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DOCUHENT BESOHE 



ED 115 151 



HE 006 924 



AOTHOH 
TITLE 

POB DfiTE 
NOTE 

EDES PBICE 
DESCBIPTORS 



Hartman, Robert H« 

Th-e Federal Budget Outlook and Its Icpiications for 
Higher Education* 
10 Jan 75 
lOp* 

MF-$0*76 HC-$1*58 Plus Postage 

Budgeting; Cost Effectiveness; ♦Economic Climate; 
♦Economic Factors; Expenditures; ♦Federal 
Legislation; ♦Post Secondary Education; ♦Taxes 



ABSTRACT 



Given the need for a 
government in the short-run and given 
on our budgeting and taxing process o 
to happen to federal expenditures for 
likely to arise are: (1) in this next 
excuse for holding back new higher ed 
fuller-funding of old programs becaus 
cuts are to be used to bring the econ 
changes should be (primarily) tempora 
the prerequisites for a sensible tax- 
put in place* How the government deci 
economic stimulus and long-term budge 
will determine the fate of federal ai 
(Author/KE) 



large stimulus by the federal 
the need for structural reform 
ver the long-run, what is likely 
higher edtication? Two issues 
year there is absolutely no 
ucation programs or 
e of "inflation"; and (2) if tax 
omy out of the doldrums, the tax 
ry ones* During the recovery, 
and-budgeting process should be 
des the big issues of short-term 
t reform more than anything else 
d to postsecondary education.* 



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ERIC 



Robert W.- Hartman 
Jan. 10, 1975 



The Federal Budget Oiitioolr bsyi Its Iraplications 
For Higher Education 



I start with two famous scriptural quotations: 

"It takes a fool to try tu predict the federal budget 
tv/o v/eeks before it is released and 

"It takes an economist to confuse a simple situation." 

Ify overall plan is to prove that the union of these two sets of 
characterictics is alive and well at Iho Mayflower Hotel. 

The Federal Budget Outlook 

The confusion one senses in the newc^papers about fiscal policy is, 
in a sense, sxarprising. In contrast to the past few years, there is 
widespread corisensus today on the state of the economy: it is slipping, 
rapidly. This ought to mean that the required fiscal policy is one of 
stimulus — of considerable magnitude, and the sooner the better. And 
yet within the past month we have had on the table simultaneously proposals 
for income tax surcharges, multi billion dollar energy tax increases, and 
proposed budget cuts. Things are begirirdng to settle down to a discussion 
of tax reductions, but the range of proposed reductions — anywhere from 
$10 to $35 billion ~ stagger the mind. 

It would be comforting* for me to tell you that the range of fiscal 
policy prescriptions stem from different conceptioni? of the relative 
damage done to our society by inflation and unemployment. If that wei^e 



U S DEPARTMENTOFHEALTM 
EDUCATION A WELPARP 
NATIONAL rNSmUTE OF 



the case, I could tell the story in good gxay/bad guy terms and v.e could 
all rejoice in the fact that v^e are back to politics as usual, with the 
liberals on one side ar.d the corxseryatives the other. 

But I am convinced that part of today's debate stems from the fact 
that there is disagreement over what federal budgetary stance cor^stitutes 
a stimulus, a depressant or a neutral pogture. On this technical issue 
there is no bad guy/good guy dichotomy but rather the v;rong vie^v — \7hich 
for the sake of brevity I will call William Sdjnon's position ~ and the 
right view — which I will now try to explain. 

Innumerable speeches and testimonies of the Secretary of the Treasury 
inexorably focus on the growth in federal expenditures or in the federal 
deficit as the measure of the stimulation exerted by the federal government 
on the economy. There are maiQr thirjgs wrong with this view but I want to 
focus on one, which is not widely understood: this is the ter-dency of the 
federal individual income tax to automatically increase its drain ox\ real 
income (and thus real spending power) in times of inflation. Unless this 
tendency is recognized, it is impossible to "understand what is required 
of the federal goverment to offset such a drain on* demand for goods, 
services, and ultimately for workers. 

In 1973, a typical federal taxpayer might have been earning $15,000. 
Assumirig a joint return with k exemptions and a reasonable estimate of 
deductions,* such a taxpayer would have paid $1,600 in federal taxes. 
What would have happened to this taxpayer's liability in 197** had his real 
income remained fixed? — thus ^ abstracting from the decli}:>e in economy 

* Deductions are assumed to be $3,000. 

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ERIC 



and focusing on the tax system itself. 

With an inflation rate of 11% the taxpayer family's incanF'^iould 
have risen to $16,650 (11^ by assumption) but his taxes v^o'ald have gone 
up to almost $1,900, an increase of about I8 percent/ Part of this 
increase can properly be treated as an automatic stabilizer — - the built-in 
feature of the tax system that raises or lowers actual tax liabilities to 
counter the business cycle. But when one removes, this (desirable) cyclical 
component, and focuses on the increase in real taxes at a constant level 
of real income, there remains an increase in federal income taxes of about 
6M percent for the typical taxpayer between 1973 and 197^.^ The economic 
effects of the inflation- induced automatic growth in real taxes at a fixed 
level of real income is exactly the same as if Congress had voted to impose 
a tax surcharge ~ it depresses demand in the economy and slows down 
employment . 

