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8 1st S e a s i^ 88}
JO IN T COM M ITTEE P R IN T
FEDERAL EXPENDITURE POLICY
FOR ECONOMIC GROWTH
AND STABILITY
PAPERS SUBMITTED BY PANELISTS APPEARING
BEFORE THE SUBCOMMITTEE ON FISCAL POLICY
JOINT ECONOMIC COMMITTEE
NOVEM BER 5, 1957
Printed for the use of the Joint Economic Committee
8 1st Session*8}
JO IN T C O M M ITTEE P RIN T
FEDERAL EXPENDITURE POLICY
FOR ECONOMIC GROWTH
AND STABILITY
PAPERS SUBMITTED BY PANELISTS'APPEARING
BEFORE THE SUBCOMMITTEE ON FISCAL POLICY
JOINT ECONOMIC COMMITTEE
Printed for the use of the Joint Economic Committee
UNITED STATES
GOVERNMENT PRINTING OFFICE
97735
W ASHINGTON : 1957
For sale by the Superintendent of Documents, U. S. Government Printing Office
Washington 25, D. C. - Price $3.25
JO IN T ECONOMIC COM M ITTEE
(Created pursuant to sec. 5 (a ) of Public Law 304, 79th Cong.)
W E IG H T P A T M A N , Representative from Texas, Chairman
J O H N S P A R K M A N , Senator from Alabama, Vice Chairman
SENATE
H O U SE O F R E P R E S E N T A T IV E S
R IC H A R D B O L L IN G , Missouri
W IL B U R D. M IL L S , Arkansas
A U G U S T IN E B. K E L L E Y , Pennsylvania
H E N R Y O. T A L L E , Iowa
-'•‘M A S B. CU R T IS, Missouri
lR E N C E E . K IL B U R N , New York
P A U L H . D O U G LA S, Illinois
J. W IL L IA M F U L B R IG H T , Arkansas
JO SE P H C. O’M A H O N E Y , W yom ing
R A L P H E. F L A N D E R S , Vermont
A R T H U R V. W A T K IN S , Utah
B A R R Y G O L D W A T E R , Arizona
John W . L ehm an, A cting E xecu tive D irector
Subcommittee
on
F iscal P olicy
W IL B U R D . M IL L S, Arkansas, Chairman
T H O M A S B . C U R T IS, Missouri
P A U L H . D O U G L A S, Illinois
JO SEPH C. O’M A H O N E Y , W yom ing
B A R R Y G O L D W A T E R , Arizona
Noeman B . T u rd , Econom ist
LETTERS OF TRANSMITTAL
N
Hon. W
r ig h t
P
atm an
, ,
,
ovem ber
5, 1957.
Chairman, Joint Economic Committee
United States Mouse of Representatives
W ashington25 D. C.
D e a r M r . P a t m a n : Transmitted herewith are the papers submitted
by the panelists invited to appear before the Subcommittee on Fiscal
Policy in its study of Federal expenditure policy for economic growth
and stability. The subcommittee has undertaken this study pursuant
to the findings and recommendations of the full committee in its
February 28,1957, report on the January 1957 Economic Report of the
President.
These papers are presented in advance of the subcommittee’s hear
ings, to be held November 18-27, to provide members of the subcom
mittee, the panelistsj and the public an opportunity to examine the
major issues lying within the scope of the study as they will be devel
oped in oral statements and discussion at the hearings.
,
,
W ilb u r D . M ills ,
Chairman Subcommittee on Fiscal Policy.
h i
Hon. W
il b u r
,
"
D. M i l l s ,
N ovem ber
,,
5, 1957.
Chairman Subcommittee on Fiscal Policy
United States'House of Representatives
Washington25, D. C.
D e a r M r . M i l l s : Transmitted herewith are the papers submitted
by the panelists invited to appear before the Subcommittee on Fiscal
Policy m its study of Federal expenditure policy for economic growth
and stability. The papers are presented in order of the scheduled ap
pearance of the panelists during the subcommittee’s hearings, Novem
ber 18-27.
The topics to which these papers are addressed were selected by the
staff economist, Norman B. Ture, pursuant to the suggestions and in
structions of the subcommittee. Every effort has been made to insure
representation of the varying expert viewpoints on the issues covered.
These papers are presented as submitted without editing by the staff.
J oh n W . L e h m a n ,
■
Act i ng Executive Director.
CONTENTS
Introduction by Wilbur D. Mills, Chairman, Subcommittee on Fiscal
Policy . ------- ------------------------------------ ------------------- -------- -----------------I. Historical Magnitudes and Developments Affecting the Amount
and Type o f Federal Expenditures . . __________________________
Historical Changes in Demands for Public Expenditures for
Community Amenities, Charles E. Lindblom, associate pro
fessor o f economics, Yale University_______________________
Federal Expenditure, Economic Growth, and Instability,
Robert T. Patterson, associate professor o f economics,
Claremont Men’s College
______________________________
Growth o f Government Over the Past 50 Years: An Analytical
Review, Arnold M. Soloway, assistant professor o f economics,
Harvard University _____________________________________
Some Historical Aspects of Federal Fiscal Policy, 1790-1956,
Paul B. Trescott, associate professor of economics, Kenyon
'
College _________________________________________________
II. Considerations in Determining Government Functions____________
Expansion of Governmental Responsibilities, Solomon Barkin,
director of research, Textile Workers Union of America,
A F L -C IO ________________________________________________
Economics and the Applied Theory of Public Expenditures,
Walter W. Heller, professor o f economics, School of Business
Administration, University of Minnesota__________________
Principles of Budget Determination, Richard A. Musgrave,
professor o f economics, University o f M ich iga n ___________
Some Problems in Optimizing the Level of Public Expenditures,
Kenyon E. Poole, professor of economics, Northwestern
U n iversity_______________________________________________
Government and the Market, Procter Thomson, associate pro
fessor of economics, Claremont Men’s College and Claremont
Graduate School__________________________________________
Federal Expenditures in Modem America, Frazar B. Wilde,
Chairman, Research and Policy Committee, Committee for
Economic Development, and president, Connecticut General
Life Insurance C o_________________________________________
III. Level of Government at Which Public Functions Are Performed__
Level o f Government at Which Public Functions Are Performed,
George C. S. Benson, president, Claremont Men’s C ollege..
Federal Expenditure and State Functions, James M. Buchanan,
chairman, department o f economics, University o f Virginia
Increasing Role of Intergovernment Transfer Payments in the
Performance of State and Local Functions, Frank L. Fembach, economist, Department o f Research, American Federa
tion of Labor and Congress o f Industrial Organizations____
Centralized Versus Decentralized Finance, Harold M. Groves,
professor of economics, University of Wisconsin____________
Expenditure Policy for Economic Growth and Stability in a
Federal Setting, Werner Hochwald, chairman, department
of economics, Washington University______________________
Adjustment of Governmental Responsibilities Via Grants,
James A. Maxwell, professor of economics, Clark University.
Tenable Range of Functions of Local Government, George J.
Stigler, professor of economics, Columbia University_______
VII
Pa«
xvn
xix
1
7
19
60
85
87
98
108
116
130
153
163
165
174
180
188
195
200
213
V in
CONTENTS
Page
IV. Economy and Efficiency in Government Expenditures____________
Some Devices for Increasing Efficiency in Government Expendi
ture, O. H. Brownlee, professor o f economics, University of
M in n esota_______________________________________________
Economy and Efficiency in Government Expenditures, Albert
G. Buehler, professor o f public finance, University of Penn
sylvania ____________ _____ :_______________________________
Interest Rate in Cost-Benefit Analysis, Arnold C. Harberger,
associate professor of economics, University of Chicago_____
Economy in Government Spending: The Concept, C. Lowell
Harriss, associate professor of economics, Columbia Uni
versity____________________________________________________
Criteria of Efficiency in Government Expenditures, Roland N.
McKean, the R A N D Corp., Santa Monica, Calif_________
Economy and Efficiency in Government Expenditures, Wilson
Wright, economist, Procter & Gamble Co__________________
V. Federal Expenditures and Economic Growth______________________
Contribution of Federal Expenditures to Economic Growth
and Stability, Evsey D. Domar, professor of political econ
omy, the Johns Hopkins University________________________
Government Expenditures and Growth, James S. Duesenberry,
professor Of economics, Harvard University________________
Federal Expenditures and Economic Growth, George G. Hagedorn, associate director of research, National Association of
Manufacturers___________________________ :________________
Federal Expenditures and Economic Growth, Stanley H. Ruttenberg, director of research, American Federation of Labor
and Congress of Industrial Organizations__________________
Federal Expenditures and Economic Growth: Analysis and
Policy, Daniel C. Vandermeulen, associate professor of
economics, Claremont Graduate School and Claremont
Men’s College______________________ i _____________________
Government Expenditure and Economic Growth, David Mc
Cord Wright, William Dow professor o f economics and
political science, McGill University, Montreal, Canada_____
VI. Federal Expenditures and Economic Stability_____________________
Government Spending and Economic Stability, Walter D.
Fackler, assistant director of economic research, Chamber of
Commerce of the United States____________________________
Anticyclical Expenditure Variation, Walter Froehlich, professor
of economics, Robert A. Johnston College of Business Ad
ministration, Marquette University__________ I ____________
Federal Spending and the Stability of the Postwar Economy,
Bert Q. Hickman, the Brookings Institution_______________
Varying Public Construction and Housing To Promote Eco
nomic Stability, Sherman J. Maisel, professor of business
administration, University of California (Berkeley)________
Federal Spending and Economic Stability, Ralph Robey,
economic adviser, National Association of Manufacturers..
Government Interest Payments: Their Relationship to Eco
nomic Growth and Stability, James R. Schlesinger, assistant
professor of economics, University of Virginia______________
Federal Expenditure and Economic Stability: The Fallacy of
the Balanced Budget, Harold M. Somers, dean and professor
of economics, School of Business Administration, University
of B u ffa lo ..______________________________________________
VII. Procedures for Determining Federal Spending Programs__________
Hidden Effects of Federal Credit Programs, George F. Break,
associate professor of economics, University of California,
Berkeley_______________________________________ ______ ____
Guides and Procedures for Determining Federal Expenditure
Programs, Gerhard Colm, chief economist, National Planning
Association________________________________________________
Basic Weakness in Federal Budget Procedure, George Y.
Harvey, director, Bureau o f Government Research, Univer
sity of Missouri___________________________________________
221
223
230
239
242
252
258
265
267
285
292
299
308
319
323
325
343
357
382
398
404
412
421
423
433
444
CONTENTS
VII. Procedures for Determining Federal Spending, Etc.— Continued
Systemic Improvement in the Federal Budgetary Process,
Walter G. Held, secretary, Committee on Government Ex
penditures, Chamber of Commerce of the United States____
Improving Budget Procedures in Congress, Roswell Magill,
president, Tax Foundation, Inc., partner, Cravath, Swaine
& M oore__________________________________________________
Government Budgets and Their Relation to National Accounts,
Richard Ruggles, professor of economics, Yale University;
and Nancy D. Ruggles, Bureau of Economic Affairs, United
Nations___________________________________________________
Federal Government Spending Process, Murray L. Weidenbaum, senior operations analyst, Convair, General Dynamics
Corp_____________________________________________________
VIII.fFederal Expenditures for National Security_______________________
Military Expenditures, Economic Growth, and Stability,
Arthur E. Bums, professor of economics, dean, The Graduate
Council, the George Washington University________________
Economic Effects of Postwar National Security Expenditures,
Leo Fishman, professor of economics and finance, and Betty
G. Fishman, lecturer in economics, West Virginia University.
Impacts of National Security Expenditures Upon the Stability
and Growth of the American Economy, George H. Hilde
brand, professor of economics and director of the Institute of
Industrial Relations, University of California, Los Angeles;
and Norman V. Breckner, assistant professor of economics,
University of California, Los Angeles______________________
Federal Spending for National Security, David Novick, chief,
Cost-Analysis Department, the R A N D Corp., Santa Monica,
Calif_____________________________________________________
Defense Budget, Arthur Smithies, Nathaniel Ropes professor of
economics, Harvard University____________________________
IX.JFederal Expenditures for Foreign Aid____________________________
Relationship of the Federal Government’s Foreign Aid Pro
grams and Expenditures to the Processes of Economic Growth
in the Private Sectors of the Economy; the Usefulness or
Limitations of Such Programs for Purposes of Stabilization;
and the Standards Employed by the Department of State in
Determining the Kind and Size of Such Programs Requested,
John S. Hoghland II, Acting Assistant Secretary of State for
Congressional Relations___________________________________
Foreign Aid Expenditures of the United States, Robert E.
Asher, the Brookings Institution___________________________
America’s Foreign Aid Program, Robert E. Baldwin, professor
of economics, University of California, Los Angeles________
Some Notes on Foreign Economic Aid, M. Bronfenbrenner,
professor of economics, Michigan State University_________
Perspective on Foreign Aid, Howard S. Ellis, Flood professor of
economics, University of California, Berkeley, Calif________
Self-Help, Traditional Investment and Foreign Economic Aid,
Virgil Salera, senior economist, American Enterprise Asso
ciation____________________________________________________
Foreign Aid— Some Issues and Problems in Assessment, Wilson
Schmidt, associate professor of economics, the George Wash
ington University_________________________________________
X . Federal Expenditures for Natural Resources Development________
Federal Expenditures and Programs for the Development o f
Natural Resources, Fred A. Seaton, Secretary of the Interior.
Evaluation of Federal Expenditures for Water Resources Proj
ects, Otto Eckstein, assistant professor of economics, Harvard
University________________________________________________
Water Resources, Martin G. Glaeser, professor of economics and
commerce, University of Wisconsin________________________
Use of Natural Resource Expenditures to Promote Growth and
Stability in the American Economy, Lawrence G. Hines,
professor of economics, Dartmouth College________________
EC
Page
455
477
483
493
507
509
518
523
542
551
559
561
570
595
605
613
620
627
643
645
657
668
683
X . Federal Expenditures for Natural Resources Development—-Con.
Federal Expenditure Policy for Economic Growth and Stability
in the Area o f Natural Resource Development With Special
Reference to the Potential Impact of Atomic-Energy Devel
opments on the Energy, Fuel, and Power Economies of the
Country, Karl M. Mayer, Washington, D. C _______________
Development of Nuclear Energy, Perry D. Teitelbaum, econ
omist, Council for Economic and Industry Research, Inc.,
and Philip Mullenbach, research director, Nuclear Energy
Study, the Twentieth Century Fund, Washington, D. C ____
Atomic Power and Energy Resource Planning, Richard A.
Tybout, associate professor of economics, the Ohio State
University________________________________________________
X I. Federal Expenditures for Regional Development__________________
Area Development Expenditures and Economic Stability in .
Local Areas, Frederick H. Mueller, Acting Secretary of
Commerce__________________________ ju,____________________
Federal Expenditures for Regional Development, Walter Isard,
professor of economics, University of Pennsylvania_________
Problems in Evaluating Federal Expenditures for Regional
Development, Robert A. Kavesh, business economist, the
Chase Manhattan Bank___________________________________
Aspects of Regional Economic Growth, Robert E. Kuenne,
assistant professor of economics, Princeton University_____
Regional Framework for Government Expenditures, Charles M.
Tiebout, assistant professor of economics, Northwestern
University________________________________________________
X II. Federal Expenditures for Housing and Urban Redevelopment_____
Construction Costs and Government Policy, David M. Blank,
associate economic adviser, Columbia Broadcasting System,
Inc., New York, N. Y _____________________________________
Fiscal Implications of Federal Housing Programs, Leo Grebler,
National Bureau of Economic Research___________________
Federal Expenditures for Housing and Urban Redevelopment,
Robinson Newcomb, economic consultant, Washington, D. C_
Federal Expenditures for Housing and Urban Redevelopment,
Boris Shishkin, secretary, Housing Committee, American
Federation of Labor and Congress of Industrial Organiza
tions______________________________________________________
X III. Federal Expenditures for Development of Human Resources,
Including Health, Education, and Social Security_______________
Relationship of Health, Education, and Social Security Pro
grams Administered by the Department of Health, Educa
tion, and Welfare to Economic Growth and Stability,
Marion B. Folsom, Secretary of Health, Education, and
Welfare___________________________________________________
Federal Government’s Labor and Manpower Programs, James
P. Mitchell, Secretary of Labor___________________________
Education and Economic Growth, Howard R. Bowen, presi
dent, and John C. Dawson, assistant professor of economics,
Grinnell College___________________________________________
Federal Expenditure Policy for Health, Education and Social
Security, W. Glenn Campbell, director of research, American
Enterprise Association, Washington, D. C _________________
Health, Education, and Welfare Policies and Expenditures for
Economic Growth and the General Welfare, Wilbur J.
Cohen, professor of public welfare administration, School of
Social Work, University of Michigan_______________________
Importance of Federal Expenditures for Development of
Human Resources Through Education, Arthur F. Corey,
State executive secretary, California Teachers A ssociation..
Federal Investments in Human Resources, Katherine Ellickson,
assistant director, Department of Social Security, American
Federation of Labor and Congress of Industrial Organizations.
Perspectives for a Human Resource Policy, Eli Ginzberg, pro
fessor of economics and director, Conservation of Human
Resources Project, Columbia University___________________
Page
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801
803
805
807
812
818
825
827
832
844
855
861
863
885
894
906
919
956
968
980
CONTENTS
XI
X III. Federal Expenditures for Development o f Human Resources,
Including Health, Education, and Social Security— Continued
Pension Structure, Daniel M. Holland, associate professor of
economics, School of Commerce, New York University____
985
Welfare programs and Economic Growth and Stability,
Clarence D. Long, professor of economics, and Selma Mushkin, research associate School of Hygiene and Public Health
and Department of Political Economy, Johns Hopkins
University________________________________________________
1010
Federal Responsibilities for Education, Paul J. Strayer, asso
ciate professor of economics, Princeton University_________
1032
Criteria of Federal Welfare Expenditures: A Lawyer’s View,
Alanson W. Willcox, former general counsel, Federal Security
Agency___________________________________________________
1038
XIV. Federal Expenditures for Transportation, Particularly Highways
and Other Public Works______________________________________
1047
Federal Highway Act of 1956, and Federal-Aid Airport Pro
gram, Frederick H. Mueller, Acting Secretary of Commerce.. 1049
Civil Works Program and Economic Growth, Dewey Short,
Assistant Secretary of the Army (Civil-Military Affairs)___ 1063a
Federal Expenditures for Transportation, Burton N. Behling,
economist, Bureau of Railway Economics, Association of
American Railroads_______________________________________
1064
Federal Highway Program, J. F. Due, professor of economics,
University of Illinois______________________________________
1073
Federal Government’s Role in the Highway Program, William C.
Flaherty, Chrysler Corp___________________________________ 1082
Public Works— Fond Hopes and Harsh Realities, Roger A.
Freeman, vice president, Institute for Social Science Research,
Washington, D. C ________________________________________
1087
How T o Provide the Roads for Which Users Are Willing To
Pay, H. S. Houthakker, professor of economics, Stanford
University________________________________________________
1107
Highway Expenditures for Economic Growth and Stability,
Richard M. Zettel, research economist, Institute of Trans
portation and Traffic Engineering, University of California-. 1119
XV. Federal Expenditures for Research and Development_____________ 1133
Atomic Energy Commission Programs, Economic Growth and
Stability, K . E. Fields, General Manager, Atomic Energy
Commission_______________________________________________ 1135
Federal Research Expenditure Policy and Its Relation to Eco
nomic Growth and Stability, Ralph E. Burgess, economist,
American Cyanamid Co___________________________________ 1140
Federal Research— Stimulator of Progress, E. Finley Carter,
director, Stanford Research Institute______________________
1147
Federal Expenditure Policy for Research and Development,
Forest G. Hill, Melvin H. Baker associate professor of Ameri
can Enterprise, University of Buffalo______________________
1165
Issues of Federal Science Policy, John C. Honey, executive
associate, Carnegie Corporation of New York______________ 1182
Federal Expenditures for Research and Development, Frank D.
Newbury, economic and management consultant, formerly
Assistant Secretary of Defense (Research and Engineering). 1195
CONTRIBUTORS
Asher, Robert E., the Brookings Institution, the Foreign Aid Expenditures
of the United States__________________________________________________
Baldwin, Robert E., professor of economics, University of California, Los
Angeles, America’s Foreign Aid Program______________________________
Barkin, Solomon, director of research, Textile Workers Union of America,
AFL-CIO, Expansion of Governmental Responsibilities______________
Behling, Burton N., economist, Bureau of Railway Economics, Association
of American Railroads, Federal Expenditures for Transportation______
Benson, George C. S., president, Claremont Men’s College, Level of Gov
ernment at Which Public Functions Are Performed__________________
570
595
87
1064
165
Xn
CONTENTS
Blank, David M., associate economic adviser, Columbia Broadcasting
System, Inc., New York, N. Y., Construction Costs and Government
■ Policy________________________________________________________________
Bowen, Howard R., president, and John C. Dawson, assistant professor of
economics, Grinnell College, Education and Economic Growth________
Break, George F., associate professor of economics, University of Cali
fornia, Berkeley, The Hidden Effects of Federal Credit Programs______
Breckner, Norman V., assistant professor of economics, and George H.
Hildebrand, professor of economics and director of the Institute of In
dustrial Relations, University of California, Los Angeles, the Impacts of
National Security Expenditures Upon the Stability and Growth of the
American Economy___________________________________________________
Bronfenbrenner, M .t professor of economics, Michigan State University,
Some Notes on Foreign Economic Aid________________________________
Brownlee, O. H., professor of economics, University of Minnesota, Some
Devices for Increasing Efficiency in Government Expenditure_________
Buchanan, James M., chairman, department of economics, University of
Virginia, Federal Expenditures and State Functions___________________
Buehler, Albert G., professor of public finance, University of Pennsylvania,
Economy and Efficiency in Government Expenditures________________
Burgess, Ralph E., economist, American Cyannmid Co., Federal Research
Expenditure Policy and Its Relation to Economic Growth and Stability- _
Burns, Arthur E., professor of economics, dean, The Graduate Council, The
George Washington University, Military Expenditures, Economic
Growth, and Stability________________________________________________
Campbell, W. Glenn, director of research, American Enterprise Association,
Washington, D. C., Federal Expenditure Policy for Health, Education,
and Social Security___________________________________________________
Carter, E. Finley, director, Stanford Research Institute, Federal Re
search— Stimulator of Progress________________________________________
Cohen, Wilbur J., professor of public welfare administration, School of
Social Work, University of Michigan, Health, Education, and Welfare
Policies and Expenditures for Economic Growth and the General
Welfare______________________________________________________________
Colm, Gerhard, chief economist, National Planning Association, Guides
and Procedures for Determining Federal Expenditure Programs_______
Corey, Arthur F., State executive secretary, California Teachers College,
the Importance of Federal Expenditures for Development of Human
Resources Through Education________________________________________
Dawson, John C., assistant professor of economics, and Howard R. Bowen,
president, Grinnell College, Education and Economic Growth_________
Domar, Evsey D., professor of political economy, the Johns Hopkins Uni
versity, Contribution of Federal Expenditures to Economic Growth
and S tability-,,______________________________________________________
Due, J. F., professor of economics, University of Illinois, the Federal
Highway Program____________________________________________________
Duesenberry, James S., professor of economics, Harvard University,
Government Expenditures and Growth________________________________
Eckstein, Otto, assistant professor of economics, Harvard University,
Evaluation of Federal Expenditures for Water Resources Projects_____
Ellickson, Katherine, assistant director, department of social security,
American Federation of Labor and Congress of Industrial Organizations,
Federal Investments in Human Resources_____________________________
Ellis, Howard S., Flood professor of economics, University of California,
Berkeley, Calif., A Perspective on Foreign Aid________________________
Fackler, Walter D., assistant director of economic research, Chamber of
Commerce of the United States, Government Spending and Economic
Stability______________________________________________________________
Fernbach, Frank L., economist, Department of Research, American Federa
tion of Labor and Congress of Industrial Organizations, The Increasing
Role of Intergovernment Transfer Payments in the Performance of
State and Local Functions____________________________________________
Fields, K. E., General Manager, Atomic Energy Commission, Atomic
Energy Commission Programs, Economic Growth and Stability_______
Fishman, Betty G., lecturer in economics, and Leo Fishman, professor of
economics and finance, West Virginia University, Economic Effects of
Postwar National Security Expenditures______________________________
Pas*
827
894
423
523
605
223
174
230
1140
509
906
1147
919
433
956
894
267
1073
285
657
968
613
325
180
1135
518
CONTENTS
X IU
Fishman, Leo, professor of economics and finance, and Betty G. Fishman,
lecturer in economics, West Virginia University, Economic Effects of P»e«
Postwar National Security Expenditures______________________________
518
Flaherty, William C., Chrysler Corp., The Federal Government’s Role in
the Highway Program________________________________________________ 1082
Folsom, Marion B., Secretary of Health, Education, and Welfare, Rela
tionship of Health, Education, and Social Security Programs Admin
istered by the Department of Health, Education, and Welfare to
863
Economic Growth and Stability______________________________________
Freeman, Roger A., vice president, Institute for Social Science Research,
Washington, D. C., Public Works— Fond Hopes and Harsh Realities__ 1087
Froehlich, Walter, professor of economics, Robert A. Johnston College of
Business Administration, Marquette Univeisity, Anti cyclical Expendi
ture Variation________________________________________________________
343
Ginzberg, Eli, professor of economics and director, Conservation of Human
Resources Project, Columbia University, Perspective for a Human
Resource Policy---------------------------------------------------------------------------------980
Glaeser, Martin G., professor of economics and commerce, University of
Wisconsin, Water Resources__________________________________________
668
Grebler, Leo, National Bureau of Economic Research, Fiscal Implications of
Federal Housing Programs___________________________________________
832
Groves, Harold M., professor of economics, University of Wisconsin,
Centralized Versus Decentralized Finance_____________________________
188
Hagedorn, George C., associate director of research, National Association
of Manufacturer*, Federal Expenditures and Economic Growth_______
292
Harberger, Arnold C., associate professor of economics, University of
Chicago, the Interest Rate in Cost-Benefit Analysis___________________
239
Harriss, C. Lowell, associate professor of economics, Columbia University,
242
Economy in Government Spending: the Concept_____________________
Harvey, George Y., director, bureau of government research, University of
Missouri, Basic Weakness in Federal Budget Procedure_______________
444
Held, Walter G., secretary, Committee on Government Expenditures,
Chamber of Commerce of the United States, Systemic Improvement
in the Federal Budgetary Process_____________________________________
455
Heller, Walter W., professor of economics, School of Business Adminis
tration, University of Minnesota, Economics and the Applied Theory of
Public Expenditures__________________________________________________
98
Hickman, Bert G., the Brookings Institution, Federal Spending and the
Stability of the Postwar Economy____________________________________
357
Hildebrand, George H., professor of economics and director of the Institute
of Industrial Relations, and Norman V. Breckner, assistant professor of
economics, University of California, Los Angeles, the Impacts of National
Security Expenditures Upon the Stability and Growth of the American
Economy____________________________________________________________
523
Hill, Forest G., Melvin H. Baker associate professor of American enter
prise, University of Buffalo, Federal Expenditure Policy for Research
and Development____________________________________________________
1165
Hines, Lawrence G., professor of economics, Dartmouth College, the Use
of Natural Resource Expenditures To Promote Growth and Stability in
the American Econom y______________________________________________
683
Hochwald, Werner, chairman department of economics, Washington Uni
versity, Expenditure Policy for Economic Growth and Stability in a
Federal Setting______________________________________________________
195
Hoghland, John S., II, Acting Assistant Secretary of State for Congres
sional Relations, the Relationship of the Federal Government’s Foreign
Aid Programs and Expenditures to the Processes of Economic Growth in
the Private Sectors of the Economy; the Usefulness or Limitations of
Such Programs for Purposes of Stabilization; and the Standards Em
ployed by the Department of State in Determining the Kind and Size of
Such Programs Requested____________________________________________
561
Holland, Daniel M., associate professor of economics, School of Commerce,
New York University, the Pension Structure_________________________
985
Honey, John C., executive associate, Carnegie Corporation of New York,
1182
Issues of Federal Science Policy______________________________________
Houthakker, H. S., professor of economics, Stanford University, How
To Provide the Roads for Which Users Are Willing To Pay___________
1107
Isard, Walter, professor of economics, University of Pennsylvania, Federal
Expenditures for Regional Development______________________________
805
X IV
CONTENTS
Kavesh, Robert A., business economist, the Chase Manhattan Bank,
Problems in Evaluating Federal Expenditures for Regional Develop- Page
ment___________ __________________________ ______________________ 807
Kuenne, Robert E., assistant professor of economics, Princeton University,
Aspects of Regional Economic Growth________________________________
812
Lindblom, Charles E., associate professor of economics, Yale University,
Historical Changes in Demands for Public Expenditures for Community
1
Amenities__________________________ ______ ___________________________
Long, Clarence D., professor of economics, and Selma Mushkin, research
associate, School of Hygiene and Public Health and Department of
Political Economy, Johns Hopkins University, Welfare Programs and
1010
Economic Growth and S ta b ility ,-______________________________ „ ____
Magill, Roswell, president, Tax Foundation, Inc., partner, Cravath,
Swaine & Moore, Improving Budget Procedures in Congress___________
477
Maisel, Sherman J., professor of business administration, University of Cal
ifornia (Berkeley), Varying Public Construction and Housing To Promote
Economic Stability________________ ________ ___________________________
382
Maxwell, James A., professor of economics, Clark University, Adjustment
of Governmental Responsibilities Via Grants__________________________
200
Mayer, Karl M., Washington, D . C., Federal Expenditure Policy for
Economic Growth and Stability in the Area of Natural Resource
Development With Special Reference to the Potential Impact of AtomicEnergy Developments on the Energy, Fuel, and Power Economies of
the Country__________________________________________________________
701
McKean, Roland N., the R A N D Corp., Santa Monica Calif., Criteria of
Efficiency in Government Expenditures_______________________________
252
Mitchell, James P., Secretary of Labor, the Federal Government’s Labor
and Manpower Programs_____________________________________________
885
Mueller, Frederick H., Acting Secretary of Commerce:
Area Development Expenditures and Economic Stability in Local
Areas____________________________________________________________
803
Federal Highway Act of 1956, and Federal-Aid Airport Program Policies
and Procedures__________________________________________________
1049
Mullenbach, Philip, research director, Nuclear Energy Study, the Twen
tieth Century Fund, and Perry D. Teitelbaum, economist, Council for
Economic and Industry Research, Inc., the Development of Nuclear
Energy_______________________________________________________________
715
Musgrave, Richard A., professor of economics, University of Michigan,
Principles of Budget Determination___________________________________
108
Mushkin, Selma, research associate, School of Hygiene and Public Health
and Department of Political Economy, and Clarence D . Long, professor
of economics, Johns Hopkins University, Welfare Programs and Eco
nomic Growth and Stability___________________________________________ 1010
Newbury, Frank D., economic and management consultant, formerly
Assistant Secretary o f Defense (Research and Engineering), Federal
Expenditures for Research and Development______________________1195
Newcomb, Robinson, economic consultant, Washington, D. C., Federal
Expenditures for Housing and Urban Redevelopment_________________
844
Novick, David, chief, cost analysis department, the R A N D Corp., Santa
Monica, Caliif., Federal Spending for National Security________________
542
Patterson, Robert T., associate professor of economics, Claremont Men’s
College, Federal Expenditure, Economic Growth, and Instability______
7
Poole, Kenyon E., professor of economics, Northwestern University, Some
Problems in Optimizing the Level of Public Expenditures_____________
116
Robey, Ralph, economic adviser, National Association of Manufacturers,
Federal Spending and Economic Stability_____________________________
398
Ruggles, Nancy D., Bureau of Economic Affairs, United Nations, and
Richard Ruggles, professor o f economics, Yale University, Government
Budgets and Their Relation to National Accounts_____________________
483
Ruggles, Richard, professor o f economics, Yale University, and Nancy D.
Ruggles, Bureau o f Economic Affairs, United Nations, Government
Budgets and Their Relation to National Accounts_____________________
483
Ruttenberg, Stanley H., director of research, American Federation of
Labor and Congress of Industrial Organizations, Federal Expenditures
and Economic Growth________________________________________________
299
Salera, Virgil, Senior economist, American Enterprise Association, Self
Help, Traditional Investment and Foreign Economic Aid_____________
620
CONTENTS
XV
Schlesinger, James R., assistant professor of economics, University of
Virginia, Government Interest Payments: Their Relationship to
Pas®
Economic Growth and Stability______________________________________
404
Schmidt, Wilson, associate professor of economics, the George Washington
627
University, Foreign Aid— Some Issues and Problems in Assessment____
Seaton, Fred A., Secretary o f the Interior, Federal Expenditures and
Programs for the Development o f Natural Resources__________________
645
Shishkin, Boris, secretary, Housing Committee, American Federation of
Labor and Congress of Industrial Relations, Federal Expenditures for
Housing and Urban Redevelopment__________________________________
855
Short, Dewey, Assistant Secretary of the Army (Civil-Military Affairs),
Civil Works Programs and Economic Growth_________________________ 1063a
Smithies, Arthur, Nathaniel Ropes professor of economics, Harvard Uni
versity, the Defense Budget__________________________________________
551
Soloway, Arnold M., assistant professor of economics, Harvard University,
the Growth of Government Over the Past 50 Years: An Analytical
Review______________________________________________________________
19
Somers, Harold M., dean and professor of economics, School of Business
Administration, University of Buffalo, Federal Expenditure and Eco
nomic Stability: The Fallacy of the Balanced Budget_________________
412
Stigler, George J., professor of economics, Columbia University, The
213
Tenable Range of Functions of Local Government____________________
Strayer, Paul J., associate professor of economics, Princeton University,
Federal Responsibility for Education_________________________________
1032
Teitelbaum, Peter D., economist, Council for Economic and Industry
Research, Inc., and Philip Mullenbach, research director, Nuclear Energy
Study, the Twentieth Century Fund, Washington, D. C., the Develop
ment of Nuclear Energy______________________________________________
715
Thomson, Procter, associate professor of economics, Claremont Men’s
College, and Claremont Graduate School, Government and the Market130
Tiebout, Charles M., assistant professor of economics, Northeastern Uni
versity, A Regional Framework for Government Expenditures________
818
Trescott, Paul B., associate professor of economics, Kenyon College, Some
Historical Aspects of Federal Fiscal Policy, 1790-1956_______ __________
60
Tybout, Richard A., associate professor of economics, the Ohio State
University, Atomic Power and Energy Resource Planning_____________
736
Vandermeulen, Daniel C., associate professor of economics, Claremont
Graduate School and Claremont Men’s College, Federal Expenditures
308
and Economic Growth: Analysis and Policy__________________________
Weidenbaum, Murray L., senior operations analyst, Convair, General
Dynamics Corp., The Federal Government Spending Process_________
493
Wilde, Frazar B., chairman, Research and Policy Committee, Committee
for Economic Development, and president, Connecticut General Life
Insurance Co., Federal Expenditures in Modern America______________
153
Willcox, Alanson W., former general counsel, Federal Security Agency,
Criteria of Federal Welfare Expenditures: A Lawyer’s View__________
1038
Wright, David McCord, William Dow professor of economics and political
science, McGill University, Montreal, Canada, Government Expenditure
and Economic Growth_______________________________________________
319
Wright, Wilson, economist, Procter & Gamble Co., Economy and Efficiency
258
in Government Expenditures_________________________________________
Zettel, Richard M., research economist, Institute of transportation and
Traffic Engineering, University of California, Highway Expenditures for
Economic Growth and Stability______________________________________
1119
INTRODUCTION B Y W ILB U R D. M ILLS, CHAIRM AN
SUBCOM M ITTEE ON FISCAL POLICY
Two years ago, the Subcommittee on Tax Policy of the Joint Eco
nomic Committee undertook a study of Federal tax policy for eco
nomic growth and stability. The purposes of that study were to add
to our understanding of the manner in which our Federal revenue
system affects the Nation’s economic development and to formulate
general economic principles upon which future tax policy, consistent
with the requirements for steady economic growth, might be based.
The impress of that study, I believe, will be a lasting one. The Sub
committee on Fiscal Policy has now turned its attention to the expendi
ture policies of the Federal Government, and their relationship to
the economic stabilization and growth objectives of the Employment
Act.
The Joint Economic Committee is not a legislating committee, but
under the Employment Act it is charged with making studies of the
major economic programs of the Federal Government as a guide to
the legislating committees. The Subcommittee on Fiscal Policy recog
nizes, of course, that many considerations other than those of the
Employment Act enter into decisions governing Federal spending
programs. But it must also be recognized that virtually all Federal
Government activities may have significant effects on many individ
uals and groups in the economy and, consequently, on the total amount
and character of the Nation’s economic activity. Federal Govern
ment expenditure programs, therefore, may have important conse
quences with respect to the effectiveness of the specific public policies
aimed at attaining the Employment Act objectives. The subcommit
tee is hopeful that this study, directed at improving and refining our
knowledge of the complex relationships between the scope and char
acter of Government activity and that of the private sectors in our
dynamic economy, will be of value to those in the executive branch
of the Government as well as in the Congress who share responsibility
for the formulation of Federal spending programs.
The study seeks first to develop an historical perspective concerning
changes in the amount and character of Federal spending, and the
relationship of such changes to major developments in the structure
of the American economy. The second part of the study is concerned
with basic economic principles and criteria bearing on the relation
ship between Federal Government activities and Employment Act
objectives. The third phase of the study examines the impact of sev
eral major Federal programs on the rate and character of the Nation’s
economic growth and on the conditions for maintaining economic
stability.
The subcommittee has sought the widest possible representation of
expert viewpoints on the many important issues embraced by this
X V II
97735— 57--------2
XVm
INTRODUCTION
study. The list of contributors suggested by the subcommittee’s staff,
I believe, fully reflects this instruction.
On behalf of the subcommittee, I wish to commend the contributors
for the valuable materials they have presented in this volume. They
have given generously of their time and resources, and rendered a
significant public service.
I. H ISTORICAL MAGNITUDES AND DEVELOPMENTS
AFFECTING THE AMOUNT AND TYPE OF
FEDERAL EXPENDITURES
XIX
H ISTORICAL M AG N ITU D ES A N D D EVELOPM ENTS A F
FECTIN G TH E AM OUNT AND TYP E OF FEDER AL
E X PE N D ITU R E S
HISTORICAL CHANGES IN DEMANDS FOR PUBLIC
EXPENDITURES FOR COMMUNITY AMENITIES
Charles E. Lindblom, associate professor of economics, Yale University
In the late twenties, the Federal Government spent only $1 out of
every $5 of public expenditures in the United States, State and local
governments spending $4 out of every $5. With the great depression
and World War II both throwing responsibilities upon government
that only the Federal Government could shoulder, it is not at all
surprising that by the end of the war, the earlier situation had been
reversed, with the Federal Government spending 4 out of 5 public
expenditures dollars. But a striking feature of the period since 1946
is that, despite continued high Federal expenditures, State and local
governments had risen by 1956 to about 40 percent of public expendi
tures and are still rising.
The almost explosive expansion of State and local government ex
penditures has drawn much comment, and predictions are freely being
made that the expansion will continue. The significance of the upsurge
is to be found in the character of State and local expenditures, as con
trasted to Federal. What has been mushrooming is expenditures on
community amenities. The demands that spark the growth are not
those for regulatory functions, economic security, or economic develop
ment, but are instead demands for better education, better health,
more pleasant cities, recreation, and mobility.
For the Federal Government, the significance of these burgeoning
demands for amenities lies, in turn, in the possibility that the Federal
Government will either be called upon to meet some of the new de
mands directly, or to come to the aid of the States and localities with
grants, or to reduce Federal taxes so that State and local governments
can accumulate the revenues required to support their growing
functions.
Where did the new demands come from ? How stable are they likely
to be ? Will they probably increase or decline ? In this paper, I shall
try to point up some historical changes that help answer these ques
tions and—more generally—throw light on the magnitude of expendi
tures that might be called for in the awakened pursuit of those
amenities of life that can most easily be attained only through collec
tive action.
In America’s early years, public economic policy was preoccupied
with the economic security of a poor and precarious society. In the
very earliest colonial ventures, mere survival overrode any other policy
l
2
ECONOMIC GROWTH AND STABILITY
objective. At a second stage, public economic policy was tailored to
economic development to achieve the remarkable rise in personal in
come that marked the 19th century. But again in the 20th century,
policy became preoccupied with economic security—this time not the
insecurities of a new continent but the economic insecurities of a com
plex, unstable, depression-prone economic system. It is quite possible
that we are now moving for the second time into a period o f expan
sion and development as a fourth stage in the sequence. In the quick
ened pursuit of collective amenities, we may be on the threshold of
a long period of expansion that will, as did the three earlier stages,
put its distinctive stamp on the economy. The possibility of dividing
American economic history into these four stages proves nothing, to
be sure; but it suggests that present straws in the wind may presage
not simply a minor alteration of our course but a fundamental change
in the character of American life. Hence the growth of public ex
penditures on amenities ought to be investigated without any attempt
to minimize its possible significance.
C
ommon
H
ypoth eses
E
x p l a in in g
A
R
is in g
E
x p e n d it u r e s
on
m e n it ie s
Rapid growth and redistribution of population
Widely remarked as the source of many new demands for water
and sewage systems, highways and streets, other public construction
and public services, rising population and suburbanization are hardly
to be questioned as major factors in post-World War II public ex
penditures. To be sure, increased density of population, up to a
point, can spread the cost of social overheads, with a consequent de
crease in per capita public expenditures, but new people in new places
undoubtedly call for public expenditures, especially capital outlays,
and too high a density o f population probably pushes expenditures
on social overheads beyond a point of diminishing returns. But
rapid population growth and movement we have had before in the
history of the United States, and, without belittling its immediate
importance for State and local expenditures on amenities, one would
doubt that it would produce a lasting and major redirection of public
policy toward collective amenities unlike anything we have seen
before.
Growing social interdependence
Modem technology, the scale of business enterprise, and urbaniza
tion have unquestionably created a high order of social interdependence
in our society, running far beyond the interdependence of frontier
farmers or early artisans. And everyone recognizes that this grow
ing interdependence has increasingly thrust regulatory, protective,
and developmental functions upon government. It seems fairly clear
that it also makes it impossible for individuals to enjoyy many of
the amenities of life, such as certain kinds of recreation and easy
mobility, without calling upon government to clear the way. And it
is, of course, interdependence that makes each child’s education the
concern of every citizen and turns education from a privately con
sumed service into a collectively demanded and regulated one. Again,
however, while growing interdependence explains some of the slowly
growing expenditures on collective amenities over the course of
3
ECONOMIC GROWTH AND STABILITY
American history, it does not promise a sharp or revolutionary alter
ation in public expenditures on them.
Rising income and wealth
In rising income and wealth, we come to a phenomenon capable
of sparking a dramatic alteration of public policy in the direction of
collective amenities. We can now and increasingly in the near fu
ture afford even lavish outlays on education, recreation, highways,
physical and mental health, urban redevelopment, and the like, for
we have finally arrived at a level of personal income where we begin to
wonder how to dispose of it, as is indicated by the character of Amer
ican advertising and consumer response to it. There is little doubt
that rising income, together with the new aspirations that accompany
it, accounts for much of the postwar demands for better education,
for example.
New leisure
The air is thick these days with talk of reducing the workweek,
and the earlier achieved and prospective growth of leisure is the other
side of the coin of increased income. We do not demand increased
expenditures on community amenities only because we can afford them
but also because we have time to enjoy them. Leisure is an enormous
stimulant to aspiration.
The end of 'poverty
A development may sometimes go so far as to appear to have fun
damentally changed its own character. The rise of American income
has now gone so far as to have nearly eliminated poverty, in the
usual sense of the term. Because it has been engraved upon our
minds that the poor we shall always have with us, such a development
can have great and dramatic consequences for our views of the world
and for our aspirations. It is, of course, too early to say. But is it
not believable that citizens freed from the age-old concern over pov
erty will find new goals of public policy, new causes, new issues,
and find themselves caught up in an enthusiastic and accelerated
demand for the amenities of life that seemed both too much and too
immoral to hope for in the face of poverty among their fellow citi
zens? We should not underrate the force of such intangibles of
history.
D
e c l in in g
D
ebate an d
op
E m e r g in g A g r e e m e n t
G overnm ent
on th e
R
ole
Of the above historical changes, some would appear to account for
a relatively small shift in public expenditures toward the amenities,
while the full significance of some of the others will better be seen if
they are coupled with a further historical change that outweighs
them all; the slow but unmistakable decline of the debate over the
proper functions of government and emerging agreement that govern
ment is an instrument to be used fairly freely in the pursuit of a wide
variety of goals. It is as though we had finally decided to free a
fettered giant.
Because the new agreement is, although overwhelming, still not
unanimous, it is alarming to those who do not share it. But, whether
alarming or gratifying, it has come to pass.
4
ECONOMIC GROWTH AND STABILITY
The emergent agreement can be described by contrasting it with the
debate it supersedes. It was a debate over the role of government in
which policy alternatives where identified with the grand alternatives
of socialism and capitalism and in which the dominant view was that
only by holding fast to private enterprise free from government dom
ination could the evils of socialism be avoided. Even small policy
alternatives, as, for example, those pertaining to details of monetary
policy or the securities markets, were often debated as though the
alternatives were not these policies at all but the two great institutions
of socialism and capitalism.
Frightened by our own discussion of policy, we have hesitated to
employ government as freely as we now appear to intend for the
future.
Evidence that the debate is almost over has been conspicuous in
recent years. In the last presidential campaign, the Democrats’ pov
erty of campaign issues revealed the degree to which both major
parties agreed on the role of government. It was no longer possible,
as it had been in New and Fair Deal days, for the Democrats to find
challenging functions for government that would separate the two
parties. Or consider the flavor of some of the new conservatism,
about which we have been hearing much lately. Its stress is not on
the rugged individualism of unrestricted free enterprise but on the
conforming community, on social solidarity. The new conservatism
seems more fearful of the maverick than of strong government, and
some of the new conservatives would happily embrace a program of
collectively provided amenities with government in a paternal role if
this would strengthen the bonds of community.
More striking evidence that we are all coming to agree on the new
larger role for government is the Eisenhower budget, compelling evi
dence that public budgets cannot be significantly reduced. The cries
of anguish that greeted its announcement were loud, but because the
illusion that Republicans could cut the budget where Democrats would
not was finally, bitterly, sadly, embarrassingly destroyed.
What in our history put an end to the old debate? What accounts
for the emerging agreement on the expanded role of government?
The first explanation is that one cannot indefinitely debate irrelevancies without discovering that one is doing so. It never was true
that each new function of government forced us to choose between
socialism and capitalism, and, while one is tempted to quote from the
historical debate to show how foolish it now looks in retrospect, it is
enough to observe how liberal and conservative alike have come to
point with pride at a growing list of governmental functions as proof
of capitalism’s flexibility in meeting the people’s problems. For some
public functions, rituai requires the old language, but few take its
irrelevancies to heart.
Secondly, our experience since the late thirties with fiscal and mone
tary controls designed to maintain full employment—and, specifically,
their relative success, have vastly increased our confidence in the in
struments of government.
Thirdly, our wartime successes in government direction of the econ
omy have given us, not a taste for the same diet in time of peace, but,
again, a greater confidence that we can employ government far beyond
the capacities we used to expect of it, and do so without fear of either
intolerable inefficiency or threats to our liberties.
ECONOMIC GROWTH AND STABILITY
5
Fourth, we have come to understand government and society better
than before, and we treat the question of governmental functions as
a subject for research and discussion rather than for simple-minded
moral pronouncements. The technical skills of economists in problems
of monetary management, which go far beyond" those of 20 years ago,
illustrate that growing knowledge makes government a more tract
able and generally useful servant.
Fifth, we agree on a new large role for government because, for the
first time in our history, we cannot deny that we can afford it.
Sixth, we agree on expanding collective consumption because con
spicuous private consumption is less admired than in the days when
Thorstein Yeblen invented the term. It is a curious shift in attitudes
that makes blue jeans as popular among the wealthy as among the
less favored. In a society as equalitarian as ours, some kinds of goods
and services are comfortably consumed only when others can share
their enjoyment; hence, the wealthy are turned to a degree from ex
clusive consumption to leadership in the demand that many of life’s
amenities be widely distributed through government. It is not the
low-income groups who are always in the forefront of campaigns for
better schools, parks, streets, and other public services.
Seventh, it may even be true that our traditional concern over the
irrationality of much government expenditure is subsiding in the
face of patterns of private consumption that flow from our phenom
enally high incomes. The demand for new novelties in consumption
“ for the man who has everything” gives one pause about the rational
ity of private consumption. So, too, the price we are willing to pay
for fashion, specifically for a series of new models in durable goods.
We like the alternatives that our wealth offers us in private consump
tion, but we cannot any longer believe, as we could when bread and
butter were more urgent needs, that private consumption is rationally
directed toward higher priority goods and services than are govern
ment expenditures. Schools, parks, highways, water, sewage disposal,
and the like come to be conceded an obvious high priority relative to
many of the private goods we can find to use up our new incomes.
Lastly, one might mention as a possible factor in the emerging
agreement on a large role for government-provided amenities the
hypothesis that our society is too much fragmented and that our
citizens want communal associations. It is only a hypothesis, but
it is thoughtfully discussed by economists impressed by the imper
sonality of the market mechanism, by psychologists and psychiatrists
impressed by evidences of personal insecurity in our large-scale so
ciety, and by sociologists impressed by the contrast between the social
bonds of mass society and the more intimate ties of earlier and smaller
societies. It is not impossible, therefore, that agreement on expansion
of the social amenities is a reaction to the destruction of older forms
of association by the expansion of the market economy.
The interpretation of historical trends is a dangerous business, all
the more so in the present case because it has not been possible to
document the analysis suggested here. But whether the reasons given
here are correct or not, agreement does appear to be emerging on a
new and large role for government; and this, above all other factors
tending in the same direction, promises for the future a revolutionary
expansion of provision of community amenities. As already indi
6
ECONOMIC GROWTH AND STABILITY
cated, the immediate demands will be largely on State and local
government; but the magnitude of the demands will raise many ques
tions of tax and expenditure policy for the Federal Government, for
it, too, will feel the force of the demands upon State and local govern
ment, as well as demands directly upon Washington.
FEDERAL EXPENDITURE, ECONOMIC GROWTH, AND
STA BILITY
Robert T. Patterson, associate professor of economics, Claremont
Men’s College
I f we bear in mind the inherently close and complex relationship
of Government spending, taxation, borrowing and debt management,
as well as monetary policy, it is appropriate to separate out and focus
attention upon any one of these parts of the fiscal-monetary pattern.
In this compendium we are particularly concerned with the signifi
cance of Federal expenditure policy in terms of economic growth
and stability, although the spending of State and local governments
is not to be overlooked.
An earlier study, made in the same manner and for the same pur
pose as the one we are engaged in, dealt with taxation.1 In its pre
liminary section, entitled Focus of Tax Policy: Short-Run Stabilizaand Long-Run Growth,” various statements appear with respect to
the nature, causes, and relationship of economic growth and stability
which are germane also to a study of Government expenditure. A l
though the present paper undertakes to offer a fresh, but not in all
ways dissimilar, view, it seems worthwhile to call attention to basic
observations made in the earlier study. One, for example, is that
although there is “ considerably less than unanimity among duly ac
credited economists about the true explanation of business cycles * * *
there is a broad range of agreement about the key role of monetary
and credit expansion and contraction in producing surges of business
and recessions.” Another is that there is general agreement that
“a lack of balance between investment and consumption may pre
cipitate severe economic ups and downs.” Still another is that “war
times excepted, when we have had a high level of business invest
ment in new producing facilities, we have had a high level of pros
perity, and when we have had a low level of such investment the
reverse has been true.” 2 These and other generalizations made in
that study, however qualified by the individual economist, may help to
clear the ground and further our progress.
The purpose of this paper is to note not only the significant changes
that have occurred in the amount and types of Federal expenditure
but also the variations in other economic phenomena which are asso
ciated with Federal financial policies. Emphasis is placed upon the
period since World War II, for a part of the question which this and
the succeeding studies will attempt to answer is whether the Federal
Government has been doing, financially, what it ought to do and leav1
United States Congress, Joint Committee on the Economic Report, Federal T ax Policy
for Economic Growth and Stability, papers submitted by panelists appearing before the
Subcommittee on T a x Policy, 84th Cfong., 1st se§s. (W ashington. Government Printing
Office, 1 9 5 5 ).
a Dexter M . Kee*er, Economic Stability and Growth, Federal T a x Policy for Economic
Growth and Stability, pp. 7 -8 .
7
8
ECONOMIC GROWTH AND1 STABILITY
ing undone what it ought not to. The earlier history of Federal spend
ing and of economic growth and instability is of value, too, for it gives
perspective and shows certain important relationships and trends—
especially the trend in Government spending, which has been the most
dramatic of.them all.
F
ederal
E
x p e n d it u r e ,
.
E
c o n o m ic
G
row th
,
and
I
n s t a b il it y ,
1789-1933
Some generalizations will save much tabular space, yet keep the
picture clear. The interrelationship of Federal spending and economic
activity has been continually of major significance only since 1933.
Until then Federal expenditure (and taxation, borrowing, and debt
management) were often incidental and random influences, although
there were times when Federal finance dominated the economy. Most
notable of these were during and immediately after the War of 1812,
the Civil War, and World War I. In quite a different way the unique
problem of surplus revenue, which appeared in the 1830’s and again
in the 1880’s and was associated with the political controversy over
the tariff, gave a special emphasis to Federal disbursements (expendi
ture, debt retirement, and even—in 1837—the division of excess ac
cumulated revenue among the States).
It cannot be said that during the 19th century and the first third
of the 20th century those who understood Government finance were
unaware of or unconcerned with the effect of the Government’s fiscal
activities upon business. At practically all times higher Treasury offi
cials were conscious of it, and when possible they made adjustments—
not always wisely—that were intended to mitigate its unfavorable in
fluences. Nevertheless, the concept of the role of government in the
Nation’s economic life was a narrow one: There was no clearly defined
fiscal policy; the spending power granted to Congress by the Consti
tution was, ordinarily, rigidly interpreted; and the Government’s
activities were, at most times, a small part of all economic activity.
Although, in this period, there was never any large, planned ex
penditure program intended to promote economic growth, there was
an astonishing increase in real national wealth and income. It was
not due to any single cause—climate, natural resources, the industrial
revolution, the frontier, population growth, the character of the peo
ple, education, a Federal Constitution, saving and investment, an im
proving monetary system, economic instability, or some other—but to
a complexity of causes. Planned Federal spending for broad economic
effects, however, was not one of them.
Along with the remarkable growth of wealth and income there was
marked economic instability. Prices rose and fell; booms, panics, and
depressions ran their course; many fortunes were made which waves of
bankruptcy wiped out. There were periods of mass unemployment
with attendant misery and despair. The purchasing power of specie
and paper currency varied with the phases of the business cycle; and
at times when the currency was irredeemable its value depreciated
drastically, though in each such instance redeemability finally restored
it. The credit of the Government, too, fluctuated, Sometimes mark
edly and adversely, when the requirement of war or of unwise peace
time fiscal and monetary policies threatened the future value of the
Government’s obligations or cast a shadow upon its integrity.
ECONOMIC GROWTH AND STABILITY
9
Instabilities such as these were concomitants of great economic
growth. Their various effects upon it, however, cannot all be sepa
rated out. Some of them would seem to have been far from conducive
to long-run growth. Others, however, may have been essential to it.
Any decline m the Government’s credit and any marked decline in the
value of the currency with its attendant inflationary effect on the price
level—as such instabilities induced consumption spending and specu
lation rather than saving and investment—were probably not, although
in the shorter run the inflationary stimulation could, like a narcotic
acting upon the human system, make them seem to be. The panics
and depressions—drastic perhaps in proportion to the debris of finan
cial excesses, unwise investment, and false values which they cleared
away—may well have been a necessary part of long-run real growth,
though during them those who suffered would have found this hard
to believe.
Because of the enormous change in magnitude of Federal expendi
ture over the course of time table 1 shows, in millions of dollars, the
trend prior to 1933, while later as well as some overlapping data, in
billions of dollars, appear in tables below.
T a b le 1.— Expenditure
of the Federal Government: selected years, 1789-1932
[In millions of dollars]
1789-91______________________________________________________________
4. 3
1800_________________________________________________________________
10.8
1825_________________________________________________________________
15. 9
1850_________________________________________________________________
39. 5
1865_________________________________________________________________ 1, 297.6
1875_________________________________________________________________
274.6
1900_________________________________________________________________
520. 9
1910_________________________________________________________________
693.6
191 9
18,514.9
192 0
6,403.3
1925_________________________________________________________________ 3,063.1
1930_________________________________________________________________ 3,440.3
1932_________________________________________________________________ 4, 659. 2
Source: Annual Report of the Secretary of the Treasury on the State of the Finances,
1956.
F
ederal,
S tate,
and
L
ocal
E
x p e n d it u r e
Before observing further the trends of Federal expenditure and
economic growth and the nature of various phenomena associated with
them, it is appropriate to note certain trends in expenditure by State
and local government and their relation to that of the Federal Gov
ernment.
During the 19th century, except for a time when State governments
participated in canal construction and in railroad building and bank
ing, their expenditures were kept to a minimum and were mostly con
cerned with the functions of general government, although some out
lays were made for education, assistance to agriculture, and for con
struction and operation of asylums and hospitals. In the 20th cen
tury, and especially from 1920 onward, State government expenditure
increased enormously, rising from about $350 million in 1913 to $21.7
billion in 1956. Construction and maintenance of highways, support
of education, and social-welfare activities accounted for the greater
part of this expansion. The relative amounts of these and other ex
penditures have varied widely among the individual States.
10
ECONOMIC GROWTH AND STABILITY
Local government expenditure increased almost continually from
1800 onward. Before 1860 municipal activities expanded greatly due
to population increase, urbanization, and a public demand for more
and better services at the local governmental level. Thereafter the
increase continued, but at a slower rate and with retrenchments in
depression periods. Between 1913 and 1956 expenditures by local gov
ernments rose from $1.5 billion to $28.3 billion. The major outlays
today are for education, construction and maintenance of streets and
highways, and public health and sanitation.
T a b le 2.—The
recent trend in State and local expenditures, 1958-561
[In billions of dollars]
'■i
Year
•.
State
Local
16.8
18.7
20.4
21.7
1953 ................................................... - ......................................................................
1954
...................................................................................................................
1955
..........................................................................................................
1956 .............................................................................................................................
21.7
23.8
26.2
28.3
. Total
38.5
42.5
46.6
50.0
i Without exclusion for transactions between levels of government.
Source: U. S. Department of Commerce, Bureau of the Census, Summary of Governmental Finances,
1955,1956.
Before the middle of the 1930’s expenditure of the Federal Govern
ment was the lesser part of all Government expenditure, except dur
ing wars and for snort periods following them. Ordinarily, since
1890, Federal expenditure was between 25 and 30 percent of the total,
local expenditure was 50 to 60 percent, and State expenditure ranged
from 10 to 20 percent. In the period 1953-56 State and local expendi
tures together varied from 30 to 37 percent of all Government ex
penditure while Federal expenditure was between 63 and 70 percent.
During that time local expenditure exceeded that of the States by
about 30 percent, and nearly a third of State expenditure was of an
intergovernmental nature.
T a b le 8
—Percentage distribution of Government expenditure: Selected years,
1890-1956
Year
Federal
1 8 9 0 -...........
1 9 1 3 ......___
1919____— .
1939................
1933................
1936................
35.6
26.8
87.5
27.0
35.7
52.7
State and
local
64.4
73.2
12.5
73.0
64.3
47.3
Total
•
100
100
100
100
100
100
Year
1940... ..........
1944 ...........
1948
1955..............
1956 . - _
Federal
48.5
92.1
67.6
64.2
63.3
State and
local
51.5
7,9
32.5
35.8
36.7
Total
100
100
100
100
100
ii'V. i
Sources: William J. Shultz and O. Lowell Harries, American Public Finanoe, 6th edition (New York:
Prentice-Hall, Inc., 1954), p. 20; and 17. S. Department of Commerce, Bureau of the Census, Survey of
Governmental Finances In 1958, 1956.
ECONOMIC GROWTH AND STABILITY
T
he
M
ore
R
ecent
E
x p a n s io n o f
F
ederal
11
S p e n d in g
The following tables show the nature and trend of expenditure by
the Federal Government in more recent times:
Table 4.—Budget
receipts and expenditures: Selected fiscal years, 1900-57
[In billions of dollars]
Year
1900.
1910.
1920.
1930.
1935.
1940.
1945.
1946.
1947.
1948
Net
receipts 1
Expendi
tures
0.6
0.5
.7
6.4
3.4
6.5
9.1
98.4
60.4
39.0
33.1
.7
6.7
4.2
3.7
5.1
44.5
39.8
39.8
41.5
Surplus or
deficit (—)
Year
(2)
1949_________
1950................
1951.................
1952................
1953_________
1954________
1955........... .
1956................
1957 3..............
(2)
.7
-
2.8
-3 .9
-53.9
-20.7
.8
8.4
Net
receipts 1
Expendi
tures
37.7
36.5
47.6
61.4
64.8
64.7
6 .4
68.2
70.1
39.5
39.6
44.1
65.4
74.3
67.8
64.6
66.5
69.3
Surplus or
deficit (—)
- 1.8
-3 .1
3.5
-4 .0
- 9 .5
- 3 .1
- 4 .2
1.6
1.6
* Total receipts less refunds of receipts beginning with fiscal year 1931, and less transfer of tax receipts to
the Federal old-age and survivors' insurance trust fund beginning with fiscal 1937 and to the railroad
retirement account beginning with fiscal 1938.
2 Less than $50,000,000.
3 Preliminary.
Sources: Annual report of the Secretary of the Treasury on the State of the Finances, 1956; and Treasury
Bulletin, August 1957.
T a ble 5.—Expenditure
by major functions, fiscal years 1988-40
[In billions of dollars]
1933
1934
1935
National defense....................................
Veterans’ Administration__________
0.7
.9
0.5
.6
0.7
.6
Public works.........................................
Aid to agriculture..................................
Relief and work relief...........................
Other departmental..............................
Interest on public debt........................
Other2.....................................................
.4
.2
.4
.4
.7
.3
.7
.8
1.8
.3
.8
.5
Grand total 8_.............................
3.9
6.0
1936
1937
1938
1939
1940
.9
1.1
2.3
.3
.8
.3
0.9
2.4
0)
.7
.9
2.3
.3
.7
.3
0.9
1.1
.2
1.0
1.0
2.4
.4
.9
.3
1.0
.6
.3
.8
.9
1.9
.4
.9
.5
1.2
.6
.3
1.0
1.2
2.6
.5
.9
.4
1.6
.6
.4
.9
1.6
1.9
.6
1.0
.5
7.0
8.7
8.2
7.2
8.7
9.0
i Less than $30,000,000.
* See aqnual reports of the Secretary of the Treasury for breakdown of this item.
* Adjustments of some of these data have been made to more recent annual reports.
total because of rounding.
Some figures do not
Source: Annual Report of the Secretary of the Treasury on the State of the Finances, 1940.
T able 6.—Expenditure 6y
major functions, fiscal years 1941-47
[In billions of dollars]
1941
National defense and related activities............
1942
1943
1944
1945
1946
6.7
28.3
75.3
89.7
90.5
.6
11
.1
5.4
.6
23
1
4.2
.
.6
1.8
1
1.9
.
.7
2.6
.3
2.2
2.1
36
1.7
2.5
48 9
.7
4.3
4.7
3.0
2.1
17.3
4.4
7.3
5.0
3.0
5.5
13.8
34.4
79.7
95.6
100.4
63.7
42.5
i In table 4 this item is excluded.
Source: Annual Report of the Secretary of the Treasury on the State of the Finances, 1947.
1947
12
ECONOMIC GROWTH AND STABILITY
Table 7.— Budget expenditures by major classifications, fiscal years 1948-571
[In billions of dollars]
1948
1949
1950
1951
1952
1953
1954
1955
Major national sectirity......... ..........: .................. 11.8
International affairs and finance......................... 4.6
Veterans' services and benefits............................ 6.7
Labor and welfare..................................................
1.3
Agriculture and agricultural resources..............
.6
Natural resources...................................................
.6
Commerce and housing........................................
1.4
1.3
General Government... ..
. .. ....... ............
Interest on public d e b t ......................................
5.2
12.9
6.1
6.7
1.6
2.5
1.0
1.9
1.1
5.4
13.0
4.7
6.6
2.0
2.8
1.2
2.0
1.2
5.7
22.4
3.7
5.3
2.1
.6
1.3
2.2
1.3
5.6
44,0
2.8
4.9
2.2
1.0
1.4
2.6
1.5
5.9
50.4
2.2
4.3
2.4
2.9
1.5
2.5
1.5
6.5
46.9
1.7
4.3
2.5
2.6
1.3
.8
1.2
6.4
40.6
2.1
4.5
2.6
4.4
1.2
1.5
1.2
6.4
1956
40.6
1.8
4.8
2.8
4.9
1.1
2.0
1.6
6.8
1 Details of expenditure within these classifications are shown in each annual report of the Secretary of
the Treasury on the state oTthe finances, 1948-56.
Source: Annual Report of the Secretary of the Treasury on the State of the Finances, 1956.
Two broad generalizations may be made at this point. In the period
1933-40, Federal spending more than doubled, most of the increase
being due to expenditure policies related to the great depression.
Thereafter until the present time defense spending has dominated, but
in markedly different amounts and at quite different ratios to all other
expenditure in the annual budgets.
It does not seem conceivable that huge expenditure for war and de
fense can be conducive to long-run economic growth and stability.
Some people hold that a modicum of such expenditure at certain times
can be, but there is certainly room for argument. As for the other
expenditures of the Federal Government, some are productive, some
are wasteful and uneconomic, and some are merely transfer payments.
The assignments to other panelists indicate that these various kinds
of expenditure are to be considered elaborately and thoroughly for
their implications with respect to economic growth and stability.
E
c o n o m ic
G
row th
,
1790-1957
National-wealth data are, at best, rough estimates. The latest year
for which they are available is 1952. Since between 1940 and 1952
the purchasing power of the dollar (as measured by consumer prices)
had fallen by 47 percent, the 1952 figure of $1,128.4 billion in total
national wealth would be $597.8 billion when adujsted to 1940 dollars.
T a b l e 8 .—Estimates
of national wealth, in current dollars, selected years,
1790-1952
[In billions of dollars]
_____
1790______ _____ _
I860__ ■______ —_________
1825 ____________ __________
1850_____________ __________
1860________ __ _ _________
1S70________
— __________
1880 ___________ __________
_________
1890
_ _
________
1900 _________
-
1.2
2.4
3. S
7.1
16.2
126.5
43.3
65.0
87.7
__ __
152.0
1910- —
1920 —
_____ _
_ _
374.4
1930— _
____________
410.1
344.9
1935
_____ ___________
1940 _
____ ________
424.2
1945
_
_ ___________
570.6
1949 ___
____ __ _ 898.2
1952 _ _
_
21,128.4
1 This figure has been reduced to a gold basis.
3 This total for 1952 includes land valuation as of 1949, the latest year for which such
data is available.
Source: TJ. S. Department of Commerce, Bureau of the Census, Historical Statistics of
the United States, 1 7 8 9 -1 9 4 5 , and Statistical Abstract o f the United States, 1956.
13
ECONOMIC GROWTH AND STABILITY
Estimates of gross national product—the total national output of
goods and services at market prices—go back only to 1869. Table 9
shows total and per capita gross national product in constant (1947)
in the purchasing power of the dollar. In table 10, however, are
shown total and per capita gross national product in constant (1947)
dollars for the period 1929-56.
T a b le 9.—Gross
,
national product or expenditure in current dollars, selected
years 1869-19511
,
[In billions of dollars]
___ ____
1869-78
_
7 .0 1941 _ _________
. __________
1874-83—
„ ___________
8 .9 1942___ _
_____________________
18 79 -8 8. - _
_____________
10 .7 1943_________ „
11 .9 1944—
1884-93
_
__ __________
_____________
_ _
_________ 12 .7 1945
1889-98
__
_____ _____
_____
1894-1903 _______ __ ___________
15 .7 1946____ ___ _ __________________
1899-1908 —
.. _
_ _
_ 2 1 . 6 1947_________
__________ _
_ _ 2 8 .8 1948______________ _______________
1904-13
_____ _____
_______
40. 1 1949 _________
.
_____
1909-18
__
1914-23
— _ _ _ 6 1 .9 1950
_
____
—
_ _______________
_______
8 1 .2 1951____
1919-28 _
____
79.1 1952______________________
1924-33 ____
... - ____
_____
_ 104.4 1953 _____________ ____________
1929 _
— _
1930 .
_
91.1 1954
1933 — _____
— _
__ 56 .0 1955 —
_ _
_____
1935—
_
_. —
72.5 1956
__
_ _
1940________
....
_______
100.6 1957 (M arch)___ ______ ____ __
1929 are averages per year by decades, as calculated by Kuznets.
1 The figures prior
S ources: Historic
Commerce, Office of
Statistics of the United States, 1 7 8 9 -1 9 4 5 , and Department of
usiness Economics, Survey of Current Business, July 1957.
and per capita gross national product in constant (1947)
dollars selected years, 1929-56
T able 10.—To
,
Total
Year
1929
......................
1933
_________
1940____
1945 ...........................I 9 6 0 .............................
1951................................
12 5.8
159.1
19 2.5
21 1.4
213.6
20 9.2
23 2.2
25 7.3
25 7.3
285.1
328.2
345. 5
363.2
363.2
391.7
4 1 4 .7
Billions of
dollars
$149.3
103.7
171.6
263.1
264.7
282.9
Per capita
$1, 225
825
1,299
1,880
1, 745
1, 833
Year
Total
1952................................
1953................................
1954_________________
1955.......................... .
1956................................
Billions of
dollars
$293.7
305.3
301.3
322.8
332.0
Per capita
$1,868
1,920
1,850
1.954
1,973
Source: Data for gross national product, 1929-56, and for per capita gross national product 1929-54, Statis
tical Abstract of the United States, 1956 and Survey of Current Business, July 1957; per capita calculations
for 1955 and 1956 are based on data in Survey of Current Business, July 1957.
Although gross national product is commonly used to measure or
suggest the level of prosperity, its size could quite conceivably bear
an inverse relationship to national well being. If, for example,
Germany had used such calculations in the period 1920-23 when its
currency depreciated to one-trilliontli of its 1914 value and the
nation was sinking deeper into poverty, the figures on gross national
product would have reached very high levels. Even when gross na
tional product is adjusted to changes in the price level it reflects a
variety of activities which do not add to national well being: that
part of government spending which is wasted or goes for war or for
armament, giveaway programs, that part of private domestic in
vestment and net foreign investment that may eventually be lost, in
direct taxes, personal consumption expenditures which rest on debt
that must be paid out of future income.
97735— 57--------3
14
ECONOMIC GROWTH AND STABILITY
I f we could reduce our defense program, eliminate waste and loss,
and prevent further depreciation in the purchasing power of the
dollar, the figures on gross national product would certainly decline,
assuming no compensatory increase in the volume and value of goods
and services produced for civilian use. Under such conditions it
would certainly be erroneous to say that national economic well being
had declined along with the decline in gross national product. Eco
nomic growth, although indicated by the rise in gross national prod
uct as expressed in constant dollars, was probably not as great as the
figures suggest.
T
h e
I
ncrease
in
th e
F
ederal
D
ebt
Due to deficit budgetary policies which were at first associated
with depression and then with the prosecution of wars and with
defense preparations, the Federal debt has risen astronomically since
1930. Simply stated, most of the present debt represents the excess
of Federal expenditure over revenue during that period of time. A l
though consideration of the Federal debt and its management must
here be ancillary to our study of Government expenditure, the role
of the debt in its present largely unfunded form may be of even
more significance—in an adverse way—for economic growth and
stability than future expenditure policies, good or bad, which are
carried out within a balanced budget.
The problem of the debt ties in closely with monetary policy, and
it is quite technical. Suffice it to say here that a very large part of a
huge debt is payable on demand and within a short period of time.
That is, much of the debt can be converted into currency, bank de
posits, and bank reserves at the whim of the holders. Thus, any
general expectation of fiscal (or monetary) policy that is conducive
to further depreciation of the dollar would increase the preference
for goods and other property over dollars and fixed-dollar obliga
tions, with the likelihood of a resulting inflationary price rise of such
violence and dimension that only the most rigid overall controls
could repress it. The present unfunded debt has a tremendous in
flationary potential. It is, of course, the result of a long period of
unfunded deficit expenditures.
T a b le 11.—Principal
of the public debt and gross debt per capita: Selected years,
1900-51
Year
1900_________________
1910_____ ____________
1920____ ____________
1930. ................. ............
1935_____ ___________
1940_____ ___________
1945___ _____________
Total gross
debt
Billions of
dollars
$1.3
1.1
24.3
16.2
28.7
43.0
258.7
Gross debt
per capita
(to nearest
dollar)
$17
12
228
132
226
325
1, 849
Year
1946____________ ____
1947____ ___________ _
1950................................
1955_________________
1956_________________
1957 i.................... .........
Total gross
debt
Billions of
dollars
$269.4
258.3
257.4
274.4
272.8
270.5
Gross debt
per capita
(to nearest
dollar)
$1, 905
1,792
1,697
1,660
1,623
1, 582
1 Preliminary.
Source: Annual Report of the Secretary of the Treasury on the State of the Finances, 1956; per capita
gross debt figure for 1957 is derived from Treasury Bulletin, 1957.
15
ECONOMIC GROWTH AND STABILITY
F
u ll
E
m plo ym en t
an d
th e
P
u r c h a s in g
P
ow er
of th e
D
ollar
Since the United States entered World War II the only important
element in our economy that has shown stability is employment (or
unemployment). Although the total civilian labor force has in
creased from year to year it has been almost fully kept at work. The
percent of that force which has been unemployed at any one time
since 1945 has ranged from a high of only 5.5 in 1949 to a low of 2.5
in 1953. These figures may be contrasted with the 24.9 percent un
employed in 1933.
War and defense expenditures have undoubtedly had much to do
with this phenomenon of long-run relatively full employment. When
wars ended or defense expenditures were reduced, however, consumer
and business spending and increased outlays by State and local gov
ernments took up much of the slack. In this period the marked in
crease of all debt, public and private, appears to have been an impor
tant sustaining influence on the high level of employment. With the
Nation’s productive resources continually and practically fully used,
and with the purchasing media of the country augmented by mone
tized debt and an easy-money policy, increasing demand for goods and
services pushed against a supply that could not so rapidly be in
creased. The result was the inflationary phenomena of rising prices
and a decline in the purchasing power of the dollar, as well as con
tinual full employment.
Table 12.— Unemployment, 19^1-57
Y ear:
194 1
194 2
194 3
194 4
194 5
1940________
194 7
194 8
1949
Percent of
civilian labor force
unemployed
9.9
4. 7
1.9
1.2
1.9
3. 9
3.6
3.4
5. 5
Percent of
civilian labor force
unemployed
1950
.
1951 _
__
1952 .
.
1053 ____
1954___ _
.
_
1955 _____
1956
.
...
_
1957 (July)
- _
5. 0
3. 0
2.
2.
4.
3.
4.
—
Sources : Data for 1 9 4 6 -5 5 , Statistical Abstract of the United States, 1956 ; calculations
for 1956 and 1957 are based on data in Federal Reserve Bulletin, August 1957.
T able 13.—Purchasing power o / the dollar, 1939-57
[1 9 4 7 -4 9 = 100. Obtained by computing reciprocals of Consumer Price Index compiled by
Department of labor, Bureau of Labor S tatistics; these reciprocals are expressed as
percentages with average of base period 1 9 4 7 -4 9 = : 100]
Y ear:
1939_
1940
1941
19421943_
1944_
19451946_
1947_
1948_
Monthly
average
168.4
__ 166.9
__ 159.0
1-13.5
135. 1
__ 133.0
__ 130.0
119.9
.- :04. 7
.- 97.3
Monthly
average
194 9
_
195 0
_
195 1
195 2
_
195 3
_
195 4
_
195 5
1956:----------------------------------1957 (Ju n e)_______________
98.2
97.3
90.1
88.1
87.4
87.1
87.3
86.1
83.2
S ou rces : D a ta f o r 1 9 3 9 -5 5 , S ta tistica l A b s tra ct o f th e U n ite d S ta tes, 1 95 6 ; ca lcu la tio n s
f o r 1 95 6 an<l 1957 a re based on d a ta in F ed era l R eserv e B u lle tin , A u g u st 1957.
16
ECONOMIC GROWTH AND STABILITY
In the years between 1941 and 1957 the conjunction of circum
stances which stimulated public and private spending was consonant
with the provision of the Employment Act of 1946 “to promote maxi
mum employment.” Except, however, as the full employment con
cept made deficit spending ( and the inflationary way in which it was
financed) more acceptable that it otherwise would have been, most of
the pressure for spending by the Federal Government came from
other sources, which, nevertheless, put heavy demands on the labor
market. Elsewhere in the economy the full employment doctrine was
being implemented automatically by the increasing amount of pur
chasing media which flooded the economy.
I f one is willing to believe that war and defense expenditures have
been for those purposes only, then we must look to other parts of the
budgets of this period for any deliberately intended “ full employ
ment” spending. Other papers in this compendium will undoubtedly
do that. The point to be made here is that the Federal spending and
the kind of financing that took place brought and helped to sustain
relatively full employment, but it was accompanied by a depreciation
in the value of the dollar to less than half of what it had been at the
beginning of the period. Let us observe just one aspect of that depre
ciation—its effect on savings.
The effect of the depreciation of the dollar on certain kinds of sav
ings is vividly illustrated in a recent study made by Prof. Walter E.
:Spahr.3
Although the following portion of it is offered to show only one
aspect of the overall effect of inflationary policies, its implications are
broad. Moreover, just since December 1956, the terminal point for
most parts of the study, some further loss in purchasing power has
occurred.
The losses in purchasing power of the following sample
items of savings should constitute an arresting illustration
of the subtle and far-reaching destructive powers of a depre
ciated currency while it contributes to high prices and ex
pansion in productive activity and profits (often paper
profits) in various other kinds of activities. This economic
disease is analogous to a cancerous growth and is not widely
understood, partly because people’s savings are remote as
compared with considerations relating to immediate income.
Instead of computing the purchasing power of the savings
in these six categories as of December 1956, in terms of the
dollar of 1939, the computation rests upon a much smaller
item—the average holdings in each 6 categories—4 for the
period December 1939 to December 1956, and 2 for the period
December 1939 to December 1955.
The loss in the purchasing power of these six items alone—
losses of over $184 billion—is approximately 97 times the loss
of $1,901 million of depositors in banks for the years 1921-33.
3
Losses In Purchasing: Power Arising From Our Depreciated Dollar, Economists* Na
tional Committee on Monetary Policy, New York, 1957.
ECONOMIC GROWTH AND STABILITY
T a b le 14.— 18- and 17-year average
17
holdings
United States savings bonds (18 years)______________________
Time deposits, all banks (18 years)--------------------------------------Savings capital, savings and loan associations (18 years)____
L ife insurance in force (17 years)___________________________
Annuities in force (17 years)_______________________________
Social-security trust and unemployment funds (18 years)____
$42,180,000,000
50, 704,600,000
13,786,100,000
203,424,900,000
1,112,600,000
17,834,200,000
Total average holdings_______________________________
329,042, 400, 000
Loss in purchasing power on these average holdings__________ $184, 263, 744, 000
Percentage loss_____________________________________________
56
Bank deposit loss, 1921-38__________________________________
$1,901,000, 000
C o n c l u sio n
Granting that there has been substantial economic growth in the
past two decades, even though in actuality it was not as great in
amount as the adjusted gross national product figures indicate (see
table 10), it is valid to question (1) whether the real growth of wealth
and income would not have been greater under some other set of con
ditions of Federal expenditure, and (2) whether the conditions under
which the growth has occurred have been such that some of their effect
will carry over to impede growth in the future.
Further study is needed to determine whether, in an unregimented
society, we can have maximum long-run growth without the cleansing
function of the downward phases of the business cycle, however they
may be modifiable by sound policies and practices and by financial
self-restraint on the part of both the Government and the people.
Expectation that markets will go down as well as up is itself a power
ful restraint upon financial excesses.
The continual desirability of full employment has been emphasized
under the assumption that it is essential to stability and long-run
growth. This assumption must now be questioned. Full employment
may be a wholesome phenomenon or an unwholesome one, depending
upon many circumstances. How that level of employment is reached
and maintained is an important consideration. Perhaps we should
look upon full employment as a worthwhile incidental goal to be
sought in every sound way, but, when reached, to be regarded as a
signal for great caution.
Because at times in the past there have been great suffering and
loss due to unemployment, it does not necessarily follow that con
tinual full employment is the measure most conducive to long-run
growth. The prospect, in the coming decades, of great employment
transitions and fewer working hours for almost everyone, due to
automation and other technological advances, should help to reconcile
us to some unemployment as well as to governmental aid to those on
whom the brunt of it will fall.
The real goal is maximum long-run growth. How much long-run
stability we can expect in a dynamic, growing economy is still a ques
tion, but we are now seeing evidence that full employment induced by
inflationary Government spending and borrowing is not the way to
achieve it. Under the conditions that have developed, the prospect for
any real stability is small compared with the likelihood of either
severe deflation or marked further inflation, an alternative being rigid,
overall, governmental control of the economy.
18
ECONOMIC GROWTH AND STABILITY
Another, and far more desirable, alternative is the development and
application of fiscal and monetary policies of a kind that will prevent
severe deflation while requiring the funding o f near-money forms of
public debt and encouraging public and private thrift and a high
level of business investment.
THE GROWTH OF GOVERNMENT OYER THE PAST 50
Y E A R S : AN ANALYTICAL REVIEW
Arnold M. Soloway, assistant professor of economics, Harvard
University
I
n t r o d u c t io n
Although American citizens are largely inured to the colossal and
spectacular, they are acutely aware of the spectacular growth of gov
ernment in recent decades—higher taxes, increased spending, more
government regulation, and so forth. The statistics of growth, how
ever expressed, are always overwhelming, and it has already become
a cliche to point out, for example, that today’s interest charges on the
national debt are more than four times total government spending
only 50 years ago.
Only slightly less obvious is the fact that our whole conception of
government’s responsibility is far different today from what it was
in 1900. Compare, for example, the following excerpts from two
messages to Congress: 1
* * * I do not believe that the power and duty of the
General Government ought to be extended to the relief of
individual suffering which is in no manner properly related
to the public service or benefit. A prevalent tendency to dis
regard the limited mission of this power and duty should, I
think, be steadfastly resisted, to the end that the lesson should
be constantly enforced that though the people support the
Government, the Government should not support the people
(Grover Cleveland, February 16, 1887).
The human problems of individual citizens are a proper
and important concern of our Government. One such prob
lem that faces every individual is the provision of economic
security for his old age and economic security for his family
in the event of his death. To help individuals provide for
that security—to reduce both the fear and the incidence of
destitution to the minimum—to promote the confidence of
every individual in the future—these are proper aims of all
levels of government, including the Federal Government
(Dwight D. Eisenhower, January 14,1954).
The overall growth of government in the United States implied in
this contrast of views, and the distribution of that growth among all
three levels of our government—Federal, State, and local—have had
tremendous impact on the whole economic climate. It is the purpose
of this paper to examine (1) the aggregate growth of government in
the United States over roughly the past 50 years; (2) the basic causes
1
Cited in Social W elfare in the United States, Poyntz Tyler, editor, the Reference Shelf,
vol. 27, No. 3, H . W . W ilson Co., New York, 1955, p. 10.
19
20
ECONOMIC GROWTH AND STABILITY
of government’s growth; (3) the relative growth of Federal, State,
and local governments.
This analytical review will, it is hoped, provide some strong impli
cations, if not conclusions, about the future course of government ac
tivity in the United States.
M
easu res of
G
row th
There are a number of different indexes by which the growth and
importance of government in the total economy can be gaged.2 One
such measure is government’s absorption of productive resources—
labor and capital. With respect to labor, in 1900, Federal, State, and
local governments together employed less than 1.2 million people,
about 4.2 percent of all employed workers. In 1956, total government
employment was just under 10 million, roughly 17 percent of total
full-time employment.* Thus, government growth, as measured by
increased direct employment, was over 700 percent. It can also be
summarized as follows: In 1900, 1 out of every 25 employed workers
worked for the government; in 1954,1 out of every 5.9 employed work
ers worked for the government.
The growth of government’s share of the national stock of capital
goods has been little less impressive than its growth in direct employ
ment. Government’s share of total investment from 19732 to 1946 was
32 percent, almost one-third, and its share of total national capital
asset value increased from 6.6 percent to 20.6 percent.4 Thus, while in
1902 the total value of government property, excluding military assets,
roads and streets, and land was $6.7 billion, by 1946, the latest year
for which data are available, such property was valued at $45.3 billion
(1929 prices).' Measured in constant prices, from 1902 to 1946 gov
ernment’s capital asset holdings, including land, grew by 326 percent.*
In addition to the labor and capital government employs directly,
it also absorbs great amounts of these resources through its purchases
of goods and services from the private sector of the economy. To
measure the total volume of resources absorbed by government, we
must add to the labor and capital directly employed the value of gov
ernment’s purchases of goods and services from the rest of the
economy.
In 1903, government purchases of goods and services from the pri
vate sector were about $752 million, and in 1956 they were some $80.2
billion.1
a Great contributions to the understanding of the growth of government have been made
recently in : The Trend of Government Activity in the United States Since 1900, Solomon
Fabricant, National Bureau of Economic Research, Inc., New York, 1 9 5 2 ; Am erica’ s Needs
and Resources, a New Survey, Dewhurst and Associates, Twentieth Century Fund, New
York, 1955, ch. 1 8 ; A Century and a H a lf of Federal Expenditures, M. Slade Kendrick,
N ational Bureau of Economic Research, Occasional Paper 48, New York, 1955.
8
Government employment and total employment for 1956 are in full-time equivalent
numbers, but, for 1900, we used the census figure for “ Em ployed,” cf. Fabricant, op. cit.,
appendix B ; series D -6 2 -7 6 , Historical Statistics of the United States, 1 7 8 9 -1 9 4 5 , a
supplement to the Statistical Abstract of the United States, Census Bureau ; Survey o f
Current Business, July 1957.
4 Fabricant, op. cit., table 4. p. 20.
6 Ibid., table 3, p. 19. M ilitary assets, roads, streets, and land are excluded from these
comparisons except as noted.
6 This figure includes land, but excludes roads, streets, and related assets, and assets of
defense corporations. Ibid., table 6 , p. 24.
7 Government purchases of goods and services prior to 1929 are estim ates derived from
Fabricant, op. cit., table 5, p. 2 2 ; gross national product for 1913 is Kuznets’ e stim ate;
other data computed from Survey of Current Business, July and A ugust 1955.
ECONOMIC GROWTH AND STABILITY
21
As a share of gross national product, government purchases of goods
and services rose from 3.6 percent in 1913 to 9.7 percent in 1956. Thus,
the fraction of total national output (GNP) absorbed by government
through its purchases from the private sector of the economy was
almost 3 times greater in 1956 than it was in 1913. The magnitude of
the absolute increase again looms clearly when we recall that in the
same period the gross national product itself grew 10 times larger,
from $40 billion in 1913 to over $414 billion by 1956.
The inputs of labor and capital for the production of government
services together give a total measure of government’s absorption of
productive resources. It is estimated that total real resources put
into government’s nondefense activity rose over 400 percent between
1900 and 1949; and into all government activities, “ probably over
700 percent” .8 Even with a most liberal allowance for error, it is
patently clear that the growth of government measured by its absorp
tion of productive resources has been very great indeed; but, at the
very best, this measure alone is too restricted for our purpose. We are
here concerned with the growth of government in a broader sense than
that which measuring only inputs of labor and capital affords.
Total government expenditures is a more inclusive measure because
it includes expenditures for transfer and net interest payments in addi
tion to the value of government’s absorption of productive resources.9
Although transfer and net interest payments do not represent addi
tional absorption of real resources, they reflect, just as much as any
other expenditures, increases in government activity called forth by
the complex of national circumstance. Therefore, total government
expenditure is, for us, a more useful index of government growth.
Total government expenditure in current dollars rose from $1.5
billion in 1902 to $104 billion in 1955, an increase of 69 times, while the
gross national product increased by roughly 20 times in the same 54year period.10
Although government expenditure provides the most inclusive index
of the quantitatively measurable growth in government, obviously it
falls far short of measuring the full growth of government’s impact on
the Nation’s economy. The effects of new legislation, court decisions,
and administrative regulations, in such fields as labor relations, in
dustrial organization, agriculture, natural resources, and transporta
tion, is not easily measured in dollar terms.
For a full evaluation of government’s growth, however, these aspects
o f government activity should be considered along with the growth
in government expenditure. Although we cannot give them quanti
tative significance we shall have them in mind as we turn to a brief
analysis of the underlying causes of governmental growth.
8 These estimates are given, and should be taken, only as rough approximations. Aside
from the many statistical problems inherent in the construction of such a broad index over
so long a period, some of the vital data— value of military assets used by Government, for
example— are not available. For our purpose, however, the possible margin of error
involved in these estimates is of little consequence.
9 Fabricants’ expenditure figures include an imputed net rent of 4 percent on the 1989
book value of government nonmilitary capital assets, but in most calculations, as he points
out, interest on the public debt is taken as the measure of the services of government capi
tal. or these services are ignored (pp. 12. 2 6 ).
W e are following conventional procedure
and using the Department of Commerce figures for total government expenditures, which,
therefore, will exceed Fabricant’ s measure of total Input by the difference between his
imputed rent and net interest payments on the public debt, and by the addition of transfer
payments.
10 The gross national product for 1902 is estimated at some $ 2 0.7 billions on the basis
of Kuznet’ s figures for annual average gross national product in current prices for the
decades 1 8 9 4 -1 9 0 3 ($15.7 billion) and 1 8 9 9 -1 9 0 8 ($21.6 billion).
Cf. Kuznets, S.,
National Product Since 1869, National Bureau of Economic Research, New York, 1946.
22
S
om e
ECONOMIC GROWTH AND STABILITY
M
ajo r
E
lem en ts
U
n d e r l y in g
E
th e
G
r ow th
in
G
overnm ent
x p e n d it u r e s
Population growth
Between 1900 and 1957 the population of the United States grew
from 76 million to 170 million. Although a larger citizenry does not
ordinarily require an equal proportionate increase in expenditures for
all types of government activity, this population increase of 217 per
cent obviously would itself cali forth a sizable increase in aggregate
government expenditures. For the period 1913-50, for example, it
is estimated that population growth alone was responsible for $4.6
billion, or 6.9 percent, of the total government expenditure increase of
$66.4 billion (1950 prices).11 This estimate, however, does not take
into account important changes in population characteristics and
therefore understates the effect of population changes on government
expenditure.
Among the changes in population characteristics which also imply
greater government expenditures there is, for example, the fact that
the median age of the population rose from 22.9 years in 1900 to 30.9
years in 1950. The greater proportion of older people in the 1950
total is underscored by the fact that the percentage of those over 65
years of age almost doubled—from 4.1 percent in 1900 to 8.1 percent by
1950. Although the proportion of school-age people—5 to 19—■
dropped from 36.7 percent in 1900 to only 23.3 percent in 1950, the
actual number rose from 27.9 million persons to 35.1 million persons,
and the proportion attending school rose from 62.6 percent to 79
percent.
Even more significant than the change in age distribution in terms
of its effect on government costs, was the shift of population from rural
to urban status. In 1900, the population of the United States was
divided 60 percent rural and 40 percent urban. By 1950, the propor
tions had more than switched: 64 percent urban and only 36 percent
rural.12 The move from a dominantly rural status also involved a
multiplication of urban centers, and while in 1900 we had only 38
centers of more than 100,000 population, by 1950 we had 107. Simi
larly, the proportion of people living in communities of more than
10,000 grew from 31.7 percent in 1900 to 49 percent by 1950.
A related factor with definite cost implications for government is
that the growth of population was not evenly spread through the
Nation. From 1900 to 1950 the Northeast lost 1.5 percent of its pro
portion of total national population; the South lost 1 percent; the
North Central region lost 5.2 percent; and the West gained 13.1 per
cent. Although the day of the Indian wars and two-gun desperadoes
had passed by 1913, it would seem that the growth of population in the
relatively newly settled West called forth larger amounts of govern
ment expenditure than would have been required had population
growth been restricted to the older, established areas of the country.
Price level changes
The secularly rising price level has been another obvious influence
raising the dollar volume of government expenditure. The longperiod decline of the purchasing power of the dollar, in evidence
11 Dewhurst, op. cit., p. 595.
u New census definition. A ll data in these comparisons from Census of Population.
ECONOMIC GROWTH AND STABILITY
23
since about 1850, has continued through the present. There has been
some irregularity, occasioned by cyclical ups and downs, but, for the
period as a whole, the purchasing power of the dollar has moved in a
downward direction. For example, a 1939 consumer dollar had the
purchasing power equivalent of $2.58 in 1850, $1.80 in 1900, and only
$0.52 in 1953.13 The wholesale dollar moved somewhat less dramati
cally over the past 100 years but it, too, has definitely tended down
ward—from a 1939 purchasing power equivalent of $1.23 in 1850 to
$0.45 in 1953.
Neither the consumer nor wholesale price index is completely ade
quate, however, for accurately translating government expenditures
into dollars of constant buying power and thus making expenditures
in different years comparable without distortion from price changes.
This is so because the effect of price changes on government expendi
ture varies with the different proportions of special kinds of goods
and services which make up the government expenditure total. For
example, a 1913 dollar spent on education would have bought $3.94
worth of service in 1950, but a 1913 dollar for interest on the debt
would have purchased only $0.86 worth in 1950. Similarly, a 1913
dollar for current supplies would have bought $4.72 worth in 1950,
but a 1913 dollar for construction would have bought only $2.32 worth
in 1950.14 Because of such variations a composite index is not an
accurate guide for deflating government expenditures. Fortunately,,
however, separate price indexes for 27 major categories of government
expenditures have been computed for several benchmark years with
1950 as the base year.15
Using these indexes, government expenditures in 1950 dollars in
creased 7.2 times from 1913 to 1950, while in current dollars the in
crease was 22.4 times. It is estimated also that 31.2 percent of the
total dollar increase (of $66.4 billion) of government expenditures
between 1913 and 1950 was due to price level changes alone.16 That
is, some $20.7 billion of a total 1950 expenditure of $69.5 billion was
due solely to the upward movement of prices since 1913.
Increased services
Increased services was the greatest single cause of the rise in gov
ernment expenditure over the past half century. The expansion of
existing services and the introduction of new services alone caused a
rise of $27.1 billion (1950 dollars) in government expenditure be
tween 1913 and 1950.17 Thus, while population increase accounted for
6.9 percent, the expanded scope of government services accounted for
40.9 percent. The remaining 21 percent of the increase in government
expenditure is attributed to the interaction of all three causes: popu
lation growth, price-level change, and increased services.
Increased services is not only the most important single cause of the
growth in government expenditures over the past decades, it is also
much the most interesting.
13 Estimates from Department of Labor, Bureau of Labor Statistics, and the Industrial
Conference Board.
14 Cf. Dewhurst, op. cit., pp. 590—593. A ll following estimates are also from this.
16 These indexes were constructed by Owen C. Gretton of the Census Bureau, in consulta
tion with Kilpatrick & Drury. Cf. Dewhurst, op. cit., p. 590.
24
ECONOMIC GROWTH AND STABILITY
T
he
P
u b l ic
D
em and
When we study people’s behavior in the private sector of the econ
omy we use certain concepts, such as consumer demand and consump
tion function, which help us to understand why people spend their
money as they do. We have learned, for example, that the proportion
o f an individual’s income which he will spend on consumption goods
and services is related, among other things, to his present level of
income, his past income, experience, and his future expectations. We
know, too, that as a person’s income increases he spends a greater abso
lute amount on consumption goods. He not only buys more clothing,
entertainment, and medical care, but he also tends to buy better qual
ity products. Also, as income rises, people spend more on new kinds
of purchases. They carry more and different types of insurance, they
increase the amount of their charitable contributions, and in general
they tend to exploit more fully the opportunities of life in an ad
vanced society.
Much of what the study of consumer demand in the private econ
omy has taught us about people’s private behavior is also applicable
to their communal behavior. The spending patterns of private indi
viduals are not determined by influences which are restricted uniquely
to the private sector of the economy. Indeed, not only is the public
spending pattern largely determined by the same general influences,
but public and private spending often are complementary in a high
degree. There would be little sense, for example, in spending a large
amount privately for a high-speed, low-slung, 304-horsepower auto
mobile if we did not also spend publicly for the superhighway on
which it could be driven.
What, then, were the major influences on spending—public and pri
vate—over the past half century ?
The single most pervasive economic fact of the past 50 years has
been the great rise m our national output. The value of goods and
services produced per man-hour of labor in the private sector of the
economy rose from 75.5 cents to 203.1 cents (1950 dollars) between
1900 and 1952.18 This 170-percent increase in man-hour productivity
is reflected in the growth of national income from 79.7 billion in 1909
to $274.7 billion in 1953 (1950 dollars).19 Per capita disposable in
come rose from about $775 in 1909 to about $1,350 by 1953 (1950
dollars). There is also ample evidence of a marked upward shift in
the income distribution of family units, particularly since the 1930’s.20
All of this means that increased output has made us collectively, as a
nation and as individual and family consuming units, much richer
now than we were at the turn of the century.
It was not possible for our society to become so much richer with
out experiencing, at the same time, other significant changes. We
could not have our increased productivity and keep everything else as
it was. In the process of becoming richer, life in our society, and for
us as individuals, became more complex. Today’s techniques of pro
duction in industry and agriculture require bigger, more complicated,
18 Dewhurst, op. cit., p. 89, table 30.
10 Ibid., appendix 4 -2 , table B , pp. 9 5 9 -9 6 0 .
20
Cf. Goldsmith, Jaszi, K aitz, Goldenburg, Size Distribution o f Income Since the Mid
T hirties,” Review of Economics and Statistics, February 1954, also for 1 944 to 1954,
Income Distribution in the United StateB, A Supplement to the Survey of Current Business,
U. S. Department of Commerce, Office of Business Economics, W ashington, D . C., 1953.
ECONOMIC GROWTH AND STABILITY
25
and more expensive machinery. To organize efficiently production
and distribution of the things we produce, we use larger plants and
business units today than we did in 1900. From the standpoint both
of the supply of labor and the provision of concentrated market areas
for our increased output we had to leave the pastoral countryside and
move to congested urban centers. Urbanization was in this respect
basic to the great technological progress we have had; but, in fact,
the whole technology of life has changed.
The greatly increased volume and variety of goods and services we
consume not only have raised our standard of living; they have also
changed our way of life.
