become increasingly
insensitive to slack demand in the economy. In the 1969-70 recession, rising economic slack had no effect on the rate of inflation.
What little moderation did occur in the rise of consumer prices in
1970 reflected developments affecting food prices. Moreover, the
increase in average hourly earnings in the private nonfarm sector
of the economy did not decelerate at all.
In the recession of 1974-75, the improvement which did occur on
the price front appears to have been due much less to economic
slack than to the termination of special factors affecting prices in
1974. Food supplies became more ample, the OPEC oil price increase worked its way through the economic system, and the onetime adjustment of wages and prices after the removal of controls
finally ended. And so from the middle of 1975 until very recently,
the underlying rate of inflation, despite several years of very high
unemployment, remained in the 6- to 6½-percent range.
Significant reductions in the inflation rate could be accomplished
today if we were willing to tolerate massive unemployment for
very long periods of time. Such a policy would not only be
unacceptable from the perspective of social policy, but would also
complicate our efforts to curb inflation over the longer pull.
As economic growth slows excessively, the unemployment rate
begins to rise. As high unemployment continues, pressures mount
to inaugurate major new Federal programs to provide employment.
And as capacity utilization rates fall, business profits are reduced
even more than other forms of income.
Sluggish growth of sales, low utilization rates, and depressed
profits discourage businesses from investments that are needed to
increase productivity and to keep the Nation's capital stock growing in line with a rising labor force.
We have been through a period like this only recently, and the
resulting slowdown in business investment has clearly affected our
rate of productivity growth. We do not need another such period.
We are better off to seek cautious, prudent policies that avoid a
roller coaster of boom and bust.
For these reasons, the administration has recommended an economic policy posture that will enable us to maintain growth of
output near the economy's long-term potential. Accomplishing this
objective will require a tax cut next year. Otherwise, increases in
social security taxes scheduled under law and the automatic increase in tax burdens that results from inflation will drag heavily
on consumer spending and imperil that source of strength in the
economy.
We also need a substantial business tax cut to stimulate investment, both to keep the current rate of economic growth at a
satisfactory level and to provide the growth and modernization of
capacity required over the long run to deal with the inflation
problem.
The Federal deficit for fiscal year 1979 still is very large, even
though it has been reduced by $12 billion in the most recent
budgetary projections. We must work to bring that deficit down
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
80
over time as the economy strengthens, and indeed, we expect to
make substantial progress in that direction in 1980.
Mr. Chairman, as I stated, a significant reduction in business
taxes is essential both to continued economic growth and to our
anti-inflation effort. I would like to make clear, however, that a
large reduction in capital gains taxes, as has been proposed by
some Members of Congress, is not an effective substitute for the
reductions in busin•ess taxes proposed by the President.
Reductions in capital gains taxes are not likely to be an efficient
method of stimulating investment. Of all capital gains realized
each year, about 60 percent or less can be attributed to the sale of
assets that are closely related to productive enterprise. A large
part of capital gains stems from sales of private homes, timber,
land, jewelry, art, and similar items. Relative to reductions in the
corporate income tax, increases in the investment tax credit or
liberalization of depreciation, capital gains tax reductions are,
therefore, a far less effective means of allocating scarce revenue
resources toward the stimulation of investment.
It has been asserted that the cut in capital gains along the lines
proposed by Congressman Steiger would lead to increases in stock
prices as great as 20 to 40 percent, and thus provide a major spur
to investment. Now, no one can predict with any confidence the
impact of tax reductions on stock prices, and I am not going to try.
But estimates of this magnitude border on sheer fantasy. The total
reduction in taxes under Congressman Steiger's proposal, for example, would be about $2.1 billion per year, at current income levels,
of which only about $500 million would accrue to holders of
common stock, given the ratio of realization of capital gains on
stocks to other realization of gains that we have experienced normally.
Five hundred million dollars is roughly one-half of 1 percent of
the $1 trillion total value of common stock in this country. How an
increase in the after-tax income equal to one-half of 1 percent of
asset values is supposed to increase those values by 20 to 40 percent escapes me.
Moreover, the argument that capital gains taxes are a particularly orierous disincentive to investment is difficult to accept on the
basis of the data and statistics we have. Only 10 percent of all
Federal income taxes on returns to capital stems from the capital
gains tax. Other taxes-including corporate profits taxes and individual income taxes on property income, dividends, and interestaccount for the other 90 percent of taxes on income from capital.
And while, theoretically, the maximum capital gains tax rate could
be almost 50 percent, the average rate actually paid in 1976 was
only about 16 percent. Even of taxpayers with more than $200,000
in adjusted gross income, the average tax paid on capital gains was
only about 27 ½ percent. Fewer than five-hundredths of 1 percent
of taxpayers reporting capital gains paid a tax as high as 40 percent on that income.
The issue, Mr. Chairman, is not whether the economy needs tax
reduction designed to stimulate business investment. Such a stimulus is indeed vitally necessary. Rather, the issue revolves around
the fairest and most efficient means of doing so. The administration has proposed net business tax reductions of over $5 ½ billion
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
81
and total tax reductions on capital income of $7 billion. Analysis of
both fairness and effectiveness in investment stimulation indicates
that this approach is far superior to the kind of tax cuts incorporated in the Steiger amendment.
Mr. Chairman, in your letter to me asking me to testify, and in
your opening comments, you also indicated you had some interest
in an analysis of the impacts of the Kemp-Roth tax proposal. On
the one hand, I have not incorporated those in my formal testimony, but, on the other hand, I do have some written analysis which I
furnished to the committee this morning and would like to submit
for the record. Let me summarize, if I might, what I believe that
analysis would show.
[The information referred to was not submitted for the record at
time of printing.]
Mr. SCHULTZE. Let me start with the fact, and I am repeating
what I said in my testimony, that the American economy does need
a tax reduction. It does need a tax reduction in 1979. Individuals
confronted with rising social security taxes and inflation-generated
increases in effective tax rates need tax relief if consumption is not
to falter. Business tax relief is needed to promote greater investment.
The administration has proposed a $20 billion reduction effective
January 1, 1979. Depending upon the course of private economic
activity, additional tax reductions may be necessary in later years.
So the question at issue is not whether tax reduction is needed but
the appropriate size and timing of the cut.
The Kemp-Roth proposal would enact a 3-year tax cut that would
reduce taxes by about $30 billion in 1979, and build to a $110 to
$120 billion rate of tax reduction by 1981. Committing the Federal
Government now to a tax cut of such dimensions is, I think, a surefire recipe for inflation. What the effects of the Kemp-Roth proposal would be .on economic activity and prices is a matter of some
dispute. Congressman Kemp, in testimony before the House Ways
and Means Committee, presented simulations from an econometric
model suggesting that his proposal would increase the annual rate
of GNP growth over a 10-year period by only 0.13 percentage
points-about one-tenth of 1 percent-a year but would increase
the rate of consumer price inflation by 1 percentage point per year
by 1982. Moreover, these simulations suggested that the Federal
deficit would rise to $90 billion-3½ percent of GNP-by 1980.
Some proponents of the Kemp-Roth proposal claim that, because it
would unlock private incentives and thereby increase productive
capacity, the national income would rise so much that the tax cut
would actually increase, rather than decrease Federal revenues.
Let me first examine this latter claim that we get a free lunch,
in effect. Let me start first by noting that the Kemp-Roth tax
proposal, when fully in effect in 1981, would cut the Federal revenue yield $110 billion to $120 billion. As a rough rule-of-thumb, Mr.
Chairman, at the new, lower tax rates in the Kemp-Roth proposal,
it would take about a $5 increase in GNP to generate $1 of additional revenues. There is a 20-percent relationship. So, if you cut
taxes by $110 billion, you would have to have a $550 billion increase in GNP to generate enough revenue to give us a free lunch,
that is, to make it all up. That is about a 20-percent increase in
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
82
what the GNP is likely to be in 1981, give or take a little. Estimates are not that certain, but an 18- to 22-percent increase in
GNP is required.
Now, traditional analysis of the effects of economic policy do
indicate that $1 of tax cut will give you more than $1 of the money
value of GNP. The typical analyses incorporated in virtually all
the major economic models suggest it is $2. That is, for $1 tax cut,
you may get back $2 in additional value of GNP. The Kemp-Roth
proposal, i!!-,-order to raise GNP enough to make it back, would
require that number to be five, which is out of line with any
estimates I have seen of the impact of taxes on GNP. But let's say
you did cut taxes by 1981 by $110 billion to $120 billion, and you
got it back in the sense that you had a $550 billion increase in the
demand for goods and services. What would that do?
Well, it is fairly clear that unless there were substantial slack in
the economy to be made up-substantial excess capacity and substantial unemployment-this magnitude of increase in GNP, 20percent in the demand for goods and services, would have to be
matched by a 20-percent increase in the supply of goods and
services. Suppose for generosity that we assume there would be 3or 4-percent slack in the economy by 1981, so you could get 3 or 4
percent additional supply out of using up the slack. You would still
have to increase supply of goods and services by 15 percent through
this tax cut in order to get a free lunch-that is, in order to get
GNP up enough without inflation, in order to pay back the taxes.
What is the possibility of a tax cut increasing the supply of goods
and services, the capacity in the economy, by 15 percent? There are
only two ways you can .do it logically. You can increase the supply
of labor. Because of the lower taxes, people could work longer
hours, or more people could come into the labor force. That is one
way of doing it. But, virtually everything we know about the response of the labor force to higher income suggests this is highly
unlikely. The Kemp-Roth tax cut would add about 5 percent to the
average income of the average worker.
In the past, as income has risen quite logically over long periods
of time, working hours have been reduced as people took out some
of their increased living standards in more leisure. So, to suggest
there would be a big burst of additional labor input on account of a
5-percent increase in after-tax income, flies in the face of experience.
But let me assume, again to be generous, that this 15-percent
increase in supply is made up partly by a 5-percent increase, which
is a big increase, in the hours of work or of the total labor effort, if
you will, put in the economy. I still have to get 10 percent addition
to supply out of higher productivity.
So the Kemp-Roth tax cut would cut taxes by $110 billion. The
proponents claim you would get enough GNP increase to get it
back, that is, $550 billion times 20 percent. Being very generous all
the way across the board, I come down to the bottom line, I have to
have a 10-percent increase in productivity in a 3-year period because of higher investments in order to make that possible.
Now, we do have a lot of economic estimates from a lot of
analyses on how much increase in investment it would take to get
a 10-percent increase in productivity in our economy. Remember
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
83
that productivity grows about 2 percent a year. How much would it
take over a 3-year period to get another 10 percent? What these
analyses show is, first, in 3 years it is physically impossible. The
point is that designing, planning, ordering, installing, and breaking
in new plants and equipment, on a big scale is more than can be
done in 3 years.
I am going to be generous again. Let's give them 10 years. How
much investment would be needed to increase productivity by 10
percent over a 10-year period? It turns out, using average estimates
of the relationship that you would have to double the share of
investment in GNP in order to do it, from 10 percent of GNP to 20
percent of GNP or about a $200 billion increase in the annual rate
of investment.
It seems to me when you go through all these assumptions, Mr.
Chairman, it is clear, first, that there is nothing in the economic
evidence to suggest the demand for goods and services would increase by five times the size of the tax cut, but, second, even .if it
did, the impact of that kind of increase in the demand for goods
and services would be incredibly inflationary unless supply rose to
meet it, and all the evidence indicates there is absolutely no likelihood of that. What you can therefore be sure of is that this proposal would be very substantially inflationary. It wouldn't increase
GNP by any $550 billion. It would, however, increase the demand
for goods and services maybe by a $200 billion. No question, put
$110 billion back in the people's pockets, and you would get a big
increase in the demand for goods and services, only partly
matched, because it is so huge, by an increase in supply. With that
you would have yourself in a real inflation.
Now, again, let me close as I began; this is not a debate about
whether this economy needs a tax cut. It needs one; the administration proposed one; the Budget Committees have it included in
their budget resolution. Whatever the kind of arguments between
the administration and the House Ways and Means Committee,
they are also planning and proposing a significant tax cut. That
isn't the question. The question is how big, and, more importantly,
whether it is wise to commit ourselves now for an uncertain future
to a huge tax cut 3 years down the way in the hope, which cannot
be supported by economic analysis, that it will somehow unlock
such a cornucopia of additional capacity and supply that it won't
be inflationary. I should suggest it would be highly improper to
make such a commitment.
Thank you, Mr. Chairman.
[Testimony resumes on p. 90.]
[The prepared statement of Mr. Schultze follows:]
PREPARED STATEMENT OF HON. CHARLF.B
L.
8cHULTZE
Good morning, I am pleased to appear before this committee today to discuss the
economic outlook for the rest of 1978 and for 1979, and to outline for you the
administration's recommendations on budgetary and fiscal policies.
More than 3 years have elapsed since the American economy touched the bottom
of the worst recession of the postwar period. During the past 3 years, our economy
has staged a notable recovery.
The Nation's real output of goods and services has increased by 16 percent. We
have made major progress against unemployment. In May 1975, 9.1 percent of the
civilian labor force was out of work. In December 1976, the rate was still 7.8
percent. By last month, the rate of unemployment had fallen to 5.7 percent.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
84
The utilization of our Nation's industrial plant has also improved-rising from 70
percent in early 1975 to 84 percent recently. Per capita disposable income, after
adjustment for inflation, has risen by 13 percent, and business profits have increased substantially.
We are now in the fourth year of economic recovery. While the pace of recovery
will, and indeed should moderate, there is no fundamental reason it cannot continue-if we pursue the appropriate budgetary and economic policies in the months
and years ahead.
Unfortunately, in the battle with inflation, the record of the past 3 years is not so
good. During the first half of 1975, the rate of inflation came down quickly from the
double-digit pace of 1974 to a range of 6 to 6½ percent. Since then, however, there
has been no fundamental improvement in the inflation situation. And since late last
year, prices have been moving up at a disconcertingly rapid pace.
Inflation is the most serious economic problem we face today. It creates major
inequities, since some people and groups have far less protection against it than
others. As inflation has remained high in the United States-indeed increased in
recent months-while continuing to fall in many other industrial countries, downward pressure is exerted on the exchange value of the dollar. Most importantly, we
must make better progress against inflation as a prerequisite to continuation of
strong economic recovery.
The challenge that confronts us is to deal with inflation in ways that do not undo
our progress in promoting economic growth and reducing unemployment. Specifically with respect to the overall fiscal policies that concern this committee, we must
act with prudence and caution, pursuing a budgetary course that promotes a moderate pace of economic growth. To seek a rate of economic growth substantially
greater than the growth of the Nation's potential would, under current conditions,
seriously court the danger of heating up inflation. But to adopt policies that severely depress the rate of economic growth would be equally unwise.
The record of the last decade demonstrates that an overheated economy will
indeed accelerate inflation but that a sluggish economy will not cure it except very,
very slowly and at very great cost. Unemployment is still very high among the
young, the poor, and minorities. Trying to "wring-out" inflation with economic slack
would set back for years progress in bringing those individuals into the mainstream
of the economy. It would also reduce profits and sales, and discourage business firms
from investing-worsening the outlook for productivity growth and so contributing
to inflationary problems in the longer term future.
By exerting a drag on the growth of world trade, a weak U.S. economy would also
undermine prospects for sustaining the fragile and incomplete recovery abroad.
Slow growth in foreign economies, in turn, would dim the outlook for our export
markets, and heighten still further the pressures for protectionism that are building
across the globe.
Economic policies in the period ahead, therefore, must aim to keep us on a course
that is consistent over the long run with steady and sustainable improvement in the
health of the overall economy. Let me turn now to the goals and policies the
administration recommends to achieve that objective.
GOAL.5 FOR 1978 AND 1979
In the January budget, the administration set as its objective real growth in GNP
of 4.5 to 5 percent in 1978 and in 1979. In the intervening months, unemployment
has declined far more rapidly than we had anticipated, while inflation has worsened. Under these circumstances, economic growth at the pace projected early in
1978 would probably cause the rate of unemployment to drop substantially below
our current estimates, and put strong upward pressure on wage rates. Inflationary
pressures in the economy might be aggravated significantly.
We have therefore set more modest growth objectives for the period ahead. We
are aiming for an overall growth rate of about 4 percent per year in 1978 and 1979.
That is slightly above the longrun growth rate of the Nation's productive potential,
which is about 3½ percent a year. We still can and should make gradual further
progress against unemployment, but we must design our economic policies to maintain rates of economic growth that do not add an element of excess demand to the
inflation problem.
In cooperation with the Congress and the Budget Committees, the administration
has adjusted its fiscal policy recommendations to reflect recent changes in the
economic situation. We have reduced the size of the recommended tax cut by $5
billion and postponed the effective date to January 1, 1979. This has trimmed $10
billion from the magnitude of tax reduction in fiscal year 1979. Outlays, and the
budget deficit, in the current fiscal year are expected to be about $11 billion lower
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
85
than projected in the January budget. Outlay projections for fiscal year 1979 have
been lowered by $4 ½ billion, and together with the smaller tax cut, this will reduce
the projected deficit in fiscal year 1979 by $12 billion. In order to achieve this result,
we urge the Congress in its authorization and appropriation actions to stay within
the limits proposed by the President. On its part, the administration will continue
to seek economies and efficiencies in the operation of Federal programs, so as to
carry out the programs enacted by the Congress at the lowest possible cost to the
American taxpayer.
Final decisions on the President's recommendations for the fiscal year 1980
budget will not of course be made until the end of the year, and will take into
account economic developments over the intervening period. The prospect today
indicates quite clearly that keeping economic growth along the desired path will
require that the budget deficit in 1980 be significantly below that for 1979. To that
end, the President has instructed Federal agencies, in planning their 1980 budget
submissions, to reduce outlays substantially below those currently projected in the
Mid-Session Budget Review.
THE ECONOMIC OUTLOOK FOR 1978 AND 1979
The course of fiscal policy that we now are recommending to the Congress is, in
our view, consistent with an economic growth rate of about 4 percent in 1978 and
again in 1979. Since January, several developments besides the change in budgetary
policy have been working to reduce the outlook for economic growth. The rate of
inflation increased in the first half of this year. That increase was due in substantial measure to sharply rising food prices and the effects on prices of imports of the
depreciation of the dol!ar. These sources of higher inflation absorb purchasing
power of the majority of consumers, who must spend more of their incomes to buy
food and imported goods, and who therefore have less to spend on other goods and
services. As a result, the outlook for real personal consumption expenditures has
dimmed.
The sharp rise in interest rates has also had a direct dampening effect on
economic expansion by raising the cost of buying a home or making a business
investment. Rates have risen in response to the increased credit demands that have
accompanied continued growth and more rapidly rising prices, combined with actions by the Federal Reserve to tighten credit in an effort to hold down the growth
in the monetary aggregates.
Our forecast for the rest of 1978 and for 1979 takes account of these developments. It is based on three key assumptions about economic policy:
First, that the Congress, in its actions on tax and expenditure legislation,
pursues the overall fiscal policies recommended in the Mid-Session Budget
Review.
Second, that conditions in the money and credit markets do not lead to a
significant rise in interest rates.
Third, that the high rate of inflation in the first half of the year-which was
fed by a number of special factors-eases during the second half, and that the
underlying rate of inflation does not accelerate in 1979.
Due to the cold winter weather, the effects of the coal strike, and other special
factors, the economy did not grow at all in the first quarter of 1978. But all the
indicators suggest a strong rebound in the second quarter, with real GNP growing
at an annual rate of 8 to 9 percent. Much of the second quarter's strong performance represents a makeup of first quarter losses, and recent data suggest that much
of the bulge in growth associated with this makeup process is already behind us.
We expect the rate of growth in the second half of this year to be in the 3½- to 4percent range, or somewhat slower than the average of the first two quarters.
Growth would weaken further in 1979 in the absence of the $20 billion tax cut
proposed by the administration, and incorporated in the First Concurrent Budget
Resolution. With it, however, growth in personal consumption and investment
should be strengthened enough to maintain a growth rate of close to 4 percent again
in 1979.
By early next year, the recovery from the 1975 recession will be 4 years old. Some
analysts have questioned whether it is realistic to suppose that recovery can be
stretched into a fifth year. Past experience does suggest that recoveries tend to lose
momentum as they age. In this recovery, as in earlier ones, consumers have added
to their stocks of durable goods, and in the process have increased their installment
debts. Backlogs of housing demand have been reduced, and mortgage debt has risen.
With less thrust from these two critical sectors, growth in the recovery is slowing.
But that process does not imply that a recession is just around the corner, or even
that growth must slowup unduly.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
86
During the current upswing we have generally avoided the kinds of major imbalances that, in the past, often have brought recoveries to an end. Inventories today
are lean. The ratio of inventories to final sales of businesses at the end of 1977 was
the lowest in over a decade.
The overhang of apartments and offices that glutted the market 4 or 5 years ago
has largely been eliminated, and vacancy rates for apartments today are unusually
low. Nonfinancial corporations are less liquid today than a year or two ago, but
distortions in balance sheets that undermined corporate health in the early 1970's
have not been a significant problem in this recovery.
Finally-aside from some residential building materials-there are no major signs
of bottlenecks or shortages that could lead to hoarding of raw materials and skyrocketing prices for materials and finished goods. The rise in unfilled orders for
durable goods has been moderate; in fact, the ratio of such orders to shipments of
durable goods is about as low now as at any time since mid-1964.
Thus, the prospects remain good that economic growth can continue at a moderate but satisfactory pace. Business investment should be an important source of
thrust to the economy. The most recent survey by the Commerce Department of
business intentions to invest implies an investment increase in 1978 of about 5 to
5½ percent, after adjustment for inflation. Other indicators suggest a somewhat
larger rise. New orders and contracts for new plant and equipment have been
strong in the early months of 1978-some 11 percent above 1 year ago, adjusted for
inflation. Capital appropriations of manufacturing firms have also remained strong.
The substantial cut in business taxes proposed by the administration should
strengthen business profits and investment plans in 1979.
Personal consumption expenditures also should continue to rise at a healthy 4percent rate next year, about in line with growth in the overall economy. The
individual tax reductions proposed for 1979 will strengthen consumers' purchasing
power. And the impact of rising food prices and of the depreciation of the dollar on
consumer buying should be lessened as those sources of inflation moderate in the
period ahead. The personal saving rate has returned to about a normal level by
historical standards. A modest increase in the saving rate could occur next year, but
we see no reason to expect a major shift in consumers' savings patterns. Consumer
confidence, although it has declined somewhat, is still quite high. While consumer
spending will not be a major source of new thrust to growth, the evidence does not
suggest a significant weakening in consumer spending is on the horizon.
Some decline in housing starts and in residential construction is likely later this
year and in 1979, given current levels of mortgage interest rates. Mortgage lending
institutions are in a stronger financial position now, however, than they were in
previous periods of cyclical expansion when rising market interest rates dried up
the inflow of savings. Moreover, the demand for housing remains strong. Therefore,
giV'en the maintenance of roughly current monetary conditions a sharp decline in
housing starts is unlikely, and the strength of business investment and personal
consumption should provide for a relatively healthy economy late this year and in
1979.
Growth of about 4 percent per year in 1978 and 1979 probably will mean a
gradual further decline in the rate of unemployment. Forecasting the future course
of unemployment, however, is more difficult than usual. During the past year-even
before taking into account the dramatic fall in unemployment in June-unemployment declined much further, given the growth of economic activity, than past
relationships would have suggested. We do not yet know the extent to which this is
a temporary phenomenon that may be reversed, or symptomatic of a more persistent new relationship. The very sharp additional decline in June simply adds to the
puzzle. the unemployment data are based on a household survey of employment and
unemployment. Independent data on the June employment increase, based on a
survey of business firms showed a much smaller rise in employment than that
shown in the household survey. It is possible-although there is no hard evidencethat part of the very large decline in unemployment in June reflects a statistical
aberration. Given these uncertainties, our best estimate is that the rate of unemployment will stay close to its current level for the remainder of 1978, and then
drift slowly downward next year.
The marked improvement in the unemployment picture over the past year is a
welcome contribution to achieving our most important economic and social objectives. But it has occurred in large measure because of disappointingly small increases in productivity-a development that, if it continues, would add to costs and
complicate an already serious inflation problem.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
87
THE OUTLOOK FOR PRICES
The rate of inflation began to move up late in 1977 and has accelerated sharply
further this year. From December to May, consumer prices rose at an annual rate of
10-percent, and prices of producer finished goods rose at a 10-percent annual rate in
the first 6 months of this year.
The acceleration in inflation early this year is reminiscent of the experience in
1977, when rapidly rising food prices pushed up the CPI at a 9-percent annual rate
in the first 6 months of the year. The increase in food prices moderated during the
second half of 1977, and the overall rate of inflation therefore declined substantially. Although the sources of the latest inflationary surge are somewhat different,
there is good reason to expect a repeat of last year's pattern. While any slowdown in
inflation later this year would, of course, be welcome, the longer term rate of
inflation will remain too high, and the risks that it will accelerate are too great to
ignore. Inflation is our most serious economic problem, and dealing with it must
receive top priority.
The worsening of inflation early this year stemmed to an important degree from a
very rapid increase in food prices. From December to May, food prices at the
consumer level rose at an 18½-percent annual rate. Meat prices rose substantially,
in part because the long period of reducing our beef cattle herds was coming to an
end and some increase in price was necessary to encourage cattle ranchers to
rebuild herds. Other meat prices rose as consumers switched from beef to less
expensive meats. The price of pork was driven up further when unexpectedly cold
winter weather reduced prospective pork supplies for 1978. Cold and rainy weather
in California during the winter and spring also adversely affected prices and supplies of fruits and vegetables.
Other special factors made modest contributions to the higher inflation rate, such
as the increase in the minimum wage in January and the effect on prices of
imported items of the 7 ½-percent devaluation of the dollar which occurred in the
past year.
As in 1977, the outlook for the second half of 1978 is for considerable improvement in the rate of inflation. The rise of food prices should slow substantially.
Cattle prices are below their earlier peak levels. Moreover, strong production of
poultry and increased output of pork in the second half are expected to moderate
the rate of meat price increase for the remainder of 1978. Vegetable supplies should
increase significantly as the summer crops are harvested, and prices of some of
them should decline. Major grain and feed crops-such as wheat, corn and soybeans-are in relatively good supply this year, and prices for those crops should be
increasing less rapidly as the year proceeds.
The contribution to inflation from other special factors should also be less in the
second half of this year and in 1979. A more stable dollar in foreign exchange
markets should contribute less to inflation. Moreover, the increase in Governmentmandated payroll costs will be less in 1979 than in 1978.
In stressing the role of special factors that have aggravated the rate of inflation
this year, I do not mean to minimize the seriousness of the inflation problem. Even
after all of these special factors are allowed for, some worsening in the course of
inflation remains. The chief problem lies in the fact that pressures on costs of
production are mounting.
A year ago, unit costs of production were rising at an annual rate of around 6 to
6½ percent. Since then, the average rate of wage increase appears to have risen by
one-half of a percentage point. Productivity growth, meanwhile, has been very
disappointing.
The longer term trend rate of growth in unit production costs is a fundamental
determinant of the underlying rate of inflation. How much the underlying rate has
increased over the past year is difficult to judge, but it may have crept up from the
6- to 6½-percent range to the neighborhood of 7 percent. Moreover, this upcreep
could continue if wages and fringe benefits received by small unions and by nonunion workers rose still more rapidly in an effort to close the gap which opened up
earlier between settlements won by large unions and the wages and benefits earned
by others. If an acceleration of inflation is to be avoided, it is essential that the
remaining gap be closed by a significant deceleration in the rate of increase in
major union contracts in the new round of collective bargaining that begins in 1979.
ECONOMIC POLICY AND THE INFLATION PROBLEM
Let me now turn specifically to the kinds of policies we must pursue to combat
the serious inflation problem that confronts us. Monetary and fiscal restraint have
an important role to play in this endeavor. Past experience indicates that an
overheated economy leads to an acceleration of inflation then tends to become built
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
88
into the economic system. We must therefore follow a course of policy that avoids
the emergence of excess demand, which would cause prices to rise even faster than
they have recently. As I indicated earlier, the degree of fiscal stimulus has been cut
back for just that reason. At the present time, we are aiming for a rate of economic
expansion near the growth of our longrun potential so that economic overheating
will be avoided.
You may ask why, in light of the seriousness of our inflation problem, we should
not slam on the fiscal and monetary brakes in an effort to make greater progress in
reducing inflation. Experience clearly demonstrates that this would be an ineffective route to follow.
Slowing ecomomic growth still more, to a pace well below the economy's potential,
would have some effect on the rate of wage and price increase, but only a small one.
Over ·the past two decades, the rate of wage and price increase has become increasingly insensitive to slack demand in the economy. During the course of the 1948-49
recession, rising unemployment led to a very sharp reduction in the rate of wage
increase in manufacturing. Consumer prices stopped rising altogether and actually
fell somewhat. In the years since 1949, the responsiveness of wages and prices to
economic slack has gradually weakened. In the 1969-70 recession, rising economic
slack had no effect on the rate of inflation. What little moderation did occur in the
rise of consumer prices in 1970 reflected developments affecting food prices. Moreover, the increase in average hourly earnings in the private nonfarm sector of the
economy did not decelerate at all.
In the recession of 1974-75, the improvement on the price front appears to have
been due much less to economic slack than to the termination of special factors
affecting prices in 197 4. Food supplies became more ample, the OPEC oil price
increase worked its way through the economic system, and the one-time adjustment
of wages and prices after the removal of controls finally ended. From the middle of
1975 until very recently, the underlying rate of inflation, despite several years of
very high unemployment, remained in the 6 to 6½ percent range.
Significant reductions in the inflation rate could be accomplished today if we were
willing to tolerate massive unemployment for very long periods of time. Such a
policy would not only be unacceptable from the perspective of social policy, but also
complicate our efforts to curb inflation over the longer run. As economic growth
slows below potential, the unemployment rate begins to rise. As high unemployment
continues, pressures mount to inaugurate major new Federal programs to provide
employment. And as capacity utilization rates fall, business profits are reduced even
more than other forms of income. Sluggish growth of sales, low utilization rates, and
depressed profits discourage businesses from investments that are needed to increase productivity and to keep the Nation's capital stock growing in line with a
rising labor force. We have been through a period like this only recently, and the
resulting slowdown in business investment has clearly affected our rate of productivity growth. We do not need another such period. We are far better off to seek
·
policies that avoid a roller coaster of boom and bust.
For these reasons, the administration has recommended an economic posture that
will enable us to maintain growth of output near the economy's long-term potential.
Accomplishing this objective, however, will require a signficant tax cut next year.
Otherwise, increases in social security taxes scheduled under law and the automatic
increase in tax burdens that results from inflation will drag heavily on consumer
spending and imperil that critical source of strength in the economy. We also need a
substantial business tax cut to stimulate investment, both to keep the current rate
of economic growth at a satisfactory level and to provide the growth and modernization of capacity required over the long run to deal with the inflation problem.
The Federal deficit for fiscal year 1979 still is very large, even though it has been
reduced by $12 billion in the most recent hudgetary projections, We must work to
bring the deficit down over time as the economy strengthens. The speed with which
this can be accomplished, while maintaining satisfactory economic growth, will
depend heavily on developments in other sectors. Last year, State and local governments reported an aggregate budget surplus of $30 billion. Moreover, our current
account deficit of international payments was $15 billion. In total, the flow of
income to State and local governments and abroad was $50 billion greater than the
return flow of spending from these sectors back into the income stream. The
unprecedented size of these withdrawals put a large burden on the Federal budget
to help maintain economic growth. As these huge withdrawals from the spending
stream gradually decline, as they are expected to do, it will be possible, and indeed
necessary, to move toward a balanced Federal budget in order to meet our desired
growth objectives. We -expect to make substantial progress in that direction in fiscal
year 1980.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
89
I stated earlier that a significant reduction in business truces is essential both to
continued economic growth and to our anti-inflation effort. I would like to make
clear, however, that a large reduction in capital gains truces, as has been proposed
by some Members of Congress, is not an effective substitute for the reductions in
business truces proposed by the President.
Reductions in capital gains truces are not likely to be an efficient method of
stimulating investment. Of all capital gains realized each year, about 60 percent or
less can be attributed to the sale of assets that are closely related to productive
enterprise. The bulk of capital gains stems from sales of private homes, timber,
land, jewelry, art, and similar items. Relative to reductions in the corporate income
true, increases in the investment true credit, or liberalization of depreciation, capital
gains true reductions are, therefore, a far less effective means of allocating scarce
revenue resources toward the stimulation of investment.
It has been asserted that the cut in capital gains along the lines proposed by
Congressman Steiger would lead to increases in stock prices as great as 20 to 40
percent, and thus provide a major spur to investment. No one can predict with any
confidence the impact of tax reductions on stock prices. But estimates of this
magnitude border on sheer fantasy. The total reduction in truces under Congressman
Steiger's proposal, for example, would be about $2.1 billion per year, at current
income levels, of which only about $500 million would accrue to holders of common
stocks. Five hundred million dollars is roughly one-half of 1 percent of the $1 trillion
total value of common stock in this country. How an increase in the after-true
income equal to one-half of 1 percent of asset values is supposed to increase those
values by 20 to 40 percent escapes me.
Moreover, the argument that capital gains taxes are a particularly onerous disincentive to investment is difficult to accept. Only 10 percent of all Federal income
truces on returns to capital stems from the capital gains true. Other truces-including
corporate profits truces and individual income truces on property income, dividends,
and interest-account for the other 90 percent. And while theoretically the maximum capital gains true rate could be almost 50 percent, the average rate actually
paid in 1976 was only about 16 percent. Even for taxpayers with more than $200,000
in adjusted gross income, the average true paid on capital gains was only about 27 ½
percent. Fewer than five-hundredths of 1 percent of trucpayers reporting capital
gains paid a true as high as 40 percent on that income.
Reductions in capital gains truces of the kind that have been proposed would be of
major benefit to a few wealthy individuals. Under the plan proposed by Congressman Steiger, four-fifths of the true reduction would go to taxpayers with expanded
incomes (i.e., adjusted gross plus items of true preference) greater than $100,000.
Some 3,000 beneficiaries of this proposal, with $1 million or more of income, would
receive an average true reduction of $214,000 each. That is an exorbitant price to pay
for a true incentive that would do little to stimulate investment, or to relieve a tax
that, when examined carefully, is not all that burdensome.
The issue is not whether the economy needs true reduction designed to stimulate
business investment. Such a stimulus is indeed vitally necessary. Rather, the issue
revolves around the fairest and most efficient means of doing so. The administration
has proposed net business true reductions of over $5 ½ billion and total tax reductions on capital income of $7 billion. Analysis of both fairness and effectiveness in
investment stimulation indicates that this approach is far superior to the kind of
true cuts incorporated in the Steiger amendment.
OTHER POLICY CONCERNS
My testimony today has focused principally on the macroeconomic policies needed
to reach our economic objectives. Macroeconomic policies alone, however, are not
enough. Unless they are supplemented with other programs targeted at specific
problems, inflation will continue at much too high a rate, and structural unemployment will not be reduced appreciably.
Solutions to these problems do not generally fall under the purview of this
committee, so I will keep my comments on them brief. But a few words on the other
components of the administration's approach to combating inflation and reducing
unemployment are in order.
I have already stated that getting control of inflation is the most critical problem
that our Nation faces today. Prudent fiscal and monetary policies are essential to
avoid economic overheating, but they are not an effective means of reducing the
underlying inflation rate we have inherited from the past. The President's deceleration program is the best vehicle to do this. In the early months of this program, we
have received considerable support from the business community. As the year
progresses, of course, more and more businesses wilJ face the difficult decisions they
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
90
must take to meet the deceleration standard, and we will be monitoring price
developments very closely.
The growth of wage costs must also be decelerated. In particular, we cannot
realistically hope to achieve our goals for the economy unless the gap that has
opened between the earnings of workers in large unions and workers in the rest of
the economy is closed through greater wage restraint on the part of large unions,
rather than through faster increases in the wages of other workers in the economy.
We also must press forward with programs to address the problem of structural
unemployment. In the President's budget in January, we proposed a series of
initiatives to address the needs of the young and the unskilled workers who must be
assisted in gaining the skills they need to join permanently the ranks of the
employed. Since January, the Labor Intensive Public Works program and the new
employment tax credit proposed as part of the President's Urban Initiative offer
additional ways to address this debilitating problem. We will have to move gradually if we are not to put too much pressure on the overall economy, but we must not,
and will not, turn our backs on those whose chances for employment are still
discouragingly low.
The CHAIRMAN. How would you distinguish the Kemp-Roth proposal from the Kennedy-Johnson tax cut and the economic conditions at that time? What are the differences?
Mr. SCHULTZE. Two big distinctions: The Kemp-Roth is a larger
tax cut. Second, taking place in an economy with much less slack
in it. The Kennedy-Johnson tax cut was smaller. The KennedyJohnson tax cut was larger than the cut the administration is
proposing now but a good bit smaller than the Kemp-Roth.
Second, it took place in an economy with a good bit more room
and slack in it. And finally, it took place in an economy with the
rate of inflation running 1 ½ to 2 percent, where we _are dealing
with an economy in which you have to walk a much more careful
line because of the rate of inflation we are facing. Therefore, I
would say for all three of those reasons there is a very large
difference between the two.
The CHAIRMAN. Thank you. In your testimony-Mrs. HOLT. Mr. Chairman, could I ask one question right with
the question you just asked about the Kennedy-Johnson tax cut?
What was the GNP then? You say it was a very small tax
reduction, but, as I recall it, it was roughly comparable percentagewise.
Mr. SCHULTZE. It was about 2 percent of GNP.
Mrs. HOLT. And what are we talking about here?
Mr. SCHULTZE. We are talking now something that would be just
about, when the Kemp-Roth would be fully in effect, just about
double that in an economy with much higher inflation and much
less slack.
Mrs. HOLT. What is the slack we are talking about?
Mr. SCHULTZE. What I am talking about is excess capacity.
Mrs. HOLT. What is our excess capacity?
Mr. SCHULTZE. We would suggest that perhaps now there might
be 4-percent slack. But if you move too quickly to remove it, that
would be inflationary. It is the amount of slack and how fast you
move to remove it. Don't get me wrong. I do not suggest that we
don't need not only the tax cut this year, but in future years
additional tax cuts. There is no question of it. What I question is
whether or not under current circumstances it is wise to commit
ourselves now in law to this phasing in of that size tax cut in this
economy. That is my point.
Mrs. HOLT. Thank you, Mr. Chairman.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
91
The CHAIRMAN. You are saying with the slack in the economy
that we are presently at about 83 percent of capacity?
Mr. SCHULTZE. On industrial capacity, that is right.
The CHAIRMAN. And the ideal would be about 87 percent?
Mr. SCHULTZE. Somewhere between 87 and 89 percent; something
like that.
The CHAIRMAN. That would be full capacity?
Mr. ScHULTZE. But it is also labor force. There are two parts to
capacity; the room you have to expand your employment without
putting upward pressure on wage rates and expanding the industrial use.
The CHAIRMAN. On page 3, you say that we must act to promote
"a moderate pace of economic growth. To seek a rate of economic
growth substantially greater than the growth of the Nation's potential would * * * seriously court the danger of heating up inflation."
And then on page 4, you say, "We are aiming for an overall
growth rate of about 4 percent in 1978 and 1979." On page 16, you
say, "We must, therefore, follow a course of policy that avoids the
emergence of excess demand which would cause prices to rise even
faster than they have recently."
How are we doing these things, through tightening monetary
policy or reduction of stimulus, reduction of Federal spending?
What are the plans of the administration to accomplish this end?
Also, bring in the monetary situation and the relationships with
the Federal Reserve. What are we doing in this area?
Mr. SCHULTZE. What the administration has proposed, and what
is incorporated in the First Concurrent Resolution, very roughly, is
a fiscal policy with a tax reduction of a size which would be
calculated to keep the economy going as far as budgetary policy is
concerned, to put enough additional money in consumer pockets to
keep the economy going at that moderate rate.
Compared to recommendations early in the year, the fiscal
stimulus that has been recommended has been reduced for the
reasons I indicated but not eliminated. So that is No. 1.
No. 2, you have to put it in the context of the fact I mentioned
earlier that other taxes are rising, and so we are trying to balance
these off to give us the tax reduction, on the one hand, against the
tax increases that will occur because of social security and inflation, to give us about the right growth.
Second, the interest rates and monetary conditions have tightened over the last 6 months, and that will tend to hold the rate of
growth down some. Our projections are based on the assumption
that the current degree of tightness remains roughly the same. I
am not trying to call it to a decimal point, but that it remains
roughly the same. We think the combination of that would give us
this moderate, responsible, satisfactory rate of growth under the
circumstances we are now in.
Let me note several things. For example, in the latest midyear
budget review in reestimating expenditures in line with current
experience and the administration's budget proposals, we come to
an expenditure estimate for 1979 of $496.5 billion, I believe it is.
That is below the estimate of expenditures contained in the First
Cop.current Budget Resolution, not so much because of estimating
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
92
differences, but because there are some policy differences. And so if
the full policy of the budget resolution were carried out and estimates remain the same of the spending rate, spending would be
slightly higher than what is in the midyear budget review.
But on the assumption of those midyear budget review figures,
on the tax side and expenditure side, we think that will be about
the right rate of growth.
The CHAIRMAN. Thank you very much. Mr. Stokes?
Mr. STOKES. Thank you, Mr. Chairman.
Mr. Schultze, you cite the fact that unemployment has been
reduced from 9.1 percent to its current figure of 5.7 percent. You
do not appear to be able to tell us in your testimony, however, the
precise factors that have culminated in order to bring about this
reduction in unemployment in the economy. At the same time, you
cite the fact that unemployment is still very high among our
young, our poor, and our minorities. Can you explain for us what
factors operate in the economy that would cause this kind of a
reduction to take place, and yet, at the same time, has had very
little, if any, impact upon unemployment among these three
groups?
Mr. SCHULTZE. Mr. Stokes, I will try. We have to admit that we
have large areas of ignorance in some of this, but let me try.
First, there has been a reduction in unemployment among disadvantaged groups. The problem, however, is that it was so very, very
high to start with; so even after that reduction it remains high.
That is No. 1. There has been some reduction but not enough.
Second, one of the points of import of my testimony is that in the
reduction of unemployment to date there have been several factors
involved. First, the rate of expansion of the overall economy, which
generates more jobs. Second, specific programs targeted at those
groups of unemployed whose unemployment rate is very high,
public service employment, youth employment measures, and the
like-that has also been a factor.
In the period ahead we are going to have to rely more on those
targeted measures and somewhat less on just simple overall economic expansion because now more and more we have to target
our efforts at getting the rate of unemployment lower among
groups where that rate remains very high. And we also have,
finally, to remember if we really want to make this successful over
the long run it can't be just Government hiring. We have to get the
private sector more interested in hiring from those groups, and,
therefore, among other proposals the President has made this year,
was the significant new proposal for tax incentives to employers
explicitly to hire from among the disadvantaged, as a step-I don't
claim it is going to be the only thing needed over the years aheadbut as an initial step in trying to get this done.
In summary, therefore, you are quite right where we have ended
up with respect to unemployment; among black youth, in particular, it is still scandalously high. It has come down some, but it
started so very high that even after coming down some, not a lot,
we still have a lot of work to do on that, not just through the
overall expansion of the economy but by targeted measures.
Mr. STOKES. Referencing the latter part of your reply, I see how
the President's urban policy proposal, with built-in tax incentives
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
93
for the purposes of hiring the disadvantaged, might be a vehicle
that can be utilized in order to reduce unemployment. I have some
difficulty, however, understanding how, if we use the administration's approach of an overall tax cut for business, we can be assured that such a tax cut would be utilized for the same purpose as
would tax incentives.
Mr. SCHULTZE. In the first place, it won't, Mr. Stokes, in the
sense it is not targeted in the same direction. We have two arrows,
if you will, in our quiver. We do need the targeted incentives to
hire the disadvantaged, but in the long run we also need for the
health of the overall economy an expansion in industrial capacity
and productivity, because what we don't want to do is in 1980 run
up against bottlenecks that will turn the whole economy down.
Therefore, there are two parts, if you will: Incentives to hire the
disadvantaged and incentives to expand capacity. We think both
are needed, not just one.
Mr. STOKES. On the latter part, what assurance do you have that
the tax cut would be utilized for the purpose of expansion of
business?
Mr. SCHULTZE. Mr. Stokes, in the sense of legal assurances, none.
In the sense of economic analysis, which indicates such tax reductions in the past do tend to stimulate business investments, plenty.
But no legal assurance any more than when we cut taxes on
consumers we have legal assurance they will spend it. But normal
economic analysis tells us that yes, there will be a response, so
hence, for all sorts of reasons, we don't attempt to write legal
assurances in the law.
The CHAIRMAN. The time of the gentleman has expired. Mr.
Mattox?
Mr. MATTOX. Mr. Schultze, I have listened to your testimony, and
I have a particular concern about the administration's viewpoint
about the tax cut. I think we are in the controversy concerning the
Kemp-Roth plan and all these other plans because the administration has steadfastly dug its heels in and refused to take the recommendation of this Budget Committee as to forming a recommendation for a social security tax cuts.
We have increased social security taxes, and it seems to me that
an appropriate place to give relief would be in the area that the
people most certainly want. That tax cut quite obviously would
help both the working people in the community and the businesses
that employ people throughout our economy. And would probably
be the most helpful thing in the area of unemployment relief.
I am curious as to why we can't seem to get that point across to
the administration. I would like to know what your viewpoint is in
comparing the social security tax relief with one of these other
areas of relief, including capital gains relief.
Mr. SCHULTZE. Mr. Mattox, in the first place, a little history is
instructive, I think. You may recall in December the Congress
passed, and the President signed, a bill substantially increasing
social security taxes in order to finance the social security system.
Second, a reduction in social security taxes now reversing that
decision on the basis of considerations of the moment, without
embodying it in a major set of reforms with respect to the whole
32-052 0 - 78 - 7
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
94
long-term financing of social security would, they think, be irresponsible.
It is not that over the long run we don't want to look carefully at
the whole financing of that system and whether the route we are
going is exactly right. It may well not be, but we don't want to do
it piecemeal. We don't want to do it on the spur of the moment
because that, in turn, would set a precedent and open up, I think,
some really bad possibilities for the future with respect to the longrun financial security of that system.
Therefore, in principle and over the longer term, you have a
point. To do it this year in terms of immediate needs on an ad hoc
basis, it seems to me to make no sense.
One other point: The Secretary of HEW has appointed a social
security advisory committee, which will be coming forth with a
major review of that system, both the benefit side and the revenue
side. Then indeed it might be time to look at this, but not this year.
Mr. MATTOX. I think the question is, we have seen this problem
developing for at least the last 10 years, and it is a question of how
long we wait. The administration has taken up the gauntlet in a
wide assortment of areas, and it seems that we continue to put off
and to delay action that could be taken, and it could be taken
relatively quick, because all these studies we are talking about are
not that indepth and in detail.
We are hunting for some justification to take some action we
know needs to be taken and as long as we are going to give some
tax relief and give reduction, it seems to me that the place that
gives the greatest stimulus would be in the social security system.
Let me pursue it. Would you agree that the social security tax
reduction, or using general revenues to fund some of the social
security and reduce the general revenues in some form would be
more profitable than some of the other tax recommendations
taking place?
Mr. SCHULTZE. If you are asking me to compare the impact of a
social security tax reduction with, say, a Steiger amendment, you
are asking me to compare apples and peanuts. While I don't want
to let it be thought to say I would approve of a reduction in social
security taxes this year, as between those two choices, I would
prefer that to Steiger, yes.
But they are doing a different thing. I don't think that is the
choice, by the way, but if you pose the choice, yes.
Mr. MATTOX. It could be the choice?
Mr. SCHULTZE. I have never heard it put this way until this
morning.
Mr. MINETA. Would you yield?
Mr. MATTOX. Yes.
Mr. MINETA. Part of the thrust of last year's legislation was to
bring financial stability to the social security system and now that
we have done that, shouldn't we consider taking H.I. off the trust
fund? Shouldn't we consider taking the H.I. off the payroll tax?
I think it is something significant, and we are not tampering
with the stability of the assumed income on the social security
system. There are things that don't belong maybe on the social
security system, and H.1. may be one of them.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
95
Mr. SCHULTZE. Mr. Mineta, in terms of taking a fundamental and
careful look at the longrun future of the financing of the social
security system, I agree with you, and there are all sorts of things
that should be looked at and not just on the .financing side but the
benefit side as well. If you look at disability, for example, benefits
have mushroomed. What I am against, and the administration is
against, is in the context of a tax reduction for purposes of economic stimulation on an ad hoc basis to make a decision on this
without looking at the whole system between now and the year
2000, not just next year, and setting a precedent that every time
social security tax rates are about to rise, we cut them back.
So it is kind of a longrun objective. There are all kinds of things
that should be looked at. I am not against looking at them all, but
they have to be done in an overall package looking at both benefits
and revenues and looking at well into the future. I don't think this
is the environment, and the administration doesn't think this is
the environment, in which to do this.
As I say, the Secretary of HEW has appointed this year a committee to study this indepth, and I don't think we should do it now.
Mr. MATTOX. Well, I think our problem is we are trying to figure
out, Mr. Mineta and I, both, what is the environment to take this
action, and when that action is going to take place. We continue to
say, "Well, we are going to do it next year, or down the road." We
have got some stability in the system now, and I know if the
administration will get moving and start making the plans that
this Congress, the great majority of this Congress, is ready and
willing and able to move, particularly in these areas of H.I. and
D.I., if we will just take some action on it.
But it is going to take some strong leadership out of you and Mr.
Blumenthal and the President to make these actions take place. I
think that we could probably end this debate about the capital
gains, Kemp-Roth and a lot of these things, if we would go on and
do what the American people want us to do.
The CHAIRMAN. The time of the gentleman has expired. The
Congresslady from Maryland.
Mrs. HOLT. Thank you, Mr. Chairman. To follow on with this
discussion, Mr. Schultze, you said that we do need relief, and I
think that is the point we are all concerned about. Is the $20
billion on top of these other taxes that have been put on there
going to be relief? We have to look at the whole picture. Is the size
of the administration prorosal really going to be relief?
Mr. SCHULTZE. Yes, ma am, I think-well, it will be; that is No. 1.
No. 2, everybody would like to cut taxes. We want to cut taxes. The
committee wants to cut taxes. The American people want their
taxes cut. The question is, How much? The question is, What is
responsible by way of the Federal budget deficit and by way of
economic policy in the period ahead? So we are not quarreling
about basic principle. But I think it is incumbent upon the administration and the Congress to be prudent, to put a significant tax
cut into effect, but, because there is a significant tax cut which is
right, that doesn't mean one double that size or triple that size or
quadruple that size is right.
Mrs. HOLT. Is it really a tax cut if we have added all these taxes
and then we are going to give back less than this amount? Along
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
96
that same line, as an ex-director of the Bureau of the Budget,
wouldn't it be better to think about a long-term tax reduction over
a 3-year period? Of course, I would like to see you thinking along
the lines of a reduction in outlays at the same time.
Mr. SCHULTZE. I understand that, and we are.
Mrs. HoLT. As the Kemp-Roth proposes, that we do it over a
longer period of time?
Mr. SCHULTZE. Again, obviously reasonable people can argue
about the size of a tax cut. One could indeed propose a very large
tax cut phased in over 3 years, but then I think it is also incumbent on them to give us at least some broad indications of where
they would cut-I don't mean a few billion, but scores, up to
hundreds of billions from the Federal budget to match it, and I
really don't think-we want to be prudent; we want to pare down
the share that Government takes in our economy.
The President has explicitly set that as an objective on expenditures. We want to be realistic about it. You are not going to cut it
in half. I don't think anybody wants that. What we are really
talking about is giving the American people an important tax cut
but not at the same time going so far overboard we give them
inflation.
There is nothing, it seems to me, which would be worse than to
put money back in the people's pockets through a tax cut and
maybe take it away double through higher inflation.
Mrs. HOLT. What I had proposed was to reduce the rate of
growth of Government with the hope that very quickly we would
see a stabilization occur.
Along that same line, you said in your testimony that the President had instructed Federal agencies in planning their 1980 budget
submissions to reduce outlays substantially. What does that mean?
Are you asking them to reduce the rate of growth or just saying
they have to cut back?
Mr. SCHULTZE. Well, what we do is we have, and we did send to
the Congress, a projection of what expenditures would be in 1980
under current programs. Obviously growth in inflation and population adds to Federal expenditures under the social security law,
through the automatic indexing of social security and other programs. The defense budget, for example, grows as higher prices
come along. So we have an estimate of what those expenditures
would be under current programs with no new programs, and what
the President said is you have to cut below that and substantially
below it. We are not in a position, and won't be until December, to
come up with kind of a final bottom line on exactly how much you
can do, but let me assure you it will be substantial.
On the other hand, it isn't going to mean expenditures absolutely
turning down, because we do have to take care of, as I said, such
things as social security indexing, the defense budget, and the like.
Mrs. HOLT. One further question, Mr. Chairman. On the KempRoth, you said $120 billion was the figure you were using.
Mr. SCHULTZE. By 1981, when it is fully in effect.
Mrs. HOLT. It seems to me that is high. The figures I have heard
have been something like $20 billion per year. Is that not correct?
Mr. SCHULTZE. Well, it is a 30-percent tax cut on income taxes. If
you project out what kind of incomes we are going to have in 1981,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
97
you can obviously give or take some small amount, and then apply
that 30-percent tax cut to the 1981 level of income; its immediate
effect would be a cut of $110 billion to $120 billion.
Now, I grant you our gross national product would then increase,
and you would get some of that back. So the net effect wouldn't be
$100-some billion. What I am arguing against is the fact that you
would grow GNP so very much you would get it all back. No way.
Mrs. HOLT. We are not arguing really whether there is a free
lunch, but how much it is going to cost us.
Mr. SCHULTZE. In inflation.
Mrs. HOLT. In the unemployment situation, it is dropping rapidly
and yet there isn't any great increase in real growth. How do you
explain that? Is it that employers are not making long-term capital
investments and instead working their capital. harder? In other
words, are traditional measures that we use valid any more? Can
we depend on the measures that we have used conventionally?
Mr. ScHULTZE. Mrs. Holt, I wish I could give you a complete
answer to that. In all honesty, I can't. What we do know is that at
least what has happened in about the last 9 months indicates that
employment has grown relative to the growth in output by much
more than would normally be the case. This suggests one of three
possibilities. We are overestimating employment; the statistics are
wrong. That is very unlikely. We have confirmatory evidence.
Second, we are underestimating our output. That may be partly
true, but I don't think so. Third, in the last 9 months, the rate of
growth in our national productivity is less than we had been
having, and I think it may be some of that. What, I am not sure.
You do get periods in which these relationships don't stick with
historical levels.
The extent to which this is temporary or permanent I am not
sure. I think it may be a little bit of both. It does indicate the need
to get capital formation and investment growing more strongly.
There is no question of that. But I can't give you a statistical
answer as to exactly how much that would do. But it does lead in
the direction of saying, yes, increased business investment is important.
Mrs. HOLT. Thank you. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentlelady has expired.
The vote on the House floor is final passage. Do you have some
time, Mr. Schultze? We have four people here with questions, if we
went over and voted we could get you out by about 12:15.
We will stand in recess.
[After recess.]
The CHAIRMAN. The committee will please come to order.
Ms. Holtzman.
Ms. HOLTZMAN. Thank you very much, Mr. Chairman.
Mr. Schultze, I would like to ask you some questions about
inflation. I would like to start by expressing my concern about a
solution that you propose on page 18 of your testimony, namely,
that we could accomplish significant reductions in inflation if we
were to tolerate massive unemployment for a very long period of
time.
I thought that theory was discredited as a result of our experience under the past administration, when we had enormous unem
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
98
ployment and rapid inflation. I am surprised to see it being endorsed.
Mr. SCHULTZE. Ms. Holtzman, I never meant that sentence to
endorse the concept. I am saying there is probably some level of
economic slack, which if you could keep for long enough, might do
it. I happen to think it would be very bad, and socially unacceptable, but we do have-let me give you an example. We pulled
together eight independen_t economic studies of what would be the
impact on inflation if you wanted to run a policy of economic slack.
How long would it take to get how much out of the inflation rate.
They all give different answers, but to give you an idea of the
range, if you wanted to keep the unemployment rate at 6 ½ percent, that is a good eight-tenths higher than we now have, for
somewhere between 6 and 15 years, you might cut the rate of
inflation from 6½ percent to 3¼ percent. I happen to think that is
absurd. I am not endorsing it.
Ms. HOLTZMAN. We also had a IO-percent unemployment rate, as
I recall, not too long ago, and 7- or 8-percent inflation rate. I am
not sure these models or projections that you are talking about
bear much relation to reality.
I think our recent history disproved this so-called classical theory
about the relationship between inflation and unemployment.
Let me turn, then, to the question of what you think is the cause
of the inflation that we are now experiencing and how we are
going to deal with it. I don't see anything in this testimony that
addresses that, nor have I heard any other solutions. So if you
could pinpoint what you think to be the causes of the present
inflation, and what the administration is proposing to do about it,
it would be very helpful, at least for me.
Mr. SCHULTZE. In the first place, a very short answer which I will
elaborate a little on, says the reason for today's inflation is yesterday's inflation. That is, you must distinguish between what started
inflation and what keeps it going.
What really got the current high rate of inflation started was a
whole series of events in 1973 and 1974 in oil, food, worldwide boom
on raw materials, a number of things like that. That got it going.
The burden of part of my testimony, at least, and the burden of a
whole chapter in our economic report, is that the structure of our
economy is such that once inflation gets going, it tends to perpetuate itself as everybody tries to keep up with past inflation, which
makes future inflation continue. It is a price/wage, wage/price,
price/wage expectation phenomena. That is not the only thing, but
that is a big part of what has kept inflation going despite significant unemployment during the past 2 to 3 years.
Mr. MINETA. Will the gentlewoman yield?
Ms. HOLTZMAN. I will be happy to yield to my colleague.
Mr. MINETA. Thank you. I appreciate that, because I am not sure
that the American public thinks that.
Mr. SCHULTZE. No.
Mr. MINETA. All they think of is the fact that the deficit is
causing inflation. Unless the administration starts talking about
these other influences in a highly visible manner, people focus only
on the deficit.
Mr. SCHULTZE. May I respond?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
99
Ms. HOLTZMAN. I think you should address the question of
whether the high deficits we have had contribute to inflation.
Mr. SCHULTZE. Again, unfortunately, there are not many simple
things in this world. There are not any simple answers. Let me
note what is keeping the inflation going is what I said it was, a
kind of momentum, inertia, expectation.
Ms. HOLTZMAN. How long does that last?
Mr. SCHULTZE. I don't have an answer. What we are trying to do
through a voluntary program is to gradually nick it down. That is
what we are trying to do. Let me also note while the current
inflation continuance is not caused by the deficit; we also have to
be careful in the situation we are now in not to make it worse by
having too large a deficit. It is walking that line that is very
difficult.
I agree with Mr. Mineta and Ms. Holtzman-the substance of
what you have been saying-the deficit is not why inflation is
perpetuating itself, but I have to be candid and say we have to be
careful about the size of the deficits that we allow, because we can
start it creeping back up again if we overdo the deficit. It is a very
careful answer in the sense that yes, the current inflation is not
caused ·by the deficit. We also have to be very careful we don't
make it worse by having too big a deficit. It is walking that line
that we have to be very careful with.
Ms. HOLTZMAN. What you are telling me, then, is that the reason
we how have inflation is because we had some problems 5 years
ago in terms of food prices and oil prices, that we don't know how
long this inflation is going to last, and that we don't really know
what are we going to do about it. What are the administration's
policies to deal with this problem?
Mr. SCHULTZE. We have a number of policies. In the first place, if
you are saying do we have any sure-fire answer that is going to
pull that rate of inflation down to zero quickly, even halve it
quickly, no. Given the very stubborn nature of it, given the fact
that we don't want to push the economy into a recession as a
means of handling it, nor do we want wage and price controls,
what we have is a whole panoply of things. These include specific
governmental actions, to try to do its bit where it affects prices and
where it affects wages, to outline a reasonable, achievable standard
of behavior for business and labor and try to get public opinion on
our side to put public pressure on them to carry it out, to do
everything we can in our statements, and to use the instruments
and levers we have to do it. It is not necessarily going to be
unsuccessful at all. It has been done other places, other .times, not
with whopping success, but with some success.
We are not projecting that this is going to get the rate of inflation down overnight. We are saying if we keep at it, we can get the
American people to recognize what is involved; we will get some
cooperation. For example, in terms of-Ms. HOLTZMAN. What can the American people do about inflation? You talk about their getting involved.
Mr. SCHULTZE. A number of things. Partly the pressure of public
opinion. It is partly the fact that most people are not just consumers; they are also producers; they are also members of labor unions.
We think that as you can get people to realize what has to be done,
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
100
it will be easier for us to convince decisionmakers to do it. We are
getting some cooperation from business firms. We hope we can get
cooperation from both business and labor, not in cutting their wage
increases off, but in moderating them. We do want to avoid, as I
say, the two dangers of either wage and price controls-they don't
work-or running us into a recession. That won't do it, either.
This is a program that does have a chance for success, although
we have to keep working at it, and nobody can guarantee it.
Ms. HOLTZMAN. Thank you.
The CHAIRMAN. Mr. Mineta.
Mr. MINETA. Thank you, Mr. Chairman.
To followup on that, essentially I have always heard four ways to
control inflation, and the bottom one that is the last resort-wage
and price controls. That is something that is on the shelf and,
really, no one wants to use, except in short-term periods, in emergencies. So we always seem to come back to jawboning. How effective can we be in jawboning?
If you have labor that is going to be under a 4-year contract,
their leaders are going to try to squeeze as much out of that 4-year
contract as they can because they are locked in for 4 years. They
must try to foresee what the rate of inflation might be, and they
have to do something to protect their members. Yet, on the other
hand, there are not similar restrictions on the price side. If inflation doesn't slow, businesses can always raise their prices.
Traditional wisdom says that jawboning is the only route to go,
but can we rely on that? I wonder whether or not we can dust off
wage and price control in some form. I don't know. I don't like it,
but maybe traditional wisdom isn't what we need in this day and
age.
Mr. SCHULTZE. Let me make a couple of points. First with respect-and there is a real problem-that you are asking, for example, for restraint on the size of 3-year union contracts being signed.
They are taking a risk. You have to remember, however, the contracts now have two components. They have a cost-of-living escalator, which doesn't protect fully, but substantially, against changes
in prices and a fixed wage component. There is a substantial protection built into the cost-of-living escalator so the question is, Can
you bring the fixed components down some?
