THE FEDERAL BUDGET FOR 1971

MONDAY, FEBRUARY 9, 1970.

WITNESSES

DEPARTMENT OF THE TREASURY

HON. DAVID M. KENNEDY, SECRETARY

MURRAY L. WEIDENBAUM, ASSISTANT SECRETARY FOR ECONOMIC POLICY

THOMAS F. LEAHEY, ASSISTANT DIRECTOR, OFFICE OF TAX ANALYSIS

THOMAS W. WOLFE, ASSISTANT TO THE ASSISTANT SECRETARY ERNEST C. BETTS, JR., DEPUTY ASSISTANT SECRETARY FOR ADMINISTRATION AND BUDGET OFFICER

BUREAU OF THE BUDGET

HON. ROBERT P. MAYO, DIRECTOR

SAMUEL M. COHN, ASSISTANT DIRECTOR FOR BUDGET REVIEW COUNCIL OF ECONOMIC ADVISERS

HON. PAUL W. McCRACKEN, CHAIRMAN

MURRAY FOSS, SENIOR STAFF ECONOMIST

ALBERT COX, SPECIAL ASSISTANT TO THE CHAIRMAN

OPENING REMARKS OF THE CHAIRMAN

Mr. MAHON. Early in the session each year for several years we have had a meeting of the full appropriations committee for the purpose of hearing the Secretary of the Treasury and the Director of the Bureau of the Budget. We are having such a meeting today with the Secretary of the Treasury, Mr. David Kennedy, and Mr. Robert Mayo, the Director of the Bureau of the Budget. At about 11 o'clock, Mr. Paul McCracken, the chairman of the President's Council of Economic Advisers, will also be with us.

There is a great deal of concern-in fact, there is a great deal of alarm-throughout the country with regard to the fiscal situation. People are worried about high interest rates. They are concerned about tight money. They are deeply disturbed by galloping inflation.

The Government plays a role in all of these fiscal matters largely through its budget and monetary policies. Today we will be hearing Secretary Kennedy, Director Mayo, and Chairman McCracken discuss the new budget, which is just about the most important document that the President sends to Congress each year.

The President is recommending that the spending for the forthcoming fiscal year approximate slightly more than $200 billion as compared to spending during the current fiscal year of about $197.9

(1)

billion. He recommends a relatively nominal rise in overall budget spending. But the budget suggests that we increase new budget authority-the authority to commit the Federal Government to new spending by a net of about $9 billion. This more significantly indicates the trend-upward.

I think it would be well to hear you both without interruption, and then we will have a questioning period. You may proceed in your own way, Mr. Secretary.

Secretary KENNEDY. Thank you, Mr. Chairman.

GENERAL STATEMENT OF SECRETARY OF THE TREASURY

I am particularly pleased to meet with this distinguished committee which bears so great a share of the responsibility in our total effort to halt inflation and restore a sound and healthy economy. The decisions that will be made over the next few months by the men in this room will influence the course of our economy and the well-being of the average American for a good many years to come.

INFLATION

Our economy-indeed our economic system—is I think approaching one of the key junctures that have appeared periodically in our Nation's history. We have experienced over the past few years the strongest sustained surge of inflation since World War II. This has created doubt in some quarters whether the kind of economic countermeasures that have served us well in the past-actions which still leave a maximum of economic freedom to the individual-have become outmoded. As a result we hear rising demands for direct economic controls-on prices, wages, credit-and from some surprising sources. This administration has rejected the direct controls approach, which we believe is unnecessary-if we make the right fiscal decisions now. A year ago the economy was in a highly inflationary condition. Strong and rising market demand by business, consumers and Government for many months had been in excess of the Nation's capacity to produce the required goods and services. Eight successive years of Federal deficits, culminating in the high $25 billion deficit of fiscal 1968, had steadily fueled the fires of inflation.