Another major, though not unrelated, influence on the national
spending pattern is the fact that we have become a high-preparedness
nation. From 1952 through 1955, for example, we spent annually,
on the average, about $45 billion on Government purchases of goods
and services for national-security purposes. I f this was only a shortperiod budgetary phenomenon, it would still exert great influence on
the Nation’s spending, but there is considerable likelihood that this
is a condition which will be with us for many years to come. As
part of the indefinite future, it will continue to shape a large part of
our private as well as public life, even though military spending is
cut back a few billions or stretched out over a longer period. No
important economic or political issue is unaffected by the need for
maintaining a high state of national preparedness over the coming
years.
How have our increased wealth and income, urbanization, tech
nological advances, and national-security requirements influenced
public and private spending ?
The evidence is clear that as we grew richer we spent privately a
smaller proportion of our income on necessities and a larger share
on luxuries and semiluxuries. Measured in constant dollars of 1950
buying power, per capita consumption expenditures rose from $840
in 1909 to $1,400 in 1952, or 66 percent. Spending increased on all
major categories of consumption goods and services but the relative
gains were substantially different for different classes of goods and
services. Percentage gains, measured in current dollars, between 1909
and 1952, were as follows: 21
Food, liquor, and tobacco----------------------------------------------------------------------695
53-5
Clothing, accessories, and personal care_________________________________
Housing and utilities___________________________________________________
360
Household equipment and operation____________________________________
810
Consumer transportation_______________________________________________ 1,500
Medical care and insurance_____________________________________________ 1,100
Recreation----------------------------------------------------------------------------------------------1,060
Education (private)____________________________________________________
750
Religion------------------------------------------------------------------------------------------------330
Welfare (private)--------------------------------------------------------------------------------100?
The large percentage increases in expenditure for consumer trans
portation, that is, the automobile, and for medical care and insurance,
and recreation, are clearly consistent with our increased income and
wealth status. Within the categories where percentage increases were
not as outstanding, however, there were also substitutions of more
21 Dowhurst, op. cit.. pp. 1 0 1 -1 0 5 . This volume contains a comprehensive analysis of
consumption trends. See chapters 4 through 13, especially table 33, and appendix tables
4 - 4 and 4 -5 , from which most of the following data is taken.
26
ECONOMIC GROWTH AND- STABILITY
luxury-type expenditures for traditional necessities. The composi
tion of food purchases changed, for example, so that while the annual
per capita consumption of potatoes and grain products went down
from 473 pounds in 1910-14 to 270 pounds in 1951-52, the consump
tion of dairy products, eggs, citrus fruits, leafy vegetables, sugar,
coffee, tea, and cocoa, all rose. The rise in real incomes has increased
the relative consumption of more expensive foods ( although part of
the increases was also due to urbanization, education-induced changes
in our eating habits and other factors).22 Similarly, while expendi
tures on clothing, accessories, and personal care have remained much
the same as a proportion of total consumption expenditures, there has
been a relative rise in spending for sports clothes, cosmetics, and
beauty-parlor services, and a mild decline in the demand for staple
articles of clothing. The same general pattern is in evidence for
virtually all the major fields of consumption expenditure. As we
grew richer, we consumed more “rich man’s” goods and services.
The combined effect of increased wealth, urbanization, and tech
nological advances, on private-consumer spending patterns has been
profound, and is in general quite obvious. We now have different
standards of “necessity,” and as a nation we have higher consumption
aspirations than we had in the past.
The same facts, not surprisingly, also hold with respect to our
public spending. Just as we have come to demand more and better
quality products from the private sector of the economy, we have come
to demand more and better quality “ products” from government—
the public sector. We want more and better quality schools, roads,
hospitals, and recreational facilities, more adequate provision for the
aged, unemployed, infirm, and needy children, increased attention
to our natural resources, more provision for public safety, etc. As
a consequence of this growth in public demand, virtually every gov
ernment function has been expanded since 1900. This is true whether
the expansion is measured by workers employed, capital assets, or
expenditures (allowing even for price changes).23 Furthermore, the
composition of the expansion by government functions clearly re
flects the influence of increased income and wealth, urbanization, tech
nological advances, and defense requirements. Government’s per
capita expenditure on education, for example, measured in 1950 dol
lars, increased by almost 200 percent between 1913 and 1950.24 It is
significant, too, that spending for higher education grew by 29 times,
in current dollars, while expenditure on elementary and secondary
schools grew less than 12 times. The public demand has been for
more and better physical plant, for better trained teachers, and for
expansion of public education at the college and professional school
level as well as for vocational training, kindergartens, and other
special educational services. We want these added educational serv
ices because we are richer, but we also need them to insure the supply
of adequately trained personnel for our complicated production ma
chine. We need people also to man our Defense Establishment, who
cannot only read and write, but who are technically trained. In
33 Ibid., table 44, p. 131, and ch. 5.
M Fabricant, op. cit., pp. 8 2 -8 3 .
24 Dewhurst, op. cit., table 263, p. 632.
637.
Following data also from this source, pp. 625 to
ECONOMIC GROWTH AND STABILITY
27
creased income and technological progress in peace and war activities
together underlie the public demand for more and better education.
Similarly, measured in 1950 dollars, per capita expenditure on
health and community facilities increased by 176 percent between
1913 and 1950. In this category, increased expenditures for health,
hospitals, and public housing, reflect an increased sense of social re
sponsibility which grew with our wealth. It also reflects, as do more
clearly our increased expenditures on public water supply, local utili
ties and sanitation, the growth of public demand stemming from
urbanization. These last items, and other local services, would not
have figured as heavily in the growth of public demand had we re
mained primarily a rural people. Sanitation, sewerage, water supply,
even the protection of life and property, are problems which a farmer
largely meets by himself, but the conditions of city life are such that
government must take the responsibility in order to safeguard the
general health and well-being of the people.
Without laboring the point unnecessarily, it should be apparent
that the same set of related influences—increased wealth, urbanization,
technological advances, defense requirements—have caused us to in
crease also our expenditures for public welfare (397 percent), regula
tion of business and labor (149 percent), transportation (115 per
cent), agriculture and natural resources (more than 1,000 percent),
social insurance (more than 1,000 percent) and national defense
(865.1 percent).25
This upward trend of government expenditure has not, of course,
proceeded at an even annual rate. Like the growth of our national
product, it has been sporadic or steplike. Wars and depressions,
though they have been most important through their influence on
Federal expenditures gave the total upward movement some strong
boosts in particular years.28 Despite some irregularity, however, the
increased interdependence of all groups and individuals in the econ
omy, a hallmark of our economic growth, and the high state of inter
national tension, now presumably a fixture in our daily lives, have
added directly and indirectly to the demand for an expanded scope
and scale of government.
In brief, the growth of the public demand which underlay the
growth of government stems from the same basic causes that led to the
growth of big business, big labor, big agriculture, big wars—and big
depressions.
This, then, is the essence of the public demand which has brought
about the great growth of government over the past half century.
But, the general tendencies which we have explored were not some
thing new to America, or to the 20th century.27 Although we have
25 A ll p ercen ta g e in crea ses re fe r to th e p e rio d 1 9 1 3 -5 0 . T h e y a re on a p er ca p ita basis
co m p u ted in 1 950 d olla rs. C f. D ew h u rst, op. c it., table 263, p. 632.
28 C f., f o r exam ple, A C en tu ry and a H a lf o f F ed era l E x p e n d itu re s. M. Slade K en d rick ,
O cca sion a l P a p e r 48, N a tio n a l B u rea u o f E co n o m ic R esea rch , In c., N ew Y ork, 1955.
27
C h a rles J. B u llock , S elected R ea d in g s in P u b lic F in a n ce , 3d e d itio n , G in n & C o., 1924,
cli. I l l , in clu d es su m m aries o f stu dies by o th e r w r ite rs on the s ro w th o f g o v e rn m e n t
exp en d itu res in E n gla n d , F ra n ce, B elg iu m , S w itzerla n d , R ussia, I ta ly , f o r th e 1 9th c< n tu ry
and som etim es e a rlier. T h e re la tiv e g r o w th o f g ov ern m e n t and th e p riv a te eco n o m y are
n o t clea r, h ow ever, b ecause w e la ck d a ta on the m easures o f to ta l e co n o m ic g r o w th
w e ll
as o t h e r elem en ts such as w e d iscu ssed above. T h e d a ta a re u sefu l an d in terestin g ,
n everth eless, and p ro v id e som e g rea ter h is to r ic a l p ersp ectiv e on th e issue.
B u llo ck ’ s ow n
e stim ates o f th e g r o w th o f F ed era l G ov ern m en t e xp en d itu re s in th e U n ited S ta tes sh ow a
rise in per ca p ita term s from . $1.17 in 1 800 to $ 6.3 6 in 1900, w ith defin ite a cce le ra tio n o f
th e ra te o f in cre a s e in th e p o st-C iv il W a r period .
T h ere is also an in cr e a s in g flo'v o f d a ta fr o m o th e r cou n trie s f o r re la tiv e ly recen t tim es.
O ne stu dy , T h e T ren d o f P u b lic E m p loy m en t in G reat B rita in an d th e U n ited S ta tes, M oses
28
ECONOMIC GROWTH AND STABILITY
no comparable statistical measures for earlier times or other countries,
there is considerable evidence that the growth of government has been
a regular concomitant of general economic progress.
For example, as table IV indicates, for 14 countries for which we
have data, in the fiscal year 1951, there was a distinct correlation be
tween per capita national product and per capita national government
expenditures; the wealthier countries spent more per capita and
the poorer countries spent less.28 That the United States is not far
out of line with other nations’ experience is also clear. The ratio of
National Government expenditures to gross national product was
lower in the United States at 15.1 percent than it was in 11 of the 14
countries cited. The exclusion of State and local expenditures, how
ever, understates government spending more in the United States than
in other countries. Inadequate data for many of the countries pre
clude comparing other than national government spending, but using
per capita total taxes of all levels of government the same general con
clusion emerges. Taxes relative to gross national product were lower
than in the United States only in those countries (Denmark, Iceland,
Portugal, Greece, and Turkey) having either very small defense
expenditures or very low income.
Wagner’s celebrated “law of the increase of state activities” : 29
Comprehensive comparisons of different countries and
different times show that, among progressive peoples, with
which alone we are concerned, an increase regularly takes
place in the activity of both the central and the local gov
ernments. This increase is both extensive and intensive; the
central and local governments constantly undertake new func
tions, while they perform both old and new functions more
efficiently and completely. In this way the economic needs of
the people, to an increasing extent and in a more satisfactory
fashion, are satisfied. * * *
assumes real meaning when the emphasis is placed on “progressive
peoples”—which implies economic growth—-and on the influence, es
pecially in a political democracy, of the “needs of the people.”
T
he
R
e l a t iv e
G
kow th
G
or F
ederal a n d
S
tate an d
L
ocal
overnm ents
At the beginning of this century, the Federal Government collected
38 percent of all tax revenues, the States, 11 percent, the local govern
ments, 51 percent; and, the distribution of government expenditures
corresponded closely to these relative shares of tax receipts. In 1956,
the Federal share of all taxes was about 71 percent and its share of
total government expenditures was 65 percent. The States and local
governments shared almost equally the remaining 29 percent of tax
collections and spent 35 percent of the government total.
Abramovitz and Vera Eliasberg, American Economic Review, vol. X L I I I , No. 2, May 1953,
finds, for example, that in Great Britain, “ toward the end of the 19th century, not 1
worker in 25 was on the Government payroll. In the middle of the 20th century, 1 in 7
was working in a regular Government agency and nearly 1 in 4 either in such an agency
or in a nationalized industry or service" (p. 2 0 5 ). Cf., also in the same journal, Lyle C.
Fitch, Trends in Federal, State, and Local Government Expenditures Since 1890, pp.
216—233
28 Dewhurst, op. cit., table 236, p. 579.
29 Grundlegung der politischen Oekonomie, book V I, ch. 3 (3d edition, 1 8 9 3 ), cited in
Charles J. Bullock, ibid.
ECONOMIC GROWTH AND STABILITY
29
The changeover from a State-local to a Federal dominated public
fisc did not follow a smooth or consistent trend line. Two World Wars
and the great depression gave dramatic boosts to the Federal role, but
wars and depression alone fall far short of adequately explaining the
changing pattern of intergovernmental relations. For an under
standing of the growth of the role of the Federal Government it is
hardly sufficient only to point to the great rises in Federal expendi
tures which occurred under war and depression stimuli. Why, for
example, did the Federal Government grow so much in power and
prestige in the depressed thirties and State and local governments lag
so far behind ? The depression alone, though it was the most serious
in our history, did not resolve the course of intergovernmental events
in that unhappy decade.
Throughout these past 50 years there was at work, as there is now,,
a complex of economic and political forces which, though subject to
alteration by great events, are fashioned fundamentally by more con
sistent threads of the historical process. Improved communication
and transportation, the growth of a national economy, urbanization,,
increased wealth, all the elements which led to the growth in the pub
lic demand, were part of this historical process.
The great events, wars and depression, give us, however, some con
venient focal points for analysis. Accordingly, to facilitate our dis
cussion we have divided the period roughly as follows: 1900-29,1930
40, 1941-46, 1946-56. The major breaks after the turn of the cen
tury come, therefore, at the start of the great depression, the start and
the end of World War II.
Federal Government expenditures: 1900-1929
The United States emerged as a full-fledged great power during
this period, particularly after World War I, but the rise in Federal
Government expenditures only partially reflected the tremendous eco
nomic and population growth of the Nation in the same years. Total
Federal expenditure increased from about $521 million in 1900 to
$2,900 million in 1929, but as a fraction of gross national product
remained virtually the same: 2.9 percent in 1900 and 3.0 percent in
1929.30 Total per capita expenditures, measured in 1926 prices,
roughly doubled, from $12.31 in 1900 to $24.76 in 1929.31
World War I contributed more by far than any other factor to the
expenditure rise. Total Federal spending in 1914, for example, was
on the order of $735 million; in 1919 it was 25 times greater at
$18,448 million, and although it fell sharply in the next decade the
lowest point it ever reached was $2,774 million—in 1927—still some
3.8 times higher than prewar. Increased spending for defense and on
war-connected charges—mainly veteran’s benefits and services and
interest on the debt—accounted for about 85 percent of the total ex
penditure increase between 1900 and 1929. But, aside from defense
30 T h e s e p ercen ta g es are fr o m K e n d rick , op . cit., b u t th e y a p p ly to a so m e w h a t d ifferen t
y e a r th a n th e rest o f o u r d a ta .
A ctu a lly , t o ta l e xp e n d itu re s f o r th is co m p u ta tio n
re p resen t an a vera g e o f th e tw o fiscal y ea rs w h ic h in clu d e th e ca le n d a r ye a r. T h is a d ju s t
m en t does no v io le n c e to o u r co m p a rison s, h ow ev er, b eca u se o f th e tim e in te rv a l in v o lv e d .
31 E x p e n d itu re figu res in th is section a re a lso fr o m K en d rick , op . c it ., e x ce p t as o th e rw ise
n oted . D efla tion to co n s ta n t 1 926 d o lla rs w a s a ccom p lish e d b y K e n d rick w ith the use o f
th e B . L . S. W h o le sa le P r ic e In d ex . A lth o u g h w e h a v e p re v io u sly in d ica te d th e in a d e q u a cy
o f such a c o m p o site in d ex, it does serv e as a cru d e m easure o f p rice -le v e l ch a n ge s an d is
a cce p ta b le f o r th e w o rk a t h a n d w h ich does n o t req u ire a h ig h degree o f a ccu ra cy . T a b les
1 a n d 4 (b e lo w ) w e re co n s tru c te d by a p p ly in g th e sam e in d e x t o S ta te a n d lo ca l g o v e rn
m en t ex p en d itu re d ata.
9 7 7 3 5 _ 5 7 --------4
30
ECONOMIC GROWTH AND' STABILITY
and war charges there was little change in the volume of Federal
spending.
Expenditures for civil purposes, i. e., other than defense, veteran’s
benefits and services, international affairs and interest on the debt—
increased in all only by some $657 million. In constant 1926 prices
this amounted to a rise of $3.13 per capita. Most of this increase went
for transportation and communication facilities—mainly the provi
sion of navigational aids, and grants-in-aid to the States for high
way development—and general government. Somewhat more atten
tion was being paid to the development and improvement of agri
culture and natural resources, aid for the aged and infirm, the pro
motion of public health, and crime prevention and control. But for
civil functions, clearly, Federal expenditure was not very much dif
ferent in 1929 from what it had been at the dawn of the century.
Furthermore, the bulk of the Federal Government’s growth took
place in the first 20 years of the period. After World War I, the
return to normalcy was accompanied by a drop in total Federal
spending during most of the twenties as debt charges and veter
ans’ costs incident to the war decreased.
Grants-in-aid
Although Federal Government expenditure in this period was char
acterized by an extension of regular Government services and there
was little innovation of quantitative budgetary importance, there were
clear indications that the forces of change were strongly affecting
its role. Federal aid to the States for highways increased under the
Federal Aid Eoad Act (1916), from nothing in 1900 to $81 million
by 1927; for education, from less than $1 million to $11 million,
including assistance to States in paying the salaries of teachers of
vocational education (Smith-Hughes Act of 1917); and there were
also small increases for other purposes as well as some aid paid di
rectly to the local governments. Small as these aid programs appear
in retrospect, they mark a growing realization of the national nature
which some of the traditionally State and local functions were assum
ing under the pressure of general economic growth. Similar signs
were evidenced by the participation of the Federal Government in the
cost of agricultural extension work (Smith-Lever Act of 1914) in ad
dition to the annual cash payments already offered land-grant col
leges under the second Morrill Act (1890) ; the extension of Federal
assistance to States for forest-fire protection (Weeks Act o f 1911);
and in the years from 1916 to 1921, by aid offered the States to com
bat venereal disease, for the rehabilitation of persons injured in in
dustrial accidents, and for maternal and child health.
In summary, Federal aid to the State and local governments rose
from some $7 million in 1902 to $12 million in 1913. From 1913 to
1922 there was a much more substantial rise, to $108 million, and
then a period of consolidation but little expansion so that by 1927
the total of aid payments to State and local units was $116 million.
It is clear, too, that the increased flow of aid payments closely paral
leled the rising need for highways as the automobile transformed
our national transportation system. All other aid programs, especial
ly public welfare, did not fare nearly as well as the highways.32
32 For a full discussion of the development of the grants-in-aid program see James A .
Maxwell, The Fiscal Impact of Federalism in the United States, Harvard University Press,
1946.
ECONOMIC GROWTH AND STABILITY
31
State and local government expenditures: 1900-29
State and local government expenditures increased more than Fed
eral expenditures, both in absolute amount and relatively, for the
first three decades of the century. Per capita State and local ex
penditures, measured in 1926 prices increased by $44.85 from 1902 to
1927 (in contrast to Federal increases of $13.21). As a fraction of
gross national product State and local expenditures grew from 5.2
percent in 1902 to 8.7 percent in 1927 (in contrast to Federal growth
from 2.3 to 3.1 percent).
The greatest increases in State and local expenditures were for
education and highways which together accounted for more than
half the total increase. The impact of the automobile on govern
ment finances is clearly indicated by the more than tenfold increase
in highway expenditures during the 25 years from 1902 to 1927. The
increased expenditure on education was a function of the population
increase and the demand for more and better schools which we have
discussed above. There were also substantial additions to expendi
ture on hospitals, sanitation, police, and fire protection—on almost
every established function of State and local governments. And as
urbanization progressed, other local functions such as the provision
of utilities and transit facilities emerged with new importance.
In brief, increased expenditure on schools, highways, and local
services were the most important cause of increased government ex
penditure—Federal, State, and local—during the period 1900 to 1929,
and the role of the State and local governments, measured by ex
penditures, significantly increased relative to that of the Federal
Government during this period. From 1902 to 1927, for example, the
State and local share of all government expenditures rose from about
69 percent to 74 percent; and for civil functions only, from 88 percent
to 92 percent. The State and local governments clearly dominated
the public fiscal scene.
Beyond expenditures
In addition to participating in the costs of more State and local
functions through the use of grants-in-aid, the Federal Government
established a number of agencies to deal directly with developmental
and regulatory programs which had become important largely as a
result of general economic growth and the increased interdependence
which marked the development of a national economy. Some of the
more significant were:
Bureau of Standards (1901)
Bureau of Reclamation (1902)
Forest Service (1905)
National Park Service (1906)
Federal Bureau of Investigation (1908)
Bureau of Mines (1910)
Bureau of Foreign and Domestic Commerce (1912)
Children’s Bureau (1912)
Federal Reserve System (1913)
Conciliation Service (1913)
Federal Trade Commission (1914)
National Advisory Committee for Aeronautics (1915)
32
ECONOMIC GROWTH AND ST A B IU TT
Farm Credit Administration (1916)
Women’s Bureau (1918)
Federal Power Commission (1920)
There were, thus, significant changes in the scope of the Federal
Government which tend to be understated somewhat in statistical
time series, and especially by per capita comparisons of expenditure,
because they did not loom large in the Federal budget. While there
was little deviation from the traditional laissez-faire line in public
pronouncements that the business of government was governing—in
a narrow sense—there was considerable expansion in the actual range
of government activity, and even more m the potential range for
government action.
It is important, too, to observe the kinds of functions in which the
Federal Government took a stronger hand. Although the Federal
Reserve System, for example, had strong roots in our history, many
of the other activities which the Federal Government entered into
had been more exclusively the preserve of the State and local govern
ments. Welfare activities, like those involved in the Children’s
Bureau, had been a traditionally local function since the time of the
Elizabethan poor laws; labor conditions and industrial-relations prob
lems had been a matter primarily for State or local action; law en
forcement, likewise; and more or less similarly for the regulation of
domestic trade, conservation—insofar as it was practiced—and power
development. It is only fair to say, too, that none of these activities
was undertaken by virtue of an autonomous decision on the part of
the Federal Government. Strong pressures were required before the
Government, under either political party, entered any of these fields.
And underlying the pressures for extending the scope of Federal
Government activity were some of the basic forces discussed above—
the development of a national economy in which State and local bound
aries had progressively less economic significance, rapid industriali
zation, and urbanization, a growing sense of social responsibility, and
so forth. For example, as communication, commerce, and industry
became more interstate in character, the Federal Government was
forced to expand its regulatory role—just as it did, through the es
tablishment of the Federal Bureau of Investigation, as crime also
became a serious interstate matter. In fact, the Federal Government
stepped in mainly where there was strong public pressure to which
the State and local governments could not, or would not, give effective
satisfaction.
Actually, the importance of these extensions of Federal Government
activity was perhaps greatest in that they represented cumulatively a
considerable expansion of established limits for Federal Government
concern. Court decisions subsequent to cases arising from instances
of Federal Government action also added markedly to the recognition
of Federal powers—and their potential.
Thus, while the expenditure comparisons for this period show a
much greater growth for the State and local governments, the Federal
Government was having initiative forced upon it for the assumption
of new functions, many formerly State or local.
As we have previously noted, however, the development of both
increased expenditure and increased scope took place prior to the twen
ties. In fact, from 1923 to 1929, the Federal Government not only cut
ECONOMIC GROWTH AND STABILITY
33
expenditures, but also reduced its debt by about $1 billion, on the
average, each year. Andrew W. Mellon, Secretary of the Treasury,
summarized general policies when he wrote in 1924:
Since the war, two guiding principles have dominated the
financial policies of the Government. One is the balancing of
the budget, and the other is the payment of the debt.33
Thus, while the Federal Government was enjoying prosperity—
taking in more than it spent—the State and local governments were
already caught in a squeeze between burgeoning expenditure require
ments and limited fiscal capacity. The growth of public demand—for
schools and highways, especially—was so rapid in the first half of
this century that public adjustment to the concurrent need for higher
taxes apparently could not keep pace. This was particularly true for
the local governments. As school and local service expansion neces
sitated large outlays for plant and equipment, they were forced to
borrow more heavily. Total State and local debt rose from $2.1
billion in 1902 to $14.9 billion by 1927, and the local share of that total
went from roughly 80 to 87 percent. School districts, special districts,
and cities shared the bulk of the increase34 as they did the bulk of
functional responsibility. Many were faced by serious financial prob
lems before 1929.
Summary—The background for crisis
Federal, State, and local relations. For the period under review
as a whole, and particularly after World War I, there was a dispro
portionate growth of expenditures and revenues for the Federal and
State and local governments. The Federal share of total tax receipts
went up, while its share of total expenditures went down, and, con
versely, as the State and local share of all taxes went down, their
share of all expenditures went up. Consequently, during the twenties,
the Federal Government was able to reduce its indebtedness by about
$1 billion, on the average, annually. Its credit position, always good,
was made even better. The State and local governments, whose credit
was never as good as that of the Federal Government, increased their
indebtedness by about $1 billion annually, causing the total of Govern
ment obligations outstanding to remain about the same with a shift
toward more State and local debt in the total, local debt particularly.
The Federal share of tax receipts went up as a result of the Federal
Government’s exploitation of income and profits taxes after 1913. The
prosperity of the twenties caused increased yields for these taxes, even
after wartime rates were cut. The State and local governments, on
the other hand, still depended mainly on property taxation for their
revenues. The States also drew heavily on vehicular taxes during the
twenties, but in that otherwise prosperous decade the value of farm
lands and buildings declined substantially and, in the aggregate, the
property tax lost much of its yield elasticity. In a great many locali
ties, it was already proving to be overburdened.
83 Cited in Main Currents in Modern Economic Life, vol. II, Horace Taylor, editor,
Uarcourt, Brace & Co., New York, 1941, p. 280.
34 From 1902 to 1922, school-district debt rose from 2.1 to 11 percent of total State
and local d e b t: special-district debt from 0.2 to 6.2 percent; county debt from 9.3 to 13.5
p ercent; and city debt, though it fell from 73.2 to 56.6 percent, had by far the largest
dollar increase— about $4.2 billion. Cf., Historical Review of State and Local Finances,
Special Study 25, Bureau of Census, W ashington, 1948.
34
ECONOMIC GROWTH AND STABILITY
Despite revenue surpluses, the Federal Government avoided any
significant increase in functional responsibility and expenditure after
World War I. From 1922 to 1929, in fact, it was able to reduce ex
penditures as war-connected charges declined. The State and local
governments, on the other hand, were unable to resist a substantial
expansion in expenditures for their traditional responsibilities—
mainly highways and education. During the twenties, therefore, the
Federal Government hewed closely to a laissez-faire financial policy,,
while the State and local governments, often against strong opposition
from tax-conscious groups, increased their involvement in basic gov
ernmental services.
State-local relations.—The big difference between the situation of
the States and that of most local governments was that the States, by
tradition, were one step further removed from the demand for most
governmental services. Outlays by the States for education and high
ways, which accounted for more than 70 percent of the growth in total
State expenditures (including aid to localities) between 1902 and
1927, remained small compared to local outlays (less than one-half in
1927) for the same purposes. The local governments also had to face
the great bulk of increased costs for public welfare, sanitation, recrea
tion, police, and fire protection, etc. The States, insofar as they were
able to disassociate themselves from local problems, had no pressing
financial problem. Revenues from motor-vehicle taxes met the great
est part of highway requirements, and other revenue resources more
than took care of other direct State expenditures. Despite their par
ental obligations, the States, in fact, generally did resist local demands
for more aid and even for more “home rule.” They showed great re
straint in the use of the State tax power and left local responsibility
largely intact.
The local governments were severely limited in the kinds of revenue
sources they could tap, not only because (a) most State constitutions
or statutes restricted local tax and borrowing authority, but also be
cause (i ) the growth of a truly national economy made it more diffi
cult for smaller jurisdictions to use new taxes on business and persons
whose activities were not restricted by political boundaries. The re
sult was that the local governments faced an ever bigger job with rela
tively little additional help. Thus, while, from 1900 to 1929. the
number of pupils enrolled m public schools increased by 10 million,
motor-vehicle registrations grew from a few thousand to more than
26 million, and urbanization multiplied the need for local services,,
the local governments still depended on the property tax for more than
two-thirds of all their revenue. The aid they received through grants
from the States, and a little additional from the Federal Government,
grew, but never even approximated the volume that would have been
required to balance local budgets. So, the local units continued to
borrow heavily, even during the prosperous twenties, and found them
selves, even here, restricted by assorted local debt limits in State
statutes.
By 1929, therefore, as the country stood on the brink of what we call
now, somewhat optimistically, the great depression, the maladjust
ment of governmental functions and financial resources was already
clear. The obverse to the financial problems we have explored is the
matter of the Government spending which never took place and which,
now it is generally agreed, would have well served, the national inter
ECONOMIC GROWTH AND STABILITY
35
est. Before one-third of the Nation also became “ ill clad and ill
nourished,” it was already ill housed, ill schooled, and ill protected
from sickness and disaster.
The great depression, 1929—Ifl
The “great crash” of the New York stock market in October 1929
resounded throughout the financial world. Although it heralded
greater tragedy to come, the financial panic and the downward spiral
of employment and income took a little time to gather full momentum.
But by 1932 the situation was tragically clear to the country at large.
Unemployment had risen from 1.5 million in 1929 to 12.1 million by
1932, so that one-fourtli of the civilian labor force was without work.
Personal consumption expenditures had dropped by more than onethird in actual dollars, and by almost one-fifth in constant (1947)
dollars. Gross private domestic investment had gone down from over
$16 billion to less than $1 billion, and the Federal Reserve Board Index
of Industrial Production showed a drop from 110 to 58 (1935-39 =
100). The gross national product had fallen from $104.4 billion to
$58.5 billion, and per capita personal income from $684 to $320. Even
correcting for the 20-percent drop in consumer prices, per capita in
comes had fallen by more than 40 percent. In that brief span, from
1929 to 1932, the forced sales of farms—foreclosures—doubled, per
sonal savings turned negative, even the marriage rate went down by
more than 20 percent, and the birth rate also dropped noticeably.
The depression, obviously, also had devastating effects on Govern
ment revenues. All Government tax collections dropped, between
1929 and 1932, by 17.3 percent. Federal tax receipts, heavily depend
ent on cyclically responsive income and profits taxes, fell most sharply,
by 47 percent. The States, whose income came largely from motor
vehicles and property taxes, lost 3.1 percent of their tax receipts; and
the local governments, depending almost exclusively on property
taxes whose yield is relatively insensitive to changes in business condi
tions, lost less than one-half of 1 percent of their tax receipts. Even
with this drop in receipts, tax collections in 1932 amounted to 19 per
cent of the national income as opposed to 12 percent in 1929—an in
crease of more than 50 percent in the tax burden relative to the
national income.
In previous depressions, when it was felt that conditions were suf
ficiently bad, local governments had supplemented private charity
with work relief and small amounts of poor relief. The States did
very little, if anything, and the Federal Government had abided by
Grover Cleveland’s admonition that “though the people support the
Government, the Government should not support the people.”
This was a new kind of depression—much more severe and much
more persistent than any the Nation had known. Great changes
which had marked our growing output and wealth now became spec
ters : industrialization and urbanization meant that most of the people
now depended on wages and lived in cities, and when they lost their
jobs, they were left without means to obtain food, shelter, and other
necessities: the growth of a national economy and technological prog
ress meant, among other things, the commercialization of agriculture
and consequently a crucial relationship between farm product prices
and costs of production, in which fixed mortgage payments and inter
est figured heavily and led to so much hardship. In general, greater
36
ECONOMIC GROWTH AND STABILITY
economic interdependence spread the deepening blight more widely
throughout the economy, and the need for emergency relief alone was
beyond the capacity of most State and local governments to meet.
For the State and/or local governments to cope with the new kind
of depression emergency they would have had to have greatly in
creased financial support from either much higher tax collections or
increased borrowing. In fact, neither was really possible.
The tax structure of most of the States, as we have seen, had not
laeen strongly developed by 1929, and with the onset of depression
conditions it became more difficult to apply effectively new levies or
strengthen old ones. Between 1929 and 1932, 4 States added mod
erate income taxes, 2 States added death taxes, some scattered excises
appeared, but the several motor-vehicle taxes were the only ones whose
revenue yield grew at all and, as we have observed, total State tax
revenues fell by some 3 percent. Conditions were such that even had
the States possessed the ability to levy new taxes, the total economic
base was shrinking so rapidly that there was hardly a spot which could
conceivably carry increased taxation without adding to the disaster.
With income, employment, sales volume, inventory, and property
values all spiraling downward, where could additional taxes be
placed ? Even with a determination born of ignorance and obstinacy,
which was at times evidenced, the States could not meet large-scale
emergency fiscal needs by raising additional revenues from tax sources
while the economy was still moving down into the deep trough of the
depression.
Clearly, too, the local governments were in an even more difficult
situation than the States with respect to tax-raising capacity. A l
though the property tax had the most stable yield record of any tax,
it had become terribly burdensome as personal and business incomes
fell. Even though the total assessed value of all taxable property had
been reduced by $28 billion—from $169.3 billion in 1930 to $141.3 bil
lion in 1933—market values of property and, more important, the
capacity of property owners to pay taxes had fallen much more. In
fact, tax delinquency became a major problem, rising for 150 of the
largest cities from 10.1 percent in 1930 to 26.3 percent in 1933.35
What about increased borrowing to meet emergency needs?
Both the State and local governments were relatively eager to in
crease their debt obligations to meet emergency relief costs despite the
prevalence of orthodox views on the need for annually balanced budg
ets. Throughout most of the previous decade they had sold debt obli
gations on the security market at the rate of roughly $1 billion an
nually, and through 1931 they were able to continue borrowing at
about the same level. But then they were brought up short by two
important barriers: (1) Since 1842, when Rhode Island wrote a bor
rowing limit into its constitution, the practice had grown so that some
form of debt limitation was a part of nearly all State constitutions.36
The result was that most of the States could not borrow on the neces
sary scale without referral to the public or other difficult and time
85 Cf., State and Local Finances in the National Economy, Alvin H. Hansen and Harvey
S . P erlo ff; W . W . Norton & Co., New York, 1944, p. 51. This pioneering work is still, to
a remarkable extent, considering 4II that has happened since it was written, timely and
instructive.
36 Cf., Constitutional Debt Control in the States, The T ax Foundation, Inc., N ew York,
1954. A t present all but 5 States have such lim ita tio n s: Connecticut, M ississippi, New
Hampshire, Tennessee, and Vermont.
ECONOMIC GROWTH AND STABILITY
37
consuming preliminaries. Local government borrowing was also
sharply limited by State jurisdiction. Not only was new borrowing
thus restricted, but the decline in assessed values forced localities to
contract existing debt margins and undermined their credit standing.37
(2) The State and local governments were dependent for their borrow
ing, in the main, on the willingness of banks and private investors to
accept their debt obligations. There were established criteria of
soundness set up in the security market and “ adequate” security usu
ally meant a favorable economic background, good tax collections, a
low volume of tax delinquency, balanced budgets, and self-liquidating
projects. Although these criteria were more strictly held for local
governments, the States had to meet substantially the same require
ments and it became almost impossible to borrow even under very
costly terms. By 1932, in fact, 78.7 percent of all State and local is
sues bore interest rates of 4.5 percent and higher.
Even with these high interest rates the localities, in particular, had
to meet additional rigorous requirements set up by the banking com
munity. These usually involved economy provisions cutting back
activities and expenditures, agreements on tax collection and tax de
linquency policies, etc. All of these provisions were made, for exam
ple, in the so-called bankers agreement under which New York City
was enabled, after some difficulty, to fund its pressing short-term debt
obligations. The New York State Legislature also obliged the city by
reducing the mandatory pay scale for teachers so that the city’s ex
penses could be more readily reduced. In Detroit, Chicago, and other
cities, heavy cuts were forced in relief payments and other city expend
itures in order to enable them to place loans and qualify for tempo
rary credit in the financial market.
High interest rates, short-term maturities, and severe contractual
agreements for the borrowing governments were still inadequate for
enticing an adequate supply of private funds into the security market
during the rough years of the depression, 1932 to 1934. Investors had
become ultraconservative and were even leery of State and local gov
ernment obligations, especially after 3 States, Arkansas, Louisiana,
and South Carolina, and 37 large cities, were forced to default on
their debts. At one point, in fact, defaults reached approximately 15
percent of outstanding local debt issues. Not surprisingly, therefore,
in 1932, 697 issues totaling $260 million could not be sold; in 1933,
528 issues totaling $212 million failed to find buyers—even though
these issues included debt obligations of such governments as Buffalo,
Philadelphia, Cleveland, Toledo, Mississippi, and Montana.
In summary, then, the State and local governments could not, in
general, muster large additional revenues during the trough years of
the depression either by taxation or borrowing. Local governments,
carrying the greatest part of the unemployment relief burden, were
forced to slash public services to meet emergency needs, and the
States, too, were forced to adopt strong deflationary policies at a time
when private spending was already hitting bottom. In addition to
those States and localities which were forced to default on their debt
obligations, many others came dangerously close to bankruptcy—a
word which had become common currency with reference to public as
well as private institutions.
97 Much of this section on debt finance by State and local governments is taken almost
verbatim from Hansen and Perloff, op. cit.
38
ECONOMIC GROWTH AND STABILITY
Why the Federal Government grew
The Federal Government, as opposed to the State and local gov
ernments, was sheltered for a brief time (1929-30) from the effects of
the deepening depression. It was not immediately faced with rapidly
rising emergency relief demands—those were still local matters—nor
were there any other sizable increases in expenditure impending in the
proximate future, and anticipated tax receipts remained high. The
Federal surplus for the fiscal year 1929 had been about 185 millions,
and Andrew Mellon, the Secretary of the Treasury, expected higher
Treasury receipts in the following year.38 President Hoover, acting
on the advice of his Secretary of the Treasury, accordingly suggested
to the Congress that income tax rates on 1929 income, payable in 1930,
be cut in order to relieve the taxpayers. Within a month, on Decem
ber 1929, Congress enacted a new tax bill which followed the Presi
dent’s recommendations and cut the normal tax rates on individual
income from 1.5 percent, 3 percent, and 5 percent to 0.5 percent, 2 per
cent, and 4 percent, respectively, and the corporate tax rate from 12
to 11 percent. Even with this tax cut, Federal revenues at $3.6 billion
for the fiscal year ending June 1930 were higher than those of previous
years and the surplus, $184 million, was only slightly below the level
of the year before.39 Within 1 year, however, the picture was com
pletely changed. For the fiscal year 1931 the Federal Government
showed a gross deficit of $902 million, and it was clear that the unex
pected decline in business and personal incomes had cut the Federal
tax base much more heavily than had been anticipated.
Despite the deficit, Federal expenditures were allowed to move up
ward during 1931 as aid to agriculture and veterans was somewhat in
creased and public-works enterprises were moderately expanded in the
Ivope that they would stimulate business and help rebuild confidence in
the economy’s future.
The economy continued downward, however, and the pressure for
increased Federal action to speed relief and recovery grew rapidly.
Faced with a prospective deficit of almost $3 billion developing for
the fiscal year 1932,40 the Hoover administration, following accepted
doctrine, moved to return to a balanced budget by raising taxes and
cutting expenditures. President Hoover concisely summarized his ad
ministration’s point of view when he declared, in January 1932, that
“ we cannot squander ourselves into prosperity.” 41 But, in the same
month, the Reconstruction Finance Corporation was created with a
Government-subscribed capital of $500 million. Under the RFC,
home-loan banks were organized, the Federal farm-loan system was
expanded, and relief and public works activities were somewhat en
. 38 Cf., American Taxation, Its History as a Social Force in Democracy, Sidney Ratner,
W . W . Norton & Co., New York, 1942, pp. 437 ff.
391, e., the surplus of Treasury receipts over Treasury expenditures, including debt
retirement expenditures. This is the "gross” surplus as contrasted to “ net” surplus (or
“ net” deficit) where public-debt retirements are deducted from total expenditures.
40 The deficit for 1932 was $2,885.4 million, or almost $2 billion more than for 1931.
Ordinary receipts declined by about $1.2 billion, and expenditures increased by $787
million. The increased expenditure was accounted for largely by a $500 million subscrip
tion to the capital stock of the newly formed Reconstruction Finance Corporation, and a
subscription of $125 million to the capital stock of the Federal land banks. These expendi
tures were made in the effort to expand credit facilities and represented the great bulk of
recovery and relief spending for the time, although the Emergency Relief A c t (July 1932)
also provided for Federal loans to help local governments carry their relief loads. An
$803 million drop in income-tax collections was the most important factor in the decline
of ordinary receipts. Cf., Federal Finance, 1 9 2 3 -3 2 , National Ind ustiial Conference Board.
Inc., New York, 1933, pp. 6 0 -6 4 .
u Mitchell, op. cit., p. 37.
ECONOMIC GROWTH AND STABILITY
39
larged. To compensate for the Government’s depression spending
activity, however, the Revenue Act of 1932, which became law on
June 6, 1932, sharply raised all income-tax rates, lowered exemptions
and deductions for individuals and corporations, doubled the estatetax rates, restored the gift tax, and imposed excise taxes on a wide
variety of goods and services. This tax legislation represented one of
the sharpest increases in tax rates and liabilities ever enacted in time
of peace—so great was the drive for a balanced budget even as the
national economy plummeted downward.
In the ensuing fiscal year, 1933, receipts from income and profits
taxes fell, nevertheless, by about one-quarter of a billion dollars to
one-third of their 1930 level, and were not quite offset by increased
receipts from the excises and other special levies, so that total tax
revenues dropped by about $15 million.42 Even though expenditures
for the same year Avere reduced, there was another deficit of over $2.6
billion, and the Federal debt grew to $22.5 billion. The Hoover gov
ernment, unhappy though it was with unbalanced budgets, also could
not raise large, additional tax revenues during the downswing of the
depression while the national income was being cut in half.
,
The New Deal 1933-Jfi
The spring of 1933 marked the lowest point of the great depression.
State and local governments, as we have seen, were largely without
resources to meet emergency relief needs, and the Congress, after the
November 1932 elections, was dominated by “ lame ducks” who re
fused to take any vigorous action to ease the crisis. Not only was a
fourth of the Avork force unemployed and essential credit for farmers
mid businessmen unavailable, but the whole banking system was in
danger of imminent collapse as bank after bank was forced to close its
doors during the month preceding Franklin D. Roosevelt’s inaugura
tion. A sense of extreme national crisis pervaded the entire country.
Roosevelt assumed the Presidency on March 4, 1933, and th e new
administration moved Avith unparalleled speed in an effort to achieve
“relief, recovery, and reform” through “the farflung, highly varied,
sometimes contradictory program known as the NeAv Deal.” 43
The emergency relief nature of the expansion of Federal Govern
ment activity in the first years of the New Deal is amply clear from
the titles and purposes of the principal agencies created to handle the
job: (1) The Federal Emergency Relief Administration (May 1933)
was established by Congress for the purpose of assisting the States
and localities in furnishing outright relief to the needy. The States
Avere given grants of Federal funds to supplement relief funds a\railable from State and local sources, with the provision that one-lialf of
the funds was to be matched on the basis of $1 Federal for every $2
from State and local sources. By the end of 1935, when liquidation
of the agency was begun, the FERA had funneled more than $3 billion
to the States. (2) The Civil Works Administration (November 1933)
was designed to employ 4 million jobless men on work projects which
could be promptly organized. Appropriations for this program came
entirely from the Federal Government, while State CWA authorities
passed on projects which were generally sponsored and supervised by
42 Of. Cost of Government in the United States. 1933—35, National Industrial Conference
Board, Inc., New York, May 1936, p. 41. This drop in tax receipts takes into account
subsequent refunds of income and profits tax receipts.
45 Ratner, op. cit., p. 453 ff,
40
ECONOMIC GROWTH AND STABILITY
local governments. Repair and improvement of roads, streets, school
buildings, and community facilities figured prominently in the work
undertaken, as well as park, stadium, and airport construction. It
was closed out on March 31, 1934, after having spent about $1 billion
on work relief. (3) The Federal Emergency Administration of Pub
lic Works, known popularly as the PWA, was established under the
National Industrial Recovery Act (June 1933) to forward publicworks activities as a means of offering employment to the unemployed
and aid to State and local governments for their public-works needs.
Many of these measures were never intended to be anything more
than temporary relief expedients. The speed with which they were
established, revised, abandoned, or replaced stands in the legislative
record book as a commentary on the vigor, if not the certitude, with
which the Roosevelt administration met the worst period of the de
pression emergency. “ It is evident,” writes Professor Hansen, “that
the major effort was directed toward salvaging human and capital
resources.” 44
The character and scale of almost all these emergency salvage
activities were something new to Federal Government experience, and
both administrative and policy shifts were, in the early years, in
evitable. Along the line, too, the fiscal commandment for an annually
balanced budget lost much of its sanctity, and new ideas on the role
and method of Government finance in the economy came to the fore.46
Beginning with the 1934 budget, the first New Deal budget, the
Federal Government’s role in the national economy assumed a signifi
cance which had been visible previously only briefly during severe war
emergencies. From 1933 to 1934, Federal spending increased by over
$2 billion, most of the increase coming through grants to the States
and localities under a variety of emergency relief programs. These
grants jumped by more than 9 times in 1 year, from $201 million in
1933 to $1,848 million in 1934, and accounted for almost 30 percent
of total State and local expenditures. Approximately 60 percent
of all Federal appropriations were for “ recovery and relief,” " and
Federal appropriations, exclusive of those for the Reconstruction
Finance Corporation, conservation, flood control, public works other
than through the Public Works Administration and work-relief pro
grams, amounted to 43 percent of total Federal expenditures. The
Federal deficit for 1934, at $3.6 billion, was a billion dollars higher
than in 1933, and the public debt at the close of the year stood at a
record height of $27.1 billion—higher even than in 1919.
In 1935, Federal expenditures rose by about $1 billion, grants to
States and localities accounting for somewhat less than half of the
rise, and the “ relief and recovery” programs, even with the exclusions
noted above, took an even greater share—almost 58 percent of total
expenditures. By 1935, however, the national income was well on its
44 Hansen, Fiscal Policy and Business Cycles, op. c i t , p. 89. Professor Hansen cate
gorized as chiefly a “ salvage” operation the bulk of Federal policies during the thirties.
45 The effect of J. M. Keynes’ influence, especially after his visit to W ashington in July
1934, and the American proponents of the “ new economics,” particularly Professor Hansen*
is too well known to require even a footnote reference.
46 Horace Taylor, op. cit., p. 229.
ECONOMIC GROWTH AND STABILITY
41
■way back up,47and Federal revenues increased, so that the deficit was
some $0.8 billion smaller than in the preceding year; 1935 was also an
important year for reappraisal and consolidation of Federal relief
activities. First, on April 8, Congress passed the Work Relief Act,
which substituted the Works Progress Administration (W PA ) for
the Federal Emergency Relief Administration (F E R A ). With the
establishment of the W PA, the Federal Government took responsi
bility for the unemployed who were employable, but left to the States
and localities responsibility for all other relief programs.
State and local government relief responsibilities were promptly
and substantially modified by the passage of the Social Security Act
on August 14 of the same year.18 This was the most significant piece
of welfare legislation in the Nation’s history, but at the time it was
adopted it was closely related to the new work-relief program.
While the Social Security Act of 1935 was a major New Deal
achievement, it was largely a synthesis of earlier proposals, antecedent
State laws, and similar programs long established in other countries.
The British compulsory unemployment insurance law dated from
1911; during the twenties unemployment compensation was adopted
in many other countries; and Wisconsin had enacted an unemployment-compensation law in 1932. Also, by 1925, 22 foreign countries,
among them France, Germany, Italy, Russia, and Argentina, had com
pulsory old-age insurance and, following Arizona’s 1915 act, by 1933,
46 States had some form of old-age pension program. Other parts
of the social-security program enacted in 1935 and adjusted in 1939
had similar historical precedents.
In retrospect, it was only to be expected that the adoption of unem
ployment and old-age insurance and the other welfare-aid programs
would come with the great depression. For the first time in our na
tional history, we were faced with persistent mass unemployment, and
the depression forcefully highlighted basic economic changes which
had been underway for many years and which mandated a new con
ception of personal and family security requirements.49 It was not by
accident that the original Social Security Act was intimately con
nected with the Work Relief Act passed a few months earlier, and
neither was the great depression merely a historical accident.
Actually, the Social Security Act was the second major depression47 National-income estimates by the Department of Commerce for the years 1 9 2 9 -4 1 are
as fo llo w s:
[B illion s]
$ 4 9 .0 193 9
192 9
$87. 8 193 4
$ 7 2 .8
193 0
75. 7 1 9 3 5
57. 1 1 94 0
81. 6
193 1
59. 7 1 9 3 6
64. 9 1 94 1
104. 7
193 2
42. 6 193 7
73. 6
193 3
40. 2 193 8
67. 6
48 For an excellent brief summary of the Social Security Act, cf. W illiam Anderson, op.
cit., pp. 3 0 -3 9 . For a detailed analysis of the grants programs, particularly their cyclical
aspects, cf. J. A. Maxwell, Federal Grants and the Business Cycle, op. cit.
49 Speaking of the social-security legislation which initiated the system of grants to the
States and for old-age assistance, dependent or crippled children, the blind, etc., and the
old-age and survivors insurance programs, the railroad retirement program, and the
unemployment insurance programs, Professor Kendrick states: “ In view of the progress
that had already been made in this country toward public acceptance of the purposes served
hy such legislation, and in view of the actual application of similar legislation in various
foreign countries, it appears fairly certain that, irrespective of the state of employment
find trade, social legislation of the character described would, at some time, have been
enacted. The depression, however, caused the passage of these measures to come sooner
than otherwise, and, almost certainly, operated to increase the financial provision for their
implementation.”
Cf. Kendrick, A Century and a H a lf of Federal Expenditures, op. cit.,
pp. 3 5 -3 6 .
42
ECONOMIC GROWTH AND STABILITY
stimulated program which was to have lasting impact on the budget
of the Federal Government.
The first such program was embodied in the Agricultural Adjust
ment Act of 1933, which, when it was declared unconstitutional in
1936, was immediately followed by the Soil Conservation Act (1936)
and, in 1939, by the Agricultural Adjustment Act. All of these acts
were designed to provide (a) temporary subsidies through income
supplements, and (b) long-range output readjustment by subsidies
and production restrictions.50 The support of farm income through
income supplements was adopted as an emergency measure, but it be
came a regular feature, and in many instances the main issue, in sub
sequent agricultural legislation. Long-range readjustments were to
be obtained by subsidizing the shift from cotton growing to dairying
or grasslands farming, for example, and although some success was
achieved in the conservation aspects of the program, later develop
ments, notably World War II requirements, reversed much of the
movement.
The agricultural legislation of the New Deal firmly established
broad-scale Federal responsibility for the economic welfare of a siz
able portion of the agricultural population, but the approach here, too,
was not at all revolutionary. The agricultural sector of the economy
had been in a sad state since 1921. During World War I, agricultural
output had been greatly increased, mainly to meet the demand for
foodstuffs from the warring nations whose own output had been
sharply cut. Farmers borrowed in order to bring more land under
cultivation and to use the new equipment which the continuing agri
cultural revolution produced. Commercial farming became increas
ingly more important, and, after the war was over, agricultural pro
duction continued to rise as the tractor replaced the horse and electri
cal and mechanical innovation accompanied general scientific progress
in soil chemistry, animal husbandry, seed selection, etc. While farmcapital requirements and production kept rising, the market for out
put constricted. Foreign purchases of United States farm surpluses
fell off sharply as European production was restored, and as Europe’s
purchasing power in the United States was cut when United States
loans abroad were reduced, and our tariff barriers against foreign im
ports were raised. After 1925, because of the disparity in price move
ments between agricultural goods and manufactured goods, farm costs
increased relative to farm prices, and the condition of agriculture
worsened even more.
The “ farm bloc” in Congress was actively engaged in the pursuit of
aid for agriculture from the early twenties on.51 Emergency agricul
tural tariffs, marketing regulations, increased farm credit and aid to
farm cooperatives all figured in legislative proposals and were all
defeated. The McNary-Haugen bills vetoed by President Coolidge in
1927 and 1928 proposed the establishment of an “ equalization fee”
which would compensate farmers for losses sustained in selling sur
pluses abroad at low prices while they obtained higher prices from
segregated domestic sales. The, domestic prices were to be raised at
least high enough to restore the purchasing power parity between ag
50 Mitchell, op. cit., ch. V I, presents a thorough and lively discussion of this part of New
Deal policy.
51 Cf. H . G. Halcraw, Agricultural Policy of the United States, Prentice-Hall, New York,
1953.
ECONOMIC GROWTH AND STABILITY
43
ricultural and industrial prices which had existed in 1909-14. The
National Grange supported another scheme which provided, in effect,
for a Federal subsidy on agricultural exports to be paid out of tariff
receipts. Another plan, backed by the Farmers Union, provided for
a reduction of farm output through “ domestic allotment.”
Despite the spate of suggestions and recommendations, no action
was taken, except for some small aid to cooperatives and an extension
of farm credit, until President Hoover established the Federal Farm
Board in 1929. This agency undertook to stabilize prices of some
farm products through a subsidized-storage system for surpluses,
but it soon proved inadequate in the face of mounting difficulties which
followed the crash of 1929. Experience with the Federal Farm Board
indicated that a surplus-storage program could not effectively con
trol farm prices unless it was coupled with production controls. When
the New’ Deal Congress undertook to meet tiie farm problem, it adopted
the previously proposed principle of domestic allotment through
acreage and output adjustments in the first Agricultural Adjustment
Act, and, by Executive order, the President established the Com
modity Credit Corporation (CCC) to loan money on farm commodi
ties held in storage.
Without going into all the details of the first and subsequent New
Deal agricultural programs, it is clear that the basic outlines of its
policy had strong antecedent roots. The whole field of agricultural
aid had become a matter of Federal concern during the twenties, and,
while it was the intensified misery of the depression that forced vigor
ous Federal action, it seems clear that long-range maladjustments in
the agricultural sector would ultimately have brought Federal parti
cipation anyway. It had long since been clear that no independent
State or local action would suffice, and the “ farm problem” thus
achieved a lasting importance in Federal Government operations, just
as the industrial sector wTas provided for under the Social Security
Act.
In fact, the agricultural-aid and social-security programs (plus the
Railroad Retirement Act of 1939) together represent the bulk of
New Deal legislation which has had a lasting impact on the Federal
budget, and, though both programs were induced by the depression,
they had longer run justification in the great changes in the American
economy as well as previous histories here and abroad.
_In much the same way, we could trace through the history of
virtually every New Deal program. The TVA, for example,"was
made more expedient by the need for public-wTorks projects in 1933,
but agitation for such a Government program dated back at least to
Senator George W. Norris’ proposals from 1921 on, and similar de
velopment for the St. Lawrence seaway, Boulder Dam, and the Colum
bia River also had all been widely discussed well before the New Deal
came to power.
The pattern of government expenditures
The outstanding fiscal development of the depression period was,
of course, that Federal spending on civil functions—direct and through
grants-in-aid—increased eightfold between 1929 and 1940. Total Fed
eral spending rose from $2.9 billion in 1929 to $4.8 billion in 1932 and
then doubled to $9.6 billion in 1940. Of this overall increase of $6.7
billion, civil spending accounted for more than $5.7 billion. The Fed
44
ECONOMIC GROWTH AND STABILITY
eral Government in 1940 spent $1.9 billion on relief and work relief,
$1.4 billion on aid to agriculture, $1 billion on social-security programs,
interest on depression debt, and public-works administration.52 Other
sizable amounts went for conservation, flood control, and other pro
grams which also had been initiated during the depression.
In contrast to the great rise in Federal spending, State and local
government spending remained below the 1932 level of $8.4 billion
until 1935-36, and then rose gradually to $11.2 billion in 1940. A
considerable part of this rise was made possible, however, by the ex
pansion of Federal aid to State and local governments, and State and
local government spending exclusive of Federal aid did not recover to
the 1932 level until 1937-38, and by 1940 stood at $10.3 billion.
By 1940, total State spending was higher than in 1932 by $2.4 billion.
But the greatest part of this rise, some $1.4 billion, was accounted for
by expenditures under the unemployment-compensation programs of
the social-security system, increased spending for public welfare by
the States directly, and increased aid to localities for their relief and
welfare activities.
State aid to localities for education also ran higher by $300 million
in 1940, but it was mainly expenditure on relief and welfare that
brought State spending up. The States themselves had not under
taken any other significant programs and, aside from their direct
and contributory relief activities, they had left local responsibilities
virtually unaltered.
Total local government spending was $1.3 billion higher, at $7.7
billion, in 1940 than in 1932, but net of Federal and State aid which
had been increased by $1.1 billion, it barely exceeded its 1932 level in
1940. For most of the regular local-government functions—police,
fire protection, sanitation—expenditures had been cut during the
worst years of the depression and recovered only gradually after 1935.
Highway expenditure, which had amounted to $1.3 billion in 1927, had
fallen to $898 million in 1932 and remained below that level until
1946. The only important rise in local government general expendi
tures, especially for the large cities, came in public welfare. There
was also increased spending on such things as housing and community
redevelopment, natural resources, electric power services, and transit
facilities, but this spending also was largely a function of emergency
aid programs developed by the Federal Government and drew special
revenues through service charges. The chief strain on local budgets
continued to come from the relief and welfare needs of a large number
of depression victims and the indigent who were not covered by the
several programs of the Social Security Act. The local governments
still carried the great bulk of the general assistance relief burden as
well as their traditional functional responsibilities.
In brief, by 1940, Federal spending had advanced very much more
than State and local spending and reflected the new quantitative im
portance of Federal Government activity in public works and welfare
activities—which previously had been primarily the preserve of the
States and localities—and in agricultural aid—which had been rela
tively unattended. Other than for these changes which were, of
53 Public-works administration took $348 million ; social-security grants to States took
$369 m illio n ; old-age retirement took $28 million ; railroad employees’ retirement and
unemployment payments took $136 m illion ; and interest on depression debt was $247
million. Cf. Kendrick, op. cit., p. 32.
ECONOMIC GROWTH AND STABILITY
45
course, quite considerable, the spending pattern and functional respon
sibilities of all three levels of government were not significantly
altered.
With respect to a quantitative measure of the changed relative im
portance of Federal and State and local expenditures, however, there
is no clear line along which a completely unambiguous conception of
relative growth can be drawn. That part of the growth in Federal
Government spending which developed via the expansion of grants in
aid to the States and localities should not, for example, be considered
solely as a measure of Federal growth. Although in most cases Fed
eral action was critical in the establishment of grants programs, and
Federal controls were exercised in their administration, the use of
grants also enhanced the powers and responsibility of the States and
the localities. For many purposes the final spending units—the States
and localities in the case of Federal grants—gained as much effective
power as did the Federal Government. Public-assistance grants under
the social-security system, for example, are handled through the States.
The needy aged, dependent children, the blind, and since 1950 the per
manent and totally disabled, deal directly with their State govern
ments and not with Washington, D. C. Similarly, grants which make
possible improved public works, highways, housing, and community
redevelopment, etc., add to the governing capacity and to the effective
authority of State and local governments as well as to that of the
Federal Government.
In summary, increased Federal spending was the outstanding fea
ture of depression period finance, and the consequent growth in rela
tive importance of the Federal Government was most striking. But,
in absolute terms the State and local governments also emerged with
increased expenditure budgets and with a broader range of responsi
bilities—particularly in the field of public welfare.
From the vantage point of historical perspective it might appear
that alternatives c o u ld or sh o u ld have been developed allowing for
more independent State and local fiscal action in the latter thirties.
B u t, whatever alternatives might have been developed were inhibited
by a postcrisis le th a r g y among State and local governments. The im
press of th e depression was fresh upon th em , indeed th ey were not
yet free of emergency needs, and their major effort was in striving to
regain their sense of fiscal security by a return, in general, to stricter
practices of fiscal orthodoxy. Their alleged profligacy during the fat
years of th e 1920’s was n o t to be a ch a rg e w h ich c o u ld b e Drought
against th em in the lean years of the 1930’s. At the same time the
Federal Government was able and willing to expand its own efforts—
and it was infinitely easier to supplicate Washington for help than it
was to provide it from resources within most State and local jurisdic
tions.
The great growth of the Federal Government during the decade of
the thirties frequently is referred to as the start of “ the march of
power to Washington.” 53 The growth of the Federal Government
during the depression epic might be described at least as accurately
as “ the flight of responsibility to Washington.” Any lasting signifi
cant increase in Federal activity or power came about as a corollary to
its assumption of responsibility for functions which the States and
53 Cf., for example, W hite, The States and the Nation, op. cit.
07735— 57--------5
46
ECONOMIC GROWTH AND STABILITY
localities could not by themselves, or would not, undertake—and which
the public demanded from government.
W
orld
W
ar
II
D
evelopm ents:
1940-46
Federal Government -finances
The absolute and relative growth of the Federal Government during
the depression decade appears very small, indeed, when compared
with what happened in the war years: total Federal spending rocketed
from $9.6 billion to a high of $95.2 billion in 1945; net budget receipts
jumped from $5.4 billion to $46.5 billion; Federal debt outstanding
went from almost $43 billion to over $279 billion in 1946. Just the
change in sheer money magnitudes should be enough to give a sense
of the impact of (then) modern warfare on the national economy.
But dollar volumes alone actually understate substantially the war
time participation of the Government in the daily life of the Nation.
Aside from spending, taxing, and borrowing on a plane that would
have defied imagination even as late as 1940, the Federal Government
had to undertake to control virtually everything that was controllable.
Prices, wages, rents, profits, the distribution of consumer goods, and
the allocation of productive resources—all came under the purview
of the Federal Government because they were critical factors in the
prosecution of full-scale warfare.54
Federal spending
The war effort completely dominated the Federal budget from 1941
through 1946. The height of the war effort came in fiscal 1944 and
1945, but the budget for fiscal 1946 was still primarily a war budget.
Through these years civil expenditures only advanced some $1.6 bil
lion, and much of this rise was due to the effects of inflation and to
the extension of services which, although they are classified as civil,
were closely related to the war effort. In constant (1926) prices,
per capita expenditures on the civil functions actually fell from $63.40
in 1940 to a low of $41.03 in 1945—but recovered to $53.56 in 1946.
Similarly, as a percentage of the gross national product, spending
on civil functions dropped from 6.5 percent in 1940 to 3.9 percent
in 1946. The major reductions came, of course, in spending for relief
and work relief, public works, aid to agriculture.
Because so much of Federal welfare spending was in the form of
grants-in-aid established during the depression, the grants programs
underwent substantial alteration as first the defense, and then the
war boom brought the economy out of the persisting doldrums of
depression. Unemployment, still above 8 million in 1940, dropped to
670,000 in 1944, and Federal spending for emergency grants was
sharply cut. Total Federal grants had reached their peak at $2.9
billion in 1939, were cut to $2.4 billion in 1940, and petered down to
$900 million in 1946.55
The emergency grants—those instituted to provide relief and wel
fare aid during the depression—brought the total down as they fell
54 However, while the m ajor policy decisions and regulations were form ulated in W ash
ington, State and local governments carried considerable responsibility for the administra
tion of many war programs. Civil defense, selective service, rationing, and price control
were among the programs undertaken cooperatively by Federal and State and local govern
mental agencies.
55 D ata from Maxwell, Grants in Aid and the Business Cycle, op. cit.
ECONOMIC GROWTH AND STABILITY
47
from $2.3 billion in 1939 to $151 million by 1946. The regular grants,
on the other hand, ran substantially higher during the war years—
averaging about $743 million from 1941 to 1946 as compared with
$488 million in 1938 and $616 million in 1939.
Spending through grants was increased mainly for such things as
defense housing and transportation and the training of defense work
ers. National-defense requirements governed Federal spending
through grants just as they did direct Federal spending, and the ex
pansion of grants which resulted from the exigencies of war was
essentially of a temporary nature.
It is unnecessary to detail the other wartime expenditures of the
Federal Government, the bulk of which obviously was for direct mili
a r y needs. But the magnitudes are interesting. Spending for war
activities, as defined in the annual statement of the Secretary of the
Treasury, rose from $1.7 billion in 1940 to a high of more than $90
billion in 1945. In constant (1926) dollars, per capita spending for
military purposes, interest on the debt, and international affairs, rose
from $14.49 in 1940 to a high of $585.39 in 1944, and tapered down to
$285.93 in 1946. Again, as a proportion of the gross national product,
spending for these functions rose from 3 percent to almost 26 percent.
The tremendous rise in purely military expenditures deserves spe
cial mention. In constant (1926) prices total military spending in
creased from under $2 billion in 1940 to over $80 billion in 1944 and
1945, and the cost per serviceman rose from almost $5,000 in 1940 to an
annual average of $8,741 for the years 1941 through 1945.56 Actually
the sharp upward movement of military spending measured by cost
per serviceman, or by any other index, was part of a trend that started
at least a century and a half earlier. Toward the latter part of the
19th century the upward movement became more pronounced and the
cost per serviceman (in 1926 prices) moved from the vicinity of $1,500
after the Civil War to over $2,500 by the early 1900’s. World War I
boosted the figure to over the $3,000 mark, and during the 1930’s the
annual average was close to $4,000. Professor Kendrick writes as
follows:
* * * the great increase * * * in the cost per serviceman
over the century and a half cannot be explained by rising
prices. Doubtless part of the upward movement is accounted
for by a trend toward higher pay and better clothing, food,
and medical care. But by no means all the increase can be so
explained.
* * Rather, the chief reason lies in the mounting
and ultimately immense technological advance in the weapons
and equipment of the Armed Forces. * * * It is clear that an
important, and probably the major, explanation of the rising
cost per serviceman over our history has been the continuing
increase in the quality, kinds, and quantity of weapons and
equipment, and of ammunition and supplies. The rate of this
increase, slow at first, has mounted from period to period
with the rising tempo of research and invention. And as
the improved and more expensive military goods have been
adopted, the old have been discarded. Thus not only has the
cost of the original equipment been increasing, but the useful
56 D ata from Kendrick, A Century and a H a lf of Federal Expenditures, op. cit.
48
ECONOMIC GROWTH AND STABILITY
life of the units acquired has been becoming shorter. Mili
tary expenditures have increased on both counts.57
This particular aspect of technological advance obviously holds
important implications for the future of Federal-State-local fiscal
relations.
State and local government jwmices58
Spending.—The relative fiscal decline of the State and local gov
ernments, as opposed to the increased importance of the Federal Gov
ernment, which began during the depression period, was sharply ac
centuated during the war years. Despite wartime price inflation,
civil-defense programs, and other war-related expenses, actual dollar
spending by State and local governments was lower for most of the
war period than it had been in 1940. The great drop came in expen
ditures for capital outlay. Highway and school construction, for
example, were cut to the lowest possible amount, except where they
were directly related to needs arising from the relocation of labor
and other aspects of the defense effort. Total capital outlay fell,
therefore, from over $2.5 billion in 1940 to $379 million in 1944-— the
lowest level by far since World War I. Other than for the cutback
in capital outlay, however, total spending on almost every function in
creased somewhat between 1940 and 1946, but not enough to make up
for the drop in capital expenditure. Although the war brought a
tremendous economic revival, even public-welfare spending by States
and localities was a little higher through most of the war period.
Welfare spending was increased to match Federal public-assistance
grants, nullifying a drop in the need for general relief expenditure.
By 1946, however, with capital expenditures again rising to $937
million, and with the enactment of long-deferred increases in govern
ment pay scales to compensate, at least in part, for the price inflation,
State and local spending took a sharp jump to $14 billion—some $3
billion higher than in 1940. In constant (1926) prices, however, per
capita expenditures were still more than 20 percent below the 1940
level. State spending per capita in 1926 prices dropped from $50.16
in 1940 to $35.86 in 1944, and I'ecovered to $41.27 by 1946. Localgovernment spending was cut proportionately more—from $74.01 in
1940 to $49.89 in 1944, recovering only to $53.10 in 1946. In short,
State and local spending in real terms, particularly local spending,
was cut substantially during the war, and only partially recovered
in 1946. With respect to the gross national product, State spending
dropped from 5.2 to 3.4 percent, and local spending from 7.6 to 4.4
percent.
Taxation.—While the cutback in capital outlays kept total dollar
spending down during the war, tax receipts increased steadily. Gen
eral revenues ran well above general expenditures and, for the first
time in many years, State and local governments experienced budg
etary surpluses instead of deficits. Between 1941 and 1946, the only
important new tax adoptions occurred when 3 States enacted gift taxes
and 5 States added cigarette taxes. There was, in fact, considerable
pressure for reduction in State taxation as receipts from established
taxes increased with the economic revival. A number of States did
67 Ibid., pp. 45 and 48.
68 For a more complete review of the nature of wartime problems, cf. the symposium,
W artim e Problems of State and Local Finance, Tax Institute, Philadelphia, 1943.
ECONOMIC GROWTH AND STABILITY
49
reduce taxes,59 and the increase in aggregate tax yields resulted almost
entirely from the rise in incomes and consumer spending. For the
local governments, the property tax brought in moderately higher
yields, but the greatest increase came from charges and miscellaneous1
revenues. In brief, State and local tax effort was not inordinately
strained during the war—mainly because tax collections grew with
prosperity, and war conditions precluded spending on capital improve
ments which otherwise would have been undertaken. Also, of course,
States and localities, for the most part, were able to resist maintaining
their wage scales in parity with the inflationary rise of consumeroods prices. Civil servants as a group were among the hardest hit
y the wartime inflation.
Debt policy.—Because capital-investment programs wiere restricted
by war priorities, and revenues exceeded expenditures, from 1940 to
1946 State and local governments were able to effect substantial debt
reductions. Outstanding State debt was reduced by one-third, from
$3.6 billion to $2.4 billion, and local debt by about one-fifth, from $16.7
billion to $13.6 billion.60
Also, because the interest rate continued to decline, States and local
ities were able to refund some of their higher rate obligations with new
issues carrying lower interest charges. The rate on triple A securities,
for example, according to Moody’s index, dropped from 2.84 percent
in 1940 to 2.53 percent in 1946, and the annual interest cost on com
bined State and local debt outstanding was cut by about 29 percent—
in greater proportion than the actual reduction in the capital amount
of the debt.61
Postwar Federal fjiances
When the war ended, there was intense pressure for immediate relax
ation of wartime restraints and controls. Although there were already
threatening signs of growing international tension, public pressure
to return to peacetime living was so great that the decision was made
to demobilize the Armed Forces and to pursue as rapid a transition to
a peacetime economy as could be accomplished without engendering
severe economic dislocations. Once again, and quite understandably,
the Nation wanted a “return to normalcy.” But, clearly, not to the
prewar normalcy of many millions unemployed and relief or makework programs. Even during the years of extreme war effort, nation
al consumption of consumer goods and services in real terms had
increased by over 16 percent, and there was no disposition to allow
military victory to diminish the glory or dimension of national pros
perity. Both major political parties joined in enacting the Employ
ment Act of 1946, which set forth the following declaration of policy:
The Congress declares that it is the continuing policy and
responsibility of the Federal Government to use all practi
cable means consistent with its needs and obligations and other
essential considerations of national policy, with the assistance
and cooperation of industry, agriculture, labor, and State and
f
50 A s early as 1942, for example, New York reduced its personal-income tax by 25 per
cent ; in 1943, Iowa followed with a 50-percent cut, Maryland with a one-third cut, South
Dakota and W est Virginia eliminated their personal-income taxes completely, while Illinois
lowered its general sales tax, Indiana Its gross-receipts tax, etc. Cf. Hansen and Perloff,
op. cit., pp. 8 -9 .
60 These figures include enterprise debt.
61 Combined State and local debt outstanding dropped from $20.3 billion to $15.9 billion,
or by about 22 percent.
50
ECONOMIC GROWTH AND STABILITY
local governments, to coordinate and utilize all its plans,
functions, and resources for the purpose of creating and main
taining, in a manner calculated to foster and promote free
competition enterprise and the general welfare, conditions
under which there will be afforded useful employment oppor
tunities, including self-employment, for those able, willing,
and seeking to work, and to promote maximum employment,
production, and purchasing power.62
Only a brief moment of reflection is all that is required to recognize
how much different is this bipartisan view of Federal responsibility
for national economic welfare from the view that prevailed prior to
1933. The specter of a possible postwar depression was perhaps a
more powerful influence than systematic economic logic in obtaining
almost unanimous support for the Employment Act, but, nevertheless,
the result gave clear, statutory voice to the universal postwar question:
I f we can have high-level prosperity in time of war, why not in time of
peace ?
Actually, the fear of depression in the immediate postwar situation
was quite misplaced. The problem was inflation. There was a huge
backlog of pent-up demand for consumer goods, particularly auto
mobiles, household appliances, and other durables whose production
had been eliminated or severely curtailed during the war; similarly,
for housing to meet the requirements of a population grown by 9
million since 1940, and showing new high rates of family formation
and births; for public works, especially roads, hospitals, schools, etc.;
and, in greater or lesser degree, for the whole range of private and
public goods and services which constitute our proud standard of
living.
To back up their material wants, the consuming public had large
accumulations of buying power in the form of wartime cash savings,
convertible Government securities, and high current incomes from
employment and investment. State and local governments had im
proved tax yields, strengthened credit positions, and a receptive
market for their debt obligations. And, while money and credit were
plentiful, it took time for industry to retool and reorganize to meet
peacetime demands. Consequently, we experienced an inflationary
disturbance in postwar years that heightened the trend begun in 1940,
when we had started seriously to prepare for war. The buying power
of the dollar, which had dropped by 35 percent, as measured by whole
sale prices between 1940 and 1946, dropped by another 25 percent
between 1946 and 1948. The buying power of the consumer dollar
had dropped by 28 percent between 1940 and 1946, and it, too, dropped
by another 25 percent in the 2-year span between 1946 and 1948.63 The
price rises which caused this depreciation of the dollar came despite
the temporary extension of many price and wage controls—some in
attenuated form—and the maintenance of fairly rigid rent controls.
But the new, almost refreshing, experience with inflation added another
dimension to Federal responsibility for the economic welfare; stability
in the relationship between prices, wages, and other costs, was recog
62
The Employment Act of 1946, approved February 20, 1946, sec. 2, 15 TJ. S. C. 1021.
The act also provided for the establishment of the Council of Economic Advisers in the
Executive Office of the President, the submission of the President’ s Economic Report, the
establishment of the Joint (Senate-House) Committee on the Economic Report, and pro
vided for attendant staff needs, etc.
83 Data from Statistical Abstract of the United States, 1955, op. cit., p. 316.
ECONOMIC GROWTH AND STABILITY
51
nized as another important objective of national, peacetime economic
policy. Thus, in a very few years, as our perspective fought free of
narrow concentration on deep depression, fiscal and monetary meas
ures were turned increasingly on the threat of inflation. In sum, the
Federal Government now carries a more general responsibility for
maintaining a sound and healthy economy—to avoid excessive infla
tion as well as depression—by the use of all the fiscal and monetary
means which such a complete objective required.64 But inflationary
pressures in the postwar years caused considerable difficulty for all
three levels of government. And, obviously, the degree of difficulty
varied inversely with the intensity of demand for expenditure and
increases in responsiveness of their respective tax structures to price
and income changes.
Spending
Once actual hostilities ceased, the first order of Federal fiscal busi
ness was a sharp cutback in military spending. From a high of al
most $85 billion in 1945, military spending was cut to $45 billion in
1946 and down to $12 billion in 1947 through 1950. But even with
this sharp drop in military spending, the Federal budget was to re
main many times larger than ever before in time of peace. Arthur
Smithies writes:
With the end of hostilities, the President’s budget returned
to the center of the stage. In fact, in a different political
context the attitudes toward the budget in the late forties
were not unlike those of the twenties. Demands for cuts in
expenditures and taxes were insistent, but this insistence was
to yield more frustration than it did in the twenties. The
President discovered that much of the budget was uncontrol
lable. The interest bill was of course regarded as a contrac
tual obligation. Expenditures under the GI bill were con
sidered in much the same light and were likewise exempted
from the competition of the budgetary process. Aid to agri
culture was largely determined by the price-support legisla
tion. A large backlog of public-construction authorizations
made it impossible for the President to resist expansion in
that area. The main areas left for budgetary debate were the
international programs and national defense.65
The decision to demobilize and the concurrent reduction of military
spending were effectuated, as we have already noted, almost simulta
neously with the end of actual fighting. The international programs
were increased almost fourfold, however, and rose from just under
$1.5 billion in 1946 to an average of over $5.8 billion for the years 1947
through 1950. Yeterans’ benefits became a major budgetary factor and
took slightly less than $7 billion in each year from 1947 through 1949,
and were up to $9.3 billion in 1950. Interest charges went from $2.8
billion in 1945 to about $3.8 billion until 1950, when they reached $4.3
billion. Taken together, expenditures on the military, international
affairs, interest, and veterans accounted for over three-fourths of total
64 For a measure of the announced devotion to this responsibility see, for example, any
of the letters of transmittal accompanying the Economic Report of the President since
1947— and enduring past the change of administration in 1952.
65 Arthur Smithies, the Budgetary Process in the United States, McGraw-Hill Book C o New York, 1955, p. 121.
52
ECONOMIC GROWTH a n d
s ta b ility
Federal spending from 1946 through 1950. But in each of those years
the relative share taken by these categories of expenditure declined as
follows:
Percent
Percent
73
194 6
87 194 9
71
194 7
80 195 0
194 8
78
Civil expenditures thus increased in relative importance in each of
the postwar years through 1950. But, actual spending, as opposed
to budgetary authorization, for civil functions was below the 1946
level o f $8.2 billion until 1949, when it jumped to $11 billion, and then
to $12.5 billion in 1950. The more important increases in civil spend
ing between 1946 and 1950 came in support of agricultural prices and
farm income—which fluctuated widely depending on farm prices and
in the years cited went from $452 million to $1.8 billion; natural re
sources—from $251 million to over $1 billion; social security, welfare
and health—from $738 million to $1.6 billion, and transportation and
communication, particularly increased highway aid and a larger postal
deficit, from $817 million to $1.8 billion. Much of this increased
spending came in the form of increased grants to the States and to
local governments—grants-in-aid rose from $900 million in 1946 to
$2.3 billion in 1950, and shared revenues from $12.4 million to over
$20 million66—with the localities getting direct help for such things
as hospitals, airports, housing and redevelopment, and the States the
great bulk of the aid for education, highways, social welfare, health
and security.
Although civil spending in dollar terms showed a 50 percent jump,
from $8.2 billion in 1946 to $12.5 billion in 1950, in constant (1926)
dollars the change was only from $7.6 billion to $8.1 billion; and, in
constant per capita dollars there was virtually no difference—from
$53.56 to $53.60. In fact, civil spending in constant per capita dollars
was less in 1947 and 1948 than it had been for most of the 1930’s. As
a percentage of the gross national product, however, civil spending
rose from 3.9 percent to 4.4 percent, less than its proportion in the
thirties, but roughly six times greater than in the twenties, while in
the same terms other Federal spending dropped from 26 percent to
under 11 percent, still a substantial share of the national product.
The tendency of civil expenditures to increase, and military expend
itures to decrease, both absolutely and relative to total spending, after
major wars has been established as part of the historic pattern of
expenditure growth.67 But, such budgetary adjustments were never
fully accomplished until after several years of transition to peace.
Although there was a very sharp drop in purely military spending
immediately after World War II, there really was no adequate period
of time within which a new peacetime budgetary philosophy could be
developed. The initial drive was “to reduce the budget total to some
figure that was tolerable.” 68 The administration was in accord with
80 Data are from annual budgets.
67 Cf, Kendrick, A Century and a H a lf of Federal Expenditures, op. cit.
08 Smithies, op. cit., p. 122. Smithies continued: “ During the entire discussion no one
produced any definition of tolerable, and it rested on no economic analysis worthy of the
name. But the combination of intuitions and prejudices of those in authority produced
the con vie! ion that $40 billion of expenditures was definitely too high.”
And later he
states : “ The methods employed (to cut the budget) would have delighted Presidents H ard
ing and Coolidge, although they would have been stupefied by the size of the budget after
all cuts had been made.” Ibid., p. 122.
ECONOMIC GROWTH AND STABILITY
53
the Congress and the business community on the imperative nature of
cutting Federal spending.
But the shape of postwar events hardly allowed enough time for a
full reduction of military spending to a stable peacetime level. In
ternational tension between the Soviet Union and the Western Powers
began to mount even before final peace had been established, and
with the crisis in the spring of 1948 the United States decided to
rearm immediately. Although budget authorizations for 1950 were
raised, actual spending was not substantially increased until later,
when we were already involved in the Korean war, because of the lags
between authorization, programing expenditure, and actual produc
tion of material.
In brief, although we were not in a shooting war between 1946 and
1950, the United States never got back to a peacetime budget. From
cold war we went to Korea and hot war, and any potential long-run
budgetary readjustments to a stable peacetime situation were thus
foreclosed. Aside from the rise in military spending which came
mainly after 1950, there were other factors which operated against
expenditure reduction.
First, there were the fixed costs and contractual obligations we
mentioned above; second, inflation raised the cost of Government pur
chases of goods and services as well as consumer goods prices; third,
even aside from inflation-caused price increases, the rate of techno
logical advance in the weapons and other equipment of war was so
great in the short span between 1946 and 1950, that military costs
moved higher than ever. For example, the outfitting of an infantry
division cost $40 million in World War II and $200 million in 1950.139
Jet planes, rockets, atomic bombs—all added to the cost of waging
war and maintaining peace. In sum, despite a deep and widespread
conviction that the level of Federal spending should be reduced more
than it was actually at any time after World War II, it seems clear
that a conspiracy of events with the fiscal heritage of the past war com
bined to frustrate efforts at further large budget reductions.
Although the Korean war, which lasted roughly 3 years, was on a
much smaller scale than World War II, its effects on the economy and
on Government finance were quite profound. Unemployment, which
had mounted to a postwar high of 3.4 million in 1949, declined to 3.1
million in 1950,1.9 million in 1951, and to 1.6 million in 1953. Indus
trial production (1947-49 = 100) rose from 97 in 1949 to 134 in 1953.70
The national income rose from $216.2 billion in 1949 to $303.6 billion
by 1953, and after their brief respite in 1949-50, inflationary pres
sures resumed and the price level climbed again.71
Underlying the renewed upward surge of the economy was the sharp
increase in spending for national defense. Defense spending was
budgeted at $13 billion for 1950, but was raised to $22.3 billion in 1951,
$43.9 billion in 1952, and $50.3 billion in 1953. Also, although spend
ing on international programs and for veterans’ services and benefits
69 Kendrick, op. cit., p. 60.
70 Data from the Economic Almanac, 1956, the Conference Board, T. Y., Crowell & Co.,
New York, 1956, pp. 3 1 6 -3 1 7 .
71 The Bureau of Labor Statistics index (1 9 4 7 -4 9 = 100) showed wholesale commodity
prices up from 99.2 in 1949 to 103.1 in 1950, 114.8 in 1951, down to 111.6 in 1952, and
relatively stable between 110 and 112 through 1955. Consumer prices advanced from a
1949—50 level of roughly 102 to a 1 9 5 3 -5 5 level of about 114.5— with a mild upward
tendency since m id-1955.
54
ECONOMIC GROWTH AND STABILITY
dropped off rapidly, Federal spending for almost every civil function
of government increased steadily during the Korean war years. By
1953 total Federal expenditures stood at $76.6 billion.
With the end of the Korean war in early 1953, spending for national
security was again cut back. But, unlike the situation immediately
after World War II, when military spending was cut from a war-year
level of $85 billion in 1945 to only $12 billion in 1947, major national
security spending was only reduced from $50.3 billion in fiscal 1953
to $46.5 billion in 1954 and has since kept in the vicinity of $40 billion.
And, of course, there is little prospect that national-security spending
can be cut in the proximate future. Civil spending, since 1954, has
also reached new highs. From about 20 percent of the budget in 1954,
civil spending grew to 27 percent in 1956, and is estimated to reach
about 30 percent in fiscal 1958.
In the decade of the 1930’s civil spending took 61 percent of the total
budget, but national defense expenditure, of course, was very small.
At our new high budget levels, the high proportion of defense and
defense-connected spending relative to civil spending represents a situ
ation unlike any this Nation has faced before. Although civil spend
ing accounted for only 20 percent of the Federal budget for the decade
of the 1920’s, the proportionate difference then was due not nearly as
much to the large volume of defense spending as it was to the extreme
ly low level of nondefense spending. With present high levels of mili
tary spending superimposed on civil spending, which has itself
grown greatly since the thirties, we are actually in a new budgetary
epoch.
Postwar /S'tate and local finances
To many observers the financial position of State and local govern
ments at the close of the war appeared better than it had been for
many decades. Tax collections reflected full and overtime employ
ment at high wages, rising real property values, high consumption
levels for taxed commodities and services. The States had a combined
cash surplus of about $3 billion, which exceeded their gross indebted
ness by more than $500 million, and the cost of borrowing for States
and localities was down to a point where, in January 1946, the net in
terest cost to the borrower was less than 1 percent.72
It was clear, of course, that State and local governments would have
to make large expenditures on capital plant and equipment to catch up
on public improvements put off during the war years. In anticipation
of their postwar needs many States and localities had reduced their
outstanding debt or set aside a wartime revenue surplus; and in 1945,
when the end of the war seemed reasonably close at hand, there was a
concerted rush of planning and preparation for large-scale capital in
vestment programs. Even the foreseeable heavy expenditure needs
of the States and localities did little to dampen the optimism of most
observers. State and local government capital expenditures would
help cushion the widely expected postwar economic decline, the Fed
eral Government was expected to assist generously in financing these
expenditure programs, and the market for State and local debt obliga
72
Cf. M onthly Newsletter of the National City Bank of New York, February 1946, p. 22.
Also, the gross debt of States and localities had been reduced by over 18 percent since 1940,
and troublesome short-term debt had been cut from $315 million to about $25 million.
The States had contributed only about 30 percent of the total reduction in dollar terms,
but percentagewise had made about twice the progress of local governments.
ECONOMIC GROWTH AND STABIM TT
55
tions was more than receptive—especially since these issues carried
exemption from Federal income taxation and income tax rates were so
high. Furthermore, the financial position of the States, particularly,
was felt to he so strong that in their financial estimates they antici
pated meeting upward of 80 percent of their capital needs from accu
mulated surpluses, another 11 percent was to come from Federal aid,
and only 5 percent from bond financing.73 “ Pay as you go” seemed to
have a ring as true as it was pleasant, and the financial community was
concerned more than a little lest there be a dearth of State and local
bonds offered in the market.
But, almost as soon as the cheers on VJ-Day joined the historical
echoes, it became apparent that the contented look of State and local
affairs was largely unwarranted. Prices, and consequently govern
ment costs, rose substantially in 1946 and 1947. Wage scales, including
now—with some vengeance—government wage scales, were forced up
ward, labor remained scarce instead of unemployed, and construction
materials were so vigorously bid for by private enterprise in gray or
black markets, as well as through normal channels, that they were
hard to obtain and far more costly than had been anticipated. In
many cases costs rose so rapidly during the inevitable interval between
project planning and project authorization that the whole process
had to be repeated and scaled down on the basis of new cost esti
mates, with the result that heavy expenditures to meet the backlog
of capital needs were delayed. Also, State bonuses to veterans caused
a sharp increase in the need for cash, and, for this and other purposes,
as early as 1947 State and municipal bond issues for new money totaled
over $2.3 billion—approximately double the $1.2 billion in 1946 and
by far the highest volume ever recorded in any one year.74 The interest
rate on State and municipal bonds also rose sharply during the years
from 1946 through 1948, and, according to the Dow-Jones service
and other such agencies, the rise amounted to about 85 percent of
the average rate on tax-exempt issues. The interest cost was still
low in a historical sense, but substantially higher than it had been.
In brief, the States and localities were not able to accomplish the
capital improvements and additions which they needed as rapidly and
as easily as they had hoped. The record high tax receipts which had
nourished so much optimism during the war period soon appeared
inadequate again in the face of postwar inflation and the magnitude
of capital requirements. By 1947, State and local debt outstanding
was growing again and accumulated wartime surpluses were being
reduced year by year to meet general spending requirements.75 And,
as if to punish us for our earlier optimism, new expenditure demands
appeared at a faster rate than the wartime backlog could be dis
posed of. By 1954, most States found their general fund balances
dropping sharply, or depleted, as the upward climb of revenues slowed
while increased needs for schools, highways, and other institutions
were exerting even greater pressure on State and local budgets.
Thus, State and local expenditures are being forced upward (from
$37 billion in 1954 to $43 billion in 1956, for example) by a complex
73 Ibid., p. 23.
74 Ibid., issue of March 1948, p. 34.
75 The Korean war provided a revenue w indfall to the States as tax receipts, which had
been leveling off between 1948 and 1950, rose rapidly as a result of a renewed inflationary
upsurge. The w indfall allowed some further revenue surpluses, but its benefit was illusorv
in the long run.
*
56
ECONOMIC GBOWTH AND STABIM TY
of causes which are basically related to the following: The need to
make up for the deficiencies in capital programs during the war
period; the growth and shifts of population; and, of course, inflation.
To these, we must add the influence of our increased real wealth.
The public demand in the postwar period, as never before, had been
for better as well as more public services. With personal income up
from $78.7 billion in 1940 to $178 billion in 1946 and to $327 billion
in 1956, our tastes have become more expensive than ever. And, our
tastes for publicly provided goods and services have reacted in essen
tially the same way as our tastes in private consumption. So far,
although at rising interest costs, our State and local governments have
been able to debt-finance much of their capital spending. But cur
rent operating costs, which account for two-thirds of the increased
total State and local spending, have added huge pressures to State
and local finance. There does not yet appear to be any substantial
movement toward effective rationalization of their financial systems.
The problem today
The skeletal history presented in the preceding pages aimed at
defining (1) the important underlying causes of the overall growth
of government in the past half century; (2) the principal factors
which determined the distribution of that growth between the Fed
eral Government and the State and local governments; (3) the fiscal
problems which developed in the course of events. Our major pur
pose was to document these summary conclusions:
The growth of government was a necessary concomitant to the
overall growth of the country. That is, the rise in total government
spending from an amount equal to roughly 7 percent of the gross
national product in 1902 to almost 28 percent in 1956, and the con
sequent rise in taxes from something like 8 percent of the national
income to about 25 percent, are best explained in terms of the basic
factors which shaped our history: Population growth, technological
advance, urbanization, increased productivity and wealth, increased
interdependence in the national and world economies, the course of
international affairs—a depression of unprecedented severity sand
wiched between two world wars and followed by persisting cold war,
a little hot war, and the ever-present threat of atomic and hydrogen
annihilation.
The spectacular growth 'of the Federal Government since 1929,
which brought such a striking shift in the relative magnitudes of
Federal and State and local government operations, represents a nec
essary response to changed national circumstances. First, the depres
sion dramatized the high degree of interdependence of all groups in
the economy, the practical impossibility of developing local solutions,
and, consequently, the need for a new national approach to problems
of economic security. Second, World War II and the absence of real
peace after victory brought the full cost of advanced military tech
nology into a position of persistent dominance in the Nation’s eco
nomic budget. Furthermore, the technological requirements of mod
ern war, or preparing for defense against it, ramify quickly to all
aspects of life in our society, and, hence, to almost all reaches of social
policy. Only the National Government can handle this responsibility,
ECONOMIC GROWTH AND STABILITY
57
and it has had to expand its concern over a broad range of activities
as they have become closely correlated with national defense and
national security.
Despite the overwhelming impression of the increased importance
of the Federal Government, domestic governmental functions are still
handled primarily at the State and local level. In fact, more than
four-fifths of the growth in Federal spending since 1929 is attributable
to national defense and national security programs, and less than
one-fifth to expanded civil functions.
Thus, while the Federal Government in 1956 spent an amount equal
to 4.8 percent of the gross national product on civil functions, the
States and localities spent an amount equal to 10.4 percent. Although
the Federal Government’s influence on internal functions may be
greater than the proportion of its expenditure indicates—through
controls over grants-in-aid and subsidy programs, for example—the
States and localities are themselves doing more in both scope and scale
than they have ever done before. In constant (1926) dollars since
1927, for example, their spending has increased by 2.6 times and their
tax collections have almost doubled.
As a result of population growth, inflation, and higher standards of
public demand, the burden of civil functions resting on State and local
governments for education, highways, welfare, health, hospitals, hous
ing, protection, etc., has grown faster thorn, State and local revenue.
Although disparity between spending needs and revenue sources has
characterized almost the entire half century, the situation of the States
and localities has been made more critical since World War II. The
fact is that Federal financial requirements for the support of national
defense and security programs have become so great they made in
creased State and local taxation more difficult.76 States and localities,
in addition to rising operating costs, still have a backlog of capital
investment needs dating from depression and war years which is
being augmented constantly at a rapid rate by neAV plant and equip
ment requirements.
On the basis of these conclusions, it seems clear that the future
course of intergovernmental relations will depend in greatest measure
on the degree of success the States and localities achieve in meeting
their pressing fiscal problems. The issue, in purely pragmatic terms,
is whether and how the States and localities can develop the fiscal
resources they will need to finance a satisfactory level of service in the
functions for which they are responsible. In other words, we know
for certain that Government spending for most domestic purposes will
have to go up by large amounts in the coming years, but we are not
nearly so certain that the States and localities can meet the challenge.
To the extent that they fail, the Federal Government will have to fill
the breach.
70
War-connected purposes required about 2 percent of the national income at the turn
o f the century and 4 percent in 1940, but in recent years have amounted to between 18
and 20 percent. Roger A. Freeman writes : “ This prior claim on the output of goods and
services and the concomitant tax burden inevitably depress our ability to support more
liberally other public services. * * *”
Cf., Crisis in School Finance, Part I, National Tax
Journal, vol. IX , No. 1, March 1956, p. 4.
58
ECONOMIC GROWTH AND STABILITY
T a b l e I .—
Government expenditures, selected years, 1902-56
[In millions of dollars]
Federal
Year
1902..
1913-.
1922..
1927
1929..
im .
1938
1940..
1944..
1946
1948—
1950—
1952..
1954..
1956
1958 e.
State and
local,3
total
T o t a l1
Civil 2
485.2
725.0
3,296. 0
2,774.0
2,900.0
4,800.0
7, 200.0
9,600.0
93,956.0
61,738.0
36, 524.0
43,160.0
67,968.0
71,868.0
72.611.0
82.970.0
149.1
273.0
677.0
699.0
821.0
2,455.0
4,684. 0
, 550.0
7, 237.0
8,170.0
7,926.0
12,459.0
12,602. 0
13,953. 0
19,792. 0
25,331.0
6
1,095
2,257
5,652
7,810
(8)
8,403
9,988
11,240
10,499
14,067
, 260
27,905
30,863
36,607
43,152
21
State 4
188
388
1,397
2,047
(8)
2,829
4,598
5,209
5,161
7,066
11,181
15,082
15,834
18,686
21,686
Local 3
959
1,950
4,567
,359
(J)
,375
6,906
7,685
7,180
9,093
13,363
17,041
20,229
23,814
23,273
6
6
1 Totals for fiscal years 1902 through 1952, from M. Slade Kendrick, op. cit., table B - l ,
pp. 76—77. Kendrick's figures are adjusted from Treasury data to come as close as he could
make them to the measure of actual cash payments to the public. See his appendix B for
detailed notes on sources and method, pp. 6 3 -7 3 . For later fiscal years Special Analysis A,
Receipts From and Payments to the Public, Budget of the United States, 1955 and 1958.
8 Residual after deducting sum of expenditures for m ilitary purposes, veterans, interest,
and after 1915, foreign affairs.
3 Direct expenditure, as defined by the Bureau of the Census, includes all general gov
ernment expenditure plus utility, liquor store, and insurance trust expenditures. These
figures are not completely consistent with the actual cash payments measure used in the
Federal Government column, but they represent the best comparable long series for State
and local governments. Cf., Historical Statistics on State and Local Government F i
nances, 1 9 0 2 -5 3 , tables 1, 2, and 3, and Summary of Governmental Finances in 1954, 1956,
U. S. Department of Commerce, Bureau of the Census, Washington.
4 Total State expenditure including payments to local governments. Note that totals of
columns 5 and 6 exceed column 4. This is due to the inclusion of State payments to local
units in both expenditures of State and local governments.
*N o t available on census basis.
6 Estim ate from the Budget of the United States, 1958.
T a b l e I I .—
Government expenditures as percent of gross national product—
selected years 1902-56
Year
............................
.............................
............................
.............................
.............................
.............................
............................
________ __
.............................
__ _________
1902..
1913..
1922..
1927..
1929-.
1932...
1938..
1940-.
1946..
1950..
1952..
1954..
1956..
Gross
national
product
in current
prices
(billions of
dollars)
20.7
40.1
68.4
89.6
104.4
58.5
85.2
100.6
209.2
285.1
345. 5
361.2
414.7
Percent of gross national product
Federal
2.34
1.81
4.82
3.10
2.78
8.20
8.45
9. 54
29.51
15.14
19.69
19.94
17.5
Civil
0.72
.68
.99
.78
.79
4.20
5.50
6. 51
3.91
4.37
3.65
3.87
4.8
State and
local
State
5.29
5.63
8.26
8.72
0)
14.36
11.73
11.17
6.72
9. 79
8.94
10.15
10.2
Local
0.91
.97
2.04
2.28
0)
4.83
5.40
5.18
3.38
5.29
4.59
5.18
5.2
4.63
4.86
6.68
7.10
0)
10.89
8.11
7.64
4.35
5.98
5.86
6.61
5.6
i N ot available.
Sources: Gross national product for 1929-56, Survey of Current Business, Department of Commerce.
Gross national product for 1922-27, National Product Since 1869, Kuznets, N . B. E. R ., N. Y ., 1946, p.
51, and gross national product for 1902 and 1913 were estimated from p. 119. (T he 1902 figure was found
b y interpolation of the 2 overlapping 10-year estimates, 1899-1908 average equal to $21,580,000,000, and
1894-1903 average to $15,700,000,000.)
59
ECONOMIC GROWTH AND STABILITY
T a b le
111—Percentage distribution of all government taxes—selected years
1902-56
Year
Federal
State and
local
1902............................................................................................
38.0
62.0
29.2
1913-................................................................................ ........
70.8
1922_________ _____________ ____________ ____ _________
46.9
53.1
1927............................. ............................... .............................
36.3
63.7
1929. .................... ................................................. ...................
35.5
64.5
1932_________ __________ _______ _____ ________________
23.4
76.6
1934_________________ ____________ - _____ ____________
33.5
66.4
1936 .................... ................................................................
36.7
63.3
38.2
1940 .........................................................................................
61.8
79.6
20.4
1946............... ......................................................................
69.8
30.2
1950.................... ............. ....................................................
1952___________ ______ — ............................. .................. .
76.0
24.0
73.9
1954........... .......... ................................................ ...................
26.1
1956.............................................................................................
71.2
28.8
State
Local
50.8
57.6
40.5
46.9
45.0
53.1
44.2
38.6
35.6
10.4
15.2
11.8
13.5
14.2
11.3
13.2
12.5
16.8
19.6
23.5
22.2
24.7
26. 2
10.0
15.1
12.3
13.6
14.6
Sources: Annual Reports of the Secretary of the Treasury on the State of the Finances. Historical Sta.
tistlcs of the United States 1789-1945, U. S. Bureau of the Census, Washington, 1945, Series P 90-131, pp,
298-304. Summary of Governmental Finances in the United States: 1956, U. S. Bureau of the Census
Washington, 1957.
T a b le
TV.—International comparisons of public finance and
product, fiscal year 1951
Country
United States_______________ - .....................
Canada ...........................................................
Denm ark...........................................................
Great B ritain....................................................
Belgium......................... - ................... ..........
