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THE FEDERAL
BUDGET:
W HAT ARE
THE NATION’S
PRIORITIES?

FLUtHAI- R tit iiV c tA

o f m ; n n £a p o i 3s

THE FEDERAL
BUDGET:
WHAT ARE
THE NATION’S
PRIORITIES?
A Rational Debate
sponsored by the American Enterprise Institute
and held at
the Statler-Hilton Hotel
Washington, D. C.

EILEEN SHANAHAN
Moderator

THE FEDERAL
BUDGET:
WHAT ARE
THE NATION’S
PRIORITIES?
James T. Lynn
Charles L. Schultze

RATIONAL DEBATE SERIES

American Enterprise Institute for Public Policy Research
Washington, D. C

© Copyright 1976 by
American Enterprise Institute for Public Policy Research
1150 Seventeenth Street, N.W., Washington, D. C. 20036
All rights reserved under International and
Pan-American Copyright Conventions
Printed in United States of America

ISBN 0-8447-2085-2
Library of Congress Catalog Card Number 76-16471

FOREWORD

The budget that the President submits each year to Congress
is a statement of the administration’s fiscal policy, a reflection
of the administration’s priorities, and an indication of the
extent of federal involvement in the economy. All three of
these aspects of President Ford’s budget for fiscal year 1977
are discussed in this debate.
James T. Lynn and Charles L. Schultze are eloquent spokes
men for differing points of view on these matters. The argu
ments they present will assist readers in forming their own
opinions on the complex issues involved in the 1977 budget.
And the methods they use to analyze the budget will be useful
in judging future budgets.
The American Enterprise Institute is pleased to present,
as the twenty-seventh in its continuing series of Rational
Debates, this contribution to intelligent discussion of the most
important economic policy document presented each year, the
federal budget.
June 1976

William J. Baroody
President
American Enterprise Institute
for Public Policy Research

CONTENTS

FIRST LECTURE
James T. Lynn...............................................

SECOND LECTURE
Charles L. Schultze......................................... 13

III

REBUTTALS
James T. Lynn............................................... 23
Charles L. Schultze......................................... 27

DISCUSSION

FIRST LECTURE

JAMES T. LYNN

In 1962, the United States reached its first $100 billion bud
get. Now, less than fifteen years later, the decision about
the budget for the coming fiscal year— 1977— turns on
whether total outlays should be a little lower than or sub
stantially above $400 billion.
This three-fold increase in outlays has been accompanied
by an equally dramatic change in the makeup of the budget.
Contrary to what appears to be the general public understand
ing, the defense budget, which was about half of the budget
twenty years ago, now accounts only for roughly 26 percent.
Spending on payments for individuals and grants to state and
local governments, on the other hand, is up 500 percent in
the last ten years. Whereas these programs accounted for
about 19 percent of the budget some twenty years ago, they
now claim more than 55 percent.
Now, this development has its good side: it reveals a nation
that cares. As the nation has accumulated resources, it has
chosen to spend them on those with unmet needs, whether
people— the elderly, the poor, the sick—or communities,
particularly older communities.
Unfortunately, the growth in these payments for individ
uals and grants to state and local governments cannot con
tinue at the pace of the last decade or two. To give an
example: If we were to continue for the next ten years the
rate of growth in these human resource programs experienced

FIRST LECTURE

in the past ten years—growth spurred not only by expanding
population, but also by changes and additions to existing pro
grams and by new programs— and if we were to accommo
date that growth at the expense of the defense budget, the
United States would be down to its last soldier and its last
gun roughly ten years from now.
Would I like that? Would I like to have a zero defense
budget? The answer is clearly yes. One cannot have worked
in the Department of Housing and Urban Development for
two years, or in other places in the federal government, as I
have, without confronting the unmet needs in this country of
people and of communities for research, for health, for educa
tion, and for so many other programs. If we lived in a perfect
world, a world in which we could throw down our weapons
and turn them into plowshares and be sure that others would
do the same, no one— surely not I—would question a zero
defense budget. But we do not live in that kind of world. The
President knows that, and the American people know that.
Therefore, as I put it fairly often, I believe our Number One
domestic program is defense.
This year, for the first time in some years, a small expansion
is being proposed for real expenditures for defense. Even at
that, in dollars of equal purchasing power, the figure for
defense expenditures is no higher than it was before the
Korean War.
Nevertheless, we do want to cut the waste out of defense
spending. The President has made proposals to the Congress
that will result in $2.5 billion to $3 billion of savings— if
Congress takes the necessary action. Although we must be
second to no country and must have rough equivalency, the

JA M E S T . L Y N N

President has given us very strict instructions that we should
get rid of waste any place we can find it.
For another perspective on the budget, in 1947, total ex
penditures by all levels of governments— federal, state, and
local— were about 18 percent of total expenditures in the
United States. In 1955, they were around 25 percent. For
this year, while the data are still incomplete, I would guess
that total expenditures will range somewhere between 35 and
38 percent. In other words, 35 to 38 cents out of every dollar
spent in the economy will be spent by one government or
another.
Let us bring these numbers a little closer to home. They
mean that an average family of four, earning $14,000 a year,
works from New Year’s Day until approximately April 15th
(in an ironic coincidence, tax day) to pay all of its taxes—
federal, state, and local. Putting it still another way, in a
tighter time frame, this average American family works all
day Monday and the better part of Tuesday before it starts
working for itself— before it begins to make the money to
spend on its own decisions, its own choices.
The President believes that we are reaching a point, first,
where too many of the choices are being made by government
rather than by the people who earn the money and the people
who want to invest the money, and, second, where we must
reduce the massive deficits that we have been running.
What does he propose to do about it? It is generally
agreed that the federal budget for the fiscal year that begins
October 1 would run somewhere around $419 billion to
$425 billion if it were to be a business-as-usual kind of bud
get—what I call a "salami-like budget,” one that retains

FIRST LECTURE

existing programs and adds a billion here and a billion there,
until, as one wag once said, it adds up to real money. This
administration does not believe that the country can long
stand annual increases in the budget of roughly $50 billion,
around 10 or 11 percent, which has been the experience of
the last two years. The President seeks to cut back that rate
of growth to somewhere around 5.5 percent. And that means
holding expenditures for fiscal year 1977 in the range of $394
billion to $395 billion. He also says that, as a matter of eco
nomic policy, we should start on our way toward a balanced
budget in fiscal year 1979.
As most people know, this country has had very high defi
cits this last year—brought about, in the main, by the re
cession and by efforts to cope with it through increased
unemployment benefits and other help to people who have
been hurt by the recession. We believe that we can safely
get the deficit down this year to $43 billion, by holding ex
penses to $395 billion.
It should be noted, however, that the $43 billion deficit—
which represents a step on the way to a balanced budget two
years out—would allow a further tax cut beyond that enacted
last year. This further cut would give the average family
of four, making $14,000, something like $227 more in takehome pay than the current tax law would allow.
At the same time, the President points to the need for some
action to maintain the integrity of the social security system
in the years ahead. To that end, he is asking that Congress
pass a law increasing somewhat the contributions made by the
employer and by the employee—by three-tenths of 1 per
centage point each— to help make the social security fund

