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THE SECOND BUDGET RESOLUTION FOR
FISCAL YEAR 1978
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HEARINGS
BEFORE THE
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
NINETY-FIFTH CONGRESS
FIRST SESSION
JULY 19, 20, AND 21, 1977
Printed for theuse of the Committee on the Budget
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~ S'~MOO~ LB1~?/3(~'
I J ,~J Or~i ~
U.S. GOVERNMENT PRINTING OFFICF~
94-971 WASHINGTON : 1977
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COMMITTEE ON TI~E BUDGET
ROBERT N GIAIMO Connecticut Chairman
JIM WRIGHT, Texas DELBERT L. LATTA, Ohio
THOMAS L. ASHLEY, Ohio . .. JAMES T. BROYHILL, North Carolina
ROBEWL L T[JEGGETT California BARBER B CONABLE JR New York
PARREN J. MITCHELL, Maryland MARJORIE S. HOLT, Maryland
OMAR BURLESON, Texas . . JOHN H. ROUSSELOT, California
LOUIS STOKES, Ohio . JOHN J~ DUNCAN, Tennessee
ELIZABETH HOLTZMAN, New York CLAIR W. BURGENER, California
BUTLER DERRICK, South Carolina RALPH S. REGULA, Ohio
OTIS G. PIKE, New York
DONALD FRASER, Minnesota
DAVID R. OBEY, Wisconsin
WILLIAM LEHMAN, Florida. -
PAUL SIMON, Illinois .
JOSEPH L. FISHER, Virginia
NORMAN Y. MINETA, California ~
JIM MATTOX, Texas
- GEORGE Gnoss, Ea,ecutive.Dfrcctor~ . -
BRUCE MEREDITH, Assistant Director, Budget Priorities
NANCY TEETERS, Assistant Director, Economic Analysis
WENDELL BELEw, Chief Counsel
WILLIAII LILLEY III, Minority Staff Director
(II)
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CONTENTS
~ ~arings held on- Page
July 19, 1977 1
July 20, 1977 53.
July 21, 1977 130
Statement of-
Greenspan, Alan, former chairman, Council of Economic Advisers_ -- 132
Heller, Walter W., former chairman, Council of Economic Advisers__ 135
Lance, Bert, Director, Office of Management and Budget - 2
Rivlin, Dr. Alice M., Director, Congressional Budget Office; accom-
panied by Frank de Leeuw, Assistant Director for Fiscal Analysis;
and Richard Morgenstern of' the Natural Resources Division of
CBO 53.
Shultze, Charles L., Chairman, Council of Economic Advisers 29/
Additional information submitted for the record by-
Congressional Budget Office report entitled, "Recovery With Infla-
tion", submitted by Dr. Alice M. Rivlin 55'
Heller, Walter W., prepared statement 141
Lance, Bert:
Prepared statement 2
Tables in prepared statement:
T~tble 1.-1977 and 1978 Budget Totals -- 4
Table 2.-Effect of Energy Plan on 1978 Outlays and
Receipts
Table 3.-Fiscal Outlook, 1978-82 5
Rivlin, Dr. Alice M.:
Highlights of oral testimony:
Budget Goals for 1981 104
The Administration's Energy Proposals 105
The Economic Outlook 10~
The Persistence of Inflation..~_ 104
"Recovery With Inflation", Congressional Budget Office report_ 55.
Table presented in oral testimony:
Table 1.-Economic Projections Based on Current Policy,
Calendar Years 1977-78 106
Schultze, Charles L., prepared statement 31
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THE SECOND BUDGET RESOLUTION FOR FISCAL
* YEAR 1978
TUESDAY, JULY 19, 1977
HousE oi~ REPRESENTATIVES,
COMMITTEE ON THE BUDGET,
Washington, D.O.
The committee met, pursuant to notice, at 9 :40 a.m., in room 210,
Cannon House Office Building, Hon. Robert N. Giaimo, chairman,
presiding.
Present: Representatives Giaimo, Wright, Leggett, Burleson, Holtz-
man, Derrick, Pike, Fraser, Lehman, Fisher, Mineta, Mattox, Latta,
Holt, Rousselot, Burgener, and Regula.
The CHAIRMAN. The committee will please come to order. Today the
Budget Committee begins 3 days of hearings on the state of the econ-
omy and the Federal budget for fiscal year 1978. These hearings are
intended to prepare us for consideration of the Second Budget Reso'-
lution for Fiscal Year 1978.
The Second Budget Resolution, is, of course, binding. After its adop-
tion by the Congress, by September 15, neither the House nor the Sen-
ate may consider legislation that would violate the spending ceilings
or the revenue floor set in the resolution. Obviously, our committee
must set those spending ceilings and revenue floor with great care.
Today, we are honored to have with us Bert Lance, Director of the'
Office of Management and Budget, and Charles Schultze, Chairman
of the President's Council of Economic Advisers.
Tomorrow afternoon, we will receive testimony from Dr. Alice
Rivlin, Director of the Congressional Budget Office.
And Thursday morning, we will hear from two former Chairmen of
the Council of Economic Advisers, Walter Heller, who served under-
President Kennedy, and Alan Greenspan, who served under Presi-
dent Ford.
Mr. Lance and Mr. Schultze, we are interested in receiving the ad'-
ministration's views in several important areas:
First, and foremost, we would appreciate your views on the general
state of the economy for the balance of this year and for 1978; and
particularly your thoughts on the slowdown in economic growth that
nearly all economists forecast for the second half of this year.
Do you agree that there will be a slowdown? And if so, how severe
and prolonged is it likely to be? Furthermore, should the Second~
Budget Resolution attempt to counteract the possible slowdown in
some way?
Second, we would appreciate your analysis of the apparently con-
tinuing shortfall in Federal spending. As you know, the shortfali
(1)
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began in the latter half of fiscal year 1976, continued into fiscal year
1977, and, many believe, may well continue into fiscal year 1978.
What has the administration concluded as to the reasons for the
shortfall? Is it expected to continue into fiscal year 1978, and, if so,
should the Second Budget Resolution reflect that expectation? And,
what steps have you taken to minimize and, eventually, eliminate
such occurrences, which jeopardize orderly budgeting in both the
executive branch and the Congress?
Finally, we would like to receive your latest estimates on the likely
impact of the energy legislation on the fiscal year 1978 budget.
We realize that precise budget estimates may not yet be available.
However, we would like to receive the best estimates you now have
with respect to revenues and spending, and the potential economic
impact-in the short term-of the energy legislation.
Having said all of that, we will now throw the ball into your court,
Mr. Lance, and proceed with your statement, which you may either
submit or sulumarize.
STATEMENT OP BERT LANCE, DIRECTOR, OFFICE OF
MANAGEMENT AND BUDGET
Mr. LANCE. Mr. Chairman, I will be governed by what your desires
are in this area. I have a prepared statement. I apologize. I think it
was a little bit late getting to the members of the committee through
some mixup. So I don't know whether everybody has had a chance
to read it or not. I will try to go through the major points very
quickly, if that would be the way you prefer and then turn it over
to you for questions.
The CHAIRMAN. Fine, thank you very much. Your full statement
will be in the record, Mr. Lance.
~[The prepared statement of Mr. Lance follows:]
PREPARED STATEMENT OF BERT LANCE, DIRECTOR, OFFICE OF MANAGEMENT AND
BUDGET
Mr. Chairman and Members of the Committee: I am pleased to be here this
morning as you begin deliberations on the Second Concurrent Resolution on the
budget for fiscal year 1978. I would like to discuss brIefly the revised 1977 and
1978 budget estimates and long-range projections that we issued in our Mid-
Session Review.
1977 AND 1978 BUDGET TOTALS
For 1977, our current estimates show receipts at $358.3 billion and outlays
at $406.4 billion, with a deficit of $48.1 billion. These estimates are within a
billion dollars of the estimates that we sent to you in April.
For 1978, we now estimate receipts at $401.4 billion and outlays at $462.9
billion, resulting in a deficit of $61.5 billion. Our current estimate of the deficit
is $3.6 billion larger than the April estimate, with receipts somewhat lower and
outlays higher. On the other hand, our estimate of the deficit is $3.1 billion
smaller than the deficit in the first resolution for 1978 largely because our
estimate of receipts is higher. Our estimates of total outlays and budget
authority are also above the levels of the first resolution.
A table showing the 1977-78 budget totals in the Administration estimates
and the budget resolutions is attached to my statement. Mr. Chairman, with
your permission I would like to insert that table into the record.
Our current estimates include two major administration proposals that were
not included in our April estimates or the first resolution. The first is the energy
program announced by the President. on April 22. Since Mr. Eliot R. Cutler,
Associate Director of 0MB testified On the energy program before this comrn
mittee on June 29, 1977, I will not repeat the details of the President's proposals.
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A table summarizing the 1978 outlay and receipt effects of these proposals is
attached to my statement however I would like to point out that the Piesi
dent s energy proposals aie estimated to increase the deficit by about $11/2
billion in 1978, but would not have a substantial effect on the deficit through
1985 Net receipts from the proposed oil and gas use tax would offset added
outlays for the new or expanded Federal energy proposals for the 8 year period
from 1978 through 1985
The President has also presented'. a proposal to put the long-range, financing
of social security on a soundei basis V~ hue the proposed tax changes would
not become effective until 1979 or later, the general fund payments to the social
security trust funds are proposed to begin in 1978. These payments are designed
to compensate the social security system for payroll tax receipts that are lost as
the result of an unemployment rate in excess of 6 percent. They would be made
in 1978-80 and would reflect the revenue shortfalls from 1975-78. For 1978, this
payment increases budget authority by $5 2 billion Since it is a transfer between
government accounts, it does not add to total budget outth,ys.
In addition to Presidential policy changes, our Mid-Session estimates reflect
the impact of `completed congressional action through the end of June. Congres-
sional action largely on the 1977 supplemental appropriations bill and the eco
nomic stimulus proposals, has increased 1978 outlays by $0.6 billion and decreased
1978 receipts by $4.3 billion relative to the .administration requests.
Our current estimates also reflect an accounting change that makes our figures
comparable to those in the conference reports on the budget resolutions. Earned
income credit payments in excess of an individual's tax liability, formerly treated
as outlays in the budget, are now classified as income tax refunds. We made this
change primarily to avoid the confusion that resulted from different accounting
techniques in the President's budget and the budget resolutions. We also recog-
nized that there could be procedural problems for the Congress, at least in the
Senate, if such payments were not treated as' tax refunds.. At the same time,
w e do not consider this to be a precedent that allows major outlay programs to
be classified as negative receipts.
Finally, our current estimates reflect a number of estimating changes, based on
revised economic assumptions and actual experience this year. .1 know this com-
mittee is concerned about the quality of budget. estimates. In recent years, par-
ticularly sinëe the enactment of the Congressional Budget Act of 1974, there
appears to have been an upward, bias in agency estimates of outlays. Actual
outlays in fiscal years 1976 and the transition quarter were less than the. esti-
mates in the 1977 budget, and, as our downward revisions in April indicate, the
1977 estimates in the' 1978 budget also appear to have been too high.
We believe that our current estimates are reasonable; certainly, we have
made every effort to make them so. The estimates for 1977 are based upon
actual receipts and outlays for 8 months of the fiscal year and on our best judg-
ment of what the final 4 months of the year will be. While we do not rule out the
possibility that the 1978 outlay estimates might have ~some upward bias in
them, experience suggests that later add-ons may well offset any such bias.
We are continuing to review our estimates and will eliminate any biases that
we find in them. Last month, we requested the larger agencies to report on the
methods they use to estimate spending under specified programs. We also asked
them to describe how these methods are being or might be improved. `These
reports are due.in 0MB toward the end of this month. We plan to share and
review this information with the staffs of this Committee, the Senate Budget
Committee, and the Congressional Budget Office.
LONG-RANGE PROJECTIONS
The February and April revisions sent to the Congress by this Administration
did not include long-range economic and budgetary projections because of the
limited time available for preparation of the revisions. The Mid-Session Review
presents for the first time the Administration's long-range economic assumptions,
and budget projections. I would like to insert into the record a table showing
the budget totals projected through 1982
I would like to emphasize, however, that these projections differ in nature
from our estimates for 1977 and 1978. Moreover, long-range budget projections
are very sensitive to small changes in the underlying economic assumptions. It
is difficult, at best, to make accurate economic forecasts for this year and next
year, and it is virtually impossible to make them for longer time periods. There-
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fore, the long-range economic assumptions, unlike our short-range economic
forecasts, are merely projections that assume progress in moving toward a more
fully-employed economy and greater price stability. They are not forecasts of
economic events.
The budget outlays and receipts shown for the year 1979 through 1981 are also
not forecasts. In broad terms, they represent an estimate of the degree to which
resources would be committed by the continuation of existing programs modified
only by those changes already proposed by the Administration.
The difference between the outlays and receipts-the budget margin-simply
reflects the fact that under the `assumed economic conditions, receipts would
grow faster than outlays between now and 1982 if there were no further policy
changes. We know that in the past, projected margins have not been realized in
terms of budget surpluses, largely because economic and other conditions changed,
and policy changes were made to accommodate them. Therefore, the fact that
the projections show budget margins of $4 billion in 1980 and $42 billion in 1981
does not mean that we will automatically achieve the President's goal of a
balanced budget in 1981.
No attempt is made to predict future Administration or Congressional deci-
sions. As you know, the administration will submit two major proposals to the
Congress later this year. The first is welfare reform. which the President has
pledged to send to the Congress in several weeks. The long range projections
implicitly allow for welfare reform. In general, the outlays that will be folded
into the welfare reforms are included in the same agency and functional totals
as they have been in the past. In addition, there is included in the allowance
for contingencies funds that cannot be assigned to a specific function or agency
until it has been determined how they will be used. For 1979, $1.8 billion is
included and this rises to $5.5 billion by 1982.
The second major proposal that the administration will send to the Congress
later this year is tax reform. The long-range projections do not reflect the impact
of tax reform, because the administration's proposal is still being developed.
Tax reform is likely to have little or any effect on fiscal year 1978 receipts, and
therefore should not pose a problem in the development of the second concurrent
resolution. This is because it is doubtful that changes in withholding rates, if
any, would take place significantly before the end of the fiscal year, i.e., Septem-
ber 30, 1978. Moreover, while other changes in tax liabilities might effect calendar
year 1978 tax liabilities, the actual effect on receipts would not take place until
fiscal year 1979.
Mr. Chairman, this concludes my prepared remarks. I will be happy to answer
questions.
TABLE 1-1977 AND 1978 BUDGET TOTALS
[In billions of dollarsj
1977 President's budget1
-~
3d resolu-
tion
revised
February April July
Receipts
Outlays
Deficit
Budget authority
Receipts
Outlays
Deficit
Budget authority
348. 5 358. 6 358. 3
416. 6 407. 3 406. 4
356. 6
409. 2
-68. 0 -48. 7 -48. 1
463. 2 462. 1 464. 1
-52. 6
470. 2
1978 President's budget1
~-
February April July
1st
resolution
400.7 403.8 401.4
458. 5 461. 7 462. 9
396.3
460.95
-57. 7 -57. 9 -61. 5
506. 3 498. 0 504. 3
-64. 65
503. 45
I Earned income credit payments in excess of an individual's tax liability, formerly treated as outlays, are now classified
as income tax refunds.
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TABLE 2.-EFFECT OF ENERGY PLAN ON 1978 OUTLAYS AND RECEIPTS
[In billions of dollarsj
Net impact
on the budget
Outlays Receipts surplus
Conservation measures:
Crude oil equalization tax 0. 5 1 o, 5
Auto efficiency tax 5 5
Federal building retrofit . 1 -0. 1
Energy conservation retrofit . 2 -. 4 -. 6
Other conservation (2) -. 4 -. 6
Subtotal, conservation 1.3 .2 -1.1
Strategic petroleum reserve . 3 -. 3
Increased Federal fuel costs .. . 1 -. 1
Indexed Federal programs and Federal pay (2) (2)
Oil and natural gas conservation taxes
Energy R. & D -. 1 . 1
Other . 1 (2) -.
Total, President's energy plan 1. 7 . 3 -1. 4
1 Reflects only that portion of tax collections that will be returned as outlays. Other collections will be returned through
the tax system using credits.
2 $50,000,000 or less.
Note: Detail may not add to totals due to rounding.
TABLE 3.-FISCAL OUTLOOK, 1978-82 1
[In billions of dollars[
1978 current
estimate 2
1979
1980
1981
1982
Projected outlays
Projected receipts
Budget margin or deficit (-)
Budget authority
462. 9
401. 4
498. 6
466. 8
532. 7
536. 6
564. 8
606. 9
601. 0
676. 5
-61. 5
504. 3
-31. 8
551. 9
3. 9
589. 8
42. 1
620. 2
75. 5
664.3
I Earned income credit payments in excess of an individual's taxliability, formerly treated as outlays, are now classified
as income tax refunds.
Includes impact of congressional action and inaction.
The CHAIRMAN. On page 4 of your testimony you talked about the
shortfall in spending. Can you tell us more about what your expecta-
tions will be with respect to the shortfall in fiscal year 1978? You
claim to be reasonably certain that the current estimates will hold up.
Mr. LANCE. Mr. Chairman, I again have to say to you and the rnem-
bers of the committee that it is very difficult for us to feel any sense of
certainty about being able to make a real determination on the short-
fall problem. It is something that started, as you know, 1 year ago;
it has continued up until this time. I think there is some justification,
just from my own observation of the process, to think that it probably
will continue as we go forward.
We are making every effort from the viewpoint of 0MB in dealing
with the major agencies to try to get their feel for the problems and
for the circumstances as it relates to the shortfall. As we go through
the process and ask the agencies about whether they are meeting their
expenditure levels and things of this nature, they respond that they
think that they are doing so and then we still come up with a shortfall
problem.
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I think the fact that thereis some problem of ovetestirnation of the
ability to spend funds may well be systemic. I think that we are just
going to have to go ahead and gain some further experience in trying
to be able to deal with this. It is just very, very difficult to try to arrive
at any reasonable or specific solution to that problem.
The CHAIRMAN. Let me question you on another item on page 4,
earned income payments in excess of an individual's tax liability.
As you know, we have a difference of opinion on the treatment of
these matters, as to whether or not they are outlays or negative
receipts.
Mr. LANCE. Yes, sir. I understand the difficulty there and the fact
that there is a difference of opinion. It is something that, again, we in
0MB have tried to take into account. We have tried to be as consist-
ent as possible and eliminate different accounting techniques in the
budget and in the budget resolutions. I again think that this is some-
thing that we have to-
The CHAIRMAN. Can you tell us how 0MB is going to treat earned
income payments in excess of tax liabilities? Heretofore you have
treated them as outlays, as we have, but have you come to any conclu-
sion as to whether or not you are going to continue to treat them that
way?
Mr. LANCE. Well, I think the basic feeling now from the standpoint
of consistency in the process is that they probably should be treated
as negative receipts in this particular case. There may well be other
cases whereby they should be treated on the outlay side.
The CI-IAIRMAN. I was afraid you were going to say that. You know,
we have to work this problem out with the other body in one of these
conferences. Do I understand that insofar as earned income payments
are concerned you are going to treat them as negative receipts?
Mr. LANCE. That is right. Well, again I think that you have to deal
with that, Mr. Chairman, on the basis of what the circumstances really
are as you go forward. It may well be difficult to try to anticipate what
that treatment might be. I think obviously there has to be some con-
sistency, as to the basic way we think it ought to be treated, but I under-
stand that there is always room for difference of opinion with regard
to how it is handled in certain specific instances.
The CHAIRMAN. Mr. Latta.
Mr. LATTA. Thank you very much. Mr. Lance, it is always good to
have you before this committee.
Mr. LANCE. Thank you, Mr. Latta.
Mr LATTA. Coming back to the question that the chairman asked
about, the shortfall in spending, is this not really an indication that the
economy is in much better shape than the liberal spenders in the Con-
gress want to admit?
Mr. LANCE. That is an interesting question, Mr. Latta, as you well
know, and I am sure this is one of the reasons that you ask it.
I think one thing, and I am not sure that my colleague, Dr. Schultze,
would always agree with what I am about to say in that regard. I
think it does point out the fact that the economy continued to grow
and develop even with the shortfall in governmental expeiiditures.
Historically there has been some discussion and some argument about
the overall effect of governmental expenditures. The question that Dr.
Schultze and all of us talk about all the time is whether all Govern-
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ment spending, even if some of it is wasteful, is beneficial to the econ-
omy. That is the kind of question that you get into.
I think one of the interesting circumstances is that the economy has
continued to improve and that unemployment has shown marked
declines even with this continuing shortfall in the area of governmental
expenditures. So I think it has not had the effect that some people felt
that might have had with regard to the overall aspects of the short-
fall problem.
Mr. LAITA. Assuming this committee was correct in the budget figure
we came up with in our first resolution, it certainly is not correct today
as we look at the appropriations bills that passed the Congress, they
are about $5 billion less than the figure that came out of this committee
when you total them all up. So the economy is either improving or we
were wrong by $5 billion.
Mr. LANCE. I think the economy is improving. I do not think there
has been any question about that. Over the past several months, the
economy has improved.
Mr. LATTA. On page 7 of your statement you make the statement, or
raise the question in my mind and might raise a question in a lot of
people's minds, on the top of page 7: "Therefore the fact that the pro-
jections show budget margins of $4 billion in 1980 and $42 billion in
1981does not mean that we will automatically achieve the President's
goal of a balanced budget in 1981." Some people might read into that
you are backing away from the balanced budget by 1981. I certainly
hope that is not correct.
Mr. LANCE. No, sir, that is not the case. I simply felt that it was
important that the long-range projections in our midyear revisions,
which show a surplus of $4 billion in 1980 and a surplus of $41 billion
in 1981, did not mean that it would be easy to accomplish the goal of a
balanced budget by fiscal year 1981 or that it would automatically
happen. Certainly there are hard decisions that have to be made in the
process between now and then.
We feel that we are going to have to make some Of those hard deci-
sions in preparation of the 1979 fiscal year budget in order to attain
the goal of a balanced budget. We have not backed off from that com-
mitment at all.
Mr. LATTA. Let me ask you about one of those hard decisions that
you will have to make in a matter of days. We have the agriculture
bill starting before the 1-louse today and the figure that probably will
come out of the House and come out of the Senate will be higher than
the figure of this administration.
How much higher can this figure be, in your judgment, and not be
subject to a veto?
Mr. LANCE. Again, that is a very difficult question for me to try to
answer at this particular juncture. I think we will have to wait and
see what develops as the deliberations move along with regard to what
that number could be or what it should be in regard to what the Presi-
dent ultimately will do. I do not have a predetermined number in mind
about that particular circumstance.
Mr. LATTA. There has not been any talk down there?
Mr. LANCE. Yes, I am sure there has been some talk, but I am sure
there has been no decision reached.
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Mr. LATTA.' Well, we are going to be faced with that decision here..
iVe have farmers throughout the country that are producing wheat
below the cost of production. We have a surplus coming on.
`Mr. LANCE. It is a problem.
Mr. LArPA. We have a lot of farmers who want to stay in business.
Mr. LANCE. And we want them to stay in business.
Mr. LArrA. This year they are getting less than $2, quite a drop from
last year; the same way with corn, not quite so much. It is a problem
we are going to have to face and we ought to have some guidance.
Mr. LANCE. Yes, sir, I am sure that that guidance will be forthcom-
:`mg as the days move along from the standpoint of the President's
`wiews but, so far as I know to my own certain knowledge, there has
~een no decision made.
Mr. LArPA. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Leggett.
Mr. LEGGETr. Thank you, Mr. Chairman. Mr. Lance, it is nice to see
you again. I did not get a chance to hear all of your oral testimony,
but I have read it. You have quite an optimistic analysis, particu-
larly for 1979 and 1980.
As I see it, the real nuts and bolts is that you project increased ex-
penditures over the next 2 years over the 1978 budget of some $70
`billion and increased income of about $140 billion. I suspect that
income is based on a projection of growth. What assumptions do you
make in that regard?
Mr. LANCE. I think Dr. Schultze really could respond to that much
`better than I can, Congressman.
Mr. LEGGETT. Very good.
Mr. LANCE. If you do not mind hearing him, he can be more suc-
cinct about what his assumptions are than I am.
Mr. LEGGETT. All right. I can ask you all at once or I can break it
up. `What are your assumptions as far as cost of a national health
insurance program? What are your assumptions with regard to the
energy import program; is it dependent on our getting down to a 5-
million-barrel a day import? `What do you assume as far as agricul-
tural expenditures are concerned?
I guess fourth and fifth, we are concerned on our National Defense
and International Affairs Task Force that we are all tracking costs
in the same direction. Frankly, we have had some projections that
have come to our committee from the Department. of Defense, and
particularly from their comptroller, Mr. Wacker, who does an cx-
~cellent job, that seems at times to be different from what we are at-
tempting to do.
For example, I find that Mr. Wacker has apparently three different
budgets. He has the one of the President, the one that has been ad-
justed for the B-i, the one that has not; lie has the one for the public
consumption and one for in-house consumption. Our question to him
is: How do any or all of these budgets integrate with the balanced
budget in 1980?
H~ said, roughly we are going to get to the bottom of it, we are go-
ing to do a study. So the question is, Have you integrated the aspira-
tions of the Department of Defense with your projections in 1980,
and is it consistent with any of the current 5-year plans? I will ask
~[r. Schultze that.
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Mr. StJ~1ULTZE. Well, there are two parts to the question. My col~
league threw to me the economic question.
Mr.LANCE. I will take back the other-
Mr. SCHULTZE. He can have back the defense question.
Mr. LANCE. I will take that one back.
Mr. SCHTJLTZE. On the economic question, essentially let me explain
how this was done. Through 1978 we attempted as best we could, and
it is always imperfect to do a forecast of where the economy was
likely to go over the next year and a half, between flOW and the end
of 1978, which you need of course for your revenues and other as-
sumptions. From then on, what we did was to set out in 1981 and
1982 some reasonable economic goals with respect to unemployment~
reduced inflation, and then estimate what the revenues would be if
we met those goals, without necessarily saying we are sitting here and
doing for you a could forecast; that, "Yes, sir, we are going to meet
them all."
So really, those long-range budgetary estimates are based on tw~
different kinds of approach. In the first year and a half it is a straight
forecast, as best we could make it. From there on out, we set out how
will the budget look if the economy moved toward some reasonable
achievable and reasonable optimistic goals on the revenue side.
Mr. LEGGETT. `Which means what, that we can track?
Mr. SCHULTZE. I am sorry-which means that the rate of iinemploy-
ment would fall to about 434 percent in 1981, and 41/2 percent in 1982~
If you look at page-as a matter of fact in quite specific terms, if you.
look at page 55 of the midsession review presentation, it lays it out
each year. It would mean that our real gross national product would
grow at about a 5-percent rate over the next several years; all the way
through, as a matter of fact, to 1981, and then the rate of growth would
fall off slightly to a little over 4 percent. It would mean that the rate of
price increase would be in the 6-percent range for the next year and a
half or so and gradually fall off to 4 percent.
It would mean, as I indicated earlier, that the unemployment rate,
which is now as you know in round numbers 7 percent, would fall
gradually to about 434 Percent in 1981 and 41/2 percent in 1982 and as
I stress, what we have done in making this up is to lay out some rea~
sonably achievable goals and indicate what the revenues would look
lik~ if w~ mr't th~ economic goals.
The CHAIRMAN. The time of the gentlemen has expired.
Mr. LECGETT. He has not answered the other parts yet on insurance
and defense.
The Chairman. All ri~rht. Mr. Lance.
Mr. LANCE. Quickly I will try to respond about the defense question
first.
We have in our budoet review sessions with the Defense Denart-
ment. of course, taken into consideration their 5-year plan, and that is
a part of what our projections are as we ~o forward.
The cme~tion about three or four different bud~ets. T guess that is
a part of the process. Everybody tries to have what they would like
to have., and they have what they think they can get, and that sort of
thing. So I think that that is a part of the process. But we have looked
at the 5-year plan in regard to our deliberations thus far.
PAGENO="0014"
,10
1\Tith regard to i~tioual health insuranc~ we have n~t taken that
into consideration yet in these forecasts except to say that we think we
will have a start in that area by fiscal year 1980; as to the cost, what
it would be, that still has to be determined.
The CHAIRMAN. Thank you, Mr. Lance.
Let me say to the members of the committee that Mr. Lance has to
leave at 11 o'clock. We have heard his testimony, but have not heard
Dr. Schultze's testimony as yet. Would you confine your questions to
Mr. Lance so that we can then proceed with Dr. Schultze after 11
o'clock. Mr. Burleson.
Mr. BiJRLESON. Thank you very much, Mr. Chairman.
Mr. Lance, do you still seriously contend that we are going to have
a balanced budget in 1981?
Mr. LANCE. Yes, we do.
~Mr. BURLESON. That is a stated determination?
Mr. LANCE. That is a stated determination.
Mr. BURLESON. As to what we are going to do?
Mr. LANCE. That is a stated determination. It is a goal that I do
not think is inconsistent with what we have done to this point. I think
~that obviously, and I am sure Dr. Schultze will touch on this as he
~talks about the economic assumptions, that we have to do it in a level
~of high economic conditions, a high-employment economy.
I do not think that anybody would doubt that high employment is
certainly paramount in the process, but we think that what we are look-
ing at now indicates that we can do that.
I might add from the standpoint of trying to lay the groundwork,
that we have done something unusual in the spring budget review
process this year. The President and the Vice President gave us 25
hours of their time to sit down with the Cabinet officers and the agency
heads. We talked about some of the basic issues that we see developing
with regard to the agencies own specific circumstances and the kind
of decisions that we will begin to make in the 1979 budget as a result
of zero-base budgeting and as a result of reorganization proposals.
This sort of thing will enable us to go ahead and make some of these
other decisions that have to be made. But we have seen nothing yet to
indicate that we cannot attain that goal.
Mr. BUIILESON. You continue to believe, as you have stated here,
contrary to what some of our economic theorists say, that it is desirable
to have a balanced budget?
Mr. LANCE. Yes, sir; I think it is very desirable.
Mr. BURLESON. Thank you. Thank you, Mr. Chairman.
The CHAIRMAN. Mrs. bit.
Mrs. bOLT. Thank you, Mr. Chairman. Welcome, Mr. Lance. I am
sorry I did not make it to the women's caucus.
Mr. LANCE. I missed you. I was looking forward to seeing you this
morning.
Mrs. bOLT. Thank you. I apologize. The midsession review projects
tax receipts rising at a `higher rate during 1978 to 1982 than the out-
lays. What would happen if, say inflation were 1-percent lower than
you have pro] ected? What would that do to the tax receipts and to
the income?
PAGENO="0015"
11
Mr. LANCE. I think, Mr. Chairman, that on this question you are
going to get better information from Dr. Schultze than you will from
me. I am not trying to evade the question. I think it is an area that
Dr. Schultze has a much better feel for.
Mrs. HOLT. All right. I will reserve that one then until after Dr.
Schultze has given us his statement.
Let's talk about the tax. reform plan, then. Have any conclusions
been reached on that? Do we know whether the plan would cause a net
reduction or a net increase in the Federal take from the private sector?
Mr. LANCE. No final conclusions have been reached with regard
to the tax reform proposals. There has been a very involved process,
with the Treasury Department getting comments from different groups
about some of the aspects of tax reform. They `have been in the process
of doing that.
I understand Secretary Blumenthal and some of his people-Mr.
Woodworth, among others-will be having a series of regional meet-
ings around the country in the next week. They will get views on the
overall aspects of tax reform, what needs to be done and how it
needs to be dealt with. Nothing basically has been decided yet as to
specifics. These decisions will take place over the next several weeks as
these things are ultimately put together.
We have had a lot of discussions. We have had a lot of time spent
by the Treasury people in trying to arrive at what were the.three basic
goals in tax reform: A sYstem that is fair and equitable, a system that
is simple as possible, and a system that provides for capital forma-
tion and capital investment incentives. These things are certainly all
a part of the overall process.
When you talk about tax reform, I am sure that you. talk about tax
cuts as well as about eliminating some provisions that may relate to
revenue increases.
Mrs. HOLT. That is what I was concerned about, the overall goal to
increase the Federal take, increase the revenue.
Mr. LANCE. No, I do `not think that is the real' goal of what we are
talking about. I think that, again, the three basic objectives are what
I just related to you. Certainly within the total package there will be
areas that will reflect decreases in revenues as well as areas that `will
reflect increases in revenues~
Mrs. HOLT. Thank you. That is all, Mr. Chairman.
The CHAIRMAN. Mrs. Holtzman.
Ms. HOLTZMAN. Thank you, Mr. Chairman. I am a little hesitant to
ask questions because I am not sure whose jurisdiction covers what.
The CHAIR~!AN. Let's try to stay with 0MB and budget.
Ms HOLTZMAN I notice in your testimony th~~t you `~re anticip~tmg
that there would be approximately $1.8 billion included for welfare' re-
form in the fiscal year 1979 budget, and $5.5 billion by 1982. Do these
figures take into account providing a comprehensive system of day
care? ,
Mr. LANCE. I will have to turn to `Pete to ask him specifically what
is included in all those numbers. Those are the estimates of the magni-
tude of the welfare refoim proposals that we piesently are talking of
PAGENO="0016"
12
As I indicated to you earlier, I am concerned about the problem of
day care expenditure levels. I think this is something that certainly
will be lOoked at in the overall aspects.
Ms. HOLTZMAN. But day care i~ not included in these figures?
Mr. LANCE. Not that I am familiar with; these figures represent
program levels.
Ms. HOLTZMAN. Let me also ask you about the public service jobs
program. This is something that concerns me very much because of
what happened in New York City last week. What are we going to be
doing to cope with the problem of unemployment, especially 40-percent
unemployment in the ghetto areas?
I want to ask you whether the public service jobs program has been
`developing as quickly as was originally anticipated and, if not, what
roadblocks have been encountered and what is 0MB trying to do
with respect to these obstacles?
Mr. LANCE. I think it goes without saying of course that this is
one of the major problems that we face from the overall economic cir-
cumstances, as well as the human circumstances, in this country.
I talked to Secretary Marshall the other day. I think that he said
there was about a 1-month delay in the process due to the late passage
of some of the legislation. This led to a concurrent delay in the imple-
mentation of some of the. programs.
I do not think there is any question whatsoever that we need to move
very, very rapidly with regard to implementation and do this as
quickly as we can. I think the need is just so great. I think obviously
the circumstances are such that we need to put full speed ahead in deal-
ing with all the circmustances that are involved.
We at 0MB are ready to do whatever is necessary to make that
process move along more rapidly. It is not an area, as you 1n~ow, that
we can do a whole lot about specifically except to try to monitor the
progress that is being made. Secretary Marshall feels this urgency
also.
Ms. ROLTZMAN. This is one of the areas I believe that there was a
shortfall in expenditures-the creation of public service jobs.
Mr. LANCE. Again I think it is just very difficult, from a practical
standpoint, to put all these mechanisms into place and get to the level
of the ultimate recipient with something taking place. You know we
get bogged down in administrative circumstances. We get bogged
down in setting up organizational structures and all the other aspects
of trying to deal with circumstances that sometimes do not relate to
the actual fact of what we are trying to do.
I would hope we are able to move much more rapidly in dealin.g
with some of these problems than we have in the past.
The CHAIRMAN. Mr. Derrick.
Mr. DERRICK. Thank you, Mr. Chairman. Mr. Lance, there is legis-
lation before the Congress which would put the Federal financing
bank on budget. I would like to know what your position would be on
this legislation, and what efforts the administration is taking tO have
the other off-budget agencies put back on budget?
Mi LANCE Congressman, I guess that my basic response to you is
that that is an area that I have somewhat mixed emotions `about. I think
that we ought `to be very straightforward and direct about what we are
talking about in the area of off-budget financing. By the same token,
PAGENO="0017"
13
it makes it very difficult, if all of a sudden you make `a change and start
including the off-budget, without going back and drawing a com-
Parison about ~what you have done in the past. I think this obviously
makes it.very hard to compare budgets.
I think the process of specificially showing w~hat those numbers are
in the budget, such as was done in the 1978 presentation to the Con-
gress, perhaps is the best way to deal with that circumstance.
Mr. DERRICK. Do you not think it is the only way to really be fair
and honest with the American people `about what is going on?
Mr. LANCE. Certainly, I think we ought to be fair. I think we ought
to be direct. I think we ought to make sure that the people understand
the way that that has `been handled in the p'ast. if all of a sudden you
just simply started including those items in the budget totals, then `in
effect you are not drawing `a fair comparison about what has been
taking place in the past.
Mr. DERRICK. We have a side `category so that we can make that 1981
deadline.
Mr. LANCE. `Obviously that is one of the problems that we face, as
you well know. As I said, that is what causes my mixed emotions abou't
it. I know that the question of back door financing and off-budget
items, is something that very definitely concerns this committee and its
members. I do not know that I have the total answer to that problem,
like I `do not have the answer to a lot of other problems. But I think
it needs to be specifically delineated that when you include it in the
budget totals, that is something that does create some problems for
comparison purposes.
Mr. DERRICK. If you would allow me to say so, I would suggest that
your answer would be that you agree with the ideas as long as they do
not mess up your goal of appearing to have a balanced budget by
1981-
Mr. LANCE. ~knd does not present them unfairly in comparative
circumstances.
Mr. DERRICK [continuing]. Can you tell me~ give us a brief summary
of what the administration is doing with respect to the implementa-
tion of zero-base budgeting, what steps you have taken in that area?
Mr. LANCE. Yes.
Mr. DERRICK. Also, are you optimistic that it might have an impact
on the 1979 budget, and will it produce some savings or a more orderly
process?
Mr. LANCE. Yes, sir. I think, of course, the savings are hard to
delineate and define and that "orderly process" better describes what
we are trying to attain. I will make another comment about the sav-
ings in just a second.
One of the things done in the 25 hours that we spent with the Presi-
dent in talking about budgetary goals and priorities with the various
departments was that the Cabinet officer or agency heads gave the
`President a report as to how they felt the implementation of zero-base
budgeting was being handled within their own areas.
At the same time, the 0MB people involved in the process gave a
report as to how they felt it h'~d been implemented up to this time
Without exceltion both the comments from the ~gency level and
dep'Lrtment level `~ere veri~ positive as were the comments from the
people at 0MB. It is something that has been accepted well. Not just
94-971-77-----2
PAGENO="0018"
14
the Cabinet people themselves, but the career people in the various
departments have accepted it as an opportunity to take a look at cir~
cuinstances, to make changes where they think change is important
and to redirect their sense of priorities.
So I would have to say to you that I am very optimistic about the
progress in implementation of zero-base budgeting at this point. It is
not as a far-reaching as we would like for it to be, naturally, because
the time frame and circumstances make it difficult. We have gotten
dowii to some of the field levels and I think this is extremely impor-
tant.
With regard to your question about savings, I think obviously
this raises a point that this committee again is very much interested in.
One of the problems I see in Government has been the fact that
sometimes you seem to penalize good judgment and reward manage-
ment that is not quite as effective as otherwise might be the case. One
of the aspects of zero-base budgeting is that as managers make deci-
sions relating to priorities and implementation of programs, then
whatever savings may come about should be given to them to redirect
in their own area, because they are the ones who are making the basic
hard choices and decisions that relate to good management. You in
effect should not take from them and give to someone else who in
effect has not done the same sort of job.
I think one of the results of zero-base budgeting is that there will be
redirection within a department or agency, regardless of whether
there are net savings.
Mr. DERRICK. You think there will be a significant impact on the
1979 budget?
Mr. LANCE. Yes, I think there will be a significant impact on the
1979 numbers.
Mr. DERRICK. Thank you.
The CHAIRMAN. The time of the gentleman has expired. Mr. Rousse-
lot.
Mr. ROUSSELOT. Thank you, Mr. Chairman. I appreciate both of
you gentlemen being here today to help give us some insight as to
the planning that you are involved in.
We do appreciate the package you set up, some of your figures.
How much input in this futuristic planning do we have for tax cuts
or can we expect for individual tax cuts, do you know in 1979, 1980,
1981?
Mr. LANCE. The numbers themselves, Congressman, do not reflect
any tax reform proposals.
Mr. RoussEI~oT. But would that not be kind of important to stimuli
that relate to capital formation?
Mr. LANCE. Yes, sir, I think it is very important to stimulus. But
I think that we ought not try to anticipate what that proposal might
be at this particular time. I think that it might give some misdirection
to what we are attempting to do and what we will be proposing in
the area of tax reform.
Obviously, as you ~e1l know, we have had discussions with this
committee before about the efficacy of tax programs to bring about
stimulation of the economy. As you have indicated, when there are
tax cuts, there are great returns in revenues somewhere along the
way as the economy continues to improve.
PAGENO="0019"
15
Mr. ROUSSELOT. In jobs, housing starts, all the things we are looking
to do?
Mr. LANCE. The whole economic well-being, and growth in the
process. But we have not taken that into consideration with regard
to the specific numbers.
Mr. ROUSSELOT. In the numbers that we have here?
Mr. LANCE. Yes, sir.
Mr. ROUSSELOT. Then to another issue. We have discussed a lot
on this committee the value of public works stimulus. But according
to the figures we have, there was a large amount for local public
works, I think $4 billion was in the stimulus package. Now the esti-
mates that we have available for us on the basis of the public works
program that was enacted last May, that is the actual spend out of
the $4 billion, it is not particularly accelerating.
For example, my understanding is that in 1977 it will probably be
somewhat less than $50 million that will have been spent out in that
time by accelerated public works. Maybe our figures are wrong.
In fiscal year 1978 the outlays will be about $2 billion and in fiscal
year 1979 about $2 billion. Now, given this information, is it not
true that the real stimulative impact of the program is not going to
occur until 1979 or 1980, assuming these figures are right?
Mr. LANCE. Of course I am sure there ~;5 a cumulative effect that
carries forward no matter what the numbers may be with regard to
expenditures. Pete says we are above the $50 million already.
Mr. ROUSSELOT. For this fiscal year?
Mr. LANOE. For this fiscal year.
Mr. ROUSSELOT. What are they exactly?
i~'1r. LANCE. He says $138 million.
Mr. IROUSSELOT. $138 million for 1977.
Mr. LANCE. Yes. We will doubleeheck those numbers through May
and communicate with you. Actual outlays totaled $108 million
through May 31 and $209 million through June 30, 1977.
Mr. R0U55EL0T. That includes the amount we passed last year. That
was not just the $4 billion that we passed in May, was it-$2 billion in
October and we passed another $4 billion in May.
Mr. LANCE. That is correct.
Mr. ROUSSELOT. That was the accelerated part of it?
Mr. LANCE. That is the accelerated part.
Mr. ROUSSELOT. How many jobs were actually produced with that
great stimulus?
