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economy relative to the private because federal expenditures expanded no faster than the overall economy as measured by potential gross national product (GNP).

Actual federal expenditures are expected to be in the order of 23 per cent of GNP for 1976, up from a level of 20.5 per cent in 1970. But this recent increase neither reflects nor necessarily portends an upward trend in this figure. The reason is that the current recession has the dual effect of temporarily raising federal expenditures above and lowering GNP below their respective longer run growth paths. If the economy were operating at the full-employment level of 5 per cent federal expenditure would be about 20 per cent of GNP. Outlays in major income security programs (such as unemployment insurance, food stamps, AFDC, and Medicaid) are very sensitive to the aggregate unemployment rate. Thus, they will be over $20 billion higher in 1976 than they would be if unemployment had remained at the 5 per cent level of 1973. Similarly, estimates of GNP are on the order of $150 billion less than it would be if we were at this same level of more full employment. As the economy moves out of the recession these temporary effects on GXP and federal expenditures will be reversed and the ratio of federal expenditures to GNP will decline.

Some of the misunderstanding that seems to exist about changes in the size of the federal budget relative to GNP, or of the public sector relative to the private sector, may stem from President Ford's budget message to Congress last February. In this message he stated that:

"Spending by all levels of government now makes up a third of our national output. Were the growth of domestic assistance programs to continue for the next two decades at the same rates as in the past 20 years, total government spending would grow to more than half of our national output ... It is hard fact, easily demonstrated by simple extrapolation."

How can this projection be reconciled with the trend of a relatively constant ratio of federal expenditures to GNP over the past two decades? The crux of the matter is that for two major reasons it is misleading to use a simple extrapolation to project the future rates of growth of income security programs. (I am reminded by a colleague that back in the 1920s two commissions were created and charged with projecting the population growth of Los Angeles and California, respectively. They worked independently and their results indicated that by today the population of Los Angeles would exceed that of California). First, such an extrapolation does not take into account the temporary effect of the recession. But, more important, the very rapid rate of income security programs over the past two decades was caused in large part by conditions that cannot replicate themselves for the next 25 years. For example:

(1) A major contributor to the explosion in the AFDC and Medicaid rolls in the mid-and late 1960s was the increase in the percentage of people eligible for the programs who participated in them. These are estimated to have gone from below 60 per cent to above 90 per cent, so there is little room for further growth for this reason. Also, the vast increase in the levels of federal outlays under the food stamp program and those programs assisting the low income aged, blind and disabled were due primarily to the legislative changes which made these programs universally available with nationally uniform benefit levels (and in the latter case shifted some of the funding to the federal government from state and local governments). Continued growth in these programs is largely dependent upon increases in the size of their eligible populations due to demographic forces or legislated increases in benefit levels. The combined effect of both of these factors is unlikely to result in a growth rate even as high as that of GNP.

(2) Over the past two decades the largest single item in the federal budget. Social Security benefits, have had their levels more than doubled by Congress. even after adjusting for inflation. In view of the projected sizeable deficits in the Social Security trust funds and the increasing adequacy of future benefits already provided for in the current law, it is very doubtful that Congress will rote increases in Social Security benefit levels over the next 25 years that rise even as fast as GNP.

This indicated slowdown in the growth rate of major income security programs is borne out in a recent report prepared by the new Congressional Budget Office. It shows that spending for these programs at both the state and federal level grew from 3.4 per cent of GNP in 1955 to 9.4 per cent in 1975; whereas, projecting to the year 2000, expenditures will still be 9.4 per cent of GNP even if benefits in all these programs grow with inflation, and will rise to only 10.4 per cent of GNP if benefits are actually increased through legislative actions to keep pace with the growth of wages in the economy. Since such a rapid expansion in income security programs over the past two decades was necessary just to maintain a trend of overall federal outlays as a relatively constant percentage of GNP, this implies that the ratio of total federal outlays to GNP would fall if other areas of the federal budget do not expand even faster than they have over the past two decades.

What are the implications of all this for the debate over the growth of government? There are several possibilities.

First, the debate may actually be over whether to reduce or maintain federal expenditures relative to GXP, not whether to increase them. Of course, this is no less a legitimate debate than the one most people may think is being engaged. It is important to ask ourselves whether a decreasing, constant or increasing share of the additional resources provided by economic growth should be allocated through the federal budget.

Second, income security programs have become a dominant factor in the federal budget and are not likely to decrease in importance in the foreseeable future. This should give us serious pause to consider both the extent to which we wish to continue this emphasis within domestic social assistance and the precise way in which we carry it out. Concerning the size of these programs, it is well to remember that, unlike direct government purchase of goods and services, income transfers do not use up any of the resources represented by our GNP; they simply transfer within the population some ability to purchase these resources. While this may be of small solace to taxpayers solely concerned about how much the government is taking out of their paychecks (and perhaps ignoring how much it is giving back to their parents or will give to them in Social Security benefits), it should be of considerable significance to those concerned about the total control over the specific use of resources that is being exerted by government rather than individual consumers. The trend of an increasing share of the federal budget going to income security programs is in this sense a trend toward a decreasing share of federal control over the specific use of the overall resources of the economy.