JA M E S T . L Y N N

whole, to prevent the depletion of its assets. Such action
would offset the benefit from the proposed further tax cut,
reducing it from $227 to around $180, but that is still a
healthy net gain in the take-home pay of the average
American taxpayer.
The President is also trying to reform a number of the
programs of the federal government, and some of these re
forms are necessary if expenditures are to be held at around
$395 billion. In fact, some $10 billion to $11 billion of the
savings implicit in that number is dependent upon congres
sional passage of revisions to existing laws. The rest of it, of
course, depends on congressional willingness to go along with
the President on appropriations for both new and existing
programs.
The President has often said, "Let’s get rid of programs that
don’t work very well to make room for programs that do.”
A good example of this effort is his proposal for consolidated
block grants— that is, pooling the money that now goes into
many individual categorical programs and spreading it
around the country to states and communities on the basis of
relative need. Under this approach, the precise ways in which
funds are used to achieve an objective set out in the law would
be determined locally.
Take the health services area, for instance. I am talking
here about the current activity under the health service pro
grams of the Department of Health, Education, and Welfare
(HEW) and am not including the health service programs
of the Veterans Administration, the Defense Department, and
the Bureau of Indian Affairs, or the tangential programs of
HUD and other agencies. The President proposes that sixteen

FIRST LECTURE

of these HEW programs, including Medicaid, be combined
in a block-grant program, with no reduction of funds, but
also with virtually no growth except for Medicaid, which
would rise $800 million in the forthcoming year. These
funds would be sent out to the states, which would decide
how the needs of lower-income families, as well as the in
stitutional and environmental health needs of the communi
ties, are going to be met.
What are the chances for bringing these proposals to frui
tion? I have to say that I do not know. We have lived in a
political world in which the motto seems to have been: Spend,
spend, spend; tax, tax, tax; reelect, reelect, reelect. In fact, I
have wondered at times whether the motto was not simply:
Spend, spend, spend; reelect, reelect, reelect.
One cannot blame Congress totally for this situation. The
American people themselves, including some of the people
that have run HUD, have split personalities in this regard.
All of us are for restraint. We all want to hold down the
deficit. We all want to get rid of inflation. We all want to
get governments off our backs. But, at the same time, in this
catalog of domestic assistance programs*—which included
1,006 at the beginning of the year and includes 1,030 now—
there is something for every business, every person, and al
most every institution in America.
What most people have said over the years is: "We’re
right with you, Mr. President, we’re right with you, Jim Lynn,
let’s hold down spending— in everybody’s program except
mine." But today I detect that the American people are wak* Editor’s note: Catalog of Federal Domestic Assistance (Washing
ton, D. C.: U.S. Government Printing Office, 1976).
8

JA M E S T . L Y N N

ing up to the fact that there is no “free lunch”— there is no
way that this country can go on year after year with massive
deficits. We must get back to balanced budgets. Doing so
is inextricably linked to combatting inflation; and if the
country continues to sustain inflation of the kind experienced
recently, it will be a country in which the system of competi
tion, of risk and reward of investment, cannot survive, let
alone flourish.
Therefore, the Ford administration thinks this is an im
portant year, a crossroads year. The outcome is largely up to
the Congress and, in turn, to the people of the United States.
If Congress does not get a message from the people— that
they want restraint, that they want programmatic reform—
the nation will not get those reforms; there will be no move
ment toward a balanced budget, no good riddance to bad
programs that do not work and no development of better
programs. But if Congress does get that message from the
people— the demand for restraint and reform— then restraint
and reform will be enacted.

SECOND LECTURE

CHARLES L. SCHULTZE

James Lynn and I each have twenty minutes to talk about a
$400 billion budget; that is $20 billion a minute. To put it
in terms of the difference between us, it turns out that we are
about $20 billion apart in our idea of what the federal budget
should be this coming fiscal year. And that works out to a
nice neat $1 billion a minute.
I want to talk about two things: The first is federal budget
policy as it relates to overall economic performance— to un
employment and inflation— and, specifically, the President’s
budget and some alternatives to it. Second, I want to look
at the particular aspects of budgetary priorities, as reflected in
the President’s budget, and, again, to consider some alterna
tives.
Let me start with the budget and the economy. At the
present time, the economy is recovering at a moderately good
clip from the worst recession in forty years. Moreover, the
likelihood is that recovery will continue at a good clip for the
next six to nine months, perhaps even a year— whatever the
fiscal 1977 budget may be, because that budget will not begin
to have its effects until next October. Output is now rising
at 6 to 7 percent a year. The underlying rate of price infla
tion, while still far too high, is running at about 5.5 to 6.5
percent a year, well below the double-digit figures of 1974.
So, even if the economy is not looking great, it is recovering
well. But look back to a year ago. At that time, the President

SECOND LECTURE

proposed a budget for fiscal 1976 with a $52 billion deficit—
resulting from $350 billion of expenditures and about $298
billion of revenues. That deficit was less than the drop in
revenues caused by the recession; on a high-employment or
full-employment basis, that budget would have been in sur
plus by $12 billion. When the President proposed that
budget, we were warned that going significantly beyond that
deficit would be dangerous, would raise interest rates, crowd
out private investment, retard recovery, and possibly re-ignite
inflation. Indeed, at least one member of the President’s
cabinet appeared to question whether even the $52 billion
deficit was not going too far.
What happened? In fact, the Congress ignored that
budget. It increased expenditures over and above the Presi
dent's request; it expanded the tax cut beyond the President’s
recommendation; under the new budget procedures that it had
just adopted, the Congress for the first time in history went
on record explicitly voting for a budget deficit larger than the
President recommended— almost $25 billion larger.
And then what happened? A pretty good recovery got
under way. Inflation did not re-ignite. Despite a poor rate of
growth in the money supply, interest rates did not rise. Pri
vate investment was not crowded out. And the President’s
reelection prospects have been improved.
I am suggesting that this year we will very likely see a
repeat performance of last year. The President has come in
with a very restrictive budget, and the Congress will more or
less ignore it and go its own merry way— passing a responsi
ble budget, but one with a somewhat higher deficit. And the
14

CHARLES L. SCHULTZE

recovery will probably continue through 1977, without reigniting inflation.
To be a little more specific: What Jim Lynn calls a handsoff budget— no new policy initiatives, continuation of exist
ing laws, enough additional money to agencies to account for
rising prices but no more—such a budget would require
expenditures of about $415 billion, given some accounting
adjustments to make them conform to the President’s pro
posals. The President’s budget calls for expenditures of $395
billion, $20 billion less.
That hands-off, no-pol icy-change budget would cut the
budget deficit next year from this year’s $75 billion to about
$50-$55 billion—or by about $20 billion. Such a budget
would be mildly restrictive. It would place us on the path
toward a balanced budget but would do so rather cautiously,
because we are just in the early stages of a recovery from a
deep recession.
Compared to that hands-off budget, the President's budget
would, first, reduce spending by $20 billion. Second, as Jim
Lynn pointed out, it would cut taxes $5 billion. Its net effect,
then, would be restrictive. It would pull about $15 billion
of additional funds out of the economy, or, to put it another
way, it would mark’ a $15 billion switch toward restriction.
The real outlays of the federal government— outlays adjusted
for inflation— would drop by 3 percent. Indeed, outside of
defense and interest, outlays would drop by 5 to 6 percent, in
terms of constant purchasing power. In other words, it would
be a significantly restrictive budget, pulling back on the fed
eral government’s stimulus to the economy at a time when

