To the Congress of the United States:
I will be working closely with the Congress in 1978 to enact a program addressed to the immediate and the longterm needs of our economy. I am proposing tax reductions and reforms to continue our strong economic recovery, to encourage increased investment by American businesses, and to create a simpler and fairer tax system. I am seeking legislation to address the special problems of the disadvantaged and the unemployed. And I am taking new steps to combat inflation.
This report to the Congress on the condition of the economy sets forth the overall framework within which my economic proposals were formulated. It outlines, for you and for the Nation, my economic priorities for the years ahead and my strategies for achieving them.
I have begun from the premise that our economy is basically healthy, but that well-chosen Government policies will assure continued progress toward our economic goals.
Last year more than four million new jobs were created in our country—an all time record—and unemployment was reduced by more than one million persons. Output rose by almost 6 percent, and the benefits of this large increase were widely shared. The after-tax income of consumers, adjusted for inflation, rose substantially during 1977. Wages of the typical American worker increased by more than the rise of prices, and business profits also advanced.
The American economy is completing three years of recovery from the severe recession of 1974-75. Recovery in most Other nations has lagged far behind our own. In the economies of our six major trading partners, seven million persons were unemployed at year's end—more than at the depths of the 1974-75 recession. Our inflation rate is also lower than in most other nations around the world. We have a great many accomplishments. But much progress remains to be made, and there are problems to be dealt with along the way.
The recession of 1974-75 was the worst in 40 years, and the substantial increase in output over the past three years still leaves the economy operating below its productive potential. We cannot be content when almost 6 1/2 million people actively seeking jobs cannot find work, when 3 1/4 million workers take part-time jobs because they cannot find full-time employment, and when one million people have stopped looking for a job because they have lost hope of finding one. We cannot be content when a substantial portion of our industrial plant stands idle, as it does today.
We cannot be satisfied with an economic recovery that bypasses significant segments of the American people. Unemployment among minorities is more than twice as high as that among whites—and unemployment among minority teenagers is tragically high. Women have fewer satisfying job opportunities than men, and older Americans often find their access to the job market blocked. Farm incomes have dropped precipitously.
We must also address other problems if we are to assure full restoration of prosperity. Inflation is a serious economic concern for all Americans. The inflation rate is too high and must be brought down. Moreover, a residue of unease and caution about the future still pervades the thinking of some of our people. Businesses are still hesitant in their long-term investment planning, and the stock market remains depressed despite the substantial increase in business profits.
The economic difficulties that we face in the United States also confront most nations around the world. Our mutual problems are the legacy of the trauma suffered by the world economy during the early 1970s. The massive escalation of oil prices since 1973 continues to impose great burdens on the world economy. Oil imports drain away the purchasing power of oil-importing nations and upset the international balance of payments.
Many foreign governments have been reluctant to adopt policies needed to stimulate economic growth because they are concerned that inflationary pressures might be renewed or that their balance of international payments might be worsened. Abroad, as well as at home, concerns about the future have deterred business investment in new plants and equipment. As a consequence, economic growth has stagnated in many countries, and the rise in the capital stock needed to increase productivity, raise standards of living, and avoid future inflationary bottlenecks is not occurring.
The problems we face today are more complex and difficult than those of an earlier era. We cannot concentrate just on inflation, or just on unemployment, or just on deficits in the Federal budget or our international payments. Nor can we act in isolation from other countries. We must deal with all of these problems simultaneously and on a worldwide basis.
Our problems cannot be solved overnight. But we can resolve them if we fix our sights on long-term objectives, adopt programs that will help us to realize our goals, and remain prepared to make adjustments as basic circumstances change.
In making my decisions on tax and budget policies for fiscal 1979, and in planning more generally for our Nation's future, I have been guided by four objectives for our economy that I believe our Nation should pursue.
We must continue to move steadily toward a high-employment economy in which the benefits of prosperity are widely shared. Progress in reducing unemployment of our labor and capital resources must be sure and sustainable. Over the next several years I believe we can increase our real output by 4 1/2 to 5 percent per year, and reduce unemployment by about one-half of a percentage point each year. An especially high priority is to increase job opportunities for the disadvantaged, particularly for black and Spanish-speaking Americans, and to deal more effectively with local pockets of unemployment, such as those in urban areas. We should eliminate unfair advantages through reform of the tax system, and restructure our welfare system to assure that the fruits of economic growth are enjoyed by all Americans.
We should rely principally on the private sector to lead the economic expansion and to create new lobs for a growing labor force. Five out of every six new jobs in the economy are created in the private sector. There are good reasons for continuing to rely mainly on the private sector in the years ahead. By emphasizing the creation of private jobs, our resources will be used more efficiently, our future capacity to produce will expand more rapidly, and the standard of living for our people will rise faster. Reliance upon the private sector does not mean neglecting the tasks that government can and must perform. The Federal Government can be an active partner to help achieve progress toward meeting national needs and, through competent management, still absorb a declining portion of the Nation's output.