Mr. LANCE. I will have to check that.
Mr. ROUSSELOT. Yes, we sure would like to know that, because we
~ear a lot of times as to how important that stimulus is to jobs.
Mr. LANCE. I think it is like so many things, that the point of imple-
mentation does take some time.
Mr. ROUSSELOT. We understand that. Of course there was $2 billion
put in place in October and started and another $4 billion for May. It
was supposed to be accelerated and we would like to know where the
jobs occurred and so forth because we constantly talk about it here and
how helpful it is.
Mr. LANCE. Yes.
Mr. ROUSSELOT. And how many jobs it is going to produce. Now, do
these jobs that are produced under these public programs in any way
PAGENO="0020"
`16
compete with what might happen in the private sector if we would
maybe come up with tax cuts, or have you looked at that?
Mr. LANCE. I have not looked at it specifically from the
standpoint-
Mr. ROUSSELOT. Since everybody seems to admit that most of the new
jobs coming onstream occur in the private sector, do we have any com-
parative `analysis as to what is produced in the way of jobs when we
have these `accelerated programs as opposed to what could occur in the'
private sector if ~ve~
Mr. LANCE [continuing]. The Commerce Department estimates that
38,150 jobs have been created to date. These jobs have been created
throughout the United States in roughly the same proportions as the
program funds. The Department of Commerce will not have precise
estimates on the number of jobs created by rounds I and II of the local
public works program until an evaluation of the program has been
completed. Current estimates of job creation range from 300,000 to
over 600,000. A recent Rand study projects 628,000 jobs resulting from
the total program.
Assuming that the economy keeps recovering at the current pace,.
there may be some competition with jobs created in the private sector'
at the end of the program. However, during the current recovery
phase, t.here should be no competition, because the construction indus-
try has not yet fully recovered.
Mr. ROUSSELOT. I am sure you are comparing those now as you look
at the future to determine where the best effort can be placed in order'
to stimulate the economy in housing, in jobs, all of the things that we
talk about.
Mr. LANCE. Also in trying to do something in the areas of great struc-
tural unemployment, where you need to try to target to do something'
about those specific circumstances.
Mr. ROUSSELOT. Right. Now, is there any chance in the so-called
discussion of shortfall that by the time we reach October 1 that the
spendout or Federal expenditure level will be even lower than you
have projected? You are not able to spend it as fast or maybe the need
is not quite-
Mr. LANCE. I am sure that that chance exists.
Mr. ROUSSELOT [continuing]. What is your guess?
Mr. LANCE. ~y guess is that levels as now projected by 0MB ar~
faily accurate.
The CHAIRMAN. The time of the gentleman has expired.
Mr. ROUSSELOT. Thank you.
The CHAIRMAN. The gentleman from Florida, Mr. Lehman, is rec-
ognized for 5 minutes. Again, we are restricting our questions to Mr.
Lance who has to leave soon. We will proceed later rtith Mr. Schultze.
Mr. LEHMAN. Just a couple of quick questions. Some of it may al-
ready have been asked.
Most of what we have done in the economic stimulus package like
th.e $4 billion in public works funding, really has not come on line yet.
A lot of the public service jobs have not been filled yet. Yet you say
the economy is improving.
What has Congress actually done to help this improvement so far,
other than provide psychological benefits by giving the appearance
that we are trying to do something about the recession? ~
PAGENO="0021"
17
Mr. LANCE. Of course I think, that is a major part. I think that
the psychology of things has a major effect on the economy. We have
talked about this factor specifically in connection with the stimulus
proposal.
As a result of the withdrawal of the rebate, of course, most of
the stimulus proposal fell into 1978. The economists felt that it might
he appropriate for the stimulus programs to be coming onstream in
the latter part of this calendar year and throughout the first part of
next calendar year.
I think just basically there has been a growing sense of confidence
in the minds of the consumers of this country. Hopefully, business
investment-capital investment-will continue to increase. I think
that this is something that reflects the progress that the admninistra-
tion has made to date with regard to dealing with some of these circum-
stances; the decline in unemployment I think has had a major effect.
Mr. LEHMAN. We have heard it said before, that style is sometimes
just as important as substance.
Mr. LANCE. Yes, sir; I think it is.
Mr. LEHMAN. I have one other question, about the administration's
hope to balance the budget by the end of the 4-year term. I was
recently in France. Their budget is absolutely balanced and yet they
have a rate of inflation that is twice what ours is. In our own economy,
then, how much real effect would a balanced budget have on the rate
of inflation?
I have never been able to see a direct relationship there, and I often
think that this is another instance of style versus substance. I think
many people would gain confidence from seeing the budget in balance,
and the rate of inflation might go down.
In your mind, what is the relationship between the rate of inflation
and bringing the budget in balance?
Mr. LANCE. In my own mind, it is hard to assign any direct relation-.
ship, numberwise, to that process. I think it is obvious, as you talk to
the American people, that they do equate budget deficits with increas-
ing inflationary pressures.
As we move toward lower deficits and toward balance in 1981, they
will view that as a major anti-inflationary circumstance and react ac-
* cordingly. I think that, obviously, the major problem with regard to
economic circumstances right now in the minds of the American peo-
ple is the problem of inflation.
Mr. LEHMAN. France, for instance, keeps its budget in balance by
*a value added tax. Is there anything similar, down the pike in this ad-
ministration? Are you considering such a tax to bring our budget in
balance?
Mr. LANCE. I a.m not in a position to be able to comment about any-
thing down the pike. Senator Long, of the Senate Finance Committee,
raised that possibility. So I am sure that that is something that will
be under discussion, not necessarily from the standpoint of the ad-
imnistration, but it will be something that will have to be looked at
by the Members of Congress in the future.
Mr. LEHMAN. Thank you. I yield back the balance of my time.
The CHAIRMAN. Mr. Fraser.
PAGENO="0022"
18
Mr. FRASER. Thank youvery much, Mr. Chairman. I am having some
difficulty understanding what the administration proposes to do about
high black youth. unemployment. I do not see any concrete program
that is making any significant impact. Is anything going to happen on
that?
Mr. LANCE. Mr. Fraser, I cannot respond directly to specifics in
that regard. The response that I would have t.o give tO you is that, of
course, I think it is one of the most major problems that we face. I
think we see that every day.
I am. sure again, as I said earlier, that Secretary Marshall views this.
as one of the major priorities of the t.hings that he has to cope with
and deal with. I cannot tell you specifically what his ideas are in that
regard, but I am sure that he is working diligently to try to have a
concrete proposal that relates to dealing with that problem.
I think it is obviousiy.one of the major problems that we ha.ve, not
just in relationship to black unemployment, but also the overall prob-
lem that half of our unemployment is in the. 16 to 24 age group. A great
proportion of it is in the black teenager group. The overall problem
will have long-range effects on the future of our economy. Those people
in that age group are deprived of the chance t.o have a job and move
toward economic independence. This is just something that has to be
dealt with and it is one I am sure Mr. Marshall is~
Mr. FRASER. I do not see anything happening. The fact that you do
not know about anything happening is not reassuring. I recognize that
some ideas are being generated in the Department of Labor. Obviously,
if we are going to do something significant, it is going to have a signifi-
cant budgetary impact.
Let me state it bluntly: What difference is there between this ad-
ministration and the last administration with respect to this issue?
What ca.n we say has improved now that the Democrats ha.ve won the
election?
Mr. LANCE. I am not able to dra.w a distinctive comparison between
the administrations. There is certainly the realization now, that this is
one of the major, major problems that we face.
Mr. FRASER. But that does not help us.
Mr. LANCE. It helps us to the e.xtent that you start on the road, Con-
gressma.n, toward dealing specifically with these problems.
Mr. FRASER. But what are we doing? We are not doing anything.
Mr. LANCE. As I say, this is an area that Secretary MarshaJi really.
will have to respond one, two, three to you about what his proposaI~
are with regard to dealing specifically with the problem. it is an area
that I am not expert in from the standpoint of what his proposals are
from that standpoint.
I will be glad to go and get that answer and then communicate it to
you, or I will be glad to have him call you and tell you specifically
what he is doing in this regard. But I think there is something signifi-
cant in the fact that we recognize the problem. It is a critical problem,
not just from the day-to-day aspects of it, but from the longer range
economic implications and the overall relationships of this country.
I think it is just something that has to be dealt with.
I am not happy or satisfied with the progress that we are making.
I am impatient, as you are impatient, about dealing specifically with
PAGENO="0023"
19
the problem because I think it ~ orsens every day that we do not deal
with it, but I simply cannot tell you specifically what we are able to
do about it.
Mr. FRASER. On table 2 of your testimony, you have an outlay of
$1/2 billion- for the crude oil equalization tax. Your footnote indicates.
that this is a portion of tax legislation that will be retuined `ts outl'tys
As I understand it, that tax would begin JanUary 1 of next year,
but any refunds will not occur until April 1979, or when people file
their tax returns. Why would there be $½ billion going back to some-
body during fiscal year 1978?
Mr. LANCE. I will have to turn to Mr. Schultze to answer that, if
he knows in that area, or Pete.
Specifically, I do not know what that item is. My understanding
was that the tax refunds would not occur until 1979.
The outlay of $½ billion for the crude oil equalization tax on table 2
is for direct payments to (1) individuals under existing income main-
tenance programs, and (2) heating oil distributors to be passed on to
home heating oil users. It is intended that these payments should be
made at appi~oximately the same fime that the tax is collected.
Because of conventions used in preparing the budget, table 2 does
not show the amounts to be returned through the tax system. Tax
rebates reduce the estimate of receipts rather than showing up as an
expenditure. Through the use of a lower withholding rate on pay-
checks, we anticipate that rebates will be made available to individuals
at about the same time the tax is collected.
Mr. FRASER. Let me add as a footnote that I am in favor of speeding
lip the refund to people who do not owe a tax. There will be a change
in withholding as I understand it, but people who do not owe a tax
will have to wait a year and a half. If there is a speedup, I am all for it.
Mr. LANCE. That may involve some social security implications but
I am not sure about that, I will have to check and tell you specifically
what that is. Congressman Conable says that it does.
Mr. FRASER. You can provide something on this for the record?
* Mr. LANCE. Yes, sir. . -
Mr. FRASER. If there is something you could do that would give us
an indication of a serious major effort to deal with the problem of high
unemployment in the ghettos of this country, I would very much ap-
preciate having that information.
Mr. LANCE. The administratiOn's principal response to the problem
of youth unemployment has been to seek new authorities and funding
tQ develop a broad range of innovative programs. These authorities are
embodied in the ~Youth Employment and Demonstration Act of 1977.
This act provides:
* -Young Adult Conservation Corps, which will provide jobs for youth in the
national parks and forests*;
-Youth Incentive Entitlement Pilot Project, which will test ways of providing
employment for school age youth;
-Youth Community. Conservation and Improvement Project, which will pro-
- vide job opportunities for many out-of-school youth; and
-Youth Employment and Training Programs, which will test alternative ap-
proaches for understanding and solving youth unemployment problems.
The Congress has already appropriated $1 billion to finance* tese
activities. While designs for these programs are still under develop-
PAGENO="0024"
20
ment, it is expected that nearly 200,000 jobs for youth will be created
with these funds. In addition, the administration has requested funds
to substantially increase the Job Corps program, which serves the most
severely disadvantaged youth.
The administration is also implementing a summer youth employ-
ment program under the Comprehensive Employment and Training
Act. This program is providing jobs for over 1 million youth this year.
Other summer youth programs funded by the Federal Government
should result in another one-half million jobs for youth this summer.
In addition, programs under title I of the Comprehensive Employment
and Training Act are expected to serve about three-quarters of a mil-
lion youth this year.
The CHAIRMAN. The time of the gentleman has expired.
Mr. Regula.
Mr. REGULA. Thank you, Mr. Chairman. Three questions, Mr. Lance.
On page 2 you say net receipts from the proposed oil and gas use tax
would offset added outlays for the new or expanded Federal energy
proposals for the 8-year period from 1978 through 1985. Does this
mean that the welihead tax in fact will not be rebated, but will be used
for other types of programs?
Mr. LANCE. Well, what we are saying in that regard and the basis
that we make that projection on is that there has been no change with
regard to our initial desires about the rebate of the welihead tax.
Mr. REGULA. Do you contemplate rebating the entirety of the well-
head tax in some form?
Mr. LANCE. In some form or fashion, and that the net effect would
be one of-
Mr. REGULA. Wash
Mr. LANCE. Right.
Mr. REGULA. Is that right?
Mr. LANCE. There will be changes, I am sure, as we go through the
process that we cannot yet anticipate.
Mr. REGULA. All right. The second question, is the administration
looking at ways to stimulate the private sector? It follows up on the
question that Mr. Fraser asked about, essentially jobs. He is, I think,
talking in terms of public sector jobs, but in the final analysis, private
sector jobs are more lasting.
Do you have any kind of a plan that you will be bringing to the
Congress to perhaps ease the regulatory burden, along with tax policy,
that will stimulate. the private sector and in effect supply the dynamics
that will provide receipts necessary for a balanced budget?
Mr. LANCE. Well, I think overall, Congressman, that job creation in
the private sector relates to, as we mentioned 1 minute ago, the style
of trying to do things. I have said all along I think there are certain
`specific areas that obviously we have to handle through the public
`sector, through governmental public service jobs.
I do not think those are permanent jobs. I think there has to be
some method for the transfer of those jobs from the public sector to the
private sector. Whether that involves some sort of incentive specifically
from the standpoint of tax policy or something else is something that
you have to try to develop and see just what is the best method of deal-
ing with it.
PAGENO="0025"
21
I think that overall as the economy continues to develop, and there
is a sense of confidence, certainty and consistency emanating from
Government, then that, too, has its effect. So I think it is a combination
of circumstances.
I think my basic respOnse to your question would be that as we
develop public service jobs and as we try to deal with specific unem-
ploymeñt problems in the public sector, that it also is mandatory that
we mOve to transfer those jobs into the private sector, so that they in
fact do become permanent. We do not want to have a situation where
-those jobs, in effect, become totally dependent upon the rise and fall
of economic well-being. I think that is one of the problems that we
have had in times past.
Mr. REGULA. Would you say that the administration will be bring-
ing some type of plan to us to cr~~te a better climate or environment
*for the private sector in terms of job production?
Mr. LANCE. I would certainly hope that would be the case. Aga1n,
this is an area where I do not have direct responsibility for the de-
velopment of plans and proposals, but I wou'd certainly hope that
this is the case. I think it is the ultimate answer to the kind of prob-
lems that we face in dealing with specific unemployment circum-
stances. There could be nothing worse, in my opinion, than to take
somebody and give them a public service job for a brief period of time,
and then simply see that job fade into oblivion and have him back in
the ranks of unemployed, without any skill, without any hope for t~he
chance to gain economic independence and the ability to make his own
way. I think that would be terribly, terribly disheartening and would
add very greatly to the social problems that we face, not to mention
the economic circumstances.
Mr. REGULA. My third question is, As part of zero-base budgeting,
which encompasses a lot of elements, are you requiring the agencies
to present alternatives to 0MB based on different levels of funding,
that is, an additional 5 percent, an additional 10 percent or additional
12 percent?
Mr. LANCE. Not from the standpoint of percentages so much, but
much more from the standpoint of what would you do with an en-
hanèed level or an austere level.
Mr. REGULA. You require that type of priority judgment?
Mr. LANCE. Yes, sir; those priority judgments are `being made.
Mr. REGULA. What is the time frame on those, iiiternally, within
your shop?
Mr. LANCE. We will begin to get those results in September and
October in order to be able to put them together and use numbers to
make the budget preparation.
Mr. REGULA. Will you make those available to us?
Mr. LANCE. If we have some vehicle for making them available to
you, Congressman-I do not know. There is an awful lot of paperwork
involved in zero-base budgeting, as you go through decision package
processes.
I do not know that there is anything that would be of benefit in
that part of the process. That is something I will have to take a look
at and see. I have no basic objection to that part of the process. I just
do not know that it wOuld be very helpful. There is a great deal of
paperwork that is involved.
PAGENO="0026"
22
The CTIAni1~IAN. The time of the gentleman has expired.
Mr.. Pike.
Mr. PIKE. Thank you, Mr. Chairman. Mr. Lance, I apologize for
having been late, but I have read your statement. I find myself sort
of in the position of a member of the audience at a showing of the play
"Peter Pan," where Peter Pan says, "You've got to believe." I want to
believe, but I have great trouble believing.
I look at your budget projections for 1979 and 1980 and you show
an increase of receipts for 1979 of approximately $65 billion, and for
1980 of $70 billion, a total of $135 billion in 2 years, roughly one-third
of the 1978 receipts figure.
How are we going to achieve this one-third increase in our Govern-
ment's receipts in 2 years?
Mr. LANCE. Congressman Pike, I think that, in response to that
question, there always is a degree of estimating that you have to try to
deal with. It is certainly not-
Mr. PIKE. What is going to happen in our Nation that allows us 2
years from now to increase our receipts by one-third and balance our
budget?
Mr. LANCE. I would hope that our economic circumstances are going
to continue to improve and that we will see further declines in the
unemployment rate. I think that is an important aspect of what we are
about. You have heard me say before that one of the first things they
told me is that for each 1-percent decline in unemployment we had a
$15 billion burden lifted from the Treasury.
Mr. PIKE. All right. So if we eliminated our unemployment alto-
gether, we still would not be there, if we had zero unemployment we
would not be there?
Mr. LANCE. I think obviously there are other things in the total eco-
nomic context that say that we would be there.
Mr. PIKE. If our economy goes as we now predict our economy is
going to go-I am not asking yOu to look way down the road to 1982,
but I do ask you to look at 1980.
Mr. LANCE. Yes.
Mr. PIKE. Are we going to have that $3.9 billion cushion?
Mr. LANCE. Again, as I tried to say earlier in response to a question,
Congressman, I do nOt thiiik that that projection there, and I am not
even sure that is a fair definition-
Mr. PIKE. Do you believe, Mr. Lance, that that is going to be true?
Mr. LANCE. The 1980 number, Mr. Pike, causes me some concern, to
be able to say that that will be definitely the case when we arrive at
that point.
Mr. PIKE. In other words, when I say I have difficulty believing,
you share my difficulty?
Mr. LANCE. My circumstance, sir, is such that I would think that
we need to talk in the broad context of trying to get to a 1981 balance,
and making sure that that will take place. lYhether or not we have a
surplus of $3.9 billion or a deficit of something less than that, and
where it might otherwise be, I think these are things we will have to
deal with as we go forward.
1 do not think there is any way to give a certainty to those nuthbers,
I think that is what you are saying is that there is no way to give a
certainty to those numbers. But, based on the economic assumptions
PAGENO="0027"
23
that Dr. Schultze and the folks on his staff and the people at 0MB
and Treasury have put together, that is a number that comes out, if all
those things took place Whether or not they take place, I cannot
answer.
Mr. PIKE. My question gets then to these assumptions. Are the
~assuinptions that you are making to get to these numbers, assumptions
of things that you really believe are going to happen?
Mr. LANCE. Certainly there is belief and also hope that some of these
things are going to take place, Congressman. I think that in any set of
circumstances that you have to have at least some degree of optimism;
if you wanted tO look on it as a worst-case basis, then I do not know
ivhat that number might show. But I think as we move forward-
Mr. PIKE. Do you not think you are sort of looking at it as a best-
case basis?
Mr. LANCE. No, sir; I do not think that is necessarily the best case.
Mr. PIKE. All right.
Mr. LANCE. I think it is a case based on circumstances that we think
there is a real possibility may occur as we move forward into fiscal
sear 1981.
Mr. PIKE. I want to believe.
Mr. LANCE. I want to, too, and I am trying to convince both of us,
1 guess, Congressman.
Mr. PIKE. I hope you are doing better with you than you are doing
irith me. I yield to Ms. 1-Ioltzman.
Ms. HOLTZMAN. I thank my colleague for yielding. I wanted to ask
a question prompted by an editorial that appeared in today's New
York Times with respect to the situation in New York.
The Times points out that: "The crisis exposed so devastatingly in
o~r home city is not a special product of New York mismanagement. It
points up a national danger that threatens dozens of communities,
mil1~ons of homes and livelihoods."
We have a situation where our national security will not necessarily
be threatened in battlefields of Europe or in Korea, but in the battle-
fields of our cities. We have a situation where unemployment is creat-
meg a danger of loss of talent and loss, of property and loss of life. I
want to know whether there is going to be any program or series of
programs that will address this problem. Or are we going to opt only
for a balanced budget at the expense of allowing our cities to become
battlefields and at the expense of inviting more crisis such as we had
last week?
Mr. LANCE. Certainly I do not think anybody would want to see our
cities become battlefields. I think that the circumstances as brought to
focus by the occurrence in New York City, once again, emphasizes our
iieed to be able to do some planning and be able to have some things
that deal with specific problems.
I am sure that the fact that there is a real problem and a real need
to be dealt with has been accentuated by that occurrence.
I think you will see something forthcoming from the administration
in trying to deal specifically with how to cope with this sort of cir-
cumstance and, overall, deal with the root cause of the problem, but it
is not going to be dealt with overnight. It is not going to be dealt with
just by rhetoric. It is going to have to be dealt with by actually get-
PAGENO="0028"
24
ting out there, seeing what the problems are, what the solutions are
to those problems and by doing them.
Ms. HOLTZMAN. I appreciate that response, but you see, the Presi-
dent asked for an answer from the Federal Power Commission with re-
spect to the engineering problems within 2 weeks. Has he called for
a similar 2 weeks' response to him about the causes of the looting and
despair, and the programs that are available to stop it?
It is not an engineering problem, it is not just a problem of an
energy shortage.
Mr. LANCE. Well, of course it is something other than an engineer-
ing problem; that is a part of the problem itself. It certainly is some-
thing that I think ought to be asked about. At the Cabinet meeting
yesterday, the President said that lie felt that we had to move ag-
gressively to try to deal with this sort of problem, not just from an
engmeermg standpoint but from the human factors that are involved.
I am sure lie will do just exactly that. I cannot think of anything
that really is any more important. I think that sort of circumstance
could take place in other sections of the country because of the great
problem of unemployment in a specific age group in this country. It
is something that causes me a great deal of concern. I just think that
we have to move as rapidly as we can to try to deal with the root cause.
The CHAIRMAN. Mr. Fisher.
Mr. FISHER. Thank you, Mr. Chairman. My question will relate
more to the line of questions that Mr. Pike was asking than to the
others, only, instead of focusing on 1980 I would like to focus on 1978.
I am looking at table 1 in the back of your testimony and I note
that the 1977 deficit estimated in July is $48 billion, and in 1978 it
is $61 billion, an increase of $13 billion; or if you take it in terms of
the Third Budget Resolution for 1977 it is a $52 billion deficit. and
the first resolution for 1978, $64 billion deficit, an increase of $12
billion.
This increase, 1977 to 1978, occurs at a. time when tl.ie economy is
picking up, most any way you look at it. Mr. Schultze's testimony goes
to that point.
My worry is, and it is a very deep concern, if we are going to come
out with a balanced budget in several years, and if the economy has
been and continues to be picking up, improving, how in the world cau
we have an increase in the deficit in 1978 compared to 1977 of $12 or $13
billion, which is 25 percent? And how do we square this out? Could you
respond?
Mr. LANCE. Yes, sir. I would be glad to respond. As you know, we
came before you in early February, I guess it was. Our projections for
1977 showed a budget deficit of $68 billion and for 1978 a budget deficit
of $58 billion, as I remember the numbers in round figures.
Of course, involved in both of those years, Congressman Fisher, were
the stimulus proposals. The tax rebate was subsequently withdrawn,
which reduced the 1977 numbers by some $11 billion. In addition, thieve
is the shortfall, which is reflected in our current numbers for 1977.
These two factors changed the progress that we estimated in February
with regard to moving from the deficit of $68 billion in 1977 to the
deficit of $58 billion in 1978 and making continued progress toward
balance in 1981.
PAGENO="0029"
25
Our current 1978 numbers still include approximately $17 billion in
stimulus, which I think has to be taken into consideration. This ought
to account for some of the increased revenues according to the truism
that Government spending does create economic stimulus.
If you took these stimulus numbers out of the 1978 total and if you
showed some shortfall provision for 1978, I think that number could
be judged to be different. But I think in 1979, of course, you will see a
significant change in the budget deficit.
Mr. FI5nER. I guess my point is that I would have expected to see
in you.r plans, your estimates, more movement toward balance in 1978.
I see a movement the other way.
Mr. LANCE. Yes, sir; but we had very little control over the 1978
numbers, as you well know. That predominantly is President Ford's
budget We did not have much input in the sense of trying to go back
and change the numbers per Se. i think you have to take into con-
sideration that this was a President Ford budget with Carter amend-
inents to it.
For the most part it does not reflect a great deal of change, simply
because of our inability to be able to make major changes.
Mr. FIsnER. It would be a nice one if we could put it across that
we are starting with President Ford's deficit budget-big deficit
budget-
Mr. LANCE. I think that is a part of the process we are starting
with. I think that is the circumstance that we start with, Congressman.
Those changes that were made related to the restoration of some cuts
that were made in the 1978 budget proposals by President Ford,
which we felt ought to be changed, and also the stimulus proposal,
which was, of course, an addition, a direct addition to the. bottom line
of the deficit.
Mr. FISHER. The stimulus, largely local public works and training
and jobs, should be yielding their fruit in 1978, should they not?
Mr. LANCE. I would hope from the standpoint of economic well-
being that it would be yielding its fruit in 1978. Some of the actual
outlays and increased revenues may not come until 1978.
Mr. Fisiu~ii. This seems to me to be the major problem with this,
it holds out the hope of bal'tnce in 1980 `md moves decisively in the
othei cinection in 1978
Mr. LANCE... 1 think that is a very valid point, Congressman,. that
we have to make cTear i.n the process. As I said when we started in
oui Febiu'uy ievisions, we w ei.c mo~ ing in the right direction, mean
ing the deficit w `is becoming less fiom 1977 to 1978, and that we
would move on forward because of the things in the. stimulus package.
Because of the fa.ct..that we had really no opportunity-and. that is
not `m criticism, just a st'ttement of circumst'tnces that existed-to
reahi change the 1978 budgets there is not much we can do about that
iJait of the,.process. We are pretty well bound by.. whatever :~hose pro-
posals were. . . .. ... ..
In 1979 w e c'~n make some changes, `mci I think ~ ou will see those
ch'inges forthcoming
Th Cii ~ir~r ~ The time of the gentlem'mn h'is expiied The Ch'ui~
would lik~to açivise the. comuiittee that Mr. Lance has to. leave at.~11
o clock I ie'mliie some members of the committee h'm~ e uot yet h'md an
01 poitunity to question him yet
PAGENO="0030"
26
Mr. LANCE. Mr. Chairman, I need to. be at the White House by
11 30 foi a meeting, so I w ill stay just until I have to leave, if th it
is all right. I hate to have to do that. I do not want to waste Dr.
Schultze s time, `tnd I felt two 01 three of these questions he could
answer in his own inimitable fashion.
The CHAIRMAN. Mr. Burgener.
Mr. BURGENER. Mr. Lance, as to these figures on table 3, I agree
with Mr. Pike. I happen to believe if we achieve .a balanced budget
by 1981 it will be good for the big cities and the small towns and
for the whole country. If we do not believe that, then we have t.o part
company and we have to go some other way. I think you believe it.
Mi LANCE Yes
Mr. BURGENER. Your first Carter budget will be fiscal year 1979.
We know we have to face the facts of life, we have a $60 billion de-
ficit for 1978. No way around it I can see. Is that thout right?
M~. LANCE. That number, of course, may change a.s a result of the
shortfall situation, but basically-
Mr. BURGENER. If we want to get down to zero in 1981 we have two
budgets, 1979 and 1980. It would seem if we cut that to $40 billion
±01 1979 and zeio foi fiscal ye'u 1981 and just hold ourselves, we `ui
going to stick to that. I realize all these other things are projections-
hut if we have the will to resolve, why couldn't we be ambitious
`~bout thinking about suipluses and just say no matter what happens
to tile economy we are not going to exceed $40 billion in 1979 and
take, that approach?
Mi LA~CE We h'~ve taken that `tppro'~ch and in our e'uly 1979
budget guidance there would be very little real growth involved in the
expenditure level. I think you will see that to be the case as we move
forward. The guidance letters we have sent out to the agencies and the
departments reflect that stance, and it is something that we are being
very determined about. The response has been good.
Mi BImGE~ER Do you think you aie going to submit a budget in
fiscal year 1979 with about a $31 billion deficit ~ Is that your best guess
for now?
Mr LANCE As it now stands with regard to what we have pioposed
frOm the outlay viewpoint, that wou'd be in the neighborhood, and that
shows very little real growth in those numbers themselves.
Mr BURGENER These are going to be veiy tough decisions
Mr. LANCE. Yes, sir; not `only froth the standpoint of the Executive
but also from the standpoint of the Congress
Mr BURGENER I just feel for the good of the oveiall welfare of
this country we have to make these tough decisions I do not think we
will, frankly I am pessrnistic about it I suie think we should Regard
less of what happens to the economy, I think we ought to just pi'un
do it
Mr.' L~CE. I am sure you understand from your work better than I
that an increase of approximately $36 billion from 1978 to 1979 is
very tight and restrictive, and it is one with great restraint I doubt
you have seen many budgets presented to you that show that sort of
restraint
Mr BURGE~ER I will aw'ut with eagerness the first Carter fisc~1
year 1979 budget. I am really waiting for that one. I really wish you
luck on it, and I hope the deficit is not over $30 billion.
PAGENO="0031"
27
The CH&IRM&N Mr Mineta
Mr MThETA Mr Lance, it is good to have you befoie the committee
In a recent article in Industiy Week you spoke of Sunset as the legis
lative complement to zero-base budgeting on the Executive side. In
order to maximize a cooperative effort between the Congress and
the executive branch, will the `idministi ation make its zero base
budget repoits `~vai1able to the various congiession'd committees di~r
ing the ieauthoriaztion re~ iew process ~
Mi L 4~NCE As I said to 1\{i Regul'i 1 minute ago I think that is
something we ought to look at I do not know wh'it in those reports
would be helpful I do not know what might not be helpful I think
that is a decision we have to take a look at and if it appears it would
be helpful from the overall standpoint-I just do not want to bog our-
selves down in a great deal of paperwork.
Mr MINETA One of the criticisms of zero base budgeting is that
it focuses almost entirely on the upcoming~ budget year. Do you think
a zero-base budget would divert time and energy away from the
foimulation of multiyear budgets ~
Mr LANCE No, I do not see that it would create any real problem in
that regard I think you can deal i~ ith that I think, of coui se, you al
ways have to have focus on the year that you ai e dealing with, the year
th'~t you ai e coming into, but I do not see that zero base budgeting
itself would be any deterrent to being able to move to multiyear
budgeting in the futui e
Mi MINET ~ To follow something the chairman asked you about the
earned income payments credit Ot course, many of us aie conceined
`ibout that because of the back door spending n'iture of that approach
The review document states, "The revised figures are now comp'ii able
to the congressional budget resolutions"
Were you aware of the difference of opinion which existed between
the House and Senate ~
Mr LANCE Yes, I am aware of the difference
Mr MINETA I have no further questions, Mr Chairman
The CHAIRMAN Mr Mattox
Mi MATTOX Mr Lance, w e are happy to have you here today, and
I would like to ask you a few very biief questions There is a proposal
under consideration to gi~ e widespread focus to the single lines of
ci edit proposal where the moneys that ai e granted to the local and
State goveinments should stay in the Treasury until they are actually
drawn out I understand HEW is using this somewhat I was wonder
lug if that approach to budgetary contiol would help both oui cash
flow problems and the pioblems of balancing the budget, getting
better control over State expenditures particularly
Mr LANCE I am sure it would have its effect I am sure there are
great political implications involved in that sort of approach and all
of a sudden saying that is the way you are going to deal with it, in
effect exercise control from the standpoint of the Federal Government
as opposed from the way it may be controlled now
From the standpoint of balancing the budget, I guess the major
contribution would be the decline in interest costs that might come
about `~s a result of having money available for us instead of some
body else's earning interest on it
Mr. MATTOX. A~re. you, making ~ny. recommend~tiôn'?'' `
PAGENO="0032"
28
Mr. LAXCE. I have not. I am not familiar with the status of iL
Mr. MATTOX. When you answered the question earlier concerning
the 5-year defense levels projections, I was not able to grasp a real
answer to what you said. The best we can tell on the basis of the
projections that are being made in the military spending, with that
portion of the budget making up something like 23 percent of the
Federal budget, it does not seem to me to be feasible. at all to talk
about balancing the budget with those projections.
Mr. LANCE. My response to the chairman was those things were
taken `into consideration but there was no strict acquiescence to the
5-year plan. WTe are aware that the. plan does sh~w a 5-year program.
Those things are taken into consideration. I do not think that. . the
pressure from the standpoint of the defense budget. has been that
evident.
Mr. MATTOx. Have you indicated to them the. opposite direction,
telling them all the budget.s are going to have to be brought back
into line including theirs?
Mr. LANCE. WTe have, indicated to them the same thing we have
indicated to the other agencies and departments, that. this .i,s a time
of restraint from the standpoint of growth of expenditures. We dicE
not exempt the Defense Department from that. circun'~st.ance. I think
you will see that reflected as we go forward.
Mr. MATTOX. In most of your basic assumptions about a balanced
budget are you taking intO consideration that you are really going
to work actn el~ to ti's to knock out ~ like thi~, conbumel
bank that the. House. just dealt with, wasting three-quarters of a
billion dollars? Are you talking about knocking out most new spend-
ing programs?
Mr. LANCE. As a result. of reorganization and as a result of zeio-
base budget.ii~g there well could be a redirection of moneys toward
things that are new piogi.ams Ceit'unl'~ I think th'ut would be one
of the beneficial effects that we could expect in the process I thmk
th'Lt we ha~ e s'ucl vei~ dilectl\ `tnd c'tndidly th'ut the numbers th'tt
are presented to you and the things that. we have talked . about in
the budget'irv process t'tke into considei'ttion no new initi'itives or
no new proguams but this does not ne2'tte the f'uct `tt `dl thit hec'in'~e
of management techniques in the p1 ocess thei e won't be moneys t~ `ul
able for new p1 ogr'trns
Mi M &rrox Foi new pi ogrims ~
Mi LA~ CF I think that is the w'my the's ought to be developed, in `u
period of tight budget'uiy iestr'unt
Mr MATTOX I `tgree with ~ oui I h'~ e been somewhat concerned
about the stimulus package th~~t you h'r~ e h'td biought to us bec'tuse
I ha~ e reports out of D'tH'ts th'~t they h'tt e h'id `u good bit of tiouble
filling some of the emplo~nient ieqmiements th'tt we h'uve pl'tced in
those pack'tges I `tin `dso conceined `ibout re'tchmg full emploi,meht
~or instance in a city like `W'tshmgton, I~ C wheie ~sou h'n e `u very
high unemployment compens'ttion figure let s s'i~ $120 to $140 `i w eek,
plus food stamps, plus fiee meçhc'tl c'tre, it is h'trd foi me to conceive
unless we make some serious ch'inges in 0111 l'tw s, that we `ire going to
be able to get our unemployment down within the next 4 veii s We
must do `Lway w ith some of the disincentn es to n oik
Mr L~NCE I would hope economic ciicumst'tnces would continue
to improve so tha't"we `will be able to obtain those goals. The private
PAGENO="0033"
29
sector ultimately I think has to deal with the question of unemploy-
ment. These things we do in Government are things that have to be
targeted. Again, I do not think we ought to be so restrictive that we
cannot get things into place and have them serve the purpose they are
intended to serve.
But I would hope tha.t the basic economy will continue to improve
so that we can see that sort of progress in the unemployment area.
The ChAIRMAN. The time of the gentleman has expired. Thank you
very much, Director Lance. We appreciate your taking the time to
come before the committee.
Now we are pleased to listen to Chairman Schultze of the Council
of Economic Advisers. Mr. Schultze, you may proceed as you wish.
STATEMENT OP CHARLES L. SCHULTZE, CHAIRMAN, COUNCIL
OP ECONOMIC ADVISERS
Mr. SCHULTZE. Thank you, Mr. Chairman and members of the com-
mittee.
You have my statement, and I think it might be most useful to the
committee if I very briefly, emphasizing the word "briefly," summar-
ized it and left the remaining time for questions.
The CHAIRMAN. Yes. Would you give particular stress to where we
are at this point in the fiscal year and what we can look forward to in
the third and fourth quarters. We are thinking about last year and
what happened. We are very concerned about a repetition this year.
Mr. SCHULTZE. As you know, the economy in the first half of this
year grew significantly more rapidly than, quite frankly, anybody
expected. In a few days the Department of Commerce will issue its
first figures on the second quarter growth in our gross national prod-
iict. But I think it is clear in the first half of this year, when all the
numbers are in, we are going to find our national economy grew at an
annual rate of about 7 percent despite the significant shock to the econ-
omy in early February because of the cold weather. In other words, it
would have been higher than that had it not been for the cold weather.
It is unanimous, I think, in the minds of everybody that either
1?nbhcly forecasts in some formal sense, or does it informally, that the
rate of economic growth will slow down some in the second half of
this year. It is our projection incorporated in the budgetary projec-
tions sent to you that. the rate of growth in the gross national product
will proceed at something over S percent-S to 51/2 percent-in the
second half of this year. I think it is fairly unanimously expected,
which does not make it right, that consumer spending, which has
led that big growth in the economy in the first half of the year, while
continuing to grow, will grow at a more moderate pace.
Second, inventory investment, which jumped very substantially in
the first half, while continuing to grow, will grow at a much more
moderate pace.
On the other hand. there will be over the next 6 months two other
things happening. The growth of Federal and' State and local spend-
ing-which has actually been negative during the fourth and first
quarters of the year, will turn around. The economic stimulus programs
in the area of public service employment, youth employment, public
works, countercyclical revenue sharing, are in effect just getting under-
94-971--77--------3
PAGENO="0034"
30
way. State and local governments, which had been severely hit by the
recession in terms of their own revenues, are with the normal lag you
always observe, begiuning to move their spending back up.
State and local government budgets , in the aggregate-this is
obviously not true of a number of areas individually-but who out-
side of their own pension funds had been in deficit 1 year ago, are
moving into a surplus now as estimated quarterly by the Department
of Commerce, and we expect their spending will pick up.
\~Te also expect that investment spending by private business firms
will continue to grow at a fairly good clip. There is every evidence by
way of the new order figures what is happening to capacity utiliza-
tion, what is happening to profits, that the groundwork is there for
continued increases in investment spending.
When we put all those together we come to a growth in our gross
national product that, as I said before, is of a little over 5 percent
during the remainder of the year, down from the 7 percent but still
sufficient to bring down the rate of unemployment further from
where it now is. We are expecting, given all the uncertainties of
projecting these kinds of numbers we are projecting, an unemploy-
ment rate by the last months of the year of something below 6~ per-
cent. The actual number that was in the submission was 6.6 percent.
Looking ahead to 1978, which is obviously of great relevance to
the committee in putting together the second concurrent resolution, we
expect that that rate of growth of about 5 percent will continue
through 1978. To say it another way, from the fourth quarter of 1977
to the fourth quarter of 1978 the real economic growth will be in the
5-percent neighborhood.
The economic stimulus package during the first part of calendar
1978 will be continuing to increase as the public service employment
comes on and the public moneys are actually put in place and the
shovels put in the ground and the work goes on.
We expect that private investment will continue to grow. Orders
and contracts for new plant and equipment adjusted for inflation have
risen about 16 percent in the last 5 months. Capacity utilization, as I
have indicated earlier, has begun to bite; that is, capacity utilization
has now moved up in the latest estimates to about 831/2 percent. The
overbuilding of commercial construction is beginning to be absorbed,
and we are beginning for the first time to see some significant increases
in contracts for commercial and industrial construction.
We trust that the Congress will shortly finish its deliberations on
the energy program, removing an inevitable area of uncertainty that
may have held up investments in some areas as businessmen wait to
find out what is going to happen to the final energy program.
We expect that consumers will move to a lower spending rate than
they have had in the first two quarters, which has been very low,
almost abnormally low. We do expect that spending rate will recede
some, but that after a couple of quarters of adjustment, consumers
will move up with the economy itself. There will either be a bio lead
or there will be a drag.
,Again, when we put all, these together, looking at the economic
stimulus package, private investment, consumption, Federal, State,
and local spending, we come to that during the next six quarters as we
PAGENO="0035"
31
move out, a rate of growth, as I say, approximating 5 percent a year,
a little more than that in the next 6 months and about 5 percent during
the four quarters of 1978. Is this an outrageously optimistic forecast?
There is not much way of answering that question except first to say
we have attempted to be reasonable. Second, we can compare it to
some of the major published forecasts, some of the more prominent
private forecasts which are published and the generally known.
If I take the six quarters from, in effect, right now until the end of
1978, let me simply list the rates of growth forecast by a number of
other forecasters and compare.
The Wharton forecast published by Professor Klein at the Univer-
sity of Pennsylvania, expects an average growth rate of 5.6 percent
over that period. We expect a growth rate of about 5 percent, a
smidgeon above. Data Resources, Inc., of Lexington, Mass., projects
4.7 percent. The University of Michigan projects 4.1 percent.
If I average all of those, including our own, it is 4.85 percent. We are
a little over 5, so we are slightly above average but not very much.
Clearly, whether this happens or not is going to depend on a num-
ber of things, in particular on whether or not we are correct that
private business investment will continue to increase at a good pace.
We think all the signs except one are that it will, but I have to say
that nobody can be terribly completely sure about this. The one sign
that we have which does not indicate it is the June survey by the
Department of Commerce on businessmen's intentions to invest, which
shows more of a leveling off than we have. On the other hand, we
think orders, contracts, capacity utilization, the big increase in the
production of business equipment in the last 4 or 5 months, which
is still continuing to grow, what profits are doing, the settling down
of some of the uncertainty over energy, all point in the direction of
continued good growth.
Therefore, we think we are presenting to the Congress a reasonable
assessment of the economic outlook, one which is consistent with
continued reductions in the rate of unemployment at a pace which
we think is sustainable, noninflationary, and provides a sound basis
for making a budget.
[The prepared statement of Mr. Schultze follows:]
PREPARED STATEMENT OF CHARLES L. SCHULTZE, CHAIRMAN, COUNCIL OF ECONOMIC
ADVISERS
This morning, I would like to review the events of the past six months and
the state of the economy currently. Your immediate concern is the Federal
budget for 1978, so I will also review the forecasts contained in the administra-
tion's July budget update and the relationship of the fiscal policies in the 1978
budget to the economic outlook.
