1981 - An Analysis of the Reagan Economic Program (for the Policies Inscribed)

8/7/2019 1981 - An Analysis of the Reagan Economic Program (for the Policies Inscribed)

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February 2 7 , 1981

AN ANALYSIS OF, THEREAGAN ECONOMIC PROGRAM

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INTRODUCTIONPresident Reagan's economic program, unveiled February 18 ,is remarkably consistent in both i ts practical and philosophicalre l i ance on the free market. The tax package, based on thebe l i e f t ha t i nd iv idua ls and corporations will respond t o a l t e r edincent ives , does not at tempt t o channel resources into favoreda c t i v i t i e s , b u t ins tead rel ies on the market t o d ir ec t the fundst o the highest uses. Many of the spending cuts were advanced t o

eliminate or. reduce federal programs which are properly in theprovince o f the pr iva te sector: for example, the Export-ImportBank, ilmtrak, the synthetic fue ls program. Following a dictum o f .Adam S m i t h , the Administration a l s o advocates reducing federalspending $2 b i l l i o n by assessing users fees f o r inland waterwaysa i rpor t s and Coast Guard services.A more subtle, b u t equally important affimation o f themarket is the Reagan Administration's decision t o take a longertenn pe rspe ct iv e. The taxi ng and spending powers o f the federalgovernment will not be used in at tempts t o counter short-termeconomic flu ct ua tio ns . :Rather, the in te n t- i s t o crea te a climate

i n which t h e government minimizes t he di st or ti on ar y e f f e c t o f taxand spending, regulatory, and monetary policies on economicdecision-making.There are essent ia l ly t w o avenues o f c r i t i c i sm o f the Reaganproposals. The f i r s t is t ha t t he s h i f t in perspect ive is ill-advised. Ogponents would argue tha t t rad i t iona l denand managenentpol ic ies a r e b o t h adequats and necessarI7. Due in part t o thedismal economic perfomance o f t h e 1970s, t h i s v i t w is h e l a 5 1 7 3r a p i d l y dwindling min orit y. The p o s i t i o n taken in this paper ist ha t t he p r iva t e sector is i n h e r c n t l y , s t & l e and that the longerterm perspective is the correct one.


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The second major area o f inquiry conce.rns the composition,mix, and .timing of spending and ta x c u t s . A t i s sue a r e : 1 )specif ic e lements o f budget and, more par t icular ly , tax cuts and2 ) the r e l a t i v e s t re n g t h of the two forces , t h e i r e f f e c t on thed e f i c i t , and i t s e f f ec t on the economy. T h i s paper addressesthese quest ions .THE REAGAN PROGRAM

Pres iden t Reagan c a l l s for FY 1982 out lays o f $ 6 9 5 . 5 b i l l i o n ,r ece ip t s o f $ 6 5 0 . 5 b i l l i o n and a $45 b i l l i o n d e f i c i t . Includedwithin these aggregates are $41.4 b i l l i o n i n spending reductions,$ 5 3 . 9 b i l l i o n i n ind iv idua l and corporate tax cu t s , and $2 b i l l i o ni n proposed users fees. Another $ 5 . 7 b i l l i o n i n off-budget cu t sa re ou t l i ned .The program a l so con ta ins $ 4 . 4 b i l l i o n i n cu rr en t f i s c a lyear budget cuts and $8.9 b i l l i o n i n tax c u t s . Fi sca l year 1981spending would total $ 6 5 4 . 7 b i l l i o n w i t h a $ 5 4 . 5 b i l l i o n d e f i c i t .

Table 1CURRENTLY ESTIMATED BUDGET OUTLOOKWITE PRESIDENT'S BUDGET SAVINGS AND TAX REDUCTION PROGRAM(dollar amounts in b i l l i o n s )

' Target outlay ceilings 654.7 695.5 733.1 771.6 844.0 912.1600.2 650.S 710.2 772.1 850.9 942.0

Target deficit ( 0 ) or surplus - 5k . 5 -45.0 -22.9 +0.5 +6.9 +29.9

Estimated receipts after tax reduction --- ---lanShare of GNPOutlaysReceipts 23.0 21.8 20.4 19.3 19.2 19.021.1 20.4 19.7 19.3 19.3 19.6

I t 1s n o t c o r r e c t t o compare the Carter Adminis t ra t ion 's TI1982 budget numbers, submitted in January, w i t h the Reagan propo-sa l because the l a t t e r was based on decidedly more opt imis t iceconomic assumptions. The vari ance i n fo recas ts a f f ec t s t h e basefrom which the changes a re ca lmla ted .Because th e Reagan program depends so much on supply-sidetax cu ts and changes i n expecta t ions, concepts which a r e over-looked o r more d i f f i cu l t t o measure i n most econometric models,there was some disagreement within the Administration about theimpact o f the economic package. In a compromise, t he fo recas t