We must contain and reduce the rate of inflation as we move toward a more fully employed economy. Inflation extracts a heavy toll from all Americans, and particularly from the poor and those on fixed incomes. Reducing inflation would benefit us all. A more stable price environment would make it easier for business firms and consumers to plan for the future. Thus, reduced inflation would substantially enhance our chances to maintain a strong economic expansion and return to a high-employment economy. In the years ahead we must seek to unwind the inflation we have inherited from the past and take the steps necessary to prevent new inflationary pressures as we approach high employment.
We must act in ways that contribute to the health of the world economy. As the strongest economy in the world, the United States has unique responsibilities to improve the international economic climate. The well-being of the United States depends on the condition of other nations around the world. Their economic destiny is, in turn, shaped by ours. The United States can retain its stature in the world only by pursuing policies that measure up to its role as a leader in international economic affairs.
These four economic objectives are sufficiently ambitious to constitute a serious challenge, but sufficiently realistic to be within our reach. A well-designed program will permit us to achieve them. The principal elements of my economic strategy are:
• Adopting promptly an effective national energy program;
• Managing Federal budget expenditures carefully and prudently, so that we can meet national needs while gradually reducing the share of our national output devoted to Federal spending;
• Using tax reductions to ensure steady growth of the private economy and reforming the tax system to make it fairer, simpler, and more progressive;
• Working to reduce the Federal deficit and balance the budget as rapidly as the developing strength of the economy allows;
• Improving existing programs and developing new ones to attack the problem of structural unemployment among the disadvantaged;
• Promoting greater business capital formation in order to enhance productivity gains, increase standards of living, and reduce the chances that capacity shortages would inhibit expansion later on;
• Adopting more effective programs to reduce the current rate of inflation and prevent a reacceleration of inflation as we approach high employment; and
• Pursuing international economic policies that promote economic recovery throughout the world, encourage an expansion of world trade, and maintain a strong international monetary system.
PROMPT ADOPTION OF THE NATIONAL
It has now been over four years since our economy was buffeted by the oil embargo and its aftermath of sharply increased oil prices. The massive oil price increase in 1973-74 contributed to the double-digit inflation of 1974 and to the worst recession in 40 years. It is a primary factor today behind the large deficit in our international balance of payments. Yet the United States still has not enacted a comprehensive and effective energy policy.
Our dependence on imported oil is sapping the strength of the American economy. Last year our imports of oil reached a total of about $45 billion, compared with $8 1/2 billion in 1973. The increased expenditures on those imports have been like a sudden and massive tax imposed on the American people. Only part of the revenues have been returned to the United States in the form of higher exports of American goods to oilproducing countries. As a consequence, that "tax" has become a major obstacle to economic growth.
The huge deficit in foreign trade arising from our oil imports has contributed to the fall in the value of the dollar abroad. The dollar's decline has raised the cost of the goods we import and contributed to inflation. Our deficit also has unsettled international monetary markets, with adverse consequences for our international trading partners. Our response to the energy crisis is therefore a central element in our international and domestic economic policy. The energy program will not solve our problems at once, but it will pave the way for a balanced foreign trade position and a strong and sound dollar.
Our energy problems will worsen in the years to come unless we curb our appetite for oil and gas. Without decisive action, we will put additional pressure on the world oil market, aggravate inflationary pressures at home, and increase our vulnerability to the threat of oil supply disruptions. Together, these forces could severely limit the potential for continued economic progress over the coming decade.
The United States has no choice but to adjust to the new era of expensive energy. We can only choose when and how. If we act today, we have time to make a gradual transition to more efficient energy use-by conserving energy, increasing domestic energy production, and developing alternative sources of energy. If we delay, adjustment later will be harsh and painful, requiring draconian measures to accomplish what can now be done gradually and with far less anguish.
The energy problem we face is enormously complex. Finding an acceptable and effective solution has not been easy for me or for the Congress. I look forward to working closely with the Congress early this year to assure a speedy resolution. An acceptable bill must satisfy the following principles:
• First, the program must effectively reduce our consumption of limited energy supplies—oil and gas—while encouraging energy production and promoting a transition to the use of resources that are more abundant.
• Second, the program must be fair. No segment of the population should bear a disproportionate share of the cost or burden of adjustment, and no industry should reap unnecessary and undeserved windfall gains.
• Third, the program must be consistent with our overall economic strategy. It must neither undermine our efforts to continue the recovery nor obstruct achievement of our long-term budgetary goals.
Dealing with the energy problem is a difficult test for our Nation. It is a test of our economic and political maturity. Our people would surely react if there were an immediate crisis. But I am asking them to undertake sacrifices to prevent a crisis. If we fail to act today, we will bring a crisis upon ourselves and our children in years to come.
CAREFUL MANAGEMENT OF FEDERAL BUDGET EXPENDITURES
My Administration has given high priority to making more effective use of limited Federal resources. In fiscal 1976, Federal outlays amounted to 22 1/2 percent of the Nation's gross national product. This is considerably higher than the share devoted to government spending that prevailed for many years. To some degree, the recent higher share reflects the fact that the economy is still performing below its capacity, and that Federal programs to support the unemployed and the needy are larger than they would be in a high-employment economy. But it also stems from very rapid growth in a number of Federal programs instituted over the past 10 to 15 years.