ECONOMIC DEVELOPMENTS IN 1977
The economy has expanded in the first half of 1977 at a pace substantially
faster than most forecasters had anticipated at the beginning of the year.
Gross national product, adjusted for inflation, rose at an annual rate of 6.9
percent in the first quarter. The second quarter increase probably will be in
the range of 61/2 to 7 percent, and could be slightly higher.
Strong gains in production translated into substantial improvements in
employment throughout the economy. Total employment rose by 2.2 million jobs
during the first half of the year, with the gains spread widely among firms in
manufacturing trade, and services. Unemployment declined by nearly a full per-
centage point since late last year. Employment gains were marked among adult
PAGENO="0036"
32
males, who generally are experienced workers being rehired after losing their
previous jobs.
In June the unemployment rate rose to 7.1 percent. A sharp increase in the
civilian labor force, rather than a decline in employment, caused this increase.
Total employment rose in June by 270,000, a healthy if somewhat slower pace
than in earlier months of this year. Employment at nonfarm establishments also
increased in June, but only about half as much as the average increase in the
prior two months.
We expect improvements in the rate of unemployment to continue, but unem-
ploymeut remains a serious problem, particularly for minorities and teenagers
who suffer from disproportionately high rates of joblessness.
GROWTH BY SECTORS IN THE FIRST HALF
Most major sectors of the economy participated in the overall advance of
economic activity in the first half of the year.
Personal consuiñption expenditures rose very strongly in ~the first quarter,
extending a trend that began in the fourth quarter of 1976. A further decline
in the overall rate of personal saving to below 5 percent-a level well below
the average in most recent years-accompanied an increase in consumer
spending of about 7 percent, at an annual rate. Part of the reduction in the
saving rate in the first quarter reflected heavy expenditures by consumers for
fuel and utility bills.
Consumer spending slowed appreciably in the second quarter, as the savings
rate began to rise from the abnormally low level of the first quarter. Sales
at retail stores, in part reflecting the shift in savings patterns, were relatively
sluggish in the second quarter, particularly for nondurable goods. Auto sales,
however, increased further to an annual rate of 11.7 million units.
The housing industry was hit hard by extraordinarily cold weather in January
and February, but bounced back quickly and strongly in succeeding months.
The number of new housing units started in the second quarter was apparently
about 10 percent higher than in the first quarter. Permits issued for new
multifamily dwellings also have been increasing as vacancy rates have declined.
New investments by businesses in plant and equipment rebounded sharply in
the first quarter. Part of the improvement reflected deliveries of autos, trucks,
and farm machinery delayed by strikes in the fourth quarter of 1976. However,
further good gains occurred in the second quarter, judging from available data.
For example, output of business equipment rose at an annual rate of 18 percent
between the first and second quarters.
Inventory investment has been a major element in the accelerated rise in
overall economic activity generally. Inventory accumulation accounted for about
40 percent of the rise in real GNP in the first quarter. Inventory investment
apparently rose still further in the second quarter, but other sectors grew more
strongly, and inventory building contributed somewhat less to the general ad-
vance in economic activity.
A portion of the second-quarter increase in inventory investment, particularly
in nondurable goods-producing industries, may have buen involuntary. In these
industries, gains in output were smaller in June, and may continue to be re-
strained in coming months, as producers work to keep inventories in line with
sales.
The foreign trade sector of the economy moderated the pace of expansion of
the economy during the first half of the year. The U.S. merchandise trade def-
icit increased in the first quarter to about $24 billion, at annual rates. While
the deficit apparently improved in the second quarter, it is still large.
Continuing dependence of the U.S. economy on imported oil is the major
contributor to the deficit in our foreigii trade balance. Heavy petroleum imports
that resulted from cold winter weather sparked the sharp increase in the first
quarter trade deficit. These imports began to recede in April and declined
sharply in May. Excluding petroleum, exports exceeded imports by $12 billion,
at annual rates, in the first five months of 1977.
Other U.S. imports are rising rapidly, however. The United States is a large
consumer of imported industrial materials and supplies. Since the second
quarter of 1975 when the recovery began, industrial output in the United States
has risen by 20 percent. Our imports other than fuel have risen by 50 percent,
in real terms.
PAGENO="0037"
33
Another factor underlying the U.S. trade deficit is the slow pace of growth
of U.S. exports. Recoveries in foreign economies are not proceeding as rapidly
as our own, and this is moderating the growth in foreign demand for American
products.
Among other major industrial nations industrial production has risexi by
an average of only 13 percent over the past two years. Moreover, the United
States is a major exporter of machinery and other equipment. Because invest-
ment is lagging abroad, our exports of machinery have suffered particularly.
Since their low point in the third quarter of 1975, these exports have gone up
by only 3 percent in real terms. The slow growth in exports does not appear to
reflect a loss of competitive position, however. Table I shows the U.S. share
of world exports for manufactured goods. Except for two unusually high quar~
ters at the end of 1975, the U.S. share has been roughly constant over the past
3 or 4 years.
An important part of the trade deficit is offset by very large inflows of earn-
ings from U.S. investments abroad and other service items. The deficit on cur-
rent account, financed by inflows of capital investment from abroad, will prob-
ably run in the neighborhood of $14 billion this year-roughly half the size
of our merchandise trade deficit.
As you know, the OPEC nations will run a current account surplus of more
than $40 billion in 1977. Necessarily, the rest of the world will run a cumula-
tive deficit of the same amount. The United States is bearing a large share of
this deficit. As a strong economy able to finance a current account deficit, it is
appropriate that we do so.
TABLE 1.-U.S. SHARE OF WORLD EXPORTS OF MANUFACTURES
[Based on value of exports]
Non- Miscel-
Manufac- electric Electric Transport Basic laneous
turing Chem- machis- machis- equip- mans- manu-
total cals ery ery ment factares factures
1970 21. 3 29. 6 28. 1 22. 7 29. 0 NA NA
1971 20.1 29.1 25.6 21.1 29.7 10.8 16.1
1972 19. 1 29. 6 25. 1 20. 9 26. 4 10. 5 15. 5
1973 19.5 28.2 25.2 21.6 27.0 11.4 16.2
1974 20. 2 27. 9 26. 3 23. 0 29. 0 12. 3 17. 3
1975-1st quarter 20. 6 20. 1 28. 4 22. 2 26. 8 12. 0 17. 6
2d quarter 20. 4 19. 4 27. 0 22. 0 26. 3 12. 0 16. 9
3d quarter 21. 9 20. 5 27. 7 22. 6 30. 3 12. 9 17. 4
4th quarter 21. 7 20. 5 28. 1 22. 4 28. 1 13. 2 17. 4
l976-lst quarter 20. 5 20. 3 26. 8 22. 7 24. 5 12. 6 17. 3
2d quarter 20.6 21. 1 26.9 23.3 25. 5 11. 8 17. 1
3d quarter 20. 2 20. 1 26. 9 23. 6 23. 8 11. 6 16. 9
4th quarter 20. 0 20. 1 26. 0 22. 4 25. 2 11. 2 16. 6
1976 value of U.S. shipments (billions of
dollars) 78.5 10.0 22.2 9.5 18.3 11.5 6.9
Note: World exports are defined as exports from the 15 major industrial coantries, which account for 80 percent of total
world exports of manufactures to non-U.S. markets. Shares are based on export values excluding shipments to the United
States.
Source: Department of Commerce.
The most appropriate and important action we should take with respect to
our trade and current account deficit is working towards a reduction in our de-
pendence on imported oil for our energy needs. The President's energy program,
which is now before the Congress, is a key to reducing dependence on imports of
fuel. Maintaining a healthy economy capable of competing actively in foreign
markets is another requirement. So long as we remain competitive, and are per-
ceived to do so, the U.S. current account deficit can and will be financed by in-
flows of capital, without significant changes in the value of the dollar in exchange
markets.
One course of policy that is not acceptable is a move towards protectionism.
The costs of such an approach can be measured in the first instance by higher
prices paid by American consumers, and in the long run by reduced efficiency
and the effect it would have in spurring similar moves abroad, at a tremendous
cost to the economic health of the entire world economy.
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34
ECONOMIC PROSPECTS FOR REST OF 1977
Recent hesitation in some economic indicators has raised questions in the
minds of some observers about the outlook for the second half of 1977. Retail sales
have been sluggish over the past several months; the increase of employment has
slowed, and in June unemployment rose.
The pace of expansion has been expected to slow from the 6% to 7 percent
pace of the first half. As the consumer savings rate returns to more normal
levels, the rate of growth in personal consumption will be lower. Inventory in-
vestment will not continue to provide the thrust to overall activity that it did
in the first half. Slower growth in these sectors has been factored into the fore-
casts the administration has presented to the Congress. We expect real growth in
the second half to remain at a healthy annual pace of 5 percent or more, com-
pared with 6% to 7 percent in the first half. Growth in overall output at that
rate will permit further progress in reducing unemployment to below 6~4 per-
cent by year end.
There are solid reasons behind this forecast. While the growth of consumer
purchases has slowed, and will proceed at a more moderate pace in the months
ahead, we do not expect a dramatic reversal in consumer spending patterns. Con-
sumer confidence remains high. The Michigan Survey Research Center's index of
consumer sentiment has climbed steadily since late 1975, and now stands higher
than at any time since May 1972. Signals from that index are supported by data
on consumers' willingness to incur debt. In the first 5 months of 1977, consumers
took on new debts at an annual rate of growth of 18 percent.
Homebuilding, a key component of the expansion thus far, is likely to con-
tinue at a high level, and may rise further. Vacancy rates for apartment build-
ings are declining and permits for multifanilly structures are rising in step. F!-
iiancial conditions remain favorable for an expansion of mortgage lending. In-
flows of savings to mortgage lenders are ample, and mortgage commitments stand
at record levels.
The Commerce Department survey of 1977 business investment plans conducted
in May has raised questions about strength in the business investment sector.
The survey found that businesses generally expect only small increases in in-
vestment outlays in the second half of 1977. But a cessation of growth in invest-
ment spending appears to be inconsistent with both the strong economic growth
we have been experiencing and the improvement in many indicators of invest-
ment plans that we have seen in recent months. Adjusted for price increases,
contracts and orders for plant and equipment in April and May were 16 percent
above the average level in the fourth quarter of last year. On balance, we expect
business investment in the second half of this year to continue increasing.
Finally, total spending by Federal, State and local governments for goods and
services will be rising strongly, in real terms, in the second half of 1977. That
is in contrast to their behavior in late 1976 and early 1977, when the inflation
adjusted level of both Federal and State and local spending declined. Among
other elements strengthening State and local spending, the President's economic
stimulus program is now getting underway, and will be adding to employment
and to outlays by these governments as the year goes on.
THE OUTLOOK IN 1978
As you know the budget projections furnished to the committee earlier this
month are based on a forecast of 5.3 percent growth in real GNP between 1977
and 1978. From the fourth quarter of 1977 to the fourth quarter of 1978 we
expect economic growth to average about 5 percent.
One major reason to expect continued growth of this magnitude is the eco-
noinic stimulus coming from the Federal budget. Outlays under the $4 billion
addition to emergency public works, the large expansion in public service employ-
ment and in youth employment programs. will be increasing rapidly. Total Fed-
eral expenditures are expected to rise by 14 percent between fiscal 1977 and 1978.
And State and local spending, bolstered by the economic stimulus program, is
likely to rise substantially in real terms over the year ahead. Faster growth in
public spending during this Period will help to overcome the effects of the slower
growth in inventory investment and personal consumption that we are fore-
casting.
The other key to the economy's performance during 1978 is business invest-
ment. We will need investment growth, in real terms, of 8 to 10 percent during
PAGENO="0039"
~35
1978 if we are to realize the 5 percent rate of total GNP growth that we have
forecast. For a variety of reasons, we are reasonably optimistic that this growth
rate can be achieved.
Excess capacity in the economy, which has been a drag on investment through-
out this recovery, is being reduced gradually. Capacity use in manufacturing has
risen to 83 percent currently, from 80 percent a year ago. Moreover, the market
is absorbing the excess supply of office buildings and shopping centers that
brought major construction projects to a standstill in many regions. As capacity
is used more fully, the need to invest in offices, plants and equipment to meet
future demand will press on American businesses. That should encourage them
to invest.
Uncertainties over eneigy policy, which may have made investment decisions
difficult, will be resolved as the Congress completes work on the President's energy
program. With their doubts set to rest about this matter, business planners should
be able to invest with more confidence.
Continued economic expansion should translate into further increases in
corporate profits over the next year or so. Higher profits also should prove an
incentive to invest in future capacity, and should help provide the funds for
making those investments.
Conditions in financial markets are likely to remain favorable to business
investment in 1978. Ample amounts of long-term funds are available at interest
rates that are relatively low, considering the premium for inflation that they
contain.
The interest rate on top-grade utility bonds, for instance, is now about 8 to
81/4 percent-a full percentage point lower than at the trough of the recession
2 years ago. Some increases in interest rates may occur as a normal part of the
recovery, but the increases should be moderate as long as the expansion remains
well balanced and inflation does not accelerate.
For the longer run future, business investment should be encouraged by tax
incentives that will be a part of the administration's tax reform package. A
broad range of options for tax changes to encourage investment is under study
within the administration. While final decisions have not been made, the Presi-
dent is committed to tax changes that encourage capital formation.
There are, of course some uncertainties in the outlook. While consumer atti-
tudes have improved markedly, confidence is not yet firmly established. The
Michigan Survey Research Center's surveys suggest that consumers are more
confident about the health of the economy in the near term than about prospects
further ahead. Business confidence also shows some weaknesses. During the
recovery thus far, the increase in investment that we have seen has been con-
centrated heavily in short-lived investments in new equipment, rather than
large-scale projects that have longer lives and involve larger risks-although
we are encouraged by recent increases in commercial and industrial contract
awards. Many factors lie behind the emphasis of business planners on short-
horizon investments, but we cannot be fully comfortable with the state of busi-
ness confidence until more interest is shown in long-term projects.
Recognizing these problems, we believe our projections through 1978 reflect
a very reasonable assessment of the economy's future path. Important forces are
working for continued expansion, and we see no reason why our forecast of 5
percent real GNP growth in 1978 should not be realized. Given the uncertainties
in the outlook, however, we will have to monitor events carefully. We must not
overreact to very short-run wiggles in the economy's performance, but we must
be willing to recognize more fundamental departures from our expected growth
path, if they occur.
THE PRICE OUTLOOK
If we are to maintain a strong expansion over the next year, we must achieve
lower rates of price increases than we experienced in early 1977. The prospects
for such a reduction in inflation are very good.
In the first 4 months of this year wholesale prices rose at an 11 percent
annual rate, while consumer prices rose at an annual rate of 10 percent. This
bulge was very heavily due to rapid increases in food and fuel prices. We ex-
pected the bulge to be temporary, and forecast a moderation of inflation in the
second half of this year. Recent developments are consistent with that expecta-
tion. The rate of increase of wholesale prices slowed in May, and wholesale prices
actually declined significantly in June. The rise of consumer prices for food was
smaller in May than the average of the first 4 months of 1977.
PAGENO="0040"
36
Retail food prices in the next few months should reflect earlier declines at
the wholesale level. As a result, the rise in food prices over the second half of
1977 should lie considerably less than the rise in prices of other goods and serv-
ices. Thus, food prices should moderate the overall rate of inflation. Next year,
with reasonably good luck with regard to the weather, food prices may rise by no
more than the increase in the general price level.
Energy prices also accelerated early this year because of the cold winter
weather. Over the next 12 to 18 months, these prices, too, probably will rise
somewhat less rapidly than their rate of advance in the first half of 1977. How-
ever, the price of energy relative to other commodities will continue to increase.
The administration's energy program includes a wellhead tax on oil that, when
it takes effect next year, will add about 0.3 percent to the overall rate of inflation.
We have included this increase in our forecast.
Tips and downs in the volatile prices of food and fuel products have not affected
the underlying rate of inflation. Excluding fuel, industrial commodity prices at
wholesale rose at an annual rate of 5 percent in the first half of 1977-somewhat
less than in the previous year. On the other hand, consumer prices excluding food
and fuel rose somewhat faster.
Costs of production in industry are still rising at about the same rate as last
year. Wages and fringes are growing at about 8 percent a year, and there are
few signs at the moment of either acceleration or deceleration of the rate of in-
crease in wages. Productivity gains still are somewhat larger than the long-run
trend rate increase of about 2 percent.
In short, the outlook for keeping the underlying rate of inflation from accelerat-
ing in 1978 seems relatively good. Better price performance over the next G
months may help reduce inflationary expectations. Meetings with leaders of
labor and management, set up in response to the President's anti-inflation pro-
gram, have produced the beginnings of what I think will be a constructive dia-
logue among the participants on the sources of inflation, and the various ways
to combat it. If, in consultation with this Labor-Management Committee, we can
develop effective procedures for moderating wage and price increases, and I am
very hopeful that we can, further improvements in the rate of inflation can be
forthcoming.
FINAL COMMENTS
In broad terms, the economy is recovering well in 1977, and is proceeding along
the track that w-e had anticipated earlier this year. The administration's 1977
goals for economic growth and reductions in unemployment appear to be within
reach. Inflation is not worsening, despite the runup of food and fuel prices this
past winter and spring. Moreover, our economic goals for 1978 appear to be
achievable.
We cannot afford to be complacent, however. Our near-term objectives for
growth and unemployment are only interim milestones on a path back to a high
employment economy. As long as a serious problem of unemployment persists,
we cannot slacken in our determination to achieve rates of economic growth
that will lead to continued and sustainable reductions in unemployment.
Inflation, too, is intolerably high. The American people regard inflation as a
problem of critical importance, and this Administration shares that concern.
We are committed to policies that will control inflation, reduce inflationary
expectations, and lower the rate of inflation itself.
The CHAIRMAN. Thank you very much, Dr. Schultze. Majority
Leader Wright.
Mr. WRIGHT. Thank you. Mr. Chairman. Dr. Schultze, I was going
to ask about business investment. I am encouraged by your outlook.
There are some real good signs what has happened to now I thiuk has
been very encouraging. Let me ask one question or perhaps a series of
questions relating to a corollary subject that the Congress is going to
have to be addressing very soon; that is the question of energy.
There is no question but that in the past economic growth rates have
been somewhat parallel to growth in the consumption of energy. That
is a fairly valid maxim. is it not?
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37
Mr. SCIrULTZE. If you say accompanied by and not caused by, I
would agree with you.
Mr. WRIGHT. Yes, accompanied by. The historic trends have some-
what paralleled, as the economy grows by 5 percent, the use of energy
has been growing by about 5 percent.
The question is, Can we structure a society in which we are conserv-
ing energy without curtailing a heal thy continuance in economic
growth rate?
Mr. SCHULTZE. Yes, sir; I think we can if we do it gradually. Iii fact,
I think that is one of the major things that underlies the President's
program ultimately. Ultimately we are going to have to learn to con-
serve energy. That does not mean to stop its growth but to conserve it.
If we have a program which moves us into that in a fairly gradual
manner, we can do it. When we get out to 1985 or 1990 and find our-
selves having to do it in 1 or 2 years, then there could be incredible
economic disruption. I think we can, but we must do it in a phased
and sensible way.
Mr. WRIGHT. Of course, part of the President's program is predi-
cated upon intention to hold down any wild escalation in the costs of
energy which could throw all of our projections askew. I commend
that, and hope we will be able to work out a program that will achieve
that end, but I get a little disturbed when I begin to think that short-
ages in energy ultimately and almost unavoidably result in escalations
in the cost of energy.
The Governors met with the President a week ago and expressed
the concern that our program was emphasizing conservation almost to
the exclusion of production, that we were thinking in terms of using
less because surely we should do so because we are a wasteful society,
but that we should also be thinking more in terms of producing more.
Do you see a situation in which the country can continue to sustain
a healthy level of economic growth such as to maintain or improve the
average standard of living of people absent equal emphasis or some-
what near equal emphasis upon finding, or developing, or producing
new or international supplies of energy to take up the slack?
Mr. SOHULTZE. Clearly we have to find alternate supplies of energy
to take up the slack. You can get a debate for more specific alterna-
tives, oil and gas, and you can get a debate as to exactly when our
supplies will begin to diminish sharply, but no debate about the fact
it will eventually happen.
It seems to me the President's program has two different emphases,
long run and short run. If I can talk about short run being 10 years, it
is a very ambitious objective. Meeting at the same time reasonable
environmental requirements will not be easy.
In the longer run, in addition to being able to find and utilize at an
appropriate rate the oil and gas which is left, in the longer run there
are the more exotic, if you will, emphases in synthetic production, in
solar, in geothermal, in fusion that we must look to. At the moment-I
am not expert in this-I believe we cannot foreclose any bets anywhere
but not try to push it so fast in some of these areas we may wreck its
commercialization by pushing too fast. So I think you have a short run
set of problems and a much longer set of problems, and the President's
program does to some extent concentrate on that 1978 to 1985 period
but it does have provisions for those longer run also.
PAGENO="0042"
38
Mr. WRIGHT. I want to thank you. My time is up.
The CHAIRMAN. Mr. Mattox.
Mr. MATTOX. Dr. Schultze, earlier this last year we had what was
called a pause in the economy; I do not know whether that is accurate
or not. It was actually during Mr. Ford's time in office. That pause in
the economy, I am not sure what the explanation was for the economy
picking up, but as soon as the general election was over the economy
started moving again and the unemployment rate started dropping.
In this last month we had a rise in the unemployment rate after it had
been dropping pretty continuously. I am just wondering whether we
are in for another pause? Has the American confidence weakened?
What is the problem?
Mr. SCH1~JLTZE. There was a pause in the economy last year which
lasted from the spring through most of the rest of the year until the
late fall. It is also clear that at the present time the rate of growth of
the economy is going to slow down some but not like last year. I say that
with more confidence maybe than I should.
Mr. MATTOX. You better be right.
Mr. SGHtTLTZE. Last year several things happened, or several things
that are not time now. In the first place, last year in the spring pretty
generally throughout the economy inventories got out of line with sales.
There was a. modest pause in consumer buying and then everybody de-
cided there was far too much inventory. In the nondurable goods manu-
facturing area there may be a little too much now but it is a confined
area compared to t.he general situation last year. Second, we will have
the economic stimulus package coming on which will provide some
stimulus. Finally, the overall rate of economic activity and capacity
utilization is up higher now. People are not overwhelmingly confident
but they are more confident. Putting all three together, while it is
indeed true the. rate of growth is not going to continue, at the 7-percent
rate we had, it is not expected the economy will go into that kind of
pause.
Mr. M~rrox. I hope you are right.
Mr. SOHULTZE. I do too.
Mr. MATTOX. We are still looking at your stimulus package and
I think those of us who supported it are still somewhat skeptical. We
have had a good bit of trouble with the stimulus package in Dallas
because first we did not get much benefit from it. The second thing
is the portions we did get. The city managers and everyone else have
complained that they have not been able to fill some of these public
service jobs, some of the public work-type jobs because of the restric-
tions that have been drafted into the bill. I am a little concerned about
those kinds of problems.
The thing that concerns me more than anything toward the unem-
ployment. situation is you are talking about pulling the unemploy-
ment rate. down to 41/2 percent. I spoke to Mr. Lance about this just
a bit. I am concerned that during the last 8 years with our changes
in our unemployment compensation, changes in our food stamp pro-
grams. and changes in our general welfare programs, we may have
created such a disincentive to work that the public service jobs may
not be quite as meaningful to us. If you are talking about $3 or $4 an
hour for public service lobs and at the same time in Washington~ D.C.,
paying $120 for unemployment insurance plus food stamps and medi-
PAGENO="0043"
39
cal care, it seems to me a person would be much wiser in Washington,
D.C., to stay unemployed than to take public service employment.
Mr. SCIIULTzE. Let me go at those one at a time because there are
two or three things.
In the first place, the decision was made initially by the adminis-
tration, and concurred in by the Congress, that we ought to try to
concentrate the additional public service jobs on the most needy in
terms of setting up criteria with respect to trying to get at those who
had very low incomes, those who run out their unemployment com-
pensation, and the like. This has two effects. We think it has a good
effect in terms of getting it where it is needed and not having what
we call a substitution effect, that is, you do not want public service
employment simply to State and local governments for hiring people
they would have hired anyway.
In order to do that, you have to set restrictions on the program which
admittedly poses some administrative difficulties and in some cases
may cause it to get going slower than you like.
Second, it also turns out there has been a lot of thought to what have
higher unemployment compensation rates done to make the people
less willing to take jobs. I do not pretend to know the answer. I think
it may be true that with high unemployment compensation people who
might have been laid off only 4 weeks take an extra 2, but if you look
at the very high rates of unemployment among teenagers, in certain
sections of the country, among certain minority groups, it turns out
a very large portion of that unemployment is not getting unemploy-
ment compensation, so while there may be some tradeoff and more dif-
ficulty to get people to take jobs, the areas you are targeting them to
generally are not getting those high benefits.
The CiiAIm~rAN. The time of the gentleman has expired. Mr. Mineta.
Mr. MINETA. Thank you, Mr. Chairman. Dr. Schiiitze, the adminis-
tration's anti-inflation program is supposed to reduce inflation to 4
percent by the end of 1979. As I understand, the program does not
contemplate price and wage controls but rather includes long-range
policies such as deregulation, lower price supports, and import com-
petition. Will such plans have enough impact on the economy to crack
what you call momentum inflation, and if there are shocks to the
economy such as in 1973 and 1974, would not the 5 to 6 percent momem-
turn inflation compound our problems?
Mr. SCIIULTZE. In the first place. to answer the questions in backward
order. if you get major shocks to the economy like massive crop short-
ages or a very large increase in OPEC oil prices, then fairly clearly,
while there are some things to prepare for those situations, they are
going to make those projections impossible to reach. We think things
can be done to reduce the impact of them in terms of anpropriate, for
example, a~ricu1tura~l stabilization policies which have a decent
reserve, and particularly farmer-held reserves of food which can mod-
erate that. We think the strategic stockpile of oil will help. But
fairly clearly I cannot tell you you can make those reductions in the
rate of inflation if you get some untoward, unpredictable major outside
shocks.
The second point we think i_s a fairly ambitious set of objectives to
get the rate of inflation down like that. I think we have no option but
to go ahead and try to do it. I think part of it depends on whether or
PAGENO="0044"
40
not we can have a fairly steady stable economic growth instead of a
stop-and-go policy in which we let the economy go down and then try
to boost it up very fast. I think it is very important to do that if you
want to get a gradual downward deceleration. But it is admittedly a
very ambitious set of objectives.
Mr. MINETA. I notice Dr. Bosworth is now going to be the new
Director of the Council on Wage and Price Stability, and I con-
gratulate the administration and you on his selection. What role will
the Council be playing in this anti-inflation program, and if these
kinds of longrun policies that we just spoke of prove to be iinsuccess-
ful, what kind of active role do you expect the Council will play or
that the President will undertake to combat inflation?
Mr. SCHULTZE. At this stage we believe the programs we put for-
ward are the ones to do the job, and, quite frankly, to answer your last
question, suppose they do not work. I do not have a set of contingency
plans.
What will the Council on Wage and Price Stability do? It will do
three major things. It is the central instrument for doing the analytical
and backup work needed to really review the economic impact of Gov-
ernment regulations. It plays a central role in doing that. It has to
draw upon the expertise of a lot of other agencies. I think there are
about 39 people in total, of whom maybe 8 to 10 devote themselves to
this problem, but they have been of major help as we gradually try to
get our hands on economic impact.
Second, it will be the work of the Council to analyze wage and
supply conditions in particular industries so we know exactly what is
going on and can, wherever it is feasible for the Government to do so,
step in and avoid inflationary situations.
Mr. MINETA. If that notification from industry is not in enough time
or not enough for us, what do we do then?
Mr. SHULTZE. We think we do have advanced discussions with in-
dustry. We want to expand that, make it more general, but we do not
see any problem with respect to timing.
Mr. MINETA. One last quick question, if I might, Mr. Chairman.
lVhat is the unemployment rate that is consistent with the full em-
* ployment gross national product? As you are well aware, the Ford
administration had readjusted full employment to be redefined like
4.5 or 4.8 percent.
Mr. SOHULTzE. I think, 4.8 percent.
Mr. MINETA. Do you agree that the "acceptable" rate of unemploy-
ment is increasing, and are there demographic trends that have
changed the definition of full employment?
Mr. SOHULTZE. I am going to have to give you a slightly complex
answer to that, namely that compared to 15 years ago, to get to any
given unemployment rate you have to do more with respect to specific
targeted structural employment programs than was the case then. Let
me say it another way. You can, and we intend to, and have used over-
all general economic policies, to push the rate of unemployment down.
But the limit to which you can go with those policies is a somewhat
higher limit, if you want, than it was 15 years ago, and dealing with
youth unemployment, minority unemployment, varying training pro-
grams is a more important component of getting unemployment down
than it used to be. I do not think there is one answer as to what is the
PAGENO="0045"
41
level you go to. I do not think we know enough about these structural
unemployment programs for me to say 4 years from now we know
exactly what to do to get the rate down. I think that target of ~½
percent is an ambitious target and it will require us developing un-
proveinents in our youth employment programs, in the way we handle
public service programs and the like.
The CHAIRMAN. Mr. Burgener.
Mr. BURGENER. Thank you, Mr. Chairman. Chairman Scliultze., in
what month will you be delivering your fiscal year 1979 budget to
Congress? Is that about February?
Mr. ScI-IuI4TzE. It is normally the last week of January. I do not
know why it should be any different this year. It might be Feb-
ruary 2.
Mr. BuRGENER. That is about 6 months off. Is it your present in-
tention, as indicated by Mr. Lance's testimony, that you will present
a budget with about a $31 billion deficit?
Mr. SGHLTLTZE. I do not know what that number is going to be.
Mr. BURGENER. It is too early to say?
Mr. SCHULTZE. That is right.
Mr. BURGENER. When do you think you might know? About how
far in advance of February?
Mr. SCHULTZE. You make successive approximations. That is, come
September, October, you try to pin it down, but then you get addi-
tional economic information, you get additional budget information,
so there is no one date except maybe the day you lock the budget up.
Mr. BURGENER. So it would be premature at this time to guess that
would be t.he amount?
Mr. SCHtJLTZE. In my judgment, it would be.
Mr. BURGENER. So that would cut the current deficit in about half,
a very monumental undertaking, which I fully support, but we are
not prepared to talk about how much of that would come because of
increased spending or increased collections.
Let's talk about minimum wage for a moment. There are some econ-
omists who allege, predict, or promise that every time you raise the
minimum wage, teenage unemployment rises. Do you believe that to
be true?
Mr. SCHULTZE. No, sir; not put that way. I think you have to talk
about the relationship between the minimum wage and other wages
and raising the minimum wage substantially at leas;t-not a modest
amount.
Mr. BUIiGENER. $2.65 is the current talked about.
Mr. SCHULTZE. That is correct.
Mr. BURGENER. You support, and therefore the administration sup-
ports the automatic escalator clause in that proposed minimum wage?
Mr. SCHULTZE. Yes, sir. What it does is keep it at a fairly steady
percentage of median and does not have the sawtooth effect it h:as had
in the past; that is, you let it come down and jack it up and then after
four slides down-
Mr. BURGENER. So you do not believe in your own judgment that
raising the minimum wage necessarily adds to teenage unemployment?
Mr. SOHULTZE. Like most things in this world, it is a matter of
degree. If I raise the minimum wage to 65 percent of median, yes.
PAGENO="0046"
42
Modest changes I don't think so, und I think that is what we are deal-
ing with at the present time.
Mr. BUEGENER. I would predict that automatic escalator increase
will be hotly debated.
Mr. SCHULTZE. I would suggest that your prediction is probably
correct.
Mr. BURGENER. I do not think it is a good idea, but that is only one
opinion here. I take it, then, that you feel an increase to $2.65 would
not add to the inflationary spiral?
Mr. SCHULTZE. No, sir. Any increase is going to have some impact,
but we think if it is small enough, it will get lost in the noise. You are
paymg more for your costs, and you might have some, but it is very
small.
Mr. BURGENER. In conclusion, I wish you well. I think you and the
administration mean to bring us, to the country, a balanced budget by
1981, but I think your main adversary will be the Congress and I
predict they will not permit you to do it. I hope I am wrong.
Mr. SCHULTZE. I think I am more sanguine.
The CHAIRMAN. Mr. Fraser.
Mr. FRASER. Thank you very much, Mr. Chairman.
Mr. Schultze, the administration has a position on price policy and
deregulation of natural gas. As I understand, the administration
opposes complete deregulation.
Mr. SCHULTZE. That is correct.
Mr. FRASER. Suppose an amendment to deregulate new natural gas
is adopted by the House and enacted into law, would there be an infla-
tionary impact from the price *rises that might result from that
change?
Mr. SCHULTZE. I do not know how much. I am not prepared to tell
you the magnitude. There would be all sorts of impacts.
Mr. FRASER. Is there any way you can provide an estimate for the
record? Could you check to see if it is possible to provide an estimate
of the amount of inflation that might be added to the economy?
Mr. SOHULTZE. I will see if between what Mr. Schlesinger's energy
staff and our people know about this that is possible.
Ascertaining the precise inflationary impact from deregulation of
natural gas is a very difficult task. Nevertheless, rough calculations
indicate that deregulation, however defined, would have an inflation-
ary impact relative to the President's plan.
To illustrate the range of this impact, consider four alternative
~Cdecontrol~~ scenarios evaluated by the White House Energy Policy
and Planning Staff:
Case 1.-Decontrol price set by retail price of industrial distillate ($2.39 in
1980, $2.50 in 1985) ; 100 percent of uncommitted interstate gas is committed at
decontrol price; and existing contract prices unchanged.
Case 2.-Same as Case 3, except 50 percent of existing contracts increased to
decontrol price by 1982, 100 percent by 1985.
* * * * * * *
Case 4.-All ga's deregulated immediately and all existing contracts increased
to control price.
The major difference between these cases, obviously, lies in the treat-
ment of existing contracts-case 1 leaves them unchanged, case 4 rolls
them over immediately to the decontrol price, and cases 2 and 3 lie
PAGENO="0047"
43
somewhere in between. It is not surprising, therefore, that the average
welihead price estimates made by the White House Energy Policy and
Planning Staff grow progressively higher as one moves from case 1 to
case 4:
Prices (rncf)
1978
1985
Case 1
Case2
$0.78
.84
$1.72
2.11
Case 3
.99
2.50
Case
2. 35
2. 50
President's plan
.68
1.26
Before turning to the inflationary impact these estimates imply, it
is important to keep in mind that the decontrol price used by the En-
ergy Policy and Planning Staff is limited to $2.50/mcf-the estimated
price equivalent of distillate. Since it is possible that natural gas
prices under deregulation could exceed $2.50/mcf, the inflation im-
pacts reported here may well be conservative.
Under immediate deregulation on both new and existing contracts-
case No. 4-the Energy Policy Staff's average wellhead price es-
timates imply an inflation rate in 1978 approximately one percentage
point higher than under the President's plan. Deregulation at a slower
pace-cases, 1, 2, and 3-would add much less to the 1978 inflation
rate-exceeding no more than approximately 0.3 percent. How much
the inflation rates in 1979 and beyond would be affected would de-
pend on the extent to which the 1978 increases were then reflected in
increased wages. A conservative assumption about the price-wage feed-
back plus an allowance for increases in gas prices after 1978 implies
that the average price level in 1985 cOuld range between 1 and 2 per-
cent higher under the various deregulation cases than under the Presi-
dent's plan. Case No. 4 would prompt the greatest inflationary im-
pact; case No. 1 the least. Again, it is important to keep in mind that
these figures may understate the inflationary impact since natural gas
prices might rise above the distillate price equivalent-$2.50/mcf.
There is one other aspect of the impact of deregulation on prices that
should be mentioned. An uncontrolled market allows the most efficient
users to bid gas away from other customers that have economical
alternatives. This "allocative efficiency" aspect is currently lacking in
the present price-controlled market. Efficient use of gas would tend
to offset the inflationary effects discussed above, although the amount
of this offset is likel~ to be small, especially in the short run.
Mr. FRASER. Do you have any views as to whether it would have an
impact on the level of unemployment?
Mr. SOHULTZE. Anything which significantly adds to the rate of
inflation-and I do not know how significant this would be; I think it
would be noticeable-it is likely but not 100 percent sure to have that
under current conditions for two reasons. Everything else being equal,
it tends to push up interest rates. Second, it probably has impacts on
expectations.
I would think the worst problem of doing it the way it was sug-
gested would be in effect, the new gas that would be deregulated would
have a very thin market, and what you would find, given the fact that
PAGENO="0048"
44
it would not be controlled for new gas nor decontrolled on the intra-
state market, you would find yourself in a snap of cold weather facing
competition for those very thin supplies of new gas, at Lord knows
what prices. They might discredit the whole thing. They might dis-
credit the ultimate movement toward deregulation.
Mr. FRASER. Our hearings on this issue suggest that the price of in-
cremental gas might double or triple. This is possible because the utili-
ties can roll the new gas in.
Mr. SGHULTZE. That is correct.
Mr. FRASER. They a~vera.ge it out so the impact on the consumer is
not quite that high. If you can provide any further detail with respect
to your response, it will be helpful to us. Thank you, Mr. Chairman.
The CuAIRxAN. Mr. Rousselot.
Mr. ROUSSELOT. Mr. Schultze, we appreciate your patience in going
through all this.
In the figures that were submitted by Mr. Lance's table 3, which
are projections for the fiscal outlook, did you participate in them in
any way? Was that strictly his office alone?
Mr. SCHULTZE. No, sir. In terms of doing the economic assumptions
on which they are based, and the revenue estimates, we participated in
that together with the Treasury Department.
Mr. ROUSSELOT. There are really three of you who participated?
Mr. SCHTJLTZE. On the expenditure side it tends to be an 0MB set of
projections.
Mr. ROUSSELOT. But you are aware of some of this?
Mr. SCHULTZE. I am not aware of all the details, but I am aware
of it.
Mr. ROUSSELOT. Are you in general agreement with these projections,
as best you can be?
Mr. SCHULTZE. Yes, sir. I think you have to understand wha.t they
are.
Mr. HOUSSELOT. If you want to explain them further, fine.
Mr. SCHULTZE. My only point is they are an attempt to give the
Congress, if I may oversimplify a little bit, what would happen to
revenues and expenditures under three sets of assumptions, first, the
economic assumptions that are in there, second-
Mr. ROUSSELOT. Did you supply those?
Mr. SCHULTZE. Jointly with the others, but I think we t.ook the
lead in that. Second, no further changes in program policy or expendi-
tures policy, simply a spending out of what is already on the books-
Mr. ROUSSELOT. No new programs?
Mr. SOHULTZE. No new programs; in fact, no discretionary increases
in existing programs. and on revenues, no changes in the tax laws.
That does not mean it is a. policy question.
Mr. ROUSSELOT. The President has suggested there may be some
substantial tax changes.
Mr. SCHULTZE. I think they are very useful information but not
in any sense forecasts of what the budget is going to look like, hut
what it would look like if you sat on your hands.
Mr. RoussELoT. So, on the basis of what you said, there are going to
be tax changes, some policy changes in programs, so we do not pay
much attention to it?
PAGENO="0049"
45
Mr. SOIIULTZE. No, sir. You do not pay attention to it as `a forecast,
but it begins to give you some idea of what room is there for changes in
expenditures or changes in taxes and `how much zero-base budgeting
will you have to do if you want to get something else.
Mr. RoussELoT. On the basis of your experience so far with zero-base
budgeting, supposing you were able to effectively put that in place by
the end of the year, would that affect the expenditure side much?
Mr. SOHIJLTZE. I am sorry, I cannot answer that, because in effect I
do not have any experience with zero-base budgeting. It is just being
started. I have no past experience with that approach.
Mr. ROUSSELOT. But I am sure you have been involved in the
discussions?
Mr. SOHULTZE. Oh, yes, sir. What it should do I think is toss up for
consideration by department heads, 0MB, and the President, some
significant options and possibilities that would not have gotten opened
up before.
Mr. Rol:rssEloT. Options how?
Mr. SCHULTZE. By forcing people to literally ask the question, what
is the purpose o~f this program, and what are some alternatives, and
what would you do if you had less money? How would you rank your
option packages?
* Mr. RoussELoT. Do you think this process will achieve any savings?
Mr. SOHTJLTZE. I would hope so, sir. I cannot give you any number,
however.
Mr. RoussELoT. I know that, but on the basis of the experience you
are now going through as it relates to this, do you see much saving in
expenditure?
Mr. SOHULTZE. What I do see is a number of very, very interesting
issues being opened up that lead in that direction.
Mr. RoussELorr. Will the judgments you make be in place in time for
us to consider in connection with the fiscal year 1978 Second Budget
Resolution?
Mr. SOHULTZE. No. Zero-base budgeting will be first applied to the
1979 budget.
Mr. RoussELoT. So we cannot have any expectations for 1978?
Mr. SCIIuLTzE. Tinder this process; no, sir.
Mr. RoussELoT. So, on the basis of these estimates we have and on
the conditions you have given us for your latest budget estimates, it
shows that the Federal deficit will rise from $48 billion in 1977 to
$61 billion in 1978. On the basis that a lot of this stimulus effort in
public works and other areas is not being spent as fast, how can you
justify a higher deficit in 1978 when we are going through an economic
expansion also?
Mr. SCHULTZE. It depends on the degree of economic expansion.
Mr. RoussELoT. You said it is-fairly good?
Mr. SCHULTZE. That is correct. It is precisely because we have not
only-not only because-but in part because we have the economic
stimulus programs in there. If we did not have them in there, I would
give you a different projection.
Mr. ROUSSELOT. You are not expanding those public works pro-
grams. I think your figure was $130-odd `million have been spent
through May. We put in $2 billion for that and you have only spent
94-971 0 - 77 - 4
PAGENO="0050"
46
$138 million, and that came out of the $2 billion that was voted in
last October?
Mr. SOHUITZE. That is correct.
Mr. ROuSSELOT. So, because we are having this economic expansion,
do we really need it.?
Mr. SCHIJLTZE. What I am saying, sir, is you do, because if you did
not have it in the economic expansion, what you could look forward
to over the next 18 months would be a lot less. I cannot say that I can
certify for the very precise quarter-by-quarter expenditure projec-
tions done under these programs. They may go somewhat lower than
that. I hope not.
Mr. ROUSSELOT. My understanding of the projection for 1978 is
roughly $2 billion. Do we really neec~ that much in 1978?
Mr. SCHULTZE. I think we do.
Mr. RotissELoT. Do you want to justify that for me in writing some-
how-I realize you cannot do it in a few minutes-why we really need
all that? Thank you.
Mr. SOIrnLTZE. You asked about the need for the stimulus pro-
gram in the face of an expansion that I characterized as fairly good to
date.
