Meanwhile, the outlays on human resources have increased and are proportionately a larger share of the overall budget dollar than are defense outlays.

Just a few highlights. It is kind of interesting to see what is happening in terms of our priorities. Sometimes we don't quite see the impact of what is going on, and this chart on environmental programs is an example. The environment has been very much under discussion in the past 2 years. You can see what has happened in the environmental area.

This is a plot of budget authority rather than outlays to show what is being projected. This part of the chart shows budget authority for recreation and parks, and so forth, and this is pollution abatement and control. You can see that this line, showing the total of the two, is just shooting right up almost off the chart.

Here is another subject that has gotten a great deal of attention, expenditures for food assistance, feeding the hungry. You read in many of the newspapers that this program has been getting cutback somehow or other. When you look at what has happened to expenditures you can see that is hardly the case. The expenditures have grown and grown exceedingly rapidly.

PROVIDING FUNDS FOR STATE AND LOCAL GOVERNMENTS

One of the chief initiatives of the President, one of the things that he has borne down on most heavily in the budget and the state of the Union message and all of his discussions and thinking, has been decentralization, changing the flow of money and power so that more of it is placed in the hands of the officials of State and local government and changing the tone and administrative thrust of people throughout Government. Against that background, it is interesting to see how the outlays for grants-in-aid have gone. You see how rapidly they have grown in the last decade, from a decade ago roughly $7 billion up to about $38 billion projected in this budget. Of course, one of the things that just must be the case is that most all of this money has had attached to it matching funds, so that through these large increases in Federal outlays with matching funds attached to them, the Federal Government has laid onto the States and the localities a Federal sense of priorities that has offset the spending of State and local funds and made the States and localities order their funds in the manner directed by Federal appropriations.

REVENUE SHARING

I think part of the fiscal crisis in the States and localities is the result of this process, and this is one of the reasons why the President in his revenue-sharing proposals, both general revenue sharing and special revenue sharing, has sought to reverse this process by removing the matching requirements from the special revenue-sharing funds and putting forward a large package of general revenue sharing.

I am sure that you are familiar with that, and I won't go into the details here on the revenue sharing as such. You are familiar with the program of $16.4 billion worth of revenue sharing in terms of budget authority, with the $5 billion in general revenue sharing projected

to rise as the personal income tax base rises reaching roughly $10 billion by the end of the decade; and with special revenue sharing involving the uniting of funds into the broad groups of education, manpower training, transportation, urban development, rural development, and law enforcement.

The categorical programs that are united into these six areas add up in budget authority to about $10.4 billion. The President then added to those, as an expression of priorities, an additional $700 million spread through these categories, and then reserved $300 million in order to be sure that we can make good. We think there is no question that we can on the whole guarantee these amounts to States and localities, although the distribution of these funds may be altered slightly by uniting them into the six broad groupings.

I have some additional terrific charts here, Mr. Chairman, but I think that maybe that is enough. You can see that in general the full employment budget concept, as the President thought about it and developed it, is a central part of his budget strategy. I have tried to convey a sense of why he adopted it, what the idea is all about.

GROSS NATIONAL PRODUCT ESTIMATE UNDERLYING BUDGET

You also raised in your opening statement a question about the economic assumption underlying the receipts estimate. I note Chairman McCracken will talk in detail about that and I won't attempt to get to it, beyond saying that my own judgment, for what it is worth—and I read in the papers that lots of people don't think it is worth very much-is that, it seems to me important for the country that we do reach the rate of growth in real` gross national product that is implied by the administration's estimate. I think that that is a perfectly attainable goal, a possible goal, a probable goal, and it would be the best estimate that I could make.

DISCIPLINE OF THE FULL EMPLOYMENT BUDGET

I also believe that we should be cognizant of the discipline implied by this concept as well as the thrust that it gives. I read that many suggestions have been made already that what this country needs is a large full employment deficit. I can only say, Mr. Chairman, that we had large full employment deficits in 1967 and 1968, and we lived very high on the hog for a year or two, but we have paid a price for that. What we have emphasized here is not any kind of a rigid sort of a formulation, but an idea that does provide a discipline. As a Budget Director, I want to assure you that I will be reminding people in the executive branch, and if anybody asks me, in the congressional branch, of the fact that there is a discipline built into the full employment budget idea, and it is very important to observe it continuously.

Thank you very much, Mr. Chairman.

Mr. MAHON. Thank you, Mr. Shultz.

Mr. McCracken, Mr. Shultz made some reference to the underpinning projections included in this budget. As you know, in the original budget, a year ago, it was estimated that during the current fiscal year 1971, we would have a unified budget surplus of $1.3 billion. In this new budget, the fiscal year 1971 unified budget is reestimated at a deficit of $18.6 billion. In other words, for a variety of reasons, there has been a worsening of about $20 billion.