With respect to wage and price controls, we do have some recent
history in the Nixon wage and price controls. What happened is,
yes, for about a year and a half they did push the rate of inflation
down some, but three things happened. In the first place, as soon
as they were lifted, prices rose sharply. Second, they were only on
for a year and a half, so it is hard to tell; but you know quite well
that with American people who are already complaining about
excessive Government regulation, Government regulation of hundreds of thousands or millions of prices is going to add greatly and
it will hurt efficiency.
And, finally, the result of the Nixon one was, after it was over,
after a year and a half, my recollection of coming to the Congress
and talking about extending the old Cost of Living Council with no
wage and price authority, you almost couldn't even get that done;
people were so fed up.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
101
I would suggest any enthusiasm for wage and price control is
something that lasts only a short period of time, and then the
people get fed up, unless there is a war, and that is another matter.
We put up with all kinds of things in a war. But in an economy
like ours you can't put up with that over a period of time, and you
are counterproductive during the period you have it. You might get
it down a little bit, but it doesn't work.
Mr. MINETA. On page 19 of your testimony, you talk about requiring a significant tax cut this next year and in the analysis on
the Kemp-Roth tax proposal you submitted also, you say there
should be a moderate tax reduction in 1979. I am wondering if we
can be going after a significant tax cut next year to accomplish the
administration's goals in terms of the long term or the moderate
tax reduction that you are referring to in reference to the KempRoth tax proposal?
Mr. SCHULTZE. I didn't mean for the adjectives moderate and
significant to mean different things. Maybe I should have checked
to make sure the adjectives were the same. Let me put it another
way. I would think with a $2 trillion gross national product, a $20
billion tax cut is moderate but not insignificant. There is nothing
you can draw out of the difference between the adjectives. I think
something can be moderate and significant.
Mr. MINETA. On page 3 of your testimony, you mention the
pressures which are growing for further protectionism across the
globe, and I basically have always considered myself a free-trade
advocate, but in the last year I see more and more tariffs, quotas,
subsidies, and other kinds of protectionist measures which are
being adopted around the world, and they are not going down.
From your perspective as an economist, .I wonder, are trade restrictions too high in this country? What is your assessment of the steel
situation, where we finally came up with a reference-of-steel-price
system?
The third area I am interested in is whether or not this wouldn't
be the wrong time to be lowering protectionist barriers because of
the state of the unemployment and some of the other things that
are impacting on our own economy?
Mr. SCHULTZE. First, with respect to steel, let me just take that.
The so-called trigger-price scheme, you have to remember that was
put in in the context of having on the books a 1974 Trade Act with
dumping provisions. Had that been carried out fully without the
trigger prices, you would have substantially greater, I think-that
was the evidence at the time-substantially greater protection. In
effect, the trigger price set up a price reference point based on the
most efficient steel producer in the world, Japan.
If the whole spate of cases that were coming up under the
dumping laws had been the way we had gone, you would have
greater protectionism.
No. 2, the major effort in this area now is in the MTN, the
multilateral trade negotiation, in which we are seeking to reduce
mutually the barriers to trade, and one of the things we are
looking for is a code on subsidies. Distortions to trade come not just
on account of the standard quotas and tariffs but also because of
subsidies some countries employ, and we are looking, as part of our
negotiating business, for improving that substantially.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
102
So I would say if you asked me the question about removing
protectionist barriers, our major effort is not a unilateral change in
this but a balanced approach, reflecting not just reduced tariffs and
barriers to trade but also reductions in the other kinds of distortions which do come about.
Mr. MINETA. The area I come from is referred to by the business
community as Silicon Valley, because it has a large part of the
semiconductor industry in it, probably producing close to about 80
percent of the semiconductors in this country. This question of
subsidy is an important one because the Japanese Government
does much of the research and development in this area of semiconductors, and they license to various companies in Japan the
product of their own research and development. Alternatively, we
have in San Jose, 50-75 companies climbing all over each other
doing the same research on their own, trying to get a foothold into
the next generation of whatever advancement there is in the semiconductor industry. Thus, there is severe adverse impact on us and
I would hope that the administration will deal with this problem.
I have contacted the International Trade Commission as well as
our own Subcommittee on Trade of the Ways and Means Committee, but I would hope that the administration would pursue this
because we always seem to wait until an industry is very sick and
distressed. I think we should take a look at our economy and
various segments of it before they get sick and make sure they
don't become distressed.
For example, it was too late to deal with the CB radio industry
when it came down to 95 percent of the production being overseas,
and there were only something like 1,500 employees in this country
by the time the International Trade Commission decided to take it
up as an issue.
At that point it was too late to deal with the CB radio industry,
and I am afraid if we take this sort of wait-and-see policy on other
segments of our industries, that we may be dealing with rather
hopeless situations.
Mr. SCHULTZE. I really don't know the silicon industry, but the
basic proposition of a mutual, not just a one-sided reduction in
trade, and paying attention to the subsidy problem is what we are
after.
Mr. MINETA. Very quickly, yesterday Barry Bosworth told the
committee that housing has experienced major rates of inflation,
which is likely to continue, and he identified many of the housing
problems as being on the supply side.
In today's testimony you say, on page 10, "Demand for housing
remains strong." Will that demand merely contribute to even
higher rates of inflation in the housing sector, and -is the housing
sector in a demand/pull inflation, as opposed to the momentum
inflation we face elsewhere?
Mr. SCHULTZE. First, I guess it is probably true that over the past
2 years the growth of housing has been very large. Since 1976 there
has been a 25-percent increase in constant dollar housing outlays.
And that has undoubtedly, particularly in the area of lumber and
other building materials, led to some demand/pull. I think that is
probably true, in the sense we have run up against some supply
problems.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
103
On the other hand, in the year ahead, while we don't think that
all housing is likely to collapse, we do expect it to level off and inch
down some so the strength of the demand/pull as supply begins to
catch up a little should be reduced if it doesn't disappear.
I think you are right; in this area there has been demand/pull
inflation. It should be less as housing moderates, and I think goes
down some, though not substantially.
The CHAIRMAN. The gentleman from South Carolina.
Mr. DERRICK. I thank the chairman, and Mr. Schultze; w~ are
delighted to have you before us.
I, quite frankly, at this point, have been unimpressed with the
administration's manner in dealing with inflation. I have watched
your career for many years and have been very impressed with
you, I might add. But what is the difference between what the
administration is not doing and what President Ford did not do
under the WIN program that we all laughed about?
Mr. SCHULTZE. The basic point is that the Nixon and Ford administrations, except the period of price controls, explicitly abjured
laying down any standards of behavior for labor and prices.
Mr. DERRICK. The WIN program was not part of the wage and
price controls.
Mr. SCHULTZE. I am saying, let me-Mr. DERRICK. You know, what you have said to me this morning,
as far as the administration is concerned is that the administration
is not willing to give any strong leadership, or to make any hard
decisions. Inflation is tearing this country up; the elderly people
and the poor people are suffering daily from it, not to mention
most other segments of the population.
But what I get out of your statement, with all deference to you,
is that we are trying to have our cake and eat it, too. The only
thing I have really heard out of the administration is talk. Why
can't we have some leadership from the administration? I mean,
why can't we look into areas like prior notice for price increases,
and prior notice for wage increases?
I don't think we are making any headway, and I don't see
anything, quite frankly, in your statement that indicates that it is
going to improve.
Mr. SCHULTZE. Mr. Derrick, in the first place, the administration,
if you mean by trying to have our cake and eat it, that the
administration is not proposing-Mr. DERRICK. What I mean by that, if you pardon me a moment,
is that you are trying to please everyone and you are not dealing
with the inflation problem. I mean you are trying to please labor;
you are trying to please business, and no one is willing to make a
hard decision.
Mr. SCHULTZE. Let me first note, at least as I read the press, I
had not thought labor was that pleased with the anti-inflation
program. That is an aside.
Mr. DERRICK. They are not out there picketing.
Mr. SCHULTZE. With respect to prenotification, that is a mirage.
We know, on wages, when the bargaining contracts are coming up.
Mr. DERRICK. I am not an advocate of prenotification. I merely
threw that out as one of the things that has been discussed. But
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
104
wouldn't it be a way to approach the matter of public pressure that
you keep referring to?
Mr. SCHULTZE. Again, I don't see what good prenotification would
do. As I say, on the wage side, we know when they are coming up.
On the price side we have had good cooperation from industry
coming to talk to us.
Mr. DERRICK. You know, the public learns about these wage
increases or the significance of them, basically, after the fact.
Maybe this would give some time, say, 30 or 60 days beforehand,
for this great mystique that we hear about of public pressure to
come forward and exert what you are talking about.
Mr. SCHULTZE. Again, I don't want to appear hardheaded; maybe
lam-Mr. DERRICK. Well, I am. You are welcome to be.
Mr. SCHULTZE. What do you get out of prenotification? On one
side, the union always comes in with an offer substantially above
what it expects to get. What are they going to prenotify, the initial
gambit?
·
On the price side it has not been our problem. We have had
some, of course; we can't handle the millions of business firms
across the country, but the major concerns are coming in to talk in
advance. Hence, rather than create a huge papermill, where we are
going to shuffle papers through the Government, whatever the
problem with the program is, that isn't it-Mr. DERRICK. I hear about all these papers and everything. It
depends on what side of a particular argument you are on.
May I get to page 7 of your statement where you say, "Our
forecast for the rest of 1978 and 1979 takes certain things into
account," and if I might say so, I think you are on rather unsteady
ground there if you think that the midyear budget review and the
tax legislation is going to come about as indicated in there, and
obviously the second area, the interest rates already are over the
Fed's projected range.
What are you going to do about Mr. Miller at the Fed? He has
threatened you, in a sense, if you don't cut back on spending
programs, and on the deficit he is going to tighten down on monetary growth so hard that we could go into another recession.
Mr. SCHULTZE. I guess it is a different interpretation. I have seen
nothing coming out of Mr. Miller which would suggest that.
Mr. DERRICK. He made a statement last week I will be glad to
furnish you with a copy of.
Mr. SCHULTZE. I cannot, in effect, give some specific forecast of
what the Federal Reserve will do. I am not trying to. I am saying
that in order to achieve the kind of moderate growth that we are
after; we think current conditions in the money markets are about
right.
Mr. DERRICK. What is the money supply rate right now?
Mr. SCHULTZE. The rate of growth in the money supply?
Mr. DERRICK. Nine percent?
Mr. SCHULTZE. No, the rate of growth that has actually occurred
in April and May is significantly larger.
Mr. DERRICK. 11.9 percent?
Mr. SCHULTZE. It was higher in May and has come down in June.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
105
Mr. DERRICK. And all the projections we . made were based on
what, 5 or 6 percent?
Mr. SCHULTZE. A range of 4 to 6½ percent.
Mr. DERRICK. Of course, a third item, with all deference to you, is
kind of a hope and prayer that everything works out.
Mr. SCHULTZE. It is more than a hope and prayer, Mr. Derrick.
There is some hope in it, that is true, but it is more than a hope
and prayer.
Mr. DERRICK. I hope there is some prayer in it, too.
Mr. SCHULTZE. Yes, sir.
Mr. DERRICK. You say that the higher rate of inflation in the
first half of the year, which was fed by a number of special factors,
which you see easing during the second half. That is a hope. And
that the underlying rate of inflation does not accelerate in 1979,
and I suppose that is another hope combined with a prayer. But
what I am trying to get to, Mr. Schultze, is that seems to me to be
a rather weak base to start from.
Mr. SCHULTZE. In the first place, to go through the three of them,
if you are telling me that the kind of expenditure restraints-the
round number $20 billion tax cut we are talking about the Congress isn't going to pass-I don't see anything to indicate these
aren't ballpark numbers.
Mr. DERRICK. We have cut substantial amounts out of outlays in
the appropriations process in the last several weeks.
Mr. SCHULTZE. In which case, fine, sir.
Mr. DERRICK. So you agree with that.
Mr. SCHULTZE. Yes, sir.
Mr. DERRICK. Mr. Bosworth told us yesterday we should not cut
back on spending.
Mr. SCHULTZE. No, sir. Let me again note that in order to come
up with the expenditure numbers which we are now projecting, the
Congress will have to come in with budget outlays somewhat below
the First Concurrent Resolution, so we welcome that. That is my
understanding of the way the numbers rack up.
Mr. DERRICK. Let me comment briefly on a couple of other
things. You know, when you folks up there were peddling the
minimum wage, you said it was not inflationary. Yet now we hear
in all of the testimony that comes from the administration that
this is part of the reason for the inflation.
Mr. MATTOX. If the gentleman will yield, I believe that tomorrow,
having had the opportunity to look at a certain portion of advanced
text from Mr. Miller, he is going to suggest possibly that we delay
the 1979 minimum wage increase because of the inflationary
impact.
Mr. DERRICK. My point is, and I thank you, Mr. Mattox, but my
point is that is it, or is it not, inflationary? As I said, when you
were peddling it, it was not inflationary, and I think, and I would
stand to be corrected on this, that the same thing was true of the
social security payroll tax increase.
Mr. SCHULTZE. Mr. Derrick, I didn't testify on the minimum
wage, but my recollection is that we did indicate that it would, by
its nature, add to costs and prices; that it would be a modest
amount, and the point is that in 1979 the increase in the minimum
wage is much smaller than this year and only slightly out of line
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
106
with the average growth in wages. It is a little larger, but not
much.
But I would have to go back and review the testimony, but we
clearly indicated it would add to costs and prices, and it would not
be a huge amount.
Mr. DERRICK. I did not get it from you, and certainly don't want
to suggest that I did, but that was not the information I received
when it was being peddled.
Let me ask you one other question, and I will wind it up. Could
you cite for me maybe one or two things that you would consider
as hard decisions that might displease a few people that the administration is willing to make to deal with inflation?
Mr. SCHULTZE. Well, let me just indicate, obviously such hard
decisions as they come along we are willing to make them, but let
me give you three examples of some we have done. First-Mr. DERRICK. I would prefer to know some you anticipate.
Mr. SCHULTZE. I understand that, Mr. Derrick, and just as soon
as the administration reaches those decisions, you will know. I
wanted to give you some indications of the kinds of ones we have
already made.
Mr. DERRICK. All right, sir. Thank you.
Mr. SCHULTZE. First, we did indicate that the President would
recommend to the Congress a 5½-percent increase in Federal pay
rather than the probable 7 ½ percent which would come along if
the simple formula were allowed to go into effect. Second, we did
lift the quota on meat imports. Third, the President did indicate
that he would use his veto on an excessively expansionary farm
bill, as a consequence of which we didn't get one. That was a
decision with some difficult political consequences that we have
heard about.
Mr. DERRICK. I wouldn't be too quick to take all the credit for not
getting it.
Mr. SCHULTZE. I am not. In all of these, let me put it this way, in
every one of these, certainly the first and the third, we need the
cooperation of the Congress, because my recollection is that the
Congress has a chance to override our 5½ percent, and we need
Congress cooperation, and on the farm bill we, of course, needed it,
too, but, on the other hand, there also were some tough political
decisions for the President to make.
Mr. DERRICK. I voted against the farm bill and agreed with the
President on it.
I would ask you if you could submit to me in writing the differences that you see between the Ford WIN program and what the
administration has done to date-back to my original question.
Mr. SCHULTZE. I will submit it in writing.
[The information referred to above follows:]
PRESIDENT FORD'S WIN PROGRAM AND PRESIDENT CARTER'S APPROACH TO
INFLATION
The differences between President Ford's WIN program and President Carter's
approach to inflation are significant and substantial. The WIN program called for a
tax surcharge, regulatory reform, action against restrictive business practices,
energy conservation, and voluntary restraint in private sector wage and price decisions.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
107
The WIN program, of course, was ill-timed. Rather than inflation, recession and
unemployment very quickly became the principal concerns of the administration
and the American people. But the program suffered from deeper flaws as well.
First, it recommended a tax increase-at a time when economic growth had
already ceased-to control an inflation that was no longer being aggravated by
excess demand. The lesson of 1970-that a world recession would do little or nothing
to slow inflation-was overlooked.
Second, it approached the inflation problems we faced too narrowly. It did not
recognize the need to address longer range structural difficulties in the economy. By
contrast, the administration's program calls for tax incentives to stimulate business
investment, and for a broad range of jobs programs designed to increase the supply
of skilled workers as the economy moves toward high employment.
Third, the President's program addresses directly some of the most important
sources of inflationary shocks. We have, with the Congress, established a grain
reserve of more than 40 million metric tons to provide a buffer against future
worldwide crop shortages. Compared with the previous administration's regulatory
efforts, the Regulatory Analysis Program established by the President and chaired
by CEA marks a significant step toward recognition of economic concerns in regulation through efforts to adopt cost-effective regulations.
Finally, the WIN program's efforts to obtain wage and price restraint was too
vague for business and labor to understand. The administration has put forth a
specific standard to guide the behavior of business and labor in making price and
wage decisions. That is, the rate of wage and price increase this year should be less
than the rate of increase, on average, in the past 2 years. While this is a flexible
standard, designed to take into account the differing situations among industries
and firms, it is a standard that in each particular case has clear-cut meaning for
workers and employers.
Mr. SCHULTZE. Somehow we got interrupted on my one major
point on that which is that if you go back and look at it, there is a
difference. We have laid out an explicit standard for behavior of
wages and prices in terms of decelerating from the last 2 years'
average. The WIN program wanted nothing to do with the Government saying anything about what should happen to wages and
prices. We do have a voluntary program with a standard of behavior, realizing it can't be one number for everything.
The WIN program was talking about consumers buying cheaper
cuts of meats and everything. This is quite explicit.
Mr. DERRICK. Let me make this comment, if I may. I say this,
that is my President up there on Pennsylvania Avenue, and I want
to see him succeed for a number of reasons, some of them selfish
and some of them not. I yield to Ms. Holtzman.
Ms. HOLTZMAN. I thank the gentleman for yielding.
The CHAIRMAN. The gentleman's time has long since expired, but
go ahead, Ms. Holtzman.
Ms. HOLTZMAN. I am interested in whether or not you consider a
vigorous antitrust enforcement part of an anti-inflation policy, and,
if so, how do you explain the recent actions taken by the Justice
Department with respect to approving mergers in the steel industry and elsewhere?
Mr. SCHULTZE. Ms. Holtzman, over the longer pull, vigorous enforcement of antitrust obviously is important. Second, the consequence of that is not that every merger is bad. Quite frankly, I
don't happen to be an expert on that particular case, the steel one
you are talking about, so I can't discuss that in detail. It is perfectly, it seems to me, consistent, and, in fact, necessary, to have an
antitrust program which is, on the one hand, vigorous but doesn't
run on the presumption that every merger is bad. There is no
necessary contribution. I am not familiar enough with the case to
discuss it.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
108
Ms. HOLTZMAN. I don't know whether or not Mr. Derrick has an
opinion on this, but it would seem to me if we are talking about
the hard decisions, somebody's toes have to be stepped on. I think
that antitrust policy is one of the areas in which the toes have not
been stepped on, and which inflation is going to continue to exist.
Mr. SCHULTZE. I agree you can't do it without stepping on toes. I
do suggest the way to do it is not finding every toe to step on, but
finding the right toes.
The CHAIRMAN. Part of the problem with wage and price controls
is that they are not popular, and every administration and everyone in Government seems to abjure them as a solution. Would we
discount wage and price control absent a war, and in a peacetime
situation, would we abjure it if the unemployment rate went into
double digits?
I wonder if we might not think about wage and price controls
under that type of runaway inflation? That being the case, isn't it
a good idea for Presidents to have built-in standby authority on
wage and price controls such as we had up until I think President
Ford asked Congress to take them away?
Mr. SCHULTZE. Mr. Chairman, I don't think so for two reasons, or
three reasons. In the first place, if you look at the current circumstances and foreseeable circumstances, in the first 6 months of this
year, inflation going into double-digit figures has been basically
fopd prices. We had virtually double-digit figures because of food
prices, and that is the one area we know you cannot put on price
controls.
No. 2, standby wage and price controls are an invitation to use
them when they shouldn't be used.
No. 3, the very process of getting that is going to cause anticipatory price increases. So on all three grounds I don't think so.
The CHAIRMAN. You say the standby feature of it would be an
invitation to-Mr. SCHULTZE. Conceivably could be an invitation to premature
use. And in the process of getting them, you have the anticipatory
price increases, and finally for reasons I indicated substantively,
literally, what they lead to is the kind of economic situation in
which they can't work.
The CHAIRMAN. Thank you. Mr. Regula.
Mr. REGULA. From what you are getting from your friends, I
think you should be looking to some of us on the other side of the
aisle; to wit, your friends are suggesting that the tough decisions
ought to be made by the administration on the anti-inflation measures as I listened to the questions. Does it strike you that maybe
the Congress should make some tough decisions on budget matters
in reducing outlays and would that be a help on solving the inflation problem?
·
Mr. SCHULTZE. Without for a moment wanting to suggest that
the Democratic majority isn't interested in that, of course it would
help.
Mr. REGULA. I have been interested in yesterday's testimony and
also today, that people have alluded to inflation as being the No. 1
problem, and yet I find very little being said about the deficit as a
cause of that problem. On a scale of 1 to 10, where would you place
the deficit as part of the contributing factor to inflation?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
109
Mr. SCHULTZE. Mr. Regula, I can't answer that question when
phrased that way. If I can answer it slightly differently, that is as I
answered earlier in the question of Mr. Mineta, the kind of momentum and inertia inflation that is a hangover from the past is
not a problem with the deficit. On the other hand, we do have to be
very careful that we don't have a deficit which heats up inflation,
and, on the other hand, we also have to be careful we don't put the
brakes on so hard we start raising unemployment.
Mr. REGULA. Do you think the present deficit heats up inflation?
Mr. SCHULTZE. I think we have already scaled it back by over $10
billion. Not at the level we are talking about, no. I think we are
going to have to work to get those expenditures down to that level,
and we should work, and if we can find additional economies, we
will, but, as an important factor in heating inflation now, no.
Mr. REGULA. The next thing, I keep hearing there has to be a
tradeoff between unemployment and inflation, and yet I look back
in the 1950's and 1960's; I think we had very low inflation rates, in
the 1- to 2-percent range and also low unemployment, but I also
note that we had very low budget deficits; in fact, we had surpluses
in some of those years. It probably averaged out from 48 to about
62 to around zero or only a slight deficit. Is there any correlation,
and what was unique about that period that we could have both
low inflation and low unemployment?
Mr. SCHULTZE. In the first place, we started with low inflation. In
fact, if you look at the inflation record in recent years, in terms of
it heating up, except for food prices if we started with low inflation
we would have had low inflation now. That is No. 1. It isn't that
inflation has heated up recently except for mainly the food price
increases.
The second proposition, there are two things which have occurred, which have helped to raise that budget deficit from an
economic standpoint. In the first place, if you look at the total
governmental sector-Federal, State, local-State and local governments are running about a $30 billion surplus. The net governmental deficit, as a proportion of our GNP, is about the lowest in the
world, literally. It is about one-fourth of the German; it is about
one-sixth of the Japanese. You can't measure central governments
alone because the relationships are so different.
That fact is importantly different from the 1960's and in order to
get recovery going, there was more of a deficit involved in the
Federal Government because there was a big surplus in the State
and local governments.
Mr. REGULA. In light of what you say, and in light of the fact
there is a $30 billion surplus out there, what would be your reaction to suggesting that we cut some of the antirecessionary measures out of the budget such as revenue sharing as a billion, public
service jobs, which, in effect, replace many of the local budgets,
temporary public works, which they could be doing themselves, and
let them use their $30 billion and thereby pull $10 billion out of
our deficit?
Mr. SCHULTZE. In the first place, you have to look at these
grants-in-aid programs on their own merits one by one. No. 2, it is
clear, just reading the newspapers, and looking at what is happening, that State and local governments are now in the process of
32-052 0 - 78 - 8
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
110
reducing taxes. I think that is good. I am not sure I would want to
get in the way of that.
Mr. REGULA. On another subject, you had discussed at great
length the Kemp-Roth and had the figures about what it would
take in the increase in the gross national product. Would, in fact,
Kemp-Roth passage result for all practical purposes in indexing the
tax code?
Mr. SCHULTZE. I would have to look at the magnitudes, Mr.
Regula, and I would be glad to give that to you on the record
whether it would be more or less than that. I am not sure. Let me
note, however, that what would really disturb me, indexing or no
indexing, is committing ourselves now to that kind of a tax cut,
that large a tax cut over 3 years, indexing or no indexing.
Mr. REGULA. Would you favor indexing?
Mr. SCHULTZE. No, sir, I don't think so. Let me indicate two
reasons for it. Obviously, again, reasonable people, it is not a
subject in which it is way out of the ballpark, but it seems to me
there are good reRsons for not indexing. In the first place, if you
begin to think about indexing the tax code, there are some parts
where you could do it easily. But in order to keep any kind of
fairness and distortions from this, you really would want to index
as much as you could of the whole code, and then you get to the
problem of indexing complicated businesses. You can index the tax
brackets; that is easy. But the whole business of business taxation,
depreciation, how do you treat interest, which is a very difficult
problem on indexing, that is No. 1. No. 2, given the fact that the
world as a whole is in an era in which inflation is much higher
than it used to be, I think it is useful to have a system which isn't
indexed so you can make decisions year-by-year or every 2 years as
the Congress can, as to exactly how much taxes should be reduced
in terms of economic circumstances. You give that flexibility away
when you index. I don't want to pound the table, but it seems to
me indexing does have real difficulties, and those are two of them.
Mr. REGULA. You mention in the testimony that to offset the
impact of Kemp-Roth we would need $500 billion GNP growth to
recover those taxes. If we look at the history of the last 3 or 4
years, we will have that as a result of inflation, so it would seem to
me it would be a wash.
Mr. SCHULTZE. No, sir. I mean you would have to have whatever
we are going to get plus another $500 billion.
Mr. REGULA. So you are saying the $500 billion would have to be
in addition to the $500 billion that probably, based on past history,
will result from inflation?
Mr. SCHULTZE. Yes, sir, and growth. I am talking about an extra
$500 billion.
Mr. REGULA. I was interested in your testimony in the First
Budget Resolution. You mention that perhaps we have made it too
attractive not to be employed, and that we should look at some of
those programs that do result in people getting substantial sums of
money without working. Would you still feel that way, and is
anything being done in the administration to evaluate whether
that should be a subject for consideration by the Congress as well
as the administration?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
111
Mr. SCHULTZE. Well, it wasn't since the time of my last testimony, but, in any event, one of the major elements of the welfare
reform program we proposed precisely went to that, in terms of the
marginal tax rates on welfare recipients and in terms of jobs as
opposed to straight welfare, precisely along those lines. I think that
had been done before my testimony. I don't remember exactly what
I said, but that was certainly consistent with it.
Mr. REGULA. One last question: You discussed at length the
capital gains this morning in the Steiger proposal. How would an
approach appeal to you that would allow a rollover of capital gains
into another investment and be deferred for tax purposes until
such time as it was taken out for spending purposes, such as is the
case with homeownership at the present time.
Second, it would have as a feature thereof an indexing that
would allow for consideration of inflationary impact on that investment so you wouldn't be, in effect, taxed on inflation increase in
value. Third, my idea that would then tax whatever net resulted at
ordinary rates for tax purposes?
Mr. SCHULTZE. Mr. Regula, there is no way in the world I could
respond to that off the top of my head; I would be glad to give you
a response for the record. The indexing problem is really a difficult
one, when you start to look at what that would imply.
With respect to the rest of it there is no way I can answer it
from the top of my head. I will be glad to give you an answer in
the record.
[The following information was received for the record:]
INDEXATION OF CAPITAL GAINS
Indexation of capital gains for inflation-so as to provide for tax of only real
capital gains-appears intuitively attractive. However, indexation of only one party
of the tax system would be inequitable. Inflation affects incomes and wealth in a
variety of ways. For example, interest rates on long-term corporate bonds are now
around 9 percent. The largest part of this return is an inflation premium. We
should not lessen the inflation effects on taxes paid on capital while leaving inflation effects in the burden of taxes on other sources of income. On the other hand,
indexation of the whole tax system would be enormously complicated.
Postponement of taxation of capital gains if the proceeds are reinvested-and
taxation at ordinary income tax rates when the proceeds are not reinvested-would
also be undesirable. If taxes on capital gains were deferred because the funds were
made available for investment purposes, equity would require that a deferral of
taxation in all other forms of income that are saved, rather than being spent for
consumption. We do need measures to stimulate more investment in our economy
but I believe there are better ways to accomplish that purpose-such as those
proposed by the administration that directly affect the rate of return on capital.
The CHAIRMAN. Thank you very much, Mr. Schultze, you have
been most helpful and informative, and we apologize for keeping
you so late, but it was worthwhile. Thank you.
The committee is in recess until 2 o'clock, when we will have Mr.
Blumenthal.
AFTERNOON SESSION
The CHAIRMAN. The committee will please come to order.
Our first witness this afternoon is Hon. W. Michael Blumenthal,
Secretary of the Treasury.
It is a pleasure to welcome you on behalf of the committee. It is
always a pleasure to visit with you and to hear from you.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
112
As you know, we are holding hearings in anticipation of developing the Second Concurrent Resolution on the Budget for Fiscal
Year 1979.
All but three of the appropriation bills have passed the House
and are under consideration in the Senate. We are meeting our
schedule for enactment of the spending bills. However, as you well
know, tax policy is not yet decided, and that is probably the understatement of the year.
We would like your recommendations as to the size and composition of the proposed tax cut. We would also like your evaluation of
the economic and budgetary impact of Congressman Steiger's proposal to cut the capital gains tax, and of the Kemp-Roth proposal
to cut individual income taxes by one-third, and to reduce the
corporate tax rate by 3 percentage points over a 3-year period.
We are all facing the very difficult task of keeping the recovery
going and reducing inflationary pressures. We would welcome any
suggestions you have as to how to accomplish this task.
Again, welcome to the committee. We are looking forward to
your testimony. You may proceed as you wish.
STATEMENT OF HON. W. MICHAEL BLUMENTHAL, SECRETARY
OF THE TREASURY
Mr. BLUMENTHAL. Thank you very much, Mr. Chairman, and
distinguished members of the committee.
I, too, welcome the opportunity to appear before you and to
address myself to the general issues that you have raised in the
context of the administration's mid-session review dealing with the
general economic situation as it relates to unemployment and inflation and growth and with particular emphasis on our tax policies.
I believe other administration witnesses appearing before you,
Mr. Chairman, have in some detail commented on the general
economic situation. I, therefore, will not do so.
I have summarized my views in the prepared remarks, which I
would like to submit to you for insertion in the record, and confine
myself to making some general comments.
I would say, by way of introduction, that I agree with my colleagues that growth in the economy for the first half is likely to
average around 4 percent in real terms. We do not see much
difference for the second half and going into next year, assuming
the tax cut that I will talk to in more detail is approved by the
Congress and monetary policy is not unduly tightened further.
I am also of the view that there is no recession in sight, based on
the data that are available to us. The balance between production
and sales is good. There are none of the real danger signals that
normally herald the advent of a recession that we can detect.
There are no great inventory imbalances that we can detect, so
the situation is relatively good.
We obviously are pleased by the recent substantial reduction in
the unemployment figures and by the addition of some 2 million
new jobs in the last 6 months.
I think this does underline the great resilience and strength of
the U.S. economy and of a free market economy, and certainly
employment has increased more rapidly than we have anticipated.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
113
I think one of the elements, however, that somewhat lessens the
pleasure we can take from that substantial reduction to a 5.7percent rate of unemployment clearly is the fact that productivity
has not been increasing in the United States at nearly the rate at
which we require it.
Related to that is the fact that investment in plant and equipment has not been increasing to the extent to which we require it.
And I think herein lies part of the explanation for the rapid
increase in employment, but it is also one of the problems we face
as we deal with inflation and other matters.
As my testimony indicates, at this stage in previous expansions
investment had exceeded its previous peak by substantial margins.
This is not now the case, and it is a worrisome thing.
We are devoting less than one-tenth of our real output to investment in new plant and equipment, which is a smaller share than
in previous periods, and certainly if we are to remain competitive
in the world markets and a free market economy we will have to
do something about that.
The tax program, to which I will speak in more detail, Mr.
Chairman, therefore, is significant in that it seeks to address itself
importantly to that particular goal.
There is another area that is disturbing, and that is the imbalance that exists in our foreign trade. We do need a better balance
to maintain a stable economy, and even though we have seen some
improvements in recent months with regard to the export-import
picture, particularly with the increased export of farm goods and
some of our manufactured goods, our imports are still much too
high. Moreover, high rates of inflation, if we cannot control them,
would further accentuate the trade imbalance. Clearly that is a
disturbing factor.
It underlines the importance of the President's energy program
to stem the import of foreign oil into the United States. It also
makes it important to bring about stability in the dollar so that
general international markets will be stabilized and trade can be
carried on at high levels.
I think in all of these factors inflation is a key, Mr. Chairman.
That is why the President, for some time now and particularly in
his April 11 anti-inflation statement, has emphasized this as one of
his greatest preoccupations.
We have had much too high rates of inflation in recent months.
Partly this has been due to food prices, and that factor should
abate. Partly it has been due to wages, particularly nonunion
wages and wages of smaller unions that have been catching up
with the larger wage settlements that have been made in the past.
And partly I think it is due to the fact that productivity has not
been increasing, as I said earlier.
The budget policies of the administration are framed with these
problems in mind, and they do indicate a strong emphasis by the
administration on the tightest possible fiscal program, particularly
for 1979 and beyond.
Outlays for 1978 at $452 billion are some $11 billion less than the
figure that we projected in January, due in part to spending shortfalls and in part to a deliberate policy on the part of the administration to hold spending down wherever possible.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
114
For 1979, as you know, we now project outlays at $497 billion,
which is $4 billion less than January, and the increase that is
implied in this number is some $5 billion less than this year's
increase over the previous year.
We are alert to the opportunities for further cuts, as you are
aware. The President has indicated that if these are possible, we
certainly should try to effect them in order to reduce the deficit in
the budget as much as possible, as quickly as possible.
We now anticipate a slightly smaller deficit of $48 ½ billion for
1979, down some $12 billion from the January figure, and we
certainly think that if that number can be further reduced it would
be highly desirable.
In that same regard we have also revised our tax program in
order to favorably impact the deficit and, therefore, inflation. That
program in its revised form differs from the President's original
program in the following respects as far as 1979 is concerned:
First, we have eliminated the recommendation for the repeal of
the tax on telephone services and to reduce Federal unemployment
insurance tax rates.
Second, we have recommended that the amount of proposed individual income tax reduction be reduced and, third, we have included a modest amount to reflect the startup costs of those elements of
the President's urban initiatives that would be implemented
through tax credits.
The total tax program has been revised to reduce it from $25
billion, and the effective date has been postponed from October 1 of
this year to January 1, 1979, so that the total fiscal year 1979 cost
would be under $15 billion.
The tax program does reflect importantly, Mr. Chairman, our
emphasis on business tax reductions. We have looked not only at
the overall total, but at the sum total of taxes on business and on
capital. For it is clear that these taxes have an economic impact on
incentives, on profitability, on incentives to invest, and so forth.
It is for this reason that we have recommended, and continue to
recommend, a cut in the corporate tax rate. We want that to be as
large as possible because we are concerned that it is this tax which
is clearly the most important one as far as business is concerned,
and needs to be reduced.
It is for this reason that we have recommended a liberalization
of the investment tax credit because we believe that creates important incentives for business to invest more and to create new jobs.
It is also for this reason, Mr. Chairman, that we have opposed
the recommendations for a substantial reduction in capital gains
taxes of the kind recommended by Congressman Steiger and of
similar proposals.
The reason simply is that that kind of reduction, which would
involve $2.4 billion in the case of the proposal made by Congressman Steiger, and well over $1 billion in other proposals that have
been made, would clearly imply a reduction in other kinds of
business taxes which we believe will do more good.
Second, the particular proposals that have been made involve
giving back tax revenues to a lot of people who would not be using
them for productive investment in business. Thus, such reductions
would not do much good for capital accumulation, for venture
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
115
capital, or for the relief of the average American who has to pay
capital gains taxes when he sells his residence.
It is these features we have particularly objected to, and it is for
these reasons we have preferred to concentrate as much as possible
on the kind of business tax relief that has been proposed and that
is inherent in the President's program.
The President, therefore, is recommending a tax program which
is directly dovetailed to the kind of economic problems we face,
which gives relief to individuals in the low- and middle-income
groups, where the impact of inflation and of higher social security
taxes is greatest, and which relieves the total load of Government
taxes on business so as to increase investment. The President's
program does this in a responsible way, by targeting as much of
the reductions as possible where it will do the most good, and by
doing it in a fair way so that the benefits do not accrue in a
regressive manner rewarding primarily those with the higher or
highest levels of income, and not having needed revenue available
for relief of middle-income and low-income groups.
The 1980 budget, which is now under discussion within the administration, upon the President's instructions, is intended to show
a substantial reduction from the deficit figure that we now project
for 1979 and, as I indicated, even for 1979 we would be satisfied
with a lower rather than a higher figure. Therefore, fiscal restraint, a balanced budget, the anti-inflation program, and a tax
program that is targeted to do the most good is the administration's approach to dealing with the existing economic problems.
Mr. Chairman, I will be happy, in answering questions, to deal
with other elements of the tax program as they may relate to the
proposals made by Congressman Kemp and Senator Roth and to
any other aspect of the tax policy which you or your colleagues
may be interested. Thank you very much.
[The prepared statement of Mr. Blumenthal follows:]
PREPARED STATEMENT OF HON.
w. MICHAEL
BLUMENTHAL
Mr. Chairman and members of this distinguished committee, I am pleased to have
the opportunity of discussing with you this afternoon the results of the administration's mid-session budget review, particularly as they relate to the future course of
the economy and the President's program for reducing inflation and unemployment.
As you requested, I will also discuss the econorr,ic implications of the proposed
changes in the size and timing of the President's tax program. Information about
each of these issues should be helpful in the committee's consideration of the Second
Concurrent Resolution on the Budget for Fiscal Year 1979.
Your review comes at a time when the economy is settling down to a more
reasonable rate of growth, after the clearly unsustainable pace in early spring when
the economy was catching up from the winter weather and the coal strike. While
figures for the second quarter are still several days away, it appears that economic
activity was fast enough to bring the rate of expansion in real GNP over the first
half of the year to about 4 percent.
We expect a pace close to this to continue over the balance of the year and, given
some success in containing inflation without further intensification of monetary
restraint, and given enactment of the administration's revised tax program, there is
no reason to expect marked deviation from this pace in 1979.
Admittedly, it is unusual to anticipate growth to continue into the fifth year of an
economic recovery. But we have been fortunate in avoiding some of the excesses
that in past recoveries have forced the economy to pause and often to reverse
direction. Production and sales have been kept in good balance; we are not suffering
from inventory imbalances that often have been the cause of production cutbacks
and swelling unemployment rolls. Indeed, the unemployment rate has dropped
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
116
sharply this year, from 6.4 percent last December to 5.7 percent in June; 2 million
new jobs have been created in the past 6 months.
Although our forecast is for continued economic progress at a sustainable rate
somewhat in excess of the economy's longrun potential-appropriate for an economy
still operating with some slack in utilization of its plant and labor resources-we
cannot afford complacency. There are significant risks in the economic outlook,
most of them on the downside. We will not be able to achieve or maintain a
satisfactory rate of growth unless we encourage a faster rate of investment in new
productive facilities, unless we restrain inflation and unless we redress the serious
imbalance in our foreign trade.
To increase productivity and offset rising labor costs, and to create jobs for the
future, we need to create the tools of production at a faster rate. Real business fixed
investment has lagged in this recovery. At this stage in previous expansions, investment had exceeded its previous peak by a margin of almost 18 percent; at present,
investment has barely reached its prerecession peak. We are devoting less than onetenth of our real output to investment in new plant and equipment, a smaller share
than in the late 1960's and early 1970's, and well below the share needed to insure
the rate of capital formation necessary to support a full-employment economy in the
1980's.
The need for accelerating capital formation in this country is well documented.
The slowing in the rate of growth in our capital stock parallels the slowing in the
growth of productivity, and is a major contributor to the inflationary pressures from
which we suffer. In the past 4 years, our manufacturing capacity has increased at
an annual rate of less than 3 percent, down 1 ½ percentage points from the growth
rate in the postwar period through 1973. Similarly since 1973, productivity growth
in manufacturing has fallen by almost 50 percent as compared to its average for
1948-73.
This need for enlarging our capital stock is addressed in the tax proposals submitted by the administration, which would directly encourage capital formation by
increasing the after-tax profitability of business investment. It is essential, for both
short- and long-term needs of the economy, that we move rapidly to establish
effective incentives for business outlays for new plant and equipment.
Another potential obstacle to achievement of the projected growth path of the
economy is the imbalance in our foreign trade. To be sure, there are some encouraging signs of improvement in our foreign trade picture, as we shake off the effects of
winter weather and as our exports increasingly respond to changed foreign exchange relationships. The rise in our exports in recent months is welcome. But
much of the increase is in agricultural exports; our exports of manufactured goods
are improving very modestly. At the same time, our imports of manufactured
products have been rising very rapidly. And oil imports, while below last year's
rate, still represent the major element in our trade deficit. Until we act decisively to
reduce oil imports, and to improve the competitive efficiency of American industry
by encouraging new investment, progress in correcting the trade imbalance will be
painfully slow. Hence, it is essential to enact the tax measures proposed by the
President, including the removal of subsidies that encourage oil imports and lower
the cost of energy below its true replacement cost.
Finally, our ability to maintain growth depends heavily on our ability to contain
inflation. Our progress on this objective continues disappointing-the latest consumer price data indicate a third month of increase at double-digit rates. Of course, food
prices are chiefly responsible for the unpleasant developments, but there is hope for
some moderation as increased supplies reach the market.
But the underlying rate of inflation-even after discounting the contribution from
volatile food prices-is still running at an unacceptably high rate. And the continued rise in wages, as smaller unions and the less-organized workers try to catch up
with the large increases achieved by the more powerful unions, threatens to keep up
the pressure on price levels, particularly in light of the poor performance of productivity.
The persistence of inflation is the major threat to achieving the goals of adequate
economic growth and increased employment opportunities. Inflation impacts adversely on real incomes and on consumer confidence and willingness to spend, and
on interest rates and mortgage credit availability. It deters business investment,
and foreshortens the time-horizon in making capital outlay decisions.
The administration's budget proposals are carefully framed to avoid exacerbating
inflationary pressures. Outlays for the current fiscal year are now projected at $452
billion, some $11 billion less than was estimated in January. This reduction is the
result primarily of smaller-than-planned spending by Government agencies, and we
have, as a matter of deliberate policy, refrained from any effort to force spending to
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
117
the original higher levels. For fiscal year 1979, we now estimate outlays at $497
billion, $4 billion less than our January estimate, and implying an increase for the
1979 fiscal year which is $5 billion smaller than for the current fiscal year. Moreover we are aggressively seeking areas in which spending can be reduced further. It
is our belief that improvements in efficiency are possible which would permit us to
deliver the desired level of public services at less cost to the taxpayer.
Even with a tax cut, it is expected that Federal revenues will rise more than
projected outlays. As a result, the estimated budget deficit for next fiscal year, at
about $48 ½ billion, is moderately below that expected for fiscal year 1978, and some
$12 billion less than was estimated in January. This scaling back in the size of the
fiscal year 1979 deficit reflects the · delay and reduction in the proposed tax cut as
well as somewhat lower outlay projections.
The revised tax program differs from the President's original program for calendar year 1979 in three respects:
1. The January budget proposal to repeal the tax on telephone services and to
reduce the Federal unemployment insurance tax rate would be deleted.
2. The amount of proposed individual income tax reduction would be reduced.
3. A modest amount is included to reflect the startup costs of those elements of
the President's urban initiatives that would be implemented through tax credits.
The size and composition of the proposed tax reductions reflect the very high
priority that the President places on encouraging business investment, increasing
productivity, and fighting inflation.
The calendar year 1979 cost of this revised tax program is estimated to be about
$20 billion. Since the effective date for the program would be January 1979, rather
than October 1978 as initially proposed, the fiscal year 1979 cost would be under $15
billion.
The decision to reduce the size of the tax cut, while reflecting our willingness to
be flexible and responsive to economic developments, does not mean that we are
ready to abandon other objectives such as tax equity. The administration, therefore,
continues to support its program for long-overdue reform of our unfair and complicated tax laws.
These new budget outlay and revenue recommendations reflect a careful balancing of the need to keep the economy on a steady growth path with a recognition of
the importance of containing inflationary pressures. President Carter is determined
to use the full powers of his office, including the veto, to ensure that spending
increases and tax cuts stay within the limits of his budget proposals. Moreover, he is
determined to move toward a balanced budget as fast as economic conditions
permit.
The fiscal posture depicted by the 1978 and 1979 estimates in the Mid-Session
Review is what we believe to be sufficient and appropriate to support economic
growth at the moderate rate now anticipated through 1979. At the present stage of
the recovery, and because of the threat to continued economic growth that would be
precipitated by a further acceleration of inflation, this degree of budgetary restraint
is essential. To depend too heavily on monetary restraint risks distorting the composition of growth and eventually aborting the expansion. Even the present degree of
monetary restraint is already being reflected in a tightening in mortgage markets
and declines in indicators of future residential construction activity.
In view of the need for continued inflation restraint, and the need for an appropriate balance between monetary and fiscal policies, it is surprising that there is
serious advocacy in Congress of massive tax reductions, reductions that would
increase the Federal deficit by incredibly large amounts over the next few years.
Instead of working toward budget balance, as does the President's program, large
tax reductions such as those proposed in S. 1860 and H .R. 8333 (Kemp-Roth) would,
on the basis of the analyses submitted by their advocates, increase the deficit by $12
billion in the first year and by $38 billion by the time the full round of tax
reductions was completed.
We do not quarrel with the proposition that tax reductions can, in an underemployed economy, stimulate economic activity and thereby ultimately return some of
the foregone revenues to the Government. But massive tax reduction in an economy
already suffering from inflationary pressures is sheer waste. We do not have the
financial or physical resources to absorb such stimulus without adding to inflationary pressures, and whatever benefits might be envisioned would be quickly negated
by the rise in prices and in interest rates.
Advocates of major tax reductions frequently cite the success of the KennedyJohnson tax reductions in support of similar action now. What is overlooked, in
these presentations, is the difference in the economic environment between that of
the early 1960's and that in which we live today. In the early 1960's, inflation was
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
118
running at less than 2 percent per year; this year we fear that the Consumer Price
Index will rise by more than 7 percent.
In the early 1960's, the Federel deficit averaged only $5 billion; even with exceptional restraint, the deficit for this fiscal year and next will average almost 10 times
that. Interest rates currently are already double the levels prevailing at the time of
the Kennedy-Johnson tax cut. To impose on our financial markets the burden of
massive increases in an already large deficit would result in either inflationary
expansion of credit or-more likely-a preemption of financial resources that would
curtail private spending and investment. There is no basis in the evidence of
previous tax reductions that capacity and productivity would increase sufficiently
rapidly to accommodate the increased demands flowing from such large, abrupt
reductions in taxes.
The administration tax and budget program is designed to lower the burden of
taxation and unleash the forces of the private sector. But it is of a magnitude
appropriate to the needs and capacity of the economy. As in most things in life,
moderation is a virtue; too much of a good thing will produce economic indigestion,
not improved economic health.
The CHAIRMAN. Thank you very much, Mr. Secretary.
I tend to agree with you that the tax cut should be in the area or
in the magnitude that you have recommended, and the revised
figure that President Carter is speaking of, which I believe is about
$20 billion on an annual calendar year basis, about $15 billion on a
fiscal year basis in the first year.
Let's talk about the realities of taxes as we approach an election
in 3 months and as we approach a Congress which is going to try to
get out of town for that election somewhere around the first of
October.
The realities suggest that rightly or wrongly there is very strong
sentiment for change in the treatment of capital gains taxation.
There is some sentiment on the minority side for a larger tax cut a
la Kemp-Roth. You could address yourself to that, too. But for the
moment let's stick to the capital gains treatment of income.
There seems to be very real support for change in that area, and
it seems to me that it is not enough to point out the inequities of
the proposal or even the threat of a veto. I think we have to either
come up with alternative proposals or some other suggestions to
counteract this.
Now, I think you know this and I think the administration
knows it, and I think you have been thinking about it. I know they
are thinking about it here in the appropriate committees of the
Congress, and I think what we need from you is a recommendation,
a proposal, one that will be more equitable than the present capital
gains proposals before the Ways and Means Committee.
Would you address yourself to that or, to be even more blunt,
what is your alternative proposal from the administration? Our
time is running out.
Mr. BLUMENTHAL. Let me deal with your blunt question with a
blunt answer, Mr. Chairman.
The administration does not have and will not have an alternative proposal to deal with the question of capital gains taxes. The
administration has put forward a tax program to the Congress and
to the appropriate committees. We have adjusted the size and
effective data to conform with the emerging economic realities. For
reasons I have indicated, it does not include reduction of capital
gains taxes. We will not make a proposal.
On the other hand, I think it is important to understand why the
particular proposals that we have seen come from the Congress are
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
119
unsatisfactory and why the President has spoken out so strongly
against them.
First of all, because the size of these capital gains tax reductions
is large, $2.4 billion in the case of Mr. Steiger's proposal, clearly if
we are to keep the deficit under control, if the total size of the cut
is not going to be greater than $20 billion or $15 billion as some
people in the House Ways and Means Committee are suggesting,
then that $2.4 billion has to come out of somebody's hide.
We don't believe that it ought to come out of the individual tax
cuts, and we don't really believe that we should take it away from
the other business taxes which also impact business and restrict
the incentive to invest. Therefore, size is a factor.
The second factor clearly is the regressive nature. I think a
proposal that puts a very large portion of the total reductions into
the pockets of those who have very high income, some 80 percent of
the $2.4 billion going to those who earn more than $100,000 a year,
clearly is inequitable and unfair.
It is not only inequitable and unfair, but it also does not stimulate investment in the same way it would if the cuts were given to
the broad cross section of middle income taxpayers who want an
incentive to invest, possibly in the stock market or in some other
productive activity.
Third, it does . not offer anything different for the homeowners
from what we have recommended. Homeowners do have a problem.
Tens of millions of Americans have homes and when they sell
them inflation accounts for some of the gain and they don't want
to be taxed on it in the same way as they have been in the past.
The fourth reason why we have opposed this is it does not, in our
view, sufficiently address itself to the problem of stimulating venture capital, equity capital, and capital accumulation. As I have
said in my remarks, the need to increase productivity, to increase
investment, to stimulate venture capital, and to promote capital
accumulation exists strongly in the U.S. economy.
In a program such as that which Mr. Steiger has proposed, in
which a lot of the benefits go to the land speculators, go to the
commodity speculators, go to the people who realize capital gains
on jewelry, on paintings, or what have you, you are wasting a lot of
valuable Treasury resources that ought to be applied to really help
business invest.
It seems to me, it is significant that the President has not said he
will not accept anything in this area. But he is not going to make
that proposal and the administration is not going to make it. If the
Congress is intent on doing something about capital gains, then in
the context of the general program which the President has put
forward, and which we consider to be sound, some recognition
should be taken of the factors that I have cited. A program that is
more limited, that can be accommodated within the $20 billion cut,
that is more progressive, that benefits the average homeowner,
that creates an incentive for venture capital and capital accumulation, certainly, as Secretary of the Treasury, I would want to look
at it very closely and would be much more inclined to recommend
it to the President.
I cannot tell you what the President would say. I think it is
significant he has not said he will not accept anything in this area.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
120
The CHAIRMAN. What you are saying is you certainly would be
receptive to suggestions from up here that would be more equitable
in nature and carry out the purposes that you have just outlined
there?
Mr. BLUMENTHAL. That is my view, Mr. Chairman.
The CHAIRMAN. When you speak of better ways of stimulating
investment and venture capital, are you talking about reduction of
rates and different treatment of accelerated depreciation and investment tax credit and those traditional areas? Is that what you
had in mind?
Mr. BLUMENTHAL. We have, of course, a proposal on investment
tax credit before you and I know that the business community is
very interested in that. No; I was referring to the fact that one of
the arguments made in favor of a reduction in capital gains tax
rates, which I hear from Wall Street, I hear from the business
community, I hear from the investing community generally, is that
it may be helpful to channel more money into equity markets.
Clearly, there has been a deficiency of capital going into equity
markets, the d bt equity ratios of corporations are high, and it
would be desirable to channel more capital into equity markets.
Additional capital raised in this way can be used to create more
jobs and increase productivity.
Particularly, people have said that the venture capitalist, who
has to take risks, is dissuaded from putting his money into such
kinds of ventures because the tax at the end, if he does hit the
jackpot, is too high. I really had in mind, if there are going to be
proposals from the Congress on capital gains, focusing them on
those areas that are particulary directed toward these kinds of
purposes rather than spreading them across the board and giving
them to those who, (a) really don't need it, and (b) won't invest it in
productive facilities.
The CHAIRMAN. In pointing out the need for fiscal restraint you
note a massive tax reduction would· increase the Federal deficit by
incredibly large amounts over the next few years. Supporters of the
Kemp-Roth proposal have suggested that the Treasury made similar kinds of estimates at the time of the Kennedy-Johnson tax cuts,
estimates of revenue that they say turned out to be wrong.
Could you lay out for us the Treasury's estimates of revenues on
a unified basis for period 1963 to 1968? If you could give us those
for the record and probably just comment on them now.
Mr. BLUMENTHAL. Yes. I will take you up on that, Mr. Chairman.
I don't have it with me. I will submit it for the record.
[The following information was received for the record:]
ESTIMATED REVENUES OF UNIFIED BUDGET RECEIPTS
Actual unified budget receipts rose $54 billion from 1962 to 1968. For this same
period Treasury estimates reported in the budgets predicted a $52 billion increase.
In both 1963 and 1968 (after adjusting for the proposed surcharge which was
delayed until fiscal year 1969) the level of receipts were, in fact, overestimated by
Treasury. For the 6-year period, 1963 through 1968 the average estimating error
was 4.6 percent. These errors ranged from a low of less than three-fourths of 1
percent for 1965 to a high of nearly 8½ percent for 1966.
Attached are two tables which explain these calculations in more detail.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
121
ESTIMATED AND ACTUAL GROWTH OF UNIFIED BUDGET RECEIPTS, 1963-68
[In billions of dollars]
Fiscal year-
1963
Actual growth of receirts .... ...... ..........
Treasury estimates o the growth of
receipts 2.......... .. ...... .........................
Treasury estimates according to Congressman Kemp • .............................
1
1964
1965
1966
1967
6.9
6.1
4.2
14.0
18.7
13.4
3.9
4.7
5.3
16.7
-2.4
-5.2
-13.3
-20.0
-23.7
Cumulative
1968
1963-68
4.1
54.0
8.3
52.2
-24.4
-89.0
3
1 Calculated as the year-over-year increase in actual receipts measured on the unified budget concept. Source: "The Budget of the
United States Government" for fiscal years 1964-70.
2 Calculated as the difference between receipts estimated 18 months prior to the end of the fiscal year and those estimated at the
same time for the fiscal year in progress, measured on the unified budget concept. Source: ''The Budget of the United States
Government" for fiscal years 1963-68.
3 Estimates for 1968 have been adjusted to exclude the proposed income tax surcharge which did not take effect until fiscal year
1969.
•statement of Congressman Jack Kemp. Source: "Congressional Record," Apr. 6, 1978, page H2579.
Note: Details may not add to total~ d_ue to rounding.
Source: Office of the Secretary of the Treasury, Office of Tax Analysis, June 27, 1978.
COMPARISON OF ESTIMATED AND ACTUAL UNIFIED BUDGET RECEIPTS, 1963-68
[In billions of dollars]
Fiscal year-
1963
1964
1965
1966
1967
1968
1963 budget (January 1962 ..........................................
113.5 ...................................... ....................................................... ..
1964 budget January 1963 ..........................................
105,4
109.3 ...................................... ......................................
1965 budget January 1964 .......................................... 1 106.6
lll.3
115.9 .........................................................
1
1966 budget January 1965 .......................................... ...................
112.7
114.6
119.8 ......................................
1
1967 budget January 1966 ............................................................. ...................
116.8
124.7
141.4 ................. ..
1968 budget January 1967 ............................................................. ................... ................... 1 130.9
150.3
158.6
Actual receipts .................................................................
106.6
112.7
116.8
130.9
149.6
153.7
Estimating errors:
Estimate made 18 months prior to year end minus
actual receipts.....................................................
+7.0
-3.4
-0.9
-11.0
-8.1
+4.9
Error as percent of actual receipts..........................
+6.5
-3.0
-0.8
-8.4
-5.4
+3.2
1 Denotes actual level of unified budget receipts.
Note: Details may not add to totals due to rounding.
Source: Office of the Secretary of the Treasury, Office of Tax Analysis, July 14, 1978.
Mr. BLUMENTHAL. Let me comment on the Kemp-Roth
proposals, generally.
I think that analogies are always risky. They are particularly
risky in economics, as we well know. And in this particular instance the simple analogy to the early , or mid-1960's is not only
risky but it is exceedingly faulty and just plain wrong, in my
judgment.
The conditions under which we are operating are entirely different. Let me give you a few of the differences and I think you will
get the flavor of the reasons why we are most skeptical that you
can look at the 1963-65 situation and say the same thing would
happen in 1978.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
122
From the fourth quarter of 1962 to the fourth quarter of 1963,
the Consumer Price Index increased by only 1.4 percent. During
the past year, unfortunately, we are looking at a consumer price
increase of almost 7 percent. And we expect it might be over 7
percent for the next year.
We looked at a prime rate in 1963 of 4½ percent. On July 7,
1978, the average prime rate was 9 percent. We had a deficit in the
Federal budget in the fourth quarter of 1963 of close to zero,
virtually a balanced budget. We are operating now with a deficit of
over $50 billion. We are operating today at 84 percent of industrial
capacity and higher in some critical sectors. Operating rates were
lower during that period.
Moreover, we have seen a number of major factors changing in
the economy. Employment population ratios are much higher today
than they were then. Labor force participation rates are much
higher today than then. So we are operating in an inflationary
environment with very different statistics, very different utilization
rates, and it simply is not plausible, therefore, to say that the same
relationships, the same impact that occurred in 1963 through 1965,
would occur again, under the very changed circumstances that
exist in 1978.
What happened in 1964 was that the demand was impacted
considerably and given that the supply was available, inflationary
pressures did not result. There is no evidence at all that what we
are facing now is a lack of demand, that we substantially need to
stimulate demand. There is also no evidence that, in the short run
at least, the kinds of tax cuts proposed would stimulate an expansion of supply and productive capacity in the way suggested.
The fact is that the claims that have been made by the proponents of Kemp-Roth that it would bring forth greatly increased
effort on the part of individuals and business, and that these increased efforts would raise economic activity, expand capacity, and
bring in more revenue for the Treasury, are assertions not backed
by any empirical evidence that we can lay our fingers on. So, I
think, Mr. Chairman, it is for this reason that we are most dubious.
Now, even the studies that have been commissioned by Mr.
Kemp-Mr. SIMON. Would the chairman yield?
The CHAIRMAN. Let him finish.
Mr. SIMON. Excuse me, if I could, I hate to interrupt because I
agree with your general thrust of what you are saying on KempRoth. But, everything you say, when you say there is no need to
stimulate demand and everything, suggests to me that maybe our
colleagues from Texas and Ohio on Ways and Means may be correct in saying we should not have any tax cut other than a simple
extension of the tax cut we have had previously.
Mr. BLUMENTHAL. I will address myself to this if you will, sir.
We have names and labels for all of these things, I guess that is
Vanik-Pickle; at least in the House Ways and Means Committee it
is Vanik-Pickle. I don't know what it is on the Budget Committee,
and I will be happy to comment on that part of it, which is the
other wing.
Mr. SIMON. Excuse me. All right.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
123
Mr. BLUMENTHAL. The final point I wanted to make is that even
the studies that have been commissioned by Mr. Kemp himself
show that in the first 3 years, what we would have would be a
larger deficit. That is unavoidable, because even if these favorable
consequences ensue, they would ensue over a longer period of time.
So certainly his own studies indicate the deficit in the first year
would be increased by $12.4 billion and in the third year by some
$37 .9 billion. In addition, these studies show that at least 1 percent
would be added to the inflation rate. And as my colleague, Charles
Schultze, has indicated to you, he thinks that 1 percent is probably
on the conservative side, and I agree with him in that regard.
So we certainly would be operating, therefore, with a $60 to $70
billion deficit the first year and a larger one in the next year.
There is no empirical evidence that we can put our finger on
which indicates that under the circumstances in which this economy is operating today all of that will be washed out by people
working harder and more people coming into the labor force. Bear
in mind we already have very high participation rates.
Since demand is not going to be stimulated in the same way in
which it was in the early 1960's the same effects cannot be expected. Even the study by Norman Ture, which uses a model of the
type suggested by Mr. Laffer, who is one of the economist fathers
of this approach, as I understand it, indicates that even after 10
years, the revenues of the Treasury, would be down, compared to
present levels, by $43 billion.
Mr. Chairman, I can elaborate on it further, but I think under
those circumstances we simply do not think it is responsible to ask
for those kinds of cuts unaccompanied by spending cuts.
Now, if the proponents of it would indicate that the Congress
were willing to vote spending cuts of some 34 percent over the next
3 years to match the 34 percent tax reduction, then I think we
would clearly at least have something where the two sides fit. I
don't know whether that would be a desirable policy, but at least
the two sides would fit. In this case the two sides really don't fit.
The CHAIRMAN. The two sides might fit, but it would create some
problems.
Mr. BLUMENTHAL. I think it would. Mr. Chairman would you like
me to respond to the idea that there should not be a tax cut at all?
The CHAIRMAN. Fine.
Mr. BLUMENTHAL. I think, as I indicated in my opening remarks,
sir, our best estimates indicate the need for a tax cut. I have to
hasten to add that these are estimates and, of course, we can be
wrorig. Unfortunately economics is not sufficiently precise and with
all of the computers in the world we really cannot say this with
100-percent precision but, as best as we can tell, our analysis
indicates that a $15 billion cut in fiscal year 1979 and a $20 billion
cut for the full calendar year of 1979, will give us a growth rate in
this country of a little over 4 percent. That kind of growth rate is
somewhat in excess of the long-term sustainable rate of growth. I
would say even we need about 3 ½ percent or so of real growth just
to stay even.
Without a tax cut there would be an effective increase in taxes
on lower and middle income Americans in particular, who are
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
124
impacted by inflation and by higher social security taxes, and we
don't think that is fair.