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anticipates real growth rates of 4..2 percent, 5 . 0 percent, 4.5percent, 4.2 percent, and 4.2 percent from 1982 through 1986.The consumer price index will fall from 11.1 percent this year to8.3 percent in 1982 and 6.2 percent in 1983.Table 2

ECONOMIC ASSUMPTIONS(Calendar Years)1981 1982 1983 1984 1985 1986Nominal Gross NationalProduct (b i l l ions)('Percent Change) $2,920.0 $3,293.011.1 12.8 $3,700 O12.4 $4,098.010.8 $4,500.0 $4,919.8 9

Real Gross NationalProduct (billions,1972 dollars)(Percent Change)

Implicit PriceDeflator(Percent Change)Consumer Price Index*1967 = 100(Percent Change)Unemployment Rate(Percent)

1,497.0 1,560.01.1 4.2 1,638.05.0 1,711.04.5

195.09.9 211.0 226.0 240.08.3 7.0 6.0274.0 297.011.1 8.3

7.8 7.2

._ 315.06.2

6.6%PI fo r urban wage earners. and c ler ica l workers (CPI-W) .

333.05.5

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1,783.0 i;ssa4.2 4252.05.4 2654

3 4 8 . o 3634.7 4

6.0 5

ANALYSISThe following analysis will be divided in two parts. Thefirst will be an examination of the program elements designed toalter the economic incentives to work, save, and invest. Theseconsist primarily of tax cuts and changes in programs, such asunemployment insurance and trade adjustment assistance. Thesecond portion of the analysis will focus on the proposed spendingcuts, their efficacy, and completeness.

ECONOMIC INCENTIVESThe T a x ProposalPresident -Reagan's tax proposal is a sweeping p l a n to returnmuch economic decision-making to the purview o f the f r ee ma r ke t .The proposal differs from tax cuts o f recent years in that it isnot aimed at stimulating aggregate demand through changes in the

average tax rates. Rather, it is designed to increase w o r k ,


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saving s, and investment through changes i n the marginal tax .r a t e s . The gen era l philosophy behind this type o f t ax cu t ist h a t the many a r t i f i c i a l re l a t i ve pr ice d i s tor t io ns make itb e t t e r t o lower marginal r a t es and decrease a l l biases ra t he rthan at tempt t o chip away str uc tu ra l l y a t each one in div idu ally .If th e p l a n is adopted,. marginal tax r a t e s f o r personalincome w i l l be cu t by 5 percen t , s t a r t i ng on J u l y 1, 1981. In1982 and 1983, these w i l l be c u t by an addi t iona l 1 0 percent p e ryear , and i n 1984 the p l a n c a l l s f o r a f i na l S percent cut .There w a s debate as to whether t h e m a x i m u m tax on unearnedincome should be dropped immediately from 70 percent t o 50 percentDue t o po l i t i ca l c ir cums tances , the decision was made not t oe f f e c t t h a t change immediately. However, when the plan i s fullyimplemented, marginal tax r a t e s w i l l range from 1 0 percent t o 50percent .

Table 3THE ADMINISTRATION'S PROPOSED TAX RATE SCHEDULESFOR 1981, 1982, 1983, AND 1984

JOINT RETURNS

TaxableincomeAdministration ProposalPresent Law 1981 . 1982 1983 . 1984Tax Rate Tax Race Tax Rate Tax Rate Tax Rabracket on income on income on income on income on inci n bracket in bracket i n bracket in bracket in brac( d o l l a r s ) (percent) (percent) (percent) (percent) (perce

$ 0 - 3,4003,400 - 5,500 '5,500 - 7,600I0% 0% 0% 0% 0%14 13 12 11 10

16 15 14 12 117,600 - 11,900 18 17 15 14 1311,900 - 16,000 21 20 18 16 1516,000 - 20,200 24 23 21 19 La

20,200 - 24,600 28 27 24 22 2 124,600 - 29,900 32 30 27 24 2329,900 - 35,200, 37 35 3 1 28 2735,200 - 45,800 43 41 37 33 3245,800 - 60,000 49 47 42 3a 3660,000 - 85,600 54 5 1 47 lr2 6085,600 - 109,400 5 9 56 50 45 43162,400 - 215,400 68 6 5 58 5 2 $9109,400 - 162,400 64 6 1 55 G9 47215,400 and over 70 66 60 53 50


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The depreciation propogal i s a s l ig ht ly revised vers ion ofthe Capi ta l C o s t Recovery A c t of 1979 , introduced by CongressmenBarber Conable (R-New York) and James Jones (D-Oklahoma). Underthe Pres ident ' s p lan the usefu l l i f e concep t is scrapped and thefollowing ca te go rie s and write -off period s would be establ ished.

