Outlays in 1964 were $50.8 billion, and they rise to $92.8 billion in fiscal year 1976. That's a rise of $42 billion, nearly doubling. But in constant prices (excluding retired pay), we see a $22-billion drop, about 20 percent.

DEPARTMENT OF DEFENSE BUDGET TRENDS
(BILLIONS OF CONSTANT FY 1976 $)

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 FISCAL YEARS

Inflation has been such that, even though our spending has nearly doubled. our program in real terms-manpower and purchasing power-is down 20 percent.

From 1968 to 1976, note that our program in real terms fell by $59 billion41 percent. In spite of this, our spending in current prices doesn't drop at allin fact it rises substantially, by $14.8 billion or 19 percent. This reflects inflation plus the growth in the retired population.

Spending in current prices is forecast to rise to $140 billion in 1980. That's nearly 3 times the 1964 level, a growth of some $89 billion. But that extra $89 billion, under our forecasts, will buy us nothing in real terms-manpower and purchasing power. In fact, the 1980 program will be about 7 percent below the 1964 program in terms of real buying power.

Even in a single year-from fiscal year 1975 to fiscal year 1976-we shall see that inflation adds over $10 billion to our requirements. And, over a span of years, as this chart shows, the impact is immense.

This phenomenon is by no means limited to defense. This chart shows the pattern for public spending, and for the entire economy. The chart shows 1964 and 1976 spending, in current and constant prices.

CURRENT AND REAL SPENDING, FY 1964 AND FY 1976

All spending in current prices increases dramatically over this period-defense least of all. While defense spending rises $41 billion-78 percent-other Federal spending nearly quadruples (up 286 percent), as does state and local government spending (up 284 percent). Total spending in the entire economy-measured by GNP is up 161 percent, or $984 billion.

These do not represent real increases in buying power. They are all heavily eroded by inflation. For example, nondefense Federal spending nearly quadruples in current prices, rising from $66 billion to $255 billion. Inflation takes a $77billion bite out of that, however. So the real growth is $112 billion, or 78 percent. A healthy growth, to be sure, but far from quadrupling.

The same is true of state and local government spending-again, inflation adds $77 billion to costs. Again, outlays in current prices nearly quadruple, but real growth is just 82 percent.

For the entire economy, the GNP rises by 161 percent in dollars. In real terms, the growth is 44 percent. Inflation, about $500 billion of it, consumes the remainder of the dollar growth.

Inflation also has had a sharp impact on defense, but no greater than for other sectors of public spending. The difference is that spending in other sectors rose more than enough to cover inflation-$189 billion for other Federal programs, and $196 billion for state and local governments, versus $41 billion for defense. Defense spending didn't rise by enough to cover inflation. In real terms, there is thus an increase in the other sectors and a decline in defense.

FEDERAL OUTLAYS-CONSTANT 1976 DOLLARS

300

200

100

1950 52 54 56 58 60 62 64 66 68 70 72 74 76 Fiscal Years

Estimate

This chart shows the Federal budget trend in fiscal year 1976 prices. These are OMB figures. One of the striking things is that the fiscal year 1976 Federal budget, in total, is not much higher than the 1968 level, in real terms. There is an increase of about $10 billion. There is a rise of $171 billion in current prices (95 percent) but inflation consumes almost all of that. Within this relatively-fixed total, there is a drop of $60 billion for defense and a rise of $70 billion for other programs.

The point of all this is that we must make some allowances for inflation before we can make a sensible assessment of spending trends. Current dollar spending throughout the economy has been increasing at a fantastic rate. We know that these increases don't measure changes in real income. All housewives, and most economists, are well aware that the dollar won't buy what it did before. Allowances are made for this throughout the economy: in pension payments, welfare payments, wage agreements and other forms of contracts. The question is not whether inflation exists, and has an effect on our spending. We know it does. It is pointless to spend any time in debating that point. The question, it seems

to me, is whether we have made reasonable adjustments for inflation-whether we have used reasonable factors in expressing our estimates in constant prices.

This chart shows a comparison of the factors we use with those used by the Department of Commerce for the Federal Government as a whole, and for state and local governments. The Commerce figures on this chart extend through fiscal year 1974, and I direct your attention only to the figures through fiscal year 1974. These figures are on a base of 1958. Note that we calculate less inflation for the DoD than Commerce calculates for the Federal Government as a whole, and considerably less than Commerce calculates for state and local governments.

ANNUAL INFLATION RATES

This chart shows the inflation rates we have used for the fiscal year 1976 budget, compared to the most common measures for the economy as a whole. The timing is quite different among the various series. The wholesale price index grew rapidly for two years and now, we hope, will level off. The consumer price index and the GNP deflator rose more gradually and will continue to rise from fiscal year 1975 to fiscal year 1976, as wholesale price increases work their way through other sectors of the economy.

The defense inflation rates are shown to the right. There are different rates for TOA and outlays. The TOA for any year actually spends out over several years, a portion each year. In measuring TOA inflation from one year to the next, it is necessary to consider the spendout percentages and outlay inflation rates for the several years involved.

In general, our inflation rate estimates for the three years are in the middlelower than the wholesale price index, higher than the others.

From 1975 to 1976, our inflation rate estimate is about the same as for the CPI or the GNP deflator.

In summary, Mr. Chairman, the inflation rates that we have used, past and projected, are well in line with accepted measures.

BUDGET PREPARATION AND INFLATION FORECASTS

For the past several years, Mr. Chairman, we have developed forecasts of inflation in connection with our budget estimates. We have used these forecasts in the fund requests for major weapon systems and construction projects. On an overall summary basis, we have used these inflation forecasts to translate the budget totals into constant prices, to reflect trends in real buying power.

Our forecasts of inflation for the past several years have been far too low. We simply never foresaw the surge in prices. We had plenty of company-none of the economic policymakers or forecasters saw what was coming. It's necessary to consider the environment in which each of the last several budgets was prepared.

The fiscal year 1973 budget was prepared in the fall of 1971. Economic controls had just been imposed (August 1971) and the outlook, of course, was for very stable prices.

The fiscal year 1974 budget was prepared in the fall of 1972. Inflation over the past 12 months had been 3 percent, and once again, the forcast was highly optimistic.

The fiscal year 1975 budget was prepared in the fall of 1973. Wholesale prices had risen some 18 percent over the past 12 months but the forecasters assured us this was due to some one-time shocks and the future would be better. The concensus forecast, governmental and private, was for inflation in the 4 to 5 percent range. We believed it. Recall that this was what we were thinking in developing the fiscal year 1975 budget, which you are using as a basis of comparison today. At that time, none of us had yet waited in a line for gasoline. In economic terms, the fall of 1973-when we developed the fiscal year 1975 estimates-was a very long time ago.

This chart suggests the impact. Note that we now forecast TOA inflation at 36.3 percent from fiscal year 1973 to fiscal year 1976. In February 1974, we were projecting 23.3 percent. We missed by 13 points. This means that the fiscal year 1975 program we were contemplating a year ago would cost more than $10 billion above what we planned, due to unforeseen inflation.

This cumulative forecasting error is a compound total, pay rates and purchase prices combined. As to pay rates, our current forecasts for 1973-76 combined are very nearly the same as our forecasts of a year ago. The entire error is in the purchase area. Fiscal year 1976 purchase prices are about 22 percent higher than we expected a year ago.