The President's goals of getting Federal spending down to 21
percent of GNP, and keeping Federal taxes as a constant or slightly reduced percentage of personal income would not be possible.
We could not achieve it. We would, in fact, be increasing taxes that
are paid by lower and middle income Americans, and we don't
think that is fair.
Also, we do believe, as I said earlier, that we need to provide
incentives for business to invest and to create more jobs for the
· future ·and to maintain growth at 4 percent or so. Therefore,
having no tax cuts at all, I believe would go too much in the other
direction. It's the wrong way to balance the budget. We need to
balance the budget by keeping spending under control and getting
it down and not by effectively raising taxes on the average American.
The CHAIRMAN. Thank you. Mr. Conable.
Mr. CONABLE. Thank you, Mr. Chairman.
I have not been at the Budget Committee for awhile, and I am
pleased to note we have abandoned the 5-minute rule during my
absence, because I have a lot of questions which I would like to ask.
The CHAIRMAN. We have not abandoned the 5-minute rule, Mr.
Conable, but we are going to give you equal time.
Mr. CoN ABLE. First of all, Mr. Secretary, I am sure you are not
aware of it, but I would like to call to your attention a recent study
of Martin Feldstein on the impact of a 25 percent maximum capital
gains rate on the probable amounts of capital gains claimed in
1973, the last year for which firm figures were available to him.
It's a very interesting study. It indicates generally that there would
have been three times as many-capital gains claimed in 1973 at the
25 percent rate as there were at the rate which then obtained.
You know, I am sure if I were in the administration I would be
very much concerned about inflation and thinking about the various components of our present rate of inflation and I am sure you
do look at that list.
I have made a list of seven components and I would like your
assessment. I don't ask that you try to quantify what each is
contributing to the rate of inflation at the present time, but I
would like your assessment of which ones you think are most
necessary for us to deal with if we are to get our rate of inflation
back to a manageable prospect for the country. Let me list them.
First: Fiscal and monetary policy, including the problems of deficit.
Second: Food and fuel price increase, special problems of that
sort.
Third: The decline of the dollar abroad, and its impact on imports and exports, and the related issue of protectionism, reducing
competition within our American market and permitting some industries to raise domestic prices as a result of the decline in the
competition.
Fourth: The mandated expenses, such things as safety requirements, environmental consequences, Davis-Bacon and so forth.
Fifth: The increases in the minimum wage, social security taxes,
the total burden of taxation. You will note many of these items
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
125
have to do with Government, and so we can deal with them directly in one way or another. But I realize there are other factors
besides that.
Sixth: The problems of industrywide bargaining and large wage
settlements, which is going to be a serious problem next year. It is
a problem now because industrywide bargaining obviously does not
need to be reflected in changing competitive concerns among the
components of that industry.
Seventh: The shortfalls in investment and ultimately in productivity and supply, which are also, I think, a long-term concern and
may have some impact in the future, particularly if we get into
demand-pull inflation instead of cost-push.
Now, looking at these seven items, can you tell me which ones
you think are most critical at this point, which ones are the largest
and most serious components now and for the immediate future at
this rate of inflation? I don't ask for your solutions," I would just
like to get some idea of what you think we ought to really focus on
the most.
Mr. BLUMENTHAL. Mr. Conable, I see now why you asked for
equal time. I am going to have to ask for equal time, too, because
the answer to that question, if I were to do even minimal justice to
it, would cause me the severe wrath of the chairman in taking up
his time.
·
Mr. CONABLE. The chairman is a very agreeable man, very patient and extremely kind to members of the minority who ask long
questions.
Mr. BLUMENTHAL. I thought you were including me as a member
of the minority.
First of all, let me say I think your list probably could be expanded somewhat to include other factors.
Mr. CONABLE. I don't claim to be an economist, sir.
Mr. BLUMENTHAL. But taking those seven as you listed them, I
would say I fully agree with you, all seven of them are important
factors. It is difficult to single any one out.
I would hazard the hypothesis that, one, fiscal and monetary
policy ·is probably the key to it, although it alone will not do the
job. The point being that, in my judgment, we cannot succeed in
reducing inflation if we do not follow very careful and conservative
fiscal and monetary policies at the present time. Not only is the
Government clearly a big factor in the overall economy but also
the Government sets the tone, hopefully, the Government provides
signals for the rest of the economy, and has much to do with the
general level of confidence or lack of it. Therefore, fiscal and monetary policies are critical. And I would say we are partners in this in
the executive and legislative branches, for obviously we both share
the responsibility for how we come out on this.
I think, second, is the importance of the shortfall . investments.
Let me ask you one further question. Are you talking about the
most critical factors, the ones with the largest need in terms of the
immediate impact?
Mr. CONABLE. Well, what ought we be focusing on more than
others?
Mr. BLUMENTHAL. All right. I think shortfalls in investment,
productivity, and supply I wou) d put very high up on the list.
32-052 0 - 78 - 9
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
126
Now, that does not have an immediate impact, obviously, but it
does have one 3, 4, 5 years down the road. If we don't take the
leadtime and do it now we will be in a worse fix 2 or 3 years from
now than we are today. We certainly will have continuing inflationary problems unless we deal with the need to increase our
productivity and our capacity. So I would assign equally high priority to that. That is, of course, what the tax debate is all about.
I would say that the question of fuel imports, decline of competitiveness and protectionism are other very important issues. There
we have some countervailing pressures that I think we need to
take into account. The program to develop greater self-sufficiency
in energy, to encourage conservation of energy, clearly has some
shortrun inflationary impacts. We cannot get away from that. That
is a cost I think the economy and all of us have to bear.
I think in the medium and longer run it actually is anti-inflationary for various reasons you well understand, but it does have
an inflationary impact. Yet I would concentrate on it because it
tends to lead to greater stability of the dollar and, therefore, helps
the trade environment. Fighting protectionism, which is highly
inflationary, and promoting exports in particular, in my judgment,
are also critically important to this anti-inflation effort.
Now, all of these other things, minimum wages, social security
taxes and taxation I put under fiscal policy really. I subsum them
under that. I don't believe you can isolate these. Certainly the
social security taxes and taxation is part of the fiscal policy, and
minimum wage is also important. I would not put it-Mr. CONABLE. They become elements of cost quite apart from the
impact on fiscal policy.
Mr. BLUMENTHAL. Sure, they are. They are elements of cost but,
on the other hand-Mr. CONABLE. That is why I put minimum wage with those
rather than isolating that. I meant to look at that apsect of it. I
realize fiscal policy is something, too.
Mr. BLUMENTHAL. Finally, I wouldn't call it industrywide bargaining, I would list union wage policies and business practices.
Mr. CONABLE. Business practices obviously are involved. They are
going to take a tough line if they know they can pass it all on
because there is no competitive pressure on them to absorb any
part of it.
Mr. BLUMENTHAL. In other words, under six I would have wage
policies and business practices. Clearly, these two things fit together.
Mr. CONABLE. You left out mandated expenses.
Mr. BLUMENTHAL. Yes, we are beginning to work on this. I think
that is very, very important and it seems to be terribly difficult to
do anything about it. Anything the Congress can do in that area.
Mr. CONABLE. It is not unrelated to shortfall investments. Many
of these things are interrelated and perhaps artificially isolated in
my list.
Mr. BLUMENTHAL. I would say in conclusion, sir, that I would
place an attack on mandated expenses, on inflationary, ineffective,
mandated cost increases, and there are plenty in the U.S. economy
and every corporate executive can give you chapter and verse on it,
of highest importance to this country.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
127
In my judgment the President has his hands tied in this area.
The Congress is under great difficulty in this area and we better
address ourselves to it sooner rather than later.
So I would say I put that high up on the list. I put it together
with shortfalls in investment because that takes time, too, but
unless we attack those two things, we won't have it better 3, 4
years from now.
Mr. CoN ABLE. Thank you, Mr. Secretary. Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much. The time of the gentleman has expired. The Chair recognizes Mr. Mineta.
Mr. MINETA. Thank you very much, Mr. Chairman.
Mr. Secretary, it is good to see you and I hope your father is
having a good time in San Jose.
On page 5 you speak of inflationary pressures of wage increases,
and concurrently, to follow up on this question that my colleague
from New York had, labor is being criticized as a major impetus in
the continuation of inflation. What has been the actual wage experience in the entire economy? Which groups within the labor force
have gained the most? If we engage in the traditional policies of
demand restraint to deal with inflation, which groups do you think
will be possibly thrown out of work?
Mr. BLUMENTHAL. Mr. · Mineta, I don't have the exact figures
before me. I think in a period of almost certain recession which
follows high inflation, it is the average worker who suffers most
from the lack of employment, higher unemployment really impacts
him, and I think the experience of the middle seventies indicates
that real wages do not keep up in that situation with the increases
in the cost of living.
So the worker, everybody gets the short end of the stick to some
extent, but labor in particular. For that reason I think labor has a
particular stake in making sure that inflation does not get out of
hand. For the extent to which it does lead to recessions, which it
always does, there will be great suffering.
My impression is, as I recall the figures, and I would be glad to
submit them-I don't have them at my fingertips-that is exactly
what has happened in the period in the middle seventies, that real
wages did not go up, they declined in fact for a period of time and
that the wage settlements that were agreed to were not sufficient
to make up for that kind of loss.
Recent wage settlements have been higher partly to make up for
that shortfall and perhaps because there has been a tendency to
try to get ahead of that. Now what we are seeing is that smaller
union and nonunion wages are also rising quite significantly to
catch up with the larger union wage settlements that have been
made.
I am not one who puts the blame on wage settlements, just as I
don't think it is fair to put the blame on business and say it is
anticompetitive practices of business that are causing this inflation. I am persuaded that in a complex economy such as ours, it is
all of these factors interacting and, importantly, and you notice I
put it No. 1 on Mr. Conable's list, fiscal and monetary policy of the
Government. That has to lead the way.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
128
But then we can't succeed unless there is an understanding that
in the long run if you increase wages more than productivity, you
are never going to ratchet this thing down.
Mr. MINETA. In that wage-price spiral, in that momentum inflation, where do you jump in? Where do you step in to try and
decelerate that?
Mr. BLUMENTHAL. Well, the problem is, I think, what we are
dealing with are sort of self-fulfilling prophesies, if you will. The
President's deceleration standard that he talked about in his April
11 speech-Mr. MINETA. Is that the 5½ percent?
Mr. BLUMENTHAL. No, the 5½ percent is the Government workers part of it. The President said he wanted to keep increases in
Government pay to no more than 5½ percent, which is lower,
which is deceleration from the previous year.
He said he hoped that if he took action to have a tight fiscal
program, if he kept Government pay increases to 5½ percent, if he
froze the pay of Government executives, if he got the deficit down
more quickly and put a tight rein on Government spending, if he
did all of these things, then we could get inflation to subside
somewhat. But we need more, we also need deceleration in wages
and prices. If simultaneously business and labor would commit
themselves to accept wage and price increases at a less rapid rate
than the average of the previous 2 years, then prices would increase less rapidly. They wouldn't need as large an increase, they
would be no worse off and we would bring inflation down.
If, however, one side said it doesn't trust the other, it is not going
to happen, I better get in and get mine quick and early, the other
side will have to do the same and we will be invalidating what we
are trying to do.
He felt he was taking the first step with this program and was
saying to business and labor, you had better do the same thing or it
will fail. That is the philosophy behind a deceleration standard
which is voluntary, because we don't believe in inflexible wage and
price controls. If labor and business will agree to wage and price
increases which are less than the average of the previous 2 years, if
they are willing to do that, we will all be better off. But that is
easier to say than to do. That is the philosophy behind that approach.
Mr. MINETA. It seems to me prices and wages have really been
inflexible, downward.
Mr. BLUMENTHAL. They are more rigid than they have been in
past periods. We find a higher rate o( inflation associated with a
given level of unemployment than used to be the case in the early
and midsixties, for example, which is why comparisons with that
period are so difficult to make. There is that rigidity, it takes
longer, there is longer leadtime. Therefore we need greater patienc.e, yet we seem to have less, not more, these days. We look at
last month's figures and try to make policy instead of giving it
enough time, looking ahead a little and waiting over a longer
period.
Mr. MINETA. One effect of inflation is to increase the revenues of
the Federal Government automatically because of the progressive
nature of our tax structure. There are a number of proposals
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
before Congress to remove that inflationary basis by indexing the
code for the effects of inflation. Do you think that the inflationinduced revenue is substantial and do you think moving to index
the Tax Code would be wise?
Mr. BLUMENTHAL. I believe it would not be wise, Mr. Mineta. Our
problem, and one of the sources of the rigidities that we have in
our economy at the present moment is that a large portion of
payments received by individuals is already indexed, too large a
portion is indexed.
Mr. MINETA. Cost of living benefits?
Mr. BLUMENTHAL. Yes; they are indexed. The Finance Minister
of Brazil, where indexing has become a way of life because they
have had rates of inflation which I hope we will never see in this
country, said if there is one thing you want to avoid doing, one
thing above all, is to get yourself caught on this kind of indexing.
For then you write in a rate of inflation and you are never able to
get rid of it.
We have a form of informal indexing which I think is much
better and that is, if you will permit me to be so bold as to suggest,
the U.S. Congress. The U.S. Congress every couple of years, or
maybe each year, considers tax legislation and when you look at
the curve of tax reductions that have been voted, you see in fact
that they have been steady reductions to take account of. the
moving into higher tax brackets.
I think that is a more flexible device because at least it provides
the opportunity, whether the Congress takes it or not, and I sometimes regret you don't take it more, to adjust a system in an antiinflationary way and allocate these revenues in an effe9tive
manner.
If it is done mathematically and mechanically, you have 1robbed
yourself of that option. As long as you make sure you don't follow
the advice of those who say don't cut taxes, because then you really
would put people in higher brackets, but you cut them enough to
take account of inflation and do it in a flexible manner, you are
indexing effectively in a better way than if you did it mechanically.
The CHAIRMAN .. The time of the gentleman has expired. The
gentleman from Ohio, Mr. Regula.
Mr. REGULA. Thank you, Mr. Chairman.
Mr. Secretary, you mentioned earlier that you might be part of
the minority. After reading your statement and listening to your
response to Mr. Conable, I would welcome you.
I particularly congratulate you on the statement, and I don't
think it has been made in the hearings thus far, that "to depend
too heavily on monetary restraint risk is distorting the composition
of growth and eventually aborting the expansion." I hope all will
pay heed to that.
You mentioned the trade imbalance and at the same time your
concern for protectionism. On page 3 you say, "Unless ·we redress
the serious imbalance in our foreign trade," and you mention this a
couple of times. How do you deal with the dichotomy involved
here? Of course, unless we have some restraints, that is, protectionism, if you will, the trigger price mechanisms, et cetera, we run the
risk of this flow in an environment of free trade but perhaps not
fair trade. Second, of course, the fact that $5 billion in interest
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
130
payments on the national debt are flowing out of the country to
foreign investors is another element in the imbalance of foreign
trade. How do you propose to deal with this seemingly contradictory situation?
Mr. BLUMENTHAL. Let me deal with the last point first and then
come to the main point which you raise which I think is a very
real one.
I am not particularly worried about interest payments on U.S.
debt to foreigners for two reasons. One, it means that the foreigner
is investing in the United States and I want more of that. I think
that is good for the U.S. economy, it is good for our balance of
payments, in fact, and it is certainly good for jobs and in every
way, shape or form.
I should also add that what we earn from abroad is quite a bit
greater than we pay out anyway. So we are doing well in that area
and I wouldn't want to restrict it or cut it down .
. I think the basic issue you raise is very important because obviously in a world which is not free, as far as trade barriers are
concerned, you can't have one country, even one as large as the
United States, that practices a certain kind of policy without
taking seriously into account what happens to jobs in this country
if other countries don't do the same thing. The fact is that no
country, including the United States, really practices a policy of
open trade completely.
You mentioned trigger prices. We have all kinds of restrictions
on agriculture and other commodities. Other countries have the
same thing.
I think that we have to be cognizant, and it is politically unrealistic to expect anything else, that there are individual situations, in
which protection and relief to individual industries for limited
periods needs to be provided while we bargain with other countries
to make sure that we get an equal deal for our exports and while
we adjust internally in those individual circumstances where a
particular group is suffering.
That does not in any way deny the validity of the basic concept
that protectionism hurts everybody and overall you try to get the
level of protection down. The whole history in this regard of U.S.
policy since the end of the war, on a bipartisan basis, regardless of
who has been in office, has been to subscribe to the notion that
protectionism a la the 1930's hurts us all. I am happy to see that
we are making progress again in Geneva to bring protection down
for all countries, but we were also talking about a safeguard clause
at the same time.
That is one of the things we have to negotiate, so that we all
have the right, in isolated instances, to have time to make adjustments and to protect people's jobs in individual circumstances.
Mr. REGULA. Thank you. You make quite a point of capital
formation and I think accurately so. It is a serious problem and
you, of course, question the proposals that are pending on the
capital gains tax.
How would the idea of allowing reinvestment of any capital gain
in another type investment, and not taxing it until such time as it
is used as a spending-until you took out your profits and, second,
as part of this, allowing an indexing of any capital gain that would
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
131
result from simple inflation so that the tax would be paid at
ordinary rates but it would only be paid on money that is being
used to spend and also that represents real dollar profit to the
individual?
Mr. BLUMENTHAL. This kind of a rollover provision, as it has
been called, which we do have in the code for housing-if you buy
another house in 18 months or less-has been looked at carefully
by us, as has the second idea that you put forward of indexing so as
to adjust the sales price for inflation, the idea being you don't tax
inflation.
Mr. REGULA. As I understand, many countries have no capital
gains tax.
Mr. BLUMENTHAL. Well, you have to be very careful about that
one, Mr. Regula. For example, the Germans are always cited as
having no tax on capital gains, which is true. But what people
don't point out is they have something in its place, which is worse.
They have a wealth tax and the difference between a capital gains
and a wealth tax is in capital gains you only tax the gains when
you realize them. In the wealth tax, each year they come around
and look at the net worth, on paper, and tax both the unrealized
and realized gain. That is worse.
I always say to people when they cite Germany as the shining
example, do you really want us to propose to the Congress that we
substitute a wealth tax for a capital gains tax.
In Japan the situation is more complicated for they have a
system that taxes capital gains at ordinary rates for all but stocks
and those they don't tax at all.
I think you can't compare specific aspects of a particular tax
system with any other. You have to look at the total tax structure.
Then you come up with one conclusion, which I think most Americans would be shocked to realize, and that is that taxes in this
country-we complain because they are so high-are lower by any
measure than in most other developed countries in the world. That
is something for us to be proud of, but also to be concerned that we
don't lose it, because if we did, we might be in the same fix as some
of the countries that have allowed their tax rates to go so high.
Quickly on the rollover, we have looked at that." I really think
that dealing directly with homeowners, perhaps extending the
benefits that they already have, dealing in a more targeted fashion
by offering incentives to people who want to invest in venture
capital and risk their money, are better ways. It is again a question
of alternatives. If we use the money for one thing, we don't have it
for another.
One of the reasons it is a better way is that my colleagues in the
Treasury tell me it is exceedingly complicated to have these rollover provisions. We would have to come and ask you for a rather
large increase in an appropriation for more revenue agents because, bear in mind, we would have to trace through each transaction, not just for houses but for whatever other purpose, trace
through each particular taxpayer reinvestment. Was it the same
money that was reinvested, how long was it held. Imagine, 10, 20
years out what kind of records you would have to keep.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
182
In terms of tax administration, it becomes a practically impossible problem for us to solve, and we feel we have other ways of
doing the same thing but doing it better.
Mr. REGULA. One 9-uick question. You make quite a point of
productivity. You don t speak to it in terms of the governmental
sector which takes a good chunk of money. Do you think Civil
Service reform would enhance productivity in the governmental
sector?
Mr. BLUMENTHAL. I am almost embarrassed that you ask me
these questions, sir, because it almost seems as if I have fed them
to you, which I haven't, I hasten to add.
Certainly for anyone coming from private industry into the Government, and having the responsibility for administering or attempting to administer a department of 125,000 people, there is
nothing that is more discouraging than the present set of impediments on executives, and on the President ultimately, in managing
things efficiently and in providing for greater productivity. Let me
give you one example in that regard.
The Treasury recently proposed a very small simplification in
the management structure of certain Internal Revenue offices. The
sum total of that reorganization-I hope these numbers are right,
they are about right in order of magnitude certainly-would have
involved the reduction of slots to the tune of 242. That is 242 out of
80,000 people in the Internal Revenue Service, with an annual
saving of about $7 million. While $7 million is but a drop in the
bucket for the total Federal Government, it is a way to make
things more efficient. We would have gotten more efficiency by
making the system simpler.
I think as a Member of Congress you can imagine the kind of
problems we ran into. In certain particular offices it meant the
reduction of six job slots but not people who would lose their jobs.
They might be transferred or go through attrition. It wasn't 242
people unemployed, but 242 people transferred or absorbed through
attrition.
The comments from Members of Congress, who shall be nameless
here, as to "What are you doing?" "What are you doing to my
district, four jobs, six jobs?" were tremendous. There were threats
that our budget would be impounded or that other terrible retribution would be visited upon us, resolutions introduced. That is one of
the ways in which we have to struggle to get greater productivity
in the Government.
Civil Service reform, which allows the transfer of people, which
provides incentives, which makes management of people in the
Government move into the 20th century and move within shouting
distance of what is done in industry, is very important and I hope
you all support the President's program in that regard.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Ohio, Mr. Stokes, is recognized.
Mr. STOKES. Thank you, Mr. Chairman.
Mr. Secretary, my first question deals with the administration's
capital gains tax approach. When we consider the present unemployment picture and acknowledge the fact that there has been
some overall general reduction in the unemployment rate, and, at
the same time, we know that the young, minorities, and the poor
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
133
are experiencing an extraordinarily high rate of unemployment, in
fact, an intolerable rate, it just seems to me that the capital gains
tax approach actually enhances or encourages capital growth at
the expense of the marginal labor market. Wouldn't it be better for
us to try and take an approach where you would have encouragement or enhancement with reference to growth in the labor
market?
Mr. BLUMENTHAL. Well, Mr. Stokes, I think that one should say
in all fairness that those who have proposed capital gains tax relief
have argued that by providing greater incentives to invest, you
create more jobs, and I think if it is under certain circumstances
that may be true. I carefully say under certain circumstances, not
under all circumstances, and not in all ways. Some of the ways
proposed would not do so. I think there is some truth in that.
Clearly, however, if the resources that are used for that purpose-and that is the point I made at the beginning of my remarks
in answer to the chairman's question-are taken away from lowerand middle-income people, or from other kinds of tax reduction
that are really job creating, as for example, targeted job tax credit,
clearly you would have the kind of problem on your hands that you
are referring to.
That is why how we spend that $20 billion is important if we
want to use tax relief to create the maximum number of jobs, and
to target them to the areas where we have the highest levels of
unemployment. Even last month, black unemployment was still at
11.9 percent and teenager unemployment still at 14.2 percent. So
while we are happy about the 5. 7 percent overall rate, we are not
at all happy about these other numbers.
That is critically important, and I agree we have to be very
careful and not rush in and hurt these kinds of factors that we also
want to improve.
Mr. STOKES. I would also question whether the venture capital
approach, which you spoke of with reference to Mr. Regula's question, wouldn't be more efficient if targeted to small businesses
rather than to business straight across-the-board. Wouldn't it have
a greater impact?
Mr. BLUMENTHAL. I think there is a valid argument that can be
made, sir, that the venture capital typically is a small businessman. The great developments in this country, I am sorry to say,
having come out of a very large company, are not typically made
by.very large companies. They are made by small people who have
an idea and develop it if they can raise the capital, and that is a
problem now.
So if you provide an incentive for venture capital, a good portion
would go to smaller comRanies anyway. I would say also that a job
is a job is a job. I don t really care if in the city of Detroit or
Cleveland, or wherever, whether an additional job is created by a
small or large company, as long as it is created. And if we find
through business tax reductions the best possible way of creating
additional jobs in those areas, where unemployment is still high, I
will be very happy.
Mr. STOKES. I have one further question. In your formal testimony you me~tion the administration's continued support of tax
reform. Given the short time that Congress will be in session with
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
134
an October adjournment presently scheduled, what realistically is
the administration's thoughts for tax reform in this Congress?
Mr. BLUMENTHAL. Mr. Stokes, the administration has its proposal
before the Congress. It has not changed that proposal with respect
to the reforms, both to make the system simpler as well as to make
it fairer. We hope, and the President is very anxious, to have the
Congress enact the maximum of those reforms-all of them, if
possible.
I recognize that time is getting short. It is, therefore, urgent that
the House and then the Senate, get on with the consideration of a
tax bill. We have not pulled back from that, and we will be working actively to convince the Congress to adopt the maximum
number of the reforms that have been suggested, because we believe that they are fair and, incidentally, provide revenue, additional revenue, which can be used more productively and more effectively if it were available to us.
Mr. STOKES. Thank you, Mr. Chairman. Thank you, Mr. Secretary.
The CHAIRMAN. The gentlelady from Maryland.
Mrs. HOLT. Thank you, Mr. Chairman.
Mr. Secretary, I apologize for not being here to hear your statement.
Mr. Bosworth testified yesterday before the committee, and I
don't want to misquote him, but I think he said there was no
correlation between budget deficits and inflation. This statement
disturbed me. While it may have been historically true at some
time, don't you believe that the huge deficits, both in relative and
absolute size that we have had back to back, are a contributory
factor in inflation?
Mr. BLUMENTHAL. I haven't seen the precise statement which
Mr. Bosworth made. I would say if he stated flatly that budget
deficits are not correlated with inflation, I would disagree with
him. I think that is clearly not true. Mr. Bosworth is a very able
economist. He probably qualified that statement in some way.
Mrs. HOLT. That is why I don't want to misquote him.
The CHAIRMAN. If the gentlelady would yield-I don't think Mr.
Bosworth said it flat out. It was part of a broader statement where
he was talking about the many causes of inflation and that it
wasn't correct to say that large deficits are the only cause.
Mrs. HoLT. I withdraw the question then, and I will reword it.
Do you think that there is a correlation between budget deficits
and inflation and, really, that they force the Fed to pursue a more
expansionary policy? And even more than that, it seems to me that
it is the confidence of the people.
Now when we offered our first budget resolution, I offered an
amendment that would have held our spending-I was trying to
hold it to current services because I felt that would be real leadership-to labor, to everybody else, to say, "OK, Government is going
to try to do its part," and I think that is where we really should
start, is to establish some kind of appropriate growth My second
question: What do you think an appropriate growth rate is? Or am
I right in my attitude about that?
Mr. BLUMENTHAL. Mr. Conable earlier gave me a list of seven
possible, or in his judgment likely, causes of inflation, and I indi-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
135
cated to him that while I accepted each one of those seven as being
a contributory factor, probably he and I could agree on two or
three additional ones at least. I think therein partly lies the
answer to your question.
Inflation is caused by many factors; therefore, an attack on inflation must address itself to all of these. I think then, in that context, answering your question specifically, in a period in which the
economy is operating at a high level of capacity-which it is,
relatively speaking now, with rates of unemployment that have
been dropping, with industrial capacity that is not at maximum
but that is high-a deficit of the size that we are having is a
contributing factor in my judgment.
You can't measure it by a $3 billion or $5 billion difference
either way, but clearly if we did not have the $48.5 billion deficit, if
we were in balance, that would be better for inflation.
There is a second factor quite apart from the numbers, which is
the psychology you referred to. I think that the signal that is sent,
as you correctly stated-to the business community, to labor, to the
financial community and to the international community-from a
balanced budget, as against a $50 billion deficit, is clear.
Furthermore, I also agree that two large deficits back to back
make it that much worse. I think, therefore, that the President's
strong commitment as a candidate, reiterated again and again,
that he will be working hard to move that deficit down and bring
the budget into balance, is very significant.
I have sat in enough budget meetings now with him and with my
colleagues to have a clear appreciation of the difficulties on doing
it quickly. His control over the budget is not as large as some
people well might think; a lot of mandated programs really are
outside of his control. Nevertheless, I think it has to be done,
spending reductions need to be carried out. If we were in a very
slack economy, my answer would possibly be somewhat different,
but we are not.
Mrs. HOLT. Do you think it would be disruptive if we tried to
reduce the growth rate of Government? Wouldn't that be a good
approach, to say we are going to reduce it 1 percentage point this
year, or hold it to current services and try to continue that for 3 or
4 years and, hopefully, at the end of that time that we would have
reached a stable situation?
Mr. BLUMENTHAL. I think that the President's approach, which
allows spending to go up less rapidly than the GNP and makes
Government a smaller share of the total, is the correct approach.
As he has pointed out, Federal Government spending has risen to
close to 23 percent of GNP, but he wants to gradually bring it
down to 21 percent by 1981.
If we can accomplish that, if the Congress would help us, I think
we would achieve the goal that you have in mind.
The CHAIRMAN. The time of the gentlelady has expired.
We have a vote on. We have two gentlemen here who have some
questions to ask, and we can do it if we stick to the 5-minute rule.
Mr. Pike.
Mr. PIKE. Mr. Chairman, in view of the fact I was so late, I will
pass.
The CHAIRMAN. Thank you. Mr. Latta.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
136
Mr. LATTA. Thank you, Mr. Chairman.
I am sorry, Mr. Secretary, I was detained in the Rules Committee, getting out grist for the mill next week and didn't get to hear
all your testimony. I have just a couple of short questions.
Since the unemployment rate is dropping so rapidly, and we all
are pleased with that, as you indicated on page 2, and 2 million
new jobs have been created in the past 6 months, do you really
think we need 725,000 public service jobs in our budget for fiscal
year 1979?
Mr. BLUMENTHAL. I think so, Mr. Latta. As I pointed out a
moment ago in response to a question by Mr. Stokes, even with a
5.7 average, we have 14.2 percent of teenagers, 11.9 percent of
black workers unemployed. This particular program is not one that
stimulates the economy generally but it is focused on particular
groups in which the level of unemployment is high.
I don't have the statistics here, but if we looked at unemployment in the inner cities, for example, where this program is also
concentrated, you would find much higher rates than the average.
On the other hand, for example, the unemployment rate for adult
men is down to 3.9 percent, which is a much better number. So we
still need these public service jobs in order to deal with these
particular groups and do so on a focused basis, which is much
better than general stimulation.
Mr. LATTA. Well, it seems to me, though, that in this time when
employment is increasing so rapidly it would be a good time to
bring these people into the mainstream, if we possibly could, rather
than putting them on public service jobs and keeping them there.
Mr. BLUMENTHAL. Well, the problem is that there is great rigidity in doing that. In 1975 when we had 8.5 percent unemployment
on the average, we had 13.9 percent unemployment for black workers. In 1977 we had reduced 8.5 percent to 7 percent, and we still
had 13.1 percent black unemployment. Very little improvment.
Now we are down to 5.7 percent overall, but are still at 11.9
percent black unemployment. The same thing with teenagers-it
has dropped from 18 or 19 percent to the lowest in a good many
years-14.2 percent. These groups just don't respond with general
economic activity as we would expect and want them to.
Mr. LATTA. Mr. Secretary, I read in the paper this morning about
an Ullman-Jones approach now. It seems like the chairman of the
Ways and Means Committee is endorsing the Jones approach on
capital gains tax. Does that indicate that the administration is
changing its position?
Mr. BLUMENTHAL. No; it does not, Mr. Latta. The President did
indicate in his last press conference that for the reasons I have laid
out for this committee in some detail, he did not feel he could
accept either the Steiger or the Jones approach to capital gains.
Mr. LATTA. How high do you think he could go?
Mr. BLUMENTHAL. He hasn't said that he will go anywhere as far
as that issue is concerned. On the other hand, he also has not said
that he will not go somewhere. As long as it meets the criteria that
I have suggested, which is my own analysis of the situation-there
may be a change, but it depends on what other proposals are made.
Mr. LATTA. I have several questions, but one particularly affects
my district. Since we have Sylvania in my district-and you are
.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
137
familiar with what recently happened by virtue of the Supreme
Court decision on imports from Japan-we had a similar situation
which hit the television industry very hard a year ago when the
President intervened after the Federal Trade Commission had
made a decision.
These two acts hit the television industry very, very hard and I
can see a lot of employment going overseas as well as a lot of
dollars, and when our balance of trade is as it is today, it would
seem to me that the administration should be changing its position
on these imports. Is there any chance in the foreseeable future that
the administration might recognize that we have a problem here
and might change its position?
Mr. BLUMENTHAL. I think the administration does recognize that
where there are particular problems, particularly those that are of
a transitional nature, that some relief is indicated.
In the case of television, some voluntary arrangements, if I remember correctly, were entered into with some countries a year
ago. I don't believe that the administration is likely to change its
position on the basic question of whether or not the indirect taxes
that are rebated by some exporting countries are countervailed in
the United States, which is what the Supreme Court decision was
about. That is a system that has been in effect for decades and we
think there is good justification for not countervailing those.
But where there are particular problems the President has-with
due consideration to inflation and unemployment-taken action
from time to time and I am sure he would consider doing so again.
The CHAIRMAN. Thank you very much, Mr. Secretary, for taking
the time to be with us and giving us the informative material
which you have, and the benefit of your views. Thank you.
Mr. BLUMENTHAL. Thank you, Mr. Chairman.
The CHAIRMAN. The committee stands in adjournment until tomorrow at 10 o'clock.
[Whereupon, the hearing adjourned until Thursday, July 13,
1978, at 10 a.m.]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
ECONOMIC OUTLOOK AT MID-SUMMER
THURSDAY, JULY 13, 1978
HOUSE OF REPRESENTATIVES,
CoMMITTEE ON THE BUDGET,
. Washington, D. C.
The committee met, pursuant to notice, at 10:30 a.m., in room
210, Cannon House Office Building, Hon. Robert N. Giaimo, chairman of the committee, presiding.
The CHAIRMAN. The committee will please come to order. Our
witness this morning is G. William Miller, Chairman of the Board
of Governors of the Federal Reserve System.
Mr. Miller, it is our pleasure to welcome you on this, your first
appearance before the House Budget Committee. We truly welcome
you and are delighted to have you here. We look forward to cooperating with you and the Federal Reserve System in the coordination
of monetary and fiscal policy, not only in the months ahead, but
also in the longer run.
·
We are, of course, interested in your forecast of the future path
of the economy and your opinion as to the size and composition of
the tax cut that will be included in the second budget resolution.
We are also interested in what course you think monetary policy
should take over the next 12 to 18 months. We are all faced with
the very difficult task of continuing the recovery from the 1975
recession and at the same time reducing the rate of inflation. We
would certainly welcome any suggestions that you have as to how
we accomplish this.
AB you know clearly better than anyone else, the conduct of
monetary policy is of the greatest importance, not only to this
committee, but to the country as a whole, and we wish you well in
your new position and your new undertaking.
Welcome again to the committee. You may proceed as you wish.
STATEMENT OF HON. G. WILLIAM MILLER, CHAIRMAN, BOARD
OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. MILLER. Thank you very much, Mr. Chairman.
Mr. Chairman and members of the committee, I do appreciate
this opportunity to make my first appearance before your Budget
Committee and to convey to you the view of the Federal Reserve on
the state of the economy as well as the economic policy issues
facing us.
Mr. Chairman, with your permission, I would suggest that the
prepared text I have submitted be included in the record, and that
perhaps, just to aid the discussion, I will hit its highlights. Then we
can turn our attention to the questions that you have in mind.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
(139)
140
The CHAIRMAN. Without objection, we will include your statement in the record and you may highlight it.
Mr. MILLER. Thank you.
The economy is now in its fourth year of expansion and, fortunately, unemployment has been substantially reduced. However,
the Nation is beset by an unacceptably high and recently accelerating rate of inflation, and budget deficits continue large for this
stage of the expansion. It is essential that longer term policies be
structured to confront these problems.
Economic growth, though uneven so far this year, has been on
the whole satisfactory. We had a zero growth rate in the first
quarter, and will probably show a real rate of growth of 8 to 9
percent in the second. The average rate of growth is satisfactory,
but its unevenness has caused certain problems.
The vigor of employment growth is one important measure of the
underlying momentum of the economy. The addition of 2¼ million
jobs so far this year has pushed the unemployment rate substantially lower, and you will find in the materials I submitted, a chart
that shows how we have moved along in reaching this objective.
The unemployment rate does remain unacceptably high, particularly for minorities and youth, but we can be encouraged by the
progress to date.
[Charts referred to may be found at the end of Mr. Miller's
prepared statement.]
Mr. MILLER. Recent data indicate some slowing in the extremely
rapid growth of overall activity during the spring rebound. Economic expansion will be reasonably well maintained in the near
term, but will certainly drop below the high level in the second
quarter.
Sustaining the economy will be a number of important segments.
Consumer demand remains strong. You recall that we have had
recently a very satisfactory rate of automobile sales. Some of the
purchases by consumers~ however, may have represented buying in
anticipation of future price increases and, to that degree, there
may be some distortion in quarterly economic activity. However,
surveys indicate a continuing relatively high level of consumer
confidence, so we can expect this segment of the economy to continue to be supportive of expansion.
The business sector should also continue to be a source of support. Inventory policies are such and inventory conditions are such
that we can expect to see moderate increases in spending for
inventories. We also have survey information that would indicate
continued moderate increases in capital spending.
In contrast, residential construction will probably cease to be a
source of support for the economy. Housing has been operating at a
relatively high level, a satisfactory level, but with credit markets
what they are we can expect some slackening, although certainly
not the kind of downturn that would indicate a recession.
On balance, the evidence suggests further moderate growth in
aggregate demand over the near term, sustaining one of the most
durable expansions of the postwar period. But the longer term
outlook is clouded by the price situation. So far this year, consumer
prices have risen at over a IO-percent annual rate as compared
with about 6.8 percent in the same period in 1977.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
141
The food sector has been particularly disturbing and has contributed significantly to inflation, but prices outside the food area have
also moved up sharply recently and are continuing to fuel inflation.
We expect some relief later this year from the slowing of food
price increases, but with the economy moving into a period of
heavy collective bargaining, the intensified inflation is likely to be
reflected in larger wage adjustments and more rapid increase in
labor costs.
Turning to interest rates, in the last year or so, private and
governmental credit demands have risen, putting considerable
upward pressure on interest rates. At the same time, the recent
and expected inflation has also been an extremely important factor
underlying the increase in interest rates contributing to money and
credit demand and conditioning the stance of monetary policy.
Obviously inflation increases the volume of credit necessary to
finance any given level of economic activity. Individuals have to
borrow more to acquire houses, cars, and other durables. In the
business sector, the rise in the dollar volume of spending on inventories and fixed capital, a significant portion of which represents
rising prices, has outstripped internal funds generation, producing
a marked increase in borrowing.
In addition to the direct effect of rising prices on credit demands,
the prevalent expectation that the rate of inflation will remain
high, if not accelerate, has always increased the demands for goods
that require financing. The volume of borrowing has been strengthened by existing homeowners withdrawing part of their rising
equity in the housing stock, and this, too, has contributed to the
upward pressure from increased credit demands.
Borrowing has contributed to worrisome distortions in the financial positions of consumers and businesses. As to consumers, the
consumer and mortgage loan repayments have now risen to a near
record level as a percent of disposable income. You will find in the
material I submitted, a chart showing that almost 20 percent of
disposable income is now committed to servicing these debts. Thus
far, households have handled this situation well, but it is a cause
for concern, requiring careful watch.
In the business sector, the pattern of financing has similarly
begun to cause concern. An increasing share of business credit
requirements have been handled through short-term borrowings,
especially at banks, and this has added to the pressure.
While one would expect strong credit demands as a normal counterpart of a healthy and growing economy, a significant, and I am
afraid expanding, share of recent credit growth is both the direct
and indirect result of inflation. Moreover, mounting inflation expectations raise the specter of possible speculative excesses leading
to shortrun explosion of credit and output and subsequently to
recession. The Federal Reserve' s firming of monetary policy has
been designed to minimize the possibility of such an undesirable
outcome.
In the presence of strong credit demands, the worsening of inflation, and the Federal Reserve's efforts to contain excessive monetary expansion, market interest rates have risen significantly. Most
short-term rates have increased about 1 to 1 ½ percent since the
32-052 0 - 78 - 10
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
142
beginning of this year. This rise in market interest rates has been
accompanied by slower growth of savings in banks and thrift institutions. As a result, growth rates of the broader monetary aggregate, M2 and MJ have remained within the Federal Reserve' s
longrun ranges.
The slower rate of growth of savings has threatened to retard the
housing industry. Therefore, the Federal regulatory agencies recently took action to increase the competitiveness of bank and
thrift deposits subject to regulatory ceilings in order to maintain
the flow of credit to housing. Two new savings instruments were
authorized effective June 1, and the early evidence indicates this
has helped significantly in sustaining flows of funds to thrifts and
money for the housing industry.
The persistence of a large Federal budget deficit at this advanced
stage of our economic expansion is another disturbing problem.
During the last recession, large deficits were both a consequence of
and a reasonable policy response to the underutilization of our.
productive resources. Developments this year, however, suggest
that the Federal Government should be moving with deliberate
speed to rein in its compensatory policies. The level of private
sector activity has risen markedly over the past several years, and
there now appears to be much less usable slack in the economy and
much less need for Federal deficits to sustain the economy.
Positive steps are thus in order to lessen the Government's competition with the private sector for resources. The Federal Government has a constructive role to play in moderating the ups and
downs in economic activity. In the present circumstances, a damper
on further expansion of Federal expenditures would help to assure
a continued, sustained, long-term economic growth.
In my view, the task of reducing the Federal share of GNP
should begin now. I believe we should strive to reduce the Federal
Government's share of GNP from more than 22 percent at present
to 20 percent or so over the period of 5 to 7 years. As you will note
in chart 6 submitted to you with my testimony, this kind of reduction would merely return us to the share of Government activity
that existed in the early 1960's. It would, therefore, be a very
reasonable undertaking.
Moreover, private capital investment should be encouraged directly by offering incentives to businesses to expand their stock of
plant and equipment. Capital accumulation is the chief engine of
long-range growth, of labor productivity, and rising living standards. Yet, depreciation guidelines and the resulting deductions
have not approached actual replacement costs in periods of inflation. Present depreciation tax laws should be liberalized. For example, businessmen could be permitted to use a shorter writeoff
period for machinery, equipment, and structures.
A larger share of GNP must be devoted to capital investment. It
will not be enough simply to reach the investment proportion of
10½ to 11 percent of GNP that has characterized past periods of
prosperity and low unemployment. In my opinion, the Nation must
set an ambitious goal of, say, 12 percent of GNP for an extended
period, a level that would support increased growth and increased
productivity and help to reduce inflation.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
143
Establishment of a high-growth, low-inflation economy would be
facilitated by extensive reform of costly Government regulations.
In this connection, the President's recent Executive order to improve the regulatory process is encouraging and deserves full support and cooperation.
In the same vein, it is important that we consider alternatives to
those programs that tend to limit competition and raise prices.
Notable examples are import controls, price supports, the DavisBacon and Walsh-Healy Acts. In addition, it seems appropriate to
consider deferring the increase in the minimum wage that is scheduled for January 1, 1979, given its implications for cost and for
youth employment opportunities.
It is my belief that a reduction of budget deficits and restructuring of taxes to help investment, along with prudent monetary
management by the Federal Reserve, should, over time, lead to an
economy that enjoys sustained growth, price stability, and a sound
dollar.
Thank you very much, Mr. Chairman.
[Testimony resumes on p. 162.]
[The prepared statement of Mr. Miller follows:]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
144
PREPARED STATEMENT OF HON.
G.
WILLIAM MILLER
Mr. Chairman and members of . the Committee,· I appreciate t_his
opportunity to meet with you to convey the views of the Federal Rese~e
Board on the state of the economy as well as on economic policy issues
facing the nation.
The economy is now in its fourth year of expansion and unemployment has been substantially reduced. However, the nation is beset
by an unacceptably high and recently _a ccelerating inflation, and budget
deficits continue large for this stage of the expansio,n.
It is essen-
~ial that long~~-term policies be structured to confront these problems,
while supporting continued growth.
PACE OF GROWTH MAINTAINED RECENTLY
Economic growth, though uneven so far this year, has been on
the whole satisfactory.
As you know, the severe weather and the coal
strike temporarily halted over-all expansion during the winter.
How-
ever, with the subsequent surge in activity--illustrated in the first
chart--growth of real GNP in the first half appears to have averaged
about a 4-1/2 per cent annual rate, close to the average pace over
the first three years of the present expansion.
The vigor of employment growth is one important measure of
the underlying momentum of the economy, and indicates that business has
confidence in the sustainability of the expansion.
The addition of
2-1/4 million jobs so far this year has pushed the unemployment rate
substantially lower--as illustrated in the lower panels of the chart--
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
145
and supported brisk growth of personal income.
Almost all groups of
workers have benefited from improved job opportunities, though the
unemployment rate remains unacceptably high for minorities and youth.
AND THE NEAR-TERM OUTLOOK APPEARS FAVORABLE
Not surprisingly, recent data indicate some slowing from the
extremely rapid growth of over-all activity during the spring rebound.
Even so, the fundamental determinants of final demand suggest that
economic expansion will be reasonably well maintained in the near term.
In particular, consumer demand remains strong.
Auto sales
continue at extremely high rates following the turnaround that began
in March.
Some of the surge in durable goods purchases appears to
have represented buying in anticipation of further price rises. Gains
in retail sales outside the automotive area have moderated somewhat
recently, but this was to be expected following the extremely rapid
sales pace of February and March.
With surveys indicating a con-
tinued high level of consumer confidence, sustained moderate growth
in income should support further expansion of consumer outlays over
the near term.
The business sector also should continue to be a source of
support to activity.
Inventory policies have been conservative over
the past several years, and businesses have in general thus avoided
the imbalances that interrupted previous expansions.
Various invest-
ment surveys, as well as data on equipment orders and construction
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
146
contracts, suggest moderate increases in capital spending over the
balance of this year.
In contrast, it appears likely that residential construction
will cease to be the source of support that it has been in this
expansion.
While housing activity currently remains at a high level,
mortgage markets have tightened considerably and it is likely that
residential construction will begin to slacken in coming months.
And growth in State and local government outlays is likely to remain
modest. These jurisdictions have pursued relatively conservative
spending practices and this reluctance to accelerate spending seems
unlikely to change, especially in light of tax relief mandated by
Proposition 13 in California and the possibility of similar actions
elsewhere. But our net export position, which has deteriorated over
the past two years, should improve somewhat over the next year.
Imports are likely to rise at a slower pace. At the same time, exports
should pick up if activity abroad increases as expected and as the
changes in exchange rates which have occurred over recent months
improve the competitive position of U.S. goods.
INFLATION CONTINUES AS OUR BASIC PROBLEM
On balance, the evidence suggests further moderate growth of
aggregate demand over the near term, sustaining one of the most durable
expansions of the postwar period.
clouded by the price situation.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
But the longer term outlook is
During the first three years of the
147
expansion inflation rates were very high by historical standards,
and there has now been a further acceleration of price increases,
as shown in Chart 2.
So far this year consumer prices have
risen at a 10.2 per cent annual rate, as compared to 6.8 per cent
in 1977. A key element in the price surge this year has been the
adverse developments in the food sector, as meat production has
been constrained by an ongoing reduction in the nation's cattle
herds. However, prices outside the food area have also moved up
sharply recently. Retail prices of. nonfood commodities and services
rose at an 8 per cent annual rate during the first five months of
the year--up appreciably from the 6-1/2 per cent rate in 1977.
We can expect some relief later this year from a slowing
of food price increases. But with the economy moving into a period
of heavy collective bargaining, the intensified inflation is likely
to be reflected in larger wage adjustments, and a more rapid increase
in labor costs. These costs also will be boosted early next year by
additional mandated increases in social security taxes and in the
minimum wage. The continued interplay of wage and price rises,
coupled with the legislated cost increases, makes it difficult to
anticipate much relief from underlying inflationary pressures over
the next year.
RISING INFLATION AND RISING INTEREST RATES ARE TWO SIDES
OF THE SAME COIN
In the last year or so, private and governmental credit
demands have risen, putting upward pressure on interest rates.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
148
At the same time, the recent and expected inflation· also has been
an extremely important factor underlying the increase in interest
rates, contributing to money and credit demands and conditioning
the stance of monetary policy. Obviously, inflation increases the
volume of credit necessary to finance any level of economic activity.
Individuals have to borrow more to acquire houses, cars and other
durables. In the business sector, the rise in the dollar volume
of spending on inventories and fixed capital, a significant portion
of which represents rising prices, has outstripped intern~! funds
generation, producing a marked increase in borrowing this year.
In addition to the direct effect of rising prices on credit
demands, the prevalent expectation that the rate of inflation will
remain extremely high-if not accelerate--has also increased the
demand for goods requiring financing. As noted earlier, the extremely
strong pace of automobile sales recently appears to have reflected
consumer attempts to beat expected price rises. Home sales may
have been similarly buoyed by the perception that waiting can only
result in having to pay higher prices later. Such purchases have
contributed to record instalment debt financing and to substantial
additions to mortgage -debt. The volume of borrowing also has been
strengthened by existing home owners withdrawing part of their rising
equity in the housing stock, partly to finance major expenditures
and to otherwise maintain living standards in an inflationary
environment.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
149
Borrowers appear to be counting on the general rise in
nominal incomes that accompanies most inflations to help service
their growing debt burden.
This, in fact, has been a major ingre-
dient in the upward pressures on interest rates.
Borrowers are
willing to pay higher interest rates because they expect that their
future debt burdens will be eased by rising nominal incomes;
mean-
while lenders seek higher interest rates in order to protect their
real position.
CURRENT BORROWING LEVELS IMPLY FUTURE RISKS
Moreover, such borrowing has contributed to worrisome distortions in the financial positions of consumers and businesses. For
example, the ratio of cons\uner and mortgage loan repayments to disposable income is now at a near record level (Chart 3).
Thus far, house-
holds have apparently been able to service this debt with little
problem.
Recently, however, delinquency rates have edged higher,
although they remain well below previous peaks. Nonetheless, the
level of household indebtedness is of concern, since it may constrain
future spending, and could give rise to more widespread financial
difficulties--especially if the rate of income growth were to slow.
In the business sector, the pattern of financin~ has similarly
begun to cause some concern.
An
increasing share of business credit
requirements recently has been met through short-term borrowing,
especially at banks, and businesses have slowed their accumulation
of liquid assets. As a result of these changes in the composition
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
150
of business assets and liabilities, corporate liquidity has deteriorated recently, although balance sheets remain in considerably
stronger condition than they were in 1974 (Chart 4).
RESPONSE OF MONETARY POLICY
While one would expect strong credit demands as a normal
counterpart of a healthy and growing economy, a significant-and
I am afraid expanding--share of recent credit growth is both the
direct and indirect result of inflation. Moreover, mounting inflationary expectations raise the specter of possible speculative
excesses, leading to a short-run explosion of credit and output,
and subsequently to recession.
The Federal Reserve's firming of
monetary policy has been designed to minimize the possibility of
such an outcome.
In the presence of strong credit demands, the worsening of
inflation, and the Federal Reserve's efforts to contain excessive
monetary expansion, market interest rates have risen signficantly
further.
Most short-term rates have increased by 1 to 1-1/2 per-
centage points since the beginning of the year and long term bond
yields have followed much the same pattern, as illustrated in
Chart 5.
The rise of market interest rates has been accompanied
by slower growth of savings and small-denomination time accounts at
banks and thrift institutions.
As
a result, growth rates of broader
monetary aggregates--M-2 and M-3--have remained withirt the Federal
Reserve's long-run ranges.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
151
The slower rate of growth of savings and small-denomination
time deposits has threatened to retard housing activity.
Therefore,
in an environment of rising interest rates, the Federal regulatory
agencies have recently taken action to increase the competitiveness
of bank and thrift deposits subject to regulatory ceilings in order
to maintain the flow of credit to housing.
Two new savings instru-
ments were authorized effective June 1--a variable-ceiling, six-month
certificate, with weekly ceiling rates tied to yields on newly issued
Treasury bills, and an eight-year certificate carrying ceiling rates
of 7-3/4 and 8 per cent for banks and thrifts, respectively.
The
limited - available evidence suggests that these new instruments,
especially the defensive six-month certificates, are playing a significant role in he.lping to sustain net deposit inflows to thrift
institutions, even as market interest rates have risen further.
CONTINUED HIGH DEFICITS A MAJOR PROBLEM
The persistence of large Federal budget deficits at this
advanced stage of our economic expansion is a disturQing problem.
Businesses and households have had to compete for funds in credit
markets with the public sector, whose borrowing this year has continued at a _high level.
During the last recession, large deficits were both a consequence of and a reasonable policy response to the under-utilization of our productive resources.
The Federal government cut taxes
and increased the size of public employment and other spending
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
152
programs.
Continued large Federal deficits were justified well into
the recovery period, since the expansive impact of Federal fiscal
policy was offset in part by sizab~e budget surpluses by States and
localities, together with an increasing foreign sector deficit, both
of which drained purchasing power away from the private sector of the
economy. Developments this year, however, suggest that the Federal
government should be moving with deliberate speed to rein in compensatory policies. The level of private sector activity has risen markedly
over the past several years, and there now appe~rs to be much less
usable slack in the economy.
Moreover, the over-all surplus of States
and localities appears likely--in the wake of Proposition 13 in California and related developments--to be swinging back toward balance.
WE MUST REDUCE GROWTH OF FEDERAL EXPENDITURES
Positive steps are thus in order to lessen the government's
competition with the private sector for resources.
ment has
a constructive
in economic activity.
The Federal govern-
role to play in moderating the ups and downs
In the present circumstances, a damper on
furthe~ expansion of Federal expenditures would help to assure a continuation of sustained long-term economic growth.
In my view, the task of reducing the Federal share of GNP
should begin now.
A careful, systematic review must be undertaken
to reduce or eliminate those Federal programs that are ineffective
or that have outlived their usefulness.
We also need to recognize
the limits on government resources when considering alternative
spending proposals.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
153
I believe that we should strive to reduce the Federal
government's share of GNP from more than 22 per cent at present
to 20 per cent or so over a period of five to seven years. As
can be seen in Chart 6, such a reduction would not fully return
the government proportion to that of the early 1960's.
As
spending is brought under tighter control, govern-
ment will become less prominent as a borrower in credit markets.
A lower government profile will facilitate the flow of credit to
the housing sector where it is becoming scarce, and to the business sector where it can be put to use in rebuilding our currently inadequate stock of fixed capital.
MEASURES NEEDED TO ENCOURAGE INVESTMENT
Moreover, private capital investment should be encouraged
directly by offering incentives to business to expand their stock
of plant and equipment. Capital accumulation is the chief engine
of long-range growth of labor productivity and rising living standards.
Yet for an extended period, the nation's tax policies have not provided adequate incentives for business investment. In particular,
depreciation guidelines and the resulting deductions have not
approached actual replacement costs in periods of inflation. Present
depreciation-tax laws should be liberalized. For example, businessmen
could be permitted to use a shorter write-off period for machinery,
equipment and structures.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
Careful consideration also should be given
154
to present laws that tax corporate profits twice--first at the firm
and then at the stockholder level.
Given the neglect of investment which has eroded the nation's
capital stock, as well as the need to accommodate to the reality of
scarcer and more expensive energy, a larger share of GNP must be
devoted to capital investment. It will not be enough simply to reach
the investment proportion of 10-1/2 to 11 per cent that has been characteristic of past periods of prosperity and low unemployment.
In
my opinion, the nation must set an ambitious goal of, say, 12 per
cent of GNP for an extended period--a level that would support
increased growth and productivity.
STRUCTURAL REFORMS ARE ALSO NECESSARY
Establishment of a high-growth, low-inflation economy would
be facilitated by extensive reform of costly governmental regulations.
Regulatory activities in the health, safety and environmental protection areas may not always achieve the desired outcome at minimum
costs, and they need to be reviewed with that thought in mind.
Simi-
larly, market- and price-regulation programs should be carefully
reexamined to ensure that their benefits outweigh their costs. In
this connection, the President's recent executive order to improve
the regulatory process is most encouraging and it deserves the fullest
possible support and cooperation.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
155
In the same vein, it is important that we carefully consider
alternatives for those programs that tend to limit competition and
raise prices.
Notable examples are import controls, price supports,
and the Davis-Bacon and Walsh-Healy Acts.
In addition, it seems
appropriate to consider deferring the increase in the minimum wage
that is scheduled for January 1, 1979, given its implications for
costs and for youth employment opportunities.
To conclude, it is my belief that a reduction of budget
deficits and restructuring of taxes to help investment, along
with prudent monetary management by the Federal Reserve, should,
over time, lead to an economy that enjoys sustained growth, price
stability and a sound dollar.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
156
Chart 1
CURRENT ECONOMIC INDICATORS
Per cent change
Industrial Production
Per cent change
8
Total Construction Spending
2.0
4
1.0
+
.........~~~·~...........--~.,....~.....,...,~~.........CJ.--1
+0
0
4
------------~---~1.0
J
1977
F
J F
M A M
1978
1977
Billions of dollars
M A M
1978
MIiiions of units
Auto Sales
10
62
I
6
4
58
2
J
1977
F M A M J
JFMAMJ
1978
1977
Per cent
MIiiions of workers
Payroll Employment
1978
Unemployment Rate
86
I
14
7
12
I
10
J
1977
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
F M A M J
1978
JFMAMJ
1977
1978
157
Chart 2
MEASURES OF AGGREGATE INFLATION
PERCENTAGE CHANGE FROM PREVIOUS PERIOD, ANNUAL RATE
GROSS DOMESTIC BUSINESS PRODUCT
Fixed-Weighted Price Index
9
6
3
1975
1976
1977
1978
'79
CONSUMER PRICES
All Items
9
6
3
Dacamt>erM•Y change
1975
1976
1977
1978
'79
PRODUCER PRICES
Total Finished Goods
9
6
3
DecemberJune change
1975
32-052 0 - 78 - 11
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1976
1977
1978
'79
158
Chart 3
HOUSEHOLD BORROWING
Annual rate, bllllons of dollars
140
60
20
+
0
1974
1975
1976
1977
1978
HOUSEHOLD DEBT REPAYMENTS
Relative to Disposable Personal Income
Per cent
20
19
18
1974
1975
1976
1977
1978
* Monthly net change in amount outstanding of Total Consumer Instalment Credit .
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
159
Chart 4
CORPORATE FINANCE
Borrowing
BIiiions of dollars
60
45
30
15
+
0
1974
1975
1976
1977
1978
Balance Sheet Ratios
15
Per Cent
30
Liquid Assets to
Short-Term Liabilities
25
Short-Term Debt to
Total Debt
1974
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1975
1976
1977
1978
160
Chart 5
Per cent
INTEREST RATES
12
10
Aaa Utility Bonds
New Issue
8
e
3-Month Treasury Bills
1974
• Week of July 5th
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1975
1976
1977
4
1978
161
Chari I
BUDGET OUTLA VS AS A PER CENT OF GNP
'60
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
'65
Per cent
'70
'75
'78
162
The CHAiltMAN. Thank you very much, Mr. Miller.
Mr. Miller, next weekend, the Economic Summit will convene in
Bonn, Germany. What do you expect the results of that meeting
will be, and what should or could come out of such a meeting?
Mr. MILLER. Over the last dozen years, Mr. Chairman, the world
has developed toward increasing interdependence among all nations-certainly an increasing interdependence among developed
nations. Economies are linked together. So it is important that
there be a procedure and a mechanism by which the heads of state
and heads of government of the leading industrial nations can keep
in close touch and learn the implications of their own economic
policies and actions as they affect the whole world and the welfare
of all countries.
So these meetings over the last few years, I think, have been an
encouraging development. However, it is a mistake 1 in my opinion,
to expect that each and every year, just because the pages of the
calendar have been turned for 12 months, that any major new
initiatives or major new developments are in order.
The summit this year should be looked upon as an opportunity to
update the trends of the past year, to become acquainted with the
internal considerations that are influencing the economic policies
of major nations, and to continue to seek ways to harmonize and to
reach a confluence of interest.
·
It would be unrealistic to expect the leaders of our governments,
at this point, to come up with some all-embracing solutions. This is
a time to consolidate; it is a time to harmonize; it is a time to
understand. I don't believe that it is a time when we should expect
major new initiatives.
The CHAIRMAN. You said in your statement:
Privat~ capital investment should be encouraged directly by offering incentives to
business to expand their stock of plant and equipment. Capital accumulation is the
chief engine of long-range. growth and rising living standards.
And then you address yourself to some of the tax policies to
bring this about, specifically changes in the depreciation tax laws,
a liberalization thereof. There is a pretty broad recognition that we
have to encourage and develop greater incentives to business to
invest, and one of the arguments, as you well know, favors changes
in the treatment of capital gains taxation. Would that accomplish
the desired result?
Mr. MILLER. There have been a number of proposals in Congress
for liberalizing-reducing-capital gains taxes. In my judgment,
these would not have an efficient or direct impact on capital spending by businesses. I could list several kinds of tax policies that
would result in a more direct stimulus to business fixed investments, and we might look at the merits of each.
One is a reduction in corporate taxes, increasing cash flow to
corporations. The trouble with this particular solution is that there
is no assured link between a lower tax rate and spending for
capital investment. A lower tax rate means more cash flow, but the
cash released could be used for inventories, for dividends, for
higher profits, and not necessarily for spending.
A second method is subsidized interest rates, which we have seen
in revenue bond financing. This approach does give an incentive
for investment, but is not really the right solution, long term, and
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
163
therefore not the solution for a massive change in capital spending
plans.
A third possibility is the investment tax credit, or higher rates of
depreciation.
The investment tax credit is a very useful method of increasing
cash flows and creating greater incentives for investment by reducing the risks that go with investments when there are unknown
and unsure markets and unknown and unsure costs. But the investment tax credit is also a forever-reduction of taxes. So it can
never be recaptured.
On the other hand, faster depreciation is a very efficient way to
stimulate capital investment. It is directly linked to investment;
there is no reduction in Federal revenue unless there is an investment. And once the investment is made and the writeoff takes ,
place, then, of course, all that faster writeoffs do is defer taxes. The
businessman recaptures his capital sooner and reduces his risk, but
once he has recaptured his capital he keeps paying taxes. Therefore, the Treasury gets more for its dollar by deferral than it does
through an investment tax credit.
So a higher rate of depreciation is one of the most efficient
systems, and I am hopeful that Congress, in looking at the tax
package that is now being shaped, will give this method a good
deal of consideration. I know that so far the preference has been to
reduce corporate tax rates; I don't object to that in principle, but I
would point out that there is no direct linkage between that reduction and stimulating investments.