Category Write-off Periods0 Automobiles and l ight trucks 3 years0 R & D capi tal 3 years0 A l l other machinery0 Public uti l i ty capital with a previousguidel ine l i fe of under 18 years

5 years

5 years0 Owner-occupied non-residential structures 10 years0 Public util ity capital with previousguidel ine l i fe o f over 18 years LO years0 Other nou-tesidential structures 15 years0 Low income rental housing 15 years0 Residential rental buildings 18 years

The 3 o f S o f and 10-year categories qua l i fy for a super-ac ce le ra ted write -of f method invo lvin g an optimal cbmbination ofthe l 'double declining balance1' and I f sum of the years d i g i t s "methods of de pr ec ia ti on . The '15- and 18-year categories mus t use"s t ra ight l ine" methods.The 3-year category qu al if ie s f or a 6 percent Investment TaxC r e d i t (ITC) and the 5-year category qualif ies for a 1 0 percentITC as does p u b l i c u t i l i t y ca p i t a l i n t he 10-year ca tegory.Str uc tur es i n the lO-year category are considered t o besec t ion 1245 prope rty f o r purposes of reca pture, b u t the 15- and18-year c ate go ries a re considered t o b e sec t ion 1250 property.

This permi t s t he l a t t e r two categor ies t o b e subjec t t o somecap i t a l ga ins t axa t ion , as opposed t o ordina ry income tax ati on a tthe poin t of sale . 'The Individual CutsThe d is ti n c ti o n between personal and busin ess cuts is ana r t i f i c i a l one. Ind iv idual s own a l l bus inesses and all businessincome accrues t o individuals i n one form o r another. Thus, anytax change ,that affects personal saving affects businesses andany business tax cut w i l l have an effect on personal w e l l being.


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.The cur ren t t ax code contains s e r i o u s d i s to r t i ona ry f a c t o r swhich lead t o eff ic iency losses . t o soc ie ty .m u l t i p l e taxation of income f rom personal saving, the . t ax sys tenc rea t e s a b i a s i n f avor o f consumption and against saving. Lesssaving means less investment, which hampers economic growth.

the work e f f o r t . Once ag ain , th is causes an eff iciency loss t osociety because the c o s t o f working relative t o l e i sure o r non-market a c t i v i t y is d i s t o r t e d .

Because of i t s

High marginal tax r a t e s on labor income a r t i f i c i a l l y penal ize

A l l economic decisions are made a t the margin. That i s , aworker makes h i s decision t o work o r not t o work based on the taxtreatment of add i t i ona l do l l a r s o f labor income, not on thet reatment of dol la r s earned in the pas t . I f r e l a t i ve p r i ces a r ed i s t o r t e d , it i s only through changes i n mirginal ta x r at es th a tthe d i s t o r t i o n s w i l l be minimized.What w i l l the 30 perce nt across-the-board c u t i n marginalr a t e s accomplish? Since the pr ice of labor r e l a t i v e t o l e i s u r eis exact ly the a f t e r tax r e a l wage ra te , a cu t i n marginal ta xrates on labor income w i l l increase the marginal wage rate,thereby making work more p r o f i t a b l e and leisure more c o s t l y .The proposed indiv idua l cu t s a l so ind i re c t l y a t t ac k theant i -saving bias in the tax code.- In a manner s imi l a r . t o thee f f e c t on the work-leisure choice, the cuts i n marginal r a t es

w i l l advantageously affect the save-consume decision.the present tax rate on income from savings for a jo in t re turn o f$10 ,000 i s 54 percent . By 1984, t h a t w i l l be reduced t o 40perce nt. Thus, f o r each one hundred d o ll a rs of savings incurr ed,the individual w i l l re ta in an addi t ional 14 percent .mul t i fo ld t axa t ion of income f rom capi ta l , inc luding the t axa t ionof in t e r e s t income, dividends, and ca pi ta l 'gains. Since the t o pmarginal tax r a t e w i l l be 5 0 percent, some of these d i s t o r t i o n smay be s izab le .

For example

Distortions, however, w i l l s t i l l e x i s t . There i s still a

A pr iv a t e inves to r i n this bracket is taxed a t the ra te o f50 perc ent on new income. I f he decides t o invest some o f h i sa f t e r - t a x d o l l a r s , the re turn on h i s investment w i l l a l so betaxed at the r a t e o f 50 percent . Thus, the inherent b ias aga ins tsaving and investment continues, a l be i t a t a diminished r a te .