Most of our Federal expenditure programs are designed to achieve important national goals that the private sector of the economy cannot accomplish. Only the government can provide for the national defense, and government resources are essential to cushion the hardships created by economic recession, to preserve our national resources, to protect the environment, and to meet other critical needs.
The Federal Government has a particular obligation to provide assistance to those who remain in need even during good times. Last year I presented to the Congress a program to reform the welfare system—the Better Jobs and Income Act of 1977—that is a concrete example of our commitment to devote resources to the most pressing national needs. My program will cost money. But it also will establish a more easily understood welfare system that is less costly to administer, less subject to abuse, and more responsive to the true needs of those who receive a helping hand from government. This program will create up to 1.4 million jobs for those able to work, and it will replace the patchwork of Federal, State, and local programs with a consistent income-support system that will relieve much of the enormous burden now placed on State and local governments.
In the management of a business enterprise, efficiency is enforced by the discipline of the market place. The collective judgments of millions of consumers establish an environment in which waste and efficiency are eventually penalized. The government, however, is not subject to that discipline. We in government must therefore impose stringent controls on ourselves to ensure greater efficiency and to make better choices among the possible uses of the taxpayers' money.
To assist us in this endeavor, I have adopted methods of budgetary control that have been tested in the business community. Early last year I asked the Office of Management and Budget to inaugurate a system of zero-based budgeting throughout the Federal Government. Within this budgetary system, every Federal program is given careful scrutiny-no matter how large or how small it may be, no matter how long it has been in existence or how recently established. This new system of budgetary planning helped to hold down less essential outlays in the budget for fiscal 1979 and focus our resources on our important national needs. It will produce even greater savings in subsequent years. A process of multiyear budgeting also has been inaugurated within the Federal Government that will require tentative budget plans to be developed and reviewed for three years ahead. With this system we can more effectively control future expenditures-by avoiding commitments now to endeavors that would grow in the future beyond the proportions we desire.
In formulating my recommendations for the 1979 budget, I have exercised very strict controls over spending. Adjusted for inflation, the increase in outlays has been held to less than 2 percent and the share of Federal expenditures in GNP will fall to 22.0 percent. I intend to continue prudent expenditure controls in the future. With good management we can, I believe, achieve our Nation's important social goals and still reduce over time the share of gross national product committed to Federal expenditures to about 21 percent.
USING TAX REDUCTIONS TO PROMOTE STEADY ECONOMIC EXPANSION
I propose to rely principally upon growth in the private sector of the economy to reduce unemployment and raise incomes. Special Federal efforts will, of course, be necessary to deal with such problems as structural unemployment, but tax reductions will be the primary means by which Federal budget policy will promote growth. Careful management of budget outlays and a growing economy should permit substantial reductions in the years ahead. Tax reductions will be needed to strengthen consumer purchasing power and expand consumer markets. Stable growth in markets, together with added tax incentives for business, will lead to rising business investment and growing productivity.
As inflation and real economic growth raise the incomes of most Americans, they are pushed into higher income tax brackets. The tax burden on individuals is raised just as if higher rates had been enacted. The payroll taxes levied on workers and business firms for social security and unemployment insurance will also increase substantially over the years ahead. These are very large increases, but they are needed to keep our social security and unemployment insurance systems soundly financed.
Between 1977 and 1979, taxes on businesses and individuals will rise very sharply as a result of these several factors. Even though our economy is basically healthy, this increasingly heavy tax burden would exert a mounting drag on economic growth. It must, therefore. be counteracted by tax reductions. The magnitude and timing of the reductions should be designed to maintain economic growth at a steady pace, taking into account the effects both of the growing tax burden and of other factors at work in the economy.
Consistent with this strategy, I am proposing a $25 billion program of net tax reductions accompanied by substantial tax reforms.
Individual income taxes will be reduced primarily through across-the-board reductions in personal tax rates, with special emphasis on low- and middle-income taxpayers. Personal taxes also will be simplified by my proposal to replace the existing personal exemption and credit with a tax credit of $240 for each person in the taxpayer's family.
There also will be important reforms that will improve the individual income tax system and raise substantial revenues, enabling me to recommend larger personal tax reductions.
Overall, I am proposing personal tax reductions of $24 billion, offset by $7 billion in tax reforms. These tax cuts, which will take effect next October 1, will significantly improve the progressivity of the tax system. The typical four-person family with $15,000 in income will receive a tax cut of $258 or more than 19 percent. As a result of the changes I am recommending, filling out tax returns will be simpler for many people.
Individuals also will benefit from reductions I have proposed in the Federal excise tax on telephone bills, and in the Federal payroll tax for unemployment insurance. These two proposals will add about $2 billion to consumers' purchasing power that will be realized principality through lower prices.