When we go to something like capital gains taxes, of course, the
linkage is a very remote one. Capital gains taxes relate to the sale
of capital assets. But the ownership of stock in a corporation and
the profit accumulated by investors when the stock goes up doesn't
generate any cash for the corporation to invest. Nor does it generate any incentive for investment even if, with resulting better
market prices, the corporation has an incentive to issue stock to
raise capital. When a corporation raises capital, it may raise it for
all kinds of activities, not just for capital spending. Moreover, any
effects of capital gains reductions are delayed.
Of all the choices, the one that I would recommend to you for
highest priority consideration is a very substantial acceleration in
the writeoff of productive assets. This is the kind of incentive we
have utilized in periods of emergency in the past, when a 5-year
writeoff during the war created a tremendous stimulus.
The CHAIRMAN. Thank you. I am going to recognize Mr. Fisher.
Mr. FISHER. Thank you, Mr. Chairman. I listened most attentively to what you had to say, Mr. Miller, on the merits of different
ways of stimulating investment of capital formation, and I tend to
agree with what you say.
What would you think of a combination of some reduction in the
corporate income tax rates combined with a faster writeoff of depreciation, and some improvement in the investment tax credit?
This would put the corporations in better cash position to elect to
invest more if they wish, rather than declare dividends or doing
something else, and would also give them the favorable situation of
a faster writeoff or a higher investment tax credit.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
164
Mr. MILLER. Congressman Fisher, let me just back off a minute
and put the problem in context. I would like to be responsive. I
think your thoughts are very sound, but I would like to develop
them a little.
The first point is to recognize that, given the condition of the
economy and the priority to reduce the Federal deficit, we have to
limit the tax reductions that are made. So first we have to decide
how much we think we can afford; and certainly a tax reduction,
effective next January 1, of between $15 and $20 billion-of about
$18 billion, say-is reasonable. How much of that should go to
individuals-to relieve the increasing burden of inflation, payroll
taxes and the progressivity of the income tax brackets-is important and debatable; perhaps two-thirds of it should go to that use.
But if one concludes that there is $5 billion to $7 billion that
could be allocated to business, then the question is how best to
allocate it. I have no objection to a judicious allocation, balancing
those tax policies which directly intensify investment and those
which help corporations that are not in the productive sector of the
economy; and we must recognize that those corporations too, need
help.
I think that what you are talking about is a very sensible,
balanced approach. I would want a very good part of that business
allocation to go toward helping investment, because I am convinced
that the next leg of development has to be investment to sustain
growth in this economy.
We have been underinvesting for so long. The Japanese invest
over 20 percent of their GNP in business investments, the Germans
15 percent. We invest 8 or 9 percent. My suggestion is that we get
up to 12 percent; we have been up to 11 percent in some periods.
People say we are investing 9 percent and that getting to 12
percent would be an enormous jump; it wouldn't in relative terms.
And if what we are speaking of is new investment in lieu of budget
deficits or in lieu of too much personal consumption that does
contribute to inflation, I think it is a very healthy alternate way to
go. I would commend the thought you have in mind with your
suggestion.
Mr. FISHER. Could I continue, Mr. Chairman?
The CHAIRMAN. Yes.
Mr. FISHER. This all makes great sense to me, and I am delighted
to hear your thoughts on this subject. With my colleagues on the
Ways and Means Committee, for some weeks now I have been
advocating $15 billion, $18 billion, in tax cuts, most of which would
come in the rates but reserving a fair chunk of it for more direct
stimulation on investment by way of credit and accelerated depreciation, and I have thought the ratio ought to be about 2 to 1, two
parts for the relief of individuals to one part business, which is a
much more favorable ratio to business than the total tax collections from individuals and bt1sinesses would have, which would be
what, 5 or 6 to 1.
And this seems to be a good way to recognize really the current
and long-term need for stimulating investment, so you come down
to exactly what is the best way to do it, and I am delighted that we
seem to be in some agreement here.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
165
I am hoping that we can put together a tax cut package, the
general magnitude of which would offset the automatic tax increases that result from inflation and, to some extent, the social
security tax increase, which will take another jump in January,
and incorporate considerable stimulation to all kinds of business
and, at the same time, not go too far so that the macro, the overall,
will be inflationary.
This is a difficult balancing act and my sensing, apparently like
yours, is that the total magnitude is in the $15 billion to $20 billion
range, with a good chunk of that for as direct and meaningful
business investment stimulation as we can do, and I am much
attracted to this combination of business tax cuts on the corporate
rate, plus a further favorable treatment directly of investment
through either or both the investment tax credit and better rules
for depreciation.
Are there any other ways that you can think of that we could
pinpoint a stimulation to new equities, even venture-type equities,
beyond what we have talked about so far? Could you carve out
some kind of preference for new equities, or equities in new corporations, or what are your thoughts along that line? You have had
immense experience in the business world and in venture companies.
Mr. MILLER. That is right. I have been involved in venture companies. Congressman Fisher, let me say that the judgmental calls
that need to be made in fiscal policy and monetary policy right
now are as difficult as we are apt to see, because we are in a very
difficult period. The judgments we make this year will set the stage
for many years to come, so I take very seriously the matter of
seeking a better coordination between monetary and fiscal policy
and, in seeking this coordination to be willing to suggest things in
the fiscal area that I think would be in harmony. What you are
suggesting is exactly on the right track.
In answer to your question, there are many, many ways to carve
out initiatives that aid new businesses. I always hesitate, however,
to begin to segment our tax structure, because it feeds a tendency
to overmanage and to interrupt the natural adjustment process
that should take place. I suppose my preference is that we begin to
think in terms of where this Nation wants to go, in economic
values over a 5- or 7-year period and to make sure we are not just
thinking of I-year policies. A policy of cutting back the Federal
deficit, balancing the budget by 1982, and reducing the Federal
Government's component of the GNP over 5 or 7 years-gradually,
so that it doesn't create a problem-makes sense.
I thought the stimulation of capital investment was timely this
year. I think that next year would be the time to look at special
incentives for venture capital. We don't want to get running ahead
of ourselves; and we should take these policies seriatim, make them
work consecutively to sustain the objectives we want to accomplish.
I have talked, as you know, about a model economy, how it
should look in 5 or 7 years. If we think that way, we can begin to
make policies that fit in year after year toward our achieving the
desired goal. So I don't want to duck your question, but I think it
would be better to put off consideration of any segmented effort to
help venture businesses until next year. Let's get about using the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
166
limited resources of $15 billion or $18 billion or $20 billion this
coming fiscal year to rifle-shoot at the problems.
Mr. FISHER. I have tried to think of some way of defining a
special preference for venture capital investment and haven't had
too much luck with it. If you and your associates have your minds
on this and devise any way of doing this, I would certainly like to
know.
Mr. MILLER. There are many, many policies that could be adopted. For example, for newly incorporated enterprises of certain
sizes, you could certainly go back to a more favorable capital gains
tax rate. Or you could do what was done by the SBA; that is, if one
invests in a small business which shows a capital appreciation, one
takes a capital gains treatment. If the business shows a loss, one
takes an ordinary income loss. That was the SBA way to stimulate
small business investment. Such opportunities are still around, but
the climate hasn't been too ripe for getting those kinds of businesses going. That is why I am so anxious to curb the inflationary
forces and get the investment cycle started, because I think that
will create the climate in which small business will prosper and
new enterprise start out.
Mr. FISHER. Just one more question. Of course, there is much
interest now in changing the capital gains tax, and you have already talked some about it, and I am interested in that. The
difficulties with the so-called Steiger proposal, as I see it, are that
by going back to the pre-1969 treatment, it rather effectively guts
or eliminates the minimum tax, which, for all its difficulties, has
been placed in the law; it has been there for awhile; it has been
expanded rather than contracted some since it was started, and it
symbolizes something, and that gives me a problem.
But more to the point of this discussion, it does seem to me, as it
apparently does to you, that there are better ways of changing
business taxes to stimulate investment than the kind of treatment
of capital gains that is being so much talked of.
I wish there was some way we could really focus attention on
changes in business taxes that would have the best chance of
stimulating investment, and it does seem to me round about, indirect, and not likely to be very successful if you stimulate investment by reducing capital gains that individuals receive, most of
which isn't in equity markets anyhow, in securities, and even much
of that would be reinvested in very much the same kind of thing.
If you have any further thoughts on the relative merits of these
different ways of stimulating investments, I would like to have
them.
Mr. MILLER. I would be glad to submit them. I agree with what
you say. Our limited ability to respond by cutting taxes should be
dedicated to those areas where we get the most results for the least
loss in revenues. I am not opposed in any way, philosophically, to
reducing the burden of taxes on capital or reducing the burden of
double taxation of dividends from corporate profits. I have no
philosophical problem with these approaches.
[The information requested above follows:]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
167
EFFECTIVE WAYS OF STIMULATING INVESTMENTS
As my prepared statement and my response to the Chairman's questions indicate,
I believe the most direct and efficient stimulus would be a substantial shortening of
the writeoff period for productive assets. One way to do this would be to standardize
the depreciation period and permit businesses to writeoff machinery and equipment
in 5 years and structures in 10 years. If that seems too large and costly at this time,
all writeoff periods could be shortened proportionately by widening the permissible
asset-depreciation range, say from 20 to 25 percent.
Even without the need to stimulate investment, however, some shortening of
writeoff periods would probably be appropriate, in order to conform the service lives
allowed for tax purposes to economic service lives. In recent years, the economic
service lives of many types of equipment and structures have been significantly
shortened by technological progress, the increase in the relative price of energy, and
the raising of environmental standards. The time has probably come to take another look at the useful-life guidelines that underlie present writeoff periods, and
the Congress might want to ask the Treasury to undertake a new study to see what
liberalizations to tax service lives are needed.
Mr. MILLER. But I do have a commitment to putting things in
priority, and I am convinced that these approaches should not be
the priority at this time. I have no objection to looking at them as
they can be fitted into a long-term plan in which we keep our other
objectives in order-in which we do work toward a balanced budget
with full employment, toward getting the inflation rate down, and
so forth.
Incidentally, the tax reduction policies to relieve individuals and
provide equity are important. But individual Americans will benefit greatly from a program that stimulates investment, because
such a program will stimulate jobs and stimulate productivity
gains, which will reduce costs and reduce prices. Along with the
equity consideratio·n s of relieving them of the tax burden, that
would do more for Americans than almost anything else we could
accomplish.
Mr. FISHER. Thank you.
The CHAIRMAN. The gentlemen from South Carolina.
Mr. DERRICK. I thank the chairman. Mr. Miller, we are delighted
to have you with us this morning.
Mr. MILLER. Thank you, Mr. Derrick.
Mr. DERRICK. In reading some of your recent statements, I'd say
you have made some hard decisions.
Just to digress for a moment, I will tell Mr. Fisher that last
night, I read his "Dear Colleague" letter on reducing inflation, and
you have some very good points.
Mr. Miller, I have three areas I would like to address myself to.
What is the growth rate in M1 at the moment?
Mr. MILLER. So far this year-from the fourth quarter of last ·
year through the second quarter of this year-the growth rate for
M1 has been 7.6 percent. From the first quarter through the second
quarter of this year it has been 9½ percent. The second quarter
showed quite a strong growth, higher than we would like. We had
high nominal activity in the second quarter for reasons I mentioned, and M1 did break out quite strongly.
Mr. DERRICK. I notice in your statement that you say M2 and Ms
long-term projections are pretty much fitting in there. What are
those?
Mr. MILLER. Let me give you the ranges for all of the aggregates.
For M1 our range recently has been a 4- to 6 ½-percent rate of
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
168
growth. Last year, the rate of growth was 7.9 percent; this year, on
average, it is running close to 8, which is above our range, and
worrisome.
As to M2, the growth rate range has been 6½ to 9 percent; and
on Ma, 7½ to 10 percent.
We have been unable to stay in the range on M1, I think, for
reasons of higher inflation and higher nominal activity, and also
because of some technical problems with tax collections in April,
when there was some delay in processing. We had an unfavorable
M1 situation.
Mr. DERRICK. In view of the GNP growth rate and rising interest
rates, what do you see over the next 12 months on interest rates? I
am very concerned about the construction industry, because we
could get into a situation somewhat like that we experienced in
197 4. Do you see this as a possibility? How long do you see interest
rates remaining at the levels they are now?
Mr. MILLER. I see interest rates rising. The possibility of a credit
crunch is a great worry, and something we are working hard to
avoid. Since my 4 months in Washington, the Federal Reserve has
tended to react rather promptly to the growth in aggregates and
tried to act prudently and in advance so as to avoid the necessity of
facing tougher issues; the sooner one gets started, the easier it is.
But we face a dilemma. Unless the American public is alerted to
the dangers of inflation, we will never get effective anti-inflation
programs. But once they are alerted to the dangers, there is anticipatory buying against inflation which leads to increased credit
demands and works against what we want to accomplish; more
credit demands have pushed interest rates up. Temporarily we
have had to suffer from upward pressures on interest rates in order
to mobilize the fight against inflation.
My hope-and I cannot give you a promise-my hope is that we
are nearing a time when those anticipatory purchases will be over,
that, with the second quarter of catchup we are past this bulge and
that the pressures will begin to abate. The actions being taken by
Congress to reduce the fiscal stimulus will help us, and, as the year
progresses, I hope we will find that we are at or near the top of the
interest rate cycle and that we can begin to be under less pressure.
That doesn't mean we will see interest rates drop much, but if we
can top out-Mr. DERRICK. I am concerned about the interest rates, but, of
course, I am also probably as much concerned about the availability of credit in this area.
Am I to understand, I don't want to put words in your mouth,
that you see a slackening of that upward pressure during the last
part of this year?
Mr. MILLER. Congressman Derrick, I personally see some slackening of the pressure. Let me be clear about this, because I don't
want to be misunderstood: I did say I worried about a credit
crunch, but I see nothing in the immediate future-in the foreseeable future-that would cause the unavailability of the capital
necessary to maintain the proper rate of growth in the economy,
the rate of growth we are all anticipating.
My view is that under these circumstances the right plan is to
aim for a 3½- to 4-percent rate of real growth-not try to achieve
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
169
more because we would begin to run into these pressures. We also
want to avoid falling below that rate because then we would create
the potential for a recession and that would be counterproductive.
Mr. DERRICK. I thank you very much. I have two other areas. I
notice you join with many of us in Congress in feeling that something needs to be done about the deficit, and it is one of the major
causes of inflation. Would you suggest that this deficit be decreased
by a cutback in spending or are you suggesting that it be done by
raising taxes?
Mr. MILLER. There are only two choices, as I have pointed out
many times. To spend less, or to collect more. Those are the only
choices, unfortunately.
During this current planning cycle for fiscal year 1979 we must
try to do both. But because of the difficulty at this late stage of
making very large inroads in cutting spending, it is necessary to
curtail our aspirations for lowering taxes. The 5- or 7-year plan
that I outlined should focus on reducing spending, and thereby
reducing the deficit, and thereby, in effect, releasing opportunities
for spending decisions and investment decisions to be returned to
the private sector rather than made by the Government.
Mr. DERRICK. Mr. Miller, I thank you very much, and I am in
complete agreement with you on what you said so far. As far as I
know, every witness that has appeared before this committee in
the 4 years that I have been here is in agreement with you.
Now we come to the next question. Would you advise us where
you think we should cut this spending, specifically?
Mr. MILLER. I have hesitated to interject myself into spending
priorities for the Nation, which I think is the responsibility of the
Executive and the Congress.
Mr. DERRICK. I understand that that is our mandate but we are
asking for advice.
Mr. MILLER. My advice is that what is needed at this stage is not
so much to find one little nugget that would reduce spending-that
is probably impossible-but to undertake a comprehensive management effort and to concentrate on doing everything better and
. more efficiently. We should concentrate on agreeing not to initiate
new programs that will lead to further funding requirements and
on not doing what we have done in the past; that is, starting
programs that seemed inexpensive but ended up as an expensive
package.
I am not prepared at this stage to suggest the dismantling of any
major programs. I would ask your willingness to defer my comments on that. I would rather see us concentrate on what I consider to be the first phase of a reduction in Federal expenditures,
which requires that .we do things better and more efficiently. I can
guarantee you, that in any enterprise as large as the Federal
Government substantial savings can be made if we go to work on
it.
Mr. DERRIC~. Mr. Miller, I quite agree with you, and I think
. most people do. The hard decision, as you well know, comes down
as to where you do it, and, as I recall an article in a national
publication about you recently, you said that the problem with
inflation is that no one is willing to make those hard decisions, and
if you decide that there are any major programs that need to be
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
170
dismantled or would be worth taking a look at, I would appreciate
it if you would advise the committee and me-and I say that in all
seriousness-I would be delighted to know what your thoughts are.
Mr. MILLER. I would be pleased to do so.
[The information requested above follows:]
EVALUATING COST-EFFECTIVENESS OF GOVERNMENT PROGRAMS
Most Government programs provide benefits to some members of the public. The
question of whether specific programs are cost-effective requires a careful evaluation which the Congress and the Executive are in a far better position to make than
I am. But even without program-by-program evaluation, effective steps can be taken
to curb increases in Federal spending.
A cap on Federal pay increases, such as the administration has proposed, is a
necessary discipline, since it sets an example to State and local government workers
as well as to workers in the private sector. In addition, a modest across-the-board
cut in spending programs of about $5 billion could undoubtedly be absorbed without
major detriment to the effectiveness of Federal programs. Such a reduction would
equal only about 1 percent of total spending. It is true that some programs lend
themselves to being cut back more easily than others-the so-called "uncontrollable" outlays. But even if a $5 billion cut this fiscal year were concentrated entirely
in the relatively controllable program outlays, the reduction would total less than 4
percent.
And efforts should be undertaken to trim the growth of relatively "uncontrollable" spending in future years. When grants to other governments or entitlements to
individuals are authorized, it is of vital importance to consider the future consequences of such acts. Such concern today can prevent a large increase in "uncontrollable" spending later on.
Mr. DERRICK. May I jump to one last area. Could you give us a
few comments on your analysis of the Kemp-Roth proposal?
Mr. MILLER. Yes, sir. I feel that the kind of approach that I have
just been outlining would be far preferable to legislation that reduces revenues but is not linked up to a reduction in spending. If
we make a commitment to reduce taxes and reduce the collection
of revenues in today's climate, with today's rate of inflation and
today's level of deficit, we are certainly going to create a much
larger Federal deficit over the period of implementing this legislation, regardless of what can be done in reducing spending, during
that time. The result is going to be highly inflationary and work
against everything we are trying to accomplish.
The more sensible plan is the one I have b~en trying to promote;
that is deciding where we want to be in 5 to 7 years, beginning a
reduction in Federal expenditures, and as we reduce them, cutting
taxes to give back the dividends to people and to businesses. We
should not legislate tax reductions in advance, because next year,
after taxes will already have been cut, the Congress may not be
willing to make the hard decision to cut expenditures.
Mr. DERRICK. I gather from what you say that you think the
Congress should make the hard spending decisions first, and then if
that works out, the easy tax decisions?
Mr. MILLER. The easy decision is to give people money. The hard
decision is to cut down the spending so that you release the money
that permits you to declare a dividend.
I want to read from yesterday's New York Times. I was taken by
this article by Felix Rohatyn and his experience in trying to help
in New York City. This paragraph is right on the point you are
talking about. He says:
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
171
There is no place for statesmanship in government today because the political
cost of statesmanship is too great. Most of the meaningful decisions required from
government today are unpleasant. They involve vocal, powerful, competing interests. They involve living up to overcommitments made by previous officeholders
unwilling to face facts in their own time and place. My role as Chairman of the
Municipal Assistance Corporation was symbolic of the failure of government as well
as pointing to the increasingly important role to be played by the private citizen.
I agree with what he is saying, and then again I don't agree: I
think there is a place for statesmanship now because the political
cost of not facing these issues is too high.
Mr. DERRICK. Do you believe that the Kemp-Roth proposal would
result in substantially larger deficits and therefore be inflationary?
Mr. MILLER. Yes, sir. I think it would be unwise to adopt that
legislation at this stage. Its basic premise cannot be ignored; that
is, that when and as Government spending is cut, the return of
resources to the private sector would be desirable. But the decisions
to cut spending should be made first and the decisions to reduce
taxes later.
Mr. DERRICK. I thank you for your very candid answer.
The CHAIRMAN. The time of the gentleman has expired.
We all want to have the chance to question the witness, and if
we would all stay as close as we can to the 5-minute rule~Mr. MILLER. Perhaps my answers have been too long, Mr. Chairman.
The CHAIRMAN. No; your answers are excellent. It is just the
desire of the members to ask you all kinds of questions, but I am
going to ask the members to try to cooperate a little more, and I
don't say that now that I am ready to call upon the minority side.
Mr. Regula from Ohio is recognized .
.Mr. REGULA. Mr. Chairman, I am tempted to say amen to all we
have heard this morning. I want to compliment you, Mr. Chairman, on a thoughtful blueprint for statesmanship for this congressional body. I am going to insert in the record today a copy of your
remarks. I hope every Member will read them. I am only sorry
that the entire Congress isn't here this morning, and I might add I
hope you will send a copy over to the White House, also.
I think you stated so beautifully what needs to be done in this
country.
I do have a couple of questions. I suppose I am a bit biased in
that several months ago I introduced a tax bill that provides for
accelerated rates of depreciation, and I agree completely with what
you have outlined. Let me back up and ask if you think that tax
changes should be targeted to achieve specific objectives, that is,
capital formation, rather than just a broad-based type of cut?
Mr. MILLER. Yes; I think that at this point most of our fiscal
actions need to be targeted. Otherwise, I think the linkage between
the general flow of cash and its consequences as far as what we
need in the economy at this time are too remote. We need far
better linkages; we don't have the time to let a system. work its
way through in a more general way.
Mr. REGULA. Given that background, what would be your reaction to, in terms of depreciation, allowing the businessman to make
the judgment if he wants a 1-year writeoff, 2, or 5, or whatever,
because, in the final analysis the tax receipts will be the same?
They just may not come in the same year.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
172
Second, absent that, what is your reaction to a 1-year writeoff for
any Government-mandated nonproductive equipment; and, third,
at least some type of credit for interest, perhaps the first $100 of
interest on savings, tax-free as a means of inducing greater savings?
Mr. MILLER. The best system for depreciation, in the long run,
would be to leave it optional, as you suggest; write off assets
anytime you want. I would be cautious, however, and remind you
that if we are going to limit our tax reduction to $15 billion or $20
billion on January 1-and if only one-third of it is going to be
allocated to business-we want to be sure that a proposal along
your lines would be phased in so as not to impact against our
budget objective.
But in principle, I agree with you. Actually, once you get over
the hurdle of an optional writeoff, then depreciation is a one-time
adjustment; you have only deferred the tax, you haven't forgiven
it. It works extremely well.
_ You might want to consider linking optional depreciation with a
requirement that any public corporation write off its assets for
purposes of reporting to shareholders the same way as used for tax
purposes; then you would have a real discipline. It would cause
businessmen to act for shareholders like they do for Uncle Sam. I
would be in favor of that, but I expect it would not be very popular
with business executives.
As to the second suggestion-writeoffs for Government-mandated
nonproductive equipment-I would think that if you are going to
have an optional writeoff period, you could start with mandated
pollution control equipment-allowing a 100-percent writeoff in 1
year or over 20 years, but a writeoff only once. As to nonmandated
investments, at this stage I would favor a 5-year writeoff, and
observe the revenue effects and then see when you can afford to
liberalize more.
I am a little reluctant at this stage to recommend your suggestion as to savings. I am not opposed to it philosophically, but at the
moment it would complicate achieving our priorities. We should
make these other adjustments first and let them work through the
economy and see what happens to savings. We are coming to a
period when I think savings are going to increase. We may not
want to draw that much out of the other activities of the economy,
so I would be cautious on that one.
Mr. REGULA. Thank you.
You state in your testimony that net exports should improve
somewhat next year. How much, if any, do you attribute this to the
depreciating dollar? Obviously, the dollar has been depreciating in
relationship to the German mark and the Japanese yen, thus far
without any appreciable improvement in our trade balances.
In your opinion, have world markets become so integrated that
exchanges in depreciation are no longer an effective means of
securing permanent improvement in our trade balances?
Mr. MILLER. Exports do pick up as a result of exchange adjustments; we have seen this in connection with the Canadian dollar
and with the Italian lira. The first effect of the decline in the
dollar is to work against us, but then, in due course, there is an
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
173
opportunity for exports to pick up, and I believe that will happen
to a degree-to a degree.
Another factor that will influence the growth of our exports is
the relative growth rate of our economy as compared to other
industrialized economies. We have been working our way out of the
great recession of 1974-75 at a much more rapid rate than the rest
of the world. Now we are coming down to a sustainable ratehopefully in the 3½- to 4-percent range-and some other countries
are coming up a little. This converging of the relative rates of
growth is going to help us on exports. We will be importing less
and sending out more relatively speaking.
The final thing that is important to increasing our exports-and
my own recommendation-is that we start a major export drive, so
that over a period of a number of years we build our exports up
from 7 percent of GNP to 10 percent. That will give us the absorptive power to help other nations by buying more of their goods, and
will also get us out of the deficit position; it would help the dollar
enormously.
To do that we have to change our emphasis. We in the United
States have not been international traders. A small amount of our
GNP reflects trade, nothing like many other countries, because we
have never felt the need to develop the marketing.
Elimination of relief under section 911, a congressional action,
which was postponed recently, would increase the cost of maintaining Americans abroad to service and support U.S. sales. It would be
a step in the wrong direction. If we penalize Americans for going
overseas, how are we going to get salesmen or technicians overseas? We have to change our attitude and become oriented and
organized for exporting. Once we do, we can be good exporters.
Mr. RoussELOT. Would you yield?
Mr. REGULA. Yes.
Mr. RoussELOT. Would you suggest the Ways and Means Committee repeal that outright now?
Mr. MILLER. I think the sooner that matter is settled, the better.
Mr. RoussELOT. We are hearing from a lot of companies that
they are losing employees over the whole thing.
Mr. MILLER. The cost is so great, that the customer won't absorb
it. To maintain a $20,000 employee overseas costs $100,000. The
customers won't pay that.
Mr. RoussELOT. Thank you for the comments. Thank you for
yielding.
Mr. REGULA. To what extent have the recent budget deficits,
which for peacetime recovery years have been unprecedented in
relative and absolute magnitude, hampered your ability to pursue
an anti-inflationary policy without causing unacceptably large increases in interest rates or are you going to be required to substitute monetary policy when you should not be, to overcome the
erroneous fiscal policies of this Congress?
Mr. MILLER. Too much of the burden over the last 12 years has
been placed on monetary policy. Monetary policy has its Limitations if other considerations are such that monetary policy is left
as the only balance wheel against inflation, the ultimate consequence is to bring about distress and difficulty. I think it is high
time-and it is encouraging to see trends in this direction-for
32 - 052 0 - 78 - 12
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
174
fiscal policy to carry far more of the burden. That is beginning to
happen, and I am pleased and commend Congress for the steps it
has already taken. But I am sure more needs to be done, as was
mentioned in the discussion with Congressman Derrick.
Mr. REGULA. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Texas, Mr. Mattox.
Mr. MATTOX. Mr. Miller, I am pleased to hear your testimony
today. I know it is kind of like the preacher sometimes preaching
to all the good church members. Some of us have been saying some
of the things you have said with regularity.
I think from being out visiting with the business community-I
am from Dallas, and visiting with those folks-frankly they are
scared to death of the Fed. They are literally scared to death that
the Fed is going to continue to tighten the screws on the economy
and cause some serious problems in the future.
If you walk out there and talk to the business community, say
what troubles you and what is keeping you from investing, there
are two answers to it. It is not the tax policies ordinarily, not those
things. They say first that inflation has us scared to death. We
don't know what is going to happen to the price of our products,
and then the other one is that we don't know what is going to
happen to these interest rates. We don't know whether to invest
now, or not invest; we don't know when we do invest if the Fed is
going to put such a clamp on the economy it will kill all the
demand for our products and then send us into a deep recession.
And I know that you are on kind of the horns of dilemma. I have
heard you describe the need for increased capital investment and
increased spending in that area. And, at the same time, the Fed
appears to be tightening up the interest rates, or at least attempting to cause interest rates to gradually keep up, in an effort to try
to slow the economy down at the same time. I don't understand
exactly how you can suggest that we need the big capital spending
and, at the same time, cause interest rates to go up which, in
effect, is probably the one thing that kills off capital spending. The
businessman will not spend because he thinks money is too expensive, and it is so much more difficult to make a profit when the
money is expensive.
Mr. MILLER. In the past, the Federal Reserve has been the whipping boy in hard times; it was easy to point to the Federal Reserve
as the guilty party in times of economic downturn. It is easy to
point to the Federal Reserve because if it is the only game in town,
it is left to try to fight inflation alone. This can only be done by
restraining the growth of the monetary aggregates so as to slow
down an overheated or inflationary economy. The side effects, unfortunately, can lead to difficulty for a time.
That is why we have been arguing so strongly for more coordination, to relieve the burden on the Federal Reserve. As to the level
of interest rates, we are concerned. We are not pleased by high
interest rates, but they are the natural consequence of the overall
economic policies that the United States has been following. One
thing that causes higher interest rates is inflation. Long-term capital, throughout the 25 years that I have been around in business,
has cost about 3 percent in real terms. Add to 3 percent the rate of
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
175
inflation and you pay the total. If inflation is 7 percent, it takes an
interest rate of 10 percent to get a real return of 3 percent for the
investor. And if lou don't give a real return on money, capital will
fly and you wont have it. Unfortunately inflation makes it expensive to attract capital to invest. Any nation that has tried to hold
interest rates down in the face of inflation has seen capital leave
the country, or go into gold; it won't go into investment because it
would be taxed away. The capital would be taxed away.
The old saying is that, in time of inflation people are interested
not just in the return "on" their principal, but in the return "of'
their principal. They don't want to see it come back with less
purchasing power than they started out with. In addition, an economy that is not only growing in real terms but in nominal terms
takes more money to finance because of inflation. So we have,
suddenly, a growth in credit demand to finance the same level of
fiscal activity, and that increase of credit demand means that there
is not enough money around in banks or sources of capital, so
interest rates go up.
The Federal Reserve, in trying to restrain the forces that will
inevitably lead to higher inflation rates, does have to do some
tightening which does cause some of the increase in the short-term
interest rates.
·
The Federal Reserve, has faced this terrible dilemma since I
have been in Washington. If it should say, "Well, in the face of
these conditions we better keep interest rates low," and if we
should print enough money to do that, business people would be
happy for 6 or 8 or 9 months, but then the economy would see
double-digit inflation and the interest rates would be far higher,
and there would be nothing the Federal Reserve could do. There is
not enough money to prevent us from getting into severe difficulties if we try to take that path.
If, on the other hand, we are responsible and prudent and lean
against inflation, yes, interest rates do go up and people do worry
about it. But it is the bitter medicine that we must take as a
consequence of actions over the past 12 years that have put us in
this terrible position. We didn't finance the war in Vietnam; we
put on wage and price controls that didn't work; we let the international monetary system break down; we didn't have an energy
program, the oil boycott was able to work against us, and we have
experienced a fivefold increase in energy; we had Watergate, with
its aftermath, with nobody trusting Government or other institution_s. Everything broke down or deteriorated.
Now we have to build ourselves back. We have to face the music,
take it like it is, pay the price for our past sins, and sin no more.
Mr. MATTOX. I appreciate what you are saying, but the problem
is-Mr. MILLER. I am from Texas, but not all sinners come from
Texas.
Mr. MATTOX. Over at the Federal Reserve, you must be tearing
yourselves apart because of these inconsistent areas of logic. It is
impossible for us to be demanding the kind of increase in industrial
growth and increased real growth in our economy, and, at the
same time, making the business community scared to death by the
increasing of the interest rates. I mean it is just not possible.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
176
But I think the point, if there would be a point to be made, is
that this Congress is operating right now with not much change in
attitude from where we were 2 or 3 years ago. We still have
accelerated public works programs that we had in the 1979 budget.
We have the countercyclical money in there; we have the revenuesharing money in there; we have the title VI public employment
type activity at the rate of 725,000 people; we are still pursuing the
course of pushing the economy forward very rapidly, as rapidly as
we can, without causing even more substantial deficit.
It would be easy for us to bring the economy in control if we cut
back on those programs-into a more balanced situation. But, at
the same time we are pushing those goals, the Federal Reserve is
putting the screws on, putting the brakes on, raising interest rates
which, in effect, appears that we are getting back in some degree,
to the same place the Congress was in with Arthur Burns, when
the Fed was taking exactly countervailing action from what the
Congress was taking, about the time .we were in our serious recession.
Mr. MILLER. I think there is more compatibility now, though,
between Congress and the Federal Reserve than I would have
expected.
Mr. MATTOX. I agree with that, let me assure you.
Mr. MILLER. Let me remind you, Congressman Mattox, that we
saw a rather interesting phenomenon this year. The Federal Reserve acted promptly and forcefully to tighten the money supply,
and to tighten the economy in the face of inflationary forces, and
the stock market went up. That has never happened in recent
times. So while you may be hearing from worried businessmen, the
judgment of the market was that the actions of the Federal Reserve were positive and were ones which could be reflected in a
willingness to spend and invest.
Mr. DERRICK. Will the gentleman yield?
The CHAIRMAN. I am going to have to really advise the gentleman that his time has expired, at least three times.
Mr. MATTOX. Mr. Chairman, it seems to me we may be pointing
up the fallacy of the committee process when you have a man of
the ability and character of our witness when the members of the
committee are limited to asking 5 minutes of questions. Even all of
our combined logic and reasoning should indicate that we probably
should destroy the committee system and find a better approach to
managing the Government, because it is surely evident to me we
are accomplishing very little.
The CHAIRMAN. That may well be, but your other colleagues
eagerly are awaiting.
Mr. MATTOX. I understand entirely. I am saying maybe that is
the reason the Government is not working very well.
The CHAIRMAN. It probably is one of the reasons.
Mr. MILLER. You know, my plan to fight inflation is to ask
Congress to pass a law to ban air-conditioning in Washington. That
would clean out Washington in the summer, and there wouldn't be
any mistakes made.
The CHAIRMAN. The gentleman from Ohio, Mr. Latta, is recognized for 5 minutes.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
177
Mr. LATIA. It is a pleasure to have you before the committee this
morning. I agree with a lot of what you said and especially when
you say that the Fed has been playing the only game in town, and
I fully understand what you mean by that statement. It has been
the only real restraining influence on inflation that we have had
here.
·
I am pleased, having followed your actions since you have been
in office, to say that I believe those restraining influences will ·
continue at the Federal Reserve, and I commend you for carrying
on those policies.
Mr. MILLER. Thank you.
Mr. LATIA. I note a few places in your testimony where you
differ with the administration. Maybe you can convince the administration to adopt your policies. For example, on page 10 you say, "I
believe that we should strive to reduce the Federal Government
share of the GNP from more than 22 percent at present to 20
percent or so over a period of 5 to 7 years." The administration's
position is 21 percent, and that little variance there, between 22
and 21 percent, will mean about $25 billion a year.
Mr. MILLER. Currently. It will mean more later.
Mr. LATIA. I wonder if you couldn't bring your tremendous influence to bear at the White House to see if we couldn't cut back $25
billion.
Mr. MILLER. I appreciate your confidence in my influence at the
White House. I will certainly carry the message.
Mr. LATIA. On that same page, you have a couple of other
suggestions that I wish you could influence Mr. Ullman on the
Ways and Means Committee to adopt, where you say, "Present
depreciation tax laws should be liberalized. For example, businessmen could be permitted to use a shorter writeoff period for machinery, equipment and structures." They should have done that a long
time ago. They shouldn't have to wait for you to come up here and
tell them to do it.
I wish you could use your influence on that committee to get
that done because I think it would help tremendously, and you go
on to say, "Careful consideration also should be given to present
laws that tax corporate profits twice, first at the firm and then at
the stockholder level.''
We have heard that preached around here for a long time. You
shouldn't have double taxation on dividends, but nothing ever
seems to be done about it. Hopefully, when you get before the
Ways and Means Committee-and I am sure you will in the future,
and you probably have been in the past-but convince them to do
something about that.
Do you think your prospects for convincing them are good or
bad?
Mr. CONABLE. Even before you answer, you have convinced me.
Mr. MILLER. There are a lot of good ideas in Washington and the
time is ripe for some of them, I think.
Mr. LATIA. You make another good one on the last page. I don't
know why you waited until the last page to make it. "In addition,
it seems appropriate to consider deferring the increase in the minimum wage that is scheduled for January 1, 1979." I agree with you
100 percent. I voted against that increase for the very reason you
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
178
are saying it shouldn't be increased on January 1, 1979, because it
was inflationary. But downtown and here in the majority of the
Congress, they thought, boy, this is a good thing to do.
Mr. MILLER. May I address myself to that for a moment, Congressman Latta?
Mr. LATTA. Surely.
Mr. MILLER. I am sure the change in the minimum wage was
enacted in good faith and with goodwill and without any expectation that the consequences would be what they have turned out to
be. Let me first point out the consequences this year. I am not sure
you all know what has happened this year.
The rate of wage increases in the first half of this year was over
8 percent. And with the increase in the minimum wage, the increase in the social security payroll taxes, and the unemployment
insurance tax, the increase in total hourly compensation in the
first quarter of this year was 13½ percent. This year the effect of
the minimum wage will be to add about one-half of 1 percent to the
rate of inflation.
We are going to have another dose of that increase on January 1,
1979, and it is going to add another one-half percent to inflation
next year. If we make no other changes, the mandated increase in
the minimum wage and in payroll taxes on January 1, 1979, will
increase the projected hourly compensation from 8 percent to 12½
percent in that quarter. The increase in the minimum wage will
add one-half of 1 percent to inflation next year.
Now is there anything that could cut one-half percent off the
rate of inflation easier than facing up to the effect of that minimum wage increase now and deferring it for a couple years? It does
not help people to give them something with one hand and take it
away with the other by putting on this cruel tax of inflation that
hurts everybody. A few people are affected by the minimum wage;
everybody is affected by inflation.
This is something that could be done now. It would be statesmanlike; it would be courageous. It would not be popular, but it is time
for some unpopular things like that to be done.
Mr. REGULA. Would you yield?
Mr. LATTA. I would be happy to yield. I want to thank you for a
tremendous statement.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Florida, Mr. Lehman.
Mr. LEHMAN. Thank you, Mr. Chairman. I have a tendency to
talk about subjects I actually see and experience in the district I
represent. For instance, just a few years ago, downtown Miami was
kind of a disaster area, but today, all the stores on Flagler Street
are rented and rents are going up. Burdine's, the big downtown
department store, is renovating and enlarging, and the recently
completed Omni complex downtown is running several years ahead
of expectations. Even the 50-year-old boomtime dwellings on Miami
Beach, are being sold now for the first time in a number of years.
This is the result of people coming from other countries to buy
our bargains. People come from Latin America and elsewhere into
the Miami area and load up. You can see them going out with huge
cartons of American-made goods.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
179
Our inflation may be bad, but compared to inflation in the rest
of the world, ours is not that serious. My question is, are we really
dealing in a reality, and how much effect can our own domestic
fiscal or tax policy really have on our inflation unless we can get a
handle on rising costs outside this country?
We existed in a fairytale world of low-cost goods we could get
cheap from the developing nations. We are not going to get them
cheap any more, so are we really deceiving our people in saying
that what we do with interest rates and other Federal policies can
give us a handle on inflation?
I guess what I am trying to ask is can what we do in this country
have a significant effect on inflation if we can't control inflation
beyond our borders, as evidenced by the circumstances I see in my
own area?
Mr. MILLER. Thank you, Mr. Congressman. I want to respond at
some length and probably take more time to answer than I should.
We cannot be complacent about inflation. We cannot allow ourselves to believe that a rate of 7-percent inflation is acceptable or
tolerable. I will give you a couple of examples of why we cannot.
In the first place, we are not just any nation in the world. We
are a nation whose production represents 30 percent of the production of the whole world. If this great country should erode and
destroy its values, the effect on the whole world would be enormous and the probability of instability and tension and war could
be increased. We must have a stable economy; we must have price
stability; we must achieve all of the economic objectives we believe
in.
I have been telling this year's university graduates what inflation means to them. The people who are graduating this year are
highly motivated, well trained, and determined to take a constructive role in our society, but they are not familiar with inflation and
deflation because they are young and they haven't had the experience. What has happened in the last few years has been bad, but if
the current rate of inflation continues until these young people
reach age 65, then the dollar they hold today will be worth less
than a dime at that time. We just can't let that happen.
I will give you another example. In the 16th century, Spain was
the greatest beneficiary of the discovery of the New World. Massive
amounts of gold were introduced into Spain from America, giving
unearned purchasing power that drove up prices 1,000 percent and
built the most elegant society that Europe had ever seen. But
Spain didn't invest anything; it consumed everything. And by the
17th century, Spain was, economically speaking, barefoot.
The United States in the 20th century has built the most affluent nation the world has ever known, with the highest standard of
living for the most number of people. But it has discovered the
printing press and unearned purchasing power. If we continue to
consume and continue to put too little back-not enough to maintain the productive capacity to sustain ourselves-we will run the
risk of being barefoot in the 21st century. We have to face up to
these issues.
Mr. LEHMAN. I just wanted to find out how much control over
our own destiny we really have in this effort because of the effect
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
180
on the rest of the world. No matter how hard we try, can we really
do it?
Mr. MILLER. Yes, sir, we can do it. We really can. Some figures
have just been passed to me regarding experience in some of the
major countries. Japan, for instance, suffered 22-percent inflation
in 197 4; this year their rate of inflation is far below ours, but it
was 22 percent just a few years ago. England had a very high level
of inflation, 24 percent in 1975; they are now down to the same
rate of inflation as the United States. From 1975 to 1978 they have
brought down the rate of inflation to the same level as ours.
Mr. LEHMAN. There is hope.
Mr. MILLER. There is plenty of hope.
The CHAIRMAN. The time of the gentleman has expired. Mr.
Rousselot.
Mr. RousSELOT. Thank you, Mr. Chairman.
I appreciate the Chairman's testimony and many of these comments that he has made since then in answer to questions.
· Right before us now is the finalization of a budget resolution
relating to 1979, and you mention in your testimony that we must
reduce the growth of Federal expenditures we have projected for
1979 in our First Budget Resolution, and you mention that we need
to control that increase in Government expenditure.
Some of us have advocated, but we have not been a majority, a
closer restraint on those increases in immediate expenditures, as
you know. There is a real difference of degree as to what that
should be. If you were able to have a heavy input to this committee, what would your judgment be as to what the increase in
Federal expenditure should be for 1979 percentagewise? It is going
to be, under the 1979 resolution, between 10 and 11 percent. What
would you suggest, since you put such heavy emphasis on restraining the increase in Government expenditure?
Mr. MILLER. The original proposal was for spending of about $500
billion. I think you are now talking about around $496 billion
under the current resolution; am I correct?
Mr. RoussELOT. That is OMB's latest estimate.
Mr. MILLER. Ideally, I would like to see that reduced another $10
billion. But I must be honest with you; I don't think that is practical given your timetable. If you could keep that resolution at
around $490 billion, that would be another major contribution.
Mr. RoussELOT. $490 billion?
Mr. MILLER. In spending, yes, sir.
Mr. RoussELOT. But preferably another $10 billion.
Mr. MILLER. You asked me what I would prefer if I were the
ruler of the universe.
Mr. RoussELOT. As you know, Mrs. Holt and Mr. Fisher had a
similar suggestion, arid we voted on this in this committee and lost
by one or two votes, so maybe we can reintroduce that idea and do
better this time.
Mr. MILLER. A combination of the changes in the tax program,
and some changes in spending would go a long way in the right
direction.
Mr. RoussELOT. I appreciate your suggestion, and I appreciate
your being candid. I appreciate that you said idealistically. Maybe
we idealists can try again.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
181
You also related very heavily in your statement to the issue of
controlling the growth of Federal expenditures, and the issue of the
measures needed to encourage investment because the Federal
Government has been, as you have stated, one of the main competitors in the marketplace for money as we refinance old debts or
finance new debt. That is not a brandnew theme, as you know. To
what degree do we as a Government, need to reduce our competition in the marketplace for money? You made some specific suggestions.
Mr. MILLER. When I took office at the Federal Reserve, the
economic plan for fiscal ,year 1979 involved a budget deficit of $60
billion and off-budget borrowing of $12 billion for a $72 billion
presence of the Federal Government in markets. I believe that the
plan now is shaping up to be around $60 billion; maybe it could be
squeezed more.
Mr. RoussELOT. Especially if there are further shortfalls on the
expenditure side.
Mr. MILLER. Yes; if you put further caps on spending. The $12
billion reduction is a very substantial step in the right direction,
and I must say I have great admiration for even that accomplishment. I know the difficulties; and I give great credit for what has
already been accomplished. If more can be done in fiscal year 1979,
I would welcome it.
But the schedule I would like to see is a reduction in the deficit
to below $50 billion in fiscal year 1979; to below $40 billion or
about $35 billion the following year; to below $20 billion or about
$17 billion the next year; and to achieve a balanced budget with
full employment in 1982.
That kind of program makes sense to me. I don't believe we can
solve our problems with erratic motions. We can't suddenly cut $50
billion. We have to start the right trend and move the throttle with
some gentleness. This jerking around does shake up the passengers.
It is time we went on a steady and constant course. That is the
better way to do it. The market will adjust better; it will give
greater assurance that the mechanisms are in place. That is the
timetable I would recommend.
Mr. RoussELOT. Do you think we should target for a deficit of $40
billion in 1979?
Mr. MILLER. To get down to $45 billion would be, I think, quite
satisfactory. If you try to get below that, you are going to have a
more rapid-Mr. RoussELOT. That, of course, is what the Holt-Fisher amendment attempted to do. I appreciate your comments.
The CHAIRMAN. The time of the Congressman has expired. The
gentlelady from New York.
Ms. HOLTZMAN. Thank you, Mr. Chairman, and welcome to the
committee, Mr. Miller. I want to ask you about two matters. The
first has to do with reduction in Government spending and the
other with increased interest rates.
I take it that the increase in interest rates was designed to
prevent an increase in the amount of money in the economy and
thereby reduce inflation. But, of course, raising interest rates,
itself, is inflationary. I would like to get some idea from you as to
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
182
when you think the action that was taken by the Fed to raise the
interest rates will result in a reduced inflation?
Mr. MILLER. One of the problems the Federal Reserve has, Ms.
Holtzman, is the difficulty of timelags; what we do isn't seen at the
time and by the time it cycles through it is forgotten.
If the Federal Reserve were to supply additional reserves to the
banking system and create more credit or money, short-term interest rates might thereby be lowered. It is not at all sure that longterm rates would be lowered. They might be higher, because of the
expectation that the result of all that credit would be inflation.
Capital to be loaned for a long period of time would tend to be
unavailable; it would tend to sit on the sidelines waiting.
While the short-term effect of the Federal Reserve's tightening
and restraining is to bias interest rates up, its long-term effectover 18 months, or over a 3-year period-is to bring down the
inflation rate.
It is that long lag that makes it so hard for us to get people to
appreciate how we work and why it is so important we don't put
action off. If we continue to validate inflation, it will look good for
me for 6 months, but I know what damage I will do to the economy
by that sort of process after 2 years.
·
Ms. HOLTZMAN. I see, so the results of the efforts that have been
taken by the Fed in raising interest rates will be seen in approximately 18 months to 3 years?
Mr. MILLER. And, of course, interest rates, as I mentioned before,
are influenced not just by what the Federal Reserve does, but by
the general demand for credit that is in turn influenced by the rate
of inflation which requires more money to finance the same level
of ~ctivity, and so forth.
Ms. HOLTZMAN. I would like to turn now to the issue of Government spending. I am concerned that when we talk about inflation
we do not fall into cliches, and that is why I want to raise with you
two points that I don't think you touched on.
The first is that not all Government spending is equally inflationary. For example, without making any value judgment, military spending is, per se, inflationary. We may, of course, be willing
to pay their price, but, by definition, this type of Government
spending creates inflation.
Second, the loss of dollars abroad, and the failure to return those
dollars to the United States, resulting in an enormous negative
balance of payments, also creates inflationary pressures.
I would like you to address these two items as contributing
factors to the inflation we are now experiencing. It is easy to pick
on the minimum wage, as a prime cause of inflation because it has
always been a subject of controversy, and it has always been easy
to pick on Government spending in general. But I would like to
have a sense that we are thinking through the larger picture, that
is, the extent to which the loss of American dollars abroad is
creating inflation, and the impact of these enormous military expenditures which are, by definition, inflationary. We may be willing to pay the price, but I don't see anybody measuring the inflationary impact of them as we are measuring the impact of the
minimum wage.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
183
Mr. MILLER. Let me talk about the balance-of-payments problem
first, if I may. There are two levels of concern about the value of
the dollar. One is over short-term movements that relate to confidence, speculation, market actions; these can be generated by
forces that do not necessarily show a fundamental problem.
The long-term value of the dollar is determined by more fundamental issues, and there are two fundamental situations that have
worked to cause a decline of the value of the dollar. One is inflation. Relative inflation against other countries puts us in a position
where the dollar has less purchasing power and therefore has to be
worth less than some other currency that hasn't been eroded by
inflation.
The second issue is our balance of current account payments,
which you mentioned. We have to have a balancing inflow of
capital to make up for that, which can have a very inflationary
impact.
The decline of the dollar since last September will produce an
increase of about 1 percent in this year's rate of inflation. So I am
absolutely with you that we must address the balance-of-payments
problem vigorously; we need to do that.
Ms. HOLTZMAN. I take it from your figures that this inflationary
impact is greater than that caused by the minimum wage?
Mr. MILLER. The minimum wage adds half a percent. The minimum wage can be changed by an act of Congress. You can't change
the balance of current accounts without a much more massive
program. You have to get an export drive going, dismantle some of
the inhibitions to exports, and so forth. I am for attacking those
problems, as I tried to point out, and I have been advocating a
national policy to increase our exports.
Minimum wage action could be taken immediately and would
not hurt people. It hurts people more to tax them through inflation
which takes away their resourGes. But I don't want to make value
judgments about these things either.
I am trying to say that in the last analysis the welfare of all
Americans is affected more by inflation than by almost anything
else. I mentioned what would happen to college graduates this
year, what would happen to the values that surround their lives;
what would happen would be dreadful. We all do have tough
decisions. We should attack all of these problems.
I had a chance before to single out where to cut Government
spending, and I said I would submit some ideas; I feel this is a
congressional prerogative. I agree with you that not all Government spending is inflationary and that not all Government ~pending cuts can take place at once because, as I mentioned, too erratic
a change creates a drag on the economy. You would get recession,
and if you get recession, that will create high unemployment,
which will create deficits, which will give us another kind of inflation. That is the peculiar thing about our economy now.
The theory used to be that if you moved into low economic
activity and recessions you would get a cutback in inflation. We
found that isn't true; our transfer payments have just about offset
that effect so we have to find other ways to curb inflation. That ii,
why I have tried to emphasize that the policy of the Federal
Reserve is to walk through a narrow tunnel, a narrow valley
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
184
where, on the one hand, we can't allow the economy to grow so fast
as to unleash more inflationary forces and, on the other we can't
afford the heavy restraint that would produce a recession.
The judgmental problems are so difficult right now. We must
make better calls than we have ever made in order to work
through this period.
The CHAIRMAN. The time of the gentlelady has expired. The
gentlelady from Maryland.
Mrs. HOLT. Thank you, Mr. Chairman.
Mr. Chairman, on the amendment that I offered to the First
Concurrent Resolution, I made an effort to limit the rate of growth
of Government, and one of the big things that I was concerned
about there is the confidence. I think you have mentioned it two or
three times this morning, "shaking up the passengers," and I think
if we are going to get anybody, labor, management, anybody else to
realize that we are serious about inflation, that we have to provide
the leadership. So the amendment was almost permitted to pass
when it got to the floor, and I think that means that the majority
of the American people want to see it happen.
Now, the thing that I would like for you to elaborate on for me is
this confidence factor. There is some authority that the surge in
the second quarter could have been anticipatory buying. Would you
comment on that, how these things affect it?
Mr. MILLER. Yes; I would be delighted to, Congresswoman Holt.
The second quarter growth was somewhat influenced, I believe, by
anticipatory buying of durables, of large ticket items. With the
expectation of inflation, families made purchases earlier, financing
them because of the availability of credit sources.
On the other hand, the second quarter was not characterized this
way entirely. It also reflected a catchup from the first quarter in
which, because of the winter and the coal strike, we had zero real
growth.
Confidence is hard to measure. In my limited experience in
Washington, I have noted that when there is a nationwide sense of
greater fiscal discipline, coupled with prudent monetary discipline,
confidence is created. This is true whether confidence is measured
by the Michigan poll or by some business survey or by what markets actually do and how people vote with their money. The sense
that we in the Government are going to act positively to curtail
inflation generates a sense of confidence.
That is why the things we are talking about today are so important. Not only are they important intrinsically, but they are important in demonstrating that, having created the problems that we
have over the past dozen years, we also have the fortitude and the
willingness to start changing policies with some perception of
where we are going and a commitment to stick with it. You cannot
solve problems built up over a dozen years by policies taken over 3
months.
But we have to start to show constancy and purpose and determination over time. Then I am sure confidence will rebound, and
conditions will allow us to use inflation in a positive way, as the
common enemy against whom we can all rally. When we unify this
Nation through a common purpose with our self-interests all aimed
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
185
against the same target, we can do wonders. That is why I am sure
we can win.
Mrs. HOLT. Do you think it would be effective to legislate a cap
on Federal outlays, a percentage of GNP, except in the case of
national emergency? Do you think that would ever work?
Mr. MILLER. I don't object to the discipline. But I am skeptical of
long-term, legislated caps because I believe that the world is too
complex, and this sounds like too easy a solution. I would rather
have us announce a program, a plan-like the model economy I
have been talking about-and then be sure each Congress fits its
action into that plan, but does not get locked in. You just can't
measure this year what next year will be like.
Mrs. HOLT. Sort of like a Budget Committee setting aggregates
based on the econometric models that we see.
Mr. MILLER. Yes.
Mrs. HOLT. Thank you.
The CHAIRMAN. The time of the gentlelady has expired, and I
might add I got the message.
Mr. MILLER. I thought there was a message there.
Mrs. HOLT. Thank you.
The CHAIRMAN. The gentleman from New York, Mr. Conable.
Mr. CONABLE. Thank you. Chairman Miller, welcome to the committee. I am sure you have been welcomed many times today, as
many of us find your testimony refreshing.
Let me ask you, I have heard it said that the old traditional
measures of M1 and M2 are not necessarily all that accurate at this
point, and that the economy cannot be understood except in terms
also of the vastly expanding long-term credit, where people seem to
be willing to commit themselves despite the high interest rates to a
considerable obligation that would not have been taken on in more
traditional times. Is there something to that?
Mr. MILLER. Yes; there is. Once you develop a certain tolerance
for it, inflation is, I suppose, like other habits in life-Mr. CONABLE. It is not only a tolerance; it is a sophistication that
leads people to believe they should go ahead and commit themselves no matter how high the interest rate, because it is going to
be worse in the future. Isn't that it?
Mr. MILLER. It is more than that. It is the feeling they should
commit themselves not only because it is going to be worse in the
future, but also because if they believe inflation is going to persist,
they see they can pay back their debt in depreciated dollars. The
psychology works the wrong way, and that is why I mention the
fact that, when we fight inflation we have to fight this tendency of
perpetuating it. That is why I think all the techniques that index
and accommodate inflation are wrong; they make it a heads-I-win/
tails-I-win situation. When any individual is indexed for inflation,
this creates an enormous incentive to overborrow; you know you
are protected because you will have more income to pay back your
loan-and in depreciated dollars. Or if you end up without inflation, you win that way too. So it is an unsatisfactory situation for
curbing inflation.
I don't want to get into your question about M1 and M2 until we
have more time to explore it. But, briefly, we are seeing changes in
payment mechanisms, and we do have in times of inflation, the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
186
tendency for more sophisticated cash management and greater velocity in money; this creates certain new phenomena for us to deal
with in monetary policy. I know you are aware of all these things.
Mr. CONABLE. I wanted to get your view as to whether or not we
really did need some statistical review of this whole area.
I would like to ask you, also, sir, if we are doing enough to
sustain the value of the dollar abroad? There is a general feeling
that somehow we have a unilateral policy to depreciate the dollar;
it will help us sell our exports abroad; it will increase the cost of
imports in our market and solve some of our trade problems.
Some of our trading partners are accusing us of deliberately
fostering this. We counter by saying, "Go ahead and debase your
own currency; deflate and maybe you will succeed in more of our
goods." And that is kind of crazy advice to be giving people like the
Germans and Japanese, who have been managing their economy
better than we have. Are we doing what we can? We really can't
afford the Russian roulette of debasing the dollars abroad when so
many dollars are being held there. We could have a dollar panic.
From your view as a central banker, have we propped the dollar
enough, or are we running some very unacceptable risks?
Mr. MILLER. Congressman Conable, let me go back to the basics
for a moment. I would like to put to rest any thought that a
depreciated dollar has any value to the United States. That idea is
false.
Mr. CONABLE. There is some value, but there is a lot of risk, too.
Mr. MILLER. You know, the dollar is the principal currency for
trade and investment in the world; it is the principal reserve asset.
So a decline in the value of the dollar disrupts international trade,
which hurts the United States; a declining dollar disrupts international investments, which hurts the United States; a declining
dollar increases the cost of imports and reduces the competition
from imports and causes inflation in this country, which is against
the interest of the United States.
Every aspect of a declining dollar works against the interests of
the United States. We have to say that loud and clear to everyone.
I say it to every foreign central banker and every Government
official who comes to see me. Believe me, we are not interested in
devaluing the dollar at the Federal Reserve; we are not. We are
interested in seeing a strong and stable dollar. It has to be in the
U.S. interest to do that.
Now, are we doing enough? We have been taking some bridging
actions, and the dollar now has about the same value it had 4
months ago, when I arrived here. That doesn't prove anything; it
could drop or go up tomorrow. These are temporary actions, but I
think we have been forceful in taking them and, to a degree,
effective. The only way to do enough is to get our house in order bl
bringing down inflation and balancing our trade deficits. We don t
have to solve the problem overnight, but we do have to start the
trend in the right direction. If we turn down the trend on inflation
and start to reduce the foreign account deficit, I can assure you the
dollar will strengthen. And if we continue on those trend lines, the
dollar will again be an asset with the preeminence it needs to have
if we are to create stable conditions for trade, investment, and for
the prosperous development of the whole world.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
187
Mr. CONABLE. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired.
Chairman Miller, I want to thank you for what I consider to be
an outstanding performance by you in coming up here and being
candid with us, and so informative and helpful and educational.
You really have been. And it is refreshing, and it is very helpful.
You said somewhere along the way today that we are paying for
the sins of the past, and we are. And I want to assure you that I
have been trying for some time to sin less, and I am going to try
even harder, and I am going to try to persuade some of my colleagues that we have to do less sinning if we are to get our
economic house in order.
Mr. CONABLE. Mr. Chairman, we could go on sinning, but it
hasn't been much fun, either.
The CHAIRMAN. I think the gentleman is right.
Thank you, Chairman Miller, and come back again.
Mr. MILLER. Thank you very much, Mr. Chairman. I have enjoyed the session and appreciate the courtesies you have extended
to me.
[Whereupon, at 12:20 p.m., the committee adjourned, to reconvene at 10 a.m., Monday, July 31, 1978.]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
ECONOMIC OUTLOOK AT MID-SUMMER
MONDAY, JULY 31, 1978 ·
HOUSE OF REPRESENTATIVES·,
CoMMITTEE ON THE BUDGET,
Washington, D.C.
The committee met, pursuant to· notice, at. 10:45 a.m., in room
210, Cannon House Office Building, Hon. Robert N. Giaimo, chairman of the committee, presiding.
The CHAIRMAN. The committee will please come to order.
The gentleman from Texas.
Mr. MATTOX. Mr. Chairman, prior to our actually getting started
in the hearings today, if I might, I would like to submit for the
record two sections of material, one being a statement by me that
deals with the subject of indexing the Federal structure as a
method of insuring stability when the prices of goods, particularly
oil and food are controlled artificially through the market system.
The statement that I am submitting was prepared with the assistance of Dr. Tom Dernburg, who is the economist of the Joint
Economic Committee. I would ask unanimous consent for its inclusion in the record.
The CHAIRMAN. Without objection, the gentleman's statement
will be included in the record.
Mr. MATTOX. I have already sent copies to each of the members'
offices, and I would be glad to provide others.
The second thing I would like to submit is a short article that
deals with and is somewhat critical of the CETA public works
program. The purpose of submitting this is because-The CHAIRMAN. Will the gentleman yield?
Mr. MATTOX. Yes.
The CHAIRMAN. I notice this article says "CETA: $11-Billion
Boondoggle." You say somewhat critical?
Mr. MATTOX. Mr. Chairman, as you well know, I have been
somewhat critical of the administration's CETA program. I think it
is going to be difficult for us to continue to fund the program that
has the kind of irresponsible administration taking place in it that
this one does, and I am submitting it for that purpose and for
consideration. I am sure that there are many articles that have
been written on the fine things that have taken place in· CETA.
This particular one deals with problems dealing with CETA. I
would ask unanimous consent for the article to be included in the
record.
The CHAIRMAN. Without objection, both items will be inserted in
the record.
[Testimony resumes on p. 195.]
[The material referred to above follows:]
(189)
32-052 0 - 78 - 13
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
190
ECONOMIC STABILITY AND INFLATION INDEXING OF THE INDIVIDUAL INCOME TAX
(Submitted by Hon. Jim Mattox)
I am pleased to have the opportunity to submit this statement on the inflation
correction, or indexing, of the individual income tax to the House Budget Committee.
Indexing of the income tax is an idea whose time has come. A properly indexed
tax system can eliminate many of the legitimate complaints about the inequity of
our tax system, and it can also contribute to the growth and stability of our
economy. In my judgment, indexing of the income tax will prove to be both good
politics and good economics.
In the past discussions of indexing have been dominated by ideology. I am,
however, hopeful that henceforth we can discuss the issue on its economic merits.
Conservatives have tended to favor indexing of the income tax because this slows
the rate at which progressive taxes run up Federal revenues and permit the Government to increase its claim over real resources. Liberals, of course, have opposed
indexation for precisely the same reason. History-with considerable assistance
from Congress-has declared this debate a draw. Since 1950 total Federal revenue
has averaged 19.1 percent of GNP. It has exceeded 20 percent of GNP only in 1968,
1969 and also in 1974 when that was exceedingly harmful to the economy. The
Federal Government's share of the Nation's income has shown virtually no tendency to increase.
