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there, other than into an arena which I think would be evidenced and identified as one of pure panic on the part of the Congress? Where would you go from there is that should happen?

Secretary BLUMENTHAL. Senator, first of all I fully agree with you that this issue is so important, that what is required is not scorn but rather hard thought, and I commend all of you for engaging in that hard thought.

I do not believe in the possibility of fine tuning. I think that is implicit in what I have said about the weaknesses of these econometric models. We just don't know enough. We have to admit that. I say that, having studied economics for a good number of years and concluded that the limits of knowledge are very great.

Where would we go if, in fact, there were such an amendment passed to the Constitution? I think we would be in the kind of situation that I tried to describe in my opening remarks. There would be clearly a certain amount of confusion on the part of Members of Congress, on the part of the people in the executive branch who have lived with the different system for a long time, who can't really envision how it would function, and then there would be accommodation, but accommodation with a question mark.

The people would figure out: Well, now let's see, what can we shove off the budget, how can we define expenditures and revenues in such a vay as to get around this? How can we put back on the States a lot of expenditures that we have made, and while it may be correct for you to say that this is a kind of punitive attitude, I must say I have a fair amount of sympathy if the majority of the States, or two-thirds of, the States, have said, hey, put your house in order, that we then say OK, you want us to keep your taxes down, so your constituents don't have to pay so much, then we have less revenue now, we have got less to share with you.

I don't think that is necessarily punitive. I think that it would be logical that if the States have said, look, I balanced my State budget every year, why don't you do the same, that the Federal Government says, well, we don't do it, inter alia, because we have certain requirements, defense and everything else, but we also must keep up, and we also have the requirement to share revenue with you, so we will reduce that.

That is unavoidable. Where you would be, therefore, is that people would get busy to try to find ways to live within that, living within that, which means finding all of these evasive ways of doing so, plus, I am afraid, since they couldn't totally escape the implications of this, they would still be in a bit of a straitjacket. It would mean, as Senator Hatch has indicated, that we would have wider swings. You would say, maybe you would have some of those, but it wouldn't be that bad. You would have wider swings. I guess it is a question for you to judge whether it is in Wyoming, Utah, New York, or Indiana; you would have to judge whether or not those wide swings make sense. The chairman happens to come from a State in which my previous company had a lot of, has a lot of, activities. When there has been a downturn, it means a lot of layoffs in South Bend, Ind.

I don't know whether that company has anything in Wyoming, but in many States it means a lot of layoffs. If you have wider swings, you have more layoffs; more layoffs means somebody is going to have

to help support these people. That is where you would be. You would have wider swings with deeper layoffs during those periods.

Senator SIMPSON. I appreciate that response. Just a couple more questions. Do you really feel that the theory of spend and spend and elect and elect and the accompanying deficits that go with that will not continue far into the foreseeable future?

Secretary BLUMENTHAL. I think, as a general rule, it seems to serve people in public office well, as a general rule. I think I have noticed, however, that in the last couple of years throughout the world, including in this country, there is a change that is occurring, and a very welcome change in that the limits to spending as a means of creating happiness among the constituents, I think, is being felt. I don't know whether that is a temporary phenomenon or whether, within the next downturn, people will forget about this or whether it is a fairly permanent one. I think it is a fairly permanent one and therefore it seems that increasingly elected political officials are recognizing the limitation of that. I am glad that they are.

Senator SIMPSON. It is heartening to hear you say that, that you find that as a welcome change. I think what we saw in England in the last couple of weeks, and in Canada yesterday, is another example of this stop, as we refer to it around here.

Just another question. How much of the planning balanced budget in 1981 and 1982–I like the way the Budget Committee has gone forward with their planned balancing-how much do you believe will be due to higher taxes resulting from inflation generated bracket, tax bracket creep, as it is referred to, which is not an entomological term? I have heard conflicting figures, and that is why I ask.

Secretary BLUMENTHAL. Would you allow me to submit that for the record? In other words, I would like to give you a precise answer as to what the higher inflation rate means in the way of additional revenues that bring about this surplus that I think the chairman referred to earlier. I don't know exactly how much that is. It is different at different levels of inflation. I will give you an answer on that.

Senator SIMPSON. I would very much appreciate that. Material subsequently submitted for the record follows: Infation moves taxpayers into higher marginal tax brackets thereby increasing their real tax rate. This effect will increase receipts in fiscal years 1980 and 1981 by about $10 billion and $22 billion respectively using 1979 as the base year.

Senator SIMPSON. Finally, Mr. Secretary, do you think that economic conditions in this country actually justified the deficits in 19 of the last 20 years?

Secretary BLUMENTHAL. I don't think that, with the benefit of hindsight, having had these large deficits 19 of the last 20 years was a sensible national policy. No, I don't believe that. I do believe that in some of those years it made sense to have a deficit; some, but not all 19 out of all 20.

Senator SIMPSON. In that area, you have stated in your remarks, although not overly enamored with the forecasting reliability of the econometric models, that you have more confidence in their ability to explain the past.

