[c]

March 21, 1958

MEMORANDUM FOR MR. KISSINGER

Subject: **Subpanel IV**

**Enclosures:**

1. Final sections of Mr. Stein's draft

2. Comparative analysis of the Wilde and Perkins revision of the social objectives section.

Mr. Wilde's letter. (You already have the Perkins draft)

3. Carbon of NH letter to Mr. McCabe.

Note: Question of delaying the meeting until five has been sent to his secretary. *

cc: Miss Lyman
* HAK may come to NY on Tuesday, 3/25

IV - Report

March 12, 1958 R

# U. S. ECONOMIC AND SOCIAL OBJECTIVES AND POLICY

## Table of Contents

Page

<table><tr><td>I. The Problem</td><td>1</td></tr><tr><td>II. The Framework of Economic and Social Policy</td><td>6</td></tr><tr><td>III. Stability and Budgets</td><td>13</td></tr><tr><td>A. Economic Stability</td><td>14</td></tr><tr><td>B. Budget and Tax Policies</td><td>26</td></tr><tr><td>1. Providing for Essential Expenditures</td><td>26</td></tr><tr><td>2. Tax Policies and Private Incentives</td><td>32</td></tr><tr><td>IV. Problems in Achieving Rapid Growth</td><td>42</td></tr><tr><td>A. The Problem of Motivation</td><td>43</td></tr><tr><td>B. Agriculture -- A Case Study in the Problem of Adaptation</td><td>47</td></tr><tr><td>C. The Direction of Investment</td><td>52</td></tr><tr><td>1. Access to Investment Funds for Growing Businesses</td><td>52</td></tr><tr><td>2. The Transportation Problem</td><td>56</td></tr><tr><td>3. Natural Resources and Atomic Energy</td><td>64</td></tr><tr><td>4. Government Investment</td><td>74</td></tr><tr><td>V. The Uses of Growth</td><td>77</td></tr><tr><td>A. Government Uses of National Output</td><td>80</td></tr><tr><td>B. Raising Minimum Standards of Living</td><td>84</td></tr><tr><td>C. Increasing Earnings</td><td>89</td></tr><tr><td>D. Social Insurance</td><td>91</td></tr><tr><td>E. Supplements to Income</td><td>94</td></tr><tr><td>F. Urban Renewal</td><td>98</td></tr><tr><td>G. Medical Care</td><td>103</td></tr><tr><td>VI. A Trial Balance</td><td>106</td></tr></table>

IV - Report

March 12, 1958

# I. THE PROBLEM

As this report is written, in the spring of 1958, total production in the United States is running about 5 per cent below the $450 billion a year rate of which we are now capable. Thus, we are losing, because of the recession in business activity, over $20 billion of annual output.

This is a loss that even as rich an economy as ours can ill afford, especially when its burden is heavily concentrated on those who are unemployed or working short hours.

The waste and burden of the recession must be quickly ended.

We shall consider in this report some of the ways in which that may be done. But we shall consider this problem as part of a still larger one.

The problem of this report -- and of the country -- is not only how we shall utilize the nation's present ability to produce but also how we shall steadily and rapidly increase the nation's ability to produce and how we shall best use that ability. In short -- how to get and how to use economic growth.

We are now capable of producing $450 billion worth of goods and services a year. Since the end of World War II, production has increased by about 4 per cent a year on the average. Continuation of this rate of increase would give us a production capability of $900 billion by 1975. (This is not so far away. Children born this year will not have finished high school by 1975.) In the 75 years before World War II our production grew on the average by about 3 per cent a year. If we should resume growth

IV - Report

March 12, 1958

at this rate, we would reach a production capability of $750 billion in
1975.

Thus the apparently small difference between a 3 per cent and a
4 per cent growth rate makes a difference of about $150 billion in product
at the end of 17 years -- over one-third of this year's production. In a
crude way this enormous difference indicates the importance of trying to
achieve a rapid rate of growth. But the real range of possibilities is not
bounded by 3 per cent at the bottom and 4 per cent at the top. We are not
automatically assured of maintaining 3 per cent. On the other hand, there
is no good reason to think that 4 per cent could not be exceeded, if that
were strongly desired and intelligently sought.

A national product of $900 billion, or even of $450 billion, is a
powerful tool. But that is all. The product permits, but does not itself
assure, achievement of important individual and social objectives. For that,
something more is needed -- wisdom in the use of the product.

We have recently awakened to the fact that our great national
product does not itself adequately provide for the most obvious and vital
national objective -- national security against an external threat. With
today's technology, complete security is not available to the richest and
strongest of nations. But we have clearly not achieved even the measure
of security that our economy could provide.

National security is only the most obvious case. There are many
other aspects of our life about which we can ask whether we are getting as

IV - Report

March 12, 1958

- 3 -

much out of our production capability as we could and should. Have we
done what the economy would permit to abolish the degradation of extreme
poverty, to protect families against the great risks of illness and unemploy-
ment, to make the opportunities of our society open to all? Is the average
family, with an income exceeding the average income of any other society,
past or present, getting from it a satisfying standard of living, rather than
ostentation and triviality? Are we using, or only killing, the leisure time
that increasing productivity has afforded us?

We do not ask these questions to criticize the past. Our concern
is with the future. Even if the answers to all these questions were "yes" --
and we do not think anyone can say this without reservation -- it would be
clear that this result has not come about automatically. Insofar as we are
using our capabilities well it is because thought and effort have been
devoted to doing so. Our main point is that to get the maximum advantage
of our increasing production capability in the future we shall have to devote
thought and effort to the problem.

Even a doubling of our ability to produce by 1975 -- staggering as
that prospect is -- will not change the essential character of the problem of
making the best use of the product. The problem is one of choice. Even
$900 billion of production will not enable us to do or have everything that
would be desired or desirable. As we shall show in a later section of this
report, it is not difficult to add up a list of "requirements," "demands,"
"claims," exceeding even a much enlarged national product. All of these

IV - Report

March 12, 1958

claims are in some degree "good." To get the best use of our capabilities we must choose among alternative uses, foregoing some that are good in order to have others that are more valuable.