The reason for this stability is that Congress has granted periodic tax relief in a
manner that offsets the tendency for the progressive income tax to increase the
Federal share of national income. Consequently, I believe it is fair to say that the
issue has less to do with the relative size of the public sector, than with the question
of whether it is better for the economy if tax relief is granted on a piecemeal basis,
or whether it is better for relief to occur automatically. In a subsequent part of my
statement, I shall indicate why the latter is to be preferred. First, however, I wish to
explain the mechanics of the indexing scheme. It can, I believe, be accomplished
quite simply and with virtually no administrative complexity.
A correctly indexed progressive income tax would permit average tax rates for
individuals to change when real income changes, but not when a rise in money
income is offset by a rise in prices. The appropriate way to effect this is to widen
bracket limits, exemptions, standard deductions, and tax credits at a rate equal to
the rate of inflation. In this way the real values of these categories are held
constant and this prevents an individual from moving into a higher bracket if his
money income increases no faster than prices.
In addition to the foregoing changes, appropriate inflation correction of the individual income tax should include a redefinition of some items of taxable income
that are distorted by inflation. An obvious example is the taxation of nominal
capital gains; a practice that is unfair, wasteful, and injurious to capital formation.
Certainly a homeowner who has held his property for over 20 years ought not-as
at present-have to pay a capital gains tax on that part of the gain that stems from
general inflation. Similarly, small savers have suffered greatly from the practice of
taxing nominal interest. These savers do not have access to the full scope of the
capital market. They are likely to be restricted to saving deposits and similar
instruments whose nominal yields are held down by law. When the inflation rate
rises above these controlled interest rates-as happened in 197 4 and is happening
again-these savers suffer an erosion in the real value of their savings and, to add
insult to injury, they must pay taxes on the nominal interest they earn. The
appropriate way to deal with this problem is to tax only real interest. This is
computed quite simply by subtracting the inflation rate from the nominal interest
rate. If the resulting real rate is negative, the taxpayer should be permitted to
reduce his taxable income by the amount of his loss.
Once these simple reforms are enacted the average aggregate rate of income tax
will no longer vary with the inflation rate. The question to which I wish to devote
most of the remainder of my statement is whether such neutrality with respect to
inflation is desirable from the point of view of economic stability. Will our economy
be more or less resistant to the effects of shocks? Will our economy be more or less
inflation prone?
The conventional view has been that progressive taxation of money income contributes to the stability of the economy. During inflation the disproportionate rise in
taxes in t he unindexed system slows the growth of disposable income and consumer
spending and thereby helps to moderate inflation. Conversely, progressivity, causes
tax yield to fall disproportionately more rapidly than personal income when eco-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
191
nomic activity declines. This prevents disposa,ble income from falling less than
would otherwise be the case, and this helps to hold up consumer spending.
The conventional view would not be subject to dispute if real and money income
always moved in the same direction, as would be the case if inflation were always
the product of excessive demand. And if this were always the case I would not be an
advocate of income tax indexing. But recently we have learned that inflation can
also come about from restrictions on the supply side. The chief shocks that come to
mind, of course, are the very sharp increases in world food and oil prices that
occurred in 1973-74. Such supply restrictions tend to raise prices and at the same
time they tend to reduce output. If the response to these supply shocks is a
restrictive monetary-fiscal policy, the decline in output will be that much greater,
while almost no headway will be made against inflation since there is very little
that domestic policy can do about prices that are determined by external conditions
or acts of nature.
Despite the inappropriateness of such policy it is exactly the sort of policy that
was pursued in 1974, and this is a major reason why the recession of 1974-75 was
the worst since the Great Depression of the 1930's. To be sure, some of the restrictions that occurred in 197 4 was the direct produce of conscious policy decisions. But
in addition, considerable damage came about automatically because of the operation
of our unindexed income tax during a period of acute stagflation.
To illustrate, here is what happened between the fourth quarter of 1973 and the
third quarter of 197 4, the period during which most of the damage was done. Real
GNP fell at an annual rate of 3.2 percent. However, because of the inflation rate of
11.1 percent (as measured by the GNP deflator) money GNP increased 7.6 percent
and personal income rose 9.4 percent. Personal income is the tax base of the
individual income tax. Its rapid increase, combined with the progressivity of the
income tax rates, caused revenue from the income tax to rise 15.8 percent. The
result was that the ratio of income tax receipts to personal income rose from 11
percent to 11.5 percent during this period-a period during which real output and
real wages were falling.
This did incalculable harm to the economy. It meant that our income tax acted as
an automatic destabilizer rather than the automatic stabilizer that conventional
wisdom and the economics textbooks have led us to expect. An automatic stabilizer
causes the ratio of the tax to its base-the aggregate tax rate if you will-to fall
when real income falls. But in 197 4 the opposite happened. Had the income tax
been indexed, the aggregate tax rate, instead of rising to 11.5 percent, would, in
fact, have fallen to about 10.9 percent. Thus, this experience shows that indexing is
the difference between an income tax that is an automatic stabilizer all of the time,
and one that is an automatic stabilizer only some of the time.
As I noted earlier, Congress has granted tax relief so as to keep Federal receipts
roughly constant as a proportion of GNP. However, in the 1974-75 period this relief
did not come until March 1975, at which time the recession had already touched
bottom. Clearly it would have been better for tax relief to have come earlier. One
trouble with discretionary policy is that it often does not get put in place until after
the damage has been done. Indexing of the individual income tax would help to
avert this problem; and that is perhaps the most important economic argument in
favor of it.
I know of no responsible economist who would claim that the economy would not
have been better off in 1974-75 had the income tax been indexed. Nevertheless,
there are those who regard that episode 8;S a special case, and also those who feel
that indexing will eventually add to inflation because they think it will, on balance,
imply lower taxes than the present system.
Economic events are nothing but a series of special cases. I therefore see no
reason for risking another debacle of the 1974-75 variety when this can easily be
avoided by constructing a neutral tax system. Furthermore, indexing does not
necessarily imply lower taxes as seems obvious from the unwritten law that Congress almost always holds taxes below 20 percent of GNP. But beyond these conventional considerations, there is good reason to suppose that indexing of the individual
income tax may actually reduce inflation. There are two reasons for this; and I wish
to comment on them briefly.
First, our conservative friends have been telling us that high marginal rates of
taxation tend to reduce work effort, or what most economists call labor supply. Most
students of this issue would concede that this is the case, but there is considerable
dispute about its quantitative importance. Whatever the extent of the response, a
reduction in labor supply in response to higher taxes implies an upward push of
wages, a consequent rise in prices, and a reduction in employment. In conventional
economics tax increases reduce total demand and this lowers prices and employ-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
192
ment. But if the tax increase is also accompanied by an upward wage shove, the
employment reduction will be accentuated (since both the tax and the wage push
effects work in that direction), while the price effects tend to offset each other and
may, on balance, produce more inflation.
This argument has been propounded by a number of contemporary economists,
and if it is valid, it means that the unindexed tax system may act as an automatic
mechanism that generates both higher prices and higher unemployment. Inflation
carries taxpayers into higher brackets. The resulting reduction in real take-home
pay leads to an attempt to compensate for the loss by higher wage demands. The
higher wages are then pushed forward into higher prices. Both the higher taxes and
the higher prices reduce consumer real disposable income and therefore consumer
spending. They therefore reduce production and employment. The result, then, may
be a built-in mechanism that worsens stagflation. That is to say, it automatically
contributes both to a higher rate of inflation and a higher rate of unemployment.
Indexing is sometimes viewed as a concession to inflation. It is important to note,
however, that in European countries-where there has been considerable experience
with attempts to slow inflation through incomes policy-indexing of the income tax
is viewed as an indispensible ingredient of a successful incomes policy. I do not
know if we will wish to adopt definite wage-price guideposts in the future. However,
in case we do, it is important to be aware that the success of such a program is
likely to be impaired by our present tax system. For example, a Kennedy-type
guidepost policy which permits wages to rise at the rate of productivity growth,
implies a freezing of the relative shares of income that go to wages and profit. But if
rising income puts taxpayers into higher brackets, their after tax income will rise
less rapidly than the growth of productivity, and when that happens the incomes
agreement will very likely break down and aggressive wage demands will resume.
What I am suggesting is that the Government's own tax policy may undermine
the wage restraint program that the Government itself is attempting to foster. To
put the point differently, an agreement to fix the relative income shares between
business and labor is not enough. The Government also has to play the game fairly
by agreeing to hold its relative share constant. Rising marginal tax rates are
incompatible with that requirement.
I cannot promise that we will have less inflation if we index the income tax, but I
certainly believe that the arguments presented here make this a strong possibility.
That indexing would help to protect the economy from the impact of supply shocks
is not subject to dispute.
There remains one objection that we hear in the Congress and that is that
indexing would deprive the Congress of the pleasure and political reward of granting periodic tax reduction. Considering the time and agony that has gone into the
current debate over taxes, I wonder if tax cutting really is a pleasure. Some time
ago Congress decided to forego the pleasures of providing semi-annual increases in
social security benefits by replacing this ritual with an indexing scheme. This has
removed a source of friction and I daresay that indexing of the income tax might
have the same effect.
Nevertheless, let me address this issue by closing with some quantitative estimates of the cost of an indexing scheme if that were to be initiated in 1979. In this
calculation I assume, as in the Wharton May 30 forecast, that personal income will
rise 12.3 percent in 1979 and that consumer prices will rise 7.3 percent. Revenue
from the personal income tax is estimated at $197.5 billion for calendar year 1978,
so that with the usual assumed responsiveness, of taxes with respect to personal ·
income of about 1.5, revenue would rise by $35.5 billion. Of this total $13.9 billion
would be attributable to real growth, and $21.6 billion would be due to inflation. In
the indexed system the portion due to inflation would be directly proportional to the
rise in the price level and would come to $14.4 billion. Thus the net budget cost of
indexing the individual income tax would be only $7.2 billion in calendar year 1979.
It is extraordinary how much can be brought at such low budget cost. Revenues
still will rise progressively with respect to increased real income, and Congress
therefore still has plenty of room to cut taxes. However, with an indexed system,
Congress will have to address itself to the issue of how to raise real growth, and it
will no longer be able to finance programs through revenues produced by inflation.
That, in addition to what I have said earlier, ought to be plenty of incentive to cut
back or eliminate many of the congressional and administration actions that directly add to inflation. Government ought not to have a stake in inflation.
In closing, I believe that inflation indexing of the individual income tax is no
longer a partisan issue and should not be treated as such. Indexing will help our
economy and it will help to defuse some of the more irresponsible tax proposals that
are presently before us. If I interpret the supporters of Congressman Steiger, and of
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
193
Congressman Kemp and Senator Roth correctly, their chief concern is with the
effect that inflation has had on tax liabilities. My proposal attacks that problem
directly, fairly, responsibly, and in a manner beneficial to the economy.
CETA: $11 BILLION
BooNDOGGLE
(By Ralph Kinney Bennett)
(This Federal plan to help the hardcore unemployed has become a grotesque Lazy
Susan of programs that are rife with waste and mismanagement as funds are
dispensed in everything-for-everybody style.)
What have your Federal tax dollars been doing lately? Just take a look.
In Chicago, they paid a young man $750 a month to teach inner-city youth how to
slap various parts of their bodies rhythmically and become "human drums."
In Salem, Oreg., they financed the construction of a steel-reinforced concrete rock,
30 feet high and 60 feet across, on a small island in the Willamette River. It will be
used for practice by rock climbers.
In Miami, Fla., they paid for a "nude sculpting workshop" in which naked men
and women ran hands over one another's bodies. (This was to help them discover
that they had ''both male and female qualities.")
In Atlanta, Ga., they paid the former leader of the Black Panther Party, an
avowed Marxist-Leninist, $475 a month to, as he says, "keep an eye on city, county
and State governments and their jiving of the masses."
In Ventura, Calif., they enabled 101 people to count the dogs, cats and horses in
the county. And in Pinellas County, Fla., they paid 22 "outreach workers" to go
door to door and find people to add to the food-stamp rolls.
The U.S taxpayer, somewhat inured to Federal boondoggles, might well greet
body drummers and animal enumerators with sighs of resignation. But these examples deserve a closer look because they and hundreds like them have been financed
out of a single Federal law, the Comprehensive Employment and Training Act,
known as CETA.
Enacted in 1973, CETA was supposed to funnel Federal money to state, county
and local governments to provide unskilled or low-skilled workers with public
service jobs in health, education, law enforcement, sanitation and the like. The jobs
were to be useful to both the public and to the individual hired. And they were to be
temporary-to give the disadvantaged the initial training needed to find productive
employment, generally in the private sector.
But during the 1974-75 recession, Congress persuaded the Ford administration to
go along in transforming CETA into an everything-for-everybody unemployment
cure. House Education and Labor Committee Chairman Carl Perkins (D., Ky.)
assured restive colleagues that "this is just a temporary emergency bill to get us
through the next few months until we go to work on more durable long-term
solutions."
&andal-pocked.-This assurance was quickly lost in the administrative shuffle.
An initial $3.8-billion effort to put the Nation's most desperate people to work
became a grotesque Lazy Susan of programs, dispensing $11.4 billion in the past
fiscal year. Quite obviously, some Americans have been helped through this massive
outpouring of tax dollars. But, with scandal rife and payrolls clogged with would-be
artists, political activists and college-educated professionals, the program has degenerated into an unfortunate joke on the genuinely disadvantaged.
Local governments began openly subsidizing payrolls with CETA money to the
point where 15, 25, 30 percent and more of their employes are now drawing Federal
paychecks. The Wall Street Journal notes that the spending for jobs "is in fact a
system, now well advanced, for transferring the fiscal burdens of the nation's cities
to the federal government." And Rep. Jim Mattox (D., Texas), a supporter of the
original CETA concept, admits the program now "runs the risk of becomming an
elite Peace Corps in our own country," dispensing jobs that bear no relationship to
the needs and abilities of the hardcore jobless.
CETA programs have become so pockmarked with scandal that the Department of
Labor has instituted a 200-man permanent investigation unit to probe abuses such
as these:
Choice jobs.-In Chicago, while mailbags full of applications from the genuinely
unemployed piled up beneath their desks, job "screeners" handed out choice $7 ,000to $9,000-a-year CETA jobs as political plums. The jobs went to applicants who had
letters of recommendation from city aldermen. In Baltimore, loose eligibility guidelines resulted in CETA jobs going to the wife of a State supreme court judge, the
daughter of a U.S. Court of Appeals judge, the son of the vice president of a large
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
194
brewing company, the son of a city public works superintendent, and the son of a
member of the Maryland House of Delegates.
Ghost employes.-In Atlanta, a CETA administrative employe credited thousands
of dollars' worth of work hours to nonexistent workers, then pocketed the money
herself. Other CETA "workers" were found to be drawing two paychecks for two
different public service jobs and showing up at neither one. In Cincinnati, a private
employment agency "filled" 79 nonexistent jobs for which it received $47,250 in
CETA funds from the city.
Lax administration.-In Buffalo, N.Y., one of the cities hardest hit by unemployment, Federal investigators and a grand jury have been trying to follow the trail of
millions of dollars in the mismanaged CETA program that has been marked by
sloppy auditing, ineligible participants, nepotism and illegal political activity. In
East St. Louis, Ill., administrative costs for each CETA job ran to $17,872-five
times the national average of $3,761. In New York City, $500,000 in expenses for a
summer youth program was unaccounted for. Many employes sat around all day
doing nothing. One group of youths supposedly training to become recreational
supervisors, was paid to play softball each day.
But these scandals, so characteristic whenever there is a massive influx of loosely
audited Federal money, are only a sideshow to the real problem: CETA has become
so far removed from its legislative intent that it constitutes a fraud on taxpayers
and-:-most poignantly-on the disadvantaged whose hopes for lasting, useful employment it has f,usely raised.
CETA junkies.-The administration boasted last March that it had created
425,000 new CETA jobs in less than a year. The jobs, scattered through tens of
thousands of local projects, consumed more than $8 billion in tax money. (Some of
this money is returned to the Treasury, of course, in income tax payments.) By
contrast, tax-producing jobs in the private economy increased by 440,000 in a single
month-November 1977-during the same time period. And a closer look at those
425,000 new CETA jobs reveals that they have very little net effect on the unemployment picture.
.
The big reason for CETA's less-than-sparkling record on job creation is the fact
that many cities, towns and counties absorb CETA funds into their existing payrolls
to relieve local tax pressure and balance budgets. It has been estimated that CETA
finances four existing jobs for every new one it creates.
Philadelphia's Maior Frank Rizzo brags that he makes "maximum use" of CETApaid personnel to ' hold down" locally funded costs. Twenty percent of the New ·
York City work force is CETA-paid. CETA paychecks go to 32.8 percent of the city
employes in Buffalo; 25.8 percent in Hartford, Conn.; 22.8 percent in Newark, N.J.
In many cases, local governments have dismissed employes, then hired them back as
CETA employes. "The cities are addicted to the CETA narcotic," says Rep. Barber
Conable (R., N.Y.).
A recent study by the Brookings Institution indicates that Federal funds, mostly
CETA will amount to at least half as much money as that raised through local taxes
in ·Philadelphia, Detroit, Baltimore, Cleveland, Buffalo, St. Louis, and Newark.
Instead of directly assisting the hardcore unemployed, CETA money is replacing
local funds.
Ballerinas on the do_le.-CETA true impact on hardcore unemployment is further
distorted by the fact that it has evolved into a kind of Federal job fair in which the
individual desires of some take precedence over the· real needs of many. The lowskilled worker who can't get his foot in the employment door in wealthy Montgomery County, Md., may be somewhat bewildered to fmd that CETA funds are paying
nine young women $145 a week to take ballet lessons full time (they give occasional
benefit performances for county residents).
And the ballerinas, like the young body drummer, are not isolated CETA "arts"
programs are funding at least 10,000 men and women-many of whom have left jobs
in the private economy-to paint, sculpt, make movies, create street theater, play
guitar, weave and make pottery at public expense of more than $75 million a year.
It seems that CETA money is waiting for anyone resourceful enough to tap into it
in the name of performing some kind of "public service." So in Los Angeles, "Gay
Community Services" secured $640,000 from CETA to provide, among other services,
information "about gay lifestyles and gay people's problems."
Training hoax.-Beyond the matter of dubious job funding lies a further dispiriting problem for the low-skilled jobseeker. CETA if funding thousands of "high
entry" jobs that obviously demand skills marketable in the private economy. Many
cities augment the $10,000 CETA maximum pay to create white-collar jobs paying
$15,000 or $20,000 a year. In Washington, D.C., the city council amassed one of the
country's largest council staffs, paying 56 of its 126 employes with CETA money.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
195
With CETA funds, Northumberland County, Va., hired a retired Navy captain to be
sanitary district administrator.
With such jobs absorbing much of the CETA money, job training-which could
best help the hardcore unemployed-has been relegated to a relatively minor
status. In fiscal 1977 CETA devoted a mere 1.5 percent of its $11.4-billion budget to
on-the-job training.
In New Hampshire, Joseph Zellner, deputy commissioner for employment and
training, laments, "We've been saturated with money earmarked for public service
but little for providing lasting jobs for the unemployed." Thus, he says, businesses
in the State are having a hard time finding takers for advertised jobs in carpentry,
construction, clerical and other skills, while non-tax-producing, public-sector jobs in
the State continue to expand.
·
CETA jobs, no matter how dubious or frivolous their value, are plainly attractive.
The pay is high (CETA workers make $10,000 a year picking up junk from vacant
Philadelphia lots), and the work is often not demanding (one summer CETA daycamp program in New York had six workers caring for four children). As economist
David Meiselman notes in a penetrating study of public sector jobs, "More unemployment results as workers wait longer and search longer for preferred public
.
sector jobs rather than take private sector jobs."
New flpproach.-Despite the rising evidence of the program's inefficacy as a cure
for unemployment, the Carter administration plans to maintain the present CETA
jobs level at 725,000, pouring an additional $6.2 billion into the program in fiscal
1979 while trying somehow to fashion ways to more precisely target funds for the
hard core jobless. But more and more Congressmen are wondering if this is the
answer. Says Congressman Jack Kemp (R., N.Y.), "An expanded CETA is going to
further slow the proven ability of the private economy to produce real jobs. What's
needed is not additional billions in Federal spending but tax cuts that will guarantee business expansion and the creation of permanent, tax-paying jobs."
Perhaps, as the CETA program becomes more entrenched, we should all listen to
the small voice of experience from the town of Boston, N.Y. (pop. 8,000), which
sought to dip into the CETA trough, then realized its mistake. Town officials wrote
President Carter:
"The Boston Town Board certainly wants to see unemployment rates reduced, but
we want to see permanent improvements which increase our Nation's productivity
and increase our gross national product. The Board would appreciate your support
and action to terminate the [CETA] program and begin constructive programs to
create permanent work positions in the private sector."
The CHAIRMAN. Today we intend to conclude testimony on the
Second Budget Resolution for Fiscal Year 1979 which will set a
binding spending ceiling and revenue floor for the fiscal year beginning this October 1.
While I have already announced the chairman's recommendations for the Second Budget Resolution, the committee will only
work its will upon them later this week. I want to assure today's
witnesses that the Budget Committee has made no final decisions
as yet and that my own recommendations are not inflexible. The
recommendations, or chairman's mark, are in effect a starting
point for the committee when it begins marking up the second
resolution on Wednesday. We hope to order the resolution reported
this week and bring it to the floor of the House about August 15.
I will be recommending to the committee outlays of $490.4 billion, revenues of $446.8 billion, and a deficit of $43.6 billion. The
recent acceleration of inflation has made it imperative to reduce
the Federal deficit. My recommendations would reduce it by $17
billion from the $60.6 billion proposed by the President last January.
Our witness this morning is Dr. Rudy Oswald, research director of
the AFL-CIO. We welcome you to the Budget Committee, Dr.
Oswald. I notice you have Robert McGlotten with you. Will you
both come up to the witness table.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
196
We are interested this morning in hearing your comments on the
present direction of the Nation's fiscal policy. We would particularly like to know what tax policy you think the Congress should
adopt.
As you know, last Thursday the Ways and Means Committee
reported out a tax package totaling $16 billion on a calendar year
basis. But several substitute proposals are likely to be in order on
the floor. We would be interested in your assessment of the KempRoth and Fisher substitutes among others.
Dr. Oswald, you may proceed as you wish.
STATEMENT OF DR. RUDY OSWALD, RESEARCH DIRECTOR,
AMERICAN FEDERATION OF LABOR AND CONGRESS OF INDUSTRIAL ORGANIZATIONS, ACCOMPANIED BY ROBERT M.
McGLOTTEN, LEGISLATIVE REPRESENTATIVE, AFL-CIO
Dr. OSWALD. Mr. Chairman, I appreciate this opportunity to present the AFL-CIO's recommendations on the congressional budget
for fiscal 1979 and also on those tax matters that you mentioned.
We urge this committee to support a budget that clearly and
unequivocably reflects the needs to stimulate the U.S. economy and
to put the Nation and its people back to work. And we urge this
committee to reject counterproductive, across-the-board budget cuts
that will cripple job-creating programs and offset any beneficial
effects from a tax cut.
There is still a long way to go to a healthy, full employment
economy. Although the Nation is into the fourth year of a slow,
halting economic recovery, the danger of slowdown and recession
hangs over the U.S. economy. Industry is operating at only 84
percent of capacity. Interest rates are high. The prime rate, now at
9 percent, has risen nearly 50 percent in 14 months. Tight money is
slowing housing and investment by local government and small
business investment.
Unemployment is still high. Although the official June unemployment figures show improvement as the result of targeted programs to provide jobs, especially for teenagers, by the AFL-CIO's
more comprehensive measure-which includes workers too discouraged to look for jobs and workers forced to work part time because
full-time jobs are not available-there are still more than 8 million
workers suffering unemployment and serious income loss.
This Nation must generate 4 million new jobs a year for the next
4 years to provide work for the currently unemployed and for those
who will be joining the work force.
Against this background, we want to state that we are willing to
support budget cuts where new data and new information and new
estimates from the Congressional Budget Office or from .the administration clearly indicate that existing appropriated funds will not
be spent.
We want waste and fat cut out of the budget but we don't want
existing people-oriented and job-creating programs crippled under
the guise of budget cutting.
We are deeply concerned about proposals to cut the budget in
some arbitrary manner without regard to the specific impact of
such cuts and without regard to the Nation's need for continuing
economic stimulation, without regard to the need for maintaining
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
197
and expanding job-creating programs, and without regard to the
need to maintain essential social programs.
If the House Budget Committee should agree to proposals for
across-the-board budget cuts, it will be abdicating its own functions
and prerogatives.
The House Budget Committee has an important role in the
budget process. This role involves making decisions on specific,
detailed components of the total Federal budget, with the right to
propose specific cuts and specific increases in the budget. To give
up this powerful decisionmaking prerogative is to abdicate power
and to acquiesce in the erosion of the role and the power of the
Budget Committee.
The administration in its Mid-Session Review of the Fiscal Year
1979 Budget and later in testimony to this committee has been
cutting back its projections for economic growth and it has cut
back its proposed tax cut stimulus and it has cut back projected
Federal outlays for fiscal year 1979 by $4½ billion.
T:be chairman's own economic projections and recommendations
are for a cut of $8.4 billion in spending for 1979.
The 4 percent growth rate set by the administration as a goal for
1978 and 1979 is too low. Higher levels of real economic growth are
needed to create andequate number of jobs, to get more economic
utilization of productive capacity, to break inflationary supply bottlenecks, and to generate additional Federal tax revenues.
Unfortunately, slow growth means less Federal tax revenue. Citibank's publication, "Economic Week," recently pointed out that a
shortfall of 1 percent in the rate of GNP growth from the Government's estimate would cut some $10 billion from the Government's
tax receipts.
It is clear, therefore, economic stimulus along the lines urged by
the AFL-CIO would actually increase job-creating economic growth
and would increase Federal revenues and thus would do more to
reduce the Federal deficit than the proposed budget cuts.
About three-fourths of the fiscal year 1979 Federal budget is
relatively uncontrollable. Social security, veterans programs, public
assistance, commodity support programs, interest payments on the
Federal debt, revenue-sharing commitments, and payments in
fiscal year 1979 for contracts made in earlier years are all uncontrollable. It is almost impossible to make any significant cuts in
these areas of the budget.
Defense spending makes up about half of the remaining portion
of the budget and so-called discretionary domestic social programs
make up the remainder of the budget. These include education,
health, employment and training, child care, services for the elderly, vocational rehabilitation, housing and other such programs.
A 2 percent cut in a $500 billion Federal budget translates into a
$10 billion budget cut. Cuts in the defense budget pose problems of
national security. Nondefense cuts will fall on domestic social programs.
In effect, what may have started out as an effort to cut 2 percent
across-the-board on all parts of the Federal budget would end up as
a cut primarily applied to people-oriented and job-creating programs which have the greatest potential for stimulating consumer
buying power and jobs and output of goods and services.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
198
Congress should maintain and expand labor-intensive public
works and public service employment programs, and youth, housing, and urban assistance programs for the Nation's major cities,
where inner-city unemployment remains at crisis levels.
The application of a 2-percent-across-the-board cutback on Federal budget spending-or any other flat across-the-board cutbackwould impose seriously disproportionate cuts on the so-called "discretionary" people-oriented education, health, and job-creating programs of the Federal Government.
The AFL-CIO is deeply concerned about the danger of budget
cuts offsetting beneficial effects from tax cuts. A preoccupation
with reducing the fiscal year 1979 budget deficit by cutting Federal
spending does not make sense in the present state of the economy.
It would actually be counterproductive.
This is one key reason for the AFL-CIO tax-cut proposal. We
want to get more money into the hands of low- and middle-income
families whose spending gives the biggest stimulus to the economy.
This, presumably, is a goal the administration shares. This is a
goal we believe Congress shares.
We are calling for enactment of a fair and responsible $11 billion
individual income tax cut, to be accomplished simply by increasing
the present $35 per person general tax credit to $150.
Such a measure would provide its greatest relief to low- and
middle-income taxpayers and large families-those groups hardest
hit by the inflated costs of the basic necessities of life-food and
shelter. Based on the Labor Department's budget for a moderate
income family of four, food cost increases amounted to $335 a year
or almost $90 per person over the past year. Under our proposal,
the typical family of four would receive a tax cut of more than
$400.
Such a tax cut would be easy to understand as well as equitable.
It would cost about $11 billion during fiscal year 1979. Most taxpayers would receive a reduction and 83 percent of the benefits
would go to those with incomes of $30,000 a year or less-85
percent of all taxpayers. Many lower income taxpayers would be
removed from the tax rolls.
I would like to interject, Mr. Chairman, in terms of your earlier
comments that a proposal by Mr. Corman comes closest to our
proposal, and Mr. Fisher's proposal is also a step in that direction,
over the proposals recommended by the Ways and Means Committee last week.
We believe such action is needed because:
There is widespread agreement that a tax cut of reasonable
proportions is needed to avert a recession in 1979.
Starting January 1, the social security payroll taxes will increase
draining an additional $7.4 billion out of the economy.
Three provisions of the current income tax law, including the
current $35 tax credit, will expire December 31 and, in the absence
of any relief, taxes would increase by $9 billion next year.
Taxpayer discontent and frustration cannot be ignored. However,
many of the tax-cut proposals being put before the Congress and
the American public are clearly unfair and would make a mockery
out of the need for tax justice and heighten taxpayer resentment.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
199
While we support a tax cut to strengthen the economy and cut
the burden on low- and middle-income workers and consumers,
that cut must be fair and maintain a balance between the need for
consumer purchasing power and essential public facilities, services,
and programs.
The Roth-Kemp tax cut proposals meets none of these tests. It
would hamstring social and economic progress, fuel inflation and
make a mockery out of the need for a tax justice. Nearly 44
percent of the Roth-Kemp tax cut would go to taxpayers with
income over $30,000-only 12 percent of all taxpayers.
Slashing individual and corporate income taxes would cost the
Treasury, after 3 years, $122 billion a year-more than the country
now spends for all national defense needs.
Such a permanent, inequitable, and drastic cut of the Government's income is frightening.
Unfortunately-in spite of the clear need for a fair and responsible tax cut to stimulate private consumer spending, and in spite of
the clear need for maintaining and increasing Federal outlays to
boost public and private spending-the Carter administration is
behaving in a confused and contradictory manner on basic fiscal
policy.
It is clear to us that the economy need both kinds of stimulusthe stimulus of tax cuts and the stimulus of at least current levels
of Federal spending. The $11 billion tax cut proposed by the
AFL-CIO will help avert recession.
Full employment-without inflation-can be achieved by balanced, healthy growth in the private sector, supported by effective
job-creating Federal policies and programs. Like all Americans, we
are concerned about inflation. American workers, along with retirees, suffer more than anyone else because of inflation.
But the right solution to inflation is appropriate anti-inflation
programs targeted against the real causes of inflation-not arbitrary, indiscriminate budget cutting aimed simply at reducing the
size of the Federal budget deficit.
We want a workable anti-inflation policy that deals with the real
sources of inflation-not wage pressures but supply shortages, idle
productive capacity, high interest rates, and actions of foreign oilproducing countries. Food, fuel, home mortgage costs, and medical
care are the principal causes of today's inflation.
Reducing unemployment and stimulating economic growth are
the keys to fighting inflation. Unemployment means lost income
and lost consumer buying power, lost business sales, high overhead
costs, and low levels of investment in new, more efficient and
productive plant, machinery and equipment.
The AFL-CIO urges action in these specific areas of major inflationary price pressures:
AN IMMEDIATE REDUCTION IN INTEREST RATES, PARTICULARLY FOR
HOME MORTGAGES, AND THE ALLOCATION OF CREDIT TO SOCIALLY
NECESSARY INVESTMENT
The recent actions of the Federal Reserve Board in returning to
the discredited policies of tight money and high interest rates
threaten the entire anti-inflation program. High interest rates
push up costs throughout the economy.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
200
CONTINUED EMPHASIS ON JOB-CREATING PROGRAMS TO REDUCE THE
LEVEL OF UNEMPLOYMENT
Unemployment is inflationary, since idle workers are not producing goods and services. Increased production, brought about by
higher employment levels, will reduce unit costs and the wasteful
costs of maintaining unused plant and equipment.
ESTABLISHMENT OF RESERVE STOCKPILES AND EFFECTIVE EXPORT CONTROLS ON AGRICULTURAL COMMODITIES AND OTHER RAW MATERIALS
IN SHORT SUPPLY
We-recognize the fact that the family farmer is not responsible
for food price increases. Taking the profit out of commodity speculation would increase the return to the farmer and reduce the price
to the consumer. We believe that the Government should assert
some measure of control over food exports to assure stable prices to
both the farmer and the consumer, and over the export of other
raw material in short supply, such as lumber.
CONTINUED REGULATION OF NATURAL GAS
While we have long supported increased development of domestic
energy sources, we believe that deregulation of natural gas would
only add to the price consumers pay without increasing supplies
and would be severely inflationary.
ENACTMENT OF A HOSPl'J:'AL COST CONTAINMENT PROGRAM
An effective program which holds down rapidly escalating medical costs-without placing the burden on the wages of the low-paid
hospital workers whose wages are not responsible for medical cost
incre~es-would reduce one of the most inflationary pressures. An
effective program is necessary to hold down physician fees-another major factor in medical cost inflation.
Mr. Chairman, the AFL-CIO is very much concerned about the
continuing needs for economic stimulus and job creation to maintain the momentum achieved in reducing unemployment. We share
the views of Secretary of Labor Ray Marshall who recently warned
against the danger of overoptimism about the current unemployment situation this way:
There are those who are now saying that unemployment has declined so much
that we no longer need a large-scale public service jobs program.
This is a very dangerous misconception.
I say to you today that I do not believe that we can keep unemployment under 6
percent over the next year without a full-scale public service jobs program.
Any ill-advised cuts in the CETA program run the risk of destroying the progress
we have made in putting America back to work. Cutting CETA is tantamount to
saying that 6.0 percent unemployment is full employment.
We share those quotations and views expressed by Secretary of
Labor Ray Marshall.
_
This warning from the Secretary of Labor correctly points to the
need for further economic stimulus from the Federal budget.
In conclusion, therefore, we urge this committee to approve a
fiscal year 1979 Federal budget that will stimulate balanced,
healthy economic growth aimed at full employment without inflation. We urge this committee to reject proposals for across-theboard budget cuts. And we urge you to maintain basic people
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
201
oriented and job-creating domestic programs which add to the Nation's social and economic welfare.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much, Dr. Oswald.
On page 4 of your statement you say that the AFL-CIO is deeply
concerned about the danger of spending cuts offsetting benefits
which would otherwise result from any tax cuts. Then you present
the AFL-CIO tax cut proposal and you say you want to get more
money into the hands of low- and middle-income families whose
spending gives the biggest stimulus to the economy. You set that
forth as a goal we all should share.
Given today's economic conditions, with inflation raging the way
it is, and with stimulus already built into our fiscal program, is it
the wisest thing in the world to have additional stimulus in the
shape of tax cuts designed primarily to increase consumption?
Dr. OSWALD. Mr. Giaimo, the projections of nearly all economists
is for a slowdown in the second half of this year. The growth rate
in the first half of this year was much slower than anticipated. In
the first quarter of the year it actually declined and the second
quarter the growth rate was 7 percent, which for the first half of
the year leaves us at a growth rate of less than 4 percent.
Projections for the second half of the year are for an even slower
rate of growth than for all of 1979, much slower. If we don't have
some stimulus, we will have substantially increasing unemployment, and it will be starting not from a rate of unemployment of
4.8 percent as existed in 1973 when we went into the 1975 recession. But we are now at 5.7 percent unemployment officially, a
higher unemployment level than we have had in any period except
in recessions previous to this time.
The CHAIRMAN. One of the major controversies raging over the
nature of tax reduction legislation is whether or not the reduction
should be designed to provide stimulus via increased consumer
spending or increased productivity through the encouragement of
investment activity and capital formation. As you know, there is
considerable opinion in the favor of encouraging investment activity and investor confidence. Would you specifically address yourself
to this approach and give us your thoughts on it?
Dr. OswALD. I would just like to comment that the best way to
get new investment is to get increased consumer spending and
demand in the economy. Part of the more rapid growth in the
second quarter of this year also came about as a result of very
rapid growth in business investment, which grew at a 15 percent
rate without new tax stimulus for business.
Business is going to invest if it has an opportunity to make goods
that will be sold rather than on the basis of new tax cuts. The tax
cut proposals that are being considered really give disproportionate
cuts to the wealthy in our society and would give no guarantee at
all that there will be more investment forthcoming.
The CHAIRMAN. Thank you. Mr. Mitchell.
Mr. MITCHELL. Thank you, Mr. Chairman.
I am generally supportive of your statement with regard to reducing unemployment. However, I want to speak to the issue very
briefly, if I may.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
202
I know that there is a strong feeling that the private sector
should supply a disproportionate number of the jobs in this country, and I think that is right. I also realize that there are mounting
criticisms against the Government's attempts to create jobs, but in
your statement you indicated some of the developments which I
think justify the Government's role in job creation, particularly in
the absence of private sector jobs. If I may, let me emphasize one
or two additional points.
Chairman Miller of the Federal Reserve Board testified before
the Banking Finance and Urban Affairs last week. In his testimony
he indicated that for fiscal year 1979 the .real growth rate would
probably be somewhere between 3½ and 3¾ percent, not 4 percent,
and obviously this estimate of economic growth is not conducive to
the private sector increasing its employment efforts.
In addition, high interest rates tend to depress the private sector's efforts to create more jobs.
Chairman Miller has indicated that he expects those rates to
prevail throughout fiscal year 1979.
I know as well as you that there are numerous attempts being
made to slash programs contained in the budget. But if you take
those first two factors, the lack of real growth for 1979, and the
fact that higher interest rates will prevail for most of fiscal year
1979, it is difficult to expect the private sector to produce enough
jobs to substantially reduce unemployment.
Therefore, I would argue further and support your position. Initially, we inadequately funded all of these employment programs.
Consequently, it is not enough just to maintain them at their fiscal
year 1978 levels, especially in light of the two conditions that I
mentioned earlier. Clearly, the burden must fall on the Federal
Government to step up its efforts to stimulate the economy and to
fight joblessness.
I have no specific questions. But I think that the members of the
Budget Committee understand the problem of unemployment in its
full context and I hope that they would not slash our jobs programs.
Mr. Chairman, as you know, I didn't mention black unemployment. I won't. I wouldn't do that. I think that the black unemployment problem has been abandoned. We have decided to use blacks
as pawns in the game of economic expendiency.
My remarks were for the general good, the general well-being of
the country. Thank you, Mr. Chairman.
The CHAIRMAN. Thank you. Mr. Conable.
Mr. CONABLE. Thank you, Mr. Chairman.
Good morning, gentlemen. It is nice to have you before us. Thank
you for your testimony.
I would like to ask if you think productivity is a problem. It is, of
course, bound to be a major concern of labor. But doesn't productivity have something to do with the increase in real wages that you
can get for your people in a period, particularly in a time of
inflation when otherwise it just becomes a matter of trying to keep
up with inflation, unless you can increase your productivity? Obviously, you are going to have to use pressures of collective bargaining to try to g~t a bigger piece of the pie, and it is much easier if
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
203
you can point to increased productivity. How do you think we can
achieve that?
I note only macroeconomic suggestions here, increased stimulus
for greater consumer spending. Do you think that is the way to get
more investment?
We have been doing that for a long time, and our productivity
has gone down. I think since I have been in Congress 14 years, we
have stimulated the economy roughly 28 times, and despite that
effort-you can always say, well, we haven't done enough, I suppose-but despite that effort productivity has sagged.
How do you think we can deal specifically with this issue, other
than by trying to encourage that very ephemeral and volatile
condition, consumer confidence and consumer demand?
Dr. OSWALD. Mr. Conable, we did have our most rapid periods of
productivity growth in the 1960's, at the same time that we had a
long period of rapid economic growth. We have had big drops in
productivity as a result of the recessions that have taken place in
the 1970's. We had actual declines in productivity during the
1970-71 recession, and substantial declines again in the 1974-75
recession, and so much of the problem of the slowdown in productivity in the 1970's is related to the poor overall economic performance. That is the reason that we have been urging stimulus for the
economy to put the economy back on a general growth path.
If we have sustained economic growth, then we will have greater
productivity, but if 1979 is the start of a new recession, then we
will have substantial drops in productivity again, and even more
severe inflationary pressures.
Mr. CONABLE. But do we not have a very high level of consumer
spending now? Is it not as a matter of fact unusually high, given
this rate of inflation?
Dr. OSWALD. Consumer spending has been the force that has kept
the economy going currently in terms of the recovery. Last quarter
there was also a substantial boost in business investment, but there
have been substantial reductions in the Federal purchase of foods
and services, which has weakened the recovery, but it has been
consumer spending that has played the most important role in the
continuation of the recovery.
Mr. CONABLE. You think that is the only ingredient then, something that we ought to admittedly have at a fairly high level now,
the only ingredient that we can use to increase productivity is to
further stimulate the economy?
Dr. OSWALD. If we do not continue to stimulate the economy, we
will have a substantial likelihood of a recession in 1979. The projections made by nearly the whole range of economic forecasters, who
are basing their projections on the stimulus of a tax cut of approximately $15 billion for fiscal year 1979, are still projecting growth
rates of less than 4 percent.
Mr. CONABLE. Is your major objection to the Ways and Means bill
that it gives disproportionate benefits to the well-to-do via the
reduction in capital gains rate?
Dr. OSWALD. The bill provides for a reduction in capital gains
rate and a reduction of tax rates which give disproportionate benefit to the higher income recipients.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
204
Mr. CONABLE. I realize the AFL-CIO has a major involvement in
public employee unions, and that for that reason maintenance of a
high level of Government services is in your interest, but you do
not feel that productivity in the private sector is of comparable
importance at this point, that it at least should have structural
rather than macroeconomic interest of the sort that the Ways and
Means Committee has proposed apparently?
Dr. OSWALD. Mr. Conable, we feel that the Ways and Means
Committee proposal would not stimulate productivity. What it
would do is give large tax breaks to the wealthy, who may or may
not invest that money, who may spend that money in the United
States or may spend it abroad or may not spend it at all, whereas
if you gave-Mr. CONABLE. If they do not spend it all, you think they will put
it in the bank somewhere and only build houses with it?
Dr. OSWALD. They may put it in gold or diamonds.
Mr. CONABLE. Or municipal bonds?
Dr. OswALD. But if you give the majority of the tax cut to the
majority of the people, which you would not do under the Ways
and Means bill, then you would have real stimulus for the economy, and you would at least distribute the tax cut equitably among
the American taxpayers.
Mr. CONABLE. It seems to me, sir, that the position your organization has taken has resulted in very heavy taxes for the working
people, declining productivity, and therefore uphill work in trying
to get better wages in an expanding economy I really think it is
time for us to try something else.
I must acknowfedge that I am not sure we have the right
answer, but I think that it has been pretty well demonstrated that
the course you are advocating has not been the right answer, and
what we have had so far has been just a mindless application of an
unsuccessful formula for macroeconomic stimulation.
I do not expect any agreement with that statement.
Dr. OSWALD. It worked very well in the 1960's.
Mr. CONABLE. That is when we had a war on.
Dr. OswALD. Before the war there was also very rapid economic
growth. As you may recall, in the early sixties there was a rate of
productivity growth of over 3 percent a year, 3.4 percent a year on
a 5-year average in the early sixties, between 1960 and 1965, and
that growth in productivity came about through expansion of the
private economy, through overall economic stimulus.
Mr. CONABLE. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Texas, Mr. Burleson.
Mr. BURLESON. I will pass, Mr. Chairman, thank you.
The CHAIRMAN. The gentleman from New York, Mr. Pike.
Mr. PIKE. Thank you, Mr. Chairman. Dr. Oswald, how long have
you been with the AFL-CIO?
Dr. OSWALD. I have been with the AFL-CIO for 20 years.
Mr. PIKE. How long have you been their research director?
Dr. OSWALD. For 2 years. Nat Goldfinger had been research
director for many years prior to that.
Mr. PIKE. Do you ever recall a time when the AFL-CIO was not
advocating greater Government spending for creating jobs?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
205
Dr. OSWALD. Mr. Pike, the proposals vary according to the economic-Mr. PIKE. Well, do you ever recall a time when they were advocating something which in my judgment would be anti-inflationary,
such as cutting back on Government spending?
Dr. OSWALD. Mr. Pike, in terms of Government spending, we
have urged increases in taxes in the sixties, when there was the
expansion of the Vietnam war.
Mr. PIKE. But then you had a huge increase in Government
spending.
Dr. OswALD. Yes, and we asked for increases in taxes to offset
that.
Mr. PIKE. Right, but have you ever asked for less Government
spending?
Dr. OSWALD. We have asked for less Government spending for
specific programs, and I think that is also what we are asking you
to do now, to look at specific programs.
Mr. PIKE. But like anyone else, you say do not touch ours, and all
I am trying to say is, it just seems to me that in good times or bad,
inflationary or not inflationary, economy booming or recession, you
are always advocating the same thing.
Dr. OSWALD. No, that is not true.
Mr. PIKE. Well, I have only been here 18 years, so I cannot say
what you have been doing over 20 years, but in my 18 years that is
all I have ever heard the AFL-CIO advocate.
Now you say we are in the fourth year of a recovery from the
bottom of a recession. Without going back to the sixties, and without going back to the early seventies, what has happened to productivity during those last 4 years? It has gone down, has it not?
Dr. OSWALD. No. Productivity increased very rapidly in 1976, less
rapidly in 1977, and if growth does not continue in 1978 at a
substantial rate, we will not have substantial rates of increase in
productivity this time.
Mr. PIKE. Do you consider the programs which you are advocating, CETA, for example, to be efficient programs as far as productivity is concerned?
Dr. OswALD. Let me just go back and give you the numbers on
productivity as reported for 1976 and 1977. The output per manhour in the private sector grew at a rate of 4.2 percent in 1976, and
at 2.6 percent in 1977. In terms of CETA, obviously the very
important goal of providing people with skills has been an important contribution of the whole CETA program.
Mr. PIKE. Oh, yes, but you are talking about a goal. I am asking,
are the programs productive programs? Do they show high productivity, or do they show very low productivity?
Dr. OSWALD. They show that they do provide workers without
skills new job training, in order to be able to fulfill the needs of our
society, and one of the basic elements by which we get productivity
growth is by having a trained work force that is skilled.
Mr. PIKE. I will simply say you are talking about the great goals
that we attribute to these programs. It is my personal judgment
that their efficiency rating, the productivity of the programs themselves, is very, very low.
32-052 0 - 78 - 14
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
206
You say that the real sources of inflation are "not wage pressures but supply shortages, identical productive capacity, high interest rates and actions of foreign oil-producing countries," and you
use as your next example food. Is there a supply shortage in food?
Dr. OSWALD. There is a supply shortage of certain foods. Beef
prices have increased 30 percent since last October.
Mr. PIKE. So have the prices of all the rest of the food, not as
rapidly as the beef prices, but they have all increased. Is not food
one of the few things in America we have really a huge surplus of?
It is our largest export, is it not?
Dr. OSWALD. And some of the exports may well have contributed
to the increase in price in the first half of this year. The export of
food has gone up by $1. 7 billion in the first half of this year.
Mr. PIKE. The farmers tell us that they cannot even make it
without (a) exporting, and (b) huge price increases, but you are
listing food as the chief cause, or you are listing it as the prime
example of inflation.
Dr. OSWALD. It is very clear in looking at Consumer Price Index
that in the first half of this year food prices have increased 17
percent at an annual rate.
Mr. PIKE. I agree with you.
Dr. OSWALD. More than doubled.
Mr. PIKE. And despite the fact that we have food coming out of
our ears?
Dr. OSWALD. I would like to point out a recent study by UNCTED
of what they claim is a major reason for some of the increases in
the price of both food and raw materials. They say it is because of
control of a few large corporations over food and raw material
processing. They use an example of cotton, where they say that 15
corporations worldwide control the price of cotton. They do not
blame it on the farmers but rather they blame it-Mr. PIKE. They may well be right, but it seems to me that there
is no more competitive industry in America than agriculture. We
have only 31/a automobile producers in this country, but we have
tens of thousands of food producers, so I just do not think you can
blame it on a food cartel.
Dr. OSWALD. But there are claims that certain corporations have
cornered the commodities futures market for particular items and
have influenced the price that farmers receive.
Mr. PIKE. You have gone from food to cotton?
Dr. OSWALD. No. You also have commodities futures in wheat,
soybeans, and hogs.
Mr. PIKE. I hear what you are saying. I do not buy it but I hear
it.
The CHAIRMAN. The time of the gentleman is expiring. It has
expired. The gentleman from Texas, Mr. Mattox.
Mr. MA'ITOX. I am interested in the statement that you made,
Dr. Oswald. I have heard your statements concerning the AFL-CIO
position on the general tax cut issue. I would be interested in
knowing whether you have continued to maintain your overall
position and the position that was taken in the Budget Committee
in the first resolution of asking for a reduction in social security
taxes or a conversion of general revenues to social security taxes as
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
207
a means of giving stimulus to the economy, and also tax relief to
the working people of the country.
·
Dr. OSWALD. Mr. Mattox, we still support that, and support Mr.
Giaimo's proposal, for the Second Budget Resolution.
We find the part of the proposal of Mr. Fisher for his alternate
tax proposal as a very important means of trying to move in that
direction.
Mr. MA'ITOX. Do you have any reason to believe we are going to
move in that direction?
Dr. OSWALD. Mr. Mattox, I am afraid that it seems that the
Congress recently has not been paying much attention to most of
the American people, at least if I read what has happened with the
bill that was reported by the Ways and Means Committee, because
only a very few wealthy individuals would get most of the money,
and unless we stop fooling people in terms of who gets the benfits
from these tax cuts, we are going to wake up and find that the
American people are aware that the tax cuts are going to the
wealthy and not to them.
Mr. MA'ITOX. How many members does the AFL-CIO have nationally?
Dr. OswALD. It has 14 million members.
Mr. MA'ITOX. It seems that with the combined role of the
AFL-CIO and the other working people out in the country, that we
could bring about a democratic tax proposal, a democratic tax
program, rather than one Mr. Ullman has ushered forth through
the Ways and Means Committee.
Dr. OswALD. I would hope so.
Mr. MA'ITOX. I am a little concerned. I honestly am. I am concerned about the Democratic platform and the actions of that
committee.
Let me take a statement and move forth with it. I am interested
in knowing your general assessment of the countercyclical program. You know that program is in serious trouble in the Government Operations Committee. I have reason to believe that the
subcommittee considered that and very well may opt to strike the
program, which is worth about $1 billion, I think $800 million. I
would be interested in knowing what you think about that action.
Dr. OSWALD. When we testified on the First Budget Resolution,
we spoke strongly in behalf of that policy. We are very much
concerned that the tax system be equitable, and the countercyclical
program operate in a way that really brings about a much more
equitable tax system, because Federal taxes are raised on a much
more equitable basis than the property taxes that are the basis for
many local governments, so the countercyclical program is a means
of providing funds in a much more equitable manner.
Mr. MA'ITOX. Do you think those funds are actually being provided to the cities of the country in an equitable fashion?
Dr. OSWALD. Mr. Mattox, we have been somewhat disturbed with
the allocation of funds, and I think the question is not to scrap the
program but to improve the allocation formula.
Mr. MA'ITOX. The thing that concerns me is if we keep bringing
forth these programs, and as we bring them forth we recognize
that these programs are not doing what we intend for them to do,
and we recognize that the allocations are not proper, and we are
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
208
not stimulating right and we are not doing this and not doing that,
but for some reason we cannot ever seem to disassemble them or
make them work right. I bring you to the issue of the CETA
program.
I have studied the CETA program rather closely in the last year.
I think this is probably your child, it has probably been your child
more than any other group; you've been more responsible for it
than any other group, and the approach of attempting to get at the
hardcore unemployed has totally escaped that program. I say totally and I mean totally, because I think that the program has not
done anywhere near what you originally conceived that you would
like for it to do.
I understand that your approach is, let's reform the program and
let's try to make it work right. Well, it appears pretty obvious that
we cannot make the program right at the level of 725,000 jobs,
because we cannot seem to administer it, and I agree with Ray
Marshall's statements. They are great statements, but his department is supposed to be administering that program, and it is a
disaster, so why should we give any great credence to that approach?
But assuming we cannot with 725,000, would it not be sensible to
maybe step that program back to say 600,000 or even 500,000 and
see if we can administer at a somewhat lower level to make it
work? Then if we can make it work at that level, then maybe
expand it to a greater and greater level. Is that not sensible?
Dr. OSWALD. Mr. Mattox, Mr. McGlotten has worked on CETA
for many years.
Mr. MATTOX. I know he has.
Mr. PIKE. It is his child?
Mr. McGLOTTEN. Mr. Mattox, let me first of all say that in terms
of the problems that the CETA program has had, I think first of all
we have to look at the history of the CETA program. It was
enacted in 1973. Title II was public service employment at approximately 150,000 jobs at that particular time, and it was running
very, very well.
In 1974 when the bottom fell out of the economy, we put on a
title VI to increase the authorization to deal with the unemployment problem. In 1975 in June we increased it a little bit more,
and in 1976 we still increased it a little bit more.
I am saying all that to say that during times of high unemployment we increased the number of jobs to deal with the unemployment problem. As a result of trying to deal with that problem, I
think many of the prime sponsors who were out there, and I do not
believe that mayors and county officials have any more knowledge
of manpower problems than the Labor Department does, but at
that particular time there was an increase and they tried to do the
best they could do.
As a result, there were some abuses, but I think if you look at
the program overall, you will find that the benefits have
outweighed the abuses. I think less than 2 percent of the amount of
job slots in the program have been found to be somewhat abusive,
dealing with the question of substitution, nepotism, and that kind
of thing.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
209
Mr. MATTOX. I think that depends on how you define those
things because I do not agree with any figure like that. I can go out
and count by hand and find the 2 percent easily.
The CHAIRMAN. The time of the gentleman is expiring.
Mr. MATTOX. Is expiring?
The CHAIRMAN. Go ahead, complete your question.
Mr. MATTOX. I think I have probably already made the point that
I am trying to make. The thing about it is, I think you will agree
that the program is not operating the way that we would really
like for it to operate. I think that is a fair assessment. I do not
think there is anything unfair about it. It just seems that to accept
responsibility for having these kinds of programs, and for the good
of the community it would be best for us to, when they are not
working exactly the way we want them to, is, instead of keep
charging forward, regroup and try to make it work a little better,
rather than having to get to the point where we have it just
destroyed entirely rather than just try to rebuild it.
Mr. McGLOTTEN. If I may just respond just for a couple of seconds, Mr. Chairman. Let me say to you, since the buildup, Mr.
Mattox, and since they have changed the eligibility criteria, and I
think looking at the present figures, most of the criticism that I
knew that Members of Congress have comes from a study that was
taken in 1974 and 1975, not in terms of the buildup, when you
went from 310 to 725,000 jobs.
You know there is the increased participation of the AFDC recipients, more unemployed people of 15 weeks or longer. I think there
have been a tremendous amount of changes that have taken place
in 1977-78.
·
Mr. MATTOX. I agree, but most of the criticisms I have are still
valid ones, and they have not changed. I have a feeling they have
gotten a heck of a lot worse.
The CHAIRMAN. The gentleman from Ohio, Mr. Latta.
Mr. LATTA. Thank you. Gentlemen, it is always good to have you
testify before the committee and give your viewpoints. I commend
you on your suggestion on page 2 where you are willing to support
tax cuts or budget cuts. Would you be more specific? Everybody is
against waste in Government. Where would you cut?
Dr. OswALD. Mr. Latta, the chairman in his proposal for the
Second Concurrent Resolution has noted some $8.4 billion in tax
cuts, which reflect a number of cuts in various areas, as well as
some increases, where either various agencies will not be able to
spend what has been allocated, where there have been changes in
legislation since the First Concurrent Budget Resolution, or where
th~re have been Appropriations Committee actions which lead to
such reductions.
We feel that such tax cuts reflect specific changes that have
taken place between May and the end of July. We feel that such
cuts are the sort that obviously the Budget Committee should be
looking at.
Mr. LATTA. May I interrupt you there? My quesiton was directed
toward budget cuts, what is cut out of the budget in addition to the
ways you mentioned.
Dr. OSWALD. That is an $8.4 billion cut.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
210
Mr. LATTA. Those are largely shortfalls. What we are saying is,
the agencies did not meet their spending goals and therefore you
have a shortfall.
The CHAIRMAN. Will the gentleman yield?
Mr. LATTA. I will be happy to yield.
The CHAIRMAN. Some of it is shortfall, with much of it in the
defense category, which would seem to indicate that defense is
getting more money than can be spent each year. Some of it, I
think about $3 billion of it, is the result of reductions recommended by the Appropriations Committee in a number of different programs. Some of it stems from a delay in initiatives requiring legislation that was intended to get on the books this year, such as the
urban policy package. So I think the shortfall is a mix. I think that
is basically what he is trying to say.
Incidentally, there are some increases to offset the reduction,
because of legislative reforms which Congress for one reason or
another has not or will not enact-wage reform, hospital cost containment, social security et cetera.
Mr. LATTA. I knew the chairman's answer. I wanted the witness'
answer.
Mr. PIKE. Point of order, Mr. Chairman. You talked Mr. Latta
right out of all his time.
The CHAIRMAN. I know I did.
Mr. LATTA. I take it back. I want to be specific because it is
important to know what you have in mind when you talk about
budget cuts. For example, you probably read and heard about the
waste in HEW that GAO found-$7 billion. An effort was made
when the HEW bill was on the floor to just cut out half the waste.
Let me ask you this: Did your organization support that amendment?
Dr. OSWALD. Mr. Latta, we did not support the amendment.
Mr. LATTA. What in HEW would you want to cut out?
Dr. OSWALD. Mr. Latta, we do support all efforts to try and
assure that the programs teach those people for whom the programs have been intended, and we support actions that assure that
waste does not take place in a program. We don't think that . you
get at the waste by just arbitrarily setting a limit on the money for
the Department of HEW.
Mr. LATTA. Apparently you don't want to give me, or give the
committee, specifics about budget cuts that we are all looking for.
Let's move on to something else.
You talk about high interest rates. Everybody is against high
interest rates, but can we agree that with a one-half trillion dollar
budget in 1 year that this might add something to inflation and
consequently raise interest rates because Government has to go out
and borrow so much? Treasury is going to go this week again with
a sale for some refinancing and they are going to be selling Treasury notes for something like 8% percent, a very high figure for
long-term notes, and just what we are talking about that drives up
interest rates that you are against.
Dr. OSWALD. Mr. Latta, the drive up of the interest rates is not
because-Mr. LATTA. Of the Government's spending.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
211
Dr. OSWALD [continuing]. Of the movement into the market of
the Government as much as the rediscount rate set by the Federal
Reserve Board. By pushing up the rediscount rate, it has forced up
interest rates across the board.
Now that is an appropriate policy if you are fighting a sort of
inflation that is based on an overheated economy, where you have
an overabundance of consumer demand and a shortage of supply,
such as existed right after World War II. Then people had money
to spend. They had savings during World War II and you had a
shortage of goods. At that time, high interest rates would cool
down the economy and would have the effect of curtailing the
inflation.
Today, a high interest rate only adds to the inflation and is built
into the cost of the deficit here; it has gone up $1 billion in the new
mark of the chairman.
Mr. LA'ITA. It really doesn't affect the interest rates when the
Government has to go out and borrow, say, $45 billion or $50
billion to finance the debt; that doesn't affect interest rates?
Dr. OswALD. Not as substantially as the level of the rediscount
rates that are established by the Federal Reserve Board.
Mr. LA'ITA. Let me go on to page 5.
Dr. OswALD. Mr. Latta, if I may go on-interest rates fell in 1975
when we had a deficit of over $60 billion, but we had a big recession at that time, so just the level of borrowing of the Federal
Government itself is not the primary determinant of the interest
rate.
Mr. LA'ITA. I see where you want export controls on agricultural
commodities; is that correct?
Dr. OSWALD. We would like the Government to have a role in the
export of agricultural commodities, such as the Canadians do in
terms of wheat, and as you recall, in the 1972, 1973, 1974 period,
the large export of wheat to Russia was a primary cause of some of
the price increases that took place at that time.
Mr. LA'ITA. You probably realize-one more question, Mr. Chairman-that we have a serious balance-of-payments problem in this
country, and if you are going to cut down on exports of agricultural
commodities, how is that going to affect that problem? Isn't it
going to complicate it and make it worse?
Dr. OswALD. Mr. Latta, if we are paying toward the balance-ofpayment problems with an inflationary food policy, then we
haven't accomplished anything; and I would like to bring to your
attention the fact that agricultural exports did increase substantially in the first half of this year, at the same time that we had a
17-percent increase in food prices in this country; and we think
that you do have to look at both of them together.
Mr. LA'ITA. You have to look at the farmer, too. There are a lot
of them in this country that have to live, too.
Dr. OswALD. We have been very supportive of programs to aid
farmers, but some of the gains of the exports have not been going
to farmers. As a matter of fact, in the 1973-74 wheat deals with
Russia and China, it was shown that most of the benefits did not go
to the farmers but rather to a few large corporations.
Mr. LA'ITA. A lot of the benefits went to the longshoremen who
were striking; they got what they wanted.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
212
The CHAIRMAN. The time of the gentleman from Ohio has expired. The gentleman from Illinois, Mr. Simon.
Mr. SIMON. Thank you, Mr. Chairman.
I agree with much of what you have to say. In response to
suggestions of my colleagues on the productivity area, it does seem
to me-and this is in partial response to my colleague from New
York-that where Government programs hit at structural unemployment-and we recognize that we are just not going to let
people starve; we are either going to pay them for doing nothing or
pay them for doing something-it just makes infinitely more sense
to pay people for being productive.
There are major deficiencies with CETA. I think the major deficiency being that we still view it as a temporary thing and we have
not really viewed unemployment-structural unemployment-as a
permanent phenomenon in our society; and I think it is-and you
and I agree on some of the things, some of the features that ought
to be in the program; but I think that is one thing.
The second thing is, if we are really aiming at increasing productivity, then the cuts by the Ways and Means Committee-meaning
no disrespect to that committee-ought to be in the area of depreciation allowance, speeding that up, rather than the capital gains
area.