.....................
N orw ay............................
F r a n c e ............................................ .................
Netherlands........................................... ..........
Germany............................................................
Italy.
. _ _
.................
Austria..
................................................
Portugal.............................................................
Greece................................................................
T urkey...............................................................
national
Percent of gross national product
Gross
national
product per Taxes of
National
Defense
National
govern
capita
all govern
expendi
govern
ments
ment ex
ture
ment gross
penditure 1
debt
$2,023
1,432
800
792
779
760
736
690
529
509
324
308
285
243
161
22.3
23.1
19.7
19.0
34.4
25.0
26.1
29.8
29.0
31.0
20.7
30.9
9.7
16.7
17.9
15.1
2 17.0
12.4
14.9
27.3
24.0
16.0
25.5
24.7
21.7
19.3
34.0
7.6
33.7
20.1
7.1
4.7
1.6
6.7
2.9
2.8
7.8
4.2
4.9
4.2
.9
2.1
9.8
6.5
83
(8)
42
21
188
75
65
47
130
23
34
31
16
10
18
1
2
“ National” refers to the central governmental authority; in the United States it refers to the Federal
Government.
Preliminary figure,
s N ot available.
Source: Division of Statistics and Reports, Mutual Security Administration (table IV , Dewhurst, opj
cit., table 236, p. 579).
SOME HISTORICAL ASPECTS OF FEDERAL FISCAL
POLICY, 1790-1956
Paul B. Trescott, associate professor of economics, Kenyon College
Traditional views of fiscal policy tended to treat Government ex
penditures as the means to the performance of Government functions,
and to regard revenue measures as a means to both. Modern income
analysis, by contrast, has tended to stress the money-flow aspects of
aggregate Government financial transactions in relation to national
levels of spending, output, and prices. This paper will deal with both
aspects. It will describe and analyze briefly the historical develop
ment of Federal expenditures by function and of the attending revenue
structure. The relations between fiscal policy and wartime inflations
will be investigated, also the reciprocal interaction of fiscal policy with
peacetime economic fluctuations. The fiscal ideas underlying such
policies will also be treated. The possible effects of the tax structure
and public debt policy on economic growth will receive some attention.
Discussion of some of the conceptual problems and statistical sources
encountered in a historical treatment of this sort will conclude the
paper.
T h e G r o w t h o f F e d e r a l E x p e n d i t u r e s , 1790-1956
During the first full year of its existence, the Federal Government
spent less than $1 million. In fiscal 1956, Federal cash payments to
the public totaled more than $70 billion. Current levels of Federal
spending are about 10,000 times as large as those of the 1790’s and
about 200 times as large as those of the 1890’s.
The pattern of this vast growth over time is shown in the accom
panying chart. A cursory examination will reveal its most striking
feature to be the influence of wars on the pattern of increase. The
large eruptions reflect the War of 1812, the Civil War, and World
Wars I and II. Instead of a gradual, even, upward movement, Fed
eral expenditures have shown a series of plateaus. Wars have pushed
expenditures to high levels. With the return of peace, spending has
fallen, but never to prewar levels. Usually the war has left a heritage
of increased expenditures for interest and veterans. Between wars,
expenditures show several long periods of relative stability or even
decline, until the next war forced them to still higher levels. Such
60
ECONOMIC GROWTH AND STABILITY
61
FED ER A L EXPENDITURES, 1 79 0-1956
Sources: 1790-1860, author’s estimates; 1861-1916, author’s preliminary esti
mates : pp. 81-83 ; 1917-52, Kendrick, a century and a half of Federal expendi
tures, National Bureau of Economic Research, 1955, p. 77; 1953-56, annual
budget volumes for 1955-58.
periods have been lacking in recent years. Since 1900 there has been
a stronger upward tendency in “ normal” Federal expenditures, and
since 1945 the earlier distinction between wartime and peacetime
periods has largely evaporated.
Table I summarizes the growth of expenditures in absolute terms
and also gives some information on the composition of expenditures
and their relation to other economic magnitudes. It shows that ex
penditures for defense and for interest, veterans’ benefits, and other
war-related items have usually dominated Federal spending. In only
one of the selected periods, that of the 1930’s, do the other items ac
count for more than half. This does not obliterate the fact that these
civil expenditures in each period were larger than in the previous one.
In 1956, this civil category accounted for nearly $20 billion of Federal
spending.
97735— 57------- 6
62
ECONOMIC GROWTH AND STABILITY
T a b l e I. —
The growth of Federal expenditures and their relation to other
economic magnitudes, 1790-1956
Average annual expenditures
Period
N um ber
of years
Warrelated
Other
Total
Average
per capita
1926 prices
Average
ratio to
gross
national
product
Millions of dollars
1790-1811................................. .
1812-15................ ........................
1816-36____ __________________
1837-61______________________
1862-65................ .................... .
1866-90.................................. .
1891-1916................ ....................
22
4
21
24tf
4
25
26
6.0
26.7
13.7
27.3
708.0
227.0
357.0
2.0
2.8
6.1
18.4
19.0
66.0
171.0
8.0
29.5
19.8
45.7
727.0
293.0
528.0
Percent
1.60
3.25
2.45
2.95
24.40
7.60
10.0
1-2
1-2
1-2
3-5
10-14
3-4
2-3
Billions of dollars
1917-19..........................................
1920-29.............. ..........................
1930-41_______________ _______
1942-45....... ............ .....................
1946-56.............. .........................
3
10
12
4
11
10.6
2.8
2.9
70.0
45.0
0.4
.7
4.2
6.0
12.0
11.0
3.5
7.1
76.0
57.0
82.0
28.0
71.0
461.0
225.0
Percent
17-18
4
10
40
18
N o t e s . — Figures are for calendar years through 1842, 6 months of 1843, thereafter fiscal
years ending June 30.
W ar-related expenditures include m ilitary, veterans, foreign, and Interest.
Averages relative to population are means of annual estimates, as are those for gross
national product since 1861. For earlier years, relation to gross national product Indicates
probable range.
Sou rces: 1 7 9 0 -1 9 1 6 based on author’ s annual estimates, discussed at end. 1 9 1 7 -5 2 ,
M . Slade Kendrick, A Century and a H a lf of Federal Expenditures, National Bureau of
Economic Research, 1955 ; 1953—56, Budget of the United States, annual volumes for
1 9 5 5 -5 8 .
We can better obtain perspective on the magnitudes and growth of
Federal outlays by comparing them with some measures of the size
of the economic system. We should also allow for the fact that the
value of the dollar has not remained constant. Since 1790, the popula
tion of the United States has increased from about 4 million to about
170 million—more than fortyfold. The purchasing power of the dol
lar, as measured by wholesale prices, has fallen to about one-third of its
1790 value—although such long-run comparisons are virtually mean
ingless because of changes in the composition of output. In our table,
figures showing Federal expenditures per capita, in 1926 prices, take
account of the changes just noted. These show that the increase in
spending was not great relative to price and population change in the
peacetime periods through 1929.
The type of comparison most dear to the economist is that between
Government expenditures and some measure of national income or
output. Precisely what such comparisons show and how they should
be made are questions we will sidestep. We will merely take gross
national product as a measure of the size of the Nation’s economy.
Gross national product (GNP) has grown more rapidly than popula
tion as a result of increased productivity stemming from improved
organization, technological advance, and an increasing stock of capital
goods. Output per capita in the United States has risen to more than
10 times what it was in the first part of the 19th century. Table I
contains a column of data relating Federal spending to GNP in each
period. This comparison reduces the growth of Federal spending to
ECONOMIC GROWTH AND STABILITY
63
somewhat more modest proportions. I f we concentrate on peacetime
periods, we find an increase in the ratio from something under 2 per
cent before 1812 to something under 20 percent in most recent times.
These statistical relationships do not go very far to explain why the
increases in spending have occurred. Some economists have sug
gested that there is a kind of law of increasing Government activ
ity—that as the living standard of an economy rises, public opinion
will bring about a larger relative amount of Government activity.
Most Government services are not vital for subsistence, but higher
living standards bring more desire for Government services, while in
creasing people’s willingness and ability to pay for them. To use a
modem idiom, Government activities may be purchased out of super
numerary income—income above that needed for necessities, which
rises faster than total income.
This explanation, usually advanced to account for increases in de
sirable Government activities, may paradoxically help explain the
relative increase in war expenditures. In part the increasing costs
of American wars reflect the higher emotional involvement of the
population in total war. Another contributing factor, as Professor
Kendrick has pointed out, has been changes in military technology.1
But part of the explanation is that a wealthy, highly productive na
tion can devote a larger proportion of its resources to military pur
poses without infringing on the necessities of life. The high propor
tion of our output devoted to military uses during World War II was
more readily achieved because the economy had been in a period of
depression, which kept people’s accustomed standard of necessity
fairly low, and also permitted a great increase in total output.
But to deal adequately with the peacetime growth of Federal
expenditures, whether war-related or not, one must be more specific
about public attitudes toward Government actions, the political struc
ture, and the revenue base.
Federal expenditure policies in the 19th century
Our figures show that the growth of Federal expenditures in peace
time periods was relatively slow in the 19th century—indeed, down
through the 1920’s—relative to the growth of the economy. Govern
ment spending seemed to approximate a normal level of somewhat
under 5 percent of GNP. The activities on which the Government
spent most of its money showed a remarkable degree of stability
throughout the 19th century. In the years 1789 through 1860, about
five-sixths of Federal expenditures went for defense, general govern
ment, Indian affairs, veterans’ pensions, interest, and postal service
deficits. In 1890 these activities accounted for virtually the identical
percentage, although the relative shares were different. In 1789-1860,
about 5 percent of Federal spending went for aids to commerce and
transportation, chiefly lighthouses and river and harbor improve
ments. In 1890 this percentage was also practically identical. Only
about 10 percent of total spending in each case fell outside these activi
ties, and some of that reflected such common items as surveying and
selling the public lands, and District of Columbia expenditures.
1 M. Slade Kendrick, A Century and a H a lf of Federal Expenditures, National Bureau
of Economic Research, New York, 1955, pp. 4 2 -4 8 , 5 7 -6 2 .
64
ECONOMIC GROWTH AND STABILITY
By 1910, the share of the first group of activities had fallen below
80 percent. In the category of transportation facilities, expenditures
on rivers arid harbors were exceeded by those on the Panama Canal,
pushing the total for the category above 10 percent. Conservationoriented activities in the Interior Department, agricultural expendi
tures (which had been minute in 1890), and the outlays of the newly
formed Department of Commerce and Labor accounted for another
7 percent. Since 1910, the increase in the dollar volume of Federal
expenditures has been accompanied by the proliferation of Federal
activities. We might say that in the 19th century expenditure growth
increased the scale of Federal activities, but that during the 20th
century, their scope has increased also.
We may be able to throw light on the reasons for these divergent
patterns by adopting an unconventional approach. Instead of asking
why expenditures grew, let us ask why they did not grow more in
both scale and scope before, say, World War I. We can dismiss at
the outset one possible explanation—that there was no pressure from
the public for Government services and actions. Recent research in
economic history has produced a mass of evidence that demands for
Government action were widespread and strong throughout the 19th
century, particularly from businessmen.2 There are a number o f
specific factors which account for their slight effect on Federal
spending:
1. The Federal system. The greater part of the demand for Gov
ernment action involved State and often local governments. State aid,
participation, and regulation were very evident in the development of
roads, canals, railroads, and banks before 1860.
2. The separation of powers in the Federal Government. Members
of Congress have typically been most sensitive to demands for serv
ices from particular constituent groups. The President and other exec
utive officials are, however, more at liberty to pattern their conduct
after a general theory of government. In the 19th century most
Presidents, strong or weak, held pronounced views about the proper
role of the Federal Government relative to the States and to the pri
vate economy. In particular, they shared a general sense of the limi
tations imposed by the Constitution on Federal activities. Not only
was Presidential leadership lacking on behalf of spending increases,
but strong Presidential pressure was often exerted to keep Federal
activity limited. The history of this can be read in part in the se
quence of Presidential vetoes, from Madison’s veto of the bonus bill of
1817 through Coolidge’s veto of the McNary-Haugen bills in the
1920’s.3 We will also find evidence of it in the attitude of officials
toward fiscal policy during economic depressions. One might note
that the strong pressures against spending came from the Executive
more than from the judiciary. No Federal spending program of con
sequence fell afoul oi the courts until the 1930’s.
2 T his literature is excellently summarized in Robert A . Lively, The American S ystem :
A Review Article, Business History Review, March 1955.
3
Other notable items in the series should be Monroe’s veto of a bill to charge tails on
the Cumberland road, Jackson’s veto of bills to buy stock in the M aysville turnpike and
Louisville and Portland Canal corporations, Polk’ s and Arthur’s vetoes of river and harbor
bills, Johnson’s veto of the Freedmen’ s Bureau bill, and Cleveland’ s vetoes of pension, river
and harbor, and drought-relief bills. Others which involved the scope of Federal activity
were those of Jackson and Tyler on bills to charter a national bank, and those of Pierce
and Buchanan on bills to distribute public lands for certain welfare purposes.
ECONOMIC GROWTH AND STABILITY
65
3. The Federal Government was able to meet demands on it by ac
tions which involved little or no expenditure of money or which even
brought revenue. Major programs which involved little expenditure
would include the national banking and Federal Reserve systems,
antitrust and the Federal Trade Commission, and the regulation of
railways and other industries. In the 19th century, the Government
also was able to take substantial actions with its great nonmonetary
asset, the public lands. In part, the low level of veterans’ pension
payments prior to the Civil War reflected the use of land bounties to
servicemen. Federal land grants for aid to railways and education
were vastly more important than the cash expenditures for such pur
poses. And of course in the case of the tariff, the Government was able
to meet demands for assistance to business in a manner which brought
revenue. These factors indicate that a study of expenditure patterns
alone is seriously inadequate for an understanding of the general eco
nomic role of the Federal Government before 1900.
4. Federal expenditures were inhibited at times by the nature of the
tax structure and the abhorrence of debt. Prior to the Civil War, the
tariff was the chief source of Federal revenue, but its revenue aspect
was never the sole consideration. During the years 1833-60, the polit
ical power of southern interests made it impossible to increase rates
(except in the face of large depression deficits in 1842), and in fact
created a strong pressure to reduce them as imports grew. Abhor
rence of debt manifested itself in a strong priority for debt retirement
in times when revenues were abundant (1825-36,1850-56), and in de
termination to reduce expenditures in times of depression and low
revenue.
5. Although there emerged in the latter part of the 19th century two
large “underprivileged” groups, the farmers and the industrial work
ing class, the farmers tended to concentrate their attention on such
Government actions as monetary reform, lower tariffs, and antitrust.
The working class was in large measure politically impotent, because
of the high proportion of immigrants, but even the sector of labor with
the highest political potential preferred to seek gains through craft or
ganization and collective bargaining rather than through Government
action.
The increases in Federal expenditures prior to 1900 took place in
well-established channels and at times when the limitations noted were
relatively weak. One major influence toward growth was the terri
torial expansion of the United States under the stimulus of population
increase. A large part of defense expenditure went for frontier pro
tection against Indians, and was greatly in demand especially after
the territorial increases of the 1840’s. Expenditures for Indian affairs,
postal service, and transportation facilities were all linked to terri
torial expansion.
The successive periods of war also tended, to some extent, to create
the revenue necessary for higher subsequent expenditures such as
veterans' benefits. The high tariff rates and belated internal duties of
the War of 1812 brought a flood of revenue after the war, and the
tariff was never restored to its prewar level, although the internal
duties were soon repealed.4 The Civil War created a revenue base
4
Paradoxically, the large relative increase in pension expenditures after 1816 went
almost entirely to Revolutionary veterans and their survivors. Arm y veterans of 1812
received no pensions until after the Civil W ar, nor did those of the Mexican W ar.
66
ECONOMIC GROWTH AND STABILITY
of excise taxes on tobacco and alcoholic beverages which were not
removed after the war, and which had a sumptuary aspect which
made reduction unpopular in some quarters. Pension increases after
1865 were also attractive to Republican politicians because of their
geographic distribution. But the big increase in pension payments
came some 25 years after the Civil War, when the tariff was bringing
in high revenues at a time when the political pressures for protection
were too high to permit rate reductions.
Federal expenditure policies in the 20th century
The large increase in Federal expenditures relative to GNP has
taken place in the 20th century, particularly the years since 1930. This
has been a growth in both the scale and scope of Federal action, with
an enormous proliferation in the number of Federal activities and
the assumption of responsibilities previously left either to States and
localities or regarded as private concerns.5
This change can be explained to a large degree in terms of modifica
tion in the forces formerly limiting expansion. The economy has
become a national unit, which State and local governments have been
less able to cope with. The Federal Government has tapped phe
nomenal new revenue sources which have completely eclipsed the
relatively cumbersome resources of States and localities and have
increased Federal spending capacity. In addition, during the 1920’s
and 1930’s, these new taxes on personal and corporate incomes were
largely imposed on a wealthy minority, so that they did not have the
political unpopularity which has increasingly attached to the per
sonal tax in its more recent role as a mass levy. By the 1920’s farmers
had become a more effective political power and were demanding
positive Federal action rather than regulation of alleged “ exploiters.”
The curbing of immigration in the 1920’s helped pave the way for the
more effective integration of the working class into the political struc
ture. The process of Federal expansion was given considerable im
petus by positive Presidential leadership from Theodore Roosevelt
and Woodrow Wilson.
But the structural and psychological changes just listed took on
effective significance as forces promoting Federal expansion chiefly
under the influence of the economic depression of the 1930’s. Although
President Hoover’s ideological commitment to a limited role of Federal
action was flexible enough to accept the Farm Board and Reconstruc
tion Finance Corporation, he balked at Federal assumption from the
States and localities of responsibility for direct relief. But the de
bility of State and local revenue and credit resources led them to
default on this and other responsibilities. Federal expansion into
this and other areas found a politically effective champion in Franklin
Roosevelt. Hoover’s defeat in the midst of economic chaos repre
sented a thorough discrediting of the traditional ideology of rigidly
limited Federal activity, although some of the worst parts of that
ideology were the last to be discarded.
6 A good idea of this proliferation is conveyed by Solomon Fabricant, The Trend of
Government Activity in the United States Since 1900, National Bureau o f Economic
Research, New York, 1952, pp. 6 1 -7 2 , 2 4 2 -2 4 7 .
See also Paul Studenski and Herman
Krooss, Financial H istory of the United States, M cGraw-Hill, New York, 1 9 52, pp. 2 6 3 -2 7 0 .
ECONOMIC GROWTH AND STABILITY
67
The largest portion of depression-inspired expenditures under the
New Deal went into such straightforward and necessary objectives
as relief (chiefly FERA and W PA) and public works.6 I f anything,
these were too small relative to the task. In any case, they were
temporary and went out of existence during the war.
However, the depression was also the occasion for the inception of
programs of farm-price supports and other subsidies, and for the
social-security program. Both of these were originally very badly
designed as part of fiscal policy to relieve depression, but have become,
paradoxically, important parts of the Government’s standby protec
tion against any subsequent depression.
Many of the most controversial expansions of Federal functions in
the 1930’s did not entail great expenditure increases. Monetary and
banking reconstruction, the National Labor Relations Act, the wagehour law, the NRA and its unwholesome progeny—none of these re
quired great financial expense, but each extended Federal influence
drastically. It is very doubtful if any of them made any appreciable
contribution to recovery, just as it is unlikely that any of them could
have been adopted without the depression as background.
The high level of expenditures in the past decade reflects the assump
tion by the Federal Government of a degree of responsibility for main
taining world peace and order far greater than before 1940. Parallel
ing this has been the continued responsibility assumed during the
1930’s to maintain and increase domestic living standards. The bulk
of Federal spending continues to reflect military outlays. But our
expenditure classification should not cause us to overlook the great
contribution made toward the “welfare state” by the postwar veterans’
program.
With these responsibilities, there has developed no philosophy of
the proper role of the Federal Government relative to the States or to
private activity as rigorous or widely accepted as the old. This is
as true in judicial constitutional interpretation as elsewhere. In many
respects, the traditional view was obsolete, particularly in its dedica
tion to an automatic monetary mechanism and its rejection of depres
sion deficit spending. But the lack of some such standard raises
the danger that Federal spending programs will deteriorate into mere
acts of vote buying. There is also the danger that the Government
will exercise its responsibilities toward individual’s living standards
in such a manner as to create a “ rich man’s welfare state,” in the phrase
of Blair Bolles. Many Government programs have created vested
interests who were not intended as the beneficiaries but whose welfare
is heavily dependent on the program—the construction and farmimplement industries, for example. At the same time, as the investi
gations of the Joint Economic Committee have brought out, the pro
grams of the welfare state may be of little benefit to the really de
pressed members of the economy whose needs are most urgent.
The great increases in Federal spending have reflected in part a
growing role for Government in general relative to private activity
in the economy, and in part a shift in the magnitude of Federal activity
relative to other Government units. These changes are described and
analyzed in detail by Fabricant. We shall do no more than set forth
some of his data which measure them.
6 See Kendrick, op. cit., pp. 3 1 -3 6 .
68
ECONOMIC GROWTH AN© STABILITY
T a b le
II.—Some measures of the changing role of governments since 1900
Expenditures
(billions)
Purchases
(billions)
1949
1903
$0.6
1.1
$36.2
23.6
1.7
59.8
1903
1900
1955
$0.2
.6
.8
Ratio of total of total government to total
Em ploym ent
(thousands)
1949
$46.7
30.1
312
852
3,608
3,478
76.8
1,164
7,086
20
4
12
4
Sources: Solomon Fabricant, The Trend of Government A ctivity in theUnited States Since 1900, National
Bureau of Econom ic Research, 1952; 1955 figures from Economic Report of the President, 1957. For a similar
attempt at measurement, see R . A. Musgrave and J. M . Culbertson, The Growth of P ublic Expenditures
in the United States, 1890-1948, National Tax Journal, June 1953.
E
v o l u t io n
of t h e
F
ederal
R
evenue
S tructu re,
1790-1956
Table I I I presents the general magnitudes and composition of Fed
eral revenues for the same time periods used for expenditures. Since
revenue growth has roughly paralleled that of expenditures, we will
not devote separate attention to comparisons of tax levels with output,
population, or prices. Our concern will be with some of the influences
on revenue development, and its implications.
T a b le II I .—
The Federal revenue Structure, 1790-1956
Average annual tax revenue
Period
Number
of years
Customs
Income
and
profits
Land
sales
Other
Other
Total
Total
M illions of dollars
1790 to
1812 to
1816 to
1837 to
1862 to
1866 to
1891 to
1811_________
1815_________
1836_________
1861_________
1865_________
1890_________
1916................
22
4
21
24^
4
25
26
9.3
9.5
22.8
35.8
121.0
200.0
235.0
(')
(3)
(3)
522
512
« 15
a 0.4
* 2.9
.8
4
71.0
136.0
245.0
9.7
12.4
23.6
35.8
213.0
348.0
495.0
0.3
1.1
4.1
3.5
1.0
6.0
7.0
0.1
.4
.2
1.4
9.0
4.0
15.0
10.1
13.9
27.9
40.6
223.0
358.0
517.0
0.2
.5
.6
1.0
2.0
3.2
4.3
4.8
35.0
57.0
Billions of dollars
1917 to
1920 to
1930 to
1942 to
1946 to
1919.................
1929____ ____
1941_________
1945_________
1956.............
3
10
12
4
11
0.2
.0
.3
(J)
1.0
1.9
2.3
8 2.7
8 29.0
M6.0
0.9
1.0
1.2
5.0
9.0
3.0
3.8
4.2
34.0
55.0
0)
C)
0)
(7)
(’)
3
Tax on bank dividends, 1796-1802—no separate data.
2 Levied 1791-1802 only.
3 Tax on bank dividends yielded about $0.1 million annually, 1815-18.
* Levied 1814-17 only.
s Levied 1863-72 only.
* Beginning 1910.
Less than significant minimum at this level of rounding.
* Includes social-security taxes for old-age and unemployment insurance.
7
N o t e s . —Totals
are net of refunds, but customs and land sales include certain related fees.
Sources: See end of paper.
Choice of Federal revenue sources, within the limits imposed by
the Constitution, has always represented a compromise between the
political problem of distributing the burden, the administrative prob
lem of collection, and the economic problem of the size and stability
ECONOMIC GROWTH AND STABILITY
69
of the revenue source. In the early 19th century the tariff met these
needs to a higher degree than other feasible taxes, and served as the
main, or, in many years, the only source of tax revenue. Hamilton’s
excise program was widely disliked. Objection to the whisky excise
(even then the chief revenue producer) came from the large number
of small western farmers who relied on the still to furnish a readily
marketable cash crop. Thomas Jefferson regarded it as a major
achievement of his presidency that all the internal taxes were termi
nated and exclusive reliance placed on the tariff. This was preferred
because of its relative invisibility to consumers, because some protec
tionist sentiment already existed, and because it was levied at one of
the few points in the economy where transactions in money pre
dominated.
Extensive reliance on the tariff had several important implications.
First, because of the waxing and waning of effective protectionist
sentiment, tariff rates were likely to be determined partly for reasons
unrelated to revenues and expenditures. Second, the money-flow
effects of tariff changes were ambiguous. Higher rates would tend to
lower money incomes by diverting more money to the Government
(assuming expenditures unchanged), but this might be offset by a
shift in private expenditures from imported to home products. Third,
the tariff proved a poor revenue source during wars, which usually
interfered with trade. Fourth, revenues from the tariff (and from its
chief supplement before 1860, sales of public lands) were very sensi
tive to economic fluctuations. In periods of recession, imports usually
fell sharply, cutting revenues, and resulting in deficits since expendi
tures were reduced only gradually. This gave the Federal fiscal sys
tem a degree of “built-in flexibility.”
During the Civil War, a comprehensive program of excise and
related taxes was reinstituted. Many of these were repealed at the
end of the war, but taxes on tobacco products and alcoholic beverages
were retained, and furnished a large share of Federal revenues down
through World War I. The liquor producers were no longer numerous
enough nor able to muster sufficient sympathy to escape taxation.
The Civil War also brought the first Federal income tax, but this was
repealed in 1872.
Tariff controversy over protectionism continued in the post-1865
period, with the protectionists generally having more success than
in prewar years. They suffered an embarrassment of riches in the
1880’s, when revenues rose rapidly at a time when it was difficult to
retire much of the Federal debt. The solution, as noted above, was
chiefly a great increase in pension spending.
The revenue pattern of the post-Civil War period, with its heavy
reliance on indirect taxation, probably produced a regressive incidence
of burden. However, it was generally favorable to saving and invest
ment while bearing relatively hard on consumption. The excise taxes
demonstrated more stability of yield in economic fluctuations, and
thus reduced the degree of automatic flexibility.
The progressive era and World War I worked a revolution in
Federal revenues. A constitutional amendment opened the way for
a personal income-tax law in 1913, while a tax on corporation profits
was imposed in 1910. The war emergency brought drastic increases
in rates, and the income and profits taxes leaped into the dominant
'position which they have held ever since. During the war, the
70
ECONOMIC GROWTH AND STABILITY
personal tax approached the character of a mass tax, but the subse
quent exemptions restored it to the status of a tax on the wealthy
minority, which it remained, with modifications, until World War II.
During the depression, tax rates were drastically increased, in direct
contravention of modern fiscal thinking. The increases offset in con
siderable measure the beneficial effects of increased expenditures.
The principal innovation of permanent significance came in. the socialsecurity program, which imposed wage and payroll taxes. By 1956
these taxes (including State payments into the Federal Treasury)
accounted for more than 10 percent of Federal revenue.
Revenues from personal and corporate income taxes have continued
to dominate the Federal revenue structure during the past decade.
In recent years, the personal tax has alone furnished about two-fifths,
and the corporate tax about one-fourth, of Federal revenue. Excise
taxes have yielded about one-sixth. Public policy toward the tariff
and the public lands has lost any relation to Government revenues.
A number of circumstances influenced the rapid shift from indirect
to direct taxation. Necessary prerequisites were the rise of the cor
poration as the dominant form of business organization, the shift
in the labor force toward occupations paying money incomes for
services, and a relatively high degree of efficiency in administration
and of voluntary compliance by the public. Probably current levels
of personal tax collection would be difficult without withholding at
the source. There have also been changes in effective public opinion
on the subject of proper tax burdens, but these are not as easy to
trace as the development of actual tax policy might suggest.7 Prob
ably more important has been the changing political potency of highversus low-income groups.
At present the Federal tax burden is much more progressive with
respect to income than it was in the latter part of the 19th century.
This probably also means that it falls more heavily on sources of
funds for saving and investment (not assumed to be identical), what
ever the effects on incentives. The present system also possesses a
relatively high degree of automatic flexibility in response to economic
fluctuations. This flexibility is more significant than that of the 19th
century because of the larger absolute level of tax revenues.8
T
he
P
a t te r n of
F
is c a l
P
o l ic y as a
W
hole
Modern income analysis has thrown much more attention on the re
lation between the total money flow into and out of the Government
and the level of national money income. Analysis of fiscal policy
has given particular emphasis to two situations: wars and depressions.
In wartime, Government fiscal policy may be excessively inflationary,
whereas in depressed times an upward influence on incomes and spend
7 There was considerable sentiment favoring progressive rate structure in the early 19th
century, and the Federal direct tax of 1798 imposed a progressive rate on real property.
8 Recent attempts to measure the flexibility of the revenue system indicate that the
decrease in Federal cash receipts would range between 20 and 35 percent of any decline in
gross national product. The effect on private spending for consumption and investment
would probably be less, especially where the corporate tax is involved. See Everett E.
Hagen, Federal Taxation and Economic Stabilization, Federal Tax Policy for Economic
Growth and Stability : Papers Submitted by Panelists, Joint Committee on the Economic
Report, W ashington, 1955, pp. 5 8 - 6 0 : papers and comments by David W . Lusher, Samuel
M . Cohn, Gerhard Colm, A. G. H art, Joseph A. Pechman, Richard Goode, Ida C. Merriam,
and K arl A. Fox in Policies To Combat Depression, National Bureau of Economic Research,
New York, 1956.
71
ECONOMIC GROWTH AND STABILITY
ing is desired. We will examine each of these aspects of fiscal policy
historically.
Fiscal policy in wartime—Deficits and inflation
During the period under study, the Federal Government engaged
in four major wars. In table IV are summarized some of the im
portant aspects of aggregate fiscal policy in these periods. The data
indicate that substantial deficits have been the rule, although revenues
as well as expenditures have usually been higher than before the
war. In no case did the Government succeed in covering as much
as half of its expenditures by current revenues. Further, each of
the four wars was a period of substantial price inflation. The figures
suggest some improvement in recent times, but the price figure for
World War II probably overstates the value of the dollar (because
of quality deterioration, shortages, etc.) and does not take account
of continuing price increases after 1945.
T a b l e IV . —
Federal fiscal policies and wartime inflation
Expenditures
Period
Average reve
nues
Average
1812 to
1862 to
1917 to
1942 to
1815...
$14,000,000
1865...
223,000,000
1919... 3,200,000,000
1945... 35,000,000,000
$30,000,000
727,000,000
11,000,000,000
76,000,000,000
Ratio to Ratio to
average of
gross
prewar 5 national
years
product
300
1,100
1, 570
800
3- 5
10-14
17-18
40
Share of
gross
national
product
taken b y
L/nited
States
2- 4
9-11
14-16
38
Increase in prices over
last prewar year
Wholesale
prices
Consumer
prices
50
100
60
35
75
60
30
N o t e . — Calendar years 1812-15; fiscal years ending June 30 thereafter.
Price data are those of Bureau of Labor Statistics, including unpublished consumer price data for Civil
W ar. Calculation is based on annual averages for calendar year and results are rounded. Published data
are from Historical Statistics of the United States and Federal Reserve Bulletin.
The four wartime periods have differed considerably in the propor
tion of expenditures covered by revenues, and in the general magnitude
of Federal operations. The Federal Government’s absorption of re
sources during the War of 1812 was less than 5 percent of the Nation’s
output, whereas World War II required about 40 percent.9 The
Civil War appears to have involved a smaller share than World War
I, but this result is questionable, since our figure compares Federal
(northern) purchases with total national output. As a percentage of
northern output alone, Federal purchases would probably have
amounted to about 15 percent.
_ Although abhorrence of debt was a fairly constant factor in peace
time fiscal policy, Government officials were relatively tolerant in their
attitude toward wartime deficits.10 There was no recognition of the
9 The inflation during the W ar of 1812 was completely out of proportion to the expan
sionary force of Government deficit spending. In part, it reflected additional credit crea
tion by the banks, but chiefly it resulted from the drastic dislocation of international and
interregional trade by both American and British policies. Prices of imported products
rose far more than those produced at home.
10 Albert Gallatin’ s maxims undoubtedly helped strengthen a tendency in fiscal policy
which would have existed anyway. In 1807 he argued that “ the losses and deprivations
caused by * * * war should not be aggravated by taxes beyond what is strictly necessary.”
Loans should be the chief source of funds, with increases in taxation only sufficient to
cover “ the annual expenses on a peace establishment, the interest on the existing debt, and
the interest on the loans which may be raised” (American State P ap e rs: Finance, II, 2 4 8 ).
H a lf a century later Secretary Salmon P. Chase advocated the same program for Civil W ar
finance.
72
ECONOMIC GROWTH AND STABILITY
function of taxes to curb excessive private spending. The chief ar
gument for them was that they would improve the Government’s
credit standing by assuring a secure basis for interest payments and
debt redemption.11
While 19th century officials ignored the inflationary consequences
of deficits per se, they were not indifferent as to the manner in which
the deficits were financed. Efforts were usually made to cover them
through loans, but these were never sufficient. During the War o f
1812 the Treasury issued interest-bearing Treasury notes which were
designed to circulate as a close substitute for currency. During the
Civil War, the Government created the first Federal paper currency
to become a permanent part of the Nation’s monetary system. Half a
million dollars of paper currency was issued, which directly covered
about one-fifth of the total deficit, and also made it easier to finance
the rest by borrowing back some of the currency. But in addition to
these actual issues of currency or near-currency, the war loans drew
heavily on expanded bank credit in notes and deposits, which also
increased the money supply. Although official understanding of the
inflationary nature of monetary expansion was not lacking, there was
a strong tendency to concentrate on the maintenance or resumption o f
convertibility into specie, assuming that prices and other economic
factors would automatically achieve satisfactory levels.
The crude device of direct currency issues on a large scale has been
rendered obsolete by the establishment of the Federal Reserve System.
During World War I, sale of Federal securities was facilitated by the
expansion of Federal Reserve credit in rediscounts and loans to banks.
Individuals and business firms were encouraged to borrow from banks
in order to buy war bonds, and banks themselves purchased substan
tial amounts. During World War II, the Federal Reserve itself pur
chased large amounts of securities in the open market, enabling the
banks to purchase a still larger quantity with the resulting reserves.
In every war, except that of 1812, the Government made substantial
efforts to achieve wide distribution of ownership of war securities
among individuals. In general, however, wartime borrowing has
been chiefly a disguise for money creation. It is not obvious that the
issue of interest-bearing securities which do not serve to divert funds
out of private spending is really the most rational technique of war
finance.
One of the first fruits of national income analysis was the better
recognition during World War II of the merits of high taxes in curb
ing inflationary pressures, as well as of the dangers which inflation
might entail. This improved attitude toward taxation was also very
much in evidence during the Korean emergency.
Wartime fiscal policies provide most of the direct historical evi
dence available about the potential effects of Federal deficits in raising
national money incomes. Interpreting the evidence is complicated,
however, by the association of deficits with money creation. One
cannot disprove the arguments of convinced adherents of the quantity
theory of money that it is the latter which really provides the expan
sionary push.
“ See Henry C. Adam s, Public Debts, 1888, p. 119.
73
ECONOMIC GROWTH AND STABILITY
Fiscal policy and economic -fluctuations
The history of the American economy from 1790 to 1945 is a his
tory of considerable instability in production, employment, prices, and
incomes. Even in the agrarian days before 1860, wide fluctuations in
farm prices on international markets, combined with the inevitable
burden of farm debt, created widespread periodic farm distress to be
added to the unemployment in the less developed construction and
manufacturing sectors of the economy. Nineteenth century fluctua
tions stemmed in part from the balance of international payments,
through changes in foreign demands for American goods and in the
flow of foreign capital to this country. To these influences were added
an unsound banking system, which received most of the blame, and a
pattern of investment in fixed capital which was very unstable.
Table V shows in briefest outline the behavior of Federal surpluses
and deficits during seven major business-cycle peaks and recessions.
In each case there is a strong correspondence between fiscal policy and
the phase of the cycle. With one exception, the Government shifted
from a position of surplus at or before the peak to one of deficit during
the recession. The one exception was in the high-surplus times of
the 1870‘s, and then the surplus dropped off sharply in recession.
This pattern was largely imposed on the Government by declining
revenues in recession.
T a b le
V.— Federal surpluses and deficits during major cycle peaks and recessions,
1815-1932
(Surplus or d eficit ( —) expressed as p ercent of average revenue an d expenditure during the in clu d ed cycle]
Period
1815-21
1 ____________________________
2 __________ _____ _______
3 ____ ____________ _______
4 (peak)_______
......
__
D-------- ------- ------------------6____________ ____ ________
' --------------------------- ----------
63
67
40
6
12
-5
-1 0
1834-42
12
65
83
— 132
1854-60
5
12
-1 9
-3 0
-2 3
32
12
16
3
-4 2
-2 7
-1 5
1870-76
36
29
34
18
8
5
8
1890-96
30
13
4
3
-2 0
-1 3
-1 1
1904-11
1926-32
-9
-6
4
12
-1 2
-1 7
-3
29
32
27
26
25
-2 9
-8 2
Average revenue and expenditures
Millions cf dollars... _____
Fercent of gross national
product_________ _______
24.9
29.4
61.8
316
335
589
3,400
1-2
1-2
1-2
4-5
2-3
2-3
4-5
N o t e — D ata for 1834-37 are on left side, 1838-42 on right side o f the co lu m n for 1834-42, since b o th 1837
an d 1839 are regarded as peak years.
When deficits resulted, they were usually financed through borrow
ing from banks, drawing on Federal cash balances, or issuing more
currency or near-currency. Consequently .they probably exerted some
cushioning effect during recessions. It is not certain that surpluses
exerted any check during boom periods, however, since repaying the
public debt often channeled funds into an active capital market where
they were in demand.
The cushioning effect of Federal deficits was limited by the tend
ency to cut Federal expenditures in response to declining revenues
during 19th century recessions. However, expenditures were actually
increased in the recession following 1907, chiefly for naval expansion.
74
ECONOMIC GROWTH AND STABILITY
And in the years following 1929, spending rose through programs
aimed at the economic slump itself.
In all cases except possibly that of post 1929, the magnitude of Fed
eral deficits relative to total GNP was so small as to render their pos
sible income effects insignificant.
_
Contemporary official opinion disapproved of depression deficits,
but generally tax rates were not increased to do away with them.
The tariff increase of 1842 is somewhat of an exception, and a clearer
exception was another tariff increase of 1875. In both cases, however,
the increases were desired for protectionist as well as revenue purposes.
Further, their effect on national money income was not necessarily
deflationary. We conclude that tax increases did not impair the ex
pansionary effects of Federal deficit spending in pre-1929 depressions.
The case of the recession years following 1929 is drastically differ
ent. Although minor tax reductions were made in 1930, in 1932 a
Democratic House joined a Republican Senate and President Hoover
in enacting the largest peacetime tax increase in history. This meas
ure cut substantially into the beneficial effects of the increased Fed
eral spending. We shall return to this shortly.
Public opinion in and out of the Government has always been
painfully aware of economic depressions and articulate in search of
a cure. But throughout the 19th century and well into the 20th, the
discussion of the causes and possible remedies ran heavily in terms
of money and the banking system. Emphasis in fiscal theory was
placed on the monetary effects of Federal surpluses and deficits,
rather than their direct relation to income flows.12
Nor was Treasury concern with money and banks merely a matter
of thinking and talking. From the time of Hamilton, Treasury offi
cials used their discretionary authority over the public debt and the
Government’s cash balance as methods of trying to alleviate depres
sions, panics, and stringencies. After the Civil War the Treasury
was intimately concerned with this at all times, until the formation
of the Federal Reserve System.13 When an occasional insight into
the potential benefits of depression deficits did appear, it was usually
accompanied by constitutional scruples against such action.14
Fiscal policy a/)lddepression, 1929-Jfi
The management of Federal fiscal policy during the depression is
still interesting and relevant to contemporary affairs. Numerous er
roneous views about it still prevail. The student of stabilization pol
icy must be especially concerned with two common assertions. One is
12 Considering the relative magnitudes Involved, this was perhaps the correct emphasis.
In the years 1 8 4 6 -6 0 , fo r instance, Treasury transactions were carried on chiefly in specie,
and the scale of absorptions and releases of specie by the Treasury made a much larger
impact on bank reserves than did fiscal policy on incomes. I have quoted some relatively
sophisticated theories of this monetary relationship by contemporary writers both in and
out of Government in 'The Idea of “ Biuilt-In Flexibility,” 1 8 3 7 -6 0 , Public F inance/Finances
Publiques. X I : 4, 1956.
18 See Esther Rogoff T aus, Central Banking Functions of the United States Treasury,
Columbia University Press, New York, 1943.
14
In face of declining revenues during the panic of 1857, Secretary of the Treasury
Howell Cobb wrote, “ I t is seriously urged that our expenditures should be increased for the
purpose of affording relief to the country. Such a policy would undoubtedly furnish
employment to large numbers of worthy citizens. I t would require the use of large
amounts of money, to be raised either by a loan or * * * Treasury notes, and would thus
afford temporary relief to the country to an extent limited only by the discretion of the
Government * * *. But where shall we look for the power to do this in the Constitu
tion ?” Cobb did urge that expenditures not be reduced, even if deficits had to be incurred.
Annual Report on the State of the Finances, 35th Cong., 1st sess., H . Doc. No. 3, p. 11.
President Buchanan endorsed the principle of expenditure maintenance, and the extent of
reductions was slight.
75
ECONOMIC GROWTH AND STABILITY
that such New Deal measures as agricultural supports, the NRA, the
National Labor Relations Act, social security, the wage-hour law, and
monetary and banking reforms restored the country to prosperity.
The second, from a different quarter, is that the New Deal was an em
bodiment of Keynesian doctrine, that it engaged in large-scale deficit
financing, and that the evident failure to cure the depression proves
that deficit spending won’t work.
Table V I summarizes some of the important economic magnitudes
of the depression years.
T a b le
VI.— Statistical background of the great depression
Consumption
Calendar year
1929____ ____ _
1930_____________
1931...... ............
1932_____ ____ _
1933_____________
1934...____ ______
1935______ _______
1936_____________
1937_____________
1938_____________
1939____ ________
1940........................
Fiscal year
1929.............. .
1930................
1931................
1932....... .........
1933-........... .
1934________
Gross
national
product
Output
in 1929
prices
BiUions
$104
91
76
59
56
65
73
83
91
85
91
101
Billions
$104
95
88
77
73
80
90
100
108
102
110
120
Federal
revenues
Billions
$3.8
4.0
3.2
2.0
2.1
3.1
Federal
expendi
tures
Billions
$2.9
3.1
4.1
4.8
4.7
6.5
As percent
of dis
posable
incomes
Total
Billions
$79
71
61
49
46
52
56
63
67
65
68
72
Percent
95
95
96
101
101
100
96
95
95
98
96
94
Deficit C— )
or surplus
Fiscal year
Billions
$0.9
.9
- 1 .0
- 2 .7
—2. 6
—3.3
1935................
1936..............
1937................
1938.............. .
1939................
1940—
Gross busi
ness in
vestment
Govern
ment pur
chases
Billions
$13.0
8.0
4.0
.3
1.0
2.0
5.0
7.0
10.0
5.0
7.0
10.0
Billions
$9
9
9
8
8
10
12
12
12
13
13
14
Federal
revenues
Billions
$3.8
4.2
5.6
7.0
6.6
6.9
Federal
expendi
tures
Billions
$6.3
7.6
8.4
7.2
9.4
9.6
Percent
of labor
force un
employed
Percent
3
9
16
24
25
22
20
17
14
19
17
15
Deficit (—)
or surplus
Billions
-$ 2 .4
-3 .5
- 2 .8
-.1
-2 .9
-2 .7
Sources: Economic Report of the President, 1956; Department of Commerce, National Income, 1954;
Historical and Descriptive Supplement to Economic Indicators, 1957.
The late 1920’s were years in which, under the influence of the
stock-market boom, industrial capital equipment was built up at a
rate which could only have been sustained if total expenditures for
goods and services increased more rapidly than they could be ex
pected to. Once actual expansion ceased, as it did in the summer of
1929, business needs for additional capital goods fell. And when de
mand for output began to fall, many firms found themselves with ex
cessive capital. The downswing was a reciprocal process in which
business investment and personal consumption spending kept pushing
each other further down. By 1932 business investment had nearly
ceased altogether.
The figures indicate that the decline in consumer spending was
wholly induced by declining incomes—in fact consumers spent a larger
proportion of their incomes than in prosperous times. Much of the
decline in investment can also be regarded as induced by falling de
mand. The reluctance of consumers to cut their spending in proper
76
ECONOMIC GROWTH AND STABILITY
tion to their incomes—in fact, their willingness to spend more than
their disposable incomes in 1932-33—probably did the most to pre
vent the decline from continuing further.
The Hoover administration was not indifferent to the distress
around it. In fact, the President spoke truthfully when he as
serted in 1931 that—
for the first time in history the Federal Government has
taken an extensive and positive part in mitigating the effects
of depression and expediting recovery.13
Emergency agencies were created; innumerable conferences were held.
More important, Federal expenditures were increased substantially,
with particular emphasis on construction. The Government had
started from a position of substantial surplus, and for a time could
spend more without a deficit. In combination with declining rev
enues, however, this increase produced large deficits in fiscal 1932 and
1933—larger on the average, in fact, than those of the 6 subsequent
years of the New Deal. The deficits alarmed the President, and dur
ing the last 2 years of his administration he manifested a concern
for cutting expenditures and increasing tax revenues which amounted
to an obsession. This concern stemmed in part from a conviction
that deficits were economically harmful.16 Unfortunately for the
Nation’s economy, most respectable opinion shared this view. Con
sequently Congress enacted in 1932 a substantial increase in income and
excise taxes.
Hoover’s defeat and the advent of the NewTDeal in 1933 opened the
way for a drastic reorientation of Federal functions, but this did not
extend to fiscal policy.
Our statistics drive home two important facts: First, the New Deal
did not get the country out of the depression. Average annual ememployment did not fall below 14 percent in the years 1933-40 and
was still 10 percent in 1941. Second, the New Deal did not engage
in large-scale deficit spending. Federal expenditures rose substan
tially, but wyere matched by higher taxes. The experience of the
1930’s gives us little evidence of the potential effectiveness of deficits
in depression. The rapid expansion of output and unemployment
under the stimulus of large deficits in World War II are much more
indicative of their potential power.
There is ample evidence that President Roosevelt largely shared the
fiscal views of his predecessor. During the campaign in 1932 he
criticized Hoover for incurring deficits and promised to wipe them
out through economy. Upon inauguration he took steps to reduce
15 W illiam S. Myers and W alter H. Newton, The Hoover Adm inistration : A Documented
N arrative Charles,Scribner's Sons, New York, 1936, p. 20.
16 In 1932 he stated that “ It is generally agreed that the balancing of the Federal budget
and unimpaired national credit is indispensible to the restoration of confidence and to the
very start of economic recovery * *
Quoted In James A . Maxwell, Fiscal Policy,
Henry Holt, New York, 1955. p. 13. For a history and analysis of this and related Ideas,
see Jesse V . Burkhead. The Balanced Budget, Quarterly Journal of Economics, May 1954,
reprinted in Arthur Smithies and J. Keith Butters, eds., Readings in Fiscal Policy, Kicharrt
1). Irwin, Homewood, 111., 1 9 5 5 ; Sidney S. Alexander, Opposition to Deficit Spending for
1lie Prevention of Unemployment in Income, Employment, and Public P o lic y : Essays in
Honor of Alvin Hansen, W . W . Norton, New York, 1948.
ECONOMIC GROWTH AND STABILITY
77
Government salaries and veterans’ pensions. In his budget message
of January 1934, he stated:
we should plan to have a definitely balanced budget for the
third year of recovery and from that time on seek a continuing
reduction of the national debt.
Taxes were increased in every year from 1933 through 1937. The first
agricultural adjustment program was financially based on a wickedly
regressive processing tax, rather than deficits. The social security
system was set up with a strongly deflationary reserve provision and
a regressive tax-rate structure. New Deal deficits were, through 1937,
the inadvertent and undesired result of expenditures undertaken for
their own sake.17
President Roosevelt did not see the depression as a problem of inade
quate spending, but rather of undesirable price declines. In aiming
his recovery measures chiefly at prices, he failed to distinguish be
tween higher prices as a symptom of strong demand and as a symptom
of short supply. His administration also interpreted the depression
largely in terms of the particular problems of particular distressed
sectors, without perceiving their common difficulty. In consequence,
the emphasis of the so-called “ recovery” program was on measures
essentially restrictionist in their nature, notably the NRA and the
first AAA. Likewise, the revaluation of the dollar, the National
Labor Relations Act, and the wages and hours law did not bring any
net increase in the total income and spending capacity of the economy
as a whole.
In 1937, expenditure cuts recommended by the President and the
influx of social-security tax revenues reduced the Federal cash deficit
almost to zero. Partly in consequence, the economy fell into a short
but painful and disturbing recession. This finally brought the Presi
dent to accept a positive role for fiscal policy as such, as evidenced by
his “spend-lend” program and budget message of January 1939, and
expenditure increases restored the cash deficit.
On the whole, New Deal fiscal policies made no strong contribution
to recovery.18 Their shortcomings are measured by the slow and
tortuous rise in consumption. Tax increases prevented the rise of
Federal expenditures from p r o d u c i n g any substantial increase in
consumer disposable incomes. Had the latter risen, consumer spend
ing would undoubtedly have gone higher and helped restore business
investment.
Several relevant lessons may be derived from New Deal experience.
Adherents of fiscal conservatism may note that public opinion will not
tolerate Government inaction in the face of depression. Consequently,
if the Government does not do the right things (increasing total
spending), it will probably do the wrong things—things which in
17 “ There is no evidence that the administration, as distinct from some persons within
it and some economists offering advice from outside, ever had a conscious interest in fiscal
policy as an instrument of recovery prior to the new depression in 1938. Government
spending was primarily for relief and was regarded only as the unavoidable accompani
ment of unemployment until recovery could be achieved by other means.”
John H . W il
liams. The Implications of Fiscal Policy for Monetary Policy and the Banking System,
Papers and Proceedings of the American Economic System March 1942, reprinted in
Rendines in Fiscal Policy, pp. 1 9 0 -1 9 1 .
18 This is the conclusion reached by E. Cary Brown, Fiscal Policy in the Thirties : A
Reappraisal, American Economic Review, December 1956.
Compare the more favorable
view reached by Gerhard Colm, Public Spending and Recovery in the United States,
abridged from Social Research, May 1936, in his Essays in Public Finance and Fiscal
Policy, Oxford University Press, New York, 1955.
97735— 57--------7
78
ECONOMIC GROWTH AND STABILITY
crease Government intervention in detailed production, price, and
income decisions, or which give favored groups protection from the
rigors of competition and change. Deficit spending may appear more
attractive as an alternative to these. Latter-day liberals may be re
minded that good intentions are not sufficient to produce good policies,
even if wrapped in the finest rhetoric. And one should not accept
uncritically the whole panoply of New Deal measures on the assump
tion that they really restored the economy to a prosperous condition.
However, in all fairness, we must point out that many New Deal meas
ures, while ineffectual in curing the depression of the 1930’s, have
become important parts of our defense against any future depression.
This refers particularly to the structural reforms of the banking and
financial system and to the automatic flexibility latent in the social
security and agricultural programs.
Recent developments and contemporary problems
Fiscal policy since 1940 has been marked by a much higher degree
of rationality than before, particularly since the Employment Act of
1946. The performance of fiscal policy, as measured by the mainte
nance of high production and employment, has been good. Recessions
have been mild and have been met with appropriate responses in tax
and spending policies. Closer examination may leave us uncertain as
to what this experience proves, however.
First, high levels of demand in recent years have reflected continued
high Federal defense spending and a relatively unflagging rate of
business-capital formation. There has been no practical demonstra
tion of what fiscal policy could do to reduce the adverse effects should
either of these decline substantially.
Second, the good performance of fiscal policy in offsetting recessions
has been partly good luck. This is notoriously evident in the case of
the tax reduction of 1948, passed over a Presidential veto in the last
stages of inflation, to go into effect just as the economy was sliding into
unforeseen recession. More favorable in appearance was the willing
ness of the Republican administration to reduce taxes and incur
deficits during the recession of 1953—but the recession itself stemmed
largely from cuts in defense spending.
Third, fiscal policy has shown much less capacity for curbing infla
tion. This partly reflects the political difficulty that counterinflation
measures reduce people’s access to money and are therefore likely to
be unpopular. But there are other limitations. It would have been
undesirable to increase taxes in World War II sufficiently to drain
off inflationary demands, although more could probably have been
done safely than was. The Korean emergency indicated that fiscal
policy probably cannot cope with a sudden outburst of private scare
buying, although the flexible tax structure undoubtedly absorbed some
of the pressure, and tax-rate increases were admirably strong.
Most recently, the outbreak of the “ new inflation” in the last 18
months has raised the disturbing possibility that some inflation may
come from costs rather than excessive demand. The actual importance
of the Federal budget itself as an inflationary force in this period
remains unclear, although it is easy to find fault with the view that
the cash budget cannot be inflationary unless it shows a deficit. The
proper role of fiscal policy in such an inflation is also unclear—can
price increases be prevented by curtailing demand without producing
ECONOMIC GROWTH AND STABILITY
79
too much unemployment and loss of output ? The contemporary chal
lenge to fiscal policy seems to lie in the problem of inflation controlj
and particularly in controlling the expansion of Federal spending in
the face of many legitimate demands and needs for increases.19
F
is c a l
P
o l ic y
and
E
c o n o m ic
G
row th
The relation between fiscal policy and economic growth takes many
forms. Obviously Government functions and activities such as re
search, public capital formation, health and education programs, etc.,
can actively promote growth. This discussion will deal only with
aspects which pertain to fiscal policy as a whole. Two chief types of
influence can be distinguished. On one hand, a fiscal policy which pro
motes economic stability, high incomes and demands, and relatively
full employment will undoubtedly help to stimulate the incentives of
business firms to invest and to innovate.20 But we have no real his
torical evidence on this as yet.
Fiscal policy can also influence the availability of funds for invest
ment. Historically the important influences have been the tax struc
ture and public-debt policy. The tariff-excise combination of the
19th century probably placed the burden primarily on consumption.
The shift to personal and corporate income and profits taxes has un
doubtedly increased the relative burden on saving, and through it, on
investment. Probably the most serious aspect of this has been the dis
advantage imposed on the investment capacity of small, growing firms.
One’s judgment on the relative loss to aggregate investment must cer
tainly be conditioned by the enormous volume of capital formation
whicla the economy has generated in the past decade.21
Public-debt policy may also exert a substantial influence on the
volume of investable funds. Historically, Federal borrowing lias
generally occurred during periods of war or depression and has in
variably drawn to a large extent on newly created money or idle
balances, instead of diverting funds from private capital formation.
Debt retirement, however, has generally occurred in prosperous times,
when the demand for funds has been high for capital formation. Debt
retirement has commonly placed funds in the hands of wealthy in
dividuals and financial institutions, so that they were likely to move
into other investments rather than consumption.
Together, the revenue and public-debt policies of the 19th century
probably exerted an influence in the direction of “ forced saving,”
diverting funds out of consumption into investment. However, the
Government’s revenues from land sales removed some funds from the
capital market.
A rough estimate, making allowance for issue and redemption of
currency and near-money, suggests that Federal finance shifted about
19 An excellent brief review of the period since 1930 is given in Gerhard Colm, Fiscal
Policy and the Federal Budget, in Max Millikan, ed., Income Stabilization for a Developing
Democracy, Yale University Press, New Haven, 1953, pp. 2 1 4 -2 2 7 .
On the postwar period,
see also Alvin H . Hansen, The American Economy, M cGraw-Hill, New York, 1957, pp.
9 0 -1 3 1 .
20 One m ust beware of the fallacy in the often-encountered argument that the Govern
ment must promote high consumption (e. g., through taxes which bear more on saving) in
order to stimulate (induced) investment. Any kind of spending for the products of a
capital-using firm can stimulate induced investment, and consumption may actually do
so less than some other possible types. A high-consumption economy may be desirable, but
hardl^ because it w ill produce a high rate of output growth. I t is a high-demand, fullemployment economy generally which is desired.
21 On these matters, see papers by R. A. Musgrave, J. K . Butters, and Paul W . McCracken
in Federal Tax Policy for Economic Growth and Stability.
80
ECONOMIC GROWTH AND STABILITY
$80 millions into the capital market from consumption in 1790-1860,
most of it representing redemption of securities for which the Govern
ment received no money originally. During the period of heavy
postwar debt retirement in 1866-90, about $600 million was so shifted,
but in the period 1891-1916, the Government was a net borrower of
about $250 million.
During the 1920’s, the Government poured some $9 billion into debt
retirement, but the reduction in saving through progressive taxation
may have been equally large. After World War II, net cash debt
retirements in 1947-52 totaled about $30 billion. Most o f this passed
through commercial banks and insurance companies (directly, or in
directly through shifts in remaining debt) into other financial assets
and thus into the capital market.22 Again, the adverse effect of taxa
tion on saving may have offset this. But one should certainly not look
merely at that adverse effect without noting that the debt retirement
may have offset it.
S
om e
C
onceptual
P
roblem s
U
n d e r l y in g
H
is t o r ic a l
A
n a l y s is
The characteristic analysis of fiscal policy runs in terms of such
aggregates as revenues, expenditures, surpluses and deficits. Defini
tions and computations of these have traditionally been determined
by the information needs of government officials, which have not al
ways coincided with the interests of economists.
One approach to fiscal data would follow the conventions of national
income accounting. Government revenues and expenditures would
be those included in the income and product accounts as computed by
the Department of Commerce.23 This particular compilation has sev
eral possible drawbacks. It gives taxes on the basis of accruals rather
than collections, and it omits certain transactions which seem to fall
economically in between income and product at one extreme and pub
lic debt at the other. These are mainly Government lending and re
payment, and in the past, transactions in land. These drawbacks do
not exist in the cash consolidated statement of receipts from and pay
ments to the public which currently appears in the annual budget
document. The figures used in this paper come closer to the latter
basis of calculation.
Use of the term “ cash” in the latter case is somewhat misleading—
“ current account” would be more nearly correct. A genuine cashconsolidated account for the Government is found in the money-flow
analysis developed by Morris Copeland and now published by the
Federal Reserve Board of Governors.24 This approach has the advan
tage of incorporating public-debt policy, which may be significant
even for short-term fiscal interpretations. It is generally assumed,
for example, that a cash surplus is deflationary, but if the funds are
used to repay publicly held debt in prosperous times, when the funds
find their way promptly into private spending, the conclusion may be
unwarranted.
31 See data In Federal Reserve Bulletin. August 1953, pp. 857, 865, 874.
28 See National Income, 1954, pp. 1 7 0 -1 7 3 , for figures on this basis.
*
See particularly their Flow of Funds in the United States, 1 9 3 9 -5 3 , 1955. I have com
puted a set of money-flow accounts for the Federal Government for 1 7 9 0 -1 8 6 0 which are
In process o f publication by the National Bureau of Economic Research in a volume of
papers on 19th century economic growth.
ECONOMIC GROWTH AND STABILITY
81
As a rule, added refinements, with their costs in compiling and
complications in using, are only as valuable as the uniformities of
behavior on which they rest. What one really wants to know to
analyze fiscal policy is, first, from whom did the money come and
what would those people have done with it otherwise; and second, to
whom did the Government pay it, and what did the recipients do with
it? Variations in the response to one tax or one spending program
may create a degree of indeterminacy which swamps added refinements
in classification.
S t a t is t ic a l S ou rces
and
M
ethods
The “ official” figures on Federal receipts and expenditures as pub
lished in numerous Treasury and other documents contain certain de
ficiencies for the economist. In part these stem from the classifica
tions, which are administrative rather than either functional or eco
nomic. In part they stem from capricious patterns of inclusion and
exclusion. For the years since World War I, the official figures have
been badly inadequate because of the existence of Government corpo
rations and trust funds whose activities are not accurately reflected by
summary data on receipts and expenditures in traditional form. For
recent years, the problems have been recognized and met to some ex
tent by the statistical devices noted above. They give data back as
far as 1929, usually. Professor Kendrick has computed cash-consoli
dated expenditures data for earlier years, but they are not ideal for
pre-1900 dates.
The defects in the official data exist for figures all the way back to the
1790’s. One systematic distortion, more important before 1870, was
the lack of conformity between the accounts of the Treasury, which
the official data summarize, and the accounts of the collecting and dis
bursing officers who actually dealt with the public. During the Civil
War, for instance, more than $100 million shown by Treasury figures
as spent was actually accumulated in disbursing officers’ balances from
which most of it was disgorged in 1866.
The transactions of the Post Office were also outside the ordinary
Treasury summaries, and while this paper adheres to the convention
of netting postal transactions, it does not imply unqualified approval.
There have also been trust funds and/or Government corporations as
far back as 1796. The security-holding trust fund was extensively
used prior to 1860, with considerable investments being made in State
government bonds. After the Civil War, this practice largely gave
way to the use of bookkeeping trust funds not involving segregated
accounts, but these gave rise to fictitious transactions in the summary
accounts.
Treasury summary figures make some unsatisfactory inclusions and
exclusions. Their totals for ordinary receipts sometimes include
seigniorage charges and premiums on sale of gold or securities. Ex
penditure totals may include debt premiums paid, trust fund or other
security transactions, and tax refunds. They do not show the pay
ment of $28 million surplus revenue to States in 1837.
The statistics on receipts and expenditures used in this paper were
compiled in an effort to overcome these shortcomings. They consist
of completed estimates for 1789-1860, fairly close preliminary esti
mates for 1861-90, and a relatively sloppy first approximation for
82
ECONOMIC GROWTH AND STABILITY
1891-1916. From that point I have used Kendrick’s data, which
merge into the contemporary official publications. For receipts, my
approximations go to 1929.
Estimates through 1890 were constructed on the basis of the annual
Account of Receipts and Expenditures of the United States, published
by the Register of the Treasury. These present in vast detail the data
which are the basis for the summary totals appearing in the Treasury
annual reports. The detail is generally adequate to classify the items
and remove undesirable ones.25
For the period through 1860, separate financial accounts were com
piled for all Federal agencies carrying on financial transactions.
These were derived chiefly from the annual or other published re
ports of executive departments appearing in the series of American
State Papers or the executive documents of Congress. From all these
was computed a consolidated money-flow account of all transactions
with the public.
For the period 1861-90, a sampling of sources indicated that the
discrepancies arising out of collecting officers’ accounts were negli
gible. The time lag in expenditures, reflected in changing levels of
disbursing officers’ balances was occasionally important, however.
For the war period, these balances were ascertained as much as pos
sible from detailed reports. For the peacetime periods, however,
they were estimated to be a relatively constant and in the long run
declining fraction of transactions.
One major adjustment was imposed on the data for 1862-79. Dur
ing this period the Treasury conducted part of its transactions in
com and part in currency which was substantially depreciated relative
to coin. In order to show all transactions in a common unit, customs
revenues and interest payments (which were made in coin) were con
verted to currency values by multiplying them by the average gold
premium of the year.
For the years after 1890, estimates were constructed from Treasury
annual reports. For the entire period 1790-1916, data were adjusted
to exclude tax refunds, interest receipts, sales of Government prop
erty, and certain fictitious trust-fund transactions from both receipts
and expenditures. Revenues from seigniorage and securities issues
were excluded, as were expenditures for securities. The postal ac
count was modified to contain the actual difference between revenues
and expenditures, rather than the payment to or from the Treasury.
The “ official” cash-revenue figures for 1929—47 do not show the com
position of revenues. I estimated these to be the same proportion of
totals as the accrual data in National Income, 1954, pages 170-171.
For the 1948-58 data were obtained from the annual budget documents
for 1950-58. Refunds were excluded, their distribution being roughly
estimated. I doubt that my revenue series is exactly commensurable
with that for expenditures, particularly for 1920-29.
25 Incidentally, it is clear that the data in Receipts and Expenditures, and therefore in
the Treasury summary tables, reflect warrants actually paid by the Treasurer (through
1890, at le a st), and not merely w arrants issued, as alleged in the explanations of the
Treasury summary tables. For an explanation, see Secretary Bristow ’ s statement in 44th
Con?.. 1st sess., Senate Reports, No. 371 (1 8 7 6 ), pp. 3 6 -3 7 .
ECONOMIC GROWTH AND STABILITY
83
Other data used in table I were assembled in the following manner.
GNP figures for 1790-1865 were based on my own estimates (expressed
as a range). These were derived by adjusting the estimates of K,. F.
Martin to meet certain conditions suggested by Kuznets.28 For pre1861, Federal expenditures are so small that a wide range of inde
terminacy in GNP figures does not change the percentage very much.
For the Civil War period, I made annual range estimates, adjusting
1860 estimates with price data.
For all the data on per capita expenditures in 1926 prices, and for
GNP comparisons after 1865, I adjusted Kendrick’s figures in pro
portion to the discrepancy between them and mine. This somewhat
piratical technique saved me a vast amount of work, and I am most
grateful to the National Bureau of Economic Research for permitting
the use of this material.
*
M artin’s estimates are given in Studies in Enterprise and Social Progress, National
Industrial Conference Board, New York, 1939, p. 79. See Simon Kuznets, National Income
Estimates for the United States Prior to 1870, Journal of Economic History, June 1952.
I figured GNP to be 10 to 15 percent above national income.
II. CONSIDERATIONS IN DETERMINING
GOVERNMENT FUNCTIONS
85
CONSIDERATIONS IN D ETERM IN ING GOVERNM ENT
FUNCTIONS
EXPANSION OF GOVERNMENTAL RESPONSIBILITIES
Solomon Barkin, director of research, Textile Workers Union of
America, AFL-CIO
Concepts of the proper functions of government have been pro
foundly changed during the last few decades. Older shibboleths,
which hailed the best government as the one which governed least,
are now of little use in evaluating the propriety of new functions.
They reflect the rear-guard defenses of dogmatists opposed to the
Government’s assuming any new functions no matter what the national
need for such action.
Adam Smith defined the duties of government as being defense,
internal justice, and the erection and mainenance of public institu
tions and public works, including roads and education. They longserved as guides for the students of government. Except for unusual
conflicts such as the present dispute over school integration, where
people are ready to destroy historic educational institutions to frus
trate the application of the Supreme Court orders, few have challenged
the above definitions. But we have now gone far beyond this level of
thinking. The major issues now center about the question of which
positive functions the Government shall assume. Which gaps in our
social and economic system and failings in our present operations
should be met by assigning them to Government ?
D
e p r e s s io n
an d
W
a r t im e
F
u n c t io n s
S
h r u n k e n
In considering the current status of governmental operations and
expenditures, the striking fact is that we have completed what many
have characterized as the historic process of divestiture following a
sharp upsurge in new governmental functions. During the last 10
years this country saw the Government scrap many functions; these
primarily were institutions and organizations developed to solve the
problems of the depression and to meet the needs of highly centralized
controls during both World War II and the Korean war. As a result
of the investigations conducted by the Hoover Commission, and the
subsequent activities of the Director of the Bureau of the Budget and
officials of the Defense Department, the Government abandoned many
so-called commercial activities. The present administration has also
been intent on limiting the area of governmental responsibilities, and
has liquidated some activities and tried vigorously to limit others.
These efforts have aroused considerable opposition in many areas,
particularly in the field of power generation and multipurpose river
87
88
ECONOMIC GROWTH AND STABILITY
development. Our Nation has probably arrived at a balance of pres
sures, with the current functions representing the relatively new, more
permanent basic level of governmental functions.
F
orm s
of
G
overnm ental
D
is c h a r g e
of
F
u n c t io n s
Eecent developments have added new complexities to this problem
of distinguishing public from private functions. When the govern
ment assumes direct responsibilities in a given area, it no longer auto
matically means direct operations therein. There is no necessary in
ference that an operating institution will be erected or that an army
of employees will be necessary for the particular function. Govern
mental policy and interest may be implemented in the above tradi
tional way, or it may be reflected through its program of purchases
of goods and services, by the use of its credit position, the transfer of
payments, or regulation and control of particular private operations.
Many significant recent extensions in government interest in the oper
ation of our private economy have required few additional employees.
Moreover, the implementation of our monetary policy has called for
little direct use of Federal funds. The assurance of proper minimum
wages and working conditions has necessitated few employees or gov
ernmental expenses other than those required in the direct administra
tion of the law itself. Economic policy directives are being used to
implement government purposes.
The relative importance of these nonoperating governmental func
tions is well illustrated by the figures on government employment
and expenditures. In 1956,9.7 million persons were in the government
service out of a national total of 65.7 million employed persons, or
14 percent. Of the government workers, 4.5 million were with the
Federal Government, of which 2.8 million were military and 1.7 mil
lion civilian employees, and only one-half million were employed in
Federal enterprise; 4.4 million were with State and local services, and
one-third of a million were with local and State governmental
enterprises.
The wages and salaries for compensating all government employees
amounted to $36 billion, representing only 36 percent of the net gov
ernment expenditures. Governmental purchases from business
amounted to $40.3 billion, or about 40 percent of the expenditures.
Transfer payments in the form of social-insurance benefits, military
benefits, and direct relief amounted to $17.2 billion. Interest pay
ments would increase the above transfer payments by $5.7 billion,
bringing this area to 23 percent of governmental expenditures. These
sums, of course, do not include the vast amount of outstanding gov
ernmental guaranties supporting private credit. The man-hours of
work devoted by private industry to serving the government as pur
chaser of goods and services and stimulated by government action may
far exceed those hired directly by the government (table I).
P
r iv a t e
S o c ie t y U ses C o l l e c t iv e I n s t it u t io n s a n d P r iv a t e E
t u r e s A r e I n f l u e n c e d b y G o v e r n m e n t a l P o l ic y
x p e n d i
The essential characteristic of a governmental organization is that
it is a community institution whose functions are prescribed and funds
allotted to it by a governmental body. It is controlled through the
ECONOMIC GROWTH AND STABILITY
89
budget. The alternatives in our private economy and society have
some similarities. True, the market more or less determines these
operations. But we are no longer faced with the simple choice of
large government versus the single individual. The latter has found
it desirable to organize into voluntary groups which require no gov
ernmental authority or support, or to secure sanction from the govern
ment for forming such groups. The business corporation, the philan
thropic foundation, and many trusts and membership organizations
are creatures of the government administered by private authority.
The important fact for our present purpose is that the individual
assigns some of his power over personal expenditures to these groups.
They spend it for him. For example, instead of granting charitable
aid himself, he is likely to give his money to a phdanthropic institu
tion. Incidentally, some of these organizations, like the community
chests, collect funds on such a wide basis that it is tantamount to a
voluntary levy upon the local citizens. Similarly, members pay dues
to their unions, and in union shops all must pay, or to membership
organizations for the realization of common purposes. Many of these
groups operate on the budget rather than the market principle.
I f the previous discussion highlights how much less appropriate
is the use of the old dichotomy between the public and private econo
mies, so the older contrasts may not be employed for the study of col
lective versus private expenditure. The latter is now significantly
controlled and affected by governmental influences so it is more an in
strument of public purpose than a completely independent agent.
Personal expenditures are at all times a function of prevailing social
patterns; new governmental controls have been developed to further
restrict private choices of expenditures.
Besides the basic protective legislation related to cleanliness, pure
goods and drugs, labeling, and other similar controls, and taxes on
items such as alcoholic beverages, we have seen two major develop
ments affecting private expenditures. The first is represented by the
growth of welfare programs. Funds are transferred to people who
would otherwise not have been able to purchase specific goods and
services or proper amounts of them. Matching this so-called welfare
state, which slogan became an issue of national concern some 5 years
ago, is the relatively less-trumpeted development, the incentive state.
Not only are governmental funds transferred to certain private busi
ness in the form of subsidies, and generous sales of government sur
pluses or properties, but the government has used various financial
inducements to stimulate businessmen to engage in specific functions
such as housing, construction, research activities, expansion of capacity
for the production of vital war materials, and general industrial pro
duction. Even the individual has been provided incentives to spend
his funds in governmentally approved ways. The Federal incometax system allows generous exemptions to philanthropic contributions,
which have led to the creation of thousands of foundations for the
organized expenditure of funds for these purposes. These exemp
tions, in effect, allow the private administration of publicly taxable
funds.
A review of this twofold development involving, on the one hand,
the multiplication of the forms of government influence ranging from
governmental enterprises to a positive system of economic policy im
plementation and the appearance of many collective institutions for
90
ECONOMIC GROWTH AND STABILITY
the spending of private funds, and, on the other hand, the striking
growth in incentives guiding private expenditures and the transfer of
purchasing power among private citizens, clearly unfolds the fact
that any determination respecting a governmental function and re
sponsibility does not automatically carry with it a decision on the
form of governmental intervention in a particular area. The decision
as to whether the influence is to be exerted through direction, opera
tion as a public enterprise, or some less direct or completely indirect
form of influence, is a moot question. Similarly, the fact that the
forms of governmental operation and influence are most diverse, per
mits it more easily to extend its concern and to condition the behavior
of individuals in a wider area of our private society and economy.
Since the choice is not merely between governmental and private enter
prise, various means can be devised to achieve public purposes. Where
particular gaps or failings are recognized in our economic or social
structure and performance, the government can intervene or influence
the situation without necessarily establishing a public enterprise. The
issue as to what is a public function must, therefore, be defined in
terms of this concept o f the wide range of choice of methods of exerting
influence available to governmental authorities.
G
oods
A
re
N
ot
I
nherently
P
r iv a t e
or
P
u b l ic
Beyond the areas of governmental responsibility set forth by Adam
Smith, distinctions between public and private goods appear quite
contrived. Physical characteristics as to divisibility are hardly ger
mane. Many goods and services originally furnished by private
enterprises have now become public goods and services. Governments
have assumed the operation of services in some communities which
remain private in others. Shifts have continued without basically
changing the character of the goods or services.
What has happened in such transfers is that the community has
determined through its legislative or executive bodies that the methods
of distribution and the volume of goods or services, available to the
people in a system built on the market principles, are not adequate.
The benefits have been deemed so important to the community that the
means of producing or distributing particular goods and services have
become public. The determination has been made on the basis of the
belief that the benefits should be widely shared. In other instances
the conversion has been made because of the conviction that a public
body might be more economic or might perform services not now con
sidered worthwhile to private interests. Such has been the argument
for multipurpose development of river valleys by those who have
pressed for public enterprises in these areas. The public bodies have
been established for other functions where private resources are con
sidered inadequate or unwilling to take the risk.
In each case, therefore, the shift has occurred from private to pub
lic performance, or the particular good or service has been decided to
be a public good because the legislative bodies have determined it to
be necessary in the public interest. The merits and disadvantages
must be argued specifically in terms of the particular project rather
than on the basis of general assumptions and the preference for one
form of enterprise or another.
91
ECONOMIC GROWTH AND STABILITY
The same approach needs also to be taken in connection with the
proposals for establishing new public interest and concern in one or
another area of our social and economic structure. The issue is pri
marily whether the currently available goods or services meet the pub
lic needs. Are the effects compatible with the public interest? Do
the market influences assure an adequate total supply of goods and
services ? Are they being distributed among the population in proper
amounts? Are prices compatible with the public interest? Are the
types of goods and services needed in the society being produced and
offered ? Are we getting a desirable pattern of use of resources and
manpower ? Is economic power being adequately diffused ?
A negative answer to these inquiries does not necessarily mean, as
we have indicated, that the only alternative is government enterprise.
The gaps and failings in our structure may be overcome by other means
which will serve the stated tests. Distress in some of our cities or the
shortage of economic opportunities in underdeveloped areas can be
overcome frequently, not by wholesale introduction of public goods
and enterprises, but by the completion of several public works which
would open up the areas to private development, as the TY A did for
its region and the St. Lawrence Waterway is likely to do for the North
ern States of our country. We have learned from our economic aid to
underdeveloped countries that a few strategic public works which
would not be undertaken by private capital can often generate exten
sive industrial development. So we find that the provision in the
housing laws for the absorption of losses in land purchase by local
communities and the Federal Government has stimulated urban re
development in many cities which had suffered from the heavy hand of
blight. Government guaranties on home loans have stimulated our
entire home construction industry. Similarly, the modernization of
the current building codes would so reduce costs as to open up vast
opportunities for new construction.
The basic challenge is, therefore, not to distinguish between public
and private goods but to determine the effectiveness of the operation
of the private society and economy and to seek methods of correcting
whatever the shortcomings may be, whether they be omissions or
imperfections.
G
o vern m en t
H
as
P
o s it iv e
F
u n c t io n s
I
ts
G
in
H
e l p in g
S
o c ie t y
R
e a l iz e
oals
Having accepted the primary governmental functions set forth in
the earliest writings on political economy, governments for many
decades operated within this range of responsibilities. Their activi
ties expanded primarily as populations grew, as the land area of the
nation was extended, as wealth increased and industrialization cre
ated new demands. However, the functions remained narrowly cir
cumscribed. Government expenditures before the Civil War repre
sented about 1.5 percent of the national income. Military engage
ments not only raised the immediate costs of government but signifi
cantly raised them in the years following the war, as many costs per
sisted. Between the Civil War and World War I government ex
penditures were higher and represented about 2.7 percent of the gross
national product; the percentage would be higher if calculated in
92
ECONOMIC GROWTH AND STABILITY
terms of national income. After World War I the rate rose to about
3.1 percent.
The major rise in the level of Government expenditures grew out
of the crash of 1929 and the subsequent depression. The concepts of
Government’s responsibilities were drastically altered. The laissezfaire philosophy of the previous century and a half was replaced by
a new vision of Government as being a positive force responsible for
closing the gaps in the private economy and mitigating or correcting
its failings. The individual person was no longer to be abandoned to
his fate. His difficulties were no longer regarded as personal weak
nesses for which he was to do penance by continued misery. They
were often the result of social forces over which he had no control.
As a member of society, he was entitled to a minimum of benefits which
would enable him to take advantage of opportunities for self-support
when they arose. The Government was responsible for the direction
of the economy so that its efforts would supplement and reinforce
those of private industry in providing employment opportunities and
productive economic activity for the people.
The recognition of these positive responsibilities led to a new series
of governmental programs. Some were directed at failings. Others
were intended to initiate activities and services which were not being
provided by the private economy. The programs were directed at
the most diverse facets of the economy. Some were designed to stimu
late business. The Government entered upon large construction
projects and embarked upon providing new services such as research,
theater, music, and art. The private and public relief systems were
modernized and the old poor-law concepts swept aside. Assistance
to the unemployed became a public function. New codes were drafted
for industry to provide guides for its conduct and minimum terms of
employment. Other institutions like the banks, stock market, and
commodity exchanges were rehabilitated. Tremendous projects such
as TV A were initiated to strengthen the economy of entire regions.
Social insurance systems started major public schemes of aid to
individuals. Conservation programs were executed to develop and
preserve our natural resources.
These programs affirmed Government’s positive economic and social
responsibilities. It could not stand idly by while the country went to
rack and ruin. Businessmen, bankers, farmers, and workers demanded
action. It had to take steps both to rehabilitate the country and
mitigate the suffering of the people and stop the loss and waste of
national resources and wealth.
Governmental expenditures for these purposes are no longer con
sidered unproductive. It is now generally believed that governmental
expenditures during periods of less than full employment are highly
productive and lead to the utilization of resources and manpower
which would otherwise remain idle. The older economic theories
which assumed stability with minor variations and couldn’t conceive
of major depressions had provided no alternative but to wait for recov
ery while the patient’s economic blood was let. Such views are too
brash for the current era in which there is an open conflict between
economic systems on their comparative abiilty to provide employ
ment and promote economic well-being.
Still new tests for Government to meet were born during the war.
The failings of the past had created a longing for the Government to
ECONOMIC GROWTH AND STABILITY
93
assume more positive functions. Moreover, the stupendous achieve
ments recorded by Government as a wartime planner and guide for
the economy reaffirmed the public’s belief that this instrument could
also solve the maladies and defects of a peacetime society and economy.
The new responsibilities assigned to the Government were no longer
limited to those of aiding in the recovery of a society and economy
in complete distress. Its obligations are more continuous and posi
tive. These new tests were formally developed and articulated as
American policy in the Employment Act of 1946. It declares that
it is—
The continuing policy and responsibility of the Federal
Government to use all practicable means * * * to coordinate
and utilize all of its plans, functions, and resources, for the
purpose of creating and maintaining, in a manner calculated
to foster and promote free competitive enterprise and the
general welfare conditions under which there will be useful
employment opportunities including self-employment, for
those a'ble, willing, and seeking to work, and to promote
maximum employment production and purchasing power.
The Federal Government has sought to implement these broad
directives. During the last decade we have enjoyed an unusual era
of economic growth and high employment. During the last year we
faced problems of stabilizing our price structure to prevent the infla
tionary forces from weakening the foundations of our economy. Peo
ple who closed their minds to direct controls and considered only
indirect monetary techniques for restraining price rises, raised the
question of the possible conflict between full employment and price
stability.
Both goals, wTe contend, are compatible. The present administra
tion has failed to choose procedures for effecting stability which are
themselves consonant with the maintenance of full employment and
balanced growth. The monetary controls which we have employed
originate from an outgrown economic philosophy derived from a
time when people and government suffered and tolerated the sharp
swings of the business cycle. These theorists and practitioners are
imprisoned by their conceptions and assumptions which are out o f
tune with an economy in which full employment and balanced growth
are essential goals and cannot be subordinated to a third goal such
as price stability. Policies must be devised to realize concurrently
theses three objectives of full employment, growth, and stability.
The concept of full employment provides us with a measure of the
degree of underutilization of our manpower. It supplies a measure
of the upper limits of economic activity and social well-being which
we can attain with our material resources and capital.
We have also accepted economic growth as an essential objective.
It responds to the underlying yearning for progress in an opti
mistic western society. The channel to progress is through economic
expansion. The Government’s responsibility is to facilitate this proc
ess. Besides helping to maintain a climate conducive to full employ
ment it must help dormant and declining areas and industries find
the formula for their rejuvenation. Where the latter fails, new de
signs must be evolved for the distressed areas. Help can be fur
nished them through technical assistance and finance as we have done
94
ECONOMIC GROWTH AND STABILITY
through our foreign-aid programs. This is the objective of the area
assistance bill now before Congress.
Stable growth means not omy that prices remain relatively stable
but also that the growth process is balanced. It is the unevenness
in the rate of expansion and the accumulation of demand in specific
sectors which currently create the environment for inflation in our
economy. The excessive demands on structural steel and other key
commodities necessary for the expansion of our capital goods in
dustries sparked much of our current inflationary price movement.
The Government’s responsibility is to restrain unjustified price in
creases and to help balance demand through appeals and controls
and possibly to build new capacity to meet these rising economic needs
where private industry proceeds at too slow a pace. Economic bal
ance demands careful appraisal of our areas of growth and our
physical and human resources. Economic balance also calls for an
appropriate pattern of large and small businesses.
One other function of government is to help translate economic
growth into rising living standards. In our economy we boast that
such has happened; and indeed the facts support this conclusion.
“ People’s capitalism” is the phrase coined to describe our system as
contrasted with others. Certainly we can boast, in the words of
a recent panel group sponsored by the Advertising Council, of en
joying a “ rising dynamic way of life and the broad distribution of
the benefits of the economy among the people through a high stand
ard of living for the bulk of the population” (The American Round
Table, sponsored by Yale University and the Advertising Council,
Discussions on People’s Capitalism at Yale University, New Haven,
Conn., November 16 and 17, 1956, Advertising Council, 1957, p. 13).
These criteria may be differently defined. But in my concept it
would include the realization of constantly rising living standards;
higher level minimum wages for the entire work population; equal
pay for men and women; collective bargaining as the practice of
industrial relations; shorter working hours; longer productive work
lives; adequate educational and training facilities for youths, adults,
and older persons; adequate social insurance and assistance to provide
basic economic security; adequate hospital and medical care; sufficient
number and high standards of housing; local cultural and recrea
tional facilities and vast opportunities for personal development.
These social goods and resources often have to be supported by some
level of government. The essential test is whether the needs and as
pirations of the American people are being fulfilled under existing
arrangements. Where they are not, it is the responsibility of the
Government to take positive steps to insure their fulfillment. The
form of operation is a later question to be faced.
In American society, we have placed a strong emphasis on efficient
execution. I f early solutions do not meet this test, we shall evolve
the proper ones through debate and effort. As an example, we are
now trying assiduously to evolve a system of medical care which
will satisfy our population. We have relied on private systems.
Their defects have been manifoldly revealed. Improvements are
being made in response to the strong criticism and the appearance
of new competitive services. This two-fold process will continue, we
hope, to shape our institutions to serve us better.
95
ECONOMIC GROWTH AND STABILITY
The conservation and development of our resources has been a long
established goal for American government. Similarly, we must list a
sound agricultural economy as a primary objective for our Federal
agencies. National security and the appropriate forms of foreign aid
to protect ourselves and stimulate and assist the development of inde
pendent, viable, and growing nations are part of our current inter
national policy. Traditionally our governments concern themselves
with the promotion of an adequate transportation system both for
military and commercial purposes. Research and scientific develop
ment are new responsibilities which technology makes necessary, be
cause private endeavors have been limited and must be stimulated, and
many pioneering efforts require huge financial outlays and entail great
risks. Adequate statistical services are vital to a properly function
ing industrial society and must be supplied primarily by the Govern
ment. Finally, no government can neglect promoting an adequate
urban plan for its population.
_
C O N C L U SIO N
These, then, are some of the positive functions of government.
They are a far cry from the modest list of governmental responsibili
ties recognized before 1929. The Government has an obligation to
help realize these new objectives. It cannot sit back prayerfully and
hope that these ends will be realized. It must determine whether the
state of well-being conforms to these purposes. I f there are gaps in
our private society and economy, and if the performances do not meet
the tests, it has an obligation to intervene and help the citizenry realize
these ends for which the society has been created.
T a b le
I .— Government expenditures, 1956
[Millions of dollars]
Total
Total____ ________________ ____________________________
Purchase of goods and services........................................................
Compensation of employees..................................................
Net purchases from business.....................................................
Less domestic sales of surplus consumption goods........
Federal
$104,218
$72,012
$35, 483
80,227
36,068
40,245
12.818
27, 542
115
3, 914
17,150
47,199
18, 798
24, 487
2, 774
21, 828
115
3,914
13,491
3,277
5,198
2,847
33,028
17, 270
15, 758
10,044
5,714
5,739
4,592
Subsidies less current surplus of Government enterprises.........
State and
local
3. 659
541
1,745
Source: Survey of Current Business.
APPEN D IX
F
ederal
C
ash
P
a ym e n ts
an d
R
C
r e d it
G
u a r a n t ie s
b y
T
ypes
of
e c ip ie n t s
There are no data available which provide a convenient and ex
plicit summary of cash payments, loans, investments, subsidies, and
transfer payments to individuals not in the Government’s employ.
Special analysis D of the budget provides some data on this subject
by noting the beneficiary of the expenditures, which is, in some cases,
a private individual. In the latter instances, the data has been ab
96
ECONOMIC GROWTH AND STABILITY
stracted, but this material does not provide a full listing of the data,
particularly in such areas as public works, military procurement, and
expenditures for developmental purposes.
Tabulations are available for the calendar years 1951-52 appearing
in the report of the Council of Economic Advisors, which provide a
better insight into the allocation of funds by type of recipient. We
would recommend that the Joint Economic Committee request the
Bureau of the Budget to develop a current supplementary table which
explicitly sets forth the Federal Government’s expenditures by type
of recipient and which would proceed beyond the classifications shown
in the attached table. The exhibit would clearly arrange the expendi
tures to indicate which are made through procurement or contract
with private persons or bodies.
Because we believe such tabulations are desirable and would throw
light on the extent to which the Federal Government now depends
upon such private persons and bodies for the services and goods it
uses or furnishes to the American people, we are attaching the table
for the calendar years 1951-52.
Federal cash payments to the public by type of recipient and transactions,
calendar years 1951-52
[Billions of dollars]
1951
Cash payments
1952, 1st
half I
1st half
2d half
3.0
1.5
1.5
.9
.4
.4
.5
3.8
1.9
1.9
2.1
Payments to business for goods and services:
Public works:
Federal........................ .......................- - - ............. ..........
Grants-in-aid and loans for public works...................
Other goods and services 5-.
...................................
Payments to foreign countries and international insti
tutions for goods and services..... ............................ ........
2.1
.8
.9
.9
.3
.4
1.1
.5
.6
1.3
.3
.4
Total_____________________________________________
3.8
1.6
2.2
2.0
Direct cash payments for goods and services—payments for
military services:'
Military personnel.......................................................... ..........
Major procurement and production......................... .............
Militarv public works___
. .
...........
Stockpiling of strategic and critical materials. ______ ____
Operation and maintenance of equipment, research and
development, reserve forces, and other.................................
9.7
7.5
1.2
.7
4.4
2.8
.3
.4
5.3
4.7
.9
.3
5. 7
6.5
1.1
.5
Direct cash payments for goods and services, excluding pay
ments for military services:2
• Payments to individuals for services rendered:
Civilian wages and salaries (excluding Post Office):
___
_____ ________ ____ .. _ .
Federal3.
Grants- and loans-in-aid for performance of specified
services.net4............ .................................................. .
Total____ ________________________________________
Total_______________________________________ _________
Loans and transfer payments to individuals:
Social insurance and public assistanceFederal employees’ retirement benefit payments............
Old-age and disability benefit payments..........................
Unemoloyment insurance benefit payments....................
Grants-in-aid for public assistance....................................
Readjustment benefits, pensions, and other payments to
veterans 8.............................................................. .
...............
Loans to homeowners, net...........................................................
Interest ®..........................................................................................
Other 10.............................................................................................
Total................................. .......... ............................... ............
See footnotes at ond of tablo.
Total
.1
(6)
(6)
1.6
(6)
10.7
4.3
6.3
7.1
29.8
12.2
17.5
20.9
.3
2.2
.9
1.2
.1
1.1
.5
.6
.I
1.1
.4
.6
.2
1.2
.6
.6
5.2
.1
1.1
2.6
(•)
.6
-.2
2.7
.1
.5
(*)
5.4
5.6
1
11.0
2.3
(s)
.6
-. 2
5.2
97
ECONOMIC GROWTH AND STABILITY
Federal cash payments to the public by type of recipient and transactions,
calendar years 1951-52 — Continued
[Billions of dollars]
1951
Cash payments
1952, 1st
half i
Total
Loans, investments, subsidies, and other transfers to business
and agriculture:
Farmers:
* Price support, net (including supply program)...............
International Wheat Agreement.........................................
Other loans and direct subsidies to farmers......................
Business:
Home mortgage purchases from financial institutions...
Direct subsidy payments.............................. - .....................
Subsidy arising from the postal deficit....................................
-.4
.2
.8
1st half
2d half
-.4
.1
.4
- .1
.1
.3
.2
.5
(a)
(0)
.7
3.1
(8)
(«)
.4
1.5
-.2
.1
.5
.2
.3
(«)
(0)
.3
1.6
(«)
(*)
.4
1.4
4.8
2.3
2.5
2.4
1.6
2.9
.3
.7
1.6
.2
1.0
1.3
.1
1.4
1.2
.1
Loans and transfer payments to foreign countries and interna
tional institutions:
Unilateral transfers:
Subscriptions to the International Bank and Monetary
Fund (net cash withdrawals)....... ...........................................
(0)
4.7
Clearing account for outstanding checks and telegraphic reports.
+.1
Total Federal cash payments to the public..........................
58.0
(«)
2.4
(9)
25.7
<6)
(a)
2.4
2.7
+ .1
+ .3
32.3
35.6
1 Estimates based on incomplete data.
2 Differs from the national income concept of ‘ ‘ Government purchases of goods and services” by excluding,
in addition to military services, farm price-support expenditures, and unilateral aid to foreign countries.
Grants to States and localities for public works, here included as a Federal expenditure, would be included
in the national income accounts as a State and local expenditure. There are other less significant differences
between the two concepts.
3 Excludes payroll deductions for Federal employees’ retirement.
4 Includes all grants-in-aid and loans to public bodies for purposes other than public works and public
assistance. Includes, in addition, H of Federal expenditures for veterans’ tuition, books, and supplies.
6 This figure is obtained as a residual by deducting all other expenditures from total cash payments to
the public. This residual is subject to a high margin of error, since many of the detailed expenditure figures
are estimated from records maintained on different bases. Conceptually, it includes purchases of supplies
and equipment, payments for transportation, communication, and various contractual services.
• Less than $50,000,000.
? Excludes retired pay and redemption of Armed Forces leave bonds which are included below as pay
ments to veterans. Also excludes payroll deductions for civilian employees’ retirement.
* Includes cashing of terminal-leave bonds retired pay of military personnel, and national service and
government life insurance refunds and benefits in addition to veterans' pensions and readjustment benefits.
Includes only li of payments for veterans’ tuition, books, and supplies.
► 8 Includes a small amount of interest on tax refunds in addition to iuterest on tax refunds in addition to
interest on the public debt. Interest paid to business includes about $100,000,000 of interest paid each year
by the Federal Government to State and local governments. (Interest in appendix table A-2—Consumer
account—is net and is on an accrual rather than a cash basis; it includes interest paid by State and local
Government corporations.)
Represents transactions in deposit funds (including partially owned Government corporations) and
in trust funds not specified elsewhere.
N o t e .— D etail w ill n ot necessarily a d d to totals because of rounding.
Source: Bureau of the Budget.
ECONOMICS AND THE APPLIED THEORY OF PUBLIC
EXPENDITURES
Walter W. Heller, professor of economics, School of Business
Administration, University of Minnesota
What does the economist have to offer a perplexed public and its
policymaking representatives on the theory of Government functions
as they affect the budget? The cynic’s offhand answer, “not much,”
may be close to the mark if one demands definitive rules of thumb
for determining the precise scope of Government functions and level
of Government expenditures. But if, instead, the demand is for
economic guidelines to aid the budgetary decisionmaker (1) in blend
ing rationally the service, stabilization, and income-transfer func
tions of Government, (2) in identifying those deficiencies in the private-market mechanism which call for Government budgetary action
or, more broadly, those activities where Government use or control of
resources promises greater returns than private use or control, and
(3) in selecting the most efficient means of carrying out Government
functions and activities (whether by Government production, con
tracts with private producers, transfer payments, loans, guaranties,
tax concessions, and so forth)—if this is the nature of the demands
on him, the economist is prepared to make a modest offering now
and to work along lines that, promise a greater contribution m the
future.
In a sense, this paper is a progress report designed to show where
the economist can already offer some useful counsel, to indicate some
of the lines along which promising work is being done, and to suggest
certain limitations or constraints within which the economic criteria
for dividing resources between public and private use must be applied.
A
B
a s ic
F
ramew ork
As a first step in the search for economic guideposts, we need to
disentangle, classify, and define the basic objectives and functions of
Government that shape its budgetary decisions. Fortunately, Prof.
Richard A. Musgrave has developed a conceptual framework for this
task in his “multiple theory of budget determination.” Although he
speaks for himself in this volume and elsewhere,1 a brief examination
of his contribution provides a most useful point of departure for a
schematic review of expenditure theory.
The component functions of the budget as he brings them into
focus are: (1) The service, or want-satisfying, function: to provide
for the satisfaction of those individual wants which the market mecha
nism cannot satisfy effectively (e. g., education and conservation) or
1
See, for example, A M ultiple Theory o f Budget Determination, Finanzarchiv 1957,
vol. 13, No. 3, pp. 3 3 3 -3 4 3 , ana the relevant chapters of his forthcoming treatise on public
finance.
98
ECONOMIC GROWTH AND STABILITY
99
is incapable of satisfying (e. g., defense and justice); (2) the incometransfer or distributional function: to make those corrections in the
existing income distribution (by size, by occupational groups, by geo
graphical area, etc.) which society desires; and (3) the stabilization
function: to join with monetary policy and other measures to raise
or lower the level of aggregate demand so as to maintain full employ
ment and avoid inflation. For purposes of the panel discussion of
which this paper is a part, the first function is o f dominant interest,
and the succeeding sections of the paper return to it. But several
general implications of the Musgrave system as a whole deserve atten
tion before turning to specifics.
Musgrave’s formulation helps unclutter our thinking on the com
ponent parts of the budget decision. It drives home the significant
point that our decisions on how much and what kind of want-satisfy
ing services to provide by Government budgets need not be tied to our
demands on the budget for correction of either the existing patterns
of income distribution or the level of aggregate demand. I f we prefer,
we can have a small budget for services (financed by taxes levied on
the benefit principle) combined with a big budget for redistributive
transfers of income (financed by taxes levied on the ability principle),
or vice versa; and either combination can be coupled with either a
deficit to stimulate demand and employment or a surplus to reduce
demand and check inflation. In this respect, it is reminiscent of
Samuelson’s “daring doctrine” that by appropriate fiscal-monetary
policy “a community can have full employment, can at the same time
have the rate of capital formation it wants, and can accomplish all
this compatibly with the degree of income-redistributing taxation it
ethically desires.2 Musgrave, in turn, points the way to achieving any
combination of Government services, income redistribution, and eco
nomic redistribution, and economic stability we set our sights on.
So far, so good. The waters, though deep, are clear and relatively
still. They get somewhat muddied and troubled when we move from
the clear-cut want-satisfying programs (subject to the benefit prin
ciple) and clear-cut distributive programs (subject to the ability
principle) into dual-purpose programs, transfers-in-kind in the form
of subsidized housing, medical care, vocational education, and so forth.
For here we are no longer furnishing services that the majority has
voted to meet its own needs (including both selfishly motivated needs
like defense and police protection and socially motivated needs like
foreign aid) via Government, but are in effect requiring the minority
to accept services which they might or might not have bought had they
been handed an equivalent amount of cash. Perhaps they would have
preferred to spend it on wine, women, and song, but the majority is
apparently saying, “ No, we know what’s best for you.” Can this be
justified?
It may be digressing to do so, but let us consider for a moment the
provision of free vocational education as a case in point. It might
be argued that vocational training results in a direct increase in earn
ing power of the trainee (since employers will be willing to pay him
higher wages) and that it should therefore be left in private hands
2
Paul A . Samuelson, The New Look in Tax and Fiscal Policy, in Federal T ax Policy for
Economic Growth and Stability, Joint Committee on the Economic Report, Washington,
November 9 ,1 9 5 5 , p. 234.
