Annual Message to the Congress: The Economic Report of the President

To the Congress of the United States:

The past year was a year of sound economic achievement. A year ago I said that my key economic goal was "to create an economic environment in which sustainable noninflationary growth can be achieved." While much remains to be done we have built a very solid foundation for further economic gains in 1977 and beyond. The recovery has continued to produce substantial gains in output and employment. Unemployment remains much too high, but the marked reduction that we see in inflation as well as in inflationary expectations represents significant progress toward regaining the stable noninflationary prosperity that has been our goal.

The gross national product, adjusted for inflation, rose by slightly more than 6 percent last year. The rise in production was extremely rapid at the beginning of 1976. The advance moderated during the spring, but at the close of the year the recovery showed signs of reacceleration. In December more than 88 million Americans were employed, an increase of about 3 million from last December and more than 4 million above the 1975 recession low. Economic gains were widespread. Real incomes continued their rise, consumer expenditures also moved upward, business investment began to recover, and housing construction improved significantly. Unemployment dropped sharply in the early months of last year, although it rose again as the extraordinarily rapid expansion in the labor force outpaced the creation of new jobs.

Substantial headway was also made on the inflation front. Since late 1975 the consumer price index has risen only 5 percent, a full percentage point less than was anticipated and a noteworthy improvement over the 12 percent inflation rate of 1974. Wage settlements continued to moderate. Record crops and more ample supplies of farm products halted the sharp increases in food prices. As fears of inflation ebbed, interest rates declined, contrary to most expectations at the beginning of the year; and the stock market, reflecting this heightened confidence, was close to the highs of the year when trading ended in 1976. The lower rate of inflation and the improved state of financial markets attest to the significant progress we have made during the past year toward reestablishing a stable, noninflationary, full-employment economy.

If this goal is to be fully realized, the present policy of moderation in fiscal and monetary affairs and of relying on a restored vitality in the private sector must continue. We need tax reductions to support a lasting economic recovery and to provide relief from the increases in real tax burdens induced by inflation. In the long run, inflation and real economic growth will constantly push taxpayers into higher and higher tax brackets unless tax laws are changed. Some believe that these additional tax receipts should be spent on new Government programs. I do not. Instead I believe that the Congress should counteract the growing burden imposed by the tax system--and the reduction of private incentives that it implies--by periodically providing offsetting tax cuts while continuing to restrain the rate of growth of Government spending.

The creation of permanent, meaningful, and productive jobs for our growing labor force requires a higher level of private investment. Tax reductions must be so designed that measures to stimulate consumption are balanced by those which will increase investment. Investment has for some time been falling short of the levels required if we are to provide enough productive jobs for our people at rising real wage rates, and if we hope to renew and improve our capital stock so that we can meet our requirements for energy and make headway toward environmental, job safety, and other goals. Investment has grown more slowly than would normally be true at this stage of a recovery. A stronger spur to investment in productive plant and equipment is necessary for the further improvement in production and employment in 1977 and beyond.

TAX REDUCTIONS

In October 1975, I presented to the Congress a program of tax cuts and spending restraints that would have reduced the burden of government for all taxpayers. It would have given the American people more freedom to spend their incomes as they choose rather than as Washington chooses for them, and it would have increased incentives to expand investment. However, the Congress decided otherwise--to increase spending far more than I wanted and to cut taxes far less than I wanted.

Earlier this month I again sent to the Congress my recommendations to cut taxes. I have once more urged a permanent increase in the personal exemption from $750 to $1,000 to replace the system of temporary tax credits that has so greatly complicated the individual income tax return. I am also recommending a higher income allowance and a series of permanent tax rate reductions. My proposals provide income tax relief for individuals that will total $10 billion in 1977.

To encourage the investment that will mean good steady jobs for our expanding labor force, I am recommending once again a permanent reduction in the corporate income tax from 48 to 46 percent. I urge as well the enactment of legislation to make permanent the extension of the 10 percent investment tax credit and the increased corporate surtax exemption provided by the Tax Reform Act of 1976. In the longer run we must eliminate the double taxation of dividend payments. I am therefore renewing my proposal to integrate corporate and personal income taxes gradually over a period of years beginning in 1978.

I am also renewing my recommendation of accelerated depreciation for investment in new plants and equipment undertaken in areas where unemployment is 7 percent or higher. I am firmly convinced that this is a far better way to raise employment where the economy has not caught up with the recovery than adding layer upon layer of new spending programs.

Although such tax cuts for individuals and businesses are desirable at this time to support stronger consumer and capital goods markets, we must be mindful of the need to bring down our large Federal budget deficit as quickly as possible. As the economy improves and the demand for private credit becomes greater, Federal borrowing requirements to finance the deficit must be lowered to avoid preempting funds needed for private investment and to ensure steady progress in the battle against inflation. Accordingly, in my Budget Message I am again recommending responsible restraint in the growth of Federal budget outlays. These policies will also bring us closer to our goals of stable noninflationary prosperity.

