opportunity and because it is being thrust upon us in the way in which we cannot ignore. Thirty States have already issued a call for a Constitutional Convention. Just four more are necessary for that

to occur.

Then it becomes mandatory for the Congress to call such a convention. I think the Congress ought to act, and act responsibly, before that happens. I think that push, along with the public opinion that it represents, will force us to find accommodation of viewpoint behind one or another of the several proposals. I mean most sincerely, while I think the formulation that I have drafted is the way I would approach it, I am perfectly willing to join with others behind some other proposal if that is what it takes to get such an amendment submitted.

Senator HATCH. We appreciate your testimony here today. Thank

you.

Senator McCLURE. Thank you.

Senator BAYH. Thank you, Senator McClure.

Senator MCCLURE. Thank you, Senator Bayh.

Senator BAYH. We are privileged this morning to have as the next witness a man who has a greater responsibility for trying to deal with the monetary problems of the country than any other living human being.

He seems to be bearing up rather well under those responsibilities, as onerous as they are. I think they are in good hands.

Mr. Secretary, it is a privilege to have you with us this morning. We are anxious to see what you have to say.

TESTIMONY OF HON. W. MICHAEL BLUMENTHAL, SECRETARY OF THE TREASURY

Secretary BLUMENTHAL. Thank you very much, Mr. Chairman, distinguished members of the committee.

I greatly appreciate the opportunity to testify before you, Mr. Chairman, on this important question, which really goes to the heart of how we manage our economy; and of the role that the Federal budget and balancing the Federal budget plays in that process.

I have a statement, which I would like to submit for the record, with your permission, Mr. Chairman, and then just make some general comments.

Senator BAYH. Without objection, we will file the statement as if it had been given in total.

Secretary BLUMENTHAL. Since the weight of my testimony is going to be in the direction of strongly questioning the wisdom of any kind of constitutional requirement to balance the budget, the reasons for which I will try to layout for you, Mr. Chairman, let me begin by stating clearly that I feel strongly that the President's commitment to achieve budget balance as quickly as possible, as soon as economically prudent and feasible, is absolutely correct.

Let me recall that it was the President as candidate Carter who strongly indicated that it was his intention by the end of his first term to achieve a balanced budget, when at the time the deficit in the Federal budget was well in excess of $60 billion.

I think the requirement of balancing the budget is as urgent today, indeed more urgent than it was then. I think that we are well underway

toward achieving it. I think it is absolutely essential that we move in that direction, and I think the President deserves a great deal of the credit for moving us in that direction under difficult circumstances. Not only has the deficit been reduced from some $66 billion when he first came into office to less than $30 billion at the present time, and not only is there every intention of moving toward a balance as soon as possible, but also, Federal spending as a percentage of our GNP has been reduced from about 22.6 percent in the fiscal year when President Carter took office to about 21.6 percent, and his intention is to reduce it further.

Thus, I make these points at the outset, Mr. Chairman, to leave no doubt in your mind and in the minds of your colleagues that we are fully in accord with the notion that the budget needs to be balanced, and the administration's policy, indeed, is moving in that direction. Having said that, and having stated it clearly and firmly, the question, then, is whether or not we are to mandate that budget balance is going to be the Federal policy forever; whether we are going to enshrine that policy forever within the Constitution, regardless of changing economic and political circumstances in the country and in the world; and whether or not we are going to rob ourselves forevermore in the future, under any and all circumstances, of the flexibility that the tool of budgeting provides.

I would have to say to you that I consider such a move to be ridiculous.

And I would like to lay out for you why I think that it is ridiculous. I think it is as ridiculous to enshrine a particular economic policy in the Constitution as it would have been years ago to enshrine in the Constitution the policy of some element of our economic landscape that made sense in the 19th century or the end of the 18th century, but that hardly would be appropriate or relevant in the last part of the 20th century or in the 21st century.