100
ECONOMIC GROWTH AND STABILITY
or, if furnished publicly, should be financed under the market prin
ciple (by direct charges to the recipient of the service) rather than
the budget principle (provided free of charge and financed by general
taxation).3 In terms of the service budget alone, the foregoing con-clusion is probably right. But bringing in the redistributive motive
puts subsidized vocational training m a different light. The voting
majority may feel that income transferred in this form constitutes a
more efficient and desirable form of transfer than a direct cash trans
fer. It insures that the transferred economic power won’t be squan
dered in foolish and dissolute ways. It approaches reduction of
•economic inequality through greater equality of opportunity. In the
process, it strengthens the economy’s productive capacity.
The new welfare economics may protest that this is a form of
tyranny of the majority of the voters over the minority, that each
individual is his own best judge of his welfare. Since the equivalent
•cash payment would have been spent differently, it is said to be a
violation of consumer sovereignty. But it is also quite possible that
the recipient of the transfer in kind will vote with the majority to
have this kind of program rather than a direct cash payment. The
individual may accept and welcome the discipline in such an arrange
ment which overcomes his own self-deplored lack of willpower (a
lack which is not restricted to children, aged persons, and imbeciles).
How many of us would “prefer” to spend our time quite differently
than we do if left to our own devices, yet are willing to accept, or even
welcome, the tyranny of a deadline as a condition of participating in
a desirable project? Seen in this light, the transfer in kind may
interfere more with license than with freedom of consumer choice.
I do not mean to dismiss the “ tyranny” argument, but its force is
certainly softened by the kind of consideration just examined. It
may be further softened if we accept the proposition that the respon
sibility of the voters’ representatives goes beyond a mere recording of
individual preferences to leadership and education designed to re
direct individual preferences along lines which a social consensus
deems more constructive.
Even beyond this, the transfer in kind may actually have a large
service component, i. e., secondary benefits which accrue to others
than the direct recipient of the service.4 For example, low-income
housing may confer indirect benefits on high-income people in sur
rounding areas for which they are willing to pay a considerable price.
Subsidized housing projects may replace unsightly slums, arrest ur
ban blight which threatens to encroach on better neighborhoods, and
reduce fire and police protection costs. To this extent, taxes on highincome people to subsidize low-cost housing may in large part be a
8
For a discussion of these principles see Gerhard Colm, Essays in Public Finance and
Fiscal Policy, New York, 1955, pp. 8 -1 1 .
4
To the extent that the income transfer motive is the sole or dominant motive for keep
ing certain services on the public budget (or at least causing us to supply them on the
budget principle rather than the market principle), a rise in average fam ily income and
a decline in inequality will eventually bring us to a point where programs such as vocational
education and low-cost housing should be moved off of the Government budget and into the
market economy. T his point is undoubtedly much more distant for some programs than
others. Also, I do not mean to suggest that the main impact of economic growth and
prosperity is to reduce Government expenditures. Both in the case of intermediate public
goods (such as roads), the demand for which typically moves in accord with private goods,
and in the case of “ end item” services (such as better education and recreation), the
demand for which increases with higher standards of living, economic growth and pros
perity mean higher rather than lower demands for Government services.
(See Gerhard
Colm, Comments on Samuelson’s Theory of Public Finance, The Review of Economics and
Statistics, November 1956, vol. 38, p. 41 0 .)
ECONOMIC GROWTH AND STABILITY
101
payment for the indirect benefits they receive rather than a transfer
payment. Clearly identifying and separating the service elements
from the redistributive element in this manner suggests that the wants
of third-party beneficiaries are being satisfied by using the direct
recipient of subsidized housing, medical care, education and the lik**
as the instrument, willing or unwilling, for this purpose.
This formulation may also shed new light on the theory of pro
gressive taxation. Musgrave suggests that high-income people may
be willing to pay proportionately more for a given government serv
ice than low-income people (i. e., the income elasticity of demand for
the service is greater than unity), even in the case of government serv
ices like defense and justice which by their nature must be consumed
in equal amounts by all persons. Add to this consideration the im
portant indirect stake which the upper income groups have in sub
sidized programs for the lower income groups (i. e., programs not
equally consumed by all). The direct beneficiary may put a low value
on the service and a high value on money, while the indirect bene
ficiary (who gets secondary benefits in protection from epidemics, in
arresting of urban blight, in a more stable body politic and labor
force, and so forth) may put a relatively high value on the service and
a low value on money. The tax policy result: progressive taxation on
the benefit principle.6
Although the foregoing discussion leads us afield from the strict
question of what functions government should undertake, it under
scores an important point that should not be overlooked in the course
of separate inquiries into tax and expenditure principles: the two
are intertwined in both a conceptual and a practical way. Our con
cept of government functions, both in their service and in their redis
tributive elements, has obvious implications for tax theory. Also, as
will be noted below, expenditure and tax instruments are often alter
native means of accomplishing a given governmental objective. For
example, one can give government support to the oil and gas industry,
to foreign investment, or to agriculture either by outright subsidy re
flected in higher expenditures or by tax concessions reflected in lower
tax revenues.
The Musgrave contribution provides an instructive illustration of
the intellectual process at work, a process of which the Joint Economic
Committee’s hearings are an essential part. His formulation, even
though not yet published in definitive form, has already clarified and
stimulated thinking on public expenditure theory (a field compara
tively neglected in favor of work on tax theory and policy) and has
provided a base for further contributions to the subject. This is not
to say that his system is complete, that it will not be modified, or per
haps even replaced in the course of time. It is a framework for think
ing about the problem rather than an operational prescription for
5
Prof. Joseph A. M cKenna, building on the Musgrave formulation and adding to it
the assumption of diminishing marginal utility of money (an assumption Musgrave explicity eschews in drawing inferences for progressive taxation from the service budget),
sets up the concept of “ maximum taxable benefit,” the amount of money any beneficiary—
primary or secondary— of a public service would pay if forced to do so rather than do
without the service. For services to consumers, this maximum taxable benefit would be
the marginal utility of the service divided by the marginal utility of money, while for
business services, it could ordinarily be obtained directly in terms of money savings or
increased receipts. In this formulation, a public service would be undertaken only if
the sum of the maximum taxable benefits for all beneficiaries exceeds the cost of the service.
(Th is formulation is developed by McKenna in an unpublished paper, Reflections on Public
Expenditures, St. Louis University, May 3957.)
102
ECONOMIC GROWTH AND STABILITY
government budget accounting. It has no unequivocal place in it for
those government services which represent a satisfaction of “merit
wants,” (those which reflect a collective, or majority judgment that
certain services should be provided even if they interfere with indi
vidual preferences'). Nor does it appear to provide explicitly for some
of the resource-allocating functions of the budget such as changing
the balance between consumption and investment to influence the
growth rate, redirecting resources from one industry to another (e. g.,
from other industries to the petroleum industry), from one stage of
production to another (e. g., in favor of the extractive stage) or from
one geographical area to another (e. g., in favor of foreign versus
domestic investment) .6 But, in spite of these conceptual and practical
limitations, encouraging progress has been made toward clearing away
the analytical underbrush and revealing more clearly the choices that
have to be made and the problems that have to be solved.
E
c o n o m ic
D
e t e r m in a n t s
of
th e
A
P
roper
S
phere
of
G
overn m en t
c t iv it y
Given a framework for straight thinking about budget functions,
the economist is brought face to face with two questions that come
closer to the central problem of the proper sphere of Government
activity. First, where competitive bidding via the pricing mechanism
is inapplicable, how are the preferences of voters for governmental
services to be revealed, measured, and appropriately financed ? Sec
ond, waiving the question of measurement of preferences, where would
the line between public and private control over resources be drawn
if economic efficiency were the only criterion to be implied ?
On the first question, insofar as it relates to individual preferences
for public goods, economists have agreed on the nature and difficulty
of the problem, have made some intriguing suggestions as to its solu
tion, and have concluded that it is next to insoluble. The key diffi
culty is that the voting process, unlike the pricing process, does not
force the consumer of public goods to show his hand. The essence of
preference measurement is the showing of how much of one good or
service the consumer is willing to forgo as the price of acquiring
another. But the amount of a public good or service (say, of defense,
police protection, or schooling) available to the voter is independent
of the amount he pays in taxes or the intensity of his demand for it.7
Unless and until we devise a reliable and reasonably accurate method
of detecting specific voter preferences in some detail, our definition of
the proper sphere of government activity will have to rely chiefly on
6 Some of these reallocations represent an implementation of foreign policy and national
defense, others represent simply a substitution of collective judgment or political pressure
for the rule of the market as to the most efficient distribution of productive resources.
In terms of the Musgrave framework, perhaps some of the expenditure and tax subsidies
to specific industries may simply be an inefficient way of providing a larger amount of
defense or other services. They would thus fit, albeit rather uncomfortably, into the
service budget.
7 For an illuminating exploration of ways and means to get at a more valid and clear-cut
expression of voter preferences for government services, see the pioneering work by Howard
R. Bowen, Toward Social Economy, New York, 1948, especially ch. 18, Collective Choice.
In this chapter Bowen explores both voting and polling techniques for ascertaining those
individual tastes and preferences which cannot find expression in, or be measured by, the
market mechanism.
ECONOMIC GROWTH AND STABILITY
103
the informed judgment and perception of those whom we vote into
legislative and executive office.8
This being the case, the economist’s task is to contribute what he
can to this informed judgment and perception. In effect, the econ
omist’s job becomes one of telling the voters and their representa
tives what their preferences as to governmental activities would be
if they were guided by the principle of economic efficiency. In doing
so, the economist is not proposing that decisions as to what kinds of
activities should be assigned to government—what wants should'be
satisfied and resources should be redirected through government ac
tion—should be made on economic grounds alone. He is fully aware
that values such as those of political and economic freedom play a
vital role in these decisions. But he can perform the valuable service
of identifying those deficiencies in the market mechanism and those
inherent economic characteristics of government which make it eco
nomically advantageous to have certain services provided by govern
ment rather than by private initiative. In other words he can show
where government intervention in resource allocation and use prom
ises a greater return per unit of input than untrammeled private use.
The economist recognizes, of course, that there are areas in which
he is necessarily mute, or at least should not speak unless spoken to.
These are the areas of pure public goods, whose benefits are clearly
indivisible and nonmarketable, and no amount of economic wisdom
can determine the appropriate levels of output and expenditure.9 In
the realm of defense, for example, one successful Russian earth satel
lite or intercontinental ballistics missile will (and should) outweigh
10,000 economists in determining the appropriate level of expendi
tures. At most, the economist stands ready to offer analysis and
judgments as to the critical levels of defense expenditures beyond
which they threaten serious inflation in the absence of drastic tax ac
tion or curtailment of civilian programs, or, given that action,
threaten impairment of producer incentives and essential civilian
programs.
A much more fruitful activity for the economist is to demonstrate
the economic advantage offered by government intervention, budge
tary and otherwise, in those intermediate service areas where benefits
are at least partially divisible and marketable. A number of econ
omists have made useful contributions on this front.10 In what
situations does economic logic point to government intervention to
correct the market mechanism’s allocation of resources in the interests
of greater efficiency in their use ?
8 Insofar as voter wants in the public sphere go beyond individualistic preferences to
general welfare choices (as Colm, in his article commenting on Samuelson’s theory, argues
that they not only do, but should), the problem changes form, but the desirability of
sharper definition of voter preferences remains undiminished.
9 No attempt is made here to define a public good. Samuelson (in The Pure Theory of
Public Expenditures, The Review of Economics and Statistics, November 1954, vol. 36,
p. 387) has defined “ collective consumption goods” as those in which one individual’s
consumption of the good leads to no diminution of any other individual’s consumption of
that good. McKenna (op. cit.) would broaden the definition to include as public goods all
those that provide “ benefit simultaneously and automatically to more than one member of
society.”
It would seem that while the former definition leaves out many goods provided
under the budget principle, M cKenna’s embraces quite a number provided under the market
principle.
10 See, for example, O. H . Brownlee and E. D. Allen, Economics of Public Finance, second
edition, New York, 1954, ch. 10, The Role of Government Expenditure. See also M ax F.
Millikan, Objectives for Economic Policy in a Democracy (especially pp. 6 2 - 6 8 ) , and
Robert Dahl and Charles E. Lindblom, Variation in Public Expenditure, both in Income
Stabilization for a Developing Democracy, Max F. Millikan, editor, New Haven, 1953.
104
ECONOMIC GROWTH AND STABILITY
1. Where there are important third-party benefits (also known as
extra-buyer benefits or beneficial neighborhood effects) which accrue
to others than the direct beneficiary of the service as in the case o f
education, disease prevention, police and fire protection, the market
price and demand schedules underestimate the marginal and total
social benefits provided by the service in question. By and large, the
direct beneficiaries are the only ones who enter the private market as
buyers, with the result that the services would be undervalued,
underpriced, and underproduced unless government entered the trans
action. Government is the instrument for representing the third-party
beneficiaries and correcting the deficiency of the market place (though
this is not to deny that private religious and philanthropic organiza
tions, for example, also represent third-party beneficiaries and operate'
on budget rather than market principles).
2. Just as there may be indirect benefits not reflected in market
demand, there may be indirect costs inflicted on society which do not
enter the private producer’s costs and therefore do not influence market
supply. Classic examples are the costs of smog, water pollution,
denuding of forests, and the like. In these areas, private output will
exceed the optimum level unless government corrects the situation
either by regulation or by a combination of expenditure and charge
backs to the private producers involved.
3. Where a service is best provided, for technical reasons, as a
monopoly (e. g., postal service, electricity, railroad transportation),
the Government is expected to step in either by regulation or operation
to avoid costly duplication and improve the quality of service.
Ideally, its function would also be to guide prices toward levels
consistent with optimum output.11 Involved here is the problem of
the decreasing cost industry, where efficient plant size is so large rela
tive to total demand that average cost decreases as output increases,
and the market solution of the output and price problem will not result
in best use of the productive assets. To push production to a point
representing an ideal use of resources may require, if not government
operation, a subsidy financed out of tax revenues.
4. Government may enjoy some advantages in production or dis
tribution which make it an inherently more efficient producer o f cer
tain services. Here, the classic case is highways, streets, and side
walks. By providing them free to all comers, Government effects sub
stantial savings in costs of distribution since it does not have to meter
the service and charge a price for each specific use. In this category
we might also fit projects, such as the initial development of atomic
energy, which involves such great risks and huge accumulations of
capital that the private market does not have the financial tools to
cope with them.
Although the foregoing list could be lengthened, it serves to cover
the major types of mixed economic situations (i. e., those in which
resource allocation could be guided either by the market mechanism
alone, or by Government alone, or by a combination of the two) in
which the economist 9ees opportunities for improved deployment of
productive resources via Government action.
31 Note that the Government here is likely to be applying the market principle rather
than the budget principle, though it has the advantage of beinp able to combine the two.
F or example, in the postal service it can subsidize parts of the service in accord with
assumed social priorities, while making other parts pay their way.
105
ECONOMIC GROWTH AND STABILITY
A
l t e r n a t iv e
M
ean s of
C
a r r y in g
O
u t
G
overnm ent
F
u n c t io n s
Given the decisions as to the appropriate sphere of Government
activity (on the basis not merely of considerations of greatest eco
nomic gain but also of value preferences), there remains the problem
of choice among alternative methods to implement these decisions,
to achieve given aims and satisfy expressed public wants. This
choice will affect the budget in different ways. It may increase ex
penditures, decrease revenues, establish contingent liabilities, or per
haps have no effect on the budget at all (exoept for a small amount of
administrative expenses involved in the supervisory and regulatory ac
tivities) . Since the operational question is not merely what functions
and activities Government should carry out, but what budgetary prin
ciples and expenditure levels these lead to, the problem of implementa
tion must be included in any applied theory of public expenditures.
Here, the economist’s role is to determine the most efficient method
of providing the service or otherwise influencing resource allocation.
He is concerned with minimizing costs, i. e., achieving the stated ob
jective with a minimum expediture of resources. Needless to say,
other considerations will also influence the selection among alternative
means, as even a brief consideration of the types of choices involved in
the implementation process will make clear.
What are these choices? Take first the case of direct satisfaction
of individuals’ public wants. Should the Government produce the de
sired public goods or obtain them from private industry by purchase or
contract? To accomplish redistributive ends, should the Govern
ment provide transfers in cash or transfers in kind ? 12 Should Gov
ernment rely on public production of educational services, or should
it consider private production combined with earmarked transfers of
purchasing power to parents ? Thus far, the choices all involve direct
budgetary expenditures, the level of which differs, at least marginally,
depending on the relative efficiency of the method chosen. But in
making his choice, the policymaker must consider not merely the direct
costs of providing the service but whether one method involves more
or less disturbance of private market incentives and patterns of pro
duction than another, whether it involves more or less interference
with individual freedom (which is largely a function of the extent of
Government expenditures and intervention but certainly in part also
a function of the form of that intervention), and so on.
Another set of choices may take the item off of the expenditure
side of the budget entirely, or leave it there only contingently. Should
such subsidies as those to promote oil and gas exploration, stimulate
foreign investment, expand the merchant marine, promote low-cost
housing, and increase the flow of strategic minerals take the form of
(1) outright subsidies or above-market-price purchase programs, (2)
Government loan programs, (3) Government guaranties, or (4) tax
u One involves so-called resource-using (also called factor-purchase or exhaustive)
Government expenditures, i. e., payments in exchange for current goods and services
The other involves
transfer payments, i. e., payments made without any provision of current goods and
■services in return, with direct control over resources passing into private hands.
Tendered, with direct control of resources remaining in public hands.
106
ECONOMIC GROWTH AND STABILITY
concessions? The choice will clearly involve quite different impacts
on Government expenditures.13
In many of these cases, the economist can be helpful with his effi
ciency criterion. But one would be naive to think that efficiency alone
dictates the choice. The economist may show that a direct subsidy
could stimulate a given amount of private direct investment abroad,
or a given amount of exploration for oil and gas, with a much smaller
cost to the budget than is implicitly required in the tax concession
method of achieving the same end. Yet, the costlier tax concession
method may be preferred for two simple reasons: (1) it is virtually
self-administering, involving no administrative hierarchy to substi
tute its authority for relatively free private decisions, and (2) it does
not involve an increase in the expenditure side of the budget, a fact
which has certain attractions to the Executive and Congress.
As yet, no clear boundary lines have been drawn among the various
form of Government intervention to mark off those that properly
belong within the scope of public expenditure theory. But this illus
trative review of the various choices makes clear that some forms of
Government activity which are not reflected in expenditures at all
(tax concessions) or only contingently (guaranties) are an integral
part of such expenditure theory. In fact, there may be a stronger
case for embracing these in expenditure theory than many Govern
ment activities which require budgetary outlays but are conducted
on the pricing principle, i. e., Government enterprise activities.
Economists are conducting some provocative inquiries into ques
tions of alternative methods of carrying out Government programs
in areas where the answers had heretofore been taken for granted.
For example, the transfer of schooling to a private production and
Government transfer payment basis has been urged by Prof. Milton
Friedman as a more efficient means of providing the desired service.14
Prof. O. H. Brownlee is currently probing further into this question,
as well as the possibilities of transferring other publicly produced
services into the sphere of private production. Once fairly conclusive
findings are devised as to the mthods most likely to minimize costs,
there remains the vital task of blending these findings with the non
monetary values that would be gained or lost in the process of trans
ferring from public to private production.
S
om e
C
o n s t r a in t s o n t h e
A
C
p p l ic a t io n o f
S
p e c if ic
E
c o n o m ic
r it e r ia
Repeatedly in this discussion, the note has been sounded that,
in determining the level of Government activity, the policymaker
cannot live by economics alone. More particularly, we need to guard
against setting up our economic guides solely in terms of those
considerations which lend themselves to sharp economic analysis
13
Even within the bounds of a particular program, these impacts can vary sharply.
Thus, a direct lending program can be handled by using either funds provided by the
TJ. S. Treasury, in which case it w ill be reflected in Government expenditures and debts,
or as was recently the case in the Federal housing program, funds raised by direct sales of
debentures to the public, which are not recorded as part o f Government expenditures and
debts.
See M ilton Friedman, T he Role of Government in Education, in Economics and The
Public interest, Robert A. Solo, editor, New Brunswick, 1955, pp. 1 2 3 -1 4 4 . In his
prescription, Friedman would, of course, have Government regulate the private schools
to the extent of insuring that they meet certain minimum standards in their programs and
facilities.
11
ECONOMIC GROWTH AND STABILITY
107
and definition. In other words, the role of both economic and non
economic constraints must be given full weight.
The former include a host of considerations relating particularly
to economic motivation in Government versus private undertakings.
Government may, for example, have a decided edge in the efficiency
of distribution or be able to achieve a better balancing of social
costs and social benefits in a variety of fields. Yet, there may be
important offsets to these economic advantages in terms of (1)
bureaucracy, (2) lack of the profit criterion to gage the results of
Government activities, and (3) undesigned or unintended (presuma
bly adverse) economic effects of taxation.15
The latter factor, in particular the fact that tax financing of public
services involves breaking the link between an individual’s cost of a
given service and his benefit from it, may involve important offsets to
economic advantages otherwise gained by Government expenditure.
Thus far, to be sure, no dire consequences of the disincentive effects of
taxation have been firmly proved, but changes in the form of private
economic activity to minimize taxes are certainly a cost that must
be weighed when netting out the balance of economic advantage in
Government versus private performance of services.
Beyond the economic factors, one encounters an even more basic
and less manageable constraint, namely that of freedom of choice.
Thus, it is quite conceivable that following the kinds of economic cri
teria discussed earlier in the paper would take us considerably farther
in the direction of Government spending and control over resource
allocation than we would wish to go in terms of possible impairment
of economic and political freedom. This consideration enters im
portantly not merely in decisions as to the proper range of Govern
ment activity but also in choosing among alternative methods of
providing Government services.
This is not to imply that all value considerations run counter to
the expansion of the Government sector of our economy. Such ex
pansion may serve a number of social values, such as greater equality
of income and opportunity, a more acceptable social environment, and
so on.18
To get all of these considerations into the decision-making equa
tion on private versus public provision of a particular service, or
on the choice among alternative forms of providing the service, re
quires a wisdom which goes well beyond the field of economics. Per
haps this explains why so few economists enter politics.
“ These less sharply defined economic effects have to be balanced, of course, against
comparable and perhaps offsetting drawbacks in the market mechanism. For an explora
tion of some of these factors, both in the private and the public sphere, see Robert A. Daht
and Charles E. Lindblom, Politics, Economics, and W elfare, New York, 1953, especially
pt. V . See also C. Lowell Harriss, Government Spending: Issues of Theory and Practices,
Public Finance, vol. 12. 1957, pp. 7 -1 9 .
16 This type of consideration is examined in W illiam Vickrey, An Exchange of Questions
Between Economics and Philosophy, in Goals of Economic Life, edited by A . Dudley Ward,.
New York, 1953, pp. 1 4 8 -1 7 7 . See also Fax F. Millikan, op. cit.
PRINCIPLES OF BUDGET DETERMINATION
Richard A. Musgrave, professor of economics, University of
Michigan
The people of the United States are generally agreed that the econ
omy is to be organized on the premise of free consumer choice, that
production is to be carried on by privately owned and operated firms,
and that the market should be relied upon where possible to transmit
the desires of the consumer to these firms. This being our basic form
of organization, why is it that a substantial part of the economy’s
output is provided for through the budget? This question must be
answered to begin with, if we wish to say something about the
“proper” scope or composition of the budget.
The budgetary activity of the Government is needed because the
ricing system of the market cannot deal with all the tasks that must
e met in order to operate a sound economy and a healthy society.
Certain tasks must be performed by government. Some may deplore
this fact and dream of a setting where everyone could live in peace
without any kind of governmental activity; others may feel that the
necessity of social and economic policy at the governmental level en
riches the challenge of social life and makes for a more balanced
society. Whatever one’s values in this respect, the nature of things
is such that budgetary activity is needed. The question then is under
what circumstances and why this need arises.
The answer to this question is too complex to permit a simple and
uniform solution. In my own thinking I have found it useful to dis
tinguish between three major functions of budget policy, including—
1. The provision for social wants, which requires the Govern
ment to impose taxes and make expenditures for goods and serv
ices, to be supplied free of direct charge to the consumer;
2. The application of certain corrections to the distribution of
income as determined in the market requiring the Government to
add to the income of some by transfers while reducing the income
of others by taxes; and
3. The use of budget policy for purposes of economic stabili
zation, rendering it necessary under some conditions to raise the
level of demand by a deficit policy and under others to curtail
demand by a surplus policy.
I shall comment briefly on the nature of each of these three functions,
and on how they are interrelated.
E
P
r o v is io n
for
S
o c ia l
W
an ts
When I say that the Government must provide for the satisfaction
of social wants, it does not follow that the Government itself must
carry on the production of the goods and services which are needed to
satisfy these wants. This may be necessary in some cases, as for in108
ECONOMIC GROWTH AND STABILITY
109
stance with the provision for police protection, which can hardly be
left to a private agent, but this is the exception rather than the rule.
In most cases there is no such need. I f new planes or government
buildings are to be provided for, they may be purchased from private
firms. The essence of budgetary provision for the satisfaction of
social wants, therefore, is not production by government. It is pay
ment for goods and services through budgetary finance, and supply
of such services free of direct charge to the consumer.
What, then, are the social wants which must be provided for in
this fashion? Some people have argued that they are wants which
in a mysterious fashion are experienced by the Nation as a whole, and
thus reflect the desires of the collective entity. This makes little sense
in our setting. The desire for the satisfaction of social wants is ex
perienced by individuals, no less than that for the satisfaction of pri
vate wants. This is not where the difference lies. The basic problem
of social wants arises because their satisfaction, by their very nature,
requires that the goods and services in question must be consumed in
equal amounts by all. Social wants differ in this important respect
from private wants, where each consumer may arrange his personal
pattern of consumption such as to satisfy his own personal tastes.
Thus, I may go to the market and purchase whatever amounts and
type of clothing, housing, or food may suit my tastes and resources;
but I must be satisfied with the same municipal services as are re
ceived by my neighbors, or with the same degree and type of foreign
protection as is granted to all other citizens of the United States. This
crucial fact, that certain services must be consumed in equal amounts
by all, has important consequences.
One consequence is that you cannot apply what I like to refer to
as the exclusion principle.1 Since all people must consume the same
amounts, no one can be excluded from the enjoyment of services
aimed at the satisfaction of social wants. Everyone benefits, whether
he contributes little or heavily to their cost. Now you might say that
this is not too difficult a problem. Let the tax collector see to it that
everyone pays. Unfortunately this overlooks the real difficulty. The
real difficulty is not that people are unwilling to pay unless forced
to; it is that of determining just how much various people should be
called upon to contribute.
This difficulty does not arise with the satisfaction of private wants
in the market. Here the individual consumer is forced to bid against
others in order to get what he wants. The pricing mechanism, as it
were, is an auctioning device by which things go to those who value
them most, as evidenced by what they are willing to pay. People
must bid to get what they want, and thereby provide the producer
with the necessary signal of what to produce. In the case of social
wants this signal is not forthcoming. Consumers know that they can
not be excluded and that their own contribution will weigh very
lightly in the total picture. Thus they will not reveal their true pref
erences on a voluntary basis and offer to pay accordingly. Therefore
it is no easy task to determine just what social wants should be rec
ognized and how much each should be called upon to contribute.
1
A second consequence, which has been pointed out by Professor Samuelson, is that there
would be no single best solution to the budget problem, applying the usual criterion of
economic efficiency, even if the preferences of all individuals were known. T his aspect is
•omitted from the present discussion,
97733— 57--------9
110
ECONOMIC GROWTH AND STABILITY
A further difference is this: For goods supplied in the satisfaction of
private wants, competition sets a uniform price in the market. In
dividual consumers, depending on their personal tastes, can buy dif
ferent amounts at that price. For goods supplied in the satisfac
tion of social wants, all must consume the same amount, and those who
value public services more highly must pay a higher unit price.
This much is clear, but the question is just what should be supplied
and just how much each should pay. The market cannot give the
solution and a political process is needed to accomplish this task. By
choosing among various budget programs, including various expend
iture plans and various tax plans to cover the costs, the voters can
express their preferences in the matter. Since they know that the
law, once decided upon, will apply to each of them, they will find it
in their interest to reveal their preferences and to vote for the plan,
or the approximation thereto, which is most appealing to them. Thus
preferences are revealed through the political process. While the
minority might be dissatisfied, and strategies might be used in voting,
an acceptable approximation to the preferences of the individual
members of the group is reached.
All this is somewhat of an oversimplification. Individuals do not
vote personally on each issue. Rather, they elect representatives who
vote for them. Thus, the function of the representative is to crystal
lize public opinion with regard to such issues, budgetary and other,
and to find groups of issues on which their constituents can agree.
The Member of Congress is a go-between, whose function it is to work
out compromises and solutions which are acceptable to the majority.
By saying this I do not mean to slight the educational function of
political leadership, nor do I wish to underestimate the importance of
the contribution to be rendered by the executive branch and by the
civil service. All these are important, but the basic process is one
of transforming individual preferences into social wants.
In taking this view of social wants, I am thinking in the framework
of what since Adam Smith has been referred to as the benefit principle
of taxation. In other words, budget policy should provide for goods
and services in response to the social wants of individuals, and to
make this possible, individuals should contribute as closely as possible
in response to their evaluation of these social wants. The great value
of this approach, from the point of view of the economist, is that it
requires us to determine public expenditures together with the revenue
side of the budget. In this basic sense, there can be no theory of
public expenditures without a theory of taxation, and vice versa.
What does the benefit approach mean regarding the distribution of
the tax bill between people with different levels of income ? I will not
attempt to answer this in a categorical form, but I can point to the
considerations on which the answer should depend: This is whether
the goods and services supplied for the satisfaction of social wants are
largely in the nature of necessities or luxuries. I f they are largely
in the nature of necessities, the answer leads to regression; if they are
primarily in the nature of luxuries the answer points to progression.
I f people wish to spend the same fraction at all levels of income the
answer leads to proportional taxation.2 While a moderate degree of
3 In technical terms, the tax structure w ill be proportional if the income elasticity of
social w ants is unity, progressive if it is greater than unity, and regressive if it is smaller
than unity.
ECONOMIC GROWTH AND STABILITY
111
progression would seem the reasonable answer, this is by no means the
only consideration entering into the distribution of the total tax bill.
Finally, a word about the matter of budgetary balance. Insofar as
the satisfaction of social wants is concerned, the budget must be bal
anced, in the sense that goods provided for through the budget must
be paid for over their useful life. This merely reflects the fact that
resources used for the satisfaction of social wants cannot be used for
other purposes, and someone must bear the cost. At the same time,
we shall see that this is only one among other considerations. It does
not follow that the total budget must be balanced.
I need hardly add that this brief disi ussion of social wants does not
cover the entire picture. Not all public services are supplied in
response to the individual preferences of the consumers. There may
be instances when the majority decides that certain wants of indi
viduals should be satisfied, even though these individuals would prefer
to be given the cash and use it for other purposes. Free education or
hospital services may be cited to illustrate this case. This type of
public service requires a different explanation. However, note that
the benefits derived from such services extend beyond the specific bene
ficiary, and thus approach what I have described as the central type
of social wants.
A
d ju stm ents in
t h e
D
is t r ib u t io n
of
I
ncom e
I now turn to the second function of budget policy, which is to pro
vide for adjustments in the distribution of income. We are all agreed
that it is the responsibility of society to undertake certain adjustments
in the distribution of income, which results from the forces of the
market, the laws of inheritance, and differences in abilities to acquire
income. Babies must be assured adequate food, the sick and the aged
must be given proper care, and so forth. Beyond this, some hold to an
idea of the good society which requires a fairly extensive degree of
income equalization, others would favor a moderate degree of equali
zation, while still others might oppose any such measure and favor
a high degree of inequality. These are matters of social philosophy
and value judgment on which we all have our own views. Moreover,
consideration must be given to the interrelation between income dis
tribution and the total income which is available for distribution.
My concern here is not with the question as to which is the best set
of values. While I happen to feel that progressive taxation is fair,
this is not the point. My point is that if society wishes to make dis
tributional adjustments, it is desirable as a matter of economic policy
to make them through the tax-transfer mechanism of the budget. This
is preferable to distributional adjustments via manipulation of par
ticular prices, be it of products or of factors of production. Certainly,
we cannot accept the stricture that the purpose of taxation is to finance
public services and nothing else, and that, therefore, they “must not”
be used for distributional adjustments. There is no such law in the
order of things. Indeed, where distributional adjustments are to be
made, this is the logical way in which to make them.
The determination of the desired degree and type of distributional
adjustment is, again a matter of political process, and I will not discuss
it here. Let us suppose that some degree of income equalization is to
be accomplished. This calls for taxes on some people with incomes
112
ECONOMIC GROWTH AND STABILITY
above the average and for transfer payments to some people with
incomes below the average. Insofar as distributional adjustments are
concerned, the budget must again be balanced. Now you may argue
that such a general tax-transfer scheme does not appear in the budget,
except perhaps in the social-security programs, and that our budget
does not engage in distributional adjustments. This is not the case.
The distributional adjustments are implicit in a distribution of the
overall tax bill in a way which is more progressive than would be
justified on the basis of assigning the cost of social wants on a benefit
basis. In other words, the budget as we know it and as it is enacted
reflects the net result of various component policies. More about this
in a moment.
Just as my discussion of allocating the cost of social wants moved in
the context of a benefit approach to taxation, so does the problem of
distributional adjustment belong in the sphere of ability to pay and
equal sacrifice doctrines. The two approaches are wholly compatible
if each is viewed in its own context. The argument that the cost of
public services should be allocated in accordance with ability to pay
sounds nice, but it gives us no foundation on which to decide what
public services should be rendered. This can be done only in relation
to individual preferences and implies the spirit of benefit taxation.
I can see no other approach that leads to a sensible solution. At the
same time, it is non sequitur to argue that progressive taxation is out
o f order because (assuming this to be the case) benefit taxation requires
proportional rates. The element of progression may be called for in
order to implement distributional adjustments, which is quite a differ
ent matter.
Failure to distinguish between the problem of distributional adjust
ment and the problem of providing for the satisfaction of social wants
leads to confusion on both counts. I f the degree of distributional
adjustment is tied to the level of the budget, some may favor an
increase in the level of public services as a means of extending distri
butional adjustments, even though they do not support budget expan
sion on the basis of benefit taxation; and others, who would favor an
expansion of the budget on this basis will oppose it because in practice
it is related to an extension of distributional adjustments. Moreover,
these relationships change with the level of taxation and the existing
tax structure. While there was a time when the marginal taxpayer
was the fellow with the large income, we are now in a situation where
increased levels of public services largely involve increased tax contri
butions from (or exclude tax reductions for) people in the middle or
middle to lower income groups. Thus the politics of the fiscal problem
are changed and essential public services will go begging in the
process.
B
udget
P
o l ic y
an d
S
t a b il iz a t io n
I now turn to my third function of budget policy, which is the use
of tax ajid expenditure measures as a means of economic stabilization.
The great achievement of the fiscal-policy discussion of the last 26
years is the by now fairly general recognition that fiscal policy must
play art important role in economic stabilization. The old view that
the budget should be balanced is applicable only if we consider our
first and second functions of budget policy, and even here some tem
porary exceptions may arise. Once the stabilization function is intro
ECONOMIC GROWTH AND STABILITY
113
duced, deficit finance is called for under conditions of potential de
pression, and surplus finance is called for under conditions of
potential inflation. The point to be noted here is that the stabiliza
tion objective of budget policy can be achieved without contradicting
the other requirements of budget policy, namely, efficient provision
for social wants and the application of distributional adjustments.
Regarding the proper level of public services, this means that there
is no excuse for make-work expenditures during a depression, just as
there is no excuse for cutting essential public services during periods
of high activity. Precisely the same fallacy is involved in both cases.
An increase in public services during the depression is in order, only
to the extent that the decline in private expenditures for some pur
poses (such as investment) frees resources which people may wish to
allocate in part to the satisfaction of social wants; and!a decrease in
public services is in order during the boom only to the extent that
people wish to divert resources from public use to meet an increased
demand for resources for other uses. This sets the limits of the
permissible adjustment: There is no justification for raising the level
of public services merely to increase aggregate demand, since this
can be done also by lowering taxes; and there is no justification for
cutting public services merely to curtail demand since this can be done
also by raising taxes.
Moreover, there is no need for permitting considerations of sta
bilization policy to interfere with desired distributional adjustments.
Thus it was argued frequently during the thirties and forties that
taxes on lower incomes should be avoided because this would under
mine demand and that therefore a more progressive tax structure
was needed; and vice versa for the current case of inflation where it
is held that progression should be reduced to secure a shift of re
sources from consumption to investment, thus providing for increased
capacity in order to check inflation. The argument makes sense in both
cases if we assume that the total level of tax yield is given, but it
breaks down if we allow for adjustments in the level of taxation. The
level of taxation which is required for purposes of stabilization should
depend upon the distribution of the tax bill, and not the other way
round.
N
et
B
udget
and
S e p a r a t io n
of
I
ssu es
j
To bring my point into focus, let me exaggerate a little and assume
that there are actually 3 different budgets, pursuing respectively my
3 functions of budget policy. First, there is the budget to provide for
the satisfaction of social wants, where taxes are allocated m line with
a benefit principle of taxation. By its nature, this budget is balanced
over the useful life of the services which are supplied. Secondly,
there is the budget to provide for distributional adjustments, involv
ing tax and transfer payments. By its nature, this budget is balanced
as well. Then there is the budget designed to stabilize the level of
demand. By its nature, this budget involves either taxes or transfer
payments, proportional to what is considered the proper state of
income distribution.
We may think of these budgets as being determined in an inter
dependent system, where the manager of each of the three branches
114
ECONOMIC GROWTH AND STABILITY
takes the action of the other branches as given.3 Having determined
the three budgets, the Government may proceed to administer each
budget separately. This would involve various sets of taxes and/or
transfers for any one person. To simplifj7matters, it will be desirable
to clear the tax and transfer payments against each other, and thus to
administer one net budget policy only.
The actual tax and expenditure plan enacted by the Congress in any
one year reflects such a net budget. This is of advantage as a matter
o f administrative convenience, but it blurs the issues. While it may
be difficult as a matter of legislative procedure to determine inde
pendently each of the three subbudgets noted in my discussion, some
lesser steps may be taken in the organization of the budget process, on
both the executive and the legislative side, to move the problem into
a better perspective. To say the least, an understanding of the three
objectives as distinct issues is prerequisite to efficient budget planning.
The preceding discussion will suffice to show that it is exceedingly
difficult to establish a simple set of principles by which to secure an
8 T o illustrate, let me assume that there are two taxpayers only, X and Z. Assume
further that the full employment income equals $100, and that X ’ s earnings are divided
such that X receives $70 while Z receives $30. Now suppose that the Distribution Branch
imposes taxes of $10 on X and pays $10 of transfers to Z, the desired distribution being
such that X is to receive 60 percent and Z is to receive 4 0 percent.
Next, let me suppose that with an income of $100, distributed in this fashion, private
expenditure on consumption equals $60 and that expenditures on investment equal $30.
Moreover, the manager of the Stabilization Branch is informed that expenditures for the
satisfaction of social wants equal $22. This means that total expenditures equal $112
and are $12 above the full employment level. To simplify matters, let us hold investment
constant. In order to lower consumption by $12 the Stabilization Branch w ill impose
taxes of $ 2 0 , it being assumed that the ratio or consumption to income is constant at 60
percent.
In order not to interfere with the distributional adjustment, $12 w ill be paid
by X and $8 by Z.
The income of X now equals $70 — $ 1 0 — $12 = $48, while that of Z equals $30 + 10 — $8
= 3 2 . Now suppose that both wish to spend 27.5 percent of their income on the satisfac
tion of social wants. Thus for the satisfaction of social wants taxes equal $13.2 0 for X and
$ 8 .80 for Z, with total expenditures for the satisfaction of social w ants equal to $22.
T he three subbudgets involve the following transactions :
X
Z
Total
Satisfaction of social wants:
Taxes.............................................................................................
13.2
8.8
22.0
22.0
00.0
Distributional adjustment:
10.0
10.0
10.0
10.0
00.0
Stabilization adjustment:
12.0
8.0
20.0
20.0
Net budget:
35.2
6.8
42.0
22.0
20.0
Instead of collecting 3 separate taxes from X it will be more convenient to collect the total of $35.20; and
instead of collecting 2 taxes for Z and paying 1 transfer, it will be more convenient to collect net taxes of
$6.80. W e thus have net tax receipts of $42 which after allowingfor goods ajld service expenditures of $22
leave us with a surplus of $20, equal to the surplus in the stabilization operation. A similar illustration
might be given where the stabilization operation involves a deficit, in which case there appears a correspond
ing deficit in the net budget. Finally note that the distribution of the tax bill in the net budget is more
progressive than that for carrying the cost of social wants, but less progressive than that involved in the
distributional adjustment only.
ECONOMIC GROWTH AND STABILITY
115
efficient determination of public expenditures. This task involves the
determination of the total budget plan, including the revenue as well
as the expenditure side, and it comprises quite distinct sets of objec
tives or functions of budget policy. The issues involved are the more
difficult as they cannot be solved, or be solved in part only, by the
ordinary tools of economic analysis. The political process of decision
making becomes an inherent part of the problem.
At the same time, the complexity of the problem establishes 110 pre
sumption that the use of resources for the satisfaction of social wants
is less efficient than its use for the satisfaction of private wants. This
must be kept in mind if we are to see the problem of social-want satis
faction in its proper perspective. While it is obvious that any ex
penditure objective, once decided upon, should be accomplished at
minimum cost, the objective of efficiency in public expenditure plan
ning must not be confused with minimizing the level of such expendi
tures. By the very nature of the budget as an allocation problem, the
danger of inefficiency arises with insufficient as well as with excessive
outlays.
SOME PROBLEMS IN OPTIMIZING THE LEVEL OF
PUBLIC EXPENDITURES
Kenyon E. Poole, professor of economics, Northwestern University
S
u m m a r y
In this paper I should like to discuss a few of the problems that
are met with in the determination of the optimum level of Federal
expenditures, with particular reference to stable economic growth. It
may be useful to preface the more extended remarks with a brief
summary of the major points that will be covered in the text.
It seems to me that there is a tendency on the part of many com
mentators on the problem of Federal finance to be unduly pessimistic
on the effectiveness of the budgetary process in holding Federal ex
penditures to the level that makes a maximum contribution to aggre
gate social welfare. In an age in which economic resources are still
scarce, public information media can be counted upon to call atten
tion to any really serious misallocation of resources between the public
and the private sectors of the economy, or within the public sector.
It has to be conceded, of course, that the complexities of the budgetary
process, and the obstacles to making close calculations with respect to
the relative social desirability of public and private spending pro
grams, provide room for much difference of opinion on the effective
ness with which our economic institutions allocate resources. What
should not be conceded is the contention that these difficulties make
intelligent budgeting of resources for maximum social welfare an
unattainable objective.
In accordance with the relatively optimistic attitude adopted here
toward the possibility of intelligent budgeting, two commonly held
and widely divergent opinions are rejected. One is the view that the
secular rise in gross national product entitles the Federal Government
to proceed with additional social-welfare programs on some kind of
automatic basis, and the other is the frequently expressed view that
Federal expenditures are “too high,” or that they have risen too
rapidly. Both of these opinions beg the question by making tacit
assumptions on which there is room for disagreement. It is merely
an assumption that government is entitled to share in any definite way
in the annual increments to national product; but on the other hand
it is to be expected that as an economy grows, the absolute economic
importance of government will grow with it. The job that has to be
done is to determine how far and in what directions government func
tions should evolve when population, national output, and productiv
ity are growing.
By restricting the discussion of Federal spending to problems of
economic growth, we exclude two types of programs. Day-to-day
housekeeping expenditures, though both affecting and affected by
economic growth, are not a primary consideration. Moreover, Fed
116
ECONOMIC GROWTH AND STABILITY
117
eral programs which may be definitely classed as social consumption
are not directly relevant. A problem is posed in practice, however,
in differentiating between programs which increase the capacity of
the economy to produce goods and services (or to make progress in
some broader sense), and those which merely contribute to current
social consumption. The difficulty is, of course, that many programs
have aspects of both. Examples which readily come to mind com
prise most of the major Federal nonmilitary programs: Federal aid
to schools, hospitals, residential construction, depressed areas, slum
clearance, highways, aid to small business, social security, and the like.
In passing judgment on the admissibility of particular programs we
should be careful to distinguish between their social consumption
aspects and their capacity for contributing to growth. Both are
equally relevant to social welfare; but it is necessary to face up to the
implications of selecting a given ratio between the two objectives, and
this involves taking a long look at every proposed program with this
distinction in mind. This is an aspect of Federal budgeting which
has not received sufficient attention in the past.
A possible defect in our capacity for properly evaluating the net
welfare contribution of Federal expenditures for economic develop
ment stems from the fact that there is less resistance to spending pro
grams that can be financed out of an automatic rise in tax receipts as
national income rises than there is for programs that require a rise
in tax rates. The reason is that public opinion seems to be fairly
united on the view that tax rates, and especially income-tax progres
sion, have reached (or surpassed) permissible peacetime limits. Im
plicitly this means that the public believes that Federal spending has
already gone somewhat beyond the point at which its net marginal
contribution to national welfare is negative. The effect is that ade
quate consideration may not always be given to the relative impetus
to economic growth (and thus to an ultimate rise in the tax base and
tax yields) of development programs that initially, at least, require
a rise in tax rates. This disability is not a prohibition, however, and
it therefore is of interest to consider 1 or 2 points that bear on the
effects on economic stability of a rise in Federal spending that is
financed by a rise in tax rates.
One point is the possibility that destabilizing effects may arise out
of an increasing divergence between the nominal and the actual incometax rate structure when already high nominal rates are increased. The
higher rate schedule stimulates individuals and firms to seek a multi
plication of exemptions, and the distortions caused by the varying suc
cess of different groups may adversely affect investment. Another
destabilizing effect of increased tax rates appears if increased excise
tax rates, or increased rates of other taxes entering into cost of pro
duction, result in a rise in the Consumer Price Index. The conse
quences of increased tax rates are thus complex, and the particular
mixture of inflationary and deflationary effects that is experienced de
pends on circumstances.
A discussion of the growth functions of Federal expenditure pro
grams leads into the question of efficiency of Government operations.
In this context efficiency is not closely related to the narrow concept
of minimization of waste in Government offices, but is concerned with
the question of the scope of Government functions, and the coordina
118
ECONOMIC GROWTH AND STABILITY
tion of the objectives of the various Government agencies. In other
words, concern is with the efficiency of resource utilization by the Gov
ernment within the context of efficiency of resource utilization for the
economy as a whole. It is this broader concept of efficiency, rather
than the narrow “office-manager” concept, that ought to be used in
determining the limits and judging the effectiveness of Government
functions.
Finally, this paper calls attention to an aspect of the impact of a
high Federal spending floor on economic stability. To a significant
extent the knowledge that Federal spending is high, and will remain
high, is a substitute for a large volume of liquid assets in providing a
stimulus to private investment. So long as the monetary authority
refrains from taking strong steps to discourage private borrowing,
firms and individuals can borrow from banks (and thus create pur
chasing power) with the certainty of a massive basic demand for prod
ucts on the part of the Government. Thus an important contribution
is made to investment for growth in the private sector; but in these
circumstances the assurance of price stabiltiy appears to call for a more
determined Federal Reserve policy than would be needed in the ab
sence of the Government spending floor. In other words, there may
be a bias toward optimism which might on occasion have to be counter
acted in the interest of inflation control. It can be argued that inter
est rate policy may therefore have to be supplemented with other types
of control, particularly controls over investment through internal
financing.
T
he
P
r e c o n d it io n
or E
f f e c t iv e
B
u d g e t in g
The public finance theorist tells us that the cost of producing an
additional unit of public goods is the sacrifice of real private con
sumption or investment that is necessary to release the resources
needed to give effect to the increase in public spending. In order to
maximize social welfare, therefore, public expenditures should be
pushed to the point at which the social satisfaction obtainable from
an additional (or marginal) dollar spent on publicly produced goods
no longer exceeds that of a dollar spent on privately produced goods.1
(Publicly produced goods are defined here in a broad sense, including
not only government services, but also the net satisfactions derived
from government transfer expenditures.)
This concept is basic, and underlies the budgetary procedures in
any political system. The principle is being applied whenever an
intelligent decision is made, but it is qualified under rule by pressure
groups if the wishes of the strong are accorded a heavier weight than
those of the weak (for example, producers versus consumers). It is
true that we have an exceedingly difficult hurdle to surmount when
we attempt to translate this marginal principle into practical action.
1
A t first blush one hesitates to state a proposition that would appear to be, in theory at
least, so obvious. That there is nothing obvious about its practical political application
is apparent from the manner in which ( 1 ) protagonists of increased provision of govern
mental welfare services simply assume that the more of these services the economy pro
duces, the greater the net contribution to social welfare, and (2 ) exponents of Federal tax
reduction assert that “ expenditures have risen too rapidly and have reached too high a
level.”
In seeking the optimum level of public services in a mainly free enterprise econ
omy, this is, of course, precisely the issue that must be debated. The implications of the
problem can be clearly seen if one consults Governor Stevenson’s campaign statement
entitled “ A Program for the.True Economy : Where Is the Money Coming F rom ?” and tile
comments thereon by selected economists, Review of Economics and Statistics, M ay 1957,
pp. 134 H , and the Committee for Economic Development, T a x deduction and Tax
Iteform— W hen and How, M ay 1957, pp. 10 ff.
ECONOMIC GROWTH AND STABILITY
119
Developed by economic theorists for use in thinking about the optimi
zation of public expenditures, it is subjected to severe criticism (pos
sibly too severe criticism) by those who are experienced in the
budgetary process and are impressed by the complexities of political
decision making.2 (1) It assumes substantial knowledge on the
part of the public of the available alternatives; (2) it supposes that
substitutions between public and private spending can be made in
small enough units so that some attention is paid to the sacrifice
in the consumption of private goods that must be made when gov
ernment spending is increased; (3) it assumes that the welfare con
tributions of alternative public expenditure programs are compar
able; (4) it takes it for granted that the general public and its
legislative representatives make a reasonably successful attempt to
reconcile future social welfare with present social welfare; (5) it,
assumes that account is taken of the fact that a particular objective,
like growth or a welfare program, produces incidental adverse,
social eifects, and that some government-produced goods hurt one
group of individuals while benefiting others, or while benefiting
society as a whole (for example, an airport in a residential area):
and (6) it assumes that it is not a fatal defect of decision-making
that many individuals and groups favor or oppose on purely dog
matic or sentimental grounds increases in the relative importance of
Federal expenditures within the framework of aggregate spending.
I f we consider these points in order, the practical difficulties come
into focus at once, and not the least of them is the irreconcilability
of opposed value judgments, upon which the economist has no special
competence what ever to give an opinion.
Thus, (1) no one has ever suggested a completely satisfactory means
of providing the knowledge of alternatives that is needed to permit
full weight to be given in our fiscal thinking to the public and private
goods and services that must be forgone when a decision is taken to
tax and to spend for a particular purpose; (2) even if such a tool
were perfected, the fact that no price is too great to pay for adequate
self-defense, for example, is an indication of the impossibility of
making close, marginal calculations in Federal spending; (3) our
ideas with respect to comparability of the satisfactions from alternative
forms of public expenditure are fuzzy; (4) little success can be ex
pected from an attempt to reconcile future with present social welfare
so long as economists and others divide themselves neatly between
those who believe we should encourage present consumption at the
expense of present investment and future consumption and those who
believe that we should do the reverse; 3 (5) surprisingly little attention
2 See, for example, Jesse Burkhead, Government Budgeting (W iley, 1 9 5 6 )? pp. 42, 44, who
states that “ Marginal social benefit and marginal social cost are attractive phrases, but
they are devoid of explicit con te n t;” and with respect to the allocation of public expendi
tures, “ A t the time when decisions are in process, marginal theory provides no guidelines
for the Allocation of public expenditures/’ This statement appears to be rather extreme,
since budget making and budget cutting are by no means always across-the-board.
3 See the opposed testimony of several prominent economists at the hearings before the
Joint Economic Committee in June of this y e a r : Fiscal Policy Implications of the Eco
nomic Outlook and Budget Developments. Federal Reserve Board Chairman Martin has
stated (Senate Finnnce Committee hearing, August 19 of this year) that present inflation
ary pressures arise out of overspending and undersaving (and that the Federal Government
may be the “ chief offender” ) . The counterargument would be that a high ratio of con
sumption to income makes an invaluable contribution to full employment, which is itself
indispensable to rapid capital formation. But, again, it has been argued that the rate of
capital formation in the fifties has been somewhat less than that of the twenties, with the
implication that the saving-consumption ratio might well be increased. When the question
is raised whether the level of saving in the twenties may have been too high to sustain
full employment, the elusiveness of this whole issue becomes apparent.
120
ECONOMIC GROWTH AND STABILITY
is ever paid to the long-term adverse welfare effects of public spending
programs; and (6) to the extent that individuals and groups have
preconceptions and particularistic points of view, the conditions are
lacking for an objective, socially oriented approach to welfare
economics.
All these obstacles to applying the marginal principle in order to
ascertain the correct level and distribution of Federal expenditures
are serious ones, and they stand out ominously in the dark shadows
of the budgetary process. They have to be borne in mind when we
are considering the net contribution that can be made by Federal
spending and taxing to the maintenance of the maximum rate of
growth (assuming that we want to maximize growth) that is con
sistent with the minimum acceptable degree of economic stability.
Yet they are not insurmountable so long as the issues are debated in
the full glare of publicity. Indeed, to take any other view would be
to admit that public spending decisions are completely haphazard,
and, despite all the shortcomings of the budgetary process, this is
patently untrue.
T
he
R
ole
or
the
F
ederal
G
overnm ent in
E
c o n o m ic
G
row th
In consonance with the terms of reference of these hearings, I shall
limit myself to a discussion of Federal expenditures for growth and
stability. At the same time, an adequate level of current maintenance
expenditures and spending for protection is an indispensable prerequi
site to growth, if not to stability, and both these types of expenditures
are themselves dependent on the rate of growth. Consequently, they
are likely to rise over the long run, and thus they are necessarily
always under consideration, implicitly if not explicity.
At the outset it may be noted that a public spending policy aimed
at encouraging growth exerts complex effects on economic stability.
Federal expenditures on production factors place a floor under aggre
gate demand, and, to that extent, reduce the danger of both cyclical
downturns and secular stagnation. On the other hand, a concomitant
of growth is a rise in the flow of goods and services, which, taken
by itself, is a deflationary factor. The net effect cannot be easily
foreseen very far in advance. Moreover, unless great care is taken
in the choice and magnitude of governmental projects, the private
sector may react adversely to increased competition for limited sup
plies of savings and scarce resources. In contrast to the possible de
flationary effects of government spending for growth are the infla
tionary implications. The acceleration of rates of growth may pro
vide the background for creeping inflation, and to avoid this a care
ful balance needs to be kept between public and private investment
programs. Moreover, there is always some danger that the public
may ultimately react to a lengthy period of creeping inflation by
shifting into assets that are believed to be inflation proof. I f this
occurs, there is no guaranty that the pace of inflation will not be great
ly accelerated.
It is easy to approve, in general terms, any rise in aggregate spend
ing that is expected to contribute to stable growth. The trick is to
determine, of the expenditures that can be made for this purpose,
what proportion should be undertaken by the Federal Government.
This problem has roots that are deep in the Nation’s history. It will
121
ECONOMIC GROWTH AND STABILITY
be recalled that Alexander Hamilton held to the view that growth
would be stimulated if the National Government would take the lead
in economic life, whereas his opponents divided themselves between
two positions; (1) that the private sector could do the job best un
aided by government except in essentials like protection of life and
property, and (2) that the States, rather than the National Govern
ment, should assume responsibility for certain risky and expensive
developmental investment projects. In seeking to maximize growth,
we must accept one important human characteristic. It is a rare in
dividual who concerns himself much that growth should be stable,
provided only that it is rapid. Feelings run strong, however, on
the ratio in which the public and private sectors should share respon
sibility for spending for growth; and purely economic judgments are
modified, and may at times even be submerged, by political philoso
phies.
The feeling is widespread that we are helpless in stemming the
tide of Federal spending. But what is meant by this? Net budget
expenditures, which were 15.3 percent of gross national product in
fiscal 1949, after rising to 20.4 percent in fiscal 1953, had declined
again to 16.1 percent by 1956. Gross national product has been rising
steadily, while Federal spending has been subject to considerable
fluctuations, primarily in response to the military situation. Private
spending has likewise been rising, however, and there is no a priori
reason why a long-term rise in gross national product should not con
sist, in part, of publicly produced goods and services. Indeed, it
might be a contribution to clarity of thought if we ceased making
regretful references to our inability to prevent a secular rise in Fed
eral spending. Economic growth implies an expansion in the output
of both public and private goods.
It is not impossible, moreover, that balanced growth may call for
an increase in the ratio of public to private goods during certain
phases of economic and political development. The latter statement
receives support from the relatively sharp rise in State and local
expenditures in recent years, much of which has been in direct re
sponse to a public demand for new types of State and local serv
ices. Many of them, like hospitals, highways, and standards of police
protection, are at once cause and effect of economic growth. A
similar point applies to some Federal expenditure programs. It
might be found, for example, that a rising proportion of Federal
spending to gross national product would be justified by the need to
react to the effects of growing international pressures which them
selves are a corollary of growth of populations and of the expansion of
economic aspirations of all nations. To the extent that this were true,
a rising trend of Federal expenditures would be as much a result of
growth as a cause of it. We may have to reckon with the possibility,
as the expensiveness of national defense rises, that the ratio of Fed
eral spending to national income will rise.
R
is in g
G
ross
N
a t io n a l
P
roduct
as
F
ederal
P
a
J
u s t if ic a t io n
for
E
xpanded
rograms
A line of argument has often been set forth, and recently discussed
by a symposium of economists, the acceptance of which would, indeed,
greatly complicate the task of making an objective assessment of the
122
ECONOMIC GROWTH AND STABILITY
relative satisfactions to be derived from public and private spending.
This is the view (mentioned in footnote 1) that, even with present tax
rates, prospective economic growth can be counted upon to finance
automatically such desirable public services as medical and unem
ployment insurance, a really adequate system of public education, slum
clearance, the development of natural resources, and an expanded
concept of old-age security. I f this argument is taken to mean only
that the automatic annual increase in Federal tax revenues can be
counted upon to finance some rate of secular rise in Federal expendi
tures, then it is not very interesting as a basis for establishing future
spending policy. But if it is meant that we have some slack to play
with in the budget, and that surely we can earmark a portion of the
annual increment in national product for welfare purposes, or, in
deed, for any particular objective, we are perilously close to being in
the position of short circuiting the budgetary process. The essence
of budgeting is to reexamine constantly the relative merits of the
performance of functions by the public or private sector, as well as
the merits of performance versus nonperformance of the function.
Budgetary experience in this country runs strangely counter to the
view that there is no problem to be faced in financing a planned secular
increase in Federal welfare and other programs simply because at
constant tax rates the total rise in Federal tax receipts over some
period of years will be several times the total cost of the programs.
It is a matter of record that revenues have not been, and are not now,
adequate at present tax rates to finance all the programs that are
urged upon (and by) the American people each year. Where, then,
would we be if we went ahead and earmarked funds for an expansion
of Federal programs ?
The immediate answer would appear to be that either tax rates
would have to be raised, or other spending programs would have to be
curtailed. In fairness, however, this answer needs to be qualified.
O f the Federal programs mentioned above, some contribute to eco
nomic growth and some do not (or do so to a very minor extent).
Those which do not (namely, all those which come under the rubric
“ the better life” ) would be a deadweight charge on future budgets.
But those which do facilitate growth also serve to enhance taxable
capacity, and in some instances they may do so relatively to alternative
programs undertaken in the private sector.
It seems imperative that the public should always be informed in
advance of the cost to the Nation, in terms of foregone possibilities
of growth, of an option in favor of a diversion of resources toward
the better life. The voting appeal of liberalized social-security bene
fits, for example, is very great. Therefore we need estimates of the
cost to the private sector, in terms of taxes, that must be paid over
the long term, taking account of increased revenue needs due to popu
lation growth and to changes in the age distribution of the population.
Moreover, account must be taken of the forms which demands for
further elaboration of the good-life concept are likely to take, merely
in consequence of the acceptance of initial and successive phases of
the program. For in accepting a program of this sort we are not
only committing ourselves to the cost of foreseeable welfare and other
government services. In addition, we are assuming responsibility
for the automatic increases in the. cost of these programs that result
ECONOMIC GROWTH AND STABILITY
123
from rapid population growth; and we are advancing one step along
the road toward the acceptance of at present unthought-of spending
programs, since the achievement of one goal opens way for the struggle
for another.
It is important to note that nothing in this discussion should be
construed as representing basic opposition to an expansion of Federal
spending programs intended to contribute to growth and long-term
social welfare. We need a healthy competition between the public and
private sectors for the privilege of implementing the investment de
cisions that will optimize the utilization of resources at the disposal
of the economy. Given the criteria of optimization, the test is rela
tive efficiency, and there is no reason to advocate reduced expenditures
merely because this permits a reduction in tax rates. But the good
life ought not to be confused with economic development. We should
be quite clear on the distinction between those Federal expenditures
that can reasonably be considered to contribute to growth and those
which are synonymous with consumption. This distinction is often
obscure in the realm of public spending.
Let us reject, therefore, the view that our dearest objective is always
to strive to reduce Federal spending, however desirable judiciously
spaced intermittent economy drives may be. On the contrary, we
should be prepared to consider acceptance of an expansion of Federal
programs when it can be established that they will make a greater
contribution to desired growth, per dollar of expenditure, than would
private investment programs. No purely genera 1discussion can enter
into the manifold details that have to be sifted in giving effect to this
judgment. One may simply state the belief that this is an area in
which the planning principle, because of its obvious usefulness, should
be acceptable to everyone. At what point, for example, does invest
ment in educational resources cease to contribute to growth and become
a form of consumption? Remembering the serious political conse
quences of “ overeducation” in certain European countries during
the interwar period, we may ask whether we do not need a detailed
forecast of the economy’s future needs for trained personnel in order
that intelligent decisions can be taken with respect to what the de
sirable contribution of the Federal Government to education should
be. (Similar exhaustive investigations ought to be made, and kept
current, with respect to all long-range Federal programs.) It is
quite clear that productivity will be raised by improved standards of
education only up to the point at which the working force is optimally
distributed among job opportunities. Beyond that point educational
expenditures become a form of luxury. This may be all to the good
socially; but it will not necessarily contribute to growth.
H
ig h
T
ax
R
a tes as a n
O
b stacle to
E
xpanded
F
ederal
S p e n d in g
It is quite a step from the argument that a portion of the annual
increment to real national income should always be earmarked for
Federal spending to the view that at some point positive steps may
have to be taken to curtail the expansion of Federal programs. I f we
look at economic growth alone as a criterion for Federal expenditure
policy, we do not discover at the present moment any compelling
argument in favor of the curtailment of Government spending.
Notwithstanding some recent slowing down in productivity incre
124
ECONOMIC GROWTH AND STABILITY
ments, there appears to be no serious dissatisfaction with the current
rate of growth in real national product, nor with the part played
by the Federal Government in providing the basis for it.4 On the
other hand, we must reckon with the eventuality that, taking into
account the possibility of the need for a rise in military expenditures,
the level of desirable Federal spending programs may rise sufficiently
to call for higher tax rates. I f this were to occur it would be necessary
to subtract from any contribution made by increased Federal expendi
tures to economic growth the adverse effect that was produced on
private investment and initiative by higher tax rates, and hence on
the rate of growth in the private sector.
_ At the risk of repetition, it should be emphasized that this problem
is nonexistent to the extent that the rising tax base associated with
rising gross national product provides each year an automatic increase
in tax revenues. Under current tax rates? and with current annual
increments to GNP, about $3 billion of additional revenues come auto
matically into the Treasury each year. Only a portion of this, how
ever, is available for programs designed to stimulate growth. Not
only does this figure have to be deflated for a rising price level, but
also account has to be taken of automatic increases in Federal spend
ing under a wide variety of programs which are themselves a func
tion of growth in population, for example, grants to States and local
ities, highway programs, collection and analysis of statistics, services
to agriculture and industry, and so on. Even when this is done, how
ever, a modest residual is left which might be employed to finance
new governmental programs without the aid of new taxes. But no
one can predict for many years the cost of maintaining international
political and military equilibrium, and it is therefore conceivable that
m the light of urgent national defense projects desirable civil spend
ing programs could not be financed solely out of automatic annual
increments of tax revenues.
D
e s t a b il iz in g
E
ffects of
I
n creased
T
a x
R
ates
It is rather unlikely that at present high income-tax rates public
opinion would be favorable to tax increases even in order to finance
growth programs that might ultimately contribute more to national
income (and to the tax base) than would the private investment pro
grams that would have to be sacrificed unless taxes on consumption
were increased.5
Nevertheless it is of some interest to glance at a possible conse
quence of any significant further rise in personal income tax rates.
There is good reason to believe that pressure for exemptions and
favorable tax rates under the income tax are some kind of a function
of the severity of the nominal rate structure. If this is so, then a
further rise in income-tax rates would tend to shift the income-tax
burden still further in the direction of those individuals and pro
prietorships which are not in a position to benefit from such conces
4 Moreover, despite the large space devoted to the Inflation problem In the press, there Is
so fa r little evidence that the public feels great concern over a gradually rising price level
(though this situation could change drastically). On the contrary, many policymakers
show signs of being more fearful of temporary periods of declining prices than of a long
term upward trend in prices.
6
It is hardly to be expected that if tax-rate increases were found to be necessary, the
income tax would be exempt.
ECONOMIC GROWTH AND STABILITY
125
sions as percentage depletion, accelerated amortization, conversion of
ordinary income into capital gains, and so on. Consequently, those
who were unable to escape the effects of the higher nominal rates
would invest less (because of higher marginal tax rates), and would,,
moreover, have smaller after-tax incomes. But those who did man
age to avoid being subject to the higher rates would have no incentive
or capacity to increase investment (ignoring the income effects of the
additional Federal spending). Consequently there would be a net
adverse effect on that part of economic growth that is accounted for
by investment in the private sector.6
One argument in favor of holding any rise in Federal peacetime
expenditures within the limits of the automatic increment of tax
receipts determined by current rates of growth in gross nationl product
is the difficulty of finding new revenue sources that are not destabiliz
ing.
As stated above, further rises in personal income-tax rates
would probably have disincentive effects on those who are unable to
escape the nominal rates. With respect to death taxes, there is scope
for increased rates and lower exemptions, but this scope is limited.
The other major alternatives, sales, and excise taxes, have a potentially
serious defect if they are exploited during a period of creeping infla
tion, or when there is a delicate balance in the economy between
inflationary and deflationary forces. The Consumer Price Index of
the Bureau of Labor Statistics, which is the index used in most wageescalator agreements, includes “ sales taxes, retail excise taxes, customs
duties, and all manufacturers’ and processors’ taxes passed on to the
consumer.” Thus any increase in the rates or coverage of these taxes
causes an automatic rise in the Consumer Price Index, and therefore
in all wage rates either formally covered in escalator agreements or in
practice tied to the cost of living in wage bargaining. The number of
workers directly or indirectly covered under formal escalator agree
ments (nearly 4 million at the present time) is of special significance,
for there is no room for doubt that their hourly wages will increase
in accordance with specified rises in the Consumer Price Index. At
the same time it is precisely during a period of rising prices that we
find the maximum number of workers covered under escalator agree
ments.7
In view of the fact that the two effects mentioned above tend to
offset each other (higher income-tax rates are here viewed as defla
tionary, and higher excise-tax rates as inflationary) it may be reason
able to infer that some combination of rises in the rates of each tax
could be found which would be reasonably neutral to inflation. An
important difficulty, however, is the distortion caused by the mixture
of unemployment and rising prices. Higher income-tax rates would
tend to discourage output, while higher sales-tax rates would stimulate
<6 A possible exception to this statement may be of interest. I f we start with a suffi
ciently progressive rate structure in the higher brackets, the pressure for exemptions and
special treatment may be very great if income tax rates are raised still further. I f this is
so, an increase in the nominal rate structure could actually result in a lessening of the
tax burden on the higher-income groups.
(This is what would actually occur if a very
high rate structure were to lead to the exemption of realized capital gains from the income
tax.)i Conceivably the consequence might be a net increase in investment by them, since
in the extreme case assumed here their after-tax incomes would be higher under the higher
nominal tax rate structure. The practical application of this case is probably unimpor'
tant, but it serves to call attention to the nature of the economic effects of a high nominal
income tax rate structure, which are usually ignored in favor of discussions of equity
effects.
7 Moreover, the recent growing popularity of the longer term labor contract had already
led to wider adoption of the clause even in advance of the price rise of 1956.
97735— 57— •
— 10
126
ECONOMIC GROWTH AND STABILITY
price and wage rises. The situation would be one of a mixture of rising
prices and soft spots. The very evident confusion of economists in
trying to explain economic trends in the circumstances of the past
year or two, when a somewhat similar situation has developed for
other reasons, is testimony to the obstacles which would face an
attempt to prevent the appearance of destabilizing effects if substan
tial additional tax revenue should come to be needed.
There is, to be sure, an alternative tax which does not suffer from
the “cost-inflationary” defect of sales taxes. This is a spending tax
o f the type proposed by the Treasury in 1942. This tax, levied at
progressive rates on an individual’s spending, provides no mechanism
whereby the tax shows up in the Consumer Price Index, and there
fore contains no element of cost-push inflation.8 At fixed rates, and
with relatively low personal exemptions, this tax could be used to
finance an increased amount of Federal investment expenditures with
out disincentive effects on either private investment or personal con
sumption. A Federal spending and tax policy could thus be evolved
which would be consistent with both growth and price stability,
though at a political cost. The cost would be a substantial increase in
the role of government in the overall planning of resource use. But
this eventuality is really implied anyhow in a fiscal program aimed
simultaneously at growth and economic stability.
A
C
r it e r io n
of
E
f f ic ie n c y
of
G
overn m en t
S
p e n d in g
P
rograms
It is difficult to conceive of a discussion of government spending
functions that omits reference to the question of economy and efficiency
in Federal expenditures. The greater the efficiency with which gov
ernment performs its services, the easier it becomes to gain public
acceptance of the diversion of a given quantity of resources from pri
vate to public use. Unfortunately, as everyone knows, it is far from
simple to compare efficiency in the private and public sectors. The
efficiency of private enterprise is tested in terms of bankruptcies and
declines in capital values that are often associated with bargain pur
chase by a more aggressive management group. No such objective
market test is at hand for government services, and this fact not only
complicates the problem of ascertaining the efficiency with which gov
ernment agencies operate, but makes the public sector vulnerable to
frivolous, along with the justified, charges of inefficiency. It is often
forgotten, moreover, that it is no easy matter to measure the efficiency
of private enterprise. Furthermore, government action itself con
tributes to the degree of efficiency that is achieved by the private
sector. Again, subsidies, favorable tax treatment, tariff protection,
and the like may find legitimate support on one ground or another;
yet they obviously widen the range within which inefficiency on the
part of private management can conceal itself. I would contend that
relative efficiency, in any narrow sense, does not provide much of a
basis for helping us decide the proper scope of governmental func
tions. In any event, each government agency ought to be glad to
8
It might be worthwhile for Congress to reexamine the good and bad points of this tax
in the light of the growing importance of wage cost-of-living clauses, and of the possibility
that valorization clauses may sometime become increasingly popular in many types of
contracts besides wage agreements (for example, ind^x bonds, variable annuities, escalated
social security payments, etc.). For a recent searching analysis of this tax see Nicholas
Kaldor, A n Expenditure T ax, George Allen and Unwin, L td., London, 1&55.
127
ECONOMIC GROWTH AND STABILITY
subject itself to a periodic checkup on efficiency, and to report its
progress in reducing cost per unit of output.
In a broader sense, the question of efficiency borders on that of the
determination of the limits of government functions. Here efficiency
is conceived of, not in the technical sense of output per worker, but
with respect to the form that the long-term objectives of government
programs ought to take in the light of forecasts of the future needs of
the Nation. In other words, efficiency is conceived of in terms of
output per unit of resources. In this area Congress might sponsor
technical studies, perhaps undertaken by the staffs of appropriate
joint committees, of the alternative short- and long-term objectives
o f major national welfare and other spending programs. This would
give much-needed assistance to administrative agencies in making
their self-evaluations, and would at the same time help to keep deci
sions on the scope of government functions from being made on oppor
tunistic grounds. Certainly these decisions are ultimately political
ones; but holders of public office would clearly benefit from analyses
made by technical experts, and important public spending issues would
receive the benefit of timely clarification. One is struck with the need
for maximum agility on the part of both government and private
enterprise in making their decisions to devote resources to promising
developmental projects, and in determining upon a method for shar
ing responsibility for them. Any equilibrium between public and
private spending plans must be tentative and subject to change. There
is no room for dogma in allocating functions between government and
private enterprise. We are engaged in a constant process of trial
and error, and we can maximize the rate at which we learn, only if
programs are constantly reassessed.9
T
he
I
m pact
or
a
H
ig h
F
S p e n d in g
S t a b il it y
ederal
F
loor
on
E
c o n o m ic
Up to this point we have been primarily concerned with the question
of the impact of Federal spending programs on growth. It is nec
essary also to take account of the ways in which the floor of Federal
spending, as well as probable changes in Federal spending levels in
response to fluctuations in income and employment, react upon spend
ing in the private sector. The importance of doing this lies in the fact
that the level of private investment spending (and through the mul
tiplier, consumption spending) is partly, indeed significantly, deter
mined by the fact that Federal spending is high, will remain high, and
is likely to rise on the advent of any serious unemployment. The
world situation assures a minimum Federal budget in the vicinity of
$70 billion. Moreover, the great expansion of economic activity in
recent years has necessitated a substantial rise in State and local pro
grams ; and since these promise to continue to increase, private long
term investment decisions are made in the light of knowledge that
public demand for resources will rise secularly. It is true that cut
backs in Federal spending in the interest of economy add their weight
to the soft spots caused by specific overproduction, inventory reduc
tions, and lagging consumer demand. But even those who stress these
9
A case in point is the difficulty of coordinating the objectives o f different Federal
agencies. For example, the Department of Agriculture is continually concerned with the
problem of excess capacity in agriculture, while the Bureau of Reclamation’s irrigation
program obviously adds to it.
128
ECONOMIC GROWTH AND STABILITY
phenomena, and who believe that maintenance of expansion rates
rather than the danger of inflation is the major economic problem
facing this country today, would probably grant that these adverse
signs are primarily structural and temporary in nature.
A high floor under government spending has a direct effect on
economic development. It also has an indirect effect by way of its
encouragement or discouragement to private investment spending.
Provided that aggregate spending is not so high that interest rates
are driven up to the point of discouraging private investment, a high
level of government spending is a favorable sign for full employment
and for the contribution of the private sector to rapid economic
growth. Viewed in the broadest possible terms, one of the tasks o f
the Federal budgetary process is to take a position on the rate of pri
vate capital formation that is the optimum precondition of the desired
rate of expansion of Federal (and State and local) developmental
programs. Economic progress is maximized when the correct bal
ance is struck between public and private spending programs.
Permanent full employment (with no more than relatively minor
recessions) in a free-enterprise economy is an achievable objective
provided two hurdles can be surmounted. First, the private sec
tor must be permanently convinced that the demand for resources
for public use will rise indefinitely in response to growing demand
for the kinds of programs that are best undertaken by government.
In the public sector there is no important question of a lack of pur
chasing power; what has to be established is the reasonable certainty
of a public desire for the expansion of governmental programs. Sec
ond, some kind of procedure has to be worked out whereby competi
tion between government and private enterprise for limited re
sources is not allowed to lead to an inflationary situation that is serious
enough to be a prelude to crisis and possible collapse in the private
sector. The problem is complicated by the fact that within the pri
vate sector itself specific overproduction and miscalculations are inte
gral to the investment decision-making process, and serious deflation
ary consequences can ensue if rapidly rising interest rates happen to
coincide with inventory reductions and cutbacks resulting from tem
porary overproduction.
Any defects attributable to monetary and fiscal policy as instru
ments of inflation control are magnified under circumstances of high
level Federal spending and taxing, and particularly so under a philos
ophy of assuring government its share m the secular rise in national
product and in responsibility for rising national economic potential.
The problem arises out of the fact that while monetary and fiscal
policy are suitable instruments for discouraging private spending,
they are quite irrelevant to the control of Federal (though not, of
course, State and local) spending.10 Sharp criticism has been directed
10
This is a worldwide phenomenon. Considerable complaint has been voiced in a number
of European countries that fear o f inflation leads governments to impose controls on private
investment and consumption, while no similarly effective instruments are at hand to curb
ambitious public spending programs. One difficulty is th at whereas controls over the
private sector can be made to operate more or less continuously, national governments often
tend to delay moderating action with respect to their own spending programs until a serious
international monetary crisis has arisen. Some method needs to be evolved that w ill
encourage national governments to submit to a more continuous regulation of spending pro
grams }n the light of w hat the governments themselves expect the private sector to accom
plish* for economlcrgrowth and stability. -In-a word, the..instruments of economic control
a t the disposal o f free enterprise were developed prior to the appearance of national govern
ments as massive users of economic resources, and are inadequate to cope with present-day
problems.
ECONOMIC GROWTH AND STABILITY
129
in recent months against a monetary policy that is credited with
being effective in stiffening the terms of borrowing to potential home
owners, small and new business, and farmers. The Treasury’s difficul
ties with debt financing are indeed well publicized; but while borrow
ing problems discourage private investment and consumption spend
ing, they do not enter into legislative spending decisions. This phe
nomenon has been complained of in many countries, centrally con
trolled and decentralized alike, in the postwar decade, and it appears
to be part of the price that has to be paid for full employment.
Recent discussion has called attention to a further complicating
element in inflation control.11 Monetary policy is alleged to suffer
from the serious defect that its major influence is exerted in restrict
ing investment in the competitive sections of the market; big busi
ness and oligopoly can utilize price policy and reinvested earnings
as a defense against monetary control. In my judgment it is not
necessary or desirable to carry too far the basically valid point that
monetary policy can never be as important an instrument of control
as it was thought to be in an era when the commercial banking
system occupied a highly strategic position in the aggregate credit
flow. Institutions have changed; they have not been swept away.
The correct course would appear to be to forge supplementary politi
cal institutional weapons that will assist in the control of investment
by large enterprise and by the Federal Government. The dice are
loaded in their favor in the struggle for scarce resources. Moreover,
there is always the threat that any sign of weakening on the part of
the relatively competitive segment of the private sector of the econ
omy will be taken as an invitation to government or big business to
step in and fill the gap. There may be cogent reasons why further
concentration of economic power in the hands of the Federal Govern
ment and big business is desirable. But it would seem imperative at
the earliest possible moment to establish ground rules which, if there
is found to be an imbalance of power at the expense of the private
sector, and specifically at the expense of new and small enterprise,
make it possible and likely that steps will be quickly taken to redress
it.
11
Cf., for example, J. K . Galbraith, Market Structure and Stabilization Policy, Review
of Economics and Statistics, May 1957, pt. V.
GOVERNMENT AND THE MARKET
Procter Thomson, associate professor of economics, Claremont Men’s
College and Claremont Graduate School
T
h e
D
iv is io n
of
L
abor
B
etw een
G
o vern m en t
a n d
th e
M
arket
Most of the great problems of social policy in this century involve
the division of labor between government and the market. The con
ditions of freedom and equity, of order, efficiency, and progress de
pend upon our answer to the question: What things should be done
by group decision operating through the political process, and what
things should be done by individual decisions mediated by the mecha
nism of the market ? The line which divides these processes is neither
intuitively obvious nor eternally fixed; it must be decided by free
discussion among the responsible citizens of a free society; it changes
according to the circumstances of the times, the understanding of the
citizenry, and the capabilities of the Government. Nevertheless, there
are some general principles which can, or should, guide rational dis
cussion of this great problem.1
What are the peculiar characteristics of these two processes ? What
ends do they seek ? How can they work together to achieve these ends ?
The 'political process
In any society, the political process is concerned with the allocation
of power. In a democratic society that process is designed to secure
a group consensus on specific issues of social policy. The consensus
is always subject, to discussion and modification, but, while it remains
in effect, the rules of the game compel individual dissent to be subor
dinated to group decision. An importer of Swiss watches, for exam
ple, may doubt the wisdom of protective tariffs, but, so long as these
duties stand on the schedules, he foots the bill and harbors his ques
tions till the next election.
I f we take a broad and cursory view of the political process, we
find that the scene is occupied by the following groups of actors: 2
First, the electorate, the citizens, who exercise the franchise in the
light of their values, their information, and their interests; second,
the political parties, who propose issues to the electorate; third, the
1 For background, see Frank H . Knight, The Ethics of Competition, The Ethics of Com
petition and Other Essays, reprint edition, London, George Allen & Unwin, 1936, especially
pp. 49—58. Classical discussion of the problem can be found in Adam Smith, W ealth of'
Nations, book V, ch. i : Of the Expenses of the Sovereign or Commonwealth, and John
Stuart Mill, Principles of Political Economy, book V, ch. i : Of the Functions of Govern
ment ; ch. x i : Of the Grounds and L im its of the Laissez-Faire or Non-Interference Principle.
For a summary of current economic thought, see Fritz Machlup, The Division of L abor
Between Government and Private Enterpise, American Economic Review, X X X I I I (March
1 9 4 3 ), pp. 8 7 -1 0 4 . For a sociological treatment, se?* Max Web'»f, The Theory of Social
and Economic Organization, translated by A . M. Henderson and Talcott Parsons, New
York ; Oxford University Press, 1947. ch. ii. Also consult Henry C. Simons, A Positive
Program for Laissez-Faire, Economic Policy for a Free Society, Chicago, the University o f
Chicago Press, 1948.
2
This is an expanded version of the list given in Ernest Barker, The Parliamentary
System of Government, Essays on Government, second ‘ edition, Oxford, the Clarendon^
Press, 1951.
130
ECONOMIC GKOWTH AND STABILITY
131
legislature or parliament, who are selected by the electorate, from the
parties, to represent their interests and to transplant the general
consensus into specific laws; fourth, the executive, who translates both
the laws of the legislature and the consensus of the body politic into
specific acts of policy; fifth, the permanent bureaucracy, who carry
out the details of executive policy and perform the routine tasks of
government; sixth, the judiciary, who interpret the law and adjudicate
disputes.
The role-structure of the political process is extraordinarily com
plex. Equally complex are the functions carried on within this struc
ture. For, in all its variety and complexity, the political process repre
sents the most characteristic activity of organized society; namely,
problem solving according to specified rules, under given conditions,
in an environment of uncertainty. Despite the humbug and chicanery,
the oratory and ideologies which lend color and interest to the process,
political choice in a democratic society is the solution of common prob
lems through group discussion. Discussion is the essence of demo
cracy. And since the solution of the problem cannot be known before
hand, the outcome of the process is indeterminant; it cannot be pre
dicted from given conditions. In this respect it differs radically from
the market process in which the given conditions of consumer pref
erences, industrial technology, and available resources dictate the
outcome within tolerable limits of accuracy.
Another outstanding feature of decisions made through political
discussion is their uniformity. They must be, so to speak, the same for
everyone-—everyone, that is, whose circumstances are similar. By con
trast with the market mechanism, individual differences are not taken
into account save through the ad hoc device of administrative dis
cretion. For example, if the political process determined the disposi
tion of goods among consumers, every household might have an annual
dividend of 4 pairs of shoes and 5 quarts of whisky, even though a
barefoot teetotaler would find these goods superfluous. On distribu
tion day he would truck them to the public square and barter them for
something else, a costly and annoying expedient which the price sys
tem renders unnecessary.
Despite the in determinancy of the political process in general, the
roles of some of the actors can be identified and tentative predictions
ventured. The individual citizen, in his capacity as a voter, a lobby
ist, and a political persuader, acts to maximize the satisfactions he
receives from his government. Representatives act to maximize their
terms of office. Political parties act to maximize the power they com
mand which, under democratic conditions, is equivalent to maximizing
the votes they receive.3 In this connection, political parties act as
entrepreneurs and innovators. Just as entrepreneurs m the market
economy design and offer for sale the commodities among which con
sumers choose, so political parties package the issues on which elec
tions are decided. But the range of choices is much narrower for the
American voter than for the American consumer. The voter, there
fore, is confronted with a “tie-in purchase.” To buy a box of apples,
he must take a peck of leeks. To get a labor and taxation policy he
likes, he may have to swallow a foreign policy he abominates.
8 Anthony Downs, An Economic Theory of Democracy, New York, Harper & Bros., 1957*
132
ECONOMIC GROWTH AND STABILITY
The differences between voting and purchasing also call for brief
comment. In democratic societies, the rule is, “ One citizen, one
vote”—except for juveniles, prisoners, and migrants across political
boundaries unable to establish legal residence before the election. In
the market, the rule is “ Purchases are made with money, and money in
come is distributed among people in accord with inheritance, effort,
and the chances of life.” Though public policy must ultimately be
ratified by votes, voting is by no means the crucial nexus of the poli
tical process, and the formal equality of the ballot box is countervailed
a hundred times over by inequalities of power and ability which make
themselves felt in the strategy of decision. Given its initial inequal
ity in the distribution of wealth and income, the democracy of the
market consists in the fact that one man’s dollar is the equal of another
man’s dollar. Neither race, religion, nor prejudice can stay these in
struments from their appointed ends—to guide production and govern
the allocation of resources. Finally, the voting mechanism accom
plishes its results indirectly and by remote control, as it were; the vote
does not immediately call forth that which was voted for. Purchas
ing, on the other hand, both indicates a preference and accomplishes
possession of the thing preferred.4
Problem solving through the political process is a necessary conse
quence of the existence of uncertainty. The degree of uncertainty
faced by the society exercises a profound influence on the structure and
function of its institutions: The greater the degree of uncertainty,
the higher is the cost of acquiring information on issues of public
policy. The ordinary citizen being unwilling to bear the costs of ac
quainting himself with the issues, society specializes the function of
detailed policy decisions in a small group of elected representatives.
But, again, the greater the uncertainty, the greater the likelihood of
error. Thus, the necessity of checks and balances to hold legislative
folly within tolerable limits. Political parties are another byproduct
of uncertainty; they specify the issues to which voters react, and
conduct exploratory expeditions to sample the consensus of the body
politic. The normal administrative work of the bureaucracy repre
sents still another aspect of society’s unending struggle to routinize
the unexpected.
I f uncertainty were to vanish, by far the greater part of the appara
tus of government would be altogether superfluous. No uncertainty,
no problems; no problems, no politics. For in a world without uncer
tainty the costs of acquiring information about the future are reduced
from infinity to zero; the consensus of the body politic is formulated
and made known without doubt or delay. Therefore “ representative”
government and political parties would be obsolescent. Administra
tive decisions would be reduced to repetitive routine so that the execu
tive arm of the Government would consist of tax collectors and pro
ducers of public services. Given perfect certainty, both the verdict
o f justice and the balance sheet of power are intuitively obvious so
that neither adjudication nor a trial of strength are necessary. Order
follows inevitably. For disorder arises either from fraud or from
an appeal to force; the first is impossible when concealment is impos
sible and the second is superfluous when the outcome is inevitable.
4 For further comment, see James M . Buchanan, Social Choice, Democracy, and Free
Markets. Journal of Political Economy, L X I I (A pril 1 9 5 4 ), pp. 1 1 4 -1 2 3 .
ECONOMIC GROWTH AND STABILITY
13a
In this event a society which shared a common pattern of values and
which was not plagued with fundamental conflicts of interest has no
use for a central authority to maintain order. A society divided into
contending interest groups but united by a common standard of justice
would decide differences by rational compromise in order to establish
equity and preserve stability. In both cases the reserves of force are
impounded in a common bank and need never pass into active circu
lation. (Only the uncertain society needs a central authority to col
lect and, on occasion, spend these reserves of force.) But a divided
society without common standards of justice would impose order in
the interests of the strongest.3
The marhet mechanism
The market mechanism is concerned with the allocation of resources.
It is designed to answer the questions: (1) What things shall be pro
duced? (2) How shall they be produced? (3) How shall the output
be distributed among the agents who, jointly, produce it? (4) How
shall society provide for maintenance and progress ?
In an individualistic social order characterized by free exchange,
private property, and personal responsibility these decisions are ini
tiated by individual consumers and individual producers; but the
market is a device for making these multitudes of choices mutually
consistent, for translating individual decisions about bread, houses,
and automobiles into social decisions about prices and outputs. For
the buyer, prices are costs which provide both a signal and an incentive
to cut back on his use of things that are dear and push forward on
his use of things that are cheap. For the seller, prices are returns
which provide both signal and incentive to make more of the things
that are expensive and less of those that are cheap. For the system
as a whole, prices settle at the level which clears the market. The
prices of productive services, together with the pattern of ownership
of resources, determine the distribution of income among persons and
families; and the income of resource owners represents the costs of
producers, while the expenditures of resource owners—as consumers
of goods and services—represents the income of producers.
The broad and general case for the free market is simply this: Left
to their own devices owners of resources will be guided by the signals
of the market to put scarce agencies to the most productive uses.
Given freedom of maneuver plus reasonable knowledge of the facts,
resources will be channeled into the areas where demand is brisk and
returns are high and diverted from the uses where demand is slack
and returns are low. And the attempt of each economic agent to
maximize his net returns leads, under free competition, to equal re
turns at the margin for agents of equal capacity. Finally, equal
returns at the margin means maximum returns for the community
as a whole.
But even if the system of the market worked with perfect efficiency,
the ends it secures are no better and no worse than the initial dis
tribution of resource ownership on which it is based. Allocative
efficiency does not mean distributive justice. Further, the sovereign
consumer whom the market serves may command it to perform serv
6
In the uncertain society, as Thomas Hobbes argued in his Leviathan (1 6 5 1 ), preserva
tion of order is the elementary task of civilized government. But whatever the degree of
uncertainty, order without equity is tyranny.
134
ECONOMIC GROWTH AND STABILITY
ices which are, at best, frivolous and, at worst, subversive of higher
esthetic and moral values.® Consumer sovereignty is no guaranty
of individual integrity.
These, however, are evils easier indicted than remedied. For, in
addition to the democratic presumption of individual responsibility
which forbids arbitrary interference with the means he commands
and the ends he chooses, we encounter the political dilemma that public
intervention can scarcely be expected to rise above the private standdards of the citizens who sanction it. It would be a rare thing, indeed,
if citizens displayed more wisdom at the polls than in the market.
Still further, one of the notorious facts of economic and social life
is that not all individuals have effective power to exercise their formal
freedoms. Freedom without power is illusory. The faith, the pre
sumption, or the hope that the individual is the best judge of his own
interests is altogether untrue if his abilities are limited or his under
standing corrupted. Here again, however, democracy faces one of
its critical dilemmas: How do we detect significant aberrations from
rational self-interest and how do we intervene to correct them ? Above
and beyond the limits of individual ability are the subtle barriers
to formal freedoms erected by prejudice, by custom, and by overt
coalitions that narrow his range of effective action.
The market, like the political process, is powerfully affected by the
degree of uncertainty which the society faces. Economic knowledge
is a scarce commodity; and actual adjustments of the market are bound
to diverge from the ideal because of the intrusion of the unexpected
into the affairs of both producers and consumers. Chance creates both
windfall gains and losses in the lifetime income stream of the indi
vidual. Uncertainty also takes its toll on the income stream of the
society in the form of periodic fluctuations in income, employment,
and prices. The market creates an elaborate series of adjustments to
handle the problem of uncertainty. The major adjustment consists
of a division of labor between those who receive relatively fixed re
turns (sellers of labor and renters of capital) and those who receive
fluctuating returns (stockholders or owners) based on the fortunes of
the enterprise. In this picture, the business entrepreneur bundles to
gether the risks which a specific firm is designed to exploit and sells
pieces of these chances to owners (or to himself) who pledge their
capital to the firm.
In the absence of uncertainty, most of economic life would be re
duced to repetitive routine. Entrepreneurship would vanish; admin
istration and decisionmaking would become unnecessary. The busi
ness cycle would cease to trouble us. The economic problems remain
ing would be the age old ones of scarcity and poverty in—I might
add—an environment of unrelieved monotony.
F
ram ew o rk
A
c t iv it ie s
of
G
overnm ent
In discussing the various grounds on which government participates
in economic activity, I have divided the normative role of the state
into two broad categories. The first covers the “ framework” or regu
latory activities of government, the second the “ allocative” activities.
Framework activities establish the structure within which the market
8 Frank H . Knight, The Ethics of Competition.
ECONOMIC GROWTH AND STABILITY
135
functions. They alter or help to establish the “given conditions”—
the tastes, resources, and technology—which govern the equilibrium
of market forces. Though framework activities involve some use of
resources, this aspect of the problem is relatively trivial; the chief
issue is the substantive content of the rules and orders which govern
ment establishes. Allocative activities, on the other hand, involve
substantial use of resources, or modify the distribution of income, or
affect the level of economic activity. As we shall see presently, there
is some overlap in these categories.
In this and the section following I have attempted to say what
government should do; i. e., to extract from the existing body of doc
trine in political economy some normative criteria for the economic
role of the state. But Leviathan has an insatiable appetite; in the
effort to satisfy the political temper of the times, parties often pro
pose and enact measures of doubtful—doubtful, I say, not negative—■
economic value. These dubious expedients are briefly treated under
the catchall heading of “ Price Fixing and Government Enterprise.”
Rules of the game
In democratic societies, standards of behavior can be regarded as a
series of overlapping circles: The circle of broadest compass is the
mores, values, and norms of the society. Inside this is the domain of
the common law, based on judicial recognition of social mores. Inside
this is basic or constitutional law plus judicial interpretation of con
stitutional provisions. Still narrower in scope but more detailed in
form is statutory law. At the final and smallest of the circles we find
administrative law and administrative custom.7
Government, then, codifies and administers the common rules of the
market as part of this set of overlapping sanctions. It does in two
different ways.
1. Standards and norms: The State is the agency which standardizes
practices. The great body of doctrine which defines the “law of con
tract,” establishes the meaning of “ private property,” or implements
“ the rule of reason” represents the standardizing activities of govern
ment as the articulate instrument of custom. This body of rules gov
erns the legal qualities of money, the procedures for buying and selling,
the liabilities of partners and stockholders, the means for collecting
debts, and the paths to be followed in going into bankruptcy. Law and
administrative decisions also guide the process of taking out a trade
mark, of conducting collective bargaining, of selling stocks and bonds,
and of passing on an inheritance.
These positive rules implement order and stability in commercial
interchange. In economic terms, they are part of the definition of
“ resources.” For an agent of production is not just a technological
datum, for example, so many acres of land or man-hours of labor; it is
that plus an invisible penumbra of rights and duties embodied in the
law of contract and other parts of the framework.8
2. Prevention of force and fraud: Government exercises a monopoly
o f force in order to prevent fraud and forestall the use of force by
7 The breadth of the circles does not indicate legal priority. Constitutions and statutes
can. to be sure, set aside the common law, and the evolution of judicial decisions which
modify the common law need not parallel the evolution of the mores. I am indebted to
m y colleague Prof. W inston M. Fick for this formulation.
8 The “ institutions of the contract” is discussed in fimile Durkheim, On the Division of
^Labor in Society, translated by G. Simpson. New Y o r k : The Macmillan Co., 1933.
136
ECONOMIC GROWTH AND STABILITY
private parties. Private force must be held in check, because its use
is subversive of both public order and justice. So far as the market
is concerned, the reservoir of force at the disposal of the State is em
ployed to uphold contracts and prevent “taxation” of one private
citizen by another.
Though illegal use of force almost always involves fraud or con
cealment, prevention of fraud per se rests on different grounds than
does prevention of force. In the long run the fraudulent merchant,
the vendor of stocks in nonexistent oil wells, or the manufacturer of
tainted foods would be forced into bankruptcy by a free and informed
market. But in the meantime the costs of detecting fraud through
trial and error involve extraordinary burdens on those who are short
changed, fleeced, or poisoned. It is cheaper all around, therefore, to
rule these practices illegal and provide the machinery for enforcing
these rules. At the Federal level the Pure Food and Drug Act or the
activities of the Securities and Exchange Commission are notable
examples of this practice.
Defining the group whose welfare is to be maximized
Part of the exercise of national sovereignty consists in defining the
limits of the social body whose welfare is to be maximized. In prac
tice this ordinarily means the ethnic and racial groups who occupy the
territory of the state. This object is implemented by a simple but
enormously important device—the restriction of immigration.
The broad outlines of social policy on immigration are very largely
a closed issue in most nations of the Western World, though they may
be reopened for review by changes in the balance of power or by shifts
in population structure. Barriers to migration raise the income of
labor competitive to potential immigrants and lower the earnings of
specialized resources that are complementary to potential migrants.
I f no restraints are imposed on exports of capital or imports of com
modities, neither the rate of interest nor the relative price of interna
tionally traded goods will be much affected by these barriers.
Freedom of entry
Given a framework of rules and a definition of the group to be
served, the case for freedom of entry is overwhelming on both eco
nomic and political grounds. Freedom of access is both an impli
cation of political democracy and a necessary condition for economic
efficiency.
So far as economic efficiency is concerned, barriers to entry result
in the production of less of the restricted commodities and more of
all other things than the economy either wants or could have if the
barriers were broken down. How do these restrictions arise and how
should the State move to demolish them? In the absence of public
intervention, the degree of restraint on the free movement of re
sources would be established by the balance of two contrary tenden
cies : On the one hand, there is a clear and obvious gain from combin
ing to restrict competition and raise prices—as, for example, a coalition
of bakers or of housebuilders in a particular locality or a cartel of
metal fabricators or a syndicate of truckdrivers in the country at large.
(These gains are greater the smaller the possibility of securing substi
ECONOMIC GROWTH AND STABILITY
137
tutes for the commodity or service the coalition controls.) 9 On the
other hand the costs or coordinating the coalition plus the restless
forces of competition act to erode these gains away.
The State should, and in some cases does, aid the market in restrain
ing the growth of coalitions. As a minimum it ought not to counte
nance nor encourage these barriers by law and administrative decisions
that create a favorable climate for suspending competition. At the
maximum it ought to seek out and break up trusts, combines, and
syndicates. This is no easy matter as the complex history of law and
court procedures under antitrust clearly demonstrates. However the
existence of the Sherman and Clayton Acts plus the activities of the
Federal Trade Commission have exercised a profound influence on
our economic structure and have helped to prevent the growth of
cartelized inefficiency on the European model.
Restrictive practices by trade unions represent still another exam
ple of barriers to free entry. The union need not ration entry to
the trade or occupation by direct controls such as membership quotas,
elaborate apprenticeship requirements, or high membership dues.
The same result can be accomplished indirectly by persuading the
buyer of labor services not to oiler employment below some stipulated
wage. The wage rations entry. Unlike producer coalitions, unions
have very low overhead costs and can proliferate indefinitely without
running into diseconomies of scale.
Regulation of natural monopoly
Natural monopoly is an obvious candidate for public regulation.
Monopoly creates economic inefficiency by distorting the pattern of
production. The price of monopolized articles is higher, the output
lower, and the output of all other things is greater than would be the
case if monopoly were conducted in the public interest.10
Natural monopoly ordinarily arises when the advantages of largescale production plus the conditions of demand are such that one pro
ducer engrosses the entire market for a commodity. And competi
tion in the industry will be imperfect if production and demand con
ditions are such that a small number of firms dominate the scene. For
either pure monopoly or “competition among the few,” the individual
producer occupies a large enough share of the market so that varia
tions in his output exert an appreciable influence on the price of the
goods. In the effort to maximize returns producers will jack up prices
above the incremental costs of production.