Business taxes will be reduced by more than $8 billion in 1979 under my tax program, offset partially by more than $2 billion in business tax reforms for a net tax reduction of nearly $6 billion. I have recommended that the overall corporate tax rate be reduced on October 1 from the current 48 percent to 45 percent, and be cut further to 44 percent in 1980. I also recommend that the existing 10-percent investment tax credit be made permanent, and that the benefits of this credit be extended to investments in industrial and utility structures. My proposal will enable businesses to use the investment tax credit to offset up to 90 percent of their Federal tax liability, compared with the 50-percent limit now imposed.
Important new tax reforms also will affect businesses. I am, for example, proposing to reduce the deductibility of a large class of business entertainment expenses. I have also proposed changes in the tax status of international business transactions that are of significant cost to taxpayers but that benefit the public insufficiently.
Because tax reform measures will raise $9 billion in revenue, it has been possible for me to recommend $34 billion in overall tax reductions while keeping the net loss in revenues to $25 billion, the level I believe is appropriate given the state of our economy and the size of the budget deficit.
These proposals do not include any adjustment to take account of congressional action on my energy proposals. I proposed last April that the Congress pass a wellhead tax and rebate the proceeds of that tax directly to the American people. This is the best course to follow because it protects the real incomes of consumers and avoids a new source of fiscal drag. If the final energy bill includes a full rebate of the net proceeds of the wellhead tax, no further action on my part will be necessary. However. if the final bill allows for a rebate only for 1978 as provided in the House version-1 will send a supplemental message to the Congress recommending that the individual tax reduction I am now proposing be increased by the amount of the net proceeds of the wellhead tax.
These tax reductions are essential to healthy economic recovery during 1978 and 1979. Prospects for continuation of that recovery in the near term are favorable. Consumers have been spending freely, and many other economic indicators recently have been moving up strongly. Without the tax reductions I have proposed, however, the longer-term prospects for economic growth would become increasingly poor. Because of the fiscal drag imposed by rising payroll taxes and inflation, economic growth would slow substantially in late 1978, and fall to about 3 1/2 percent in 1979. The unemployment rate would stop declining and might begin to rise again, and the growth of investment outlays for new plant and equipment would slow significantly.
With the reductions in taxes I have proposed, on the other hand, the economy should grow by 4 1/2 to 5 percent in both 1978 and 1979. Nearly one million new jobs would be created. Unemployment would therefore continue to fall and by late 1979 should be down to around 5 1/2 to 6 percent. Capacity utilization and after-tax business profits would both improve, and thus the rate of investment in new plants and equipment should increase significantly.
Success in keeping a firm rein on spending will permit further tax reductions in years to come. Our ability to foresee the future course of the economy is not good enough, however, to enable us to know when additional reductions will be needed or how large they should be. It would therefore be imprudent to plan specific policy measures now for more than the current and the next fiscal year. But I will make recommendations for budget and tax policies for 1980 and beyond that are in keeping with our objectives of steady growth in the economy, more stable prices, and principal reliance on the private sector to achieve economic expansion.
WORKING TO REDUCE THE FEDERAL DEFICIT AND BALANCE THE BUDGET AS SOON AS THE STRENGTH OF THE ECONOMY ALLOWS
Federal budgetary policy can play a constructive role in maintaining the health of the economy. There are times when large deficits in the Federal budget must be tolerated because they are needed to bolster the purchasing power of consumers and businesses. A budget deficit that persisted during a period of high employment and strong further growth of private demand, however, would put upward pressures on prices and would aggravate our inflationary problem. Under those circumstances, a budget deficit would also absorb savings that would be better used by the private sector to build new factories and offices and to purchase new machines. In order to assure that our economic progress remains on a solid footing and is not undermined by inflation, we must reduce the Federal budget deficit and achieve a balanced budget as soon as the developing strength in the economy allows.
The first requisite is careful management and control of Federal spending. The second is a prudent weighing of the need for tax reductions against the goal of budget balance.
This year I have proposed budgets that call for a deficit of $62 billion in 1978, and one only slightly smaller in 1979. Had I decided not to recommend a tax cut to put additional purchasing power in the hands of consumers and businesses, the deficit in 1979 could have been $15 to $20 billion smaller. But I believe that tax reduction is essential to continued progress in an economy still characterized by substantial unemployment and idle plant capacity.
How rapidly we can restore budget balance depends on the strength of the private economy. Over the next few years, two factors will be of particular importance.
The first is the financial condition of State and local governments. In the past, the aggregate budget of these governments tended to be approximately in balance. Today the State and local sector as a whole is in surplus. In 1977, for example, aggregate State and local receipts from all sources exceeded expenditures by nearly $30 billion. This overall surplus does not mean that every State and local government is in good financial condition. Many are hard pressed. Moreover, a large part of the aggregate surplus represents accumulations of pension funds for the 13 million employees of State and local governments.
Substantial surpluses in the State and local sector are likely to continue in the future. They absorb the incomes of consumers and business, and so act as a drag on the economy.