This report considers what "we" must do to grow rapidly and how "we" may best use the product of this growth. It is necessary, in a society like ours, to ask who this "we" is, and indeed whether there is any such "we" at all. Is it not true that the growth of the American economy is the sum of the increases of the production and income of millions of people, each using his labor and savings as he sees fit? And is not the use of the national product simply the sum of the uses that each of the millions of individuals and families makes of its own income? And in this case, is the "we" who is to generate growth and use it anything more than an abstract statistical total of discrete units with no common purpose or ability to decide and to act? Unless it is proposed to tell each of these millions of units how to produce and consume -- which is clearly impossible and improper -- is there any "we" to whom this report could be addressed?

The picture of an individualist society implicit in these questions is in large part a true picture of America. We wish to preserve the features of American society so described, because they are sources of freedom and strength. But this is not the whole picture of the American society. The whole national product and its use are of interest to the whole society, not only to the individuals who produce and use each piece of it. In reflection of this the society influences economic growth and its uses in many

IV - Report

March 12, 1958

important ways. We are probably most conscious of the role of the federal
government. But at many critical points state and local governments have
a
the key influence. There are voluntary associations of great variety --
educational, philanthropic, representative -- operating not only in a group
interest but also out of some conception of socially-desired objectives.
Beyond all this, the decisions of individuals are conditioned by socially-
determined attitudes and ways of thinking and acting. There is a public
policy toward economic growth and its uses, and it is to this public policy
that our report is addressed.

We shall be talking in this report about problems. It is difficult
to do this at any length without leaving the impression that our society
consists of nothing but problems. We want to disclaim that interpretation
at the outset. We believe that American society is and has been highly
successful. This report concentrates on problems simply because it is
the problems, not the successes, that require attention.

IV - Report

March 12, 1958

## II. THE FRAMEWORK OF ECONOMIC AND SOCIAL POLICY

America will wrestle with the problems of getting and using economic growth in the next decade or two largely within a framework set by conditions existing today. We have a certain size and character of population, certain land with certain resources under it, certain man-made physical assets, certain public and private institutions. While these things will change, they will change out of what we have, which will importantly determine the range within which change can occur.

These conditions we have mentioned are known, or objectively ascertainable, reasonably well. But this is not true of another set of conditions no less important. That is the body of ideas, attitudes, values about our society and about ourselves that condition what we seek to do and how we seek to do it. These ideas are not fully reflected in our actions -- in part because the ideas themselves are inconsistent and must be compromised. But nevertheless the ideas are facts that influence the "real" world. We think it important to set out here our view of these ideas -- or at least those among them most relevant to our paper, so that what follows may be better understood.

1. Material advancement, and the hard work and thrift necessary to attain it, are highly valued by Americans and the American society. This is in part the historical product of the Calvinist movement that was sweeping the Western world when American society was being formed. In part it reflects the attitudes of those immigrants who throughout our history

IV - Report

March 12, 1958

selected themselves to come here because they were willing to bear much
to better themselves. In part it results from the fact that opportunities were
great here and effort "paid off." Whatever it causes, the attitude toward
work and economic advance is so pervasive that we are hardly conscious
of it as distinguishing us from any other society.

2. The national attitudes towards the distribution of income and its uses is a blend of individualism and social consciousness. The belief that the laborer is worthy of his hire, that a man is entitled to what he produces, is dominant. But this belief is tempered, certainly in the ideal and to a significant degree in application, by concern for the underprivileged and by a certain streak of egalitarianism. Similarly, the idea that a man's income and assets are his own to be used as he wishes is real but limited by considerations of social responsibility. The precise combination of individual rights and social responsibilities has changed over time and has always been in some dispute; the reconciliation or compromise remains, and will probably always remain, one of our great problems.

3. The notion of a classless society occupies a leading place in American ideology. Failure to approach this ideal with respect to the relations among racial, ethnic and religious groups is a shameful blot upon American society. But the ideal, as ideal, is unquestioned save by a lunatic fringe. And in economic terms the ideal has been reasonably well implemented. Mobility among economic groups is relatively high, and a public policy to preserve and increase this mobility is recognized. The ideal

IV - Report

March 12, 1958

and its degree of realization in the economic sphere keep American economic
disputes -- while sometimes sharp and bitter -- from turning into irrecon-
cilable class antagonisms.

4. The American economic system operates within a democratic political framework. In effect this means the supremacy of the political ideal over the economic, and since that political ideal is ultimately responsive to the will of the people, it results in the constant adaptation of the economic system to the political wishes of the electorate. The democratic concept in America has always expressed itself in a suspicion of power, private or public, and in the insistence that power be limited, regularized, and legitimized by public consent. The wariness with which the public eye has regarded size, whether in Washington or Detroit, has resulted in the gradual evolution of an attitude of self-consciousness on the part of big organizations, economic or political. Big business has been a focal point of attack over the American past, justly and unjustly. Whatever the merits of the specific attacks, their consequence has been the gradual recognition on the part of business that its ultimate justification was public service. Recently part of the labor movement has been under-going the same kind of public scrutiny, a procedure that has resulted in a greater recognition of the public responsibilities of these large and powerful unions.

5. Government's proper role in the economy is powerful but limited in character and method. There is a division of function between the private

IV - Report

March 12, 1958

economy and the government. The line of this division is not between
important and unimportant activities or between powerful and weak activities.
Neither is the division described by saying that the private economy does
what it can and the government does what remains that is desirable or
"necessary" -- although there is some element of this. And it is not
quite accurate to describe the relation by the words "partnership" or "mixed";
"specialization" is more descriptive.

