The federal budget: the need for choice

Charles L. Schultze

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The Federal Budget: the Need for Choice ost of us, most of the time, are not engaged in making choices, in the sense of deliberately weighing eosts and gains and selecting alternative courses of action on the basis of that evaluation. In our personal lives, in business, and in government, the vast majority of our activities are

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Mr. Schultze has been Director of the Bureau of the Budget since 1une 1, 1965. Immediately prior to his appointment to this post by the President, he was Professor of Economics at the University oJ Maryland, a part-time senior staff member of the Brookings Institution and a consultant to the Bureau of the Budget. Mr. Schultze has also served on the faculty of Indiana University. His publications include Prices, Costs, and Outputs for the Postwar Decade and National In-

come Analysis.

S U M M E R , 1966

guided by routine, according to habits or rules of thumb derived from past experience. And this, of course, is neeessary. But what marks great men, successful business firms, and great societies is not the routine they live by, but the choices they make. Indeed, today's ehoiee determines tomorrow's routine. It is the law of our world that every gain involves a cost. The essence of wise ehoiee therefore lies in selecting those alternatives that maximize gains relative to costs. And wise choices involve both decisions to undertake new ventures and decisions to abandon old and unprofitable ones. In government, there are two basic problems of choice. First, in those great objects of government, like national defense, education, and public

health, both gains and costs are exceedingly difficult of measurement (though not, I might add, of rational analysis). Second, in some eases, though not all, one man's gain is another man's cost. Yet choose we must - o r aeeept the slow stagnation that a changing world inevitably forees on an unchanging institution, be it a business firm or a government. The great majority of the choices that the federal government makes are ultimately budgetary choices. The budget total reflects the over-all division of national resources between the private and the government sectors of the economy. The internal composition of the budget reflects thousands of choices among individual programs. A quick review of the over-all magnitude and composition of the federal

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budget provides a convenient introduction to the problem of making choices in the federal government. SIZE AND COMPOSITION

The President's budget proposals for the fiscal year 1967-the twelve months beginning this July 1-call for total cash outlays of $145 billion, equal to roughly one-fifth of gross national product. This total includes expenditures from the various self-financed trust funds, chiefly social security and highway grants-in-aid. Expenditures in the administrative budget, which excludes the transactions of these funds, will amount to $112.8 billion in 1987, slightly less than 15 per cent of CNr. During the past ten years, administrative budget expenditures have fluctuated between 15 and 17 per cent of CNP, with a slight downtrend since 1963. Even with the $10.5 billion included in the 1967 budget for the added costs of our operations in Vietnam, budget expenditures as a percentage of GNe will continue to decline slightly. This reflects both the rapid growth in national output and the fact that, under the President's budget proposals, expenditures outside of Vietnam are being held practically unchanged from 1966 to 1967. Expenditures for national defense programs and for defense-related purposes-notably veterans' benefits and interest on the public debt, which was largely incurred in the second World W a r - h a v e always been a substantial part of the total expenditures of the federal government. Indeed, in the postwar period they have dominated the budget, representing roughly twothirds or more of total expenditures in most years.

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Nondefense expenditures-that is, administrative budget outlays excluding national defense, veterans' programs, and interest-have grown fairly steadily in amount over the years. But they still represent a small percentage of GNP, smaller indeed than in the 1930's when newly adopted antidepression programs were operating. During the 1920's nondefense expenditures fluctuated between ~A and 1 per cent of the GNP. By 1935, they amounted to 6.3 per cent of the CNP, and in 1939 had risen to 7.1 per cent. Twenty-eight years later, in fiscal year 1967, nondefense expenditures are expected to total only 4,~ per cent of the CNX~, The absolute growth seen in the nondefense sector of the budget in the last decade has been accompanied by significant changes in the composition of the programs and expenditures involved. Consider the reasons: Our population increased by nearly 30 million people in the last ten years. There has been a marked increase in the age groups under 18 and over 65, which have greater need for such public services as education and health care. There has been an increase of over 30 per cent in the number of people living in urban areas. The urban population now represents 70 per cent of the total. The nation's standard of living rose nearly 25 per cent, measured in terms of real disposable income per capita. This income growth, in turn, led to demands for better public services as well as higher quality private goods and services. And with the affluence of the majority, we have become increasingly aware of the problems of the poor among us and more interested in try ing to assure equal opportunities for all.