The second factor affecting the pace at which we can expect to move toward budget balance is the large deficit in America's foreign trade in goods and services. Imports into the United States have been swollen by the enormous quantity of oil we buy abroad to drive our cars, heat our homes, and fuel our industry. Our exports have grown only slowly, in large measure because economic growth abroad has been much slower than in the United States. As a result, the United States last year recorded a deficit of close to $18 billion in our current international accounts. This deficit has the same general effect on economic activity as a multibillion dollar increase in taxes.
Enactment of an effective energy program ultimately will reverse our growing dependence on oil imports. Moreover, economic growth in other countries should be improving over the next few years. But we may expect a current account deficit of some size to continue in the near future.
If strong economic expansion is to be maintained in the face of these major drains on the economy, additional tax reductions may be necessary beyond those I have proposed for 1979. But we will be better able to judge this question in a year or two, and we should not prejudge it now.
In formulating my budgetary decisions thus far, I have been careful to avoid commitments that would make it impossible for us to balance the budget by 1981. With unusually strong growth in the private economy, we would need a balanced Federal budget. In an economy growing less strongly, however, balancing the budget by 1981 would be possible only by forgoing tax reductions needed to reach our goal of high employment. In those circumstances, the date for reaching the goal of budget balance would have to be deferred.
What is important is that the planning and execution of Federal fiscal policies proceed in a prudent manner. Every decision on spending and taxes during my Administration has been, and will continue to be, made in the context of longrun budgetary planning that avoids the creation of excess demand during periods of high employment. That is an essential ingredient of responsible budgetary policy.
PROGRAMS TO ATTACK THE PROBLEM OF STRUCTURAL UNEMPLOYMENT
Meaningful job opportunities ought to be available for all Americans who wish to work. But overall fiscal and monetary policy alone will not provide employment to many in our Nation. If we are to reduce unemployment satisfactorily, we must do more.
Eleven percent of adult American workers from minority groups are now jobless—close to the rate a year ago, and over twice as high as the unemployment rate for white adults. About 17 percent of our teenagers are unemployed today; among black teenagers the unemployment rate is nearly 40 percent. These intolerably high rates of unemployment must be brought down. This is an important goal, but achieving it will be a difficult task.
A generally healthy and growing economy is a prerequisite for dealing effectively with structural unemployment, but it is not enough. Even in good times some groups suffer from very high unemployment, which adds to the difficulty of achieving low unemployment and low inflation simultaneously. As the economy moves toward high employment, employers try to fill job vacancies from those groups of workers with substantial training and experience. Wage rates are bid up and prices follow, while large numbers from other groups are still looking unsuccessfully for work. Efforts to reduce unemployment among the unskilled and otherwise disadvantaged can be frustrated by inflationary pressures set off in those sectors of the labor market already fully employed.
To reach high levels of employment while maintaining reasonable price stability, we must take effective and adequate measures now to increase the employment opportunities of the disadvantaged. This principle is a key element of the Humphrey-Hawkins Bill—The Full Employment and Balanced Growth Act. I support this legislation and hope the Congress will enact it.
We have already taken several significant steps in this direction. Last year I proposed and the Congress appropriated $8.4 billion to expand the Public Service Employment Program to 725,000 jobs. These jobs are more sharply targeted on the long-term unemployed and the poor than previous programs under the Comprehensive Employment and Training Act. Direct opportunities for youth also have been expanded. The Youth Employment and Demonstration Projects Act of 1977, which is providing job experience and training in skills to unemployed youths, also was proposed by my Administration and enacted in 1977, providing 166,000 work and training positions for unemployed youths.
Several further measures are proposed in my 1979 budget. I have recommended that Public Service Employment be continued at the 725,000 job level throughout 1979, and that the number of jobs be phased down gradually in subsequent years as progress is made in reducing the overall level of unemployment. I have also recommended an expansion to $1.2 billion of the Youth Employment Demonstration Projects Act to provide work opportunities and skill training for the unemployed youth who most need help. The Better Jobs and Income Program that I sent to the Congress in mid-1977 will create up to 1.4 million jobs, supplemented by cash allowances, for poor people who are able to work. An initial demonstration project for this program that will create 50,000 jobs is proposed in my 1979 budget, and more jobs will be phased in gradually once the welfare reform program is enacted.
Government programs can provide valuable assistance to the unemployed. In the end, however, we must turn to the private sector for the bulk of permanent job opportunities for the disadvantaged. It is in private industry that most productive jobs with opportunity for advancement are found. For this reason, I am requesting $400 million in my 1979 budget to begin a major new initiative for private sector hiring of the disadvantaged. Details of this proposal will be submitted to the Congress shortly. I am requesting the fullest cooperation of the business community in this initiative and have been assured by business leaders that it will be forthcoming.
GREATER EMPHASIS ON PROMOTING BUSINESS CAPITAL FORMATION
Over a broad expanse of years, improvement of the standard of living in this Nation depends primarily on growth in the productivity of the American work force. During the first two decades of the postwar period, the productivity of American labor increased at an average annual rate of about 3 percent. Over the past ten years, however, productivity growth has slowed markedly—to about 2 percent or less a year.