It is more difficult to say what the division of function is than what
it is not. The basic idea has to do with freedom and with the consistency
of an activity of government with the freedom of individuals. And this in
turn depends very much upon the "generality" of the function -- whether
it permits a selective influence to be brought to bear upon particular
individuals or small groups. Thus the power to control the quantity of
money is a very great power over the economy, much greater, for example,
than the power to fix the purity of a particular commodity. But the former
is a proper function of government. Although it affects different individuals
differently, it does not permit the government to single out individuals or
groups for differential treatment. And the power to fix particular prices
does confer such power over individuals and is improper -- with exceptions.

This line, or rather vague zone of demarcation, is undoubtedly
crossed at many points. But where this is justified exceptional circumstances
of a limiting nature are adduced -- such as cases of national security or
cases in which government power is the alternative to concentrated private
power.

IV - Report

March 12, 1958

Today, as always, there is a considerable difference of opinion about the specific economic activities that fall within the proper sphere of government. This is especially true with respect to new activities.

The principle that old activities are good activities works strongly here.

But we believe that the following list of functions of government in the economy in general terms would meet substantial acceptance:

a. To preserve competition and freedom in the private economy.

b. To assist in the stabilization of the economy by the use of instruments essentially derived from its monetary and fiscal power.

c. To make investments where the full benefits could not be captured by private investors and which therefore would not be provided by private investment even though the total benefits would exceed the cost. This is a large category, of which roads and schools are examples.

d. To regulate private activities that have serious social costs beyond the costs that enter into the reckoning of the private activities who conduct them. Excessive exploitation of certain kinds of natural resources falls in this category.

e. To prevent and relieve poverty and economic insecurity.

IV - Report

March 12, 1958

- 11 -

f. To utilize the nation's economic resources in the interests of the nation's security.

6. Most important of all, for conditioning the future growth of America, is our national aspiration to growth. This aspiration, which playeu so extraordinary a role in the building of America, is not only a matter of economic motivation.

In the driving energy with which we assailed the wilderness, planted our cities, and developed our economy, there was a quality of impetuous vitality and hopefulness. Bold, imaginative, sometimes ruthless and even cruel, it was above all a tremendous human adventure.

That quality of adventuresomeness and competitiveness marks it still. But the problems of the future will call for a different direction of the spirit of adventure and competition. A necessary consequence of a growing economy is that its "frontiers" cannot remain fixed. As our society becomes more complicated and interdependent, it is inevitable that the frontier moves into ever more subtle fields. In the nineteenth century the open offer of lands available to those who had the courage to reach them colored the outlook of those who stayed behind no less than of those who ventured west. Afterwards new frontiers -- of minerals extraction, trade and industry -- opened new vistas of opportunity. Today it is not the geographic frontier which beckons us, but the frontiers of science, and of human relationships. Whatever aspect of American life we consider --

IV - Report

March 12, 1958

population trends, manner of living, technological change, the role of
government -- we confront enormous transformations which are rapidly
accelerating.

The deepest transformation we are undergoing may be psychological.
In the past, American society did not really have to ask itself for what
purpose it worked so hard, competed so aggressively, built so furiously:
the answer was determined by the need to conquer a wilderness. But as
a subsistence economy has changed to an economy of increasing comfort,
the challenges to the pioneering spirit become ever more complex.

The lesson of the past is never automatic. A society which seeks
to apply its experiences mechanically soon stagnates. The past furnishes
us an attitude and a point of view. It cannot serve as a substitute for
creativity.

We will obtain the resources for dealing with our problems from
the continuing process of growth which has characterized our society. But
we will derive our sense of direction and our dynamism from our purpose
and our vision. This in fact, is the deepest lesson of our past.

IV - Report

March 12, 1958

- 13 -

### III. STABILITY AND BUDGETS

The problems with which this report deals - 1) how to get growth and 2) how to use growth -- cannot be neatly separated from each other for several reasons.

One of the main uses of the product generated by economic growth is to generate more growth. We use our rising product, in part, to increase our investment in productive physical assets, in education and in research that will raise production still further.

In another, subtler, sense, the production of growth and the consumption of its fruits are intertwined. A large part of the time of adult Americans, and probably a larger part of their energies, is devoted to production. The physical conditions and human relations of the production process, as well as the character of the work itself, mean as much for his happiness and welfare, as do the quantity and quality of his consumption and the use he makes of his leisure time.

Moreover, almost all of the specific policy problems encountered in the acceleration of growth have significant growth-using aspects, and the reverse is also true. For example, the improvement of education is a way to speed up growth; it is also a way to bring about better uses of the product and is itself one of the most satisfying uses. We can look upon the agricultural problem as one of sharing the benefits of growth with a certain sector of

IV - Report

March 12, 1958

- 14 -

the population or as a problem of increasing growth by speeding the movement of a certain sector of the labor force into more productive employments.

Despite these interrelations we shall, for convenience, divide most of the problems of this paper into two categories -- those mainly related to the promotion of growth, discussed in Chapter IV, and those mainly related to the uses of growth, discussed in Chapter V.

However, there are two questions so pervasive in their impact that they cannot be divided, even with considerable arbitrariness, into these two categories. They are the maintenance of economic stability -- the avoidance of recessions and inflation -- and policy with respect to the level and character of the budget and taxes. These two problems we shall consider here.

## A. Economic Stability

There is no need in this paper to argue the evils of recessions or the importance of maintaining high employment. Recession means more than failure to use our production capability well; it means failure to use a part of it at all. One of the main objectives for which we seek growth is to achieve protection for all from extreme poverty and insecurity. But recession means complete loss of income for some, sharp reduction for others and great insecurity for many more. Moreover, recessions retard the process of growth itself, chiefly by slowing down the rate of investment in expanded and improved productive capacity.