We recognized that an inflationary condition which had developed momentum over a period of years could not be stopped short without resort to Draconian measures which could change and disrupt our entire economic system. The real need was a shift in the emphasis of our stabilization measures-in the posture of our Government-from uncertainty to firm restraint. Reliance was placed on vigorous use of the established economic stabilization tools that we believe in the long run are most compatible with the maintenance of a strong free enterprise system.

So a tight restraint was placed on Federal spending with cutbacks made wherever possible. The Congress was urged to maintain the level of tax revenue required by the inflationary situation. As a result, the near record budget deficit of fiscal 1968 was followed by a surplus in 1969. With your cooperation a surplus will be maintained through

1971.

On the monetary front, the Federal Reserve held a tight rein on credit. This has created real difficulties not least for the Treasury. But firm control on credit was indispensable to the success of the overall effort. In short, the established stabilization actions that have worked effectively in the past were applied with vigor across-theboard.

We believe that given time these measures will do the job. I recognize that the results up to now-in terms of price changes-will not satisfy any of you in this room. They don't satisfy me. But there are definite indications that the policy of restraint is taking hold. The rate of expanding GNP in the past three-quarters has slowed. Consumer demand is easing. There are growing signs that business is taking a hard look at planned expansion in investment. And, of course, Federal spending has been very definitely leveling off.

None of this is pleasant. But it is an essential part of the process to "cool" the economy, and to slow the price increase and the demand for credit and ultimately reduce the cost of credit. We have reached a difficult point in the fight against inflation, but if we maintain our resolve and work together-the administration and the Congress I am confident that the fight will be won. And all of you in this committee have a vital role to play.

In preparing the new budget we have worked hard to come up with tight and realistic figures both on the expenditure and receipts side. We believe that the economic effect of this budget will be to further strengthen the resistance against rising prices we have been building up during the past year. While the level of overall spending has been restrained, this administration fully recognizes that some increase in spending will be required to meet essential national needs in certain areas. But these and other vital programs that will be needed in the years to come can effectively move forward only in the context of a strong and stable national economy. A return to price stability and sustainable economic growth must, therefore, be of the highest priority.

There are, of course, risks in maintaining a general policy of economic restraint. While risks are inherent in any anti-inflation program, this administration has attempted to minimize them. This is why we have avoided excessive and abrupt restraint actions. I believe that our present economic policy will avoid a serious downturn while successfully reducing inflationary pressures. However, there are discretionary powers in competent hands which I think give us pretty good assurance that timely countermeasures will be taken if and when they become clearly required.

ESTIMATES OF FEDERAL REVENUE

My colleagues will cover the expenditure and economic implications of the budget in more depth. At this point I want to review with you the Treasury's primary responsibility in the budget process the inflow of Federal revenue. In past years Treasury estimates of Federal revenue in the January budget have tended to be on the conservative side. I think it particularly important for the 1971 budget to be in this tradition. President Nixon has made it clear that the budget is to continue in surplus. He has also made it clear our assumptions on

expenditure and revenue must be realistic. The estimate of Federal revenue is therefore based on a cautious appraisal of the economic outlook. Similarly, we consider realistic our assumption that Congress will act favorably on the minor tax changes we have requested.

ECONOMIC ASSUMPTIONS

Briefly here are the major features of the revenue side of the Federal Budget. Budget receipts in fiscal year 1971 are estimated at $202.1 billion, an increase of $2.7 billion over fiscal 1970. This estimate is based on an expectation that the gross national product in calendar 1970 will total $985 billion, an increase of $53 billion over calendar 1969. This contrasts with a GNP increase of $67 billion in calendar 1969 over 1968. Corporate profits in calendar 1970 are estimated to be $89 billion-a drop of $5 billion compared with 1969.

We are working hard to speed the time when price stability will be achieved. While I am confident that these efforts will be reflected in an improved price picture during 1970, it would be unrealistic to project a halt in price increases during this year. Our estimate, therefore, assumes a further rise in prices but at a slower rate than in 1969.