I happen to agree with the importance of interest rates. My
present inclination, frankly, is to support the Yanik-Pickle approach, because if we can reduce the demands-and I think my
colleague from Ohio is correct-if there is less demand from the
Federal Government for borrowing, that is going to have a healthy
effect on interest rates; plus I have had some conversations with
one of the members of the Federal Reserve Board and I think it is
likely that if we reduce that deficit another $16 billion, there will
be a reduction in interest rates in the Nation, and that can stimulate the economy more than any additional $15 billion or $16
billion in tax cuts.
I am just curious. If you face the situation where we end up with
the program that emerged from Ways and Means-and, incidentally, as I read the statements and recalling a meeting with the
chairman of the Senate Finance Committee-what may emerge
from the Senate Finance Committee may be appreciably worse
than what came from Ways and Means. But if I have to face a
situation of what emerged from Ways and Means and YanikPickle, it seems to me Yanik-Pickle is going to do more to help the
economy of this Nation than what emerged from Ways and Means.
Am I correct or incorrect in that assumption?
Dr. OswALD. We think that what emerged from Ways and Means
is clearly an inequitable program that provides most of the tax
relief only to the wealthy, and we are in perfect agreement that
that would be a disastrous move by this Congress in terms of
equity in our society.
The Yanik-Pickle amendment would provide no stimulus whatsoever to the economy; it would offset the approximate $9 billion
drag that would occur from policies that expire at the end of this
year.
We still have about a $7 billion drag from the increase in social
security. We would hope that there would be more of a move
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
213
toward the Corman or even the Fisher-type alternative than the
one that was reported by the Ways and Means Committee.
Mr. SIMON. But I am not sure I agree with you when you say it
would be a drag. If, in fact, it ended up reducing interest rates,
couldn't it be that that would stimulate the economy as much as
what has emerged from Ways and Means?
Dr. OSWALD. Mr. Simon, the interest rates will not automatically
come down if the Federal budget deficit is $37 billion, or $43 billion
as put forth in the chairman's proposal; it can come down if the
Federal Reserve Board will stop increasing the rediscount rate.
Mr. SIMON. It could, but you would recognize that the probability
of that happening would increase tremendously?
Dr. OSWALD. Not for a $6 billion or $7 billion reduction in the
amount that the deficit is up or down.
Mr. SIMON. Let me then get back to my question which didn't get
answered, if I may, and I understand your reason for reluctance to
answer. Faced with a choice of Yanik-Pickle or what emerged from
Ways and Means, which would you vote for?
Dr. OSWALD. Mr. Simon, the reason I haven't answered it more
directly, is that this is one of the things that the executive council
of the AFL-CIO will itself be reviewing because of our concern
with the inequitable proposal that has come from Ways and Means.
The executive council will be meeting a week from today and
may take a formal position that answers your question. I would
prefer not to answer it more directly at this point.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from California, Mr. Mineta.
Mr. MINETA. Thank you, Mr. Chairman.
Dr. Oswald, I appreciate your testimony here today. On page 4
you indicate "a preoccupation with reducing the fiscal 1979 budget
·deficit by cutting Federal spending does not make sense in the
present state of the economy." Then at the bottom of the page you
also say,"Taxpayer discontent and frustration cannot be ignored."
It seems to me somewhere we have to be dealing with that whole
issue and that that is what we are attempting to do in the Second
Budget Resolution.
Then on page 5, at the bottom, you deal with some of the causal
factors about inflationary pressures, and I am wondering, can you
get into some more specifics about how we can deal with these
inflationary pressures.
Dr. OswALD. Mr. Mineta, on the food side, which in the first half
of this year I had indicated had been increasing at a rate of 17
percent on an annual rate, we need to have policies that assure
that such things as the commodities futures market is operating in
a way to provide farmers with adequate funds and assurances of a
fair return without causing severe inflationary pressures of its
own.
Mr. MINETA. Price support programs?
Dr. OSWALD. In terms of price support programs, they should be
programs that provide farmers with a fair return, with maybe
some maximum, as has been considered a number of times and has
not passed the House, so that rather than unlimited supports for
any particular farmer, that the price supports have a limit in
terms of the amount that any particular farmer might receive.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
214
Mr. MINETA. How do we deal with sugar, for instance, where it is
about 68, as a rule, what the farmers are getting, and yet the cost
of production for the farmer is up around 11 cents, and as I
understand it, there is a bill in Agriculture to have a support
program at roughly 16 cents, how do we deal with that in terms of
looking at the farmers' plight and at the same time seeing what
kind of inflationary pressures that kind of a bill in Agriculture
would add?
Dr. OSWALD. Mr. Mineta, we have tried to review the sugar price
bill and at this point we haven't finished that review; so I cannot
give you a clear answer on that bill, but we share the concern that
you mentioned.
Mr. MINETA. What about fuel, should the President impose
import limitations, quotas?
Dr. OswALD. We would rather have import quotas than the proposal he once made, of an additional surcharge on foreign oil. We
have said before that if the need is to have some sort of a rationing
system, that rationing is better than an inflationary proposal
·
which would raise the price.
For many people in our society, the car is a necessity to get to
and from work. We support policies that do not raise energy prices
but that will lead to conservation, and we have long supported
programs that would lead to the development of new energy
sources so that we won't have such a severe dependence on oil
imports.
During the first half of this year we did import some nearly $2
billion less in oil than we did in the first half of 1977, and I think
that some of the benefits of the Alaskan oil have begun to appear,
and I hope we get even more benefits from natural gas from
Canada shortly.
We are distressed with the moves to deregulate natural gas, for
example, which we feel would only result in a price increase and
would not lead to more natural gas being produced.
Mr. MINETA. Dr. Oswald, I appreciate the statement you presented here today. Thank you.
The CHAIRMAN. The time of the gentleman has expired. Does the
gentleman from New York seek recognition?
Mr. PIKE. Yes, Mr. Chairman.
Dr. Oswald, your tax proposal is a $11 billion tax cut for individuals; is that correct?
Dr. OSWALD. Yes; assuming a start in January in 1979, $11
billion would be in the fiscal cost.
Mr. PIKE. What was the total amount of your tax cut?
Dr. OSWALD. We have only made a proposal in the area of
individual tax cut.
Mr. PIKE. So there was nothing for corporations or for businesses
in your proposal?
Dr. OSWALD. We have not made any recommendations for a tax
cut for corporations or businesses.
Mr. PIKE. Was that to be a refundable credit?
Dr. OSWALD. No; it was to be just to increase the current $35 tax
credit to $150. It would not be refundable, but its distributional
aspects would be such that most of the benefits would go to those
with income below $30,000.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
215
Mr. PIKE. Mr. McGlotten, you said that the criticism of the
CETA progam is based on an old study, 1974, 1975 study. Isn't that
the period in which you said that the CETA program was working
well?
Mr. McGLOTTEN. No. I indicated that that was the period of
growth in the CETA program and I suspect that many of the
abuses-Mr. PIKE. What was the period when they had 150,000 CETA
jobs?
Mr. McGLOTTEN. That was in 1973.
Mr. PIKE. Wasn't the 1974 study based on the 1973 program?
Mr. McGLOTTEN. No. The 1974 study was based on title Vl which
came into existence in December of 1974. If you remember, this
was close to Christmas, when we decided to do something about the
high unemployment rate.
Mr. PIKE. Right. If the program worked well at 150,000 jobs,
doesn't that sort of take you to where Mr. Mattox was trying to
take you?
Mr. McGLOTTEN. No, because at the time of the buildup, what
happened, it worked well in 1973 and part of 1974 under title II
which dealt specifically with the whole question of structurally
unemployed. When it got involved in a kind of cyclical unemployment, it was just hard to define who was structurally unemployed
and who was not structurally unemployed.
Mr. PIKE. I agree that is a problem. I would also agree there are
people who are structurally unemployed, but defining is a real
problem.
You have come out against cutting waste in Government spending, which is not a new breakthrough on anybody's part, but don't
you think that the concept of saying that you are going to cut the
budget only where the departments have not spent the money is
about the most wasteful motivation you can think of? I can't think
of anything which is more likely to get departments to spend
money than the concept that the budget is going to be cut if they
don't spend the money.
Dr. OswALD. Mr. Pike, Congress continuously reviews programs
that are administered by various agencies, as you well know.
Mr. PIKE. I served for 14 years on the Armed Service Committee.
I have watched how Congress has kept a hawk eye on defense
spending and cut it to the bone year after year, just as they did
this year. Please go ahead.
Dr. OSWALD. There are some programs that are curtailed and
there are some that are expanded. I think that is an appropriate
role at this particular point.
Mr. PIKE. Yes, but Congress almost always expands defense programs. Isn't that a fair statement? Do you really think Congress'
oversight of spending programs amounts to a hill of beans?
Dr. OswALD. Congress does attempt to do, I think-Mr. PIKE. Congressmen like to get elected.
Dr. OSWALD. But the means is not to approach defense problems
by some arbitrary number that just is selected out of a hat and say
that we are going to take care of our defense needs by arbitrarily
cutting an agency by $10 billion. I think that is a real problem.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
216
Mr. PIKE. The constituency of each congressional committee is
such that whoever is reviewing the programs wants to increase the
program that it is reviewing.
Mr. Mattox, I resent your coaching the witness.
Mr. MATTOX. I have been trying to help you. We can't seem to
get our point across.
Mr. PIKE. Mr. Chairman, I yield back the balance of time that I
do not have left.
The CHAIRMAN. The time of the gentleman has expired.
We want to thank both of you for testifying and responding to
the questions here today. Thank you very much.
The Chair recognizes the gentleman from California, Mr. Mineta,
for an inquiry.
Mr. MINETA. Thank you, Mr. Chairman.
I know that tomorrow, under the suspension calendar, we are
going to have H.R. 12972, dealing with the SSI for the handicapped.
The concern that has been raised with me is whether or not within
the budget resolution there is enough to accommodate the will of
the House should it pass this bill by its two-thirds majority tomorrow; and so I would like to inquire of staff about the possibility of
making sure that the amount necessary for this bill is included and
that there is enough room in the budget resolution for H.R. 12972,
recognizing that we don't work on the line item. I am just wondering within the gross amounts for the program-The CHAIRMAN. If the gentleman will yield, this matter was
brought to my attention today too, and I would like to work this
out as best we can, to make sure that we don't jeopardize this
program's chances by excluding it in the Budget Committee's deliberations during markup.
Part of the problem, is that Ways and Means did not see fit to
accord the legislation high priority in its March 15 302 allocation.
Since then, however, they have reported out a :bill and it is coming
up on the floor tomorrow.
I think there is a lot of merit to this legislation, and I think we
should encourage its passage. I think it needs encouragement.
I am sure we can find a way this week, as we markup, to make
certain that it is accommodated, even though, as you know, we
don't line item.
Mr. MINETA. I appreciate the assurances of the chairman, and
this will be, I think, a subject we can take up Wednesday when we
start marking up the Second Resolution.
The CHAIRMAN. Right.
Mr. MINETA. Thank you very much.
The CHAIRMAN. Let me remind everyone that we are meeting at
1 o'clock for an early warning briefing. At 2 o'clock we will have
the Director of 0MB followed by the Chamber of Commerce representative.
The hearing stands adjourned until 2 o'clock.
AFI'ERNOON SESSION
The CHAIRMAN. The committee will please come to order.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
217
Today we intend to conclude testimony on the Second Budget
Resolution for Fiscal Year 1979, which will set a binding spending
ceiling and revenue floor for the fiscal year ·beginning October 1.
While I have already announced the chairman's recommendations for the Second Budget Resolution, I want to assure today's
witnesses that the Budget Committee has made no decisions and
that my own recommendations are not inflexible. The recommendation or chairman's mark will serve merely as the starting point
when the committee begins marking up th~ Second Resolution on
Wednesday. We hope to order the resolution reported this week
and to bring it to the floor of the House about August 15.
I will be recommending to the committee outlays of $490.49
billion, revenues of $446.8 billion, a deficit of $43.6 billion. That
deficit is $17 billion below the $60.6 billion deficit presented by
President Carter last January.
Our first witness this afternoon is James T. McIntyre, Jr., Director of the Office of Management and Budget. Welcome to the
Budget Committee.
As you can see, we have taken seriously the recommendation you
made last week to the Senate to reduce expenditures. The outlays
are considerably below the $496.6 billion estimate of July 6. Even
$490.4 billion may be on the high side, if reductions are made in
the course of floor consideration of the two remaining appropriation bills-defense and foreign aid.
As we markup, we will be looking for additional ways to reduce
expenditures. We would appreciate any suggestions you have along
those lines, Mr. McIntyre.
The Ways and Means Committee, as you know, reported out a
$16 billion-on a calendar basis-tax reduction last Thursday. In
contrast to most tax bills, this one will have a rule which will
permit the consideration of several substitutes. We would like your
opinion of the Kemp-Roth and Fisher substitutes.
With that, Mr. McIntyre, we welcome you again to the committee. We have enjoyed working with you and your able staff
throughout the year, and we look forward to further cooperation in
bringing this budget deficit down-hopefully to a balanced budget
within a very few years.
You may proceed as you wish, Mr. McIntyre.
STATEMENT OF HON. JAMES T. McINTYRE, JR., DIRECTOR,
OFFICE OF MANAGEMENT AND BUDGET, ACCOMPANIED BY
BOWMAN CUTTER, EXECUTIVE ASSOCIATE DIRECTOR FOR
BUDGET; AND CAREY P. MODLIN, DEPUTY ASSISTANT DIRECTOR FOR BUDGET REVIEW
Mr. McINTYRE. Thank you, Mr. Chairman. I am pleased to
appear before this committee as you conclude your hearings on the
Second Budget Resolution for Fiscal Year 1979.
I ,h ave ,with me today Bowman Cutter, who is Executive Associate Director for Budget, and Pete Modlin, who is in our Budget
Review Division.
On July 6, we issued the Mid-Session Review of the Budget,
revising budget estimates for 1978, 1979, and subsequent years. I
will discuss these estimates briefly.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
218
I would urge the committee to be and continue to be rigorous in
the review it undertakes as it prepares the Second Concurrent
Resolution, with the objective of producing a resolution that calls
for lower spending. Budget restraint is appropriate now. It is consistent with both the economic outlook and the need for increased
governmental efficiency, which spending restraint will encourage.
1978 AND 1979 BUDGET ESTIMATES
In the table entitled, "1978 and 1979 Budget Totals" in my prepared statement, our 1978 and 1979 revisions show lower Federal
spending and lower deficits than were projected in January. The
fiscal year 1978 deficit is now estimated at $51.1 billion, $10.6
billion less than the January budget estimate. This decrease can be
attributed almost entirely to a lower estimate of Federal spending.
Our current estimate of the deficit for 1979 is $48.5 billion, $12
billion below the January budget. This decrease reflects: The
change in administration tax policy to delay the proposed tax cut
and to reduce it from an annual rate of $25 billion to $20 billion;
intensive administration efforts to constrain 1979 spending; and a
shortfall of Federal outlays in a number of categories from the
January budget.
ECONOMIC ASSUMPTIONS.
I should like, first, to discuss briefly the economic assumptions
that underlie the Mid-Session Review estimates. I will not go into
detail on this because Chairman Schultze has already testified on
this. The economic outlook for calendar years 1978 and 1979 shows
higher inflation, lower real growth, and less unemployment than
were forecast in January. The rate of inflation is now predicted to
be about 7 percent during 1978 and about 6½ percent during 1979.
These figures are above the January budget assumptions by about
1 percentage point for 1978 and one-half percentage point for 1979.
The rate of real growth is less than was forecast in January by
about one-half percentage point in both 1978 and 1979. Despite this
lower real growth, the expansion in employment and the decline in
the unemployment rate are expected to equal .o r exceed earlier
expectations. Progress on the employment front this year has been
considerably greater than we had anticipated.
RECEIPTS
Receipts in 1978 are now estimated at $401.2 billion, about the
same as estimated in January. Receipts in 1979 are estimated to be
$448.2 billion, almost $8 billion above the January budget estimate.
Changes in legislation since January add almost $10 billion to 1979
receipts, while revised incomes and technical reestimates reduce
receipts in 1979 by about $2 billion. With respect to legislation, the
delay in the effective date of the administration's tax reduction
and reform proposals from October 1978 to January 1979, and the
reduction in the size of the tax cut from an annual rate of $25
billion to $20 billion, increases 1979 receipts by $11 billion. Delayed
enactment of the President's energy tax proposals reduces 1979
receipts by about $1 billion.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
219
OUTLAYS
Our estimates of outlays for 1978 have been reduced by $10.8
billion since the January budget, to $452.3 billion. For 1979, a
thorough review of planned outlays and actual spending experience
has enabled the administration to reduce spending estimates by
$4½ billion below the January budget to $496.6 billion. A table
showing the outlay changes since January is attached to my statement.
Examination of actual spending thus far this year indicates that
most agencies have fallen below the spending plans consistent with
their January estimates. It is clear that the tendency of agencies to
overestimate spending for the current year-which has caused
shortfalls in all but one year since 1970-has continued. Our 1979
outlay estimates are based upon, among other things, experience to
date in 1978, not on a completed year. In the light of the record of
shortfalls in recent years, we cannot say with any degree of assurance that further shortfalls will not occur in 1979. During the past
year, 0MB has worked with Federal agencies to improve the quality of their estimates. We think these estimates have improved, but
the revisions incorporated in the Mid-Session Review demonstrate
that vigorous efforts to improve them further must be continued.
Our current estimate of spending in 1979-$496.6 billion- is $2.2
billion below the First Budget Resolution. Moreover, our estimates
include $1.4 billion in outlays for energy rebates to offset proposed
new energy taxes. These outlays, which do not affect the deficit,
are not included in the First Resolution. Adjusting for this difference, the current administration outlay total is actually $3.6 billion
below the resolution. Virtually all of this difference represents
policy increases implicit in the resolution.
BUDGET AUTHORITY
The current estimate of total budget authority in 1978 is $503.8
billion, about the same as in January, and $2.1 billion above the
March estimate. Most of the change since March is due to the
increased authority required for disaster relief and loans, and reestimates of trust funds receipts and interest. Since January, our
estimates of 1978 budget authority have been above the Second
Resolution and the CBO scorekeeping estimates because of technical estimating differences.
Our current estimate of budget authority in 1979 is $571.4 billion, $2.4 billion above the January estimate and $4.9 billion above
the March estimate. Increases in budget authority for the urban
initiative, water resources, and other programs are partly offset by
the elimination of the allowance for contingencies and revisions in
the estimates for several trust fund receipts.
Even though the First Budget Resolution for 1979 assumes discretionary budget authority increases for many programs, the resolution is $2.6 billion below the administration total. One reason for
this is the fact that the resolution rejects or reduces several items
that require relatively large amounts of budget authority, such as
the municipal bond option and forward funding for certain education and health programs. In most cases, these cuts have virtually
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
220
no impact on the size of the deficit in 1979 and will do little, if
anything, to hold down the deficit in future years.
THE LONG-RANGE BUDGET OUTLOOK
As required, this Mid-Session Review also presents longer range
budget estimates. I want to stress, and stress strongly, that the
estimates for fiscal year 1980 and beyond do not represent the
actual totals to be published in the President's 1980 budget that we
will send to the Congress early next year. I think the current
estimate of 1980 outlays is unacceptably high. I think the current
estimate of the 1980 deficit is unacceptably high. Between now and
the end of the calendar year we will work to get those numbers
down-both the spending number and the deficit number. I think,
and I have told the President, that it is imperative that we continue to strive for more fiscal restraint.
CONCLUSION
In conclusion, I would like to reiterate my belief that it is imperative that there be a general tightening down on all Federal
spending that is not mandatory.
·
I say this for two reasons. First, restraint in 1979 spending would
represent an appropriate fiscal policy in an economy in which
unemployment has declined more than ·had been expected and in
which prices are rising rapidly. Such restraint would show that the
Federal Government is serious about our anti-inflation program,
and would permit a better balance of fiscal and monetary policies.
In addition, it would be an effective means of encouraging increased governmental efficiency.
Second, as I noted earlier, the budget outlook for 1980 is disturbing. It is already clear that spending in 1980, which under current
programs and administration proposals would approach $550 billion, is going to have to be pared back very significantly. It is by no
means too early to begin dealing with this problem.
Thus, the message I want to leave with the distinguished members of this committee today is that the administration is ready
and willing to work with the Budget Committees, the Appropriations Committees, and others in the Congress to limit the growth
in Federal spending. I believe that by a combination of tighter
estimates, eliminating the discretionary spending increases over
the President's budget implicit in the First Resolution and in some
of the bills currently pending before the Congress, and perhaps
even an across-the-board cut, we could achieve a substantial reduction in 1979 spending.
As I stated last week, it is my belief that a target of total outlays
in the neighborhood of $491-$492 billion for a cut of about $5
billion would be an appropriate objective of such an exercise.
Mr. Chairman, I was pleased when you announced last Friday
that you are recommending to this committee that the Second
Concurrent Resolution set $490.4 billion as the appropriate level of
outlays for 1979. When adjusted to take into account the energy
tax rebates, of $1.4 billion, your figure is virtually identical to the
target the administration is suggesting-in the neighborhood of
$491 billion to $492 billion.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
221
As our difference on the energy tax rebates illustrate, we are not
likely to agree in every detail on the composition of the total, but
our closeness on the appropriate total for outlays is very encouraging.
I look forward to working with this committee and with others in
the Congress to maintain the budget discipline that the total requires, and I am convinced that strict discipline will be required,
for it is doubtful that the desired total can be achieved without
some program reductions.
Mr. Chairman, as you know, we have a close working relationship with your committee staff in this effort, and we will continue
to pursue this effort.
That concludes my prepared statement, Mr. Chairman. I would
be happy to answer any questions you might have.
[The prepared statement of Mr. McIntyre follows:]
PREPARED STATEMENT OF HON. JAMES
T.
McINTYRE, JR.
Mr. Chairman and members of the committee, I am pleased to appear before this
committee as you conclude your hearings on the Second Budget Resolution for
Fiscal Year 1979. On July 6, we issued the Mid-Session Review of the budget,
revising budget estimates for 1978, 1979, and subsequent years. I will discuss these
estimates briefly.
I would urge the committee to be rigorous in the review it undertakes as it
prepares the Second Concurrent Resolution, with the objective of producing a resolution that calls for lower spending. Budget restraint is appropriate now. It is
consistent with both the economic outlook and the need for increased governmental
efficiency, which spending restraint will encourage.
1978 AND 1979 BUDGET ESTIMATES
As shown in the following table, our 1978 and 1979 revisions show lower Federal
spending and lower deficits than were projected in January. The fiscal year 1978
deficit is now estimated at $51.1 billion, $10.6 .billion less than the January budget
estimate. This decrease can be attributed almost entirely to a lower estimate of
Federal spending. Our current estimate of the deficit for 1979 is $48.5 billion, $12
billion below the January budget. This decrease reflects:
The change in administration tax policy to delay the proposed tax cut and to
reduce it from an annual rate of $25 billion to $20 billion;
Intensive administration efforts to constrain 1979 spending; and
A shortfall of Federal outlays in a number of categories from the January budget.
32-052 0 - 78 - 15
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
222
1978 AND 1979 BUDGET TOTALS
[In billions of dollars]
1978
President's budget
January
1
March
1
July
Second
resolution
Receipts ................................................................... .
Outlays ......................................................................
401.3
463.1
401.4
454.4
401.2
452.3
397.0
458.25
Deficit .........................................................
Budget authority ..................................................... ..
- 61.8
503.9
- 53.0
501.7
- 51.1
503.8
-61.25
500.1
1
July
First
resolution
- - - -- -- -- - - -- - - -- -- -
1979
President's budget
January
1
March
Receipts ....................................................................
Outlays......................................................................
440.5
501.0
440.7
500.2
448.2
496.6
447.9
498.8
Deficit .........................................................
Budget authority .......................................................
- 60.5
569.1
- 59.5
566.6
- 48.5
571.4
- 50.9
568.85
- - - - - - - - - - - -- -- -
1 Revised for accounting changes. Earned income credit payments in excess of an individual's tax liability, formerly treated as
income tax refunds, are now classified as outlays. In addition, the budget estimates now include activities of the exchange stabilization
fund that were formerly off-budget.
Economic assumptions. -I should like, first, to discuss briefly the economic assumptions that underlie the Mid-Session Review estimates. I will not go into detail
on this because Chairman Schultze has already testified on this. The economic
outlook for calendar years 1978 and 1979 shows higher inflation, lower real growth,
and less unemployment than were forecast in January. The rate of inflation is now
predicted to be about 7 percent during 1978 and about 6½ percent during 1979.
These figures are above . the January budget assumptions by about 1 percentage
point for 1978 and a one-percentage point for 1979.
The rate of real growth is less than was forecast in January by about one-half
percentage point in both 1978 and 1979. Despite this lower real growth, the expansion is employment and the decline in the unemployment rate are expected to equal
or exceed earlier expectations. Progress on the employment front this year has been
considerably greater than we had anticipated.
Receipts.-Receipts in 1978 are now estimated at $401.2 billion, about the same as
estimated in January. Receipts in 1979 are estimated to be $448.2 billion, almost $8
billion above the January budget estimate. Changes in legislation since January add
almost $10 billion to 1979 receipts, while revised incomes and technical reestimates
reduce receipts in 1979 by about $2 billion. With respect to legislation, the delay in
the effective date of the administration's tax reduction and reform proposals from
October 1978 to January 1979, and the reduction in the size of the tax cut from an
annual rate of $25 billion to $20 billion, increases 1979 receipts by $11 billion.
Delayed enactment of the President's energy tax proposals reduces 1979 receipts by
about $1 billion.
Outlays.-Our estimates of outlays for 1978 have been reduced by $10.8 billion
since the January budget, to $452.3 billion. For 1979, a thorough review of planned
outlays and actual spending experience has enabled the administration to reduce
spending estimates by $4½ billion below the January budget to $496.6 billion. A
table showing the outlay changes since January is attached to my statement.
Examination of actual spending thus far this year indicates that most agencies
have fallen below the spending plans consistent with their January estimates. It is
clear that the tendency of agencies to overestimate spending for the current yearwhich has caused shortfalls in all but one year since 1970-has continued. Our 1979
outlay estimates are based upon, among other things, experience to date in 1978,
not on a completed year. In the light of the record of shortfalls in recent years, we
cannot say with assurance that further shortfalls will not occur in 1979. During the
past year, 0MB has worked with Federal agencies to improve the quality of their
estimates. Compared to 1977, these estimates have improved, but the revisions
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
223
incorporated in the Mid-Session Review demonstrate that vigorous efforts to improve them further must be continued.
Our current estimate of spending in 1979-$496.6 billion-is $2.2 billion below the
First Budget Resolution. Moreover, our estimates include $1.4 billion in outlays for
energy rebates to offset proposed new energy taxes. These outlays, which do not
affect the deficit, are not included in the First Resolution. Adjusting for this difference, the current administration outlay total it actually $3.6 billion below the
resolution. Virtually all of this difference represents policy increases implicit in the
resolution.
Budget authority.-The current estimate of total budget authority in 1978 is
$503.8 billion, about the same as in January, and $2.1 billion above the March
estimate. Most of the change since March is due to the increased authority required
for disaster relief and loans, and reestimates of trust funds receipts and interest.
Since January, our estimates of 1978 budget authority have been abovf:' the Second
Resolution and the CBO scorekeeping estimates because of technical estimating
differences.
Our current estimate of budget authority in 1979 is $571.4 billion, $2.4 billion
above the January estimate and $4.9 billion above the March estimate. Increases in
budget authority for the urban initiative, water resources, and other programs are
partly offset by the elimination of the allowance for contingencies and revisions in
the estimates for several trust fund receipts.
Even though the First Budget Resolution for 1979 assumes discretionary budget
authority increases for many programs, the resolution is $2.6 billion below the
administration total. One reason for this is the fact that the resolution rejects or
reduces several items that require relatively large amounts of budget authority,
such as the municipal bond option and forward funding for certain education and
health programs. In most cases, these cuts have virtually no impact on the size of
the deficit in 1979 and will do little, if anything, to hold down the deficit in future
years.
THE LONG-RANGE BUOOET OUTLOOK
As required, this Mid-Session .Review also presents longer range budget estimates.
I want to stress, and stress strongly, that the estimates for fiscal year 1980 and
beyond do not represent the actual totals to be published in the President's 1980
budget that we will send to the Congress early next year. I think the current
estimate of 1980 outlays is unacceptably high. I think the current estimate of the
1980 deficit is unacceptably high. Between now and the end of the calendar year we
will work to get those numbers down-both the spending number and the deficit
number. I think, and I have told the President, that it is imperative that we
continue to strive for more fiscal restraint.
THE BUDGET OUTLOOK, 1979- 1983
[In billions of dollars]
Receipts ........................................................
Outlays..........................................................
1979
1980
1981
1982
1983
448.2
496.6
507.3
549.4
580.0
591.3
651.3
631.0
720.5
671.5
- 48.5
571.4
- 42.1
625.2
- 11.3
680.6
20.3
728.8
49.0
768.8
- - - - - - - -- - -- - -- - - -- - -
SurpIus or deficit ( - ) ...................
Budget authority ...........................................
Note.- The budget details for 1980 and 1981 do not reflect budget or fiscal policies desired by the Administration for those years.
CONCLUSION
In conclusion, I would like to reiterate my belief that it is imperative that there
be a general tightening down on all Federal spending that is not mandatory.
I say this for two reasons. First, restraint in 1979 spending would represent an
appropriate fiscal policy in an economy in which unemployment has declined more
than had been expected. and in which prices are rising rapidly. Such restraint would
show that the Federal Government is serious about our anti-inflation program, and
would permit a better balance of fiscal and monetary policies. In addition, it would
be an effective means of encouraging increased governmental efficiency.
Second, as I noted earlier, the budget outlook for 1980 is disturbing. It is already
clear that spending in 1980, which under current programs and administration
proposals would approach $550 billion, is going to have to be pared back very
significantly. It is by no means too early to begin dealing with this problem.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
224
Thus, the message I want to leave with the distinguished members of this committee today is that the administration is ready and willing to work with the Budget
Committees, the Appropriations Committees, and others in the Congress to limit the
growth in Federal spending. I believe that by a combination of ti~hter estimates,
eliminating the discretionary spending increases over the President s budget implicit in the First Resolution and in some of the bills currently pending before the
Congress, and perhaps even an across-the-board cut, we could achieve a substantial
reduction in 1979 spending. It is my belief that a target of total outlays in the
neighborhood of $491-$492 billion for a cut of about $5 billion would be an appropriate objective of such an exercise.
Mr. Chairman, as you know, we have been working with your committee staff in
this effort, and we will continue to pursue this effort.
That concludes my prepared statement, Mr. Chairman. I would be happy to
answer any questions·you might have.
Enclosures.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
225
CHANGE IN BUDGET OUTLAYS, 1978 AND 1979
(in billions of dollars)
1978
1979
.
.
463. 1
-0.5
501. 0
0.8
.
-1.5
.
-2.0
0.2
.
.
-0.2
-1.5
-0.4
.
.
.
.
-0.9
-0.6
-0.5
- 1. 0
-0.5
Subtotal, Reestimates .......... .
~
_,. 6
454.4
500.2
January estimate 1/ ..........................
Policy changes~ ....... . ... ..... .. ..... ....
Reestimates:
Department of Defense-Military .........
Energy, natural resources, environment,
and transportation ................ .. ..
Benefit payments for individuals:
Unemployment benefits ...............
Other ...............................
Other:
International financial programs ....
Net interest ........................
Offshore oil ........................
Other ..................... . .........
March 13 estimate 1/ .........................
Policy changes:Urban initiative .......................
Farm bill ..............................
Other program changes (~et) . ...........
Contingency allowance ..................
.
.
.
.
.
0.2
-0.5
-0.4
. 1. 0
0.5
1. 2
-1. 4
Subtotal, Policy changes .. . .... .
Reestimates:
Department of Defense-Military ......... .
Energy, natural resources, environment,
and transportation:
TVA power marketing ................. .
Other .......... ................... .. .
Benefit payments for individuals:
Unemployment benefits .............. . .
Other ..........•.....................
Other:
International financial programs .... .
Net interest ........................ .
Local public works ........ . ......... .
Farm price supports ..... ....... . .... .
Other ........................... . ....·
-=..Q..:.l
-0.5
0. 1
Subtotal, Reestimates .......... .
-2.2
----=.U
Current estimate ............................. .
452,3
496.6
1/ Adjusted for accounting changes .
$50 mil lion or less.
Y
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
0.2
1.3
- ,. 8
-3.0
0.2
-1.5
0.6
-0.9
-0.4
-0.3
-0.7
-*
0.8
0.5
0.7
-0.4
-0. 1
-0. 1
226
CHANGE IN BUDGET AUTHORITY, 1978 AND 1979
(in billions of dollars)
January budget estimate 1/ ............. ......
Policy changes:
Higher education initiative ............
Other program changes (net) ............
Contingency allowance ..................
1978
1979
.
503.9
569. 1
.
.
.
-0.4
1. 2
1. 1
---=l.:.l
Subtotal, Policy changes ....... .
Reestimates:
Municipal bond option .................. .
Other .................................. .
-0.4
1. 0
~
~
Subtotal, Reestimates .......... .
~
-=l..:2.
March estimate 1/ ............................ .
Policy changes:
Urban initiative ....................... .
Water resources initiative ............. .
Veterans pension reform ................ .
Energy rebates (delay in enactment) .... .
Con Rail . ............... -. ............... .
Federal pay cap ........ ·................ .
Other program changes .. ..... ... ... .. .. . .
Contingency allowance .................. .
501.7
566.6
-0.3
5.9
0.8
0.5
-0 .5
0.4
-0.3
1. 1
Subtotal, Policy changes ....... .
Reestimates:
Disaster relief ........................ .
Military sales trust fund .............. .
Social security and medicare trust funds
Unemployment trust fund and receipts ... .
Net interest .... .......... ........ .. . .. .
Other ........... ......... ..... ......... .
0.3
6.,
0.9
0.8
0.3
-0.8
0.5
-0.2
1 .o
- 1. 9
0. 1
*
• Subtotal, Reestimates .......... .
~
-1.2
Current estimate ........ . .................... .
503.8
571. 4
1/ Adjusted for accounting changes.
$50 million or less.
*
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
- 1. 8
0.6
~
-0.,
227
The CHAIRMAN. Thank you very much, Mr. Director.
In view of your spending reestimates, and in view of the review
of the economic situation that you have recently undertaken, and
taking cognizance of the heavy pressures from inflation, would you
comment on the wisdom of having a tax cut, whether it should be
of perhaps a somewhat smaller size, and what the composition of
that tax cut should be.
Mr. McINTYRE. Mr. Chairman, the administration is on record in
support of a tax cut. In fact, we have recommended that the
Congress consider a tax cut of $19 billion, with the approximate
distribution about one-third corporate and two-thirds personal. I
think that a tax cut is desirable. As I testified before this committee earlier this year, I think it is desirable for several reasons.
I think it is desirable, first of all, to keep the economy moving
forward strongly and to provide a small amount of fiscal stimulus
to keep our economic growth healthy.
Second, I think, it is important to overcome the additional taxes
that come into effect automatically in January of 1979 through the
social security laws, and also to overcome and help make up for the
loss of expendable income by virtue of people moving into higher
income tax brackets as a result of inflation.
The answer to your question is yes, I think a tax cut is needed. I
think that a cut in the neighborhood of $20 billion, is appropriate,
and this is the administration's position on the tax cut.
The CHAIRMAN. You would be concerned, would you not, with
substantially larger tax cuts contributing to inflation?
Mr. McINTYRE. Yes, we certainly are concerned about proposals
that would include substantially more than the $20 billion tax cut
the administration has recommended, particularly at this time, in
which we are seeing increased pressures on inflation, and particularly since there is such concern about the size of the Federal
deficit, and the effects that that deficit might have on inflation.
The CHAIRMAN. Now that the enactment of welfare reform appears unlikely this year, does the administration support interim
fiscal relief in fiscal year 1979 as proposed in different versions by
both the Committee on Ways and Means and the Senate Finance
Committee?
.
Mr. McINTYRE. Mr. Chairman, our proposals on fiscal relief are
linked to enactment of welfare reform. Fiscal relief would be a
program that we could support, but only on the assumption that
the two are linked.
As we move toward welfare reform, we should keep in mind the
basic objectives-the increase in work incentives, tying the jobs
and the cash payment elements, and also consolidating some of the
Federal programs-as well as the link to fiscal relief that I referred
to earlier.
The CHAIRMAN. Thank you very much. Mr. Latta.
Mr. LATTA. Thank you very much, Mr. Chairman. It is good to
have you here, Mr. Director. You mentioned some cuts, and we are
all interested in cuts. The question is, where? Have you any suggestions, specifically?
Mr. McINTYRE. Well, I have made several suggestions about the
way to go about achieving these cuts. The President has submitted
to the Congress a budget that reflects his priorities. In that budget
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
228
the President did submit some changes in programs that are being
debated, for example, health and hospital cost containment and
some minor cuts in the social security area.
Mr. LATTA. What kinds of cuts in social security?
Mr. McINTYRE. There are some minor changes in the benefits. I
could get you a list of those, Mr. Latta.
Mr. LATTA. Will submit that for the record?
Mr. McINTYRE. Yes.
[The information referred to above follows:]
PROPOSED SOCIAL SECURITY CUTS
· 1. Restriction of retroactivity in claiming benefits.-Reduces the permissible retroactivity from 12 months to 3 months. Estimated savings in 1979-$121 million.
2. Month of initial benefits.-Benefits would begin in the month in which applicants met all requirements throughout the month rather than within the month.
Estimated savings in 1979-$138 million.
3. Minimum benefit provision.....:....Eliminates the $121.80 minimum benefit for persons coming on the rolls after December 1978; denies cost-of-living adjustment in
minimum for those already on the rolls. Estimated savings in 1979-$60 million.
4. Maximum student benefits.-Repeat of earlier submission to limit social security benefits for students over age 18 to the BEOGS grant. Estimated savings in
1979-$117 million.
Mr. LATTA. Thank you.
Mr. McINTYRE. You know, my feeling at this point is that we
should work cooperatively with the Appropriations and Budget
Committees and others in the Congress to seek some agreement on
the areas where reductions are possible, and where the spending
estimates can be tightened generally. We have also recommended
that the discretionary increases over the President's request be
changed, and that we move back toward the President's request. If
necessary, if after this cooperative effort we still need to make
some changes, we may want to consider across-the-board cuts to
achieve any additional reductions. This is nothing novel. The
House has already recommended this in several bills.
I think this is the responsible way for us to proceed because it
focuses on trying to cooperate with the Congress and to reach
agreement with the Congress. It strengthens and supports the congressional budget process by working within the process. It offers a
way to generally tighten Federal spending without disrupting Federal programs.
Mr. LATTA. How about impact aid? Is the administration recommending anything in this area?
Mr. McINTYRE. We have recommended that you go back to the
President's budget. The House is some $200 million above the
President's request. We would certainly like to see that moved
back toward the President's request.
Mr. LATTA. Let me say I concur. You know we have had every
President since President Eisenhower making the presumption we
never seem to make much effort here in the Congress to get it cut
back.
These enormous shortfalls, as you indicated when you were here
previously, are a problem. You indicated that perhaps you are
making some headway, but we still have about a $6.5 billion problem right now, as you have indicated. I just wonder what went
wrong that we are off that much.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
229
Are we overappropriating in various areas? Should we take a
look at that if we are overappropriating and cut them back?
Mr. McINTYRE. Mr. Latta, it is very difficult. If I knew the
answer to the shortfall problem, I would remedy it. I don't mean
that in a short sort of way. I really mean if I could find the answer,
I would try to do something about it. What we have done is we
have tried to monitor the shortfall for the last several years to
determine if there are any patterns in the shortfall. There are
many reasons for it. Agencies do overestimate. That is one reason.
Sometimes we have difficulties in getting funds obligated because
of contractual negotiations or something happens in the process
and we are unable to obligate the funds, dr get the contracts signed
as rapidly as we thought. Sometimes there are natural occurrences
such as the cold weather that have some deterrent effect upon
spending patterns. I don't have a specific answer. All I can tell you
is that we are concerned about it in 0MB. We are going to continue to work hard to try to get the estimates more reasonable and
more in line with what actual expenditures are.
Mr. LATTA. I was disturbed, as I am sure every Member of
Congress was disturbed, about the $7 billion that GAO found in
waste in HEW, and I just wonder what action, if any, 0MB took
when this announcement was made. Did you make any type of
investigation or give any thought to perhaps reducing the amount
that they were requesting in fiscal year 1979, saying, "Look, you
have '$7 billion that they found in waste; we're going to cut you
back."?
Mr. McINTYRE. First of all, I think that that was a report of the
Inspector General of HEW that estimated there was as much as $7
billion in waste. But the answer to your specific question is that I
did ask my staff to look into this report; and I believe Mr. Cutter
can give some light on what the staff has actually done.
Mr. LATTA. Would you repeat that name, please?
Mr. McINTYRE. Mr. Cutter, who is here with me right now.
Mr. CtrrrER. Congressman, the difficulty with being able to proceed directly to action from that report was that it was, in fact, an
estimate; it looked at procedures in the entitlement programs and
estimated that there was as much as $7 billion in waste. It didn't
go down account by account and say "There is x millions of dollars in
waste here," and say "Why?". The estimate was made from a look
at how the Federal Government makes payments and on what
terms and how State governments make payments and on what
terms in the entitlement programs.
The difficulty with going through and simply taking out $7 billion in the appropriation and our recommendation for the appropriation is that those are entitlement programs and by law what~
ever payment is required is going to be made. Therefore, what we
really have to do is look at the procedures and change them where
we agree that, in fact, they lead to waste.
What we have at 0MB, what we have been doing and what we
are strengthening as a result of that report and our own general
perception that there is such a problem, is what we have called
quality control programs in the general area of entitlements.
One of the major problems with the budget-and I am sure you
have heard this before-is that 57 percent of it is uncontrollable by
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
230
law; 57 percent of it stems from entitlement programs in which a
class of beneficiaries and set of benefits are defined and the
number of beneficiaries is multiplied by the nature of the benefits
to get the payment.
In a program like that, program structure never gets looked at
as closely as, for example, you, the Budget Committees and the
Appropriations Committees, look at more discretionary programs.
Therefore, procedures tend to develop over time which are simply
inappropriate. What we have tried to do and are trying to do
cooperatively with HEW in our quality control programs, is to do a
careful statistical analysis of the methods by which payments are
made and the nature of the payments, in order to come to some
determination about precisely how a program operation can be
changed.
That is a long answer to a short question, but the point is that I
think there was an estimate based on a sense about procedures,
and we are trying to define with some precision where those procedures are inappropriate.
Mr. LATIA. Thank you very much.
Mr. McINTYRE. Can I make one positive statement about things
we are doing that I have been involved in with the Secretary? We
have taken some specific steps with the Secretary to eliminate
fraud and waste in the student grant and loan programs. I think
you are probably aware of this effort.
Mr. LATIA. I am.
Mr. McINTYRE. And we have been working with the Secretary in
that effort.
Mr. LATIA. May I ask one more question? Have we gotten down
the number of people who are making in excess of $40,000, working
for the Government, who are in default on their loans?
Mr. McINTYRE. I don't have that information, but I think the
Secretary probably does. I can check it, if you desire.
The CHAIRMAN. The gentleman from Texas, Mr. Mattox.
Mr. MATIOX. Mr. McIntyre, I have been, I would say, rather
critical of the countercyclical programs that we have had, and I
have been looking at, and I have asked to have prepared for me a
memo on the administration's program that they are developing to
take the place of countercyclical-the Supplemental Fiscal Assistance Act.
Looking at it, I am somewhat concerned because it would indicate to me that the program the administration is pushing is
moving even more drastically in the direction of general revenue
sharing, most difficult at best to administer, and using to a great
extent estimates, and it appears to me that we are going to be
providing-if we do carry this program forward-benefits to 26,211
local governments, which is about 70 percent of all the generalpurpose, local government entities in the entire country.
That is about 9,000 more than are getting countercyclical aid
today, and the allocation formula relies very heavily on the unemployment rates; and those unemployment rates are available for
only about 5,000 of the local entities, which would indicate that the
rest of them are going to be general-estimate-type formulas.
When you look at the per capita division that exists and that is
provided, when a city like New York City, I understand, is going to
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
231
get about, I believe it is, one-fifth of the entire benefit out of the
entire program, that kind of worries me. I understand that there
are several things to be concerned about, and I am just curious if it
wouldn't be better for us just to kill this program, kill countercyclical, and move on to a program that provides health care benefits
and educational benefits and provides some other direct beneficialtype aid, rather than just doling this money out to many local
municipalities that have surpluses and States that have surpluses,
particularly in light of our $40 million or $50 million deficit?
We don't have anything to be doling out. Why don't we cut back?
You can't share. It is difficult to share a deficit. We continue to do
it. So if the administration is legitimatly interested in cutting this
budget, how much can we cut back in this countercyclical if we just
kill it off?
Mr. McINTYRE. Mr. Mattox, first of all, the administration feels
strongly that the supplemental fiscal assistance program is a desirable program.
Mr. MATTOX. Why?
Mr. McINTYRE. I will tell you in just a moment. In fact, we
looked at it very carefully as we studied the urban policy and
developed our recommendations for the urban program. It makes a
change basically from a general approach to one in which local
governments in distress benefit from this program. We thought
that this was a change the Congress also was in favor of; the fact
that it does benefit those local governments that are in distress
seems to be an important aspect.
Mr. MATTOX. Let me interrupt. Do we have 26,000 local governments that are under stress or under strain?
Mr. McINTYRE. I don't have the number of local governments
that would qualify under the provisions of the program, but there
are a lot of local governments in this country.
Mr. MATTOX. Yes, sir, I understand there are, and on the basis of
the memo that I have developed, it appears that we are talking
about a much greater area of giving benefits than would otherwise
be justified.
Dallas, Tex., the city I am from, which is not eligible for countercyclical, manages to get some money under this program that you
are developing and I know Dallas has a very substantial budget
surplus, and it would seem to me that when you start talking
about local municipalities that are in distress, you have your formulas mixed up some way or other.
Mr. McINTYRE. I don't know the unemployment rate for Dallas.
Mr. MATTOX. It is one of the lowest in the nation; it is lower than
full employment, based on the figures that exist, that your office
uses; so it seems to me that we have some problems. If we legitimately want to cut this budget and want to balance it, rather than
hanging this money out for everybody that would like to have a
little piece of it, we ought to get on about some fiscal integrity.
Let me ask you one other question that deals with this area of
CETA. We have not been able to administer 725,000 CETA jobs
under title VI, public service jobs. We have just not been able to do
it. If we can't administer it, and it is pretty obvious that we can't,
why is it that the administration is not seeking to cut that program back a little bit, so that we can get it under contr~l, maybe
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
232
cut it back to 500,000 jobs or 600,000 jobs, so maybe we could
administer it?
You know if we can't administer a big program, malbe we can
cut it back and get a little better handle on it. Wouldn t that be a
better thing and maybe save us a billion or two?
Mr. McINTYRE. My position on the number of public service jobs
authorized by CETA is that at this particular time the recommendations of the administration seem to be reasonable; however, if
the unemployment rate should continue to drop, and if the drop
that we have seen in the past month should prove to be a permanent-type drop, as opposed to an aberration, then I personally
would be willing to review the public service employment program.
Now I recognize that the Secretary of Labor in a speech last
week indicated that he thought that it was important to continue
at the current level of 725,000 jobs. What I -am saying is that I, as
the Director of 0MB, would personally be willing to reexamine
that number should we continue to have substantial improvements
in the unemployment rate.
One thing that I think we often overlook is that we have been
extraordinarily successful in getting the unemployment rate down
over the past 19, 18 months.
Mr. MATTOX. I agree with you.
Mr. McINTYRE. I think the Congress, as well as the administration, can take great pride and should take great pride in it, Mr.
Mattox.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Virginia, Mr. Fisher.
Mr. MATTOX. Mr. Chairman, may I submit one more question for
purposes of the record and just ask one more for the purpose of the
record?
The CHAIRMAN. You are well over the 5-minute rule.
Mr. MATTOX. I understand. I will submit it in writing, if the
Chair would like.
The CHAIRMAN. No. Go ahead.
Mr. MATTOX. I know your office has moved, and is in the process
of moving, to evaluate the usefulness or lack of usefulness of the
major regional councils established around the United States. For
purposes of the record, I wish that you would provide me, or the
committee, with some indication of what the possibilities are of
either doing away with those councils or making them effective,
and what kind of budgetary expenditures it calls for to continue to
maintain those regional councils.
Mr. McINTYRE. Mr. Chairman, if I may make one point about
that, we would be glad to provide the committee with that information. It will not be completed probably for, I would say, 30 to 60
days at least. As soon as it is completed, I will see that you get a
copy, and the other members of the committee.
Mr. MATTOX. Thank you.
[At the time printing the information referred to above was not
received.]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
233
The CHAIRMAN. Mr. Fisher.
Mr. FISHER. Thank you, Mr. Chairman.
I would like to inquire into the reasons for the drop in estimated
outlays in fiscal year 1979. In Janaury when we started off, the
estimate was $501 billion and now it is $496.6 billion, around $5
billion less. I guess the chairman's mark shows-The CHAIRMAN. $490.4 billion.
Mr. FISHER. I haven't seen the details, $490.4 billion. There is
kind of a downward trajectory here as the different estimates and
marks and so on have come along. I would like to understand in
some detail what makes that up.
Mr. McINTYRE. Mr. Fisher, let me direct you to the Mid-Session
Review publication. Table 4 of that publication has the details.
Some of the highlights of that include reestimates in the Department of Defense and in the Department of Energy; and then there
are some reestimates in the benefits payments area. If it meets
with your approval, rather than going through the details, we have
them on a table in our Mid-Session Review and I will be glad to go
into any further details you might desire.
Mr. FISHER. Is all of the drop to be accounted for by reestimates,
that is, shortfalls in spending? Is there anything in addition to that
in the picture?
Mr. McINTYRE. I believe that most of it-I hate to use the allinclusive word "all", but most of it is reestimates on the outlay side
now.
Mr. FISHER. Do you think you have taken into account fully the
assumption you make about inflation in the cost that the Government has to pay? Would you expect that to go up as compared to
what we now have before us?
Mr. McINTYRE. You have hit on a subject near and dear to my
heart, Mr. Fisher. Some people feel that we ought to automatically
adjust all Federal programs to take into account inflation. I think
that is a circular argument, because once you start recognizing
inflation for all discretionary programs in the Federal budget, it
almost becomes a self-fulfilling prophecy.
I, personally, feel you ought to budget based on what you can
afford to spend, and that then produces great efficiencies in the
agencies.
Mr. FISHER. I quite agree with you on your general statement
about built-in escalating factors. It is a self-defeating kind of process; but still and all, you have to make your estimates of inflation
in order to put down numbers here for outlays, and given the
recent rapid increase in costs and it strikes me that you may be on
the low side on this account; and it also strikes me, just looking at
these figures that, as is typical, not only while you have been
Director but for a long time, we underestimate the shortfall, and I
would probably take a small bet that even these figures underestimate what is likely to happen.
So these two factors offset one another somewhat. My speculation is that the shortfall will lower the outlays more than the
inflation will raise them, compared to what is here. I would be
interested in your comments on that.
Mr. McINTYRE. Based on the most recent evidence, we could
probably expect the inflation rate to be higher than the midsession
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
234
estimates indicate. I think Chairman Schultze indicated that over
the weekend. He said he felt that based on the most recent evidence-which we did not have, as you know, until last Friday-it
appears that the pressures on inflation are even more than we
could anticipate in the midsession review.
Mr. FISHER. If you get any further thoughts on this general
subject, I would like to have them anytime.
One final question: In your testimony you talk about different
ways of restraining the increase in outlays, and as the last possibility you mention even the possibility of an across-the-board cut.
Could you enlarge a little on that? How far across the board, and
across the board of what programs? Would they be the all others
but the 57 percent of entitlements that you mentioned a moment
ago?
Mr. McINTYRE. Seventy-five percent.
Mr. FISHER. Or 75 percent by the time you count other things?
Or would they include some of the entitlement programs? The
entitlement programs themselves in terms of outlays depend considerably on the state of the economy and the outlook for inflation
and everything else.
You are not entitled to unemployment compensation unless you
are unemployed. You are not entitled to full social security benefits
unless you fully retire, up to a certain age, and so the so-called
entitlement programs are not as rigid and fixed as a lot of people
think.
The agricultural programs, many of them, are entitlement programs but they hinge on the price of farm products, the number of
people who apply for food stamps and so forth. So I am inviting you
to extend the notion of an across-the-board cut from just the more
narrowly defined and discretionary programs and extending the
concept to include some of what you would call entitlement programs.
Mr. McINTYRE. Mr. Fisher, I would like to know how to do that
legally, because if an individual is entitled to a social security
benefit, then we must pay him the benefits.
Mr. FISHER. I must say, one point could come out of increase in
efficiency-it is a bit ham-handed and clumsy-or out of fraud and
abuse, or some combination of these things. I might want to argue
that another 1 percent, or another 1 percentage point, could come
out of just the tiniest readjustment of some of the basic assumptions of inflation, employment, unemployment, productivity.
The CHAIRMAN. The time of the gentleman has expired.
Mr. FISHER. I realize that and I end on this note, and invite other
responses.
The CHAIRMAN. Mr. Conable.
Mr. CONABLE. Thank you, Mr. Chairman. Welcome, Mr. Director,
back before the committee. I guess we are going to see a lot of each
other over the years.
Mr. McINTYRE. I hope so.
Mr. CONABLE. I am not terribly impressed with savings that come
about as a result of reestimates. You get a certain sense of loss of
control as you find you have planned wrong; but I realize one of
the most volatile items is the rate of inflation, and it has an impact
both on revenue and on expenditure.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
235
Are there any rules of thumb you can give us on that? You have
estimated still a 7-percent rate of inflation which, I think, is sanguine in the extreme, and I am wondering, if it is 8 percent, will
we be worse off in terms of what we have to .pay for Government
goods and services or will we be better off because a 1-percent
inflation rate increases the revenues by 1.4 percent or something
like that? What kind of rules of thumb can you give us for judging
these things as we try to go through our own estimates and find a
pretty volatile set of circumstances on which to predict?
Mr. McINTYRE. Mr. Conable, I understand that we have given
some of those rules of thumb before, and I would be glad to supply
them for the record.
[The following information was supplied for the record:]
GUIDANCE IN FBrlMATING EFFECTS OF HIGHER INFLATION ON THE BUDGET
Higher inflation increases outlays, but it increases receipts by a greater amount.
Tax collections rise almost immediately as a result of inflation, in large part due to
our system of withholding. On the outlay side, however, longer timelags generally
exist, even for programs for which automatic cost-of-living adjustments are provided
by statute.
The effects of a higher rate of inflation depend critically on timing: When the
higher rate begins and how long it remains higher. Our rough calculations are that
if the rate of inflation (as measured by the GNP deflator) is 1 percentage point
higher beginning the first quarter of calendar year 1979 and continuing through
1981, the effects in the last 9 months of fiscal year 1979 would be rather smallabout a 0.4 percent increase in receipts and onEH1uarter of 1 percent increase in
outlays. In fiscal year 1980, the effects would grow to about 1.5 percent higher
receipts and 0.9 percent higher outlays. In fiscal year 1981, the effects would
amount to about 21/a percent higher receipts and 1 ½ percent higher outlays. Applying these percentages to budget estimates in our Mid-Session Review of the Budget
yields the following dollar magnitudes for this 1 percent inflation rate differential:
ESTIMATED EFFECTS ON THE BUDGET OF 1 PERCENT HIGHER INFLATION RATE BEGINNING 1979:1
[In billions of dollars]
Fiscal year1979
1980
1981
Outlays .................................................................................................................
+ 1.7
+1.2
+ 7.7
+5.1
+ 13.7
+8.9
Deficit....................................................................................................
-0.5
-2.6
-4.8
Receipts ...............................................................................................................
-----------
One "rule of thumb" these estimates suggest is that they effect of a higher rate of
inflation on outlays for any given year will be only on the order ot two-thirds as
great as the effect on that year's receipts.
Mr. McINTYRE. In general, I would like to say that inflation
affects the Government differently, just as it does individuals, because it depends on what goods and services you buy and how
much inflation affects those goods and services, but my understanding is-Mr. CoNABLE. There is a big impact for a medical program, for
instance. There is a big impact for defense spending, but less for
some of the other items.
Mr. McINTYRE. I am informed that in one rule of thumb that has
been generally used is that in general inflation affects revenues
more than-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
236
Mr. CONABLE. It has a long-term impact because it buys so many
of them under contract and has direct control over such things as
wages. Well, your Mid-Session Review shows that the budget authority went up by a total of $7.1 billion and outlays went up by
$2.1 billion as a result of changes due to policy initiatives. Do you
have any breakdown as to which of these initiatives were caused by
Executive changes and which by legislative changes? In other
words, to what degree is the Congress responsible for that and to
what degree is the President? I assume the Congress takes the
lion's share, in fact, particularly with respect to entitlement programs; is that so?
Mr. McINTYRE. The budget authority that I was referring to in
my testimony was primarily those that the administration had
recommended.
Mr. CoNABLE. I see. The recommendation by the administration,
you assume, results in that kind of an increase?
Mr. McINTYRE. $2.4 billion above the January estimate.
Mr. CONABLE. $2.4 billion in outlays?
Mr. McINTYRE. No; that is budget authority.
Mr. CONABLE. I am talking about those that were due to policy
initiatives and not due to simple reestimates.
Mr. McINTYRE. What I am giving you is basically a net figure for
budget authority.
Mr. CONABLE. You are up and down, if you are talking about
reestimates, but the changes due to policy initiatives are up in both
cases. You're talking about fiscal year 1979 now?
Mr. McINTYRE. That is correct; fiscal year 1979. There are some
policy changes that relate to the urban initiatives-water resources, education. There is a detailed table, table No. 7, on page 16
of the Mid-Session Review.
Mr. CONABLE. Fine. Thank you.
Mr. McINTYRE. It gives that list of changes.
Mr. CONABLE. Thank you for pointing that out. I wanted to take
a look at it.
One thing that concerns me, as I listen to presidential rhetoric
anyway, he is talking about how we have to get tough on spending
during fiscal year 1980, and I agree with that. I think it is obvious
that we are going to have to lean very hard on the growth of
Government; but what about fiscal year 1979? We are still up here
in the condition where we can influence the course, and I am
somewhat concerned about that.
I wish the President would talk about that to as great a degree
as he seems to be talking about 1980. I realize you are starting on
1980 now and that is an obvious place to focus, but I don't think it
is too late in fiscal year 1979, and we would like all the help we
can get, if policy initiatives are driving us up at this point, and
then the President says something about how serious we are about
1980, and that is the only reason I was asking that particular
question.
The CHAIRMAN . The time of the gentleman has expired. You can
respond.
Mr. McINTYRE. Mr. Conable, I would welcome the opportunity to
continue to work with this committee and the Appropriations Committees to attempt to get the 1979 spending down. In fact, my
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
237
recommendations require that we work together to get the number
down to the $491 billion to $492 billion range that we are talking
about.
I am trying to recall if all of these policy changes were mentioned to the committee earlier in the year when the January
budget was discussed or not. I know that the urban initiative
program was mentioned to the committee. I know that the education program was mentiond to the committee. I think we discussed
water resources-I am not absolutely certain, but I believe that we
did.
Mr. CoNABLE. That has been subject to some negotiation, I think.
Mr. McINTYRE. I believe we mentioned that we would be recommending some new initiatives for the Congress in that particular
area.
So the point is that most of these policy initiatives were discussed .earlier this year when the January budget was debated. It is
not something that we sprung on the Congress. It was not an
afterthought, after the budget was prepared.
Mr. CONABLE. I greatly appreciate my chairman's patience.
The CHAIRMAN. The gentleman from Maryland, Mr. Mitchell.
Mr. MITCHELL. Mr. McIntyre, you propose an across-the-board cut
for fiscal year 1980. How much, what percentage?
Mr. McINTYRE. I am not proposing an across-the-board cut for
·
fiscal year 1980.
Mr. MITCHELL. 1979?
Mr. McINTYRE. Or 1979. I am suggesting that if we cannot
achieve our objectives to reduce the spending to the $491 billion to
$492 billion range, then we may have to resort to an across-theboard approach to help get to that amount.
Mr. MITCHELL. I am glad this issue has been cleared up for me.
Honestly, this practice of across-the-board cuts, this Proposition 13
syndrome, is very discouraging.
I think the Budget Committee in general has done a pretty good
job each year of reducing the deficit and I think it is nonsensical to
resort to disruptive across-the-board cuts. Why not let the Budget
Committees continue their work of gradually cutting back on Government spending? In that connection, I want to help you a little
bit, if I may.
Since we have already abandoned the fight against unemployment, we have dropped that fight altogether, why don't we isolate
the manpower training programs which have a high incidence of
blacks and other minorities and merely cut them? That would be
consonant with the general abandonment of the minority unemployment problem.
Mr. McINTYRE. Who is we? The administration has strongly supported minority training programs, an expansion in Federal purchasing from minority businesses, and minority participation in
the Federal Government's programs.
Mr. MITCHELL. Oh, I am making a collective "we", the Congress
and the administration too, because we are maintaining present
levels over suggestions of cutbacks in public service and CETA.
I just want to be helpful and suggest that we can painlessly
reduce the Federal budget and then the admiration and love of the
minority black community.
32-052 0 - 78 - 16
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
288
The CHAIRMAN. Would you yield? Is that in the nature of a
question?
Mr. MITCHELL. The nature of a suggestion. I thought that would
be helpful.
Mr. McINTYRE. We would probably reject that suggestion, Mr.
Mitchell.
Mr. MITCHELL. I hope you can persuade some of the Members of
the House and this committee to also reject it.
One other question, Mr. McIntyre: The Department of Defense
accounts for about 31 percent of your shortfall in spending in 1978;
yet, throughout your testimony and your written statement, you
refer to lower spending. You refer to the matter of agencies estimating their budget requests. Enlighten me just a little bit. Isn't
that the function of the Office of Managment and Budget, to see to
it that these gross overestimates, such as in the case of the Department of Defense, do not occur?
Mr. McINTYRE. Absolutely; it is one of our jobs. I have, since I
have assumed the directorship, pursued this very vigorously, Mr.
Mitchell. I want to try to get the shortfall out. I think we have
some initiatives that we have underway right now that you, from
the tone of that question, might find interesting. It certainly is our
job and we are pursuing it vigorously.