SECOND LECTURE

the economy is about one-quarter of the way out of the re
cession.
As I have said, this set of actions would have no impact in
1976. The economy will keep on moving along. The real
question is, could economic recovery continue at reasonable
rates in 1977 with that kind of a budget? The President’s
budget obviously implies his belief that a very strong per
formance in the private economy will keep recovery going,
more than compensating for the fact that the federal govern
ment would be very substantially pulling in its horns.
Let me remind you that to reduce unemployment by 1
percentage point a year, a relatively modest objective over
the next several years, takes 7 percent annual growth in the
national economy; and unemployment currently stands a
shade below 8 percent.
A little exercise in arithmetic will demonstrate what is
required to meet that objective of a growth rate somewhere
between 6 and 7 percent a year.
First, let’s take the President’s budget, adjust it for infla
tion, and see how much the federal government will be
purchasing from the economy and how much private con
sumption it will be financing through its social security and
other programs. Add to that the purchases of state and local
governments, and the sum is the total that the governmental
sector of the economy would be contributing to our national
recovery over the next year, given the President’s budget.
Then simply calculate how much the gross national product
would have to grow to reach the President’s own announced
target of 6 percent growth in the economy.
16

CHARLES L. SCHULTZE

Subtracting the first from the second tells us how much the
private economy would have to grow to keep decent recovery
going with the President’s budget. It turns out that to reach
the President’s own modest targets for growth, with his
budget, the private economy would have to grow at a 9 per
cent rate in 1977, the second year of recovery.
Finally, let us compare that required growth with each
prior postwar recovery. The average rate of growth in the
private economy in the second year of postwar recoveries has
been 5 percent. And, within this average, in no such year
has the private economy grown by anywhere near as much
as the 9 percent required to keep recovery going with the
President’s budget. Only one year came close— the year of
the big explosion in private demand, when the Chinese
marched into North Korea. And even that kind of explosion
will not quite do the trick.
Put in another way: If the private economy in 1977 grows
at the same rate, on the average, that has characterized other
postwar recoveries (again, given the President’s restrictive
budget), it would be a rate of growth that would hold the
unemployment rate roughly unchanged in the neighborhood
of 7 percent.
Clearly, therefore, the administration is taking a gamble
with this budget. It is gambling that a restrictive budget, one
that puts expenditures $20 billion below what they would be
in a hands-off budget and gives only $5 billion additional net
tax cuts, will nevertheless be consistent with continued re
covery because private demand will grow at a rate well above
that of any prior postwar experience.

SECOND LECTURE

Now, there are two ways that could happen. The first
would require very cheap money, very low interest rates— that
is, a very large increase in the money supply. Yet, I see abso
lutely no sign, either that the Federal Reserve Board is about
to provide that kind of increase, or that the administration is
encouraging the Federal Reserve to do so. Thus, unless
things are turned completely on their heads, this condition is
not likely to prevail.
The second route to an unusual expansion of private de
mand originates in what I call the psychological theory of
reverse causation: it postulates that because businessmen and
consumers in this country are worried about big government,
if the administration only shows them that it intends to be
very restrictive, they will be so satisfied they will substantially
increase their long-range investment and expenditure pro
grams. Thus, paradoxically, a budget that pulls the economy
back will, in the end, stimulate it. To be consistent, the same
people who propose this would have to assert that, when the
economy is really booming, the appropriate government
policy to lick inflation is to stimulate vigorously to cause the
private economy to pull back. I just do not believe this
psychological theory of reverse causation.
In my judgment, prudence dictates that we pursue a budget
that moves modestly towards restriction during this early part
of the recovery from our recession, but much less sharply than
the administration’s budget does. That much more moderate
move would call for what I have termed a hands-off budget:
expenditures continuing to move ahead to about $415 bil
lion—and an extension of the tax cuts that Congress enacted
last year, with perhaps as much as $5 billion additional.
18

CHARLES L. SCHULTZE

I think such a budget would make much more sense, be
much more prudent, and— though nothing in this world is
risk free— run very little risk of adding significantly to
inflation during the year 1977. This is not to say that the
same budget policy should still be followed in 1978, or 1979,
or 1980. But it is the budget policy for this stage of recovery
from the deepest recession in forty years.
Now, let me turn to priorities on the domestic budget, an
area where I think there is some good news and some bad
news in the administration's budget.
First, I fully agree with the administration’s move to con
solidate, reform, and streamline a number of categorical
grant-in-aid programs to state and local governments, pulling
back on excessive federal control and blocking programs
together to make them more rational. At the same time, one
should not confuse reduction in expenditures with reform.
The administration proposes to streamline, modify, and com
bine separate grant programs and, at the same time, cut fund
ing for them. Logically, these are two separate actions.
Given the condition of state and local finances, and given
the current situation in the economy, it seems to me that
whereas grants can be consolidated, the level of grant sup
port need not be cut. In the case of education and health
grants to state and local governments, there is, indeed, a
melange of individual, chaotic, topsy-like grants that need to
be pulled together— but not cut by $3 billion, as the admin
istration proposes. I see no rationale for that.
In the case of Medicaid, which is a joint federal-state pro
gram of medical care for the poor, the administration pro
poses a consolidation with other grants, into one big block.

SECOND LECTURE

That, I think, would be a move in the wrong direction. In
Medicaid, unlike categorical grants for health service delivery,
the direction should be toward federalizing. To put it more
generally, in the various federal income-maintenance pro
grams, like food stamps, cash welfare, and Medicaid, we
should be moving to consolidate, to integrate, and to federal
ize, so as to bring about a minimum-standard federal system.
In education and health services, on the other hand, the cur
rent system of chaotic, categorical, narrow little grants to
state and local governments should be consolidated, inte
grated, and defederalized.
Finally, defederalization should not be accompanied by
cutting. My point is that the administration has confused sev
eral issues. In the area of income maintenance programs we
want more federal control, a more rational system, and mini
mum national standards. But in other areas, we need to turn
more control over to the state and local governments. A good
direction for one program area, in other words, is not neces
sarily a good direction for another.
Therefore, by way of cleaning up those program charts,
there is good news: the administration should be congratu
lated for moving vigorously to do it. But there is bad news
if, at the same time, the administration pulls back the level of
financial support to state and local governments, for no eco
nomic or social reason dictates doing so at this time.

REBUTTALS

JAMES T. LYNN

One of the things that interests me in debates on the proper
size of the deficit for fiscal year 1977 is that the reaction
usually is (a) there should be a bigger deficit, and (b) the
way to get one is by accommodating bigger expenditures. It
seems to me, and I know that Dr. Schultze agrees, that the
two issues— the proper level of stimulus by way of the deficit
for the year and the means of providing that stimulus— are
quite separate.
Many of my friends on the other side of the aisle are saying
these days, “We really do need a much bigger deficit.” But
it is funny how that position always accommodates a businessas-usual growth in those 1,030 programs: once we have de
cided upon a big deficit and can rationalize or justify it, we
can say to all you folks, "Let me tell you, that gives us a
chance to add more money to all these programs. And doesn’t
that make me a hero with every interest group in America?”
My point is that there is a difference between the amount
of the deficit and how you arrive at it. Getting a bigger one
does not necessarily mean adding to these programs. It could
mean lowering taxes.
The second thing that interests me is how the administra
tion came in with a proposed deficit of $52 billion for fiscal
year 1976, and now, alas, the deficit is up to $76 billion. Let
me say to Dr. Schultze that we do not want to take any
credit for that $76 billion; it is all yours. In fact, as the figure

