difficult to have accurate long-term forecasts, we will be very interested in your views as you see the economy looking down the road beyond 1976 and at least the first part of 1977.

With that, we will take no more of your time, just ask you to proceed. So that you will know. I may have to leave at about 10 minutes to 11, but the committee will be chaired by Congressman Long; and we will proceed with the questions. Senator Proxmire will be here and other members will also be present.

STATEMENT OF WALTER W. HELLER, REGENTS' PROFESSOR OF ECONOMICS, UNIVERSITY OF MINNESOTA

Mr. HELLER. Mr. Chairman, with your permission I would like to handle part of my testimony by reference to the article I wrote for yesterday's Wall Street Journal on the economic outlook for 1976-77 and Mr. Ford's budget.

Chairman HUMPHREY. Do you have copies?

Mr. HELLER. It is attached to my prepared statement.

Chairman HUMPHREY. We will, of course, incorporate that in the

record.

Mr. HELLER. Thank you.

Let me highlight a few points in that analysis and then go on to consider some desirable policy moves in the 1976 setting before winding up with an expression of concern over what might be called "the misguiding of the American public" on a number of key economic issues and economic facts. As for the 1976 economic scene, one cannot stress too strongly the importance of differentiating between the direction and level of economic activity. Unless that distinction is constantly borne in mind, the signals for economic policy are likely to be read incorrectly.

The upward course of the U.S. economy in 1976 isn't in doubt. Given the lags in the impact of economic policy, I would say that the first 6 months' performance is pretty well foreordained. It is true, however, that the second half could be imperiled if, first of all, the Federal Reserve were to hit the economy in the solar plexus with a sharp shift toward tighter money and rising interest rates; and second, if the White House and the Congress fail to find a mutually acceptable formula for extending the temporary $18 billion tax cut. Also, full acceptance of Ford's budget would hit the economy with a sickening thud later in 1976-mostly after the election.

Now, on the somewhat perilous assumption that these policy mistakes will not be made, George Perry and I project a somewhat more vigorous rise in real GNP-7 percent year over year-than the private consensus forecast, as well as the administration's forecast.

We project a somewhat stronger rise in both consumption and business capital spending than most forecasters-and let me refer you to my statement for the reasoning behind that conclusion-except to mention the dazzling upswing in corporate profits. Corporate profits hit a postwar low, it's true, in 1974 at only 8 percent of corporate product. But the newly revised Commerce figures show that after-tax profits rose from an annual rate of $60 billion in the first quarter of last vear to an estimated $88 billion in the fourth quarter: and they will go right on up this year to over $100 billion by the fourth quarter. That's after-tax profits at annual rate.

Chairman HUMPHREY. Now, why do you say $100 billion? Mr. HELLER. In the fourth quarter of this year, it is my best estimate it would be about $103, $104 billion at an annual rate. Chairman HUMPHREY. In the fourth quarter of 1976.

Mr. HELLER. In the fourth quarter of 1976.

Chairman HUMPHREY. That's fantastic.

Mr. HELLER. And perhaps an even more meaningful comparison is to take 1974 versus 1976, after correction for inventory evaluation, that is, if you take inventory values at replacement cost, so that you take out these fluctuations. On this basis, 1976 profits as Perry and I see it, would be 50 percent-54 percent to be precise; in our forecastabove 1974. So, bedrock profits, taking out inventory changes, are making a very nice recovery from that 1974 low point. And when we couple those profits with the cash flow from depreciation, and so forth, with the incentive of bigger investment tax credits and better access to capital markets now that the stock market is pepping up again, one can foresee repeated upward revisions of capital spending.

Now, even if the economy, under these favorable policy assumptions and this is where I get to the level, rather than the direction of the economy-even if it achieves this above-trend pace of expansion that we project, can one really settle for this, let alone accept restrictive White House and Federal Reserve policies for 1977 in light of the present and prospective levels of economic activity?

Now, as 1976 began, the unemployed labor pool equaled well over 9 million workers and by the way, even with the encouraging news about the unemployment figures today, we are going to find the number hovering around 9 million. But where do I get the 9 million? Well, there are now 7.3 million officially unemployed-plus nearly 1 million discouraged workers-about 900,000; and 311⁄2 million part-time workers who are available for full-time work. That is, 3 million part-time workers who would like to work up to 40 hours a week are averaging 22 hours a week. That adds up to an unemployed labor-pool equivalent of about 9 million.