Mr. MITCHELL. Good. I wish you a great deal of success, because
each year that I have been on the Budget Committee it has been
the Department of Defense which has been the gross, flagrant
culprit in terms of overestimating and thereby causing the resultant shortfalls in spending.
In the President's urban initiatives, there were several things
the President suggested-the General Services Administration program for locating Federal facilities in cities, formation of an urban
interagency coordinating council, and the design of improved urban
data and information system.
Could you give me a progress report .on those three? There were
seven major items. I won't list all of them. Could you give me a
progress report on any of those three? I think that these three
initiatives are primarily under the jurisdiction of the administration.
Mr. McINTYRE. The three were the-Mr. MITCHELL. The General Services Administration program for
locating Federal facilities in cities, the formation of an urban interagency coordinating council, and the design of an improved urban
data and information system-those three out of seven.
Mr. McINTYRE. I can tell you from my own personal knowledge
the Interagency Coordinating Council has been created and is operating.
Mr. MITCHELL. Who heads that up?
Mr. McINTYRE. Mr. Watson, of the White House staff.
Mr. MITCHELL. A good man.
Mr. McINTYRE. We agree on something.
Mr. MITCHELL. My time has expired. Just slip me a note.
Mr. McINTYRE. I will get you a report on the other two. In fact, I
can get you one on all seven.
[The information referred to above follows:]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
239
URBAN DATA TASK FORCE
The first meeting of the Urban Data Task Force was held on June 22, 1978.
Assistant Secretary of the Department of Housing and Urban Development, Donna
E. Shalala, chaired the meeting and attendees included representatives from Commerce, EPA, HEW, Justice, Interior, Transportation, Treasury, and HUD. At the
meeting the Task Force approved a preliminary work program consisting of three
tasks: 1. The development of a priority set of urban indicators; 2. The development
of an expanded set of more comprehensive urban indicators; and 3. The identification of State and local government data needs.
Assistant Secretary Shalala's staff, in cooperation with the staff of the Office of
Federal Statistical Policy and Standards of the Department of Commerce, is currently concentrating on the development of the priority urban indicators. That work
includes both developing an inventory of urban data sets currently collected by the
Federal Government and working with the various Federal departments to identify
their urban concerns.
Preliminary results will be presented to the task force at its second meeting
scheduled for September. Work on the other two tasks is proceeding as outlined in
the work program.
GENERAL SERVICES ADMINISTRATION PROGRAM FOR LocATING FEDERAL FACILITIES
IN CITIES
This program has been reviewed within the administration and the President is
expected to sign an Executive order on Federal Space Management within a few
weeks. This order will encourage the location of Federal facilities on a priority basis
in cities whenever such location is not inconsistent with agency missions.
The CHAIRMAN. The gentleman from South Carolina is recognized under the 5-minute rule.
Mr. DERRICK. Thank you, Mr. Chairman.
The CHAIRMAN. That is not directed to you. That is directed at
the committee.
Mr. DERRICK. Mr. McIntyre, I have a couple of observations to
make, and then a couple of questions.
The observation is that when you folks were up here peddling
the social security program and the minimum wage increase, you
kept telling us that it was not inflationary. Now we hear the
administration cite the minimum wage increase and social security
as part of the reason we are enjoying a double-digit inflation right
at this moment.
My question is, and following up on what Mr. Mitchell said, do
you know of any conscious agency overestimates that have been
brought to your attention?
Mr. McINTYRE. Not in the sense of deliberate, no.
Mr. DERRICK. That is exactly what I mean.
Mr'. McINTYRE. I do not know of any deliberate overestimates. Do
you know of any?
Mr. DERRICK. No, I don't, but I am not the head of the 0MB
either. Have you satisfied yourself reasonably well that there
aren't any?
Mr. McINTYRE. Deliberate in the sense of premeditated, sat down
and, ''Well, we are going to-Mr. DERRICK. With malice aforethought.
Mr. McINTYRE. I am not sure there are any that were deliberate,
with malice aforethought, but let me make some general observations. I think that there is a tendency in the agencies to be sure
that they have sufficient funds to carry out their programs. I think
that there is some concern that if they don't estimate a little on
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
240
the high side, they might come up short toward the end of the year
and not be able to carry out their programs or objectives.
Mr. DERRICK. I call that conscious overestimating.
Mr. McINTYRE. No, I don't think it is sitting down and deliberately saying, "Well, we know we are not going to spend this much, but
we are going to request it, anyway." I think what the agencies try
to do is try to be sure that they have sufficient funds to carry out
their responsibilities. I would say to you also that these figures are
reviewed by your staff, too, and the CBO, as well as by 0MB.
Mr. DERRICK. Mr. McIntyre, you and I come from the same part
of the country. Are you going to tell me that you don't think there
is any conscious overestimating, or that you can't find any?
Mr. McINTYRE. What goes on in people's minds, Mr. Derrick,
neither you nor I will ever really realize; but, again, just for
somebody to sit down and deliberately try to fool 0MB and fool
Congress, I don't think so.
Mr. DERRICK. Are you telling me that when someone makes an
overestimate to try to cover themselves, and comes to this Congress
and tells us consciously that they need more money than they
know that they are going to need, that that is not malice aforethought?
Mr. McINTYRE. I am not suggesting that they know that they are
not going to need that much.
Mr. DERRICK. They are either abusing their statutory power or
they are incompetent, a:r;id there really isn't a whole lot of difference as far as I am concerned. I would like to see 0MB get on this,
because I have a strong feeling that there is a great deal of it going
on based on the figures that we see.
Anyway, let's get to the next question. When we prepared the
First Budget Resolution, you folks told us that we were going to
have a midyear savings of about $463 million of outlays because of
changes in social security and the AFDC program. We took that
into consideration in the First Budget Resolution, and it was only
on July 20 that you transmitted the social security proposals, and
we haven't heard anything about AFDC yet. How in the world can
we work with you folks if you aren't going to get legislation over
here in time for us to consider it?
Mr. McINTYRE. I assume that you are talking about the proposals
to change programs and thereby save some money?
Mr. DERRICK. That is right. In the President's budget they
amount to $453 million in outlays and we cut them down on our
first budget to $200 million.
Mr. McINTYRE. I share your concern about the lateness of some
of the proposals getting to the Congress. When I found out that the
proposals were not up here, I immediately got on the telephone
with the Secretary and instructed him to get those proposals prepared and up here. I assume they are all before the Congress.
Mr. DERRICK. Let me just hit on one other brief thing here, and
you have touched on it several times already.
Of course, you understand, I know that 75 to 77 percent of this
budget falls into what we call uncontrollables, so when you are
asking for a $5 billion cut, what you are suggesting-unless you are
willing to make substantial cuts in the "uncontrollables" -you are
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
241
really talking about cutting about $5 billion out of that remaining
23 or 24 percent.
Now I have been asking people, starting back with Secretary
Simon, when he first appeared before this committee, where specifically they would make the cuts, and I have yet to get a direct
answer. There is no problem to say that you are going to cut $5
billion. I mean, you might as well make it $20 or $50 billion while
you are at it; but when it comes down to where to do the cutting,
that is another matter. I was wondering if you might have some
specific suggestions.
Mr. McINTYRE. Some of the suggestions I have are things you
have heard and haven't done anything about, such as hospital cost
containment. We need to move that bill.
Mr. DERRICK. You are the ones that had those votes worked out,
not I. Don't start throwing that at the Budget Committee.
Mr. McINTYRE. I am speaking of the generic "you" now. We
made several recommendations about savings and we need to move
on those. I think they are important.
As far as coming up here and giving the Congress a list in the
middle of the Appropriations Committee's deliberations, I think it
would be more prudent for us to work carefully with the respective
committees and try to cooperatively come up with programs that
we can agree on that we can reduce. Otherwise, we divert attention
from our common objective to set a total spending figure, which is
the responsibility of this committee, and we begin to focus more on
the differences between the administration policy and congressional policy.
I think the first step is to set the total. The second step is to
work out the differences between those totals. Once we get that
total, then we would propose to continue to work with the Budget
Committee and the Appropriations Committees and other relevant
committees, and the leadership in the Congress, to make those
specific program area reductions. And one final point: I did not, in
my testimony, eliminate the possibility of additional shortfalls.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Ohio is recognized.
Mr. REGULA. Thank you, Mr. Chairman.
To follow up a little bit on Mr. Derrick's questioning, you responded to a question by Mr. Fisher with words to the effect that
you want to build in greater efficiency. What is your impression in
your tenure as Director of 0MB, is there a great deal of efficiency
in the management of Government?
Mr. McINTYRE. Let me turn that around. I think there are a lot
of inefficiencies in the management of Government.
Mr. REGULA. What do you propose to do about them?
Mr. McINTYRE. We have several things that we are trying to do
about it. One of the recommendations is to tighten down on the
Federal budget so that managers in the Government will have to
become more efficient, more effective, with limited resources. Such
tightening requires managers to be more efficient in carrying out
their programs.
There are a number of other things that we have tried to do that
may or may not be within the consideration of the Budget Committee. We are concerned about the paperwork and the amount of
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
242
regulations that the Federal Government imposes. In our management side at OMB-and, by the way, I might add here that I think
this is often overlooked, that there is a management side of OMBand we are trying to do something about management in the
Federal Government.
Mr. REGULA. May I interrupt there and ask if you have a staff
person in most of the agencies who is evaluating the management
techniques of those agencies?
Mr. McINTYRE. We don't have a large enough staff to assign
somebody to every agency; but in our budget hearings, one of the
responsibilities of our examiners is to discuss the performance of
an agency in carrying out its programs. In specific areas where we
have specific studies underway to evaluate the performance of
specific agencies. For example we are looking at the way that cash
is managed in specific agencies in the Government. I have a very
small staff on the management side, the evaluation unit, which
works with the evaluation units in the various agencies, to try to
evaluate how well the Federal Government is carrying out its
responsibilities.
Mr. REGULA. Do you require the agency heads, in submitting
their requests to you, to prioritize their submissions in terms of
program development, so that you can say, "Well, in light of what
we can spend without disrupting the economy this year, this has to
fall away." Is there any set of priorities that you receive?
Mr. McINTYRE. Absolutely. As part of the zero-base budget process, all agencies are required to submit their budget requests in the
form of priorities.
Mr. REGULA. As part of that, do they give you an evaluation and
their opinion as to how that program is working in terms of costeffecti veness?
Mr. McINTYRE. To the extent that there are data available, we
try to get that data.
Mr. REGULA. Is that public information, so that the public and
Members of Congress and, in particular, the members of this committee, could receive these evaluations made by agency heads?
Mr. McINTYRE. We have instructed every agency head upon receiving a request from a member of this committee or of Congress,
to provide such information.
Mr. REGULA. Does this include their evaluation of priorities
within their own agency?
Mr. McINTYRE. As far as their own priority submissions, yes.
Mr. REGULA. Have you had much success in implementing zerobase budgeting? I recall the last time you testified you couldn't
really point to any instances in the original January budget submission as to where this had been applied.
Mr. McINTYRE. I would differ a little bit with the last statement.
We have had some success with zero-base budgeting. We put out a
report back in the spring in which we did our own self-evaluation
of the zero-base process. I think we were quite candid in that, more
so than any Government agency is likely to be.
We admitted shortcomings; we admitted some successes. I think
it will be more successful this year because this Federal Government is about the biggest business going, that I know of, and the
fact that we have the program actually implemented throughout
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
243
the Federal Government, to me, is a huge success. But, yes, there
are some successes and I will be glad to send you a copy of our
evaluation of that.
Mr. REGULA. I would like to have that.
[Testimony resumes on p. 248.]
[The information referred to above follows:]
[From the Office of the White Hol18e Press Secretary]
THE WHITE HousE.-The White House released today a detailed assessment of
first-year results of zero-base budgeting (ZBB) in the Federal Government. It found
that departments and agencies "got off to a good start" in putting th~ process to
work.
President Carter commended department heads recently for instituting ZBB
within the short time available to develop the fiscal year 1979 budget and said he
expected the process "to aid even more in the 1980 budget cycle." ZBB provides a
systematic process by which managers at various levels Cilil analyze performance
and allocate resources effectively and economically among Government programs.
James T. McIntyre, Jr., Director of the Office of Management and Budget, said his
agency is revising ZBB guidelines to make the process even more useful in tightening the 1980 budget. 0MB prepared the first-year assessment, which noted that:
Agency budget priorities were explicitly identified and stated; agencies were better
able to restrain the size of their budget requests; and Management participation in
the budget process increased at all levels. As a result, agencies generally reported a
better understanding of the relationship of their separate program plans and policy
initiatives.
The report describes some of the savings attributable to ZBB. No single dollar
figure can be pinned down to represent total ZBB economies in the 1979 budget, the
report explained, since many resulted from a combination of factors. The report
does cite a number of instances in which operations were discontinued or funds and
personnel were shifted to achieve maximum use of the dollar.
Savings were realized when requests for more money could not be justified within
the ZBB discipline. In addition, many large requests never reached 0MB because
agencies recognized in ranking priorities that the proposals could not be justified.
Major changes to improve the 1980 process will emphasize the development and
study of minimum program levels, eliminate unnecessary paperwork, and broaden
the involvement of managers.
AssF.SSMENT OF THE
FmsT YEAR
OF ZERO-BASE BUDGETING
A. INTRODUCTION
The 1979 Budget that President Carter transmitted to the Congress in January
1978 was the first Federal budget prepared using zero-base budgeting (ZBB) principles and procedures.
B. WHAT ZBB IS
ZBB provides a single systematic process for allocating resources. There are six
basic steps in the process: (1) the identification of decision units; (2) the definition of
objectives; (3) the analysis of alternative methods of accomplishing objectives; (4) the
analysis of different levels of peformance; (5) the preparation of decision packages;
and (6) the ranking of all alternative program levels in order of priority.
A more detailed explanation of how the ZBB process works is included in section
E.
C. RESULTS IN THE FIRST YEAR
Federal agencies got off to a good start in installing zero-base budgeting. It was
natural that agencies would encounter problems in converting to ZBB in 1 year. The
development of the procedure was marked by confusion that occurred before some
agencies could complete the design of their ZBB system's and provide needed training for their personnel. Overall, however, the administration is pleased with the
first-!_ear results _and anticipates an easier effort and increased benefits next year.
1. Fi,rst-year benefits.-A number of benefits from ZBB resulted from the examination of alternative methods of accomplishing objectives. Some of the alternatives
developed in the budget cycle were incorporated in the agency request, and will
result in increased efiiciency and effectiveness rather than direct dollar savings.
Other alternatives are continuing to be examined outside the budget cycle.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
244
Examples of these benefits include: In the National Aeronautics and Space Administration (NASA), the decision was made to discontinue the individual testing of
space shuttle engine components prior to the testing of complete systems.
In the Environmental Protection Agency (EPA), areas were identified where more
reliance could be placed on State programs (e.g., certification and training for the
Pesticides Program), thereby allowing Federal staff to be redirected to higher priority needs.
Within the National Transportation Safety Board, changes were made in the
railroad accident investigation program to decrease the emphasis on trespasser
accidents and to focus more attention on accidents with greater safety promotion
potential.
Within the Interstate Commerce Commission, proposals were made to transfer
staff into the field to respond better to complaints made by shippers.
Direct benefits were also derived from the examination and ranking of different
levels of effort. Most agencies found that such examination was helpful in identifying potential program trade-offs.
Within the Department of Justice, recommendations were made to reprogram
resources to higher priority areas, such as the Immigration and Naturalization
Service and the Legal Divisions.
Within EPA, more than 8 percent of the personnel in air pollution abatement
programs were recommended to be shifted to health-related activities identified in
the Clean Air Act Amendments.
Also within EPA, more than 12 percent of the personnel in the pesticides programs were recommended to be shifted into such areas as enforcement and abatement and control.
Within the Department of Transportation (DOT), a complete phase-out of the
Coast Guard's boating safety grant program was recommended, because it was
determined-as a result of a zero-base review-that the program had achieved its
objective of expanding State boating safety programs.
Also within DOT, the National Highway Traffic Safety Administration determined that funds used for Incentive Safety Grants could be used more effectively for
its basic safety grant program.
Within the United States Information Agency, now being consolidated in the
International Communication Agency, the process facilitated trade-offs within and
between elements of the major overseas programs. In addition, more than 4 percent
of the resources devoted to the headquarters media support functions were transferred to overseas programs and to the Voice of America.
Within the Department of Labor, 25 low-priority positions were eliminated from
overhead areas within the Occupational Safety and Health Administration.
Also within the Department of Labor, seven positions were eliminated from· the
Bureau of International Labor Affairs.
For the Corps of Engineers, the quality of the budget justifications for authorized
studies was improved by better identifying low-priority ongoing studies.
The ranking of priorities represented a significant improvement over the past
budgetary process. In addition to providing a clear statement of priorities, it had
several associated benefits:
Top agency policy officials became more heavily involved in the budget process
and, consequently, made decisions based on more understanding than in previous
years.
It proved to be an excellent tool for new policy officials to learn more about their
agency's programs.
It resulted in better communication among top, middle, and lower levels of
management.
0MB staff found the rankings beneficial in arriving at their recommendations.
The ranking process stimulated trade-offs within and between programs. It often
resulted in extensive reallocation of funds from lower to higher priority areas
because ZBB made such potential trade-offs more visible.
One of the administration's major goals in establishing ZBB was to increase
managerial involvement in the budget process. Of the 19 cabinet departments and
large independent agencies,'14 reported substantially greater management involvement in the budget process than in previous years. The other five agencies, the
Energy Research and Development Administration (now in the Department of
Energy), Department of Justice, Department of Transportation, Civil Service Commission, and National Science Foundation, have traditionally emphasized heavy
managerial involvement in their budget processes. More than 9,500 agency managers prepared approximately 25,000 internal decision packages for the fiscal year
1979 Budget, and thousands more managers reviewed and ranked these budget
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
245
proposals. After consolidations and the elimination of lower ranked packages, the
agencies submitted approximately 10,000 packages to 0MB in September 1977.
Largely because of this greater managerial involvement, many of the agencies
reported greater clarity of program objectives and reported greater managerial
understanding of the relationship of their budget requests to program plans, including policy initiatives. This greater understanding should make the achievement of
program objectives more likely. Some examples of the benefits of ZBB follow:
In the Department of State, managers at various levels were involved more
intensely in the budgeting process, resulting in a keener appreciation of the allocation of resources.
In the Department of Justice, the ranking procedure caused the executive staff to
address many issues that would not have been addressed under traditional budgeting approaches.
In the Department of Agriculture, the process aided decisionmaking on possible
program trade-offs. Key program managers had more extensive involvement in
developing and evaluating the budget request than before.
In the Department of Housing and Urban Development, there was a significant
increase in the involvement of managers in the budget process, resulting in a
dramatic improvement in the quality of the analysis in the budget submission.
Although it would be desirable to point to a single figure that represents the total
ZBB savings, it is not possible to do so because:
Many budget decisions that resulted in savings cannot be attributed to one factor
(i.e., ZBB), but generally are due to a combination of factors (for example, new
agency management, changes in policy direction, and the findings of new or ongoing studies-as well as ZBB).
Dollar savings were realized when requests for added resources could not be
justified within the discipline imposed by the ZBB process. Such savings are generally not identifiable because they occur at levels within the agency which cannot be
isolated in the higher level agency ZBB reviews.
Program efficiencies may be due to productivity gains that may not be necessarily
ZBB-related.
In some instances, the examination of minimum program and funding levels, as
required by ZBB, played a part in holding down agency requests for added funding.
Many large dollar requests never reached 0MB because the decision package writeup and the ranking processes made it apparent to the agency that the request could
not be justified. The Department of Transportation, the Department of State, and
International Security Assistance noted that the ZBB process-especially rankingenabled them to hold down their requests more than in previous years. Moreover,
the ZBB ranking assured that agency requests in excess of their budget guidance
amounts were displayed for the first time in priority sequence, thereby providing an
explicit statement of the agency's priorities for consideration by 0MB and the
president in evaluating the budget request.
As the President said before taking office, the impact of zero-base budgeting in
the State of Georgia was quite subtle, but nevertheless real. That has been the
experience this past year in the Federal Government. ZBB helped improve budget
analysis throughout the Government by making it possible for reviewers to examine
budgets more systematically and with greater understanding. However, neither ZBB
nor any other analytical budget process can be substituted for the political trade-offs
that are, and ought to be, part of the decisionmaking process.
2. First-year problems.-The volume of agency budget justifications increased markedly. With the exception of NASA, all of the 19 large agencies experienced increases in paperwork over last year. Agency' and 0MB staff noted a significant
increase in workload as a result. This occurred in spite of attempts by most agencies
to guard against excessive paperwork that might tie up the review and ranking
process. In almost all cases, however, the agencies were able to keep the extra.
paperwork to a manageable level.
In some instances, expanded managerial involvement caused agencies to prepare
more paper than could be examined given the time constraints of the budget cycle.
Most agencies are now focusing on adjustments needed to assure that they can fully
examine all viable budget alernatives that are prepared for the 1980 budget cycle.
The paperwork required to support the improved budget analyses under ZBB will be
greater than before ZBB. Nevertheless, the volume of paperwork for most agencies
will either stabilize or be reduced from last year's levels.
0MB staff noted some gaps in information that resulted from the transition to
ZBB and from some unavoidable first-year deficiencies in the design of agency ZBB
systems. Recognizing this possiblity, and anticipating requests from congressional
appropriations, budget, and substantive committees, many agencies also prepared
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
246
traditional budget justifications. With a year of experience, the information gaps
should be minimal next year.
Although most agencies were satisfied with the decision unit structure, some
found that their structures did not readily meet their decisionmaking needs. In
some instances, the decision units covered too broad an area to permit effective
review. In other instances, the decision units were developed at too low a level,
resulting in too much paperwork. Modifications are being made to rectify this
problem for the 1980 cycle.
.
A number of agencies had trouble defining program objectives, making it difficult
in some cases for the agencies and for 0MB to arrive at budget recommendations.
There is a clear need for improvement in this area.
Most agencies experienced difficulty in the identification of minimum levels. In
some agencies, the minimum levels were so close to the current level that an
effective review of a possible lower program level was precluded. At times, the
minimum levels focused on what would not be accomplished rather than on what
could still be accomplished. In other instances, the minimum levels were arbitrarily
developed below realistic levels.
In developing detailed instructions, some agencies required that the minimum
levels be no more than a certain percentage (generally 75 percent to 80 percent) of
the current year funding level. The percentage definition did have some advantages.
It saved time for some managers. In addition, the percentage approach helped
ensure that managers would at least examine the effects of a significant reduction
from their current program level.
However, use of percentages had drawbacks. It often discouraged managers from
doing the basic analysis of existing programs that is vital to ZBB. It may ·also have
resulted in minimum levels that were below the level of feasibility.
Most agencies, especially the larger ones, also experienced difficulty in ranking.
The major causes of problems in ranking were as follows:
For most agency officials, this was the first time they were required to provide
explicit program priorities.
In the more heterogeneous departments, it was especially difficult to compare the
marginal contributions of varied and diverse programs.
Many Federal programs are relatively uncontrollable in the short run due to
mandatory statutory provisions. Their inclusion in the ranking appeared to some to
raise conceptual inconsistencies.
Many agencies expressed concern over the relatively large amount of time and
top-level effort that was required to rank large numbers of packages. Nevertheless,
most agencies were satisfied that the resulting statement of priorities was valid, and
most analysts found that the ranking process provided a better basis for their
recommendations.
D. APPLICABILITY OF THE PROCESS
As expected, most agencies found ZBB techniques regarding program levels and
ranking to be more useful for discretionary programs with measurable outputs than
for relatively uncontrollable programs.
As might be expected, more changes are normally proposed for controllable programs than for those that are relatively uncontrollable. By definition, managers
have some discretion to modify controllable programs and little or none to modify
relatively uncontrollable programs.
However, ZBB can be beneficial for uncontrollable programs, especially when
considering major program changes. The effects of legislative proposals to change
uncontrollable programs can be analyzed and ranked against other desired spending
programs just as readily as for relatively controllable programs.
ZBB also served to highlight the weaknesses in existing justifications for many
programs. One of the strengths of ZBB is that it provides a tool with which
management can study the impact of change in existing programs and funding.
Programs with measurable outputs are thereby better suited to the ZBB discipline,
since the relationships between the funding, activity, and output levels can be
ascertained. It is therefore important to develop appropriate measures of accomplishment whenever possible.
E. HOW IT WORKS
The ZBB process, as noted earlier, involves six basic steps. Each plays a significant part in an agency's examination of what it needs to accomplish its mission,
both economically and effectively.
1. Identification of decision units.-Decision units are the building blocks of the
budget request and form the basis upon which budget requests are prepared, ana-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
247
1Y7,ed, and reviewed. A decision unit is the program or organizational entity for
which budgets are prepared and for which a manager makes significant decisions on
the amount of spending and the scope or quality of work to be performed. It may be
any distinct part of an agency, from a health funding unit to a personnel office.
Since significant decisions are usually made at many levels within agencies, ZBB
requires greater managerial involvement than do most other budget systems.
2. Definition of objectives.-The first step taken by the decision unit manager is to
define the long- and short-term objectives of the unit. Objectives provide a benchmark against which the projected accomplishments of existing and proposed budget
alternatives are measured.
3. Analysis of alternative methods of accomplishing objectives.-Subsequent to the
definition of objectives, an analysis is conducted of the alternative methods that
could be used to accomplish those objectives. This analysis forces a rethinking of the
current way of doing business by encouraging managers to study alternative methods of operation that differ from existing practices. This analysis often requires a
reexamination of the program, including the possible need to revise legislation,
organizational structure, and existing managerial practices. It also requires managers to search for innovative ways to improve effectiveness or to achieve program
objectives at lower costs.
4. Analysis of different levels of performance....;...The determination of the best
method to accomplish program objectives precedes the analysis of different levels of
performance for the decision unit. This analysis provides management with a range
of choices on program levels, so that the resulting budget request best reflects the
priorities of the agency. Levels of performance are defined as follows:
(a) Minimum level.-The program, activity, or funding level below which it is not
feasible to continue operations because no constructive contribution can be made
toward fulfilling its objective.
(b) Current level.-The level that would be reflected in the budget if existing fiscal
year activities were carried on at current service or output levels without major
policy changes
(c) Intermediate level.-A level between the minimum and current levels.
(d) Enhancement over the current level.-A level of performance above the current
level that promises sufficient benefits to warrant the review and approval of higher
authorities.
The minimum level challenges the general assumption that current performance
levels need not be questioned for purposes of budget review. As a result, the
minimum level is usually the most difficult to define in terms that satisfy agency
managers. However, the identification of a minimum level is fundamental to the
ZBB discipline, forcing managers, if done properly, to consider the budget from zero.
It provides the basis for analyzing marginal increases in performance that are
reflected in the intermediate, current, and enhancement levels.
5. Preparation of decision packages.-Each level of performance that is developed
for a decision unit is described in a decision package. This package is the action
document that is used to justify each level of performance for a decision unit. The
decision package includes such information as:
Activities to be carried out at the given level of performance.
A description of the funds and other resources required to perform the given level
of activity.
A description of the anticipated results.
Other information that provides higher levels of management with the information needed to understand the request and to evaluate its importance in relationship to other requests (e.g., required legislation, the effects of new funding).
If the total number of decision packages within the agency is too numerous for
higher level review, agencies may recast the content of the lower level packages
into a smaller number of consolidated decision packages. This process allows top
management to focus on broader program priorities.
6. Ranking.-After decision packages are developed for each unit, they are evaluated and ranked in order of importance by each higher level of management. This
provides management with a method of determining the specific content of their
budget request at varying agenc_ywide funding_ levels. The ranking also permits
management to determine which programs fall within or outside of a specific budget
total. In this way, it is easier to determine the program effects of various budget
totals at any review level.
Based on the final ranking, agency budget staff prepare detailed budget schedules
and other information summarizing and explaining the agency's budget request.
This includes special analyses that are required to convey more fully the required
justifications to decisionmakers within and outside of the agency.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
248
F. HOW ZBB CAME TO BE USED IN THE FEDERAL BUDGET PROCESS
When Jimmy Carter was elected Governor of Georgia in 1970, one of his first jobs
was to make budget recommendations for the State's programs for fiscal year 1972.
The budget requests for 1972 submitted by the State agencies totaled more than 50
percent above the available resources. In addition, the agencies had not arranged
their requests in any particular order of priority. He recognized that the State
needed a better process to ensure that budget resources were allocated effectively
among competing programs.
The Governor became convinced that ZBB would be an improvement over traditional budgeting systems, and he moved quickly to apply ZBB in the 1973 budget
cycle. ZBB is now being used in more than 100 State and local governments and
private organizations.
After winning the election, President Carter said major benefits for the taxpayer
should result from the use of ZBB in the Federal Government. He cautioned,
however:
"I don't want to mislead you and leave the impression that implementing zerobase budgeting will create instant miracles in the Federal Government. In Georgia,
its impact during my incumbency was quite subtle, but nevertheless real, in making
basic changes in our Government's operation. No doubt it will continue to generate
improvements in the years ahead. "
0MB guidelines for preparation of the 1979 budget provided a Government-wide
framework for ZBB. However, because of the wide diversity in their programs,
legislation, organization, and management, individual agencies were given considerable flexibility to develop procedures to meet their specific needs.
G. FUTURE IMPROVEMENTS AND CHANGES
Next year's process for the 1980 budget cycle will build on this year's experience.
The President has recently sent a memorandum to the heads of all agencies asking
them to ensure deeper and broader managerial involvement in ZBB than was
generally possible for the 1979 Budget. Because agencies are now more experienced
with ZBB, the President has also asked that duplicate (traditional and ZBB) submissions to 0MB be avoided. This should minimize nonessential paperwork and improve decisionmaking in the executive branch.
In addition, modifications have been made to the 0MB Government-wide guidelines and to individual agency systems to help improve the 1980 process. The major
modifications follow:
Agencies will be required to place greater emphasis on the preparation and
analysis of minimum levels. In those instances where a percentage of the current
level is used to develop minimum levels, agencies will be urged to treat this as only
a general guideline rather than as an absolute requirement to be met in every
instance.
Decision packages will focus on the marginal services or benefits associated with
packages above the minimum levels. This will help reduce paperwork and ease the
preparation and review of the materials.
Adjustments are planned to agency decision unit structures that caused problems
in the 1979 budget cycle.
Agencies will be urged to complete the linkage of existing planning and evaluation systems with the ZBB decisionmaking process.
0MB and agency representatives, in most cases, have agreed upon the major
adjustments needed in agency ZBB systems. These adjustments, coupled with the
experience gained in the first year, should result in a smoother process and improved results in the 1980 cycle.
Mr. REGULA. Two quick questions: As Director of 0MB, what is
your reaction to current Federal Reserve policies?
Mr. McINTYRE. That is a broad question, Mr. Regula. In my
prepared statement I suggested that through a tighter fiscal policy
we could perhaps get a more accommodating monetary policy-Mr. REGULA. True.
Mr. McINTYRE [continuing]. And I think that that really is how I
have to look at the policy of the Fed from my perspective as one of
the chief formulators of the executive branch fiscal policy. I think
that we need to look at monetary policy very carefully, particularly
as we enter into this phase of the economy. I have recommended a
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
249
tighter fiscal policy in hopes that we can get a more accommodating monetary policy as we move forward in this economy.
The CHAIRMAN. The time of the gentleman has expired. The
gentleman from Illinois, Mr. Simon.
Mr. SIMON. If I may followthrough on your last response to my
colleague from Ohio, suggesting through a tighter fiscal policy a
more accommodating monetary policy. I had a conversation with a
member of the Board of Governors of the Federal Reserve Board,
in which he suggested the very real possibility or probability that if
the Yanik-Pickle proposal were accepted, that the interest rates
could be reduced.
What if you had a choice on taxation between what has emerged
from the Ways and Means Committee and the Yanik-Pickle proposal, simply to extend 1977 taxes with no additional tax reduction.
What would your choice be-faced with those two alternatives?
Mr. McINTYRE. What was the first alternative?
Mr. SIMON. The first alternative is the tax program as it has
emerged from Ways and Means, the tax cut there.
Mr. McINTYRE. I would have to say that the administration's own
tax· recommendations are the ones that I support, that I think are
the most important-Mr. SIMON. I understand that.
Mr. McINTYRE [continuing]. And my preference is for the administration's proposals, Mr. Simon.
Mr. SIMON. I undersand that, but sometimes you don't get those
kinds of alternatives.
Mr. McINTYRE. I would rather reserve judgment and try to work
to perfect the administation's policy as opposed to picking something that does not represent the administration's policy at this
time.
Mr. SIMON. I thank you.
One comment: Talking about productivity, the Comptroller General testified before a task force-and I sent a copy of his testimony
to your office-that productivity in Government employment is
something that is talked about but the followthrough has not been
very effective, and his strong recommendation was that 0MB is the
office that really ought to have the followthrough and that there
ought to be substantially more followthrough on productivity than
there has been. Do you have any comments on that?
Mr. McINTYRE. Yes, Mr. Simon. I am very concerned about the
decline in productivity in the Government. I am also concerned
about the decline in productivity in the private sector. As far as
where I can have some effect, I do think 0MB has a role to play in
helping improve productivity in the Federal Government.
I have instructed my management people to give this attention
as we followthrough on the civil service reform that the President
has recommended, and that is now before both Houses of Congress.
As we evaluate and look at budget requests we will also be giving
particular attention to productivity in the various Federal agencies. I think it is an area 0MB can have an impact in, and one I
have a personal interest in.
Mr. Cutter would like to add something to that.
Mr. CUTTER. Congressman Simon, earlier this year, when we
began to feel that the nature of the debate that occurs sporadically
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
250
about whether the number of Federal employees is too small or too
great, we felt that the data or the information on which such
arguments were waged was far too general and far too anecdotal.
As a general rule, both in the administration and on the Hill,
you can find very strong general views that there are too many
Federal employees, and very strong and specific views that in any
given program there are too few; that has just been common.
Mr. SIMON. If I may interrupt, I am not suggesting that there are
too many-Mr. CUTTER. Oh, no; I am aware of that.
Mr. SIMON. If the two of you have not read Mr. Staats' testimony, I think it would be worth your reading, because he indicates
that we are paying lip service to productivity, we are not really
doing much.
Mr. CUTTER. The only point I was going to make was that Mr.
McIntyre asked me to set up within OMB-within the examining
units, because that tends to be where the data are-a group to look
at personnel requirements, so that we can make some specific
recommendations to the President, both in this next budget year
and over the long term. We are looking at all of the data that
currently exist as to Federal Government productivity and how it
differs by nature of the work force and how it differs by agency
across the Government.
To really get a refined understanding of those data is an extremely difficult problem. To look at it with some vigor and not
make just general points is extremely difficult.
Mr. SIMON. We are talking about long budget items. Does your
office keep track of them, and are we monitoring what is happening in the off-budget area also?
Mr. McINTYRE. Yes, we do, and we have a study underway in
0MB to address this particular problem in conjunction with a
review of credit policy, looking toward making some recommendations to the Congress next year.
Mr. SIMON. Thank you, Mr. Chairman.
The CHAIRMAN. The gentleman from California, Mr. Leggett.
Mr. LEGGETT. Thank you, Mr. Chairman, and welcome to the
committee again, Mr. Director.
I think that we appear to be generally targeting in the same
direction. I don't know that that is too dramatic, but we do.
You point up that we have more inflation than we thought we
were going to get, and less growth than we thought we were going
to get, but more employment than we thought we were going to
get; and I presume that your forecasts are very much in line with
the experts on this committee, and all of our econometric model
studies and things like that just don't seem to be able to give us
the right information. How do you account for this? Have you
made any critique of it?
Mr. McINTYRE. My staff of economists have been working very
closely with the Council of Economic Advisers, particularly with
Chairman Schultze, to try to identify some of the reasons for the
dramatic drops in unemployment and what has happened to us on
inflation.
I would say that while productivity does play a role in the large
number of new jobs I am not personally certain that that is the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
251
only reason we have seen this dramatic increase in the number of
new jobs and the tremendous drop in unemployment; but it is
certainly a factor.
Mr. LEGGETT. I get the idea that when we get into the business of
fine tuning, many times we are dealing with things that are almost
beside the point, and all we are really capable of doing is dealing in
gross concepts, and that seems to be about as good as we can do.
I know your estimate of receipts for the economy was very consistent. Your January, March, and your current projections were
exactly on target, in spite of inflation and in spite of more people
going to work; so I suspect that you probably are on target, but for
maybe reasons that you didn't anticipate. Anyway, the numbers
came out, very coincidentally, the same.
As far as the projection for 1979, as I see it, you are indicating
that we ought to cut something like $5 billion to get down into the
low 490' s as far as our spending program goes, and as I understand
it, that is the chairman's mark, to get down into that area; and I
guess we have pretty well done that to date by existing cuts in
appropriation bills, whether it be by policy change or by percentage cuts or whatever, and therefore the $5 billion that you suggest
cutting to get down to $491 and $492 billion-let me ask youwould that be the same $5 billion cut that has already taken place
to get down to the chairman's $490 billion mark?
Mr. McINTYRE. I haven't seen the details of the chairman's $490
billion mark, but, as I said earlier, I doubt very seriously they
would be the same. There are at least two areas that I am concerned about: One, of course, is the way the budget resolution
handles the President's energy program. We would count another
$1.4 billion in our budget authority and outlay figures. In fact, we
do include $1.4 billion in our figures for the President's energy
program. This is not included in the chairman's recommendation.
As I pointed out in my testimony, this simply illustrates the fact
that certainly there are going to be some areas of policy difference.
The CHAIRMAN. Will the gentleman yield?
Mr. LEGGETT. Surely.
The CHAIRMAN. Your outlay figures do not include a cut of
approximately $3 billion out by the House Appropriations Committee, do they?
Mr. McINTYRE. No, but these are cuts from the First Resolution,
which was above the President's budget in some cases.
The CHAIRMAN. We do in our mark, so that would account for
some of the difference. I think our estimate of outlays under the
urban package, although not high the first year, are probably a
little different from yours.
Mr. McINTYRE. That is correct.
The CHAIRMAN. That wouldn't account for all of it.
I think we have some later reestimates that you did not take into
account-Mr. McINTYRE. I think that is true.
The CHAIRMAN [continuing]. Which probably account for the bulk
of the remainder. Thank you.
Mr. LEGGETT. The question comes up, how do we effect cuts in
fiscal year 1979 this late in the program in developing the 1979
budget? We have finished in the House about 10 of the appropri-
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
252
ation bills. We have our target resolution, Apparently the infrastructure of your numbers is not like the infrastructure of our
numbers, getting down to the $491 billion. How do we get the extra
money, either in or out of the program, at this point, considering
the fact that we are almost done with the appropriation process?
Mr. McINTYRE. We are a long way along in the appropriation
process, but I am sure that we are not that close to being through
with it. There is still consideration, as you pointed out, of a couple
of bills in the House, and there are a number of bills in the Senate.
The Second Resolution has to be adopted, so we still have a way
.to go yet, although we are far along in the appropriation process.
That is why I have recommended that we work together, rather
than coming up here and giving you a list. I know that there are
going to be policy differences between the Executive and the Congress. Let's see if we can't work these things out reasonably. If we
can't then only as a last resort, I would recommend the across-theboard cuts that Mr. Mitchell raised some questions about. I think
this is the most reasonable approach to dealing with this very
complex issue.
Mr. LEGGETT. Let me ask you just one more question here. I
notice in your reestimates, practically all of your reestimates that
you have here for fiscal year 1979, policy changes, obviously, of
policy changes you are going to have some new numbers. If you
don't pass an energy bill, you get some new numbers. If you have
more people at work, you get new numbers. If you don't pass the
coastal zone bill, the offshore oil doesn't come in, and you estimate
the interest would be going down the first part of the year, and the
latter part of the year we estimate it is going up-so, it kind of
balances out.
The same thing for international programs-that kind of balances out, but the item that seems to stick out, really, as has been
pointed out by Mr. Mitchell, is the defense item, and where we are
down in the January estimate $1.5 billion, and we are down now in
the current estimate by another $1.8 billion, that gives us a $3.3
billion reduction in outlays, and as you recall, last year, in fact,
$1.5 billion lapsed in June, and we estimate that $1.6 billion will
lapse come the end of September.
So the question is, Why are defense items seemingly so critical?
We seem to scrap-with or without 0MB approval-so many items
on the floor, over whether or not we are going to have $1 billion or
not in the defense accounts, and again it is the roughest estimate
that we have in the total program, but we fight hardest on that
one item to get every last, seemingly, nickel and dime in the
defense budget.
Mr. McINTYRE. I would make two points in answer to your question: First of all, we give very high priority to the defense and
national security of our country.
Mr. LEGGETT. I am well aware of that.
Mr. McINTYRE. I think that one way you measure that commitment is through the budget and the financing of programs for
national security and the defense of our Nation.
Mr. LEGGETT. Is this part of the general syndrome then of erring
on the high side consistently?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
253
The CHAIRMAN. I am going to have to call time on the gentleman. The gentleman has gone well over his time. I am perfectly
willing to let the witness complete an answer, but not to continue a
discussion.
Mr. McINTYRE. Mr. Chairman, I would be glad to complete it in
writing, if you so desire, or I would just make a second point.
The CHAIRMAN. You can respond to the gentleman's question,
but we can't have a running discourse.
Mr. McINTYRE. My second point is that it is true that the defense
outlays have constituted a substantial portion of the shortfall. I
might mention that most of the shortfall has occurred in the
construction and procurement programs. There are a number of
reasons for this. The changes in spending patterns and rates over
the years have affected our ability to spend the appropriations for
defense. Bad weather early this winter held up some of the construction programs. There are a number of factors. Not all of it can
be explained, but some of it can.
What we have attempted to do, as I pointed out, is to try to get
as good a handle on this problem as we possibly can in 0MB and to
make sure that the appropriations are reasonable and the outlay
estimates are also reasonable.
The CHAIRMAN. The gentleman from California, Mr. Rousselot, is
recognized for 5 minutes.
Mr. RoussELOT. Thank you, Mr. Chairman. Mr. McIntyre, we
appreciate your reanalysis of the budget for the Second Concurrent
Resolution.
On two occasions, once before this committee and once before
Banking, Finance and Urban Affairs, when we were discussing
with Chairman Miller, who obviously is heavily involved in the
economy in many ways, especially trying to help when necessary to
pick up on the deficit problem when that exists, when you can't
sell it in the marketplace. His statement was that he felt that we
could with some effort trim expenditures for 1979 by about $10
billion. He said that was his judgment. He didn't expect it to be a
perfect judgment. Would you comment on that?
You had admitted that we could, obviously, in your current
public statements, probably trim from our original budget resolution, and, really, we are just putting a restraint on increases, we
are not really cutting our present levels of expenditure; we are just
accommodating more modest increases. Would you comment on
that statement?
The CHAIRMAN. Would the gentleman yield?
Mr. RoussELOT. Of course.
The CHAIRMAN. I am interested in the response to this question,
but did you indicate what amount is being cut by $10 billion?
Mr. RoussELOT. Yes; $498 billion.
The CHAIRMAN. The $498 billion which was in the First Budget
Resolution?
Mr. RoussELOT. Yes. I am sure he understands that.
The CHAIRMAN. I wanted to be sure I understood.
Mr. RoussELOT. I just thought Chairman Miller was a man of
reason, and I just wondered if there had been any coordination.
Mr. McINTYRE. Mr. Rousselot, I meet with Chairman Miller periodically to discuss some areas of mutual interest and, needless to
32-052 0 - 78 - 1 7
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
254
say, the deficit is an area of mutual interest. We have talked about
ways of dealing with the Federal budget and so I think I am fairly
familiar with some of the chairman's concerns. I must say that I
share his concern about the deficit and what it means in fiscal
policy and what it means in the private sector in terms of inflation,
crowding out, and so forth.
I think that we have taken steps to recognize that the economy
is different today than it was in January when we sent this budget
to you. In fact, our own recommendations would get the deficit
down to about $43 billion.
Mr. RoussELOT. You are sharing the thought that deficit financing does affect the private sector in its ability to produce jobs is
appreciated.
Mr. McINTYRE. First of all, I would submit to you that the
administration has taken substantial steps to try to get the deficit
down. We have reduced the tax cut by $5 billion annually and
recommended a deferment of the effective date, which increases
1979 receipts by almost $11 billion.
We have recommended through reestimates a $496:6 billion
outlay figure and suggested that an additional $5 billion of reduction be made in outlays in 1979. I think we are well on the way
toward trying to get this deficit down.
Mr. RoussELOT. I am asking, do you think it is possible to get
$488 billion as an expenditure level if we really work at it here?
The CHAIRMAN. Will the gentleman yield?
Mr. RoussELOT. Let me have him answer the question and then I
would be glad to have you join in.
Mr. McINTYRE. I have said that I think from a fiscal policy point
of view something in the neighborhood of $491 to $492 billion is
desirable.
Mr. RoussELOT. Do you think we could possibly get it down to
Chairman Miller's goal-he said it was a goal-to $488 billion, the
expenditure level?
Mr. McINTYRE. If you could do it, fine. I think it would be
extraordinarily difficult to do so. I would also say that there does
come a point at which we would have some real concerns about the
effect that a significantly lower figure than what we have recommended could have upon our overall economic well-being.
Mr. RoussELOT. I appreciate that.
Mr. McINTYRE. We feel that the point of around $490 billion is a
good place to be tight.
Mr. RoussELOT. Thank you. Now I yield to my chairman.
The CHAIRMAN. I just want to indicate, as you well know, that
while the first budget resolution had outlays of $498.8 billion, the
one I am recommending to you has only $490.3 billion.
Mr. RoussELOT. I appreciate your frugality.
The CHAIRMAN. Well, that is $8.5 billion toward the $10 billion
you are talking about. If we could get a few additional reforms
implemented we might even be able to pick up the other $1.5
billion more.
Mr. RoussELOT. We may get some more cuts in appropriations.
The CHAIRMAN. Fine. We may get some in appropriations. We
may get some in some other programs. It depends on where you
want to make the cuts, however.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
255
Anyway, the gentleman's time long has expired.
Mr. RoussELOT. Not really. You took time out for the tape.
The CHAIRMAN. Even with that, the sands have run out.
Mr. RoussELOT. I yield to my chairman.
The CHAIRMAN. I now recognize the gentleman from California,
Mr. Mineta.
Mr. MINETA. Thank you very much, Mr. Chairman. Mr. Director,
I apologize for being late. I was testifying before the Rules Committee on a piece of legislation which, I think, is important toward
trying to get a handle on this budget, and that is with reference to
sunset legislation.
I would like to start, however, with the conclusion that you come
to, and in that connection you talk about the Federal Government's seriousness about its anti-inflationary program and the
need to restrain spending. You suggest a $5 billion cut may be an
appropriate objective in that regard. Quite frankly, I am disturbed
not so much as it is a $5 billion cut but most economists, including
administration economists, tell us we are not in a demand-pull
kind of inflation but rather a momentum kind of inflation, and
that in their opinion a $5 billion reduction amounts to a very small
fiscal policy action that would have no impact on inflation. While a
$5 billion cut might be a desirable goal, why do you think it is ·an
important element in the fight against inflation?
Mr. McINTYRE. Mr. Mineta, I think that perhaps the statement
that you made might have been true up to a point of about 6
percent. But once I think we broke the 6-percent barrier, then it
became a different issue with us. I would also make this point, that
we are talking about a budget for fiscal year 1979. All of our
economists-I am not certain who you have been talking with-are
very concerned about the pressures of increased inflation and feel
that it is time to do something now.
We cannot afford to wait 3 or 4 or 5 months or until next
January to grapple with this problem.
Mr. MINETA. There is no question there is a great deal of concern
about inflation. That is primary, and I think the attention has to
be focused there. It seems to me that the thing that concerns me is
that that kind of statement seems to perpetuate the notion that
Government spending alone is the sole cause of inflation. I just
think that does a disservice in terms of perpetuating a myth.
Mr. McINTYRE. Let me state that I have never said Government
spending is the sole source of inflation. I think it certainly has a
significant effect in an economy such as we find ourselves right
now, particularly as we get closer to full potential in the economy.
I believe Chairman Schultz' figures indicate we are at about 84
percent.
·
I think there are other pressures that have an impact on inflation, and we have tried to tackle those. I think we must deal with
the ever-increasing effects of increased wages and prices. We have
tried to deal with that through a voluntary program, and I think
that is the proper way to pursue this effort.
We also, I think, have to show that we in the Federal Government are serious about inflation. There are too many people
around this country and in this Government who have long held
the view there was only one inflation fighter in town, and that was
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
256
the fare, and I am here to ·tell you there is another one, that is,
Jimmy Carter. He has put forth a comprehensive program. It is
our opinion that the Federal deficit and getting a handle on tight
fiscal policy is important in this effort to battle inflation, but I do
not think we have said that the deficit is the sole source or the
principal cause of inflation.
Mr. MINETA. Your comment about the management side of 0MB
and the budget side having to get together is something that is
important. I know I had a brief conversation with Mr. Carter about
this, a 109 circular, and applying it against the public to the
General Services Administration. I think it has in effect a more
closely felt impact on Federal procurement practices, and I would
hope 0MB would have a chance to take a look at that.
In your statement you also have in here there is an increase due
to the increase in budget authority for the urban initiatives. What
is included in there, and how much of an increase in budget outlay
is there? Have you included accelerated public works?
Mr. McINTYRE. Total budget authority in 1979 for the urban
initiative is $5.9 billion. The 1979 outlays figure is much smaller,
about $1 billion.
There is money recommended for the so-called soft public works
program.
Mr. MINETA. That is the intensified public works?
Mr. McINTYRE. Yes.
Mr. MINETA. What about the local public works?
Mr. McINTYRE. No.
Mr. MINETA. What about countercyclical?
Mr. McINTYRE. Countercyclical revenue sharing?
Mr. MINETA. Supplementary fiscal assistance.
Mr. McINTYRE. Yes, and we feel strongly about that program.
There is also a countercyclical jobs recommendation for CETA.
The CHAIRMAN. The time of the gentleman has expired. The
gentlewoman from Maryland is recognized.
Mrs. HOLT. Thank you, Mr. Chairman~ I will be brief. I want to
ask one quick question.
Mr. McIntyre, it seems to me that we are talking about inflation
and deficit spending being the critical thing that we are really
trying to get a handle on. Yet I get the feeling we are just playing
games with it, that we really are not making any efforts at all. If
we talk about the $5 billion cut, our amendment that we offered to
the first concurrent budget resolution was 488, now we can drop
that down. I believe we could go to 480 and simply slow the rate of
growth.
If you look back, if you go from 1977 to 1979 and look at some of
the growth rate in some of these functions-international affairs,
47.9-your estimate would be 54; energy, 147; housing credit, 299.
Those are tremendous increases. Why couldn't we just slow the
rate of growth a little bit at this time in our economic recovery?
Then, on the other hand, we are talking about something like
$23 billion increase in taxes with a tax cut of $15 billion which is
still going to leave an $8 billion tax increase. I cannot see where we
are really talking about any tax cuts at all.
It just seems to me we could go much further than this. I would
like to hear your comments on that.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
257
Mr. McINTYRE. Mrs. Holt, that is a very broad area to address.
First of all, as I said in answer to Mr. Rousselot' s question, I think
there is a point at which fiscal policy demands that we have a
certain budget level.
Mrs. HOLT. Of increased spending?
Mr. McINTYRE. A total budget level of total expenditures by the
Federal Government. We specifically recommended $491 to $492
billion in outlays as the appropriate level for the Federal budget.
Mrs. HOLT. But we are increasing new initiatives, we are getting
ourselves into more and more trouble. We hear over here constantly that part of our budget is uncontrollable, we cannot do anything
about it, and we are just creating more of that if we go into new
initiatives at this point. I think everybody is recognizing that reduction of the deficit, reduction of spending is the way we should
be going today. I have not heard anybody deny that, and yet we are
just paying lip service to it.
Mr. McINTYRE. I think that we would all agree there are certain
national priorities that we need to address. We have tried to do
that in the energy area. That is one reason there has been a
significant increase in the Department of Energy budget.
Mrs. HOLT. But we have not done anything. We are just increasing their budget.
Mr. McINTYRE. We have created a department, we have given it
a mission, and they are in the process of carrying out some of the
responsibilities that this Congress gave them in the statute that
created the new agency and established its overall missions. I think
they are doing some things. They may not be doing everything as
well as we would like, but we are making some progress in dealing
with a very serious national priority.
One of the increases in the Federal budget is an increase in the
defense budget. Again I would submit to you there are very sound
policy reasons for recommending those increases.
Some of our differences have been over the priorities of those
increases, not so much over whether or not a given total was
desirable, but how it should be spent.
We had to fund the farm legislation that Congress passed last
year so that caused a substantial increase in the Agriculture Department's budget. I could go on and explain every one of those
increases.
Mrs. HOLT. I am just saying we should not restrain the rate of
growth-Mr. McINTYRE. No. I specifically called for a growth pause in the
1980 budget.
Mrs. HOLT. How about 1979?
Mr. McINTYRE. We have recommended a further reduction in the
1979 budget of some $5 billion below the midsession estimates.
Mrs. HOLT. But that is just the point I am making. Mr. Mineta
said he didn't think that was really slowing the rate of growth. I
think it is minimal. It is not going to have the effect that we want
it to have.
Mr. McINTYRE. This represents a $17 billion decrease in the
deficit from the January proposals.
Mrs. HOLT. Thank you, Mr. Chairman.
The CHAIRMAN. The gentleman from Ohio.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
258
Mr. LATTA. One quick question, Mr. McIntyre. A year or so ago
we heard a lot about zero-base budget. What has happened to that
concept?
Mr. McINTYRE. It is still around, it is still kicking. We are going
to use it again this year. I have a report in which we did about as
fair and frank an evaluation as any governmental agency would do
about its own initiatives. I would be glad to see that you get a copy
of it. It points out that there were shortcomings last year, and we
are moving to overcome those shortcomings and I think the report
on this year's performance will be a much improved report with
many more suggestions.
Mr. LATTA. I would like to have a copy of it.
!"The report referred to may be found on p. 243.]
Mr. LATTA. Thank you.
The CHAIRMAN. Mr. Director, I want to thank you very much for
your testimony and for your responses to the questions from the
members of the committee. We thank you again for your cooperation.
Mr. McINTYRE. Thank you, Mr. Chairman.
The CHAIRMAN. Our final witnesses this afternoon are Shearon
Harris, chairman; Richard Lesher, president; and Jack Carlson,
vice president and chief economist of the Chamber of Commerce of
the United States.
As you know, the committee will begin marking up the Second
Concurrent Resolution on the budget this Wednesday. My recommendations to the committee would result in a deficit of $43.6
billion-a $17 billion reduction from the $60.6 billion deficit proposed last January by the President.
Gentlemen, we are interested in whether you think expenditures
should be further reduced and whether the percentage cut acrossthe-board method of achieving reductions is an efficient way to do
it.
The Ways and Means Committee, as you also know, completed
action on a tax bill last Thursday. Under the rules that are likely
to be adopted for the tax bill, several substitutes will be in order.
We would like to have your opinions of the Kemp-Roth and Fisher
proposals, as well as the bill as reported. You may proceed as you
wish.
One point I would like to make. We tri~ very hard to obtain
copies of your testimony in advance of your appearance because it
is always more helpful to us and the staff when we get testimony
in advance. It would help in future hearings if we could have the
statements in advance. That way we can review it and ask more
intelligent questions. You may proceed.
STATEMENT OF SHEARON HARRIS, CHAIRMAN; RICHARD
LESHER, PRESIDENT; AND JACK CARLSON, VICE PRESIDENT
AND CHIEF ECONOMIST, CHAMBER OF COMMERCE OF THE
UNITED STATES
Mr..HARRIS. Thank you, Mr. Chairman, members of the committee. I am Shearon Harris, chairman of the Chamber of Commerce
of the United States. That is a part-time position. My full-time
occupation is chairman of the board and chief executive officer of
Carolina Power and Light Co.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
259
I first would like to apologize for any problems we created in not
being able to provide our testimony. The final copy was placed in
my hand as I left the office to come to this hearing. We have not
had it ourselves, and we would have provided it had we been able
to provide it earlier, and in the future I hope we will not cause you
any such inconvenience.
I would like for the testimony to appear in the record of this
hearing on the Second Concurrent Resolution as if I had read it all.
The CHAIRMAN. Without objection, we will include your statement in the record.
Mr. HARRIS. I would like to concisely make the points that we
think are most salient in this rather carefully thought out document. The care in thinking it out is the problem in not getting it
here earlier. You have spent a great deal of time in this hearing on
the Second Concurrent Budget Resolution. I regret I have not been
here so I could say I agree with this and disagree with that and
focus on what has already been put before you and to some extent
by necessity it may be a little redundant to make some of our
points.
Let me say that the national chamber attempting to act for its
business community constituency is deeply concerned about inflation. We have resolved to attempt to lead a business community
action program to reduce inflation, to create, if we can, a political
climate in which every elected public official would find it popular
and patriotic to go to the roots of the causes of inflation.
Double digit inflation, 10.4 percent. The CPI rate for the year
1978 so far produces the equivalent of an annual loss of $3,000 per
average family. The 7.4-percent rate for the 12 months just ended
is unacceptable, but the administration forecasts that we should
expect a 7-percent rate for the foreseeable future. This undermines
all savings, all pensions. For example, $100, as you are familiar
with the arithmetic, put in a retirement program and held in it for
20 years loses in its buying power down to about $28. As we
continue what I regard as irresponsible fiscal and monetary administration, we stand on the . brink of a corrective recession unless
through an orderly process in our society we can wind down over a
period maybe as long as we have taken to wind up to this level.
Our National Chamber survey conducted for us by the Gallup
organization says that this aura of fear of inflation is reducing the
willingness to make investment. The University of Michigan and
the Gallup surveys have indicated that consumers are really fearful in the marketplace even though as of today they seem to be
buying fairly strongly.
We think it is rather universally agreed, Mr. Chairman, that
President Carter has correctly identified inflation as the Nation's
No. 1 problem. We think also related to inflation as the No. 1
problem, the counterproductivity of our national tax policy probably should be considered as part of the No. 1 problem. Every 1percent increase in prices unintentionally increases the level of tax
as was fixed by the Congress, resulting in a 1 ¼-percent increase in
Federal taxes. We have seen 12-percent growth in taxation in 1978,
and the administration's pending proposal before you represents
another 12-percent increase in taxation for 1979.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
260
Federal taxes now stand at the equivalent of $6,700 per family,
with the pending proposals before the Congress to increase it by
$800 per family for fiscal year 1979. Twenty-four percent of personal income before taxes is what the Federal establishment is now
taking, and it is the highest tax rate in 30 years and it endangers
the very basic freedoms upon which this democracy has been
founded. It discourages investment, it limits productive capacity, it
creates bottlenecks. It slows down productivity and our productive
capacity is not keeping up with the huge increase in employment.
So I would say that unintentionally the situation in which we
exist today represents inflation as the cruelest tax of all, and
unfortunately it hits those the hardest who are the least able to
bear it.
You have had some discussion about whether deficit spending is
the cause of inflation or whether it is one of the principal causes of
inflation. Mr. Chairman and members of the committee, the National Chamber would submit to you that it is one of the principal
causes, and .it is also coupled with other Government policy such as
increases in minimum wage, social security taxes, farm price supports, compliance with the myriad regulations, with property taxes,
all of which are driving inflation.
There is discussion in recent times about what is the real significance of Proposition 13 in California. On a Chamber mission I
spent the last few days of May and the first few days the week
before the June 6 primary in California visiting in southern California. I would not have believed what I observed had I not been
there to see it. I do not think that Mr. Jarvis and Mr. Gann created
a tax .revolution in California. I think the vote on June 6 was the
culmination of the real sentiment of hundreds of thousands of
voters that we have too much government and it is costing us too
much to have it. There are now 30 States that are also considering
some form of spending and taxing limitations.
So we submit that a responsible leadership in the Federal Government today should provide a more orderly way of reordering
the Federal budget. I want to associate myself with your remarks,
Mr. Chairman, and commend you for the leadership that I consider
you are providing, and particularly, I should like to adopt, as if I
had said it myself-and I wish that I had-your language in saying
that ''' restrained spending will signal to the Nation that the Congress is dead serious about fighting inflation."
I would agree with you that is the key issue involved in the
deliberations over the Second Concurrent Resolution.
I think this committee has a magnificent opportunity to render
great leadership in the manner in which you deal with this Second
Concurrent Resolution.
The Chamber, in its prepared testimony, has put before you
suggested solutions that involve slowing down Government spending, taxing and the growth in the deficit and eventually over time
to bring the budget into balance. We strongly recommend that in
the Second Concurrent Resolution you provide or contemplate both
sizable tax relief and spending limitations for fiscal year 1979. We
recommend $25 to $30 billion of tax relief on an annual basis,
which is about twice as much as the Ways and Means Committee
today recommends. We recommend targeting one-third of that tax
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
261
relief to encourage job-creating, capacity-expaning, and inflationdampening investment.
We recommend $32 billion or a 7 percent limit to the growth in
budget outlays.
Let me come back to rour remarks, Mr. Chairman, with respect
to. restrained spending ' signaling to the Nation that the Congress
is dead serious about fighting inflation." Given a 7-percent inflation rate, can the Congress be dead serious if it recommends a
growth in spending greater than the inflation rate of about 7
percent? We believe that such a limit, coupled with an appropriate
degree of tax relief, which would limit the deficit spending to
something around $40 billion, a little under your $43.6 billion,
would be a really dead serious indication.
Mr. Chairman, on pages 10 and 12 of the prepared testimony we
submit to you suggestions about 5-year planning, which we also
submit is in accordance with the requirement of the law. I shall
not deal further with that except that obviously if we are going to
deal with inflation we must create an understanding in the public
throughout the whole economy that we are on a sustained program
over a period of time. We cannot take a little dip this year and
expect it to do the jQb forever.
So we must signal a sustained commitment to continuing to cut
the deficit and to let the private sector of the economy operate
with greater freedom and therefore with greater success and with
greater contribution to the good of the country.
With that, my associates and I would be happy to try to entertain your questions. If you get too technical with numbers, I am
going to rely upon my associates to assist me.
[Testimony resumes on p. 285.]
TThe-·prepared statement of Mr. Harris follows:]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
262
STATEMENT
on
SECOND CONCURRENT BUDGET RESOLUTION
before the
HOUSE COMMITTEE ON THE BUDGET
for the
CHAMBER OF COMMERCE OF THE UNITED STATES
by
Chairman Shearon Harris, President Richard Lesher
Vice President Jack Carlson
July 31, 1978
I am Shearon Harris, Chairman of the Board of the Chamber of Commerce
of the United States.