We have so far enjoyed an expansion led by growth of personal con-
sumption. It is common for household consumption to be the prime
mover of the early part of an expansion. Over the nine quarters from
the fourth quarter of 1977 through the first quarter of this year, the
growth of consumer demand relative to that of household income was
sufficient to bring the personal saving rate down fairly smoothly from
7.5 percent to 4.1 percent. Such a dramatic growth of consumption can-
not endure. Indeed, already in the second quarter of this year we
have had a. sharp weakening in consumer spending and an increase
in the saving rate.
This was expected and means that sustaining economic growth now
must depend on other sectors. One of these is State and local govern-
ments. While these governmental units have improved their fiscal posi-
tions in the past 2 years, this improvement partly reflects a stringency
in their purchases. Therefore, given the combination of a counter-
cyclical need for stronger growth in nonconsumption demand and the
needs which can be met by expended youth training, public service em-
ployment and public works, I feel that we very much need at this
time to incur the Federal deficits needed to sustain the stimulus pro-
gram.
Most of the spending elements of the programs are scheduled to
come fully onstream between now and next spring. So we are just
now seeing the beginning. You pointed out the delay in disbursing
funds voted last October. We are taking actions to assure that a similar
lag does not occur in disbursing funds voted this year.,
The CHAIRMAN. `The time of the gentleman has expired.
Ms. Holtzman.
Ms. HOLTZMAN. Thank you. Mr. Chairman. Mr. Schultze, I want
to quickly ask you a question that relates to page 5 of your testimony.
You said that, excluding petroleum, our exports exceed imports by $12
billion. If you take arms sales out of that, what is our export picture,
what does it look like?
PAGENO="0051"
47
Mr. SCHULTZE. I would have to give you an answer in writing be-
cause I do not know. It is nothing like 12, but I do not know what it is.
If you look at the way it hits the balance, the arms sales about net be-
cause we are giving as much credits making sales, and that about nets
on the balance.
Ms. HOLTZMAN. Are our arms sales about $8 billion?
Mr. SCHULTZE. Our arms sales are $8 billion, but in getting to the
$8 billion we are giving a lot of credit. So the impact of the arms sales
on the balance-you are not collecting $8 billion in cash. I do not know
what that net is. If you want to look at its impact on the deficit, you
have to look at the offset, when you---
Ms. HOLTZMAN. I thought the picture that you were drawing with
regard to exports had to do with how our economic prospects were not
as bad as they could be, because we still are making exports abroad.
I want to know what happens if you take arms sales out of those
exports.
Mr. ScHULTZE. If you want to look at that, it would be less-if you
took them all out it would be less by the amount of the arms sales.
Ms. HOLTZMAN. I would like to talk to you about these projections
you have been testifying about and what `connection t'hey have with
what is going on in the biggest city in this country and in other cities.
The 6.6 percent that you expect to get to in terms of unemployment
by December-what does that mean in terms of unemployment in our
larger cities?
Mr. SCHULTZE. I do not have the number of what the unemployment
rate would be in say major metropolitan areas that goes with this.
Ms. I{OLTZMAN. Does that not have to be part, Dr. Schultze, of any
kind of economic analysis? What does it. mean ultimately for us to
achieve a 5-percent growth rate but leave our cities devastated, leave
our cities battlefields, endanger life and property, give nobody a sense
of hope, continue 40 percent unemployment in urban minority com-
mnunities?
Mr. SCHtJLTZE. I think the two things are closely related. There is
no way, no way that the major cities of this country can become more
healthy in a weak economy.
Ms. HOLTZMAN. What I am asking you is, Are they going to become
healthy in a strong economy?
Mr. SCHULTZE. The second thing it also says is, it is going to be
very difficult to get to a healthy economy without at the same tune
having employment programs which particularly go after the areas
and groups with very high unemployment. The two are related
together.
We have made a start on that, it is only a start but in the first 6
months we have put into effect substantial increases in youth employ-
ment programs, public service employment programs. The welfare
program the President is considering will do substantially more for
employment. There remains more to be done, which has to be thought
out so we can get programs which are effective.
I think that is one of the major problems, how does one design pro-
grams which really do the job?
Ms. HOLTZMAN. If I may say something with respect to the admin-
istration's welfare program, I would like you to explain how you can
possibly `have a work component as central part. of this welfare reform
PAGENO="0052"
48
program if you do not have day care? I do not understand how you
can expect any mother to leave her children and go to work-even if the
Commander in Chief orders it. Most of the people on welfare are
women.
Mr. SOHULTZE. This may very well `be true, but a large part-a
very significant part of those jobs will also be for two-parent families.
Ms. HOLTZMAN. A larger part of them consists of one-parent fam-
ilies.
Mr. SOHULTZE. A large number of the people who are unemployed
and poor, or employed part time casually, are from two-parent fam-
ilies, so both need to be taken into account. You are quite right, it may
very well be a problem.
Ms. HOLTZMAN. It may be a problem.
Mr. SOHULTZE. Pardon?
Ms. HOLTZMAN. It may be a problem.
Mr. SCHnLTZE. It may very well be a problem.
Ms. HOLTZMAN. You do not think it is a problem?
Mr. SCHULTZE. I am not sure I am expert enough on it to know.
Ms. HOLTZMAN. If you cannot answer that, I am ~just worried about
the expertise involved in the rest of the answers, with all due respect.
I am concerned also with respect to the youth employment programs
which have not gone into full operation yet.
Mr. SCHULTZE. Do you remember when it got passed? I am not sure
I exactly remember. I think it was only about a month ago.
Ms. HOLTZMAN. Yes, but with regard to the accelerated public works
program and some of the other public employment programs, we would
have anticipated that the Government would have helped prime spon-
sors to get ready so they could be brought onstream more rapidly.
Mr. SOHULTZE. Yes. Again on the extent to which we did or did not
help the prime sponsors, I am not sure. My understanding was that
the older public service program in effect before we came in was up to
speed and the question now is to get the other one on target as soon as
possible.
Ms. HOLTZMAN. There is going to be a shortfall anticipated of
around $300 million in spending in the public service employment,
as I understand it.
Mr. SOHULTZE. Part of that is because I think the legislation was
passed about a month or a month and a half, I am not complaining,
I am saying it was passed about a month or month and a half later
than we had assumed.
The CHAIRMAN. The time of the gentlelady has expired.
Mr. Leggett.
Mr. LEGOETT. Thank you, Mr. Chairman.
You indicate on page 16 of your statement, Mr. Schultze, at the
bottom: "The administration's 1977 goals for economic growth and
reductions in unemployment appear to be within reach. Inflation is
not worsening." Then on the next page, in the last paragraph, you say:
"Inflation, too, is intolerably high." What do you mean by these state-
ments?
Mr. SCHtTLTZE. The first 5 months of this year, the rate of inflation
in consumer prices was about 10 percent, clearly intolerably high. We
think it is very likely to be, over the next 6 months, down in the 6-per-
cent ball park. That is also too high. It is going to be very, very diffi-
PAGENO="0053"
49
cult to get i.t below that. We think we can, but it is going to be very
difficult, and it is going to be a gradual process.
So I break my answer therefore between the fact that we see very
good, almost certain signs, of that rate of inflation coming down sig-
nificantly from the first 4 or 5 months of this year, and that to get it
below the 6 is where it is going to be very difficult.
Mr. LEGGETT. You have had growth, I guess, if receipts in Govern-
ment are a measure of the growth in the economy, and sometimes they
are. You have gone, starting in 1972, from $24 billion to $32 billion to
$16 billion to $19 billion to $54 billion to $39 billion to $61 billion. Now
over the next 2 years you plan to go to $65 billion and $70 billion
respectively. These are all in real dollars?
Mr. SOHULTZE. No, no, I do not think so. Those receipt increases ar~
not. They are the actual.
Mr. LEGGETT. These are actual dollars?
Mr. SdHULTZI~. Yes, reflecting both real growth and inflation.
Mr. LEGGETr. Yes, that is right. The question is, How do you control
inflation with the projected growth that you are anticipating in re-
ceipts? It would appear that we are projecting a higher growth in
receipts than we have experienced for any 2-year period in a long,
long time.
It would seem to me that would indicate that inflation is going to be
exacerbated unless you take some very clever action to prevent it.
You indicate you have the Wage Price Council looking at Govern-
ment regulations. Of course, our administration did not discover that
because the Ford administration was very aggressively working with
a number of us on trying to control regulation. It is a verY difficult
political job.
Mr. SCrnTLTZE. That is right.
Mr. LEGGETT. We are jawboning, I guess, where we can. Yet wages
still seem to be going up at a rate of 8 percent, considerably in excess
of productivity, which would seem to indicate that we have some
built-in inflation that is going to be very difficult to control.
Mr. SCHTJLTZE. I agree, I think the real question is, can we not get
that rate of inflation to zero quickly? I see no hope for getting it to
zero quickly. Can we get it down from 6 to 5 to 4 over the next 3 to 4
years? We think if we pursue an economic policy which walks that
line between continuing to reduce the rate of unemployment but you
do not overdo it. We think there is some chance when you combine
that kind of steady policy with what we can do in the area of regula-
tion with what we can do in terms of working with labor and manage-
ment, we think there is a chance of doing it.
Mr. LEGGETT. Your targets, sometimes you justify them-those on
table 3-as being supported by the Wharton school. Sometimes you
say that they are merely hopes. The question is, are they realistic or
are they, overly ambitious? Are we stretching the state of the
art to achieve these anticipated results? I would compound that.
You are working now with your 1979 budget. Is the bottom line
minus $31 billion deficit for 1979, or in that area?
Mr. SOHULTZE. I cannot literally, I cannot tell you what that is yet
until we really get-we are now just in the process of going out to the
agencies for their zero-base budgeting, their submissions, and we are
going to learn a lot more about the economy in September and Octo-
PAGENO="0054"
50
her. I cannot literally tell you what the number is. It will be lower
than 1978 by a significant amount, hut what the number is I cannot
tell you.
The CHAIRMAN. The time of the gentleman has expired.
Mrs. Holt.
Mrs. HOLT. Thank you, Mr. Chairman.
Mr. Schultze, in reading your statement and hearing your state-
ment this morning, I do not get the concern about the international
situation that I feel. I have been deeply concerned, I do not know if
you remember when you were here in February 1 asked you and
Secretary Blumenthal about the possibility of g~tting the Federal
Republic of Germany and Japan to stimulate their economies to the
extent that we are, and Secretary Blumenthal expressed great con-
fidence that he was going to be able to do that.
Now we see in the morning paper that the dollar has reached a
record low against the German mark and the Japanese yen. Both of
those countries are accumulating heavy surpluses. I just do not see any
hope that we are going to do any better. I do not see anything in the
energy program that is going to make us use any less foreign fuel.
It seems to me you say imports are rising rapidly, it looks as if they
are going to continue to rise. Does th.at not concern you?
Mr. SOHULTZE. I think you have to interpret it very carefully.
No. 1, the most important thing we can do is in the energy area, but
here you are facing the problem that even when you do that, it takes a
couple of years to begin to turn it around.
The second thing with respect to what is happening to the yen and
the mark, that is precisely what we want to happen, wmong other
things. Those surpluses are being reflected in an appreciation of their
currencies. A very large part., not all but a very large part of what
happened to the dollar in the last 2 or 3 weeks is precisely what has
been happening to the yen and the mark, and in turn that is exactly
what ought to be happening to those two currencies, given the rela-
tively strong surpluses of these countries, that will tend to make their
exports more expensive, it will take time, but it will change the pat-
terns of trade. That is exactly why floating rates of exchange are used.
I am not suggesting we should be complacent., but exactly what
we want in some sense to happen is the yen and the mark to float and
we do not attempt to interpret that as something had.
Mrs. HOLT. There has not been the stimulation in the economy? A.s
I understand, the Germans have declined.
Mr. SCHnLTZE. The Germans have taken some action. They have
insist.ed in public and private conversations that those actions taken
together with what is happening with the Germans in particular in
their economy will lead to the 41/2 percent growth rate that they talked
about at the summit. .
There are differences of opinion on this, but we have been talking
to them, just as with the Japanese. The Japanese have taken a nuni-
her of actions in the area of stimulating their economy. They may
have to do more. .
Mrs. HOLT. In your midsession review-I asked this question of
Mr. Lance and I would iike to give, it to you if I may-you project
tax receipts rising at a higher rate than t.he outlays. Of course higher
inflation pushes taxpayers into higher a.nd higher income tax brackets.
PAGENO="0055"
51
What is going `to happen to the. projections if the inflation rate for
1978 drops'? Suppose it is 1 percent lower, what will that do to the
receipts?
Mr. SCHTJLTZE. I cannot give you a numerical amount, but a 1 per-
cent lower rate of inflation would tend to reduce receipts by more than
it would reduce expenditures. Therefore the paradox; it turns out that
inflation tends to push up receipts more than expenditures and there-
fore, when you do this sort of exercise, it gives you apparently an
easier chance of balancing the budget. But nobody, and I mean no-
body, wants to use inflation as a way to try to balance the budget.
It is nevertheless true that if you go through `and do this exercise
with a 1 percent lower inflation, it will cut receipts more than expendi-
tures. I hope that happens, I really hope that `happens. I much prefer
to see somewhat lower revenues relative to expenditures in some of
these out-years if we get more of a reduction in the rate of inflation
than we think we are.
We do have some built in, a reduction in the rate of inflation, but I
hope we see more.
Mrs. HOLT. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Schultze, in the fall and winter of 1976, ~you
remember, we had a drastic downturn in the economy.
Now we are optimistic that that is not going to happen this sum-
mer and fall and winter. Yet we do have some indicators that show
a slowing down of the rapid rate of growth that we have had. We still
have weak bUsiness investment; we have slowing in consumer spending.
Why do we feel so optimistic that we are going to avoid the severe
downturn that occurred last year?
Mr. SOIIULTzE. Let me start `by saying we are not seeing weak busi-
ness investment, we are seeing business investment pick up rather
strongly.
The CHAIRMAN. But we still characterize it as weak.
Mr. SOHTJLTZE. it is weak compared to where it would have `been if
it started picking up strongly 1 year ago, but if you look at the last
quarter or two, it is picking up rather well. Compared to the prior
peak, it is indeed weak, but that is because it went down so far and
did not come up much.
Second3 1 cannot see, it is not absolutely impossible, but we see little
possibility of consumer spending over these next two quarters drop-
ping. I think the real question is, How fast will it rise?
We have assumed in our projections sonic reduction in the rate of
income at which consumers spend, but even so, we still come out with
our 5 percent in effect, forecast.
We see Federal and State and local expenditures on goods and
services turning around from what has `been happening. We see home
building continuing strong, in fact edging up, not increasing at the
rate it increased in the past year, but `still edging up some.
Finally-not finally-we do not see the same kind of situation that
existed last. year that gave you that pause.
The CHAIRMAN. Why is that?
Mr. SOHULTZE. No. 1, widespread increases in in~rentories relative to
sales with business stocks getting out of line. Now there is one area, as
I indicated earlier in answer to a question, nondurable goods manu-
facturing where that may be happening now, but it is a very small
PAGENO="0056"
52
area compared to what happened last year. There may be 1 month or 2
in which you will get some adjustments in nondurable goods
production.
We also observed that last year you had just begun to come out
of the recovery. Capacity utilization rates were quite low. We think
the confidence of businessmen and consumers was much more sensi-
tive then than it is now. Hence, even if you get 1 or 2 months in
which the indicators move sideways, you do not have that inventory
sales imbalance and very low rate of capacity utilization which gave
you trouble last year.
Finally, though I have already answered that in part, you do
have coming onstream, however you might quarrel about those pro-
grams, those economic stimulus programs which you did not have
last year, and that should give us some support.
The CHAIRMAN. What kind of monetary policy is needed for the
next six quarters?
Mr. SGHULTZE. I am not sure I can give you a precise description
for a monetary policy. In any sustained recovery-in the first place,
if you look at interest rates now, they are below where they were~ at
the trough of the recession, which is almost unprecedented. There
have been `a lot of particular reasons for that. Over the next six
quarters I would suggest that, while some modest increases in interest
rates may be forthcoming if our projections are correct and the
economy strengthens continuously, but I would say they should be
relatively modest.
Let me put it another way: If we continue to get the same per-
formance with respect to the velocity of money that we have been
having, then in about the upper end of the Federal Reserve's target
range, we should be able to make this.
The CHAIRMAN. Thank you very much.
Mr. ROUSSELOT. What about the money supply?
Mr. SOHULTZE. I am saying at the upper end, money supply grow-
ing, near the Federal Reserve, 61/2 percent.
Mr. RoussELoT. You said 61/2 percent?
Mr. SOHULTZE. Yes, 61/2 percent. I do not want to be very precise
about this, but it ought to be roughly consistent.
Mr. ROUSSELOT. That is right with all the predictions. Thank you.
The CHAIRMAN. One last question. Do you feel optimistic that we
can avoid a third budget resolution? -
Mr. SGHULTZE. Yes, I do. I do not want to be put in the position
of saying I am so cocksure about these forecasts that I just know
early next year everything is going to be just like we said it is. We
would not have given you these figures if we did not believe in them.
The CHAIRMAN. You feel reasonably comfortable?
Mr. SCHULTZE. I think reasonably comfortable is the right word.
The CHAIRMAN. I am hopeful we will not need one. Thank you
very much.
The committee is adjourned until tomorrow.
[Whereupon, at 12:30 p.m., the committee adjourned until Wednes-
day, July 20, 1977, at 1:30 p.m.]
PAGENO="0057"
THE SECOND BUDGET RESOLUTION FOR FISCAL
YEAR 1978
WEDNESDAY, JULY 20, 1977
HOUSE OF REPRESENTATIVES,
COMMITTEE ON THE BUDGET,
Washington, D.C.
The committee met, pursuant to notice, at 1:30 p.m., in room 210,
Cannon House Office Building, Hon. Robert N. Giaimo, chairman
of the committee, presiding.
Present: Representatives Giaimo, Leggett, Mitchell, Burleson,
Derrick, Pike, Fraser, Lehman, Simon, Latta, Conable, Rousselot,
Holt, and Regula.
The CHAIRMAN. The committee will please come to order. This after-
noon the committee receives testimony from Dr. Alice M. Rivlin,
Director of the CBO. We are happy to have you here today. We under-
stand you testified in the other body this mornilig. You notice we are
starting promptly.
As you know, next week we will mark up the Second Budget
Resolution for fiscal year 1978. We have two important areas that
we would like to have your address.
First, the economic forecast for the balance of this year, and for
1978-will there be a real slowdown, and if so, how deep and how
long will it last? If not, why not? What differentiates this period
from last year, when we seem to have started out well and then
went downhill in the third and fourth quarters?
Second, the likely budget impact in fiscal year 1978 of energy legis-
lation which is now being considered by the Ashley committee. What
is the budget impact of the bills already reported to that committee?
What budget impact can we expect from the Ashley committee
proposals?
STATEMENT OF DR. ALICE M. RIVLIN, DIRECTOR, CONGRES-
SIONAL BUDGET OFFICE; ACCOMPANIED BY FRANK de LEEUW,
ASSISTANT DIRECTOR FOR FISCAL ANALYSIS; AND RICHARD
MORGENSTERN OF THE NATURAL RESOURCES AND COM-
MERCE DIVISION OF CBO
Dr. RIvLIN. Thank you, Mr. Chairman. I am delighted that this
hearing has started on time.
My statement this morning covers the economic outlook, both
short and long run, and the possible impact of new initiatives in the
(53)
PAGENO="0058"
54
energy area. You already have copies of OBO's latest economic
report, Recovery With Inflation, and the statement will begin with a
summary of that report.
I would be happy to submit the full report for inclusion in the
record.
The CHAIRMAN. Without objection.
[Testimony resumes on p. 102.]
[The report referred to follows:]
PAGENO="0059"
55
RECOVERY
wrrH INFLATW~
July 1977
t~ oU~eds
~ Washington, D.C.
PAGENO="0060"
56
PREFACE
Recovery With Inflation is one of a series of reports
on the state of the economy issued periodically by the Congres-
sional Budget Office. In keeping with CBO's mandate to provide
nonpartisan analysis of policy options, the report contains no
recommendations. It was prepared by Bill Beeman, Marvin Phaup,
Cornelia Motheral, Michael Owen, Richard Stromberg, Christine
Kuduk, and other members of the Fiscal Analysis staff, under
the direction of Frank de Leeuw. The report was typed by
Dorothy J. Kornegay and Marsha Mottesheard and edited by
Patricia H. Johnston.
Alice M. Rivlin
Director
iii
PAGENO="0061"
57
SUMMARY
As recovery from the 1973-1975 recession enters its
third year, the economy continues to suffer from a large
volume of unused resources. The best-known measure of unused
resources, the unemployment rate, stood at 7.1 percent in
June. This statistic must be interpreted with caution since an
unemployment rate of 7.1 percent today is equivalent, in terms
of labor market pressures, to a rate at least 1 percentage
point lower twenty years ago. Some other indicators of unused
resources do not show as much contrast with earlier recoveries
as the unemployment rate; but they, too, indicate a continuing,
if diminishing, gap between actual and potential output.
In spite of persisting economic slack, prices continue
to rise at roughly a six percent annual rate. Short spurts or
declines in food and energy prices push the overall indexes
away from 6 percent; but when the temporary forces abate, the
underlying rate returns. This report concentrates on the
puzzle of continuing inflation in a slack economy. It dis-
cusses the outlook for a continuation of this situation, the
origin and momentum of high rates of inflation, and possible
remedies for inflation in a slack economy.
The outlook has not changed significantly since the
enactment of the First Concurrent Resolution on the 1978
Budget. Signs of more vigorous growth in spring data are being
succeeded by some weakness in the latest data. Averaging
through these fluctuating indicators, CBO's projections show a
slow narrowing of the gap between actual and potential output
with the rate of inflation remaining high by historical stan-
dards. Growth in real output (GNP in 1972 dollars) is pro-
jected as slowing from its recent 7 percent annual rate to a
range of 3.6 to 5.1 percent in 1978. Growth in this range is
enough to reduce unemployment and narrow the output gap, but
only at a slow pace. The unemployment rate is estimated to
decline to the 5.9 to 6.9 percent range at the end of 1978.
Consumer prices, which rose by 6.7 percent over the last 12
months, are projected to increase more slowly as food prices
moderate. An increase of 4.5 to 6.5 percent in 1978 is pro-
jected. The forecast is summarized in the following table.
ix
PAGENO="0062"
58
ECONOMIC PROJECTIONS, 19 77-1978
1977
1978
Growth in Constant-Dollar
GNP, Fourth Quarter to
Fourth Quarter (Percent)
5.0
to
6.0
3.6
to
5.1
Unemployment Rate, Fourth
Quarter (Percent)
6.6
to
7.2
5.9
to
6.9
Inflation Rate, Consumer
Price Index, Fourth
Quarter to Fourth
Quarter (Percent)
6.0
to
7.0
4.5
to
6.5
The assumptions underlying this forecast include:
o Food price increases settling down to a 5 to 6 percent
annual rate of increase and energy prices continuing to
rise at a 10 to 12 percent rate;
o A slight shortfall in federal spending below the
First Concurrent Resolution on the Federal Budget
for Fiscal Year 1978;
o Growth in the broadly defined money stock (M2) near the
upper end of the 7 to 9.5 percent target range recently
announced by the Chairman of the Federal Reserve
Board.
The forecast does not include the effects of the Presi-
dent's energy proposals or other Presidential initiatives not
embodied in the first concurrent resolution. Additional
spending or tax reductions would raise projected economic
growth in 1978.
x
PAGENO="0063"
59
Changes in outlays would have little effect on prices in
l978, although increases in energy excise taxes or payroll
taxes could add to inflation in that year. The principal
reason why the inflation forecast continues fairly high by
historical standards is that once inflation is anticipated as a
continuing feature of economic life, it gets built into
a great nany economic contracts and decisions and develops very
strong momentum. During the last decade, inflation has become
embedded strongly in our economic machinery. The rapid spread
of cost-of-living-adjusted labor contracts, the reflection of
inflationary expectations in a broad spectrum of interest
rates, and the automatic linking of major federal entitlement
programs to consumer price increases are a few important
examples.
There are no costless ways to reduce inflation quickly.
Contractionary macroeconomic policies reduce inflation eventu-
ally but carry a grave risk of causing recession. A fiscal
policy restrictive enough to take 1 percentage point off the
rate of inflation three years from now is estimated to cost 1.2
percentage points more in the unemployment rate--an addition of
more than a million to the number of unemployed workers--in the
first year of the policy, and continuing serious unemployment
impacts for several years thereafter.
Wage and price guidelines or controls have succeeded
in reducing inflation while they have been in effect. Evidence
suggests, however, that part of the gain in lower inflation
rates is only temporary and that there are often substantial
associated problems of evasion, inefficiency, and inequity.
Policies to reduce price increases in individual sectors--
control of hospital costs or holding down increases in the
minimum wage, for example--can lead to modest improvement in
the inflation outlook, but are strongly resisted by the groups
whose incomes might be adversely affected.
Finally, a number of tax incentive and related schemes
to penalize inflation or reward wage stability may offer a
promising strategy, but must be rated uncertain because they
are untried. Further thought and possibly experimentation with
these newer ideas and perseverance on special steps for indivi-
dual sectors may yield some benefits. As a basis for budget
planning for 1978, however, the realistic outlook is for no
more than a slow unwinding of the current rate of inflation.
xi
PAGENO="0064"
60
CHAPTER I. INTRODUCTION
As the upswing following the 1973-1975 recession enters
its third year, the economy continues to suffer from a large
volume of unused resources. The most comprehensive measure
of unused resources is the gap between real Gross National
Product (GNP), the nation's output of goods and services,
and potential real GNP, a measure of the economy's produc-
tive capacity. In late 1973 before the recession began,
there was no gap: actual real GNP was equal to estimated
potential GNP (see Figure 1). 1/
By the trough of the recession in the first quarter of
1975, a gap had opened up equal to nearly 11 percent of poten-
tial GNP and about twice as large as the average gap which
developed during the previous four recessions. The subsequent
expansion cut the gap in half by the second quarter of 1977, to
just under 6 percent. Although the situation has greatly
improved since early 1975, the gap still represents a loss of
about $500 of GNP per person annually and remains much larger
than the average gap at the same stage in earlier expan-
sions. (In the bottom panel of Figure 1 and in several subse-
quent figures, the current recession-recovery period is com-
pared with previous recession-recovery periods, lined up
so that the cycle troughs are plotted at the same calendar
quarter.)
1/ Potential GNP is the amount of real GNP the economy could
produce with high utilization of labor and capital
resources. Output above potential is not impossible
but is likely to be accompanied by accelerating inflation.
The estimate of potential GNP used in this report is the
recently revised one described in the January 1977 Econo
mic Report of the President, pp. 52-56. It takes account
of changing rates of growth of productivity, of the labor
force, and of the stock of fixed capital, and of a 0.9
percentage point increase in the estimated unemployment
rate at potential, discussed in the text below. The level
of potential GNP is a matter of controversy among econo-
raists; some have proposed higher, and some lower, measures
than the one used in this report.
PAGENO="0065"
Figure 1
Actual and Potential Real GNP
Billions of 1972 Dollars
1400 -
SDURCES: Actual GNP - U.S. Department of Commerce, Bureao of Economic Analysis.
Second quarter 1977 estimated by CBO.
Potential GNP - Council of Ecnnomic Advisers, Economic Report of the President, 1977.
NOTES: The latest value plotted for 197377 is an estimate for the second qoarter sf1977.
The boniness cycle trough is the last qoarter of recession, as designated by the National Bureau of
Economic Research.
61
1300 -
1200 -
Actsal GNP
1974
I I
1976
1977
1975
Calendar Years
Percent ACTUAL AS A PERCENT OF POTENTIAL
100 -
rage of Four
I
90 -
5 Quarters Business 5 Quarters 10 Quarters
Before Trough Cycle After Trough After Troagh
Trough
2
94-971 0 - 77 - 5
PAGENO="0066"
62
In spite of the large volume of unused resources, infla-
tion continues at a rate of approximately 6 percent. To be
sure, the rate of inflation has come down sharply from the
double-digit rates of 1974. But the peak rates of 1974 were
heavily influenced not only by worldwide demand pressures but
also by high farm price increases, the ending of general price
controls, and the OPEC quadrupling of crude oil prices. It is
the ending of the effects of these special factors that ex-
plains the bulk of the reduction in inflation since 1974.
Even after the reduction, the current rate of inflation
remains above rates during the same stage of earlier expan-
sions, as shown in Figure 2. Inflation seems unlikely to
continue to accelerate as it did in 1969-1974, since the
special factors just discussed were beginning to drive up
prices during the third year of that expansion. On the other
hand, no one is projecting a rapid return of the inflation rate
to the 2 percent average of earlier recoveries (an average
depressed somewhat by wage and price guidelines during one of
the expansions and an early recession terminating another).
In a textbook world, the persistence of a larger than
usual volume of unused resources should help moderate wage
demands and lead to intensified competition and price dis-
counts. Evidently in the U.S. economy today, this is not
happening or is happening very slowly. This report focuses
on the possible causes of, and possible remedies for, this
apparent paradox.
BOW MUCH UNUSED RESOURCES?
Some analysts have argued that the answer to the puzzle is
that the volume of unused resouces is really much smaller than
conventional measures indicate, particularly with respect to
unemployment. It is argued that the current 7 percent rate is
not at all comparable with 7 percent unemployment in earlier
years.
Almost all experts agree that there is some validity to
this argument. One recent analysis of unemployment trends
estimated that an unemployment rate equivalent to 4.0 percent
in 1955 is now 4.9 percent, an estimate based both on rising
3
PAGENO="0067"
63
Figure 2
Inflation in Recession and Recovery
(Percent Change from a Year Earlier in Quarterly Average Consumer Price Index)
14
5 Quarters Business
Before Trough cycle
Trough
SOURCES: u.s. Department of Labor, Bureau of Labor Statistics. Second quarter 197/ oortly estimated by CBO.
NOTES: The latest value plotted for 1973.77 is an estimate for the second quarter of 1977.
The businoss cycle trough is the last quarter of recession, as designated by the Nationnl Buroau of
Economic Research.
"Aoerage of three preotous cycles" is an average of the recessiotrecovery periods 1953-58, t957-~32
and 1959.94.
/
/
12
10
8
6
4
2
0
- ~
\
\
/
/
I,
/ 196974
//
/
/
/
/ /
/
/
/ /
/
/
/
/
/
/
-.-.~. -~`~
\Asseruge of Three Previous cyctes ~, ~.,.
*\ ,.-`,,
I -~
5 Quarters 10 Quarters 1 5 Quarters
After Trough After Trough After Trough
4
PAGENO="0068"
64
proportions in the labor force of certain groups (teenagers and
adult women) with high job turnover and on the increase in the
unemployment rate of young persons relative to that of adults.
Other factors more difficult to quantify may have further
increased the unemployment rate equivalent to 4 percent in the
l95Os--closer to 5.5 percent, according to the same analy-
sis. 2/ Among these factors are the increased coverage and
duration of unemployment benefits and the growth of other
sources of income support for some of the unemployed, such as
welfare and food stamps, all of which make job search less
urgent during spells of unemployment. If the estimate of 5.5
percent is accurate--a matter of vigorous dispute among experts
--then changes in the labor market account for about half of
the difference between today's unemployment rate and the 4
percent that prevailed in the mid-l95Os. Correcting for these
changes would bring the current unemployment rate much closer
to the average of earlier recoveries, but still somewhat less
favorable.
The less favorable unemployment situation is due not
only to recent output movements--an exceptionally deep reces-
sion followed by an average rate of recovery--but also to a
number of special labor market trends. One of them is an
extremely rapid growth in the labor force, shown in Figure 3.
During the 1973-1977 downturn and expansion, the civilian labor
force grew by 7.4 million persons, an annual growth rate of 2.3
percent. In earlier recession-recovery periods, the comparable
growth rate was only 1.5 percent. Adult females accounted for
4.4 million of the total gain, partly because the adult popula-
tion is growing rapidly and partly because the proportion of
adult females who enter the labor force continues to rise from
year to year.
It is not simply among adult women that the labor market
remains slack in comparison with previous recoveries. The
unemployment rate for adult women is currently 6.9 percent,
well above the average of 5 percent at the same stage of
earlier recoveries; but the unemployment rate among adult men
is 5.1 percent currently, with 4 percent for the average of
four previous recoveries. The rate for teenagers is 18.1
2/ Council of Economic Advisers, Economic Report of the
President (January 1977), p. 51.
5
PAGENO="0069"
65
Figure 3
Labor Force, Employment, and Unemployment
CIVILIAN EMPLOYMENT
Indexes, business cycle peak = 100
106 - -
/ ,//
104 - /~verage of Four -
Previous Cycles
SOURCE: U.S. Department nf Labor. Bureau of Labor Statistics.
NOTES: The latent values plotted for 1973-77 are for the second quarter of 1977.
The business cycle peak is the last quarter of enpansion preceding the recession, and the business cycle
trough is the last quarter of the recession, as designated by the National Bureau of Economic Research.
108
CIVILIAN LABOR FORCE
inn,
106
104
102
100
98
5 Quarters Business 5 Quarters 10 Quarters
Before Cycle After After
Trough Trough Trough Trough
15 Quarters
After
Trough
5 Quarters Business 5 Quarters 10 Quarters 15 Quarters
Before Cycle After After After
Trough Trough Trough Trough Trough
PAGENO="0070"
66
percent, compared with an earlier average of 14 percent.
Nonwhite teenagers--the group having by far the highest unem-
ploymenc--Iiave an unemployment rate of 38.1 percent, compared
with about 28 percent in previous recoveries.
Growth in jobs during the current recession-recovery has
been slightly above the average of earlier periods (see Figure
3), somewhat mitigating the impact on unemployment of rapid
growth in the labor force. This maintenance of job growth in
spite of the output gap that developed during the recession is
another way of saying that the growth in productivity, or
output per worker, has been slower in the 1970s than it was
during the two previous decades. 3/ Possibly there is a
relationship between the rapid growth in the labor force,
including an increasing proportion of maw entrants and inex-
perienced workers, and the relatively slow growth in producti-
vity.
Outside of the labor market, measures of capacity utiliza-
tion (utilization of plant and equipment) in manufacturing are
currently roughly comparable with earlier expansions. The
latest utilization rate, according to both the Bureau of
Economic Analysis and the Federal Reserve Board indexes, is 83
percent, a rate below peaks reached in earlier expansions but
at the sane time a rate typical of the third year of upswings
following recessions.
Much of the. contrast between what these capacity utiliza-
tion measures show and what unemployment rates show is a
contrast between the behavior of the labor force and the
behavior of industrial capacity. While the labor force has
been growing exceptionally rapidly, expansion of industrial
capacity has been lagging behind earlier growth rates and has
thus limited the amount of excess capacity.
3/ For a discussion of the slowing of productivity growth
and its causes, see the CBG Report, Sustaining a Balanced
Expansion (August 1976), Chapter 4.
7
PAGENO="0071"
67
The contrast between rapid labor force growth and slow
capacity growth is troublesome, for it means that, as the
economy approaches full utilization of capacity, bottlenecks
may arise while unemployment of labor remains substantial. At
the present time, however, the evidence overall suggests that
the economy continues to be characterized by a large volume of
unused resources. The most comprehensive measure of unused
resources, based on the stock of plant and equipment as well as
on the labor force, is the gap between actual and potential GNP
depicted in Figure 1. This measure indicates a contrast with
earlier recoveries as well as a continuing margin below earlier
peaks.
PROSPECTS FOR IMPROVEMENT
Over the next year and a half, the output gap seems likely
to narrow gradually and the rate of inflation to persist in the
neighborhood of 4.5 to 6.5 percent. Chapter II of this report
presents these projections after a review of recent develop-
ments and major factors affecting demands. The prospect is,
thus, for some improvement in the economic situation, but
nevertheless for a continuation of relatively high inflation
even without excess demand.
The principal explanation for this phenomenon, offered in
the third chapter of this report, is the strong momentum which
inflation ~5evelops once it is anticipated as a continuing
feature of economic life. During the last decade, inflation
has become strongly embedded in a great many areas of the
economy. The rapid spread of cost-of-living adjustments in
labor contracts, the reflection of inflationary expectations in
a broad spectrum of interest rates, and the indexation of major
federal entitlement programs are a few important examples.
These developments, intended as defenses against the effects
of inflation, have also made the reduction of inflation a long
and difficult process. Even though the current demand situa-
tion is not driving prices up, the outlook is for a continua-
tion of recent inflation rates.
8
PAGENO="0072"
68
CHAPTER II. THE OUTLOOK
The CBO forecast, presented later in this chapter, is
not substantially different from the economic assumptions
underlying the First Concurrent Resolution for the Fiscal Year
1978 Budget. CBO forecasts moderate economic expansion
during the next six quarters (through calendar year 1978), with
the unemployment rate in the 5.9 to 6.9 percent range by the
end of 1978. The rise in prices (as measured by the CPI) is
expected to moderate from the advanced rates of the first half
of this year (about 8.5 percent), with inflation rates in the
4.5 to 6.5 percent range through 1978.
The midpoint of this forecast range suggests gradual
progress in reducing unemployment but little improvement in the
underlying rate of inflation (now about 6 percent). This is
because inflationary pressures, once started, tend to be
persistent and respond very gradually to a moderation in
economic growth. As explained in the third chapter of this
report, there does not appear to be any budget or incomes
policy that could quickly achieve a reduction in the inflation
rate without either an unacceptable loss in output and rise in
unemployment or an eventual sacrifice of efficiency and equity.
There now appears to be more than the usual degree of
uncertainty in the economic outlook. If economic growth
appears to be proceeding at the lower end of this forecast
range, with little or no improvement in the unemployment rate,
the Congress might want to stimulate the economy. If economic
growth continues at the high end of the forecast range, how-
ever--say, at 5 percent or more--additional stimulative
policies might begin to add to inflationary pressures by the
end of 1978. - In view of the current uncertainty, a policy
decision based on either end of the forecast range apears to be
premature now.
The last section in this chapter identifies some of the
sources of uncertainty in the economic outlook as well as the
economic indicators that should be monitored to see if and
where we are going off track. This chapter begins with a
review of current and prospective demands by sector.
9
PAGENO="0073"
CUERENT ~E~DS~.tN DEMANDS
Despite the gains in ecofiomic activi~y outing the last
half year, there is little doubt that the overall etonomic
situation is worse than e~tperienced at this stage in earlier
recoveries Total demands retnain `i4ell below potential output,
and the unemployment rate is still exceptionally high A
usdul measure of the state of demand ia total final sales of
goods and services i~ constant (1972) dollars Equal to CNP
minus inventory change, this tnea5ute removes much of the
quarter-to-quarter voJ~atiiity of GNP growth.a Compared to
earlier recoveri*e$~ as Figure 4 shows, this cottiprehensive
measure of demand remains ~gk. During the 1973-1975 receSsion
it fell much more than in earlier rac~ssions, while since the
bottom of the re~essioñ L~ han tjsen at about its average
rate during recovety pet~ods~ The gap between this business
cycle and the average of earlier cycles which opened up during
the recession, consequently, has not yet been closed.
Figure 4
Real Final Sales
115
fntfeses, business cycle peak = 100 .,.---
110 - ~`~Avisrägê of l~our Pievious Cycles
~
90 -
¶1 ... .....
5 Quarters Business 5 Quarters 10 Quarters 15 Quartets
Before Cycle After After After
Trough Trough Trough Trough Trough
SOURCE: U.S. Deportment of Commerce, Bureau of Economic Analysis.
NOTES: The latest ealues plotted for 1973-77 are for the first quarter of 1977.
The business cycle peak is the last quarter of espansioo preceding the recession, and the business cycle trough
is the last quarter of the recession, as designated by the National Bureau sf Economic Research.
10
PAGENO="0074"
70
The pace of economic activity in the first `half of this
year was bolstered by developments that generally have only
temporary effects. The rebound from the auto strike that
occurred in the fall of 1976 and the decline in the personal
saving rate are not likely to be sustained for long. Barring
unforeseen strength in final demands, the inventoty buildup can
be expected to be completed during the second quarter or
shortly thereafter. If so, inventory investment is not likely
to add significantly to economic growth for the remainder of
the year. At the present tine there appears to be little
prospect for other sectors of demand providing enough stimulus
to maintain the growth rate of the first half of this year~
Consum~p~
Consumer expenditures have grown at a relatively rapid
pace since the recession trough, contributing somewhat more
than usual to the recovery in real GNP. In fact, the gap
between consumer spending in this business cycle and earlier
recoveries--caused by the unusually severe decline during
the recession--has been narrowing, especially in recent
quarters (see Figure 5, upper left graph). The growth in
consumer spending has been sustained, however, to a large
extent by a decline in the saving rate (see lower left graph of
Figure 5). Except for the initial burst produced by the 1975
rebate, the growth in real disposable income since the trough
has been in line with previous cyclical experience. Real
incomes have not rebounded to the prerecession trend line. By
the first quarter of 1977 real disposable income, shown in the
upper right graph of Figure 5, was 5.2 percent above the
prerecession peak, compared to the average of about 10 percent
in comparable periods of previous expansions.
The outlook for consumer spending for the next few
quarters is for slower growth than the rapid 7 percent pace
(1972 dollars) experienced last winter. Large increases in
output and employment since last fall have provided signifi-
cant gains in income that favor continued growth in consump-
tion. The declining saving rate reached a low 4.8 percent in
the first quarter of this year, however, which suggests the
spending pace may not be sustainable. Among special factors
accounting for the low saving rate -during the winter were
11
PAGENO="0075"
71
Figure 5
Consumption Spending
REAL PERSONAL CONSUMPTION
130 r EXPENDITURES, TOTAL~~~~
Indexes, business cycle peak = 100
120L -
5 Quarters Business 5 Quarters 10 Quarters 15 Quarters
Before Cycle After After After
Trough Trough Troogh Trough Trough
5 Quarters Business 5 Quarters 10 Quarters 15 Quarters
Before Cycle After After After
Trough Trough Trough Trough Trough
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis.
NOTES: The latest value plotted for 1973-77 is fur the first quarter of 1977.
The business cycle peak is the last quarter of eupansiuu preceding the recession, and the business cycle
trough is the last quarter of the recession, as designated by the National Bureau of Economic Research.
110 -
Average of Four Previous Cycleu
197377
90 -
80
REAL PERSONAL DISPOSABLE INCOME
l3Li
Indexes, business cycle peak 100
Average of Four Previous Cycles
110- H
~ ~~~1973/7
901- -
80L I I I I -
I I I
SAVING RATE (Personai Saving As a
10 Percent of Disposable Income)
Indexes, business cycle peak = 100
REAL PERSONAL CONSUMPTION
130 - EXPENDITURES. DURABLES
Indexnu, business cycle peak 100
12
PAGENO="0076"
72
the post-strike rebound in auto sales, a sharp increase in
fuel consumption because of cold weather, and a speedup in
estate tax payments in the first quarter resulting from earlier
legislative changes.