Second, total output is running at least $150 billion a year below the economy's high-employment potential; and I think that's a very modest number, Mr. Chairman. You know me as an old conservative in these matters. I could say $175, but in order to avoid criticism I put it at $150 billion because there are some that don't feel we can achieve as high a level of employment as some others.

And third, even after a 7-percent gain in output this year, we will end the year with recessionlike levels of unemployment, at 74 percent; of capacity utilization rates in manufacturing, at about 80 percent; and of economic slack, with actual output running about $125 billion below potential output, conservatively measured at 5 percent unemployment.

Now, I say "recessionlike" advisedly because, looking at the four previous recessions since 1950, the unemployment rate at the bottom of those recessions, in the trough quarter, averaged 6.2 percent. We will be a full percentage point above the bottom of the preceding four recessions.

Capacity utilization at the trough averaged about 77 percent. In other words, you asked about 1977, we will be entering that year at

unemployment rates and excess capacity levels comparable to those at the bottom of our previous recessions in this generation.

Now, what about the prospects for inflation? High as it is by national standards, inflation will continue to moderate in 1976. Again, to save time, let me skip to the concluding statement on this particular point.

Coupling the abatement of food and fuel inflation with the modest impact of demand pressures and an 8-percent average pay increase that we foresee this year, one can reasonably project a 534-percent rise in the GNP deflator, or about 6 percent in the cost of living.

Now, turning to policy. If the President's budget and tax proposals were enacted, the recovery would be dealt a severe blow while the economy is still operating far below target levels. The high employment surplus would rise by $19 billion for the fiscal year 1977, with restrictive pressure becoming particularly sharp during calendar 1977 when the proposed payroll tax increases would go into effect.

Now, that $19 billion a year means a much bigger swing during 1976-77. The special analyses in the President's budget show that there would be a $30 billion jump in fiscal restrictions in 15 months, from the spring of 1976 to the summer of 1977. The Federal budget would be tightening its noose by $30 billion on an economy that is still far from anything resembling full employment. A restrictive swing of that magnitude took a huge toll in jobs and output in 1959-60 and again in 1972-74; and I just hope we don't repeat those disastrous experiences.

Rather than accept the 1977 Ford economy model budget, and an economic policy that resolves all doubts in favor of a go-slow expansion and risk a new recession, the more prudent course would be to follow monetary and fiscal policies that will step up the rate of expansion in 1976 and continue in 1977, until that erosive waste of human and material resources has been brought back within tolerable bounds. Let me suggest several components of such a policy.

1. Put Mr. Ford's budget on the course of economic, social, and political responsibility. It would be well within that course for Congress to bring budget spending at least up to a maintenance-ofservices level of $414 billion. Indeed, Alice Rivlin puts the baseline budget at $425 billion-$31 billion above Ford's fiscal squeeze budget. From a purely economic point of view, the minimum task of Congress is to prevent the budget from turning restrictive in the face of recessionlike levels of unemployment and unused capacity. Perhaps Congress will want to put more tax cuts and less spending in the economic mix that I might prefer. But, one way or another, it must overcome the $19 billion swing toward economic restriction. Indeed, the $19 billion year over year, or $30 billion if you take it from the spring of 1976 to summer of 1977.

The Ford administration and the Federal Reserve are still fighting the last war against inflation. I don't see why they can't see what it took to give us that double-digit inflation in 1973-74 that, by the way, fooled us all-we all did a poor job of forecasting that. We took a fiveply shellacking: A fivefold jump in oil prices, a 40-percent jump in food prices in 21 years, a double devaluation of the dollar, decontrol of wages and prices, and a worldwide commodity price boom. Those things simply aren't in the cards for 1976-77.

2. The Congress should do what it can to prevent monetary policy from swinging toward restriction at this stage of the game. I find it, by the way, passing strange that the Federal Reserve, whose Chairman has not been bashful in making known his distaste for monetarist formulas, and the congressional banking committees, whose objectives would be far better served by emphasis on moderate levels of interest rates than by lock-step limits on money supply increases I find it passing strange that they should have coalescedand I'm delighted that Senator Proxmire is here to hear this; I want to repeat this.

Senator PROXMIRE. I just came in as you chastised me, I was reading that; that's very unfair, very unfair.

Mr. HELLER. Well, I'm happy to hear it's unfair.