REBUTTALS

goes a little higher, I hope that my friends on the other side of
the aisle will take full credit for it. To this day, we still do
not feel— the President does not and I most surely do not—
that we needed anywhere near a $76 billion deficit.
My calculations indicate that at least $10 billion—perhaps
$11 billion—of that excess over what the President wanted
is due to congressional initiatives and rejections of the Presi
dent's proposals for recisions, deferrals or legislative changes.
The Ford administration believes the economy would be
in a good recovery right now even if the deficit had not been
so high. Now, that is a tough position to argue: I cannot
prove it one way and Charles Schultze cannot prove it the
other. Nevertheless, I am firmly convinced of it.
One last point: We hear"a lot about how the government
must keep up— about how the government must spend as it
did before or everything will go to the devil. "Fiscal drag” is
the term for it, I think. I have said it before, and I will say
it again—I think fiscal drag is like the varsity drag: each one
had its day, and that day has passed.
I believe that, if we give a signal to the private sector that
we do mean business about getting deficits down and that the
Department of the Treasury really will not be in there com
peting for the money, we will see very strong growth in the
private sector.
Now you said, Dr. Schultze, that you would be all for that
approach if we were willing to apply it symmetrically— to
expand expenditures when the economy was booming. But I
do not believe that is a valid test. I think we all acknowledge
that there is a band of stimulus. If we should go above that
band, we could encounter the troubles that other countries
24

JA M E S T . L Y N N

have had. None of us knows where the edge is— where
stimulus becomes excessive. All we know is that it is a little
like walking along a cliff in the dark: you do not know
where the edge of that cliff is, but if you reach it and go over
it, there is no way of coming back. And so with the economy.
If we have left a much wider margin between us and the
edge than is needed, we can always add stimulus. But it is
hard to take it away once it has been applied.

CHARLES L. SCHULTZE

I have several problems with this approach. First, there is
more than one place on a cliff to fall off. You can also fall
off into a resumption of a recession and an increase in unem
ployment. I quite agree that it is a very difficult line to walk,
but a little bit more fear about falling off the cliff at one point
might balance the fear of falling off at another.
Second, it is interesting that, according to the administra
tion’s argument, a higher deficit does not stimulate the econ
omy, presumably, but somehow a deficit that is "too high”
will cause inflation. I do not quite understand that. It may
be a kind of threshold theory: the extra $10 billion or $15
billion worth of deficit that the Congress put in did not help
stimulate demand, but a larger deficit would somehow over
stimulate the economy. I have not been able to follow that
line of reasoning.
To turn to the very legitimate point that James Lynn
raises: If a given economic stimulus is desired, why does it
always have to be achieved through higher expenditures?
Why not use lower expenditures and a larger tax cut? That
surely would not bother me. However, we have to make
judgments about what we buy with a tax cut and what we
buy with an expenditure reduction.
Looking at the areas for which the Ford administration is
planning reductions, I find that something like $7 billion to
$8 billion of the cuts are in grants— financial support to
state and local governments. In my judgment, cutting ex

REBUTTALS

penditures by this amount and then reducing taxes would not
save the taxpayer very much. What it would mean is larger
financial requirements on the part of state and local govern
ments and thus higher state and local taxes, most of which
are much more inequitable and less economically efficient
than federal taxes. So expenditure reductions and tax cuts
are not really such a neat, single package.
Finally, let me say quite frankly, I am not ashamed of
wanting a larger deficit. In the right period of time, under
the right economic circumstances, a larger deficit can be a
good thing. Too much of any good thing, including candy,
can be bad for you. But nothing scares me— nor should it
scare anybody—about a rational argument for an appropri
ately sized deficit to help this economy continue on the road
to prosperity.
Rational men—and I trust we are both rational— can argue
about what is the appropriate size of the deficit, but deficit is
not a scare word.

DISCUSSION

EILEEN SHANAHAN, New York Times, and moderator
of the debate: You’ve heard the arguments about the Presi
dent’s proposed budget for fiscal year 1977. James T. Lynn,
the present director of the budget, has told us that the budget
is one that cares about human problems, that defense ex
penditures are as high as they are only because an unfortunate
world requires it, and that the deficit is as high as it can be
without running some economic dangers. And Charles
Schultze, who was budget director in the Johnson administra
tion and is now an economist with the Brookings Institution,
has said that the budget presents some grave dangers to the
nation: that with the economy still coming out of a bad re
cession, higher spending and a larger deficit are required to
ensure that unemployment will keep moving down, that the
economy will rebound fast enough.
Moving to the questions, I assert the moderator’s privilege
of asking the first one. Charlie Schultze, you have said that
you approve of the President’s plan to consolidate some cate
gorical programs but that the waters shouldn’t be muddied by
simultaneously cutting the available funds for such things as
health and education. My question is, If this is not the right
year to cut, is there a right year to cut?
DR. SCHULTZE: Once you block them together, I don’t
see why any year would provide a reason to cut federal outlays
for state and local programs for education and health. I do

DISCUSSION

not see why it is not good national policy to have some
significant, not necessarily rapidly growing, fraction of finan
cial support for education somewhat redistributed from state
and local governments to the federal government.
So, my answer is, I see no reason why any year in the fore
seeable future would be a good year to cut those programs.
MS. SHANAHAN: Mr. Lynn, I want to ask you to com
ment on Dr. Schultze’s statement that the economy is doing
as well as it is right now—unemployment coming down
nicely, inflation easing—only because the Democratic Con
gress violated the President’s budget for last year—cut taxes
more, created some additional spending, and enlarged the
deficit.
MR. LYNN: I would say that is not the reason at all; but
as I have said before, this will be an endless debate, par
ticularly in an election year. I do recall that back in February
and March of last year, when things were gloomy indeed, a
number of economists (not including Dr. Schultze) thought
that even a stimulus of $70 billion wouldn’t be enough. Some
people were saying that $90 billion, $100 billion, would be a
good starter. There were cries of gloom and doom that, with
out deficits of that size, recession would spiral into neverending depression.
I really believe that we could have gotten along just as
well in the $50 billion or $60 billion range. I think the defi
cit initially went higher than the $50 billion because of
estimating errors. The developing severity of the recession
required upward revisions in the estimated deficit. More
people were unemployed than we had predicted, and receipts
were less than they might have been otherwise. So our deficit
32

DISCUSSION

increased in part because of reestimates, which we learned
about after the budget had been put to bed— and that’s why
the President dramatically drew that line with the squeaky
chalk at $60 billion.
One of the things that is very difficult for a budgeteer— and
I know that Charlie will agree with this— is having people
understand that budget-making in large measure is estimating,
and that some of those estimates are easy to make accurately
and others are very difficult. For the toughest one of all, try
receipts from the outer continental shelf.
MS. SHANAHAN: You missed that by a full $4 billion
last year.
MR. LYNN: That’s right. And, as I said this year, here
are our calculations, here is how we made them, and if some
body has a better way, please be our guest. But my point is
that I believe this economy made a comeback because inven
tories worked their way down. There was some effort toward
governmental restraint. If I recall correctly, the loyal opposi
tion took credit for having cut some $ 15 billion or $20 bil
lion out of requests that otherwise would have been made by
the Congress. However, though there was less governmental
spending than there might have been, I believe that we would
have had essentially the same recovery with even less.
What happened is that consumer confidence came back
pretty strongly. People started buying. The tax reduction
helped fairly substantially, I think, though I don’t believe it
had to be as deep as it was.
In my view, what we saw was the bleed-off of inventories
through continued buying by consumers. They saw some
effort by Congress— not anywhere near what we would have