Moreover, we can expect more of the same in the coming year. Even 
with inflation ebbing somewhat — as most . forecasters predict — real tax 



* Assuming that deductions rise by 11 percent, the same rate as income, 
the tax liability rises to $1,800.^0. The implied elasticity of tax 
liabilities to income is about .1 .65 . c .f . Pechmsn, BPEA. 

Expressed in 197^^ dollars, the 1973 tax liability of $1,600 becomes 
$1,776. The 197lf tax liability of $1,890. Uo (see last footnote) 
represents a 6.4 percent increase over $1,776, both measured in 197k 
dollars . 



rates v/ill probably rise another 3.k percent.* Thus over the tv/o years 
covering the calendar years 197^4 and 1975, inflation alone has raised 
personal income taxes in real terms by over 12 percent .* With a fiscal 
year I975 individual income tax take of about $125 billion, these tax 
hikes alone account for a drag on the economy of about $15 billion. 

Thus, just to offset the backdoor t,ax personal income tax increases*"^' 
that will have taken place will require expenditure increases or tax 
reductions of $15 billion this year. 

A federal governnent that simply offset inflation induced tax 
increases would not be doing enough in a growing economy. Each year as 
the labor force grows and its productivity increases/** the governnent 
must spend more (or tax less) lest it exert a drag on aggregate demand. 
A reasonable estimate of these growth requirements would amount to about 



* This result presumes an increase in the GNP deflator of 9.1 percent in 
calendar year 1975, as projected in "The 1976 Current Services Budget: 
A Staff Study," Joint Economic Committee, (mimeo, Dec. 31, I97U), p. 16 
To calculate the percent increase in real taxes (r^) 
I used the formula 1 + n ^p 



1 + = ■ T ^ r — where 

1 + -^T) 



^ n = elasticity of taxes with respect to income growth (equals I.65). 
r_= the rate of growth of prices. 

A similar, but much sma.ller, phenomenon may be occurring in corporate 
profits taxes, the real yield on which is increased by price-induced 
inventory capital gair^. However, these tax increases can be largely 
offset by corporations if they switch to the LIFO accounting convention. 
I do not have the data on which to estimate the net effect of those 
corporate tax influences. 

One should not be mislead by recent reductioris in productivity, most of 
which are related to the business cycle ~ not to any intrinsic, long-term 
productivity decline. 



10 percent for the two-year period 197l4-75 c^-^.d applied to all federa*' 

* 

spending (net of uremployment benefits ) of about $293 billion in 
fiscal 1975, growth I'nposes a reeded expar^^ion of fedei^al sperdir.g or 
net tax relief of atout .$30 billion. 

Combining the inflation and growth estimates, and converting the 
result into fiscal 1976 dollars, we are talkirig here of added federal 
spending (or tax relief) in the ball park of about $5^ billion or a 
budget total of $362 billion .lust to remain neutral , offsetting the drag 
of inflation and growi;h in 197^ and 1975. I should further note that I 
am bending over backwards to be conservative here, not compensating at 
all for a small social security tax increase in 1975 or for inflation- 
induced corporate profits rate hikes . 



The debate that engages the nation should be over how quickly we 
ought to be restoring the economy to its desired path — that is, how 
much in excess of $360 billion (read how much in excess of a $50 
billion deficit) we will need in the coming fiscal year. Instead, all 



* Unemployment benefits in fiscal 1975, are estimated at $6.1 billion from 
the February budget plus increases of $3.3 billion receni^iy estijnated by the 
JEC, op. cit. The 10 percent estimated is based on real growth of k percent 
per annum and on elasticity of total federal taxes of 1.25. 
Inflation- induced tax increases plus growth requirements amount to $^9 
billion in fiscal year 1976 dollars. This sum is added to the $298 
billion in. fiscal year 1975 federal outlays, net of unemployment com-" ^ 
pensation, and then lU .6 billion of ur^emplojinent tror^-^fers are added 
to attain, a fiscal 76 total. Thus inflation and growth account for $'49 
billion of the increase; the remainder is the growth of unemployment 
compcr^^ation. (On the- latter see JEC, op. cit.) 



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signals point to the Administration being so overwhelmed by the budget 

deficit iiaplications of even a-mpdest stimulative program that we will 

have too little of it. Congress, meunv.hile, has yet to show that the 
increased powers it has voted itself will result in a coherent attack on 
the growing weakness in the economy. I suspect that as time marches on, 
and the unsmployment rate marches up, even bond market barJkers will 
realize that the worst thing for them is a populace with declining 
incomes and declining savings . The deficit bullet will then be bitten, 
probably too late to make the Bicentennial Year an occasion for celebra- 
tion. 