IV - Report

March 12, 1958

- 15 -

Deep dragging depressions, of the 1929-1939 variety, are no longer
possible in America. On the other hand we do not believe that it is, or will
be, possible to eliminate all fluctuations and recessions. The millions of
households, businesses and governments in the United States are legally and
economically free to vary, and do vary, the rate of their purchases of goods
and services -- which means indirectly their employment of labor -- from
time to time. There is a tendency for a decline of purchases by some units
and sectors of the economy to stimulate an increase by other sectors. But
this response takes time. It cannot be instantaneously adequate. Therefore,
in absence of deliberate government action to prevent it, purchases, pro-
duction and employment will fluctuate. Government has means to add to pur-
chases and employment. Most important, it can increase its own purchases
and it can stimulate the purchases of individuals and businesses by cutting
their taxes. While these are instruments of great power, they cannot come
into effect instantaneously once the existence of a business recession and
unemployment show the need for them. And the attempt to make the action
more timely by responding to a forecast of decline, rather than to the fact of
decline, will often fail because of the fallibility of forecasting.

But to recognize that some fluctuations are unavoidable is not to say
that nothing more can be done. Between the minimum recession and unem-
ployment that is unavoidable and the maximum that is now possible is still
a significant range. It is important to narrow this range still further, and to
hold possible fluctuations as closely as we can to the unavoidable minimum.

IV - Report

March 12, 1958

- 16 -

There are two kinds of problems in narrowing the range of possible recessions. These may be called the economic problem and the political problem, although the terms are not exactly descriptive. We have already suggested the nature of the economic problem. It is to reduce lags in the response of corrective measures to the need for them. The political problem is to achieve enough understanding and responsibility to discontinue anti-recession measures when they are no longer needed, because unless there is reasonable assurance of this there are risks in using the measures when they are needed.

The economic problem has three aspects:

1. The more rapid and accurate identification of the existing economic situation. This would be greatly aided by more and better current monthly and quarterly statistics for such key series as gross national product, national income and personal income, industrial production, employment and unemployment, and consumer and wholesale price indexes, together with their major components. Elimination of the existing gaps and deficiences in current information on business profits, trade inventories, construction activity, saving, and physical output are a few of the improvements that would be particularly helpful. Since current developments take on significance only when related to usual economic patterns and previous experience, more intensive analysis of past periods is also needed.

IV - Report

March 12, 1958

- 17 -

2. Approach toward more reliable forecasting of economic turning points and of the magnitude of likely movement once a turn has been made.

The most promising general approach to better short-term forecasting are the collection of information on the spending intentions of economic units, and the collection of statistics on activities that normally precede actual spending.

In the former category, existing surveys of plant and equipment expenditure programs of business, and of consumer plans for the purchase of houses and consumer durables, already helpful, should be strengthened through enlargement of samples and scope. A similar survey of the spending plans of state and local governments, and perhaps of major types of nonprofit organizations (particularly for capital outlays), should be feasible. A series that would accurately forecast monthly or quarterly changes in business inventories, a crucial element in short-term business movements, is probably unattainable, since actual changes are so largely dependent on conditions, particularly sales that are outside the control of the responding business. However, experimentation with surveys of inventory intentions may yield techniques that would indicate whether firms regard their inventories as large or small in relation to existing and expected sales. Such information would be most helpful.

Among existing statistics for activities that usually anticipate actual spending and sales are new orders received by manufacturers, orders placed

IV - Report

March 12, 1958

- 18 -

by department stores, housing starts, and construction contract awards.
Business capital appropriations is a recent addition to the list. Most of
the existing series could be significantly improved if funds were made avail-
able for the purpose. Additional useful data of this sort would probably be
found if serious experimentation were undertaken with a prospect of estab-
lishing a continuing series when its value was established.

3. More rapid effective action once the need for it is detected.
The action involved here is mainly in the federal budget. There has been
substantial progress on this front as compared with twenty-five years ago.
Perhaps the main progress has been negative -- not that we are so much
better prepared to act quickly in the right direction but that we are quite
unlikely to act in the wrong direction by raising taxes and cutting expenditures
in a recession. But there has, of course, been other progress as well. We
have an unemployment compensation system that automatically pays out more
money when unemployment rises. We have a tax system that promptly begins
to take in much less money when employment and incomes fall. We have
greatly improved public understanding of the need for and nature of corrective
action in a recession.

However there has been relatively little progress, and even little
attention to the problem, in the last ten years -- since the lessons of the
depression were consolidated after the war. There has been a tendency to
be satisfied with what has been achieved and to regard further steps as

IV - Report

March 12, 1958

- 19 -

politically or administratively impossible. Even on so elementary a matter
as the maintenance of a shelf of public works, financed, planned, and ready
to go when needed, our current state of preparation is not impressive.

We are not suggesting that a lot of new "gadgets" be adopted on a
crash basis. We are suggesting that much more attention be given to con-
ceiving and carefully considering means to increase the critical ingredients
of a defense against recession -- speed, flexibility, and reversibility. We
have in mind such questions as the following:

a. Could provision be made for automatically supplementing
the amount and duration of unemployment benefits when unemploy-
ment in the nation or in the state exceeds a specified figure? The
existing limits are presumably intended, in part, to maintain an
incentive for the unemployed person to seek work vigorously. The
likelihood of this incentive being effective is reduced when
national or regional unemployment is larger.

b. Could insurance be provided against some part of the income
loss from short hours?

c. Could Congress authorize the President to reduce specified
taxes under specified conditions of recession, for a specified period
or until specified economic conditions were achieved?

d. Could a practical system of income-tax averaging be devised
that would pay refunds in a year when their income is low to persons
who had previously paid tax on a higher income?

IV - Report

March 12, 1958

- 20 -

e. Can the expenditures of state and local governments be given a more flexible cyclical pattern? State and local purchase of goods and services are much larger than federal purchases if we exclude national security programs, which are not well suited for anti recession use. The possibility of adapting the timing of these state and local purchases to the needs of economic stabilization has barely been touched.