The reasons for this break with past trends are complex, but one factor that clearly stands out is the relatively slow growth ill the stock of business plant and equipment. Historically, improvements in productivity have been linked closely to investment in plant and equipment. Investment in new facilities has embodied new and more productive technology and has provided our work force with more and better tools.
Business investment has lagged during the recovery for several reasons. Some of the fears engendered by the steep recession and severe inflation of 1973-75 have remained and have reduced the incentive for businesses to invest. Uncertainties about energy supplies and energy prices have also been a deterrent to investment, and so have concerns about governmental regulations in a variety of areas. Finally, high costs of capital goods and a depressed stock market have diminished the incentives and raised the costs to businesses of investment in new plant and equipment.
Industrial capacity is ample now. But without a substantial increase in investment over the next few years, problems would build for the future. Rapid growth of capacity is needed to assure that shortages of particular products do not emerge before we regain high employment. If capacity is not sufficient, bottlenecks may develop in some sectors, forcing up prices of industrial commodities. Inadequate rates of capital formation will also hold back the gains in productivity needed to improve standards of living and to avoid further aggravation of our inflation problem.
My tax and other economic proposals will encourage a greater rate of business investment in several ways. By promoting a sustainable rate of economic recovery, they will assure businesses of an expanding market for the output from new factories and equipment. The specific tax reductions for business I have proposed will increase after-tax profits and so directly provide additional incentives for investment.
We must also have conditions in financial markets that permit businesses to raise the funds they need for investment. Prudent Federal budgetary policies will contribute significantly to that end, as will policies that deal effectively with inflation. Both will ease the Federal Reserve's task of pursuing monetary policies that support full recovery.
MORE EFFECTIVE PROGRAMS TO REDUCE THE RATE OF INFLATION
We cannot achieve full prosperity unless we deal effectively with inflation. We must take steps to reduce the high rate of inflation inherited from the past and to guard against a renewed outbreak of inflation as we regain a high-employment economy.
Our economy is not suffering at present from excess demand. Monetary growth in recent years has not been excessive, and Federal budget deficits have occurred in an economy with high unemployment and excess capacity. Yet prices continue to rise as a result of an inflationary process that has been under way for a decade.
Our present inflation began back in the late 1960's and accelerated sharply in the early ,years of the 1970's. Since 1974 the rate of consumer price inflation has declined substantially—from 12 percent to between 6 and 6 1/2 percent at present. But that improvement is due largely to the termination of special influences affecting prices during 1974—the sharp rise of food and fuel prices, and the bulge in prices following the removal of wage and price controls.
Recent experience has demonstrated that the inflation we have inherited from the past cannot be cured by policies that slow growth and keep unemployment high. Since 1975, inflation has persisted stubbornly at a 6 to 6 1/2 percent rate-even though unemployment went as high as 9 percent and still stands above 6 percent, and even though a substantial proportion of our industrial capacity has been idle. The human tragedy and waste of resources associated with policies of slow growth are intolerable, and the impact of such policies on the current inflation is very small. Moreover, by discouraging investment in new capacity, slow growth sows the seeds of future inflationary problems when the economy does return to high employment. Economic stagnation is not the answer to inflation.
Our first task in combating inflation is to guard against a renewed outbreak of higher price increases in the future. Firm discipline over the Federal budget and a prudent monetary policy are the most important steps that can be taken. Programs to attack structural pockets of unemployment among our people will make it possible to achieve higher levels of employment without exerting pressures on prices. Greater investment also will make a major contribution toward assuring that the capacity of our industry will be adequate to meet the needs of a high-employment economy.
Enactment of an energy program will eventually reduce the demand for oil imports-contributing to market conditions that discourage substantial oil price increases, and combating the inflation that results from a decline in the exchange value of the dollar. The programs I have inaugurated to build a 30- to 35-million metric ton grain reserve will provide a buffer against sudden upward movements in food prices in the event of bad weather.
Our second task—reducing the current rate of inflation—will be harder. Yet we must tackle the problem. Unless the inflation rate is brought down, the rate of price increase may well rise as unemployment falls to lower levels in later years, with consequences that would thwart our efforts to bring about full recovery.
The government has an obligation to set an example for the private sector, and we can play an important role in moderating inflation by reducing the effects of our own actions on prices. By adopting tax incentives and other policies to improve the growth of investment and productivity, we will help reduce the rise in costs and hence in prices.
The excise tax reductions I have proposed in my 1979 budget also will contribute moderately to lower costs and prices.
Government regulations also add to costs and raise prices. To some extent, this is the inevitable cost of much needed improvements in the environment and in the health and safety of workers and consumers. But there is no question that the scope of regulation has become excessive and that too little attention is given to its economic costs. We should not, and will not, give up our efforts to achieve cleaner air and water and a safer workplace. But, wherever possible, the extent of regulation should be reduced. We have eliminated hundreds of unneeded regulations already and will continue to pare down the remainder.