In considering the particular way in which we provide income assistance, we should heed the urging of President Ford, also from his budget message: *The growth of these domestic assistance programs has taken place in a largely unplanned, piecemeal fashion. This has resulted in too many overlapping programs, lack of coordination, and inequities. Some of the less needy now receive a disproportionate share of federal benefits, while some who are more needy receive less. We must redouble the efforts of the past five years to rationalize and streamline these programs. This means working toward a stable and integrated system of programs that reflects the conscience of a compassionate society but avoids a growing preponderance of the public sector over the private."

Presumably part of the President's motivation in his earlier quoted statement about the implication of the future growth of domestic assistance was to dramatize the concern raised by the rapid expansion of income security programs. As expenditures for these purposes continue to increase, it becomes even more costly to neglect or postpone needed reforms. It would be most unfortunate, however, if false impressions about the contribution of income security programs to “a growing preponderance of the public sector over the private" prevent us from spending the additional marginal sums that are inevitably required to bring about sound structural reform in a compassionate manner.

Perceptions about the relative size of federal expenditures may be temporarily jaundiced by the current combination of recession and inflation which have resulted in rising taxes and declining purchasing power for the typical house

hold, but we have to look beyond this to other facts. Expenditures by state and local governments over the past two decades, unlike those of the federal government, have increased substantially faster than GNP, thus causing an overall increase in the relative size of the public sector. Also, the more modest growth rate of the federal budget does not reflect the extent to which it has expanded its direct influence over the allocation of resources through often inefficient regulatory processes. I suspect that the public should place greater emphasis on these factors, and less on the dollar flow through the federal budget, as major contributors of their growing unease with government. Maybe it will as the recession abates.

Chairman HUMPHREY. Mr. Palmer's article is a very thoughtful article about growth. And I would like to ask you to look at this article and if possible, Mr. Lynn, to submit a response to it.

Mr. Lynn. Certainly." I think it would be more in the nature of a compliment, sir.

Chairman HUMPHREY. Have you read the article?

Mr. Lynn. Yes; and it is quite a thoughtful article. We might have a little different emphasis here and there, but it wouldn't be a response; it would simply be a supplement.

Chairman HUMPHREY. I think we will adjourn the hearings and any additional questions, if any, will be sent to you and we will communicate with your staff.

Mr. Lynn. Thank you. It has been a pleasure to be here.

[The following questions and answers were subsequently supplied for the record :]



CURRENT SERVICES BUDGET Question. In November, OMB prepared estimates of the cost in fiscal 1977 of maintaining the present level of real Federal services. These estimates, which have been termed the "current services" budget, have been most helpful.

What would also be very helpful would be an updated set of these current services estimates and a comparison with the President's recommendations. In that way we could identify precisely where the President has recommended policy changes. I wrote and asked you to prepare such a comparison. You have replied that time constraints and the fact that not all fiscal 1976 appropriations are completed prevent your doing so.

However, the Congressional Budget Office has prepared an updated comparison. May I ask whether you consider their numbers accurate and their comparison fair. That is, since you have not been able to supply this table yourself, will you give the CBO numbers your endorsement ?

If you do not consider the CBO estimates adequate, then you would be well advised to give us your own, despite the difficulties involved. The purpose of requiring the current services budget was to facilitate the identification of the President's proposed policy changes, and we intend to proceed to make such an identification as best we can.

In future years, will you be able to include in the budget a table comparing Presidential recommendations with current service estimates ?

Answer. We have examined the five-year projections prepared by the Congressional Budget Office using a current services budget concept. The document itself does not contain sufficient detail to permit a full analysis and understanding of the estimates. In addition, it is not always clear what conceptual approach the CBO has followed. However, we have recently received a staff working paper which provides supplementary information and we will analyze their projections in light of this information. In the meantime,

1 The response to be supplied for the record was not available at time of printing the hearings.

it is difficult for us to know whether the numbers are ones we would agree with. We would be happy to get in touch with the JEC staff when we have received this additional information from CBO and have had a chance to analyze their estimates on that basis. This analysis should provide an adequate understanding of any differences in approach between the CBO and OMB, and this would be more useful than an attempt by OMB to provide updated current services budget estimates. As you are aware, the CBO itself has been working for several months on their projections and we do not believe that an additional set of current services projections by OMB at this time would be justified in view of the very substantial workload involved.

THE BUDGET AND STATE AND LOCAL GOVERNMENTS Question. President Ford has been very critical of Ronald Regan's proposal to return $90 billion worth of expenditures to the State and local governments on the grounds that it would be an excessive burden to impose on already overused regressive taxes. Yet the President's own budget offers a number of "behind the scenes" changes that will result in higher costs for State and local governments, and thus higher state and local taxes. Can you tell us the additional cost imposed upon State and local governments of each of the following proposed changes ?

(1) Social Security tax changes that will require higher contributions from State and local governments.