Secretary BLUMENTHAL. You can look back on what actually happened and try to interpret. That is not that difficult because you have all of the variables before you. You see what actually happened. You can try to establish theories about cause and effect, but honest people can differ honestly; basically that is possible.

But to try to predict what happens 20 months from now, 2 years from now, is exceedingly difficult. Witness the fact that we had 6.9 percent increase in real terms in the GNP in the last quarter of last year, and there isn't one economist inside or outside the Government, in the Congress or in the executive branch who predicted that. But now they will all tell you why it is. That is what I mean.

Senator Simpson. I appreciate very much your candor and as I say I have watched you with interest from afar. Now I will be watching you from a closer vantage point and hope you continue bloody but unbowed in your efforts. Thank you very much.

Secretary BLUMENTHAL. Thank you.

Senator Bayh. Thank you very much, Mr. Secretary. We appreciate it. [The prepared statement of Secretary Blumenthal follows:)

PREPARED STATEMENT OF Hon. W. MICHAEL BLUMENTHAL Mr. Chairman and Members of the Committee: I am pleased to be here today to discuss with the Committee the proposed Constitutional amendments requiring either a balanced Federal budget or restricting in some way the growth of Federal outlays.

So that there is no misunderstanding about the position of this Administration toward inflation, fiscal responsibility, and the role of government versus the private sector, let me reiterate that this Administration is unequivacolly committed to bringing the Federal budget into blance, and to doing so as swiftly as economic prudence permits.

Firm and continued restraint on Federal spending is the central element in achieving this commitment.

Since President Carter has taken office, we have already made impressive progress in this direction. The Federal deficit has been reduced from $66 billion in fiscal year 1976 to a projected deficit of less than $30 billion in 1980, a reduction of more than half. During this same period, the share of our national income and output devoted to Federal spending has been reduced-from 22.6 percent in 1976 to 21.6 percent in the current fiscal year, and a further reduction is proposed for 1980 and subsequent years.

A policy of fiscal restraint, reduced growth in Federal outlays, and a shrinking Federal deficit is the appropriate and necessary budget policy for today's economie circumstances, when the economy is reaching its capacity limits and inflationary pressures are accelerat But is it clearly not the approrpriate policy for all economic circumstances. Indeed, the moderately stimulative policy pursued over the past several years enabled the economy to recover from the deepest recession since the 1930's and to put almost 8 million Americans to work.

It is neither possible nor desirable to reduce the complex process of fiscal policy to the single constraint of budget balance. Flexibility is the necessary element of an effective fiscal strategy. Constitutionally mandating a balanced budget woull undermine our efforts to develop and practice prudent economic policy.

Strict budget balance at all times, which is the mandate of most of the amend. ments proposed in recent months, has several major flaws.

First, the deficit varies with economic conditions that are neither wholeli predictable nor wholely controllable. Congress can and does limit the aggregat level of spending. But it cannot control total receipts. While tax rates can live legislated in precise terms, taxable incomes can and do vary as total output, employment, and incomes fluctuate. Consequently, a budget that would be in balance at one level of output and income would be in deficit or surplus at other levels of economic activity. It is possible to aim fiscal policy at the objective of a balanced budget, but achieving this objective depends on a complex of factors that determines the economy's aggregate activity and income, a complex in which Federal spending and Federal tax rates are only partial influences.

This brings me to the second point: a rigid balanced budget mandate coulil exacerbate economic fluctuations. If income falls unexpectedly, then budget balance can be achieved only if tax rates are raised, or spending for the quarter


of the total budget that can be controlled on an annual basis is drastically reduced. But such actions would be counterproductive because they would reduce output, employment, and incomes still further, resulting in bigger deficits which would, under a balanced budget mandate, require even larger cuts in spending and/or increases in tax rates. This is a formula for deepening recession, not for promoting economic stability,

This type of scenario cannot be dismissed as pure speculation. Although I am not overly enamored of the forecasting reliability of econometric models, I have somewhat more confidence in their ability to explain the past. Several econometric exercises show that if the Federal Government had been required to halance the budget during the 1973–1975 recession, the economic consequences would have been far more severe than they actually were. A study by the Council of Economic Advisers, using three independent econometric models, showed that if there had been mandatory budget balance during the 1973–1975 period, the unemployment rate would have risen to about 12 percent in 1975, compared with the actual rate of 8.5 percent. The number of unemployed would have increased to about 11 million during that year. Our real gross national product in 1975 would have been about 12 percent below the 1973 level. Rather than just a serious recession, the American economy would have suffered its first real depression since the 1930s.

The Federal budget can and has been used as a stabilizing tool when economic activity weakens. Annual budget balance, however, would eliminate this stabilization tool. In effect, a budget balance requirement would elevate that objective alove other important goals such as high employment and healthy economic growth.

Moreover, a balanced budget amendment would need very complicated escape clauses for contingencies that cannot be foreseen.

The most obvious is that of war, which brings sudden and substantial increases in defense spending. If a balanced budget requirement were in place, either taxes would have to be raised, nondefense outlays reduced, or both. A large part of nondefense outlays-almost 90 percent--are uncontrollable, however, so that the compensating outlay reductions, which could be sizable, would have to come out of a limited number of programs.