DISCUSSION

preferred, but some— to show some responsibility through
the new congressional budget process that you talked about,
Charlie. And it gave them the feeling that maybe it won’t be
business as usual—maybe these people really are trying to
get a handle on expenditure growth.
What worries me with respect to some of the $76 billion is
what it means for "outyear” expenses— those in years after
this one. I look at the kinds of proposals that the President
has been holding off satisfactorily so far and I’m concerned.
For example, the main effects of that so-called jobs bill, which
involves spending of $6.5 billion, wouldn’t be felt in fiscal
year 1976; $2.5 billion would come in 1977, and roughly
another $2 billion each in 1978 and 1979.
Now Congress comes along each year and starts adding
budget authority in these various programs. It would be well
and good if the process could be fine-tuned, so that a precise
amount, say $3 billion could be added for 1977. But that
isn’t the way it works. Instead, when Congress adds to a
highway program, it also adds a little bit for other public
works or an environmental unit, and the effect is felt in 1978,
1979, when we may not need or want it anymore. How are
we going to turn it off then?
MS. SHANAHAN: We are now ready for questions from
the audience.
ROBERT WEINTRAUB, Department of the Treasury:
As I listen to you gentlemen, I am reminded of the impor
tance of interest rates and of the fact that about a year ago,
the monetarists—and their occasional or quasi-friends, the
crowding-out theorists, and people at the Federal Reserve as
well—were saying that if the deficits were to go above the
34

DISCUSSION

$50 billion that the President was then calling for, interest
rates would surely rise. They were talking, of course, about
fiscal policy. Oddly enough, the fiscalists, including members
all along the Brookings-New Haven-Cambridge axis, were
saying that if the money supply ( meaning Al,) didn’t grow
at 10 to 12 percent per annum, interest rates would surely
rise. Curiously, as it has turned out this past year, fiscal policy
was more stimulatory and the deficit was higher than the
monetarists and their friends said they should be, and Af,
growth was considerably lower than the fiscalists said it
should be, and interest rates fell.
Could either of you explain why?
MR. LYNN: Charlie, go ahead. [Laughter.]
DR. SCHULTZE: As a matter of fact, most members of
the staff of the Federal Reserve are running around wringing
their hands trying to find out why.
You are perfectly correct: with a $75 billion deficit and
the rate of growth in the money supply that the Federal Re
serve announced it would pursue— it actually pursued a some
what lower rate— every past relationship that I know between
gross national product and all the other economic variables
indicated that interest rates should have been somewhat
higher than they now are. I like to put it this way: there has
occurred what is to me— and to most of the people I know—
an inexplicable decline in the demand for money, out of the
range, to my knowledge, of even the more complicated past
econometric models. Whether it is temporary, or what it
means, I am not sure; and I don’t want to suggest that there
are not industrious, bright people in the country— sitting in

DISCUSSION

this room, for all I know—who can explain it. But I simply
don’t know why.
MS. SHANAHAN: Jim Lynn, does the administration
agree that this is a mystery and, if so, how does that affect
policy?
MR. LYNN: I think we share in part—at least, I do per
sonally— Charlie’s uncertainty about the causes. And I’m sure
a lot of theses will be written for master’s and doctor’s de
grees over the next three or four years trying to explain them.
But I do remember hearing Arthur Burns sayjng for many,
many moons that there is a change going on in the velocity of
money and in management of money, and urging us not to
keep our eye on A!, that much, to look at Af^ and AI2 prime
and some other things.
MS. SHANAHAN: Wait a minute. Let’s talk a little
English. How does that affect budget policy?
MR. LYNN: On the budgetary side, I have to say that I do
not know precisely why, either. I can say, again, that I think
part of it has been that the recession proceeded in more of a
V-shape than anybody expected it to and that that had some
thing to do with it. We had a period of three to six months
in which the economy was falling off sharply— a lot more
quickly than any of us thought it would. And there was a
falling off in the demand for business loans, which at least
partially explains the drop in interest rates.
I will say, though, that it’s this very kind of uncertainty—
and Charlie talks about falling off the cliff at various points—
that makes me worry about sitting here in this same debate a
year and a half from now asking, "Well, now, how did we get
back to double-digit inflation?” and having some erudite econ

DISCUSSION

omist explain, "Well, it was a little of the satifras with imaniseital mixing with a metafrac, and that’s how we got to it.”
I’m scared to death of getting back to double-digit infla
tion. And that is why I say you must approach that cliff of
too much stimulus very, very cautiously— particularly for the
year ahead, the period we're talking about.
DR. SCHULTZE: If I take, not some riproaring liberaldemocratic New Haven-Cambridge-Brookings-axis forecast,
but the administration’s forecast of 6 percent annual growth
in GNP, which I presume the administration thinks is rea
sonable, I have trouble seeing how this budget policy will get
you there.
MR. LYNN: If I might comment on that just one second,
Charlie, I’ve read your testimony before Senator Muskie’s
Budget Committee, and I’ve also heard you tonight. You do
this arithmetic— so much by state and local governments, so
much by the federal government, leaving so much that the
private sector has to do. I think you will concede that one
great unknown is how much substitution effect there is when
you do have federal, or state or local, involvement and that
we really don’t know how much sliding around, of overlap or
gap, there is between the private and public sectors. Isn’t that
true?
DR. SCHULTZE: Yes, but it’s irrelevant because (a) I
was very generous in not assuming much change in state and
local expenditures because of the cuts in grants and aids—
that is, I just assumed that substitution— and (b) I haven’t
said that I know what is going to happen to private demand,
but only that, looking at past experience, if your scenario is

DISCUSSION

to work out, private demand will have to explode as it did
after Korea. Maybe it will.
MR. LYNN: Well, we put in our projection the exact
figures that we expect. And I hope, incidentally, that when
the congressional budget committees come out with their
findings and recommendations, they will at least give explicit
forecasts of their assumptions the way we did.
MEL BARNEY, Texas Instruments, Inc.: Dr. Schultze,
what specifically would you spend the extra $20 billion on?
DR. SCHULTZE: Well, one way of answering that is to
look at what the administration is cutting out in its $20
billion, because I think parts of those cuts— not all of them—
ought to be restored, at least during the next year. In the
first place, I would not reduce public-service employment as
rapidly as the administration proposes—by $1.8 billion.
Now, don’t get me wrong: I do not happen to think that
public-service employment is the world’s great answer to our
problems. And I don’t think that is the way to get back to
full employment without inflation, as apparently the sponsors
of some bills on the Hill now seem to think.
I have also indicated that I do not think this is the year
to pull out about $7 billion of grants-in-aid in real terms,
excluding public-service employment, even though I would
consolidate them.
I would handle the Medicare problem differently. The
administration has, I think, a basically sound approach to
Medicare: give the old people larger coverage for catastrophic
expenditures, make them pay more for low, small, medical
expenditures. That’s a good idea; it helps control cost. But
the proposal would do it in a way which would require the
38

DISCUSSION

elderly to pay out $2 billion more than they do now. I would
have the same program, but increase cash benefits by $2 bil
lion to make up for that.
Adding up all of these things, you begin to get to my
spending target for fiscal year 1977 of $415 billion. In other
words, in many areas, I would tend to restructure the budget
the way the administration wants to, but I would maintain
the level of funding, particularly for state and local govern
ments. In effect, that would add not all, but most of that
money I’m talking about.
A. B. VAN DER VOORT, Machinery and Allied Products
Institute: I would like to raise a question about the unemploy
ment rate, which, of course, is a central concern. Isn’t a lot
of our unemployment structural in nature, a good deal more
of it than was the case ten or fifteen years ago, and doesn’t
this mean that we will have to settle for a somewhat higher
unemployment rate, given the same level of general economic
activity, than we had ten or fifteen years ago? What unem
ployment rate is feasible under today’s circumstances, and
how can we avoid returning to double-digit inflation in the
attempt to reduce it below that level?
MR. LYNN: Well, it is true that you cannot look at un
employment as a monolithic problem and assume that every
person’s problem is the same. First, there is a chronically
unemployed group, the minorities in the inner city. They
represent a classic case of a real problem that we have yet to
get a handle on. Perhaps, here and there, we have made some
encouraging progress, but we still haven’t really come to
grips with the problem. Then there are the new entrants
into the labor force— not just those from high school, but