INTERNATIONAL DEVELOPMENTS

Much progress was evident in the rest of the world last year, and international economic cooperation continued to improve. Restoration of a stable growth path, however, has proved difficult. Throughout the world, countries are still grappling with the complicated and painful aftermath of inflation, recession, and the sharp increases in the relative price of energy. Serious social and political problems have made these adjustments more difficult.

When I met with the leaders of the major industrial nations in the summer of 1976, the restoration of full employment in our several economies was the most important item on our agenda. Stable full employment and continued improvement in the well-being of our own peoples and the world population at large, we agreed, will take a number of years. Although the course of faster expansion seems attractive, it is clearly risky. Impatience which leads to a reacceleration of inflation could jeopardize the significant progress we have achieved so far.

The costly lessons of the past decade are inescapable. High and variable inflation rates are incompatible with sustainable growth. Overly expansionary policies contributed to the very high inflation rate and, in turn, to the deepest worldwide recession since the 1930s. Policy changes and adjustments will doubtless be needed in 1977 and thereafter. But policies must hold to a reasonably steady and predictable course. In particular, the measures we select to further our economic expansion must not raise the risk of future inflation.

The growing recognition among nations of their interdependence has helped to create the cooperation that is now apparent among members of the industrial community. The mutuality of the policy goals of the developed and developing countries needs to be better understood on each side. For this reason the discussions between developed and developing countries during 1976 have attempted to foster a climate in which our joint interests and our diverse concerns can be freely expressed. Although the progress so far achieved has disappointed some, it has helped us avoid the sometimes easier but mutually destructive course of trade restrictions.

ENERGY POLICY

Energy matters retain their troublesome hold among the problems threatening the Nation's long-run prosperity. The sharp increases in oil prices in 1973-75 imposed major costs upon our economy. We have done much to accommodate the new higher prices for energy, but some aspects of energy policy have hampered the adjustment. The Congress has continued to. hold prices for domestically produced oil and natural gas well below world market levels. These lower energy prices have encouraged the inefficient use of energy and discouraged efforts to expand domestic supplies and improve the energy efficiency of the overall capital stock.

The recovery has heightened the demand for energy and thus resulted in greater imports of oil. In consequence the United States now depends even more heavily upon imported petroleum and is even more vulnerable than a year ago to future price manipulation and interruptions in supply. Now that the problems of recession and inflation are receding, we can more vigorously address this difficulty. The energy program that I have presented before is .designed to answer the longer need.

First steps are under way toward creating a strategic oil reserve which will help shield us from disruptions in supply. The OPEC pricing decisions of December were a forceful reminder of the Nation's growing need for protection against foreign moves that affect the price and can alter the availability of imported oil. Strategic storage will provide a first line of defense against the threat of disrupted supplies. This vital program must be implemented, and we must also take positive steps to lessen our economic dependence upon foreign oil.

Measures that will make us less dependent on foreign energy supplies have been proposed by this Administration; but unfortunately many of the most important proposals have not yet been accepted by the Congress. Some of the measures involve present costs which will yield much greater future benefits. Others, which would lead to more efficient use of our energy resources, would benefit the Nation immediately as well as in the future.

It is critically important--for energy security, environmental quality, and long-term economic productivity--that prices of domestic petroleum and natural gas be allowed to match more closely the full cost of these fuels. In the immediate future oil prices should be allowed to rise as they were intended to do under the Energy Policy and Conservation Act. Steps should also be taken which would help close the gap more rapidly between domestic and world market prices for petroleum, allow a free-market price for North Slope Alaskan oil, and deregulate the wellhead price of new natural gas.

Although a number of inconsistencies remain, the relation between the Nation's goals for energy and for the environment has become clearer and the effects of existing policies more fully known. The time is ripe for reexamining environmental policy and determining whether the ends we all seek can be achieved at a lower cost to the economy and to the security of our energy supplies.

Taken together, all of the actions recommended here would help the economy to adjust to the new energy situation and do much to ensure more reliable supplies of energy for the future. They would also signal to the world that this Nation is serious about developing secure supplies of energy. Most important, these efforts would encourage conservation and give industry the confidence that will spur the production of both conventional fuels and substitutes.

REGULATORY REFORM

As economic problems have arisen and been dealt with by new policy initiatives, the Government's role in the economy has grown ever larger. The number of commissions, agencies, administrations, bureaus, and offices set up to conduct programs increases constantly. Each appears important when it is first established. The trouble is that they are seldom, if ever, terminated when they have accomplished their original mission. By one recent count there were 1,200 Federal Government organizations alone having significant powers to regulate a wide and growing range of economic activities.

The direct Federal outlay to control practices in the private sector is substantial. Even more important are the losses that these activities impose on the production and distribution of goods and services throughout the economy. No accurate measure of the total costs and benefits of actions by the regulatory agencies is possible at this time or perhaps ever. Although all Americans are aware of the substantial benefits which regulations produce in their everyday lives, we frequently lose sight of the efforts of such programs in restricting the growth of productivity.

The use of newly developed technology, the development of new companies and products, and the opening up of new occupations have all been impeded by the need for licenses, certification, review, and legal judgments introduced by one agency or another. When innovative activities are discouraged progress is curbed throughout the economy, even in those areas where some regulation is justified. Regulations must therefore be reexamined to ensure the removal of costly and counterproductive regulations and to identify those whose need bas passed. Where benefits seem large we should make sure that the benefits are realized at the least possible cost.