We believe that serious efforts along these lines will greatly increase the possibility of flexible action to confine recessions within narrower limits. But the critical limitation is the political one. The budget actions that are appropriate for dealing with a recession -- increasing expenditures and cutting taxes -- are politically popular. The natural desire for higher expenditures and lower taxes is normally held in check by respect for the idea of balancing the budget and by fear of inflation. But when these restraints are relaxed two dangers appear. One is that expenditure increases and tax reductions will go too far. The other is that they will continue in force too long. It will be difficult, politically, to get taxes raised after they have been cut in the recession or to get expenditure programs terminated. The possible results are inflation, unnecessary enlargement of the federal debt, permanent expenditure programs that would not have been adopted under conditions of high employment, and distortion of the tax structure.

These dangers must be weighed against the need to combat the recession. If the recession is very serious, action will be justified despite the

IV - Report

March 12, 1958

- 21 -

dangers. But in a less serious recession the risks of doing nothing will be smaller than the risks of departing from the normal budgetary restraints. To put the matter another way, strong action to stop a recession has a cost in the form of a risk of future injury to the economy from overdoing the action and continuing it too long. The more we can reduce this cost, the safer and more feasible it will be to invoke strong action in a mild recession.

The risks we are discussing result from the political attractiveness of big spending and low taxes. These risks can basically be reduced only by improved public understanding and national leadership.

Our current situation, in the spring of 1958, both illustrates the problem and provides an opportunity for the exercise of leadership to improve understanding. The country is being deluged with proposals to increase public expenditures or cut taxes in order to combat the recession. These proposals are often advanced without any clear indication of how much they would cost or how much effect they would have in any finite period. Almost never do they reflect any idea of how much is desirable to do or how much is dangerous to do. Perhaps even more important, these proposed measures usually contain no provision for their termination when the occasion that inspired them comes to an end; frequently there is a clear intent that they should not be terminated.

On the other hand there are people who resist any strong action. In part they take this position because they fear to open the door to action without limit of amount or duration.

IV - Report
March 12, 1958

This Panel believes that the time has come for vigorous action. The economy has already fallen as far as it did in 1949 or 1954 and there is no clear sign that the fall is decelerating. But we believe that those who recommend action have a responsibility to specify how much it is to be in total and when or under what conditions it is to end. This is necessary not only to get the right answers. It is also necessary to focus attention on the right questions and to advance public understanding.

(At this point I would insert the Panel's recommendations. These should be attuned to the state of the economy and of the debate as near as possible to the Report's publication. I hesitate to write them now. Something can be drafted just before the Panel meets if that is desired. CED will probably have a statement out before then and that may serve as a take-off point for Panel discussion.)

Recessions would be much easier to prevent or correct if inflation were not also an evil. But inflation is an evil, even if less obvious. The evil of recession is clear because recession is a phenomenon of the "real" world -- a decline in the real quantities of goods and serviced produced. But inflation is something that happens to numbers on pieces of paper -- to prices -- not necessarily to the real things on which we live. And there are people who ask why we should give up, or risk, anything real for the sake of stability in these numbers.

However this "unreal" phenomenon, the rise of prices and decline in the value of money, has real consequences. Certainly from the standpoint of

IV - Report

March 12, 1958

[y]

- 23 -

the objectives of this report, which include not only rapid economic growth but also good use of the product, these consequences must be regarded as adverse. Inflation seriously affects the distribution of income -- some gain and others lose -- and therefore the distribution of the product, in ways that cannot be called good. People gain and others lose from inflation without regard to their contribution to national production, their need or any other standard of a "good" use of the national output. In fact, by its effects on persons with relatively fixed incomes, which includes most aged and dependent persons, inflation is one of the main obstacles to the attack upon poverty and insecurity.

The effects of inflation upon the rate of economic growth -- as distinguished from the distribution of the product -- are difficult to appraise. The American economy has grown rapidly in some periods when prices were rising, in other periods when prices were falling and in still other when they were stable. The historical evidence does not support the view that inflation is good even necessary for growth. But there are many reasons to believe that a long-continued inflation which is confidently expected by all would be harmful to growth -- primarily because it would retard saving.

The problems of preventing inflation are in many ways similar to the problems of dealing with recessions. In general the necessary condition for preventing inflation are known and means exist for bringing that condition about, not exactly but tolerably well. The necessary condition is that money expenditures on goods and services should not rise too fast. The means for

IV - Report

March 12, 1958

- 24 -

bringing this would operate to make money scarce and expensive and to make
taxes high relative to expenditures. The operation of these instruments is
subject to various lags and to uncertainty of forecasting that make some error
unavoidable. Moreover the different policy instruments available have dif-
ferent effects, and it is not known what combination of instruments is best
from all points of view. There is much to be done in improving instruments
for restraint of demand and increasing understanding of their use. But still
deficiencies of this kind are not the main obstacles to preventing inflation.

One of the main obstacles, as in the case of recession, is political.
The appropriate remedies for recession are so popular that we hesitate to open
the bottle for fear of an overdose. The appropriate remedies for inflation are
in the nature of the case unpopular. They all involve keeping someone from
getting what he wants -- by making it hard for him to borrow, or requiring
him to pay high taxes or curtailing some government expenditure from which
he benefits. Now it is true that these measures need not reduce the total real
incomes, real product and real benefits that we get out of the economy. But
even if this is recognized -- and it is not adequately recognized -- a diffi-
culty would remain. Anti-inflationary restraints do not fall as the gentle rain
from heaven; they have to be meted out and will affect different people dif-
ferently. Therefore it is always difficult to get agreement on any particular
combination of anti-inflationary measures. The resistance of each sector of
the economy to those restraints that particularly affect it may make the whole
effort inadequate.

IV - Report

March 12, 1958

[y]

- 25 -

Again the problem is essentially one of understanding. There is a
general interest in preventing inflation, in which the great majority shares.
If this interest is understood it will provide the necessary political support
for anti-inflation policy. And as we look back at the progress of public under-
standing of economic matters over the past generation we see no reason to
despair.