DISCUSSION

also the older, married second wage earner in the family.
You are right: we have to take a look at each one of those
problems and address them separately. But even taking
account of these special groups, our unemployment rate today
still reflects the vestiges of the recession.
I think we sometimes get carried away with a precise
number. I’m encouraged—I've heard it twice tonight and
hear others acknowledge it— that we have made some real
progress in getting the unemployment rate down in the last
four to five months. When you go from a rate of 8-9 percent
to 6-7 percent, as we have over the last year, that’s not bad.
But we still have a long way to go.
I would prefer to put it this way: our goal is a situation
in which everybody who wants a job can find one. Now,
whether that comes about with an unemployment rate of
X or Y isn't nearly as important as achieving that overall
objective.
DR. SCHULTZE: The central problem in pushing the
unemployment rate down is that, as it goes lower and lower
and lower and the labor market gets tighter and tighter and
tighter, the threat of re-igniting inflation becomes greater.
I happen to be very pessimistic about that, as a matter of fact.
I think that the level of unemployment at which inflation
would get ticked off again is higher than it used to be.
Maybe, for a lot of structural reasons, we have to worry
about renewed inflation when we get the unemployment rate
down to between 5 and 5.5 percent instead of to 4 percent.
Having said that, I think that the central problem of the
Western industrial world is how to get the unemployment
rate significantly lower without re-igniting inflation. That
40

DISCUSSION

may be an overstatement, but that’s all right. In my view, no
single thing will be more effective against the major social
problems in this country than a tight labor market. We can
have government programs coming out of our ears, but unless
employers are really demanding labor, we’re not going to get
good manpower training, and we are not going to integrate
the lowest 15 percent of the population into the productive
system.
Therefore, because I am very pessimistic about getting the
unemployment rate much below 5.5 or 5 percent without
re-igniting inflation and because I think doing so is crucial
for the minorities, for social problems, for people in general,
I am reluctantly forced to the conclusion that we have got
to find a socially acceptable way to impose wage controls.
Otherwise, in the long run, we’re in trouble.
So I agree fully with the import of the question, but I just
think you can’t give up on pushing the unemployment rate {
down.
JAMES CARY, Copley New Service, Washington: Given
the present prospects for an improving economy, what do each
of the gentlemen expect the unemployment rate and the infla
tion rate to be by the time the election is held in November?
MR. LYNN: Alan Greenspan, chairman of the Council
of Economic Advisers, has said that he looks for an unemploy
ment rate of somewhere between 7 and 7.5 percent in the
last quarter of this year. He has also said that we will have
to look carefully at the figures—
MS. SHANAHAN: Excuse me, Jim. I know you’ve been
on vacation for five days. He has indicated just recently that,

DISCUSSION

based on the other good February numbers, he thinks the
rate could go below 7 before the end of the year.
MR. LYNN: Well, I was about to say— I hadn’t read his
latest clips in the last five days— that in talks I have had with
him, he has said that if these very good figures we’ve had in
the first two months of the year continue we would have to
revise our forecast. But he wanted to see another month of
the figures before he did that. I think being cautious in this
area is wise. I’d rather have erred on the up side and say
we’ve got better news than we had before.
On the inflation rate, if I recall correctly, we’re saying
somewhere around 5.9 for the consumer price index at the
end of the year. I don’t believe that Alan Greenspan has said
much about changing that one.
So many things can influence a number of that kind. I
hope for the best, but you can’t ever tell. Our undue depen
dence on Middle Eastern oil is one factor: who knows what
will happen there? Rainfall out in the Midwest is another
factor. I must admit that ten years ago, when I practiced law,
I didn’t give much attention to that, but today, I give it a lot
of attention. I also pay a lot of attention to the deficit and,
notwithstanding conflicting views on issues where reason
able minds may differ, I’d like to see what kind of signals the
Congress of the United States gives the American people and
businesses by way of how big that deficit is.
MS. SHANAHAN: Charlie, do you want to comment on
those forecasts?
DR. SCHULTZE: I wouldn’t disagree with those conclu
sions. Without giving point estimates, I would say that
unemployment is going to continue going down this year.
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DISCUSSION

As a matter of fact, I think we had better be careful because
in the next three months we may get some false signals, and,
even though the situation is continuing to improve, it’s just
possible that unemployment will stop its decline or even tick
up a little bit for technical reasons. Nevertheless, I think
the chances are very high that during this year the rate of
unemployment will continue down and the rate of inflation,
barring bad luck on food or oil, will not reaccelerate and
will stay in the range that I consider the underlying rate
we're now stuck at—something between 5.5 and 6.5 percent.
So I don’t disagree with you.
MS. SHANAHAN: Let me interject here. I keep seeing
more and more caveats in the economic forecasts about
"barring crop failures at home and abroad.” Do we already
know something that has brought about such an intensifica
tion of worry about this possibility?
MR. LYNN: I hadn’t deliberately intensified it, Eileen,
because, reading what the people in the Agriculture Depart
ment have to say, the die is by no means cast in this regard.
So, this isn’t a further caution, at least on my part. It is just
the normal caution in that area.
MS. SHANAHAN: It seems to me it has cropped up a lot
lately.
MR. LYNN: You didn’t mean a pun with the "cropped
up,” did you?
MS. SHANAHAN: No, I didn’t.
CLINTON H. WHITEHURST, Clemson University: I
note that Mr. Carter, Mr. Jackson, and Mr. Wallace, on the
Democratic side, have all opted for a strong national defense,
and Mr. Ford and Mr. Reagan have opted the same way. The

DISCUSSION

present defense budget is $100 billion plus a fraction in the
fiscal year, and $112 billion for total obligational authority.
Now, is this large enough, is it small enough, and what
impact do the panelists see this having on the whole budget
picture?
MS. SHANAHAN: Are you talking about the longerterm future, as well as the immediate year?
PROFESSOR WHITEHURST: Yes. All of the presiden
tial candidates are arguing for greater expenditures, and I
would like the panelists to give us their views on this.
MS. SHANAHAN: All right. Where will the defense
budget go, where should it go, and what is the economic and
budgetary impact through the next presidential term, who
ever occupies the White House?
MR. LYNN: There are lots of unknowns when you take a
term of four years—and we’re speaking about a date four
years and nine months from now. Things can happen in the
world that change your estimates of the budget over that
period. They could be for the good, or they could be for the
bad. As both the President and Secretary of Defense Donald
Rumsfeld have said, there are unknowns even now. We have
a study underway on whether the Navy needs more forces,
and that could result in an additional budget request. Second,
if the current SALT negotiations do not come to a satisfactory
conclusion, more funds may be required.
The only thing I think we can say at this point is that we
believe that, subject to this kind of contingency, the budget
as submitted for the next year, along with the general pattern
of increases for the future, is adequate and will maintain
rough equivalency. It is certainly not a rich budget for
44