Our country always has been a dynamic one and I hope it always will be. Economic policy must be adapted to the change that is ever present in a dynamic society. Indeed, if you go back and look at the record of the discussions of our Founding Fathers, if you look at the Federalist Papers, if you look, indeed, at some of the statements made by, among others, my illustrious predecessor, the first Secretary of the Treasury, Alexander Hamilton, you will find very clearly enshrined in those documents the notion that what is required is flexibility, the flexibility to adjust to changing circumstances and that, indeed, the Constitution was framed with that principle in mind. Let me go into the particular reasons why a constitutional requirement for budget balance is, as I have characterized it, ridiculous. In the first place, it would be extremely difficult, indeed impossible, in my judgment, to administer such a provision, to take account of unforeseen circumstances.

Bear in mind that our budget process requires the executive branch to decide on a budget for a given fiscal year some 20 months in advance of its completion. This is exceedingly difficult.

We simply do not have the tools for forecasting so far in advance. Certainly, present evidence clearly indicates how difficult it is for economists inside and outside the Government and, therefore, for those consumers of the product of economists, such as Government administrators and executives, people who have to make the decisions,

as you and I do, to anticipate what really is going to happen within the economy.

In other words, there is a very important difference between stating the objective of a budget balance and the ability to actually achieve it. That difference has to do with the fact that a given budget will be at balance at one level of national income but not at balance at another level of national income.

The point that I am making is, we simply cannot predict economic circumstances 20 months into the future with sufficient accuracy to forecast the level of income that would yield precisely a balanced budget.

There are three variables, Mr. Chairman, that have to do with whether we achieve budget balance or not.

One of these is Federal Government expenditures, the second is the schedule of Federal tax rates, and the third is taxable income. The Congress and the Executive have certain controls over Federal expenditures and tax rates. We have no such control with regard to taxable income, and we cannot predict precisely its level.

Therefore, to avoid the occurrance of a Federal deficit, we would have to plan for a surplus to take care of contingencies; it is not possible to plan for a balanced budget every year.

Having continual surpluses would be very onerous on the economy. And I don't think any one of the various proponents of a balanced budget amendment has suggested that we should plan for substantial surpluses in order to be sure that we can be in balance.

Let me cite the second reason why I think this idea of having budget balance as a constitutional requirement is ridiculous.

If you go back to our past history and you try to simulate what would have happened if we had attempted to obey a constitutional requirement that the Federal budget be in annual balance, you would find that as a result of such an attempt, the economy would have turned down from manageable recessions into severe depressions. The attempt to follow the balanced budget rule would have exacerbated substantially the problems that are inherent in a downturn and would have made it very much more difficult to lift the economy out of them. The reason is very simple: If the economy goes into a recession and income falls-which is a way of defining a recession-then we must do two things in order to balance the budget. We must either raise taxes or cut expenditures. Indeed, some of the proposals would require that such budget adjustments occur automatically. But, if in response to a decline in income you raise tax rates or you cut expenditures, people will have even less income to spend, economic activity will recede further as will tax revenues and we will have an even larger deficit.

So, we would be on a downward spiral with a downward ratchet. We would have to raise taxes or cut expenditures so much that we would actually turn a recession into a depression.

The Council of Economic Advisers has simulated such a situation, as have certain outside observers.

The CEA took the period of fiscal year 1974 to fiscal year 1976 and asked the question, based on that historical experience: What would have happened if we would have been required to achieve budget balance during the fiscal years 1974 to 1976?

You may recall that, in fact, during those years the actual unified budget deficit grew from $4.7 to $66.4 billion.

Because of the multiplier effect, we would have required between $1.5 to $2 billion either in expenditure cuts or effective tax increases in order to achieve a $1 billion reduction in the deficit.

According to the econometric models an attempt to balance the budget in 1975 would have given perverse results. Instead of an 81⁄2percent unemployment rate, we would have had a 12-percent unemployment rate; the real GNP, which dropped in 1975 by 1.3 percent, would have dropped by 9.5 percent; and, incidentally the inflation rate which actually went up by 7%1⁄2 percent would have been reduced in 1975 by 1 percentage point to 6.5 percent.