The Michigan Survey Research Center survey of consumer
attitudes, taken in May 1977, also suggests that growth in
consumer spending will moderate somewhat from the advanced
first-quarter rate. The survey found its consumer sentiment
index to be about unchanged from the improved level reached
nine months earlier. Moreover, prior to May the improved level
of confidence was maintained by optimistic expectations, while
more recently confidence depended more on favorable evaluations
of current conditions than on expectations of further improve-
ment.
Business Fixed Investment
Business spending for capital goods continues to provide
less stimulus in this expansion than in previous recoveries.
As shown in Figure 6, the decline in real spending was larger
and longer in the last recession than in previous cycles.
Furthermore the growth of this sector since the recession
trough has lagged behind previous experience. In the first
quarter of 1977 real spending for nonresidential fixed invest-
ment was still 8.4 percent below its previous peak, twelve
quarters earlier. Both equipment and structures have lagged in
this recovery but, perhaps because of previous over-building
and the extreme financial stringency that preceded the reces-
sion, nonresidential construction has been particularly de-
pressed.
Advance indicators of business capital spending suggest
continuation~ of growth above trend but offer little hope for a
significant acceleration in investment for the remainder of
this year. The latest Commerce Department survey of business
capital spending plans, conducted in late April and May,
indicates that businesses plan to increase their investment
spending by 12.3 percent in the current calendar year. Assum-
ing no change from last year in price behavior, the survey
implies a gain in real capital spending of about 7.5 percent in
1977. While this rate of growth exceeds the expected growth in
overall real GNP, it falls far short of rates of growth of
investment during earlier capital spending boom periods.
13
PAGENO="0077"
Figure 6
Nonresidential Fixed Investment
115
110
U.S. Department of Commerce, Bureau of Economic Analysis.
The lateot values plotted for 197377 are for the first quarter of 1977.
The business cycle peak is the last quarter of eupansiso preceding the recessiso, and the busioess cycle
trough is the last quarter of the recession, as designated by the National Bureau of Economic Research.
73
105
100
95
90
85
80
5 Quarters
Before
Trough
SQURCE:
NQTES:
1~
Business 5 Quarters 10 Quarters 15 Quarters
Cycle After After After
Trough Trough Trough Trough
14
PAGENO="0078"
74
An encouraging aspect of the Commerce survey is that, in
almost every major industry grouping, business firms are
planning faster growth than in the previous year. A sound
basis for continued expansion in the next few quarters is also
indicated by the growing backlog of orders for nondefense
capital goods and machine tools and by the capital appropria-
tions of the 1,000 largest manufacturers. There is also some
evidence that nonresidential construction may be picking up.
None of these indicators point, however, to an investment boom
such as experienced in some past periods.
One reason that a full-fledged capital boom has not
developed is the continuing gap between output and capacity in
many industries. Another reason is that the investment boom of
the 1960s, strongest of the last 30 years, was boosted by two
special stimulative policies: liberalized depreciation guide-
lines and the introduction of the investment tax credit. No
comparable change in investment incentives has taken place
recently.
Hou~~g
Residential construction continues to be a source of
strength in the current economic expansion. Real outlays
increased by 23 percent in 1976. By the fourth quarter of
the year, private housing starts reached a 1.77 million unit
annual rate, about 800,000 above the 1975 trough. Extremely
cold weather delayed residential construction for a time last
winter, but activity bounced back in the spring and has since
remained strong, as shown in Figure 7.
The recent strength in housing construction has been
concentrated very largely in the single-family sector, which
has reached new highs recently. Multifamily housing construc-
tion was hit very hard in the last recession by excessive
construction prior to the recession and by a financial crisis
affecting the availability of construction loans. While
there has been some growth in the multifamily construction
sector--particularly in the second half of 1976 when processing
of federal subsidies was accelerated--activity remains far
below earlier peaks (see Figure 7).
The fundamental problem with multifamily housing construc-
tion seems to be profitability. Despite increased demand for
rental space, increases in construction costs and operating
15
PAGENO="0079"
Figure 7
Housing Starts
Millions of Units -
1.6
1.4
1.2
1.0
.8
SOURCE: U.S. Oepartment of Commerce, Bureau of tho Census. Second quarter 1977 partly estimated by CBO.
costs on completed units have outrun rents in recent years.
In some areas, actual or threatened rent controls may also be
retarding activity.
There is reason to believe that individuals who might
otherwise rent have a strong interest in single-family homes as
a hedge against inflation. In recent years, single-family
houses have been one of the few assets that are readily avail-
able to many consumers and whose market value has increased
steadily in real terms. While homebuying as an inflation hedge
may stimulate demand, it carries the danger of promoting a
speculative boom followed by a decline--a pattern suggested by
the California housing market in recent months.
The major determinants of construction in the
sector remain favorable to high levels of activity.
vacancies have declined sharply for three quarters.
/
.6
.4
.2
\
\
1968 69 70 71
Multifamily ~./
,- %%~~/
72 73
Calendar Years
74 75 76 77
housing
Rental
While
16
PAGENO="0080"
76
slowing recently, financial flQw5 to thrift institutions
have been strong ~or some time, aftd, even If short term in-
terest rates rise moderately as projected, thrift institutions
should have ample liquidity *f or at least the next few quarters.
Meanwhile, sizable real personal income gains in combination
with demographic pressures should ensure sufficient housing
demand.
State and Local Purchases
State and local government purchases, in constant dollars,
have not been a source of strength recently. As shown in the
upper left graph of Figure 8, this sector was hit hard by
recession, contrary to past experience, and has grown much less
than usual in the current econ~mIc expansion. In 1975 state
and local purchases increased 2.6 percent in real terms, with
much of the gain due to a huge increase in federal grants
largely for public service employment. State and local spend-.
ing in 1972 dollars has leveled off since then, showing no
growth from the fourth quarter of 1975 to the fourth quarter of
1976. In the first quarter of this year, real purchases by
state and local governments recorded a second consecutive
quarterly decrease.
The decline in spending by this sector last winter appears
to have been partly due to temporary factors, such as the
effect of cold weather on construction activity. But the
growth trend in state and local spending has also been reduced
by more permanent developments. Demand for local public
services has eased because of reduced growth in the school age
population. The slowdown also reflects increased caution
on the part of public officials and voters brought about by
the severe recession and the financial problems of New York and
other cities, mostly in the Northeast. These developments are
expected to keep spending growth rates moderate over the next
18 months, although a pickup in federal grants for public
service jobs is expected to boost growth in the near term.
State and local government revenues have grown much
more rapidly than spending since the recovery began. As a
result, this sector is now showing large surpluses even in
operational activities (excluding trust funds). This has
helped these governments reduce debt burdens and improve
17
PAGENO="0081"
77
Figure 8
Selected Components of Real GNP
130 -
120
110
100
90
80
140
130
120
110
100
90
80
~`
18
4
-1
INVENTORY INVESTMENT
140 STATE AND LOCAL GOVERNMENT PURCHASES
Indexes, business cycle peak 100
,-.
Average of Four Previous Cycles ~
,
-
-S.,.
,-
5~/
(As a Percent of Real GNP)
-2 -
(I
L~ I
EXPORTS
Indexes, business cycle peak = 100
-,
,-
Average of Four Previous Cycles J
I
I
~,~1973.77
-
~"III
5 Quarters Business 5 Quarters 10 Quarners 15 Quarsers
Before Cycle After After After
Trough Trough Trough Trough Trough
90
80
U
S Quarters Business 5 Quarters 10 Quarters 15 Quarters
Before Cycle After After After
Trough Trough Trough Trough Trough
SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis.
NOTES: The latest values plotted for 197377 are for the first quarter sf1977.
The business cycle peak is the last quarter of expansion preceding the recession, and the business cycle
trough is the last quarter of the recession, as designated by the National Bureau of Economic Research.
04-971 0 - 77 - 6
PAGENO="0082"
78
their liquidity positions. If the accumulation of surpluses in
the operational accounts should persist for some time, slower
tax increases or possibly some increase in the pace of spending
could result.
Inventory Investment
Inventory investment has fluctuated widely during the
upswing of the last two years. The record inventory liquida-
tion of the past recession did not come to an end until the
first quarter of 1976, when GNP growth jumped ahead as a result
of the shift toward accumulation. After holding constant for
two quarters, real inventory investment then dropped to nearly
zero during the fourth quarter, in response to the auto strike
and weak final demands early in the fall (see upper right graph
of Figure 8). The first quarter of 1977 brought a sharp
rebound, following a pickup in final sales in the last months
of 1976.
Book value data suggest continued inventory building.
Inventory/sales ratios indicate that stocks may be adequate at
the trade level, except perhaps f~r sotne types of autos, but
are still relatively low in the manufacturing sector. It seems
likely, therefore, that inventory investment will remain strong
in the second quarter. Barring unforeseen developments in
final demands, this latest adjustment in inventories should
soon be completed, and inventory investment is projected at a
moderately high level in the second half of the year and in
1978.
Foreign Sector
A positive net export balance, characteristic of the U.S.
economy over much of the past 25 years, does not appear to be
likely in the immediate future. Following net export balances
of more than $7 billion in 1973 and 1974, the U.S. recession,
generally sharper than the decline abroad, caused imports
to fall while exports increased slightly and generated a net
export surplus of $20.5 billion in 1975 (all in current
dollars). In the next year, import growth exceeded that of
exports, leading to a decline in the surplus to $6.6 billion.
19
PAGENO="0083"
79
The growth of imports in 1976 reflected increased purchases of
foreign oil and the expanding U.S. economy. Export growth was
held down by the relatively modest economic recoveries among
our major trading partners. As a result of these developments
and perhaps the earlier appreciation of the U.S. dollar in
foreign exchange markets, the net export position of the U.S.
continued to deteriorate, reaching a $6.2 billion deficit in
the first quarter of 1977. (Exports and imports are shown in
real terms in the lower two graphs of Figure 8.)
The rapid growth of oil imports is expected to slow
somewhat as oil from Alaskan fields begins to have an influence
toward the end of this year. Trade surpluses for agricultural
commodities and manufactured goods have weakened recently,
however, and are not likely to pick up, if forecasts of good
world crops and continued moderate growth abroad are realized.
Countering the deficit for merchandise flows is a surplus on
the services account that measures income from U.S. foreign
investment and travel and transportation services. Overall,
the outlook for the next few quarters is that net exports of
goods and services will not provide notable economic stimulus.
PROJECTIONS FOR 1977 AND 1978
Economic activity, as measured by real GNP growth, has
increased on average at a 5.9 percent rate since the recession
trough in the first quarter of 1975. The record inventory
adjustment in this cycle has accounted for an unusually large
part of this growth; gains in final sales (in 1972 dollars)
have averaged 4.6 percent over this period.
The CBO forecast for the remainder of 1977 and 1978
shows final sales continuing to grow near the average for this
expansion. Gains in total output are expected to be well below
the recent pace of 7 percent, however, and also somewhat below
the average for this expansion because no further acceleration
in inventory investment is anticipated in the near term.
20
PAGENO="0084"
80
Taking into consideration recent trends in activity, the
CBO forecast, presented in Table 1, has the following main
characteristics:
o Real GNP will grow at a 5.0 to 6.0 percent rate during
1977 and 3.6 to 5.1 percent during 1978.
o The unemployment rate will decline gradually from 7
percent in the spring of this year to a 5.9 to 6.9
percent range by the last quarter of 1978.
o The inflation rate, as measured by the Consumer
Price Index, is expected to be in the 6.0 to 7.0
percent range in 1977, due in part to food price
increases that have already taken place, and then to
fall to a 4.5 to 6.5 percent range during and through
the end of 1978.
Although CBO forecasts a slowdown in GNP growth, the
projection is optimistic when compared to historical experi-
ence. If growth proceeds at the midpoint of the forecast
range, the gap between the current recovery and the average of
earlier expansions will disappear. Of course, this is partly
due to the projected length of the current expansion. At the
end of 1978, when the forecast ends, the expansion phase
of this cycle will be 15 quarters old. By comparison, three of
the last four expansions had come to an end before 15 quarters.
Despite the projected gap between actual (projected)
and potential output, the outlook is for little change in the
underlying rate of inflation. The CBO forecast for price
increases in the 4.5 to 6.5 percent range during 1978, shown in
Table 1, does imply, however, a substantial reduction in the
inflation rate from that experienced in the first half of this
year with its rapid climb in food prices.
The forecast assumes that increases in retail food prices
will settle down to a 5 to 6 percent rate of increase over the
forecast period. By contrast, fuel price increases are expected
to remain at the more advanced rates experienced recently,
averaging 10 to 12 percent at wholesale over the forecast
period. Advance indicators such as crude materials prices,
labor market pressures, and inventory levels in relation to
21
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TABLE 1. ECONOMIC PROJECTIONS BASED ON CURRENT POLICY, CALENDAR YEARS 1977-1978
L e v e
1 5
Pates of
Change
(Percent)
1976:4
1977:4
to
1977:4
1978:4
to
Actual
1976:4 1977:1
Projected
1977:4 1978:4
GNP (Billions of Current
Dollars)
1,745
1,799
1,940 to 1,980
2,130 to 2,190
11.0 to 13.0
8.5
to
11.5
GNP (Billions of 1972
Dollars)
1,280
1,302
1,345 to 1,360.
1,395 to 1,425
5.0 to 6.0
3.6
to
5.1
General Price Index (GNP
Deflator, 1972 = 100)
136
138
144 to 146
152 to 155
6.0 to 7.0
4.5
to
6.5
Consumer Price Index
(1967 = 100)
174
177
184 to 186
193 to 197
6.0 to 7.0
4.5
to
6.5
Unemployment Pate (Per-
centage Points)
7.9
7.4
6.6 to 7.2
5.9
PAGENO="0086"
82
sales suggest that other consumer prices will rise at a 5.5 to
6 percent rate later this year, 1/ and CBO is projecting a
slightly lower rate of advance later in 1978. Chapter III
analyzes broadly the causes of the present high rate of infla-
tion and prospects for reducing it.
In regard to stabilization policy the projection assumes,
in accordance with recent trends, that federal spending will
fall a few billion dollars short of the Congressional targets
of $409.2 billion in fiscal year 1977 and $461.0 billion, in
fiscal year 1978. Otherwise, the projection assumes current
budget policy, with no provision for proposals not in the First
Concurrent Resolution on the Budget for Fiscal Year 1978. The
fiscal stimulus enacted by the Congress last spring--the
increase in public service employment, accelerated public
works, the reduction in personal income taxes, and job credits,
etc.--is included and has a significant effect on projected
growth.
The Administration's proposal for a national energy
program is not included in the forecast. A CBO analysis
indicates that it would have very little impact on economic
growth through 1978. 2/ Also excluded from the forecast is the
Administration's proposed financing for social security. This
program would involve some shifting of funds from general
revenue to social security during 1978, but it would have
minimal impact on net revenues through the forecast period and
little impact on overall economic activity.
The projection assumes monetary growth at the high end of
the Federal Reserve target range, with a gradual rise in short
1/ The relationship between consumer prices and advance
indicators is described in a forthcoming CBO technical
paper, Early Warnings of Inflation.
2/ For a discussion of the short-run macroeconomic impact
of this program through 1980, see CBO Staff Working
Paper, President Carter's Energy Proposals: A Perspec-
tive (June 1977), Chapter IX, pp. 104-114.
23
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83
term interest rates-S-about 1 percentage point for Treasury
bill rates over the next six quarters. Monetary policy is
discussed further in the section below on forecast uncertainty.
UNCERTAINTIES IN THE OUTLOOK FOR REAL GROWTH
Any forecast extending a year and a half into the future
is subject to a great deal of uncertainty. With six months of
the year already passed, there is reason to be somewhat more
confident of the outloOk for 1977 than for 1978. But the
record of economic forecasts suggests we must nOt attach any
certainty even to the forecast ranges, because the probability
of activity being outside the ranges is not negligible. Risks
stem both from the principal policy assumptions and from
assumptions concerning behavorial characteristics of some
sectors.
On the policy side, the size of the federal spending
shortfall--the gap between budget estimates and actual federal
spending--cannot easily be predicted because its sources are
not fully understood. CBO's projection assumes no further
widening of the gap between estimated outlays in the Congres-
sional budget resolution and actual spending, but it is possi-
ble that there will actually be a larger shortfall, which would
tend to reduce projected economic growth rates. The mid-
session budget review by the Administration, however, projected
federal spending in 1978 slightly higher than the first concur-
rent resolution, with the President's energy proposals account-
ing for much of the difference.
One of the most critical assumptions of the forecast has
tO do with monetary policy and the behavior of financial
markets. The forecast assumes that M2, currency plus demand
and time deposits at commercial banks, will grow at the upper
end of the target range recently announced by the Federal
Reserve--7 to 9.5 percent--and that short-term interest
rates will increase by only 1 percentage point over the next
24
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84
six quarters. With current dollar GNP growth projected in the
8.5 to 11.5 percent range, the forecast assumes M2 velocity
(the ratio of current dollar GNP to M2) 3/ can continue to
rise and that such an increase would not be inconsistent with a
modest increase in interest rates--en assuoiptiofl that is not
out of line with the experience of the past few years.
These financial assumptions involve two related risks,
however. First, it is possible that the Federal ReCerve will
hold the growth of money aggregates below the upper end of the
target ranges or that it will lower its targets from time to
time, as suggested by the chairman of the Federal Reserve
Board in recent testimony. The second risk involves the
possibility that monetary velocity will return to historical
patterns. Slower growth in velocity, combined with moderate
expansion of money aggregates, would lead to much sharper
increases in interest rates, with real output and, possibly,
prices coning in below projected levels.
One of the key unCertainties about private demands is the
saving rate. The projection of consumer spending behavior
assumes the saving rate will turn up from the very low value
recorded in the first quarter of this year, but remain in the 5
to 6 percent range throughout the forecast period. Even 5 to 6
percent is substantially below the rates recorded in recent
years, however, and, therefore, there appears to be some risk
that the forecast of consumer behavior is too optimistic.
Another key uncertainty is the future of business fixed
investment. CBO's ptojection of {nvestment spending--only
slightly more optimistic than the Commerce survey--may be
exceeded, if capacity utilization rates move up faster than
expected and gains in corporate liquidity remain strong. Those
with a more optimistic view of 1978 real growth prospects than
the CBO projection are counting on a major investment boom to
develop some tine late in 1977.
3/ See CBO Report, Sustaining A Balanced Expansion (August 3,
1976), pp. 32-35, for a more detailed discussion of the
velocity of money.
25
PAGENO="0089"
85
The CBO forecast of moderate growth in economic activity
over the next six quarters could thus prove either too high or
too low. What would be the early signs that the economy is not
on the projected track? One signal would be a sigmificant
revision, either up or down, in business capital spendimg plans
reported to the Commerce Department in their August survey
(to be released im early September). Such a development
could significantly change the outlook for real growth.
For residential investment, future activity is signalled by
mortgage market developments and housing starts.
In the consumption sector, an indicator would be a
sustained weakness or acceleration in purchases of durable
goods (see lower right graph of Figure 5). Auto purchases in
particular are projected to stay in the range of 11 to 11.5
million units throughout the projection period, and a signifi-
cantly higher or lower sales rate would also affect the out-
look.
Stronger growth than projected for a few quarters would
not be cause for alarm because margins of unused capacity
exist, and there would be sufficient time to devise am approp-
riate policy response before inflation effects became signifi-
cant. But if output begins to weaken below the current f ore-
cast and the assumptions underlying the first concurrent
resolution, the Congress may wish to consider policies to
stimulate the economy.
Earlier this year, when output fell significantly below
the assumptions underlying the Second Concurrent Resolution
for Fiscal Year 1977, the Congress enacted a package of busi-
ness and personal tax cuts and increases in spending in public
employment, public works, and revenue sharing. While one
element of the package proposed by the Administration, a rebate
on 1976 income taxes, was not enacted, other programs are
adding to demands in 1977 and 1978. Projected growth in 1978
would be significantly weaker without these programs.
26
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86
CHAPTER III. INFLATION
Broad agreement exists that inflation is harmful, and that
it is likely to persist. This chapter discusses these two
comfortless judgments. To explain the first, it begins with a
description of some characteristic effects of inflation. To
explain the second--the persistence of inflation--it discusses
the inflation process. The chapter concludes with some anti-
inflation policy options.
THE MEANING OF INFLATION
Inflation is often taken to mean a continuimg rise in
the general price level. A difficulty with this definition is
that it glosses over a fundamental characteristic of inflation:
inflation changes relative prices. 1/ That is, if a quart of
milk costs twice as much as a loaf of bread before inflation,
it is unlikely to cost exactly twice as much during or immedi-
ately after inflation. If a week's wages buy a television set
before inflation, there is no assurance that they will do so
afterwards.
In fact, inflation without changes in relative prices has
never occurred; if it did, no one would mind very much. If
pensions, wages, salaries, rent, profits, and the prices of all
goods and services increased at the same rate, it would be a
nuisance, but no one would be badly harmed.
Public concern with inflation is based in large part on
its effects on the structure of relative prices and incomes.
Some examples are given in Figure 9. The upper left graph
compares the annual percent change in the Consumer Price
1/ D. R. Vining, Jr., and T. C. Elwertowski, "The Relation-
ship Between Relative Prices and the General Price Level,"
American Economic Review (September 1976), pp. 699-708.
27
PAGENO="0091"
87
Figure 9
Inflation, Relative Prices, and Incomes
Percent Percent
per Year INFLATION AND per Year
SOURCES: U.S. Oepassmens of Labor, Bureau of Labor Staoistico for price and compenoation data.
Farm prices, foel prices, and prices by stage of processing are components of the Wholesale
Price mien. U.S. Treasury Oeportment for Treooory bill rate. Federal Reserve Board for
ceiling rate on bank savings acc005ts.
Caleisdar Years
1950 55 60 65 70 75
Calendar Years
28
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88
Index (CPI) with the annual percent change in average hourly
(nonfarm) labor compensation. Because output per worker grows
over tine, conpensation tends to rise faster than prices. As
nay be seen in the figure, however, the nargin of compensation
over prices narrows during accelerating inflation. Indeed, in
1974 under the combined effects of inflation and recession, the
CPI rose faster than compensation, and real earnings--the
purchasing power of an hour's work--declined.
The behavior of the CPI and the prices of two specific
types of goods, agricultural products and fuel, are com-
pared in the upper right graph. Differences between the rate
of change in the CPI and the rate of change in farm and fuel
prices have tended to increase during periods of accelerating
inflation. Moreover, while rising farm and fuel prices in
1972-1973 and 1973-1974, respectively, received much publicity,
farm prices increased less than the overall CPI in 1967-1968,
1970-1971 and 1974-1976. Similarly, fuel was becoming rela-
tively cheaper during most of the period from 1958 through
1970.
The lower left graph depicts variations in the rates of
change of crude and intermediate materials and finished goods
prices. Price changes among these three broad categories
appear most disparate during periods of increasing inflation.
All three charts show the tendency for all prices to increase
during inflation; but some prices increase much faster than
others, with some prices leading the average and others follow-
ing with a lag.
WHY RELATIVE PRICE CHANGES OCCUR DURING INFLATION
The relation between inflation and changes in relative
prices is one in which causation seems to run both ways:
changes in relative prices are caused by inflation and infla-
tion is caused by increases in the absolute (and relative)
prices of individual goods and services.
Inflation causes changes in relative prices because
most individual prices are not changed either continuously or
simultaneously. Over the past five calendar years, the annual
rate of inflation in the United States, as measured by the
29
PAGENO="0093"
89
CPI, has been 3.3, 6.2, 11.0, 9.1 and 5.8 percent. For rela-
tive prices to have remained unchanged, all prices would have
had to rise continuously or in simultaneous steps at the same
rate as the average. The facts are otherwise. Prices that
change day-to-day or in lockstep with others are the exception;
for example, open-market interest rates, prices of equity
shares, and some wholesale commodity prices. The lower
right hand graph of Figure 9 provides an example of one
price that in recent years has responded quickly to changes in
the rate of inflation--the three-month Treasury bill (interest)
rate--and an example of one that responds more slowly--the
maximum interest rate paid on regular savings accounts at
federally insured commercial banks. From 1965 to the present,
the ceiling rate on savings accounts was changed only twice;
over most of this period the rate of inflation exceeded the
interest ceiling.
Another infrequently adjusted price is the wage rate.
Most wages are adjusted for inflation no more than once a
year. Of the 10 million workers covered by major collective
bargaining agreements (those covering more than 1,000 em-
ployees), fewer than 25 percent receive cost-of-living adjust-
ments more frequently than once a year. In contrast, income
tax rates rise automatically with current dollar income
because of the progressive rate structure. Worse yet, some
pensions and annuities are permanently fixed in dollar amount
and thus decline in real value during inflation. In sum,
because all prices do not increase at the same time or at the
same rate, inflation changes relative prices and the distribu-
tion of real income.
An increase in an individual price also pushes up the
general level of prices. The large absolute (and relative)
increase in the price of energy is a commonly cited, recent
example. Higher prices for petroleum and related increases in
prices of electricity, natural gas, and coal contributed to a
higher price level directly and indirectly by raising the cost
of producing almost everything else. As was observed in
late 1973 and 1974, the immediate effect of pervasively higher
prices for goods and services accompanied by slowly changing
wages and salaries was that consumer spending for some goods
30
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90
was reduced. Reductions in spending lower output and raise
unemployment. 2/ Monetary and fiscal policies may become more
expansionary in response to higher unemployment rates. These
~olicies may reduce unemployment, but they are also apt to
perpetuate a high rate of inflation. Thus, individual price
increases, through their effects on costs, unemployment, and
government policy, can lead to inflation.
THE CAUSES OF INFLATION
Prices of individual goods and services are jointly
determined by buyers and sellers. At each possible price, there
is some quantity of the good that suppliers are willing to sell
and that purchasers are willing to buy. The market price will
tend toward that price at which desired sales are equal to
desired purchases. Market prices are raised by developments
that reduce the quantity offered for sale at any particular
price (a fall in supply) or that increase the quantity buyers
offer to purchase at any particular price (an increase in
demand). When speaking of the the entire economy, therefore,
it is convenient to classify the causes of a higher general
price level into those that increase aggregate demand and those
that decrease aggregate supply.
Aggregate demand may be increased by an expansionary
monetary policy, a tax cut, an increase in government spending,
a rise in the propensity to consume, an investment boom, or
growing foreign demand for U.S. goods. Aggregate supply may be
reduced by crop failures; the formation of cartels to restrict
supply and raise price; restrictions on imports such as tar-
iffs, quotas, and "orderly marketing agreements"; higher
minimum wage laws; and government regulations and private
agreements that interfere with an efficient use of resources.
2/ Higher energy prices also signal an increasing scarcity
of energy and provide incentives for more resources to be
used in the conservation and recovery of energy. The
resulting shift of resources among uses may also contribute
to higher transitional unemployment.
31
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91
Many of these factors were at work between the mid-1960s
and the inflation surge of 1973-1974. Monetary growth accele-
rated; government spending increased sharply during the Vietnam
War; the tax incentives and sustained expansion of the early
l960s created a major investment boom. An expanding world
economy coupled with U.S. devaluations stimulated exports
and raised the price of imports, and crop failures were wide-
spread in the early l970s. Finally, world oil prices quadru-
pled in 1974. These factors were the major causes of the
subsequent period of rapid inflation.
In assessing the recent high inflation, it is important
to recognize a fundamental difference in inflation triggered by
a fall in supply as distinct from one caused by an increase in
aggregate demand. The difference is that with a fall in
aggregate supply, such as might result from a crop failure or
a reduced supply of energy, some real output is irretriev-
ably lost. Economic policy cannot offset the direct, real
effects of poor growing conditions or reduced supplies of
natural resources, although policy can limit output reductions
in sectors not directly affected by supply changes. Inflation
triggered by increased demand, in contrast, will not initially
reduce real output.
THE PERSISTENCE OF INFLATION
One basic reason for the persistence of inflation is that
policymakers strive to achieve low unemployment as well as low
inflation. When aggregate demand weakens and unemployment
rises, economic policynakers nay respond with more expansive
policies. Similarly, efforts by policymakers to offset the
unemployment effects associated with a fall in supply provide
underpinning for continuing upward price pressures.
The response of economic policy to the unemployment
effects of changes in aggregate demand and supply is not
the only source of persistence in rising prices. Another very
important one is the way consumers, labor, and business adapt
to the expectation of inflation. In order to describe these
adjustments, it is useful to distinguish cases in which infla-
tion occurs unexpectedly from those cases in which the infla-
tion is anticipated. Consider first an economy with approxi-
mate price stability, in which the annual rate of price change
32
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92
varies only between 1 and 3 percent with an average of 2
percent. This was roughly the U.S. experience from the Korean
War to the Vietnam War. Given the previous ten years' experi-
ence, it was reasonable to assume in 1965 that the inflation
rate in the future would be about 2 percent. Reasonable, but
wrong.
Because the inflation of the late l960s and early l970s
was largely unanticipated, the implicit and explicit contracts
of trade, finance, and employment were drawn without provision
for inflation. As a result, inflation changed the relative
price structure and thus led to large redistributions of income
and wealth. Creditors generally suffered losses to debtors
when debtors made repayment in dollars with reduced purchasing
power. Workers whose wages did not keep pace with the average
rate of change in prices saw their real incomes decline. 3/ In
general, those who had agreed to supply goods and services at
specified prices on the assumption of a modest rise in prices
were stuck with prices that were `too low" until those prices
could be renegotiated.
The magnitude of losses resulting from the failure to
foresee the inflation caused people to anticipate future
inflation and to change their behavior accordingly. The length
of long-term, fixed-price contracts tended to be shortened. 4/
More tine and effort were diverted from other uses to the
3/ Some evidence suggests that inflation also changed the
relative wage structure. See A. H. Packer and S. H.
Park, "Distortions in Relative Wages and Shifts in the
Phillips Curve," Review of Economics and Statistics, LV, 1
(February 1973), pp. 16-22.
4/ Benjamin Klein, "The Social Costs of Recent Inflation:
The Mirage of Steady `Anticipated' Inflation", Institu
tional Arrangements and the Inflation Problem, Volume 3 in
the Carnegie-Rochester Conferences Supplement to the
Journal of Monetary Economics (August 1976), pp. 185-212.
33
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93
attempt to forecast price changes and to profit from those
forecasts. Catch-up wage settlements were made. Provisions
for automatic cost-of-living adjustments were negotiated
into many labor contracts. At the beginning of 1977, about 60
percent of the workers covered by major collective bargaining
agreements were entitled to some cost-of-living escalation. In
1965, only 25 percent of these workers were entitled to such
wage adjustments. Where permitted to do so by regulation,
interest rates rose to include a higher inflation premium. For
example, the long-term, Aaa-rated corporate bond rate rose from
4.5 percent in 1965 to 8.8 percent in 1975. Household survey
data show that changed expectations about the future course of
prices were not confined to labor leaders, firms, and large
investors. The Survey Research Center at the University
of Michigan reported that respondents who expected the next
year's inflation rate to exceed 4 percent increased from 27
percent in 1966 to 55 percent in 1975.
These changes in the anticipated rate of inflation and
in people's behavior reduced, though they did not eliminate,
the redistributional consequences of subsequent inflation.
By reordering commercial agreements and financial plans
on the expectation of inflation, however, they also provided
inflation with a very strong momentum.
Once the expectation of inflation becomes incorporated
into contracts, informal agreements, and plans, stopping that
inflation becomes a very complex feat. Suppose, for example,
that economic policymakers try to stop an anticipated inflation
quickly through sharply restrictive monetary and fiscal poli-
cies. The first effect of these policies is to reduce total
spending. But with many prices already scheduled to rise, the
principal impact of the spending cutback will be to increase
unemployment and to idle productive capacity. In time, these
output effects will cause some downward revisions in actual and
expected prices, if the demand weakness is considered to
be more than just a temporary aberration. These price revi-
sions, in turn, will tend to restore employment levels. Until
inflationary expectations are revised downward, though, the
major impact of the anti-inflation policy will be on real
economic variables such as employment, production, and income.
An actual rate of inflation below the anticipated rate
also has redistributional consequences similar in character
but opposite in sign to those resulting from an actual rate
34
94-971 0 - 77 - 7
PAGENO="0098"
94
above the anticipated rate. In this case, debtors lose and
creditors gain. Buyers who have contracted to purchase goods
at prices reflecting inflationary expectations lose and sellers
gain.
Although the distinction between anticipated and unantici-
pated inflation is helpful in assessing inflation's effects and
in appreciating how it acquires a monentum, all inflation is to
some extent unanticipated. Not everyone will anticipate the
actual rate correctly. Given wide variations in the actual
inflation rate, such as that of the United States during the
last five years, people will anticipate, with varying degrees
of likelihood, a range of inflation rates. A large number of
possible outcomes amounts to increased uncertainty. Such
uncertainty is, in itself, undesirable and many people would
pay something to avoid it. But awareness of a whole range of
possible inflation rates also means that, as prices change,
economic units will not be able to distinguish clearly a
relative price change (for example, a change in the real value
of what they have to sell) from a general inflation price
change. People, therefore, experience greater difficulty in
interpreting the meaning of price changes during inflation.
As a result, the price mechanism becomes a less efficient
communications system.
POLICY OPTIONS FOR REDUCING INFLATION
If policyrnakers wish to attempt to slow inflation, a wide
variety of options is available. Most of these either reduce
aggregate demand or increase aggregate supply. Four types of
policies are considered here: a deflationary macroeconomic
policy; wage-price controls or guidelines; ad hoc price reduc-
tion measures aimed at selected markets; and tax incentives
designed to encourage price stability. These policies would
have different effects on inflation, both with respect to
timing and total impact. Most would prove costly in terms of
other Congressional goals.
A Deflationary Fiscal or Monetary Policy
There is a sense in which it is correct to say that
inflation continues only because economic policy permits it to
do so. Monetary and fiscal policies exist that could arrest
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95
the rise in the price level. The cost of those policies in
terms of unemployment and lost production would be great,
however. Given the strength of inflationary expectations, even
the goal of a modest reduction in the rate of inflation risks
stalling the recovery, though the inflation-arresting effects
of such a policy could be pronounced in the more distant
future. The tradeoff of current employment and output for
future price stability cou]~d be avoided only if price expecta-
tions were to be revised down quickly in response to a defla-
tionary policy and if the prices in contracts and agree-
ments could be adjusted immediately in line with those new
expectations.
Econometric analysis carried out by CBO suggests that a
fiscal policy change equivalent to a $43 billion cut in
federal government expenditures--about two percent of GNP--
below a current policy projection starting in fiscal year 1978
would be required to reduce the inflation rate by 1 percentage
point in 1980. As shown in Table 2, such a policy is esLtimated
to reduce real GNP (1972 dollars) by $51 billion in the first
year and $61 billion (about 4 percent) in the second year. The
negative effect on employment would be at its peak in the
second year, when the average annual unemployment rate would he
increased by 1.6 percentage points, or about a million and a
half unemployed workers.
Incomes Policies or Wag~~rice Controls
The importance of inflationary expectations in the perpet-
uation of inflation and the desire to reduce those expecta-
tions without paying a high price in terms of unemployment has
often prompted the suggestion that wages and prices ought to be
controlled more or less directly through so-called incomes
policies.
The United States has had some experience with several
forms of these: mandatory controls during the Korean War;
guideposts and "jawboningT' (attempting to affect prices by
persuasion) during 1962-1966; the New Economic Policy of
1971-1974 which included periods of wage-price freeze as well
as more flexible mandatory and voluntary controls; and the
current activities of the Council on Wage and Price Stability
whose principal instruments are persuasion and publicity.
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96
TABLE 2. ESTIMATED EFFECT OF A CUT IN FEDERAL GOVERNMENT
SPENDING TO REDUCE INFLATION BY 1 PERCENTAGE
POINT, FISCAL YEARS 1978, 1979, and 1980
1978
1979
1980
Change in Federal Purchases
(Billions of Dollars)
-43
-43
-43
Change in the Inflation Rate
(Percentage Points)
a!
-0.3
-0.8
-1.0
Change in Real GNP
(Billions of 1972 Dollars)
-51
-61
-40
Change in the Unemployment
Rate (Percentage Points)
+1.2
+1.6
+1.2
a! Fourth quarter over fourth quarter change in the CPI.
NOTE: In all cases, "change" refers to the difference from a
baseline projection without the spending reduction.
Controls on prices and wages seem to be a direct and
low-cost cure for inflation. During periods when such controls
have been in effect, they appeared to have held down the rate
of inflation somewhat. But, while the cost of a general defla-
tionary monetary or fiscal policy is likely to be painfully
apparent in the unemployment figures, the substantial costs of
incomes policies are mostly hidden. The more restrictive the
policy--a complete freeze is an extreme example--the greater
the likelihood it will succeed in temporarily holding down the
measured rate of inflation but the greater its costs.
37
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97
A recent CBO study of incomes policies 5/ reviewed U.S.
experience and identified some of the difficulties associated
with these programs. Fundamental among these has been the
difficulty of establishing a ruling "principle behind the
policy"; that is, a set of decision standards that are eff i-
cient and equitable while also effective and feasible. Such a
set of standards may not exist. As a consequence, the policies
seem to lead to inefficiencies and inequities and a breakdown
of public support. The administrative cost of controls can
also be substantial. In addition, these policies are often
thought to create a depressing climate for business enterprise
and investment.
Specific Market Interventions /
There are two distinct, separable aspects of an anti-
inflation strategy of intervention in particular markets. For
one, it is suggested that the government intervene directly in
some markets to hold down prices. For the other, the intent is
to reduce and abolish government-mandated minimum prices.
The notion of a selective incomes policy is based on the
idea that by directly retarding the rate of increase for those
key goods and services that are going up in price most rapidly,
inflation can be slowed. Rapid price increases in a particular
sector are usually symptomatic of fundamental conditions
peculiar to that industry. For example, a recent Council on
Wage and Price Stability study 6/ of health care cost found
that unique structural characteristics of the health care
industry underlie its extraordinary inflationary behavior."
Specifically, ". . . the primary supplier of medical services,
the physician, usually determines the level of services re-
quired by the consumer. . . .Moreover, medical services are
5/ CBO Background Paper, Incomes Policies in the United
States: Historical Review and Some Issues (May 1977).
6/ Council on Wage and Price Stability, The Complex Puzzle
of Rising Health Care Cost: Can the Private Sector
Fit It Together? (December 1976).
38
PAGENO="0102"
98
largely paid for through a system of third-party payors,
insurance companies and government health programs . . ." that
weakens the incentives physicians, hospitals, arid patients may
have to hold down costs. `Any policies aimed at mitigating
inflation in this sector must address these structural pecu-
liarities."
Even if some form of intervention--such as the proposed
Hospital Cost Containment Act of 1977 which aims to restrict
the growth of hospital revenues and capital expenditures--is
adopted and proves effective in substantially cutting the rise
in medical costs, the direct effect on inflation will be rather
small. For example, if the 1976 rise in medical care costs had
been cut by one-fourth, the CPI would still have risen by 5.6
percent instead of the 5.8 percent actually realized.
A number of government policies, adopted for other rea-
sons, are in force whose effects are to raise prices. Examples
include minimum wage laws, agricultural and dairy price sup-
ports, restrictions on imports, the regulation of transporta-
tion rates, and environmental and health/safety regulations.
Reduction or repeal of these measures over a period of time is
sometimes suggested as a means of reducing the rate of increase
in prices and lowering inflationary expectations. Repeal, of
course, would cause some considerable losses to the beneficia-
ries of these policies and hence would encounter determined
opposition.
All of these options for stopping inflation are costly:
general deflation risks ending the recovery; wage and price
controls can temporarily suppress inflation but at the cost of
misallocating resources and creating inequities; selective
controls aimed at particular sectors of the economy will
eventually have to come to grips with the underlying reasons
for rising prices in that sector; and many interests will
defend the continuation of government price supports.
Tax-Based Incomes Policies and Related Proposals
In recent years there have been proposals to use tax
incentives and other schemes to encourage more moderate
price behavior. Like the incomes policies described above,
39
PAGENO="0103"
99
these mechanisms are generally directed at decisions of indi-
viduals, with the goal of ensuring that wage rates, on average,
do not rise much faster than labor productivity. Rather than
overriding market forces, these newer proposals attempt to take
advantage of market incentives by making moderate price and
wage increases a matter of self-interest for firms and em-
ployees.
The best known of these proposals involves tax incentives
to reward or penalize wage decisions that deviate from some
established standard. A number of such tax proposals exist but
only two specific examples are described below.
The first approach, aimed at employers, would tax em-
ployers who grant wage increases in excess of the standard. 7/
It is assumed that the tax surcharge could not easily be passed
on to consumers by way of higher prices because some competi-
tors might not have incurred as large a surcharge. As a result
of the tax employers would become more resistant to wage
demands.
A more recent proposal uses tax incentives to restrain
employee wage demands. 8/ Under this proposal, payroll taxes
would be reduced for employees in proportion to the degree
of wage restraint exercised. If the average wage for a firn
increased 1 percent less than some designated standard,
then the payroll tax rate would be cut by, perhaps, a full
percentage point for the employees of that firm. The tax cut
would last for one year only, unless wage increases in the
following year were again held below that year's standard.
7/ Sidney Weintraub and Henry Wallich, "A Tax Based Incomes
Policy," Journal of Economic Issues (June 1971), pp.
1-19.
8/ Lawrence Seidman, "A Payroll Tax Credit To Restrain
Inflation," National Tax Journal, XXIX.4 (December 1976),
pp. 398-412.
40
PAGENO="0104"
100
Other innovative anti-inflation mechanisms would not
employ tax incentives, but would rely instead on the federal
distribution of marketable wage-increase permits, without which
firms could not raise wages. 91 These permits would allow wage
increases equal to 3 percent of the annual wage bill (the
assumed productivity increase) and would be distributed to
firms in accordance with their previous annual wage bill and
collected from firms according to current wages paid. Because
the permits could be traded, growing firms that need to attract
more workers would seek additional permits while others,
particularly declining firms, would seek to sell their unused
permits. But the overall wage bill for the economy could not
legally increase faster than the value of total permits issued.
All of these proposals would encounter numerous adminstra-
tive problems. How is the "standard" wage increase to be
determined? How are catchup wage increases and long-term
contract agreements to be handled? The tax proposals would
have to be carefully designed to prevent the establishment of
loopholes.