DISCUSSION

defense. If Congress rejects the expenditure savings that the
President has proposed, he’ll have to ask for another $2 bil
lion to get his requested level of purchases, because he has
assumed that $2 billion of savings.
MS. SHANAHAN: You’re talking about the proposed
pay adjustments?
MR. LYNN: Yes, adjustments in pay increases, housing
allowances, commissaries— a list of efficiencies as long as
your arm, some of which will require legislative change to
accomplish. If we do not get those changes, we might have
to increase the budget. It’s adequate, but it’s certainly not
a rich budget.
DR. SCHULTZE: For the first time, after having declined
for many years, the defense budget in real terms is turning
up; that is, adjusted for inflation, or in dollars of constant
purchasing power, the defense budget has now begun to turn
around slightly. It will turn around a lot more with the very
large increases proposed in the President’s budget— for
example, the 40 percent increase in the funds requested for
procurement, which won’t show up in expenditures for some
time.
I, myself, am puzzled and a bit disturbed by the recent
newspaper reports— hopefully, the CIA found out a long
time ago— of a large Soviet build-up.
I think the central question probably is not so much
whether the defense budget, in real terms, ought to increase.
The magnitudes, given the size of our overall economy, aren’t
all that big. We are talking, in terms of real increase, about
maybe $10 billion in procurement over several years. Look-

DISCUSSION

ing down the road to 1980 in a $1.9 trillion economy, $10
billion isn’t huge.
What really disturbs me is whether we’re going to be
pouring tremendous sums into sustaining a dinosaur complex.
We have not yet, I think, bitten the bullet on the Navy. The
issue is not one of increasing the number of Navy ships; we
probably need to do so. The issue is the kind of ships. We are
still going ahead to build those $2 billion floating targets
that we call aircraft carriers, and we are making them all
nuclear. By the way, this is not just the administration’s
doing. The Congress, in its infinite defense-cutting wisdom,
put an item in the defense authorization bill that all ships
must be nuclear unless the President explicitly said otherwise.
The President didn’t explicitly say otherwise, so we’re building
a nuclear strike cruiser.
The new Navy and Air Force planes, the F-15 and the
F-16, are going to cost something like three to five times in
real, constant-purchasing-power terms what their immediate
predecessor, the F-4, cost.
I don’t so much begrudge the increase in the defense budget.
It might be necessary, finally, to turn this downward trend
around and put in some more real money. But I’m beginning
to worry that we’re building ourselves an incredibly costly,
unmanageable and, in the long run, self-defeating, goldplated, big-target, high expense Navy— and Air Force. It’s
the use of the money, not the amount, that puzzles and
bothers me.
MS. SHANAHAN: I want to follow up on that because
I think there is tremendous interest in the defense budget.
Congressman Adams of Washington, the very thoughtful
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DISCUSSION

chairman of the House Budget Committee, said the other day
that he felt a lot of major decisions ought to be postponed
this year: the B-l bomber, Navy modernization, the cruise
missile, and the expansion in the Trident program— along
with some domestic programs such as health insurance and
welfare reform. His reason for believing that Congress
shouldn’t lock us into anything this year, shouldn’t make the
commitments the administration is asking for, is that this is
an election year and we should w^ait until the people have
spoken and given the next Congress and the next, or the
same, President a mandate.
I wonder what both of you, as experienced administrators
and budget directors who have lived in the administrative
world and the political world, think about that concept.
MR. LYNN: I would say, first, that it is an interesting
concept. Next year we could say that, after all, we have a
brand-new President, or we have a continuing President but
a new Congress for him to work with— which I hope and
expect to be the case— and we ought at least to let them have
a year to work together before doing anything crucial. There
will always be an excuse to put things off another year.
Second, we’ve been putting off decisions in a number of
these areas for years now.
Third, I couldn’t agree with Charlie more about looking
hard at each one of those programs. And both the President
and Secretary of Defense Rumsfeld have asked Congress to
do that, because we believe the time has come when we have
to order the long-lead-time items for the B-l bomber, when
we have to move on the Trident missile, when we need the
extra divisions, the extra tactical forces in the Air Force,

DISCUSSION

and so on. It is true, Charlie, that the cost of those weapons
keeps going up every year. The weapons get more and more
sophisticated, and we live in a day when we pay in current
dollars, not constant dollars.
But I do think it’s good for the members of Congress to
look at every one of those items. Were convinced that if
they look at them carefully, they will agree that we were
right in asking for them. But that, of course, is Congress's
prerogative.
DR. SCHULTZE: One of the problems is, I think, that
you can’t make a general statement on that. You have to
look at each program, by itself, to determine where you have
a genuine watershed decision. For example, it may turn out
— taking an example from thin air— that you can’t follow
this procedure with the B-l bomber. You’ve got to say go or
no go; you can’t keep it ticking over for a year. Now, it may
turn out that you can, and, if so, it might not be a bad idea.
I happen to believe that that proposal is meant to keep the
Air Force from being the silent silo sitters of the 1970s.
[Laughter.] And it’s not the way to strengthen the Air Force.
For another example, I think there is no need to make a
decision this year on the long-lead-time items on a new
nuclear-powered carrier— $2 billion with all the planes on
its deck—that would be delivered in 1981, perhaps. And
there may be some other items that could be postponed, but
Jim may be right, there are a whole batch of them that you
just can’t wait for.
Let me add several other points. First, the manpower costs
of the defense budget, for many good and sufficient reasons,
have grown tremendously, eating up a large part of that

DISCUSSION

budget. And I think there are economies that could be made,
but, in any event, those costs are there already.
In addition, the incredibly increased cost per unit of the
new equipment we’re buying puts a tremendous squeeze on
the quantity we can buy. So no matter whether Jim Lynn
and the President put in an extra $5 billion or $10 billion,
in the long run it isn’t anywhere near enough to overcome
this trend.
And I am beginning to believe— but am still unsure— that,
unlike the last five years, the central defense debate of the
next five years may not be on how big the defense budget
should be and how much we can transfer from defense to
social programs— which is a legitimate debate, but may be
a dying one. The central debate may be, rather, on what
kind of a defense establishment we want to have by way of
flexibility, easy expansibility in time of war, kind of equip
ment, and the like.
MR. LYNN: But, Charlie, that’s a very healthy defense
issue. And it’s the kind of thing that should be debated,
quite apart from orders of priorities, because, today, I think,
the American people generally don’t want the U.S. to be in
a second position militarily. They do, of course, value their
national freedom, and a strong defense force is essential to
guaranteeing this freedom. Their reluctance has arisen from
the suspicion that we are building a gold-plated this, that, or
the other thing which is not needed. Therefore, I think our
job is to convince the American people that what we’re
asking for in that budget is only what we need and what
makes sense. And if we can’t convince them of that, we
shouldn't have those things. But I think we can.