The ind iv idua l cu t s proposed by President Reagan a r e a goods t e p i n the r i g h t d i r e c t i o n . Much more, however, remains t o b edone. Had the maximum tax on unearned income i n th e proposalbeen dropped imqed ia te ly t o 50 gercent and had t h e r e duc t i onsproceeded f rom t h e r e , t h e e f f e c t s would be more p o s i t i v e .The Depreciat ion ProgramThe Pres iden t ' s proposed depreciat ion system is very closet o being an ideal system. I t accomplishes two things: . 1 ) it


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- lowers the overall marginal tax rate on income f rom cap i t a l , and2 ) it removes a very s e r i o u s bias against investment in long-l ivedasse t s . F u r t h e r , it diminishes much o f t h e complexity and admini-s t r a t i v e burden .associated w i t h the present depreciat ion system.payments are deferred. Thus, the discounted value o f these taxpayments i s lessened. For the same reason t h a t double taxationo f personal saving i s dis tor t iona ry, high marginal tax ra te s onthe income from phys ica l capi ta l i s dis tor t ionary . The cur renttax t reatment poses a re la t i ve dis in cent i ve t o investment inphysical ca p it al . Only the immediate expensing of c a p i t a l a s s e t sw i l l provide a clim ate i n which investment decision s w i l l be madei r r e spec t ive o f the tax system -- the des i red , ' ' neut ra l " resu l t .G i v e n p o l i t i c a l r e a l i t i e s , the Pres iden t ' s d e p r i c i a t i o n proposalapproximates this desired n e u t r a l i t y .

By allo win g firms t o recover t he i r c a p it a l more quickly, ta x

I t i s f innly es tab l i shed in the economic l i terature thatbusinesses are quite respons,ive t o changes i n marginal ta x r at e son income from capital. As a r e s u l t of the new depreciationsystem w e can expect new investment i n productive, physicalc a p i t a l . A second major efficiency gain w i l l come from theremoval of a present-law bi as ag ai ns t c e rt ai n types of c a p i t a l .A major d i s t o r t i o n t h a t e x i s t s i n the cur rent tax code i sthe bia s towards investment in short- l ived assets a t the expenseo f long-lived a ss e ts . By cl in gi ng t o the "useful l i f e " concept,p resen t law insures tha t the re levant pr ice of a long-lived a ss etr e l a t i v e t o a shor t - l i ved a s se t i s higher than would be the case

i n a non-tax world. This fac tor has contr ibuted t o a tax-induceds h i f t of resources i n our economy. I t cannot b e claimed t h a t a l lthe woes o f the s t ee l indus t ry , for example, are t o be blamed onthis d i s t o r t i o n , b u t c e r t a i n l y it has been a contr ibu tin g fa ct or .This obsession with the usefu l l i f e concept stems from thebe l i e f t h a t deprec ia t ion for tax purposes must be matched w i t hactual economic depreciation or the loss of value an ass et suf fer sp e r accounting per iod . The t r a d i t i o n a l wisdom holds t h a t such asystem would be neut ra l w i t h respect t o assets of d i f f e r i n gd u ra b il i t ie s. Recent, more sop his t ica ted ana lys is has shown t h a ti n the context of developments over t i m e , the t r a d i t i o n a l wisdom

is fa l s e and i n f ac t d i scr imina tes aga ins t long- lived as se t s .The proposed depreciation system will r e tu rn t he r e l a t i vepos i t ions o f shor t - and long-lived assets t o t h e i r proper place.No longer w i l l there a tax-induced incentive t o favor investment 'i n shor t - l i ved asse t s .C r i t i c s argue t h a t t h e Reagan tax p r o p o s a l , by re turning somuch money t o the pr iva t e sector , w i l l c rea t e a demand p u l lin fl at io n. However, in fl a t i o n occurs' on l y if t he r a t e o f growthi n the money su p p l y exceeds the ra. te o f growth o f goods andser r ices . Therefore , w e need only worry about i n f l a t i o n i fwhatever de f ic i t ex i s t s i s funded th rough monetary expansion by


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the Fed. As long as the Fed holds the l ine and fo l lows a r a t i ona lsteady , monetary po licy , th er e w i l l b e no infclat ionary effects .The Reagan program specifies a des i r e for a gradual reduction inthe money supply and credit growth rate t o one-half the cu rr en tl eve l s by 1986 .The Administration a lso has in dic ate d i t s support f o r theFederal Reserve pol icy of ta rg et in g money aggregates r at he r thani n t e r e s t r a t es . W i t h d e f i c i t s of $ 5 4 . 5 b i l l i o n i n FY 1981 and$45 b i l l i o n i n E'Y 1982, c r i t i c s cha rge i n t e r e s t r a t e s w i l l skyroc-k e t , thereby negating the benef i c i a l e f f ec t s of the t ax cu t .The unprecented change i n the tax treatment o f a l l forms ofsavings wi l l , however, cl ea rl y incre ase the supply o f loanablefunds. Treasury Sec reta ry Regan has estimated t h a t as much aqtwo-thirds of the tax reduction w i l l be saved. The demand forloanable funds w i l l a l so i nc rease. I t i s poss ib le tha t theremight be some i n i t i a l p re ss ure on the capi ta l markets .