I am accompanied by Richard Lesher, President and
Jack Carlson, Vice President and Chief Economist of the National Chamber.
On
behalf of the National Chamber's 75,000 members, we greatly appreciate the
opportunity to present our views on the Second Concurrent Budget Resolution.
RECOMMENDATIONS
The National Chamber strongly recommends that the Second Concurrent
Budget Resolution provide both sizeable tax relief and spending limitations
during fiscal year 1979.
•
We recommend:
$25 to $30 billion of tax relief on an annual basis, about twice
as much as proposed by the Ways and Means Committee;
•
targeting one-third of the tax relief to encourage job-creating
capacity-expanding, and inflation-dampening investment;
•
$32 billion or 7% limit to the growth of Budget Outlays, enough
to provide for current services and prior commitments;
•
limit the growth of Budget Authority which is excessively building
up spending for fiscal years 1980 and 1981;
•
limit the federal deficit to $35 to $40 billion, required to help
bring down inflation and allow interest rates to subside.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
263
•
limit growth of the federal debt to $40 billion, so as to reduce
the 1110rtgage on the lives of all Americans.
In regard to the specific components of the Budget Resolution, the
National Chamber recommends fiscal year 1979 limits as follows:
•
Federal Receipts of $441 billion
•
Budget Outlays of $480 billion
•
Federal Deficit of $39 billion
•
Budget Authority of $550 billion or less
•
Federal Debt Limit of $830 billion (see Table 1).
The Chamber's recommendations contrast with the First Concurrent
Resolution targets, the Chairman's Recommendations for the Second Resolution and
the Administration's latest estimates (see Table 1).
TABLE 1
CHAMBER'S RECOMMENDATIONS, CONGRESS' FIRST RESOLUTION,
AND HOUSE BUDGET COMMITTEE CHAIIU-f.AN'S RECOMMENDATIONS FOR
SECOND CONCURRENT BUDGET RESOLUTION
(Billions of Dollars)
FY 1978
Chamber
FY 1979
Congress'
First
Resolution
FY 1979 f!/
Chairman's
Recommendations
Second Resolution FY 1979 f!/
Administration's MidYear Review
FY 1979 p_/
$448
$401
448~:./
$441
$448
$447
Federal Outlays
480
499
490
497
Federal Deficit
-47
-39
-51
-44
-49
Federal Budget
Authority
507
550
569
561
571
Debt Outstanding
(end of year)
768
834
849
841 E._/
848
Federal Receipts
f!/ "Chairman's Recommendations for the Second Concurrent Budget Resolution on the
Fiscal Year 1979 Budget," Committee on the Budget, U. S. House of Representatives,
July 28, 1978.
p_/ "Mid-Session Review of the 1979 Fiscal Budget," Office of Management and Budget,
July 6, 1978.
!::._/ Chamber estimate of additional shortfall in FY1978 spending. The 0MB estimates
$452 and the CBO estimates $451, but both these sources have over-estimated
outlays and underestimated the shortfalls during both 1977 and 1978.
fl_/ Estimated from other fiscal data.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
264
In comparison with the Congress' First Concurrent Budget Resolution, the
Chamber's recommendations would:
•
reduce federal t~es by an additional $7 billion, which means about
$117 1110re in tax relief for the average American family;
•
trim $19 billion of federal outlays from an 11% to 7% growth, and at
least that-amount of Budget Authority;
•
lower the federal deficit by $12 billion;
•
trim $19 billion of Federal Debt Outstanding, equivalent to $317
lower mortgage on each family (see Table 2).
TABLE 2
COMPARISON OF CHAMBER'S RECOMMENDATIONS
AND THE CONGRESSIONAL FIRST CONCURRENT BUDGET RESOLUTION
FOR THE FISCAL YEAR 1979 BUDGET
(Billions of Dollars)
Increase in
Billions of Dollars
Congress
First
Resolu•
Chamber tion !/
Chamber
Im-
provement
Percent Growth
Congress
First
ResoChamber lution
Increase Per Family
Chamber
Imprc-vement
Congress
First
ResoChamber lution
ChamberImprovement
Receipts
$40
$47
$7
10%
12%
2%
$667
$784
$117
Outlays
$32
$51
$19
7%
11%
$533
$850
$317
Deficit
$39
$51
$12
-17%
9%
4%
-26%
$650
$850
$200
Authority
$43
$62
$19
8%
12%
4%
$716
$1033
$317
Debt
Outstanding
$62
$81
$19
8%
11%
3%
$1033
$1350
$317
!_/ "Chairman's Recommendations for the Second Concurrent Resolution on the
Fiscal Year 1979 Budget," Committee on the Budget, U.S. House of
Representatives, July 28, 1978.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
265
However, the Budget Committee Chairman's Recommendations provide for
some improvement. Nonetheless, in comparison with the Chairip.n's proposal, the
Chamber's recommendations would:
•
reduce federal taxes by an additional $7 billion, which means about
$ll6 more in tax relief for the average American family;
•
trim additional $10 billion of federal outlays, from a 9% to 7% growth,
and at least that amount of Budget Authority;
•
lower the federal deficit by $5 billion;
•
trim $11 billion of Federal Debt Outstanding, equivalent to $184
lower 1110rtgage on each family (see Table 3).
TABLE 3
COMPARISON OF CHAMBER'S RECOMMENDATIONS
AND THE HOUSE BUDGET COMMITTEE CHAIRMAN'S RECOMMENDATIONS FOR THE
SECOND CONCURRENT RESOLUTION FOR THE- FISCAL YEAR 1979 BUDGET
B1i1fg~;e~feD~Y1ars
Budget
ChairmanSecond
ResoluChamber tion!/
Increase per Family
Percent Growth
Budget
Chair-
Chamber
Improvement
Chamber
Second ImReso- proveChamber lution ment
man
Budget
Chairman
Second
ResoChamber lution
Chamber
Improvement
Receipts
$40
$47
$7
10%
12%
2%
$667
$783
$116
Outlays
$32
$42
$10
7%
9%
2%
$533
$700
$167
De!'icit
$39
$44
$5
-17%
-6%
-11%
$650
$733
$83
Budget
Authority
$43
$54
$11
8%
11%
3%
$716
$900
$184
Debt
Outstanding
$62
$73
$11
8%
10%
2%
$1033
$1216
$184
!_/
"Chairman's Recommendations for the Second Concurrent Resolution on the
Fiscal Year 1979 Budget," Committee on the Budget, U.S. House of
Representatives, July 28, 1978.
32-052 0 - 78 - 18
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
266
Unfortunately, the Administration's current estimates are less
attractive, as updated in the Mid-Year Review in July. In comparison with the
'
Administration's estimates1 the Chamber's recommendations would:
•
reduce federal taxes by an additional $8 billion, or by 2%, which
means about $133 more tax relief for the average .Al!lerican family;
•
trim federal spending by $17 billion, fr0111 10% to 7% growth, and at
least that amount of Budget Authority;
•
lower the federal deficit by $10 billion;
•
trim $18 billion of Federal Debt Outstanding, equivalent to $300
lower mortgage on each family (see Table 4).
TABLE 4
COMPARISON OF CHAMBER'S RECOMMENDATIONS
AND THE ADMINISTRATION'S MID-YEAR REVIEW
OF THE FISCAL YEAR 1979 BUDGET
Increase in
Billions of Dollars
Percent
Admi- Chamber
niImstra- proveChamber
Chamber tion!/ ment
Increase per Family
Admi- Chamber
niImstra- proveChambet
tion ment
Administration
Chamber
Improvement
Receipts
$40
$48
$8
10%
12%
2%
$667
$800
$133
Outlays
$32
$49
$17
$283
$49
$10
4%
21%
$816
$39
10%
41.
$533
Deficit
7%
-171.
$650
$816
$166
Budget
Authority
$43
$64
$21
8%
13%
5%
$716
$1067
$351
Debt
Outstanding
$62
$80
$18
6%
10%
2%
$1033
$1333
$300
!./
''Mid-Session Review of the 1979 Fiscal Year Budget," Office of Management
and Budget, July 6, 1978; and 0MB Director's House Budget Committee
Testimony, July 26, 1978.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
267
JUSTIFICATION
After receiving the President's proposed fiscal year 1979 budget and
observing the behavior of t~e Congress, George G. Mahon, Chairman of the House
Appropriations Committee testified (February l, 1978) that the President's
budget policies
" . .. are not without risks.
inflation.
The biggest risk, in my judgment, is
For years now the Federal Government has been generating large
budget deficits and increases in the national debt. During the
severe recession of 1974-75, there was probably some justification
for this but that recession is clearly behind us.
The same economic philosophy ttrat calls for ·g overnment spending
stimulus in economically depressed times calls for surpluses or at
least less deficit spending in ill!proved times. But instead of
following this philosophy, the President and the Congress are applying
only the spending side of the philosophy, not the restraint side.
It seems to me there are inflationary pressures here along with
increased interest rates and a tightening of funds for private borrowers
as the economy continues to improve and the idle productive capacity of
our economy begins to be utilized." (Underlining provided.)
In the same Hearing he added:
"I also applaud the concept of promoting economic growth by means of
proposed tax legislation, not stimulus through massive new shotgun
spending programs. I have not been impressed with the results of
hastily conceived spending programs as a cure for the Nation's
economic woes."
He supported placing " ... principal reliance for economic growth . on the
private sector."
The National Chamber agrees with Chairman Mahon's observation and
laments the fact that neither the Administration nor the Congress followed his
advice.
Since February when Chairman Mahon issued these words, both the
President and the Congress have proposed higher spending, less tax relief and
thus higher taxes, and therefore less reliance on the private sector (see
Chart 1).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
268
CHART l
CHANGES FROM JANUARY TO JULY IN SPENDING, TAXES-AND TAX RELIEF
PROPOSED FOR FISCAL YEAR 1979
(Billions of Dollars)
,.
OUTLAYS
50
-
40
30
-
$46
TAX RECEIPTS
$47
-
$45-47
-
TAX RELIEF
48
-
$39
E!_
2
20
10
-
-
Jan.
Carter
May
First
Resolution
July
Congress
and
Carter
Jan.
May
Carter First
Resolution
July
Congress
and
Carter
Jan.
Carter
$15
$12-$14
.
-
May
First
Resolution
July
Ways &
Means
and
Carter
-
This is equivalent to shrinking tax relief for the average family from $417 to
$233 or increasing the tax burden from $616 to $800 (see Table 5).
TABLE 5
CHANGES FROM JANUARY TO JULY IN TAX RELIEF AND RECEIPTS
PROPOSED BY THE ADMINISTRATION AND THE CONGRESS
(Dollars per Family)
Loss for Taxpayers
from Jan. to July
January
May
July
Tax Relief
$417
$250
$233
$184
Additional Receipts
$616
$784
$800
$184
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
269
The increase in tax burden would occur in every state (see Table 6).
TABLE 6
CHANGES FROM JANUARY TO JULY IN ADMINISTRATION'S AND CONGRESS'
PROPOSED TAXES FOR AN AVERAGE FAMILY FOR FISCAL YEAR 1979
States
UNITED STATES
Alabama
Alaska
Arizona
Arkansas
California
Colorado
Connecticut
Delaware
Dist. of Columbia
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Increase in
Tax Burden
$184
172
297
176
170
217
212
237
235
247
177
176
236
172 1
237
177
182
186
162
167
161
232
172
187
187
137
States
Missouri
Montana
Nebraska
Nevada
New Hampshire
New Jersev
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming
Increase in
Tax Burden
$172
169
192
196
177
235
147
217
165
212
172
162
176
182
184
157
162
157
179
234
166
189
191
157
183
184
The Chamber's tax relief proposals for fiscal year 1979 are smaller
than past tax relief during the last 25 years (see Chart 2).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
270
CHART 2
CHAMBER TAX RELIEF COMPARED WITH OTHER TAX REiIEF
(Tax relief in other years or for a state were sized
for the U.S. economy in fiscal year 1979 in annualized billions of dollars)
100
90
75
55
50
"'"
35
25
25-30
-
16-19
I
Proposition
13
1963-64
1975
Chamber
Tax
Tax
Tax
Relief
Relief
Relief
Admin.
and
Congress
The Chamber proposal to limit spending to the level of the current
services budget which provides for past and present commitments, may be
considered unnecessarily generous.
Clearly, application of productivity
improvements that are taken for granted in the private sector would mean the
Federal government could free 2% to 3% or $8 to $12 billion of resources for new
initiatives.
The National Commission on Federal Paperwork has identified areas
where government waste can be greatly reduced.
The General Services
Administration has uncovered rampant overpayment for government services.
HEW Secretary Califano and his Inspector General have identified waste and
fraud exceeding 5% of many programs.
These revelations clearly indicate that
reducticn in waste and increased productivity need not be limited to the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
271
"controllable" programs but can be applied across all programs.
Therefore, the
National Chamber rec0111111ends that any necessary trimming in the growth of Budget
Outlays and Authority should_: occur across most programs.
Such an approach
; ,'
nearly passed the House of Representatives during the debate over the First
Concurrent Budget Resolution O'isher Amendment).
Of course, the Chamber's
recommendations should not preclude trimming some programs deeper than others or
refraining from initiating new programs.
For example, the proposal to create a
new program to give money to state and local governments (Supplementary
Fiscal Assistance Act R.R. 12293) as a counter to Proposition 13 and other state
and local efforts to limit government taxing and spending appears to undermine
representative government.
THE NEXT FIVE YEARS
~979-1983)
Appropriately, the Budget and Impoundment Control Act of 1974 requires
a five year planning budget for setting taxes and spending.
That law requires
that the report by the Committee on the First Budget Resolution "shall include
projections •.•• for the period of five fiscal years •••• of the estimated
levels of total budget outlays, .••• total new budget auth9rity, the estimated
revenues to be received, and the estimated surplus or deficit ••.. and the
estimated levels of tax expenditures ••.. by major functional categories ...• "
(Underlining provided.)
We urge that the House Budget Committee now follow this requirement and
the spirit of the law and provide such a projection and use it for setting a
policy course for fiscal year 1979 in the context of the next five years.
In
particular, we recommend the Committee propose 1979 actions and present projections
through 1983 which would make possible lower spending and thereby tax relief
starting in fiscal year 1979 and extending through 1983.
When considering FY _1979 in the perspective of the next 5 years the
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
272
National Chamber recommends the Administration and the Members of Congress commit
themselves to policies that will reduce inflation by at least one-half percent each
year until price stabili~y is achieved.
In the context of th: Budget Resolution
process, the National Chamber recommends the following objectives:
•
slow down the reiord growth of taxes to much less than the growth
of each person's income;
•
slow down the record growth of spending to about the rate of
inflation;
•
reduce the size of the federal deficit and achieve a balanced
budget by 1982 and maintain a balanced budget at high levels of
employment;
•
encourage job-creating, productivity-increasing, capacity-expanding
and inflation-dampening investment; and
•
increase individual choice and personal freedom by reducing federal
taxes and spending from 22% to 18½% of Gross National Product.
These objectives can be achieved only by slowing down the growth of
federal taxing and spending such as indicated by the fol:owing pattern (see
Table 7).
TABLE 7
CHAMBER RECOMMENDATIONS FOR FISCAL POLICY
FORECAST
FY78
FY79
FY80
FY81
FY82
FY83
Tax Receipts
.Percentage of GNP
$401
20%
$441
19.5%
$484
19.3%
$530
19.0%
$580
18.8%
$617
18.5%
Outlays
Percentage of GNP
$448
22%
$480
21.2%
$511
20.3%
$544
19.5%
$580
18 . 8%
$617
18.5%
-48
-39
-27
-14
0
0
507
24.8
550
24.3
580
23.1
61021.9
640
20.. 9.
6.70
19..i
Deficit
Budget Authority
Percentage of GNP
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
273
The Administration's "Outlook" (and presumably Congressional
estimates) are far less desirable in comparison with the National Chamber's
recommendations.
The Chamber's fiscal policies would save $142 billion
of taxes during the next fi~e years (see Table 8).
TABLE 8
TAX INCREASES
(Billion dollar changes in level)
FORECAST
1979
1980
1981
1982
1983
1979-1983
Chamber Recommendation!/
$40
$43
$46
$50
$37
$216
Administration Outlook!/
47
59
73
84
95
358
!!/
Same percentage increase as FY 1981 estimate.
For the average American family, federal taxes would grow more slowly
with the Chamber's recommendations (see Table 9).
TABLE 9
TAX INCREASES FOR THE AVERAGE FAMllY
FORECAST
Chamber
Administration
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
1979
1980
1981
$550
$613
783
983
1982
1983
$650
$690
$730
1217
1400
1600
274
Consequently, the Chamber recommendations would save $2,650
taxes within the next five years (see Table 10).
TABLE 10
CHAMBER TAX SAVINGS FOR THE AVEBAGE FAMILY
IN COMPARISON WITH THE ADMINISTRATION AND THE CONGRESS
Administration
1979
1980
1981
1982
1983
$233
$370
$567
$660
$820
5-Year Total
$2,650
The Chamber's recommendations would greatly reduce the National Debt by
$190 billion by fiscal year 1983, equivalent to reducing the mortgage on
the life of the average American family of $3,167 (see Table 11) .
TABLE 11
LOWER NATIONAL DEBT IF
CHAMBER RECOMMENDATIONS ACCEPTED
(End of FY 1983)
Per Family
Administration
$190 B.
$3,167
If the Chamber's recommendations are followed, by 1981 tax relief could
be nearly comparable to Proposition 13 and larger than recent tax relief.
The
economy will be healthier and generate higher incomes and consequently create
greater tax liabilities.
Consequently, additional tax receipts from a
faster growing economy would offset about 40% of the initial tax relief (see
Chart 3).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
275
CHART 3
CHAMBER'S TAX RELIEF COMPARED WITH OTHER
TAX RELIEF BY FY 1981 (INITIAL AND NET)
125
115
100
INITIAL
100
INITIAL
75
71
70
so
25
Proposition
13
1979-81
1963-64
1975
Chamber
Tax
Relief
Tax
Relief
Tax
Relief
Adm.
and
Congress
1978
NEED TO STIMULATE INVESTMENT
Not only is the size of the tax relief important for fighting inflation,
increasing wages and providing jobs, but also the composition of tax
relief.
The federal tax structure greatly discourages investment in modern tools for
the growing work force .
For example, the allowance provided under tax laws for
replacing worn out equipment and structures was $17 billion short of replacement
costs during 1977.
Consequently, taxes were artificially increased and the
Federal government siphoned funds away from investment.
Investment, after adjusting for inflation, has grown only 1.1% since
1973 while new workers needing modern tools nave grown by 2½%.
In spite of
slightl_y . lower working hours, capital per labor hour is growing more slowly and
is a major cause for slower productivity growth and a decline in real average
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
276
weekly earnings of non-farm workers (see Table 12).
TABLE 12
SLOWING ANNUAL GROWTH RATES IN INVESTMENT AND THE
RESULTING SLOW-DOWN IN PRODUCTIVITY AND REAL WAGES GROWTH
Investment Growth After
Adjusting for Inflation
Capital per
Labor Hour
1,/
Productivity
Growth
Real 1/
Wages
1948-1966
3 . 4%
3.1%
3.3%
2.7%
1966-1973
3.0%
2.8%
2.1%
1.0%
1973-1978
Second
Quarter
1.1%
1.5%
0.8%
-1.0%
];/
1:./
Economic Report of the President, January 1978, and Bureau of Labor
Statistics.
Real Average weekly earnings in Nonagricultural Industries.
Government tax and spending policies have increasingly ignored
the plight of workers having to work with obsolete and worn out tools.
A greater
proportion of tax relief provided in the past was earmarked for encouraging
investment in better plant and equipment for workers than now proposed for 1979
(see Table 13),
TABLE 13
PROPORTION OF TAX RELIEF
FOR INVESTMENT
Admin.
Proposal
for 1979
1/3
1/4
1/5
In dollar amounts, tax relief for stimulating investment would be shrunk
severely (see Chart 4).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
277
CHART 4
PAST TAX RELIEF F0R BUSINESS INVESTMENT
SIZED FOR THE FY 1979 GNP
Tax/GNP-----------------------.
,'
20
1.0%
B
$18 B,
o.
10 B
0.5%
$7 B.
0.3
1963-64
JOHNSON
$5 B.
0.2%
1979
1975
FORD
CARTER
Even seemingly useful legislation enacted for other reasons during 1977
will reduce investment by $2,900 for each new worker during 1979 (see Tacle 14).
TABLE 14
LEGISLATION ENACTED BY THE CONGRESS
AND SIGNED INTO LAW BY THE
PRESIDENT DURING 1977
Increase in Minimum Wage
Increase in Social Security Taxes
Increase in Farm Price Supports
Increase in Federal Pay
Total
Impact on Investment
For Each New Worker
1978
1979
1980
1985
-150
-2,350
-2,600
-2,400
0
-200
-600
-2,750
-150
-250
-200
-250
-50
-100
-100
-100
-2,900
-3,500
-5,500
-350
This trend towards discouraging investlllent in modern tools for American
workers must be reversed.
The National Chamber recommends one-third of tax
relief be earmarked for encouraging investment.
Stimulus of investment can be
achieved by:
• providing a permanent 12% investment tax credit on an expenditure basis,
uniformly applied to all business, without limitation based on tax
liability,_ and extending to structures;
• reducing the tax on capital gains;
• adopting a complete capital cost recovery system;
• reducing corporate normal and surtax rates; and
• eliminating the double taxation of corporate income.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
278
The Chamber-Gallup Business Confidence Survey indicates that nearly
one-half of American business would increase their investment in equipment and
'
structures if tax relief were provided to stimulate investment.
Moreover, the
investment would occur in ali regions of the country, including central cities
in which are distressed economic areas.
Based
upon forecast economic conditions and past experience each initial
$1 billion of tax relief could cause as high as $6 billion to be spent for plant
and equipment, cause production capacity to expand by as much as 0.3% which
would reduce bottleneck inflation, create 240,000 new jobs, and increase average
family income by as much as $80 (see Table 15).
TABLE 15
IMPACT OF $1 BnLION OF TAX RELIEF WITHIN 4 YEARS
Corporate
Rate
Investment
Tax Credit
Capital
Gains
Depreciation
Allowance
$4-$6
$2-$4
$2-$3
0.3%
0.2%
0.2%
0.1%
Jobs (000)
180-240
100-180
110-170
60-90
Famil/ Income
$60-$80
$35-$60
$35-$50
20-30
-
Investment (Billions)
Capacity Expansion
$1-$2
Tax relief to stimulate investment results in two-thirds of the final
benefits accruing to low or middle income families.
About two-thirds of the
investment-led growth in the economy occurs in wages and salaries which are
paid primarily to workers from low and middle income families.
Investment created jobs could be a far less costly way to create jobs
than public sector jobs or public works (see Table 16).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
279
TABLE 16
INCREASED EMPLOYMENT FROM INVESTMENTSTIMULATING TAX RELIEF COMPARED TO OTHER STIMULUS
FOR CREATING NEW JOBS (FY 1979)
Tax Relief or Spending
Cost per Job
Higher Investment Tax Credit,
Capital Gains Tax Reduction or
Improved Depreciation Allowance
$5,000 to $10,000
Public Sector Jobs Spending
$10,000 to $13,000
Labor Intensive Public Works
Spending
$25,000 to $35,000
Proposed Local Public Works
Spending
$25,000 to $50,000
ECONOMIC CONSEQUENCES
The government's fiscal policies could produce:
•
persistent inflation at or above 7%
•
unemployment at or above 6%
•
low rates of investment
•
greater loss of individual freedom because of taxes and spending
growing faster than income.
Therefore, ·the economy could be plagued by high inflationary government
spending, high taxing and less individual choice by 1983 (see Table 17).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
280
TABLE 17
LONG RANGE ECONOMIC OUTLOOK
WITHOUT CHAMBER'S RECOMMENDATIONS
. (Billions of Dollars)
1983
!!..Jlli.
FY
$2,254
$3,291
Percent Change
10.4%
9.4%
GNP in 1978 Dollars
$2,108
$2,393
Gross National Product
Percent Change
Business Fixed Investment
3.0%
3.3%
$223
$268
Percent Change
5.7%
4.8%
Consumer Price Rate
7.2%
7.0%
Total Employment (Changes in Level)
1.0
8.9
Unemployment Rate
6.2
6.2
Capacity Utilization
83
83
Federal Outlays as percentage of
before tax income (Personal Income)
27
26
Federal Tax Receipts as percentage of
before tax income (Personal Income)
25
24
-49
-65
Federal Deficit
Source:
U.S. Chamber of Commerce, Forecast and Survey Center.
Assumptions and modelling by Dr. Jack Carlson and
George Tresnak using econometric models of Data
Resources, Inc. and Chase Econometric Associates.
The Chamber's recommendations could change the outlook significantly
by slowing down federal spending and taxing, achieving a balanced budget; and
the capacity-expanding and productivity-increasing invest111ent would bring down
the rate of inflation (see Table 18).
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
281
TABLE 18
LONG RANGE ECONOMIC OUTLOOK WITH THE
CHAMBER'S RECCMMENDATIONS FOR TAX RELIEF AND
SPENDING LIMITATIONS 1/
(Billions of Dollars) -
:-
FY 79
FY 80
FY 81
FY 82
FY 83
Gross National Product ( $ Billions)
Percent Change
2,260
10.7
2,513
11.2
2,785
10.8
3,066
10.1
3,366
9.8
GNP in 1978 Dollars ($ Billions)
Percent Change
2,112
3.5
2,199
4.1
2,287
4.0
2,378
4.0
2,473
4.0
GNP Deflater(%)
7.0
6.8
6.6
6.2
5.9
Consumer Price Index
6.9
6,6
6.4
6.2
5.9
Additional Employment (Millions)
Unemployment Rate (%)
1.2
6.3
2.5
6.0
2.4
5.7
2.4
5.5
2.4
5.4
Productivity(%)
2.1
3.3
2.9
2.7
2.5
Investment
Percent Change
Capacity Utilization (%)
224
6.1
85
244
8.7
86
269
10.3
86
300
11.7
86
336
11. 7
86
441
10.0
484
9.8
530
9.5
580
9.4
617
6.5
480
7.0
-39
511
6.5
-27
544
6.5
-14
580
6.5
0
, 617
6.5
0
19.5
21.2
24.2
26.3
19.3
20.3
24.0
25.2
19.0
19.5
23.6
24.2
18.8
18.8
23.3
23.3
18.5
18.5
23.0
23.0
Federal Tax Receipts (Billions)
Percent Change
Federal Outlays($ Billions)
Percent Change
Federal Budget Balance ($ Billions)
Receipts as~ of GNP
Outlays as% of .GNP
Receipts as% of Personal Income
Outlays as .% of Personal Income
1/
Fiscal Policy Assumptions:
o Personal tax relief of $13 billion in FY1979 (equivalent to $18 billion
in calendar year 1979), $32 billion in FY1980, $54 billion in FY1981,
$78 billion in FY1982, and $104 billion in FY1983.
o
Investment tax relief of $7 billion in FY1979, $17 billion in FY1980,
$28 billion in FY1981, $41 billion in FY1982, and $55 billion in FY1983.
o Federal spending limitation of $32 billion increase (current services
budget) in FY1979 and 6.5% increase each year thereafter.
Source:
U.S. Chamber of Commerce, Forecast and Survey Center. Assumptions and
modelling by Dr. Jack Carlson and George Tresnak using econometric
models of Data Resources, Inc. and Chase Econometrics Associates.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
282
Specifically, the Chamber's rec011D11endations would produce the following
improvements for the average American family by 1983:
•
save $2,650 in federal taxes in 1983 alone and would have saved
$5,483 between f979 and 1983;
•
retain individual choice and freedom by reducing government spending
and taxes from 24%-26% before tax income (Personal Income) to 23%;
•
reduce consumer prices by 3%, equivalent to $1,360 of purchasing
power;
•
create 2 million additional jobs (see Table 19).
TABLE 19
ECONOMIC IMPACT OF CHAMBER TAX RELIEF
AND SPENDING LniITATION RECOMMENDATIONS
(Change in Levels)
Gross National Product(%)
FY79
FY80
FY81
FY82
FY83
3.3
0.2
1.3
2.0
2.6
Consumption
0.3
1.3
1.9
2.6
3.5
Business Fixed Investment
0.5
3.7
8.0
13.7
15.9
11.0
18.5
22.3
25.1
27.8
0.2
0.5
1.0
1.5
2.0
-0.l
-0.3
-0.5
-0.7
-0.8
Net Exports
Employment (Million Jobs)
·-
Unemployment Rate(% Level)
After-Tax Family Income (P. I.)
146
461
741
937
1106
GNP Deflater
-0.3
-0.5
-0.8
-1.5
-2.5
Consumer Prices
-0.3
-0.7
-1.2
-1.9
-3.0
Capacity Utilization (% Level)
l
-0.l
1
3
3
3
-0.2
-0.4
-o. 7
-1.2
AAA Corporate Bonds (Level Change)
1/
Fiscal Policy Assumptions
o Personal tax relief of $13 billion in FY1979 (equivalent to $18 billion
in calendar year 1979), $32 billion in FY1980, $54 billion in FY1981,
$78 billion in FY1982, and $104 billion in FY1983.
o Investment tax relief of $7 billion in FY1979, $17 billion in FY1980,
$28 billion in FY1981, $41 billion in FY1982, and $55 billion in FY1983.
o Federal Spending limitation of $32 billion increase (current services
budget) in FY1979 and 6.5% increase each year thereafter.
Source:
U.S. Chamber of Commerce, Forecast and Survey Center. Assumptions and
modelling by Dr. Jack Carlson and George Tresnak using econometric
models of Data Resources, Inc. and Chase Econometrics Associates.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
283
The Chamber's recommendations would benefit families in each state.
For
example, the average family in Connecticut would save $2,840 in federal taxes in
1983 and would have saved $5.:,875 in taxes from 1979 through 1983, experience 3.6%
less consumer price inflation and 1.3 percentage points lower long term interest
rates; $602 million additional investlllent; 3.9% less government control over the
lives of Connecticut families (see Table 20).
SUMMARY
The National Chamber calls upon the Congress to repent of its spending
and taxing ways and slow down the growth of both taxes and spending and aim for
a feasible balanced budget by 1982 by actions for 1979 and a charted path for
1980 through 1983.
The necessary tax relief should include one-third for
stimulating investment.
The results of such an approach would be a much
healthier economy and less oppressive government.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
284
TABLE 20
Ec011omc G&ina by 1983 C.awied by Ch.amber T.&l<
!lelief !lac011Dm1d.aticu I.ti Coml)&risot1 \/1th 1
The .\dministrati011' s Out.loo Ir.
( 1983 Change in Lave.ls)
Greater
T.&l< S.av1.D1s
Per Family
($7 8/Faaily l
l!NIT'Ell STAT!S
ilabama
ilaslr.&
.l.riZOlla
Arlr..aasas
C.a.liforui.a
~0.1.oraa.o
Connac ticuc
Delavar ■
I
i
!
I
Dist. of Columbia
Florida
<.eorgi.a
!!avail
Id.aha
!lliaois
Iadi&aa
,ova
i:aaaaa
!Ceatuclr.y
Louisiana
M&iD•
M.aryl.aad
M&uachwietts
~chi1aa
:iinnasota
Misaisaippi
:usaour1.
Montana
llebraslr..a
Nevada
llev llampshir ■
.1av .;arsay
llev l!axico
Nev !orlr.
llorth C.aroliaa
llouh Dair.au.
1983
l979-l983
2,6 50
l,624
3,169
2,687
1,644
3, 495
3,483
3 , 360
6,557
5,560
3, 402
7·,231
Lover
Couaumer
PriCH
Lover Lo11g
Tani Interest
ila.tH
(%)
(%)
-3.1
-2.4
-5.1
-2.9
-2,4
-3.5
•l,I
--0.8
-1.8
-L.O
--0.8
•l.2
,,,,J
-J. ,
•lol
4 Ul
5,875
5,935
5,739
4,229
4,U l
7,137
4,4 17
6,088
4,920
-3.6
-3.6
-4.0
-2. 9
•2, I
-3.9
-2.7
-3.6
-2 . 9
•l.3
-1.3
•l.4
-l.O
-1 .0
-1. 4
-1.0
-1.3
·l,O
602
160
24
883
963
56
120
2,487
1,565
'-•OV7
J,.J'70
•J,l
•l , I
2,415
1,925
2,258
2,324
4,997
3,982
4,673
4,809
z,ao1
,,ao1
3,272
2,798
2,992
1,801
2,485
2,337
2, 786
2,061
•• llO
6,771
5, 790
6,191
3,726
4,Jbb
5,142
4,835
5,764
4,264
-3.2
-2.5
-2. 7
-2.4
-3.,
-2 . i
-3.2
-3.2
-2.2
-2.8
-3,2
-3.4
-2.8
-1.1
--0. 9
-1.0
--0.9
•l,2
•l,O
•I, I
-1.1
--0,8
•I ,0
•l , O
-1.2
•l.2
•l .O
-z.'l
o,u, ..
•J,0
•L.J
4,5 28
8,4 50
4,042
5,082
-2.4
-3,5
-2.5
-3.2
\JRl.0
, ,100
Oklahom.a
I, 916
2,559
2,403
2,625
•.•""'
3,965
--0.8
-1.2
--0,9
• l,I
-1.u
--0,9
•l,O
•l.!
-1 . I
-u. 9
•l.O
--0,9
-1.1
-L.4
5,295
4,971
5, •32
-,.~
-2.6
-2.9
-J.O
•3. I
~oucn 1,;.&ro.1..:.n.a
1, / I l
J,0 0/
-,.,
South Dair.eta
2, 160
l, 764
2,028
2,065
4,468
3,650
4,195
4,2 72
-2.1
-2.5
-3.0
-3 , 9
/ VO
.::i,oOZ
-z.o
-Q.<j
2,164
2,662
2,0 24
2, 947
2,831
4,477
S,S09
4,1 87
5,097
5,858
-3. 2
-3.2
-2.4
-3. I
-3. I
•L.I
•L.I
--0.9
-1. 1
-l , I
Tann.a ■■ Tua■
tltah
•=t
Vir1iDi.a
r.Juhingtoa
'•••t Virginia
'ilisc0t1a1n
llyoming
Sourc• :
40,118
963
60
321
361
2,808
2,840
2,868
2,774
2,044
.,u4u
3,450
2,135
2,943
2,378
,, uo
Pa1111.9ylvani&
ll.hode bl.and
UDt
(l!ill1011a of
78 ilo.llars )
,,,J~
2,188
4 ,084
l, 953
2,456
Ora1011
Icva ■ c-
l,
,&z
321
602
1,123
201
481
802
2, 848
522
361
642
120
160
32
120
l,404
120
2,307
1 ,444
1.0
2,768
361
481
2,247
160
883
28
963
3, 209
120
80
842
682
361
923
20
t..aaa Govermua.c
Addi-
As • %
ti011■ .l
of
Job ■
Persoll■.l
Iacoma
( %)
2,115,000
32,443
3,667
23,835
20,087
221,080
-3.3
-2.5
-5 .5
-3.1
-2.5
-3. 7
• ~• <l;)IS I
-J. ,.
30, 179 1
6,064
-3 . 9
-3.8
-4.3
.3. l
-2.9
-4,2
-2. 9
-3 . 8
.3. I
-3,3
-3.4
-2.6
-2.9
•2.6
-3. 7
-2.9
-3.4
-3.4
-2. 4
.3. I
-3.0
.3,5
-3.6
-3.0
-3.8
-2.5
-3.7
-2. 7
-3.4
-3.:
-2 . a
-3.t
-3.2
-3.,
-z. 7
-2.9
-2 . 7
-3.2
-4. I
-2 , 7
-3.4
-3. 4
-2 , 6
-3.J
-3.J
;~:~;i
52,029
8,632
8 , 092
105 ,238
52,501
Z9, bb4
23,251
31,214
33,816
9 662
40,106
53,917
83,387
40, 757
21,660
47,135
7,216
l6, 748
7,369
8 255
68 , 277
10,859
161,043
58,519
6 249
105,334
26,428
24,791
109,798
8 721
28,909
6,936
46,659
!JO, 343
12 845
4,254
53,S32
32,264
l5,05I
46, 474
4,450
I
I
tl . S. Ch•mber of Coaaerc•, :'or ■ cast and S11rve1 Canter. Auumption• and aiodelliag by
Dr. Jack Carlson and George Trunalr. u•ing ec011om•t::.-ic aiodels of Data ?e1ourcu, Inc.
and Chase F.:conom•c-rics . .Aasoc i ac1s.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
285
The CHAIRMAN. Thank you very much, Mr. Harris. You say that
the Chamber is deeply concerned about inflation, and I know you
are. Then you recommend a tax cut of $25 to $30 billion. You also
recommend an additional $10 billion reduction in spending, and I
believe your $10 billion is below-Mr. HARRIS. Our $10 billion would take you to the $480 billion
you have been discussing.
The CHAIRMAN. You would be at the $480 billion rather than
$490 billion?
Mr. HARRIS. Yes, sir.
The CHAIRMAN. As you know, we are trying to get spending
down in this committee and in the Congress. However, in the event
that there were not to be an additional $10 billion spending reduction in fiscal year 1979, would you still, given your concern for
inflation, recommend a $25 to $30 billion tax cut?
Mr. HARRIS. Mr. Chairman, I would stick, with the linkage.
The CHAIRMAN. You would. You would say it should be accompanied by an additional $10 billion cut?
Mr. CAR~ON. We think it is important to keep the deficit going
down and below $40 billion. So to the extent you increase spending,
tax relief has to suffer.
The CHAIRMAN. Then you would not agree with a substantial tax
cut in the area of $25 to $30 billion without additional spending
reductions?
Mr. HARRIS. That is a correct statement of our position, sir.
Mr. CAR~ON. But we are strongly advocating that the taxpayer
ought not _to be traded off.
The CHAIRMAN. I understand. I do not want to trap you. I think
you understand what I am getting at. You know that there are
proposals to have a substantial tax cut somewhere in the neighborhood of $28 billion the first year, with larger reductions the second
and third year as well. They are not tied to a $10 billion reduction
in expenditures as they have been in the past. I believe you had
such a proposal last year or earlier this year.
·
But I understand the present tax proposal known as the KempRoth proposal would not be tied to an additional $10 billion reduction. I just wanted to get your opinion.
Mr. HARRIS. In our testimony we have tied the tax reduction to a
spending limitation.
The CHAIRMAN. Yes, and I think we should. I have been trying,
as you know, to get the message across that we must get the deficit
down as much as we possibly can and as quickly as we can. Obviously none of us believes we can eliminate it all in 1 year or even
in 2, but we should strive to get rid of this deficit within 3 years.
I feel that the elimination of the deficit is one of the most
important steps that Congress or the Government can take to
indicate to the private sector our seriousness in combating inflation.
There is a serious question as to whether we should have any tax
cut this year, as you know. The idea is to hold the line on spending
and at the same time see if we can get it down below but certainly
hold it at $490 billion, which is a reduction from where we started
out. Then if we were to have no tax cuts we could get an additional
$15 billion or more-perhaps somewhat less-off the deficit.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
286
Would you comment on the proposal of some Members of Con-:
gress not to have any tax cut at all?
Mr. HARRIS. Mr. Chairman, I would offer a comment which is
really not representative of a specific policy resolution by the
Chamber board but represents more a personal view of my own as
to how to deal with the whole inflation problem. I think I come up
this way. Obviously we have to reduce spending in order to reduce
taxes, and as we take off taxes, we ought to at the same time relate
some of the spending reduction to reducing deficit and some of it to
stimulating the economy.
·
I think this is a sort of seed corn proposition where if you took
off an additional $15 billion of taxes and held spending tight and
reduced the deficit by $10 billion, the additional $15 billion goes
back to the taxpayer. So the next time he files his 1040 tax return
he is out there helping every Member of Congress to stand fast on
the spending.
If you are going to get that voter to support you in standing fast
on the spending limitation, you have to give him a little back on
his tax return while he is pressing you to stop the spending. That
is a personal reaction as to the best strategy to deal with the
problem.
The CHAIRMAN. Would you like to respond, Mr. Carlson?
Mr. C~oN. Yes. I think it is important also to note that the
tax structure, given the inflation we have, is greatly discouraging
investment, and tax relief in the investment area is mighty important to increase the capacity of the economy so you won't have
these bottlenecks we are starting to see.
The CHAIRMAN. So you think that you would not agree with the
Pickle-Vanik proposal that there should be no additional tax cut?
Mr. CARL90N. No, sir. We would think the Ways and Means
Committee proposal right now is a good starting point to add to
and especially to keep one-third to encourage investment.
The CHAIRMAN. You stated that deficit spending is one of the
major causes of inflation, although you also mentioned overregulation, property taxes and farm prices because of Government subsidies as contributors. Could you tell me what you think some of the
other major causes of inflation are that are less closely related to
Government?
Mr. HARRIS. First let me say that I think my colleagues and I
agree that probably about 60 percent of the driving forces of inflation are related to Government policies and Government action,
deficit spending being one of those, regulation being another.
I would say that the discouragement or the disincentive to save
that flows from our tax policy is an important third part of the 60
percent attributable to Government policy and Government action.
Another 20 percent is probably related to our imbalance in payments in our foreign trade. A great deal of that is attributable to
our imported energy for which at the moment we do not have an
instant solution. The remaining 20 percent I would submit is
mostly related to wage adjustments that do not have an equal
relationship to increase in productivity.
I would be quick to point out to you that I think that last 20
percent is not as much a driving force as it is a following force. If
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
287
you would deal with the other 80 percent, you would moderate the
demand for wages and it would not follow quite as fast.
The CHAIRMAN. Thank you. That is a good answer. The gentleman from Ohio, Mr. Latta.
Mr. LATTA. Thank you. Gentlemen, it is very nice to have you
this afternoon. Sorry you had to wait so long.
We had a witness before the committee this morning, Dr.
Oswald, representing the American Federation of Labor~ He made
a couple of suggestions, and I would like to have your comments on
them. He said, "We are calling for enactment of a fair and responsible $11 billion individual income tax cut to be accomplished
simply by increasing the present $35 per person general tax credit
to $150." Would you care to comment on that suggestion?
Mr~ CARLSON. Yes, sir. We think it is very important at this point
to encourage investment because the 10 million increase in employment that we have seen since 1975 has not been accompanied with
an appropriate increase in investment. So consequently on the
average they are working with inferior tools, plant and equipment,
and we need to have a marked increase to make those workers
much more productive so the real wages can go up.
Also, we would differ with the cuts being just for the low end of
the income spectrum. We think inflation affects all Americans and
a tax cut should be across the board as opposed to just one group in
the country.
Mr. LATTA. Did we not go down that road a few years ago-the
$50 rebate they were going to give to everybody?
Mr. CARLSON. Yes, sir, last year, and the President withdrew
that. I think he is wise in withdrawing the $50 rebate because of
the yo-yo effect of that kind of proposal.
Mr. LATTA. He also made this rather startling recommendation:
Establishment of reserve stockpiles-talking about Iagricultural
stockpiles-and effective export controls on agricultural commod-·
ities. Since we have to depend on those exports of agricultural
commodities to get us at least $26 billion worth of exports, I
wonder. how export control would affect those exports and where
our balance of payments might be if we went that route.
Mr. CARLSON. That would be devastating on exports and ·balance
of payments to have export controls that were effective in any way.
It would lead to a further devaluation of the dollar, and if that
were to occur instead of having 1 percent of the inflation rate
being caused by the increase in imports, it would be much higher.
Clearly that is the wrong way to go. Having some reserves for
drought years is rather important but not for speculating in the
marketplace.
Mr. LESHER. In the long term, that would be devasting to the
economy because it would dry up the supply of agricultural products for markets abroad in the longer term. And looking to the
longer term, we will need to rely increasingly on farm exports for
payment for those natural resources that we buy abroad. So that
would be a serious mistake to follow that policy.
Mr. LATTA. While we are talking about agricultural matters, let
me ask you a related question which concerns me very much. We
have had going on for the last couple of years negotiations for an
international wheat agreement whereby the United States would
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
288
be limited in its exports, and so on. Would you care to comment on
that?
Mr. CARLSON. Sir, we would generally be opposed to any cartel
monopoly-type arrangement where in fact a few countries or companies were to control products through some sort of an agreement
to fix the price.
Mr. LATTA. These limitations would be on the exporting countries of the world. We had the Secretary of Agriculture before this
committee several months ago, and he was very much for it and
said the negotiations are going on now.
Mr. CARLSON. I think one has to find out what kind of arrangement he is talking about. If you are talking about having reserves
on hand to take care of drought conditions around the world, that
is one thing, another if you are trying to influence the terms of
trade, the prices the exporting countries receive over an extended
period of time, that is another. That would be rather protectionist
oriented and I would prefer not to see us move in that direction.
Mr. LATTA. I would like to suggest to the Chamber that they look
into this matter quite thoroughly because, as I say, it is ongoing
and they are trying to bring about such an agreement. We had the
Secretary of Agriculture say he was all for those agreements.
Mr. HARRIS. We appreciate your suggestion and we will look into
it.
The CHAIRMAN. Mrs. Holt.
Mrs. HOLT. I have no questions. Thank you, gentlemen.
The CHAIRMAN. Mr. Rousselot.
Mr. RoussELOT. I appreciate your testimony especially since several of your recommendations concur with several of us on this
committee, and also those of us that serve on some of the other
committees.
Since you have recommended a $25 billion to $30 billion tax
relief, and you both said across the board, is the makeup of those
tax relief proposals across the board in the personal income tax
field and corporate also?
Mr. CARLSON. On the investment side, as opposed to encouraging
consumption, we would encourage capital gains tax relief, investment tax credit extended to structures, the corporate rate reduction, both the surtax and a normal tax, and we encourage in time
more adequate depreciation so that it fully recovers.
Mr. RoussEWT. How much of a reduction have you called for?
Mr. CARLSON. We think the Ways and Means Committee's
markup is a starting point. We would want the reduction in corporate rates to go up to 3 or 4 percent, depending on the size of the
total tax cut.
Mr. RoussEWT. You mean down the road?
Mr. CARLSON. Yes, if in fact we have the $25 billion to $30 billion
tax cut, and you are talking about one-third for investment purposes, then it would be appropriate in a mix of encouraging investment to have a larger reduction in the corporate rate.
Mr. RoussEWT. When you make these suggestions of tax reductions, do you project the same way that former Chairman of the
Council on Economic Advisers Heller does, that there is no feedback effect down the road, or is it just a flat reduction in revenues
to the Federal Government, period? Is there any feedback effect?
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
289
Mr. CARLSON. Yes. I think Dr. Heller would also estimate some
feedback, maybe not as much.
Mr. RoussELOT. Not very much?
Mr. CARLSON. Our estimates of feedback would be comparable to
what Nancy Teeters has talked about elsewhere. There is some
feedback; revenues do go up because of a faster growing economy,
so tax receipts go up and give some offset to the initial cuts.
Mr. RoussELOT. How much of a feedback?
Mr. CARLSON. I clearly think 40 percent, so a net tax cut would
be about 60 percent of what you start with.
Mr. RoussELOT. At what period of time does this 40-percent feedback affect?
Mr. CARLSON. It takes a period of time, certainly a couple of
years. It depends on the startup time on investment, and one thing
about investments, they also increase capacity and increase productivity, so you have more efficiency in the economy by encouraging
investment and consequently less inflation by going as we are
proposing; that is, one-third of a tax cut for investment purposes.
So we end up with 3 percentage points a year lower inflation over
our planning horizon_than the program we think you are going to
follow.
Mr. RoussELOT. Three percent less inflation?
Mr. CARLSON. Yes.
Mr. HARRIS. You would not want to overlook in evaluating the
feedback rate the fact that we really literally have a sort of pentup accumulation of potential capital investment. It has been lacking for some time. If we would adopt a policy and satisfy the
economy, particularly investment managers, that we are on the
sustained continued program that I mentioned to the chairman, I
think you would release some of that pent-up investment right now
so that when you say-Mr. RoussELOT. So the effect would be immediate, you are
saying?
Mr. HARRIS. Some of it would come immediately, yes.
Mr. CARLSON. One does not need to speculate on the reaction of
the economy to a tax relief to show it is wise to go that direction.
Mr. RoussELOT. Are you familiar with Mr. Heller's editorial in
the Wall Street Journal a few weeks ago where he just said it
would be a total loss if the Kemp-Roth bill was put in, $115 billion
over a loss of revenue over a period of 3 to 4 years?
Mr. CARLSON. No. In fact, we have estimates over a 4-year period
of over $100 billion and we have the estimates of what the tax
effect will be, in terms of feedback, in our testimony. Clearly it
does encourage the economy. It depends on whether you are running the economy at overcapacity and really adding to inflation,
which were his words.
Mr. RoussELOT. Right. That was his prime worry, that it would
add more to inflation.
Mr. CARLSON. Yes. 1f you have spending limitations in the direction our Chamber chairman has talked about, then you make room
for the tax cuts so you do not have that feeding of inflation; in fact,
you abate inflation because you are adding to capacity.
Mr. RoussELOT. So your statement is, then, that with the $25
billion to $30 billion tax cut as you have suggested, accompanied by
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
290
the reduction in increase in expenditure level by the Federal Government-your 7-percent increase-you do not have all of that
revenue loss projection that Dr. Heller suggests?
Mr. CARLSON. No. There is additional growth to the economy that
cuts the net tax.
Mr. RoussELOT.· Are there other economists that agree with that?
Mr. CARLSON. I think most agree there is some feedback.
Mr. RoussELOT. I know there is disagreement as to how much.
Mr. CARLSON. The real debate right now is whether you would
recover all of it or some of it.
Mr. RoussELOT. Right. We understand that.
Mr. CARLSON. You do not need to be speculative of whether you
recover all of it to make your argument that tax cuts are wise.
Mr. RoussELOT. Dr. Heller made a flat-out statement it is a $150
billion loss flat out. To cope with that argument, which I am sure
we are going to hear on the floor, we would like to have your
backup material. I know part of it is in your testimony. We evidently need more than one economist to back that up if we are
going to present some of those arguments on the floor. I happen to
.
agree with much of what you said in your statement here.
Mr. CARLSON. I would like you to refer to page 14 where we have
tried to show the initial tax relief and what the net tax relief
might be of Proposition 13 applied to the Federal Government or
our tax relief we propose or the 1963-64 tax relief sized for the
larger economy today or the 1975 tax cut to get some sort of order
of magnitude.
Mr. RoussELOT. Are there other economists besides yourself who
agree with this thesis?
Mr. CARLSON. I think Arthur Okun, who made the estimates and
who was also chairman of the Economic Advisers Council, made
the estimates of the Walter Heller tax program of 1963-64 to find
if there is a feedback effect.
Mr. RoussELOT. Obviously you know by the article if you read it,
Dr. Heller said there is a loss of $150 billion in revenue, period. I
know that argument is going to be used on the floor.
Mr. CARLSON. Taken out of context, that statement is wrong.
Mr. RoussELOT. Thank you.
The CHAIRMAN. Mr. Regula.
Mr. REGULA. Thank you, Mr. Chairman. Just a couple of questions.
You mention the investment tax credit as being an important
feature; in fact, you suggest a 12-percent rate. How about expanding this to include not only structures but modernization so that
the cities, particularly those with older industries which have a
problem of retraining, would benefit from that type of inducement
for modernization? How would you react to that?
Mr. CARLSON. Yes, sir, we support that.
Mr. REGULA. As to using the investment tax credit for that
purpose, have you so testified in the Ways and Means Committee?
Mr. CARLSON. Yes, we have, even though the testimony was not
specifically aimed at that particular tax provision. We have in
principle supported a movement in that direction.
Mr. LESHER. We think it is time to experiment with using tax
incentives to get jobs back in the cities, because tax penalties have
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
291
been driving jobs out of the cities, so we would like to see a little
bit of reversal of the knee-jerk reaction that we have been following for 4 years.
Mr. REGULA. Have you developed some other proposals beyond
just the investment tax credit for modernization? I like this idea of
other kind of tax incentives to get jobs into the central city, and
this might be far more effective than some of the social programs
we have been talking about.
Mr. LESHER. Our tax policy also favors a tax subsidy for jobs that
are created in the inner city.
Mr. REGULA. Very good.
Mr. CARLSON. For people who are structurally unemployed.
Mr. REGULA. I congratulate you on that. One other question.
How would you react in terms of capital formation to some type of
substantially accelerated depreciation as a means of quick capital
recovery to get that money back to reinvest and also to avoid the
erosion of inflation on the purchasing power of that capital?
Mr. CARLSON. We think it is wise that the tax structure should
be such that a person, as the structure wears out, can recover his
costs to replace it. Last year Americans were $17 billion short of
having adequate funds to replace. So adequate costs recovery,
either accelerated depreciation or straight line with reduced life, is
a wise direction to go.
Mr. REGULA. The other thing. How much of a deficit do you
think we could take, or how much should it be reduced in order to
send out a message which would restore confidence in the business
community? What is the magic figure for fiscal year 1979 in your
judgment?
Mr. CARLSO~. I think a deficit between $35 to $40 billion is called
for. Even that deficit is not back to the old rule of thumb of a
balanced full-employment budget, which according to the Congressional Budget Office is going to run around $20 billion in deficit
with the administration plans up to date.
Clearly, moving that down toward the full employment balance
or a deficit next year of $35 to $40 billion and then going down to
$20 billion the following year and a balanced budget by 1982, but
without necessarily having taxes in double-digit growth to bring it
into balance, not increasing the size of Government but having the
relative size of Government shrink somewhat, is our preferred
path.
Mr. REGULA. Thank you, Mr. Chairman.
The CHAIRMAN. Gentlemen, you may not have had much time to
study it but I am sure you are familiar with the tax package .voted
out the other night. I would be interested in your comments. I
heard one of you say it is a good tax bill to start with. Would you
comment further on it for us.
Mr. CARLSON. Yes, sir. We do think that it is a good starting
point, the Jones compromise modified at the $16 billion annual
level. We would prefer it to be a larger size and we would prefer to
have a larger proportion of whatever size to encourage investment.
In fact, we would support a full Steiger amendment as opposed to a
modified or half Steiger amendment to that bill. We would support
the investment tax credit being extended to all structures, not just
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
292
to the highly limited number, and we would like to see more effort
go on in terms of more adequate depreciation allowance.
If you had a larger package, then you could have more than a 2percentage point reduction in the corporate rate. We do support
larger tax relief on the low end of the corporate rate for small
business. We prefer a two-step process as opposed to the process
that was applied in that bill, but we would have the steps here so
there would be greater tax relief for smaller businesses.
."
Those are the changes we would recommend that the Congres~
consider in marking up that bill.
Mr. LESHER. This country is falling far behind in the rate of
productivity of the other Western nations and lagging in the rate
of capital formation. If you are concerned with inflation, you have
to be concerned with those two issues. You have to be concerned
with productivity broadlyAMost of the things we are doing tend to
impinge upon productivity, so you have to look to tax policy to look
for incentives for capital formation, which in turn will lead to
increases in the rate of growth of productivity.
The CHAIRMAN. You would agree that this tax cut proposal of
Ways and Means seems to be different from earlier ones in that it
seems to be directed more toward capital formation incentives and
stimulus in the private sector. I think that is a healthy start.
Mr. LESHER. Yes; we applaud that very much. That is a remarkable turn from the rumors that came out of Capitol Hill and the
administration all last year that we were going to see an increase
in the tax on capital gains. In our opinion this was one of the most
devastating things that was taking place last year. Nothing can be
more devastating to investor confidence than to suggest that capital gains taxes are beginning to go up and that the rules of the
game will be changed periodically.
I believe, as our chairman pointed out in the opening statement~
that the problems we are talking about here today, inflation, taxation, and productivity, are long-term problems. It is going to take
a long-term program to solve them, so we will be back again next
year hoping some of these new directions pick up momentum and
we see a decided emphasis on the investment portion of tax reduction.
Mr. HARRIS. Mr. Chairman, I would invite your attention to our "'
table 16 on page 18, where we try to compare the cost of creating
jobs. This trend of giving the tax reduction to the private sector to
encourage investment is a more efficient way of getting the same
thing done that we have been trying to do through Government
spending.
Mr. CARLSON. I would also like to add, Mr. Chairman, that it is
not correct to say that tax relief to encourage investment is only
for millionaires, because the jobs that are created, whether it is
capital gains tax relief or the others, are disproportionately filled
by workers from middle and lower income households. Consequently, encouraging investment actually disproportionately drives
money toward middle and lower income people, not the other way
around. So the President's statement is highly misleading in this
area in terms of programs that are aimed toward tax relief for
investment.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
293
The CHAIRMAN. Thank you very much. Are there any further
questions? If not, this concludes the hearing. Again we thank you
very much for your patience, but especially for your testimony and
responses.
Mr. HARRIS. We appreciate the opportunity to appear, Mr. Chairman.
The CHAIRMAN. The committee stands adjourned.
lb:sPONSE TO QUESTIONS FROM CoNGRESSMAN PAUL SIMON BY
HoN. BARRY P. BoswoRTH
Question. In the whole tax reduction area, I am interested in what the impact on
inflation is of a $20 billion tax reduction versus $15 billion, versus the Vanick-Pickle
proposal for no additional tax reduction. Or, also in theory just the theoretical
question whether it is wiser to have a general tax reduction that stimulates the
economy generally or to put a specific amount into a government program where you
aim it at structural unemployment?
Answer. The difference between the inflationary impacts of $15 and $20 billion
general tax cuts is negligible. This is not to 91!y_,_ however, that the manner in which
the tax reduction is allocated is unimportant. Which income classes get the tax break
and for what purposes does have a differential effect.
We are presently in an inflationary situation that has a great deal of built-in
momentum. At the same time, increases in payroll taxes and fiscal drag (due to the
movement into higher tax brackets as inflationary artificially increases nominal
income) threatens to reverse the impressive gains we have made in employment.
Thus, there is a need for a tax cut of $15 to $20 billion to maintain moderate economic
expansion. The difference between a cut of this magnitude and no cut at all is
estimated to be only a tenth of a percentage point.
On the other hand, this clearly is not the time to increase the budget deficit. While
an abrupt balancing of the budget would be much too severe a response to the
inflation, a gradual reduction in the deficit, accompanied by other anti-inflationary
measures, can be successful in reducing both the rate of inflation and the unemployment rate as we approach the potential of the economy in coming years.
The issue of the theoretical value of a general tax reduction versus employment
programs has not yet been resolved in the profession. Undoubtedly, as we approach
ca,f!~~tfs constraints in the economy, some structural measures are necessary. The
A · tration has tried a very balanced approach. Since many of these programs are
new, we have recommended gradual increases in their outlays. This will permit time
for proper testing and evaluation. At the same time, a tax reduction bill was proposed
because of the above-mentioned fiscal drag and payroll taxes and because of the need
for new investment in the economy.
Question. In view of your comments on the agricultural situation, I am interested in
the set-aside and what impact that has, and if this is wise, taking a look at the
inflation thing?
Answer. Acreage set-asides are a direct means of reducing supplies and thus
maintaining market prices. Their inflationary impact depends upon whether or not
prices are raised above the minimum support level. H not, the set-aside reduces the
costs of purchasing grains for the reserve. The wisdom of this action, in tum, depends
upon the adequacy of the reserve to meet future contingencies. In my view, existing
wheat reserves are adequate and a set-aside is an appropriate way of reducing budget
costs. However, the same is not true for feed grains where the available reserve is at
critically low levels.
Question. In connection with agriculture, whether we should not be more reliant on
target prices and in the process lower the price of food?
Answer. In the short run, an emphasis on target prices as a means of maintaining
farm income is less inflationary than the manipulation of support prices. The first
triggers budgetary payments whereas the latter specifies a minimum level of market
prices. In general, the cost to consumers is the same since they pay either in the form
of higher prices or higher taxes. But, the direct-payments route avoids the
passthrough of costs into other prices and wages. However, over longer periods of
time, the large budget outlays associated with target prices generate pressures to shift
the. highly visible pa~ents out of the budget and into less viable higher private
market prices. Thus, high target prices do, over time, lead to high support prices.
Question. I have suggested the possibility of the Congressional Budget Office having
an inflation impact statement with every bill that emerges from a committee of the
House. I would be interested in your reaction to that.
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
294
Answer. I would strongly encourage and support efforts to provide an inflation
impact analysis for major legislation. However, I would hope that its format would be
structured to be more useful for decisionmaking than that of the environmental
impact statement.
Question. You mentioned regulations. I just had some correspondence which amazed
me that shows that the environmental impact statement has increased the length of
the time it takes to okay bridge construction from 1 year to about 5 years. I would be
interested in and I have made notes for Allen Cissel of my staff to find out whether
any bridge anywhere was ever turned down for environmental impact reasons.
Answer. We are also concerned with the delays imposed by the regulatory process
and the inflationary costs associated with such delays. There is a need to expedite the
procedures for issuing construction permits. Therefore, we were encouraged by
reports of a new program, announced by the Environmental Protection Agency only
18E6 week, which promises to red\,lce the often lengthy delays faced by industries
required to obtain pollution control permits. Hopefully, this is an indication of the
kind of improvement in this type of procedure which can be extended to other types of
regulation. At the same time we feel that despite the costs involved, some investigation is necessary to insure that potentially adverse results, which can be extremely
costly, are avoided.
Question. I think I am correct in saying Italy and the United States are the only
nations that do not have either standby wage and price controls or some type of wage
and price controls. Does it in theory make sense to have some standby wage and price
controls and, if not, Dick Bolling this morning before this committee talked about
some advanced notice on price increases.
Answer. The history of wage and price controls has not been encouraging. Controls
simply have not worked well in this country or in any other country, with the
exception of their use as in national emergencies such as war. Consequently, they are,
at best, a short-term measure which seem inappropriate as a response to the
continuing inflation problem that this nation faces today. Since we view this policy
response as inappropriate, the request for the authority is unnecessary. In fact, the
authority itself, could actually cause anticipatory wage and price increases.
As for the suggestion of prenotification on price increases, the Council has worked
with some industries on this matter. More cooperation from certain industries is
necessary, but we anticipate that this will be forthcoming.
Question. Finally, do you have any impression of the impact or the desirability of
having off-budget agencies with their expenditures without Congressional control, and
the off-budget guaranteed loans?
Answer. The Office of Management and Budget is presently studying ways to
achieve better control over credit programs. The administration will shortly propose
to the Congress, after working with the appropriate congressional committees, a set of
control procedures.
[Whereupon, at 5:10 p.m., the committee adjourned.]
https://fraser.stlouisfed.org
Federal Reserve Bank of St. Louis
0
@FedFRASER