DISCUSSION

ARTHUR CAROL, economic consultant, Washington,
D.G: Mr. Lynn, for a given level of fiscal stimulus, are we
to be indifferent between whether it comes from the public
or the private sector?
MR. LYNN: No, I don’t think we should be indifferent.
I think, though, that one of the places I draw the line is using
up a given amount of stimulus by adding to expenditures
because it’s the easy way out. Dr. Schultze talked about a
$7 billion reduction in grants-in-aid. Now, reductions have
been recommended in some areas. But I think Dr. Schultze’s
premise is that all programs should be increased by the
dollar amounts necessary to adjust for inflation and should
maintain the same purchasing power as a year ago. I disagree.
In my judgment, a number of programs shouldn’t be expanded.
And yet, every year, inexorably, we give them more money.
A blend of stimulus from the private and public sectors is
important and I think that the President’s budget offers such
a blend.
I rarely hear anybody mention the increases in government
outlays that our budget provides in some areas— almost a
half billion dollars in budget authority for block grants for
community development, for example. That outlay won’t be
felt for another year at least; and, as a matter of fact, outlays
in this area are down slightly as the old categorical programs
of model cities phase out and the new programs come in.
On public works, this budget is up, if I recall correctly, some
17 percent in current dollars over last year’s budget, and
highways are up several $100 million. But what the President
is saying is, If we want to stimulate construction, for example,
let’s do it through the private sector, by giving a special
50

DISCUSSION

depreciation rate to people who build new plants or shopping
centers, or the like, in areas where unemployment is highest.
I'd rather do it that way than through public works on the
federal side.
MS. SHANAHAN: While we’re talking about that,
because of my particular interest in taxes, I'm sorry that
neither one of you has talked about the growth in what
have come to be called tax expenditures— the taxes that are
not collected because of some preferential provision in the
tax laws. And, Mr. Lynn, since you are concerned about the
growth in outlays, how come you never mentioned that as a
problem and, in fact, just advocated a new one?
MR. LYNN: I think that issue has to be examined in much
the same way as outlays. I couldn’t agree with you more. And
that’s why, as you may have noticed this year, every time we
got into a functional category in the budget we give detail—
MS. SHANAHAN: That’s mandated by Congress; under
the budget act you have to do that.
MR. LYNN: Well, some of the details that we included
in the text of the functional statements weren’t mandated by
anybody. All we had to do to comply with that statute was
to put in the section on tax expenditures. Showing it in
juxtaposition to actual expenditures was our own doing,
because we wanted to stress that not only the payment of
cash by the government, but also its losses in receipts, can
have a social purpose, a business-incentive purpose, whatever
it may be.
I think we do have to scrutinize tax expenditures in much
the same way as outlays. At the same time, we have to take
a harder look at off-budget items on the outlay side: guar

DISCUSSION

anteed loans, the government-sponsored agencies, and so on.
Incidentally, when I hear the economists discuss the budget,
they usually don’t say much about the stimulus provided by
some of the off-budget things in this budget.
DAVID I. MEISELMAN, Virginia Polytechnic Institute
and State University: I’d like to follow up Mr. Lynn’s com
ment on disagreement among economists about the fiscal
stimulus of government expenditures.
I first started studying economics toward the end of the
Second World War. At that time, the best and the brightest
of the economists forecast that, because of the sharp decline
in government expenditures associated within winning the
war, we were likely to return to the Great Depression of the
1930s with huge unemployment. That forecast, based on a
reading of the fiscal-policy numbers, was greatly in error.
It turned out that when the public sector got smaller, the
private sector got larger.
After that, I became an economist and I went through the
usual things having to do with econometrics and what not,
to win my Brownie points; and it turns out that over the
long pull, when the public sector gets bigger, the private
sector gets smaller, and when the public sector gets smaller,
the private sector gets larger. Over the short pull, when
government expenditures go up, it’s very hard beyond three
months— and I’m very dubious about those numbers— to
know what, in fact, the so-called fiscal stimulus is.
So, Dr. Schultze, what is the basis for your arguments that
somehow we need a large government budget, or that at
least we ought to resist restraining the growth in the budget,
to make sure that the private sector itself doesn’t get smaller?
52

DISCUSSION

DR. SCHULTZE: The basic reason is that I don’t agree
with your premise. I don’t think there is any warrant in
postwar cycles for the conclusion that in a cyclical upturn,
when the government gets larger, the private sector gets
smaller. Had that been true, the recession would have con
tinued last year and unemployment would have been about
15 percent. Strangely enough, the budget got larger and so
did the private economy.
Presumably, as economists, we know that when the economy
is close to full employment—that is, when the pie is a given
size— if the government takes a larger slice, there is less
left for the private sector. And we all know that; you’re
exactly correct. What I had hoped we had learned over the
last thirty years was that, in periods of recession, when you
increase the governmental stimulus, you can get increases
both in the private and in the public sector. And there are
a lot of ways to apply stimulus— not only through expendi
tures, but tax cuts or easier monetary policy, though here
let’s just talk about fiscal policy.
Now, we can argue like the devil about the magnitude of
the needed stimulus and about how far we want to push it,
about the inflationary risk we’re running. But, I thought we
had learned that it is in periods of recession that you use
stimulus. Not only that, I also thought we had learned the
converse: when you’re in a period of inflation you can
decrease the government sector and thereby also decrease the
private sector and so reduce excessive demand in the economy.
But maybe we haven’t learned that.
CARL NOLLER, Committee to Investigate a Balanced
Federal Budget, a Democratic research organization on

DISCUSSION

Capitol Hill: The National Bureau of Economic Research, I
think, has said that the economy bottomed out in about April
1975. And the most optimistic estimates I’ve seen for any
thing approaching a balanced federal budget is sometime in
fiscal 1979, which would be three-and-a-half years into the
upturn in the business cycle.
My question to Dr. Schultze is, Can we run the massive
deficits that are projected— $30 billion or more— that long
into the upturn in the business cycle?
DR. SCHULTZE: Well, that’s the kind of question I’m
not sure I can answer without beginning to think through
the specific numbers. My judgment is— but there’s a lot of
room for error in it— that with today’s tax rates and a
no-policy-change budget, we would end up with a budget
approximately in balance in 1979, at a level of employment
somewhere between 5 and 5.5 percent. That’s roughly in the
ballpark.
The deficits between then and now, as we move our way
back to balance, would not, in and of themselves, disturb me.
What does disturb me is that no matter what we use— budget
deficits, easy money, revivalism, I don’t care what—to get the
economy going and to substantially lower the unemployment
rate, we’re in danger of ticking off inflation. And it’s not so
much the deficits per se that do that, as it is pushing the
unemployment rate to low levels.
MS. SHANAHAN: I want to thank this lively audience
and, in particular, I want to thank James T. Lynn, our present
budget director, and Charles L. Schultze, a former budget
director, for coming to grips with some real issues. [Applause.]

Book and cover design by Pat Taylor

T H E F E D E R A L B U D G E T : W H A T A R E T H E N A T IO N ’S PRI
O R ITIE S ? pits two of the nation’s most respected budget
experts in a debate on the federal budget for fiscal year
1977. Jam es T . Lynn cautions that the country cannot
stand annual increases of 10 to 11 percent in spending—
like those occurring in fiscal 1975 and 1976— and argues
that the administration’s 5.5 percent increase to $395 bil
lion for 1977 would reduce the deficit, stimulate business
and consumer confidence, and thereby promote growth in
the private sector. In his view, the major programmatic
initiative in the President’s budget is the proposal to con
solidate grants-in-aid into large block grants locally ad
ministered. Charles L. Schultze also favors consolidation
of grants-in-aid but opposes the administration’s recom
mendation that the dollar value of the grants should be
reduced in the process. Schultze contends that if Con
gress approves the President’s budget as submitted, and
if the economy grows at its average pace for previous post
war recoveries, the unemployment rate will still be roughly
7 percent by the end of 1977. He recommends that federal
spending be increased to about $415 billion to promote
more rapid economic recovery.
Jam es T . Lynn became director of the Office of Manage
ment and Budget in 1975, after serving for two years as
secretary of housing and urban development. He moved
to Washington in 1969, as general counsel for the Depart
ment of Commerce, after practicing law in Cleveland. Lynn
holds degrees from Western Reserve University and Har
vard Law School. Charles L. Schultze, a senior fellow with
the Brookings Institution, was assistant director and then
director of the Bureau of the Budget from 1962 to 1968.
He also serves as chairman of the board of the Urban
Institute and as'professor of economics at the University
of Maryland. He holds degrees from Georgetown Uni
versity and the University of Maryland.

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