One of the assumptions in that original budget was that Congress would pass certain legislation to raise revenues or reduce expenditures. There are many other factors involved. I hope in your statement that you will cover some of the things that tend to justify and explain this radically changed budgetary outlook for the current fiscal year.

We are pleased to have you before us, Mr. McCracken. We have heard you before and know of your dedication and knowledge of the subject. We know what you say will be valuable to the committee and to the Congress.

STATEMENT OF THE CHAIRMAN, COUNCIL OF ECONOMIC ADVISERS

Mr. MCCRACKEN. Thank you very much, Mr. Chairman and members of the committee. I want to express also my very deep appreciation for this opportunity to be here this afternoon. I do have, Mr. Chairman, a statement that is a little longer than I think it would be appropriate to read. I would like to summarize it in my comments here and then submit the entire statement for the record.

Mr. MAHON. That will be entirely satisfactory.

In previous years we have always had this hearing printed and made available to the Congress and to the country. Certainly we want the printed version to contain all of the helpful information that we will need in the consideration of the President's budget and various programs which have been submitted. So use your own judgment as to how to proceed.

Mr. MCCRACKEN. Thank you. (The statement follows:)

STATEMENT OF PAUL W. MCCRACKEN, CHAIRMAN OF THE COUNCIL OF

ECONOMIC ADVISERS

Mr. CHAIRMAN. I welcome this opportunity to appear before the Appropriations Committee today. Since the Secretary of the Treasury and the Director of the Office of Management and Budget have covered the budget and fiscal picture, my brief remarks will be concerned with the interrelationships between the budget and the economy.

I

We want the fiscal activities of Government to do two types of things for us. For one thing, they should provide for the amounts and kinds of consumption, investment, and transfers of purchasing power that we want to do collectively through Government. Through them we make provision for education, research, buildings, national defense, welfare, and other programs that cannot be handled effectively on an individual basis. These are the programmatic aspects of the budget, and inevitably they must consume much of Government's budgetary activities since competition among rival claims for our productive resources is becoming increasingly intense.

We also want the budget to be a fiscal plan whose implementation will be consistent with and help us to attain our overall economic objectives for "employment, production, and purchasing power" (in the language from section 2 of the Employment Act of 1946). And that means that the first requirement in the deployment of economic policies must be a clear and explicit view about where we want the economy generally to go in the year or so ahead. Economic objectives and economic policies are inextricably intertwined. This is good sense, but section 3 of the Employment Act of 1946 does explicitly call on the President to transmit each year to the Congress an economic report "setting forth the levels of employment, production, and purchasing power * ** needed to carry out the policy declared in section 2 * * *"

п

The objectives for economic policies in 1971, set forth in the Economic Report as required, are to resume a vigorous and orderly expansion of the economy in 1971, with gains in real output and employment and further progress against inflation. It has been given expression in the GNP projection of $1,065 billion. This is an ambitious target, but an ambitious objective for economic policy is now in order because of the need to expand job opportunities. Under pressure of the disinflationary policies in 1969 and 1970, businesses took stern actions to pare excessive costs and to achieve a more lean and efficient operation. As the economy now expands we can expect to see large gains in productivity. These gains, the ongoing growth of the labor force, and for some operations the return to a full workweek mean that we can have the large increases in output that are needed before the economy again crowds against the outer limits of its productivity capacity.

Moreover, we need a vigorous expansion to facilitate the job creation essential for absorbing into productive employment those leaving the service or whose incomes were terminated by reduced defense production. As pointed out in the Economic Report, employment attributable to Department of Defense expenditures will have decreased by 1.8 million people from its peak in fiscal year 1968 to fiscal year 1971, of which the decline in private employment will account for 1.3 million. Since this problem is more difficult than if these had been spread more evenly over the economy, a strong general course for the economy is more than ever urgent for 1971.

At the same time the $1,065 billion is an objective that is well within the demonstrated capability of the economy to achieve. It would mean a 9-percent rise in the dollar volume of economic activity, as measured by GNP, from 1970 to 1971; and it would involve a rise of 11 percent from the strike-depressed fourth quarter of 1970 to the final quarter of the current year. From 1958, when the price level stabilized after the inflation of the mid-1950's, through last year an increase at the annual rate of at least 11 percent was recorded in seven quarters, and in 12 quarters the rate was 9 percent or more.

The figure of $1,065 billion has drawn so much attention that the reasonable nature of the basic economic assumptions has been given inadequate attention. There are really five of these basic assumptions. One is the President's fiscal plan as put forward in the budget message and a complementary monetary policy.

Second, the saving rate is assumed to be 6.9 percent in 1971. This is below the 7.3 percent for 1970 but still well above the 6-percent average for the decade of the 1960's.