Given the definition of “the commodity,” the degree of monopoly
power depends on the extent of substitution in both production and
consumption. Everyone has a bit of a monopoly on something: The
unctuous manners of a neighborhood grocery-store proprietor may
earn him a preferred position over his quarrelsome competitors, but
if he attempts to capitalize this dividend into his prices he will merely
increase the business of the chainstore down the block. A rutabaga
9 Fpr discussion o f the underlying economic issues see Alfred Marshall, Principles of
Economics, 8th edition : L on d o n : Macmillan '&> Co., 1920, book V ., ch. v i ; as modified
hy J. R. Hicks, The Theory of W ages. Reprint edition ; New York : Peter Smith, 1948,
pp. 2 4 1 -2 4 7 . Further see George J. Stigler, The Theory of Price, revised edition ; New
T ark : The.Macmillan Co., 1952, p. 208.
v
10 Melvin W . Reder, Studies in the Theory of W elfare Economics. New York : Columbia
University Press, 1 9 4 7 ; ch. IV , An Obstacle to the Attainm ent of Maximum W e lfa re :
M onop6Iv.
138
ECONOMIC GROWTH AND STABILITY
monopoly would be of small avail so long as potatoes, lima beans, and
squash could readily be had. A monopoly on gas or electric power ina particular town is a somewhat more serious matter, however, because
of the unavailability of close substitutes. Most State and local regu
lation of monopoly lies in the field of public utilities, and the Federal
Power Commission exercises jurisdiction over interstate movements
of natural gas and hydroelectric power. A monopoly over a factor
of production such as aluminum would also raise questions of public
policy even though a host of other metals compete with it for its
various purposes.
Now given the economic indictment of monopoly, regulation ought
to be designed to encourage efficient use of resources; that is, to force
the monopoly to price at its incremental cost of production. But this
criterion raises a host of technical issues which it is inappropriate to
pursue here.11
In some instances the public may elect to take over and run the
monopoly. In principle, both regulation and operation should arrive
at the same end, but since the latter involves government ownership
and allocation of resources it will be briefly treated under another
heading.
External economies and diseconomies
In allocating resources by the market, private welfare is synony
mous with public welfare so long as prices reflect the full costs or the
full benefits of economic activity. But this reflection is often imper
fect, and some of these imperfections raise important issues of policy.
A famous illustrative example concerns the manufacture of a com
modity which creates smoke or noxious vapors that pollute the sur
rounding air. The “private cost” to the manufacturer is the expense
of labor, raw materials, wear and tear on the plant, et cetera, incurred
in producing the article. The “social cost” is that plus the incon
venience and danger which pollution creates for the inhabitants
roundabout.12 For an inhabitant of southern California this is no
trivial example, I might add. (In the long run with free choice of
places of residence no one would put up with the nuisance unless he
felt that other advantages of the locale compensated for it; and thus
the place affected would have to offer lower rents or a higher dividend
of conveniences in order to be of equal attractiveness with other places.
Thus, the long-run cost of the nuisance would be the distortion it
created in regard to choice of residence.)
This case illustrates an external diseconomy—external because it
operates outside the price system and diseconomy because it creates
a cost for someone. In general an external economy (or diseconomy)
is created whenever the consumption or production of some com
modity or service by one agent creates benefits (or costs) for other
persons not covered in the price. There are four categories of these
external effects: (1) between consumers, (2) between producers, (3)
from producers to consumers, and (4) from consumers to producers.13
In order to push forward on the production and consumption of
11 For a summary of these issues see Nancy Ruggles, The W elfare Basis of the'Ma'rginal
Cost Pricing Principle and Recent Developments in ,th e Theory of Marginal Cost Pricing,
Review of Economic Studies, X V I I ( 1 9 4 9 -5 0 ) , 2 9 -4 6 , 1 0 7 -1 2 6 .
12 A . C. Pigou, The Economics of W elfare, 4th ed ition ; L ond on: Macmillan & Co., 193 2 ;
pt. II, ch. IX .
13Tibor Scitovsky, Two Concepts of External Economies, Journal of Political Econdmy,
J -X II (April 1 9 5 4 ), 1 4 3 -1 5 1 .
ECONOMIC GROWTH AND STABILITY
139
things which create external economies and to cut back on those that
create diseconomies, public intervention in the interests of economic
efficiency is required if the effects are important enough to be worth
bothering about. In some instances laws and regulation alone will
suffice; in others—to be discussed under the second of our major
headings—public resources must be expended.
For the smoke nuisance case, as an example, zoning regulations
and requirements concerning manufacturing processes, private in
cinerators, and perhaps automobile exhausts seem the appropriate
remedy, though—as the Los Angeles case again demonstrates—con
siderable research, financed by public money, will be needed before
precise correctives are discovered.
Most of the important cases where regulation is appropriate in
volve external diseconomies between producers, or between producers
and consumers. Many of these instances also involve the conserva
tion of resources.
An important instance where intervention can improve allocation
is presented by external diseconomies between lumbering and farm
ing. Cutting timber increases the rate at which water drains off
the surface and exposes farmlands downhill or downstream to the
likelihood of flood and erosion. Various remedies have been pro
posed: one is a requirement that lumber companies replant as they
cut (some of them find this profitable to do on their ow n); another
is that they modify the cutting pattern so as to leave undergrowth
and small trees standing.
External diseconomies between producers in the same industry
are exemplified by the extraction of crude oil from a particular de
posit or pool. I f drilling rights are owned by a variety of operators,
each will seek to pump the deposit as rapidly as possible with the
result that pressure of natural gas inside the dome will fall and
cut down the yield of the pool. Each producer creates external dis
economies for the others. But production could be maximized if
ownership were unified so that external burdens would be trans
formed into internal costs. I f one producer cannot buy out the
others—because it is too troublesome or requires more capital than
he can lay his hands on—unified extraction can be achieved by public
regulation, providing the rules are enforceable and technologically
feasible.14
The fisheries case is another instance of producer diseconomies,
with one additional complication—the economic opportunity, the fish
ing ground, cannot be owned. Given certain biological variables,
which are but imperfectly known at present, the annual rate of take
will exert an influence on the total population of certain species of
ocean fish. But the individual fisherman does not consider changes
in the underlying stock of resources when he voyages out to make
his catch. Each one, consequently, creates diseconomies for the
others; rational management of the fish population goes by default
and is left to chance.15 The remedy would appear to include some
sort of international licensing organization.
Still another aspect of producer diseconomies is found in activities
whose unregulated pursuit would clutter up the city streets or create
14 Clair W ilcox, Public Policies Toward Business. Chicago : Richard D. Irwin, Inc.,
1955, pp. 3 6 3 -3 6 6 .
15Anthony Scott. The F ish ery: The Objectives of Sole Ownership, Journal of Political
Economy. t/X II I (April 1 9 5 5 ), 1 1 6 -1 2 4 .
140
ECONOMIC GROWTH AND STABILITY
chaos through unlimited exploitation of limited facilities. An inter
esting, but somewhat trivial example, is taxicabs in metropolitan
areas. In the interests of holding down the burden on other forms of
traffic, the number of licenses granted to cabdrivers is limited, the
number being decided by a rough estimate of the advantages of
service to the consumer versus the disadvantages of cabs to other
drivers. Taverns and liquor stores are similarly limited on the pre
sumption, no doubt, that a plethora of such facilities would lower the
character and quality of the region. A much more important example
is Federal licensing of radio and TV broadcasting in order to prevent
■dual exploitation of a single channel. Now, whatever the grounds
on which such limits are fixed, the license to exploit the facility repre
sents a partial patent of monopoly. Public authority may place
hedges on the license; for example, the Federal Communications Com
mission in granting TV licenses seeks to disperse control over the
channels of mass communication. But other things the same, it is
surely contrary to either policy or economy to give these prerequisites
away. They should be sold on the open market to the highest bidder—
providing the applicant meets the other conditions which policy im
poses. This criterion most certainly applies to radio and television
franchises.
Economies in pursuing interests and acquiring knowledge
The case for the free market presumes that the individual knows
his own interests and is aware of economic alternatives. Common
observation suggests that departures in practice from these conditions
are as pervasive as they are regrettable. Individual conduct shows
many instances of obstinate attachment to “ irrational” objectives;
the costs of acquiring knowledge of the market are frequently so high
that, in the absence of outside help, the sensible man decides that it
is more efficient to remain ignorant.
Now the paternalistic role of the state in democratic societies, inter
vention to improve behavior or combat ignorance, is capable of infinite
abuse and must be severely limited. The following represent some of
the steps that may be taken on this ground.
Some transactions are restricted or altogether prohibited—e- g.,
sale of habit-forming drugs, gambling, and the practice of the world’s
oldest profession. While dope addiction and other aberrations work
some hardships on persons outside the transaction, i. e., create external
diseconomies, the primary reason for their prohibition is that they do
violence to the self.
On a somewhat different level, the state requires the individual
to maintain ownership in himself; he may offer his services for rent
hut cannot sell himself in bondage. Nor can individual citizens sell
their electoral franchise. Clearly, however, these actions are pro
hibited because of their adverse external effects since, if widely prac
ticed, they would subvert the whole climate of freedom.
An intrusion of the state which is widely accepted in practice but
still debated in principle is compulsory saving under the Social Secu
rity Act. Although the actuarial value of the pension exceeds the
accumulated worth of the contributions, the compulsory portion of
old-age and survivors insurance is founded on the theory that the
ordinary worker shortchanges his future, i. e., discounts future income
at a higher rate of interest than he ought rationally to employ.
ECONOMIC GROWTH AND STABILITY
141
A still different set of interventions, directed, I think, against the
effects of ignorance of market alternatives is licensing of professional
practitioners such as doctors, lawyers, and pharmacists. A free mar
ket with exact knowledge makes licensing unnecessary, for the self
interest of the buyer rewards the seller according to his worth, and
the incompetent can find no customers. But in the absence of exact
k n o A v l e d g e the license testifies, when properly a d m i n i s t e r e d , t o s o m e
m i n i m u m level of c o m p e t e n c e and saves the t i m e and c o s t of deter
mining whether the practitioner deserves his title. For law or medi
cine these costs would be high. I doubt whether the same is true,
however, for barbers, beauticians, and others who need a public cer
tificate to set up shop.
A l l o c a t iv e A c t iv it ie s o r G o v e r n m e n t
“Allocative"’ activities of Government employ resources, influence
the distribution of income, or affect the level of national output.
Despite their great variety and complexity and despite the even greater
complexity of that incredible document, the Federal Budget, which
authorizes them, the grounds or reasons for undertaking them are rel
atively few in number.
Indivisible services
Among its other functions, market price is a rationing device which
governs the volume of goods or services at the disposal or the user. No
price, no service. But many activities that are “ in the highest degree
necessary” cannot be rationed by price and must be available to every
one if they are available to anyone. An example which conveys the
essence of the case: lighthouses.16
In some cases an indivisible activity could easily be carried on by a
voluntary agency which supported itself by fees charged to the user.
Shipowners, conceivably, might band together in an association to
build lighthouses, or the residents of a river valley might embark 011 a
joint operation to control floods—another indivisible activity which
Government ordinarily performs—but the difficulties of promoting
and administering the agency, the trouble involved in collecting fees
from unwilling beneficiaries, etc., would render the prospect of such
associations dubious. I 11 this connection, however, Government may
be regarded as a holding company for a group of associations render
ing a variety of indivisible services to the citizenry.17 While Govern
ment can more readily promote and finance such associations, the hold
ing company is likely to be somewhat larger than optimum size (and
not always responsive to the needs of its customers).
Headed by national defense, the dominant function of central gov
ernments under existing conditions, the major indivisible services may
be listed as follows:
1. National defense and related functions
2. Police protection
Foreign aid and development
4. Public health
5. Pure research
'" .r . S. M ill. P rin e ;i>l<‘S. Kk. V. ch. X I . sec. 1 “).
17 P a u l A. S<nmieIson, T h e P ure T h eory o f P u b lic E xp en d itu res, R eview o f E con om ies
iind .Statistics. X X X V T (N ovem b er 11)54), :>8T--:)8D.
11
142
ECONOMIC GROWTH AND STABILITY
6. Navigational aids and flood control
7. Streets and highways—with exceptions as noted below
8. Wildlife preservation
9. Public monuments, buildings, and parks—with exceptions
Comments on selected items:
(2) Individuals can and do hire private watchmen and carry arms
to fend off marauders but prevention, detection, and punishment of
crime are public offices.
(3) Foreign aid is a function of political and military policy, but
long range economic development probably depends on exports of
private capital.
(4) Pure research is undertaken both by government and by private
nonprofit agencies, such as universities and foundations.
(6) Navigational aids and flood control on inland waterways are
often conducted jointly with power production and irrigation which
can be rationed by prices.
(7) Save for limited access roads and bridges, highways are indi
visible services in the first instance but can be financed % taxes on
cars and gasoline in joint demand with highways. These taxes rep
resent user charges whose yield provides a clue to the optimum size of
the highway network.
(9) Imposing public edifices and parks, to the extent they have
esthetic value, are an indivisible service for the public in general.
But visiting a national park, hunting on a game preserve, and using a
public recreation facility should, if practicable, be rationed by admis
sion, charges or licences in order to prevent overcrowding and cover
the costs of operation.18
How should indivisible services be produced ? Both economic ef
ficiency and political liberty require that Government use the signals
and incentives of the price system in acquiring and combining the
resources which supply these services. The market for indivisibles is
blind on the demand side, but the supply side should use prices to the
fullest extent possible. This clearly implies (1) that Government
should pay market prices for the resources it hires, (2) that, when
ever possible, Government should contract with private producers to
perform services instead of supplying them directly. For, to,amplify
the second of these criteria, the optimum size of government from the
standpoint of political policy may exceed the optimum for purposes
of managerial efficiency. I f public bodies can contract out or delegate
the task of management to private enterprise, they may both reduce
the costs and improve the quality of operations.
To exemplify: Highways, public buildings, and dams can be, and
normally are, built by private contractors rather than by public em
ployees. The complex weapons and devices needed for military pre
paredness in the postatomic age are manufactured by private con
cerns rather than by Government arsenals. The thousands of different
items used in the daily operation of government are ordinarily pur
chased from private dealers. To these statements there are some ex
ceptions. Highway departments sometimes build their own roads;
the Military Establishment does manufacture some of its Own weap
ons ; and Government agencies sometimes fabricate their own supplies.
U Procter Thomson, Prices Versus Taxes in the Allocation of Public Resources, Proceed
ings of the 48th Annual Conference of the National Tax Association. Sacramento, C a lif.:
National Tax Association, 1956, pp. 1 4 0 -1 5 7 .
ECONOMIC GROWTH AND STABILITY
143
These exceptions ought to be rigorously and carefully scrutinized.
In all too many cases the waste and malfeasance which there occurs
would be incompatible with survival under private auspices. But the
details of this topic belong elsewhere.
Requisition of military7 manpower represents one important area
where Government ignores the signals of the price system though, to
be sure, the ground rules for the draft vary from time to time and
coercion is sweetened by persuasion. As a result, it is impossible to
ascertain the real costs of defense, i. e., the costs in terms of the value
of manpower in other uses. Cheap military manpower secured via the
draft is, moreover, an expensive bargain in the long run. In an age
where the soldier must command a formidable arsenal of technical
weapons, these reluctant defenders are scarcely the equal of a seasoned
cadre of professionals recruited by voluntary inducements. At a time,
moreover, where potential annihilation lurks in the dark of night for
those who stay at home as well as those who go to war, no great pre
mium would be necessary to hire all the permanent staff of our forces
or to pay, if need be, for short periods of duty followed by transfer
to the Reserves. In a mature and responsible society, finally, a mer
cenary army of professional soldiers poses no great threat to our dem
ocratic freedoms.
External economies and diseconomies
As was argued above, prices sometimes fail to reflect the full costs
and benefits of particular activities, with the result that the private
market produces too few of the things that create external economies
and too many of those that create diseconomies. In many cases these
departures from optimum can be handled by public regulation and in
volve no direct use of resources. Particularly is this true of external
diseconomies, e. g., the smoke-nuisance case and the oil-well case. But
where the activity creates benefits for persons other than the producer
or consumer, a subsidy is needed to stimulate its production. From
the standpoint of public resources, education represents by far the
most important example of this principle.
The education of individual A produces, of course, a direct and
immediate benefit to A himself; and self-interest alone would induce
him, or his parents acting for him, to build up his capital of ability.
But A's education also confers advantages on B. and C, and D. For
in a democratic society with a universal franchise, education is a
necessary condition for wise and responsible exercise of political free
doms. A. if uninstructed and ignorant, could not exercise his fran
chise wisely and an illiterate electorate would imperil the wholp future
of democracy. Further, cultural interchange and all the amenities
of civilized society demand individual sensitivity to values, ideas, and
the world about us. But if left to its own devices, family A might not
purchase as much schooling as B, C, and J) would like to see them buy.
This important instance of external economies in consumption justifies
public subsidy for education.
The school government, in this context, is a corporation that imple
ments the interest of each in the education of others. For. to be sure,
B’s concern for A (and A ’s for B, etc.) could be implemented by a
series of private gifts. But these interests would be better served by
a mutual compact among families A, B, C, and D stipulating that each
would match—or meet in some agreed ratio—the contributions of the
144
ECONOMIC GROWTH AND STABILITY
other. A community referendum oil school taxes and expenditures
assumes precisely this sort of mutual compact. Because of external
economies, families A, B, C, and D would elect to expend a greater
amount per child than would have resulted from individual purchases
plus private philanthropy.
Public subsidies for schools could be exponded in a number of ways.
Government could subsidize private schools; it could dispense certifi
cates to the family, who could spend 1lie certificate at an accredited
school of their choice; or it could operate schools as a department of
government. For political and other reasons, current practice favors
the latter alternative.
External economies are a pervasive feature of human life but most
of them are too trivial to be worth bothering about as subjects of pub
lic intervention. Examples are the householder whose well-kept lawn
beautifies the neighborhood, or the merchant whose store window's
gladden the eye of passing pedestrians.
An analytical curiosity which puzzles and intrigues economists but
may or may not be of great practical importance is the possibility of
“ increasing returns to scale” for a particular industry. In this form
of external economy, expansion of production by the firm lowers costs
for the industry because optimum size for the exploitation of some
common facility has not yet been achieved.19 These cases, when iden
tified, are appropriate candidates for subsidy. But possibilities for
such economies appear to be rather limited, and, in any event, no one
seems able to identify these curiosities in practice.20
Ojteration of natural monopolies
Monopoly, as already argued, represents an obvious threat to effi
ciency. The case for controlling it bv public intervention is equally
obvious. The choice between regulation or public operation turns
upon some difficult issues of politics, economics, and administration
whose solution varies according to circumstances. Regulation may
tempt an alert and aggressive monopoly to befuddle or bribe the
regulators. Operation involves the possibility of aggravated bureau
cratic waste.
Monopolies in power, water, gas, and transport are often operated
by municipalities. The Post Office Department is a monopoly operated
by the Federal Government. ITow should these monopolies be con
ducted? On the one hand, optimum efficiency is achieved when the
price of the service covers the cost of producing the last unit of that
service. On the other hand optimum efficiency requires that total sales
receipts cover total costs of producing the service; for taxes to finance
subsidies inevitably warp the pattern of economic alternatives; more
over equity (equal treatment of equals) is violated when nonusers
subsidize users—except in special cases where nonusers receive benefits
that are not reflected in the structure of prices. These criteria conflict
when the demand schedule for the service intersects the schedule of
incremental (or marginal) costs at a point which lies belowT the
schedule of average costs.21
19 AIJvn Youri". Increasing: Returns and Economic Progress. Economic Journal, X X X V I I I
(December 1 9 2 8 ). 5 2 7 -5 4 2 .
30 Scitovslry. External Economics, .T. P. E .. L X II.
21 For background and further exposition see the articles of Nancy Ruggles cited in
footnote 11. Roughly, however, when average cost (total cost divided by number of
units) falls as output rises, because of economies of scale, the expenses of producing the
last increment of the service are bound to be lower than the average cost of the entire
ECONOMIC GROWTH AXU STABILITY
145
I f pricing on the basis of incremental costs involves subsidizing the
monopoly from the Public Treasury, the governing authority has a
number of strings to its bow which it can employ in important special
cases. It can vary the quality of the product. By reducing the cost
and quality of its services it can eventually come to rest at a point
where demand price, incremental cost, and average cost coincide, and
where incremental pricing, therefore, just covers total expenses.22
For the post office, a Federal monopoly which chronically runs at
a substantial deficit, these technical considerations are relevant and
important.23 Under existing practices and rates, the postal deficit
subsidizes advertisers, book publishers, magazines, other departments
of government, and inhabitants of rural areas. (Due to the vagaries
of Government accounting, the post office does not bear the full cost
of contributions to pensions for employees; on the other hand it is,
or was, used as a vehicle for delivering handsome subsidies to private
transport agencies such as airlines.) Subsidy in general is justified
by the presence of a substantial degree of external economies. In the
remote past subventions to publishers might have been justified as a
contribution to literacy and education. Surely this presumption is of
negligible worth at the present juncture. Surely, also, the disecono
mies of high taxes render the postal deficit, and the additional taxa
tion thereto attached, an enterprise devoutly to be liquidated.
Through what steps can the postal service be induced to balance its
budget ? First, put it on notice that it must balance its accounts.
Second, unscramble the records so that it bears the full costs, but no
more than the full costs, of its operation; this implies payment by
other departments for use of postal buildings and delivery of Gov
ernment mail and payment of overhead and retirement costs by the
post office. Third, and most important, let it set its own rates and
establish a defensible system of mail classification. Under this dis
pensation the postal service would be a quasi-independent corporation
free to use the methods of the market, save for the stipulation that
(having no stockholders) surpluses, if any, must be plowed into ad
ditional facilities. Deficits, when they occurred, would be financed by
postal bonds sold to the private market.
I f these three steps were taken, might it not be possible to contem
plate a fourth and more radical proposal, namely opening the postal
business to private enterprise? The quaint and antiquated devices
range of output.
(For instance if a batter who is bitting .250 before a particular game,
pulls his average down, his “ incremental” performance that day was less than 1 out of 4.)
It follows as a matter of simple arithmetic that incremental cost times number of units
sold frills short of total cost.
32 The existence of an equilibrium at this intersection can be shown as fo llo w s : Given
an enterprise where incremental cost and demand schedules intersect at any point, each in
crease (or decrease) in quality w ill raise (or lower) the cost schedules and raise (or lower)
the demand schedule. Given diminishing returns to investment in quality of service, each
rise in quality will raise the demand price (for a given output) by loss than the cost
p rice ; each fall in quality will lower the demand price by less than the cost price.
Eventually the average cost schedule can be made to overtake the demand schedule where
the former crosses the schedule of incremental costs.
By similar reasoning, a monopoly that earns a surplus in the first instance is in the
happy position of being able to achieve balance by raising its level of service.
If, now, increasing returns to investment in quality prevail over the relevant range, a
public monopoly that incurrs a deficit in the first instance should raise rather than lower
the quality el" its service.
W h at do variations in “quality” entail? For a city transport system obviously, or for
the Federal Post Office (as argued below) many such variations in convenience, promptness,
and comfort can be undertaken. For municipal gas, water, and electricity, technical
possibilities of variation are much more limited. Installing and repairing facilities, and
billing customers would appear to exhaust the range.
23 Jane Kennedy, Structure and Policy in Postal Rates, Journal of Political Economv,
L X V (June 1 9 5 7 ), 1 8 5 -2 0 8 .
‘
146
ECONOMIC GROWTH AND STABILITY
by which, it is sometimes alleged, the post office conducts operations
would be put to the test of the market, while prospects of private
monopoly would be counteracted by public competition.
Equality
A free and open market tends to pay productive agents the value
of what they produce. The income of individuals depends on the unit
price of productive services times the number of units which they
own—including both capital goods and their own labor power. The
number of units of productive services which they own, or have em
bodied in them, depends on inheritance, effort, and luck. For reasons
too obvious to enumerate, the benefits of inheritance, effort, and luck
are not equally distributed in the existing social order and are not
likely to be so distributed in any conceivable scheme of social organi
zation.
But inevitability does not justify inequality. More accurately
speaking, inequality of wealth and income can be modified by social
policy; and a democratic social order is powerfully determined to
undertake that policy. Equality, or mitigation of gross inequalities,
is both an end value of the democratic community and a means to
other ends.
In this context the happiest exercise of the power of the state
is to promote equality by removing the barriers which restrict oppor
tunity ; barriers founded on caste or prejudice, barriers heightened by
the presence of ignorance, and barriers which the market itself
would sweep away if given scope to do so—all this is a necessary
exercise of democratic public power.24
The State also intervenes to purchase equality, or mitigate inequity,
through the tax-expenditure mechanism. Depending on the schedule
of taxes and the imputation of benefits to individuals, the balance of
benefits bestowed minus taxes collected is generally positive for the
lower income groups and negative for higher income groups.23 De
spite opportunities for evasion, the saw tooth monster embodied in
present income and inheritance tax schedules has cut down signifi
cantly on the relative share of upper income groups in the Nation
divided over the past quarter century.26 Approach toward equality,
then, is both a valid aim and a real accomplishment of our democratic
fiscal system.
Given the conditions of economic life, a tax-expenditure system
which promotes equality conflicts, after a certain point, with other
end values of the community. Specifically it conflicts, after some
specified point, with productivity. In full perspective, the relation
between equality and productivity doubtless runs as follows: I f wealth
and income were very unequally distributed, there is a range over
which the community could probably achieve both higher output and
more equality by redistributing resources from rich to poor. I f redis
tribution continued, a point of maximum productivity and moderate
equality would be reached. Thereafter, additional degrees of equality
could be purchased only at the expense of some sacrifice of productiv
24
Allan G. B. Fisher, Alternative Techniques for Promoting Equality in a Capitalist
Society, American Economic Review, X L (M ay 1 9 5 0 ), 3 5 6 -3 6 8 .
23 James M. Buchanan, The Pure Theory of Government Finance : A Suggested A p
proach, Journal of Political Economy, L V II (December 1 9 4 9 ), 4 9 6 -5 0 5 , refers to this
balance— with the sign reversed, however— as the “ fiscal residuum.”
28 Simon Kuznets, Shares of Upper Income Groups in Income and Savings, New Y o r k :
National Bureau of Economic Research, 1952.
ECONOMIC GROWTH AND STABILITY
147
ity. These sacrifices would be small at first, but would increase steadily
till, at the limit, complete equality—the same income for everyone—
would be reached only by a very considerable sacrifice of total output.
Now why must equality and productivity be competitive values
beyond a certain point ? Answer No. 1 is to be found in the adverse
incentive effect of progressive taxation on initiative, risk taking, and
enterprise. Answer No. 2 rests on the adverse incentive effect of receiv
ing income without expending effort. (Up to a point, of course, the
latter effect would be counterbalanced by improvements in ability
and standard of living created by subsidies to low-income families.)
To continue: So long as society can get more of both values, both
more equality and more income (from a given body of resources), it
would be wasteful not to do so. But the problem of choice arises when
the two values cannot increase simultaneously, when, tliat is, addi
tional equality can be purchased only by some sacrifice of productivity
and progress. Because we are, or may be, faced with this kind of
choice is, of course, no reason for abjuring additional equality. We
may judge it worth the price. But in so judging we must take account
of the terms of trade between equality and productivity. Here, in
brief, is a central problem of democratic government—how much
more (or less) equality do we want in terms of the sacrifice (or gain)
in productivity involved in moving toward it.
Finally, equality is not achieved by any one activity of government.
It is a byproduct and an end product of the whole system of govern
ment finance.
II vn iemitaI■ianism
The market is an impersonal agency. It takes no account of need
unless signalized by price and recognizes virtues only when they are
marketable. In larger perspective, however, “ no man is an island,”
or. in the language of economics rather than literature, one man’s
utility function may contain a term for the welfare of another. Hu
manitarian activities are thus an important special case of external
effects between consumers.
Humanitarian objectives can be undertaken by voluntary nonprofit
agencies to which individuals contribute in accord with their means
and desires. (In the division of labor between government and the
market these institutions share some of the elements of both.) Citi
zen X , however, might be more willing to support some humanitarian
activity if assured that Y and Z would follow suit. Accordingly he
makes a compact with them under which each is to vote on the amount
that all will contribute. Before voting, they decide that the total will
be allocated between them in accord with their means. In this way
each dollar that X contributes will be accompanied by, say, half a
dollar from Y and two from Z. When the vote is taken, therefore,
the tax each levies on himself exceeds the amount he would have
contributed on his own. Government philanthropy, then, can be re
garded as a device to administer such a compact for the community as
a whole, voting, of course, being conducted by representatives rather
than by the entire electorate.
Humanitarian activities of government include a series of transfer
payments for assistance to dependent children, aid to the aged, com
pensation of the unemployed, and general relief for the indigent and
unfortunate.
148
ECONOMIC GROWTH AND STABILITY
Economic stability
An economic environment of individual decisions, mutual inter
dependence, and uncertain prospects is inevitably subject to fluctua
tions in income, employment, and prices. While these erratic move
ments are, in some sense, a concomitant of progress, the business cycle
generates a train of evils which no responsible society will passively
endure. (1) Uncertainty itself creates costs; elaborate and expensive
adjustments must be undertaken by individuals in order to cope
with it. (2) Both inflation and depression generate diseconomies in
the form of overexpansion of certain sectors of the economy during
a runaway boom and underutilization of resources during a slump.
(3) The incidence of the cycle is inequitably distributed between
individuals. (4) Aggravated uncertainty of the system plus waste
and inequity generate political pressures which threaten the stability
of democracy.
From the individual point of view the cycle appears as a capital
levy of arbitrary amount, levied without announcement or compen
sation. I f the cycle cannot be tamed but must be accepted as an
act of providence, social policy, as a bare minimum, ought to share
its burdens more equitably.
Under modern conditions, the cycle can, or some of its components
can, be mitigated, though not completely controlled, by fiscal and
monetary policy. Government can stabilize certain elements of the
budget and these in turn can exert a tranquillizing effect upon the
market; it can stabilize the level of expenditures over the cycle: it
can fix the rates, though not the yield, of the tax system; it can sta
bilize the quantity of money but not, of course, the number of times
that money circulates during the period.
Government can also intervene to stabilize several important vari
ables for the market as a whole. It can, if needed, fix the price of
particular things though not the quality and quantity of goods ex
changed af this price; it can fix the rate of interest; it can stabilize
the genera! level of prices; and it can stabilize the level of employ
ment.
Under modern conditions, however, the chief problems of fiscal
policy are conflict among objectives and inadequacy of means. Re
garding conflict, the Government may not be able simultaneously to
stabilize the level of prices and the volume of employment. Full em
ployment at forced draft spells inflation, although the terms of trade
between more inflation and more employment vary erratically over
the course of the cycle. Regarding means, stabilizing either employ
ment or prices or some selected combination of the two can be attempted
either through automatic devices or through forecasting and admin
istrative action. Automatic devices or built-in stabilizers fake time
to operate; forecasting is subject to error, and administrative action
may involve both error and delay.
In any event economists know appallingly little about the cure of
the cycle and still less about its causes. The situation counsels humility,
caution—and more resources for basic research.
149
ECONOMIC GROWTH AND STABILITY
M
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•On an ad hoc basis, the Central Government intervenes to regulate
the prices of particular goods and services. In most instances save
the control of prices during wartime, these interventions establish
minimum prices and redound to the advantage of particular producers.
Primary instances of these activities are farm price supports, tariffs,
transportation prices, and minimum wage legislation.
In the short run, parity prices and production quotas on basic agri
cultural commodities sold in the private market represent an income
subsidy to wealthy farmers financed by a sales tax on low income city
consumers. For the rise in price is equivalent to a levy on consump
tion; the larger the farmer’s output (or acreage) the greater is the
extent of the subsidy which this rise in prices (or soil bank payments)
confers upon him; and the wheat, cotton, corn, and tobacco which this
program covers are staples of the city worker’s budget. (The portion
of the crop sequestered in storage by the Commodity Credit Corpora
tion and its equivalents is paid for from general revenues, though a
portion of the cost may be recovered if the commodity is later sold or
dumped abroad.)
In the long run, the portion of the subsidy that finds its way into
income of farm labor tends to retard the migration of workers to the
city and slow down the rate of urban economic development. The
portion imputed to land bids up the price of farms.27 In addition to
the income subsidy, the stability of agricultural prices which the pro
gram administers enables farmers to employ resources more effec
tively.28
Tariffs and import quotas subsidize producers at the expense of
consumers in the short run, while in the long run they draw more
resources into the protected trades than would otherwise be the case
and lower the national dividend by cutting us off from the advantages
of international specialization. In addition, tariff hampers exports,
fosters domestic monopoly, and creates political pressures for subsi
dies to foreign governments. Tariff, however, prevents deterioration
in the economic position of workers and investors who are threatened
by foreign competition and who can raise enough leverage to secure
protection.
The legal minimum wage raises the price but reduces the volume of
employment for workers in the trades it protects. For no tendency
in economics is more certain or definite than the principle that states:
the higher the price of something, other things the same, the less the
volume of purchases. This principle, unfortunately, applies to the
hiring of unskilled workers in sweated industries. An effective floor
on wages which raises costs of production will diminish employment
because, first, employers substitute capital for labor and, second, con
sumers substitute other goods for those produced by the protected
trades. I f demand for unskilled labor is elastic the minimum wage
also reduces the total wages bill and purchasing power placed in the
hands of the protected workers.
27 For general discussion see T. W . Schultz, Agriculture in an Unstable Economy, New
York : M cGraw-Hill, 1945.
25 D. Galp Johnson, Forward Prices for Agriculture, Chicago : The University of Chicago
Prns-'o:. 1947.
150
ECONOMIC GROWTH AND STABILITY
Benefits of minimum wages are secured by those who gain employ
ment under its provisions. Costs are borne, first, by the workers whom
it prices out of the market, second, by consumers who buy the products
of protected industries, and third, by resources which are comple
mentary to unskilled labor.
Government enterprises
In addition to operating natural monopolies which sell to the gen
eral public, Government also produces a great variety of supplies and
services; for many, but not all of these, Government itself is the sole
customer. The Defense Department operates a galaxy of establish
ments which manufacture arms, build ships, and produce supplies.
The Government operates a railroad in Alaska and in Panama; it has
turned its hand to the production of rum and molasses in the Virgin
Islands; it lends money to farmers (the Farmers’ Home Administra
tion), to small-business men (the Small Business Administration),
and to importers and exporters (the Export-Import Bank). It builds
and owns ships which are leased to private concerns. Finally, Govern
ment is the landlord of 400 millions of acres within the 48 States.
What issues of principle and practice are raised by these activities ?
In general, as suggested above, Government is a most indifferent
manager of enterprises. Why ? Because Government employees are
stupid and lazy ? Not at all; here, as elsewhere, the servant is worthy
of his hire. Because the civil service, while an admirable device for
preventing corruption, tends to protect mediocrity and inhibit initia
tive ? Perhaps; but too much cannot be made of this argument. Be
cause Government is immune from the discipline of the competitive
market? In part, yes, but large sections of corporate bureaucracy
also enjoy some relative immunity. The ineffectiveness of Govern
ment management arises from its diseconomies of scale. Government
is too large for maximum efficiency. Or, put a bit more carefully,
Government may be no larger than necessary in order to discharge
the functions which it alone must command, but if some activity which
the market couTd have performed is added to its structure, that ac
tivity will, in general, be conducted less effectively than it could have
been conducted by the market. Not only that; but the addition of this
activity will dilute the managerial capacity of the top echelon, and
existing activities will suffer in consequence.
Now, of course, this general presumption must be modified in par
ticular cases. Many old-line Government bureaus (such as the For
estry Service) and many quasi-public corporations (such as the TVA)
have great dedication and initiative with high esprit de corps amongst
their staff and are fully the equal of comparable sectors of private
enterprise. But the general presumption against Government enter
prise should not lightly be cast aside. Government ought not to dupli
cate the efforts of the market and when it has done so, because of some
temporary expediency, it should withdraw as gracefully and rapidly
as possible. Exceptions require very strong proof indeed.
Unfortunately, once Government is embroiled in one of these ven
tures, the cost of disentanglement is high. In some cases no private
firms are willing to take the thing off the Government’s hands save at
bargain-basement prices. Or—as in the case of loans to farmers and
small-business men—the activity involves a concealed subsidy which
the political power of the beneficiaries is mobilized to retain. Or an
ECONOMIC GROWTH AND STABILITY
151
arsenal, a manufacturing plant, and an insurance agency become sym
bols of empire and all the massive power and artful devices of en
trenched bureaucracy are arrayed in their defense.
R a t io n a l C h o ic e i n B u d g e t a r y P o l ic y
Given the grounds which sanction Government activities, how
should we decide how much of our resources to devote to public pur
poses? Since the market cannot register the demand for these serv
ices, the political process must answer this question for us.
To economize on the labor of decision-making, elected representa
tives review policy and decide the details of public expenditure. In
this, however, they do but reflect the ultimate consensus of the body
politic so far as it lies within their power to determine it. Let us
inquire, therefore, how the rational society would determine expendi
tures if the people themselves, after due investigation and debate, held
a mass referendum on budgetary policy.
The decision could be made in two separate stages. The first order
of business would be determination of the system of taxes, i. e., the
array of rates for collecting any given amount of revenue from vari
ous income groups. To simplify exposition let us suppose that the
revenue is to be collected by a universal tax on personal income.
For each amount of revenue some sets of rates promise more equality,
and some less; some would exact a smaller sacrifice in productivity,
others a greater sacrifice. Indeed each set of rates would yield a spe
cific combination of equality and productivity. The rational voter
would select the rates that corresponded to his preferences as a citi
zen and his interests as a producer.
The society as a whole, let us say, decides to accept some rough
average of the systems of rates for which its members voted. This
being decided, the taxes levied upon members of each income class
for each different amount of revenue are ascertained and announced.
Our citizen-taxpayers repair to the polls again to vote for the level
of expenditures. Let us suppose that they are to cast a separate vot e
for each of the major categories: national defense, health and wel
fare, conservation, and so forth. How does the rational taxpayer cast
his vote? He is aware that, say, expenditures of $10 billion of the
community entail $100 in personal taxes, $15 billions, $150 and so on.
Given his income and the structure of taxes, each extra dollar levied
on him is accompanied by an additional $l0o million from the com
munity at large. (These accompanying amounts, of course, vary
from one income group to another and from one expenditure level to
another.) As a rational citizen-taxpayer he assesses the technical
results of these expenditures and evaluates the personal satisfactions
they create for him. For each class of activities, he votes for the level
of public expenditures where the satisfactions created through Gov
ernment by the outlay which necessarily accompanies the last dollar
in personal taxes equal the satisfactions he would have secured from a
dollar of private expenditure. He equalizes at the margin the satis
factions secured from alternative avenues of expenditure.
Depending on their income, their preferences, and the structure of
the tax system, each individual selects some different level of expendi
tures in each category of the budget. The community, let us suppose,
balances off these votes by compromising at the median, by taking.
152
ECONOMIC GROWTH AND STABILITY
that is, the level which slices the votes in half; 50 percent voted for
some higher level, 50 percent for some lower amount.
The result, inevitably, satisfies no one perfectly and dissatisfies some
exceedingly. First, the tax system appears arbitrary when viewed
by citizens who hold different preferences for the terms of trade
between equality and productivity. Second, the degree of freedom
the voter exercises depends on the number of expenditure categories
arrayed for his decision. Third, the optimum for which he votes
is surrounded by a margin of doubt. For his choice on “ national de
fense” is bound" to be affected by public expenditures and personal
taxes for “ conservation.” But he votes for each in ignorance of the
amount the community will determine for the other. Fourth, the
community—under the median rule or any other rule—is not likely
to satisfy his preferences precisely (unless, by accident, he was the
median voter). If, for instance, the community chooses $10 billion,
those who wanted more will feel shortchanged, while those who
selected less may fancy themselves abused.
What role does representative government play in rational budg
etary policy? The variety and complexity of government is beyond
the scope of the ordinary citizen, nor would it be at all sensible for
him to spend any large fraction of his time and his fortune in public
business. That task is entrusted to elected agents who both accumu
late knowledge of public affairs and serve as middlemen between
the body politic and its government. Even the most dedicated of
these agents can form no more than a rough estimate of the issues at
stake, and can collect only the most cursory of samples of the true
state of public opinion. But given their limits and their commit
ments, the role of the legislator is to vote as the citizens would have
voted if they knew as much as he knows.
FEDERAL EXPENDITURES IK MODERN AMERICA
Frazar B. Wilde,1 chairman, Research and Policy Committee, Com
mittee for Economic Development, and president, Connecticut Gen
eral Life Insurance Co.
I welcome this study of the principles that should underlie Federal
decisions to spend money. We have fallen into the habit of thinking
that, where Federal expenditures are concerned, we should consider
every case on its merits. Even in these terms, on a case-by-case basis,
we do not do well—often what passes for merit has little relation to the
national welfare. But, in addition, to consider each case on its merits
is not really to consider the merits of any case. Each decision can be
made properly only in the light of the other decisions that must simul
taneously be made. And this is possible only if all decisions are illu
minated by certain common principles. This is why I am pleased that
one agency of the Congress is now discussing the principles of Federal
expenditure policy.
In conducting this very valuable inquiry, I hope the subcommittee
will bear in mind one important fact about the American economy
that many people disregard in making recommendations about Federal
expenditures. That fact is that we have developed in this country a
set of private institutions which have demonstrated their capacity to
meet most of our national needs through the individual efforts of our
citizens, singly or organized in businesses, labor unions, and other
associations. The basic impetus to satisfying these needs comes from
the millions of decisionmaking units in the economy who direct their
labor and financial resources into productive pursuits without inter
ference, from the Central Government.
The role of government, especially of central government, in a highly
developed, private enterprise economy like ours is vastly different
from its role in an underdeveloped country. Where the private econ
omy is incapable of generating and sustaining growth, the Govern
ment must step in to stimulate the forces of expansion. Where the
private economy is already growing at a rapid rate, the presumption
runs the other way. Although certain limited exceptions should be
recognized, it is true, in general that government intervention is likely
to do more harm than good, either because it might result in a misallocatioii of resources or because it might impair the incentives of private
individuals to produce and to undertake risks.
There is still another reason for relying less 011 the Government in
this country than elsewhere. Not only is our national product the
largest, in the world—it is also distributed more equally than in most,
other countries. This is partly the result of the tremendous growth
1 While tho views presented in this paper are within the general framework ol! policy
statements issued by the Research and Policy Committee of the Committee for Economic
Development, their particular expression and application here are the resx>onsibility of the
author alone.
158
ECONOMIC GROWTH AND STABILITY
154
we have already achieved and partly the result of our greater devotion
to the ideal of equality of opportunity.
Although we have not completely eradicated the problem of ex
tremely low incomes, we have developed efficient and equitable meth
ods of dealing with many of its basic causes. Our system of universal
education provides every child with the basic training needed to par
ticipate in the economy and to share in its output. We deal with un
employment and old age—two of the major causes of poverty—
through social insurance and private pension arrangements. And we
have a nationwide system of public assistance to help those who are
poor for other reasons.
More needs to be done to improve the lot of the less fortunate among
us, particularly to assist in developing the skills that will permit them
to earn their own livelihoods. But growth in our production carries
far more potential for removing poverty from our midst than does
a redistribution of the output we have. This is one of the more im
portant reasons why we must be sure that Federal expenditure pro
grams promote, rather than retard, economic growth.
R
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F
ederal
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co n o m y
To determine the needs for Federal spending under conditions of
growth, it is essential to discard ideas about the role of government
that are the outgrowth of the depression psychology of the 1930’s
The problem is no longer how to assist the economy in making use of
the available human and physical resources. The problem now is
how to allocate our existing scarce resources among the numerous de
mands that are placed upon them. This change is reflected in the
reasons now being given by those who support more Federal spending.
Proposals to maintain or increase the present level of Federal spending
are advanced mainly on two grounds, neither of which is related to the
high employment problem. Higher spending by the Federal Govern
ment is now justified either on the ground that growth itself creates
demands for more government services or that increased spending is
essential to promote further growth.2
I agree that economic growth increases the need for certain govern
mental services—particularly if the term “ economic growth” is under
stood to include growth in population as well as in number, size, and
geographic dispersion of the Nation's economic units. By and large,
this growth-created demand for government services is concentrated
in the traditional areas—police and fire protection, water supply,
waste disposal, highways, education, postal services, provision for the
aged, etc. We tend to take some of these services for granted, but they
are extremely important for the health of the economy.
It is important to recognize, however, that in this country most
o f these traditional services are provided by the States and local
governments, not by the Federal Government. Among the categories
mentioned above, the Federal Government is responsible for postal
services, interstate highways, and old-age and survivors’ insurance.
Otherwise, Federal expenditures consist largely of outlays for defense,
2'This discussion is limited to the nondefense portion of the Federal budget, since our
defense requirements are to an important extent independent of our growth needs.
Although the research conducted under the defense programs has contributed to the devel
opm ent of new products and new techniques, I know of nobody who would argue for a
larger defense budget on the ground that it would stimulate growth.
ECONOMIC GROWTH AND STABILITY
155
interest on the national debt, and a host of programs that subsidize
particular groups, industries, or regions in the economy, the most im
portant of which are farmers and veterans.
Although there is very little basis for measuring the increased needs
of the community for the traditional governmental services as growth
proceeds, it is probably not unrealistic to assume that, in the absence
of accumulated backlogs, expenditures for these services would in
crease in absolute terms but would either rise proportionately with
total output or perhaps decline slightly in relation to output, on the
assumption that there would be some economies of large scale.
In actual fact, cash expenditures of the States and local govern
ments 3 have increased relative to total output in recent years, from
7.7 percent in fiscal year 1948 to 9.7 percent in 1956. This increase,
instead of the sidewise movement or slight decline that might have
been expected under ordinary conditions of growth, is easy to explain.
State-local expenditures were kept to a minimum during World War
II and, before the backlog of accumulated demands could be worked
off, the Korean war intervened. On top of this, there as been a rapid
rate of growth in population and a movement of population to the
suburbs. As a result, road, school, and other public construction proj
ects have lagged behind actual needs. State-local expenditures are
still rising relative to total output, and this trend may be expected to
continue until a substantial part of the backlog has been worked off.
At the Federal level, nondefense expenditures have also increased
at a faster rate than total output. Cash expenditures, exclusive of
outlays for defense, foreign aid, and interest, rose from 5.8 percent of
the gross national product in fiscal year 1948 to an estimated 7 percent
in fiscal year 1958. On a per capita basis, and corrected for price
changes, these expenditures will be approximately 50 percent higher
in the current fiscal year than they were 10 years earlier.
Even a cursory examination of the major categories in the budget
will reveal that the recent rise in Federal nondefense expenditures
cannot be attributed to needs created by growth. For example, Fed
eral cash expenditures for agriculture increased from $0.6 billion to
$4.9 billion in the past 10 years; matching grants to the states for
assistance to the aged, the blind, and other categories of needy persons
increased from $0.7 billion to $1.7 billion; and outlays for housing,
community development, and related activities increased from $0.2
billion to $0.9 billion. Such expenditures might have been expected
to decline with the steady increase in employment and the continued
growth of the incomes and financial assets of the Nation’s families; yet
there is little evidence in recent budgets that such a decline is in
prospect.
I must confess that I have great difficulty in understanding the
argument that substantial additional Federal spending—over and
above the spending required of States and local governments—is
needed to stimulate growth. The argument seems to be that, since
growth requires more investment, investment by the Federal Govern
ment should rise proportionately as much as—and perhaps even • ore
than—investment by other sectors of the economy. This proposition
is by no means self-evident. In fact, in an economy with so many
3
Including Federal grants-in-aid and retirement and insurance trust expenditures, but
excluding outlays of utilities and liquor stores.
156
ECONOMIC GROWTH AND STABILITY
other institutions capable of supporting large-scale investment
projects—individuals, businesses, State governments, local govern
ments, quasi-public authorities, and voluntary associations—it would
seen more reasonable to suppose that less reliance need be placed on
the Federal Government as these other institutions expand their
activities.
My own view is that, given our present institutional framework, the
Federal Government should refrain from making an expenditure
unless it is absolutely certain that it is needed and that other units in
the economy cannot provide that expenditure more efficiently.
There are strong arguments for turning to the Federal Govern'
ment only as a last resort. Spending decisions will be more econo
mical and efficient if they are made directly by the people who pay the
bills. The economy will grow more rapidly if the investment of sav
ings must meet the test of profitability in a competitive market. The
freedom of the individual and the vigor of State and local govern
ment will be better protected the more limited the size and power of
the Central Government. And, in an economy where private demands
are high, we can help avoid inflationary pressures by holding down
the size of the Federal budget.
I do not want to imply that our needs for public assets are small.
On the contrary, there is need to clear the slums in our large cities; to
build more schoolrooms, hospitals, and roads; to improve our harbors
and airports; and to conserve and develop our natural resources.
But should these be provided by the Federal Government? The
answer, I believe, is that only few of these important programs may
be clearly labeled a Federal responsibility. One of the clearest cases
is the financing and planning of interstate roads. In constructing the
Nation’s highways, attention must be given to the needs of interstate
traffic and to defense needs. Furthermore, the State-local highway
programs must be coordinated so that they will result in a logical
national network. For these reasons and one other—that the program
can be financed through taxes levied on highway users and need not
be, a drain on the general revenues—-CED lias endorsed Federal par
ticipation in the construction of the Interstate Highway System.4
On the other hand, education and health are either a State-local
or private responsibility. Airport improvement (as distinct from
aids to navigation), slum clearance, and urban development programs
must be tailored to the needs of individual cities or metropolitan areas.
The improvement and operation of commercial harbor facilities is a
local. State or regional problem for which the use of a quasi-public
authority seems to best be suited. Conservation and development of
natural resources is a matter of national as well as local concern, but
Federal outlays for these purposes should be restricted to projects
that cannot be undertaken by private businesses or State and local
governments; and, in all cases, the full cost of construction and opera
tion—including the cost of capital at market rates—should be borne
by the beneficiaries of these projects.
I conclude that most of the governmental services and public assets
required under conditions of growth should be provided by the States
and local governments. Before turning to the reasons why the Fed
^Committee for Economic Development, Modernizing the Nation’ s Highways, .Tumiary
ECONOMIC GROWTH AND STABILITY
157
eral budget for nondefense purposes is nonetheless at record levels, it
is necessary to examine still another argument that has been used o f
late to justify increased Federal expenditures, namely, that the Statesand local governments do not have the financial resources to satisfythe growing demands upon them.
R o l e o f F e d e r a l A id
Some,people who agree that States and local governments have the
primary responsibility in providing governmental services under con
ditions of growth nevertheless believe that a major share of these serv
ices should be financed by the Federal Government through grants-inaid or similar devices.
Since 1940, the Federal Government has provided roughly 10 per
cent of total State-local reveues, with the exception of World War II
years and the subsequent period of readjustment. In fiscal year 1956,
total Federal aid accounted for $3.3 billion of State-local revenues—•
an amount just short of 10 percent. Since then, however, the Federal
highway program has been put into operation and the magnitude o f
Federal aid has been rising rapidly. According to the President's
budget for fiscal year 1958, Federal grants (exclusive of the proposed
school construction aid program, which was not enacted by this year’s
Congress) will amount to $5.3 billion this fiscal year and, at this level,
they will probably account for 12 to 13 percent of State-local revenues.
The use of Federal aid is not limited to a few small and isolated
activities of the State and local governments. In fiscal year 1956, 87
percent of total Federal aid was allocated to education, highways,,
public welfare, health and hospitals, and natural resources—expendi
ture categories that accounted for 74 percent of total State-local
expenditures. It is important to recognize, therefore, that the pro
posals to increase Federal aid would add greatly to an already bewild
ering variety of strongly entrenched programs.
There is a place in our financial system for Federal aid. Such
assistance should be reserved for projects, like the road program,,
in which the Federal and State or local governments have a joint
responsibility. In all cases, the State and local governments should
finance a substantial portion of the cost of the joint program on a
matching basis.
There are grave dangers in an excessive reliance by the State
and local governments on the Federal Government for financial
assistance.
In the first place, such aid may lead to an encroachment by the
Federal Government on decisions that should be made by State, county,
and city governments. Those who are familiar with local conditions
are in a much better position to gage the needs of their communities.
Second, even if Federal assistance is provided on a matching basis,
there is always a tendency for States and municipalities to allocate
more of their own resources to the areas in which Federal assistance is
given merely to obtain the Federal funds. Thus, the use of fnnds
provided by another government may result in a misallocation of
resources, with some activities being supported too handsomely and
other, more necessary, activities being starved.
s nearly as possible,
tax and expenditure decisions should be made at the same level of
govern men*, rather than at different levels.
ECONOMIC GROWTH AND STABILITY
158
Third, Federal aid has already placed a heavy burden on the
Federal Government. In the current fiscal year, grants-in-aid will
constitute approximately one-seventh of total Federal cash expendi
tures other than defense and foreign aid. The continuous rise in
Federal aid during the past decade has been an important factor in
preventing the moderation of the increase in Federal expenditures that
is necessary before Federal tax reduction becomes practical. In view
o f the urgent need for Federal tax reduction and tax reform in the
interest of promoting growth, augmentation of Federal aid programs
could delay indefinitely the revisions that have already been postponed
for much too long a period of time.
The financial problems that must be faced by the State and local
governments are admittedly formidable. They can be solved within
the traditions of our Federal system, if the States and subdivisions
accept their responsibilities. In practice, Federal assistance cannot
be confined to a few selected activities—once the assistance is extended
to another area, there will always be requests for more Federal aid as
new State-local problems arise. As the Kestnbaum Commission has
pointed out:
I f we are not willing to leave some room for diversity of
policy, to tolerate some lack of uniformity in standards, even
in matters which are of national concern and about which we
may feel strongly, the essence of federalism, even if not the
legal fiction, will have been lost. We must also realize that
it can be lost, or its vitality sapped, by nonuse of State and
local initiative as well as by overuse of national authority.
We have, therefore, as citizens a responsibility to see to it
that those legitimate needs of society that could be met by
timely State and local action do not by default have to be met
by the National Government.5
C
auses
of
H
ig h
an d
R
is in g
F
ederal
S
p e n d in g
There are two major reasons why the Federal budget continues to
rise even though it is already at record levels. First, a number of
Federal programs are misdirected—we are trying to solve problems
by spending more money, rather than by eliminating the causes that
created them. Second, the Federal Government is doing things that
the private economy or that State and local governments can do more
efficiently.
The agriculture program is perhaps the best illustration of the type
of program that should achieve the desired results at lower costs.
In its statement on agricultural policy9 CED urged that emphasis
should be placed on withdrawing whole farms from cultivation. We
also warned that, unless price supports are gradually reduced to free
market levels while the land retirement program is being carried out,
it would be impossible to bring the supply of, and the demand for,
farm products into balance. Finally, we suggested that assistance
should be provided to help some farmers find new and more satis
factory means of earning a livelihood.
5 Report of the Commission on Intergovernmental Relations, June 1955, p. 5.
6 See Economic Policy for Agriculture, 1956.
ECONOMIC GROWTH AND STABILITY
159
In actual practice, the agricultural program has worked in the
other direction in two of these respects. Price supports are being
reduced, although the pace is too slow. However, whole farms are
not being removed from cultivation under the soil-bank program;
and enough is not being done to help farmers on uneconomical farms
to move them to other occupations that provide higher income op
portunities.
Another Federal activity that needs to be reexamined critically
is the secondary mortgage purchase program of the Federal National
Mortgage Association. This program was at one time to be con
verted to a self-supporting private mutual enterprise with the pur
pose of alleviating temporary shortages of mortgage funds. Instead
it is being used to insulate the mortgage market from general mone
tary policy. In an economy with our efficient private capital mar
kets, one logical remedy to try before the Federal Government inter
venes is to permit the Federal agencies that insure and guarantee
mortgages to meet the prevailing rates.
The stockpiling programs seem to be directed more at stabilizing
prices of some metals and minerals than at meeting our security needs.
Since our stockpile exceeds $6 billion and our capacity to produce
critically necessary materials has increased substantially in the past
few years, it is time to consider revisions of these programs in the
interest of reducing prospective Federal activities.
The postal deficit of $600 million is such a self-evident disgrace
that it is hard for the ordinary citizen to understand why the Con
gress does not eliminate it. Postal rates should be raised promptly to
pay for the entire cost of the postal system, and user charges should
be adopted in other cases where individuals and private businesses
benefit directly from a Federal service.
Considerable savings can be made in the veterans’ programs by re
vising payments in accordance with the recommendations of the Pres
ident’s Commission on Veterans’ Pensions. In particular, the Com
mission’s proposals for gradual elimination of benefits for non-serviceconnected disabilities should be implemented as soon as possible.
Finally, the Federal Government should restore to the State and
local governments functions that they are in a better position to per
form. Among these are sewage and pollution-control facilities, vo
cational education, disaster relief, urban redevelopment, and public
assistance. The Joint Federal-State Action Committee, appointed
by the President, is now considering the feasibility of shifting certain
governmental functions and tax sources from the Federal Govern
ment to the State and local government. I hope that the results of
this work will provide the basis for a clearer delineation of the role
of the various levels of government in our Federal system.
The foregoing are only a few examples of the policies and pro
grams that should be reviewed in order to reduce Federal expendi
tures.
T
h e
N
eed for
B
udgetary
R
eform
There are, of course, great political obstacles to overcome if the
Federal budget is to be trimmed to its absolute essentials. As CED
indicated in its latest policy statement, the biggest obstacles are—
public defeatism about the Federal budget and the pressures of particular groups
to expand Federal programs in which they are interested. * * * Citizens will
160
ECONOMIC GROWTH AND STABILITY
have to be willing to forego Federal expenditures that are less valuable to the
Nation and to themselves than tax reduction.7
The way to overcome defeatism and apathy is to reform Federal
budgetary procedures in order to focus the attention of the public and
the Congress on the consequences of expenditure decisions. In our
study of Federal budget procedures,8 we found that the budgetary
process is deficient in two important respects, each of which must
be dealt with properly to achieve economy and discipline. First, ade
quate consideration is not given to the relation between total expendi
tures and taxes in the formulation of expenditure policy. Reduc
tion of taxes seems to be subordinated in the budget process to the
pressures for expanding the numerous activities of Government. Sec
ond, the Congress and the public are not adequately informed as to the
long-range costs of particular programs. What seems to be a rela
tively small expenditure for a new program when it is initiated often
mushrooms into billions of dollars. It is clearly impossible for Con
gress to judge the desirability of any program merely on the basis
of the current costs.
To remedy these weaknesses we emphasize five recommendations:
1. The administration must take the leadership in formulating a
policy that will leave room for tax reduction. In appraising the
worthwhileness of government activities, we should remember that
reliance on the free decisions of individuals, including their decisions
about how they will spend their income, is fundamental to our demo
cratic society.
2. Information on the purposes and relative values of budgeted ex
penditures should be presented to the Congress on a program budget
basis, so that it can evaluate the purposes of the recommended pro
grams and decide how much should be appropriated for the activi
ties of Government and how much should be allocated for tax reduc
tion. We urge the use of program budgets, because only in this way
can the great mass of information now presented in the budget be
organized to relate proposed and present programs to their costs.
Under present procedures, expenditures and appropriations are sub
divided by departments and agencies, rather than by type of activity.
The Congress and the public will be able to understand the full scope
of government activities if appropriations and expenditures are com
bined by programs rather than by departments. Some progress along
these lines has already been made, but the development of the pro
gram budget should be pushed ahead more rapidly in the near future.
3. To make budget decisions properly, Congress should have before
it estimates of revenues and expenditures, not only in the coming year
but also for 4 or 5 years ahead. Along with overall budget totals,
the estimates should include details for the major, long-term Federal
programs, whether they are included in the administrative budget
or in the cash budget.
4. The President should be given authority to veto individual
items in appropriation bills. Under present procedures, the Presi
dent cannot disapprove one item without disapproving many others
and, as a result, too many wasteful expenditures creep into the annual
budget.
7 Tax Reduction and Tax Reform— When and How. May 1056. p. 10.
* Control of Federal Government Expenditures, January 1055.
ECONOMIC GROWTH AND STABILITY
161
■>. Congressional procedures should be revised to encourage Con
gress to view government spending as a whole and to evaluate the
effect of the budget on the private economy. A joint budget-policy
conference, consisting of key congressional leaders, should be or
ganized to coordinate revenue and expenditure decisions and to set
guidelines for the separate tax and expenditure committees of the
Congress.
C
o n c l u s io n
With the Federal budget as high as it is now, it is imperative, in the
interest of economic growth, that the current upward trend in Fed
eral expenditures be moderated and, if possible, arrested. Federal ex
penditures are using up resources that might be more productively
used in the private sector of the economy or by State and local govern
ments. High Federal expenditures are absorbing incomes that might
provide an incentive to effort and enterprise, and the high Federal tax
rates needed to finance these high expenditures reduce effort and ac
tivity devoted to earning and producing income.
To say that Federal expenditures should be moderated is not the
same thing as saying that needed governmental services should not be
supported. Indeed, a growing economy requires more governmental
services, but the major responsibility for providing these services
should rest with the State and local governments. If we continue to
spend more at the Federal level, the other units will not have the finan
cial resources they will need to satisfy the demands imposed upon them
by a growing economy.
III. LEVEL OF GOVERNMENT AT W HICH PUBLIC
FUNCTIONS ARE PERFORMED
163
LE VE L OF GOVERNM ENT A T W H ICH PUBLIC
FUNCTIONS ARE PERFORMED
LEVEL OF GOVERNMENT A T W HICH PUBLIC FUNC
TIONS ARE PERFORMED
Dr. George C. S. Benson, president, Claremont Men’s College
A few decades ago, this problem could have been solved with a
very simple answer: “Read the constitutions.” The Federal Consti
tution outlined Federal powers, and the State constitutions often out
lined local functions as contrasted to State functions. Today, how
ever, the complete freedom accorded to congressional exercise of the
Federal expenditures power by the Supreme Court does place on each
Congress the awe-inspiring responsibility of redetermining the al
location of functions in those fields where expenditure is a major
item. Not only do congressional decisions determine whether or not
the Nation enters a governmental area which had formerly been con
sidered the province of the States, but Federal grants also frequently
include provisions which profoundly affect the State-local distribu
tion of functions.
G
r a n t s -i n
-A
id
Federal grants-in-aid have been a major, although not the only,
means of bringing the Federal Government into disputed, nonconstitu
tional functions. The grant device has sometimes been a useful means
of cooperative sharing of responsibility for a function between levels
of government (as, to take an obvious example, the public-health
function should be shared). It is an easy method of recognizing a
Federal “ interest” in a field, or of stimulating States and localities
to functions which they might otherwise ignore. It has, in a number
of cases, considerably improved the level of governmental administra
tion in some States and localities.
The troubles with the grant-in-aid device grow perhaps out of
the ease with which the device is used. There are now too many
grants (about 90) and those grants are too detailed. They confuse
State and local budgeting and disturb the responsibility of governors,
State legislatures, mayors, councils, and county boards for the func
tions which are supposedly allocated to those bodies. In a subtle
way grants become a means of defeating popular control of govern
ment at the State and local level. Professional officials at each level
work out their policies together, often without much regard to the
opinions of elective officers.
There are, however, some places where grants would be more de
sirable than direct Federal programs. Some of these places are sug
gested in the later discussion of specific fields. They are usually
165
166
ECONOMIC GROWTH AND STABILITY
pases where a direct Federal operation has tended to keep State gov
ernments from entering fields in which those governments should have
an interest.
H
aph azard
N
ature
or F
ederal
A
c t iv it ie s
Federal intervention in the fields which were formerly considered
State or local has, in the nature of things governmental, been some
what haphazard. It is, of course, possible to cite frequent oddities.
For example there are now some Federal activities in all major fields
of State and local expenditure, except public safety, which is in most
countries one of the first functions to be subject to central author
ity. To take another example, the Federal Government gives publicassistance grants in those special categories where the needs are most
continuous and leaves to the States the function of general relief,
which has far more bearing on the Federal Government’s full em
ployment responsibilities than do the special categories of public as
sistance. The Federal Government gives loans to aid certain local government public-works planning but then ignores the results of
such planning with some of its own expenditures. It reaches the
child-welfare worker in the county public-assistance department with
two quite uncoordinated groups of grants. It may give money to
one public-health worker from several public-health grants. It has
determined over 40 percent of State and local expenditures in Missis
sippi without any consideration of the needs of Mississippi as a whole.
The Federal Government teaches the farmer about general care of his
farm through a grants agency but about soil conservation through a
direct Federal agency.
But these and other incongruities are a natural result of the devel
opment of Federal action in the State-local field through a score or
more of Federal bureaus and an equal number of congressional com
mittees. This committee is to be congratulated for its efforts to view
these problems as a whole, and to find some general criteria for allo
cation of functions.
C r it e r ia
for
A
l l o c a t io n
A substantial number of criteria for allocating governmental func
tions come readily to mind. Is the function one which can be financed
adequately by the level concerned ? Is it a function, the financing of
which affects the general economic condition of the Nation? Is it one
which prospers better under the direct popular control of local govern
ment? Is it one which is so precious to our liberties that we do not
want unified control ? Or is it one which gains from the superior ad
ministrative technique and the greater knowledge normally to be found
on a broader level of government ? Does the function require close co
ordination with other functions which are already located at one or an
other levels of government ? Do the persons subject to it move readily
from jurisdiction to jurisdiction? I f the function is one which re
quires different policies in different sections of the country, is this not
a substantial argument for State or local administration? Is the
function one which a large central government cannot operate too
well because it involves several bureaus which are difficult to coordi
nate ?
ECONOMIC GROWTH AND STABILITY
167
One questionable criterion which is not stated above is whether or
not the function has a “national interest.” All activities of govern
ment have some degree of national interest, in the sense that most as
pects of the life of every citizen are important for national defense,
or for international relations, or for the general welfare. I f we per
mit “national interest” to be a criterion of allocation, everything will
soon be nationalized, Washington will be vastly overburdened, and
our Federal system will be gone. There may, however, be functions
in which a high degree of “national interest” justifies Federal
activity.
The above host of considerations is confusing, so it is best to begin
by looking for major criteria. Clearly the first one is that those func
tions specifically outlined in the Constitution as Federal functions
should be exercised by the National Government. This includes na
tional defense, foreign policy, international and interstate commerce,
Indian affairs, patents and copyrights, money and currency, and the
other items which you know. These functions usually cannot be
transferred to State or local levels without constitutional amendment,
probably should remain where they are, and hence are out of this dis
cussion. It should be noted that the importance of these functions
has increased vastly in the past few decades. Instead of being con
cerned with how to dispose of Federal surplus as in the last century,
we now have a Federal budget which, in the field of strictly constitu
tional Federal functions, involves expenditure of over $50 billion.
There are three important implications of the size of this Federal
budget for this committee. First, in itself these strictly Federal ex
penditures are a large enough amount to permit some delay or speedup
o f expenditures as may be dictated by national economic considera
tions. Second, it is already a sufficient array of vitally important
powers to keep the President and Congress very fully occupied. Do
we really want to add to the responsibilities of overburdened Federal
elective officers the whole range of State-local governmental activity ?
For it should be noted that once the Federal Government moves into
a field, even by the deceptively mild grants-in-aid route, the basic
policy decisions in that field will sooner or later fall back on the Presi
dent and Congress. Pressure groups would rather work on 1 Con
gress than on 48 legislatures.
A third important implication of the large, strictly Federal budget
for allocation of functions is fiscal. When the Federal Government is
carrying heavy charges for defense and foreign relations, is it finan
cially wise to increase its responsibilities in what was considered the
State and local field? Some grants in these fields tend to encourage
expenditures. For example, Federal old-age-assistance policies have
encouraged heavy expenditures in States like Louisiana and Colorado.
At a time when total governmental costs are necessarily high for de
fense, it is not wise to get into intergovernmental fiscal relationships
which encourage expenditure.
Next to the constitutional criterion for allocation of functions it
seems to the writer that the most important criterion of allocation is
the degree to which the funcion may be subject to direct popular
control. All fields of government have some technical features, but
some are much more appropriate for judgment by a local citizenry
than others. In this day of large technological organizations, it
168
ECONOMIC GROWTH AND STABILITY
seems desirable to leave to the State and local units of government
such functions as are more readily understood and directed at those
levels where the people are best able to do so.
The reasons for leaving functions to State and local units where
direct popular control is possible are well known but should be re
stated briefly. Decentralized government has the fundamental advan
tages of—
1. Preventing undue concentration of governmental power
which may be dangerous to liberty.
2. Giving citizens a greater opportunity to participate in their
government.
3. Providing greater opportunity for training political leader
ship through practice in State and local government.
4. Permitting greater adaptation of governmental policies to
the needs of particular areas.
Clearly, however, the above criterion for direct popular control
should be aided by several others. Consideration of the fiscal capa
bility of the local unit is in order. Consideration of its administra
tive capacity, either through qualifications of its personnel or through
its political willingness to recognize governmental problems, is also
in order. Also before all technological work is assigned to the Fed
eral level of government, we should reflect that its superiority is in
gathering technicians together. In some fields we need rival groups
of technicians to work out new ideas.
I f one values the Federal-State-local division of labor, he could then
allocate a substantial group of functions to the State-local level on the
ground that these functions are ones which operate better under direct
popular control and should do so for the reasons stated above. Here
we are admittedly entering a very controversial field.
The writer places these criteria very high because he assumes that
most Americans wish to maintain direct popular control. He admits,
however, that some other considerations, such as administrative con
venience of persons affected, or effect of the functions on governmental
policy in the economic field, will at times result in modification of the
results of this criterion. How do we apply these general criteria to
specific fields ?
L oad enforcement
Most Americans seem to feel that law enforcement is a field of
State or local effort. This is in part because of a natural fear of the
great power of a Federal police force, in part because of union-labor
opposition to State police forces, in part because no pressure group
has ever urged federalization. In general this desire to avoid con
centration of police power seems healthy for liberty, but it must be
admitted that a number of local police forces leave much to be desired,
and that some greater integration of our police work would be help
ful. Perhaps the services now rendered by the Federal Bureau o f
Investigation to State and local citizenry to support and improve the
functioning of their own law-enforcement agencies will be adequate.
Perhaps greater State activity is desirable.
Education
This writer would include public education in the fields which
should be left subject to direct popular control. I f the democratic
ECONOMIC GROWTH AND STABILITY
169
process of popular judgment can work anywhere it should work in
the public schools with which more voters come into direct informed
•contact than any other function of government. Technical aspects of
this field can easily be transmitted from system to system. Another
major consideration in the case of public education is the criterion of
liberty. Do we want Federal grants, to which some administrator or
subcommittee can easily attach conditions, to determine policies in our
vast public-school system ? The schools could easily become a mech
anism for political thought control on a tremendous scale. Inci
dentally, some of the groups which are now most actively working for
Federal aid to education might be among the first to regret some of the
Federal controls.
The Federal Government is already involved in a number of aspects
of public education, some of which seem questionable to this writer.
The vocational education program does not seem to have much more
of a national interest than other programs, but would be better coor
dinated with other State and local activities if it had more direct State
management. The Federal subsidies of education in federally
affected areas are justifiable on the ground of financial need, though
their distribution leaves something to be desired. The national schoollunch program of the Department of Agriculture may be a useful
means of disposing of surplus agricultural commodities, but the cash
grants under it seem to be an unnecessary expense on the Federal Gov
ernment and an intrusion on a field which belongs to States and local
ities,
W dfare
'Categorized public welfare is now so definitely under Federal con
trol that any attempts to put it elsewhere will surely raise very sub
stantial protest. Nevertheless, it seems to the writer that this is a field
of direct popular interest and control. I f we are to be taxed for the
support of our indigent fellow citizens (as most Americans will prob
ably wish to be taxed within limits) we should have some say as to the
requirements for relative support, the amount of relief payments, and
the terms of eligibility. These practices will vary greatly from sec
tion to section of the country as perhaps they should.
One exception to State and local responsibility for public welfare
is general relief, the relief to be received by the unemployed if a
severe economic situation has used up uneinployment-insitrance ben
efits. In the event of recurrence of another depression, it seems that
here is a real place for Federal help 011 the ground of the greater credit
and other financial resources of the Federal Government in such times
and the responsibility which the Federal Government has assumed
for full employment. Perhaps the mechanism for that help should
now be established.
Highways
Another field in which direct popular control is important is that of
highways and roads. Voters know what kind of roads or streets they
are using and can easily pass judgment on whether they should spend
more or less dollars for this purpose. It will be a tragedy when, as has
been seriously proposed, President and Congress must consider ques
tions of street paving. Yet the whole trend is in the direction of
greater Federal responsibility for road construction. Recent high
170
ECONOMIC GROWTH AND STABILITY
way acts have increased the percentage of grants which the Federal
Government is paying.
There are certainly some considerations for Federal interest in the
highway field. National defense is interested in an adequate interstate
network as is interstate commerce. Certain other Federal activities are
aided by better highway networks. But, as noted above, we should
be wary of this “national interest"’ criterion for allocating functions
of government. Some genuine national interest can be found in every
function of Government; so the inevitable result of pushing the national-interest criterion is complete centralization.
It seems to this writer that the better way of allocating responsi
bility for highway construction (almost all maintenance is State and
locai and no one is seriously advocating change of this allocation) is
to assume that this is a function which profits from direct popular
control, and that the Federal Government should intervene only where
the State or locality has genuine financial need. Federal funds for
construction of important interstate roads across vast desert $reas,
such as those of Nevada, are clearly appropriate. Federal funds for
construction to or through Federal facilities are also appropriate.
Some Federal aid for a definitely interstate system is also in order.
But the general Federal aid which requires apportionment of certain
percentages to rural roads and certain percentages to urban areas is
both a denial of popular control and a confusion of the responsibilities
of Government. It is well known that these allocated general aids
frequently result in less economical expenditure.
I f the Congress should decide at some future time that the general
economic condition requires more roadbuilding, it can easily find
State and local highway agencies which are able to spend the money.
Aids to agriculture
In this field, we find a curious and expensive existing allocation
of function which violates the criterion of direct popular control. The
long-established extension system is a grants-in-aid compromise by
which governmental education of the farmer benefits from national
concentration of technical knowledge and local control of the mecha
nism through which that knowledge is transmitted to the farmer. Yet
we have over decades maintained a rival agency (the Soil Conserva
tion Service) with direct Federal funds to educate the farmer on
matters of soil conservation. While this deviation from the extension
pattern could originally have been justified as a means of waking up
extension personnel who were not sufficiently aware of the importance
of soil conservation, it is today an upsetting factor in agricultural
education.
In addition we find Federal agencies passing out direct benefits to
agriculture which arevnot supportable, either as a matter of allocation
of functions or of sound public policy. The agricultural price-support
program, which may have had some justification at its inception, is
today morally and economically unsound. And, if it were sound,
it should be administered by the States as its own statute has long
permitted but the Department of Agriculture has not wished to en
courage. The actual determination of subsidies and of acreage alloca
tion at the local level is a function which Federal administrators
should wish to decentralize in a Federal system of government. This
is a function which should be subject to direct popular control.
ECONOMIC GROWTH AND STABILITY
171
Another expenditure function which is reasonably subject to direct
popular control is that of “soil conservation” benefits payments. This
program, if continued at all, would be more economically and efficiently
handled, if it were done on a grants-in-aid basis with the States. The
propriety of payments here is easily a matter of direct popular con
trol. No peculiarly Federal technical knowledge is needed. While
there is a national interest in soil conservation, it is doubtful if such
conservation is the real end of this program. In any event, the na
tional interest could be recognized adequately through a grants
program.
Social insurance
The present picture in the social-insurance field is complex. The
old-age and survivors insurance program is a direct Federal opera
tion. So is railroad and maritime workers’ compensation. Unem
ployment compensation (and the related Employment Service) is a
joint responsibility of Federal and State governments. Workmen's
compensation is a State program. All of these fields are similar in
technical difficulty, so there is no argument to justify the present di
versity. There is, however, an argument of administrative conven
ience which clearly justifies keeping old-age and survivors insurance
on a national basis. Persons are bound to move from State to State
in a mobile industrial population like ours. Recordkeeping would be
vastly confused and movements of individuals possibly handicapped
by State regulations if this function were handled on any other basis.
Coverage of individuals under workmen’s compensation is imme
diate so there is no particular reason for its not being handled on a
State basis, unless one accepts the assumption that the Federal Gov
ernment has a national interest in keeping all State workmen’s com
pensation laws up to some minimum level. Since workmen’s com
pensation is not known as an important cause of interstate competi
tion, this writer would reject the above assumption on the ground,
already stated, that we would lose our Federal system if we allocated
to the National Government all functions which have some national
interest.
Unemployment compensation and the related employment service
present a different problem. Both fields clearly involve some national
issues. The Joint Economic Committee has an interest in unemploy
ment compensation for its possible stabilizing effect on the national
economy. All of us are interested to see that people do not lose un
employment compensation as a result of an interstate movement. The
Employment Service has some role in suggesting out-of-State place
ments to unemployed workers. Yet there are powerful reasons for
keeping these services on the State-local level. Both are functions
which are reasonably susceptible to direct popular control. Some of
the functions with which they are closely related such as vocational
education, public assistance, and public education are already on that
level.
On the whole, it seems probable that the existing allocation of func
tions in these fields is relatively correct. Administrative procedures
should probably be altered, as suggested by the Commission on Inter
governmental Relations, but the sharing of Federal and State activi
ties seems correct.
172
ECONOMIC GROWTH AND STABILITY
Conservation of natural resources
In this function we also have a widely variegated pattern of opera
tions. The Federal Government owns and operates (with vastly dif
ferent policies in different bureaus) a large amount of forest land,
some parks, and a great deal of wild land. It spends funds on some
cooperative work in connection with forests, including chiefly fire
fighting. It provides the sole resources for many flood-control proj
ects and “lends” a substantial sum (much of which may never be
repaid) on reclamation projects.
The story as to how the Federal Government got itself into this
vast variety of projects is too long to tell here. It is partly because
o f the failure of States and localities to undertake this work them
selves. It is partly because no governmental agency is likely to give
up a project on which it has started.
It seems clear that most of these functions are ones which are sus
ceptible of direct popular control and which should involve a greater
participation by the States and to some extent by local levels of gov
ernment. Admittedly, any such change would have to come gradually
and after substantial education of the official personnel of some States,
perhaps through grants-in-aid. But it is clear to this writer that the
States, especially the public-land States, would be more vital units
of government if they took a constructive interest in their natural re
sources. While prediction is difficult in any field of social action, it
might prove that local ingenuity would find better methods of devel
oping some of those assets than has the Federal Government. A
recent study in California has suggested that this might be the case.
Specific recommendations are not made here because the writer
agrees with the Commission on Intergovernmental Relations and the
Second Hoover Commission that the conservation problem deserves
special treatment. But he is convinced that the States should bear
some of the costs and share in some of the controls of this field.
Control of commercial activities
The writer is not discussing the field of commercial regulation for
two reasons. First, the amount of governmental expenditure involved
is small. Second, the legal problems and confusions are very great.
Public health
These inexpensive but important activities are spread over three
major levels of government: Federal, State, and usually county.
The work on all three levels is linked together by an elaborate system
of specific grants. While there are probably too many grants, the
existence of the system seems reasonable in the light of the criteria
advanced above. Public health is largely a technical function and
most aspects of it speedily cross State and local boundary lines in a
mobile population like our own. So there is less of the argument of
direct popular control for complete local control and there are more
technical reasons for some kind of national control. But there is one
important consideration for maintaining some degree of local
autonomy, i. e., the close interrelationship of the public-health function
to several other activities which are predominantly on the State and
local level. These include public assistance, public education, and
law enforcement.
ECONOMIC GROWTH AND STABILITY
173
Fiscal aspects of allocation of functions
Since the writer is the only political scientist on the panel, he has
left fuller discussion of the fiscal problem to his colleagues from the
field of economics. He would, however, like to make two general com
ments about the basic problem of the finances of a Federal system.
TChe problem is, of course, that the Central Government can administer
most taxes at less cost and with more fairness to the community as a
whole than can State and local levels of government, although the
latter are the more logical levels for administration of many expensive
functions.
The first comment is that there is little likelihod of effective decentralizating action through return of specific taxes and functions to the
States. The Commission on Intergovernmental Relations explored
this field carefully and found no such reallocation which would not
benefit the wealthier States and hurt the poorer ones. Although our
grants system is not basically an equalizing system, it seems improb
able that the American people will consent to a change which is so far
opposite from equalizing.
The second comment is that the equalizing block grant could be well
used to replace some of the excessively specialized and control-ridden
particular grants. The Commission on Intergovernmental Relations
rejected this block-grant program on the ground that it would only add
block grants to specific grants and thus further reduce the independ
ence of States and localities. This, of course, is a psychological ap
proach which depends in part on the mood of Congress when it con
siders block grants. If a substantial portion of Congress is really
seriously concerned with the amount of national expenditure and with
the detailed control of State and local expenditure into which Congress
has been almost unconsciously gravitating, a block-grant system, with
larger aid to the poorer States might be a useful substitute for exist
ing specialized grants and a useful answer to pressure groups suggest
ing new grants.
CoKCLtrsiour
This memorandum is not much more than a series of random remarks
on a subject which deserves much fuller and more careful considera
tion. Important functions have not been considered, and of course
many of the functions which have been considered involve other
criteria than those mentioned here. The writer’s hope in submitting
these comments is to emphasize a few points of view:
First, the existing allocation of functions between levels is not very
rational, and confuses responsible government on all levels and has
an adverse effect on State and local budgeting.
Second, the concept of “national interest” has been overworked. It
could easily lead to the end of our system of decentralized government.
Third, an important criterion of allocation of function which is
often overlooked is that of the desirability of direct popular control
of many functions. Reallocation of functions should be considered in
this light.
FEDERAL EXPENDITURE AND STATE FUNCTIONS
James M. Buchanan, Chairman, Department of Economics,
University of Virginia
In his Williamsburg speech of June 24, President Eisenhower
called upon the States to assume financial responsibility for the pro
vision of public services now borne, in whole or in part, by the
Federal Government. Following this, in July, he appointed a toplevel committee to work with a committee representing the State
governors. The .preservation' erf* effeetitfe political decentralization
has, been made a subject for serious contemporary discussion.
The President made his views on these matters quite explicit. He
fecognizee the advantages o f genuinely decentralized government.
But tit the same time, he feels that there exist certain pressing
social needs which, if the States do not meet them, must be provided
for by.the Central.'Government. In this position, the President is
surely reflecting an .attitude which is widely shared. And it is this
■attitude which will possibly provide the motivation for expanded
Federal expenditure over the next decade. The Federal Government
will probably continue to assume greater and greater financial re
sponsibility for highways, schools, hospitals, resource development,
slum clearance, urban redevelopment, flood and natural disaster re
lief, etc.
.
“U
n d e n ia b l e ”
N
a t io n a l
N
eeds
In this paper, I want to examine critically this commonly held
attitude. Two specific quotations from the President’s speech pro
vide a text:
.
Every State failure to meet a pressing need has created the
opportunity, developed the excuse, and fed the temptation for
the National Government to poach on the States’ preserve.
Year by year, responding to transient popular demands, the
Congress has increased Federal functions.
Opposed though I am to needless Federal expansion, since
.
1958 I have found it necessary to urge Federal aetion in some
areas traditionally reserved to the States. In each instance,
State inaction, coupled with undeniable national need, has
forced emergency Federal intervention.
There is no ambiguity here. The needs exist. Either the States
respond to them, or the Federal Government must. On this simple
and apparently straightforward logic, the power of the States them
selves to determine whether or not there exist needs for services tra
ditionally performed has completely vanished.
Something is wrong here. The mere presence of public or collec
tive needs has become confused with the necessity for satisfying them.
The need for more and better highway facilities, for more school174
ECONOMIC GROWTH AND STABILITY
175
rooms, for more slum clearance, etc., may be readily admitted. But
needs are always relative, never absolute. The existence of “unde
niable” need does nothing toward proving that action must be taken
to meet it. Paralleling each additional need or desire, be it public or
private, there is some cost of meeting it, a cost which can be measured
in terms of the goods and services sacrificed or given up. This concept
of alternative or opportunity cost is the central principle of economics,
and we stand always in danger of overlooking it, especially in dis
cussions of public policy issues. We can collectively satisfy the need
for more schoolrooms only by giving up something else—dwelling
units, automobiles, or what have you.
Public needs become objectively meaningful only when people indi
cate a willingness to bear the necessary costs. And there is no ob
jective standard to be utilized at this point. In a democratic society,
the genuine collective needs of the people are expressed only through
their actions as voters, pressure-group members, legislators, and
administrators.
The question at issue concerns the prospects for Federal assumption,
of financial responsibility for functions traditionally performed by
the States and local units of government. The President suggests,
that the latter units have failed to meet the needs which should be
met, presumably on the basis of some objectively determinate stand
ard. But if no objective standard exists, on what basis can such a
statement make sense ?
F
ederal
V
ersu s
L
ocal
D
e c is io n
M
a k in g
It might be argued that the social decision-making process repre
sented by the Federal Government is more “ rational” than is that
represented by State and local units, that is “ rational” in the sense
that Federal decisions are more closely in correspondence with the
genuine desires of the populace. This argument appears from time
to time under different forms, but surely it has no basis either in fact
or ideal. The philosophical foundation of western civilization em
bodies the assumption that the individual acting for himself or his
family can best express his own wants. Failing this, the individual’s
desires can be more closely satisfied through decisions made in small,
closely associated groups and organizations. How else can we account
for the widespread support for such ideas as local option, home rule,
self-determination, etc. ? The individual’s wants are more adequately
expressed through the actions of a county or city school board, which
is forced to respond directly and continuously to conflicting pressures,
than through the action of the National Congress or a Federal ad
ministrative agency. At the local levels of government, the needs of
individuals are clearly manifest, but (and perhaps here is a key to
some of the confusion) so are the costs. And it is precisely because
both needs and costs can be more properly weighed that local gov
ernments many times seem to the careless observer to be backward
and unresponsive in taking positive action. Local school boards do
not always decide to build schoolrooms which some educational au
thorities, thinking only of the need, demand. But this fact in itself
is an indication that decisions are being made on a rational basis
rather than the opposite.
176
ECONOMIC GROWTH AND STABILITY
The best evidence that many of the needs for extra schoolrooms,
more roads, more hospitals, and so forth, are not undeniable is pro
vided by the fact that States and local units have not taken measures
to satisfy them. Far too often, the Federal Government-is failed
upon to assume additional financial responsibility because the direct “
connection between benefits and costs tends to become lost in the com
plex maze of Federal budgetmaking. To the individual recipient of
Federal aid, Federal financing gives the illusion of some sort of magic
although simple logic must reveal that additional Federal taxation
is necessarily present. As a general rule it may be stated that the
further removed the individual is from the governmental unit in
volved the greater the fiscal illusion becomes. This alone should give
pause to any extension of Federal financing at the expense of,. State
and local units.
W
hen
Is F e d e r a l
F
in a n c in g of
S tate F
u n c t io n s
J
u s t if ie d
?
Fiscal equalization
There are only two legitimate grounds which justify that the Fed
eral or Central Government assume some fiscal responsibility for pub
lic services performed by State and local units of government. First,
some Federal action is legitimate if the purpose is that of achieving
fiscal equalization among the various States. By fiscal equalization
I mean the equalizing o f the overall fiscal burden among the separate
State areas.
This sort of action may become necessary if there exist wide differ
ences in incomes and wealth among the separate States. Here the
Federal Government may, in the interest of both efficiency and equity,
take action to transfer funds from the richer States to the poorer
States. Such transfer is necessary due solely to the fact that average
incomes differ among the separate geographical subdivisions, and that
these differences impose differential fiscal pressures on individuals.
The individual who resides in a low-average-income State must, on
the average, be subjected to a heavier fiscal pressure than his equal in
a high-average-income State. A fiscal disadvantage is placed on the
individual who happens to reside where low income receivers are con
centrated. In more concrete terms, the Mississippi resident must pay
higher taxes to get the same quality of public services than the New
York resident, not due to any inefficiency of the Mississippi fiscal
structurej but due solely to the fact that he lives in Mississippi. The
equalization of fiscal pressures may be accepted as a proper role of
the Central Government.
But, having accepted fiscal equalization as an appropriate Federal
function, the next question becomes that of applying this legitimate
purpose to the problem of Federal financial aid to States for partic
ular State functions. There are several points to be noted.
First of all, the need for geographical equalization of fiscal pres
sure is rapidly being eliminated. Average income differentials among
the States are narrowing over time. It is not to be expected, nor
should it be hoped, that these differences will ever be fully eliminated.
Some such differentials must remain as the result of the deliberate
choices freely exercised by individuals. But regional income and
wealth differentials significant enough to warrant Federal interven
tion should assume diminishing importance over time.
ECONOMIC GROWTH AND STABILITY
177
Secondly, if Federal income transfers to accomplish fiscal equali
zation are attempted, this does nothing to suggest that particular
State functions should be singled out and designated for Federal aid.
The equalization argument is a general one, and it should be applied
for overall fiscal pressures (taxes and benefits) and not to particular
services such as education, highways, and so forth. Ideally, Federal
grants-in-aid designed to achieve equalization should be completely
unconditional, and the recipient States should be free to dispose of
such funds as they wish. Unless this procedure is adopted, State
budgets are distorted and spending upon projects of secondary im
portance may be encouraged. The equalization argument provides no
justification for Federal assumption of financial responsibility for
specific State and local functions.
Thirdly, if fiscal equalization is the main purpose to be achieved
by Federal financial aid, this can be accomplished through Federal
grants to the poorer States only. There is no equalization purpose
to be served by general Federal financial aid to all States, rich and
poor alike.
Federal grants-in-aid, in the past, have not been motivated pri
marily by the desire for fiscal equalization. The factual record indi
cates that Federal grants to States have been almost neutral in their
equalization effects. The achieving of fiscal equalization has not been
the dominant motive behind expanded Federal aid, and there seems
no reason to predict that the equalization argument will loom larger
in the future. In fact the contrary seems more likely. Federal
financial aid in the past has been tied to State performance of par
ticular public functions. This sort of financial aid must be supported
on the basis of some argument other than that of equalization.
Spillover or neighborhood effects
The second justification for expanded Federal participation in the
financing of public functions traditionally performed by State and
local units lies in the possible existence of important spillover effects
stemming from independent State action or inaction. I f the action
taken by a single State with regard to the performance or non
performance of some public service exerts significant and important
effects on citizens of other States, some basis is provided for the inter
ference of the Central Government. It is at once evident that almost
any action, public or private, carries with it some spillover effects.
The benefits from public expenditures made by individual States rare
ly fall exclusively upon residents of the spending jurisdiction. And
the social costs resulting from a failure to perform certain services
are not normally confined to a single political unit. The relevant
words become, therefore, significant and important. When do such
spillover effects become important enough to warrant Federal inter
vention? The answer here can only be discussed case by case; there
is no clear dividing line which is generally applicable.
We may, first, examine the financing of the highway system. Much
of the support for Federal financing of the Interstate System, ap
proved in 1956, was based on the presumed need for a genuinely inter
state network of highways. It was argued that full State responsi
bility would allow portions of the national network to become de
preciated to such a degree that effective interstate communication
would be disrupted or seriously impaired. No detailed empirical in
178
ECONOMIC GROWTH AND STABILITY
vestigation is required to indicate the weakness of this argument. I f
the separate States were, in fact, characterized by vastly divergent
standards of road construction, some additional Federal participation
may have been justified. But the road network of the Nation is re
markably uniform, and interstate travel is not difficult. The spill
over effects do not loom as significant or important in any meaning
ful, relative sense. There appears to have been no legitimate justi
fication for increased Federal participation in financing highway
construction. This is not, of course, to deny the existence of benefits
to be expected from a single, integrated system of trunk roads. These
are real benefits to the Nation as a whole, but they will be secured at
the cost of yet another expansion of centralized political power, a cost
which can only be indirectly calculated and which tends to be of
permanent duration.
As a second currently important case, we may consider the problem
of Federal aid for school construction. The existence of spillover
or neighborhood effects from State and local expenditure on educa
tion cannot be denied. And this is clearly a national interest in seeing
that the separate States devote adequate funds to education. The
population in any one State at any particular time is made up of
individuals educated in many of the separate States. The benefits
from educational expenditure are not limited to the citizens of the
State which finances. Having said this, the whole question now
reduces to one of assessing the significance of the spillover effects
and weighing these against the added cost which necessarily accom
panies Federal intervention.
In education, these intervention costs are likely to be especially
high. Education is not a homogeneous product, and the values of
maintaining separate systems are great. We do not know the sort
of education which is optimal, and the forcing of all public education
into a standardized straitjacket which Federal financing must involve
would destroy much helpful experimentation and divergence. It is
assumed that Federal financing will involve Federal control, sooner
or later. There seems little evidence that such control can possibly
be avoided. We may look again at the highway problem for current
evidence. Federal intervention was designed to be kept at a minimum.
Yet, before the revenue bill was enacted, Davis-Bacon provisions con
cerning wage setting were imposed, and now, only 1 short year later,
active discussion is continuing concerning Federal action to regulate
billboard advertising. It is naive to hope that Federal aid to school
construction would fare any better. It is realistic to expect that it
will fare worse.
We may summarize all this by saying that, when spill-over effects
are present, there are real benefits to be gained from the securing of
uniform national standards of performance of certain public services.
But there are also real costs involved in achieving such uniformity.
Far too often, popular discussion overlooks the cost side. The costs
are difficult to compute, because they are measurable only in terms of
power concentration. It is almost impossible to place dollar equiva
lents on costs of this nature, but this should not cause them to be
neglected. Such costs show up in damage to the whole political power
structure represented by a federally organized system. Genuine fed
eralism as a viable political form requires severe limitations on the
ECONOMIC GROWTH AND STABILITY
179
degree of power concentration in the Central Government. And,
in a country so large as the United States, genuine federalism may be
essential to the preservation of the free society.
The discussion at this point becomes one of the political philosophy,
which is inappropriate in this brief paper. Perhaps a more direct
and positive approach is more useful. Let me state that I consider
further centralization ;qf political power in the hands of the Central
Government to carry With it a real cost; that I consider^He^beneEts
to be secured from nationalizing public education, highways, and
other" similar services insufficient to warrant paying this cost. In
maThng; this statement I am. not speaking as an economist who has
measured such social intangibles as the cost of centralizing power or
the benefits of nationalizing education. No accurate...measurement
can be made. Only those directly responsible for decisions can strike
a final balance on the basis of their own attempts at measurement.
But, in undertaking this difficult task, political leaders should not
allow themselves to be^amBoozled into accepting some supposeSTy
objective measures of national need and then
pelieviiig
that because the need exlsts it must be aafasfieitL.... The implications ol
the Eisenhower-statements cited at the beginning of the paper must
be rejected. TKe failure of the States and local units to take action
in expanding certain public services is no signal for Federal Govern
ment action.
‘
C
o n c l u s io n
I shall conclude by stating that there appears to be no justification
for the Federal Government, over the next decade, to assume greater
responsibility for financing public functions now financed by States
and local units. There are good reasons which suggest that a sizable
reduction in Federal aid to States and localities should be carried
out. But it would be naive to expect such a reduction, and I am by
nature a pessimist. But by wakmg up, all too late, to the dangers
inherent in the continued concentration of power in the Central Gov
ernment, we can, perhaps, prevent further encroachment.
This study by the Joint Economic Committee is devoted to the gen
eral topic, “Federal Expenditure Policy for Economic Growth and
Stability.” The proper environment for economic growth is a poiiticoeconomic system characterized by effective decentralization of
power. Undue power concentration can only be detrimental to eco
nomic progress, whether this concentration be in the form of big
business, big labor, or big government.
THE INCREASING ROLE OF INTERGOVERNMENT TRANS
FER PAYMENTS IN THE PERFORMANCE OF STATE
AND LOCAL FUNCTIONS
Frank L. Fembach, economist, Department of Research, American
Federation of Labor and Congress of Industrial Organizations
In discussing the division of functions between governments at
various levels, it is well to keep in mind two significant facts regard
ing the existing division and the way it is being financed.
In the first place—and contrary to the impression spread by those
who ritualistically pin the “welfare state” label on the activities of
Washington—the almost all-consuming preoccupation of the Federal
Government is the fulfillment of its constitutionally imposed respon
sibility to “provide for the common defense.” Nearly 80 percent of
all of the revenue Washington collects is devoted to activities related
to this single, all-important function.
Second— and largely obscured from public consciousness because of
the impact of the mountainous Federal expenditure— is the fact that
most of the outlay for civilian public services is directly underwritten
by the States and the local governments themselves.
Stated another way, although Washington collects about 70 percent
of the tax dollars levied by all governments, the States and localities
are paying for more than 70 percent of the total cost of all civilian
public services from their own direct tax levies and charges and by
going increasingly into debt.
In fiscal 1956, according to a recent study of the Bureau,-of the
Census, the expenditures of all governments approximated $101 bil
lion (excluding all insurance-trust outlays and the utility and liquorstore operations of the States and localities).1 Of this total, the Fed
eral Government spent about $67.5 billion, including $3.3 billion trans
ferred to the States and localities in the form of grants. The States
and localities, for their part, raised and spent $33.3 billion, excluding
the Federal grants they received.
_Over half of all this governmental spending in 1956—almost $54
billion—went to meet the costs of past wars and to pay for national
defense. These exclusively Federal outlays paid the cost of veterans’
benefits, interest on the war-incurred debt, maintenance of the Armed
Forces, overseas aid, the atomic program, stockpiling, etc.2
The remaining governmental expenditure—slightly less than $47
billion—represents the total outlay by all governments for civilian
purposes in 1956. This combined Federal, State, and local govem1 Summary of Governmental Finances, Bureau of the Census, document G-GF56, August
23, 1957. Census concepts of Federal receipts and expenditures are not precisely com.
parable to those of the Budget Bureau because of the effort of the Census Bureau to con
form In structure to the system It uses for classifying State and local data.
3This total Is derived from The Budget of the United States Government for the Fiscal
Tear Ending June 30, 1958. Other figures come from Bureau of the Census sources, unless
otherwise noted.
180
ECONOMIC GROWTH AND STABILITY
18 1
mental spending to meet civilian needs equaled about 11 percent of the
value of all goods and services produced in the United States in 1956.
In comparison, the outlay for this purpose was 9 percent in 1929 s
when, however, there was no depression and war-created public con
struction lag to be overcome and no comparable pressure for expanded
public services resulting from the unprecedented postwar population
rise.
In 1956, public expenditures for civilian purposes were divided be
tween the Federal Government and the States and localities in the
following manner:
Amount
(billions)
($8W
$33^
Percent
29
(7)
71
Most of the $10 billion of Federal spending for civilian purposes
(excluding the grants to the States and localities) went for postal
services ($2.9 billion) agricultural aids ($2.9 billion) and other nat
ural resource and nonhighway transportation development purposes
($2.1 billion). Only slightly more than $2 billion remained to meet
the cost of all of the other civilian functions assumed directly by the
Federal Government.