be noted that as i n t e r e s t r a t es r i se , saving w i l l become morea t t r a c t i v e .I t shou ld

A s new productive capacity comes on stream, output w i l lexpand and r e a l i n t e r e s t r a t es w i l l s t a b i li z e . Of course, i fgovernment spending is success fu l ly cu t , there would n o t be anyi n i t i a l p r e ssu re i n cap i t a l markets. The best way t o guardagains t any shor t- run. increases i n i n te re s t ra t es is t o be vigi-l a n t on the spending s ide . '

UNEMPLOYMENT COMPENSATIONUnemployment compensation has been designed t o replace

wage. The Federal-State Extended Unemployment A c t o f 1 9 7 0 , .enacted t o give addi t iona l ass i s tance t o unemployed workersduring per i ods o f high s t a t e o r national unemployment, authorizesthe extension of benef i t s a t the r egu la r weekly amount for anaddi t iona l 13 weeks whenever the unemployment r a t e among insu re dworkers (IUR) rises above some s t a t e o r national I ' triggeringl 'l e v e l . The s t a t e t r i gg e r t a k e s . e f f e c t when the s t a t e ' s IURequals o r exceeds, for a 13-week p e r i o d , 120 percent of theaverage rate f o r the corresponding p e r i o d i n each .o f t he p r e v i o u stwo years and when such a r a t e i s a l so a t l e a s t 4 percent . As t a t e a l so has the option t o extend benefi ts i f the s t a t e ' soverall unemployment rate is a t l e a s t 5 percent f o r 13 weeks.When th e na t iona l IUR reaches 4 . 5 percent , t h e nat iona l t r iggeris and a l l s t a te s , even those w i t h r e l a t i v e l y low unemploy-ment rates, become e l i g i b l e for the. extended be ne fit s.

. approximately 50 percent of a worker's former average weekly

Unemployment compensation o f t e n has the adverse effect o fmaking layoffs desirable fo r . b o t h employees and employers.Generous benefits and added leisure t i m e often c r e a t e s i g n i f i c a n twork dis incent ives . An employer may b e induced into laying o f fmore workers during an economic downturn than he o t h e r d i s e would


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because the tax used t oa lways d i rec t ly re la ted finance unemployment compensation i s n o tt o the unemployment experience of thefirm:and generates even greater inefficiency.The extinded benefits program adds t o these d i s t o r t i o n sirm:and generates even greater inefficiency.The extinded benefits program adds t o these d i s t o r t i o n sThe Reagan Administration has proposed restructuring theextended benefits program so t h a t it would provide relief on ly t othose areas plagued by high unemployment. The changes suggested' a r e meant t o achieve results analogous t o t ax cu t s -- t o r e s to rework incentives by making employment re l a t i v e l y more a t t r a c t i v ethan UnemplOyInent. Speci fi ca ll y , the Adm in ist ra tio n's proposalwould: 1 ) el iminate the na t iona l t r i gge r ; 2 ) change the way thes t a t e t r i g g e r s a r e c a lc u la te d ; 3 ) r a i s e the s t a t e t r i g g e r l e v elf rom 4 t o 5 percent of the I U R a n d , . a t s t a t e o pt io n, t o 6 percento f the overall unemployment rate; and 4 ) s t r i c t l y enforce the newru le requi r ing c la imants t o accept any reasonable jo b o f f e r .Employment w i l l be considered acceptable i f it pays a t l e a s t theminimum wage and can replace the individual's current unemploymentinsurance benefi ts . The f i r s t two changes w i l l become e f f ec t iveJ u l y 1, 1981, while the third change would take effect only onOctober 1, 1982, thereby allowing necessary changes in state law.The 1980 Reconcil iat ion A c t already requires that the work tes tb e a p p l i e d t o a l l extended bene f i ts r ec ip ien t s a f t e r A p r i l 1 ,1981. These modifications would.'save $523 mil l ion in FY 1981 and$1.2 b i l l i o n i n EY 1982.Abolishing the nation'al trigger would reduce costly unemploy-'merit insurance benef i ts in s ta tes t h a t would otherwise n o t qual i fyfo r extended bene f i ts . In addi t ion , e f f ic iency in the l a b o r