Third, 2 million housing starts are assumed for this year. The strongly rising trend of the last year, basic needs for housing, recent actions to deter the cost inflation, and the rapidly growing abundance of mortgage money-these suggest that a volume of starts for 1971 only slightly higher than the average level of the last 2 months is not an unreasonable expectation.

Fourth, business fixed investment in 1971 is assumed to be 3 to 4 percent above that for 1970. This is 2 percentage points above that projected from a Commerce-SEC survey conducted in October and November. This is a modest adjustment to allow for such major subsequent developments as the change in depreciation rules announced in early January, dramatic declines in interest rates toward the end of last year, and the usual tendency to scale projections upward as operating rates improve.

Fifth, State and local purchases of output are assumed to rise 112 percent from 1970 to 1971. This is somewhat larger than the 9.1 percent last year, but it is the average annual increase of the 5-year period 1965-70.

The actuality for 1971 will no doubt in each case turn out to be somewhat different from the assumptions made here. Some may turn out to be too optimistic; some may turn out to be too conservative. That has always been the case, and it will probably turn out to be true for 1971. These are, however, in each case reasonable assumptions, and some of the skepticism about the projections really seems to reflect reaction to the somewhat startling figures that a trillion dollar economy inevitably produces.

Whether the economy moves along the $1,065 billion path for 1971 depends heavily on our basic economic policies as well as on these assumptions which deal with the probable response patterns within the economy. The financial plan which the President put forward in his budget message assures that fiscal policy will be playing its appropriate role in the expansion. As a rough rule of thumb the new fiscal thrust can be measured by the projected increase in outlays plus the revenue

loss from a reduction in tax rates. The effects are not, of course, instantaneous, and visible effects on the economy can be expected to come along well after the changes in fiscal policy. There are, in short, lags.

Given these lags involved, the changes in fiscal policy that will be exerting their influence on the economy during the months ahead will be partly the fiscal stimulus in fiscal year 1971 and partly that in fiscal year 1972. This fiscal thrust (increased outlays plus the revenue loss from a decline in tax rates) in fiscal year 1971 will have been over $20 billion, and it is projected to be roughly $17 billion in fiscal year 1972. This would be equivalent in its economic effect to an increase of over 10 percent in expenditures in this fiscal year and 8 percent next year. These are quite consistent with the 9 percent projected increase in GNP for calendar 1971.

Fiscal policy will be doing its part, but it cannot by itself assure a vigorous expansion. Much will also depend on monetary policy; since the money stock is now about in line with the volume of economic activity, economic expansion will require a complementary monetary expansion. And we must be unremitting in our efforts to strengthen the internal resistances of the economy to inflation. What can reasonably be said is that the budget for fiscal year 1972 is consistent with the economic objectives that have been put forward.

One further comment on fiscal policy. The full employment budget concept has been the subject of much discussion, and a few comments on that may be in order here. The President has established the general guide that budget outlays should not, except in unusual situations, exceed the revenue-generating capacity of the tax system at reasonably full employment. It is useful to ask ourselves what the new element is in this concept. It is not the concept of having the budget, in a slack period, run at a deficit; i.e., adding more to the income stream through outlays than it takes out through receipts. That de facto has been public policy for several decades. The new principle is the concept of fiscal discipline even at a time when the budget should have an expansionist effect. In a period when a stimulative budget is in order it gives guidance about how far the budget can go without introducing a fundamental imbalance that would court trouble later. If this principle is observed, with the return to full employment the tax system will then be generating enough revenues to cover outlays and eliminate the deficit. The problem, of course, in fiscal years 1966 to 1968 was that a budget condition was allowed to develop where the revenues that the tax system could generate, even with the return to full employment, fell far short of covering outlays.

III

Is a strong expansion consistent with further progress against inflation? This is understandably a question that has arisen in recent weeks. The long inflation has been too stubborn and vexatious a problem for easy optimism, and price-cost developments must be a matter of particular concern this year. Further progress here, however, is a reasonable expectation. For one thing progress has already been achieved, even though we would all agree that it has been hard going. The long acceleration in the rate of inflation was halted by late 1969 for the wholesale price index and by early 1970 for consumer prices. By the second half of the year industrial wholesale prices were rising at the rate of 3.4 percent per year, and if we exclude prices of fuel and energy (which have been particularly disturbed by special factors), the annual rate would have been still lower in the second half of 1970. We must resist reading too much into isolated figures. January is an instructive example. The substantial rise in the wholesale price index does not mean that all has been lost, and the smallest increase in 4 years in the Consumer Price Index does not mean that we have it made. What we can see is that when we stand back and look at price developments in perspective, we see that the basic trend in the rate of inflation seems to be downward, that this is more evident for wholesale than prices that consumers pay, and that this is a normal sequence when the rate of inflation is changing directions.