The States and localities spent most of the $33% billion they raised
from their own resources in 1956 in the performance of 10 major func
tions. Their outlay for these functions, in relation to total govern
mental outlays for them, follows:
Function
State Mid
local outlay
exclusive of
Federal
grants
(billions)
$12.7
6.2
2.7
1.9
1.3
1.3
.7
.5
.4
.3
Percentage
of total
govern
mental
outlay
95
88
90
53
89
100
100
100
100
62
The part played by the States and localities in providing these major
civilian services is not only surprisingly large; during the postwar
years it has been expanding.
In the 8 years from 1948 to 1956, State and local expenditures fi
nanced from their own sources (excluding Federal grants and insur
ance trust, utility and liquor-store activities) rose $17.5 billion—from
$15.8 billion to $33.3 billion—a rise of 111 percent. In the same period
Federal grants to the States and their subdivisions rose $1.4 billion, or
only 73 percent.
3 Musgrave and Culbertson, The Growth of Public Expenditures in the United States,
1890-1948, National Tax Journal, June 1953.
182
ECONOMIC GROWTH AND STABILITY
The substantial effort of the States and localities to meet the soaring
postwar demand for greater outlays for civilian governmental func
tions is reflected in the rapid rise in the tax collections and the debt of
these governments.
Between 1948 and 1956, State and local tax collections rose almost
100 percent from $13.3 billion to $26 billion, and a further rise to $28
billion is estimated for 1957. Meanwhile, State and local debt sky
rocketed 162 percent—from $18.7 billion in 1948 to $49.2 billion in 1956.
A further rise in debt of about $5 billion is estimated to have occurred
in 1957. Almost three-fourths of this indebtedness is owed by the
local governments.
The foregoing discussion has dealt primarily with the part the vari
ous governments play in performing civilian functions from revenues
derived from their own sources. It is important to note, as well, the
role of intergovernment transfer payments and the increasingly sig
nificant distinction between financing a government function and the
performance of it—a distinction which is particularly important at
the local level.
Because of the public controversy over the Federal grants-in-aid,
it has been less noted that grants and the sharing of revenue have
become increasingly important in the interrelationship between the
States and their subdivisions. In fact, the local governments actually
are the ultimate beneficiaries of almost all intergovernmental revenue
transfers. Indeed, were it not for this factor many local governments
could not possibly have continued to perform their traditional func
tions, or have attempted to assume newer ones.
In 1956 the general expenditures of the States and localities totaled
$36% billion—-they spent the $33% billion which was raised from their
own resources plus the $3% billion received in Federal grants. Twothirds of this total, however—about $24% billion—was spent by the
local governments although they were able to raise only $16.2 billion
from their own local sources.
The ability of the localities to spend substantially more on the per
formance of their functions than they raised themselves, was due to
the receipt o f $6.2 billion in net grants and shared revenue from the
States plus $0.3 billion received in direct grants from the Federal
Government.
The States, for their part, raised $15.1 billion from their own general
revenue sources and received $3 billion in Federal grants. But they
disbursed $6.2 billion more to their local governments than they re
ceived from them and, thus, revenue available to the States for their
own direct expenditure was only $11.9 billion.
Actually, the local governments not only received intergovernmental
revenue transfers equal to the entire amount of the Federal grants-inaid ; they were also the recipients of an additional transfer of revenue
from the States of an almost equal amount. Without this substantial
financial aid—more than half of which was allocated for education—
local government outlays could not possibly have accounted for more
than half of the outlay of all governments for civilian purposes during
the course of 1956.
Despite this intergovernmental aid, the mounting needs of most local
governments continue to exceed the revenue from all sources available
to meet them. How to find enough money to meet the ever-rising de
mand for increased local services—and particularly for those which
ECONOMIC GROWTH AND STABILITY
183
must be assumed by our metropolitan areas—is a major problem we
must solve. Its urgency has increased with the rapid change in the
way our people live.
America has gone through two great changes in its living patterns.
In the last quarter of the 19th century and the 1st quarter of the 20th
century, we shifted from a basically rural to a basically urban society.
Inevitably, the rise of the cities rapidly increased the cost of tradi
tional local functions—for education, sanitation, police and fire pro
tection, parks and libraries, and for public health.
With the second great change in American life-—a shift from an
urban to a basically metropolitan society—the demand for expanded
local public services has become explosive.
In 1955, almost 60 percent of our entire population was living in 172
metropolitan areas located in 42 States and the District of Columbia.
These 95 million metropolitan residents now live in an area that covers
only 7 percent of the entire territory of the United States. Further
more, this concentration is continuing to increase. In the last 5 years
alone, 97 percent of our 12 million population rise occurred in the
metropolitan areas.4
At a recent conference of State and metropolitan officials it was
aptly observed that—
The metropolitan area does not respect geography. It jumps over and around
rivers and land masses. It ignores the political lines o f districts, villages, towns,
cities, counties, and States.5
The metropolitan core city, its suburbs and its satellite cities are now
one compact and interrelated community, and its boundary becomes
further extended every day.
While about 70 percent of the 172 metropolitan areas are still con
fined within a single county, 30 are now intercounty and the bound
aries of 11 of these areas extend into 3 and even 4 counties. In addi
tion, there are 24 metropolitan areas that are now interstate.
The arrival of the metropolitan era has intensified traditional local
problems and added a host of new ones. The need for rapid mass
transportation between the core city and its suburbs, for an expanded
water supply, for the proper planning of land use to protect residential
areas from the encroachment of those that are commercial and indus
trial, for construction of low-cost housing and for the retarding of
community blight, for the ending of water and air pollution and the
elimination of industrial wastes are all concerns of the entire metro
politan area and must be cooperatively resolved. Effective fulfillment
of all of these expanding local responsibilities now requires a new kind
o f governmental effort—a united metropolitan area approach.
A variety of methods to achieve this end are now being undertaken.
In some places, the consolidation of existing historical political units
within the metropolitan area is being urged. In others, more and
more areawide functions are being undertaken by the counties. Else
where, informal cooperative metropolitan federations are being estab
lished. In some areas, special purpose governmental authorities,
intracounty and even interstate in their functions, are being set up.
4 The States and the Metropolitan Problem, a report to the Governors* Conference by
the Council of State Governments, 1956.
6 Report of the Arden House Conference on Metropolitan Area Problems, September
2 1 -2 8 , 1957.
184
ECONOMIC GROWTH AND STABILITY
All of these efforts must be encouraged. Yet, even while new ad
ministrative techniques are being devised to make the performance of
local functions more efficient, more money to finance them is still criti
cally needed.
The magnitude of the financial problem is suggested by an official
estimate of public works construction needs alone.
In 1956, total State and local outlays for new public works reached
a record $9.4 billion and the local governments accounted for 60 per
cent of this total. Nonetheless, even this huge expenditure for high
ways, educational buildings, water and sewerage works, hospital and
institutional buildings and other non-Federal public enterprises met
less than half of the current need. According to the United States
Departments of Labor and Commerce, State and local governments
should now be investing $20.4 billion in new public construction each
year if the backlog of need is to be overcome by 1965. It must be sub
stantially eliminated by then if “new and severe community problems
are to be avoided,” the Federal experts warn.6 Yet, in 1956, total
State and local public construction only measured up to 46 percent
of this goal, and each year we fail to reach it the backlog grows.
In 1956, the direct expenditure of the States for the performance of
their own general functions reached a record total of more than $12
billion, about 26 percent of all governmental outlays for civilian pur
poses. About $4.3 billion was spent for highway construction and
maintenance, $1.7 billion for institutions of higher learning, $1.6 bil
lion for public assistance, $1.4 billion for State hospitals and institu
tions, $0.7 billion for natural resources development, and $0.2 billion
for highway police activities.
All States are under constant pressure to increase their outlays for
the performance of their own statewide functions, particularly to meet
the rising demand for higher education, mental health services, recrea
tional facilities and other services. At the same time, there is also an
insistent demand that the States relieve their hard-pressed local gov
ernments of some of the functions that traditionally have been theirs—
local roadbuilding and maintenance and public assistance, for example.
Even more important, there is a mounting pressure on the States to
exercise their superior taxing power and their leadership function to
help raise far more revenue to finance local functions and to help in
crease the efficiency of the local performance.
The “creature” local governments must be allowed—in fact, must be
encouraged and aided—to coordinate their efforts to solve mutual areawide problems, both intrastate and interstate in scope.
Furthermore, the States must assist their localities to increase local
property tax yields, the source of 87 percent of the direct tax revenue
of all local governments and of 74 percent of the tax collections of
the cities in 1956. Unjustified State-imposed tax-rate limitations
must be ended. Frequent reassessments and uniform statewide assess
ment procedures must be encouraged. Besides, the States must pro
vide leadership in an effort to professionalize the role of the tax
assessor.
6 Gonstractlon Review, May 1955, p. 4, published by the U. S. Departments of Labor and
Commerce.
ECONOMIC GROWTH AND STABILITY
185
With more and more Americans working in one community but
residing and paying taxes in another, local governments must in
creasingly depend on the State to levy and collect general taxes and
then share the revenue equitably among them. By this means, and
particularly through greater statewide use of progressive levies on
income and profits, total revenue available to local governments will
increase and can be distributed more fairly, more revenue can be
obtained from taxes hased upon ability to pay, and there need be less
dependence on the plethora of local sales and payroll taxes that are
currently being imposed. Furthermore, only through special State
grants-in-aid based on the broad taxing power of the State can be
poorer localities achieve at least minimum standards in the per
formance of their local functions.
Clearly, more revenue can be obtained to finance State and local
functions by a greater use of State income taxes. In 1956, less than
17 percent of all State taxes came from this source. In 13 States, in
cluding some of the most industrialized and urbanized like Illinois,
Michigan, New Jersey, Ohio, Indiana, Washington, and Texas, no
individual income and corporate profit tax is collected at all. Even
though the Federal Government has long extended an invitation to all
of the States to enjoy a share of the revenue collected hy its progres
sive income tax—through the allowance of deductibility against the
Federal tax, wherever State income taxes are imposed—most States
have failed to take full advantage, of this revenue-sharing opportunity.
The expectation of several decades ago that the States would pro
vide great leadership in the effort to find new solutions for changing
and complex State and local problems has not been fulfilled. A l
though progress in some States can be cited, most State legislatures
are still dominated by those who look backward and are unresponsive
to modern needs. Archaic and, apparently, almost unchangeable
State constitutions keep the States and localities tied to inefficient
and outmoded practices that block progress toward more efficient
government. State and local taxes are still based almost entirely on
regressive levies. Although additional revenue could be obtained
from progressive taxes on income and profits, efforts to install them
are met with the fearsome argument that employers will be driven
to other States where the “ tax climate” is more favorable.
Rather than obstructing the solution of local problems, as is now so
frequently the case, State governments more appropriately should be
the channels through which new inspiration, ideas, and revenues flow
to their political subdivisions. This, above all, should be the function
of State governments today.
Despite the necessity for continuing vast outlays to meet the costs
of past wars and present defense requirements and for expanded pub
lic expenditures to meet civilian needs, the dominant mood is for fiscal
retrenchment. Willingness to make every necessary sacrifice for
national security is widely proclaimed. The necessity for a greater
effort to meet school, highway, health, community development, and
other civilian needs is widely acknowledged. At the same time, the
demand for tax cuts mounts.
With the Federal Government collecting 70 percent of all tax dol
lars, inevitably Washington is the main target of the economy and
tax reduction drive. And, since war and defense related costs can
186
ECONOMIC GROWTH AND STABILITY
hardly be cut substantially, it is the one-fifth of all Federal expendi
tures spent for civilian services that is facing closest scrutiny. Above
all, the Federal grants-in-aid are now under attack.
All Federal, State, and local grants should be ended, the National
Association of Manufacturers says.8 The chamber of commerce, on
the other hand, favors Federal grants for highways, airports, market
ing research, and natural resource development, but would end all
those that help raise public service standards for individuals—‘public
assistance, child welfare, education, unemployment compensation
administration, and school lunches.9
Is Federal financial aid to the States and localities to help them per
form their functions a legitimate Federal function? Since the Civil
War, when the first State land-grant colleges were established with
Federal aid, the congressional majority has viewed that it is. On the
one hand, it is widely believed that Federal funds should be used to
assist poorer States and localities raise their standards of public
service to a reasonable minimum. Furthermore, Federal grants-in
aid—through the use of the matching principle—stimulate the recip
ient States and localities to undertake and, to add their own financial
support to, new forms of public service which Congress deems vital
to the national welfare.
The variation in the capacity of the people of the different States
to meet public service costs—like the variation between the localities
'within each State—is substantial.
In 1956, for example, per capita income in West Virginia and New
Mexico was only one-half of the income in Delaware, and in Mississippi
it was about one-third. These income variations are dramatically re
flected in public service standards. In the fall of 1956, Delaware re
ported an additional public school classroom need of only 1.2 percent
of its existing supply. In contrast, West Virginia’s need was 11.3 per
cent and Mississippi 37.6 percent.10 Furthermore, the selective-service disqualification rate—which largely reflects standards of education
and health—-was only 7.9 percent for Delaware in contrast to 13.1 per
cent for New Mexico, 14.3 percent for West Virginia, and 45.3 percent
for Mississippi.11
The varying degree of achievement by these States does not reflect
a lesser effort on the part of the poorer ones. On the contrary, whereas
Delaware was spending only 1.9 percent of the personal income of its
residents to support public schools in 1953-54, Mississippi was spend
ing 2.6 percent; West Virginia, 2.9 percent; and New Mexico, 3.1 percent.12
Because of our increasingly interdependent way of life, local and
State boundaries have lost much of their importance of an earlier day.
With millions of families now migrating annually across local and
State boundaries pursuing opportunity in an economy which now is
nationwide in scope, the adequacy of essential public services—both
in the communities from which they come and to which they go—is
now a nationwide concern. The establishment of minimum nation8 Testimony of Dr. Harley L. Lutz on behalf of the National Association of Manufacturers
before the House Subcommittee on Intergovernmental Relationships Between the Federal
Government and the States and Municipalities, July 31, 1957.
0 Federal Grants-In-Aid Programs, Chamber of Commerce of the United States.
10 U. S. Office of Education, Circular No. 4 90, January 1957.
11 Statistical Abstract of the United States, 1956, U. S. Department of Commerce.
12 National Education Association, Research Division Bulletin, August 1956.
ECONOMIC GROWTH AND STABILITY
187
wide education, health, and public welfare standards for all Americans
is not merely a national concern because we are a humane people; we
need them also to protect the standards of the communities into which
the new arrivals come. And we need them to strengthen our national
security as well.
In 1956, Federal grants financed about -9 percent of all State and
local functions. What lies ahead ?
There is no.doubt that many States can meet more of their own ex
panding revenue needs through a more adequate and equitable effort.
In addition, the States and their subdivisions can do much more to
increase the efficiency with which they now perform their functions.
Furthermore, as Congress periodically reviews the Federal grant
programs, changes in emphasis and in matching formulas doubtless will
occur. Nonetheless, it is the opinion of this writer that the role of
Federal grants inevitably will become larger, not smaller, in the years
ahead.
Not only will State and local needs grow, as will the Federal respon
sibility to help meet them, but State and local dependence upon the
superior taxing power of the Federal Government will also continue
to increase.
In 1956, the 500 largest industrial corporations in the United States
sold roughly one-half of the Nation’s manufacturing and mining
output, a total of about $175 billion. They earned nearly two-thirds
of all after-tax manufacturing and mining profits.13
Increasingly it becomes evident that only the Federal Government
has sufficient means to secure an adequate and equitable tax contri
bution from the powerful private industrial, commercial, and financial
enterprises which dominate the American economy today. Increas
ingly, the Federal Government—like the States in behalf of their
localities—must exercise its broader taxing power to collect revenue,
and then to share it on the basis of equitable formulas.
The attack on Federal grants-in-aid by the NAM and chamber o f J
commerce seldom charges that the purposes now served by these
grants are unworthy of public support. It is only alleged that the
States and localities are able to bear the cost. Yet, without doubt
those who seek to whittle away the Federal grants are fully aware
that this transfer of the cost would accomplish substantial tax savings
for wealthy corporations and individuals since the Federal tax struc
ture, despite its imperfection, is essentially based upon ability to pay
in contrast to the regressive character of State and local levies.
Furthermore, it cannot be doubted that many of the services now sup
ported by Federal grants in poorer States and localities would be
terminated because State and local revenue resources are insufficient
to sustain them.
Is the Federal fiscal dilemma of increased demands for civilian
expenditures and growing demands for a general tax reduction sus
ceptible to congressional accommodation? This writer believes that
it is. Is not the present an opportune time for the Congress to close
the unjustified tax loopholes and end the illegal evasions that could
bring a multi-billion-dollar addition to Federal revenues?
13 Fortune magazine, July 1957.
CENTRALIZED VERSUS DECENTRALIZED FINANCE
Harold M. Groves, professor of economics, University of Wisconsin
It is an accepted rule that the Government should not perform
functions that can as well be performed privately and that the
Federal Government should not perform functions that can as well
be performed by State and local governments. Unfortunately this
doesn’t help very much in making decisions as to whether functions
should be assumed by the Federal Government or left to the States.
P
r e s u m p t io n
F
a v o r in g
D
e c e n t r a l iz e d
F
in a n c e
The presumption in favor of State and local government is based
on the faith that decentralization is an important constituent of
democracy. This faith is particularly plausible insofar as it applies
the rule that matters which are solely or perhaps mainly of concern
to a particular area should be left to the people of that area for de
cision. This interest in local autonomy carries the title “Home'Rule”
and it is guarded as jealously (and as frequently violated) as the
similar right of the private individual to mind his own business when
it does not conflict with that of somebody else.
Beyond this interest in home rule there are values in local govern
ment that are lost when responsibilities are assumed by central gov
ernments. One of these is participation—government by the people.
The private citizen undoubtedly finds opportunities to participate in
government at the local level which cannot be duplicated at the na
tional level. At the city hall or State capitol any public-spirited
citizen can reach his alderman or legislator in person and he can ap
pear to express his views at a public hearing. An ordinary “dirt
farmer” can do all of this and get home in time to milk the cows.
It may be prohibitively expensive for him to go to Washington
and, anyway, he would need an elaborate organization to make much
impression there. Rated by degree of participation, most democratic
government is that by popular assembly or referendum where repre
sentatives can be dispensed with entirely. Next best is representative
government in a small enough circle so that the ordinary citizen
without undue sacrifice can make himself heard and felt.
Local government also offers to many an opportunity to partici
pate in government in positions of responsibility. There are thou
sands of people whose career as a representative of the people is and
will be confined to membership on the school boards of our some
65,000 school districts. This is not only of some value in itself—it is
a training school and a testing ground from which the upper eche
lons of government recruit talent.
Local governments also serve as experiment stations in which new
ideas may be tried out without the risk and expense (to say nothing
188
ECONOMIC GROWTH AND STABILITY
189
of the inertia) that would be involved if the experiments were na
tional in scale.
These positive values of local government are reinforced by the
negative aspects of far-flung centralized bureaucracy. Distrust of
such is deeply rooted among Americans, especially those who lean
toward san antimonopoly philosophy. Central government is not
only big; it is also single; it possesses unique coercive powers; and it
offers no alternatives to its customers. Like all large monopolistic
organizations it suffers the inefficiencies that rise from inadequate
knowledge at the center of what is really needed at the periphery.
O f course, it can be argued plausibly that some central sharing in
the financial support of local functions is quite different from Fed
eral assumption of sole responsibility and control in these areas. It
is argued that in communities with limited resources, grants-in-aid
may increase local independence by freeing some of their limited
funds for services of their own choosing. But this new freedom is
like that of a son who earns part of his support and gets the re
mainder in a regular (but not guaranteed) allowance from his be
nevolent parents. He is not really fully free and responsible until he
subsists on his own income supplied by himself.
T
he
C ase
for
C e n t r a l iz e d F
in a n c e
All of the above is widely appreciated in this country. But there
is another side of the picture that offers persuasive support for a
degree of centralized responsibility at least greater than that which
prevailed in the 1920’s.
Slow progress and undemocratic procedures in State government
The States and municipalities (particularly the former) would be
in a stronger position as candidates for more responsibilities if they
had (or would) put their own house in order. Following the Com
mission on Intergovernmental Relations one can list the areas that
need attention as follows:
1. There are antiquated representation systems that underrepresent
large and recently developed centers of population in one or both
legislative bodies. What becomes of the democratic principle when
a majority in the legislature can be elected by a quarter of the eligible
voters and when A ’s vote counts for 10 times as much as B’s? Some
of this might be defended on the dubious ground of area representa
tion ; most defense is the obvious rationalization of a special interest.
Some progress in reapportionment is being made continuously but it
is not enough to offset population changes now going on; thus on
balance the problem is a growing one. Some effort has been exerted
to devise machinery that can cope with vested interests in this area
but it has been successful in only a few States.
2. There are antiquated constitutions providing for weak executives,
too many elected officers, too infrequent legislative sessions and bud
gets, too limited financial powers.
3. There are still many cases of civil service infested with patronage
and with the inferior talent that must be expected at highly inade
quate salary scales.
4. There is the record of neglect in dealing with the metropolitan
problem regarded by many critics as the No. 1 domestic issue. This
97735— 57 ------ 14
190
ECONOMIC . GROWTH AND STABILITY
is the problem which has resulted from the recent vast movement of
population into some 168 metropolitan areas and out of their centers
to their peripheries. I f these areas had governments coterminus
with their functions they would still be hard pressed with such mat
ters as strangulating traffic, decadent sections, crowded schools, de
linquent gangs, and of course excessive tax rates. Usually added to
all this is an antiquated political geography with many units of gov
ernment, some of them poaching on their neighbors. One district may
have a factory and another the workers. These problems will not
yield except to great courage and imagination at the State level.
Not too much of this kind of leadership has developed.
Regressive taxation
The States and municipalities have on the whole a regressive tax
system based at the local level on the general property tax and at the
State level on the retail sales tax. The Musgrave studies1 have in
dicated that in State and local taxes the poorest bracket of taxpayers
($0 to $2,000 net income) pay almost half again as much per thousand
dollars of net income sis the well-to-do (over $10,000 net income).
Moreover, there is ground for the view that the trend is toward more
regressivity. Eleven States have enacted sales taxes since World
War II and no States have enacted new net income taxes. This means
that a vote for decentralizing the financial responsibility for a func
tion is a vote for regressive as against progressive taxation. This
is not a matter of equity alone; it also involves economics. It is
the progressiveness of the tax system that gives it much of its builtin flexibility—its propensity to produce automatic surpluses and de
ficits to meet the needs of compensatory budgeting.
Those who favor decentralization should logically be in the front
rank of the crusaders for better and more aggressive State and local
government. Actually this is often not the case and it leads to the
•conclusion that these people are probably more interested in less
government, less total taxes, and less taxes for themselves than in
decentralization as such.
Interstate competition
The States and municipalities are in a relatively weak financial
position because they are amenable to interterritorial competition to
a far greater degree than the Federal Government.
The proposition that Federal aid involves only the collection of
revenue that might have been raised locally, the sending of this rev
enue to a distant capital, from whence it is returned with some part
missing, is at most a half-truth. The full truth would add that if
the central government (for better or for worse) did not support this
function and raise the tax for it, the function probably would not
be supported at all and the tax for it would not be raised. The com
petitive factor, among others, also provides a rationale for distributing
aid to strong districts as well as weak ones.
The degree to which taxation influences industrial location and the
degree to which competition influences State and local decisions con
cerning taxation are matters long in dispute. It is evident that State
1
Richard A. Musgrave, Incidence of the Tax Structure and Its Effects on Consumption,
Federal Tax Policy for Economic Growth and Stability, Joint Committee on the Economic
Report, 84th Cong., 1st sess., 1955, pp. 9 6 -1 1 3 .
“ECONOMIC GROWTH AND STABILITY
191
and local governments are not completely captive and that the deduc
tibility o f State and local taxes on Federal income-tax returns gives
them some protection. State and local government under the pressure
of earlier public works postponement and increased population have
been expanding their outlays for public services with some aggressive
ness. It is true also that no empirical study has ever established the
alleged fact that areas with high taxes or relatively progressive tax
systems have suffered in industrial development. But anyone who
observes legislative bodies cannot doubt that the pressure is real and
important. It is nonetheless real because a lot of it is mainly fear
psychology.
The degree of interterritorial competition is probably increasing.
A perusal of newspapers and magazines indicates that the “booster
spirit” is everywhere going strong. It takes the form of advertising,
developmental corporations, subsidies, tax exemption, and a “ favorable
tax climate.” Concerning the latter one former director of a State
division of industrial development observed: 2
In an era of industrial mobility, no State can stand alone in
its adherence to a tax structure strongly oriented to the “ abil
ity to pay” theory. Continued adherence to this theory, in
the face of defections by contiguous or “ competitive States”
will have the certain long-range effect of decreasing the rate
of personal-income growth and denying improved employ
ment opportunity to the very persons supposedly benefited by
the application of this theory.
Interdependence
The trend of the times is toward more interdependence. This thesis
can be supported by the impressive evidence concerning migration,
travel, and interterritorial exchange of all sorts. This interdepend
ence means that the people of Podunk, N". Y., have some equity m the
maintenance of public standards in Podunk, N. Mex., and vice versa.
It is characteristic of the satisfaction of human wants through govern
ment that the benefits derived from government outlay are largely
indirect and frequently extraterritorial.
The growth of interdependence is particularly relevant with regard
to education. Educational standards may seem at first to be of concern
mainly to pupils and parents or at most the citizens of the community
in which the youth are reared. But what becomes of this conclusion
when we confront the statistics of migration and observe how many
now being educated in one community turn up eventually as workers
and citizens of another ?
Interdependence means that the interest in many matters formerly
of strictly local concern is now a divided one. The degree of interest
fo r parties involved is difficult to discern and to implement. Our
Federal aid system is one means by which a partnership of interest is
combined with a partnership of financial responsibility and control.
The control issue is the most sensitive one; the Kestnbaum Commission
surveyed this area with great care and although it recommended some
changes in detail, it is fair to say that on the whole it found the con
trols conservative and salutary. They have encouraged such State
2 Robert D. Siff, Some Pertinent Points on Industrial Development Policies, Tax Policy,
Tax Institute, Princeton, vol. X X I V , Nos. 2 -3 , 1957, p. 11.
192
ECONOMIC GROWTH AND STABILITY
improvements as merit-system civil service and State highway depart
ments.
The general level of public expenditures
It is apparent that one’s reaction to the question of Federal versus
State financial responsibilities is conditioned considerably by his reac
tion. to puhfe expenditures as such. I f he thinks they are too high he
will probably favor decentralization. The States and municipalities
for reasons previously cited will not spend as freely as does the Federal
Government with its far superior taxing power. The proper level o f
overall public expenditures is the subject for other panels. Here it
may be said that proponents of liberal government spending have
these points on their side:
As the economy advances and per capita income increases, free
income (above biological necessities) increases still faster. This free
income is subject to a degree of discretion not true of the hard core o f
necessities. It is everywhere devoted in large measure to services
where the Government competes with private disposition most effec
tively. Some of the ugliest aspects of the American way of life, such
as slums, crowded schools, youth delinquency, and mental illness are
in the area where government programs are most effective. The
wastes of government are regrettable but they probably are minor
compared with those of private consumption which in the United States
are legendary. The typical American consumer thinks nothing of
driving a station wagon across town to mail a letter. Governments
are sometimes extravagant but they also frequently are niggardly.
The case I know best is the Internal Revenue Service which in the
opinion of many critics has always been substantially undermanned.
Under present conditions the belief that the acceleration of private
expenditures as against government expenditures necessarily results
in the healthiest society is not tenable.
C e n t r a l iz a t io n
and
E c o n o m ic C o n t r o l
One would be insensitive to the wave of the present if he did not
attempt to relate our problem to that of controlling inflation. For
the maintenance of at least the present Federal role in the overall
expenditure picture it can be said, looking at the long rua, that
Federal expenditures and taxes are more amenable to control than
those of the States; that the government’s large role in the economy
is what makes compensatory controls effective and that this role
would diminish if the Federal Government relinquished a large area
to the States; that it is the predominantly progressive overall tax
system that affords built-in flexibility and that this is maintained only
by the Federal Government’s role. On the other hand controllability
is no good if it isn’t used; this seems to indicate a reduction in Federal
expenditures now that inflation is our gravest problem; if the States do
not take up the slack, so much the better. Those who cherish Federal
expenditures for their nonfiscal or institutional objectives have the
obligation to offer some remedy for inflation other than reduced
public expenditures.
O f course, what would really now aid the States would be an
acceleration of economic growth, an end to inflation, a loosening of
tight money (which interferes with their borrowing), and a con
ECONOMIC GROWTH AND STABILITY
193
tinuance of Federal spending at least insofar as it supports the States.
This program sounds a little like the politician’s platform of a soldiers*
bonus, reduced taxes, and a balanced budget. But we have not ex
hausted the field when we have accepted a high level of public expendi
tures and rejected tighter money as remedies for inflation. Simplest
but not the most popular remedy is to plug loopholes in existing taxes
and thus add to the Federal budget surplus. Obviously cutting taxes
and letting expenditures ride is a perverse answer. Perhaps we should
look for something new as an inflation control; for example, decel
erated depreciation, a tax on bank loans, and a sales tax on industrial
equipment have been suggested. A graduated overall expenditure
tax to supplement the income tax would be a promising instrument
o f control if it could be administered.
On the other hand, if as alleged and as seems probable, our present
inflation problem is due in large part to cost-push causes; that is,
to monopolistic pressure (business and labor) upon the price level,
then we surely have to look for something new in inflation controls.
The nearest thing to a fertile suggestion that has so far come to our
attention is that of Sumner Slichter to disallow wage increases (for
a time) as corporate income-tax deductions. Alternatively we might
levy a special payroll excise tax in much the same way and to the
same effect. These proposals involve the administrative problem of
separating wage increases from payroll additions due to expansion;
and they throw all the onus of monopolistic pricing on labor, it
would be more logical to levy a special sales tax on the receipts from
price increases; but in only a few cases are commodities sufficiently
standardized to separate genuine price increases from changes due
to innovation in product. To all of these possibilities the objection
will be made that they constitute government tampering with the
free market. But here the ready answer is that it is the absence of a
free market that creates our problem to begin with.
At any rate it seems inadvisable to reorder our intergovernmental
fiscal relations as a remedy for inflation. That some Federal expendi
tures can and should be cut is conceded, but most of them (from our
point of view) are inelastic in the downward direction. And in some
areas expenditures should be increased.
This is not to say that nothing should be done about inflation. The
author will not attempt here to arbitrate among the several suggestions
listed above, but he does wish to leave the thought that the time is ripe
for the exercise of some further ingenuity with regard to the inflation
problem.
Q u a n t i t a t i v e P ic t u r e o r F e d e r a l - S t a t e F in a n c e
We may turn now before drawing a conclusion to the quantitative
picture and ask what it shows regarding the alleged encroachment of
the Federal Government on the States. Over the long view, the relative
position of State and local governments in total expenditures has
undoubtedly dropped sharply. In 1927 State and local expenditures
were nearly three-quarters of the total (73.1 percent); in 1940 they
were still more than half (52.8 percent); and in 1956 a little more
than one-third (33.6 percent). The 1956 proportion is the same as
that of 1948, indicating no postwar trend. Much of the recent alleged
194
ECONOMIC GROWTH AND STABILITY
aggrandizement of the Federal Government has been for military
items; if they are abstracted from the picture, Federal, State, and local
outlays are not far from equal. This was also true during the late
1930’s when the military proportion of the Federal budget was much
less. As to Federal aid, since 1940 it has increased more rapidly than
State and local expenditure but less rapidly than total expenditure.
Over the longer pull, however (comparing the present Federal posi
tion with that of the late twenties), the Federal role by any standard
has increased quite substantially. The expansion occurred during the
thirties and included, of course, the important area of social security.
Comparing the United States with other countries as to centraliza
tion one finds such data as the following (the figures indicate the
ratio of local taxes to total taxes 1947-53) : 3
United Kingdom_________________
F rance___________________________
Germany_________________________
Sweden___________________________
8 Ita ly _____________________________ IS
13 Switzerland_______________________ 51
14 Canada___________________________ 2®.
25
In conclusion and to indicate a personal position on our problem, the
author finds himself in general agreement (as to the matters discussed
in this paper) with the K estnbaum Commission’s report which may^
be summarized as followsT'The Federal system on the whole was
found to be m healthy conditma ; J&aJEaliies. QlTo^-aut(mQinx.Are
m fl'and important and always need stressing: these values may be
particular areas changing with time; it behooves the States deploring
finding p k n ty o f scope for sucTvTsion,
energy and ingenuity a,s,they^are ablfi-ta summon. The ^Federal sys
tem in thi8._comitry has preserved a. degree „of local autonomy unsur
passed at least by that of any of the world’s great powers.
The pragmatic and sensible ’ solution of Federal problems is not
likely to lie in loyalty to any slogan but in the balanced weighing o f
values in the case of each new issue as it arises.
8 Economic Commission for Europe (Research and Planning D ivision), Changes in theStructure of Taxation in Europe, Economic Bulletin for Europe, vol. II , No. 3, Geneva,
1951, p. 59 ; Canadian T ax Foundation, The National Finances, 1 9 5 4 -5 5 , Toronto, p. 10.
EXPENDITURE POLICY FOR ECONOMIC GROWTH AND
STABILITY IN A FEDERAL SETTING
Werner Hochwald, Chairman, Department of Economics,
Washington University
This paper will present a brief summary of considerations which
may influence the impact of government expenditures on economic
growth and stability in a Federal setting. For this purpose the paper
will (1) categorize the general impact of government expenditures,
(2) indicate the extent to which impacts may depend on the level of
government at which public functions are performed, and (3) the
influence of grants-in-aid on these impacts.
I m pact
or
G o v e r n m e n t E x p e n d it u r e s
Government expenditures will increase national income as govern
ment employees are paid and government contracts are let. The im
pact of these expenditures on aggregate economic growth and stability
will depend on (1) the expenditure patterns of government income
recipients (multiplier effects), (2) the expenditures private individuals
and groups forgo because of government activities (substitution
effects), (3) the total resources available to the community and their
relations to the aggregate expenditures made by all sectors of the
economy (price effects).
Multiplier effects
Government employees and contractors will spend at least part of
their income for their own consumption and investment needs. These
expenditures in turn will stimulate another round of consumption and
investment on the part of new income recipients, leading to an endless
chain of income creating new income through the spending cycle.
These multiplier effects of government expenditures, as they influence
aggregate employment and economic growth, have been discussed fre
quently in the literature of the last generation and form the basis
of government efforts to influence overall economic activity through
fiscal policy.
Multiplier effects of government expenditures may also contribute
to economic stability as they are timed to counterbalance shifts in the
expenditures of private groups. Such timing is difficult, however, and
may present serious limitations to the effectiveness of fiscal policy.
Substitution effects
Only rarely will government expenditures be a net addition to all
expenditures made by private groups. It is more likely that some
private spending will be replaced by public expenditures as services
provided by government take the place of private consumption or in
vestment. Illustrations are readily provided by public education and
free highways, by public power projects and municipal airports.
195
196
ECONOMIC GROWTH AND STABILITY
Private expenditures may also be adversely affected whenever erratic
public spending undermines confidence in the future stability of the
economy or raises doubts about the future place of the private business
sector in the economy. Any such substitution effects will counteract
the multiplier effects discussed above.
Beyond the mere size of private and public expenditures, however,
there is a more subtle issue involved here. Where economic growth
is measured in real rather than monetary terms, interest is focused
on the efficiency of resource allocation, whether the spending is done
by private or public bodies. As long as government expenditures
merely add to private spending, the issue of relative efficiency does
not arise, as it can be argued that any employment of otherwise idle
resources is more efficient than unemployment. As government takes
the place of private enterprise, however, it becomes necessary to evalu
ate these substitution effects, in ,regard to their, aggregate size as well
as to their impact on the efficiency of resource use.
Price effects
Multiplier and substitution effects thus far have been discussed with
the implicit assumption that no changes have taken place in the total
money supply: Government expenditures have been financed through
taxes or borrowing of existing funds. Where these taxes have been
raised from taxpayers who would have spent the funds if they would
have not been taxed, substitution of public for private spending is
obvious. Where the taxes are paid from funds which otherwise would
have been saved, some net addition to total spending is possible.
Governments are not limited to the spending of tax revenue. They
may borrow, either from existing funds or newly created bank credit.
Where the total money supply is expanded by government debt, gov
ernment expenditures may still proceed without overall price effects
as long as spending is matched by the more efficient employment of
resources. Where spending outruns real resource availability and
use, however, the impact of government expenditures will be partly
on prices rather than employment. Their impact on economic stability
and growth will then be impaired by the forces of inflation. Though
government expenditures will still increase money income, a growing
part of this increase will now be accounted for by purely monetary
gains without a corresponding growth in the output of real goods and
services.
L
evel
o r G overnm ent
at
W
h ic h
P
u b l ic
F
u n c t io n s
A
re
P erform ed
The above discussion applies to all levels of government. The po
litical process of decision making, the fiscal capacity of government
units, the legal authority of debt creation, the skill of tax and debt
administration, all differ on various levels of government, however.
It will be instructive, therefore, to review the impact of government
expenditures with specific reference to the level at which public func
tions are performed. This survey will again proceed in the order
followed above, reviewing in turn (1) multiplier effects, (2) substitu
tion effects, and (3) price effects.
Multiflier effects
Government employees and contractors are likely to spend their in
come regardless of the specific government unit from which they re
ECONOMIC GROWTH AND STABILITY
197
ceive their funds. Consumption multiplier effects are therefore the
same whether teachers are paid by Federal, State, or local govern
ments. Neither would it appear to matter whether old-age benefici
aries receive their checks from Federal or local authorities. Invest
ment multipliers are more readily affected by shifts in the government
spending unit as actual or potential government contractors may be
expected to “buy at home” and therefore be influenced by the geo
graphic jurisdiction of the public agencies with which they deal.
The stability of government expenditures and their multiplier ef
fects also may be subject to increasing limitations as the level of
overnment descends. The smaller the government unit, the more it
ecomes the follower rather than the leader of its economic environ
ment, subject to the general fortunes of the economic base on which its
fiscal capacity and its spending powertlepend.
f
Substitution effects
Many substitution effects are again likely to occur regardless of the
specific level of government at which the public function is performed.
There are some reasons, however, why substitution effects may be
larger at the lower level. To the extent that the fiscal capacity of
smaller government units is limited, expenditures may absorb a larger
share of local purchasing power, thus increasing the substitution of
public for private spending. Also, taxpayers may find it easier to
evade the local tax burden Dy shifting to other areas; it is this con
sideration of competitive disadvantages for local business and the
resultant substitution effects of higher taxes which often limits the
willingness of local governments to spend.
Difficult as it is to assess the aggregate size of substitution effects,
it is even more hazardous to estimate the relative efficiency of govern
ment at different levels. As local government is closer to the people
it is designed to serve, efficiency of resource use and responsiveness to
shifting needs may be better safeguarded. On the other hand, the
inefficiencies-of local patronage have been notorious at times. Few
general observations appear possible, therefore, on the more subtle
aspects of resource use efficiency on different levels of government.
Price effects
Only the Federal Government has the power to create new money.
The price effects of government expenditures are greatly influenced,
therefore, by the level of government which finances these expendi
tures. Local and State governments can borrow, yet their access to
the money market is subject to the same restraints which characterize
the borrowing activities of private groups. The inflationary poten
tial of government expenditures is, therefore, much more limited at
levels below the Central Government which combines the fiscal and
monetary powers of sovereignty.
It is this very limitation which has been the strength and weakness
o f lower level government expenditures. The need for local govemL
ment to compete in the money market with private claimants for
funds may assure more careful appraisal of government projects and
thus lead to a more efficient resource allocation among private and
public uses. On the other hand, local government units are much
less equipped to “lean against the wind” and thus may accentuate
rather than balance fluctuations in aggregate employment and income.
198
ECONOMIC GROWTH AND STABILITY
I n f l u e n c e o f G r a n t s - i n - A id
Grants-in-aid are a device of intergovernmental relations designed
to combine the fiscal advantages of each government level. The
greater fiscal capacity of the National Government is called upon to
finance expenditures of lower authorities whose more limited juris
diction is thought to assure greater efficiency and responsiveness to
local needs. The following observations will briefly indicate how
such a complex Federal setting of intergovernmental fiscal relations
may change the impact of government expenditures on economic
stability and growth. Here, again, it will be convenient to retain the
distinction among (1) multiplier effects, (2) substitution effects, and
(3) price effects.
Multiplier effects
As stated before, government income recipients are not likely to.be
influenced by the source from which they receive the funds. There
are several ways, however, through which grants-in-aid could change
these multiplier effects. First, matching grants may induce the re
ceiving government unit to spend more on its own in order to maxi
mize the fiscal benefits received from the grant; such a reshuffling of
State and city budgets is often the very purpose of matching grants
and thus leads to intergovernmental multipliers. Second, grants-inaid may be designed to redistribute income among geographic regions
and areas; to the extent that such redistribution of income from wellto-do to poor areas is accomplished, the consumption multiplier will
t>e increased.
It thus would appear that the multiplier effects of grants-in-aid
depend on the way the grant is administered. Matching grants offer
an incentive toward intergovernment multipliers yet limit the regional
redistribution of income; grants defined by local performance stand
ards rather than financial participation emphasize the regional redis
tribution of income throughout the jurisdiction of the grantor gov
ernment.
Substitution effects
Grants-in-aid minimize the substitution effects of tax inequalities
as they tend to equalize income as well as the tax burden among all
units participating in the grants. This again holds particularly for
grants requiring no financial participation of the grantee government
though to a minor extent it also holds for matching grants. While
grants-in-aid thus limit the competitive impact of Government ex
penditures among geographic areas, they may increase substitution
among resources as the larger expenditures of local governments for
goods and services bid resources away from private employment.
This latter impact is minimized if grants-in-aid are used for transfer
payments to final consumers, such as old-age assistance or educational
benefits.
The appraisal of grants-in-aid and their impact on the efficiency
o f resource allocation presents again the difficulties encountered in any
appraisal of government efficiency. Grants-in-aid wish to combine
the fiscal efficiency of big government with the citizen participation
that local government on the grassroots level appears to preserve. Yet
fiscal efficiency presents some dangers. The pain of additional State
ECONOMIC GROWTH AND STABILITY
199
local taxes may serve as a helpful yardstick to sharpen the critical
appraisal of services demanded by local constituents, an appraisal
dulled by easy access to financial support from governments of higher
jurisdiction. In fields with a strong and clearly identified national
interest, local governments can best serve their citizens by drawing on
the superior fiscal powers of the Central Government. Yet such
reliance on outside support should not impair the discipline associated
with the discomfort of higher taxes.
Price effects
To the extent that grants-in-aid rely on the fiscal and monetary
authority of the National Government, they are likely to have the same
price effects direct Federal expenditures would have. The greater
reserves available to the Federal Government for raising funds
increase their potential contribution to economic growth as well as to
price inflation. This apparent ease of Federal financial support—
based on broader geographic jurisdiction, more efficient tax and debt
administration, freedom from the fear of industrial migration and tax
evasion, ready access to the money market—offers almost irresistible
temptation of increased reliance on grants-in-aid as a convenient way
out of the financial wilderness of State-local finance.
Yet the easy way may not always be the safest way to economic
grqwth and stability. In the twin national emergencies of the great
depression and the World War, there was no choice but to turn to the
National Government for increasing support on all levels. As the
rapid growth and relative stability of the postwar decade have greatly
strengthened the national economy, State and local governments have
been endowed with increased fiscal capacity to exercise more freedom
of choice in deciding how to finance the costly public services their
electorates are demanding. Full participation on all levels of govern
ment, not only in spending funds, but also in raising the revenue
needed for these expenditures, appears the best assurance for a national
resource allocation to further economic stability and growth.
ADJUSTMENT OF GOVERNMENTAL RESPONSIBILITIES
V IA GRANTS
James A. Maxwell, professor of economics, Clark University
T he
C a s e f o e F e d e r a l is m
When our Federal system was set up nearly 160 years ago, lines were
drawn that set limits to the powers of the National Government, and
reserved certain powers to the States by constitutional provision. The
lines drawn were not, indeed, clear cut, and they are even more blurred
today. But the demarcation was and is of great significance.
The importance of the federal form of government to the United
States is not less now than then. The very growth in the duties and
complexities of government may make it more important. Some gov
ernmental decisions must be Federal, but there are many governmen
tal services affecting the diverse life of the people about which uni
form regulation and administration from a central source would be
mischievous as well as impracticable. Centralized decision would be
irresponsive to the variety of State and local needs.
The case for federalism—for decentralized decisions and adminis
tration—rests on more than an appeal to efficiency. This is a dynamic
nation; the appropriate way to handle governmental functions does
not stay put. In such circumstances, State and local governments
provide limited laboratories for experimentation in administration.
Even more important is the fact that the State and local governments
are bulwarks of democracy. Only where the people of a nation have
adequate powers of decision can they develop a public spirit and the
specific knowledge and techniques that give life to free institutions.
A strong belief in federalism should not, however, be regarded as
synonymous with an extreme belief in States rights. States rights
can be defined so as to have genuine meaning, but this meaning should
not be twisted to block adjustments in the relative responsibilities of
Federal and State-local government. In the modern world changes
must be made, and rigid resistance to change can be injurious to the
success of federalism.
At present, with respect to economic policy, no area exists from
which Congress and the States are barred by lack of constitutional
power.1 According to the Commission on Intergovernmental Rela
tions, “ the crucial questions now are questions of policy: whicliTevel
o u g lilo move? Or should both? 'O^r neither? What'are the pru
dent and proper divisions of labor"^a£~d re^onsibility between them ?
These are questions mainly for legislative judgment, and the criteria
are cliefly political, economic, ana administrative, rather than legal.
The enphasis is on mutual and complementary unclertajEinga. ia Jfurm 1 The Commission on Intergovernmental Relations, A Report to
T ransm ltta to the Congress (W ashington : June 1 9 5 5 ), p. 32.
200
the President fo r
ECONOMIC GROWTH AND STABILITY
201
therance of common aims.’ ’ 2 The Commission goes on to say that a
realisticprogramto prevent overcentralization will depend not merely
on Federal restraint, but “ on the readiness and ability of the States
and their subdivisions to assume their full share of the total task of
government.” 3
S
t a t is t ic a l
B
ackground
Table 1 shows public expenditures as a ratio of net national product
(gross national product minus capital consumption allowances) for
various nonwar years 1890-1955. For all levels of government, it was
8-11 percent of NNP 1890-1929. The figure jumped to 20 percent
during the 1930’s first because of a fall in NNP (the denominator) and
later because o f a sharp rise in government spending (the numerator).
At present, because of carry-over costs of World War II and the con
tinuance of international tensions, government takes 29 percent of
NNP.
War-related versus civilian expenditures
I f the total government expenditure is split into two broad cate
gories (a) that for war-related purposes and (Z>) that for civilian pur
poses, the significance of the former in the postwar period is apparent.
From being 3 percent of NNP in 1940, it rose to 14 percent in 1955;
government expenditures for civilian purposes, on the other hand,
declined from 17 percent to 15 percent.
Another piece of factual background is brought out by table 2. It
shows that the structure of governmental expenditure for civilian
purposes has changed notably in one respect between 1940 and 1955;
welfare expenditures grew relatively, as well as absolutely. They were
52 percent of the total in 1940 and 59 percent in 1955. The other main
category of civilian expenditure, economic development, has relatively
held its own.
Federal, State, local shares
I f next, expenditure is allocated among the three levels of govern
ment—Federal, State and local—it is not surprising to find that respon
sibility for the relative increase in government spending has been Fed
eral. Table 3 shows that, for many years before the 1930’s, Federal
expenditures in peacetime were 25-35 percent of total government
expenditure. In the depression of the 1930’s, the Federal share jumped
(to 50 percent), while that of the localities dropped (from 57 percent
in 1929 to 31 percent in 1940). By 1955, the Federal share had risen
to 62 percent and the local had fallen to 21 percent. The State share
throughout was quite stable, being 18 percent of the total in 1929 and
17 percent in 1955.
If, finally, the classification of expenditure by levels of government
is joined with the classification of war-related versus civilian, the fact
emerges that postwar the State and local governments, and especially
a Ibid., p. 33.
3 President Eisenhower repeated this thought in his speech to the Conference o f State
G o v e rn o rs on J u n e 14, 1957. He s a id : “ But, like nature, people and their governments
a re intolerant o f va cu u m s. Every State failure to meet a pressing public need has created
th e o p p o rtu n ity , - d evelop ed , the excu se, and fed th e temptation for the National Govern
m en t t o p o a ch on th e S ta te s ’ preserves. Tear by year, responding to transient popular
d em an d, th e C on gress ha s in creased Federal functions. Slowly a t first, but in recent times
m ore a n d m ore ra p id ly , th e p en d u lu m o f power has swung from our States to the Central
G ov ern m en t.'1'
202
ECONOMIC GROWTH AND STABILITY
the formerrhave expanded their civilian expenditures faster than has
the Federal Government. As table 4 shows, in 1955 the Federal share
was 29 percent; in 1940 it was 42 percent. The decline affected about
equally the two major categories of social welfare and economic devel
opment. This postwar behavior of Federal civilian expenditure is
explicable by the expansion of its war-related expenditures. What if
this latter could safely be reduced ? Reduction in Federal taxes would
be one consequence, but part of this reduction would probably be offset
by an increase in State-local taxes. Moreover, a more rapid growth
of Federal civilian spending might be expected.
In the intergovernmental statistics given above, expenditures have
been charged against the level of government providing the money,
even when this money has been turned over to another government in
the form of grants. For example, over one-half the payments to
recipients of old-age assistance is provided by Federal grants; the
Federal Government is the source of the funds which go to State and
local governments as reimbursement of expenditures already made
by them.
Table 5 shows that, while Federal grants postwar have grown
rapidly in absolute amount, the growth has not been as fast as Statelocal expenditure. Federal grants go predominantly for social wel
fare with economic development a poor second. (See table 6.) In
the next decade, however, economic development may gain ground
because of the increase in grants provided by the Highway Act of
1956, and because social insurance payments, which are not financed
via grants, will grow over expenditure for public assistance.
F ederal G rants
Grants are the chief device by which governments cooperate in
handling a function, and opinion about them has been divided. Those
critics who believe in a precise separation of governmental functions,
with assignment of complete responsibility to a level, argue that
cooperative action is relatively ineffective, leading to friction and
fumbling in administration. They are, furthermore, critical of the
process by which grants are selected. Congress makes the decision,
often guided by pressure groups which aim at bypassing the State
governments. Grants may, therefore, take the Federal Government
into functions which historically and constitutionally belong to the
States; they may bring centralization. The government which holds
the purse strings will, it is asserted, control the activity. Still another
criticism is that grants bring about a redistribution of income among
the States, so that income is taken from a rich State and transferred
to a poor one. At very best this process means a waste of crosshauling
as revenue is pulled in to Washington and then distributed to the
States.
. The proponents of Federal aid present counterconsiderations of
some persuasiveness. But in the literature dealing with Federal
grants, an interesting aspect is that whereas opposition to grants is
usually expressed in general terms, proponents tend to stress the
merits of particular grants rather than of a system of grants. For
example, the opponent of Federal grants to education will stress argu
ments relevant chiefly to this type of grant.
ECONOMIC GROWTH AND STABILITY
203
Separation of functions
For the purposes of this paper only general arguments are rele
vant, and here the most sweeping one relates to separation of gov
ernmental functions and therefore of responsibility. The desirability
of clear-cut divisions and unified decisions would be beyond dispute
if governmental functions could be neatly divided and as neatly
maintained. But no precise division has ever commanded widespread
agreement. It is of the nature of a Federal Nation like the United
States to be heterogeneous in economic interests, traditions, and social
outlook. A division which means overcentralization to one area may
mean decentralization to another.
The pages of the Report of the Commission on Intergovernmental
Relations (the Kestnbaum Commission), and of the reports of its;
study committees, offer convenient confirmation of these generaliza
tions. States such as Kansas and Oklahoma regard the Federal soilconservation program as a national responsibility which should be
State and Federal. (See Kestnbaum report, pp. 159, 164—66.) A
State like New York stresses the national importance of public hous
ing, slum clearance, and urban renewal, while a State like North
Carolina takes a very different view. Similar contrasts can be found
in the attitude toward development of water resources: Oregon versus
New Jersey; forest-fire control: New York versus Washington; for
est planting: Massachusetts versus California; stream pollution:
Connecticut versus North Dakota; natural disaster relief: Maine ver
sus Texas. In short, no manifest line can be drawn between a policy
which puts into Federal hands a power to make decisions which might
be irresponsive to the variety of geographic needs, and a policy which
puts in the hands of the States important responsibilities which they
cannot meet. Even if, at any point of time, such a line were visible, it
would inevitably get out of date. And flexible adjustment of func
tions to accord with a changing environment is not easy, since it is
of the essence of federalism to guard against frequent constitutional
change.
In circumstances of this sort, the device of grants may serve to
link the interests of the States and of the Federal Government. A
governmental function, vocation rehabilitation, which is primarily a
responsibility of State and local governments, may also be a matter of
national concern. To shift the function to the Federal level would
certainly be difficult and might be undesirable; to leave it as wholly a
State-local responsibility would be to neglect a national need. These
unsatisfactory alternatives can be avoided if the Federal Government
offers grants to stimulate State-local performance, to carry part of the
cost of the function, and to establish standards of performance at a
level appropriate to the national interest. Such a step may increase
the Federal power; it may bring some centralization, depending on
the scope and stringency of the Federal conditions. But the history
of .grants offers no instance in which a grant, has .been a prelude to
Fecleiial assumption o f control; it cloes .offer instances of ^rantrv*nich
have foutlived ^ tF^sefulness and of others which have not Been
iilapLeJto newsituation s.
Redistributive effects
The criticism that grants redistribute income among the States is
correct. I f per capita income is taken as a measure of the richness
204
ECONOMIC GROWTH AND STABILITY
or poverty of a State, rich States at present receive relatively small
grants, and poor States relatively large ones. (See table 7.) A rank
correlation of per capita grants and income by States for the fiscal
year 1953 gives a value of minus 0.59. This modest negative correla
tion for grants as a whole conceals the fact that some grants, most
notably those for health services and public assistance, are-much more
equalizing. Those for employment security, on the other hand, show
a positive correlation, i. e., larger relative grants to the richer than
to the poorer States.
Equalization by means of distribution of grants is, however, only
part of the process of interstate redistribution of governmental income.
In addition, the Federal revenue from which grants are provided
drains relatively more from the richer States. With one exception
(grants for employment security administration which come from pay
roll taxes) the money distributed as grants comes from general reve
nues. It is, therefore, reasonable to assume that the incidence of the
revenue spent as grants is the same as that of aggregate tax collec
tions. The incidence of Federal taxes per capita in fiscal 1952 ranged
from $112 for Mississippi to $1,015 for Delaware. Rank correlation
of these figures with per capita income payments for the fiscal year
1953 gives the high value o f +0.93. A visual indication of the dual
process is given by the accompanying charts, the line with the positive
slope showing the progressive incidence of Federal taxes by States,
and the line with the negative slope the regressive incidence of Federal
grant expenditures. Congress, in framing the formulas for allocation
of Federal grants should bear in mind the redistribution which comes
from raising the revenue to be spent as, grants, as well as that from
the formulas.
Equalization, carried too far, would have unfortunate effects on
resource allocation. If, for example, Government welfare services
are provided to employables at generous levels, and through equaliz
ing grants, incentive to labor mobility would be reduced. Equalizing
grants for development purposes might also create misallocation of
resources. On the other hand, equalizing grants when spent on welfare
services for unemployables would not likely impair resource alloca
tion, since mobility of persons not in the labor market should be
discouraged rather than stimulated.
The practical likelihood that Congress will overdo equalizing grants
seems not to be great. Yariable-ratio formulas, providing poor States
with a higher, and rich States with a lower percentage reimbursement
of expenditure, bring objection from the rich States. The logical
proposal that, for established welfare functions, the Federal Govern
ment should give no grants to rich States, confining itself to variableratio grants to poor States, has not appealed to Congress or to the
rich States. And yet such a scheme would require a much smaller
Federal expenditure, and it would relieve the rich States entirely
from the onus of Federal conditions.
It should also be remembered that, while equalization grant for
mulas and a progressive Federal tax system redistribute income so as
to favor the poor States, the process is less powerful than if the
Federal Government, as an alternative, took over the whole activity.
Some part of the cost of provision of a welfare expenditure, such as
old-age assistance, is shifted at present via Federal grants from tax
payers in poorer States to those in richer. But entire Federal respon
ECONOMIC GROWTH AND STABILITY
205
sibility for old-age assistance could be expected to redistribute costs
even more from poorer to richer States.
A final criticism of grants will be discussed, not because of its
weight, but because of its recurrence in popular discussion. It is that
collection of revenue by the Federal Government, and its subsequent
disbursement as grants, merely reallocates resources already under
the jurisdiction of State and local governments and available to them
for taxation. As has been indicated just above, such a statement slurs
over the important fact that, in the process, there is a redistribution of
resources so that some States get more and some less. But even if
collections and grants balanced State by State—even if the process
paralleled that of federally collected State-disbursed taxes—the de
scription would be inaccurate. Federal collection of most revenues
is more efficient and equitable than State-local collection; a given
revenue can be raised with less real cost by the Federal Government
than by State-local governments.
The gist of this discussion is that two basic difficulties stand in the
way of designation of functions as wholly Federal and wholly Statelocal. The first is that governmental interest in most functions is not
divisible into these two segments, and, as a result, responsibility can
not easily be so divided. For some functions, indeed, the division is
easy. To provide security against external aggression is a task for the
National Government; to provide internal security is a task for the
State and local governments. But the current debate concerning re
sponsibility for civil defense, and the existence of the FBI, impair
somewhat even these generalizations. The second difficulty is that the
ability of the Federal Government on the one hand, and of the Statelocal governments on the other, to collect revenue and to handle ex
penditure, is disparate. The State-local governments can handle a
great many functions more effectively than can the Federal Govern
ment. The Federal Government, however, can handle collection of
most revenues more effectively than can State-local governments. Ex
cept in time of war, the tendency is for State and local governments
as a whole to have a plethora of duties in relation to the revenues at
their effective disposal. The case of the Federal Government tends to
be the other way around. Both of these difficulties stimulate use of
grants.
D efects of F ederal G ran ts
The favorable appraisal of grants presented above should not be
allowed to obscure the fact that Federal grants, as now utilized, have
important defects. Their development has been piecemeal and hap
hazard, so that no system of grants exists. Over the years Congress,
responding to pressures, has provided conditional grants, thereby
stimulating State and local governments to spend more than they
otherwise would for specific purposes. And once in operation, grant
programs live on, even though the original national purposes behind
them have been achieved. In such cases, grants serve only the fiscal
purpose of lightening the load on State-local budgets. Even when
grants continue to achieve national objectives, they may need revision
concerning method of apportionment, conditions, and administrative
rules.
The pages of the Kestnbaum report indicate the hold of status quo on
intergovernmental financial relationships. In 280 pages 174 dissents,
97735— 57 ------ 15
ECONOMIC GROWTH AND STABILITY
206
STATE RANKS IN PER CAPITA FEDERAL TAX INCIDENCE
RANK IN PER CAPITA TAX INCIDENCE
(-FISCAL 1952) AND INCOME PAYMENTS (FISCAL 1953)
0
1©
20
30
ho
RANK IN -PER CAPITA INCOME PAUVCTTS
$0
ECONOMIC GROWTH AND STABILITY
STATE HANKS IN PER CAPITA FEDERAL
RAJIK IN PER CAPITA
GRANTS
CHAWTS AND INCOME PAYMENTS (FISCAL 19$3 )
207
208
ECONOMIC GROWTH AND STABILITY
qualifying statements, exceptions are recorded. Almost no specific
recommendation concerning grants is unanimous, and yet an academic
critic is bound to feel that the recommendations of the report were
disappointingly weak rather than bold. As such a critic, I cannot
believe that, for example, the grants for agricultural and vocational
education serve important national objectives; and that those for pub
lic assistance and for public health do not need major overhaul and
probably consolidation into block grants.
Another defect of the Kestnbaum report is that it gave very little
attention to intergovernmental tax relations. And yet even the bold
est opponent of grants is aware that discontinuance or reduction of
grants would throw a burden of expenditure upon State and local
governments which they could not easily provide. The proposition
naturally arises: Could not reduction of Federal grants be coupled
with reduction of Federal taxes? Even if State use of some tax
sources is less efficient than Federal, a realistic program of decentrali
zation which would increase the importance of the States in our Fed
eral system has marked appeal.4
The lack of boldness in the Kestnbaum report may be indicated also
by a brief examination of its treatment of present governmental re
sponsibilities for two major functions, highway construction and
unemployment insurance.
Highway construction
Responsibility for no long-established function of government has
gone through so complete a cycle of change as highways. A century
and a half ago, Federal interest in highways was strong. But in the
years after the War of 1812, the Federal Government retired from con
struction and not long afterward so did the States. The task of build
ing and maintaining highways became, in the main, a local function,
and it remained so almost to the 20th century. Roads seemed to be a
local responsibility because traffic on them was local. Then the rise of
the automobile, by revolutionizing our system of transport, also revolu
tionized the responsibilities of government toward highways. At first
there was demand even for Federal construction of a system of inter
state highways, but the more pedestrian plan of Federal grants pre
vailed, with allocation of most of the money to local roads. Gradually,
however, under the guidance of the Bureau of Public Roads, the mile
age eligible for Federal grants was limited, and in many States a
State highway system was marked out for direct construction and
maintenance by State highway departments.
The Federal grants for highways have been given a good rating by
most observers, and, in a historical sense, this rating seems correct.
Nonetheless, it seems that the political strength of the program allowed
and persuaded Congress to stick to a formula and allocation which
were out of date even before World War II. Postwar, indeed, Con
gress enlarged and revised the program, giving attention to express
highways through or around the larger cities, and to designation of an
interstate system for which the major financial responsibility is Fed
4
A t present, a Joint Federal-State Action Committee is exploring w hat can be done.
Federal relinquishment of taxes on admissions, local telephone service, club dueis, etc.,
bringing in a revenue of about $750 million, is suggested as a quid pro quo to reduction
of grants for vocational education, old-age assistance, national disaster relief, the schoollunch program, etc.
ECONOMIC GROWTH AND ‘ STABILITY
209
eral. But too much money continued to be spent on roads with rela
tively little traffic, to the neglect of heavy traffic roads and of roads in
the more populous States.
The Kestnbaum report showed little awareness of this situation. It
favored some increase of Federal aid channeled especially toward
“ highways of major importance to the national security” (p. 216) ;
it wanted “a reduction in the extent and degree of Federal super
vision" of the grants; it favored a pay-as-you-go plan financed “ pri
marily from increased motor-fuel taxes” (p. 219); it wanted repeal
of the Hayden-Cartwright Act. Yet at this very time Congress, in
framing the Highway Act of 1956, was making major decisions in
highway policy. It was to increase Federal expenditure on highways
from 10 percent of total governmental expenditure to 20 to 25 percent,
to provide for reconstruction of the 41,000-mile Interstate Highway
System almost entirely with Federal money, and to segregate Federal
highway-user taxes into a fund earmarked for highway purposes. It
may be that a mileage will emerge which is entirely a Federal respon
sibility, while the remaining mileage will be left to the State and local
governments with little or no Federal aid.
Unemployment insurance
Unemployment insurance was set up in 1935 on a cooperative
Federal-State basis by use of the tax offset. A purely Federal scheme
was thought to be impractical for a variety of complicated reasons,
among them the danger of being declared unconstitutional. The tax
offset scheme itself squeaked by the Supreme Court in 1937 in a 5 to 4
decision, with the majority putting much emphasis on their opinion
that the conditions and controls imposed by the Federal Government
were not excessive, and that the States were given a wide freedom
concerning the type of statute they might enact.
In the 20 years since this decision, the number of advocates of
federalization has grown, and, if a fresh start could be made, a
national plan of unemployment insurance might be favored. The
actual scheme of Federal-State cooperation, with its divided admin
istrative and legislative responsibilities, and the resultant diversity
of coverage, benefits, waiting periods, and tax rates, does not meet
adequately the national interest in unemployment compensation.
Merit rating, in particular, has introduced a perverse behavior of
the contribution rate which impairs countercyclical finance and en
dangers the solvency of some State reserves. These are formidable
faults which are inadequately recognized by the Kestnbaum report.5
Indeed, nowhere in the report, and in the report of its Study Com
mittee on Unemployment Compensation and Employment Service, is
the influence of status quo so marked. A bare majority of the study
committee—6 out of 11 members—favored an increase in the tax
offset from 90 to 99 percent. This would, in effect, abolish the pres
ent Federal grant for unemployment compensation and permit the
States to collect 99 percent of the employer tax. The Commission
gave its endorsement to experience rating. By a bare majority of 6
to 5, its study committee favored extension of coverage to employers
5
Four Commissioners, Senators Morse and Humphrey, Dr. W illiam Anderson, and ex«
Governor Alfred E . Driscoll, favored a national system of unemployment insurance, sup
ported and administered by the Federal Government.
210
ECONOMIC GROWTH AND STABILITY
of 1 or more employees, and the Commission went along, with 1
dissent.
.
The likelihood of major reform in unemployment insurance, not
to say federalization, is slight. The existing scheme works well
enough most of the time; it has the entrenched support of its admin
istrators and indeed of all State officials in States with strong
reserves.
C o n c l u sio n
Two related policy conclusions seem indicated by this brief survey.
(1) The present system of grants needs overhaul to eliminate grants
which no longer serve an important national purpose, to revise grants
for which conditions, administration, apportionment are inappro
priate, to add or enlarge grants for purposes where inadequate State
action is coupled with national need. (2) I f the net result is to
throw new financial responsibilities on State and local governments,
the Federal Government should offset, or more than offset, the
burden by reduction of Federal taxes, especially those suitable for
State-local administration. Such steps would help in reconstruction
of a more effective federalism.6
T able 1.— Public expenditures and net national p r o d u c ta ll levels o f government
combined ( fiscal yea rs )
1890
Expenditures (billions):
Expenditures (percent of net national product):
1929
1932
1940
1955
$0.6
.2
$8.8
1.9
$9.6
2.2
$15.5
2.5
$60.5
52.9
.8
11.0
10.7
95.0
11.8
50.7
18.0
93.0
113.4
359.5
6
2
9
2
19
4
17
3
15
14
8
11
23
20
29
1 The classification and the figures for (1890) 1940 are taken from an article The Growth of Public Expend
itures in the United States, 1890-1948, by R. A. Musgrave and J. M . Culbertson, National Tax Journal,
June 1953. The figures for 1955 are only roughly comparable with those for 1940 since I have sometimes
had to guess where Musgrave and Culbertson would put the figures.
2 War-related expenditures are defined as those of the Military Establishment, veterans’ benefits, interest
on Federal debt incurred for defense purposes, and Federal foreign aid in 1955.
T a b le 2.— Public expenditures for civilian purposes , 19^0 and 19-55,1 all levels of
government combined ( fiscal years)
1. Regulation and protection.............................
......
.................
4. Interest2. - .............................................................. ..........................
1940
1955
1940
1955
Billions
$1.0
3.6
8.0
1.3
1.7
Billions
$2.1
14.5
35.8
1.3
6.8
Percent
6
24
52
7
11
Percent
15.6
60.5
100
4
24
59
2
11
100
1 See footnote to table 1.
2 Interest on debt incurred for purposes other than defense.
6 A thorough overhaul of grants should not neglect their adaptability for countercycle
purposes. Some of the possibilities were summarized in a paper presented to your subcom
mittee by me in November 1955.
ECONOMIC GROWTH AND STABILITY
211
T able 3.— Distribution by levels o f government of public expenditures 1
(fiscal years)
1890
1929
1932
1940
1955
Billions of dollars
1. Federal............................................................................
2. State....................................... ... ................................
3. L ocal...
- ................................................................
0.3
.1
.5
2.6
1.9
6.2
3.5
2.3
6.0
9.0
3.4
5.6
70.2
19.6
23.6
Total... ____________________ _ _____________
.9
10.7
11.8
18.0
113.4
Percent of total
1. Federal............................................................................
2. State.......... ........................ ...........................................
3. Local . ...........................................................................
Total________
_______ . . . ___________ - „ .
33
12
55
24
18
57
30
20
51
50
19
31
62
17
21
100
100
100
100
100
i S ee fo o t n o t e t o t a b le 1.
N
o t e .—
F ig u res m a y n o t a d d t o t o t a ls b e c a u s e o f r o u n d in g .
T able 4.— Distribution, by levels of government, of civilian expenditure,
1940 and 1955
1940
1955
1940
Economic development:
1. Federal................................................................................... 2. State..
_. _ .......................................... .......
3. Local.............................................. ... .............................
Billions
$2
1
1
Billions
$5
6
4
Percent
55
25
20
Percent
37
38
25
Total.........................................................................................
4
15
100
100
Social welfare:
1. Federal....................- - - - - ......................................................
2. State , . _................................. .......- .
_ ________ __
3. Local...................... ... ................................................................
3
2
3
9
12
15
42
24
34
25
32
43
8
36
100
100
1
1
2
3
2
0
30
15
55
29
25
47
................................................................................
4
10
100
100
Total civilian:
1. Federal_________________ ____________
___________
2. State ................................................. .
...........
3. Local-.................... ....................................................................
7
3
6
17
19
25
42
22
36
29
32
39
16
61
100
100
Total___________ - ___ -
.
_ ,
--
.....................
Other:
1. Federal.......................................................................................
2. State.. .
..............................................................
3. Local............................................................
....................
Total---
Total............................................................- . .
N
o t e .—
.............
1955
F ig u r e s m a y n o t a d d t o t o t a ls b e c a u s e o f r o u n d in g .
T able 5.— Federal grants and State-local expenditures
1947 ___________________________________________ _______ _______ _
1953................................................... ......................... ................. ...................
1954
.................................... ............................. .
..........................
1955
- ......................................................................................
Grants
State-local
expenditures
Millions
Millions
$1,678
2.781
2,987
3,126
$14,171
32,937
36,607
40,375
Percent
11.8
8.5
8 .2
7.7
212
ECONOMIC GROWTH AND STABILITY
T a b l e 6 . —Federal
grants, 1947 and. 1955
1947
Millions
$935
(644)
602
(208)
65
10
67
1,678
1955
1947
Millions
$2,094
(1,427)
724
(584)
248
26
35
1955
Percent of
total
55
Percent of
total
67
36
23
4
1
4
8
1
1
100
100
3,126
T able 7.— Per capita income payments (fiscal 1953), Federal grants (fiscal 1D53),
Federal tax incidence (fiscal 1952), by States
Income
payments
Delaware.....................................
Nevada........................................
Connecticut. ............................
District of Columbia................
New Y o r k .................................
Illinois......................................
New Jersey........ .........................
California^.................................
Ohio............................................
Michigan.....................................
.............
Washington . . .
Maryland....................................
Massachusetts..........................
Pennsylvania.............................
Indiana........................................
Oregon.......................................
Rhode Island .........................
Wisconsin........ ..........................
Montana.....................................
Wyoming....................................
Colorado......................................
Missouri......................................
Kansas. .....................................
New Hampshire........................
Nebraska.....................................
Iowa..... .......................................
Minnesota
Arizona........................................
Utah_______________ _____ _
Texas............................................
Idaho..........................................
Vermont..... ............................
Maine..........................................
Florida.........................................
Virginia _
............................
New Mexico...............................
Oklahoma............................ .......
South Dakota............................
North Dakota............................
West Virginia.............................
Louisiana....................................
Georgia........................................
Tennessee...................................
Kentucky..................................
South Carolina..........................
North Carolina........................
Alabama ...................................
Arkansas. ............... .................
Mississippi.................................
Federal
grants
Federal tax
incidence
$1,616
$17.19
$412
2,256
2,201
2,132
2,122
2,110
2,038
2,035
2,008
1,942
1,916
1,846
1,806
1,792
1,778
1,751
1,718
1,705
1,694
1,690
1,654
1,652
1,631
1,590
1,586
1, 558
1,546
1,524
1,488
1,484
1,468
1,448
1,382
1,364
1,352
1,350
1,337
1,310
1,296
1,270
1,245
1,240
1,162
1,156
1,146
1,092
1,078
1,021
953
830
15.52
51.19
10.92
7.88
13.04
13.75
8.84
21.29
12.47
14.67
25. 71
12. 37
16.31
10.04
11.81
17.85
17. 27
14. 51
30.45
32.74
32. 85
23.68
21.79
16. 73
16.64
17. 25
18.34
25.96
28.17
18.84
24.89
21.06
18.09
17.02
13.17
30.68
34.51
28.93
27.23
19. 21
34.94
23.31
19.05
18.56
19.40
14,11
18.44
25.30
19.26
1,015
653
698
697
676
552
510
505
460
445
381
485
549
446
336
387
538
376
350
333
412
405
302
408
326
300
361
293
243
318
241
359
372
378
277
239
245
218
224
249
258
220
209
231
170
213
163
139
112
Income
payments
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Federal
grants
36
1
46
49
42
40
48
18
43
37
12
44
35
47
45
29
30
38
7
5
4
15
17
33
34
31
27
22
9
24
14
19
28
32
41
6
3
8
10
22
2
16
23
25
20
39
26
13
21
Federal tax
incidence
1
5
2
3
4
6
9
10
12
14
19
11
7
13
26
18
8
21
25
27
15
17
30
16
28
31
23
32
37
29
38
24
22
20
33
39
36
43
41
35
34
42
45
40
46
44
47
48
49
Sources: The Commission on Intergovernmental Relations, Report, pp. 303-304, Selma Mushkin, Illus
trative Estimates of Federal Expenditures and Revenues by States (U. S. Department of Health, Educa
tion, and Welfare, Washington, 1966, mimeographed), p. 58.
THE TENABLE RANGE OF FUNCTIONS OF LOCAL
GOVERNMENT
George J. Stigler, professor of economics, Columbia University
The members of the legislative, executive, and judiciary de
partments of 13 and more States, the justices of peace, officers
of militia, ministerial officers of justice, with all the county,
corporation, and town officers, for 3 million and more of peo
ple, intermixed, and having particular acquaintance with
every class and circle of people, must exceed, beyond all pro
portion, both in number and influence, those of every descrip
tion who will be employed in the administration of the Fed
eral system (The Federalist, No. 45).
The preservation of a large role in governmental activity for local
governments is widely accepted as an important social goal. No one
can doubt that the individual citizen gains greatly in political dig
nity and wisdom if he can participate m the political process beyond
casting a vote periodically. It is also generally conceded that a good
political system adapts itself to the differing circumstances and mores
of different localities, or, as I would wish to rephrase it, the system
should allow legitimate variations of types and scales of governmental
activity to correspond with variations m the preferences of different
groups of citizens.
Nor will it be denied that this social goal is being increasingly
sacrificed. In 1900, virtually all questions of housing, public health,
crime, and local transportation were dealt with exclusively by State
or local governments, and the role of the Federal Government in edu
cation, regulation of business practices, control of natural resources,
and redistribution of income was negligible. Today the Federal Gov
ernment is very active in each of these areas, and its share of responsi
bility is gradually increasing.
I propose to examine some of the reasons which are given for the
growing centralization of political processes. The proper range of
activities of government in general will not be raised. Our question
is simply this: I f the people in a given community wish to embark on
a particular governmental policy, when does the efficient discharge
of this policy require that it be imposed by a central authority also
upon other communities ?
In many minor areas of governmental activity no real questions are
raised, as yet, about the feasibility of local sovereignty. I f a given
community wishes to have superb library facilities, it can build and
pay for them; if another community wishes instead a skating rink, it
may so choose. I f individual citizens in any community disagree
strongly with the majority preferences, they may move to a more con
genial community. Since governmental functions must often be pro
vided upon a considerable scale to be tolerably efficient in execution, a
213
214
ECONOMIC GROWTH AND STABILITY
sufficiently eccentric individual may not be able to find any community
with enough like-minded individuals to be able to adopt that series
of governmental policies which would exactly suit his taste. For exam
ple, he may wish to live in a community with gravel streets and a
magnificent observatory, and find no community willing to provide
this combination. This sort of limitation is also encountered in con
suming the products of private enterprise—I may not find precisely
the automobile or typewriter that suits me.
In most areas of governmental activity, however, it is increasingly
felt that local governments are inefficient units. When any of three
types of governmental activity are sought, it is said that the unit of
effective administration must be large in scale—
1. When the object of a regulatory policy can be nullified by
the competition of (including migration to) other local govern
mental units.
2. When the source of revenue of the activity can escape finan
cial responsibility by migration to another unit.
3. When the policy is incapable of efficient performance upon a
local scale.
We consider these problems in turn.
T h e P r o b l e m o f C o m p e t it io n
Suppose that a community wishes to set a high standard of factory
safety, and requires the installation of a very expensive safety device.
Then the local portion of a much larger industry will be undersold in
the common market by factories in other communities, provided they
do not also simultaneously set as high standards of safety practices.
The local branch of the industry then dies or migrates. These facts
can be taken as data for our discussion.
The essence of this argument is that competition, which usually
works so well in the area of private enterprise, serves to defeat desir
able goals in the area of government. I f every governmental unit, save
one, were to desire and require elaborate safety devices in the facto
ries of some industry, it is claimed that their desire could be stultified
by the presence of the exceptional community which did not have this
desire, because the regulated industry would migrate to this commu
nity and escape regulation, and the knowledge that it would do so is
often enough to prevent the various communities from attempting to
regulate it.
It may be remarked that a similar argument is often encountered
in the private-enterprise sector. Plants with low wage rates, it is
often said, force plants with high wage rates to reduce their wages in
order to compete successfully in the common market. In this case the
argument is reversible: the plants with high wage rates force plants
with low wage rates to raise their wages in order to compete success
fully for workers in the common labor market. Both formulations,
however, are singularly uninformative, for they do not lead directly
to the correct conclusion, which is that the wages of all (similar)
workers must approach equality in all plants under competition, and
the common wage rate will be governed by the value of the worker’s
services in those plants which can pay this rate. Can it be that some
parallel obscurity attaches to the customary formulation of the unfor
tunate effect of competition among governments ?
ECONOMIC GROWTH AND STABILITY
215
The governmental analysis is, in fact, incomplete. Suppose any
community set the required level of safety practices as high as it
wishes, and then gave a subsidy to each enterprise in the locality equal
to the additional cost that these safety devices imposed upon the en
terprises. Then there would be no tendency for the local industry to
be handicapped in competition with other areas with lower safety
standards, and the community would enjoy more worker safety and
less of other things than other communities. If 47 percent of the lo
calities or 99 percent of the localities embark upon this policy, then 47
or 99 percent of the factories will have the desired safety practices,
and the nonconformist competitors will not have the slightest ten
dency to injure or attract these safe and expensive factories.
When a community imposes the safety regulations without giving
a compensating subsidy, its troubles arise from the fact that it is seek
ing to push these higher costs off on consumers, and neither local nor
distant consumers wish to assume this burden. The problem of com
petition resolves itself into an unwillingness of the community to bear
the costs of its policy when they are posed as an explicit burden.
A similar analysis holds when the community wishes to require of
some consumer good that it be of unusually high quality. I f it spec
ifies that only goods of this unusual quality be sold in the community,
the producers will be quite eager to meet the specifications—at a re
munerative price.
Although it involves a digression, it may be profitable to discuss
more generally our example of factory safety devices because the dis
cussion will serve to illuminate the workings of competition in general.
If workers are faced with the choice of working in one plant, un
equipped with safety devices, at an hourly rate of $1.50 but with ex
pected losses from injuries of 5 cents per hour, and in another plant
with safety devices they are offered $1.46 with no expected losses
from injuries, we should expect them to choose the latter plant. I f
under these conditions they do not choose the safer plant, the most
probable explanation is that they do not correctly appraise the ex
pected losses from injuries and the remedy is to inform them of the
consequences of working in factories unequipped with safety devices.
In a fully competitive system the entrepreneurs will supply at cost
all the safety devices that the workers demand, and all safety devices
which return (to the worker, in terms of reduced injuries) as much
or more than the cost will be adopted. It may well be that in this
situation there will be safety devices which do not pay but which
would reduce injuries further, and that the community as a whole
sets a higher value on avoidance of these injuries than the workers
themselves do. Some moral philosophers might argue that these work
ers should set a higher value on the avoidance of injuries, but the
workers do not, and in a society with free choice of occupation they
cannot be made to pay for more safety than they wish. Hence the
society must bear the costs of achieving more safety, and the sole
question is whether the costs be borne by consumers through compul
sory installation of the safety devices and restriction of supply, or by
direct grant from public funds.
The competition of other communities as tax collectors is an im
portant form of the alleged difficulty arising out of competition. Sup
pose community A wishes to have splendid and expensive schools,
216
ECONOMIC GROWTH AND STABILITY
streets, housing, poor relief, and what not. I f it levies sufficient taxes
to finance this elaborate program, a large portion of the tax base (in
dustries and well-to-do individuals) will leave the community while
simultaneously a large number of beneficiaries of the generous pro
gram may immigrate. The tax rates on the narrower tax base will
have to be prohibitive (from the viewpoint of the remaining taxpay
ers) to finance the sumptuous program.
Again we can accept the facts, with one temporary amendment.
Let us assume that the same income is received by every family, and
no questions of income redistribution are involved. Will the presence
of communities with lower tax rates defeat the ambitions of com
munity A ? The answer is clearly in the negative. There will be some
redistribution of population among communities: those people who
prefer cheaper public services and lower tax rates will move else
where, and others with opposite taste will move to A. Competition of
communities offers not obstacles but opportunities to various com
munities to choose the types and scales of governmental functions
they wish. The proviso that all family incomes are equal has a vast
influence on this argument, of course, and we turn now to income
redistribution as a goal.
T h e D is t r ib u t io n o f I n c o m e
I f all families had equal (real) income, would there be any need
for local governmental units ? Why could not each city be a private
corporation, supplying at a price the services its dwellers demanded ?
With many, many such corporations, competition would prevent mo
nopolistic pricing, and schooling and police and fire protection would
be sold at a price including a fair rate of return on investment. This
scheme would obviously be inappropriate where the service must be
a monopoly (like national defense) and probably also where the com
munity size was so large (due to the economic advantages of size) that
the communities were too few to rely upon competition, but let us put
these instances aside. We are not seeking to prove that there should
be no government, but rather to find the logic of government at the
multiunit governmental level.
A basic deficiency in this private enterprise organization of social
life, we would all agree, is that it allows excessive freedom to the indi
vidual. It would allow parents to horsewhip children, and it would
create communities populated chiefly with drunkards and drug ad
dicts—although thieves would presumably prefer to live among honest
men (even with their policemen) than only with other thieves. Pub
lic opinion would curb many undesirable personal actions, but the
society would wish to compel observance of its basic values. As a
result, we must recognize the need for political units large enough so
their numbers include enough normal people to insure the imposition
of the society’s basic moral standards on local communities. Our
States—with 1 or 2 possible western exceptions—meet this condition of
statistical large numbers.
The second basic weakness—some will call it a strength—of the pri
vate enterprise organization of local government is that it would not
permit price discrimination; it does not have the ability to redistribute
income. The purely competitive organization of local services would
ECONOMIC GROWTH AND STABILITY
217
make it impossble for a local government to obtain money from the
rich to pay for the education of the children of the poor, except to the
extent that the rich voluntarily assumed this burden.
How can local governments cope with this problem? I f 99 com
munities tax the rich to aid the poor, the rich may congregate in the
hundredth community, so this uncooperative community sets the tune.
Here competition does not perform with its usual excellence, for com
petition is the system calculated to organize only voluntary activity.
What is the correct amount of redistribution of income in light of
the society’s desires ? It is more than the unrestricted competition of
tax-free colonies of the rich would allow, but less than the most ag
gressively egalitarian community would desire. The decision must
be in some sense a national decision, for the proper amount of redis
tribution, even if rich and poor were chained to their communities,
could not depend upon the accidents of income composition of a par
ticular community. And once this level of redistribution is set, no
one community may complain if its rich citizens migrate when it seeks
to go above this level of distribution unless the society is prepared to
let the most egalitarian community set the scale of income redistri
bution.
Since redistribution is intrinsically a national policy, it should not
be restricted to a community level; a community consisting only of
poor people should receive the desired minimum social services.
Hence, in pure principle, the Federal Government should collect the
progressive levies and redistribute them (in whole or in part) to local
units with each unit receiving an amount governed by the number of
its poor and the degree of their poverty.
Given this system of tax revenue redistribution, the local govern
ments could still be allowed to perform any function which they were
competent to perform efficiently. One community might choose to
spend more on schools and less on hospitals than another, but this is
surely an area of legitimate freedom; there is no “correct” distribution
of expenditures among such functions.
In a society which has no serious program of income redistribution
(even as a means to the attainment of minimum goals), local govern
ments would face no basic revenue problems because of competition.1
It is in keeping with this argument that a century ago almost all func
tions were local and the problem of competition for the tax base was
negligible. With an appropriate fiscal system we could restore these
revenue considerations to a position of unimportance even in an era of
extensive income redistribution. There still remains the question of
whether the local governments could efficiently perform the enlarged
range of functions that modern governments have assumed. We
turn now to this question.
T he
E c o n o m ie s
of
S cale
H ow large must a governmental unit be to perform efficiently the
activities which the public wishes governments to perform? This is
an area which deserves much more attention than it appears to have
received, and the following remarks are highly tentative.
1 Perhaps a qualification should be entered with respect to the growth of taxable wealth
that escapes a general property tax. In England the desire of property owners to ease
their tax burdens was a force in the emasculation of local governm ent; see E. Cannan,
The History of Local Rates in England, second edition, 1912, ch. VI.
218
ECONOMIC GROWTH AND STABILITY
. There are a set of functions which are intrinsically national because
they are indivisible. The greatest of these is national defense, and
it would be ill-served if each State or local unit were to undertake
the defense of its own area. One may cite also foreign relations, the
national governmental machinery, and the control of relationships
among lower governmental levels.
‘ In addition to such traditional functions, one may list certain func
tions which are or can be performed at a local level but which must
be coordinated to achieve efficiency in their design. The transporta
tion systems of localities must take some account also of the needs of
long-distance transportation. The radio and television stations of
various localities must not jam one another. These are functions
which in the economist’s language, have large external economies or
diseoconomies accruing to the areas which do not participate in their
execution, so it is essential that they be formulated (although not
necessarily administered) on a larger area than the local government.
We should reserve for the Federal Government those functions
which are much more efficiently discharged on the largest scale.
When local performance involves large duplication, it is inefficient.
Thus it seems undesirable to have 48 estimates of wholesale prices
since the price movements in most regions will be parallel; on the
other hand, the calculation of cost-of-living indexes might suitably be
removed from the BLS to the States.
The optimum scale of performance has tacitly become identified
with the National, or at least the State, scale almost without examinmg the nature of the governmental functions under discussion. This
seems most surprising to the student of industrial organization; he is
accustomed to finding that the activity in an industry with a complex
technology is usually efficiently conducted by a firm smaller by almost
any measure than the government of a town of 25,000. Is there some
special characteristic of governmental functions that makes large
units necessary to efficiency ?
Only one characteristic seems a possible candidate for this role: the
great variety of functions performed by even the small governmental
units. The lack of specialization is pronounced even though politi
cal scientists complain of a multiplicity of overlapping local units
(many of which were established to evade tax or debt limits on local
units). Some of these functions can be performed efficiently on a
very small scale. Many of the most distinguished private schools
and colleges are much smaller than the school system of a town of
5,000 people. Others are more varied. A police department can
efficiently control local traffic on a small scale; in one sense it must
be worldwide to have an efficient “missing persons” bureau.
But this variety of function is not really unusual. Every enter
prise must use goods and services, or produce goods or services, which
must be produced or sold on a much wider scale than the enterprise
itself can undertake. Even a huge department store is not large
■enough to make its own delivery trucks, or to print the newspapers
in which it advertises. Just as cooperation in these matters is brought
about by the price system, so cooperation among governmental units
has been developed—and could be carried much further—to avoid the
determination and execution of all public functions by that govern
mental unit which is most efficient in conducting the function wTith the
largest scale of operation.
ECONOMIC GROWTH AND STABILITY
219
It happens, as we have already noticed, that one function of para
mount importance must be conducted on a very large scale: the col
lection of revenues designed to redistribute income. Much central
ization, in fact probably most centralization, has been a consequence
of this situation. A central government is loathe to make grants
without exercising a degree of control over the local units which
disburse the funds. No degree of control less than 100 percent, how
ever, is sufficient to guarantee local performance exactly as the cen
tral authorities wish it, and there is no obstacle except tradition to
slow down their gradual extension of controls.
The case for imposing controls over the smaller units receiving
rants, however, is far from general. The central disbursing authority
as no monopoly of wisdom. The State boards of education have
imposed a series of certification requirements on local teachers, for
example, that have done much to lower the quality of elementary
education in the United States. When central governments have
superior civil servants, as they often do, the cause lies more often in
their control of finance and authority than in the advantages of
centralization. It may be true that when most administrative units
are small the ablest men cannot conduct affairs on the largest scale,
but this seems an odd consideration to give weight in setting the func
tions of local governments in a democracy. More often the complex
ity of the tasks at the national level has reached such levels that not
the ablest men can control them efficiently.
If grants were given to local governments without supervision,
there would be some instances o f gross neglect or venality and more
variety in the quality of the performance of public functions. We
should also expect to find that much of this variety was eminently
sensible, and that many types of experimentation would constantly
be embarked upon by the more venturesome and the more foolish
communities—with large social benefits from both the successes and
the failures.
I f we give each governmental activity to the smallest governmental
unit which can efficiently perform it, there will be a vast resurgence
and revitalization of local government in America. A vast reservoir
of ability and imagination can be found in the increasing leisure time
of the population, and both public functions and private citizens
would benefit from the increased participation of citizens in political
life. An eminent and powerful structure of local government is a
basic ingredient of a society which seeks to give to the individual the
fullest possible freedom and responsibility.
f
IV. ECONOMY AND EFFICIENCY IN GOVERNMENT
EXPENDITURES
97735— 57--------16
221
ECONOM Y A N D E F F IC IE N C Y IN GOVERNMENT
E XPE N D ITU R E S
SOME DEVICES FOR INCREASING EFFICIENCY IN
GOVERNMENT EXPENDITURE
O. H. Brownlee, professor of economics, University of Minnesota
This paper treats what must be considered some comparatively
minor issues associated with government spending. It is concerned
with how to determine the levels of some of the services that govern
ment ought to provide and how such services should be produced.
Its proposals are applicable to State and local as well as Federal
expenditures. I am almost certain that other participants in this
study will point out that solutions to many of the central problems
of public expenditure policy are essentially matters of personal taste
on which unanimous agreement is not to be expected. At the present
time, I am not prepared to debate this position. Instead, I shall deal
with some problems whose solutions should not be arbitrary ones, even
though the changes in expenditures that would follow from applying
them would look small in comparison with current levels of spend
ing.
.
.
.
.
The treatment provided does not point out in detail how the princi
ples proposed might be applied. I shall sketch the applicability for
a few examples. These examples may appear to be extreme cases
and are chosen to demonstrate clearly the points I am trying to make.
These proposals when applied might prompt us to do some things in
ways much different from those currently employed.
Although I shall argue that demand and supply relations can guide
us more in determining government expenditure than currently is
the usage, this argument does not support either those who believe
that the best government is the one that does least nor those who believe
that the scope of governmental activities should be expanded. In
many areas we don’t know whether government is spending too little
or too much—even though such questions could be answered unambig
uously—because we have not obtained relevant information nor em
ployed decision-making procedures which would permit us to use the
relevant data.
G overnm ent
S p e n d in g
to
P r o v id e
S e r v ic e s
and
to
R e d is t r ib u t e
I ncom e
Government spends to provide services and to modify the dis
tribution of income from that which would prevail if it were deter
mined only by the pattern of resource ownership and resource prices.
The extent to which income should be redistributed—the tax and ex
223
224
ECONOMIC GROWTH AND STABILITY
penditure pattern together being important instruments of redis
tribution—is essentially an ethical problem and will not be discussed
here.
Goods and services that should be provided by government
The goods and services whose provision to the population should be
of interest to government and the goods and services which govern
ment should produce need not be the same things. The first group
includes things whose costs should be-covered to some extent from
tax revenues, although the organization of the production of these
things might be left completely to private enterprise. The things
whose provision to the population is a legitimate governmental con
cern includes those that one might call “ socially beneficial.” Ad
ditional consumption of such a good or service by one person increases
the welfare of other persons as well as that of the immediate consumer.
Elementary school education is a service generally believed to be o f
this kind. Because Smith’s children do not capture all of the benefits
of becoming literate and perhaps learning how to think and thus
eventually becoming better citizens than would be the case if they
were without elementary education, Jones is willing to contribute
toward the education of the Smith children, i. e., to support govern
mental expenditure for such education. It is believed that if ele
mentary school education were allocated among the population in the
same manner as steak or beer, too little of it would be produced.
Other instances of goods or services that are socially beneficial in
clude services to check the spread of communicable diseases and
various services associated with sanitation—sewage and garbage dis
posal, for example.
A second category of goods and services in whose provision gov
ernment should be interested might be called public goods,1 those
which can be consumed by one person without any reduction in the
amounts available to other persons. For example, a radio or television
transmission can be received by an additional receiving set without
affecting the reception of other receivers; one’s view of a public monu
ment is independent of the number of persons who have seen it pre
viously.
Government’s interest in socially beneficial goods is to see that their
consumption is larger than would be the case if they were distributed
in the same manner as other goods. This objective can be attained
by subsidizing producers or by giving grants to consumers conditional
upon these grants being used to purchase such goods or services.
Either approach requires governmental spending. The interest of
government in public goods also is akin to seeing that more is pro
duced than would be the case if they were privately produced'and
sold. It costs something to produce and disseminate radio programs.
Yet the best way of collecting to cover these costs is not necessarily
to charge each listener according to the amount he listens but rather
to charge him a flat fee for the opportunity to receive radio reception.
Insofar as government may act as the intermediary in collecting and
dispersing funds, government expenditure is involved.
1
Refer to Paul A. Samuelson, The Pure Theory of Public Expenditure, The Review of
Economics and Statistics, X X X V I , pp. 887^389.
ECONOMIC GROWTH AND STABILITY
225
Goods and services that should be produced by government
Whether government should produce goods and services—socially
beneficial ones, public goods, or other goods—is simply a question of
whether governmental organization of production will result in a
given amount being produced at a lower cost than would be achieved
by private producers. Thus, there is no inherent reason for a good
or service to be produced by government, even though this good is
freely distributed by government, if private producers can produce
it at less cost; nor is there any reason why government should not
produce any good or service and sell it in the market, even though
this commodity has been produced privately, if it can do so at less
cost than private producers.
In this paper I shall avoid the hardest problems—those associated
with how much production there should be of public goods and goods
with social benefits. Instead I shall deal with some of the problems
of trying to assure that the costs of producing whatever outputs
are chosen is a minimum, some of the devices that can be used for
determining the outputs of goods that are neither public goods nor
socially beneficial but in the production of which government has
definite advantages, and with some considerations in determining
whether a good is socially beneficial.
M
ore
C
W
U se o f C o n t r a c t i n g a s a D e v ic e f o r L o w e r in g
S e r v ic e s i n W h i c h G o v e r n m e n t H a s a n I n t e r e s t
id e s p r e a d
osts o f
In the United States it is widely believed that with both types
of producers having access to the same technology and the same mar
ket information, private producers will produce more efficiently than
government. There is relatively little pressure for government to
take over the production of steel or autos or most other goods and
services that are clearly neither socially beneficial nor public goods.
A foundation for this belief might be that if decision makers are
rewarded (or penalized) in accordance with the quality of the deci
sions which they make, the quality of decision making will be better
than if rewards and quality of decisions are not closely related.
Where profit is a good index of the quality of the decision, the results
of private producers’ decisions in organizing production are gen
erally accepted.
In many areas, government has chosen to specify the amount of
a product"to be produced and to let private producers produce the
product for government. The military does not produce its own
planes, tanks, etc.; the postal service hires railways and airlines to
carry mail; some school districts do not operate their own school
buses, etc. The line between where government should buy goods
and services and where it should produce them itself appears to have
been arbitrarily drawn. I f the contention that private producers
can produce more efficiently is correct, there are opportunities for
reducing costs of government—although the savings may not be
large—through more widespread application of the practice of gov
ernment specifying the task to be accomplished and letting private
producers bid for the job. For example, fire protection, garbage col
lection, mail collection and delivery, and even many law-enforcement
activities (such as checking parking violations and collecting taxes)
might be contracted to private agencies.
ECONOMIC GROWTH AND STABILITY
226
One cannot forecast accurately the outcome of more widespread ap
plication of contracting. There should be reductions in costs o f
doing some of the things now done by government. But total ex
penditure might be increased. For example, with better garbage
collection at the same cost as at present or the same kind of garbage
collection at lower cost, people might demand more of it than cur
rently is being obtained. Rather than try to guess what the expend
iture pattern would be, let me try to indicate how more widespread
use of contracting might be made by reference to an extreme case.
One function which government performs is that of levying and
collecting taxes, the procedure whereby a person may determine
his tax liability having been stated basically by legislation. There
are, of course, what many people call “inequities” in the tax structure
that are the results of legislation. However, there are others that
are essentially administrative—in the assessment of property for tax
purposes and in the undercollection of income taxes, particularly
from self-employed persons. It is claimed that these could be rem
edied by devoting more resources to tax collection, yet there is no
agreement as to how much more should be devoted to this purpose.
One way of determining this would be to sell the right to collect
a certain tax in a particular area. If taxpayers have adequate
recourse to opportunities to prove their true tax liabilities so that
they will not pay more than legally prescribed and if the right
to collect a tax sells for more than the net revenues (gross collec
tions minus collection costs) obtained by government, greater effi
ciency in tax collection would have been achieved. The tax “ farm
ers” (as they were called in earlier times when such procedures were
followed) would be organizing their resources more efficiently than
has government in collecting a given amount of revenue and/or de
voting more nearly the correct amount of resources to their function.
It might be noted that such a move might prompt legislation such
that taxpayers could more unambiguously determine their tax lia
bilities and that there should be virtually no bribery of tax collectors.
S o c ia l l y B
e n e f ic ia l
G
oods a n d
S e r v ic e s
There is not complete agreement with respect to precisely which
goods and services are socially beneficial. However, some of this
disagreement is the result of failing to distinguish between benefits
that can be rewarded through the market and those that cannot. For
example, investment in plant and equipment that will earn enough to
pay interest and amortization costs is socially beneficial in that it
results in a given amount of product being sold at a lower cost. How
ever, the making of such an investment is rewarded through the
market. I f a person learns to understand things that improve his
decision-making ability as a citizen but do not increase his market
able skills, this act is not rewarded through the market. Only the
latter kind of action warrants expenditure as a socially beneficial
action. I f there are unnatural impediments to investment that pre
vent the first kind of action from being carried out, such impedi
ments can be removed by the establishment of governmental agen
cies—for regulation or for making loans, for example—whose
expenditures are relatively insignificant.