There may be another obstacle, even more serious, in the path of anti-inflation policy. It is frequently claimed that labor organizations, or businesses, or both jointly have the power to force up labor costs and prices even in a period of slack demand. If this were the case, restraint of demand so severe as to yield intolerable unemployment would be necessary to prevent unemployment.

In our opinion the evidence for the existence of this dilemma is not conclusive. Almost all of the inflation of the past twenty years was associated with World War II and the Korean war, when demand was clearly excessive. Most of the rest of it came in the years 1955-57, and did not exceed the amount that historically has accompanied a vigorous cyclical expansion. Our experience with inflation when demand was neither excessive nor rapidly rising is too scanty to support fundamental conclusions about the inflationary bias of the American economy.

Yet we cannot confidently deny the possibility that this problem does
exist or may exist in the future. If it does, the nation would be faced with
a choice to which there can only be one answer. Power to force degradation

IV - Report
March 12, 1958

of the currency upon the community as a whole cannot be left in the hands
of either business or labor organizations. If such power exists or comes
into being it will have to be restrained. Restraint by the force of general
recognition of the evils of inflationary behavior would be most desirable. But
if this were inoperative restraint by restoration of the forces of competition
would be essential.

B. Budget and Tax Policies

In our economy, most of the impetus to growth comes from the private
sector of the economy. Free decisions of millions of consumers, workers,
businessmen, and investors largely determine the course of economic develop-
ment. Nevertheless, as we have already indicated, government plays a role
not only in promoting growth but also in using the increased product resulting
from growth for improving the welfare and security of our citizens.

Most of the issues about the government's role came to focus on the
budget, in questions about its total size, the character of the expenditures
and the nature of the taxes by which it should be financed. Many of the
expenditure programs of the government will be specifically considered in
later sections of the report. Here we look at certain general questions re-
lating to government expenditures and at the problem of taxation.

There is no simple rule of thumb to guide us in determining the correct
level of government expenditures. Budget policy should balance the social

IV - Report

March.12, 1958

- 27 -

benefits expected from the activities of government against their costs as measured by the taxes needed to finance them. But it is not easy to determine the social benefits of particular activities or to assess the costs of particular taxes. In our system of government, these judgments are made by democratically elected legislatures. By its very nature, the budget-making process is a pragmatic one and involves compromises among well-meaning people who often have conflicting points of view.

In making the proper budgetary decisions, it is no longer possible to apply literally the view that private expenditures automatically have first priority on the nation's resources. The government should abstain from embarking on unnecessary projects or from undertaking activities that can be done better by private citizens or private business. At the same time, true economy in conducting the affairs of government means that the government should not abstain from doing those things that are essential for the security and welfare of the nation.

In the present and foreseeable state of world affairs, the needs of government are bound to be large and will continue to increase. The overriding need to strengthen our national security programs (including economic assistance to the uncommitted and developing nations of the free world as well as our direct defense programs), the inadequacy of our educational system, the deterioration of our cities, the shortage of water and waste treatment facilities, roads, hospitals and other public assets -- these and other deficiencies in our public programs require immediate attention. In

IV - Report
March 12, 1958

[y]

view of these urgent requirements, expenditures at all levels of government -- federal, state and local -- will rise in the years ahead.

The fact that over-all government expenditure will have to increase to keep pace with the needs of a troubled world and of an expanding economy makes it all the more urgent to weed our nonessential government programs and to operate the essential programs at minimum cost. This is not merely a matter of financial orthodoxy, but the *only* policy that will enable us to carry out the expanded programs we need.

While each program must be considered on its merits, a great deal can be done to improve the procedures by which expenditure decisions are made and to promote greater efficiency in the way these decisions are carried out. Specifically this leads us to recommend the following measures:

a. Government budgets should be arranged to permit administrators, legislators, and the public to determine the purposes and relative values of budgeted expenditures. The federal budget, for example, is subdivided by departments and agencies, rather than by type of activity. Adoption of a program budget -- which would collect all expenditures for a given activity of government in one place, regardless of the agency that actually expends the funds -- would add greatly to the usefulness of the information in the budget and would contribute to a better understanding of the full scope of government activities.

IV - Report
March 12, 1958

- 29 -

b. Legislative procedures for appropriating money should be revised to permit the legislators to understand the implications of particular expenditure decisions and to relate them to over-all tax policy. All too often, expenditure decisions are made piecemeal and there is no method by which each decision can be evaluated in the light of the taxes that must be levied to pay for them. In the federal Congress, a special Budget Committee should be organized, consisting of key congressional leaders, to review and coordinate over-all revenue and expenditure decisions and to set guidelines for the separate tax and expenditure committees. State and local legislatures should also adapt their procedures with this end in view.

c. Government programs do not begin and end in a single year. In any one budget, some programs are declining, while others are rising. It is impossible to plan intelligently for any one year without knowing what the future requirements will be. To make budget decisions properly, estimates of revenues and expenditures are needed not only for the year ahead but also for four or five years in the future.

d. The chief executive of a governmental unit should be given the authority to veto individual items in an appropriation bill. This is particularly important at the federal level, where appropriation bills cover a wide range of activities and the

IV - Report

March 12, 1958

- 30 -

President is often compelled to approve a bill even if he strongly disapproves of some of its provisions. Only by the adoption of an item veto will it be possible to put a halt to "pork barrel" legislation which distributes government funds on the basis of patronage and political strength rather than on the basis of need.

e. Procedures should be set up to improve the management of government agencies. At the federal level, we urge the continued application of the internal economy and efficiency methods advocated by the Hoover Commission. Periodic reviews of the methods of operation of each agency by outside experts should be inaugurated and reports based on these reviews should be transmitted by the President to the Congress, with recommendations for legislative changes that may be needed to improve efficiency.