In other conceivable contingencies, a balanced budget requirement would require severe and abrupt contractions in outlay programs. A natural disaster, such as a major earthquake, might require sizable legally mandated relief expenditures that would unbalance an otherwise balanced budget. If OPEC were to raise oil prices significantly, and this had a serious impact on the economy. fiscal policy could not be used to offset the impact of the probable outflow of dollars and purchasing power from the domestic economy. An extended coal strike, railroad or truck strike, or a widespread civil disorder could have similar depressing effects on the economy which would require unanticpated outlays that would unbalance the budget. In all of these circumstances, achieving budget balance would require prompt and sometimes sizeable increases in taxes or large and destabilizing reductions in budget outlays not related to the emergency situation

A budget amendment could conceivabley be drafted that would contain sufficient exemptions and escape clauses to permit a budget to be out of balance. Indeed several of the amendments before this Committee have such provisions. However, mandating budget balance as a provision of the Federal Constitution and yet providing the necessary flexibility for emergencies would require more literary and drafting precision than anyone has the right to expect, and might well trigger extensive litigation. And, in many cases, such an amendment would either be so complicated or such a sham that it would probably accomplish less than the President has already committed himself to accomplishing.

If budget balance is mandated, it would require very precise definition of those items of receipts and expenditures that are to be counted in achieving the balance. Items that are presently classified as a “means of financing” the deficit might be reclassified as a budget receipt in order to help balance the budget, for example, seigniorage, gold sales, and savings bonds sales.

In addition, mandating budget balance would create incentives to circumvent the budget as a control mechanism. Items could be moved off-budget, as for example were the Postal Service and the Rural Telephone Bank, thus making the federal budget less, rather than more, responsive to Congressional control. Offbudget outlays rose rapidly in the mid 1970's, from half of one percent of the budget in fiscal year 1974 to 2.4 percent this year. The President's fiscal plans for fiscal year 1980 and beyond reverse this trend toward increasing the number of off-budget Federal entities, but incentives to evade mandated budget balance could put us back on the path toward evasion of strict budget discipline.

Loan guarantees and insurance could replace direct loan programs so that the outlays do not affect directly the budget totals. This would be counter to the President's proposal for a new system to control the growth of Federal activities, particularly Federally guaranteed credit.

In short, any Constitutional amendment mandating budget balance would either be so filled with loopholes as to be meaningless or so rigid as to hamper the proper conduct of economic policy or national defense. Moreover, because precision of language and terminology are essential ingredients of an amendment to the Constitution, it is difficult to conceive of language that would be enduring and unchallenged over time.

In any event, the final arbiter of the content of the Federal budget could well become the Supreme Court. This would be a radical departure from our constitutional tradition which vests the Executive and Legislative Branches with the full responsibility and authority for determining tax and expenditure policy.

The budget process established by the Congressional Budget Act of 1974 has made a major contribution toward bringing about comprehensive, logical, and responsible budgetmaking. It is a vehicle fully adequate for achieving budget balance when the Congress deems it the appropriate fiscal stance. This process, which is working well in bringing the total budget under control, would be shortcircuited by a balanced budget amendment.

Constitutional amendments should be reserved for matters that cannot be dealt with except through other means. The budget can be balanced without a constitutional amendment. In fact, as I pointed out at the beginning of my statement, this Administration is moving rapidly toward a balanced budget in a prudent and sensible manner that does not involve gimmickry and does not jeopardize the economic, social, or military goals of the Nation. I do not believe that all of these goals could be achieved if an Administration were forced to abide by a Constitutional amendment requiring mandatory budget balance every year.

Mr. Chairman, I do not question the sincereity of those who propose simple solutions to complicated problems, such as how to attain our national objectives of high employment, steady growth of output, stable prices, and a strong dollar. But in the words of President Kennedy some 17 years ago, “to attain them, we require not some automatic response but hard thought.” Mandatory budget balance offers no escape from our responsibility for making better discretionary decisions concerning economic policies, including decisions on spending and taxes.

Senator Bayh. Our next witness is our distinguished colleague from Arizona.



Senator DECONCINI. Thank you, Mr. Chairman. I will be quite brief today, realizing the time. I would first like to thank you, Senator Bayh, for holding these hearings on the various proposals that are before the committee. I am fully aware of the heavy load of this subcommittee and the tremendous amount of time that you and the staff put in not only on this subject but on many others. Being a colleague who signed the letter recently to you, I want to assure you that that letter is just as complimentary as it is urgent on those who signed it from this Senator's point of view for continued diligence and expeditious handling of this matter.

I compliment Senator Bayh time and time again in public as well as privately for taking the bullet, holding hearings on a very sensitive subject, one of high political rhetoric from many, many points of view realizing the duty and obligation and responsibility of you as chairman of this committee of protecting the Constitution, being sure that it is thoroughly reviewed before any amendments are reported out to the full committee onto the floor.

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