Moreover, these proposals implicitly assume that labor
cost pressures are the principal cause of inflation--a conjec-
tural notion at best. Attempts to broaden the proposals to
include profits, interest, and rent would, however, greatly
increase their administrative complexity.
Nevertheless, the advantage of proposals that provide
incentives for more moderate price changes cannot be dismissed.
This appears to be an area where further research, and perhaps
some experimentation, could be useful. For now, these pro-
posals must be regarded as uncertain because they are untried.
9/ Professor Abba Lerner, Queens College, City University of
New York, among others, has proposed a wage permit anti-
inflation policy.
41
PAGENO="0105"
101
CONCLUSION
The best hope ,f or controlling inflation at a reasonably
low cost may be in a multifaceted approach of preventing
excessive aggregate demand and accelerating the growth in
aggregate supply. That is the approach of the Administration's
anti-inflation program, as outlined by President Carter on
April 15, 1977, which proposes to use various, mild forms of
several options simultaneously. In his statement, the Presi-
dent called for a wide range of measures including fiscal
discipline with a coordinated monetary policy; increased
efforts by the Council on Wage and Price Stability; consulta-
tion between labor, business, and government; restraint on
hospital costs; reform of government regulation; and tax
incentives for increased investment.
None of these policies is likely to reduce the rate of
inflation quickly. Yet, taken together and implemented over
time they may make a contribution to a slow unwinding of
inflation, which is probably the best that can be expected over
the next few years.
42
PAGENO="0106"
102
THE ECONOMIC OUTLOOK
Dr. RIVLIN. The economic outlook has not changed significantly
since the enactment of the First Concurrent Resolution on the 1978
budget. Signs of more vigorous growth this past spring are being sue-
ceded by some weakness in the latest data. Averaging through these
fluctuating indicators, CBO's projections show a slow narrowing of
the gap between actual and potential output and a reduction of infla-
tion remaining high by historical standards.
Growth in real output-GNP in 1972 dollars-is projected as slow-
ing from its recent 7 percent annual rate to a range of 3.6 to 5.1
percent during 1978. Growth i~ this ra.nge would be enough to reduce
unemployment at a slow pace, to the 5.9 to 6.9 percent range at the end
of 1978.
Consumer prices, which rose by 6.7 percent over the last 12 months,
are projected to increase more slowly as food price increases moderate.
An increase of 4.5 to 6.5 percent in consumer prices in 1978 is pro-
jected. The forecast is summarized in the table on the following page.
The assumptions underlying this forecast include: Food prices
settling down to a 5 or 6 perceiit annual rate of increase after their
recent fluctuation, and energy prices continuing to rise at a 10 to 12
percent rate; a slight shortfall in Federal spending below the First
Concurrent Resolution on the Federal budget for fiscal year 1978;
growth in the broadly defined money stock--M2-near the upper end
of the 7 to 91/2 percent target range recently announced by the Chair-
man of the Federal Reserve Board.
The forecast presented by the Carter administration in its midyear
budget review is at the optimistic end of the CBO range with respect
to growth. On unemployment, the administration projects a rate of
6.6 percent at the end of this year, compared with the CBO range of
6.6 to 7.2 percent. At the end of 1978 the administration projects an
unemployment rate of 6.1 percent, compared with the CBO range of
5.9 to 6.9 percent. With respect to inflation, the administration's pro-
jections are higher than the midpoint of the CBO range, but well be-
low the upper end.
We think that is partly because they are assuming passage of the
energy program in their projections, and we are not assuming any
additional legislation beyond what is contained in the First Con-
current Resolution.
While the administration remains relatively optimistic in its view
of the outlook for economic growth, some recent economic news mdi-
cates~ weakening of demands. The unemployment rate rose from 6.9
to 7.1 percent between May and June, and aggregate hours of produc-
tion workers in the private nonfarm economy declined slightly.
Retail sales have been unchanged for 3 months in current dollars
and have declined in constant dollars. If signs of weakness grow and
the economy seems headed toward the low end of the CBO range or
lower, then the Congress might wish to consider modifying the fiscal
policy reflected in the First Concurrent Resolution.
It would be premature, however, to decide at this stage that the
economy is headed toward the lower end of the CBO range. It is pos-
sible that what we are witnessing is a faulty statistical correction for
normal, seasonal variations. Seasonal correction is especially difficult
PAGENO="0107"
103
when there are large fluctuations in the economy, as there have been
in recent years.
A significant part of the strength in early 1976, the weakness later
in that year, and the strength in early 1977 could be a bias in seasonal
adjustment procedures. This is particularly likely ~n the unemploy-
ment rate and could be affecting other data as well.
It should not, however, affect the industrial production mdcx, which
is seasonally adjusted by a different procedure from most other data-
one that deliberately omits the influence of fluctuations during 1975
and 1976. The fact that the industrial production index continued to
grow strongly in June, therefore, lends some support to this view of
recent economic statistics. If the view is correct, we would expect
unemployment and much other data as currently adjusted to show a
weak second half of 1977 followed by a strong early 1978.
Apart from seasonal adjustment, there are basic uncertainties about
the economic outlook that statistics for 1 or 2 months cannot resolve..
The future of business spending on new plant and equipment is one
of them. The CBO projection of investment spending follows fairly
closely the Commerce Department's survey of business plans for 1977
and projects an 8 percent rate of growth-in constant dollars-during
1978.
Observers with a more optimistic view of real growth prospects
than CBO projections are counting on a major investment boom to
develop sometime late in 1977.
Another key uncertainty about private demand is the saving rate.
Consumers saved less than 5 percent of their current disposable income
in the first quarter of this year, an extremely low rate influenced
by the end of the Ford Motor strike, the large fuel bills due to the cold
weather, and a change in estate and gift tax laws. The OBO forecast
projects a saving rate above the first quarter rate but remaining in the
5 to 6 percent range throughout the forecast period. Since 5 or 6 percent
is substantially below the rates recorded in recent years, this is a fairly
optimistic projection. Judgments in this area have to be tentative,
however, since data revisions could significantly alter the recent level
of savings rates. Assumptions about monetary policy and the behavior
of financial markets introduce additional uncertainty.
The CBO forecast assumes that M2, currency plus demand and time
deposits at commercial banks, will grow at the upper end of the target
range recently announced by the Federal Reserve-7 to 9.5 percent per
year-and that short-term interest rates will increase by about 1 per-
centage point over the next six quarters.
These financial assumptions involve two related risks. First, it is
possible that the Federal Reserve will hold the growth of monetary
aggregates below the upper end of the target ra~iges or that it will
lower its targets from time to time, as suggested by Chairman Burns
of the Federal Reserve Board in recent testimony. The second risk
involves the possibility that the largely unexpected stability of interest
rates in the last 2 years was an historical aberration and that even the
rate of monetary growth projected by CBO would involve a sharper
rise in short-term interest rates than the moderate upward trend in our
forecast.
PAGENO="0108"
104
BUDGET GOALS FOR 1981
Uncertainties multiply as we attempt to look beyond 1978. Neverthe-
less, it is important to address, as clearly as possible, the issue of
prospects for moving simultaneously toward a balanced budget and a
low unemployment rate over the next 4 or 5 years.
In an earlier analysis of this issue, OBO concluded that to reach
an unemployment rate of 4.5 percent and a balanced budget by 1982
would require a level of non-Federal demand that is strong by histor-
ical standards. With only moderate non-Federal demands, it would be
necessary to settle either for a continuing deficit or for a higher unem-
ployment rate.
We know of no reason to alter these conclusions. According to CBO's
latest calculations, strong non-Federal demands, including a major
investment boom in 1979 and 1980, would make it possible to reach an
unemployment rate slightly below 5 percent by 1981, and around 4.5
percent in 1982, in combination with a balanced Federal budget with
outlays equal to 21 percent of GNP. This would provide budgetary
room for new spending initiatives-above current policy-amounting
to $15 or $20 billion in 1981, and perhaps $40 to $50 billion in 1982.
Without an investment boom, even if other private demands are
strong, achieving the same unemployment goal would require con-
tinuing deficits in the neighborhood of $50 billion through 1981. Since
GNP is projected as rising during these years, roughly constant deficits
would represent a declining fraction of GNP.
THE PERSISTENCE OF INFLATION
Almost all projections of the economy over the next few years include
a continuation of inflation at rates that are high by historical stand-
ards. The CBO report on the economy just issued concentrates on the
puzzle of continuing inflation in a slack economy and addresses the
question of whether there is any prospect of quick relief from histori-
cally high rates of inflation. Unfortunately, we cannot promise you
any relief.
The principal reason why inflation rates continue high is that, once
inflation is anticipated as a continuing feature of economic life, it gets
built into a great many economic contracts and decisions and develops
very strong momentum. During the last decade, inflation has become
embedded strongly in our economic machinery. The rapid spread of
cost of living adjusted labor contracts, the reflection of inflationary
expectations in a broad spectrum of interest rates, and the automatic
linking of major Federal entitlement programs to consumer price
increases are a few important examples.
There are no costless ways to reduce inflation quickly. Contractionary
macroeconomic policies eventually reduce inflation but they carry
a grave risk of causing recession. A fiscal policy restrictive enough to
take 1 percentage point off the rate of inflation 3 years from now would
cost an estimated 1.2 percentage points more in the unemployment
rate-an addition of more than 1 million to the number of unemployed
workers-in the first year of the policy, and would have continuing
serious unemployment impacts for several years thereafter.
PAGENO="0109"
105
Wage and price guidelines or controls have often succeeded in re-
ducing inflation while they have been in effect. Evidence suggests,
however, that. part of the gain in lower inflation rates is only temporary
and that there are ofteii substantial associated problems of evasion,
inefficiency, and inequity. Policies to reduce price increases in individ-
ual sectors-to control of hospital costs or hold down increases in the
minimum wage, for example-can lead to modest improvements in the
inflation outlook but are strongly resisted by those groups whose in-
comes might be adversely affected.
Finally, a number of tax incentive and related schemes to penalize
or reward wage stability may offer a promising strategy, but they
must be rated uncertain because they are untried. Further thought and
possibly experimentation with these newer ideas, and perseverance on
special steps for individual sectors, may yield some benefits.
As a basis for `budget planning for 1978, the realistic outlook is for
no more than a slow unwinding of the current rate of inflation.
THE ADMINISTRATION'S ENERGY PROPOSALS
The Carter administration proposals with respect to energy would,
if enacted, have minor impact in 1978 `and more important impacts in
1979 and `later years. The effects of the energy program were analyzed
in a CBO report issued the first week of June. At that time we esti-
mated that the Carter energy plan would add about 1.6 percent to the
level of consumer prices by 1980, or a'bout one-half a percentage point
per year to the rate of inflation from 1978 to 1980. We also estimated
that the Carter proposals would `be likely to reduce constan't dollar
GNP by no more than 0.7 percent by the end of 1980. Unemployment
could be expected to be no more than 0.2 percentage point higher than
without the proposals by 1980. The overall conclusion of our study is
that the strategies proposed by the administration are generally ef-
fective in reducing America's energy use and dependence on oil
imports.
We believe that the administration's estimates of the energy savings
attributable to the plan are slightly over optimistic-but enactment
of the plan is likely to result in oil equivalent energy savings of at least
3.5 million barrels per day by 1985.
Recent congressional action on the energy package has raised the
possibility that prices for new natural gas will be deregulated rather
than controlled at a level of $1.75 per thousand cubic feet, adjusted
thereafter for increases in other fuel prices, as proposed by the admin-
istration. Assuming that prices for new gas would, in the short run,
rise well above the Btu equivalent for oil-to about $4 per thousan'd
cubic feet-we have estimated that deregulation of new natural gas
would increase consumer costs for new gas by an average of about $10
billion per year between now and 1985. Although estimates of addi-
tional production resulting from deregulation are speculative, we do
not believe that deregulation would increase production by more than
1 trillion cubic feet per year-the equivalent of about one-half mil-
lion barrels per day-by 1985.
Like the Carter energy proposals, deregulation would probably
add to the overall inflation rate and slightly reduce the growth of
output for a few years. We estimate that the Consumer Price Index
PAGENO="0110"
106
will rise by about one-half of 1 percent per year more with deregula-
tion than without it, during the years 1978 to 1985.
For the first part of that period, then, that would about double the
inflationary impact of the program.
The effect on output and unemployment depends on the iiivestment
response. of gas producers, which is extremely hard to forecast. It
seems likely that deregulation would add two- to four-tenths of 1 per-
centage point to the unemployment rate by 1980.
In response to a request from the chairman of this committee, CBO
is in the process of preparing estimates of the budgetary impacts of
the national energy plan, as reported by the various House commit-
tees. Our analysis indicates that in fiscal year 1978, the plan would
increase Federal outlays a maximum of $0.5 billion if the maximum
amounts were appropriated.
The Joint Committee on Internal Revenue Taxation has estimated
that the plan would reduce revenues by $1 billion in fiscal year 1978.
Taken together, the spending and revenue effects would increase the
Federal deficit by about $1.5 billion.
Beginning in fiscal year 1979, however, the situation would turn
around sharply. Instea.d of increasing the deficit, the plan w-ould re-
duce the deficit by a.n estimated $1.7 billion in fiscal year 1979 and by
much larger amounts in succeeding years.
Mr. Chairman, that concludes niy statement this morning. I will be
happy to answer any questions you or members of the committee may
have. Thank you.
[The following table was submitted by Dr. Rivlin:]
TABLE 1.-ECONOMIC PROJECTIONS BASED ON CURRENT POLICY, CALENDAR YEARS 1977-78
Levels
Rates of change (percent)
Actual
Projected
1976:4 to
1977:4 1978:4 1977:4
1977:4 to
1978:4
1976:4
1977:1
GNP (billions of current 1, 745 1,799 1,940 to 1.980__ 2,130 to 2,190___ 11 to 13 8.5 to 11.5.
dollars).
GNP (billions of 1972 dollars)_ 1,280 1, 302 1,345 to 1,360__ 1,395 to 1,425___ 5 to 6 3.6 to 5.1.
General Price Index (GNP de- 136 138 144 to 146 152 to 155 6 to 7 4.5 to 6.5.
flator, 1972=100).
Consumer Price Index (1967 174 177 184 to 186 193 to 197 6 to 7 4.5 to 6.5.
= 100).
Unemployment rate (percent- 7.9 7.4 6.6 to 7.2 5.9 to 6.9
age points).
The CHAIRMAN. Thank you very much. Business investment in new
plant and equipment has not recovered from the recession as it did in
previous recoveries. To what do you attribute the lag in new invest-
ment?
Dr. RIVLIN. The depth of the recession itself certainly had some-
thing to do with it. We have not been producing anywhere near ca-
pacity for some time. We are approaching fuller capacity now-the.
latest figures indicate around 83 percent of capacity.
But there is very little incentive to invest when capacity is substan-
tially underutilized. Uncertainty and inflation may well have been
other factors. An absence of the special kinds of tax incentives that
we had in the investment boom of the 1960's may well be a reason why
investment has not recovered so quickly as we pull out of this reces-
sion as it did in other periods.
PAGENO="0111"
107
The CHAIRMAN. Let us go over this again. We are at midpoint in
1977. Last year at this point, when the economy seemed to be going
along pretty well, it took a very severe turn downward. Now, we. are
optimistic that is not going to happen again. Why?
Dr. RIVLIN. Well, the tea leaves look a little better.
The CHAIRMAN. That is what I want to know. Other than the statis-
tics, just tell me what is it that should give us this feeling of optimism
as we approach August?
Dr. RIvr~IN. There are some things that are similar to last year. The
unemployment rate has just gone up two-tenths of 1 percent. One
might worry about that. Retail sales are flat, not very exciting, and
one might worry about that.
But on the other side. there are some signs of strength that were not
present 1 year ago. Particularly industrial production, which is a
good basic indicator of the strength of the economy, is holding up well.
Finally, investment does se.em to be `coming along, and the surveys
indicate-if one can rely on `them-that there will be continued fairly
healthy investment over the rest of this year. We are relying heavily
on the Commerce Department survey, which has a good record of
predicting.
The CHAIRMAN. Would you discuss the implications of our very
severe and unfavorable balance of payments in trade on the economy.
How will this affect us in the next four quarters?
Dr. R.IVLIN. We have had a very unfavorable situation. Our im-
ports rose dramatically, in particular, our fuel imports. Our exports
have not risen as one would hope, probably in large part because the
rest of the world is in a recession and is behind us in recovery.
One would hope that two things would happen in the fut.ure that
would improve the situation: One would be a reduction in our depend-
ence on foreign oil, which is what the President's energy-
The CHAIRMAN. Of course, our balance of trade is directly affected
by our imports of oil, which is what gives us the terribly bad balance.
Dr. RIVLIN. So any progress on oil self-sufficiency is progress there.
Then, as the rest of the world's economy picks up, we can hope for
improvement in our exports.
The CHAIRMAN. But we. don't see any quick change in our depend-
ence on importation of oil, so that that is a fixed factor for awhile.
How is this unfavorable balance of trade going to affect our economy
in the next several quarters, or in the next year and a half?
Dr. RIVLIN. The slow growth of exports is not a good sign. There
are a number of parts of the economy that are not growing very fast..
State and local spending has been one of them, and exports has been
a.nother. But these do not make up a huge part of the American
economy.
The CHAIRMAN. All right. The reason I ask you that is because the
tea leaves tell us that we feel a little more optimistic than 1 year ago.
But should we be concerned about that trade situation, and could it in
fact dampen the economic slow growth?
Dr. RIVLIN. It could dampen it a little bit, but not a great deal.
Dr. re Leeuw might want to comment a little more on this.
Dr. DE LEELTW. I have nothing to add. It is one of the unfavorable
aspects of the situation. V\Then you look at some of the others, things
don't look as bad as last year at this time.
PAGENO="0112"
108
The CHAIRMAN. Is the weakening of the dollar in foreign exchange
in relation to the yen and deutsche mark of significant economic con-
cern to us?
Dr. RivLIN. I don't think it would be something you would have to
worry about in the context of forming domestic fiscal policy.
The CHAIRMAN. All right.
Mr. Latta?
Mr. LATTA. Thank you very much.
Dr. Rivlin, it is nice to have you here. On page 4 of your statement
you indicate that the unemployment rate as projected by the admin-
istration to be 6.1 percent, but `CBO has a range of 5.9 to 6.9 percent.
Why such a spread, and why can't you come down with a more exact
figure, as the administration has done?
Dr. RIVLIN. Because forecasting is a very uncertain art, and we have
learned `by experience to hedge our bets. We and others frequently fore-
cast a range, and then the real number falls outside the range. So we are
quite careful to give a range. But I think the comparison of those
numbers does indicate that we `are a little more pessimistic than the
administration is.
If you take the midpoint of our range as our best guess, then we are
somewhat, though not dramatically, more pessimistic than they are.
Mr. LATTA. Don't you crank in the same indicators, the same figures,
as `the administration?
Dr. RIVIJIN. Sure, but not in exactly the same way.
Mr. LATTA. Not exactly the same way?
Dr. RIVLIN. Any forecast represents a combination of examining the
past relationships among indicators and using some judgment. In gen-
eral, administrations tend to be on the optimistic end of anybody's
range. It is their job to be optimistic, I think.
Mr. LATTA. I think it is generally agreed that this $4 billion economic
stimulus program of the administration that President Ford vetoed,
that President Carter wanted and got, hasn't had much effect. When do
you think it will have some effect-next year, when the unemployment
figure-
Dr. RIVLIN. Yes. We have built into our forecast some favorable ef-
fect of the stimulus package in 1978.
Mr. LATrA. How much?
Dr. RIvr!IN. About half of 1 percent on the economic growth rate.
Mr. LArrA. How about on the unemployment figure?
Dr. RIvLIN. What does that translate into in unemployment?
Dr. DR LEETJW. Two-tenths of 1 percentage point by the end of the
year.
Mr. LATTA. It costs $4 billion. That is about right, $1 million a
percentage point, when you crank it in.
You are using the same figure you would on your public service
jobs-your public projects jobs? Is that what you are doing?
Dr. RrvLIx. What I was giving you is an estimate of impact of the
whole stimulus package, which includes public service jobs, public
works, and some tax changes.
Mr. LATrA. I can't follow that because we have 725,000 public service
jobs. $4 billion in accelerated public works projects, and we only end
up with two-tenths of 1 percent.
PAGENO="0113"
109
Dr. DE LEEUW. The two-tenths of 1 percent is additional decline in
the unemployment rate that you get, from the end of this year to the
end of the next year, due to the stimulus package.
Now, the 750,000 PSE jobs is a total number of PSE jobs. We
started with 300,000, and by the end of this year we will have a lot
more than that. That two-tenths of 1 percent doesn't include nearly
all of those 750,000 PSE jobs.
Mr. LArrA. Let's go on to something else. The economic picture
looks pretty good from where I sit. If we leave it alone, I think it will
look even better. But part of it that doesn't look good is the stock
market. Why hasn't the stock market showed some improvement?
Dr. RIvI~IN. I have never ventured a stock market explanation in
my life. I don't think I will start now.
Mr. LATTA. How about the gentleman to your right. Can you give
us some explanation?
Dr. DE Lnnuw. No, I can't either.
Dr. RIvLIN. It is one of the mysteries economists don't understand
very well. It has to do with gut reactions of stockbrokers and all kinds
of other things. But certainly it has some relation to this illusive con-
fidence factor that we keep talking about. But no one can explain it
very well.
Mr. LATTA. It would seem to me that they would come forward with
seine kind of a program here that has been advocated by several Mem-
bers of Congress, on capital formation, and so forth, so that we might
stimulate that market, and stimulate some jobs in the private sector.
But, we don't hear too much about that. Are we hearing anything
from CBO on this? Should we do something taxwise to stimulate some
jobs in the private sector?
Dr. RIvLIN. CBO, as you know, doesn't make recommendations. We
would be happy-
Mr. LATTA. You had a lot of studies, though, requested by Members
of Congress.
Dr. iRIvLIN. We have looked at the unemployment tax credit, and
some other forms of tax stimuli.
Mr. LATTA. What would be your recommendation now, if you have
a recommendation, as to what type tax law we could enact that might
stimulate seine jobs in the private sector?
Dr. RIvLIN. I wouldn't make a recommendation. I think there are a
number of things you might look at.
Mr. LATTA. Like what?
Dr. RrvLIN. Like investment tax credit, for instance. Like sonic of
the proposals that I think are likely to come out of the Carter tax re-
form proposal on integrating the corporate and the personal tax
system.
Mr. LATrA. I haven't seen too much in that package to stimulate
much as far as the private sector is concerned. It seems we are going to
take from those who earn and give to those who yearn. But, other than
that, I haven't found too much. .
The CHAIRMAN. The time of the gentleman has expired. Mr. Leggett.
Mr. LEGGETT. T'hank you, Mr. Chairman. Dr. Rivlin, very nice to
have your optimistic statement presented to us. I wonder if you could
give us about 30 words on the function of the CBO.
04-971-77----S
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Dr. RIvLIN. Thirty words. The function of the CBO is to provide
support for the budget processes in the form of analysis, cost estimates,
projections, economic forecasts, and the other informational and ana-
lytical responsibilities spelled out in the Congressional Budget Act.
Mr. LEGGETT. Now, we are here goii~g through this exercise of deter-
mining what we are going to do on a second budget resolution.
Dr. RJVLIN. Right.
Mr. LEGGETT. It seems to me that essentially what we are doing is
adding up the columns, and either raising them up a little bit or push-
ing them down, depending on what the Appropriations Committees
have done in relation to our targets.
I don't really see a prayer of our reinstructing the Ways and Means
Committee or the Appropriations Committee either to go out and raise
some more money, or to put more restrictions on, or to spend less
money. So, it raises a question really as to the effectiveness of our
whole program.
We were somewhat concerned when we passed the target resolution
that perhaps we were not doing as much as we could or should. This
was particularly true after we enacted a stimulus program, and then
had part of it pulled back by the administration. We again appear as
if we are not doing very much on the final resolution.
We have made the statement that the stimulus program may mean
200,000 jobs, or 0.2 percent reduction in the unemployment rate, from
the fourth quarter of this year to the fourth quarter of next year.
But, you hedge your bets by saying that that may be within 1 mil-
lion or so-unemployment may be 5.9 or 6.9 percent. Of course, we
already have been at 6.9 percent, and today we are back up to 7.1 per-
cent this month.
The questions are, How much are we really doing, in your view?
How much effective planning are we doing in this committee? How
much planning, leadership, is CBO providing this committee? Do you
have any specific recommendations to give to us at this time to include
in the final budget resolution?
Dr. RIVLIN. Well, that is several questions, I think, Mr. Leggett.
First, about whether the committee is reafly doing anything: You
had, as you remember, a bitter fight over the First Concurrent Resolu-
tion. It was not an exercise. It really was a-
Mr. LEGGETT. We fought a bitter fight to get down to $118.5 billion
in defense spending, and the Appropriations Committee had a little
trouble enacting $116 billion.
Dr. RIvLIN. But I think no one can say that you did not fight out
the issues there. However the resolution came out, it was an interest-
ing exercise in democracy. It brought t.o the surface a lot of differing
views and differing priorities, and you made a decision.
You have stuck with it pretty well. The question to be addressed
now, and the question that I think was directed to the CBO in this
context, is: Harns the economy changed sufficiently in that interval to
warrant taking a new look and doing something else? Our answer is:
Probably not.
The outlook for the. economy, for the things that are relevant to
fiscal policy. has not changed very much since you made those difficuTt
decisions in May.
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111
That doesn't suggest that those decisions were necessarily right.
But the economy, as we see it, has not changed dramatically since then.
Mr. LEGGETT. Of course, when you testified before we presumed we
were going to go with a $10 billion rebate program, and of course
that was pulled back. In effect, we let that all slide by.
Dr. RIvLIN. That is right. We anticipated at that time that the
deficit would be somewhat larger than it has turned out to be. On the
other hand, the economy turned out somewhat stronger in the first
half of this year than expected.
The deficit for 1978 will be larger than for 1977.
Mr. LEGGETT. You indicate that the M2 will be probably at the high
range over the next year, from 7 to 91/2 percent. Doesn't that indi-
cate that is more consistent with a higher rate of inflation than a
lower rate?
Dr. RIvLIN. No. We indicate that, in making our forecast, we are
assuming that the Federal Reserve will allow the monetary aggregates
to grow nearer 91/2 than 7 percent. If one assumes that, we still think
that the inflation prospects are somewhat better than they were before.
Not that we think inflation will go away, but largely because of the
moderation in food prices, we think that inflation will not reescalate
and will dampen down somewhat at the end of 1977 and 1978.
Let me, if I may, pick up on your first question and make a further
suggestion.
I do believe that as this committee proceeds in its work it will be
extremely necessary to view the budget process dynamically as op-
posed to looking at the budget 1 year at a time and to look at several
years at once.
We have written a report that suggests that the Budget Commit-
tee move gradually over time to multiyear targeting, which I think
would enable you to get a better grip on the budget, and to have a
feeling that you were considering the spending priorities in a more
effective way.
The CHAIRMAN. The time of the gentleman has expired. Mr.
Mitchell.
Mr. MITcIIErr~. Thank you, Mr. Chairman. Dr. Rivlin you have in-
dicated that if the Congress should pass the President's energy pro-
posal, it would have an inflationary impact over the next 1, ~, or
3 years.
Dr. RIvLIN. Yes. Not a major one, but it would probably increase the
Consumer Price Index by about one-half of 1 percent per year for the
next 3 years.
Mr. MITCHELL. You have also indicated in your analysis that if the
President's energy proposal is passed, pretty much intact by the Con-
gress, unemployment would increase two-tenths of 1 percent. Is that
correct?
Dr. RIvLIN. Yes.
Mr. MITCIIELL. I have seen other analyses which indicate that over
a 3-year period the energy proposal would increase unemployment by
approximately seven-tenths or eight-tenths of 1 percent, while some
are as high as 1 percent. How did you arrive at your two-tenths of 1
percent figure?
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Dr. RIvJ11N. By running it through our usual ways of looking at the
economy, that is, with econometric models and some judgment. Let me
ask Dr. de Leeuw to comment on that. But let me say in the begrnning-
the energy sector is not a huge one. Total spending on energy is about
5 percent of GNP.
Mr. MITCHELL. Yes, but it has a tremendous ripple effect insofar as
the rest of the economy is concerned. That is why I am questioning the
two-tenths of 1-percent increase in unemployment.
Dr. DE LEEUW. Let me mention some of the things that make the un-
employment response to the energy proposal large and some of the
things that limit it.
The things that make it large are, the inflation itself, which reduces
the real purchasing power of households; and the possible effects of
that inflation on higher interest rates. The things that limit it are, first
of all, the proposal of the Carter administration to recycle a lot of the
money collected in increased taxes, to rebate it in some form to consum-
ers; second the decrease in imports which should channel more spend-
ing into domestic spending-
Mr. MITCHELL. May I interrupt you at this point. Hasn't it been
true that the matter of rebating to consumers in the past has not dem-
onstrated a substantial impact on the employment area? Isn't that
true?
Dr. DE LEEUW. Has demonstrated no-
Mr. MITCHELL. No significant impact on the unemployment figures.
Dr. DE LEEUTW. No, that would not be my judgment.
Mr. MITCHELL. All right. I am sorry I interrupted you. I think that is
my judgment. It doesn't have much of an impact. I am sorry.
Dr. DE LEEUW. The remaining positive factor would be any addi-
tional investment by energy companies as a result of the higher prices
they get on new supply. When we put together all those things, we
get a mildly unfavora~ble effect on employment-two-tenths of 1
percent.
The administration, as you know, claims that their best guess is that
there would be either no effect or a positive effect on jobs. Other studies
have come out-some, as you indicated, with large unemployment
effects, some with positive effects on jobs. But none of them is really
very large.
Mr. MITCHELL. In assessing where we are going on reducing unem-
ployment rates, have you taken into account the general posture of the
administration, which seems to favor reductions in unnecessary spend-
ing, wherever possible. That is in quotes. It distu~bs me.
Though I applauded the President's decision on the B-i, obviously
some people are going to lose jobs because of that decision. No. 2, I
don't care what position you took on the dam projects, when the deci-
sion was made not to go ahead with all of them, that had an impact
on some people, in particular those who lost jobs. I would suspect
that we are going tO get several more, maybe 10, 12 more decisions
like that., from the administration, which will result in a loss of jobs.
Did yoi~ take into account the administration's policy decisions on
projects such as that?
Dr. RIVLIN. No. When we make that kind of forecast, we are assum-
ing the current policy budget. But let me also point out that the admin-
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istration is promising new spending initiatives as well as cuts. Now,
those may not come to pass, either.
Mr. MITCHELL. My last question, then. Have you seen the latest
Department of Labor statistics with their projects about black unem-
ployment and youth unemployment over the next 3 years? Have you
seen those?
Dr. RivLmt. I don't know that I have; no.
Mr. MITCHELL. I would suggest that you read them. The projections
are absolutely distressing.
Dr. RIVLIN. The current statistics are absolutely distressing, toO.
Mr. MITCHELL. Yes, they are, but what makes me even more apple-
hensive is the projection over the next 3 years, which really runs coun-
ter to what you are suggesting as a trend.
Dr. IRIVLIN. I don't think it does.
Mr. MITCHELL. If I may, you are going to see a constant increase
in the next 3 years in black unemployment and black youth unemploy-
ment. With all of the frightful results we have seen in various
communities.
Now, I read it very carefully-that is their projection, and it does
not seem tO be yours.
Dr. RIvI~IN. No. It is consistent with the work we have done on black
youth unemployment. That is an intractable problem, which, as we
have pointed out as well, seems, unfortunately, to be immune to general
improvements in the economy.
One should not read these projections of moderate improvements
in the overall unemployment rate to be a statement that we think there
is no problem of black teenagers, or that this rate will necessarily
improve along with others. It is our judgment that this is a real
problem.
Mr. MITCHELL. My time has expired, but consider both of them, if
you will-the black youth unemployment, and the overall black unem~:
ployment, as projected by the Labor Department in its latest statis-
tics, saying an increase. You know my concern.
Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired.
Mr. Conable.
Mr. CONABLE. Thank you, Mr. Chairman. Dr. Rivliñ, I am inter-~
ested in your figures relating to the increasing tax burden, when you~
say it is going to rise from 19.7 percent of GNP to 21.8 percent. There
must be some assumptions in there beyond the force of nature, of
inflation operating on the graduated income tax, aren't there?
Dr. RrvirN. It is coming down at the moment. It is over 21 percent.
now.
Mr. CONABLE. You say in 1977 itis 19.7 percent.
Dr. BIVLIN. Can you point me to what you are citing?
Mr. CONABLE. It is your 5-year budget that projects that. Isn't
that right? What does, your 5-year budget show as a percent of
GNP? "
Dr. BIVLIN. Bevenues as a percent of GNP?
Mr. C,ONABLE. Yes, talldng about the tax burden as such. I have~
the figure of 197 percent of GNP in 1977, 21 8 percent in 1982
Dr. IRIVLIN. That may well :be right. Continued inflation would
tend to increase it without a tax ëut.
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114
Mr. CONABLE. Would it increase it that much?
Dr. RIvLIN. Yes.
Mr. CONABLE. The reason I am asking about this is I assume that
we are going to have to give some form of tax cut to get through any
major tax reform measure.
Dr. RIvLIN. It seems likely.
Mr. CONABLE. You have to buy a tax reform to a substantial extent
because when people get to the bottom line they expect their own
taxes to have gone down, since tax reform usually means to the
average American I am paying more than my share of the taxes, and
therefore they feel betrayed if their taxes don't go down. That is
why you have to give a tax cut as part of tax reform.
I am just wondering how your budget projections would be affected
by a 5-percent across-the-board reduction, or a 10-percent across~
the-board reduction, if we have to go to some reduction of that sort.
You are assuming fairly static taxes, but a progressive system, sub-
ject to inflation, and therefore some modest increase in the total tax
burden.
Dr. RIVLIN. That is right.
Mr. CONABLE. I am assuming that balancing the budget is going
to be unachievable if we do the other things that are expected of us.
So~ what impact does that have on your budget projections?
Dr. 1RIVLIN. One would, of course, have to specify exactly what
cut one was assuming.
Mr. CONABLE. About 5 or 10 percent. I assume something in that
nature is going to be necessary.
Dr. RIVLIN. When we look at the compatibility of balancing the
budget and getting back to full employment over several years, it
is true that the revenues build up rather quickly, at least when one
is assuming pretty heavy inflation. If expenditures can be held to
a constant percent of GNP, then there is room for tax cuts.
Mr. CONABLE. You would not anticipate a major impact on the large
variables in the budget as a result of such a thing? It would have a
comparatively modest impact, a 5- or 10-percent cut?
Dr. RIvI~IN. Yes.
Mr. CONABLE. Now, another thing you say in your testimony-i
percentage point off the rate of inflation 3 years from now is estimated
to cost 1.2 percentage points more in the unemployment rate. I am a
little curious about that. I thought we didn't have a strong correlation
between inflation and unemployment in recent economic statistics and
that the old classical relationship was a little frayed at this point.
Dr. RIVLIN. It has been frayed. It ha.s been partly frayed as you
look at the historical statistics over the last several years by the fact
that much of the inflation has come initially from factors that had
nothing to do with the capacity utilization in the economy.
They were outside shocks to the economy that got perpetuated in
the system, but that doesn't mean one cannot make some estimate&-
however imperfect-of what might happen if you used deflationary
policy, or a restrictive fiscal policy, to bring down inflation. That is
the kind of estimatethat that was.
Mr. CONABLE. When I ask what is the estimate based on-it is still
based on historical patterns, adjusted for some of the changes inherent
in the relationship during the past year or two?
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Dr. RIvLIN. Right. That is all there is to go on.
Mr. CONABLE. You are considering that as a changing relationship,
then?
Dr. RIvIaN. Certainly.
Mr. CONABLE. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired. The gentle-
man from Texas?
Mr. BIJRLESON. Thank you, Mr. Chairman. Dr. Rivlin, in your state-
ment, pages 8, 9, and 10, 1 think you treat generally the several sub-
jects all interelated very closely-inflation, the balancing of the budget
on the schedule the administration has for 1981, and unemployment.
As I understand your general conclusion, it is that we cannot ha'~e a
lowering of unemployment, the reduction in inflation and balance the
budget~ In other words, you can't have it both ways. Is that correct?
Dr. RIvLN. Let me put it a little differently. We are saying that it
is very difficult to wind inflation down quickly by any means we know
about. About unemployment and the balanced budget, there are trade-
offs, and we are saying that if the private sector is extremely strong,
it will be possible to have both a low unemployment rate and a bal-
anced budget. If time private sector is weaker, then the Congress will
have to choose between unbalancing the budget and foregoing the low-
unemployment rate to some extent.
Mr. BURLE5ON. In other words, it is possible to balance the budget
by 1981, reduce unemployment, and lower inflation?
Dr. RTvLIx. Yes, it is possible. Essentially we are saying: It is pos-
sible, but don't hold your breath. It depends on a lot of things besides
the Congress, and most particularly it depends on the strength of the
private sector. Under favorable conditions, it would be possible. Under
favorable conditions, it wouldn't be.
Mr. BURLESON. Well, if the economy behaved as we would like for it
to behave, some of this could come about by certain policies, controls
of one sort or another. If we leave it alone, it might behave some bet-
ter than it is now in production and employment and with a higher
level of gain in the level of the economy.
Dr. RIvLIN. Well, of course, it depends on what you mean by "leave
it alone." There are a lot of governmental policies that would be favor-
able to a strong Government investment and others that wouldn't be,
such as tight monetary policy.
Mr. BURLESON. In your statement, you mentioned deregulation of
gas, new productions new natural gas. This is a case in point of just
the things that have been mentioned, I believe you estimate deregula-
tion would only produce about 1 trillion cubic feet of gas annually
equivalent in Btu's to one-half million barrels of oil a day.
Dr. RrvI1N. Yes.
Mr. BURLESON. Are you taking into consideration, in connection
with deregulation, any plowback provision, or excess profits tax?
Dr. RIvLIN. No, but that estimate is based mainly on observations
as to what has happened to new natural gas particularly in the un-
regulated intrastate market.
Mr. BtTRLESON. As a matter of fact, I think a majority of the geo-
logists, the scientific estimators of the reserves resources in this coun-
try, both inland and offshore which I have seen, is four times your
estimate. If that is true, with the incentives to expend high risk capital
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for more exploration there would be more supply at a cheaper price.
No one has yet repealed the law of supply and demand, although some
around here seem to think we can, I think it is still a pretty solid law.
Dr. RIVLIN. So do I.
Mr. BuRLESON. Do you think we will have a balanced budget in
1981?
Dr. RIvIJN. We might come close if we're lucky.
Mr. B1IRLESON. Thank you.
The CHAIRMAN. The gentleman from South Carolina.
Mr. DERRICK. Thank you, Mr. Chairman. Dr. Rivlin, in your dis-
cussion of policies to reduce inflation, there was no mention of mone-
tary' policy. Don't you think monetary policy has an impact and can't
it be used to reduce inflation?
Dr. RIvLIN. Yes, it could be used either to increase or decrease it.
If it is expansionary, it can stimulate more inflation; if it is con-
tractionary it can reduce inflation but with substantial costs in un-
employment. Tight money resembles in this respect a restrictive fiscal
policy such as we discussed in our report. It is effective, but it is costly.
Mr. DERRICK. Would you be able to elaborate, based on the monetary
policy we have seen over the past couple of years, what we might
expect?
Dr. RIvLrN. Monetary policy over the last couple of years `has-
Mr. DERRICK. What I am really asking you, based on the last 2
years, can't you anticipate what will happen in the next 2?
Dr. R1vr~IN. No.
Mr. DERRICK. How about the tea leaves?
Dr. RIVLIN. They don't do any good, you have to be a mindreader of
Dr. Arthur Burns. But as we see it, monetary policy has not inter-
fered seriously with the recove.ry.
Mr. DERRICK. You don't think it interfered in the summer of 1975,
as to why the Federal Reserve pulled in so quick?
Dr. DR LEEUW. There was a rise in interest rate, but it lasted only a
short time.
Mr. DERRICK. You don't think it had any effect?
Dr. RIVLIN. Over the last 2 years, interest rates have behaved sur-
prisingly well and haven't risen as much as one would expect at this
stage of recovery. That doesn't mean that as one looks ahead, one
shouldn't worry about a rising interest rate. Interest rates might rise
more sharply if the Federal Reserve contracts the money supply or
the velocity money stops increasing.
Mr. DERRICK. Would reductions in trucking rates and other price
supports which reduce price competition effect the inflation rate sub-
stantially?
Dr. RIVLIN. The effect of improving-
Mr. DERRICK. There is legislation before the Congress now designed
to increase price competition in the trucking industry and airlines
industries.
Dr. RIVLIN. I don't have any quantitative estimate~ of it. One would
think this would have an effect over time. This kind of deregulation is
part of a long list of things that might make the economy less infla-
tion prone.
Mi DERRICK H'u~ e you woiked on any estimates on the pi esent farm
bill beforeus?
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Dr. RIvLIN. We have worked on cost estimates, yes.
Mr. DERRICK. 1-lave you worked on inflation estimates?
Dr. RIVLIN. No.
Mr. DERRICK. Would you care to make any projections based on the
Senate bill?
Dr. RIVLIN. Not right here, but I think we can work on it.
Mr. DERRICK. In other words, you don't have any comment on it?
Dr. RIvI4IN. No.
Mr. DERRICK. How about tariff reductions? What sort of effect will
this have on inflation? In the CBO analysis of the 1977 farm bill,
which has just been given to me, you did not go into the inflationary
impact at all?
Dr. RIvI1IN. I don't believe we did. Reducing tariffs would gener-
ally be helpful on the inflation front.
Mr. DERRICK. Thank you, Dr. Rivlin. I would like for you to let
me know what impact the farm commodity bill would have on the
rate of inflation.
The CHAIRMAN. Do you think you could get us that information
before tomorrow? I'm serious. As you well know, the amendments
are coming up tomorrow.
Mr. RoussEwr~ There are only 50.
The CHAIRMAN. Not only are there 50 in number but while we have
added this year about $2 billion for wheat and corn alone, I suspect
there will be efforts to add new huge amounts in wheat, corn.
Mr. ROUSSELOT. Not so much peanuts.
The CHAIRMAN. I recognize the gentleman's overconcern with pea-
nuts. But wheat and corn especially and I would like to know, Dr.
Rivlin, if you could give us an estimate on that by tomorrow.
Dr. RIvIJN. We will try.
The CHAIRMAN. The time of the gentleman has expired. The gentle-
lady from Maryland.
Mrs. HOLT. Thank you, Mr. Chairman. I am concerned about this
inflation we have been talking about now. For instance, if we had
relatively modest declines in the rates of inflation, wouldn't this eat
up the surpluses that you are predicting? Wouldn't that have that
kind of an effect over the 5-year projections?