market would be enhanced by eliminating one of the sources creat-ing. work d is in ce n ti ves. when the na t iona l t r i gge r is Ifon, Ibenef i ts are extended in a l l s t a t e s , even those w i t h r e l a t i v e l ylow unemployment r a t e s . Despite the cons ide rab ly b e t t e r j o boppor tun i ti e s i n such s t a t e s , unemployment may r i s e as a r e s u l tof increased work 'disincentives associated w i t h t h e a v a i l a b i l i t yo f more benefits.The proposal would al so exclude extended be ne fi ts re ci pi en tsfrom the ca lcula t ion of the IUR. The problem w i t h using the I U Ras a mea,sure of unemployment f o r t r iggering purposes is t h a t itcrea tes an extended benefits program which becomes self-perpetuat-

ing. When the t r i g g e r i s IIon,tf a l l persons f i l i n g c la ims f o rben ef i ts are included i n the IUR. T h i s r e s u l t s i n exhausteest h a t normally would no longe r be considered p a r t o f th e laborforce t o be included i n the I U R f o r an addit ional 13 weeks. Onthe other hand, when the t r i g g e r i s IIoff,If those same workers areexcluded; Making th is fundamental change would save subs tant ia lben efi t payments i n st a t e s th a t have already reached th e i r t r i g g e ring . leve1 . An even b e t t e r approach, however, would be t o use t h eov er al l unemployment ra t e i n cal cu la tin g the trigger because it. would more accu rately r e f l e c t jo b a v a i l a b i l i t y in the economy.

Raising the s t a t e t r i g g e r l e ve l i s d e s i r a b l e ' b e c a u s e itwould ensure that only those i n genuine need rece ive ass i s tance .


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Thi s, i n p a r t , is necessary t o compensate for the changing compo-s i t i o n o f the labor force, which over the years has raised the' n a tu ra l r a t e o f unemployment. F in a ll y, str en gth en ing the worktest can eliminate much o f the waste and f raud i n the program.Although the changes proposed ar e a l l d esi rab le from anef fic ie nc y and equity standpoint , th ey do no t go f a r enough. Theextended benefits program should b e e l imina ted ent i re ly .o r i g i n a l purpose of unemployment compensation was t o providetemporary r e l i e f . The program i s not su i ted t o correct long-termstructural problems.

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The

TRADE ADJUSTMENT ASSISTANCETrade Adjustment Assistance ( T U ) was introdu ced i n 1962 t oa s s i s t workers su ffe rin g from increased imports, which were a

d i rec t r e s u l t of government p o li c ie s aimed a t the l i b e r a l i z a t i o nof in te rn at io n a l tra de . Today, however, the Secretary of Laborcan decla re workers e l i g ib le i f imports have contributed s igni f i -c a n tl y t o unemployment and t o a decline i n the sales and/orproduction of the f i n n ( s ) i n que stio n. In ot he r words, workersno lo ng er have t o prove tha t they a re hur t by f ree r t r ade o r t h a timports a r e the major cause o f t he i r in jury . The primary purposeo f the TAA program i s t o he l p workers adjust t o changed economiccondi.tions by easing the t r ans i t i on pe r iod between j o b s . A s s i s t -ance avai lab le t o workers consists o f : 1 ) t ra de readjustmentallowances; 2 ) employment services; and/or 3 ) job search andrelocation allowances. TAA benefits supplement unemploymentinsurance ,be ne fi ts by providing 70 percent of a worker's formeraverage weekly wage, up t o a maximum o f the national averageweekly manufacturing wage. Because unemployment insurance-replaonly about 50 percent of gross earnings, TAA can be s i g n i f i c a n tt o the unemployed worker. In ad dit io n , these benef i t s a r e ava i lable f o r up t o a year. In FY 1980, outlays on the program hadgrown t o 1 . 7 b i l l i o n dol lars , which was more than s ix times a smuch as i n the preceding year.

c e-

The major problem w i t h TAA i s t h a t it compounds a l l theproblems associated w i t h unemployment compensation. The moregengrous benefits and the l ength ie r en t i t l ement p e r i o d exacerbatework disinc ent ive s. Greater be ne fi ts al so discourage workersfrom seek ing employment i n more stable i ndus t r i e s . Since employ-ers pay no supplemental tax f o r laying o f f workers who wouldreceive TAA b e n e f i t s , an employer may find it prof i t ab l e t o layo f f workers during a p e r i o d o f s lack demand, assuming t h a t r e l a -t ively generous TAA benef i t s will induce a worker t o wait t o bereh i red ra ther than ac t ive ly search f o r a new j o b . Fina l ly , T.Uc rea t e s i nequ i t i e s by discriminating i n favor o f a s e l e c t groupof unemployed workers, those af fec ted by imports.The Administration p r op o ses t o extend TAA benef i t s o n l y . t oth ose workers who have exhausted t h e i r regular unemploymentcompensation and t o l i m i t the s ize o f these ,benef i ts t o levels no


