Message to the Congress Transmitting the Annual Economic Report of the President

To the Congress of the United States:

In the year just ended, the first decisive steps were taken toward a fundamental reorientation of the role of the Federal Government in our economy—a reorientation that will mean more jobs, more opportunity, and more freedom for all Americans. This long overdue redirection is designed to foster the energy, creativity, and ambition of the American people so that they can create better lives for themselves, their families, and the communities in which they live. Equally important, this redirection puts the economy on the path of less inflationary but more rapid economic growth.

My economic program is based on the fundamental precept that government must respect, protect, and enhance the freedom and integrity of the individual. Economic policy must seek to create a climate that encourages the development of private institutions conducive to individual responsibility and initiative. People should be encouraged to go about their daily lives with the right and the responsibility for determining their own activities, status, and achievements.

This Report reviews the condition of the American economy as it was inherited by this Administration. It describes the policies which have been adopted to reverse the debilitating trends of the past, and which will lead to recovery in 1982 and sustained, noninflationary growth in the years to follow. And, finally, this Report explains the impact these policies will have on the economic well-being of all Americans in the years to come.

The Legacy of the Past

For several decades, an ever-larger role for the Federal Government and, more recently, inflation have sapped the economic vitality of the Nation.

In the 1960s Federal spending averaged 19.5 percent of the Nation's output. In the 1970s it rose to 20.9 percent, and in 1980 it reached 22.5 percent. The burden of tax revenues showed a similar pattern, with increasingly high tax rates stifling individual initiative and distorting the flow of saving and investment.

The substantially expanded role of the Federal Government has been far deeper and broader than even the growing burden of spending and taxing would suggest. Over the past decade the government has spun a vast web of regulations that intrude into almost every aspect of every American's working day. This regulatory web adversely affects the productivity of our Nation's businesses, farms, educational institutions, State and local governments, and the operations of the Federal Government itself. That lessened productivity growth, in turn, increases the costs of the goods and services we buy from each other. And those regulations raise the cost of government at all levels and the taxes we pay to support it.

Consider also the tragic record of inflation-that unlegislated tax on everyone's income—which causes high interest rates and discourages saving and investment. During the 1960s, the average yearly increase in the consumer price index was 2.3 percent. In the 1970s the rate more than doubled to 7.1 percent; and in the first year of the 1980s it soared to 13.5 percent. We simply cannot blame crop failures and oil price increases for our basic inflation problem. The continuous, underlying cause was poor government policy.

The combination of these two factors-ever higher rates of inflation and ever greater intrusion by the Federal Government into the Nation's economic life—have played a major part in a fundamental deterioration in the performance of our economy. In the 1960s productivity in the American economy grew at an annual rate of 2.9 percent; in the 1970s productivity growth slowed by nearly one-half, to 1.5 percent. Real gross national product per capita grew at an annual rate of 2.8 percent in the 1960s compared to 2.1 percent in the 1970s. This deterioration in our economic performance has been accompanied by inadequate growth in employment opportunities for our Nation's growing work force.

Reversing the trends of the past is not an easy task. I never thought or stated it would be. The damage that has been inflicted on our economy was done by imprudent and inappropriate policies over a period of many years; we cannot realistically expect to undo it all in a few short months. But during the past year we have made a substantial beginning.

Policies for the 1980s

Upon coming into office, my Administration set out to design and carry out a long-run economic program that would decisively reverse the trends of the past, and make growth and prosperity the norm, rather than the exception for the American economy. To that end, my first and foremost objective has been to improve the performance of the economy by reducing the role of the Federal Government in all its many dimensions. This involves a commitment to reduce Federal spending and taxing as a share of gross national product. It means a commitment to reduce progressively the size of the Federal deficit. It involves a substantial reform of Federal regulation, eliminating it where possible and simplifying it where appropriate. It means eschewing the stop-and-go economic policies of the past which, with their short-term focus, only added to our long-run economic ills.

A reduced role for the Federal Government means an enhanced role for State and local governments. A wide range of Federal activities can be more appropriately and efficiently carried out by the States. I am proposing in my Budget Message a major shift in this direction. This shift will eliminate the "freight charge" imposed by the Federal Government on the taxpayers' money when it is sent to Washington and then doled out again. It will permit a substantial reduction in Federal employment involved in administering these programs. Transfers of programs will permit public sector activities to be more closely tailored to the needs and desires of the electorate, bringing taxing and spending decisions closer to the people. Furthermore, as a result of last year's Economic Recovery Tax Act, Federal' taxation as a share of national income will be substantially reduced, providing States and localities with an expanded tax base so that they can finance those transferred programs-they wish to continue. That tax base will be further increased later in this decade, as Federal excise taxes are phased out.