To understand the major causes of the change in budget receipts in fiscal 1970-71 I refer you to the second of the tables on budget receipts appended to my statement. In the absence of any change in tax rates that is under the rates in effect during December 1969-the expected economic expansion during calendar 1970 would have increased fiscal 1971 revenues by an estimated $8.5 billion. If we add the effect of administrative actions to be taken by the Treasury to speed the collection of withheld income and excise taxes, the total revenue increase in fiscal 1971 unrelated to any legislative change would have been $9.7 billion. I might add that the planned acceleration of income tax collections does not require any earlier payments by individuals but merely a shortening of the pipeline time until these payments actually reach the Treasury.

However, the ending of the tax surcharge on June 30 will reduce potential 1971 revenue by an estimated $8.5 billion offsetting the effect of economic growth. Other changes in tax rates already scheduled under existing law will, on balance, about offset each other. The major one is a social security rate increase effective January 1, 1971. Therefore, in the absence of any further legislative action this year on taxes and taking account of expected economic growth and the speedup in tax collections-Federal revenues in fiscal 1971 would increase by about $1 billion.

The remainder of the projected $2.7 billion increase in revenues is based on proposed legislation. Of this $1.6 billion total, $0.7 billion is a recommended increase in user charges more than half of which concerns aviation. The increase in aviation charges has already passed the House of Representatives and we expect early action in the Senate. Approximately $0.6 billion would result from continuation of present automobile and telephone excises for 1 year beyond the present expiration date of January 1, 1971. The Congress has continued these rates in the past when justified by the fiscal situation. Another $0.2 billion would result from raising the social security tax base from

$7,800 to $9,000. We think this should be done in order to keep the tax base consistent with the rise in personal income. Finally, $0.1 billion would come from an increase in railroad retirement fund revenues. We ask your support of these proposals in the interest of sound budget policy.

We must recognize that the termination of the surcharge in June 1970 demands harder fiscal discipline throughout the budget. We need to wear very tight belts to validate the effective tax reduction that is already in the law. Under conditions of full employment, tax reductions which produce large deficits simply substitute an inflation tax for explicit taxes. This fiscal program, to offset the surcharge termination, therefore demands support for the modest revenue increase proposals that the President has advanced and stern resistance to additional expenditure increases.

Over the long run, additional revenues will be available under present law; and we can consider how these might best be employed for the public benefit through tax reduction, further assistance to State and local governments, new expenditure programs and debt reduction. These alternatives you should keep before you during this year and next when you are considering programs which seem to have small current cost but commit us to larger future costs.

BUSINESS TAX

The final decisions on budgets beyond fiscal year 1971 must be reserved for the future, but I would suggest one point of some importance. The Congress did enact a considerable increase in taxes on business in the Tax Reform Act of 1969 through repeal of the investment credit and otherwise. At the same time it provided substantial reduction for individuals. The business tax increases will undoubtedly have some impact on our ability to expand and improve our plant and equipment capacity. We should be prepared to face what may be a high priority need in the future for adjusting the business tax burden.

FEDERAL DEBT

With regard to the implications of the budget figures on our debt operations, I would first point out that the surplus in the unified budget will result in a decline in Federal debt held by the public. This surplus will help avoid excessive Government competition for the necessarily limited supply of credit available for private purposes notably housing. I might add that under the policy of general credit restraint over the past year, a special effort was made to ease the burden on housing. Funds made available for residential and farm mortgages by FNMA and the home loan banks increased from $3.0 billion in all of 1968 to a $10.2 billion annual rate in the third quarter of 1969.

But despite the reduction in Federal debt held by the public in 1970 and 1971, an increase in the debt ceiling will be required by the end of this fiscal year. This reflects the expansion in debt obligations held by the trust funds, as well as the need to accommodate seasonal swings between receipts and expenditures. A decision on the amount