ECONOMIC GROWTH AND STABILITY
227
Furthermore, as already has been indicated, goods or services that
are socially beneficial need not be produced by government. Unless
the government is interested in controlling the curriculum, the ap
propriate stimulation to the production of elementary education could
be provided by grants to families Cdnditi'oli&rupon such grants being
used for elementary schooling. Private producers could operate the
schools and collect for their services through fees.
An appraisal of current governmental aids to higher education pro
vides an opportunity to illustrate a confusion in popular notions of so
cially beneficial goods. Governmental aids to education are extended
not only to elementary schooling but to secondary school training and
so-called higher education—the educational services provided by col
leges and universities. Yet, it cannot be argued that training a person
to be an accountant, an engineer, an embalmer or a mathematician or
to speak French brings significant social benefits. It is true that in
creasing the number of accountants, engineers, etc., reduces the prices
for the services which they produce. But improving technology or
increasing the amount of capital employed in producing varkjus goods
and services also reduces their prices. Investment in higher education
does not differ fundamentally from any other form of investment in
the distribution of its returns among the persons making the invest
ment and others. I f a rationalization, consistent with our general
viewTs as to how resource allocation should be made, were to be pro
vided for public support to higher education, this rationalization
might be that existing market arrangements make it possible for us to
borrow to purchase a farm, a factory, or an oil well, but that borrow
ing to purchase a college education usually cannot be accomplished
through formal financial channels. Investment in higher education
thus would be too small, if we left its determination to the same forces
as are permitted to determine other investment decisions. One way to
encourage more investment in higher education is to reduce its price
through governmental grants to some colleges and universities.
However, if it is agreed that we should be interested primarily in
assuring that individuals may invest in themselves through training
on the same terms as they may invest in other assets, this objective
can be achieved by creating lending institutions for making loans to
purchase education—perhaps in creating an FHA for college educa
tions. Such institutions could require, considerably less Government
expenditure than do current arrangements—in the long run they need
not require any; and, they could result in a better allocation of educa
tional opportunity than do present institutions. At the present time,
some persons who would not buy a college education if they had the
financial resources and had to pay the full costs attend some Statesupported institutions. Others who would buy a college education if
they could borrowTthe financial resources and had to pay the full costs
cannot attend college. A loan program, in lieu of present forms of
State support, would permit the second group of individuals to attend
college, and—if educational training were priced at cost—would re
sult m the training of fewer individuals in the first group. Govern
mental operation of institutions of higher learning might continue
under the proposed arrangement. But, the reasons for such operation
are the same as those for State operation of grocery stores, filling sta
tions, etc.
ECONOMIC GROWTH AND STABILITY
228
It should be noted that pricing higher education at cost would per
mit us to determine whether too much or too little is being produced.
When a good or service is not socially beneficial and is priced below
cost, the fact that more of this good or service is demanded than is
available is not sufficient to claim that a true shortage exists. In the
long run, there would be “ shortages” (excess demand) of all such
goods and services if they were priced in this manner. Information
about the quantities of socially beneficial goods and services that
would be purchased at various prices also is required to determine
how much should be produced. Because, at some arbitrary price,
there is excess demand for such a good or service does not necessarily
mean that too little is available. Excess demand for this good also
may mean only that the price is too low.
P
u t t in g
D
W i t h R espect t o H ig h w
S u p p l y a n d D e m a n d B a s is
e c is io n s
ay
S e r v ic e s
on a
Among the goods in which government should act as collector and
disperser—if not producer—are those in which costs of collecting
from each user in accordance with the amounts used are high relative
to production costs. Water or electricity would be such a good, if
either good were cheap but meters were very expensive. A classic
example is highway services. With the exception of a few limited
access highways and bridges, the costs to private producers of col
lecting from highway users directly in accordance with use are so
high relative to construction and maintenance costs that unless gov
ernment provided highways and streets, there would be too few of
them.
For more than three decades, there has been much argument re
lating to how much should be spent on highways and who should
pay the bill. The question of who should pay the bill hinges on
whether highway service is socially beneficial. Although improved
highways cut transport costs and hence the prices of things con
sumed by persons not directly using the highways, there are many
other activities that result in reduced prices and for which no special
means of compensation are provided. Except for potential military
uses of the highways—for which the military services should pay—
the case for attributing social benefits to highway services is a weak
one.
In addition to attributing social benefits to highways, further re
sistance to conceptually applying the usual market criteria to deter
mining how much of such service should be produced has arisen from
viewing highway services as public goods. I f using a highway im
posed no maintenance costs and if there existed no problems of high
way congestion, such a view might be legitimate. However, it is not
economic to construct highways so that there are not maintenance
costs (at least for some vehicles), and street and highway congestion
is one of our most widely discussed problems. I f difference in qual
ity of service is considered—quality might be defined in terms of op
portunity to travel at a certain speed, with a certain comfort and some
specified probability of accident—much of the service offered by the
street and highway system is not a public good.
ECONOMIC GROWTH AND STABILITY
229
I f it is agreed that highway services are neither socially beneficial
nor public goods it would be desirable to try to ration these services
among users and to determine the amounts that should be produced
in the same general way as these problems are solved for other goods.
The practical problems are those of attaching appropriate prices to
highway services, collecting from highway users according to the
amounts of each of the services used and employing highway-use
data to determine the amounts of roads of various qualities to con
struct.
Some of these problems have been explored in more detail else
where2 and I will state only some of the implications of these ex
plorations here. Collecting from highway users in accordance with
the amount of service obtained can be accomplished by reliance upon
motor-fuels taxes for passengers’ care with supplementary weightdistance taxes for trucks and buses. Revenues could be allocated to
each section of the highway system in accordance with the traffic
pattern and comparisons of revenues and costs would be employed
to guide the construction and maintenance patterns. Encourage
ment to toll roads would be provided by imputing revenues to them
in the same fashion as for other roads. Thus, decisions about how
much of various kinds of highway service to provide could be based
on whether such changes would pay. We would be able to know
more clearly than we can at the present time how adequate is our
highway system.
Sum
m ary
The devices that have been suggested in this paper—more wide
spread use of contracting in the production of services provided by
government, a loan program to prospective college students rather
than an expanded State role in the production of higher education,
and the provision of highway services in accordance with market cri
teria—are all designed to make it possible for us to know more ac
curately whether the right amounts of certain kinds of services are
being provided and if the least-cost methods for providing various
amounts are being employed. The changes in government expendi
tures that would result from using such devices might not be large, but
some improvement in resource use would result.
2
See O. H. Brownlee and W alter W . Heller, Highway Financing and Development,
American Economic Review, May 1956, pp. 2 3 2 -2 5 0 .
ECONOMY AND EFFICIENCY IN GOVERNMENT
EXPENDITURES
Albert G. Buehler, professor of public finance, University of
Pennsylvania
In this paper the question of economy and efficiency will be related
to the overall problem of government expenditures. With govern
ment expenditures exceeding $100 billion a year, tax rates at high
levels, a general tendency for government activity to increase over the
years, and a common desire for economic development and stability,
it is essential to appraise at frequent intervals the operations of the
public and private sectors of the economy.
T
he
M
e a n in g of
E
conom y and
E
f f ic ie n c y
The terms “economy” and “efficiency” are variously employed in
discussions of public expenditures and taxation. Economists have
emphasized the desirability of maximizing our economic and social
welfare. They stress the objective of most effectively utilizing our
resources toward that end by promoting economic growth and sta
bility. The management of community affairs should be thrifty and
efficient in the use of our resources. Depending upon the point of
view, government expenditures for education, health, welfare, and
other approved services might be increased or decreased.
Those who are critical of increased government spending and taxa
tion often contend that both should be reduced and that more reliance
should be placed upon private initiative and action in achieving our
economic and social goals. They think of economy as requiring less
spending and of efficiency as the elimination of what they regard as
waste.
Another point of view would distinguish decisions as to public
policies and functions, on the one hand, and decisions as to manage
ment, on the other. Economy would imply the wise selection of gov
ernment policies, functions, programs, projects, and activities and
expenditures upon them. Efficiency would relate to public manage
ment in discharging public responsibilities.
Efficiency in the accounting and engineering sense would seem to be
related to unit costs and the effectiveness, as measured in terms of
standards of cost, attained in the execution of government policies and
functions. One might attempt to distinguish, however, between meas
urable money costs and social costs.
While there are many different interpretations of economy and effi
ciency in government expenditures, certain implications of these terms
are evident. It is clear that they are related to decisions as to what
expenditures governments should undertake and the effectiveness of
those expenditures as judged in relation to the criteria in mind.
230
ECONOMIC GROWTH AND STABILITY
231
Broadly speaking, they are involved in the control of government
expenditures for the advancement of approved objectives.
Is the control of government expenditures possible?
Not long ago the manager of the tax department of a large corpora
tion asked me if the effort to control government expenditures was not
a hopeless one. He apparently had in mind the failure of those who
opposed government spending policies to accomplish substantial reduc
tions in expenditures and the great difficulties encountered in securing
greater efficiency in public management.
Others seeking greatly increased funds for public education, high
ways, defense, and other functions may also feel that their efforts
to control expenditures have failed if their goals are not realized.
In a national community with over 170 million members and State and
local communities with many members, the final determination of
government expenditures is bound to be the result of many com
promises.
It would appear, however, that if we would expend more thought
and energy in formulating our economic and social objectives we might
reach a wider agreement on what they should rationally and fairly be.
If we should attain more success is agreeing upon and stating our com
munity goals, we should also be able to increase our effectiveness in
utilizing our material and human resources in advancing toward those
goals.
“
T
he
P
r in c ip l e s
of
G
overnm ent
E
x p e n d it u r e s
I f we are to achieve greater economy and efficiency in govern
ment expenditures, in relation to the use of our resources, it is neces
sary for us to formulate guiding principles and criteria by which we
shall appraise the effectiveness of such expenditures. It is suggested
that every student of government expenditures might profitably
attempt to state what he would accept as sound, basic, and equitable
principles which are also practicable of application. Suppose, for
example, that some such set of principles as those listed below are to
be followed. Do they not require so much interpretation and involve
so much controversy that there remains a wide area requiring the
determination of value judgments which will always be open to uncer
tainty and differences of opinion in our system of government? Even
so, a statement of principles may provide a greater common denomi
nator and may be helpful in planning and executing spending
programs.
Some principles o f Government expenditures
1. Government expenditures should promote the most effective
utilization of our human and other resources.
2. They should be consistent with the economic objective of an in
creasing national income flowing steadily and equitably to the popula
tion while advancing social and other community goals.
3. They should promote, or at least protect, the welfare of the
majority even though they may be designed primarily to further the
welfare of a particular class or group.
4. Careful judgment should be exercised by public officials and
the citizens to insure that the advantages of expenditures on each
public service exceed the costs and that the utilization of funds and
232
ECONOMIC GROWTH AND STABILITY
resources by governments will be more conducive to social welfare
than the private use of the same funds and resources would be.
5. In calculating the economic and social results of expenditures,,
the economic and social effects of the taxes and other receipts raised
to finance them should also be weighed.
6. Public works and other expenditures should be placed at the
most propitious time, so far as possible, for enhancing economic sta
bility, increasing the community income, and lowering the costs of'
the services performed.
7. The services and expenditures of the various units of govern
ment—Federal, State, and local—should be coordinated as effectively
as possible to obtain the maximum social benefits and to avoid an
unwise and wasteful duplication of efforts.
8. Government administration should be efficient and honest. Only
those expenditures duly authorized by law should be disbursed; all
expenditures should be accounted for completely; and public financing
should be reported intelligently and interestingly to the executive
officials, the legislature, and the citizens so that the social gains and
costs of public expenditures can be compared in as rational a manner
as possible.
C
o n f l ic t in g
O
b j e c t iv e s
I f we assume that economy, in the broad social sense, requires the
most effective utilization of our resources in the advancement of com
munity objectives, it must be conceded that there may be some conflict
among our objectives. Governments are not engaged exclusively in
promoting economic welfare because they may also be busy with
social, political, and military aims. Provisions for public safety,
both internal and external, justice, education, public health, public
welfare, and the regulation of morals no doubt greatly influence eco
nomic activity, but they may be directed largely toward noneconomic
objectives.
We may all agree that economic development and stability are
desirable, but we all know that in some measure these economic ob
jectives are in conflict with each other. Changes in the distribution
of wealth and income may be considered desirable or undesirable
objectives. The problem is not entirely an economic one, however,
for it involves moral, political, and social issues.
I f we can attain agreement on our community goals, we have the
further problem of arriving at agreement on the methods by which
the goals are to be accomplished. Should we resort to government
or private action or some combination of both ?
A very serious problem in attempting to secure the most effective
utilization of our resources is that of measuring and appraising the
results of government and private action. In coping with the agri
cultural problem, for example, how are we to determine the conse
quences of various alternatives in developing a farm-aid program?
In deciding upon an appropriate foreign-aid program, can we reach
a judgment with full information concerning the effects of foreign aid ?
The economic, social, moral, and military results of government
actions are not altogether visible and measurable in objective terms.
Our standards of measurement are likely to be subjective. Perform
ance related to such standards is appraised largely in subjective
terms.
ECONOMIC GROWTH AND STABILITY
233
Conflict not only arises in formulating community objectives but
also over the methods by which they should be advanced, not only
because of disagreement over objectives, but also because of uncer
tainty over the consequences of various courses of action. Economy
in the utilization of our human and material resources thus en
counters many grave and highly complicated problems.
D
oes
H
is t o r y
P
r o v id e a n
A
nsw er
?
An answer may be sought in history to the question: What func
tions should governments undertake and what expenditures should be
made for them ? Every student of public finance knows that in gen
eral and over the centuries, government expenditures have been in
creasing. The German social economist Adolph Wagner, stated in
1876, after a study of public expenditures in many nations,
that government activities were regularly increasing because new
functions were constantly being undertaken and both old and new
functions were being performed more efficiently and completely. He
found, apparently to his satisfaction, that public economic activities
were increasing at the expense of private, and looked forward to more
collective economic action.
It may be granted that everywhere government expenditures have
been increasing. The extent to which governments have become more
or less efficient, if one lias unit costs and relative waste in mind, has
not, to my knowledge, been determined.
The history of modern societies shows a tendency for much ac
tivity which was once regarded as private to be transferred to govern
ments, for much new activity to be assumed by governments which
had not previously been extensively provided by private action, and
for government responsibilities once looked upon as local in nature to
become increasingly national in scope. Among the more important
factors contributing to the growth of public expenditures have been
the following:
1. The expansion of public wants.
2. The rise of the modern state, with its emphasis upon service
to the citizens.
3. Costly wars and international tensions.
4. Increasing population and changes in the age and distribu
tion of population.
5. The industrial and social revolution of the 19th and 20th
centuries, with changing techniques of production, changing eco
nomic and social problems, and new efforts at social progress.
6. Rising incomes and higher levels of individual and public
consumption.
7. The direction of fiscal policies toward coping with economic
development and stability.
8. The development of government taxation and borrowing,
with consequent increases in the funds at the disposal of gov
ernments.
9. Rising prices.
Certainly, there have been many forces at work in the continuing
rise of government expenditures. In the United States, a great part
of the increasing cost of government must be attributed to the direct
ECONOMIC GROWTH AND STABILITY
234
and related costs of war and national defense. Modern nations have
become more efficient in killing and in destroying resources. In gen
eral, war would appear to be a waster of both material and human
resources. •
There is undoubtedly much waste in government, as in private and
business, activity. The growth of government expenditures must be
related to numerous complex political, economic, social, psychological,
and moral pressures. At bottom, there has been the continuing and
expanding want for public services, with resistance coming primarily
from the taxpayers and others who have felt the burden of paying
for these services.
T
he
Q
u e s t io n
or C
e n t r a l iz a t io n
I f public safety, highways, health, education, welfare, and other
functions are to be assumed by governments, to what extent should
the responsibility for the function and its financing be located at the
Federal, State, and local levels? Some persons will say, “Let com
parative efficiency decide.” Although it is not always clear what
efficiency means here, let us assume that it is a problem of assigning
functional responsibility to the level of government which can pro
vide the desired amount and quality of service at the lowest cost.
There could be little doubt that on such a basis national defense
would be located with the Federal Government, even though many
persons have vigorously assailed what they consider to be waste in
the Defense Establishment. Factors other than unit costs are in
volved, however. Unified national action in an emergency is essential.
The cost of defense in the aggregate, moreover, is so great that State
and local governments could hardly support it.
Without attempting here to evaluate the relative efficiency of the
Federal, State, and local governments in providing public services,
it may be pointed out that cost data are lacking in many areas to fur
nish a basis of comparison. To measure unit costs, we must have
units of performance which are strictly and uniformly comparable.
Such units are often unavailable.
There has been much argument over the years concerning the rel
ative efficiency of the Federal, State, and local governments in terms
of costs. Some persons contend that the large Federal Government
tends to be most efficient, apparently identifying size with efficiency.
Some argue as eloquently that the closer government is to the people,
the more the people can watch and control it, with consequent gains in
efficiency. Other persons regard the States as more efficient than the
local and Federal governments, feeling that local units are too small
for maximum efficiency in many functions and the Federal Govern
ment is too large or is too preoccupied with national defense prob
lems to offer the greatest efficiency in domestic services.
Actually, the distribution of functions among our governments has
resulted from the operation of a number of factors. Among them are
these:
1. Constitutional requirements.
2.
3.
4.
5.
Political considerations.
Available resources.
The widening community interest.
Assumed efficiency of performance.
ECONOMIC GROWTH AND STABILITY
235
6. The inherent interdependence of governments in this
country.
7. The desire for uniformity.
Perhaps most Americans believe that strong and active State and
local governments are necessary for the improvement and survival
of our type of representative government, or democracy. I f this
conviction holds, one may feel that functional and financial responsi
bility should, so far as possible, be placed at the local and State levels
even if the Federal Government would provide a more uniform and
adequate service.
I f uniformity is regarded as paramount, national responsibility will
be advocated. Bigness in government, as in business and labor, is
undoubtedly favored by many persons. Bigness may bring weaknesses
and waste, however, as students of government and society know.
I f efficiency is to be rated as a primary factor in allocating govern
mental responsibility, we may face the difficulty that wTe have in
sufficient data to determine comparative costs, or we may interpret
efficiency in terms of uniformity or the amount or quality of service
without weighing costs. One may assume that big Central Govern
ment is more or less efficient than State and local governments, or that
local governments near the people are the most or least efficient, with
out having comparative cost data. We may start out with a predilec
tion for central or local government and, through a rationalization
process, find evidence and arguments to support the conclusion which
we adopted as our initial hypothesis.
W
aste in
G
overnm ent
E
x p e n d it u r e s
Nearly everyone wants economical and efficient government when
he thinks of his taxes and other charges. He wants “ to get the most
for his money” in financing services which he thinks are essential. At
the same time, the typical citizen seems to seek, or at least accept, serv
ices of benefit to himself for which others largely or entirely pay.
The wasteful use of our resources in government expenditures
arises from wrong decisions as to public functions and provision for
them and in the inefficient and costly admmistraton of public func
tions. Waste thus arises in spending too little in some instances and
too much in others.
Social reformers would have us spend more for various social serv
ices, arguing that it is wasteful not to spend enough. Many taxpayers
groups contend that governments are assuming too many responsibili
ties and are administering their functions in a wasteful and inefficient
manner.
Waste resulting from the assumption of too many Federal responsi
bilities may be greatly reduced by slashing certain expenditures,
according to various business organizations asking for greater economy
and efficiency. They would redilce expenditures for national defense,
foreign aid, veterans’ benefits, agricultural subsidies, and other serv
ices. They would eliminate what they regard as wasteful public
works and housing expenditures, reject a general public health in
surance program, leave the financing of public education to the States,
keep the Government out of competition with private business, and,
in general, cut down on Federal expenditures.
236
ECONOMIC GROWTH AND STABILITY
The advocates of economy and efficiency have also proposed numer
ous reforms in governmtal organization and in the techniques of ad
ministration. They have supported such measures as the following:
1. The Budget and Accounting Act of 1921
2. The Corporation Control Act of 1945
3. The legislative ceiling on expenditures
4. The consolidated appropriation bill
5. Limitations on income taxes
6. Centralized purchasing
7. Improved accounting, auditing, and financial reporting
8. Adequate congressional staff for appropriation analysis
9. Performance budgeting
Many of these measures have been advocated by those desiring in
creased, as well as decreased, expenditures. Once policy decisions are
reached, efficiency in government operations would seem to be gen
erally desired. Improved budgetary and other controls should, in
deed, be helpful in arriving at policy decisions.
A
P
rogram
of
C
ontrol
The Federal budget and the budgets of some of the States and large
cities have grown to such proportions that some persons despair of
any real control over expenditures. How can anyone comprehend de
fense expenditures of $40 billion or total Federal expenditures of $70
billion or more? And who can comprehend the expenditures of thou
sands of units of government exceeding $100 billion ?
The size and direction of expenditures have been determined largely
in the rough and tumble of the budget process, with spending and
opposing pressures in continuing conflict. In our system of govern
ment, success in the control of government expenditures in the ad
vancement of our community goals requires the constant, intelligent,
fair, and constructive cooperation of the citizens and the executive
and legislative branches of our governments. Final judgments, in a
democracy, must be arrived at by compromising the different points
of view of those involved. I f we work together in a rational and
helpful manner, the compromise will be consistent with the common
goals of at least the majority.
Expenditures start with proposals for appropriations. Unless ap
propriations are controlled, expenditures cannot be controlled.
Many persons have said that Congress has lost control of the appro
priation process. But control is often in a precarious balance, and it
involves the executive branch and the citizens as well as the legisla
ture. Control must therefore be exerted at every stage of the budget
process through the best efforts of all the parties involved.
The techniques of expenditure control are, in general, well known
to students of public finance in and out of government. The will to
control is more apt to be missing than the techniques, although im
proved techniques are continually being developed. The techniques
frequently need refining and improvement, but those which are avail
able are often overlooked.
Another weakness in efforts at expenditure control is the failure
to appraise each appropriation and expenditure in relation to a total
program, and to attain consistency throughout the total program of a
government. Inconsistencies may exist in the spending program of a
ECONOMIC GROWTH AND STABILITY
237
certain department and are frequently found among the various spend
ing measures of a government. In addition, the expenditures of the
various levels of government may be somewhat inconsistent with each
other.
Democracy is a cumbersome and bungling process, in many respects.
It could, however, operate more logically, economically, and efficiently
if greater and more intelligent efforts were exerted.
An important check on the success or failure of the spending pro
gram may be found in the attitudes of the taxpayers and those who
must “ pay the bill.” Taxpayer complaints may be exaggerated with
respect to claims concerning the destructive burdens of taxation. On
the other hand, many taxes are now levied at very high rates. Many
other substantial taxes are collected indirectly from the people and
the total tax burdens are not visible, with the result that expenditures
are not, under the circumstances resisted or criticized.
Government expenditures are warranted, in the. last analysis, only
if their social benefits exceed their social costs. The effects of each
expenditure and each revenue, in relation to the total spending and
taxing picture, must therefore be appraised if Government activities
and finances are to be controlled in the best interests of the community.
Taxation does interfere with the lives and economic pursuits of
the people. Whatever may be the benefits of the expenditure of the
tax proceeds to certain groups and society at large, to the person pay
ing the bill or otherwise feeling the effects of taxation, it is a cost.
Government is justified only when it provides essential public serv
ices which would otherwise not be available and when it supplies essen
tial public services at a lower cost than other sources could.
In this brief discussion of some of the problems confronted in seek
ing the maximum economy and efficiency in Government expenditures,
more questions have been raised than have been answered. Certainly
we are a long way from the rational, fair, and complete control of
Government expenditures as a means to advance our community ob
jectives.
The techniques of control, sometimes of the nature of gadgets, will
not in themselves assure control. Nor will the reorganization of each
unit of Government and placing more responsibility for public services
and their financing on the State and local governments, however com
mendable these measures may be.
There must be an effective and continuing will to control if our hu
man and material resources are to be employed to best advantage by
governments. Such a will to control has not yet been fully developed
and exerted.
In the appropriation, expenditure, and taxation process all of the
essential information available concerning proposals and their possible
effects should be brought out in the open for the full appraisal by
citizen groups as well as public officials. The advantages and dis
advantages of each proposal should be weighed, relating the proposal
to the total program of appropriation, expenditure, and taxation.
Control, to be effective, must be exercised in all of the stages of
budgeting and taxation. It is necessarily continuing and unending.
Control requires standards of performance and the appraisal of
performance. The standards must be related to value judgments as to
97735— 57------- 17
238
ECONOMIC GROWTH AND STABILITY
what they should be. The appraisal of performance also involves
judgments.
In our representative form of government, with a Federal system,
control of Government expenditures is contingent upon the effective
teamwork of the citizens, the legislature, and the administration. The
problem is tremendously complicated. If, however, we recognize its
complications and seek out and apply the constructive measures which
are available to us, we can go a long way toward increasing the econ
omy and efficiency of our governments and keeping the tax burdens
and other costs to a rational minimum.
THE INTEREST RATE IN COST-BENEFIT ANALYSIS
.
Arnold C. Harberger, associate professor of economics,
University of Chicago
It would be hard to overstate the importance of the interest rate
used in the discounting of benefits and costs to judge the worthwhile
ness of proposed long-term Federal investments. Suppose a project
were expected to yield benefits of $1 million a year beginning 5 years
from the initiation of construction and extending indefinitely into
the future. Using an interest rate of 2y2 percent, we would evaluate
this stream of expected benefits at $35.36 million as of the date of
initiation of the project. But if we were to use a 6-percent rate, our
evaluation would be no more than $12.45 milion. The choice of inter
est rate becomes more critical, the longer the duration of the project
in question, and the longer the lag between the beginning of construc
tion and the time when benefits begin to accrue. Clearly major mis
takes can be made if the wrong interest rate is used in evaluation. I f
the cost of the above project were $20 million, it would be a fine in
vestment if 21/2 percent were the right rate and a terrible mistake if
6 percent were the right rate. I propose to argue in this paper that a
rate of 6 percent or better is the proper rate to use in evaluating
Federal projects. This compares with a rate of 2y2 percent most com
monly used by the Government agencies which undertake cost-benefit
analyses.
The justification most commonly given for the use of the 2y2 per
cent rate is that that is the rate at which the Government can borrow.
This, of course, is no longer true; perhaps a Sy2 percent rate would
accord better with the present state of the money market. Be that as
it may, my argument for a rate of 6 percent or better does not depend
critically on the state of the money market. It holds equally well
for the easy-money days immediately following the second World War
and for the hard-money period through which we are now passing.
The essence of my argument is that there exist and have existed
ever since the war widespread opportunities for investments yield
ing 6 and 8 percent and higher. So long as such opportunities are
available, our society does itself a disservice by investing at yields of
merely 2y2 or 3y2 percent. The opportunies I speak of are those at
the margins of industrial and agricultural investment, and I suspect
it is also true that investment in residential construction might yield
close to 6 percent.
Let us consider a typical industrial investment. Let it be financed
half out of equity (or retained earnings) and half out of borrowings.
What must it yield in order that it be a successful investment in the
market sense ? Presumably, the total yield should be sufficient to pay
the interest on the borrowings and provide a rate of return on the
newly invested equity equal to the market rate of return on equity.
Takirio- figures which are reasonably representative of the period since
*39
240
ECONOMIC GROWTH AND STABILITY
the war, let us assume the interest charge on borrowings to be 4 per
cent, ana the earnings yield of equities to be 10 percent. This earmngs
yield is? of course, after taxes; the before-tax yield of equity capital
has typically been in the order of 20 percent. Thus our typical suc
cessful investment yields 4 percent on half the invested funds and 20
percent on the other half, making the rate of return on the whole equal
to 12 percent. It may be objected that the 10 percent figure for earn
ings yield, -while representative of the whole postwar period, has been
rendered obsolete by the great rise in stock prices that has occurred.
For recent years a figure of 7 percent might be better for the after
tax yield of equities. This means 14 percent before tax, and together
with a 4 percent borrowing rate applied to half the total capital im
plies an overall yield on capital of 9 percent, rather than the 12percent figure obtained earlier.
Another approach to estimating the rate o f return on capital in
the United States is to compare total income received on account of
capital with the total value of the capital itself. Neither of these
components is easy to estimate, but much work has been done in re
cent years to improve our knowledge of both.1 In spite of the lack
of absolute precision in the presently available estimates, one may
feel quite confident that the stock of capital in the United States
is somewhere between 3 and 4 times the national income, and that
the income accruing to capital amounts to somewhere between onethird and one-fourth of the national income. Our estimate of the
rate of return on capital in the overall economy lies, then, in the
range between 6^4 percent (income of one-fourth divided by capital
of 4) and 11.1 percent (income of one-third divided by capital of
3), and probably closer to the middle than to the extremes of the
range.
In the case of agriculture we have a reasonably good measure of
the return on capital in the ratio of the gross rent paid to the value
of rented farms. For 12 Corn Belt States this rent/value ratio
ranged from an average of 5l£ percent in Ohio to an average of
8 percent in Wisconsin, with most States averaging between 6 and
7 percent. The figures are for 1954-57, and apply to farms rented
wholly for cash.2
It is clear that there do exist many alternative investments yield
ing 6 percent and more per year. One might ask, however, whether
these differ substantially from typical government projects in their
degree of riskiness, so as to warrant a substantially different rate of
return. I cannot help but feel that Federal projects are highly
similar in their degree of riskiness to many private projects. Both
power and irrigation facilities are provided by the private market
side by side with Federal installations, as are, from time to time, river
and harbor improvements, flood-control facilities, etc. These rank,
to the best of my judgment, neither as especially safe nor especially
risky investments. It therefore seems reasonable to expect that Fed
eral investments in these activities should pay off at least at 6 per
cent, which, as we have seen, appears to be somewhat below the aver
1 Cf. ^Raymond Goldsmith, A Study of Saving in the United States.
(Prineetopi: 1956.)
Moses ^bram ovitz, Resource and Output Trends in the United States Since 1870* American
Economic Review, M ay 1956, pp. 5 -2 3 , and the sources cited therein.
2 U. S. Department of Agriculture, The Farm Cost Situation, M ay 1957, p. 19, table 8 -
ECONOMIC GROWTH AND STABILITY
241
age return on investments in the private sector of the economy. The
purpose of Federal investment is, I believe, to improve our level of
living and that of our children; the measure of this improvement is
provided in dollar terms through the estimation of benefits. There
seems little or no justification for the Government’s withdrawing re
sources from the private sector unless these will yield as much im
provement in levels of living as ordinary private investments.
My recommending the use of a substantially higher interest rate
in cost-benefit analysis does not imply any prejudgment that serious
mistakes were made because a lower rate was used. If estimated
benefits were 5 times costs using a 2 percent rate, they would likely
turn out to exceed costs, though by a smaller margin, when a 6 or 8
percent rate was used. It is the projects which are marginal in the
first place that look bad when a higher rate is used. It is accordingly
of interest to inquire whether projects actually undertaken could pass
the test of a higher interest rate. A group of investigators at the
University of Chicago have looked into this question, using the same
benefit and cost estimates as were presented by the agency in ques
tion, but simply applying different interest rates for time discount
's .
.
Out of 24 Bureau of Reclamation projects which were in fact un
dertaken, only 8 would have been judged acceptable at a 5-percent
rate, only 2 at a 7V2 -percent rate, and only 1 at a 10-percent rate, if
only primary benefits are taken into consideration. Counting sec
ondary as well as primary benefits, 16 projects would pass the test at
the 5-percent rate, 9 at the 7^-percent rate, and 4 at the 10-percent
rate. Similar results emerged from a study of 29 Corps of Engineers
projects. However, in the case of 27 Department of Agriculture
watershed programs, practically all of the projects would stand up
under a 5-percent rate, and two-thirds would be acceptable at a 10percent rate, though one must add that the estimates of benefits, which
are the raw material of benefit-cost analysis, appear to be subject to
substantial possible error in these cases.’
Thus it appears that the use of a higher rate would have precluded
some, but by no means all of the projects actually undertaken. I
strongly recommend and urge that future Federal investments receive
scrutiny in terms of a rate or interest comparable to the return to capi
tal in the private sector. This will lead to a better use of our re
sources, and in the bargain may provide some possibilities for budget
limitation.
8 University of Chicago Office of Agricultural Economics Research.
July 18, 1956, pp. 4 -5 .
Paper No. 5612,
ECONOMY IN GOVERNMENT SPENDING: THE
CONCEPT1
C. Lowell Harriss, associate professor of economics, Columbia
'
University
The literature on government spending—official, academic, and
popular-^contains relatively little discussion of the concept of effi
ciency or economy.2 Theories about the meaning of “economy” are
implicit in the terms of reference, in the method of approach, or in
the coverage of the special commissions that seek greater efficiency.
Also largely implicit rather than clearly defined are the concepts of
economy which underlie the normal workings of the budgetary proc
ess (conceived most broadly). The writings of economists, so far
as I am aware, give the problem little explicit attention. Yet in a
world where governments have the role they do today, efficiency in
government spending has an importance that calls for our best in^
tellectual efforts.
•
T
he
G
eneral
C
oncept
or E
conom y
(E
f f ic ie n c y
)
Economizing is the process of getting good (better) Value or,
essentially the same thing, higher efficiency; success is achieved when
the use of resources yields the best result possible. The crucial ele
ment is a,relationship between (a) what is used up and ( i ) what is
received, i. e., between input and output. Only when one compares
this relationship can one study economizing.
A reduction m expenditure is not necessarily a move toward econ
omy; perhaps the loss of output is even greater. In fact, onei per
sistent fallacy in discussions of government economy is an assuffiiiption that not spending is economy; a person terminating his expendi
ture on food would find himself with more money to starve—not
my idea of economy. On the other hand, an improvement in ac
complishment which yields something highly desired is not neces
sarily evidence of greater efficiency; the cost may have been
........
excessive.
There are some other things that are not necessarily guides to
economy. The recent concern over the size of the budget totals as
such, for example, seems to me misplaced. A rising or falling ex
penditure trend, in itself, gives no indication of efficiency. No per
capita figure, no percentage relationship to national income, no com
parison with another era or another land—no such measure—can re-<
1 I t w as only late in August that a release from other commitments permitted me to
accept the invitation to participate here. M y points rest on work done over a period o f
years, without the new research I would have undertaken had time permitted.
2 The outstanding exception with which I am fam iliar is M ayor’s Committee on Manage
ment Survey, Modern Management for the City of New York, New York, 1953, vol. 1,
pp. 32 ff. M y statement in the text is not intended to disparage the work of the Hoover
or other commissions.
242
ECONOMIC GROWTH AND STABILITY
243
veal whether spending is economical. Such figures do not compare
what we get with what we pay.
The inputs of a business or a government are resources, human time
and effort., materials, the use of equipment.3 In most cases they have
money prices; consequently, a reasonably reliable money measure of
cost is available. In a more fundamental sense cost is the best alterna
tive sacrificed; money measures may not indicate the complete worth
of the alternatives sacrificed. Consequently, a look beyond money
figures is needed if costs (inputs of any economic process) are to be
measured fully. Yet these more fundamental measurements are rarely
feasible; for the most part we assume that people spending their dol
lars freely take as good account of alternatives as an imperfect world
permits. Where compulsion rather than free market choice deter
mines—and this is characteristic of the way governments get funds—
there is a presumption that dollars do not give an accurate measure
of the worth of alternatives sacrificed. Yet I know of no way to
allow for distortions in cost measurement that result from compulsion.
Still greater difficulty arises in measuring outputs of government.
The procedure used in national income accounting (valuing output
precisely at money cost, i. e., treating input arid output as identical in
money value) is utterly inappropriate tor judging economy and effi
ciency. Yet there is no other simple or precise measure of output.
Therefore, government spending presents a strikingly different prob
lem from that of either business or family spending.
Business has a tangible measure of output—the dollars customers
will pay; these dollars are just like the dollars in which costs are
paid; comparison of inputs and outputs is easy (except as gaps in time
separate them).4 Families as ultimate consumers draw upon im
mediate and direct experience to make their judgments of the worth
of spending. What the public gets from government expenditure
varies from indispensable elements of existence itself to services of
insignificant worth, perhaps even positively harmful. What are these
varied outputs worth ? And what about outputs that could be obtained
from more or different spending ? Some might be worth a great deal
more than they would cost, but so long as they are not “ purchased” we
have little basis for judgment. The difficulties of measuring outputs
create the chief obstacle to applying the traditional economic or
business concept of efficiency in government affairs.
I
m p r o v in g
M
ethods
of
O
p e r a t io n
Yet there is a level at which the problem of efficiency can be studied
and mastered without raising the more difficult issues. Here we see
the most readily understandable concept of economy. It involves
choice of methods of achieving immediate, specific objectives. The
objectives ordinarily involve operation—heating a hospital, processing
a voucher, dredging a channel, building a barracks. The thing to be
3 Government spending which transfers command over resources rather than uses them
to create goods and services presents problems treated later. The definition of ‘‘govern
ment expenditure” is in fact mtfch more complex than m ay appear. See C. Lowell Iiarriss,
Go-vernment Expenditure: Significant Issues of Definition, Journal of Finance, December
1954, pp. 3 5 1 -3 6 4 .
4 Not all-the'ob jectives businesses and businessmen seek through profitmaking activity
are sold in the market. The pure exceptions raise problems very like those that charac
terize government spending.
244
ECONOMIC GROWTH AND STABILITY
accomplished has been decided upon and defined with considerable
precision. Then the reasonably possible methods of achieving it can
be compared and the cheapest selected. The problem may closely
resemble one which business firms face; their solutions can be ex
tremely helpful.5 So can the solutions of other governments.
This approach, the application of businesslike methods, has helped
improve government efficiency. (A change in operating methods to
cut spending may also change the accomplishment; if the output is
better, the desirability of the change clear; if accomplishment suffers,
the wisdom of the change is very much harder to judge.) Frequently,
the use of business methods will require at least a temporary increase
in outlays, such as for mechanization; spending more saves money
later. So much government spending is on wages and salaries that
improvement in personnel policies (in the broadest sense) may offer
the greatest challenges to those striving for more efficiency. Promis
ing opportunities for bettering methods lie ahead, I suspect. How
ever, in view of the determined efforts of recent years, I should be
surprised if the application of business methods offers promise of
great improvements in efficiency at the Federal level except as better
methods are devised in business; Members of Congress are in a better
position than I to judge the possibilities. Yet, as has been pointed
out so often, the big problems lie elsewhere, in the formulation of
programs.
Before passing to the larger issues, however, it is wise to note some
issues which may confuse the choice of one as against another operat
ing method.
A government spending program may seek mixed objectives.
Consequently, a, businesslike method that is best for getting one part
of the objective, perhaps the dominant one, may need to be discarded
because it is ill suited for another. One thinks of the Walsh-Healey
Act, the requirement that United States ships be used for transport
ing a portion of foreign-aid cargoes, the desire to channel procurement
orders to depressed areas, or ‘%uy American.” One also thinks of
our desire to prevent corruption, dishonesty, personal favoritism—■
the “ spoils system”—even at the sacrifice of flexibility and speed.
A systematic survey of Federal spending policies would probably
reveal many examples of mixtures of objectives which influence oper
ating methods. All the objectives may be worthy. That is not the
point here. The point is that combination of objectives may impede
the choice of the least expensive operating method of achieving the
main goal. Even worse, the “mixing” adds difficulty in identifying
the method which will give the best combined result.
Difficulty in finding and using the cheapest method of achieving a
stated objective also arises from government methods of accounting
for capital items.6 I f spending proj ects provide services over different
stretches of time, or if projects involve costs that extend over varying
periods, judgments of economy can be reliable only if an appropriate
interest (discount) factor is used. The choice of am appropriate
6 Successful businesses sometimes use different methods for performing an essentially
similar function. The business world will not always contain one procedure which all
recognize as best.
* Developments since I last studied this problem may have altered some of the problems
described here.
ECONOMIC GROWTH AND STABILITY
245
figure is itself a matter for debate.7 Yet the essentiality of including
the calculation in decision making is (or ought to be) beyond dispute.
A second problem of capital accounting is depreciation (including
obsolescence) .* The traditional method of treating capital spending
plus maintenance as current expense and ignoring depreciation may
give tolerably good results for the budget as a whole, though I have
great doubts. For individual projects, such a method is certainly not
the beet man can devise. The treatment of capital expenditures on
long-lived projects as current outlays on the same basis as payment
for labor services yielding only momentary worth (delivery of today’s
mail) must distort judgments on the wisdom of capital outlays. The
concept of economy in executing programs ought to include allowance
for depreciation. Differences between leasing and ownership must
sometimes complicate measurement of efficiency.
The problem of tax exemption also arises in evaluation of one as
against another method of achieving a social objective. This country
has chosen to get much of the money for financing government from
businesses, or more generally, from the process of creating income.8
Taxes are a significant element of cost for most productive organiza
tions (creative activities). An activity that does not need to include
expense of government as a cost will appear to operate more cheaply
than activities which do pay taxes; yet the apparent “saving” is not
a reliable guide to economy.10
A less generally recognized aspect of the tax problem as it bears
upon comparisons of efficiency arises from tax exemption as a substi
tute for expenditure. Seeking an objective that requires use of re
sources, Congress may rely on some form of tax exemption.11
Occasionally, perhaps, the taxes that might otherwise be collected
can be determined to provide a good index of cost; I can think of no
case, however, in which the cost is treated along with dollar outlays
as an expense of government.
Appraising the efficiency of guaranties and insurance as devices for
achieving objectives presents other perplexing problems. Without
either an outlay or a sacrifice of revenue, government can perhaps
bring changes in the private economy. Yet how much guaranty (or
insurance) will produce how much result ? and what kind %12 More
over, there is the chance that sometime the Treasury may be called
upon to make cash payments to cover losses. But how much ? Busi
ness concepts of economy cannot really be applied to evaluate “operat
ing” methods in such cases.
I The rate used should probably be that for which Government can borrow freely in the
market for a period equal to that of the services and costs Involved.
•A third problem, the treatment of loan transactions, would be discussed in a more
complete study.
• For this purpose, the provision of housing services, through rental or owner occupancy,
is a form of income creation. The chief tax is the local property tax.
10 In trying to improve the Nation’s transportation system, for example, we sttll fail
to solve the problem of differences between forms of transport which cover less than they
cost (airlines not paying all expenses of terminals), those which pay approximately their
cost (some trucks), and those (railroads) which, in addition to paying their own expenses,
contribute to the treasuries of local, State, and the National Government for nontrans
portation functions. In trying to improve communication, comparison of the postal and
telephone systems should take aceount of the widely different tax treatment.
II Accelerated amortization is even more difficult to appraise than tax exemption. The
interest lost to the Treasury from the tax deferment cannot be determined when tile decision
to grant rapid amortization is made. Nor can we judge how much will be accomplished
that would otherwise not be done.
11'The history of “ 606 housing” insurance suggests that all results of a well-intentioned
policy are not desirable. Perhaps generous provisions for guaranty and insurance etf
home mortgage*, by stimulating demand, have raised land prices and building costs; if
so, some of the basic objectives were partially defeated. How could one, tfren, judge the
efficiency of the Government’s methods for getting the results it sought?
246
ECONOMIC GROWTH AND STABILITY
C
osts
: C
onceptual
I
ssu es
I
nvolved in
J
u d g in g
E
f f ic ie n c y
Dollars raised by either taxes or government borrowing do not
necessarily give an accurate measure of the worth of sacrificed
alternatives.13 Some of the problems involved are inherently insol
uble, but there is point in understanding them.
Most taxes are compulsory contributions, clear or hidden. They
exist because of the approval (or the absence of strong disapproval)
of representatives of a majority of the voting public.14 Yet even
casual familiarity with the process, of tax legislation should leave
no doubt that the total an individual pays can be quite different from
what would represent his freely but responsibly and conscientiously
made judgment of his proper contribution. His marginal taxes—
whether in a high personal income bracket, a tax on business earnings
that is a cost of what he buys or a reduction of his income, or an
cise tax—may or may not seem more desirable than some (marginal)
government services. Few if any of us, I suppose, could make such
a calculation for ourselves. How can we (our representatives) do so
for others? How validly can any vote of taxes—forcing payment
even from those unable to vote or voting in opposition—reflect the
worth of alternatives sacrificed ?
Some resources in private hands undoubtedly serve purposes of
slight usefulness. To take them in taxes is to impose little sacrifice
of a truly desirable alternative. The fact that this situation undoubt
edly exists has been used to justify some (a large amount of) high
bracket rates even when there is no basis for determining how much
of the money collected will actually come from such sources. Yet it is
wrong, I think but cannot prove, to attempt to justify any signifi
cant amount of government spending on the grounds that payment
can be made with tax dollars that impose slight cost on the taxpayer.
Still less justification exists for implying that we know which dollars
have such low cost.
Taxes impose a type of cost unlike that of prices.15 This cost re
sults from tax-induced distortion of economic (and social) life. The
individual (or business), with some exceptions, gets the same services
whether or not he (it) pays a Federal tax. Any one person’s or firm’s
failure to pay tax brings no loss of government service. This situa
tion contrasts with market transactions in which the product or serv
ice can be obtained only if the price is paid. Consequently, the incen
tives to escape taxes are quite different from those to avoid paying
prices. The escape (evasion or avoidance) requires time and effort,
costs which are largely pure waste for the economy; in addition, the
escape will often involve choice of actions less desirable than one would
otherwise choose. The allocation of resources becomes somewhat less
efficient. Sheer losses to the economy result, but losses which cannot be
measured.16
MRevenues from charges are more likely to measure the worth of sacrificed alternatives
tolerably well.
14Unlike many State and local taxes, Federal levies are not the result of constitutional
or charter provisions that decisively limit the freedom of the voting public. Yet the dead
hand of the past has powerful influence. Congress, the administration, and the courts
cannot in fact make frequent, large revisions In the revenue system.
15The cost of administering some taxes may be less than that of charging prices.
“ When tax rates are moderate, such distortions are insignificant; when rates are high,
the losses, while not large in the national accounts, may be more than insignificant in rela
tion to the revenue from the top rates. Some dollars the goverment gets may cost the
economy very much more than the average.
ECONOMIC GROWTH AND STABILITY
247
What the Treasury pays for funds obtained by borrowing may
represent a good measure of sacrificed alternatives. This is probably
true of proceeds of loans sold in open competitive markets when in
formation is compete and no appeals to patriotism or other such con
siderations sway decisions. To the extent that sentiment or ignorance
influences the loan terms, however, the expense to the government may
represent a less good measure of cost than might be obtained. When
the loan is compulsory, as in the case of social security, how can one
judge cost? A person compelled to lend to the Treasury for 2 per
cent when he is paying, say, 6 or 12 percent on his own (marginal)
borrowings may in a significant sense be incurring a greater cost
than the Treasury pays.
A still clearer departure of apparent money cost from the worth of
sacrificed alternatives arises when borrowings come from the banking
system, especially in times of substantial unemployment. Little or no
sacrifice of desired alternatives may then be required. At this point
we have reached more complex considerations than my space per
mits me to examine.
The upshot of these comments on cost seems to be that tax dollars
are likely to impose sacrifices worth somewhat more than the dollars
suggest, especially when tax rates are high. So will compulsory bor
rowing. Finally, conscription and other compulsion will likely in
volve costs above those shown in the Treasury’s figures.
A
t t a in m e n t s :
G oods
and
S e r v ic e s
Now we return to the heart of the problem, the need to evaluate
what is or might be obtained. Here is the task of program formula
tion. It involves two essentially different kinds of outlays: (a)
Spending to get goods and services (national defense, postal services,
tax collection); and (6) transfer spending (welfare, subsidies to
farmers) .17 The first buys goods and services which are thereby
taken from other uses; government use imposes real sacrifice, real
cost. Transfers, however, do not use up resources (except for the
relatively minor expense of administration); they do not take pro
ductive capacity from other uses to create government output.
How much benefit does society get from an element o f govern
ment spending that yields goods or services? The gains may be
incalculable in the sense of being great beyond measure. A l m o st
always the results (good or bad) are incalculable in the sense of
not being measurable. Rarely can fruits be evaluated with anything
like the precision with which a business can value what its spending
programs bring. It is even harder to envision accurately the gains
from spending programs that might be but are not being made. , The
difficulties are likely to create a sense of frustration. Yet we must
do something.
The start is to define objectives,, both ultimate and immediate,
as clearly as possible. What constitutes a better life? Peace, vic
tory, personal freedom, to be liked abroad, reduction of poverty,
health, the development of human personality and opportunity, jus
tice, equality before the law—so goes the list of things most of us
want, things that seem basic. Then one faces the choice of more
a The two groups are not sharply distinct.
248
ECONOMIC GROWTH AND STABILITY
instrumental objectives, desirable as means to help achieve the basic
ends. Some of these instrumental objectives may (or must) be
sought through government spending.18 Much of the analysis of
objectives at both levels is intuitive. W e cannot have all we want; so
we must choose from among a host of good things. Few of us as
individuals, I suspect, can measure and balance basic values to our
own satisfaction. Doing so as a group is even harder.
Confusion of instrumental objectives with those that are more
fundamental is a recurring source of difficulty; means get mixed with
ends. Success in achieving some specific goal this year— new knowl
edge about disease or improvement in recruiting Foreign Service
officers— may be a fine move toward a more basic goal— better health
or diplomacy. Yet this year’s success may only conflict with the
achievement of a more basic objective. The low-interest rate policies
of the late 1940’s and more than one feature of agricultural policy
seem to me examples; failure to raise salaries of senior civil servants
may save money now but cost heavily in longer run quality of govern
ment services. Moreover, it is not economical to do efficiently some
thing desirable if the accomplishment of something still more import
ant becomes harder as a result.19
The definition and redefinition of objectives, fundamental and in
strumental, must be a continuous process if we are to make the wisest
decisions. In a dynamic society both needs and opportunities change.
Economy requires more keeping up to date than we may think.
Enough modernization of goals to prevent the continuation of serious
waste— including waste in the form of failure to take advantage of
new spending possibilities that offer more than they would cost— is
difficult in a world where so many things press for attention.
Choice of objectives would be easier if the public had clear knowl
edge of its wants in order of priority. Unfortunately, however, the
world is too complex for public opinion to be clear on more than the
broadest matters. W e must rely upon our elected representatives (and,
in my view, the civil service). One of the greatest of the difficulties
they face is the identification of the general public interest.
Government undertakes a spending program because the public as
a whole will benefit.20 Unless there is such a paramount general con
cern, the use of public funds is not justified. Or so it seems to me.21
Yet the total gam from any program will include some more or less
specific benefits; not all individuals will be affected equally. Those
aware of greater benefits— from this dam, that research, or any mili
tary installation— are likely to press for the spending more insistently
than the average person. There may, in fact, be a oias against gen
eral benefit spending in favor of that for special interests; the strong
est pressures do not necessarily— even “in theory”— reflect what will
best serve the general interest.
Another factor adds confusion. The many elements of our society
are so interdependent that the prosperity of one influences that of
* The analysis w ill involve the question, “ I f this goal is one people in general want, why
w ill the free market not provide tne means to reach it if the w orth exceeds the cost?”
* Federal-State local rivalry fo r funds may oiTer examples. M any localities, I suspect,
spend less on schools than they would if Federal spending (and taxes) were lower. Some
o f the Federal spending m ay be done efficiently, but on projects less inportant than addi
tions to school facilities.
* Programs financed by charges on the user constitute exceptions.
a Although this view has been dominant in the legal and scholarly writings, the “ man in
the street” m ight not hold to It strongly.
ECONOMIC GROWTH AND STABILITY
249
others. Consequently, groups press for government spending to bring
them special benefits; they rest their plea on the claim that the public
as a whole will benefit; this general benefit is to come not from the
products or services created but from the diffusion through the econ
omy of secondary benefits which result from the improved position
of the special groups.22 The pressure on Congress to vote for spending
on the basis of special, rather than the general public, interest must
complicate the determination (as well as the achievement) of what is
most economical. The relative persuasiveness of special interests is
not necessarily proportionate to the contribution of their programs to
the general public interest.
Up to this point we have shown, I hope, that economy in spending
requires knowledge of (a) what the public wants (developed to a
rather refined degree) and ( b) what specific programs do contribute,
not in their totality but to the general interest.23 Our ability to judge
what the goods and services really do provide will vary. Newer
budgetary procedures help focus on this problem, but they cannot
yield all the answers we should like about what the public is now
getting.24
The most serious problems arise, I suppose, in protective functions.
This is true not only because the amounts are so large but also because
the strength of the thing to be protected against (the physical capac
ity and the willingness to use it) is unknown.25 In the case of national
defense, the ideal minimum and maximum expenditure would seem
to be the same— the amount that will just prevent the need to use
force actively. Not knowing what this amount is, however, Congress
will act economically in providing a margin over what appears essen
tial; the losses can be so tragic that the risk of error which might bring
war cannot be assumed. (Yet other outlays— on foreign service, in
formation, foreign aid— also influence the amount of our need for
defense spending.) Success may appear as waste, perhaps sheer ex
travagance. The whole concept of economy in protective (defense)
spending bristles with difficult problems, to say nothing of those that
arise in implementing a program.
Each of the other major categories of Federal spending presents
its own problems of relating (a) what the public wants to, (b) what
actual (and possible) spending does accomplish. The specialized
papers presented later will doubtless do much to illuminate the is
sues— how Congress has come to decide what the public wants, how
money is spent, what the results are, and perhaps what might be
gained from greater spending.
One more point. The use of government as an agency to achieve
objectives offers a way to serve the public interest where individuals
and voluntary associations will do nothing or too little. Sometimes
such spending can, as it were, tip a balance or fill a gap and thereby
stimulate private activities that are highly desirable. Outlays to prow The hurt to the general public from the necessary taxes is likely to be Ignored except
as some other group may point out the connection.
23 To the extent that a program is paid for by charges on users or beneficiaries, the
general interest criterion doeB not necessarily apply.
“ I t is my impression that as a rule the budget process throws little light on what
might be obtained from programs not in operation or even from bigger outlays on existing
programs.
“ Spending for research, inquiry into the unknown, presents problems that In some
w ays are more perplexing than those of protection. I t is inherently impossible to know
w hat can be obtained until the job is done.
250
ECONOMIC GROWTH AND STABILITY
fliote competition or expand knowledge are two widely different ex
amples. Spending of this sort can have a powerfully multiplying
effect; it may induce or force a mass of private activity into more
productive channels.26 In the case of economic growth there are
important examples.27
A tta in m e n ts : T r a n s fe r
E x p e n d i t u r e s 28
The concept of economy in transfer spending has received less at
tention than the growth ox such spending would seem to require. The
recipient’s benefit may be substantial, a dollar for every dollar re
ceived. Often, he makes no sacrifice of desirable alternatives to get
it.29 Sometimes there is sacrifice but of minor nature only. Normal
“economizing” forces do not motivate the recipient in limiting his
“demand.”
What is the general public benefit ? It is rarely tangible, not even
as clear as better courts, cheaper food, or less congested transport.
What the public gains is membership in a society some of whose mem
bers are in better situations than otherwise.30 The result may be a
true benefit to the general public.31 The gain is hardly measurable,
however. And who really bears the burden? One cannot be sure
there is net gain until costs and fruits are compared. The diffusion
of cost is likely to be over a group so large that no real identification
of burden is possible. Those who pay may be in no position to take
effective action to press their interests.32
Is any approach to a concept of “economy” feasible ? Within limits,
certainly.
The essential start is a clear definition of purpose or objective.
What is the need, in general and specifically ? Immediate and more
permanent? What is the public concern in meeting it? W hy? Are
there gradations in urgency ? I f so, what is the relative significance
of possible priorities ? It is questions such as these that must be an
swered. Persons concerned directly, including potential recipients,
must be consulted. Yet we can expect objective, balanced judgments—
those reflecting real concern for economy— only if final evaluations
are made by persons who can and will make the general interest para
mount.33
The next step is to compare alternative ways of attaining the goals,
considering, of course, but looking beyond administrative feasibility.
Some methods, for example, may do more than others to remove causes.
“ The situation Is usually either one In which benefits cannot be captured by a private
creator (for sale at their w orth to the public) or if captured fo r sale w ill not yield their
fu ll potential because the private owner w ill charge more than marginal cost.
27 Some of my views on this subject appear in C. Lowell Harriss, The American Economy :
Principles, Practices, Policies, 2 3 edition (Homewood : R. D. Irwin, Inc., 1 9 5 6 ), pp. 7 3 2 -7 5 0 .
28 Space limits, plus my own uncertainty, preclude a discussion here of the meaning of
“ transfer payment” and the “ transfer” element in government spending which purchases
goods and services. In some respects any government expenditure which yields substantial
benefits to specific groups is a transfer, but more common usage lim its the concept of
transfer to payments for which no goods or services are received.
59 The Government employee or a seller to the Government makes sacrifices for the
dollars he gets. I f he were not working for Government, he would do something else with
h is time and other resources. Ordinarily w hat he could earn would be alm ost as great.
30 I f interest on Government debt is a transfer— I doubt that this is the m ost helpful
method of thinking of interest— the public gain is largely some form of freedom from the
costs of inflation.
31 One of the blessings of modern productivity, in my view, is the power it gives to alleviate
destitution.
'
On the other band, opponents may exert the big pressures w hile potential beneficiaries
are generally ineffective.
33 T his statement assumes that the decision is not made by popular referendum.
ECONOMIC GROWTH AND STABILITY
251
The most economical program may be one which for a time costs more
than others but which accomplishes proportionately more. Some
transfer programs, I suspect, are less economical than they might be
because they offer benefits broadly; aid goes even where the need is
much less than that which “sells” the plan to the public. The broader
program may gain wider support than one more economical, one that
would concentrate help where it would most efficiently achieve the
objectives of general public interest. Programs in operation call for
continual examination— the basic objectives, the methods possible
under current conditions, and the procedures in use.
The concept of economy in transfer spending can, I hope, be sharp
ened. Final answers, however, will always rest on judgment. Yet
whose judgment? And how formed— on the basis or what questions
asked, what facts analyzed, what values appraised ? The papers and
hearings stimulated by the Joint Economic Committee will undoubted
ly make possible improved judgment.
C R IT E R IA OF E F F IC IE N C Y IN G OVER NM ENT
E X P E N D IT U R E S 1
Roland N. McKean, the R A N D Corp., Santa Monica, Calif.
A good deal of progress has been made in certain analytical tech
niques, for example, those of estimation and computation, that can
help us choose efficient courses of action. But one aspect of seeking
efficiency, that of devising appropriate criteria or tests of preferred
ness, is almost as troublesome as ever. Moreover, it is a crucial aspect
of choosing efficient policies; for with or without painstaking measure
ments and sophisticated computational techniques, poor criteria can
lead to some very peculiar choices. As a simple illustration, consider
the criterion and one of the choices of the efficiency expert in the play
The Pajama Game:
While I am still in bed I shave
And the lather drips and the bed gets wet,
And, oh, what a lousy shave I get
But think of the time I save.2
But let us turn to more serious problems of choice and criterion
difficulties. In this paper, I shall discuss a major complication in the
devising of criteria, a few generalizations about appropriate tests of
preferredness, and their application to specific governmental problems
of choice. These remarks apply particularly to the use of quantitative
analysis— whether called economic analysis, operations research, or
systems analysis— in seeking efficient government programs and
activities.
In comparing alternative government operations or courses of ac
tion, we cannot apply what might be called ultimate criteria. Thus
we cannot apply such tests as ^maximum well-being from available
resources.” Without more precise definitions, this is merely saying
that we want the best. And when we spell out tests of preferredness
more precisely, we find that we are using proximate criteria— that is,
practicable tests which are not necessarily or obviously consistent
with ultimate goals. The fact that we have to use such criteria makes
it easy to adopt erroneous ones.
S u b o p tim iz a tio n
a n d C r ite r ia 3
There is a mjor complication in the process of choosing that multi
plies the possibilities of going astray. This complication is the fact
1 The discussion here is based upon parts of ch. 2 in a forthcoming book, tentatively
entitled “ Efficiency in Government Through Systems Analysis, W ith Emphasis on W ater
Resources Development.” This volume, to appear in 1958, is one of a series of Publications
in Operations Research .sponsored by the Operations Research Society of America and
published by John W iley & Sons, Inc.
2 The Pajam a Game, book by George Abbott and Richard Bissell, music and lyrics by
Richard Adler and Jerry Ross, Random House, New York, 1954, p. 125.
3 For many of the points mentioned here, see Charles Hitch, Suboptimization in Opera
tions Problems, Journal of the Operations Research Society of America, May 1953,
pp. 8 7 -9 9 .
252
ECONOMIC GROWTH AND STABILITY
253
that we inevitably have to break our problems of choice into manage
able pieces or subproblems. As some have put it, the process of
choosing efficient courses of action is a process of suboptimization. In
a government or department, one man or one committee cannot pos
sibly examine all problems of choice simultaneously and select each
course of action in the light of all the other decisions. The task is
divided among various persons along hierarchical lines, some of the
broader policy choices being made by high-level officials or groups,
and others being delegated to lower levels. Similarly analysis-making
must be broken into manageable pieces, since it is impossible for a
single analysis to examine all of the alternatives. Thus comparisons
of possible courses of action always pertain to parts of the govern
ment’s problem. Other parts of the overall problem are put aside for
the moment, decisions about some matters being neglected, specific
decisions about others being taken for granted. The resulting analyses
are intended to help in finding optimal, or at least good, solutions to
subproblems: in the language of systems analysis and operations re
search, they are suboptimizations.
Table 1 may help to show precisely what is meant by suboptimiza
tion and what kind of difficulties are involved. In the allocation of
money for forest development among its component activities (labeled
“Subproblem 2” ), what should be done depends in part upon decisions
at other levels. That is, the best allocation of these funds depends
partly upon the way the whole Federal budget is allocated and partly
upon the way forest management, fire suppression, and pest control
are carried out. Nevertheless, decisions at all these levels cannot be
made simultaneously. To be sure, each decision will not be made in
complete ignorance of the others. But the allocation of funds for
forest development may be made more or less independently of deci
sions about new operating procedures, work layout, and equipment.
In the selection of specific fire-suppression equipment (subproblem 3),
the allocation of the forest budget, a higher-level choice, and the
selection of detailed operating procedures, a lower-level choice, will
probably not be accomplished at the same time. Similarly, analysis
intended to assist in such decisions inevitably looks at pieces of the
Department’s problem, with many other facets of the overall problem
temporarily fixed or ignored, because of the sheer size and complexity
of the Department’s operations.
Piecemeal analysis and decision-making have their advantages. For
one thing, as problems are broken down into smaller parts, more detail
can be taken into account. A high degree of decentralization is often
desirable so that the “man on the spot” can decide about many matters.
In analysis, somewhat similarly, considerable breakdown of govern
mental problems is desirable so that the models used in estimating
results can be “on the spot,” that is, less aggregative and more nearly
correct in their predictions than departmentwide models would be.
On the other side of the fence, there is a danger inherent in piecemeal
analysis, one whose importance can hardly be overemphasized. This
danger is that the criteria adopted in lower-level problems will not be
closely related to higher-level criteria. As mentioned before, proxi
mate criteria would have to be used in any event; but since problems
must be examined a piece at a time, a whole hierarchy of possible
criteria comes into play, and potential inconsistencies are abundant.
97735— 57--------18
254
ECONOMIC GROWTH AND STABILITY
Sub-problem 1
Figure 1.
Sub-optimization at D ifferent Levels
For example, consider subproblem 3— the selection of fire-suppres
sion equipment for the national forests. This problem of choice is
somewhat removed from top-level policy formation. In the case of
firetrucks, maximum capacity (e. g., rate of flow that pumps can
maintain) per dollar cost may seem like a plausible criterion. Yet
there is no assurance that this test is consistent with overall aims.
Suppose one engine costing $10,000 can maintain a flow of 10,000
units of water per minute— a capacity of 1 unit per dollar cost.
Another engine costing $50,000 can maintain a flow of 25,000 units
of water per minute— a capacity of one-half unit of water per dollar
cost. Is there good reason for choosing the former engine ? Is this
test closely correlated with higher-level criteria ? No, not necessarily.
The smaller engine may simply be an inexpensive way to let fires get
out of control.
ECONOMIC GROWTH AND STABILITY
255
The higher-level criterion— that is, our overall goal in forest devel
opment and forest-fire control— is something like maximum profits
to the Nation or, more specifically, maximum net value of output.
Physical output, such as the volume of water that can be pumped
per minute, need not be highly correlated with value of output.
Moreover, even when output is in value terms, the ratio of output to
cost, i. e., output per dollar cost, has no particular relationship to
maximum net value of output. Since ratios permit the scale of output
or cost to wonder willy-nilly, nothing insures their consistency with
higher-level tests. It is always hazardous, therefore, to use them
as criteria.4
S ome R
em arks on
P
roper
C r it e r ia
So much for “suboptimization” and the fact that one must be ex
tremely wary in devising criteria. What of a constructive nature
can be said ? I f output and costs can be measured in the same unit—
that is, dollars— a suitable criterion form is maximum output minus
costs. For instance, in selecting fire-suppression equipment and
methods, the test can be maximum value of output; that is, timber and
property saved, minus costs. In order to estimate value of output,
of course, one cannot examine fire trucks (or tools for constructing fire
breaks, or fire-finder devices) in isolation. In those circumstances,
only a measure of physical output could be devised. It is necessary
instead to fit the fire trucks (or other equipment being considered)
into the system in a realistic context and estimate the value of assets
saved annually with the alternative kinds of equipment.5 The kind
that yields maximum value minus costs or, if the budget is fixed, maxi
mum value for the given budget, is the most efficient.
To be sure there are supplementary considerations that cannot be
embraced in a practicable test of economic efficiency. One major con
sideration of this sort is uncertainty. Which equipment is to be pre
ferred if type A is more efficient on the average but type B gives a
higher probability of avoiding catastrophic fires? Other supple
mentary considerations, for example, so-called intangibles, are always
present. Nonetheless, the preceding test of economic efficiency is cer
tainly a major consideration— one that is highly relevant to the final
choice. This is more than can be said for many plausible criteria.
I f output and costs cannot be measured in the same units, it is im
possible to maximize value of output minus costs. This is the typical
situation in defense activities, various loan programs, social security
programs, and many other activities that provide special services to
the public. Prices that are widely acceptable cannot be given to these
outputs. Voters and officials have to attach values to various pro
grams, at least implicitly, but one man’s evaluation need not always be
valid for other persons. In the case of such activities, analyses have
to express output in physical terms, and the use of output minus costs
4 T his Is not to say that ratios should never be used In any manner. T o adjust activities
until two ratios are equal Is often a very useful device. But the maximization or
minimization of some ratio is always a dubious criterion. For a more complete discussion
of this matter, see Hitch, op. cit.
6 The streams of gains and costs should be discounted at the marginal rate of return
that could otherwise be earned, but the treatment of time streams cannot be taken up in this
short paper.
256
ECONOMIC GROWTH AND STABILITY
(e. g., 20,000 patent applications processed minus $10 million) as a
criterion becomes impossible.
The next best procedure appears to be to fix either the costs or the
output at a reasonable scale. The test can then be minimum cost of
achieving the specified physical output (e. g., patent applications
processed, capability in particular military missions) or maximum
physical output for the given cost. These two criterion forms are equiv
alent if the size of either gain or cost is the same in the two tests. I f
the test of maximum gain for a $50 budget points to the policy that
yields a gain of 100, then the test of minimum cost to achieve a fixed
gain of 100 will point to the same policy— the one that achieves the
gain of 100 at a cost of $50. The choice between these two criterion
forms depends mainly upon whether it is gain or cost that can be
fixed with the greater degree of correctness.
This leads us to a most important question: How does one determine
the right achievement or budget? I f the achievement or budget is set
uncritically, the test is not necessarily consistent with higher level cri
teria. In many problems of choice, the size of the budget or the scale
of the mission is fixed by higher authority. In these circumstances,
whichever is fixed can indeed be taken as given. I f neither is fixed, one
must txy to select the mission or budget that seems reasonable in the
light ot higher level objectives. This calls for careful inquiry into
those higher level objectives and their relationship to the mission or
budget under consideration. Another possible procedure is to try sev
eralbudget sizes or mission levels. I f the same equipment is preferred
for all task levels or budgets, that system is dominant. I f the same
course of action is not dominant, the use of several tasks or budgets
is nonetheless an essential step, because it provides the policymaker
with vital information.
A
p p l ic a t io n
to
S p e c if ic P
roblem s
What implications do these observations have concerning the com
parison of specific alternatives? Let’s look briefly at two problems
that confront government officials periodically: (1) Choosing among
alternative sizes of the budget for forest management, and (2) choos
ing among alternative personnel policies in government. In deter
mining the efficient size of the forest-management budget,6 we can
devise sensible monetary measures of both output and cost. In this
problem, then, a proper test would be similar to the criterion that
private firms presumably use— maximum expected profits or, in other
words, maximum gains minus costs (given whatever constraints exist).
That is, choose the scale of timber planting, cutting, and selling that
would yield the greatest excess of gains (discounted to their present
value) over costs (similarly discounted). The Forest Service some
times prepares analyses employing this sort of test; yet in this
problem, and in many other investment choices, less meaningful
criteria are often employed. Note that it is misleading to use a
benefit-cost ratio as a test in this case (as in most others). Unless
applied with special constraints and solely to small increments in
• 1 assume here that Federal management o f the national forests is to continue. By
“ the” forest-management budget, I mean the funds for activities leading to the sale of
timber.
ECONOMIC GROWTH AND STABILITY
257
the budget, maximizing such a ratio would favor restricting opera
tions to a small but golden opportunity— say, cutting a small amount
o f high-quality and easily accessible timber. Commonsense would
rule out this extreme, but the point is that the ratio would have little
significance.
The second problem, determining personnel policies (e. g., in the
military) is one in which output under alternative arrangements
cannot satisfactorily be measured in dollars. I f we slice off one
particular part of the problem, i. e., setting the pay structure, a
proper criterion is minimum cost of obtaining a designated set of
services (i. e., physical output). The designated set of services should
be consistent with the functions and tasks that are to be performed.
The cost, of course, should not be confined to the coming year’s ex
penses, but should be the present value of the costs for at least several
years ahead. This example too is one in which appropriate criteria
have been adopted, at least in some instances. W ith respect to mili
tary, personnel, the Cordiner report has made use of a criterion
similar to the one above in comparing its proposed pay structure
with the existing one.
Suppose we examine other alternatives in determining personnel
policies. The designated set of services, for civilian as well as mili
tary activities, should be called into question, too. W e should like
to eliminate overstaffing, to find more economical combinations of
men and equipment, to design equipment and methods of operation
that make more efficient use of personnel. For such purposes, the
minimum cost of obtaining specified services will not serve as a
criterion. Nor will such tests as physical output per worker, gaincost ratios, or the minimum cost of doing some casually specified job.
The test would have to be, in very general terms, the minimum cost
of performing a function or mission that is specified carefully in the
light of higher level criteria. To state that such a criterion form
should be used is to leave the hard work still ahead, namely, putting
down those appropriate specifications of the function to be carried
out. But the hard work is there because the problem is hard. To
avoid it by adopting nonsense criteria will not lead to sound choices.
The problems just mentioned— determining personnel policy and
the forest-management budget— are but two or myriad choices that
must be made in deciding upon government expenditures. In each of
these choices, criterion selection is a crucial aspect of either analyzing
the problem quantitatively or of just thinking about the alternatives.
And in this matter of criterion selection, it is imperative that we draw
on economic principles, together with caution and commonsense, in
stead of adopting the first plausible test that occurs to us.
ECONOMY AND EFFICIENCY IN GOVERNMENT
EXPENDITURES
Wilson Wright, economist, Procter & Gamble Co.
V
ie w p o in t
The competence of the writer is the ability to analyze economic
situations and to suggest appropriate policy and action to meii respon
sible for the management of economic affairs. Because this is the
competence and viewpoint employed, there is little unusual which can
be offered for consideration by readers of this report. Instead, what
ever value, may be assigned to the ideas presented in this report must
be attributed to the fact that the author is accustouied to evaluate
the economic consequences of expenditure made by Government from
the viewpoint of a person observing and appraising rather than as
a participant.
E
conom y,
W
aste,
E
f f ic ie n c y '
:
= '
The task of describing standards which can be used to determine
whether specific programs undertaken by the Federal Government are
economical may begin with a statement of what is understood to be
economy, waste, and efficiency.
Economy is understood to be the management of affairs with
special regard for costs and involves the husbanding of resources.
Expenditure is wasteful if it is not economical. Efficiency is under
stood to be the effectiveness of managerial action as measured by a
comparison of the product obtained with the expenditure or cost.
A s s ig n m e n t
or
R e s p o n s ib ility
A review of the organization of the Federal Government, and the
operation of the Federal Government in the past, may be used to
support the assumption that neither the Congress nor the; executive
branch of the Government actually is formally responsible for efficiency
and economy in public expenditure.
:
Persons in both the executive and legislative branches of the Gov
ernment unquestionably have been and are interested in seeing to it
that Government expenditure is made efficiently and with economy.
Yet neither the executive branch nor the Legislature is actually
charged with formal responsibility for the performance of this func
tion. The executive branch assembles budgetary data and presents
the budget to the Congress. The Congress, on the other hand, can
either add to the budget or refuse to appropriate funds necessary to
finance items in the budget. Furthermore, with several notable
exceptions, few Members of the Legislature have made efficiency and
economy in Federal expenditure the basis for their political careers.
258
ECONOMIC GROWTH AND STABILITY
259
Long ago the lack of a formal assignment of responsibility for
efficiency and economy in Government expenditure presumably was
not a matter of large importance, because the magnitude of Federal
expenditure was not such an important factor in the economy. This
situation, obviously, has been changed.
In the operation of a popular government, in which political parties
adopt specific programs and party discipline is observed, responsibil
ity for efficiency and economy may be assigned by the electorate to
the party in power. In such cases the high administrative officers
are the leaders of the party or coalition which comprises a majority
in the legislature. In this kind of a situation the citizen may hold
the party responsible for economy and efficiency. Because these char
acteristics are not to be found in our form of political organization,
economy and efficiency seem to be an interest of legislators and ad
ministrators as a consequence of their citizenship, and as responsible
individuals, rather than as a formal responsibility related to their
positions in the Government. While the lack of a formal assignment
of responsibility presumably is a defect in the organization of the
Federal Government it, also, may be noted that the management of
Federal expenditure does not appear to have been less efficient than
the performance of the comparable function by the popular govern
ments of other countries in which responsibility seems to be formally
assigned. This appears to be a tribute to the commonsense and
statesmanship of American political leaders.
S tandards
The means of measuring economy, waste, and efficiency in govern
ment apparently are quite different from those which could be em
ployed in the management of a business operation. In the manage
ment of a business the operating statement and balance sheet can be
used to indicate whether or not operations have been conducted with
efficiency. A comparison of these statements with those of similar
enterprises may be used to determine whether the operation of one
business is more efficient than the operation of another. Such meas
urements and references do not exist for the evaluation of efficiency
in government and both the objectives and the responsibilities of a
government are different from those involved in the management of a
business.
Two different types of reference may be used to determine the
economy and efficiency of expenditure. The first of these is the kind
of reference called a “principle.” Such principles, of course, are
judgments or opinions derived from the observation of experience
and developed by reasoning. The second type of standard consists
of a definition of proposed expenditure, expressed in definite num
bers. This is the “budget” which is used in managing expenditure
made by both persons and organized groups, including government.
In the conduct of business operations it is customary to seek ways
and means of reducing the expenditure defined in the budget. The
reduction of budgeted expenditure, without producing a commen
surate reduction of the volume of production, is an important func
tion of business management. In business the incentive to provide
this function is large. In the management of group operations,
where large material rewards are not obtainable by the persons who
260
ECONOMIC GROWTH AJfD STABZMTY
perform the function of managing budgeted expenditure, the incentive
must consistof personal satisfaction, approbation on the part of ot&ers,
and dedication to attainment of the task. It is also apparent that
the establishment of budgets and the actual management of budgeted
expenditure can be only the function of managers or executives who
are held responsible.
These considerations lead to the conclusion that the Congress
can only use the kinds of standards known as principles in determining
the economic and efficient types and volumes of expenditure—supple
menting the use and application of principles by obtaining responsible
assurance that the administration of expenditure budgeted is organ
ized and performed with competence.
T
hree
E
c o n o m ic
S it u a t io n s
Government expenditure is made in at least three different types of
situation. One of these types of situation is experienced when the
Nation is mobilized for war. A second type of situation is when
large numbers of the population are unemployed. The third type of
situation, which may be considered as representing “normal,” is when
neither of the first two situations obtain. In each of these three dif
ferent types of situation somewhat different concepts and standards
may be adopted and used by the Congress in evaluating expenditure.
Because the third type of situation, in which the Nation is not
mobilized for war and the number of unemployed is not large, is the
kind of a situation experienced most of the time, as well as in the pres
ent, it is appropriate to give priority to a consideration of two prin
cipal or basic standards to be used in this kind of a period.
Principle I
A first principle which may be used by the Congress in appraising
the economy and efficiency of Federal expenditure, in the situation de
fined, is derived from a consideration of the effects of Federal finance
upon the financial system of the economy as a whole. The importance
of this standard is that by observing it the Congress may avoid pre
cipitating inflation and general economic disorganization leading to
boom and depression, inflation, deflation, unemployment, and unnec
essary social friction. The principle may be stated in the follow
ing terms. The difference between Federal expenditure and income
should be adjusted to change in the demand for credit in the rest of
the economy. Another way of stating the principle is that the change
in Federal debt plus the change in other debt should be equal to the
change in the market value of national output required by the in
crease in the population and technological improvement. I f govern
ment expenditure is adjusted to fit this equation, Federal debt would
be retired in periods when the increase in the aggregate debt in
curred by the State and local governments and private borrowers
would be larger than the volume which could be equated with the
other factors. It is not enough merely to balance the Federal budget
in a situation in which State and local governments and private bor
rowers are expanding their debt beyond the limits indicated in the
equation outlined.
The consequence of violating Principle I .— The principle described
may be used to avoid large-scale long-term inflation and deflation.
ECONOMIC GROWTH AND STABILITY
261
It is assumed that it is not necessary to support the contention that
such inflation and deflation is undesirable and to be avoided. In
each period of inflation sincere, respected and honorable voices may be
heard advocating expenditure and financial procedure which is infla
tionary. Because decisions regarding government expenditure should
be debated, it is reasonable to suppose that the arguments supporting
inflationary expenditure should be heard. Inflation, however, has been
experienced for centuries. It is normal experience avoided by only
unusual nations with unusual leaders. The causes, development and
consequences have been observed, understood, defined, and explained.
There is nothing mysterious and little that is not known about the sub
ject. Deflation, of course, is a consequence of inflation.
The primary origin of inflation invariably has been and will be
an expansion of the money supply in excess of the expansion of the
volume of commodities produced. The usual and almost invariable
origin of inflation is the expansion of government debt or the debase
ment of the money supply as a consequence of political action. In
this connection it is to be noted that public debt is an important part
of the reserve held against the money supply of this country which
was incurred for political purposes. For these reasons the change in
the public debt should be adjusted to the changes indicated in the
equation described if government expenditure is to be considered eco
nomic and efficient. I f government expenditure is so large that public
debt is not adjusted to the limits defined in the equation, government
expenditure cannot be considered to be either efficient or economic.
The problem of velocity.— Although the primary origin of inflation
is an improper political use of credit, it also may be observed that a
change in the level of prices may be related to a change in the velocity
of the circulation of the money supply. This, however, is a matter
which is not amenable to control by a legislative body and may be con
sidered the special province of the persons responsible for the formula
tion and application of monetary policy. In the United States the
Federal Reserve Board, rather than the Congress, may be considered
the proper authority to deal with the problems derived from changes
in the velocity of the circulation of money.
Principle II
A second standard or principle which may be used to evaluate the
economy and efficiency of government expenditure is the magnitude
and incidence of tax rates required to raise an appropriate volume of
income. It is evident that, if expenditure is so large that the taxation
required to finance the expenditure reduces the incentive to produce
on the part of the population, the expenditure can be considered
neither economic nor efficient.
An examination of the economic consequences of the present hotch
potch of Federal tax legislation is not an appropriate subject to the
development of this paper. In passing, however, it may be noted that
existing legislation, while adequate for the purpose of obtaining the
funds with which to finance expenditure, provides incentive to finance
capital investment of all kinds with borrowed funds, provides incen
tive for small-business men to sell businesses before these become too
large, and provides incentive for persons who are unusually competent
in the management of economic affairs to avoid action which might
increase personal tax liability.
262
ECONOMIC GROWTH AND STABILITY
A succinct general label for the existing legislation might be that
it is the kind of extravagance which can be afforded temporarily by
a wealthy country in a period of booming economic activity.
U
n e c o n o m ic a n d
I
n e f f ic ie n t
S tandards
A percentage of national income
From time to time it has been suggested that an appropriate volume
of expenditure might be established by selecting some percentage of
national income. This approach has the merit of reducing, the stand
ard to a definite number. Such a number, however, would have no
relation to the use made of the funds thus obtained and would be a
violation of principle I. For these reasons there seems to be no ra
tional justification for the selection of a definite proportion of national
output as a measure of the volume of expenditure which should be used
for political purposes.
Need as a standard
, A second standard sometimes used to justify government expendi
ture is “need.” A need is a matter of opinion. Because needs are
unlimited and the means available for satisfying needs are not, it
would seem to be obvious that no expenditure should be made pri
marily because the expenditure is needed or wanted. When want or
need is the criterion used to determine whether or not expenditure
will be made it is to be expected that expenditure will be made without
reference to what can be afforded and with little regard for either
efficiency or economy.
.
E x p e n d itu r e W h e n
U n e m p lo y m e n t I s L a r g e
'
When unemployment is large the public will demand expenditure
by the Government to provide income for persons who would other
wise be unemployed. This public demand may be expected as a
consequence of widespread acceptance of the theory of compensatory
government spending, the planning of full employment and the use
of fiscal policy to support “purchasing power.”
In this connection it is interesting to observe that the .only part
of the theory of full employment by means of planning a,nd the use
of fiscal, policy which has proven actually acceptable is the idea that
government spending in excess of income is appropriate when un
employment is large. The other part of the theory has been proven
unacceptable. When a situation of full employment has obtained
governments have not been able to reduce or defer expenditure until
a time when unemployment would be experienced.
Because the. theory is widely accepted it is to be expected that there
will be a large and important demand for government spending in
excess of income when large-scale unemployment again is experienced.
It probably would be possible to observe principle I, described
in this paper, concerning government in such a time. When business
activity is reduced and unemployment is increased it is to be expected
that private borrowing also will be reduced. This would permit
government borrowing to be undertaken or increased without violat
ing principle I. In this connection, however, it is important to note,
that if government deficits become too large, property owners and
ECONOMIC GROWTH AND STABILITY
263
entrepreneurs will fear that tax rates levied upon successful busi
ness venture may be increased. I f this proves to be the case the
fear of taxation will deter the undertaking of ventures and invest
ment which will be needed to increase employment and income.
The theory that the volume of employment can be determined
largely by fiscal policy actually can be used to produce a situation
which would represent neither prosperity nor depression but eco
nomic stagnation. Government expenditure made for the purpose of
supporting employment and income but which actually produces a
stagnation of enterprise can be considered neither economic nor
efficient.
M
il it a r y
E
x p e n d it u r e
Contrary to ideas which seem to be generally accepted the condi
tion known as peace has rarely existed for very long in this world.
What is now generally thought to be peace seems to be the kind of
situation which existed when British naval power dominated the
oceans and ports of the world. This situation has not obtained since
1914. In the present and prospective unstable political world it
must be expected that a major proportion of Federal expenditure
will consist of expenditure made for military purposes.
Because expenditure for military purposes probably will be the
largest single item in the Federal budget for many years to come, it
is apparent that this item will continue to be the part of govern
ment expenditure in which efficiency and economy will be most im
portant.
Assuming that the strategic evaluation and planning of the mili
tary are adequate, rational and properly integrated, the problem of
efficiency and economy in military expenditure will consist largely of
the problem of administering the military budget. In this connec
tion recommendations have been made by the second Hoover Com
mission which supported the recommendations of the Committee on
the Business Organization of the Department of Defense.
Because the maintenance of a permanent large military organization
is relatively new in the experience of the United States it is reasonable
to assume that there is much which is not understood about how to
manage the expenditure of such an organization. The development
of such knowledge requires time, experience, and study. For these
reasons it probably will be both desirable and appropriate to establish
task forces and working groups from time to time, with functions
similar to those of the Committee on the Business Organization of
the Department of Defense. Groups commissioned for the perform
ance of this task can be used by the Congress in the way that the
managers or directors of a corporation sometimes employ the pro
fessional services of firms specializing in operations research or man
agement engineering.
C o n c l u s io n
The review of the standards which may be employed by the Congress
to determine the economy and efficiency of Government expenditure
supports the assumption that these probably must be standards con
cerned with overall Federal expenditure supplemented by responsible
assurance that funds budgeted and appropriated are being adminis
tered with competence.
Y. FEDERAL EXPENDITURES AND ECONOMIC
GROWTH
265
FEDERAL EXPENDITURES AND ECONOMIC GROWTH
CONTRIBUTION OF FEDERAL EXPENDITURES TO
ECONOMIC GROWTH AND S T A B IL IT Y 1
Evsey D. Domar, professor of political economy, the Johns Hopkins
University
I
n t r o d u c t io n
It is, I believe, a sign of progress that in the past few years we have
become increasingly concerned with economic stability and particu
larly with growth, rather than merely with full employment. (It is
interesting to note that the Employment Act of 1946 does not mention
the word “ growth.” The nearest it comes to it is in the expression
“ maximum production.” ) As goals of economic policy, full employ
ment, and growth are not incompatible, but neither are they identical.
An economy like ours growing at a sufficiently rapid rate (with the
usual qualifications regarding health, leisure, and so forth) will enjoy
full employment without worrying about it, but full employment may
or may not be used efficiently and will not necessarily result in growth.
Growth, with its emphasis on efficiency, good management, techno
logical progress, and, may I add, hard work and thrift, fits much better
with our general attitudes and is the healthier objective of the two.
That growth as such is desirable seems to me obvious. With the
present international conflict it is also a condition of survival.
I shall mean by growth the rate of increase of the total output of
goods and services, measured by real national income or product (gross
or net) or some similar series. To achieve a growing national income
two basic conditions must be satisfied: (1) There must be a growing
demand for goods and services which the economy can produce; and
(2) there must also be a growth of productive capacity. These two
conditions are closely interrelated. The first without the second will
initially result in full employment, but eventually—in inflation. The
second without the first—in unemployment and idle capacity which
will undoubtedly inhibit the growth of capacity itself. While eco
nomic stability is essentially concerned with the first condition, or
more correctly with the adjustment of demand to a given level of
capacity, and growth—with the second, it wTould be difficult, in an
economy like ours, to achieve either without the other.
Before proceeding further let me make clear that this paper is solely
concerned with Federal expenditures, and even with only certain kinds
of expenditures, not because I imagine that the change in the volume,
11
am grateful to Donald Bear of Stanford University and to Vladimir Stolkov of the
Johns Hopkins University for their help in gathering statistical materials for this paper.
They are not responsible, however, for any of my conclusions and recommendations.
267
268
ECONOMIC GROWTH AND STABILITY
timing, and composition of Federal expenditures is the only, or even
the most important, key to the problem in hand, but simply because
it is the subject of the present hearings. While the committee has
been considering one aspect of Federal policies in its bearing on growth
and stability at a time, we may hope that it will synthesize its findings
someday.
E c o n o m ic
S t a b il it y
The first aspect of our problem, the adjustment of demand to pro
ductive capacity at a given point of time—that is, economic stabiliza
tion—is a field where it is easy to advise and difficult to act. Eco
nomic discussions of the last two decades have repeatedly emphasized
that Federal expenditures should be curtailed during an inflation and
expanded during a depression, thus preventing the development of
either. This is good advice, so far as it goes. A mild inflation is
not catastrophic and is unlikely to injure growth, but it is hard to
keep an inflation mild. There is also another reason for curtailing
Federal expenditures in prosperous and inflationary times. When
productive capacity is fully utilized, any increase in Federal (or any
other) expenditures must be matched by a more or less equal reduc
tion elsewhere, achieved by taxation or inflation, and is, therefore,
costly. During a depression, however, when labor and machinery
are not fully utilized, an increase in Federal expenditures need not
and should not be matched by a corresponding reduction elsewhere
because labor, machinery, and materials do not have to be taken off
other jobs. More than that. The additional stream of Federal (or
other) expenditures will, in turn, give rise to secondary and subse
quent streams and thus increase national income by an amount greater
than the original expenditure (the so-called multiplier effect).
While our economy is seldom, if ever, in one of the extreme positions
described here, and while there is quite a difference between the sim
plicity of a textbook demonstration and reality, the essence of the
argument holds. The trouble is not with the argument itself, but
with its practical implementation. If the early arrival of a depres
sion could be foreseen, some Federal expenditures, such as those on
highwaySj could be postponed. But the slack in non-Federal expendi
tures (private, State, and local) might not take place for years to
come. How long are we to wait? Of course, if a depression does
come, Federal expenditures should be increased. This is also not
easy to do on short notice if the expenditures are to be socially useful,
yet less difficult, it seems to me, than their postponement.
I find it most fortunate that the stabilization problem will be con
sidered by a special panel, whose members, I trust, will be more in
genious in devising practical suggestions than I am. (The decision
to consider Federal expenditures in isolation from other measures,
such as taxation, is very restrictive in this connection.) Let me
make the optimistic assumption that this problem has been solved in
the sense that demand for goods and services will grow at an appro
priate rate and proceed to the problem of growth of productive
capacity.
T he
G row th
of
P r o d u c t iv e
C a p a c it y
The growth of productive capacity is a most complex phenomenon,
and any attempt to classify its ingredients in a simple (or perhaps
ECONOMIC GROWTH AND STABILITY
269
any other) fashion is unsatisfactory. No particular significance
should be attached to the following list. It is merely used as a point
of departure.
An increase in productive capacity depends on the following fac
tors:
1. An increase in the labor force (more correctly, man-hours
available).
2. An improvement in the health, education, and training of the
labor force.
3. Development of knowledge, including technical knowledge, and
its application.
4. Improved management and administration.
5. Accumulation of capital, and improvement in its quality.
6. More efficient utilization and discovery of new resources.
7. Changes in other economic factors, such as composition of out
put, industrial structure, competition, etc.
8. Changes in more general factors, such as attitudes toward work,
efforts, invention, thrift, risk, and many others which are very im
portant, perhaps more important than the strictly economic ones, but
which I am hardly competent to discuss. It is not easy to change
them by Federal expenditures, in any case.
There is no simple formula that could tell us which of these com
ponents of growth should 1)0 the particular concern of our Federal or
of any national government. No two countries, nor any one country
at different periods of time, would give the same answer. In this
particular case, it seems best to me to follow ;>ur traditions and to
modify them when reasons for a change are stro.ig.
Let us start with capital formation. Whether we could profitably
invest a larger fraction of our national income (or product) is a con
troversial subject among economists. Much, of course, depends on
the concomitant growth of the labor force and on technological
progress. Without these two, and particularly the latter, the output
contributed by an extra dollar of capital will decline with time. I
doubt if this has been the case in this country, and I believe that we
could invest a higher fraction of our income, provided anti-inflation
ary measures were undertaken at the same time. From this it does
not follow, however, that the Federal Government should participate
in capital formation on a large scale, except in such fields as highways,
where benefits are diffused; atomic energy, where returns are still
uncertain; defense installations, which serve a special purpose; and
other special fields. The bulk of our capital formation can be left in
private hands, stimulated, if necessary, by tax, credit, and other
policies. This has been our tradition, and I do not see good reasons
for changing it at the present time.
Similarly, there is no need for Federal (or any governmental) inter
ference with the growth of our labor force; that is, essentially with
the birthrate—we are doing quite well here on our own—nor with the
length of the workweek. I do not see that the Federal Government
could or should try to change our managerial or administrative meth
ods, except, perhaps, in its own backyard. The Federal Government
does concern itself with questions of competition and monopoly, but
this is hardly a field for Federal expenditures, as distinguished from
other Federal actions, except, possibly, in the allocation of Govern<1 7 7 3 5 — 5 7 --------- 1 !)
270
ECONOMIC GROWTH AND STABILITY
ment contracts. With these exclusions, the fields where Federal ex
penditures can and should contribute to growth are:
1. Education and training.
2. Development of knowledge; i. e., research.
3. Public health.
,,
4. Natural resources.
All these fields are important and deserve Federal attention, but
I shall limit my remarks to the first 2, and particularly to educa
tion, both because of my ignorance of the last 2 and because our
education and research suffer from serious deficiencies.
F e d e r a l E x p e n d it u r e s a n d E d u c a t io n
The committee is undoubtedly familiar with the shortage of quali
fied teachers, the overcrowding, and the frequently unsatisfactory
level of instruction in our public schools. I would like to discuss
here another aspect of our educational system: the waste of ability
and talent caused by the failure of a surprisingly large number of
bright high-school graduates to attend college.
In an advanced industrial society like ours, positions of importance
and responsibility in practically every field increasingly require a
college education and, frequently, postgraduate training as well.
When an able person who can benefit from such an education does
not receive it, he hurts both himself and society. It is not always
easy to identify good college material, but a high score on an intelli
gence test combined with a high performance in high school gives a
strong promise of success. Yet, according to table I, taken from a
study of the Commission on Human Resources and Advanced Training
published in 1954, 38 percent of high-school graduates in the upper
20 percent of their graduating class and with an intelligence score of
145 or over (which is very high, indeed) do not even enter college.2
For that matter, even a score of 125 is quite high—the average for
college graduates is 1213—yet, as table I shows, over 40 percent of
this group, who are also in the upper 20 percent of the graduating class,
do not go to college. In the words of Dael Wolfie, the Director of the
Commission:
:
Every year, over 150,000 pupils who could become average
or better members of most of the specialized fields graduate
from high school but do not enter college. Some of these able
students will attain positions of high responsibility; they will ,,.,
contribute as much to society and derive as much personal
satisfaction from their work as they would had they attended ,,,
college. But many will not. Without college education, .,!
they have little or no opportunity to become teachers, scien
tists, doctors, lawyers, or social scientists. They may become
businessmen, musicians, artists, journalists, or nurses, and
some of them can become engineers while others can work in
a variety of subprofessional fields. But, as a group, they can2
Dael Wolfle, America’s Resources of Specialized T a le n t; the Report of the Commission
on Human Resources and Advanced Training (New York, Harper & Bros., 1 9 5 4 ), p. 174.
T his Commission was appointed by the Conference Board of Associated Research Councils
under a grant from the Rockefeller Foundation.
,
» Ibid., p. 146.
I
271
ECONOMIC GROWTH AND STABILITY
not contribute to society as much without additional education
as they could with it.4
T a b l e I . — Percentage of high school graduates who do not enter college, classified
by intelligence and high school grades 1
A G C T score
135 to 144______________________
125 to 134................... ...................
115 to 124......................................
105 to 114_____________________
95 to 104..... ...................................
85 to 94_______________________
75 to 84 .................. ............. ........
Below 75............. ............ . . . . . .
T otal___________________
Percent
of all
highschool
gradu
ates
2.1
5.4
12.0
19.2
22.8
19.2
12.0
5.4
2. 1
High-school grades (percentile rank in graduating class)
1-20
21-40
41-00
I
i
| 61-80
59
03
07
70
72
74
77
81
84
52 i
70
74
70
79
bi
84
88
92
83
74
05 !
60
03
65
08
70
74
77
j
i
I
i
■
,
‘
81-100
j
Total
44
50
53
50
58
01
64
67
70
38
43
46
49
52
54
57
60
66
1
:
40
46
52
58
65
71
78
84
91
56
47 |
65
i
j
!
:
;
,
'■Ibid., p . 174.
The Commission concluded that—
The United States wastes much of its talent. College
graduating classes could be twice as large as they currently
are, and with no loss of quality. The potential supply gets
drained off, in large or small amounts, all the way through
the educational system. Practically all potentially good col
lege students enter, and most of them finish high school, but
after high school the loss is large. Fewer than half of the
upper 25 percent of all high-school graduates ever earn col
lege degrees; only 6 out of 10 of the top 5 percent do. So
ciety fails to secure the full benefit of many of its brightest
youth because they do not secure the education that would
enable them to work at the levels for which they are poten
tially qualified.5
It is proper to inquire at this point whether the influx of all these
bright young men and women into colleges would create an over
supply of college-trained personnel. Their admission to college need
not necessarily give rise to a sharp increase in the fraction of our pop
ulation going to college, unless this is regarded as desirable in itself.
Every college teacher is aware that a distressingly large fraction of
our present undergraduates are poor college material. Hence, a good
deal of substitution of these poor students by better ones, rather than
a net addition to them, could take place. Secondly, a rapidly grow
ing economy needs talent and ability; in turn, a better utilization of
these rare qualities promotes growth.
‘ Ibid., p. 242.
• Ibid., p. 269.
Similar evidence was obtained by another study which tried to find the relation between
the intelligence level and occupation. It was found that on the whole people of high
intelligence are concentrated in the professional, managerial, and clerical occupations;
persons of low intelligence do not usually rise to the top, but a large percentage of highly
intelligent persons (with scores of 1 4 0 -1 4 9 ) are found among skilled manual, semiskilled
and even unskilled groups. See C. A . Anderson, J. C. Brown, and M. J. Bowman, Intel
ligence and Occupational Mobility, The Journal of Political Economy, vol. L X (.Tune
1 9 5 2 ), pp. 2 1 8 -2 3 9 . Their conclusion was t M t “ Elimination of the less intelligent men
from the topmost level appears more certain than the rise of brilliant men from low posi
tions to high ones” , p. 2 2 1 .
272
ECONOMIC GROWTH AND STABILITY
These 40 or so percent of potentially excellent students do not go
to college for two sets of reasons: one is financial, the other—more
general. A study made by Ralph F. Berdie in Minnesota reveals that
only one-half of the upper 10 percent of high-school graduates who
did not intend to go to college said that they would go if funds were
available.6 The other half would not go because of lack of motiva
tion, interest, or other reasons.
A system of Federal scholarships for college and post-graduate
training would help those who do not go to college because of lack
of funds, but no miracles should be expected from it. A large num
ber, perhaps as many as two-thirds of potential recipients would go
to college in any case, though some of them would be enabled to enter
better schools and some parents would be relieved from a heavy bur
den. What worries me about a system of Federal scholarships, how
ever, is their probable restriction to some specific fields, such as sci
ences and engineering where a shortage of trained personnel seems to
exist. We certainly need able and well trained scientists and engi
neers, but we also need able doctors, lawyers, businessmen, teachers,
and even economists. We should increase our supply of scientists and
engineers by drawing into college those bright men and women who
stay out of them, rather than by denuding other professions and oc
cupations of their best personnel. The choice of study should be left
to the individual, aided by advice from his relatives and teachers and
not hampered by the promise of a scholarship in one field and its
absence in another.
federal scholarships could help solve but one aspect of the problem.