These initiatives follow some common sense approaches to making government more efficient and responsive:

• We should leave to private initiative all the functions that individuals can perform privately.

• We should use the level of government closest to the community involved for all the public functions it can handle. This principle includes encouraging intergovernmental arrangements among the State and local communities.

• Federal Government action should be reserved for those needed functions that only the national government can undertake.

The accompanying report from my Council of Economic Advisers develops the basis for these guidelines more fully.

To carry out these policies for the 1980s, my Administration has put into place a series of fundamental and far-reaching changes in Federal Government spending, taxing, and regulatory policy, and we have made clear our support for a monetary policy that will steadily bring down inflation.

Slowing the Growth of Government Spending

Last February 1 promised to bring a halt to the rapid growth of Federal spending. To that end, I made budget control the cutting edge of my program for economic recovery. Thanks to the cooperation of the Congress and the American people, we have taken a major step forward in accomplishing this objective, although much more remains to be done.

The Congress approved rescissions in the fiscal 1981 budget of $12.1 billion, by far the largest amount ever cut from the budget through this procedure. Spending for fiscal 1982 was subsequently reduced by another $35 billion. The Omnibus Budget Reconciliation Act of 1981 also cut $95 billion from the next 2 fiscal years, measured against previous spending trends. Many of these cuts in so-called "uncontrollable" programs were carried out by substantive changes in authorizing legislation, demonstrating that we can bring government spending under control—if only we have the will. These spending cuts have been made without damaging the programs that many of our truly needy Americans depend upon. Indeed, my program will continue to increase the funds, before and after allowing for inflation, that such programs receive in the future.

In this undertaking to bring spending under control, I have made a conscious effort to ensure that the Federal Government fully discharges its duty to provide all Americans with the needed services and protections that only a national government can provide. Chief among these is a strong national defense, a vital function which had been allowed to deteriorate dangerously in previous years.

As a result of my program, Federal Government spending growth has been cut drastically—from nearly 14 percent annually in the 3 fiscal years ending last September to an estimated 7 percent over the next 3 years—at the same time that we are rebuilding our national defense capabilities.

We must redouble our efforts to control the growth in spending. We face high, continuing, and troublesome deficits. Although these deficits are undesirably high, they will not jeopardize the economic recovery. We must understand the reasons behind the deficits now facing us: recession, lower inflation, and higher interest rates than anticipated. Although my original timetable for a balanced budget is no longer achievable, the factors which have postponed it do not mean we are abandoning the goal of living within our means. The appropriate ways to reducing the deficit will be working in our favor in 1982 and beyond: economic growth, lower interest rates, and spending control.

Reducing Tax Burdens

We often hear it said that we work the first few months of the year for the government and then we start to work for ourselves. But that is backwards. In fact, the first part of the year we work for ourselves. We begin working for the government only when our income reaches taxable levels. After that, the more we earn, the more we work for the government, until rising tax rates on each dollar of extra income discourage many people from further work effort or from further saving and investment.

As a result of passage of the historic Economic Recovery Tax Act of 1981, we have set in place a fundamental reorientation of our tax laws. Rather than using the tax system to redistribute existing income, we have significantly restructured it to encourage people to work, save, and invest more. Across-the-board cuts in individual income tax rates phased-in over 3 years and the indexing of tax brackets in subsequent years will help put an end to making inflation profitable for the Federal Government. The reduction in marginal rates for all taxpayers, making Individual Retirement Accounts available to all workers, cutting the top tax bracket from 70 percent to 50 percent, and reduction of the "marriage penalty" will have a powerful impact on the incentives for all Americans to work, save, and invest.

These changes are moving us away from a tax system which has encouraged individuals to borrow and spend to one in which saving and investment will be more fully rewarded.

To spur further business investment and productivity growth, the new tax law provides faster write-offs for capital investment and a restructured investment tax credit. Research and development expenditures are encouraged with a new tax credit. Small business tax rates have been reduced.

Regulatory Reform

My commitment to regulatory reform was made clear in one of my very first acts in office, when I accelerated the decontrol of crude oil prices and eliminated the cumbersome crude oil entitlements system. Only skeptics of the free market system are surprised by the results. For the first time in 10 years, crude oil production in the continental United States has begun to rise. Prices and availability are now determined by the forces of the market, not dictated by Washington. And, helped by world supply and demand developments, oil and gasoline prices have been falling, rather than rising.

I have established, by Executive order, a process whereby all executive agency regulatory activity is subject to close and sensitive monitoring by the Executive Office of the President. During the first year of my Administration, 2,893 regulations have been subjected to Executive Office review. The number of pages in the Federal Register, the daily publication that contains a record of the Federal Government's official regulatory actions, has fallen by over one-quarter after increasing steadily for a decade.