Dr. BIvLIN. Yes. It would have that effect. It would cut increase in
revenues, that is true. It would reduce some expenditures, too. BUt on
balance, it would tend to reduce revenues more.
Mrs. HOLT. In talking about the expenditures, the stock market, the
business community, and I don't know if you really answered that
question as to why it's happening, but it seems to me that lack of confi-
dence is tied almost directly to the rate of inflation. Isn't that true?
Dr. RIVLIN. Certainly, an increase in the rate of inflation and per-
sistent inflation is bad for confidence. I think the polls have certainly
shown that. On the other hand, at the moment, the polls of consumer
confidence are reasonably strong.
Mrs. HOLT. Now, yesterday, we had Mr. Schultze here and I was
asking him a question which ties into a question the chairman was
asking as to this international situation.
I remember when they were here in February, they felt very con-
fident the, Federal Republic of Germany and Japan were going to
stimulate their economies to the same degree as we were Ours.
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Mr. Schultze shocked me in saying he did not think there was any-
timing to be concerned about, that the change in value of our dollar
with respect to the mark was exactly what we wanted to happen. But
wouldn't that effect this velocity of money that we are talking about
here? Don't you feel this is the wrong way to go?
Mr. RIVLIN. No, I don't think it is something that one should really
be concerned about, although I am not an international expect.
Mrs. HOLT. But don't you think it has a real bearing on our situa-
tion, the way we react to the international situation?
Dr. RIvLIx. It may have some effect on this elusive thing called
confidence.
Mrs. HoLT. But you don't think it has any effect on the velocity of
money?
Dr. RIvLix. I am not sure it does. Let me turn to Dr. de Lecuw,
Dr. DE LEEUW. The direct price effect of a falling dollar is not adverse
to our economic growth.
Mrs. HOLT. Could we go on in that direction? Do you think that could
continue? It doesn't give you any cause for alarm at all?
Dr. DE Lni~uw. Not in the present context, no.
Mrs. HOLT. All right. One other question: In your statement you
say, "If signs of weakness grow and the economy seems headed to the
low end of the CBO range or lower, then the Congress might wish to
consider modifying the fiscal policy reflected in the First Concurrent
Resolution on the Budget." What modifications would be in order?
Or suppose it went the other way, what modifications would be in
order?
Dr. RIvI~IN. Well, if it went in a more favorable direction, if the
economy proved stronger than we think, then there probably is not
very much danger. What one might worry about, of course, is that the
current fiscal policy would be too stimulative. There doesn't seem to
be a lot of reason to worry about that right now because there is a lot of
slack in the economy. But if the economy is on a very healthy growth
path by the time you start looking at the budget again for 1979, you
would clearly want to move rather rapidly toward balancing the
budget lest you overstimulate and reescalate inflation again.
If we have a repeat of 1976 and the economy softens sore than we
think it will in the second half of 1977, then you are back in the same
situation you were in at the beginning of this year. Then one might
want to consider the same kinds of things, either a tax cut or additional
spending.
Mrs. HOLT. Do you think the action we took at the beginning of this
year was the appropriate action?
Dr. RIvLIN. The stimulus package, what remains of it, is likely to
have a favorable effect on growth and unemployment in 1978. It wasn't
a very big move but it will have some favorable effect on the economy.
Mrs. H0LT. It was not, you say, of major magnitude. Were there
any detrimental effects from the action we took that we should watch
for?
Dr. RIvLIN. The main incidental fact that one may have feared was
reescalation of the inflation. That doesn't seem to have happened. In-
flation is not getting much better. It is probably getting only a little
better but, on the other hand, it is not getting worse.
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119
Mrs. HOLT. So maybe the best thing to do would be to leave it alone
since we did not really accomplish very much.
Dr. RIVLIN. You made a major contribution in bringing down the
unemployment rate.
The CHAIRMAN. Ms. Holtzman.
Ms. HOLTZMAN. May I pass for a moment?
The CHAIRMAN. Yes.
Mr. Pike.
Mr. PIKE. First I want to apologize for not being here when you
read your statement and more so because I have to leave when I finish
asking these questions.
When we were considering the stimulus package, one of the soft
spots was housing which has now just taken off. Why?
Dr. RIVLIN. Well, single family housing has done very well. It is
holding up very nicely. Why has it taken off? Well, there is a consumer
demand for housing.
Mr. PIKE. We were reading articles as to how single family housing
was out of the price limits of most families.
Dr. RIVLIN. The absence of tight credit effects could have had some-
*thing to do with it.
Mr. PIKE. Assuming your projections as to the supply of money are
accurate, if the supply of money increases at the rate you anticipate,
why should interest rates go up a full percent over the next six
quarters?
Dr. RIVLIN. That just fits with what one would expect at this stage
of recovery. We have been predicting rising interest rates for some
time. Everybody's been predicting rising interest rates for some time
and it hasn't happened. Maybe it still won't happen. On the other hand,
it may get worse.
Mr. PIKE. If it does happen, what effect do you think that will have
on this housing boom we are having at the present time?
Dr. RIVLIN. Now very much. If it were a dramatic rise, then one
would begin to get a slowing or reversal of the flow of savings into
thrift institutions and a shortage of capital.
Mr. PIKE. There I think I part with your judgment because I think
it is not the quantity of money available for housing loans, it is the
interest rates which have deterred people, particularly in the single
family residential homes, more than anything else.
Dr. RIVLIN. These are related.
Mr. PIKE. Yes, but there was a great deal of money available, capital
available in the banks. Arthur Burns said that the Nation is awash
with liquidity. At the same time people were not building houses.
Dr. RIvLIN. Yes, and it was difficult to sell houses for awhile.
Mr. PIKE. We have operated in this country for a long time under
Republican and Democratic administrations in a realm of Govern-
ment spending which has run right around 20 percent, no matter who
was in office. The Federnl Government was spending about 20 per-
cent of the gross national income. What would happen if we cut that
down to 18 percent, something really radical like that?
Dr. RIVLIN. You could cut it down to 18 percent over time by doing
nothing at all.
Mr. PIKE. By letting inflation do the work?
PAGENO="0124"
120
Dr. RIVLIN. By letting inflation and economic growth do the work-
by simply holding the activities of the Federal Government to their
current status and increasing the outlays in accordance with growth
and population and inflation. But not taking on any new responsibili-
ties.
Mr. PIKE. What effect do you think that would have on the
economy?
Dr. RIvLIN. The effect on the economy of holding spending down
depends entirely on what you do with the taxes.
Mr. PIKE. Let us assume you give them back to the private sector.
Dr. RIvI~IN. If you did hold down Federal spending in thatsort of
a way, then you would have to make major cuts in taxes over the next
several years so as not to have a dramatically deflationary effect on
the economy.
Mr. PIKE. Let us just assume that we try to structure it `as a way in
which the decrease in Federal spending was returned `to the private
sector, dollar for dollar. What would the effect on our economy be?
Dr. RIvLIN. There is no reason to believe it would have much effect.
It might be mildly deflationary, but remember, you are not starting
from a balance now.
Mr. PIKE. I realize you are not starting from a balance `but you said
earlier the only way we will achieve the balance is through the private
sector. It just seems to me to the extent we can enlarge the private
sector we have a better chance of improving that balance.
Dr. RIVLIN. My view would be within some reasonable limit-iS, 20,
21 percent of GNP-it doesn't matter what the Federal share is. It
does matter what the difference between Federal spending and
revenues is.
The CHAIRMAN. The time of the gentleman has expired. The gentle-
man from Minnesota, Mr. Fraser.
Mr. FRASER. I gather from your statement that the increase in un-
employment will either double or treble if we go to deregulation of
natural gas.
Dr. RIVLIN. It would double.
Mr. FRASER. A further increase of unemployment of between two-
tenths and four-tenths of 1 percent.
Dr. RIVLIN. Right.
Mr. FRASER. In addition to that benefit of deregulation, you also in-
dictate there would be a rise in the Consumer Price Index by one-half
of 1 percent. Does that mean one-half of 1 pereent each year? At the
end of 3 years an increase of 11/2 percent?
Dr. RIvLIN. Yes.
Mr. FRASER. You also indicate the deregulation would provide the
equivalent of a half million barrels of oil a day by 1985?
Dr. RIvr~IN. Approximately that.
Mr. FRASER. That would come from accelerated exhaustion of re~
serves.
Dr. RIvLrn. Yes.
Mr. FRASER. The policy I call, "Drain America first."
Do you. Irnow of anything the administration is projecting that.
would, in a measurable and significant way decrease unemployment.
among young blacks in the United States?
PAGENO="0125"
121
Dr. RIvi~IN. There are a number of special e~nplôyment programs
directed atyouth.
Mr. FRASER. My question is, Do you know of any which in a signif-
icant way would decrease the level of unemployment?
Dr. RIvrjN. No.
Mr. FRASER. As I understand it, going back to deregulation for a
minute, the level of Federal expenditures rises when there is a rise in
inflation. Is that a general phenomenon?
Dr. RIvLIN. Yes.
Mr. FRASER. So in addition to deregulation causing an increase in
unemployment and an increase in the rate of inflation, there would be
some increase in Federal expenditures. Do you have any estimate as to
h~w much expenditures might rise between 1978 and 1985?
Dr. RjviijN. We estimate that an additional one-hal-f of 1 percentage
point inflation per year would add three- to four-tenths of 1 percent
each year to Federal outlays. At an outlay level of $400 billion, this
would mean $1.2 to $1.6 more growth in outlays per year. At an out-
lay level of $500 billion, it would mean $1.5 to $2 billion more increase
per year.
Mr. FRASER. Finally, if I may say, the projections you show for the
next few years, I think you said utiless we were unusually lucky or
something, really doesn't show a major decrease in unemployment.
Thus, the range you project could result in unemployment in 1978
being not much less than it is today.
Dr. RIvLIN. That is right. We foresee a fairly slow growth in the
economy, positive but low, but sufficient to lower the unemployment
rate but not by very much.
Mr. FRASER. The growth you predict in 1978 seems to be significantly
lower than that which w~ expect for the current calendar year?
Dr. RIVLIN. Yes. The first half of this calendar year was extremely
strong. We have had that. -
Mr. FRASER. If those predictions do turn out to be true we may want
to reconsider the fiscal policies built into the budget.
Dr. RIVLIN. If the economy were to end up at the lower end of our
range, the higher end of our unemployment rates, the Congress might
want to reconsider.
The CHAIRMAN. The time of the gentleman has expired. The gentle-
man from California.
Mr. ROUSSELOT. Doctor, we are delighted to see you appearing here
again. It is always interesting to read your documents. We have had
quite a bit of discussion in the Joint Economic Committee as to the ad-
visability of stimulating demand to Federal spending as opposed to
stimulating supply capacity by tax cuts which raise the after tax rate
of return on saving, investment, and work effort. Much of this depends
on your and other views as to the accuracy of capacity utilization
figures and their relation to output and employment goals. -
In a recent article by Robert H. Rasche, "The Federal Reserve
Bank of St. Louis Review", it is suggested GNP has been lowered
5 percent by OPEC prices-are you familiar with that report?
Dr. DE LEEUW. Yes.
Mr. ROUSSELOT. If he is correct, is there still room for demand
stimulus through increased Federal spending to raise output or will
increased Federal spending push up output by raising wages?
PAGENO="0126"
122
Dr. DE LEEUW. If he were correct we would be very close to the
limits of what we could do in stimulating demand before driving
prices up. However, I have serious reservation about his two
articles.
Mr. IROUSSELOT. Would you give us some kind of response to that
in writing or do you want to do it verbally, as to why you think he
is wrong?
Dr. DE LEEuW. I can indicate what I think is wrong. He has a set
of calculations based on the notion that you can instantly and
smoothly substitute energy for other things in production. If energy
becomes too expensive, you use less energy and a little more capital
and labor.
He goes from that underlying assumption to say that if the relative
cost of energy goes up by 30 or 40 percent, then it would make sense
for producers to greatly reduce their consumption of energy, and
use more of our idle capital and labor. He assumes we are now in
that output situation.
As a matter of fact, I don't think we have had that response at
all. I don't think we have yet responded to high energy prices by
cutting back on energy consumption; and I think it will take a very
long time before we get that kind of response. So long as we don't
get that kind of response, potential output does not fall in the way
he described. Rather, we are in a situation in which we have to pay
a lot more for energy-either by exporting more or by having a
balance-of-payments deficit-but we have not cut our production
capabilities.
Mr. Roussi~o'r. You are saying the cost has to go up 30 or 40
percent-
Dr. DE LEEUW. The cost of energy which is 5 percent of overall
costs.
Mr. ROTISSELOT. Maybe I can follow through on that a little more.
Dr. Rivlin, as to the after tax profits for business ~nd industry as
adjusted for the impact of inflation, the percentages of these after
tax profit~s to pretax profits have followed a sharp downward trend
in recent years. at least according to the Joint Economic Report we
get every month. I assume you follow the figures which accumulate
from different places in Government.
Dr. RIvLIN. We try to.
Mr. ROUSSELOT. So isn't this background part of the reason for
sluggish behavior in capital investment?
Dr. RIVLIN. Yes.
Mr. ROUSSELOT. What do von think we can do in the way of Gov-
ernnient and policy to alleviate this?
Dr. RIVLIN. I have no recommendations but I think there are a lot
of things which should be considered.
Mr. ROUSSELOT. I know you are not supposed to be involved in
policy but since you deal with these facts, what would your recom-
mendation do?
Dr. IRIvLIN. I couldn't answer that question.
The CIiAn~rAx. Your time has expired. Mr. Lehman.
Mr. LEnMAN. It is always .a pleasure to hear from you, Dr. Rivlin.
I am never satisfied with the questions I ask because the more I try
PAGENO="0127"
123
to get a feel for the whole concept of the economy, the less predictable
and manageable it is.
Dr. RIvLIN. You are not alone.
Mr. LEHMAN. It is kind of like art, I suppose. For example, some-
one just used the word "sluggish" economy. What does that really
mean?
Mr. ROIJSSELOT. I said, "sluggish behavior of capital investment."
Mr. LEHMAN. in plain language, that means "there ain't no business
today."
Mr. ROUSSELOT. Not much investment business.
Mr. LEHMAN. Anyway, when I meet with people they want to
know about energy. I use the words "energy problem" instead of
"energy crisis." That's another play on words.
Would "energy crisis" describe what we have today better than
"energy problem"? In your view, what would be the best way to
describe what we have?
Dr. RIvLIN. I think we have a prospect of a crisis if we don't do
something soon.
Mr. LEHMAN. Right now we have a problem.
Dr. RIvI4IN. Right now we have a problem, a developing problem,
we are extremely dependent on foreign sources of oil. It became a
crisis in 1973.
Mr. LEHMAN. Outside factors, global problems caused that. You
mentioned the fact that the energy program will slow down economic
growth by one-half percent a year. Why can't the energy program
be a growth industry? Why can't production of solar energy equip-
ment, development of gasification of coal, replacement of energy
users such as automobiles, appliances, plants, or equipment-why can't
this program actually be an economic stimulus and help our economic
growth rather than something which would be detrimental to the
gross national product? Why can't it be a positive factor?
Dr. RrvrIN. The positive factors can eventually outweigh the
negative ones.
The President's proposal is largely a conservation proposal, not
a new investment proposal. The investment aspects are clearly posi-
tive. They take awhile to develop. In the near term one would expect
the negative effect to be overtaken by positive effects, particularly in
the investment sector.
Mr. LEHMAN. The conservation part depends on human motiva-
tion, believing that the energy problem is the moral equivalent of
war. Have you seen any inclination on the part of the American peo-
ple to make sacrifices as part of the energy program? All we see are
people coming up saying you must protect this industry, you must
protect this sector. So far, I have not seen much grassroots support
for conservation. You can't mandate conservation from topside.
Dr. RIVLIN. If people really believe there is a crisis, as they clearly
did during the oil embargo, then they are presumingly willing to do
more than before.
Mr. LEHMAN. They knew it was a crisis because they had to stand
in line at the gas pump, but they were not sure then, and they are still
not convinced it was not a manipulated crisis. When you ask them on
questionnaires such as I have put out, the responses indicate they don't
believe there was a crisis at that time. I yield back my time.
PAGENO="0128"
124
The CHAIRMAN. Mr. Simon?
Mr. SIMON. What if interest rates could, instead of rising 1 percent,
could be dropped 1 percent without an increase in the money supply
faster than productivity? What would happen to the stock market, to
the construction industry, to the employment rate, and to inflation?
Dr. R.IVLIN. Holding down interest rates would have a generally
positive effect on the economic activity, all things being equal.
Mr. SIMON. So, in fact, we would have an increase in the stock
market or the private sector could expand, the stock market would be-
come a little more viable opportunity for private expansion.
Dr. RIVLIN. Maybe. I don't know that the stock market is really
that important-
Mr. SIMON. It has not been recently because, it has not been a very
viable operation. Formerly it was much more so. But wha.t about un-
employment and inflation? I would also be happy to get Dr. de Leeuw's
reaction. What would happen to unemployment and inflation?
Dr. IRIVLIN. Well, generally, unemployment would fall.
Dr. DR LEEUW. There are some times when you can clearly identify
interest rates as h'aving an effect on demands; namely, when interest
rates rise to the point where putting money into savings institutions
is a low return operation. When that happens and money flows out of
savings institutions, it is easy to see that this has an effect on the mort-
gage markets and housing.
Since short-term interest rates `are now below that level and putting
it into a Treasury bill, lowering market interest rates now wouldn't
affect savingsfiows at all.
Outside that channel, interest rates seem to have broad effects on
`things such as the stock market and on business investment decision's,
but it is much more difficult to identify those concretely.
If you were to lower interest rates now you would' be counting on
these much more uncertain `effects to stimulate the economy. If it
worked, you would get a reduction in unemployment and eventually
a higher inflation rate. But, as I say, that is much less certain than the
kinds of things that happen when short-term interest rates suddenly
`rise and make savings certificates a bad investment.
Mr. SnI0N. Part of your answer is one economists usually give and
I have never understood. That is, if the price of bread or steel goes up
it ,is inflationary, if the interest rates go up, it is deflationary. I have
never quite understood why that is the case.
Dr. DR LEE~W. High interest rates reduce demands, and that has
effects on many markets__housing investments and others. They bring
down prices after a period of time. It is true the direct impact of in-
terest rates to many households and businesses is that intere'st rates
are costs and when interest rates go up, the cost of doing business or
the cost of living goes up. But over a long period, it is outweighed
by the spending effect.
Mr. SIMON. Can't you, however, say if you raise the price of 1 ton
of steel, demand goes down also and that in a very real sense is de-
`flationary? I have never been able to follow the logic-I am trying to
grope through some things. I have never been able to see the logic
of traditional economics in this area.
Dr. DE LEEIJW. If something external to the current economic situa-
tion happened to make steel prices go up, such as when the formation
PAGENO="0129"
125
of OPEC made oil prices go up, that does have a contractionary effect
on the economy.
Mr. SIMON. It was inflationary or deflationary?
Dr. RIVLIN. It was both. It was a rise in prices and it also effected
a rise in unemployment.
Mr. SIMON. It increased unemployment?
Dr. RIVLIN.. Which in turn is generally deflationary. The initial im-
pact of interest rates is raising the costs of money, but eventually it
is deflationary.
The CHAIRMAN. Mr. Regula.
Mr. REGULA. You responded to a question from Mr. Latta that we
have had a 0.2-percent change as a result of the public work counter-
cyclical programs.
Dr. RIVLIN. We anticipate a 0.2-percent cut in unemployment as a
result of the stimulus package as a whole.
Mr. REGULA. To get a 0.2-percent change, isn't that a very expensive
expenditure?
Dr. DE LEEUW. We are talking about changes from the last quarter
of this year to the last quarter of next year. The cost associated with
that 0.2 percentage point cut in unemployment is only the amount
that the cost increases from the last quarter of this year to the last
quarter of next year.
Mr. REGULA. In line with Mr. Simon's question, would a continuing
reduction in the deficits likely cause a reduction in interest rates be-
cause of a lessening of demand generally?
So reducing deficits would be one way to hold down interest rates.
Would you say that is a fair statement?
Dr. DR LEEUW. Yes.
Mr. REGULA. In the publication "Recovery With Inflation," page
35, it says one of the four policy options for reducing inflation is tax
incentives to encourage price stability. What is meant by that?
Dr. DR LEEUW. The things we discussed in that section of the report
were a number of special proposals to tax inflation or to reward price
stability.
Mr. REGULA. You are, saying this is one of the four ways to reduce
inflation. What kind of tax incentives are you speaking of in this
statement ~
Di. DR LEEUW. One proposal discussed in the statement is simply to
increase the corporate income tax rate for those companies that have
either high wage or price increases and decrease the corporate tax
rates for others.
Mr. REGULA. In other words, to reward?
Dr. DR LEEUW. Yes. Another proposal is to change the payroll tax-
denending on wage behavior, to reward or penalize.
Mr. REGULA. A question on deregulation. You point out here de-
regulation, and I assun~e we are talking only about proposals which
would deregulate newly discovered gas and wouldn't affect contracts
in existence. You say this would cost `an additional $10 billion a year.
Is this based on not bringing in LNG gas supplies?
Dr. DR LERUw. That is based on a comparison of deregulation with
the Carter proposals.
Mr. REGULA. This is very important. In order to meet the needs, an
awful lot of gas went into the lines which was LNG from exterior
94-971---77-----9
PAGENO="0130"
126
sources so you have to take that into account when you use the $10
billion figure.
Mr. MORGENSTERN. It is a proposed deregulation of new gas com-
pared to Carter administration proposals. About use of new gas: It
sounds as though it is very expensive to use LNG, for example, but, in
fact, deregulation is more expensive because you are paying a higher
price for gas that you otherwise would have paid a lower price for,
rather than just paying the high price for, in fact, only the truly addi-
tional quantities.
Mr. REGnLA. All these removal of price control proposals are fac-
tored on newly discovered gas which would seem to be predicated on
a newly found source of LNG if we are to meet the needs of the people.
Mr. M0RGENSTERN. It is difficult to distinguish between gas that
would have been produced in the absence of deregulation and gas that
would be truly new beyond what would otherwise have been produced.
Mr. REGULA. It seems to me in arriving at the $10 billion figure there,
you made no recognition of the fact that we use as alternative sources
in the absence of new supply some very expensive gas which could, in
fact, make it a negative $10 billion.
Mr. MORGENSTERN. In the actual computation those figures were
counted in.
The CHAIRMAN. On page 12 of your statement you say:
Although estimates of additional production resulting from deregulation are
speculative, we do not believe that deregulation would increase production by
more than 1 trillion cubic feet per year-the equivalent of about one-half mil-
lion barrels per day-by 1985.
How do you know that?
Dr. RIVLIN. We don't know it for sure.
The CHAIRMAN. The argument as to whether or not to deregulate
natural gas relates to the question of how much new gas will be avail-
able. The argument is made that if you deregulate, you will develop
huge sources of new gas. That is the incentive for `deregulation. Cer-
tainly, that new gas would be most important in my part of the
country.
Yet, along come others who say: "Don't deregulate, it will cause
inflation, it will increase costs by $10 billion." Do you use that figure,
also? I know others have.
Dr. RIvr,IN. Yes.
The CHAIRMAN. Over a period of years?
Dr. RIVLIN. Right.
The CHAIRMAN. All right. But that estimate is based on the assump-
tion that there won't be significant amounts of new gas. Now, ad-
mittedly, these are estimates, but when you make a profound statement
such as that, there has to be some basis for it.
Dr. RIVLIN. Sure.
The CHAIRMAN. What is that basis? How do you know we are not
going to get significant amounts of new gas?
Dr. RIVLIN. The basic answer is that we have looked at what is
known as to reserves and behavior of gas production over the last few
years when the intrastate market has been unregulated. The increases
in gas production have not been very great. But let me get another
O~ifliOR.
PAGENO="0131"
127
Mr. MORGRN~ERN. Dr. Rivlin is correct, but let me expand. All we
have done is to increase finding rates and we have examined the num-
ber of rigs available and the number likely to be produced in the next
couple of years, and we have computed what we believe to be a maxi-.
mum production potential. I believe we have discussed this before. One
must be humble about these estimates.
The CHAIRMAN. I am going to help you to be humble about them. Are
you telling me that you base these estimates on in-house knowledge or
on estimates you obtain from other institutions?
Dr. RIVLIN. That is the point I am making.
The CHAIRMAN. I am not so sure you have that much capability in
CBO to make that kind of a geological determination unless you base
it on information developed by others. I want to know who the others
are. Part of the problem is, as you know, that we have very little infor-'
mation about gas and oil and the Government has little information
about gas and oil because the only people knowledgeable about it, thc
oil companies, haven't seen fit to share that information with us.
I want to know who else you talk to. This is a serious question be-
cause people in my area are hungry for gas. They are not going to get
any gas and may get less gas if last winter's situation was an indica.i
tion of anything.
Dr. RIVLIN. The sources available to us are the same sources avail-
able to everybody else, including the administration. Our estimates
are very similar to those of the administration because we are looking
at the same data.
The CHAIRMAN. You are factoring in information from the
industry?
Dr. RITVLJN. Yes.
The CHAIRMAN. They say they will go out and dig for gas if you
will give them the financial support. I want to know whether deregu-
lation is a sound policy. I have to vote on this matter.
Many people are saying deregulation is good policy. Others say
deregulation is not good policy because it will raise the price of gas
substantially. I want to know who is right.
Dr. RIVLIN. Part of his answer depends on: Compared to what?
No one is saying you have less gas now than you had before.
The CHAIRMAN. Your statement was that it wouldn't increase pro~
duction significantly, about the equivalent of one-half million barrels
a day.
Dr. RIvLIN. The `Carter proposal does equalize the price of inter-
state and intrastate gas which would be good for New England.
Mr. ROUSSELOT. Will the gentleman yield?
The CHAIRMAN. I will.
Mr. ROUSSELOT. Your position is substantially different from that
`of the Wall `Street Journal's. They say deregulation will produce
new gas. That is based on an ERDA study. We can't wash that away
and say they are nothing. Would you comment, additionally, are
the conclusions based on an ERDA study done this year? Would you
`be willing to comment on those editorials which appeared in the `Wall
Street Journal?
Sure, `it would be at a higher price, `but since most `of it goes to
industry, the cost to the consumer will be a lot less because when
PAGENO="0132"
128
industry uses it, it is able to distribute the price more evenly in its~
product prices.
Dr. RIvLIN. We would be happy to comment on that.
The CHAIRMAN. I wish you would. We would like to have the
sources for that very important conclusion. Are there many signifi-
cant groups who disagree and who claim that deregulation will bring
forth new gas?
Mr. ROHSSELOT. I will supply the Wall Street Journal editorial.
Dr. R1VLIN. We have that.
Mr. CONABLE. Could I ask one further short question. You say, on
page 6, you say the consumers saved less than 5 percent of their
current disposable income in the first quarter of this year, an cx-
tremely low rate influenced by the end of the Ford Motor strike, the
large fuel bills due to cold weather and `a change in estate and gift
tax laws.
* I don't follow that. Would you explain to me what the change in
estate and gift tax laws has to do with the rate of saving?
Dr. RIvLIN. Dr. de Leeuw?
Dr. DE LEErnv. There was a change in the estate and gift tax laws.
Mr.. CONABLE. I know there was a lot of confusion. It was, also
phased in, the cost basis carryover, the increase in marital deduction,
the increase in exemption, a.nd my impression is that that would have
very little impact on the rate of saving as such.
Why would the rate of saving be affected by that? Folks realize
now they cannot take it with them as they did before.
Dr. DE LEEtYW. It has had a big impact on tax payments in the first
quarter of this year, payments of estate and gift taxes. According to
the way we keep national accounts, that means that after-tax income
was lower in the first quarter of this year by the amount of the extra
estate and gift tax payments.
We are saying that did not affect people's spending patterns
particularly. The spending effects are spread out over a long period
of time. The result of having this sort of one-quarter decrease in
disposable income, and very little effect on spending, is to make the
`saving rate look very low for that quarter.
Mr. CONABLE. I am amazed that that would affect the staggering
sums of money in establishing a savings rate because it didn't have a
comparable impact on Government revenues.
Dr. DE LEEIJW. It was about $i/2 billion, wasn't it? That at an annual
rate is about two- to three-tenths on the saving rate.
Mr. CONABLE. Was this largely anticipatory, the reaction to it? A
lot of people made gifts and changed their plans at the end, of last
year in order to avoid any problems?
Dr. DE LEEUW. I think so.
Dr. RIvLIN. I can speak to that, having been one of those that did it.
You had to act by the end of December, or you lost the benefit.
Mr. CONABLE. I happen to be emotionally involved in that whole
sul)ject. I am just amazed it had appreciable impact on the savings
rate.
Dr. DE LEEUSV. We are saying it did not affect the general pattern
of spending, and it is just because the revenues were concentrated in
that one quarter that it affected saving, the difference between dis-
posable income and spending.
PAGENO="0133"
129
I think we are really agreeing with you that it did not have a
dramatic impact on people's spending behavior in that quarter. It.
just had a dramatic impact on the savings statistics as recorded in.:
that quarter.
Mr. CONABLE. Thank you. I was curious about that.
The CHAIRMAN. Thank you very much. We appreciate having you,.
Dr. Rivlin, Dr. de Leeuw, and Mr. Morgenstern.
The committee will be adjourned until 10 a.m. tomorrow morning.
[Whereupon, at 3:35 p.m. the committee adjourned, to reconvene
at 10 a.m., Thursday, July 21, 1977.]
PAGENO="0134"
PAGENO="0135"
THE SECOND BUDGET RESOLUTION FOR FISCAL
YEAR 1978
THURSDAY, JULY 21, 1977
HousE OF REPRESENTATIVES,
C0MMITVEE ON THE BUDGET,
Wa$hington, D.C.
The committee met, pursuant to notice, at 10:10 a.m., in room 210,
Cannon House Office Building, Hon. Robert N. Giaimo, chairman of
the committee, presiding.
Present: Representatives Giaimo, Mineta, Rousselot, Burgener, and
Regula.
Mr. MINETA [presiding]. In the interest of getting the committee
started and to conserve the valuable time of our distinguished guests,
this morning I will take the liberty of going ahead and starting. Chair-
man Giaimo apologizes for not being here to start the meeting. He
presently is on the floor relative to the unanimous consent item. He
felt that he should be there to be with Chairman Mahon.
It is really with a great deal of pleasure that I have this oppor-
tunity to welcome two very distinguished former chairmen of the
Council of Economic Advisers, Hon. Alan Greenspan, who served
under President Ford, and Hon. Walter Heller who served under
Presidents Kennedy and Johnson. Mr. Greenspan has rejoined his
consulting firm in New York and Professor Heller teaches at the
Tjniversity of Minnesota.
We are particularly grateful that you have taken the time to give
us the benefit of your wisdom and experience on the course of eco-
nomic developments. As you well know, the Budget Committee is
holding this hearing in preparation for the markup of the Second
Budget Resolution for Fiscal Year 1978. The progress of the economy
over the next 18 months is crucial to the decisions that the committee
makes.
The rise in the unemployment rate from 6.7 to 7.1 percent has re-
cently reawakened fears that the economy may stall again as it did
last year. We are also concerned at the slow pace of recovery in busi-
ness investment. The committee is pleased that you are here and is
looking forward to hearing your testimony. We would like each of
you to present your testimony and then be available jointly to answer
questions.
Mr. Greenspan, would you go first and then Mr. Heller.
(131)
PAGENO="0136"
132
STATEMENT OF ALAN GREENSPAN, FORMER CHAIRMAN OF
THE COUNCIL OP ECONOMIC ADVISERS
Mr. GREENSPAN. Thank you.
Mr. MINETA. Before you proceed, since we have a call of the House
right now for the vote on the floor, why don't I just go ahead and
recess the committee at this point and then we will be back in 15
minutes. At that time we will then have you go ahead and present your
testimony.
The committee will stand recessed until 10 :30.
[After recess.]
Mr. MINETA. The committee will reconvene.
We were about to start off. I believe, Mr. Greenspan, you were about
to make your presentation. Please proceed.
Mr. GREENSPAN. Thank you, Mr. Chairman. I would just like to
outline a few considerations that I see with respect to the outlook
over the next 12 to 18 months and try to indicate where I think some
of the problems are and where I think the solutions are and are not.
First, the exceptionally strong growth that we have seen in the first
half of 1977 which approximates roughly a 7-percent annual rate, is
very unlikely to continue into the second half. Most commentators
have been talking in the area of 4- to 5-percent growth rate quarter~
on-quarter at an annual rate.
I would think it is probably closer to the 5 percent, but within that
range I don't think our forecasting capacities are capable of making
that sharp a distinction.
What we have seen in the first half is an extraordinarily sharp
acceleration in consumer spending, largely coming out of the freeze
and natural gas shortage which hit the economy fairly hard in the
last weeks of January and early February.
We now find in retrospect that one of the major factors which has
fueled the consumer recovery is a rather extraordinary rise in the
amount of realized capital gains on home sales. We have had as a
consequence of the rapid, nearly 10-percent annual rise in the value
of the existing stock of housing per unit, substantial capital gains
increases.
Probably as a consequence we have had a very rapid increase in
sales of existing homes which on average have been creating $10,000
to $12,000 capital gains per unit. This has generated very large
amounts of additional consumer cash which has been, as best we can
judge, largely monetized through increases in mortgage debt and has
added very substantially to the levels of effective consumer purchas-
mg power through this spring.
These numbers are rather substantial. We are estimating increases
in the area of 50 to 100 percent in the rate of realized capital gains
over the last year or two, far in excess of the trend of disposable in-
come. This has been a factor which is likely to continue for awhile and
which is not, I think, appropriately factored into the usual forecasting
mechanisms.
The numbers are very substantial. Our preliminary estimate for the
second quarter is something in the area of about $40 billion in real-
ized capital gains at a seasonally adjusted annual rate.
PAGENO="0137"
133
Now even though we are not going to see a continuation of this
large rise in consumer spending, I cannot see how we can talk in terms
of anything which resembles stagnation. On the contrary, we are al-
ready beginning to see some quickening in contract awards and per-
mits for industrial construction. It is here in the long-lived capital
equipment and construction assets, where, if anything, the economy
has exhibited a shortfall in the degree of recovery.
By any measure that we can find, capital investment is well under
expectations for this stage of the business cycle. It is not a conse-
quence of lack of effective demand, lack of consumer purchases or lack
of final sales but largely, if not whofly, the result of an exceptionally
high degree of risk in the capital goods formation process.
We can pick this up from a variety of sources. We find, for example,
that all of our various measures of risk premiums which, although
having improved a bit over the past 2 years, are still very substantially
in excess of where they were 5 or 6 years ago and certainly a decade
ago.
Now this has very important implications for economic policy be-
cause if there are very substantial risks, the capacity of the economy
to adjust to perceived long-term changes is undercut. One of the diffi-
culties we have, for example, in adjusting to the very rapid increase
in energy costs and prices is that the capital investments which under
normal risk premium conditions, would be forthcoming for example,
new plant attempts to find new synthetic fuels, new research and de-
velopment projects, tend to get suppressed because the payoff on these
types of projects has a very long leadtime, and when risk premiums
are high, meaning that the discount rates on future expected earnings
are high, the near-term incentives are small.
So we find that even though we have had an exceptionally good
recovery in the economy to date, the high risk premiums have sup-
pressed the capital goods markets and have suppressed the adjust-
ment processes which we need as part of the normal market process
in our economy to restore long-term balance.
Now I would, therefore, conclude two things. First, because risks
are high, speculative imbalances which would then drive the economy
into a state of distortion which would in a sense require a recession
are very unlikely to happen. In other words, this means you are going
to get a very moderate, suppressed, but nonetheless sustained growth
until imbalances emerge.
Second, with high-risk premiums it is very difficult to create those
sorts of imbalances. People don't move in a way which leads to the
types of imbalances which lead to significant recessions. In this re-
spect I would not be terribly concerned, even with the continuation
of these risk premiums, that the economy would peter out and stagnate
indefinitely. That is an unlikely occurrence in any event. But even
should that be perceived as the case, increased fiscal stimulus will not
come to grips with that problem, because the problem is not inade-
quate final demand. All of our equations say that no matter how you
factor in final demand consumer purchases and the like, you cannot
explain why the current levels of capital investment are as low as
they are. They are, as far as I can see, pretty much fully explained by
the risk factor.
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134
So you cannot cure the problem, which is a very important, perhaps
the most important, problem in economic policy in this country and
perhaps. even elsewhere in the world, by increasing stimulus. That
merely increases current disposable income and current consump-
tion. Investment will not follow with high-risk premiums you cannot
convert short-term increases in sales into needs for long-term in-
creases in capital investment or capacity.
Excessive fiscal stimulus in this context is very likely to act ad-
versely to the extent that these high-risk premiums or business un-
certainties are caused, currently largely by inflationary instabilities.
Hence the extent to which one overdoes fiscal stimulus could very easily
act to atrophy business confidence even more.
V~7hile we may well, in fact almost certainly would get increased
consumer purchasing under fiscal stimulus, it strikes me that we
may find we are at the same time losing even more of our underlying
investment thrust over the longer term.
So I should say, Mr. Chairman, in summary, that we must
be very careful in evaluating what types of fiscal and monetary poli-
cies we introduce in the period immedately ahead, to recognize what
the problem is. The problem is not consumption. It is not housing. In
the private sector it is capital investment. Capital investment is not
being suppressed because of the lack of adequate fiscal stimulus.
So in my view the fiscal stimulus problem is one which we must be
very careful of, especially in view of the extraordinary shortfall that
we have seen in expenditures in recent months. We even had a short-
fall through June even though our data for June at this stage is still
quite fragmentary.
These outlays are not merely lost. They are a backing up of the
whole congressional appropriations, obligations process which will
eventually swing in the other direction. Nobody knows for certain
when, but if I had to guess at this particular stage, I would say some
time in midcalendar year 1978.
So any attempt at this point to augment the appropriations proc-
esses in a manner to get increased obligational authority could very
easily work to increase the levels of outlays at precisely the time when
it may well be they are moving far too fast and our concerns may not
be too much shortfall but too much expenditure over budget.
Needless to say, we have in the past attempted to look too closely at
what is going on currently and try to fight the current symptoms in a
way which exacerbates the longer term expenditure problems.
I must say, Mr. Chairman, that that is precisely what concerns me.
As a consequence that I would recommend that the policies of fiscal
restraint which are currently being followed to a greater or lesser
extent be continued and that there is certainly no need for any in-
creased stimulus that I can envisage, given the outlook that we see at
this time. Thank you.
The CHAIRMAN. Thank you very much, Mr. Greenspan. We appre-
ciate your appearing before the committee and offering us the benefit
of your vast experience in these areas.
We will proceed with comments and testimony from Mr. Heller at
this time. After that we will have some questions.
PAGENO="0139"
135
Let me also say I apologize for being late. I had to be on the floor
of the House to discuss a matter with the chairman of the Appropria~
tions Committee.
Mr. Heiler, it is a pleasure to see you again. We welcome you.
STATEMENT OP WALTER W. KELLER, FORMER CHAIRMAN OE
THE COUNCIL OP ECONOMIC ADVISERS
Mr. HELLER. I have a few prepared notes from which I want to
speak, but I think it would be impolite not to respond to my esteemed
colleague, Alan Greenspan, before 1 start.
Just as a courtesy, I suggest that I quite disagree with his analysis
of the shortfall of investment, the proposition that it is simply a
response to high-risk premiums. Let's say there is at least an alternative
thesis. That is, that if you work the accelerator equations, that is the
equations relating the rise in investment to the rise in consumption-.
and particularly taking into account ratios of operating levels to capac-
ity-you can explain the sluggish investment almost entirely in terms
of low output and low capacity utilization.
Therefore, one can find by my lights a good part of the answer to
the investment shortfall in inadequate demand. The best medicine for
lagging investment and business confidence is a continued stepup in
consumption and particularly consumption that will push operating
rates somewhat closer to capacity.
So, as I say, just as a courtesy, I wanted to make that comment before
I go on to other things.
Mr. GREENSPAN. Thank you, sir.
Mr. HELLER. I expect to have a response from my esteemed colleague
on my left. Now the committee has had the benefit of superb analyses
by Alan Greenspan, by the Council of Economic Advisers, by the Con-
gressional Budget Office, on the outlook for the economy in the next
18 months. So I really don't intend to dwell on that subject.
I suppose I should say that I feel that the present momentum of the
economy, plus growing business confidence, plus sustained consumer
confidence-combined with sectorial strength in Government spending
and rising strength in business fixed investment and continued strength
in housing-should be sufficient to override the moderating strength in
the consumer sector and perhaps even an associated mini-inventory
cycle.
That brings me out somewhat closer to Charles Schultze's numbers
than to Alice Rivlin's numbers. Under present policies, a 5-percent
rate of growth in real GNP in the next 12 months looks like a reason-
able bet, but it may take some fiscal stimulus or monetary ease to main-
tain that pace or certainly to improve on it throughout 1978 and into
1979. That is a very cavalier statement about the next 18 months.
I would like to turn to three other questions, if I may, that may be
of some interest to the committee.
First, is there a significant margin still existing for economic
expansion without. risking a renewal of excess demand inflation ~
Second, does it make sense to aim rather rigidly at a balanced budget
in fiscal year 1981? Third, does a sizable net tax cut make sense in
1978?
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136
And to the first question, I want to underscore the importance of
concentrating not just on how far we have come in the recovery and
how far we are going in the next 18 months, but getting a pretty firm
~f1x on where we are.
Now it is not always easy to get one's bearings on where we are
or where the economy stands today relative to its capabilities. For
example, a columnist on page 1 of the Wall Street Journal last Monday
depicts the recovery as "extraordinarly vigorous compared with its
five postwar predecessors."
Yet Geoffrey Moore and Victor Zarnowitz of the Bureau of Eco-
nomic Research, tell us that the recovery "has been of moderate
strength, close to but somewhat short of the recent recoveries."
One has a right to be a little puzzled and quizzical when you get such
opposing interpretations of the same set of facts. The National Bureau
was looking at only 4 months less of the recovery than the Wall Street
Journal article.
Quite apart from differing interpretations of recovery numbers
there is the whole question of what is the right standard by which to
gage our economic performances. Should it be the advance measured
from the 1975 trough of what was the deepest recession since the
forties? Or should it be the advance measured from the previous peaks
of economic activities in 1973?