The head of each department and agency should have available to him a strong and well-qualified management staff to keep a continuous check on operations and to advise him on needed improvements in the procedures within his department or agency.

Aside from such purely procedural changes, the public must learn to moderate its demands on government. Adequate assistance to the less fortunate among us who cannot earn a decent livelihood is essential, but there are numerous subsidies which have no place in a growing and prosperous economy.

IV - Report

March 12, 1958

- 31 -

Many of these subsidies have their roots in the 1930's or World
War II and no longer serve the public interest. For example, the stockpile
programs are now being used to support the prices of some industrial
materials, rather than to store materials that will be needed in the event
of war. Veterans receive pensions even though their disabilities have no
connection with their service to the nation during wartime. Subsidies in
other fields -- shipping and airlines, for instance -- also warrant re-
examination. And, the agriculture program should be redirected along the lines
discussed elsewhere in this report in order to achieve its objective of
balancing the demand for, and supply of, farm products more quickly and
at less cost.

The potential savings from a carefully considered review of all of
these activities could run to several billion dollars annually. This is a
cost that all of us share by paying higher taxes. We cannot hope to main-
tain at an adequate level the services that are essential to our national
survival and growth unless all groups curtail their special demands on
government.

IV - Report

March 12, 1958

- 32 -

## 2. Tax Policies and Private Incentives

Taxation is the method by which we transfer resources to the government for the construction of public assets and the provision of public services. It is the price we pay for government, and, since we demand a great deal from government, we must be willing to pay the price through adequate taxes.

A realistic approach to tax policy of the future must recognize the basic fact that large-scale reductions in the total *amount* of revenues collected by federal, state and local governments are out of the question in the face of continued world tensions. This does not mean, however, that we must live with the present tax structure. Although revenues must remain large, there is room for making reforms in the *way* taxes are levied to achieve greater equity among taxpayers and to promote incentives for growth.

Our present tax system has grown in response to diverse needs over a long period of time. This fact alone does not mean that the entire tax system is necessarily ill-suited to our needs. But it does mean that we should take the time and effort to evaluate the consequences of the tax structure and to make revisions in it where necessary.

It is obviously impossible in the brief compass of this report to consider all the detailed problems in this complex and technical field. However, we do feel it important to stress a number of points which might serve as guidelines in reshaping our tax structure to meet the needs of the future.

a. The largest source of taxation in this country is the tax on individual incomes. Our strong reliance on income taxation reflects the overwhelming view that personal incomes are the best index of

IV. - Report

March 12, 1958

- 33 -

ability to pay, and we graduate our personal income tax because we believe that those with higher incomes have a greater relative ability to pay than those in lower income classes.

But experience has shown that we impose unrealistically high rates. At all income levels, there are opportunities for people to avoid the nominal rates in ways that are perfectly legal. The reason these opportunities exist is that Congress has legislated special relief provisions designed to soften the impact of the high rates on particular groups. In some cases, the relief provisions were enacted many years ago when their revenue consequences were small. In combination, the new and the old provisions have eaten away large chunks from the tax base and, in order to raise the revenues needed, it has been necessary to maintain the rates at high levels.

This is an undesirable situation for three reasons:

In the first place, the relief provisions are not available to everybody so that two people with the same total incomes often pay substantially different taxes.

Second, Congress continues to receive demands for special relief on the ground that it is unfair to favor some groups over others. These demands are difficult to resist and the result is that the list is continuously enlarged. Moreover, the present

IV - Report

March 12, 1958

- 34 -

complexities and high marginal rates of the tax structure virtually
enforce a dubious standard of morality on taxpayers. These are
dangerous trends. If continued, they might discredit the entire
income tax and seriously endanger our ability to pay for the cost
of government.

Third, too much time and effort is spent on earning in-
comes in ways that receive preferential treatment. The effect
is to distort incentives to work, save, and invest from the
patterns which would otherwise exist. The fact that the economy
has grown despite these distortions does not prove that they are
unimportant. By removing them, we would promote a better
allocation of resources and thus insure an even greater rate of
economic growth.

We believe the country would be better served by an
income tax with lower rates that apply more equally among persons
with the same incomes. With personal incomes in excess of
$340 billion, it should not be necessary to collect $37 billion
(as we are collecting this year) with rates starting at 20 per cent
and rising to as high as 91 per cent. The rates in all brackets
could be reduced very substantially by a wholesale revision
calculated to bring a larger proportion of personal incomes into
the tax base.

IV - Report

March 12, 1958

- 35 -

b. The objective of distributing the burden of taxation fairly among taxpayers need not conflict with the objective of encouraging the work, saving, and investment incentives that play such a crucial role in the nation's economic growth. While *average* tax rates must be high, we should work toward lower *marginal* rates in order to enhance the rewards for additional effort and risk-taking. At the top level, it would be better to place greater reliance on taxation of estates and gifts than on the taxation of incomes. Reduction of the highest marginal rates should also be accompanied by the removal of special provisions that are especially favorable to high-bracket taxpayers. These include the exemption of interest on state and local government bonds and the exclusion from taxable income of capital gains accrued on assets of an individual at the time of his death. It would also be desirable to narrow the scope of the capital gains tax to exclude incomes that should properly be taxed as ordinary incomes.

In any revision of the tax structure, it is necessary to recognize that the large bulk of our taxes cannot come from a small group at the top of the income scale. We are fortunate in this country in that incomes are widely distributed. In 1955, almost 50 per cent of the total income reported on federal returns was earned by persons with incomes between $5,000 and $20,000

IV - Report

March 12, 1958

- 36 -

and they paid 53 per cent of the total tax in that year. It would be inequitable to tax persons whose incomes are below minimum subsistence; at the same time, it would be unrealistic to assume that revenue needs can be satisfied by taxing only the very wealthy. The bulk of our taxes will have to come from the middle income groups where most of the income in the nation is concentrated.

c. The problems of small business deserve special consideration in planning to improve the incentive impact of our tax system. Small businesses must rely to a major extent on the capital supplied by owner-managers and their families and close friends. With tax rates that make it difficult to save or that discourage investment in risky enterprises, the small entrepreneur is particularly vulnerable to the vicissitudes of the business cycle.