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higher than those under unemployment insurance.worker will be allowed to receive benefits from T U nd unemploy-ment 1nsuranc.e for up,to year. These changes will becomeeffective October 1, 1981, and could reduce spending by S1.15billion in EY 1982 alone.would improve efficiency within the program markedly. The resultsof several studies seem to indicate that reducing the availabilityof benefits would dramatically mitigate pernicious practices ofemployees and employers alike. One such study found that TAArecipients were much more likely to have experienced temporaryunemployment than their counterparts receiving only unemploymentinsurance. Moreover, they were much less likely to have changedtheir industry or occupation. It can be said that "one of the .surest ways to bring about adjustment is to provide no assistance,'and assistance that compensated for every burden would leave noincentive to adjust. The generous assistance payments seem toact as a deterrent to workers f rom seeking employment in newareas, thereby artificially generating too strong an attachmentto a vulnerable industry. The proposed changes are needed torestore work incentives and to discourage misuse of the program.

An unemployed

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The limitations proposed bn the availability of TIW benefits

Although the proposed changes in TAA would result in greatsavings and lead to a more efficient allocation of resources, theprogram would still have some eortcomings. Even greater savingscould be realized if t h e eligibility requirements were made morestringent by requiring workers'not only to show that they weredisplaced as a direct result of U.S. international trade liberali-zation but that it had been the single most important cause of.their injury. To further t h i s goal, the role of determiningeligibility should be returned to the 1nternational.Trade Commis-sion. The Department of Labor has all too often demonstrated abias in favor of organized lahor, many of whose members are T Urecipients. This is important because there often is only a verytenuous link between layoffs and increased unemployment fromimports. Is greater compensation then justifiable f o r workerswho are laid off because their firms failed to modernize o rbecause workers have demanded excessive compensation and, conse-quently, have effectively priced themselves out .of the market?Automobile workers, f o r example, currently receive a large amountof supplemental benefits despite the ruling by the ITC thatimports were not a substantial cause or threat of serious injuryto the U.S. auto industry. Instead, the Commission found L5atthe recession, rising costs of credit, high gasoline prices, andthe resulting shift in demand for small cars harmed the industrymore than imports. Moreover, since workers produce goods and 'serrices f o r local, regional, national, and international markets,

J . D. Richardson, "Trade Adjustment Assistance Under the U.S . Trade Acto f 1 9 7 4 : An .An aly ti cal Examination and Worker Su rv ey ," Nati onal Bureau- o f Economic Research, Working Paper 5 5 6 , September 1 9 8 0 .


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and a l l . of these workers. may be affected by unfavorable conditions,why should import-affected workers receive preferential treatments o l e l y because they happen to produce for an inte-mational market?T h i s would b e espec ia l ly t rue if increased imports were a r e s u l to f greater competi t ion rather L!an trade concessions granted by.the government. Import-affected workers, however, a re sometimesconsidered more deser ving because the i r layoff i s the r e s u l t o fpromoting a so ci al ly des ira ble pol icy, i .e . , one meant t o achievethe greater benefi t s associated w i t h fr ee tr ad e. Although th i smay be true, workers i n other indus t r i es o f t en are displaced for'equally deserving causes. For example, s t r i c t e r environmental .controls, more s t r ingent sa fe ty s t andards , and deregulat ion arej u s t a f ew .these po l i c i e s receive no supplements beyond unemployment cornpea-Yet workers who become unemployed as a r e su l t ofsat ion.

Final ly , the a v a i l a b i l i t y o f TAA a f t e r 26 weeks *of unenploy-These payments should be reduced drast ical ly, whi lement compensation readers it more l i k e an extended benefitsprogram.expanding the a v a i l a b i l i t y of the adjustment ser r ices .

SPENDING CUTSThe tax proposal, unemployment insurance, and t rade adjust -ment as sis tan ce programs a re designed t o increase incent ives t owork and invest . 'To free theE-resources for the pr iva te sectorexpansion, the AdministratiorI proposes $41.4 bi l l ion in-on-budgetspending reductions, another $S .7 b i l l i o n i n off-budget cuts, ana$2.0 billion i n usezs charges. while these cu t s a re s i gn i f i can t ,staggering t o some, there is considerable potent ia l ' for evengreater reduct ions.the remainder o f this paper w i l l examine the Pres ident ' s proposaland suggest some addit ional reduct ions.