(2) A reduction in the Federal government support of water pollution abatement programs with no offsetting change in the Federal standards.

(3) Cutbacks in mass transit operating subsidies that will force additional expenditures by local governments.

() Changes in the contributions made by State and local governments to the Unemployment Compensation Trust Fund.

(5) Cuts in Federal assistance for management and planning without an offsetting reduction in Federal requirements that these activities be carried out on a region-wide basis.

Answer. (1) The President's proposed increase in Social Security taxes is not scheduled to go into effect until January 1, 1977, at which time the economy should have improved substantially, with a corresponding improvement in State and local government finances. We believe it is appropriate that State and local governments, like other employers, pay the employer share of social security contributions for their covered workers. The increased tax rates would cost State and local governments about $400 million a year once they are in effect.

(2) Using the 1974 "EPA Needs Survey" as a base, the remaining costs for constructing all identified municipal facilities that may be eligible for federal support under P.L. 92–500 after complete obligation of the current $18 billion anthorization, are estimated to be $424.2 billion. Under current law, the Federal share would be $318.1 billion, with a non-Federal share of $106.1 billion. The program reform measures proposed by the Administration would reduce the total remaining program cost to $118.7 billion, to be financed with $50 billion in additional Federal funds and $68.7 billion in non-Federal funds.

The major factor in this reduction is the elimination of treatment for storm water discharges as a type of project eligible for construction funds, which assumes that the necessary degree of pollution abatement from these sources can be achieved by management and other non-structural techniques.

It should be noted that Federal water pollution control standards apply to only one type of facility--municipal sewage treatment plants. Contrary to the statement implicit in your quesions, none of the proposed changes would affect Federal funding for projects designed to meet existing Federal standards for the existing population. Rather, the Administration's proposals were designed to make this area top priority for Federal funding. The project features affected by the proposed changes-excess reserve capacity, construction of new sewer systems, etc.-are ones which are determined by State and local governments for which there are no Federal pollution control standards.

In summary, the thrust of the Administration's proposals is to focus Federal funding on project features designed to meet Federal standards, and to return

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to local communities the financial responsibility for project features necessitated by State and local decisions, including growth and development policies. The Environmental Impact Statement on the proposed legislation will be available shortly, and will contain additional detailed information on these issues.

(3) Funds for the mass transit formula grant program go from $300 million in 1975 to $500 million in 1976 and $650 million in 1977. The formula grant funds can be used for operating expenses or capital investment. The capital grant program also is increased (by $25 million to $1,125 million from 1976 to 1977). Therefore, federal funds available to cities and States for mass transit in 1977 will increase by $175 million over 1976. The Administration is proposing that the $650 million formula grant programs be changed to permit a maximum of 50% or $325 million of the funds to be used for operating subsidies. This would compare with about $400-$450 million of Federal funds used for operating subsidies in 1976. The other $325 million of formula grant funds will be available to the cities for capital investment (e.g., buses). The 50% limit will return to local transit systems—and the governments involved with them—the responsibility for appropriate fare structure, sound management, and efficient operations. If improvements in these respects take place, there should not be a need for a substantial increase in State and local government spending.

(4) State and local governments do not pay taxes into the unemployment insurance trust fund. Rather, they later reimburse the fund for unemployment compensation costs that arise from their workers actually collecting benefits. Thus the proposed increase in unemployment insurance taxes does not impose additional costs upon State and local governments. The President's proposal to extend regular unemployment insurance coverage to save 4.8 million State and local government employees not now covered will, however, result in increased cost. The President feels that covering these workers is an important improvement in our unemployment insurance system and that State and local governments—like other employers-should pay for the coverage of their workers. The proposal would not take effect until late in 1977, when again, an improved economy and an improved State and local fiscal situation should ease its effect. The full-year cost is estimated at about $300 to $400 million.

(5) Planning and management by State and local governments are activities that may be paid for from the consolidated grants recommended in the budget (such as the community development block grant program and the proposed financial assistance for health care program). Hence, there is less of a need for separate, categorical funds earmarked for planning, and these can be reduced. Consolidated funding will give State and local governments greater opportunity to follow their own needs and priorities in setting a balance among planning, management, and direct program activity. Because funds will be available under the consolidated grants, there should be no additional cost to State and local governments. Indeed, the efficiencies resulting from consolidation should lead to savings. The President is concerned about excessive Federal regulatory requirements—in the planning field as elsewhereand would welcome suggestions for improvement from the Congress.


Question. I may be upset by some of the erroneous statements which are made concerning the size of government and the growth of spending, but this does not mean I am unaware of the need to control spending and to achieve savings and efficiency in government. At my urging, the staff of the JEC has prepared a list of possible budget savings and made estimates of the amount which could be saved by 1981 if these were adopted. These possible savings were discussed in the December staff report on the current services budget, with which I am sure you are familiar.

I would like to ask you to give us your comment on each of those possible budget reduction measures. Which of them would the Administration support? Which were included in the President's budget this year? Are our estimates of the potential savings reasonably accurate ?

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