Revision of the tax system will not provide all of the answers to the problems of the small businessman, but it can be of substantial assistance, and we urge immediate action on several proposals that have been suggested to the Congress:

(1) Provision should be made to extend the accelerated depreciation provisions enacted in 1954 to include purchases of up to $50,000 of used assets in any one year. Under present law, these provisions apply only to new assets.

IV - Report

March 12, 1958

- 37 -

(2) The period over which business losses may be carried back should be increased from two to five years, in order to permit the small businessman to obtain an immediate tax refund in the event he sustains a loss in one year after a series of profitable years.

(3) Corporations should be entitled to carry back and to carry forward unused surtax exemptions, just as they are allowed to carry back and to carry forward losses. This revision would permit small corporations to take full advantage of the $25,000 surtax exemption in every year even though their incomes fluctuate above and below this level.

(4) Closely held corporations should be given the option of electing the tax status of partnerships.

(5) The $1,000 limitation on the offset of capital losses against ordinary incomes should be increased to $5,000. Combined with the present five-year carry-forward of capital losses, this would permit investors to offset $30,000 of capital loss against other incomes over a six-year period instead of the present $6,000.

(6) Estates consisting largely of investments in small businesses should be allowed to pay estate taxes

IV - Report

March 12, 1958

over a period of ten years without interest or penalties,
in order to prevent forced liquidation of the businesses
to discharge the overhanging tax obligation.

(7) Serious consideration should be given to the
introduction of more averaging into the income tax system.
Under present law, as a result of the graduated income
tax rates, the tax on a given amount of income is higher
if it is earned unevenly than it is if earned in equal in-
stallments over a period of years. Since income instability
is associated with risky undertakings, failure to average
incomes often places a heavy penalty on small business.

All of these suggestions are within the spirit of the present
tax laws. They would not create special tax privileges, but they
would be particularly helpful to the smaller enterprise. This nation
has grown strong primarily as a result of the vigor and imagination
of people who have started with modest beginnings. Tax reform
along the lines we have suggested should be regarded as an insur-
ance premium for a policy to reinvigorate this vital source of strength
in our economy. We have little doubt that the cost of this policy is
small in comparison with the lasting gains which the nation as a
whole would derive from it.

IV - Report

March 12, 1958

- 39 -

d. There is need for a careful review of the way in which the federal government taxes items of consumption. Selective excises are levied on a wide variety of goods and services, at different rates. Many of these taxes were adopted during World War II in an effort to discourage consumption of products using scarce materials. Now, they are discriminatory both among consumers and among producers.

Federal excises fall into four categories: (a) taxes on alcoholic beverages and tobacco products; (b) taxes on gasoline and other automotive products which are allocated to the highway trust fund; (c) taxes which fall on producers' goods and other items of business cost (for example, communications, transportation, and business machines); and (d) taxes on consumer goods, mainly consumer durables.

Of these four categories, only the first two have any logical basis for their existence in the federal revenue system. The liquor and tobacco taxes may be justified for sumptuary reasons, although not necessarily at their present high rates. The highway taxes are used to allocate the cost of the Federal Highway System among highway users.

But we believe there is no justification for the taxes in the third and fourth categories. The taxes on items entering into

IV - Report

March 12, 1958

- 40 -

business costs prejudice balanced economic development because they penalize those industries in which the taxed items are most important. The taxes on consumer goods tend to distort the pattern of demand based on consumer tastes by discouraging purchases of the taxed items. At the present time, these two groups of excises yield about $4 billion of revenue annually. High priority should be given to the gradual elimination of these taxes as revenues permit.

e. Much of the burden of future government programs that are required to sustain and promote economic growth will fall on the states and local governments. In total, these governments now spend more for nondefense purposes than does the federal government. Nevertheless, there are substantial shortages of governmental facilities of all types throughout the country.

In our system of government, we rely heavily on the states and municipalities to provide the everyday services we expect from government -- schools, water, waste disposal, fire and police protection, etc. This tradition has withstood the test of time because we have found that such governmental services can be performed most efficiently by those who are familiar with local conditions and problems. Although the

IV - Report

March 12, 1958

- 41 -

federal government should provide some financial assistance in
selected areas, it is important that the states and local govern-
ments should continue to carry the major share of the expenditure
and tax responsibilities for the services they perform.

To make this possible, the tax system of the federal
government should be brought into better relationship with those
of the states and local governments. In the competition for
public revenues, state and local governments have come off
badly. There is a very great need for a restudy of tax oppor-
tunities available to state and local governments and for more
cooperation in the administration of tax sources used both at
the federal and at the state-local levels.

IV - Report

March 12, 1958

- 42 -

IV. PROBLEMS IN ACHIEVING RAPID GROWTH

We are fortunately not in the position of having to develop from scratch the blueprint of an economy that grows. We have an economy that has grown and is growing. We propose here to look at that economy as it now exists and attempt to detect the more important obstacles that might impede its rapid growth and the points at which steps might be taken to accelerate growth.

In a general way, it may be said that an economic system will generate rapid growth if three conditions are met:

1. The people who make decisions are motivated to carry out activities that increase production and improve methods of production.

2. The system in all its aspects -- including methods and character of production; the birth, growth and death of enterprises, the industrial, geographical and occupational distribution of employment -- is highly adaptable to changing knowledge and changing demands.

3. Investment is maintained at a high rate and is well directed to its most productive uses. Investment must be understood to include the devotion of resources not only to increasing the stock of physical assets -- factories, roads, dams, etc. -- but also to improving our human resources through education and otherwise and to increasing the stock of knowledge.

We shall discuss in turn what appear to us the foreseeable problems in meeting each of these conditions.