DRI used a similar model and also simulated the results that would have pertained under a regime of balanced budgets for the period spending and increase taxes in order to balance the budget and of weakness 1974 to 1976. Their simulated results are-and I will read them to you-unemployment driven to 11.2 percent in 1975 and 11.3 percent in 1976, as compared to 8.5 and 7.7 percent in fact; in 1977, it would still have been over 9 percent, while in fact with the budget in deficit, we were reducing the unemployment rate, putting Americans back to work; real output, according to DRI would have declined 8.9 percent in 1975, as compared with the actual 1.3 percent decline; in 1973 to 1975, real output would have declined 10 percent, as compared to the actual 2.6 percent decline, four times as much of a decline; the Consumer Price Index would have increased 10.5 percent in 1974 and 8.2 percent in 1975, as compared to 11 percent and 9.1 percent, respectively; in other words, a modest reduction in the CPI increase. I think those are the major results that make the point that if we observe the balanced budget requirement we make recessions worse. In addition there are "practicalities."

Let's assume we want to follow the balanced budget policy, anyway, for one reason or another. There would be a huge argument over the simple issue of what is a revenue item and what is an expenditure, and how to treat Federal trust funds such as the social security and highway trust funds.

There are some proposals which suggest that if Members of Congress could sue in the courts to insure that the executive abide by the requirements of the Constitution, thus making the judicial branch the arbiter of the Federal budget. This would imply that the entire budget process, executive and congressional, is inadequate and that the courts must rule on what is an expenditure, what is revenue, what is to be included or excluded, and, whether there is true balance. I would think that to make our courts arbiters of the Federal budget process raises very serious questions for the flexibility and practicability of economic policy.

The tendency to use what is fondly called "creative accounting" in order to have nominal budget balance, but in fact to get around the strictures of budget balance, would be enormous. And, certainly, my 21⁄2 years in this Government have convinced me that the opportunities for ideas for creative accounting are as fertile as the mind of the the collective mind-of the people working within the Government.

For example, I refer to the practice of moving to loan programs from direct expenditures and putting those loan programs off-budget. There has been general growth of the off-budget device-and let me remind you that I am struggling, working hard with my colleagues to reduce this growth which began in the early seventies and has risen from one-half of 1 percent of the total budget in 1974 to 2.4 percent in 1979. We are trying to reduce it, hoping by 1982 to have it down to 1.9 percent. In doing so we are reversing a trend that began in 1973-74, when the Ex-Im Bank was moved off-budget as were other items. Even so, now, in 1980, we are estimating outlays of $120 billion on off-budget Federal entities. Certainly you would create an incredible pressure to move things off-budget as one way of getting around the requirement of an annually balanced budget.

The incentive for other evasions and for bad Government would be ubiquitous.

In the agricultural area, for example, instead of having a modest subsidy, a price-support program, since that weighs on the budget, there would be a tremendous incentive to move to, say, set-asides and to have huge set-asides which don't get into the budget simply in order to observe the stricture of maintaining a balanced budget.

The incentive for protectionism as a way to raise prices for all consumers, as a way to help an industry that is in some difficulty rather than through some kind of trade-adjustment program, to give you another example, would be enormous.

We would be making decisions and you would be passing laws based primarily on the straitjacket effect of a balanced budget in periods when budget balance is not appropriate and when you have good reasons for different decisions about expenditures. Thus you would be forced into passing bad laws. We in the executive branch would be thinking up devices to get around this particular stricture, by lending rather than appropriating, off-budget rather than onbudget, and passing laws that avoid Federal responsibility and force it on to the States and local governments.

In a period of a downturn, for example, you recognize that Federal income and payroll tax revenues will decline; therefore, there would be a tremendous incentive to adopt the kinds of taxes that are relatively recession-proof-the typical example of that is a property tax. Property tax is the tax upon which local governments rely. You would get into a real problem in that area.

Second, there would be a tremendous temptation to pass laws. I will give you an extreme example, Mr. Chairman.

You could pass a law requiring that in a period of downturn private employers have to pay a year's salary or 6 months' salary to people whom they no longer need or keep them on the payroll for a certain period of time. Why? Because you want to avoid the additional expenditure in unemployment compensation and social security payouts that would have to be made. So, in order to avoid increases in the Federal Government's expenditures in this instance, you shift the cost to private budgets. And you create tremendous distortions in the

economy.

So, again, the incentive to resort to evasion, to resort to bad Government would be very great.