They would not improve education in our schools, the need for which
is great. To quote again from the Commission’s report:
Of these possible courses of action, probably the most im
portant in the long run is to improve education at the ele
mentary and secondary levels. In the intermediate run, early
identification of talent plus efforts to improve motivation on
the part of both the pupil and his parents appears to be the
most promising direction of effort. And in the short run,
intensive indoctrination plus financial assistance will have the
earliest payoff.7
;
Such an improvement in our educational system will hardly be
accomplished without Federal help. But before I press this point
further, let us take a look at a few facts.
Taken as a fraction of total population, enrollment in all our schools
nnd universities, taken together, has not changed much since 1930. In
elementary and secondary schools this fraction was 23.2 percent in
1930 and 21.7 percent in 1956 (see appendix, tables A I I I -A V ) : in
universities the corresponding figures were 0.9 percent and 1.8 percent,
and total enrollment on all levels was 24.1 percent in 1930 and 23.4
percent in 1956. The proportion of young people enrolled has been
increasing, but the fraction of voung people (ages 5-24) in the total
population fell from 38.3 percent in 1930 to 31.7 percent in 1956.
With the higher birth rates since World War II, the fraction of total
population enrolled is beginning to rise.
. •’ Ralph F. Berdie, After High School. W h at? { Minneapolis, Minn., University o f Min
nesota Press, 1 9 5 3 ). The reference is taken from Wolfle, op. cit., p. 165.
1 AVolfle, op. cit.,.p. 244.
..
.
ECONOMIC GROWTH AND STABILITY
273
The fraction of our gross national product spent on education from
all sources (Federal, State, local, and private) has risen from 3.49 per
cent in 1930 to 3.87 percent in 1954, after a slight dip in 1940 and
1950 to 3.16 and 3.07 percent, respectively. (See appendix, table
AVI.) Expenditures on elementary and secondary education as frac
tions of gross national product have behaved in roughly the same man
ner, while expenditures on higher education have risen faster (from
0.69 percent in 1930 to 0.95 percent in 1954).
Thus neither the fraction of our population enrolled in school nor
that of gross national product devoted to education has shown a
marked change. Rough as these comparisons are, they leave one some
what puzzled regarding the causes of our increasingly acute educa
tional problem. Parr of the latter can be explained by a rise in what
is regarded as good education, but by far more important is the pe
culiar character of education: It is an industry deriving little benefit
from technological progress, so that real productivity per person
(teacher) engaged has not increased much, if at all, over the centuries.
True, our teachers know more (I trust) than their ancestors, but the
essential method of instruction has not changed considerably since the
days of Socrates: A teacher working directly with a class of students
without much help from mechanical devices was then and still is the
typical method. An attempt to raise the teacher’s productivity by in
creasing the size of class simply reduces the quality of instruction.
It is most ironical that while education contributes so much to eco
nomic growth—perhaps more than any other activity—it suffers from
the success of its own efforts. In industries subject to particularly
rapid technological progress productivity per worker rises and his
income can be and is raised without difficulty. This brings pressure
on less progressive industries. To keep their workers they also have
to raise wages or reduce the quality of their personnel. Their output
becomes more expensive and/or of lower quality. This is exactly
what has been happening to education.
This is not a temporary situation. The more prosperous we be
come and the faster we grow the more expensive good education will
become, unless some major technological revolution, such as mass use
of television as an instrument of instruction, transforms the education
industry. It is too early to tell whether such a change will be possible
or desirable. As things stand, it is very unlikely that this country will
have an educational system such as it deserves and badly needs and can
certainly afford without Federal participation on a large scale.
Traditionally, education, particularly on the elementary and sec
ondary level, has been regarded as a local affair. Although part of
this tradition has already been broken by State educational grants to
local governments, which are quite common, further departures from
this or any other tradition require justification.
In ages past when a person was likely to be born, live, and die in
the same community (if such times ever existed in this country) which
was economically more or less self-sufficient, it was natural to think of
education, particularly on the elementary and secondary level, in local
terms. Whatever might have been the case in the past, the geographi
cal mobility of our present population is remarkable: between 1953 and
1956 over 10 million persons per year changed their county of residence.
(See appendix, table A -V II.) Subject to annual variation, the gen
274
ECONOMIC GROWTH AND STABILITY
eral trend has been from the Northeast and South toward the West.
Must the South—our poorest region—provide education for the more
prosperous W est ?
That the economic interdependence of all regions of this country is
very great requires no elaboration. A waste of ability and talent in
any one region affects all the rest. The education and training of our
highly mobile labor force is therefore a national problem.
One may still wonder whether a proper educational system could
not be financed by local governments, with State support, particularly
in periods of high prosperity and full employment. Whether a large
increase of educational expenditures from these sources can be under
taken is a moot question. Financial ability is hard to judge. On the
whole, our poorer States, which usually also have poorer schools, are
making at least as great or even a greater educational effort than the
richer ones. Thus in 1954 Mississippi spent 3.06 percent of her per
sonal income on education; Arkansas and South Carolina 2.78 and 3.37
percent, respectively, as compared with 2.08 percent for New York,
1.80 and 2.01 percent for Connecticut and New Jersey. (The highest
ratios were in the West: in New Mexico, 3.56; Wyoming, 3.44: and
Idaho, 3.39 percent.) (See appendix, table A -IX .) That the State
and local governments find it much more difficult to raise funds than
the Federal Government does is well known. The fear of repelling
customers in case of a sales tax, and wealthy individuals in case o f an
income tax, is an important factor. Perhaps the unwillingness to tax
is as strong as inability. Be all this as it may, the fact remains that
State and local governments have not met the problem. Nor is a radi
cal improvement to be expected in the near future.
The emphasis placed in this paper on the waste of talent and ability
caused by the failure of potentially bright college students to enroll
should not give the impression that this is the only educational problem
we face. Other problems will, I presume, be discussed by the special
panel. Perhaps I may add here that it is highly desirable to raise the
general level of our college instruction. Our education is becoming
ever longer because so little is accomplished in 4 years of undergrad
uate training; a master’s degree and even a doctorate are increasingly
required. For that matter, postdoctoral training is becoming more
common. But such a reform of college education cannot be under
taken without a major improvement in our elementary and, particu
larly, high-school instruction.
F e d e r a l E x p e n d it u r e s a n d
R esearch
Expenditures on research and development from all sources (gov
ernmental, commercial, and nonprofit) have increased markedly over
recent years, rising from some $0.8 billion in 1941 to $4.6 billion in
1953, or as a fraction of gross national product from 0.6 to 1.3 percent.
Between 1941 and 1957 Federal expenditures on research and develop
ment rose from $0.2 billion to $2.6 billion, though as a fraction of
gross national product the latter figure corresponds to only some 0.6
percent. (See appendix, table A -X .) And of course the absolute
figures should be corrected for changes in the price level.
That economic growth is based on technological progress and re
search in general is clear beyond doubt. It is tempting, therefore,
ECONOMIC GROWTH AND STABILITY
275
to argue that Federal expenditures on research should increase. I
take this position, but with the following qualifications: _
1. The social usefulness of research expenditures is limited by the
supply of well-trained research workers, which in turn depends on
our educational system. I f the Federal Government increases its de
mand for them without helping to increase the supply, research
workers will be simply shifted from non-Federal to Federal projects.
In the short run this will accomplish certain specific objectives, par
ticularly connected with national defense. Its long-run effects may
be less desirable.
2. By far the largest part of Federal research expenditures—84
percent in 1956—is related to national security. (See appendix, table
A -X I.) While some of the results of these expenditures will find
peacetime uses, I cannot help wondering whether it is healthy in the
long run that only 16 percent of them are directed to nondefense
purposes.
3. Even more important is the estimate that over 90 percent of
Federal research obligations are for applied research. (See appendix,
table A -X II.) Granted that the distinction between basic and ap
plied research is vague and that the estimate is not precise, it still
remains true that the Federal Government is little concerned with
basic research. It may even be impeding it by encouraging scientists
to leave basic research where material gains, if any, are small and
move to applied projects which can be easily financed. And yet basic
research is the foundation on which all other research is built; its
benefits are widely diffused and accrue to the whole society rather
than to its direct sponsors and originators. It is difficult to find a
field more worthy of Federal support.
A p p e n d ix
This statement was made by Alfred Marshall, the great English
economist, near the turn of the century. While there is a vast differ
ence between the present American conditions and those in the England
of his time, his statement is still of interest.
The laws which govern the birth of genius are inscrutable.
It is probable that the percentage of children of the working
classes who are endowed with natural abilities of the highest
order is not so great as that of the children of people who
have attained or have inherited a higher position in society.
But since the manual labor classes are 4 or 5 times as numer
ous as all other classes put together, it is not unlikely that
more than half of the best natural genius that is born into the
country belongs to them; and of this a great part is fruitless
from want of opportunity. There is no extravagance more
prejudicial to the growth of national wealth than that waste
ful negligence which allows genius that happens to be born
of lowly parentage to expend itself in lowly work. No change
would conduce so much to a rapid increase of material wealth
as an improvement in our schools, and especially those of the
middle grades, provided it be combined with an extensive
system of scholarships, which will enable the clever son of a
workingman to rise gradually from school to school till he
276
ECONOMIC GROWTH AND STABILITY
has the best theoretical and practical education which the
age can give.
To the abilities of children of the wroking classes may be
ascribed the greater part of the success of the free towns in
the Middle Ages and of Scotland in recent times. Even
within England itself there is a lesson of the same kind to be
learned; progress is most rapid in those parts of the country
in which the greatest proportion of the leaders of industry
are the sons of workingmen. For instance, the beginning of
the manufacturing era found social distinctions more closely
marked and more firmly established in the south than in the
north of England. In the south something of a spirit of caste
has held back the workingmen and the sons of workingmen
from rising to posts of command; and the old established
families have been wanting in that elasticity and freshness of
mind which no social advantages can supply, and which comes
only from natural gifts. Tins spirit of caste, and this de
ficiency of new blood among the leaders of industry, have
mutually sustained one another; and there are not a few
towns in the south of England whose decadence within living
memory can be traced in a great measure to this cause.8
T a b le
A -I. — Estimated distribution of college graduates classified by occupation
o f father
Father’s occupation
Distribution
of 1,000
children
Percentage
of each group
graduating
from college
N um ber and percentage
among college graduates
Num ber
Skilled, unskilled, factory, etc...........................
65
128
158
162
487
1, 000
43
19
15
6
8
Percent
28
24
24
10
39
22
19
19
8
31
125
100
Source: The distribution of children was taken from Bureau of the Census report p. 20, N o. 32, Dec. 4,
1950, Children and Y outh: 1950, which gives the distribution of children under the age of 18 b y occupation
of the em ployed head of the Household. The other figures are quite tentative Commission estimates.
Dael Wolfle, America’s Resources of Specialized Talent, p. 162.
T a b le
A -I I .—-Estimated educational attainment of boys and girls with AGCT
scores of ISO or h igher 1
B oth sexes
Annual
number
152.000
148.000
80,000
70,000
2, 600
Percent
100.0
97.0
53.0
46.0
1.7
1 A ll numbers are rounded, and are based upon an age group of 2,200,000 approximately the current size;
percentage figures are of all (boys and girls, or both) in age firoup and with A G C T scores of 130 or higher.
Source: Commission estimates.
Dael W olfie, America’s Resources of Specialized Talent, p. 183.
8 Alfred M arshall, Principles of Economics (London, Macmillan & Co., 1 8 9 0 ), 1st edition,
pp. 2 7 0 -2 7 1 .
277
ECONOMIC GROWTH AND STABILITY
T a b le A - I I I . — Population,
Total con
tinental
population,
including
Armed
Forces
Year
labor force , and school enrollment
Labor force
(including
military)
Total en
rollment
in schools
(all levels)
Enrollment
in elemen
tary and
secondary
education
Enrollment
in higher
education
(3)
(4)
(5)
(6)
i 13, 980, 756
17,198, 841
19,999,148
24,061, 778
29,652,377
29,751,203
31,319,271
32,856,348
35,911,050
1 37,811,547
139,181, 765
1 13,824,000
16,961,249
19,643,933
23,463,898
28,551,640
28, 257,000
28,660,250
30, 554,464
33,396,338
135,090,618
1 36, 234, 780
(2)
O)
1890...............................................
1900___ ________________________
1910.................................................
1920........... ............ ..........................
1930_.______ ___________________
1940............................ - .................
1950____________________________
1952...................................................
1954..................................... ..............
19 5 5................ .......... ...................
1956____ ______________________ _
02, 947, 714
76, 085, 794
92,027,874
105,827,858
122,864, 499
131, 788, 208
151, 683, 000
157, 028, 000
162, 409, 000
165, 248, 000
167,181, 000
21,814,412
27,323, 055
35,749,068
41,016,851
50,080,000
56,030,000
64, 599, 000
66,426,000
67,818, 000
69, 538, 000
69, 885,000
As percent of population
Year
(7)
1 8 9 0 ..._____ _______
1900............... ..............
1910.............................
1920............. ...............
1930________________
1940........................... 1950............... .............
1952________________
1954________________
1956..............................
Elemen Enroll
Total
tary and ment in
enroll
second
higher
ment as
ary en
educa
tion as
percent rollment
of popu as percent percent
lation
of popu of popu
lation lation
(4-4-2)
(5-5-2)
(6*5-2)
As percent of labor force
Total
enroll
ment as
percent
of labor
force
(4-5-3)
Elemen
tary and
second
ary as
percent
of labor
force
(5-5-3)
(ID
(12)
(10)
(8)
(9)
22. 21
22. 60
21.73
22. 74
24.13
22. 58
20. 65
20. 92
22.11
22. 88
23. 44
21.96
22. 29
21.35
22.17
23. 24
21.44
18. 89
19. 46
20. 56
21.24
21.67
0. 25
.31
.39
.56
.90
1.13
1.75
1.47
1. 55
1.65
1.76
64. 09
62. 95
55.94
58. 66
59. 21
53.10
48. 48
49. 46
52. 95
54.38
56.09
63. 37
62. 08
54.95
57. 21
57.01
50. 43
44. 37
46. 00
49. 24
50. 46
51. 87
156, 756
237,592
355. 215
597,880
1,100,737
1,494,203
2,659,021
2,301, 884
2,514,712
2,720,929
2,946,985
As percent of total
enrollment
Enroll Elemen
Enroll
ment in tary and ment in
higher
second
higher
educa
ary en
educa
tion as rollment
tion as
percent as percent percent of
of total total enof labor
force
enroll
rollmet
ment
(6-5-3)
(6-4-4)
(5 -4)
(13)
0.72
.87
.99
1.46
2.20
2. 67
4.12
3. 47
3.71
3.91
4. 22
(14)
98. 88
98.62
98. 22
97. 52
96.29
94. 98
91.51
92.99
93.00
92. 80
92. 48
(1,V>
l.U
1.38
1.78
2.48
3.71
5.02
8.49
7. 01
7.00
7. 20
7. 52
5 Denotes estimation on basis of subsequent (or preceding) proportions of private enrollment to total
enrollment in elementary and secondary schools. Consequently, the total enrollment in elementary and
secondary schools (and in ull levels) is, in part, an estimation. '
Sou rces
fo r
T
able
A -III
Col. 2:1890 figure from Stat. Abst. 1956, p. 5, table No. 1; figures for 1900-1940 computed from Hist. Stat.,
p. 25, series B, 2, and 3; figures for 1950-5(5 from Stat. Abst., p. 5, table No. 2 (1956 figure is for December).
Col. 3: Figures for 1890-1930 are based on “ gainful worker” concept. From 1940 on the labor force con
cept is used. Difference is mainly that former excluded new workers not yet employed for 1st time,
whereas latter includes them. Figures for 1890-1920 from Hist. Stat., p. 64, series D, 32, and cover gainfully
occupied as of age 16 and over. Figures for 1930-55 from Stat. Abst. 1956, p. 197, table No. 235 and include
those gainfully occupied or in labor force (whichever is appropriate) of age 14 and over. Figure for 1956
(December) comes from Monthly Labor Review, April 1957, p. 506, table A -l.
Cols. 4, 5, and 6: Figure for 1890 enrollment in elementary and secondary schools is estimated on basis of
1890 enrollment of 12,723,000 in public elementary and secondary schools (Biennial Survey of Education,
1950-52, ch. I, p. 18. table Mo. 11) and distribution between public and private enrollment in elementary and
secondary schools in 1900 (ibid., ch. I, p. 7, table No. 4). Figure for 1890 enrollment in higher education
from Biennial Survey, 1950-52, ch. I. p. 41, table No. 34. Figures for 1900-1952 from Biennial Survey,
1950-54, ch. I, p. 7, table No. 4. Figures for 1954 from Biennial Survey, 1952-54, ch. I, p. 7, table No. 4.
Figures for 1955 and 1956 enrollment in elementary and secondary schools are estimated on basis of 1955
and 1956 enrollment in public elementary and secondary schools (30,532,166 in 1955 and 31,527,695 in 1956)
(Office of Education, supplement to circular No. 490, p. 1, table No. 1) and on basis of 1954 enrollment in
private elementary and secondary schools (Biennial Survey, 1952-54, p. 7, table No. 4) as a proportion of
total enrollment. Figures for 1955 and 1956 enrollment in higher education from Oflice of Education,
Circular Series, No. 400 (p. 7) and No. 496 (p. 2).
278
ECONOMIC GROWTH AND STABILITY
T
A -IV . — Total population and school-age population
able
Population
Total conti
of ages 5 to
nental United
States popu Population Population Population 24 as per
ages 5 to 24 ages 5 to 17 ages 18 to 24 cent of total
lation (in
cluding
population
Armed
(3 -2)
Forces)
Year
(1)
(2)
(3)
(4)
(5)
1900........... .........
1910..........- .........
1920_............. .
1930.............. .
1940_____ _____
1950____ ______
1955____ ______
76,085,794
92,027,874
105,827,858
122,864,499
131,788,208
151.683.000
165.248.000
31,845,462
36,988,359
40,746,789
47,034,979
46,351,915
46, 519,445
52,440,000
21.538.024
24,239,948
27,728,788
31,571,322
29,745,246
30.735.025
37,334,000
10,307,438
12,748,411
13,018,001
15,463,657
16,606,669
15,784,420
15,106,000
Population
of ages 5 to[
17 as per-t
cent of total
population
(4-5-2)
Population
ofages 17 to
24 as per
cent oftotal
population
(5*2)
(7)
(8)
(6)
41.85
40.19
38.50
38.28
35.17
30.67
31.73
28.31
26.34
26.20
25.70
22.57
20. 26
22.59
13.55
13.85
12.30
12. 59
12.60
10.41
9.14
Col. 2: Figures for 1900-1950 from table A -III, col. 2.
Col. 3: Figures for 1900-1950 computed from 1950 Census, Special Report P -B l, p. 93, table No. 39. Fig'
ure for 1955 computed from Current Population Reports, Series P-25, No. 121, p. 1.
Col 4: Figure for 1900 computed from 1900 Census of Population, vol. II, pt. II, p. xxxvi, table X IV .
Figure for 1910-50 computed from 1950 Census, Special Report P -B l, p. 95, table No. 43. Figure for 1955
computed from Current Population Reports, Series P-25, No. 121, p. 1.
Col. 5: Figure for 1900 computed from 1900 Census of Population vol. II, pt. II, p. xxxvi, table X V I.
Figures for 1910-50 computed from 1950 Census, Special Report P -B l, p. 95, table No. 43. Figure for 1955
from Current Population Reports, Series P-25, No. 121, p. 1.
Cols. 6, 7, Mid 8: Computed from cols. 3 and 2, cols, 4 and 2, and cols. 5 and 2, respectively.
T a b l e A -V . —
School-age population and educational enrollment
Year
Population
of ages 5
to 24
Total enroll
ment in
education
Population
of ages 5
to 17
Total enroll
ment in ele
mentary and
secondary
schools
Population
of ages 18
to 24
Total en
rollment
in higher
education
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1900.............................
1910.............................
1920.............................
1930.............................
1940_______ ________
1950....................... .
1955......... ............... .
31, 845, 462
36,988,359
40,746,789
47, 034,979
46,351,915
46, 519,445
52, 440,000
17,198,841
19, 999,148
24, 061, 778
29, 652, 377
29, 751, 203
31,319,271
i 37,811,547
21, 538,024
24,239,948
27,728, 788
31,571,322
29, 745, 246
30, 735,025
37,334,000
Year
(1)
1900......... .................................................................................. ..........
1910.................. ....................................................................................
1920......................- ....................................... ......................................
1930.......................................................................................................
1940.............. ..........- ............ .................................................. ..........
1950................ ........... ........... .......................... ................. ..................
1955____________________________ _______ ____________ _______
i Denotes estimation.
16,961, 249
19,643,933
23,463,898
28, 551, 640
28, 257, 000
28, 660, 250
» 35,090,618
10,307, 438
12, 748,411
13,018, 001
15.463, 657
16, 606, 669
15, 784, 420
15,106,000
Total enroll
Total enroll
ment in
ment in
elementary
education
and second
as percent of ary schools
population as percent of
population
of ages
5 to 24
of ages
(3*2)
5 to 17
(5*4)
(8)
54.01
54.07
59.05
63.04
64.19
67.33
72.10
(9)
78. 75
81.04
84.62
90.44
95.00
93.25
93.99
237, 592
355, 215
597,880
1,100, 737
1,494, 203
2, 659,021
2,720,929
Total enroll
ment in
higher edu
cation as
percent of
population
of ages
18 to 24
(7*6)
(10)
2.31
2.79
4.59
7.12
9.00
16.85
18.01
(See table A-III.)
Cols. 2, 4, and 6: See table A -IV , cols. 2, 3, and 4.
Cols. 3, 5, and 7: See table A -III, cols. 4, 5, and 6.
N ote.—The enrollment data include total enrollment in the particular level of education under con
sideration and consequently are not limited solely to enrollments from the age group with which it is com
pared. Enrollments by age group do not exist for some years- hence, it seems better to retain a consistent
measure for enrollment figures.
279
ECONOMIC GROWTH AND STABILITY
T a b le
A -V I .— Gross national product and educational expenditure
[All figures in thousands of dollars]
Year
Gross
national
product
(Depart
ment of
Commerce)
Gross
national
product
(Painter)
U)
(2)
(3)
1900. . .
1910........
1920____
1930
1940
1950. .
1952____
1954...
1955____
1956........
91,105,000
100,618,000
285.067.000
346.095.000
360.500.000
391.700.000
414.700.000
Year
86,600,000
88, 200,000
97,100,000
Total
Expendi Expendi
ture on
ture on
expendi
Expendi Expendi expendi
ture on
public
private
ture on
ture on
ture on
education
elemen
elemen
elemen
public
private
(including tary and tary and
higher
higher
tary and
secondary secondary education education secondary
capital
outlay)
schools
schools (including (including schools
capital
(including
(5+6+ 7+ 8) (including (including
capital
capital
capital
capital
outlay)
outlay)
outlay)
outlay)
outlay)
(5+6)
(4)
(5)
(6)
(7)
(8)
(9)
1287, 751
1 571,688
i 1,382,658
3,182,316
3,176,804
8,743,885
10,696,434
13,949,876
214,965
426,250
1,036,151
2,316,790
2,344,049
5,837,643
7,344,237
9,172,129
i 27,000
53,542
i 130,141
233,277
227,000
782,967
1,027,670
1,364,079
i 24,463
i 49,100
115,597
288,909
332,592
1,174,125
1,313,084
1,911,750
121,323
i 42,796
100,769
343,340
273,163
949,150
1,011,443
1,501,918
1241,965
1 479,792
11,166,292
2,550,067
2,571,049
6,620,610
8,371,907
10,536,208
Total expend Total expend Total expend Total State Total Federal
iture on
iture on
iture on
and local
expenditure
higher edu
public edu private edu expenditure on education
cation
(including
cation
cation
on education
(including
(including
(including
(including
capital
capital
capital
capital
capital
outlay and
outlay) (7+8) outlay) (5+7) outlay) (6+ 8)
grant to
outlay)
States)
( 10)
45,786
91,896
216,366
632,249
605,755
2,123,275
2,324,527
3,413,668
1900.
1910.
1920.
1930.
1940.
1950.
1952.
1954.
1955.
See footnote a t end of tables.
( 11)
i 239,428
i 475,350
1,151,748
2,605,699
2,676,641
7,011,768
8,657,321
11,083,879
( 12)
i 48,323
i 96,338
230,910
576,617
500,163
1, 732,117
2,039,113
2,865,997
(13)
255.000
577.000
1.705.000
2.311.000
2.638.000
7.177.000
8.318.000
10.557.000
11.907.000
(14)
174,930
3,618,900
1, 561, 574
280
ECONOMIC GROWTH AND STABILITY
Table A -V I .— Qross national product and educational expenditure^-Gontimxed
ED U C A T IO N A L E X P E N D IT U R E S AS P E R C E N T OF GROSS N A T IO N A L PR O D U CT
[A ll figures in thousands of dollars]
Total edu
cational ex
penditure
(4*2)
Year
(16)
(15)
1900______________
1910....... ..................
1920.— ...................
1930______________
1940— ...................1950...........- ............
1952.................... .
1954.........................
1955.......... .......
1956...___________
3.49
3.16
3.07
3.09
2 3.87
Total ex
penditure
on elemen
tary and
secondary
education
(9*2)
Total ex
penditure
on higher
education
(10* 2)
Total ex
penditure
on public
education
(all levels)
(11* 2)
Total ex
penditure
on private
education
(all levels)
(12* 2)
State and
local gov
ernment ex
penditure
on educa
tion
(13*2)
(17)
(18)
(19)
(20)
(21)
2.80
2.56
2.32
2.42
2.92
0.69
.60
.74
.67
.95
2.86
2.66
2.46
2.50
3.07
0.63
.50
.61
.59
.80
i
:
2; 54
2.62
2. $2
2.40
2.93
3.04
1 Federal grants to States and local governments for education included in expenditures of col. 13 and
ncluded in Federal figure in col. 14; then adding cols 13 and 14 involves double counting.
2 Denotes estimation due to the need to estimate expenditure on private elementary and secondary schools
in 1954.
S o u r c e s f o r T a b l e A -V I
,
. Col. 2. Figures for 1930-52 from National Income, 1954, supplement, pp. 162-163, table No. 2. Figures
‘for 1954 from Business Statistics, 1955, supplement, p. 3. Figures for 1955-56 from Survey of Current Busi
ness, July 1957, pp. 30-31, table No. 49.
Col. 3. Figures for entire column from Painter, Federal Reserve Bulletin, September 1945, p. 873.
Col. 5. Figures for 1900-1952 from Biennial Survey 1950-52, ch. 1, p. 18, table No. 11. Figure for 1954 from
Trends in School Finance, p. 49, table No. 42.
Col'. 6. Figures for 1910, 1930-52 from Statistical Abstract, 1956, p. 124, table No. 146. Figures for 1900,
1920, and 1954 estimated on basis of preceding (or subsequent) proportions of public and private expenditure
of total elementary and secondary expenditure.
Col. 7. Figures for 1920-52 from Statistical Abstract, 1956, p. 124, table No. 146. Figures for 1900, 1910
estimated on basis of total expenditure on higher education given in same table. Figure for 1954 from
Biennial Survey 1952-54, ch. 4,*pt. II. pp. 106,121, tables Nos. 5, 7.
Col. 8. Same as col. 7 for years 1900-1952. Figures for 1954 from Biennial Survey 1952-54, pp. 108, 122,
tables Nos. 5, 7.
Col. 13. 1900,1910, 1920,1930 figures are actually for years 1902,1913,1922, 1932, respectively. All figures
come from Historical Statistics on State and Local Government Finance 1902-53, p. 17, table I, except for
1954 and 1955 figures, which come from Summary of Government Finances in 1955, p. 26, table No. 8.:
Col. 14. 1955 figure from Federal Funds for Education, 1954-55, 1955-56, p. 24, table No. 7. 1950 figure
from Federal Funds for Education, 1950-51, 1951-52, p. 5, table No. 2. 1940 figure from Federal Funds for
Education, 1938-39, 1939-40, p. 27, table No. 5, with $21,358,000 added for expenditure not attributable to
any given State—that figure being the one for 1942.
T a b le
A -V II .— Average annual number of migrants, by region o f residence at
beginning and end of yea r: April 1953 to March 1956
Region of residence at beginning of year
Region of residence at end of
year
Northeast
,
North
Central
South
West
270,000
487,000
2, 726,000
334, 000
3,817,000
57,000
186,000
271,000
1.558.000
2.072.000
Total mi
grants into a
county of—
. . ,
Northeast. _____ ______________
North Central- —............................
South__________ ____ ___________
West___ ___ ___________ ________
Total migrants from a county in.
1.424.000
105.000
198.000
115.000
1.842.000
71,000 :
2.051.000
342, 000
238,000
2.702.000
1,822,000
2.829.000
3.538.000
2.245.000
10,434,000
Source: Current Population Reports; series P-20, No. 73, p. 18, table No. 11.
From the above information we can compute average annual net migration of each region by subtract
ing the appropriate column sum from the appropriate row sum.
T a b le
A -V III .— Average annual net migration , by regions , 1958-56
Region :
N e t migration
Northeast_________________________________________________________
—20,000
North Central____________________________________________________
127, 000
South_____________________________________________________________ —279, 000
West______________________________________________________________
173, 000
Source : Calculated from
table A -V I I .
281
ECONOMIC GROWTH AND STABILITY
T able A - I X .—
Current expenditure on public elementary and secondary schools:
and personal income, 1954, by States
[All in thousands of dollars except col. No. 5]
.
State
(1)
Northeast:
Connecticut......................................................
M a in e .___ ________ _
_______ _______
Massachusetts................... ........................... ..
New Hampshire_____ __________ . ____ .
New Jersey............ ..........................................
New York ............. ............. .................. . Pennsylvania...................................................
Rhode Island.....................................................
Vermont___________________ ______________
North Central:
........................- ..................................
Illinois
Indiana... . ............................. .......................
Iowa.______ ____________________________
Michigan______ _ ________________ ______
Minnesota... ....... . . ...........
Missouri.................................... ...............
..
Nebraska. ....................................................... .
North Dakota................................. ............. ...
O hio... ............................. . ...... ............ .......
South Dakota________ _______ ____ ________
Wisconsin....................... ........... ......... ............
South:
Alabama.................................. ............ ..............
Arkansas...................... ............ ......... ..........
Delaware............................................... ............
Florida................................................ ...............
Georgia................................................................
Kentucky__________ ______ ___________ ..
Louisiana........... ............................ ...................
Maryland................................. ......... ...........
Mississippi . . . ......... .......... ................. ....... .
North Carolina___ _____ ____ . _________
Oklahoma ___________ ____ _____ ________
South Carolina_________ _________ _______
Tennessee................... .......... . ____________
Texas. , . . ___________________ ______ ____
Virginia..... ............................................ .........
West Virginia....................................................
West:
Arizona..............................................................
C alifornia.-...........................................
Colorado.................... ..............
. . ..
Idaho..................................... ............. ..............
Montana.............. .............................................
Nevada............................. ...............................
New Mexico ............. ...................... ...........
Oregon....................... ......... .. ............. .........
Utah........... ................. . . . .
Washington....... .
........ . ............. ..........
Wyoming........ ............................ ..
.
.
District of Columbia_____ _____ ____
..
_
Expenditure
(current) on
public ele
mentary and
secondary,
schools, 1954
Personal
income,
1954
Expenditure
on schools
as percent
of personal
income,
1954
(2)
(3)
(4;
Current ex
penditure
per pupil
in average
daily at
tendance
in public
secondary
and ele
mentary
schools, 195*
United
States
average—
$264.76
(5)
$92, 755
30,872
189, 814
19.025
233,639
709,174
460, 628
25, 608
14,542
$5,156,000
1,304,000
9,448,000
894,000
11, 619,000
34,175,000
19,646,000
1, 522,000
536,000
1.80
2. 37
2.01
2.13
2.01
2.08
2.34
1.68
2. 71
$296.80
199.33
298.39
256.38333.31
361.99'
299.31
268.05
245.31.
383,164
192,114
127,059
94.014
325, 497
143, 829
139,481
59,027
28,924
338, 214
31,930
147,615
19, 786,000
7,619,000
4.449,000
3. 410. O.Ki
14.172,000
5,169, 000
7, 066, 000
2, 236,000
760, 000
17, 221,000
901,000
6, 212, 000
1.94
2.52
2. 86
2. 70
2.30
2. 78
1.97
2.64
3. 81
1.96
3.54
2. 38
318.81
279.57
273.91
263. 79*
282.82
286.59
232.79262.45.
262.40
253.88
274. 91
293.3ft
92, 895
49, 598
16, 597
123,843
125,198
78, 332
120, 523
103,849
55, 444
154, 700
96, 969
80, 527
106, 402
346. 615
118,701
76, 244
3, 239, 000
1, 781, 000
891, 000
5, 342, 000
4, 418,000
3, 594, 000
3, 742, 000
5, 079,000
1, 811,000
4, 959, 000
3,159, 000
2,391,000
4, 038.000
13.300.000
5, 193. 000
2,419, 000
2.87
2. 78
1.86
2. 32
2. 83
2.18
3. 22
2.04
3.06
3.12
3.07
3. 37
2.64
2. 61
2.29
3.15
150.8S
139.19
325. 42
228.74
177. 41
153.17
246.65
268.47
122. 6ft
176. 97
223. 87
176.34
166.36*
249.22
192.56186.09-
45,990
727, 557
69, 210
29, 229
34, 989
10,482
38. 367
91,236
34, 723
129,610
18. 434'
27, 736
1, 486, 000
27,148,000
2, 519,000
861,000
1, 074. 000
506,000
1,077,000
2, 903,000
1,146,000
4. 963. 000
536. 000
1,871,000
3.09
2.68
2. 75
3.39
3. 26
2.07
3. 56
3.14
3.03
2.61
3. 44
1.48
281.6£
314. 51
279. 76
237. 81
327. 99
294.12
264. 71
336. 72
208.18
305. 42
329.86>
302.10
Col. 2: Biennial Survey of Education, 1953-54, ch. 2, pp. 70-77, table No. 26.
Col. 3: Personal Income by States since 1929, supplement to Survey of Current Business, 1953, pp. 1
table No. 1.
Col. 4: Computed from cols. 2 and 3.
Col. 5: Biennial Survey of Education, 1953-54, pp. 102-103. table No. 39.
282
ECONOMIC GROWTH AND STABILITY
T able A - X .—
Expenditures for research and gross national product
fAll figures in thousands of'dollars]
Year
Gross
national
product
Total ex
penditures
for research
and devel
opment
(4*5+6)
Federal ex
penditures
on research
and devel
opment 12
(1)
(2)
(3)
(4)
1937,................................... - ............
1938........ - ..................................... .
1939.......................................... .........
1940........ ...........................- ..............
1941........................ .........................
1942 _____ _____________________
1943____ ______ ________________
1944........ ................................. .........
1945 ____________ ______________
1946____ ______ ________________
1947........ ............ .............................
1948_______ ________ ____ ______
1949___________ ________________
1950...................................................
1951........ .............. ............................
1952..................................................
1953....................................................
1954................... ................................
1955...................................................
1956______________ _____________
1957...................................................
90.780.000
85.227.000
91.095.000
100,618,000
125.822.000
159.133.000
192, 513,000
211.393.000
213.558.000
209, 246, 000
232, 228, 000
257.325.000
257.301.000
285.067.000
328, 232,000
345.445.000
363.218.000
361.167.000
391.692.000
414.686.000
(5)
124.000
108.000
727,900
860,300
1,032,400
1,817,200
2,040,700
1.787.800
1,999,900
2.074.800
2.142.000
2.342.800
2,680, 500
3,326, 200
4.649.000
Private com Private non
mercial ex
profit ex
penditures
penditures
on research
on research
and devel
and devel
opment
opment i
74,100
197.900
280,300
602,400
1.377.200
1, 590,700
917.800
899.900
854.800
1,082,000
1,082,800
1,300, 500
1.816.200
2,099,000
2,084, 200
2,133,400
2, 282,000
2,560,800
(6)
198,680
280,132
510.000
560.000
410.000
420.000
430.000
840.000
1.050.000
1.150.000
990.000
1.180.000
1.300.000
1.430.000
2.370.000
20,000
20,000
20,000
20,000
20,000
30.000
50.000
70.000
70.000
80.000
80,000
80,000
180,000
[Percent]
Year
(1)
1937..
1938..
1939..
1940..
1941..
1942..
1943..
1944..
1945..
1946..
1947..
1948..
1949..
1960..
1951..
1952..
1953..
1954..
1955..
1956..
1957.
Total
Federal
Private
Federal
Nonprofit
expenditures expenditures commercial expenditures expenditures
on research expenditures on research
on research
on research
and devel
and devel
on research
and devel
and devel
opment as
opment as
and devel
opment as
opment as
percent of
percent of
opment as
percent of
percent of
gross
gross
percent of
gross
total expend
national
national
gross
national
iture on
product
product
national
product
research and
(3 -2)
(4 -2 )
product
( 6 - 2)
development
(5 -2)
(4 -3)
(7)
(8)
0.14
.13
0.58
.54
.54
(10)
(9)
0.23
.28
.41
.35
.21
.20
.20
.85
.86
.81
.83
.82
.82
.96
1.28
(11)
.40
.45
.45
.38
.41
.40
.41
.65
0.02
.01
.01
.01
.01
.01
.02
.03
.03
.03
.02
.02
.05
27.19
32.58
58.35
75.79
77.95
51.34
45.00
41.20
50.51
46.22
48.52
54.60
45.15
283
ECONOMIC GROWTH AND STABILITY
.
S ou rces t o T a b le
A -X
Col. 2: Figures for 1936-56 from Survey of Current Business, July 1957, pp. 8-9, table No. 2.
Col. 3: Calculated from cols. 4, 5, and 6.
Col. 4: Figures for 1937-38 from Research—A National Resource, vol. 1, p. 66, table No. 1.
Figures for 1940-57 from Federal Funds for Science, V, pp. 46-47, table No. 10.
The 1956 and 1957 figures are estimates.
Col. 5: Figures for 1938 and 1940 are estimated from information given in Research—National Resource,
vol. II, p. 173. On the basis of the cost of research as $4,000 per man-year of research personnel, together
with that in 1940 there were 70,033 research workers in American industry (41 percent more than in 1938),
the figures for 1938 and 1940 can be derived. It is assumed that Government expenditures in 1938 and 1940
for research was entirely performed by a Government agency.
Figures for 1941-52 from Department of Defense, Growth of Scientific Research and Development, p. 10,
table No. 1. These figures apply only to industrial research in the natural sciences (including medicine)
and engineering. However, because private industry’s research in the social scicnces is probably quite
limited, expenditure for research and development in the natural sciences and engineering seems adequate.
In view of the fact that the source makes no mention as to how the data were compiled, whether or not
items such as capital outlay, etc., were included, it seems that not too much confidence can be placed in the
data. Such suspicion is reinforced by the fact that NSF data for 1953 show an almost $1,000,000,000 increase
in industrial research and development expenditures over the 1952 figure given by Department of Defense.
Figure for 1953 from Reviews of Data on Research and Development, No. 1, p. 2, table No. 1. This
figure is also for research in natural sciences alone.
Col. 6: Figures for 1941-52 from Department of Defense, Growth of Scientific Research and Development,
p. 10y table No. 1. Same comment here as to reliability of the estimate as expressed above under col. 5.
Figure for 1953 from Review of Data on Research and Development, No. 1, p. 2, table No. 1.
All figures in col. 6, as in col. 5, refer only to expenditures for research and development in the natural
sciences and engineering. The exclusion of the social sciences is probably more serious in the case of the
nonprofit institution than with private industry.
Cols. 7, 8, 9, 10, and 11: Calculated from cols. 2 and 3, 2 and 4, 2 and 5,2 and 6, and 3 and 4, respectivelyN
otes to
T
able
A -X
1 Cols. 4, 5, and 6 refer to sources of funds for research and development. The actual performance of the
research may, in the case of Government funds, be done, say, by a private commercial enterprise.
2 In col. 4 the figures for 1956 and 1957 are estimates, all other figures are actual expenditures, not obliga
tions, for fiscal, rather than calendar, years. Such figures exclude development expenditures from Depart
ment of Defense procurement funds and the pay of military personnel engaged in research and development.
The magnitude of these latter elements was, in 1955, $635,000,000 for research and development from De
partment of Defense procurement funds, and $157,000,000 of pay of military personnel engaged in research
and development. (Source: Federal Funds for Science, V, for fiscal 1955, 1956, and 1957, p. 4.) It is the
exclusion of these 2 categories of expenditures which probably accounts for the generally higher Federal
expenditure figures given in Department of Defense publication, The Growth of Scientific Research and
Development. Neither of the 2 sources include routine statistical collection and publication in the defini
tion of research and development.
The World War II expenditure on research and development by Federal Government includes expendi
ture for construction of production facilities (Oak Ridge, Los Alamos) for the atomic bomb. To this extent,
Federal research and development expenditure is overstated for World War II.
[ G e n e r a l N o t e .— All data, insofar as can be determined, include expenditures for research and develop
ment plant and equipment.
{ Since expenditures on research and development cannot be defined precisely, a good deal of variation
exists in data derived from different sources.
T a b le A - X I .—Federal research
and development expenditure, by function,
1 9 5 S -5 6 1
[All figures in thousands of dollars]
Fiscal year
National
security
(1)
(2)
1953....................................
1954....... ............ ................
1955__________________ _
1956____________________
1,830,920
1,804,310
1, 745, 672
1,862,902
Interna
Veterans’
tional
services affairs and
finance
(3)
4,600
5,130
5,312
5,870
(4)
1,792
1,143
1,144
1,421
All other research
Total Fed and development
eral research expenditures as
All other 0 and develop percent of total
ment ex
Federal research
penditures and development
(cols. 2 ,3, 4, 5)
expenditures
(cols. 5, 6)
(5)
281,572
291, 886
331, 879
358,901
(6)
2,118,884
2,102,469
2,084,007
2, 229,094
(7)
13. 29
13.88
15.93
16.10
1 Federal research and development expenditure here includes capital outlay and apparently normal
statistical collection.
2 The “ All other” includes a multitude of functions which are given separately in the source. It encom
passes: Social security, welfare, and health; housing and community development; education and g vieral
research; agriculture and agricultural resources; natural resources; transportation and communication;
finance, commerce, and industry; labor and manpower; and general government.
Sources: Cols. 2 and 5: Figures for 1953 from NSF, Federal Funds for Science, III, pp. 28-30, table No. 3.
Figures for 1954-56 from NSF, Federal Funds for Science, IV, pp. 24-26, table No. 3. 1955 and 1956 figures
are estimates. Cols. 6 and 7: Calculated as shown on table.
284
ECONOMIC GROWTH AND STABILITY
T a b le A - X I L —Basic and applied research and development in Federal
obligations, 1958-57
Fiscal year
1953............ ......................................
1954....................................................
1955.......... ................................ .........
1956........ ..........................................
1957........ ................ - ........................
Total current Federal obli Federal obli
Federal obli
gation for
gation for
gation for
basic re
applied re
research and
search and
search and
develop
develop
develop
ment
ment
ment
Thousands
$1,919.500
1, 744,000
1,887,500
2,205,205
2,382,400
Thousands
$116,000
116,000
130,100
162,100
215,100
Thousands
$1,803,500
1,628,000
1,757,400
2,043,100
2,167,300
Federal obli Federal obli
gation for
gation for
basic re
applied re
search and
search and
develop
develop
ment
ment
Percent
6.0
6.7
6.9
7.4
9.0
Percent
94.0
93. a
93.1
92.6
91.0
N o t e .— A ll o f th e figures in this table are F ederal G o v ern m en t obligations, as d istin ct from expend i
tures; hence these data are n o t ex actly com parable w ith those presented in oth er tables.
Sources: Figures for 1953 from Federal Funds for Science, III, p. 9; 1954 from Federal Funds for Science*
IV , p. 9; 1956-57 from Federal Funds for Science, V, p. 11. Figures for 1956 and 1957 are budget estimates*
GOVERNMENT EXPENDITURES AND GROWTH
James S. Duesenberry, professor of economics, Harvard University
I ntro du ction
It seems fairly clear at the outset that there are important classes
of government expenditures which have a positive effect on economic
growth. These include expenditures for education, health, urban
renewal, highway construction, water resource development, applied
research in agriculture and in the production of minerals, and basic
scientific research. Of course there are other classes of government
expenditures which contribute little or nothing to the growth process.
These include most defense expenditures (except insofar as they
produce technical progress as a byproduct) and most of the transfer
payments. Indeed, it may be argued that transfer payments for
agriculture impede progress by holding labor on the farm which
could be better used elsewhere.
Expenditures in these latter categories may be justified on other
grounds but not by their effects 011 the growth of output.
As regards those expenditures which do contribute to the growth
of output we have to ask whether they contribute enough to justify
the withdrawal of resources from other uses. We cannot have every
thing. I f we invest in education, health, and so on, we must either
forgo some current consumption or some private investment.
Two decisions are involved in setting the level of government ex
penditures which are justified by their contribution to economic
growth. These are (1) how much should be saved and invested by
the whole economy, (2) how should the investment be distributed
between public and private investment?
If we wish to increase the rate of growth or output we must in
crease the rate of growth of capital formation (in a broad sense which
includes expenditure to improve the health and education of our labor
force and increase the rate of development of technique). Three al
ternative ways of increasing capital formation may be considered: (1)
Reduction in government expenditures (relative to national income)
to permit reduction in personal taxes and thereby encourage personal
savings in order to supply more funds for private investment; (2)
reduction 111 government expenditures (relative to national income)
or increase in taxes on consumption to permit reduction in corporate
income taxes and thereby encourage private investment; (3) increase
in government expenditures which contribute to growth while cut
ting other government expenditures or increasing taxes.
It will be argued below that there is not likely to be a chronic short
age of persona] saving over the next decade. Consequently, the first
method need not be considered.
Any of a variety of combination of the other two methods would
contribute to the growth rate. I think it is likely that there is a
( i t : : : - - :,7 - 20
285
286
ECONOMIC GROWTH AND STABILITY
considerable volume of government investment which will contribute
as much to economic growth as additional private investment. I f that
is true then we will not wish to hold down government investment in
order to stimulate private investment. Our real problem is therefore
to decide how much of an increase in total investment we can afford
and how it should be divided between public and private investment.
Over the next few years considerations of national security will
probably require the maintenance of the present level of defense and
foreign-aid expenditures. Indeed, the growth of the Russian econ
omy may force us to increase defense expenditures. Most of the non
defense expenditures of both the Federal and the State and local gov
ernments consist of either transfer payments or expenditures which
do contribute substantially to economic growth, e. g., education, health,
highway construction. There are, no doubt, some government serv
ices which are not worth their cost, and some uneconomical subsidies.
Some savings could be made by improving the efficiency of govern
ment operations. But we will not be able to free any large volume
o f resources for investment by reducing government purchases of
goods and services. Additional resources for investment can only be
obtained by holding down private consumption. That can be done
either through taxation or restriction of government transfer pay
ments. There is, of course, no necessity for increasing tax rates. But
unless transfer payments are reduced it will be necessary to withhold
tax reductions from consumers in order to free resources for additional
investment.
In the remaining sections of this paper I shall consider the three
possibilities for increasing investment mentioned above, viz, (1) re
duction in personal taxation; (2) reduction in corporate taxation;
(3) increase in government investment.
A
S h ortag e of P er son a l S a v i n g s ?
In the last 3 years we have been told in innumerable speeches and
articles that there is a shortage of savings in this country. It has
usually been suggested that this shortage could be eliminated by a
reduction in government expenditures. Those statements may be
adequate enough as descriptions of the situation in the last couple of
years. I do not think, however, that there is much reason to anticipate
a shortage of savings on the average over the next decade or so. There
is always a tendency to overemphasize the significance of short-term
movements in business conditions. When there is a boom in invest
ment people talk as though it would last forever. When there is a
slump they see no end to it. Yet all our experience shows that
investment fluctuates, every rise in the ratio of investment to income
being followed before long by a decline. It is unreasonable therefore
to judge the average situation by the situation at the peak of the cycle.
During 1955 and 1956 gross private domestic investment averaged
about 15.7 percent of gross national product. That was about onehalf a percentage point above the average ratio for the postwar years.
The depression and the Second World War caused capital shortages
in both housing and industry which have now been made up. It
seems unlikely, then, that a rate of investment of as much as 15 percent
o f gross national product can be sustained in the long run. The Na
ECONOMIC GROWTH AND STABILITY
287
tional Planning Association estimates the sustainable average rate of
gross investment at 13.2 percent of gross national product. When we
view the investment performance of 1955 and 1956 against that back
ground it seems unlikely that a shortage of savings will persist over
a long period.
That conclusion is reinforced by the fact that in the last 3 years the
growth of industrial capacity has exceeded the growth of demand in
a considerable number of industries.
I conclude then that under the present tax arrangement there is no
great likelihood of a chronic shortage of saving. The Government
will not contribute anything to the Nation’s growth potential by run
ning a surplus and throwing additional funds on the market through
debt repayment. Nor will it help to cut Government expenditures
and then reduce taxes on high income persons in order to allow them
to save more.
It does not follow, however, that we cannot increase the rate of
growth of output by increasing the rate of saving and capital forma
tion. We can do so in two ways: (1) By adjusting the tax structure
and sor.iu of our financial arrangements in such a way as to increase
the demand for capital on the part of business, (2) by Government
investment in such fields as education, urban redevelopment, conserva
tion of resources and health.
C orporate T a x a t io n a n d P rivate I n v e s t m e n t
A number of witnesses before this committee have argued that a
higher rate of growth of output can be obtained by encouraging pri
vate investment. Their argument is fairly simple. We know that
there is a great deal of relatively old and inefficient plant and equip
ment in use in this country. That is a persistent situation. Old
equipment is constantly being replaced with new but at the same time
existing equipment is getting older. Since technique is constantly
improving, there is always a wide gap between the efficiency of the
oldest equipment in service and that of the best available equipment.
It seems clear that if we could reduce the age of the oldest equipment
in use we could save labor or raw materials which could be put to
other uses.
At present many companies seem to feel that an investment return
of 20 percent or more (before taxes) is required to justify the re
placement of old plant and equipment. I f the rate of return required
to justify replacement were lowered the age of the oldest equipment
in use would be reduced and the productive efficiency of our economy
would be increased.
Three different sets of factors operate to make firms require a high
prospective return on investment: (1) Some firms may simply feel
that, in view of the risk involved, an investment is not worth while
unless it can be expected to yield an after-tax return of, say, 10percent. To the extent that that is true, a reduction in the effective
corporate income tax rate on earnings from new investment would
reduce the before-tax rate of returns required to justify new invest
ment. But to the extent that losses on one venture can be offset against
profits from another the Government shares in the risk as well as in
the profits of investments. The net effect of taxation on the level of
returns required to compensate for risk should not be very great.
288
ECONOMIC GROWTH AND STABILITY
(2) Some firms may be willing to take lower expected returns on new
investment if the investment can be financed from retained earnings..
They may, however, be unwilling to take the additional financial risk
associated with the use of borrowed capital. In that case more invest
ment would be forthcoming if the corporate income tax were reduced
so as to permit an increase in the flow of retained earnings. (3)
Some firms may be willing to use a greater amount of borrowed funds
but find it impossible (except at prohibitive rates) because of “ tight”
money. As I have already indicated this may be a cyclical problem
but it is not a chronic one which can be dealt with by taxation. (4)
Because of imperfections in the capital markets some small rapidly
growing firms always find it difficult to finance investments which they
consider worth while. That problem may be dealt with by changes
in the structure of the capital market, but I shall not attempt to discuss
them here. Alternatively consideration might be given to further tax
concessions to small firms.
I have emphasized the replacement problem in the above discussion,,
but the same argument applies to the investment involved in the
introduction of new processes or new materials which may reduce
costs for other firms. It also applies to the cases involving a decision
whether to build new plant or to continue using obsolete standby
capacity.
To our sorrow no one knows how much effect tax reduction would
have on private investment. We can hardly expect that all of the in
crease in corporate profits after tax resulting from tax concessions will
go into additional investment. Some of it may be passed on to consum
ers through lower prices, and trade unions may extract some additional
wage increases. At the same time dividends may increase and some
firms wTill borrow less instead of investing more. Finally, some o f
the gain from tax reductions may be diverted into advertising and
selling expenditure rather than into productive investment. It seems
quite likely that private investment will be increased by only a frac
tion of any tax concessions given to private business.
That is not necessarily a controlling consideration. I f tax conces
sions result in price reductions, wage increases, or dividend increases,,
households are compensated for paying higher taxes in order to permit
reductions of business taxes. I f firms use the gains from tax reductions
to avoid borrowing or build up liquid assets, taxes on consumers can
be reduced without any inflationary effect. The gains to households
from these sources would, of course, be distributed differently from
those emerging from a change in taxes on households in the first
instance. But that is not necessarily a disadvantage.
To the extent that tax reductions do result in increased business
investment they should contribute to the rate of increase of produc
tivity. The possibility of reducing taxes to increase investment must
therefore be regarded as competitive with government expenditures
aimed at increasing potential output.
G overn m en t I nvestm en t
We are always inclined to think of investment as something involv
ing bricks and mortar or machines. When we think of government
investment we think of hydroelectric projects or toll roads. They are
classified as investments because they do involve physical construc
ECONOMIC GROWTH AND STABILITY
289
tion and because they produce benefits which are readily identifiable,
and measurable (if not collectible) in cash. But investments do not
have to have those characteristics. An investment is an expenditure
which produces benefits which accrue over or last for a long time.
From that point of view expenditures on education are certainly
investments. They increase the productivity of the labor force not
just in the year in which the expenditure is made but for many years
afterward. At the same time education is supposed to produce
•esthetic and social benefits which last throughout the lives of the
students. Those benefits do not appear in the national income statistics,
but we ought not to neglect them just because they cannot be rung up
-on the cash register.
A similar agument applies to urban renewal. At least a quarter of
■gross private domestic capital formation goes into residential con
struction. The figure is even larger if we add the associated construc
tion of trade and service facilities, utility construction, and public
construction. Yet while we pour billions of dollars into new con
struction we permit our enormous existing stock of housing to
deteriorate far more rapidly than is necessary. Those losses could
be avoided by programs designed to rehabilitate marginal areas where
deterioration of property has not gone too far, for the clearance of
existing slum areas, for planning the future development of metro
politan areas. Programs of that sort would save a great deal more
capital than would be required to finance them. In addition, they
would provide a continuing stream of social and esthetic benefits
worth a great deal in themselves.
It is not my purpose to argue for particular programs. The pro
grams I have mentioned are only examples. I do wish to emphasize
two points. First, that government investment in a wide range of
fields can contribute substantially to the growth of real output as
usually measured. It can do so by increasing or conserving the pro
ductivity of our existing human and natural resources. Such invest
ments may not produce revenue for the Government, but they will add
to the real output of the Nation.
It is not easy to measure the yields from education, urban redevel
opment, basic research, or expenditures to improve health. It is
fairly clear, however, that investment in the training of professionals
yields a high return on the investment. Data on the effects of other
types of education are less satisfactory. Available information on
skill differentials does suggest, however, that education does have an
appreciable effect on the “value of a man.” Similarly most experts
in the housing field seem to agree that urban renewal is economically
advantageous.
Secondly, I wish to emphasize that the nonmaterial benefits of a
large class of government expenditures should be regarded as contri
butions to economic growth even when they do not add to gross
national product in constant prices.
In discussing growth wTe tend to talk about real national product
as though we ‘were concerned with the rate of output of a single com
modity. In fact, of course, we are concerned with the output of thou
sands of different goods and services. W e add up this collection of
items by -weighting the output of each item by its relative price.
Such a procedure is necessary since we can shift resources from the
290
ECONOMIC GROWTH AND STABILITY
production of one commodity to the production of another. But if weconfine our attention to the size of gross national product in constant
prices we leave out of account the problem of choosing the composition,
of the gross national product. It is just as important to produce the
right things as it is to produce more of something. For the most
part we leave the decision as to what things are to be produced to indi
vidual consumers and the working of the market. The business com
munity has every incentive to find out, if not what the customers
want, at least what they can be made to want. I f the customers will
pay for tailfins we can have every confidence that someone will dis
cover it and supply them. The free market method of deciding what
should be produced sometimes has odd results, but most of us agree
that there is no better way to do things. When the philosophers are
kings things may be different, but meanwhile most of us are content
to rely on the vagaries of the price system.
It is clear, however, that the market process does not work for
some kinds of goods and services. Private enterprise cannot supply
services which benefit everyone at once, e. g., national defense or flood
control, or the benefits of well planned and zoned metropolitan areas.
Nor can it supply services whose benefits are diffuse or uncertain like
those from basic scientific research. Private enterprise cannot ordi
narily provide services which we wish to make available even to those
who cannot pay the full costs, e. g., education and hospital services.1
Standards of service in health, education, and other types of gov
ernment service ought to rise with rising income at least as much as
the standard of consumption of privately supplied commodities.
There is no reason to discriminate against education and in favor
of backyard barbecue equipment just because one is supplied by gov
ernment and the other by private industry. Yet there is danger
that we will hold down the expansion of government services be
cause no one advertises them.
Moreover it seems likely that government expenditures will have
to rise even if no important programs are started. Many government
services must be expanded with population. Even if there is no
further increase in the general price levelj construction costs will rise,
and so will the costs of government services. Wages in those fields,
in which productivity rises slowly, will tend to keep pace with wages
in areas in which productivity is increasing more rapidly. As a re
sult the cost of a given amount of construction or government service
will rise. Finally we must keep in mind the possibility that defense
expenditures will rise again as the Russian economy continues to
grow.
In view of those considerations government expenditures will in
crease even if there is no increase in the standard of government
services provided. There will therefore be strong resistance to an
increase in the standards o f government services. But if we do not
increase the standards of education, health, and urban living condi
tions (among other things) we will not get the full benefit of our
increasing productivity. It would be false economy to starve public
11
have not included private charitable organizations under the heading of private
enterprise. It is also true, of course, that it would be possible to depend on private firms
to operate schools or hospitals while subsidizing fees for individuals. The administrative
difficulties of such arrangements are obvious.
ECONOMIC GROWTH AND STABILITY
291
services in order to get the maximum increase in private consumption.
Indeed if it were necessary it would be better to take a slower increase
in real gross national product than to get the maximum increase
and then devote it to the wrong ends.
C o n c l u s io n
The problem of evaluating government expenditures is always one
of judging whether we get enough from them to compensate for what
we give up. A large proportion of our nondefense expenditures pro
duce benefits which accrue over a long period after the expenditure
is made. These expenditures have to be regarded as investments and
evaluated in terms of yield or rate of return on investment. I f we
make government expenditures we must give up either private con
sumption or private investment. In principle, a government expend
iture of the investment type is only justified if its yield is (a) high
enough to justify a reduction (or loss of an increase) in consumption
large enough to finance it, and (b) higher than the yield on private
investments which would be made if taxes were lower. Both tests
are involved because a reduction in consumption can always be used to
provide resources for either private or public investment. In prac
tice, however, it may not be politically feasible to give tax cuts to
business without giving them to consumers. In that case, the yield
required to justify a government expenditure is the yield required to
justify sacrificing a politically determined combination of private con
sumption and private investment.
The yield from government expenditures often involves two com
ponents : (a) Their contribution to productivity as measured by the
real gross national product; (b) the value of the nonmaterial bene
fits which they produce.
It is difficult enough to measure the effects of government expendi
tures on productivity, but at least the problem is one of measuring
objective magnitudes. But, when we deal with the nonmaterial bene
fits of education, public health, or urban renewal, we are in the realm
of value judgments. Some people feel that widespread liberal educa
tion is a priceless asset to the whole community. But, if we may
judge from the curriculums of some of our colleges, there are many
who feel that education must justify itself in dollars-and-cents terms.
Some government expenditures may be justified solely on the basis
of their effect on physical productivity. But many will appear poor
investments on that basis. They will only appear worthwhile if we
throw their nonmaterial benefits onto the scale. And the weight
given to those benefits is, in the last analysis, a matter of taste, about
which we cannot dispute.
FEDERAL EXPENDITURES AND ECONOMIC GROWTH
George G. Hagedorn, associate director of research, National
Association of Manufacturers
At the start of this study of the interconnections between Federal
spending and economic growth, it seems a fair presumption that each
will have an effect on the other. Thus, there are two separate questions
to be considered, which may be phrased as follows:
1. How are the level and nature of Federal expenditures likely
to affect our prospects for economic growth in the coming decades?
Under this heading we will want to decide whether it can be said
that one size or kind of Federal budget will promote growth and
another size and kind will impede it.
2. Assuming an environment of economic growth, hoio should
this affect our decisions as to the proper amounts and objects of
Federal spending? In other words, we will want to see how
economic growth will affect our need for, and our ability to
afford, the various types of Federal spending.
Question 1 will be taken up first.
F
ederal
S p e n d in g
as
a
D
e t e r m in a n t
of
G
row th
The entire history of the United States has been one of economic
growth. True, there have been cyclical swings above and below
the prevailing upward trend, but it would be mere confusion of
language to label these periods as alterations of the underlying growth
trend. The present panel is concerned with long-term growth trends,
rather than with cyclical fluctuations above and below them, and, in
this context, the first thing to recognize is that the upward trend
has been persistent.
With this in mind, the analyst looking for a connection between
Federal spending and economic growth must very quickly develop a
feeling of frustration. Growth has occurred under so wide a variety
of spending levels that one must wonder whether there is any con
nection whatever between the two.
During the first 140 years of our existence as an independent
nation—surely, a period of economic growth—Federal expenditures
(except during brief war periods) were at levels which must be con
sidered purely nominal compared with the levels we have become
accustomed to in recent decades. Yet the past two decades apparently
have also been a period of growth.
The fact that there has been an increase in spending levels since
pre-World War I days is too well known to require statistical cor
roboration. Yet the astounding magnitude of the change is worth
reporting :
292
293
ECONOMIC GROWTH AND STABILITY
Annual Federal expenditures in 3 periods of economic growth
1 Billions of
dollars
Average, 187.1-1910.. .... .. ................ ....................... .........
Average, 1921-30.___ ___ ________________________ __________
Average, 1947-56................... ............ ................................................
$0.4
3.4
53.4
Per capita
$6
29
342
Percent of
gross national
product
2.8
3.8
16. 5
This contrast between recent and historical levels of Federal spend
ing suggests that economic growth may be affected very little by the
level of government spending. The same conclusion is indicated by
a more detailed examination of the recent years.
Compared with historical precedents, Federal expenditures have
remained high since 1941. Yet there has been considerable variation
in spending levels within that period. These variations do not seem
to be closely related to economic growth, which proceeded throughout
the period with only short and minor interruptions.
During World War II, Federal spending amounted to almost 50
percent of our gross national product. After the war spending was
reduced to about 13 percent of gross national product. Contrary to
some predictions, this reduction caused no cessation of economic
growth. During the Korean war, expenditures rose again, reaching
21 percent of gross product in 1953. Since that year there has been
some decline and the figure for 1956 was 17 percent.
This factual record gives no support to glib assertions that there
is a determinable minimum level of Federal expenditures necessary
for the support of economic growth. Equally, the record does not
encourage the assumption that there is a clearly definable upper limit
such that when expenditures rise above it they become destructive of
prospects for growth. One is tempted to conclude that government
spending has very little to do with the process of growth, either posi
tively or negatively.
Yet commonsense forbids us to dismiss the subject with this negative
conclusion. There must be limits—both minimal and maximal—to
the levels of Federal spending which can make economic growth pos
sible, whether or not we can define those limits precisely. The subject
is worth pursuing further, provided we recognize the futility of at
tempting to set up precise operating rules on this basis.
Although the present discussion is oriented toward the spending
side of the budget, we should not forget that the effects of spending in
discouraging or encouraging growth depend to an important degree
on the methods used in obtaining the necessary funds. A badly de
signed tax system might be destructive of growth potentials even if the
total revenue it provided was moderate in amount. A well-designed
tax system might protect growth possibilities to a point much higher
in the spending scale, but certainly there are limits to this protection.
G
overn m en t as a
M
a r k e t for
G
oods a n d
S e r v ic e s
A thought which underlies some discussion of the proper level of
Federal expenditures, is that the Government is an important cus
tomer for our national output of goods and services. Approximately
294
ECONOMIC GROWTH AND STABILITY
11 percent of our total output was sold to the Federal Government
in 1956.
Every businessman recognizes the customer as a most essential ele
ment in the conduct of his business. He cannot grow—in the sense of
expanding his output and his employment—unless he can find new
customers or persuade existing customers to take more of his output.
These are indisputable facts of business life. From like considera
tions many people conclude that the Federal Government, by increas
ing its expenditures (i. e., by becoming a better customer), can provide
an essential support for economic growth. They further conclude
that as our productive capacity expands it will be more and more
necessary for the Government to take a substantial part of the product
off the market, in order that men and machines may not be left idle
through lack of sufficient demand for their expanding output.
The train of reasoning described above is not customarily expressed
explicity. The view seems to be going out of fashion that we can
predict statistically the gap between demand and potential output
and adjust Federal spending to fill it.
But emphasis on the importance of the Government as a customer
is still implicit in much of the argument over Federal spending. For
example, we hear fears that a reduction of defense spending might have
a depressing effect on our economy. With economic growth and ex
panded productivity there might seem to be even greater difficulty in
finding sufficient nongovernmental demand to keep us going.
The customary answer to this argument, and the one which will be
given here, is that there is no limit to the growth of private demand,
since human wants are insatiable.
This thesis has a stale, trite sound—more like a copybook maxim
than a realistic basis for economic confidence. Yet in our lifetime
we have seen it vindicated to an extent which should astonish even
those who have been most sure of it. In 1929 we thought we were pros
perous enough, but since that time per capita expenditures on con
sumption, in real terms, have increased by more than 50 percent. The
average person consumes half again as much, in the way of goods and
services, as he did a generation ago, and with no visible signs of
satiety. Surely the burden of proof is on those who would claim that
this process has come to an end, and that we shall henceforth be unable
to generate sufficient demand to keep an expanded economy growing.
That is not to say that there is no conceivable danger of depressed
markets in the future. Goods are produced not simply because people
want them but because they can be sold at a price which will repay
their costs and yield some profit. Unworkable relationships between
cost levels and the state of demand might make it impossible to keep
our resources at a high level of employment.
But these are problems which ought to be dealt with on their own
terms. They should be solved by preserving the flexibility of our
economy in adjusting cost and price levels to changing conditions.
Merely to offset such difficulties by increasing government spending
is to risk converting the temporary maladjustment into a chronic one.
Of course it can be argued that we will not have to worry about
these difficult problems if we simply resolve to keep government de
mand at a high enough level to keep everyone employed, no matter
what maladjustments occur. But this is the fallacy of regarding
production, rather than the enjoyment of the product, as the ultimate
295
ECONOMIC GROWTH AND STABILITY
aim of economic activity. Government spending which is motivated
solely by the desire to increase total demand is not a support to eco
nomic growth but a dissipation of the benefits of growth.
All this is not to say that there is no minimum below which Federal
expenditures may not fall without injury to economic growth. The
Government has functions to perform which are essential to the well
being of the Nation generally, and therefore to economic growth.
These, functions cost money and unless the budget provides adequately
for them, economic growth might be seriously impeded. But the basic
function of the Government is to govern, and not to provide a market
for the, Nation’s output. This still leaves a broad area of controversy
as to the proper level of government expenditures, but it is helpful
at least in clarifying the objective.
One other point which it may be well to clarify is that there is noth
ing wrong in principle with a government timing its purchases with
some regard for the possibility of getting lower prices by waiting.
Every prudent buyer will seek to time his purchases, whenever pos
sible, so as to make them in the most favorable markets. But no pru
dent buyer ever buys something he does not need or want, simply
because the market for that product is depressed.
F
ederal
E
x p e n d it u r e s
as
an
I
m p e d im e n t
to
G
row th
The discussion thus far of the impact of expenditures on growth
has dealt with the question of the minimum expenditures necessary
for growth. The conclusion has been that the minimum is set by
the need for performance of essential Government functions, rather
than by any need for contributing to market demand.
It remains to discuss the negative impact of Federal spending on
growth. In a sense all Government spending has a negative impact
since it is a withdrawal of manpower and other productive resources
which might otherwise be used in expanding the economy. The
most that can ever be said of any form of Federal spending is that
we might be even worse off if the expenditure were not made. (For
example, we certainly will not have economic growth if we lay our
selves open to external aggression through failure to provide an ade
quate national defense.)
It would probably be futile to attempt to specify the precise point
at which Government spending would become totally destructive of
economic growth—although some such limit must certainly exist.
For a period during World War II the Federal Government took
almost 50 percent of our national output. But this was under spe
cial circumstances and it seems unlikely that any such level of spend
ing could long continue and leave anything over in the way of
resources for expanding our economy.
The record of the post-World War II era is ambiguous. On the
surface it appears to have been a period of economic growth and of
expansion in our capital equipment. Yet it was also a period of
rapid consumption of our existing stock of capital. (The rate of
capital consumption is grossly understated in accounting records.)
Only a relatively small percentage of our capital outlays represents
a genuine net expansion of our productive facilities. Until we have
more perspective it will be hard to judge the impact on economic
296
ECONOMIC GROWTH AND STABILITY
growth of postwar Federal spending, which in recent years has hovered
between 16 and 21 percent of the national product.
The important point is that all Federal spending, to some degree
at least, reduces the potential for economic growth. We come back
again to the previous conclusion. Federal expenditures should be
limited to the levels necessary to support the activities which only
the Government can perform or which the Government can perform
better than anyone else. Expenditures above this level: (1) are not
needed to support demand; and (2) would deprive us of resources
otherwise available for growth.
S p e n d in g O
b j e c t iv e s
in
a
G
r o w in g
E
conom y
We have examined the impact of spending on growth, and the next
question is the impact of growth on spending—question 2, as posed at
the beginning of this paper. This may be approached either from
the point of view of needs for Government services or from the point
of view of ability to afford Government services.
First, what will be the effect of economic expansion on our need
for Federal services? A t first blush it might seem that our needs in
this respect might be expected to expand roughly in proportion to
the expansion of the economy. However an examination of the spe
cific objects of current Government spending indicates a quite con
trary conclusion:
Federal expenditures, calendar 1956
[Billions of dollars]
Purchases o f goods and services:
National defense___________________________________________________
Other national security_____________________________________________
Qther______________________________________________________________
Transfer payments_____________________________________________________
Grants-in-aid to State and local governments___________________________
Net interest paid________________________________________________________
Subsidies less current surplus o f Government enterprises________________
40. 4
2. 0
5. 2
13. 5
3 .2
5. 2
2. 8
Total____________________________________________________________
72. 3
Source : U. S. Department of Commerce.
National defense is the largest item. What our future needs for
this purpose will be is unpredictable but there is no reason to suppose
that these needs will grow pari passu with the growth of the economy.
Economic growth will neither increase nor decrease our need for
defense, which depends on other factors.
The same is true of Federal interest payments, which are deter
mined by the size of the debt and the average rate of interest on it—■
factors which are only indirectly (if at all) related to economic
growth.
The $5.2 billion of outlays for goods and services, other than na
tional defense or national securitly, may contain some items which
would have to grow along writh economic growth. These, however,
must be an extremely small part of total expenditures.
The $13.5 billion of transfer payments consists mainly of pay
ments from social insurance funds (which are outside the regular
budget) and veterans benefits. The social insurance benefits will
probably increase, but this will be the result of maturing of coil
E C O N O M IC
GROW TH
AND STABILITY
297
tiactual obligations rather than of economic growth per se. Unfortu
nately the increase will occur whether or not the economic growth
is realized.
Government expenditures of the type which are intended to relieve
individual distress might be expected to decline with economic
growth. As general economic well-being improves there is less need
for such Federal aid. Although this principle may be of little help
with respect to future benefits already contracted for, it might be
kept in mind when questions arise of expanding such obligations or
assuming new ones.
Similarly, there is reason to hope that grants-in-aid can be reduced
as economic growth progresses. With improving economic condi
tions the States and localities should become better able to take care
of their own needs, and the need for Federal assistance will decline.
Welfare expenditures generally are a process of taking money from
one group of citizens and paying it to, or spending it for the benefit
of another group. Whatever humanitarian reasons may be advanced
to justify such a process, the need for it must become less cogent as
economic growth makes us more prosperous.
Thus the Federal budget is a mixture of various kinds of expendi
ture. In some cases (covering the larger part of the budget) the
needs which the expenditure is intended to satisfy will be unaffected
by economic growth. In other cases the need will decline as the
economy grows. A comparatively small part of total expenditures
are for needs which will increase along with growth.
(This is by contrast with the expenditures of States and localities.
The;-e are mostly for the provision of essential community services
and they do increase along with the increase in population and the
growth of the economy.)
W h a t C an'
Wic
A ffo k o
\
This whole problem can be approached from a totally different
direction. Instead of asking: “What will we need?” one might
ask “What will we be able to afford?” in a growing economy. If
one cares to argue from the latter viewpoint he can claim that as our
economy grows we will be able to afford more in the way of Federal
expenditures and, therefore, we should have them.
This attitude is often met in practice When the tax system begins
to yield more than is needed to meet current expenditure levels, there
are those who will view this as an opportunity for undertaking new
expenditures, rather than for reducing tax rates. Xow we can afford
to do what we have always wanted to do, they will say.
However reasonable such an attitude may seem in particular cases,
as a long-range proposition it is a wav of getting nowhere. Its con
sistent application would mean that we are stuck forever with the
existing tax levels. It would mean that any rise in taxes for meeting
a temporary need would be built into the tax system permanently as
new uses were found for the revenue thus yielded.
The rise since World War II in Federal expenditures to levels which
would have been inconceivable in our previous peacetime history is,
in part, at least, to be explained by just such a process. We have be
come inured to tax rates which we would have resisted vigorously a
298
ECONOMIC GROWTH AND STABILITY
generation ago and the Government has found ways of spending our
larger contribution.
C o n c l u d in g R
em arks
The propriety, or impropriety, of any proposed item of Federal
expenditures is only partly a subject for economic analysis. In an
ultimate sense it is simply a question of what people want from their
government and what they are willing to pay for. When they have
made their choice it is not for the economist to say that what they
want is wrong.
Yet, in practice, the desires of the people are usually oriented to
ward general objectives and are seldom formulated into specific meassures. The task of the economist is to advise as to whether the
specific spending proposals will in fact contribute to the general ob
jectives, which he must take as given.
Since last January, the people have indicated rather clearly that
they do not want a rising level of government expenditures. The
preceding economic discussion can only add that a rising level of
expenditures is not essential to economic growth and is in fact an
impediment to it.
The conclusion of the analysis is that government expenditures
should be limited to those necessary for performing essential govern
ment services. This rule does not, of course, answer all questions but
it does answer some important ones.
There will be many problems as to what constitutes an “ essential
government service.” Neither this panel, nor any other group, can
produce a simple rule of thumb for deciding these questions. Legis
lators must be aware of what people want from their government and
what they want to pay for it, and they must offer leadership in deter
mining practical ways of attaining these goals.
FEDERAL EXPENDITURES AND ECONOMIC GROWTH
Stanley H. Ruttenberg, director of research, American Federation
of Labor and Congress of Industrial Organizations
Serious discussion in the public arena of the economic policy impli
cations of Federal expenditures has been increasingly hampered by
the barrage of emotional sloganeering of the two major business organ
izations and lack of leadership by the administration.
I f these hearings help to clear away only a small part of the emo
tional impediments to a calm appraisal of this issue, it will serve a
most worthwhile purpose.
Unfortunately, however, academic discussions of this topic can be
only partially helpful, at best. As long as the administration and
the Congress deal with this issue in the 19th century cut-expendituresenlarge-the-pork-barrel manner, little significant progress can be made
in the necessary public understanding of the role of Federal expendi
tures in our national economic development. There is a huge reservoir
of nonsense on this issue that has been spread widely by people in
responsible positions.
Federal expenditures are neither good nor bad in themselves. They
must be viewed in terms of their purpose, in relation to the gross
national product, in relation to the level and trend of private activities,
and in relation to fiscal and monetary policies.
It is sheer nonsense to say—as some have said or have implied—•
that any rise in Federal spending is a threat to our national well
being. To meet the needs of national security and some of the needs
of our growing population may well require a rising level of Federal
expenditures. Under such conditions—that characterize the current
period of our history—it is the duty of Federal Government leader
ship to seek the adoption of adequate and fair tax and monetary
policies to meet our national needs, rather than to ignore defense and
social necessities.
It is ridiculous to proclaim—as some have declared—that a dollar
spent by a private person is always somehow preferable to a dollar
spent by government. There is a positive economic role for govern
ment—defense, education, postal services, roads, and conservation of
natural resources are but a few functions that require some activities
and outlays by one or another level of government.
It serves no purpose other than confusion to wield the broadax
blindly at suggested Federal expenditures and, at the same time, to
thank God that Federal expenditures have been helping to hold up
the level of economic activities—as did many responsible people in
the first half of 1957.
Neither does it serve any purpose of achievement or understanding
to propose Federal programs on the one hand, to threaten the Nation
with disaster if they are adopted, on the other hand, and to acquiesce
299
300
ECONOMIC GROWTH AND STABILITY
quietly to their defeat—as the administration did on so many public
welfare program issues in the past session of Congress.
It is disgraceful that the Russians should have been first, in firing
successfully an ICBM. The budget and the legislated debt limit
seem to be the major criteria for meeting defense needs, as well as
public service needs.
I stress these factors because I am convinced that the subject of
Federal expenditures and economic growth, in its economic policy
implications, is more of a social and political problem than one of
economic theory. Arrival at some general conclusions on this subject
by this or any similar panel is not going to provide us with a bold
national leadership. Economic theory alone is not going to produce
serious concern among private and public policymakers with the social
objectives of a rich and productive economic system such as ours.
To discuss properly this subject of Federal expenditures and eco
nomic growth, there are a number of questions that first must be
posed and answered.
Q
u e s t io n s
on
F
ederal
E
x p e n d it u r e s
P
o l ic ie s
Can we conceivably expect, within the near future, any substantial
reduction of defense expenditures, by about $10 billion to $20 billion—
and thereby obtain some significant cuts in Federal spending? I do
not believe so, in the absence of some settlement of world tensions,
because I do not believe that the world wTe live in will permit such
cuts in Federal spending, unless we are prepared to face the alternative
of a loss of national sovereignty and a collapse of the free world. I
therefore expect Federal expenditures to be high and to remain high
in the foreseeable future, by comparison with pre-World War II
peacetime years.
Can we expect to meet the growing needs of a growing population
with real or dollar outlays for public services that are no greater than
in 1940? I think not, and I don’t see how any thinking person can
advocate chopping away at public service expenditures and expect the
Nation to maintain adequate educational, health, road, and similar
facilities. Furthermore, there have been 15 years of postponed and
neglected public service efforts. Our population has grown almost 30
percent since 1940—and the proportion of the population below work
ing-age at one end and above 65 at the other end has been rising. Not
only have public service needs as a whole grown, but the public
service needs of the young and the elderly have grown most rapidly.
In addition to the expansion and the changing characteristics of the
population, our standard of living, as well, has improved. There are
greater demands and greater needs for education beyond the ele
mentary school; technological changes in civilian pursuits and in the
Armed Forces require an increasing degree of advanced scientific edu
cation and technical training: increasing leisure has increased the
demand and need for adult education; paid holidays and vacations
have resulted in pressing demands on our existing recreational
facilities.
I f we compare nondefense budget expenditures in 1940 and 1956,
we find the following: in 1940, Federal budget expenditures for non
defense were $6.9 billion in an economy whose gross national product
ECONOMIC GROWTH AND STABILITY
301
was $100.6 billion—these outlays were 6.9 percent of total national
output. Between 1940 and 1956? our gross national product rose more
than four times and our population increased almost 30 percent. But
in 1956, Federal budget outlays for nondefense purposes were $25.8
billion—6.2 percent of $414.7 billion gross national product.
Organized business and conservative politicians screamed to high
heaven about these 1956 expenditures, predicting gloom and doom,
despite the vast subsidies that go to business, largely in the indirect
form of tax concessions. It seems to me, however, that the growth of
the population and expansion of public needs justify some significant
improvement of public and social services. Merely to have lifted
nondefense budget expenditures to 7 to 7% percent of gross national
product would have meant Federal outlays for these purposes of $29
billion to $31 billion—it would have made possible an increase of some
$3 billion to $5 billion over what was actually spent for public services
and social programs.
As I look at these figures, I am utterly convinced that the problem
is not whether we can afford some improvement of public and social
services. The problem is a political one-—with the administration and
the Congress. The question is whether our national leadership desires
a significant improvement of public and social services.
Should an expanding high-employment economy have social objec
tives that are somewhat more meaningful than rising lines on charts
and a continuing outpouring of automobiles and other consumer dur
ables? My answer is definitely in the affirmative. During the de
pression of the 1930’s, we concentrated our attention on achieving
full employment, more effective use of our productive capacity and a
more equitable distribution of income. Since 1940, we have made vast
strides in those directions. We now have the job of sustaining eco
nomic growth and high levels of employment and of achieving some
further improvements in income distribution. But more than 15 years
of generally high levels of employment and production have posed
new questions that deserve the attention of national leadership.
What is the purpose of sustaining continuing economic growth
and high levels of employment and output—is it merely to turn out
more and more automobiles and electrical appliances ? Should a rich
and growing economy seek to wipe out remaining pockets of poverty ?
Should the benefits of economic growth be used to improve the Nation’s
health and educational facilities, to eliminate slums and provide im
proved housing, to revive decaying urban centers, to encourage cul
tural activities? Should an economy, such as ours, shift an increasing
degree of attention to leisure and to leisure-related activities?
I would suggest that the Nation’s productive ability, after more
than a decade of generally high employment, makes it possible for us
to' turn at least part of our attention, to these social objectives. An
expanding and productive economy, such as ours, can afford to devote
a share of the gross national product—as well as imagination and
leadership—to eliminate poverty, to improve health ana educational
facilities, as well as housing, to redevelop our urban centers, to con
serve and develop natural resources, to expand recreational and cul
tural facilities.
Economic growth makes it possible for the Nation to devote in
creasing dollar outlays for public services and social advances. Seven
97735— 57------- 21
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ECONOMIC. GROWTH AND STABILITY
percent of a $100 billion output in 1940 was $7 billion—7 percent
ior public services, social programs and other nondefense purposes of
a $415 billion output in 1956 would have been $29 billion. Further
more, economic growth expands the tax base and revenues rise as out
put and sales grow. There is no doubt that the national economy can
afford to improve and expand its public services and devote some por
tion of its total output to enrich our social order. In some of these
areas the question, I believe, is whether we can afford not to make im
provements—in education, for example, or resource development or
urban redevelopment.
Can we expect the business community to finance such develop
ments? I think not and it would be unreasonable to expect profitseeking enterprises to do very much along these lines. It is a tragedy,
however, that the business community traditionally blocks such ad
vances by government, as revealed again, in the past few months, by
the organized business attack on Federal aid for education. The rec
ord of the business cominunity on these issues is overwhelmingly neg
ative, except where it touches the pocketbook nerve of specific business
interests, as indicated by the widespread built-in business support for
Federal outlays for road building.
N
a t io n a l
L
e a d e r s h ip
Is R
e q u ir e d
Almost all of the efforts in improving public services and in en
riching our social order, therefore, inevitably fall upon the govern
ment, upon both Federal Government leadership and expenditures.
A frequent answer to questions, such as those posed above, is to talk
about States’ rights and to declare that these tasks belong with the
States. That reply is often a subterfuge and, more often, it is mean
ingless. Many of these tasks are national in scope and require na
tional direction or coordination. Many of them are too costly for con
ventional financing by States and .local governments—they require
Federal outlays, grants-in-aid or long-term loans.
Few States have responded, with positive action, to these issues
in recent years. With their current financial burdens and constitu
tional limitations on expenditures and new bond issues, it is unreal
istic to expect much significant action on public welfare programs in
most States without long time-consuming delays, at best—especially
in the absence of courageous State leadership and national prodding
to obtain necessary constitutional changes and improvements of State
tax structures. It is no wonder that the States have done so little
in these areas in recent years. Not only are they burdened with com
mitted outlays, frequently inadequate revenues, and constitutional
limitations, but most State legislatures are so constituted as to be
far less than receptive to public service and social programs and im
provements of regressive tax structures. Most State legislatures are
poor examples of representative democratic government—with their
“ rotten borough” representation and substantial underrepresentation
of the urban population.
To talk about shifting current social welfare programs, and future
programs to the States, is to undermine the possibility that much
action on such programs will be taken in the near and foreseeable
future. It is hypocrisy on the part of the State-righters to say
that the Federal Government should not engage in civilian public
ECONOMIC GROWTH AND STABILITY
303
services such as aid to localities with chronic unemployment and
financial assistance for schools and hospitals. I f the State-righters
were sincerely interested in strengthening State governments, they
would be in the forefront of efforts to make State legislatures more
representative of the population, to modernize State constitutions,
and to rebuild their State and local tax structures on the basis of
ability to pay.
.
.
.
Federal expenditures, as I see it, have to be viewed in the light
of these and similar considerations—high dollar outlays by com
parison with pre-World War II peacetime years due to national
security requirements, the growing public service needs of a growing
population with changing characteristics, the need for social objec
tives of an expanding high-employment economy and the ability of
such an economy to turn more of its output and attention to fulfilling
these social objectives, and the reality that the States cannot be ex
pected, without long delays, to take leadership on these issues. Fed
eral expenditures have to be viewed, too, in terms of economic growth
that expands the tax base and raises the revenue potential irom a
given tax rate.
This Nation is capable of meeting its currently “normal” defense
requirements, as well as improving and expanding public services
and social programs, if we are fortunate enough to avoid all-out war
or a sudden sharp rise in defense outlays. The problem is essentially
not an economic problem—it is a political one.
M
e e t in g t h e
C
h a llen g e of
E
c o n o m ic
G
row th
Foremost, as I see it, is the issue of meeting the public service
needs and social advances of a growing population in a rich and
highly productive economy. I think it is wrong to base Federal
expenditure policies on compensatory financing alone. I f we con
tinue to concentrate all of our policies on the basis of compensatory
government operations and to delay needed programs, as we have
done since the start of World War II, we will be sadly neglecting
important underpinnings of our economic system and society.
To think of economic growth as most economic-model theorists do,
is to omit the important human and social aspects of economic de
velopment. Basically, economics is not numbers, graphs, or charts—
it is human beings and society. The school system is a major factor
in economic growth. So are the conditions of the people’s health,
housing and urban areas, roads, resource conservation and develop
ment.
In working on economic development plans for underdeveloped
countries, economists have all too often planned complicated hydro
electric and irrigation projects, without thought for the need of engi
neers; steel mills before considering the need for technically trained
workers; industrial activities while neglecting the requirement for
continuing maintenance of the equipment. In thinking about future
economic growth in the United States, we should not and cannot
ignore the human and social requirements of continuing economic
expansion.
This country’s educational system has contributed much to improv
ing, productive efficiency and economic growth. The cultural heritage
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ECONOMIC GROWTH AND STABILITY
of the Western World—and of the American people—must be ade
quately passed down to the new generation. To neglect our educa
tional system at this time of rapid technological change will under
mine the potential for economic growth and improving productive
efficiency in the future.
Not only is there obvious need for adequate educational facilities—
structures and equipment. There is also the need for teachers. So
ciety must be willing to provide these necessities, if it is to continue
its advances. Our educational system should be considered at least
as important to the Nation as automobiles and washing machines
which receive so much of the public’s attention. National and State
leadership is required to speak up clearly and forthrightly on the
needs of our educational system. Federal aid for education is essential
for the economic, as well as general, well-being of the Nation.
Resource conservation and development may be somewhat more
directly related, in the public mind, with economic growth. But even
here, practical efforts and achievements in most fields have been far
from noteworthy since the start of World War II. It took many years
of work by people like Theodore Roosevelt and Gifford Pinchot, be
fore the various levels of government and sections of industry became
concerned with conserving our timberlands. We would be hard put at
present to find national leadership of similar force in the effort to
preserve and extend our forest conservation programs, in efforts to
move toward new river valley developments that would curb flood
disasters and enrich the economic potential of several areas o f the
Nation, to conserve and develop water resources in an attempt to
forestall serious water shortages for industry and agriculture in the
Western States.
Although the administration has talked about the need for some
program to assist economically distressed communities—ever since the
1952 campaign—no legislation on this issue has yet been adopted. Im
provement of the economic conditions in such communities would
obviously be of assistance in sustaining continued economic growth.
These and similar efforts that require Federal Government outlays
and leadership are essential for continuing economic expansion. They
form part of the social underpinning for economic growth. Such
programs should be started as soon as possible and they should move
forward at a steady pace—to be curtailed in the case of a sudden sharp
rise of defense expenditures and to be stepped up when private eco
nomic activities decline.
What we need at present is not a backlog of public service pro
grams and blueprints that can serve as a means for holding many con
ferences, but going programs to strengthen and enrich our society.
M e e tin g t h e C h a lle n g e
of
t h e B u s in e s s C y c l e
In recent years, most attention to movements of the business cycle
have been on inflation rather than on deflation. High Government out
lays, by comparison with the past, we are told, are inherently inflation
ary and an excess of Government outlays over revenue will inevitably
cause demand inflation. This is decidedly not what has happened in
recent years, and experience should have taught us long ago that Gov-,
ernriient expenditures should be viewed in relation to the gross na
tional croduct and the level and trend of private activities.
ECONOMIC GROWTH AND STABILITY
305
In fiscal years 1947 and 1948, Federal outlays were declining and
there were substantial Federal cash surpluses—$6.7 billion in 1947 and
$8.9 billion in 1948. Nevertheless, there were sharp price rises in those
years due to the pent-up demand for all types of consumer and cap
ital goods and to the untimely end of OPA. In fiscal 1951, the year
of post-Korean sharp price increases, there was a cash surplus of $7.6
billion, and in fiscal 1956, when wholesale prices moved up rapidly,
there was a cash surplus of $5.1 billion.
Sharply reduced Government expenditures, as in fiscal 1947, are not
guaranties that price rises will not occur. Neither will substantial cash
surpluses, in themselves, guarantee against a rising price level.
Federal expenditures, surpluses, or deficits are neither inherently
inflationary or deflationary in themselves. The level of Federal out
lays—as well as of cash surpluses or deficits—are of great importance
when examined in relation to the levels and trends of activities in the
other sectors of our economic system and in relation to fiscal and mone
tary policies.
Concentration of Government activity on anti-inflation policies and
restrictive measures, rather than on economic growth, is a departure,
it seems to me, from the intent of the Employment Act. It is the
maintenance of economic growth to which the Federal Government is
committed under the terms of that act, although the administration
seems to be too little aware of its obligation under the law.
Continuing economic growth is essential for the maintenance of ma
terial strength and high levels of employment. It is likewise essential
for meeting national security requirements and for improving living
conditions. Economic growth in the past made possible the great
material achievements of the Nation. It can make further advances
possible.
As the economy grows, its tax base expands and increased revenues
can be collected from a proportionately smaller burden on individual
taxpayers.
. . .
Government policies and measures are important in maintaining
economic growth. Changes in Federal expenditures have an effect on
the direction of national economic activities, depending on trends in
the private sectors.
A significant change in the dollar level of Federal expenditures has
an obvious effect on the trend of economic developments, depending
on fiscal and monetary counteraction, if any. The degree of effect
would depend on the magnitude of the change, as well as on the direc
tion of private activities.
A decline of Federal expenditures of $11 billion between 1953-54
was bound to have a depressing effect, since no significant private
activity was moving up sharply. The effect of the cut of Federal
expenditures wTas to reduce orders, and induce business to cut inven
tories, output and employment in defense-related industrial plants, to
reduce income from private activities and to depress expectations
generally. The psychological effect of a significant change in direc
tion of Federal expenditures can and does have an economic impact—
as in 1953—even before the actual cuts, or increases, in government
outlays occur.
One cannot forecast these effects with mathematical certainty. It
is even more difficult to measure the precise effects of one type of pro
306
ECONOMIC GROWTH AND STABILITY
gram, as compared with an alternative program. The direction, how
ever, can more easily be foreseen.
. Improvements in the unemployment compensation and social secu
rity systems help to bolster consumer income at a time when wages
and salaries from private activities are declining. An increase in
transfer payments of $1.9 billion between 1953 and 1954 helped to pro
duce a small rise in total personal income, despite a decline in labor
and farm incomes. This maintenance of high levels of personal in
come during the 1953-54 downturn helped to reduce the impact of the
decline in government spending and in industrial output. The re
duction in personal income taxes, effective January 1, 1954, had a
similarly strengthening effect on consumer buying power, which cush
ioned the economic decline.
Alternative types of programs have differing effects in specific
areas of the country, specific industries and among specific groups of
the population. The recent cutbacks of defense outlays, particularly
aircraft, for example, have had the most notable effect as yet in Cali
fornia and seem to have dampened expectations generally.
Countercyclical policies, when economic activities are moving down,
should require, I think, a stepping up of government expenditure
programs, tax cuts or a combination of both. On this, there is little
disagreement against most Americans. There is disagreement, how
ever, on the issue of which part of the economy should receive most
government attention.
During the downturn of 1953-54, the administration strongly em
phasized its views that Federal efforts should be concentrated on
stimulating business investment. We, in organized labor, opposed
the administration’s suggestions—we were convinced that the admin
istration’s proposals were based on faulty economics and would fur
ther erode the progressivity of the Federal tax structure. We are now
convinced that the administration’s success produced a lopsided eco
nomic development between the spring of 1955 and the end of 1956—
sharply rising business investment in new plant and equipment, ac
companied by sluggish consumer markets. We are now beginning to
see some of the consequences of this lopsided development that was
encouraged by administration policies.
With current cuts in defense outlays, at a time of a general lull in
economic activities, it is my belief that a cut in the Federal income
tax—by increasing the individual exemption from $600 to $700—is
essential. It was my view before this committee, several months ago,
that congressional action on reducing individual income taxes should
have been taken immediately by the past session of Congress, accom
panied by closing some of the many tax loopholes, if possible. Action
on this issue by the forthcoming session of Congress may be too late
to halt a downturn from getting underway.
Involved in any countercyclical policies, therefore, is the economic
sector or population group to be affected and proper timing. It is
my view that under most conceivable conditions of a turning down of
economic activities, the major part of the Government effort should
be aimed at bolstering consumer buying power. In our kind of econ
omy, the long-run health of the system largely depends on consumer
activities. This point, as I see it, should be kept in mind in pursu
ECONOMIC GROWTH AND STABILITY
307
ing economic policies to forestall a decline in economic activities and,
also, in pursuing policies to curb the possibility of demand inflation.
Built-in stabilizing forces should be strengthened so that their action
may be forceful at the beginning of a downturn. That would mean,
among other things, the development of Federal standards for the un
employment compensation system and a general improvement of that
system. It would mean, too, a substantial overhaul of the Federal
tax structure to restore that structure’s progressivity—so that Fed
eral revenues could be raised more on the basis of ability to pay than
they are at present.
The built-in stabilizers, inherited from the New Deal and Fair Deal,
are strengthening factors in our economy and society. They do not
and cannot provide, however, in my opinion, a guaranty against de
pression.
While the built-in stabilizers would go to work automatically, in
case of a downturn, their operations may conceivably only alleviate
a downswing and not halt it. Tax cuts should be considered. Gov
ernment public service and social programs, under those conditions,
should be stepped up. Tax cuts and the stepping up of such pro
grams should not and need not await economic disaster—quick Federal
action is essential when production is declining and unemployment is
rising rapidly.
In order to build confidence, strong countercyclical measures should
be the announced policies of the Federal Government. The American
people have a right to expect intelligent and courageous action from
their Government.
In conclusion, I should like to emphasize my conviction that the
subject we are discussing is much more a political issue than an eco
nomic one. We need government policies to encourage continuing eco
nomic growth—certainly not government measures to restrict the gen
eral level of economic activities. We need an expansion of Federal
efforts to improve public services and to strengthen our society. We
need an equitable and progressive Federal tax structure—and in the
States, as well. We need more and better economic data and more
information about current movements of the business cycle and the
effects of specific types of Federal actions. But above all we need
national leadership, worthy of a rich and productive democratic so
ciety.
FEDERAL EXPENDITURES AND ECONOMIC GROW TH:
ANALYSIS AND POLICY
Daniel C. Vandermeulen, associate professor of economics, Claremont
Graduate School and Claremont Men’s College
Since the study of economic growth is itself in an early stage of
growth, it is not possible to analyze one aspect of the topic with full
confidence that everyone will recognize the niche into which it fits.
Accordingly, I shall use the first part of my paper to summarize some
important conclusions that economists have reached and to make some
suggestions of my own regarding a theoretical and empirical frame
work for the analysis of economic growth. This will provide a basis
for the subsequent discussion of the role and responsibility of the Fed
eral Government with respect to economic growth.
T
he
A
n a l y s is of
E
c o n o m ic
G row th
As the best general measure of economic growth, I choose real, per
capita, national income,1 appropriately adjusted for changes in per
capita leisure. Some correction also needs to be made for cyclical and
other short-run variations, 10-year averages being perhaps the best
solution. The aim of both corrections is to eliminate variations in
the utilization of resources, thus emphasizing that, basically, what is
being measured is the change in the volume of productive resources.
A per capita measure is chosen as the most appropriate for public
policy in the belief that the American public would not cheerfully
accept a growth in aggregate income that failed to exceed the growth
in population. I take the rate of growth of population as given, but
I do consider some repercussions upon governmental expenditures.
For the hypothetical man in the street the chief concern with eco
nomic growth is that it be fast enough, so that he can enjoy the benefits
of ever higher income. Such an approach is reinforced by external
military threats and by the worldwide rivalry between free and col
lectivist economic systems. This aspect of growth has been subjected
to increasing study by economists in recent years, particularly in rela
tion to underdeveloped areas. Perhaps even more attention has been
given by economists to a somewhat more technical, but nonetheless
important, facet of growth, its relation to the stability of the economic
system. As Professor Schumpeter was fond of emphasizing: “ Busi
ness cycles are the price that we must pay for progress.” The more
significant of the business-cycle theories have always, in one way or an
other, stressed this relationship. Since Keynes directed attention
toward short-run aggregative equilibrium in the 1930’s, there has been
1 Since growth is closely related to the supply of factors of production, national income
has a slight advantage over net national product in being measured at factor cost. Gross
national product overstates capital formation, and personal income is unsatisfactory because
corporate saving is excluded and transfer payments included.
308
ECONOMIC GROWTH AND STABILITY
309
an extensive development of growth models that state the conditions
for steady growth and show that failure to satisfy these conditions
may lead to secular stagnation or exhilaration, prolonged periods of
underutilization, or attempted overutilization of resources during
which cycles might also occur. Thus, economic growth is no simple
matter of pro j ecting and following trends.
;
Any determinate model or theory of growth implies, or can readily
be extended to imply, precise conclusions with respect to the role of
Federal expenditures in economic growth. At the present state of
knowledge, I do not think that we can place heavy reliance on any
single theory. The growth models, for example, have been criticized
as being overly rigid and dependent for their results on precise and
invariant values of key parameters. I concur in this despite my gen
eral belief that growth is such a sprawling and complex phenomenon
that we shall always have to rely on relatively limited and seem
ingly unrealist
@FedFRASER