I also intend to put a high priority on minimizing the adverse effects of governmental regulations on the economy. To this end, I have established a high-level interagency committee that—together with the relevant regulatory agency—will review the economic effects of major regulations. This committee will seek to assure that the costs of each regulation have been fully considered, and that all alternatives have been explored, so that we may find and apply the least costly means of achieving our regulatory objectives. I have also directed my advisers to explore ways in which we can undertake an assessment of the impact of regulation on the economy as a whole and within each major sector. We need to find a way to set priorities among regulatory objectives and understand more fully the combined effects of our regulatory actions on the private economy.
Where regulation of economic activity has become outmoded and substantial overhaul is called for, I will pursue effective legislation. For example, I have supported actively congressional efforts to reform regulation of the airline industry, and I am considering proposals to reform the regulation of other industries.
I have given special attention to reducing the runaway cost of health care. The cost of a day in the hospital has more than doubled since 1970. Continuing escalation in the charges for hospital care can no longer be tolerated. I have submitted legislation, the Hospital Cost Containment Act of 1977, that would limit sharply the rate of growth in hospital spending, and I urge the Congress to enact this legislation in 1978.
The States can also play a role in moderating. the current inflation. In 1976, State governments collected $50 billion in sales taxes. For the most part, these taxes enter directly into the cost of goods we buy and thus increase the price level. Today, State governments with significant surpluses are considering tax reductions. I urge those in a position to do so to consider the advantages to the national economy of reducing sales taxes, thereby helping to slow inflation.
Government alone cannot unwind the current inflation, however. Today's inflationary process is largely the consequence of self-fulfilling expectations. Businessmen, expecting inflation to continue, are less resistant to cost increases than they might be, since they have come to believe that, with all prices rising, their own increased costs can be passed on to consumers through higher prices. Wage increases are based on the expectation that prices will continue to rise. Wage gains in one sector spur similar demands in others.
There are gainers and losers in this process, since some groups in the economy are more successful than others at defending themselves against inflation. On the whole, however, the main result is continued inflation. No one group—neither business, nor labor, nor government—can stop this spiral on its own. What is needed is a joint effort.
Since the current inflation has developed strong momentum, it cannot be brought to a sudden halt. But we can achieve a gradual but sustained deceleration—having each succeeding year's inflation lower than the previous one. The benefits of slower growth of prices and wages would be broadly shared. Everyone would be better off. A conscious effort should be made by those who make wage and price decisions to take the individual actions necessary to bring about an economy-wide deceleration of inflation.
I am therefore asking the business community and American workers to participate in a voluntary program to decelerate the rate of price and wage increase. This program is based on the initial presumption that prices and wages in each industry should rise significantly less in 1978 than they did on average during the past two years.
I recognize that not all wages and prices can be expected to decelerate at the same pace. For example, where profit margins have been particularly squeezed, or where wages are lagging seriously, deceleration in 1978 would be less than for other firms or groups of workers. In exceptional cases deceleration may not be possible at all. Conversely, firms or groups that have done exceptionally well in the recent past may be expected to do more.
To enhance the prospects for success of this deceleration program, I have asked that major firms and unions respond to requests from members of my Administration to discuss with them on an informal basis steps that can be taken during the coming year to achieve deceleration in their industries. In reviewing the economic situation prior to making my recommendations to the Congress on the size of the pay raise for Federal workers, due to take effect next October, I will keep this objective of deceleration in mind.
This program does not establish a uniform set of numerical standards against which each price or wage action is to be measured. The past inflation has introduced too many distortions into the economy to make that possible or desirable. But it does establish a standard of behavior for each industry for the coming year: every effort should be made to reduce the rate of wage and price increase in 1978 to below the average rate of the past two years.
I have chosen this approach after reviewing extensively all of the available options. There is no guarantee that establishing a voluntary deceleration standard will unwind the current inflation. I believe, however, that with the cooperation of business and labor, this proposal will work. Deceleration is a feasible standard of behavior, for it seeks restraint in wage and price actions in exchange for a general reduction in inflation. It is also a fair standard. Industries and workers with far different histories and current situations will not be asked to fit within the constraint of a single numerical guideline.
The inflation problem will not be easy to overcome. It will take time and patience. But the importance of these efforts cannot .be overestimated. Unless we gain better control over the inflation rate, the prospects for regaining a fully employed economy will be seriously reduced. My Administration cannot and will not pursue policies in the future that threaten to trigger a new and more virulent round of inflation in this country. To do so would be the surest way of destroying the hopes of our citizens for a long-lasting prosperity.
INTERNATIONAL ECONOMIC POLICIES THAT PROMOTE ECONOMIC RECOVERY THROUGHOUT THE WORLD
Outside the United States, the world economy has seen a hesitant recovery from the deep recession of 1974-75. The rapid pace of economic growth that was widespread over most of the postwar years has all but disappeared. Unemployment is high, and in most industrial countries except the United States it is rising. Inflation is at high levels and declining only very slowly.