To reduce the regulatory burden, I asked the Congress in the last year to eliminate unnecessary and anticompetitive regulation in the airline and trucking industries. This action was to follow the path of regulatory reform that the railroad industry achieved in the Railroad Revitalization and Regulatory Reform Act of 1976. I also urged the Congress to eliminate the Federal Power Commission's controls on new gas prices, which have held back exploration and sales to the interstate pipelines serving northern and western cities. Earlier this month I once again submitted to the Congress a plan to eliminate controls on gasoline refining and marketing.

Among agencies under my jurisdiction I have set out new regulatory procedures which will make controls more effective and less costly to all concerned, but such steps are only a beginning. The Congress and the executive branch must undertake a comprehensive review to ascertain the effects of present controls, and then offer to the American people a corrective program that will cut across administrative boundaries. Only a sweeping reform will remove the regulatory burden where it is no longer justified and place the initiative for production and distribution back in the more efficient hands of private enterprise.

ROLE OF THE GOVERNMENT IN SOCIETY

I firmly believe that if we dedicate our efforts to the major problems I have outlined here we can successfully resolve them. As a people we have an extraordinary capacity to marshal our resources against even the gravest difficulties.

Unfortunately many of our problems are self-made. One which has concerned me particularly over the years is a tendency, born of goodwill and a desire to improve the state of American life, which makes us think we can create costless benefits for our people. We are unwilling to confront some of our hardest choices. We persist in the belief that we can always tolerate a little larger Federal deficit, or the creation of a little more money, especially for the sake of programs which seem to promise clear and readily definable benefits. This is a kind of self-deception that we must learn to resist.

Certainly we must adopt measures that promise to keep the economic expansion going and reduce the high unemployment. But overly expansive policies with their inevitable risk of renewed inflation are realities which are easily overlooked in the understandable desire for the immediately tangible benefits foreseen from specific programs. What we seek is a sustainable expansion and the restoration of full employment without inflation, and we must settle for no less.

The discipline implicit in a prudent fiscal policy is not easy but it offers very considerable and lasting rewards. I am hopeful that the recent creation of the budget committees to serve the Congress will help to provide this necessary discipline. Prudent budget policies are essential if we are to restore stable full-employment conditions and provide the productive jobs which our people need and want. Some part of our present deficit is the result of the recession and will accordingly disappear as full employment is restored. Beyond this, however, we must restrain the growth of Federal expenditures. If we do not, we shall have to resign ourselves to higher taxes or to high employment deficits with their inflationary consequences.

Nowhere are these tradeoffs so evident as in our social security program and our efforts to provide medical insurance for our people. I have emphasized the need to maintain a fiscally sound social security system and repeatedly rejected proposals to fund increased benefits out of what are called general revenues. The purpose of linking social security benefits to specially designated taxes is to balance the benefits to one segment of society with the costs to another segment. Our democratic processes of government work better when the costs of programs are open and visible to those who pay them. Funding our social security benefits through specifically designated payroll taxes strengthens the discipline that should govern these decisions. Benefits are not costless, and we should not allow this fact to be submerged in any general revenue funding of the social security system.

Similar pressures are building up with respect to medical care. We have become concerned, and rightly so, over sharp increases in the cost of medical care which emphasize the need to improve the efficiency and effectiveness in the delivery of health care services. These have arisen in part because the large expansion in health insurance coverage under both private and public programs has reduced the sensitivity of consumers to costs and weakened the incentives to achieve efficiencies. Individuals, businesses, and unions, confronted with the higher costs of private health insurance have begun to exert curbs on the systems for delivering health and medical service, and their influence should be salutary. I hope we will not choose to fund these costs through a comprehensive national health insurance system, since this will only weaken the incentives for improvement and efficiency that are now emerging.

These are but two examples of the pressures which threaten to erode our fiscal processes. We must recognize that making governmental expenditure policy the principal arm of demand management has undesirable consequences. Expenditure programs once in place are extremely difficult to cut back. The result is a permanent rise in Federal outlays and the risk of ever-increasing growth in the government relative to the private sector. As the experience of other countries forcibly illustrates, this is a dangerous path. It weakens incentives, reduces efficiency, leads to lagging standards of living, and carries inevitable risks of inflation. It is much better to provide fiscal adjustments through tax reductions than through Federal spending programs.

The solid improvement of this year means continued progress toward a better life for all Americans. Problems will always remain, but the future is bright with opportunities to continue strengthening our economy. Improvement is part of the American way of life, but we must recognize that few problems, when viewed realistically, lend themselves to quick and easy solution. Our policies must take into account the full costs and lasting implications of the changes we make today for whatever worthwhile reason. If they attack symptoms rather than causes, policies will be ineffective and may even preclude the very goals which we seek. Enduring improvement in the economic welfare of the American people requires that the courses we embark on to meet today's problems will also bring us closer to our more distant goals and aspirations.

GERALD R. FORD
January 18, 1977.