All of these factors have led, first, to a modest growth in budget totals and, second, to a sharp change in the composition of the budget. There has been, particularly in the last three years, a greatly increased emphasis on investment in human resources. As a percentage of administrative budget expenditures outside of defense, veterans', and interest, expenditures on health programs will rise from 3.4 per cent in 1957 to 10.7 per cent in 1967; expenditures for education and manpower training will rise from 3.3 per cent to 9.2 per cent; and the war on poverty, nonexistent in 1957, will be 4.7 per cent of the nondefense total in 1967. Combined, these categories of expenditures will increase from less than 7 per cent to almost 9.5 per cent of total nondefense outlays during the decade-a nearly fourfold rise. Looked at another way, the increase in these three programs accounts for almost 40 per cent of the total rise in nondefense outlays over the past decade and, if we exclude the space program, for fully one-half of the expenditure growth. And most of this change has occurred since 1964. In brief, therefore: Total budget expenditures have fluctuated around a constant percentage of cNP in the past decade, with a slight decline in that percentage during the past four years Expenditures for current defense, and payments on account of past wars, make up the largest part of the total (two-thirds or more) Outlays for nondefense purposes have risen moderately, but within this category there has been a sharp rise in programs aimed at investment in human resources.

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MAKING BUDGETARY CHOICES

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The absolute magnitude of the federal budget makes it a major force in the nation's economy-whether we will it or no. The "new economies" of the Kennedy and Johnson administrations, in its most basic form, is simply a recognition of this fact, and a determination to use the federal budget as a means of keeping the nation's output in step with its capacity.

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OVER-ALLBUDGET TOTALS

With this as a background, let us turn to the problem of making budgetary choices. Two kinds of choices are involved: Those that relate to over-all budget receipts and expenditures in terms of their impact on the national economy (these are problems of fiscal policy) Those that relate to the composition of the budget-the kind and magnitude of individual budget programs.

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During the period from 19'61 through 1965, the basic objective of fiscal policy was to close the gap between the nation's actual and capacity output. The required stimulating fiscal action could have come either from a sharp increase in federal expenditures or from tax reductions. The latter route was chosen, and some $20 billion of tax reductions were proposed and enacted. The results are clear and dramatic. In the five years since early 1961, real GNP has risen without interruption and at an average annual rate of over 536 per cent; even while new industrial capacity has risen rapidly, its rate of use has climbed from 78 per cent to 91 per cent; the unemployment rate has fallen below 4 per cent; 6,~6 million new jobs have been created; corporate profits after taxes have risen by almost 90 per cent; and productivity has increased at a substantial clip, raising living standards with it. Fiscal policy, of course, is a twoedged sword. It can-and must-be used to restrain inflationary pressures as well as to stimulate a faltering economy. We face the year ahead with a substantially different set of conditions from those under which the budgets of the last few years had been formulated. The major new element, of course, is the economic impact of the stepped-up conflict in Vietnam; the costs of these operations will add some $10.5 billion to federal expenditures between 1965 and 1967. This increase comes at a time when economic activity is closely approaching capacity. Taken together with the projected course of private spending, the economic situation calls for a fiscal policy shift away from economic stimulation towards restraint. The 1967 budget does make this

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switch from stimulation to moderate restraint. Several factors offset the $10.5 billion added Vietnam expenditures. First, tax revenues rise with economic growth, providing an automatic increase of some $7 billion per year. At the same time, in 1967, expenditures outside of Vietnam are being held to a $600 million increase. The net effect, therefore, of the automatic large rise in revenues, only very slightly offset by a small increase in nonVietnam expenditures, represents some $6 to $6.5 billion of fiscal restraint. Second, the surplus in the government's trust funds will rise by $3.7 billion from 1966 to 1967, yielding additional fiscal restraint. Third, the President proposed, and the Congress (in record time) enacted a series of tax increases yielding some $4.9 billion in fiscal 1967. Although some of these measures call for an acceleration of tax collections, which has a smaller restraining effect than a similar increase in tax rates, the tax changes do provide significant economic restraint. In summary, then, fiscal policy during the five years between 19'61 and 1965 consciously aimed at stimulating economic activity. In the past year, as the economy approached its potential and as the added purchases for Vietnam operations began to be felt, the budget shifted rather rapidly from a posture of fiscal stimulation to one of moderate restraint. In both cases the goal of fiscal policy is the same-noninflationary growth at a high operating level. But since the circumstances are different, the direction of policy has been changed.