But the full impact of this program cannot be found in easy-to-measure actions by the Federal Government. It is taking place outside of Washington, in large and small businesses, in State and local governments, and in our schools and hospitals where the full benefits of regulatory reform are being felt. The redirection of work and effort away from trying to cope with or anticipate Federal regulation toward more productive pursuits is how regulatory reform will make its greatest impact in raising productivity and reducing costs.

Controlling Money Growth

Monetary policy is carried out by the independent Federal Reserve System. I have made clear my support for a policy of gradual and less volatile reduction in the growth of the money supply. Such a policy will ensure that inflationary pressures will continue to decline without impairing the operation of our financial markets as they mobilize savings and direct them to their most productive uses. It will also ensure that high interest rates, with their large inflation premiums, will not longer pose a threat to the well-being of our housing and motor vehicle industries, to small business and farmers, and to all who rely upon the use of credit in their daily activities. In addition, reduced monetary volatility will strengthen confidence in monetary policy and help lower interest rates.

The International Aspects of the Program

The poor performance of the American economy over the past decade and more has had its impact on our position in the world economy. Concern about the dollar was evidenced by a prolonged period of decline in its value on foreign exchange markets. A decline in our competitiveness in many world markets reflected, in part, problems of productivity at home.

A strengthened domestic economy will mean a faster growing market for our trading partners and greater competitiveness for American exports abroad. At the same time it will mean that the dollar should increase in its attractiveness as the primary international trading currency, and thus provide more stability to world trade and finance.

I see an expansion of the international trading system as the chief instrument for economic growth in many of the less developed countries as well as an important factor in our own future and that of the world's other major industrial nations. To this end, I reaffirm my Administration's commitment to free trade. International cooperation is particularly vital, however, in confronting the challenge of increased protectionism both at home and abroad. My Administration will work closely with other nations toward reducing trade barriers on an even-handed basis.

I am sensitive to the fact that American domestic economic policies can have significant impacts on our trading partners and on the entire system of world trade and finance. But it is important for all concerned that the United States pursue economic policies that focus on our long-run problems, and lead to sustained and vigorous growth at home. In this way the United States will continue to be a constructive force in the world economy.

1981: Building for the Future

In 1981 not only were the far-reaching policies needed for the remainder of the 1980s developed and put into place, their first positive results also began to be felt.

The most significant result was the contribution these policies made to a substantial reduction in inflation, bringing badly needed relief from inflationary pressures to every American. For example, in 1980 the consumer price index rose 13.5 percent for the year as a whole; in 1981 that rate of increase was reduced substantially, to 10.4 percent. This moderation in the rate of price increases meant that inflation, "the cruelest tax," was taking less away from individual savings and taking less out of every working American's paycheck.

There are other, more indirect but equally important benefits that flow from a reduction in inflation. The historically high level of interest rates of recent years was a direct reflection of high rates of actual and expected inflation. As the events of this past year suggested, only a reduction in inflationary pressures will lead to substantial, lasting reductions in interest rates.

In the 6 months preceding this Administration's taking office, interest rates had risen rapidly, reflecting excessively fast monetary growth. Since late last summer, however, short- and long-term interest rates have, on average, moved down somewhat in response to anti-inflationary economic policies.

Unfortunately, the high and volatile money growth of the past, and the high inflation and high interest rates which accompanied it, were instrumental in bringing about the poor and highly uneven economic performance of 1980 and 1981, culminating in a sharp fall in output and a rise in unemployment in the latter months of 1981.

This Administration views the current recession with concern. I am convinced that our policies, now that they are in place, are the appropriate response to our current difficulties and will provide the basis for a vigorous economic recovery this year. It is of the greatest importance that we avoid a return to the stop-and-go policies of the past. The private sector works best when the Federal Government intervenes least. The Federal Government's task is to construct a sound, stable, long-term framework in which the private sector is the key engine to growth, employment, and rising living standards.

The policies of the past have failed. They failed because they did not provide the environment in which American energy, entrepreneurship, and talent can best be put to work. Instead of being a successful promoter of economic growth and individual freedom, government became the enemy of growth and an intruder on individual initiative and freedom. My program—a careful combination of reducing incentive-stifling taxes, slowing the growth of Federal spending and regulations, and a gradually slowing expansion of the money supply—seeks to create a new environment in which the strengths of America can be put to work for the benefit of us all. That environment will be an America in which honest work is no longer discouraged by ever-rising prices and tax rates, a country that looks forward to the future not with uncertainty but with the confidence that infused our forefathers.

RONALD REAGAN

February 10, 1982.