I think measuring our performance against troughs rather than
peaks is statistically un-American. It is the peaks, not the troughs,
that tell us something about our economic potential. By that measure,
of where we stand relative to previous peaks, our performance still
leaves much to be desired and leaves plenty of room for expansion. At
the end of 1976, as you may recall, after the first seven quarters of
recovery, real GNP was only 3 percent above the previous peak
whereas the average advance in the five previous postwar recoveries
for the same timespan was 11 percent. Business fixed investment in
real terms was 12 percent below the previous peak in 1973 as against a
postwar average of a 5-percent gain.
Now by mid-1977, assuming roughly a 7-percent rate of real GNP
gain in the first half of this year-and this is the most dangerous kind
of forecast because you can check up on me by 2 p.m. this afternoon-
real GNP was 61/2 percent above its previous peak. Against this was
just about half of the average gain in the comparable timespan of the
five previous recoveries, when we were about 12 or 13 percent above
the previous peak. Real business capital spending was still running
about 8 percent below the previous peaks in the second quarter against
an average rise of about 8 percent in the previous five business cycles.
Other measures confirm the ample U.S. economic potential that your
committee can count on in making its budget decisions, indeed the
potential that you can help realize through your budgetary policies
and actions. For example, factories were still operating at an average
of 831/2 percent of capacity in June against an 88 to 90 percent average
in 1973.
In the critical sector of materials industries-such as chemicals and
paper, basic metals and textiles-where the worst bottlenecks and
shortages occurred in 1973 and 1974, the June operating rates averaged
83.2 percent, nearly 10 points below the 93.1-percent peak in mid-1973.
So while you can compare 83 to 88 for some of the overall compari~
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137
sons, that critical sector is almost 10 points below operating rates in
mid-1973.
Finally, taking the broadest view of capacity, namely, GNP poten-
tial at full employment-which I define here as 5-percent unemploy-
ment-one finds actual output was running $116 billion below poten-
tial-this is second quarter now-$116 billion below potential as con-
servatively calculated under the formula developed by the Council of
Economic Advisers under Alan Greenspan and $148 billion as more
liberally calculated under the formula developed by George Perry of
Brookings. I got these numbers directly from the progenitors of those
two estimations.
Now clearly the margin, for unrealized growth on which fiscal and
monetary growth can draw without courting the risks of excess demand
inflation is very large.
Now let me turn to the 1981 balanced budget target. Can we and
should we balance the Federal budget by fiscal year 1981? That vexed
`question bites off a lot more than I can comfortably chew in this brief
statement. But it is so vital to the committee's efforts to formulate a
responsible fiscal policy that I should at least outline some of the
factors and issues that bear on the answers to that tough question.
The "can we" terrain, I think, is I)y now fairly familiar. To achieve
the high employment prosperity that is essential for budget balance
will require outstandingly good policy and extraordinarily good luck.
It requires nothing less than a combination of fiscal and monetary
policies that will generate ~½ percent real GNP growth per year.
between now and 1981, even in the face of budget restraint.
Now a sustained private investment boom* would have to lead the
way to get to that target. There is no precedent by the way-not even.
in the halcyon 1961-65 days of noninflationary expansion-there is no
precedent for quite such a stellar economic performance. It is not that
it can't happen here. But it would be a heroic fiscal feat to get to that
balanced budget.
The CHAIRMAN. WTould you say that again.?
Mr. HELLER. Yes. Let me recap that. To get 51/2 percent average
growth between now and 1981, under the Perry formula you would.
have to have about 5.7 percent to get his concept of full potential
while under the Greenspan CEA formula it would be about 51/4,
percent.
But to take a midfigure: To get 51/2 percent annual sustained growth
between now and 1981 and the strong levels of private investment in
housing and plant.a.nd equipment that would be needed to pull us up
at that rate is a nrecedent that has not been duplicated in the whole
postwar period. We came close in the 1961 to .1965 period, but even.
there that combination in a noninflationary environment was not
realized.
Second. it is rat..her hard to see the conditions of that period being.
dunlicated. Now that brings us to the "should we" question.
Mr. REGuLA. When you say 51/2 percent~ you are, talking about real,
growth? , . . .. .
Mr. HELLER. Yes, 51/9 percent real growth between now and 1981.
That biin~s me to the "should we `question Let me cite four issues that
e to he f'~ced in `insw eimg this question of whether we ought to
ialance the budget by 1981.
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138
First, we ought to bear in mind at the outset that a balanced budget
in the 1980's implies a considerably different macro impact, that is,
considerably less support to aggregate demand than it did in the 1950's
and 1960's.
Now why? Well, the composition of the budget has changed dra-
matically. Direct Government purchases of goods and services are a
shrinking percentage while transfer payments and grants are an ex-
panding share of total Federal outlays.
In the rnicl-1950's, purchases were two-thirds of the Federal outlays.
A little more than a decade later the proportion had dropped to one-
half. Today the proportion is about one-third of total Federal out-
lays. The rest is grants and transfer payments. The grants stand sort
of halfway between the two.
Now, a dollar of transfer payments, some part of which is tucked
away in savings, represents less aggregate demand than a dollar of
Government purchases. So a balanced budget in fiscal year 1981 would
represent a good deal more restrictive fiscal policy than a balanced
budget would have represented in the fifties or sixties.
Now, second, if the OPEC countries continue to run a large sur-
plus, if our dollar out-payments to them significantly exceed our
dollar intake from them, their surplus or savings will have to be
matched by deficits or negative savings somewhere in the U.S.
economy.
I would broaden this to the whole trade deficit or surplus, but I want
to concentrate on the most troublesome part of it, namely, the OPEC
oil surplus. If a sustained investment boom does not materialize, that
Is, if private business and homebuilders don't incur the deficits to
match that surplus, Uncle Sam will be the logical nominee-the des-
ignated hitter-to run the deficit.
Now, third, the surplus into which State and local budgets are mov-
ihg-and rather quietly State and local budgets have moved into a
sizable surplus, not so much for general financial purposes but espe-
cially in their pension and retirement funds. Overall they are taking
in-the numbers are a little hard to interpret-soinewhere between
$10 and $20 billion more than they are paying out.
Now those surpluses pose a similar offset problem. In a sense, if
no one else offsets these savings by boosting their investment and by
borrowing, the Federal Government again becomes sort of the residu-
ary legatee of the required deficit financing unless, of course, one
gives up the high employment goal.
Four, much depends on the Federal Reserve System. To the extent
that it provides the monetary conditions, the relative ease that stimu-
lates investment and absorbs the savings that otherwise become ex-
cessive, the cause of budget balance is well served: But a Federal Re-
serve dedicated above all else to slaying the inflation dragon may not
be very accommodating.
So, one of the things that has to be considered in this whole ques-
tion of what this committee and its counterpart in the Senate will have
to do is: What is the course of Federal Reserve policy, and can one get
a reasonable tradeoff with Arthur Burns?
The CHAn~rAN. Are you ~aying that our monetary policy over the
next 18 months, then, should be one of easier credit?
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139
Mr. HELLER. My feeling is that it ought to be accommodating to the
expansion process and that some of the tightening that I see in pros-
pect probably is out of place, in other words, would not well serve the
needs of the economy. But I am also saying that it is high time, dif-
ficult as it is, for greater coordination and tradeoffs between fiscal
policy and monetary policy.
If this committee in the House and Senate run a tighter fiscal
policy, there ought to be a quid pro quo in a somewhat easier mone-
tary policy. You should not be running them tight at both ends be-
cause that is too restrictive and too inimical to the objectives of a full
employment balanced budget economy.
The CHAIRMAN. What about the reverse of that, if the Congress and
the administration don't run a tight fiscal policy, does that necessitate
a tighter monetary policy?
Mr. HELLER. It does, yes. These are tradeoffs and it goes both ways.
Mr. REGIJLA. Would the chairman yield? A tighter fiscal policy in
the public sector and an expansionist monetary policy would move
the dynamics for stimulating the economy from the public to pri-
vate sector. Is that what you are saying you favor?
Mr. HELLER. If it could be worked out in such a way that the quid
pro quo would be accepted by the Fed, yes. Because we need the in-
vestment in the private sector to do the job.
One of the things that I have frantically been puzzled about as a
matter of fact, over several years is that a conservative Republican
administration-and I will try not to characterize the present Demo-
cratic administration-did not undertake a dedicated effort to de-
velop a balance that would have somewhat tighter fiscal policy in
exchange for somewhat easier monetary policy and the resulting stim-
ulus to the private sector, to housing, and to plant and equipment
investment.
The CHAIRMAN. The second bell has rung on a vote on the con-
ference report on the international financial institutions bill. We have
about 8 minutes left. May I ask the members of the committee to rush
over and come back in 8 minutes?
[After recess.]
Mr. HELLER. One final section of my opening comments relates to
the desirability of a net tax cut in 1978. Would that be responsible
fiscal policy next year?
Let me list a few considerations which add up to a "yes" answer
for a modest~ permanent tax cut in the coming year.
First, as Brookings' analysts have pointed out in their fiscal report,
a full-employment economy in 1981 would generate between $22 and
$27 billion of tax revenues in excess of the Oarter standard or target
of 21 percent of GNP. Just lop off revenue above 21 percent of GNP
under the Greenspan growth formula at full employment, and there
would be $22 billion of tax GNP. Under the George Perry approach,
it would be $27 billion. That would still allow for a sigmficant increase
in governmental programs..
About $25 billion represents the increase in income tax liabilities
between now and 1980 that would be automatically and stealthily
legislated by inflation
PAGENO="0144"
140
In other words, inflation will, in effect, legislate a $25 billion income
tax increase between now and the end of 1980. That's assuming infla-
tion at about ~½ percent a year.
Next year, it seems to me, would be an appropriate, probably even
an excellent time to return some of that $25 billion to taxpayers for
four main reasons:
The first is to lubricate the maj or tax reform which Mr. Carter
will soon launch; the second is to provide some economic insurance
that I think will be needed to keep aggregate demand and, therefore,
the economy expanding at a good clip in 1978 and later in 1979. This,
by the way, suggests not the finest of fine tuning, heaven forbid, but
it does suggest there should be some flexibility. This committee, among
others, ought to be prepared to go through that arduous process of
preparing a resolution on the budget more than twice a year if
necessary to meet the needs of a continually expanding economy. I
don't think we can make this judgment today but it is a fairly good
bet that as things unfold, some kind of stimulus would be needed.
The CHAIRMAN. To whom and how do you return that $25 billion ?
Mr. HELLER. I'll answer in terms of my biases and value preferences.
I am not speaking particularly as an economist.
I would return it, primarily, to the middle and lower income groups.
However, my third point suggests that in spite of that answer, we
need to provide an extra dimension beyond a matching of revenue
gains and losses to the positive investment environment which is
needed to bring full employment within reach by 1981. If the eco-
nomics of the situation tells us that private investment in plant equip-
ment and housing has to lead the way to give us any chance at getting
a balanced budget by 1981, then I think we have to be very conscious
of the investment environment when we formulate the total package
of taxes for 1978.
The CHAIRMAN. That's why I asked the question. I wonder what con-
sideration you have given to returning some of these taxes to the busi-
ness sector, the capital expansionary sector.
We always get into a dispute as to how to handle tax rebates or tax
reductions. We have to give something to everybody. How does it best
affect and stimulate the economy, which is one of the factors you are
trying to get at?
Mr. HELLER. So much, therefore, depends on the development of the
economy. You have some equity consideratiOns. In part, you are trying
to relieve the thrust of inflatiomi on real tax liabilities-whenever
money income i~ises faster than real income a progressive income tax
tightens the tax noose. The Carter administration is thinking of re-
turning some revenues by lowering the top rate on investment income
to 50 percent. Maybe that's enough for the upper income groups which,
as it is, pay only 30 percent in real effective tax rates anyway. But in
reducing marginal rates that might do the trick there. But you have
to do something for the middle and lower incOme tax groups.
Then the other question is the equity question: What is fair in terms
of income distribution? The third is* the question of what dO you do
to provide balanced stimulus to cofisumption and investment?
A fourth possible and probable reason for a tax cut nextyear would
be to offset some of the excessive toughness of monetary policy as it
goes on its duly self-appointed rounds in the battle against inflation.
PAGENO="0145"
141
in terms of projecting present policies, monetary positions will be too
tough.
The proposed moderate tax cut in 1978 has a very different orienta-
tion and more modest objective than the great tax cut of 1964. But it
has a construtive role to play in a fiscally responsible policy.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Heller follows:]
PREPARED STATEMENT OF WALTER W. HELLETi
In formulating its budget plans and fiscal policy, the Committee has to go well
beyond the economic outlook-the current and future pace of economic ex-
pansion-to consider such questions as the following:
Doe.s a significant margin still exist for economic expansion without risking
a renewal of excess-demand or demand-pull inflation?
Does it make sense to aim rather rigidly at a balanced budget in fiscal year
1981?
Does a sizable net tax cut make sense in 1978 as a lubricant for tax reform,
as a stimulant to the economy, as an antidote to over-zealous monetary policy?
Since the Committee has had the benefit of superb analyses of the economic
outlook by both the Council of Economic Advisers and the Congressional Budget
Office, I won't dwell in these remarks on the probable course of the economy. On
this front, I will simply say that the present momentum of the economy--com-
bined with sectoral strength in Government spending, business fixed investment,
and housing that should be sufficient to override moderating `strengths in the
consumer sector and the associated mini-inventary-cycle-bring me out closer
to the Schultze than to the Rivlin numbers. Under present policies, a 5 percent
rate Of growth in real GNP in the next 12 months looks like a reasonable bet.
But it may take some fiscal stimulus or monetary ease to maintain that pace
throughout 1978.
THE MARGIN FOR EXPANSION
Turning to the first of the three questions listed above, I want to underscore
the, importance of asking not just how far, we have come since recovery started
or how far we are going in the next 18 months, but getting a pretty firm fix on
where we are.
It's not always easy to get one~s bearings on where we are, on where the
economy stands today relative to its capabilities. For example, a page-one Wall
Street Journ'il column Pist Monday depicts the 26 month ieco~er~ (M'u( Ii 1975
to May 1977) as extiaordin~rily \igorous compaied with its five uostw `u
piedecesors let Goeffrev Moore and Victoi Zainowitz of the Nation'il B iieau
of Economic Research tell us thit the reco~ei~ (m its fist 22 mon~h',) hi~,
been of moderate strength, close to but somewhat sh6rt of the average of re-
cent recoveries." One has a right to be quizzical.
But quite apart from differing interpretations of recovery numbers, there is
the whole question of what's the right standard by which to gauge our economic
performance. Should it be (1) the advance measured from the 1975 trough of
the deepest recession since the Gieat Denression or (2) the advance ine'i me('
from the ure~ious pe'tks of economic actu itv in 1973? Measuring our perfomm'iw e
against troughs rather than previous peaks strikes me as statistically mm-Amen-
can! It is the peaks, not the troughs, that tell us something about our economic
potential By that measure our peiform'lnce leaves (a) much to be cTe'~ned md
(b) plenty of room foi expansion
At the end of 1976 after the fist 7 quarteis of recoveiv real G~P wa cnl
3 pe~cent abo~ e the pies ions peak in the 4th quartem of 1973 Tn~ comp ii ibie
growth in 5 previous postwar recoveries averaged 11 percent. Business fixed in-
~estment in ieal teims was 12 peicent below its 1973 peak against a po~tw ii
a~ erage of a 5 percent gain
By mid 1977-given ioughly a 7 peicent real GNP gain at annual r'mt~ in
the first half-ieal G~P was 61/2 peicemit abo\e its previous peal just about
half of the average gain in the compam able timespan in pre~ ious cycle ~ni1
real business capital spending was still about 8 percelitbelow the previous peak
against an averageadvance of nearly 8 percent in previous cycles. (These num-
bers are "subject to checking agaiiist the' 2d quarter GNP data being released
by Commerce today.)
94-071-77-----lO
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142
Other measures confirm the ample United States economic potential your
Committee can count on-and help realize-through your budgetary policies
and actions:
Factories operated at an average of 83.5 percent of capacity in June against
an 88 percent to 90 percent average in 1973.
In the materials industries-such as chemicals, paper, basic metals and tex-
tiles-where the worst bottlenecks and shortages occurred in 1973-74, operating
rates averaged 83.2 percent in June, or 10 points below their 93.1 percent peak
in mid-1973.
Taking the broadest view of available capacity, namely, our GNP potential at
full employment (defined here as 5 percent unemployment), one finds that actual
output was running $116 billion below potential as conservatively calculated
under the formula developed by the CEA under Alan Greenspan and $t18 billion
as more liberally calculated under the formula developed by George Perry of
Brookings.
Clearly, the margin for unrealized growth on which fiscal and monetary policy
can draw before courting the risks of excess demand is very large indeed.
THE 1981 BALANCED-BUDGET TARGET
Can we and should we balance the Federal budget by fiscal 1981? That vexed
question bites off more than I can comfortably chew in this brief statement. But
it is so vital to the Committee's efforts to formulate a responsible fiscal policy that
I should at least outline some of the factors and issues that bear on the answer.
The "can we?" terrain is by now fairly familiar. To achieve the high-employ-
ment prosperity that is essential for budget balance will require outstandingly
good policy and extraordinarily good luck. It requires nothing less than a com-
bination of fiscal and monetary policies that will generate 5'/2 percent real
GNP growth a year between now and 1981 even in the face of budget restraint.
A sustained private investment boom would have to lead the way. There is no
precedent-not even in the 1961-65 noninflationary expansion-for quite such a
stellar economic performance. Not that it couldn't happen here. But it would be
a heroic fiscal feat.
That brings us to "should we?" Let me cite just four issues that must be faced
in answering this question.
First, one should bear in mind at the outset that a balanced budget in the
1980's implies a considerably different macro-impact--considerably less support
for aggregate demand-than it did in the 1950's and 1960's. Why? Because the
composition of the budget has changed. Purchases are a shrinking percentage,
grants and transfers are an expanding share, of total Federal outlays. In the
mid-1950's purchases were two-thirds of Federal outlays; little more than a dec-
ade later, this proportion had dropped to one-half; today, it is one-third.
A dollar of transfer payments, some part of which will be tucked away in sav-
ings, represents less aggregate demand than a dollar of Government purchases.
So a balanced budget in fiscal 1981 would represent a good deal more restrictive
fiscal policy stance than a balanced budget in the 1950's or 1960's.
Second, if the OPEC countries continue to run a large surplus-if our dollar
out-payments to them significantly exceed our dollar intake from them-the sur-
plus or savings will have to be matched by deficits or negative savings somewhere
in our economy. If a sustained investment boom does not materialize-if private
business and homebuilders don't incur the deficits-Uncle Sam will be the logical
nominee.
Third, the surplus into which state-local budgets are moving-especially in
their pension and retirement fund financing-pose a similar offset problem. In a
sense, if no one else offsets those savings by boosting their investments (and bor-
rowing), the Federal Government again becomes the residuary legatee of the
required deficit financing-unless, of course, one gives up the high-employment
goal.
Fourth, much depends on the Federal Reserve System. To the extent that it
provides the monetary conditions, the relative ease, that stimulates investment
and absorbs the savings that otherwise become excessive, the cause of budget
balance is well served. But a Federal Reserve dedicated above all else to slay-
ing the inflationary dragon may not be very accommodating.
PAGENO="0147"
143
A NET TAX CUT IN 1978
Would a net tax cut be responsible fiscal policy in 1978? Let me list a few
considerations that add up to a "yes" answer for a modest permanent tax cut:
As Brookings analysts have pointed out in their fiscal 1978 edition of Setting
National Priorities, a full-employment economy in 1981 would generate between
$22 and $27 billion of tax revenues in excess of President Carter's target of a
Federal sector limited to 21 percent of GNP (while allowing for significant but
not generous increases in Federal programs).
A figure in the same ballpark-about $25 billion-represents the increase in
income tax liabilities that would be automatically "legislated" by inflation (at
5'/~ percent per year) by 1980.
Next year seems an appropriate, even an excellent, time to return some of that
sum to taxpayers, for four main reasons:
(1) to lubricate the major tax reform that Mr. Carter will soon launch;
(2) to provide some of the economic insurance needed to keep aggregate
demand, and hence the economy, expanding at a good clip later in 1978 and into
1979;
(3) to provide an extra dimension-beyond a matching of revenue gains and
losses-to the favorable investment environment needed to bring full employment
within reach by 1981;
(4) to offset some of the excessive toughness of monetary policy as it follows
its duly self-appointed rounds in the battle against inflation.
This proposed moderate tax cut in 1978 has a quite different orientation and
more modest objective than the Great Tax Cut of 1964. But it has a constructive
role to play in a fiscally responsible policy.
The CI-IAIRMAN. Let me say, it is a pleasure to have the two of you
here. You are two of America's finest national economists. You point
up the problems that we in Congress, poor souls, must face, without
nearly your experience.
Mr. GREENSPAN. We probably agree on 90 percent of the issues.
Usually we argue about the 10 percent. I can't say I find myself ter-
ribly at variance with his general view as to the tax cut. Former Presi-
dent Ford was recommending one when he set out to offset the infla-
tion tax created largely by the rise in the surtax structure. But aside
from that I think there are some fundamental differences which will
elucidate where the range of economic opinion exists among most
econoirnsts.
I would have agreed with most of what Professor Heller has said
provided we had a situation in which risk premiums or, colloquially,
business confidence was normal. Because if it were, then the impact
fiscal and monetary stimulus would behave much the way we perceive
it to have behaved in years past.
I, myself have gone through an extensive analysis of the capital
goods and find not only do we have a shortfall, but it is localized in
what we would call long-lived assets whose rate of return is not readily
perceivable until the 8th, 10th, or 15th year of the life of an asset.
We have had more than an adequate rise in assets where the cash return
is very quick, such as motor vehicles. Short-lived equipment is also
doing very well. So the capital investment shortfall is localized in
exactly the areas where one would expect that high-risk premiums or
low-business confidence would impact. This phenomenon exists not
only in the United States but to a greater extent throughout the non-
Communist world. What it does, is very dramatically changes the
nature of the types of impacts which fiscal and monetary policies have.
The sort of "other things equal" concept which is applied to the anal-
PAGENO="0148"
144
ysis of fiscal stimulus and the like, is precisel3r that, that risk premiuim
is normal. \Vhen it is not, `it fundamentally changes the response of'
the system to these various types of policies, and we have seen this
occurring in many other countries. In the most graphic form, it is,
demonstrated in the United Kingdom where we have had exceptionally
large fiscal stimuli year after year and we find somehow the economy'
continued to deteriorate. `What we are observing is the deterioration of'
the business confidence in the United Kingdom, with the consequences.
of what is known worldwide as the "British disease."
Finally, when we evaluate the efficacy of fiscal stimulus, let us re-
member that had we known the Federal expenditure shortfall which~
existed 6 months ago, that is, if we had known the actual degree of'
fiscal stimulus which would take place in the period,, subsequent to,
last December, 1 venture to say nobody would have forecast anywhere
near the type of economic growth which we subsequently saw. This.
raises `a very important question. Namely, how is it possible that we
got the type of economic response who have been seen with, that must.,
described as fiscal stimulus in the last 6 months for less' than anything:
which `had been contemplated? It is not only that we have had Federal
outlay shortfalls under expectations, but we have, also had the elirnina-.
tion of the rebate. Had they been known in advance, fiscal policy would~
have been labeled as exceptionally stringent. which, if' fiuctorecl into~
through the existing models based on Past relationships, would have-
forecast a 3- or 4-percent growth rate for. the. first half; rather tham
7 percent.
What has happened is that the risk premium has come down and
business confidence has improved. Even thouigli we have' not had any-.
thing which could be conceived of as a dramatic recovery in the capital
goods market, we have seen a recovery. Even with the subnormal coii-
fidence we do see a recovery throughout the rest of this year and
t.hrou~h 1978 which will increase capital expenditure at a' rate not tern- -
bly different from what the administration, itself, has' been estimating.
Now I a.~ree with Professor Heiler that the proba:b~l.ities `of getting -
the type ~f increase `rn private capital investment which are required'
to obtain the administration's levels .of uneinployiment by, say, 1980
are a relatively low `probability outcome.
However, in their deife.nse~ I think you `ought to recognize we are
starting from a rather low `base in the capital goods `market and accord-
ingly the leeway for a. rise is there. The probability, I' would reiterate~
is small `but it is essential that we get as nmc;h as we can in that. area
and the only way is to get risk premiums down and business confidence'
up.
Finally, with respect to tax cuts. I would think at this stage, that'.
while you can't substitute tax cuts for lack of bus'iiuess" confidence.;.
you `can at- least `partially offset it.
If you decrc;ase~ for example, the corporate. tax, you can, at least'.
in a short run. offset the high-risk' premiums' impact on' after tax
expected e.a.rnmgs. `
I ~ ie~ the le\ ci of tex on cepit'ul pci se `us the piob1ern `~ hich should
be addiessed We ha~e o~ei1o'uthd oni ta~ system in rccent `~e'u~ to
1 es 1 am i `ut~hei than enh'mnce c'upit'ul mm estmenf It us `u process w hich
has occurred since the very effective tax cuts which we,rn'iiiitiimted `by:
PAGENO="0149"
145
Walter Heller back in the early 1960's. What we need now is a
iCennedy-type tax cut which my colleague here created and supported.
]It would be a very good idea if he dragged out all his old recommenda-
tions and resubmitted them.
The CHAIRMAN. I will turn now to the minority side. We have now
a member of the mii~ority who has been straining at the leash to get
into tax cuts, and particularly the Kennedy tax cuts, which he has
been advocating for some time in this committee.
Mr. BURGENER. He used to be a Democrat.
Mr. RoussEr~oT. I didn't know about my straining at the leash.
Thank you both for being here, we appreciate it.
Dr. Heller, do you want to tell us, as the architect of the previous
Ticennedy tax cut, what portions of that you might suggest now or not
suggest? Tell us the specifics of it.
Mr. HELLER. The answer to that has to be a fairly extensive one.
Mr. ROUSSELOT. It is all right with me.
Mr. HELLER. The Kennedy tax cut in 1964 which was a $12 billion
~cut in a $636 billion economy, was almost 2 percent of GNP.
No. 1, it was one of a series of steps. It followed the investment credit
introduction and the liberal depreciation guidelines of 1962. By the
* way, that was not terribly effective until we coupled it with a strong
consumer tax cut which boosted sales volume.
Mr. RoussELoT. Across the board?
Mr. HELLER. Across the board; and somehow, I find that rising sales
volume and high and rising profile are just a marvelous tonic for busi-
-ness confidence. There is a strong correlation between the stimulus to
aggregate demand and growing business confidence, coupled with the
feeling of business that it can count `on a reasonably stable expansion-
-ary policy.
I don't want to say the advent of the Carter administration wholly
accounts for this increase in business confidence during the first 6
months but maybe it had something to do with it. I say that only partly
~acetiously.
Second, we had a special set of circumstances as related to the tax
cut, itself. V,Tith all due respect to the Congress of 1963 and 1964, there
was not as much understanding of fiscal policy then as there is today.
COne of the reasons we went for the big tax cut is because we butted our
* head against a brick wall on the expenditure side and Kennedy could
not get the Congress to go along with an expenditure expansion pro-
- gram as the path to full employment. The tax cut was an attempt to go
a route that would bring about a coalition of conservative and liberal
-elements on a modern fiscal policy. This was really a first in that
Tespect.
Third, remember as part of this argument, we had a 90-percent
:marginal tax rate. We really had to do something about the income
tax rate structure. We also wanted to do some lubricating of tax re-
form. Very little tax reform came into effect in 1964, but a little bit
-did. This is the way I put it in my Godwin lectures at Harvard: Under
-the circumstances that then prevailed, "the surest path to adequately
financed Government programs was paradoxically, through tax reduc-
tion. The upsurge of tax revenues flowing from economic expansion
-would finance higher levels of local, State, and Federal spending than
~we would have had without the tax cut's stimulus."
PAGENO="0150"
146
Mr. ROUSSELOT. Wouldn't that apply today?
Mr. HELLER. Today, it seems we have a much more open approach.
Remember, we ran into a truly brick wall. I quote here the comment
that President Kennedy made to me just 11 days before the assasi~
nation: "First," he said, "we'll get your tax cut and then we'll get
my expenditure programs."
The tax cut is not the only way to get full employment. Increasing
expenditures is a clear-cut alternative to increasing fiscal stimulus
through tax cuts.
Mr. ROUSSELOT. What would you recommend across the board?
Mr. HELLER. Of the total of about $22 to $27 billion of tax cut
margin under the Carter 21 percent of GNP formula until 1981, I
might say $10 billion of tax cut next year, or somewhat more, would
be in the ball park. But it is a little early to judge what might be
needed in terms of both lubricating tax reform and supporting eco-
nomic expansion.
Mr. ROUSSELOT. Is that about 5 percent?
Mr. HELLER. Personal tax collections would be $170 billion, so you
are talking about 6 percent on personal. I am not necessarily saying
that you should do it across-the-board, but that amount of lubrica-
tion for the reform process and for the economy might make good
sense next year. That is far from $40 billion which would be compar-
able in the 1964 tax cut.
Mr. ROUSSELOT. Twenty percent, I guess that would calculate to-
Mr. HELLER. $2 trillion-plus of GNP, in current dollars next year
and if you took about 2 percent of that, it would be about $40 billion
tax cut.
Mr. ROUSSELOT. Mr. Greenspan, do you want to comment on this?
Mr. GREENSPAN. Any form of cuts in taxes on capital investment,
irrespective of what they are, can help. The marginal impact of such
a tax on levels of economic growth and employment are probably
a larger area than anything else I think we can do. So while I tend
to favor individual tax cuts as well we must concurrently constrain
expenditures, because the one thing I don't think we need is general
overall stimulus. It would be a mistake and, turn out to be non-
stimulative over the long run.
While I do agree it would be difficult to get to a balanced budget
by 1981, it is not difficult to get there by 1982. So long as we start
moving in that direction we can create a noninflationary environ-
ment which is a necessary condition to reduce the risk premiums
which in turn is a necessary condition to get private capital invest-
ment going which is necessary to ~et the economy back on track.
The CHAIRMAN. I have a question I would like to send to you,
which can be answered in writing.
[At the time of printing the information was not received.]
The Chairman. Can you stay roughly another half hour?
Mr. HELLER. Yes.
Mr.. GREENSPAN. Yes.
[After recess.]
The CHAIRMAN. Again, we apologize for the interruption, but you
gentlemen are well aware of the problem.
Mr. Burgener.
Mr. BURGENER. Thank you, Mr.. Chairman.
PAGENO="0151"
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I would like *to ask our two distinguished witnesses-perhaps it
was covered earlier-about full employment. We had a press confer-
ence this morning introducing an illegal alien bill. We are told about
3i/2 million illegal aliens hold full-time employment in this country.
I guess we all have our own definition, but what is your definition of
full employment? What do each of you think that is, in your view?
Mr. GREENSPAN. You mean percent of the labor force?
Mr. BURGENER. Yes.
Mr. GREENSPAN. About 5 percent, meaning a level of unemployment
below which would create conditions in the system, that would begin
to give you self-defeating inflationary forces.
Mr. IJELLER. I go along with that, although I do try to distinguish
between the employment level in terms of the pivot point versus the
target point. The pivot point is what Alan Greenspan has described,
a point beyond which the aggregate demand that you generate to try
to push unemployment down begins to run off into too much in-
flation. One might set a target below that by saying, as perhaps Mr.
Carter is saying, that yes, he would like to get below that by taking
nonmonetary, nonfiscal measures, direct job creating measures to get
`below that. But that is a footnote to the target of 5 percent.
Mr. BURGENER. Some years ago we required all recipients of public
assistance to register for employment; some are employable, some
are not, some should be working, some shouldn't, for valid reasons.
But I am told this meant something like a 2-percent bulge in the real
figure, that it really increased. When you looked at 8-percent employ-
ment you might really be looking at 6 percent.
Mr. GREENSPAN. I would suspect 2 percent is too large a number.
Mr. HELLER. The Department of Labor has looked at those findings
by the two economists you are referring to and have concluded they
have vastly overrated the significance of that registration impact on
the unemployment rate. I am pretty much persuaded by the Labor
Department analysis.
Mr. BURGENER. To tax your memories and your knowledge, which
is much greater than mine, what really happened back in the era of
1920 to 1921? Is that when `Mellon was Secretary? Were there tax
cuts at that time? What was the situation? I am told after World
War I we had a quick recession and there was some debate as to what
to do about it and the Treasury said we must cut taxes, which they
did. Do you have any recollection as to that?
Mr. HELLER. Well, I have very limited recollections.
Mr. BURGENER. I don't mean were you there. I assume you must have
read about it.
Mr. ITELLER. I do remember having my first job in 1921, picking
strawberries when there was a terrific labor shortage in the Pacific
Northwest, but that was on the upswing, not the downswing.
During the early 1920's, I don't think the impact was too much in
the early 1920's and this may be a reflection of my imperfect memory
of the period. But during the 1920's, as a whole, the Mellon aim was
to cut taxes. While the 1920's ended with a bang and a crash, there
was a period of successive reductions of taxes under the Mellon
philosophy.
Mr. BURGENER. But that was unrelated, so to speak, to the crash.
Mr. GREENSPAN. That was a commodities crash which came along
very quickly and went away very quickly.
PAGENO="0152"
148
Mr. HELLER. They were not part of an anticyclical policy. We really
didn't pick up that kind of a fiscal policy until well in the 1930's.
Mr. BURGENER. Didn't we do all the wrong things in the 1930's.
Didn't we choke off credit? Whatever we did, it must have been wrong,
because it didn't work.
Mr. HELIJER. There are two concepts; among the two of us, there
are probably three.
The CHAIRMAN. Do you have to go back to the 1930's?
Mr. BtTRGENER. Yes.
Mr. HELLER. We did some of the wrong things and there is no doubt
monetary policy was restrictive. But as far as fiscal policy is concerned,
we started out by trying to balance the budget in 1933 with "tem-
porary" income tax increases and excise taxes not repealed until 1965.
So we went the dead wrong way and worsened the period. Then, later
in the period after Roosevelt began to get the message, he tried to
stimulate the economy by pump priming: Analyses by Cary Brow~i at
MIT show that the stimulus was in the right direction, but there was
not enough of it. The Federal leverage was not great enough to pull
us out of the depression.
Mr. GREENSPAN. That evaluation was made in retrospect. At the
time the general view was the huge shortfall which occurred in private
investment was due to lack of confidence. The risk premiums in the
1930's were very high and you had the same sort of phenomenon then,
multiplied manyfold, that you have now.
History tends to get reinterpreted on the basis of our current
theories. I would be much more inclined myself to accept the views
of the time, which in retrospect, I think were quite valid, namely that
we made too much of an attempt at changing the economic structure,
Government engaged in too much activism which, in turn, created a
very high degree of uncertainty and, as a consequence, led to the 1937
depression, one of the sharpest we have had in American history. So,
I would most certainly disagree that on the basis of what we know,
the degree of stimulus we had was inadequate at the time.
Mr. BURGENER. Finally, into the 1970's now-
The CHAIRMAN. Your time has expired.
What factors are most significant in the underlying inflation rate?
* Which factor is most susceptible to Government policies and actions?
What would you suggest we do and how do you evaluate our efforts
* and the Carter administration's efforts to date in that regard?
Mr. Heller.
Mr. HELLER. Do you have an hour?
The CHAIRMAN. No.
Mr. HELLER. Do we have excess demand, too many dollars chasing
too few goods? The answer is no way, as the fourth segment of my
-testimony suggested. Second, is there a lot of external shock inflation
of the type which triggered the double-digit inflation in 1973 and 1974,
for example, oil price explosions, devaluation of the dollar, and so
forth, and a 40-percent increase in food prices. You don't find much
- evidence of that unless the searing heat were to seriously damage crops.
Also, OPEC seems to be fairly quiescent. So what does it boil down to?
To cost push inflation, that is largely wage push inflation. That is not
-the same thing as saying labor is responsible for the price-wage spiral.
lIn this case those shock factors and excess demand in 1973 and 1974
PAGENO="0153"
149
created double-digit inflation, boo~ted living costs sky high and started
putting wage increases on a fairly high plateau. With an annual rise
of 8 percent or so in average hourly compensation and about a 2-percent
to 2i/2-percent offset in terms of productivity per hour, you would have
a 51/2-percerIt built-in rate of inflation. That is how most of us have
forecast inflation in the past, and it has been a fairly good way for
forecasting inflation for the past year.
So you have the self-propelling cost-price spiral. Unless you can.
deescalate that spiral, we are going to be very hard put to it to get
inflation below the 5- to 6-percent range.
It also says, by the way, that to try to choke off economic expansion
by tight money or by rigidly tight fiscal policy is going to have a very
small payoff in bringing down the inflation rate because it is not a.
demand-generated inflation, it is a cost-generated inflation..
Now as to solutions: On this, I am afraid I am a broken record. I
think we need some kind-and in the past I have had such allies as
Arthur Burns, for example-some kind of wage-price gentle restraint
with Government getting some consensus machinery operating-they
have a faint facsimile in the Reginald Jones/George Meany commit-
tee. Then, through the Council on Wage and Price Stability-
COWPS-the Government identifies what is an inflationary and non-
inflationary wage settlement, what is and is not an inflationary price
decision. I would expect some followthrough by Barry Bosworth, the
newly appointed director of COWPS, in terms of pointing the finger at
those stepping outside the bounds. That means the kind of wage-price
guidelines both labor and business hate. That may stir up fears of
full-fledged price and wage controls. There is a small minority favor-
ing these but go to 95 percent of our economics profession abhors man-
datory wage-price controls. But it does mean the Government has to
enter in a more positive way wage-price decisions in which competi-
tion is not a good policeman. In a limited way, Government has to be
the proxy for the competitive system.
That's a fairly easy thing to specify but a tough thing to implement.
I don't think the Carter administration has gone far enough, maybe
they are biding their time.
The CHAIRMAN. Thank you.
Mr. Regula.
Mr. REGULA. Both of you had said to achieve the balanced budget by
1981 would require a lot of luck and, Mr. Greenspan, if you were advis-
ing the President, given the fact of that business lack of confidence,.
and I have heard that you are advising the President in terms of his
fiscal policy, but if you were advising the President how would you
overcome this risk premium element you have alluded to? I think it is.
very important for a long-term recovery of the private sector.
Mr. GREENSPAN. It may seem I am advising the President, but I can.
assure you I am not.
First, you have to identify where the sharply higher risk premiums
have come from. There are a number of sources. Most of the blame,.
owes to the inflationary instability in our system, that `has created a
fear of further instability, which is directly convertible into the risk.
premiums which act as suppressants to capital investment. .
Therefore, more than any other condition I can think of, it is essen-~
tial to get the rate of inflation down. How you do that does involve~
PAGENO="0154"
150
differences in theory and Walter and I don't exactly have the same
view as to how to do it. I would say, without getting into a theoretical
discussion, that the key to that is to get the budget as quickly balanced
as is possible in order to remove its pressure on the capital markets,
which increased Federal borrowing tends to exert.
So I applaud the President's goal of a balanced budget by fiscal year
1981 and I wish him well. I have a suspicion he will have difficulty get-
ting there, but even if he gets it in 1982 he will have diffused most of
the inflationary pressures.
Mr. REGULA. Do you think Congress, given the multitudes of pres-
sures that we are subjected to from pressure groups, do you think we
are equipped to handle fiscal policy in our present structure which cer-
tainly seems to be a key element as I listen to your testimony?
Mr. HELLER. I will put it this way: You, the Congress, are a lot
better equipped than you were a few years ago. The existence of this
committee, the Senate committee and the joint budget process puts
you in a better position to run a responsible fiscal policy and I think
has had something to do with the fiscal restraint that has been exer-
cised. You have translated what is obviously a national desire for fis-
cal restraint, for a curbing of Government expenditures, into a re-
strictive fiscal policy. When you meaure it by the standard rule of
thumb as to what the budget would be if we were rmming at full em-
ployment, the budget deficit *this fiscal year looks like something
around $6 billion and maybe $19 billion in fiscal year 1978, under the
Carter stimulus program. So there will be some fiscal expansion in
the budget.
Mr. REGULA. You are talking in terms of a full expansion budget?
Mr. HELLER. Yes, putting this all at 5-percent unemployment, both
revenues and expenditures. Some outlays are designed to self-destruct,
such as public works programs, expenditures for countercyclical aid
to State governments, and some of the job programs. If you take that
out you find the full employment deficit is about $3 billion for fiscal
year 1977 and next year about $10 billion.
But to come back to the central point, I know it is tough, but I think
we are in a far better position to try to work out, say, a Federal Re-
serve-White House-congressional kind of coordination now, than we
would have been without the congressional cooperation a few years
ago.
The CHAIRMAN. Dr. Greenspan, how do you measure risk premiums
and in which sectors are they the highest?
Mr. GREENSPAN. It is a r~tte of discount. It is a type of interest rate
which is employed by companies in their capital appropriations proc-
esses: It is a rate which they use to discount their expected future
earnings in order to evaluate them. The larger the risk premium or
interest rate, so to speak, the less desirable is the investment, other
things equal.
It is not something which one observes directly by sample, but there
are a number of series from which one can infer what it is. One is the
yield between relatively risky corporate bonds and riskless government
bonds of the same maturity. The only difference in those two interest
rates is the degree of risk involved in investing in a medium risk sort
of corporate instrument. That would be one measure.
PAGENO="0155"
151
The second one which is employed to a larger extent by the eco-
nomics fraternity is a measure which attempts to relate the market
value of existing physical assets as represented by the market value
of their underlying securities-the value of common stock and debt-.
as a ratio to the replacement cost of those facilities. This is a meas-
ure, Mr. Chairman, which is outlined in the Ford administration's 1977
Economic Report. All measures indicate a significant increase in risk
from the late 1960's through late 1974, early 1975, with some decline
since then.
The CHAIRMAN. Wouldn't the risk premium depend upon the avail-
ability of money and wouldn't a more liberal monetary policy decrease
the risk?
Mr. GREENSPAN. I would doubt if it would have any significant im-
pact because what causes this is largely a concern over the longer
term. It is not something which is essentially related to a short-term
focus.
Certainly if it is perceived that Federal Reserve policy is essen-
tially moving to diffuse inflationary forces that would, other things
equal, tend to lower risk premiums, but I doubt if it would do it
quickly. What we need is a much longer healing process, which, sir,
is currently underway and I am frankly terribly concerned that we
are going to dissipate the progress which has been made to date.
The CHAIRMAN. Any further questions?
Mr. REGHLA. This has been one of the most instructive hearings I
have been in during my short tenure on the committee.
Mr. BrIRGENER. I echo that sentiment.
The CHAIRMAN. Thank you very much, gentlemen. I certainly want
to add my appreciation to that of the two gentlemen. We are grateful
for having the opportunity to hear from both of you. We apologize for
the delays and for the late hour.
[Whereupon, at 1:45 o'clock, the committee was adjourned.]
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