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INDIVIDUAL PROGRAMS We will now shift from consideration of over-all budget totals and their impact on the economy to a consideration of the individual programs that compose the budget. In the first place, there is no a priori way to decide in the aggregate whether a given total of budget expenditures is too high or too low. Federal spending per se is not an objective of our economy or our fiscal policy. We spend for some purpose-to provide directly an item or service that meets national objectives, to meet past obligations, or to augment private or state and local spending in desired directions. But each individual expenditure program must be judged on its own merits, and against the desirability of providing more leeway for lower tax rates and increased spending in the private sector, or higher spending in some other federal program. This proposition can be carried further. A judgment about aggregate expenditure increases cannot be made solely by an inventory and analysis of proposed new programs, however careful and prudent that analysis is. The changing conditions and circumstances that give rise to the need for new programs also call for periodic reexamination of existing ones. Aggregate budgetary totals, therefore, can be validly determined only after careful and individual review of both old and new programs. Clearly, as this nation grows, total federal expenditures will grow. We cannot meet the challenges of the coming decade with an unchanged level of federal expendi-

tures. But there is no neat relationship between the two rates of growth. In short, the problem of budget formulation necessarily involves a careful weighing of gains against costs to determine where to increase outlays in meeting important national needs and where to decrease or eliminate expenditures on outmoded or undesirable programs. This kind of choice is the essence of true economy in government. Edmund Burke, perhaps the greatest of all conservatives, once said: "Mere parsimony is not economy. Expense and great expense may be an essential part of true economy." Let me assure you, in that sense of the word there is no economy lobby in the United States today. There is a parsimony lobby which is against all government spending. There are those individuals and organizations who have had a magnificently consistent record of being against every single advance in social legislation of the past thirty-five years. But this is not true economy, any more than Sewell Avery's refusal to invest the huge cash resources of Montgomery Ward was true economy. Conversely, we also have those who think that government spending per se is desirable, that any increase is good and any decrease, no matter how wellfounded, a national tragedy. But just like the successful business firm, the federal government must intelligently seek "product improvements" and promising new "product lines" and, at the same time, weed out obsolete products and programs whose costs exceed their benefits. In intelligent budgeting, there is literally no escape from the

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painful process of choice. Slogans, dogmas, and aggregate rules of thumb simply avoid the problem. Let me cite a few cases of those areas in which increased federal expenditures meet important national needs and promise gains well in excess of costs, and areas in which expenditures can well be reduced with a net increase in the national welfare.

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OF BUDGET CHANGE

JUSTIFIED INCREASES

Education The total federal government involvement in education has grown dramatically over the past several years. Appropriations for all of the education, training, and related programs of the federal government were $4.8 billion in fiscal 1964. The President's January budget proposed appropriations of $10.2 billion for fiscal 1967, an increase of more than 100 per cent in three years. Federal outlays were less than 9 per cent of national expenditures for education in 1962, but will reach about 21 per cent in 1967.

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Among other things, this expansion reflects the importance of education in the economic world. We know that the elementary school graduate can expect to receive 40 per cent more income over his lifetime than could the nonelementary school graduate; the high school graduate can expect 42 per cent more than elementary graduates; and college graduates 70 per cent more over their lifetime than high school graduates. Viewed from the standpoint of total resources invested (including income forgone while in school), the rate of return to elementary schooling has been estimated at 15 per cent; high school, 11~,~ per cent; and college, over 10 per cent. These economic returns compare very favorably with investment in industry, and they do not include the immeasurable noneconomic benefits that an educated citizenry confer on society. The recent increase in federal education programs reflects a concern, not only for education in general, but also, and in particular, for the education of the disadvantaged. While most children come to kindergarten with a vocabulary of 3,000 to 5,000 words, the poor are often familiar with as few as 180 words. A recent report showed that in some schools attended largely by poor Negroes and Puerto Rieans, less than one out of three teachers had three years' experience. At the same time, in other schools where enrollment is from largely white families with higher incomes, no teacher had less than six years' experience. Among poor adults, about 50 per cent have less than an eighth grade education, compared with only 4 per cent among the remainder of the U.S. adult population.

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As the then Vice-President Johnson put it, some three years ago: "We have entered an age in which education is not just a luxury, permitting some men an advantage over others. It has become a necessity without which a person is defenseless in this complex industrialized society." On the margin then, an added dollar of investment in education yields a handsome return in growing economic productivity and in the general welfare.