Spending? Boosts or Tax Cuts 

Once the decision is made to stimulate the economy, the government 
will be faced with a choice of expanding through expenditure increases 
or through tax cuts. [I hope the relation of all this to financing ^ 

postsecondary education is becoming apparent / ] Although I have 

emphasized, in my remarks, the depressing effects of inflation on our 
federal taxes, it would be a mistake to conclude that the cure lies on 
the tax side. Many economists — and other conservatives (l chose my 
words carefully) — advocate the permanent cleansing of the tax system 
of the inflation- induced tax increases; this is called indexing. My view 
is that such a permanent charige would be a mistake, and to explain why 
I have to back up a bit and look at recent budget history. 



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For the past several years, whenever restraint seems to have been 
called for, the- focus of inflation-fighters has turried to the expenditure 
side of the budget. Given the fact that certain components of federal 
outlays could not be controlled in the short-run (entitlement programs, 
interest on the debt, spending on previously incurred commitments) the 
axe has fallen — at least in Presidential proposals — on a r*arrov.' part 
of the budget. In the domestic area, grants-in-aid and research stand 
out. Moreover, the focus on expenditure control has made it difficult 
to start new federal programs — or fully fund old ones — because the 
short-term budget situation has dominated the debate. 

These actions have been u failure from nearly every conceivable 
point of view. They have not held down outlays — indeed. Congress has 
taken the opportunity to expand benefits in uncontrollable programs, 
(Thus making it impossible to start up new programs in the next year.) 
Most important, however, is the fact that these expendit\ire control 
exercises have paid almost no attention to what such exercises should 
be about: namely, how to set public expenditures consistent with national 
priorities. Similarly, when Congress recently enacted a public service 
employment program much attention was paid to how fast expenditures could 
be made, rather than to the underlying structure of the program, 

I have concluded from these recent episodes that the expenditure 
side of the federal government's activities is the wrong place to regulate 
the economy's fiscal thermostat. Public priority decisions must be made 
for the long-run and, inevitably, that will imply that ar^propriations ard 
outlays must be voted on Zi multi-year I ^13 is. 

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If federal nperding v.-ore cot for ru»v--rj;i years with loxig-run 

priorities in mind, two critiotil stGpi> woudd i*;'vc to be tnkeri in the tax 
area. First, a system of quickly impic.r!?ntcir:lc U:x rebates and surcharjges 
v/ould have to be placed on the books r.o that could serve as the 

primary federal instrment for boost irg or ln;.:y -I'r.p; demc^rid. In order for 
such a system to command wide support federal U xejj would have to be 
recognized as "fair," meaning that "tax reforr:)*' — the elimination of 
abuses in the tax system — has to be given hiiih priority. Second, the 
overall tax level around which these f3tu:*chGr^'c-s and rebates would dance, 
would have to be set so as to be consistent vdth aggregate sperding 
projections and the need, if arry , for long-run public saving to erJiance 
capital growth in the economy. This menu for t^ixation — a surcharge 
and rebate system, tax reform, long-run schoduLo setting consistent 
with public service and private capital needs — take precedence over index- 
ing or any other permanent change in taxes . 

The Current Dilemmf? and the Outlook for Hlriier I v -'Ucrjtion 

Given the need for a large stimulus by tii^B federal government in the 
short-run and given the need for structural rcforin in our budgeting and 
taxing process over the long-run, what is likely to happen to federal 
expenditxires for higher education? The short nrav.er is "I don't know," . 
but I think I can give some guidance on issuf^j tint tire likely to arise. 

First, for as long as v.e continue to orcr;. on federal expenditures 
one-year-at-a-tirne . in thin 3v:xt ye^ir ■tl;ere i:-; ;.;:.: olutely no cxcuso for 



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9. 



holding back new higher education programs or fuller-fund liv; of old 
programs because of "inflation." To the extent that the iiasilc Educa- 
tional Opportunity Grant Program or other prograiiis in the I972 Amendments 
were held back out of fear of fanning the fires of inflatior;, the coming 
year is the time to undo such treatment. I hojje the debate over education 
appropriations is thus turned into a debase on the social merits in the 
long-run of the various programs authorized by the Congress. I would note, 
however, that even in the long-run there are indeed budget coiistraints , 
so that higher education, under ary budget regdjne, must justify its receipt 
of f\ands. 

Second, despite the reasoned case I thoioght I Just made for holding - 
off on permanent changes in the tax system, the temptation to do so is 
going to be very strong in the coming year. It is sijnply a fact that no 
one can gin up sensible multi-billion dollar spending programs in say, 
postsecondary education, that will result in quick employment advances. 
The lesson here I think is clear. If tax cuts are to be used to bring 
the economy out of the doldrums, the tax changes should be (primarily) 
temporary ones. During the recovery, the prerequisites for a sensible 
tax-and-budgeting process should be put in place. 

How the government decides the big issues of short-term economic 
stimuliis and long-term budget reform more than anything elae v/ill determine 
the fate of federal aid to postsecondary education. I car.'t help closing 
with another quotation "v;li#b's good for higher education is good for the 
U. S. A. and, in this case, for General Motors, too." 



ERIC 



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