The imbalances in the international economic system continue to strain the world economy. Because of the surpluses of oil-exporting countries, many countries have sizable deficits, including the United States. Some industrial nations are also running large and persistent surpluses-thus increasing the pressures on countries in deficit. These imbalances have been a major factor contributing to disorder in exchange markets in recent months.
The condition of the world economy requires above all that nations work together to develop mutually beneficial solutions to global problems. If we fail to work together, we will lose the gains in living standards arising from the expansion of world commerce over the past three decades. If the world economy becomes a collection of isolated and weak nations, we will all lose.
The first priority in our international economic policy is continued economic recovery throughout the industrial world. Growth of the U.S. economy—the largest and strongest in the world is of vital importance. The economic program that I have proposed will ensure that America remains a leader and a source of strength in the world economy. It is important that other strong nations join with us to take direct actions to spur demand within their own economies. World recovery cannot proceed if nations rely upon exports as the principal source of economic expansion.
At the same time all countries must continue the battle against inflation. This will require prudent fiscal and monetary policies. Such policies must be supplemented by steps to reduce structural unemployment, measures to avoid bottlenecks by encouraging investment, and cooperation in the accumulation of commodity reserves to insulate the world from unforeseen shocks.
Reducing the widespread imbalances in international payments will require several parallel steps. To begin with, each individual country must ensure that its own policies help relieve the strains. The United States will do its part. In 1977 we had a current account deficit of about
$18 billion. While not a cause for alarm, this is a matter of concern. We can take a most constructive step toward correcting this deficit by moving quickly to enact the National Energy Plan.
Countries in surplus should also do their part. Balance of payments surpluses in some countries have contributed to the economic stagnation among their trading partners. Where their own economies have slack, it is appropriate for nations in. surplus to stimulate the growth of domestic demand—thereby increasing their imports and improving the prospects for growth in deficit countries. In some countries, lifting restraints on imports from abroad and reducing excessive government efforts to promote exports would be useful. After consultations with the United States, the Japanese have indicated they will take a series of steps toward reducing their large surplus.
The system of flexible exchange rates for currencies also can be helpful in correcting unsustainable imbalances in payments among countries. Since its inception in 1973, this system has operated well trader unprecedented strains.
During 1977 the U.S. dollar has fallen in value against several key currencies. The decline in the dollar's value has occurred primarily against the currencies of those nations that have large trade and payments surpluses, and was not surprising in view of our large payments deficit and their surpluses. Late in 1977, however, movements in our exchange rate became both disorderly and excessively rapid. The United States reaffirmed its intention to step in when conditions in exchange markets become disorderly and to work in close cooperation with our friends abroad in this effort.
Under the flexible exchange rate system basic economic forces must continue to be the fundamental determinant of the value of currencies. However, we will not permit speculative activities in currency markets to disrupt our economy or those of our trading partners. We recognize fully our obligation in this regard, and we have taken steps to fulfill it.
Although substantial progress can be made toward a balanced world economy, some imbalances will persist for a substantial period of time. Financing requirements will remain large while adjustments occur. The private markets can and will continue to channel the bulk of the financing from surplus to deficit countries. But it is essential that adequate official financing also be available, in case of need, to encourage countries with severe payments problems to adopt orderly and responsible corrective measures. To meet this critical need the United States has strongly supported a proposal to strengthen the International Monetary Fund by the establishment of a new Supplementary Financing Facility.
The United States also will continue to contribute resources to promote growth in the economies of the developing nations. International assistance efforts-through bilateral aid and multilateral institutions-must continue to expand. We must also keep our doors open to imports from developing countries, so that their economies can grow and prosper through expanded trade.
A keystone of our international economic policy is to work with our trading partners to protect a free and open trading system. The American economy benefits by exporting those products that we make efficiently, and by importing those that we produce least efficiently. An open trading system increases our real incomes, strengthens competition in our markets, and contributes to combating inflation.
The United States will firmly resist the demands for protection that inevitably develop when the world economy suffers from high unemployment. The ensuing decline in world trade would worsen our problem of inflation, create inefficiencies in American enterprise, and lead to fewer jobs for American workers. But international competition must be fair. We have already taken and we will, when necessary, continue to take steps to ensure that our businesses and workers do not suffer from unfair trade practices.
I place great importance on the Multilateral Trade Negotiations now under way in Geneva. I believe our negotiators will bring home agreements that are fair and balanced and that will benefit our economy immensely over the years to come. The importance of these discussions can hardly be overemphasized. The trading system that emerges from the negotiations will set the tone for international commerce well into the 1980's. Our commitment to a successful conclusion to these talks underscores our long-term emphasis on the retention and expansion of open and fair trade among nations.
THE CHALLENGE BEFORE US
In this message I have outlined my fundamental economic goals and the strategy for attaining them. It is an ambitious, but I believe a realistic, agenda for the future. It calls for a broad range of actions to improve the health and fairness of the American economy. And it calls upon the American people to participate actively in many of these efforts.
I ask the Congress and the American people to join with me in a sustained effort to achieve a lasting prosperity. We all share the same fundamental goals. We can work together to reach them.
January 20, 1978.