Health Beginning with this decade, the federal government, in partnership with state and local governments and private groups, has assumed increasing responsibilities to meet the rising expectations of the public for improved health care. Expenditures for the federal government's major health programs will rise from $4.7 billion in 1963 to $10.3 billion in 1967. On a straight economic calculation, improved health care, like improved education, yields eoncrete economic dividends. Dr. Selma Mushkin has calculated that the increase in life expectancy between 1900 and 1960 has given the United States a 25 per cent larger work force. The accumulated value of increased labor output due to this longer life expectancy is estimated at more than $800 billion. And, of course, these economic calculations do not measure the incalculable increase in sheer human happiness that good health can bring. The federal government's programs in health are aimed at improving the availability, the accessibility, and the quality of health care. In terms of availability, the federal Hill-Burton hospital

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construction program has assisted in providing 286,000 new hospital beds since 1947. Currently, the most pressing need is for the modernization of some 260,000 existing beds, the larger share of them in urban areas. The President has proposed a new grant and loan program to take this next step. By 1975 we will need to graduate 11,000 doctors annually, 3,500 more per year than in 1965. Again federal programs are in operation assisting the construction of medical school facilities and the training of doctors, dentists, and nurses. The passage of Medicare last year marks a milestone in improving the accessibility of health care. It will cover about 40 per cent of medical expenditures for the nation's 19 million aged. Special programs for health care of children are also under way, most of them aimed at bringing medical services to the poor children of the nation, whose lack of care in childhood often stunts an entire life. Finally, the quality of health care is a legitimate object of federal activity. Between 1964 and 1967, federal outlays for biomedical research have risen from $1.1 to $1.5 billion. Out of this effort have emerged apparent cures of such cancers as childhood leukemia and Hodgkin's disease; a working artificial kidney; and the beginning of a possibly feasible support device for failing hearts and, in the more distant future, a complete artificial heart. On the margin, dollars spent in these programs of medical and health care are yielding massive gains in national welfare.

Urban Development Between now and the end of the century, our urban

SUMMER, 1966

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population will more than doublefrom 130 million to 280 million people. In the next forty years, this nation will have to provide as much urban housing, schools, parks, water and sewer systems, transportation facilities, and other public works as now exist, just to provide for this increased population. Moreover, much of the housing and public facilities serving our existing population will have to be replaced. Patterns of living are changing. People are moving from the central city to the suburbs. Service facilities must be built for them. In addition, the decaying cores of many of our central cities will have to be restored by repair o r rebuilding.

Only at the price of staggering economic inefficiency and massive human inconvenience can we sit back and take no action to channel this tremendous growth into livable and esthetic patterns. Most of the cost will be met by state, local, and private investors. But the federal dollar is needed-and will increasingly be needed-to provide a strategic push in the right place, at the right time, toward the right objectives.

JUSTIFIED REDUCTIONS

School Assistance for Federally Impacted Areas Since 1950, the fed-

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THINK 14

eral government has assisted school districts in areas affected by federal activity. Annual payments, which are running at about $400 million this year, compensate for the added school operating costs of providing education to children of parents who live or work on tax-exempt federal property. The President's 1967 budget recommended a reduction in impacted-area aid in light of two factors: the inequities in the present program and the enactment of the Elementary-Secondary Education Act of 1965. The formulas of the present law do not operate equitably between districts. For example, a school district with federally-connected children equal to less than 3 per cent of total attendance receives no grants, while one with 3 per cent or more receives payment on behalf of all such children (including the first 3 per cent). Payments for each child are based on the highest of three alternatives: expenditures per pupil from local revenues in comparable school districts in the state, or 50 per cent of the state average, or 50 per cent of the national average. Thus, in states where local revenues are a small fraction of total school support (the U.S. range is from 11 to 87 per cent) and in states where total per pupil expenditures are low, the federal payment can be disproportionately high in relation to the financial "burden" of federal children on the local school. The revised program would require the school district to absorb the education costs of the first 6 per cent of children whose parents work but do not live on federal property. And it would base the payment on only the local share of school costs.

An additional reason for the reduction in impacted-area aid is the growth in new educational programs, which channel federal assistance to areas of greatest need. The 1967 budget directs additional funds through Title I of the Elementary-Secondary Education Act to the education of deprived children, clearly one of the nation's highest educational priorities. In 1967, over 90 per cent of all school districts will receive such aid; only 16 per cent receive impacted-area payments. In 1966 and 1967, grants for Title I will exceed $2 billion, more than the impacted-area program has provided over the previous five years. In 1967, counties in which impactedarea school districts are located will receive 2,~ times as much (under Title I alone of the new Education Act) as they will lose by the reduction in impacted-area aid-a $5.20 million gain compared to a $216 million loss. Of the more than 1,100 counties in the nation that have received both impacted-area aid and assistance under Title I of the new act, only 172 will experience a reduction in impacted-area assistance greater than what they will receive under Title I of the new Education Act. And these tend to be relatively high-income areas in which the number of children from low-income families is quite small. Yet the outcry has been tremendous. Communities that vie for the location of federal installations and protest loudly at their closure are quick to claim that federal installations impose terrible burdens that must be fully compensated for. In this connection, it is worth noting that districts which receive significant amounts from the impacted-area program tend to have lower tax rates and lower assessment rates than their more fortunate neigh-

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