As I say, I find it passing strange that the Federal Reserve and the congressional banking committees have coalesced on monetary policy targets stated exclusively in money supply terms. Interest rates should be brought back into their proper place in setting policy targets-as, indeed, the House Banking Committee has been urging the Federal Reserve to do-but with indifferent success so far.

Arthur Burns showed again, early this week, what damage he can do. Just by manipulating the money supply targets, lowering the floor of his range for technical reasons-which immediately suggests a lower target average for a money supply increase. This quickly boosted short-term rates and took its toll in the stock market.

3. Social security payroll tax increases today-or next January 1would be the wrong medicine at the wrong place at the wrong time. It seems particularly paradoxical to consider further cuts in the income tax, our best tax, at the same time that we would boost the payroll tax, which bears hard on the poor, raises business costs, and boosts the cost of living. With contingency reserves above $40 billion, the social security system is in no immediate need of added revenues. And when that need materializes, it is high time to supplement the resources of the system with general revenues, rather than cutting income taxes while boosting payroll taxes.

4. On income taxes, an adjustment of the proposed cuts to maintain the credits and tax breaks for the lowest income groups-who are still at the bottom of a very deep job barrel and have been hit hard by the amount of composition of inflation this time around—would be very much in order.

5. Finally, just a word on wage-price policy. Although it now seems beyond the political pale in 1976, the Congress should never forget that a balanced program for full employment must contain some kind of restraint on excessive price increases exacted by concentrated industries and excessive wage increases exacted by overly powerful labor unions. Antitrust can't cope with this problem. A more effective system of flagging down excessive wage and price increases in areas of the economy where competition is not effective as a policeman must be part of a balanced program to overcome intolerable unemployment without incurring intolerable inflation.

Now, there are other policy suggestions I would have made but for the lack of time. something on public service jobs, antirecession grants, getting rid of some of our overregulation and so on. My prepared statement covers these.

But I did want to take just a few minutes to talk about the "misguiding" of the American public on economic issues. I cannot conclude these opening remarks without expressing my growing concern over the distressing tendency in recent years to miseducate and, wittingly or unwittingly, mislead the American people on vital issues of economic policy and fact. This process, calculated or not, is contributing to misunderstanding of basic economic relationships, unnecessary anxiety on many fronts, and a loss of faith in the American economy and its public institutions. Let me just cite a few examples. The Federal Government is depicted as expanding like some monstrous protoplasmic blob that threatens to snuff out economic freedom. and initiative. Yet, the facts will show that the Federal budget as a proportion of GNP held virtually steady at about 20 percent from 1953 to 1973. It is projected to rise to 21 percent in fiscal year 1977but adjusted to a full-employment basis, the figure will be right back at 20 percent.

The expansion, in other words, of the Federal sector relative to the rest of the economy in 24 years-zero.

Or, take the supposed "crushing burden of Federal debt." A striking chart included in last year's budget documents-but not thisshows that the Federal debt held by the public dropped from 82 percent of annual GNP in 1950 to 26 percent in 1974. Seen in this perspective, the public debt is a far different and more manageable problem than the general impression abroad in the land.

A third area of widespread misapprehension of the real problem centers on the large deficits in the Federal budget. Here, two misimpressions are being fostered:

The $70 to $75 billion deficit is being identified with profligacy in spending and fiscal irresponsibility when, in fact, it is almost entirely a hostage to recession. Your witnesses yesterday went over that, and I simply note that if we had something like full employment, revenues would be $50 to $55 billion higher than they are; unemployment compensation would be about $15 billion lower; and other cyclically responsive outlays would be about $5 billion lower. So, almost all of the deficit is a product of recession. Ironically, the selfsame monetary and fiscal authorities whose disastrously tight policies in 1974 helped aggravate the recession and hence the deficit are the ones who are loudest in decrying the deficit as an example of the loss of fiscal discipline.

A related charge is that Government deficits are the root of all inflationary evil. How is it, then, that inflation is ebbing in the face of the largest deficits in history?

A fourth area of anguished misapprehension relates to the social security system. The impression has been given that it is about to go broke. I need not tell this committee how far this is from the truth. May I add, Mr. Chairman, as I speak around the country on economic matters, that's usually question No. 1 by the audiences afterward, "What is going to happen to our social security? We understand that the system is going bankrupt."

How that impression has been so widely disseminated is not quite clear to me.

Chairman HUMPHREY. Reader's Digest, as you know, carried a number of articles on this, and that is a well-read magaine; there were