Following the Administration's breakdown,

Revise Entit lements t o Eliminate Unintended BenefitsThe major cuts within t h i s sect ion are reform of the foodstamp program (expected t o save S1.8 b i l l i o n i n FY 1982), elimina-t i o n of both the social security minimum payment (Sl.0 b i l l i o n )and the adult student payment (S700 m i l l i o n ) , and the es tab l i sh-ment of a cap on federa l Medicaid payments t o the s t a t e s ( S lb i l l i o n ) . The Administration also proposes t o l i m i t c o s t ofliving adjustznents for the c i v i l service ret i rement systen t oonce a year ($SlO m i l l i o n ) .Some additional changes n o t recommended by Reagan whlch'could provide s-Jbs tant ia l savings include l imi t ing ve terans 'con7ensation payments t o ' veterans and sunivors whose a i s a b i l i -

ing a l l pensions for veterans and survivors which azc n o t ' ' s e nconnected" ana dismantling th e VA 'health care ~ g s t c m . ~ any 0;'t i e s a r e tr ac e ab le e i t h e r t o combat o r job-performance, a 1-_ .n i n a

t --Ice-' '2 See C o t t o n M. Lindsay, "Veterans' Benefits and Services," in Eugene J.tluSllister, e d . , Agenda for Progress:ton, D . C . : 'Examining Federal S p e z d i n q (Washing-The Heritage Foundation, 198L), p . 2 8 6 .


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those cur rent ly rece iv ing such ass i s tance would f a l l back on thele s s remunerat ive Medicaid system bu t , des pit e th a t sh i f t , thechanges outlined above could save $8 b i l l i o n i n FY 1982.Reduce Middle-Upper Income BenefitsThe February 18 budget also ou tl in es cu ts o f $ 1 . 6 b i l l i o ntlkough the child nutrition program and $800 mi l l i on r e s t ruc tu rthe Guaranteed Student Loan and the P e l 1 grant programs. Inad di tio n, th e Student Loan Marketing Associatio n ( S a l l i e Mae)would no longer have access t o the Federal Financing Bank. Thel a t t e r would reduce fe de ra l c r e d i t demands and promote approxi-mately $15 b i l l i o n of off-budget savings over the next f iveyears . These three changes are di rec ted a t bene f i ts received bthe middle and upper income levels.

i n g

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Some add it io na l po li cy changes which would reduce the bene-f i t s received by th e non-needy include introducing co st sharingi n the Medicare pro.gram and lowering the payment limitation f o rag ri cu lt ur al def icie ncy payments from $50,000 t o $10,000.

Recover Clear ly Allocable C o s t s from UsersTo achieve $2.0 b i l l i o n i n EY 1982 receipts the Administra-t i o n proposes t o charge in lan d waterway, a i r p o r t and Coast Guardu s e r s fees through increases i n barge f u e l t axes , av ia t ion fue ltaxes , and boat and yacht owner fees res pec tive ly. Another feewhich would not .only relieve the federal government of f i s c a lr e spons ib i l i t y b u t , also promotes greater economic efficiency

would be t o incorpora te e f f lu ent t axes i n the 97th Congress'reauthor iza t ion of the Clean A i r and Water A c t s .Apply Sound Criteria t o Economic Subsidy ProgramsThe Administration a lso anti cip ate s FY 1982 savings o f $10.3b i l l i o n from changes i n subsidy programs. These include reduc tion si n d a ir y pr ice supports and Farmers Home Adminis trat ion lending.,e l iminat ion o f the Economic Development Administra tion , r e s t ru c tu r -ing the synthe t ic fue l s program and cut t in g back a l t e rn a t ive - - .energy supply programs. Furthe r reductio ns a re proposed i n theAmtrak, P o s t a l Service, and mass t r ans i t opera t ing subs id ies and

Export-Import Bank d i r e c t lend ing.r e s u l t from the phase-out o f T i t l e s 1 1 - D and VI of CETA (S3.6b i l l i o n i n FY 1982).The largest savings w i l l

There a re two cr it ic is m s of the cu t s i n subs id ie s . F i r s t ,i n most ins tances the en t i re subsidy shou ld be eliminated.Secondly, th ere were se ve ra l programs which could have beenincluded. In th e cut list the Overseas P r i v a t e Investment Corpo-ra t io n, ag ric ul tu ra l deficiency payments, and U . S . flagshipsubsidies are a l l excel lent candidates for el iminat ion.Another possibi l i ty would be t o terminate the St ra t eg i cPetroleum Reserve. The immediate d eco n t r o l o f o i l pr ices has


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cre ate d the necessary inc entiv e for the pr iva te sector t o s t o c k -p i l e res erv es. Because th er e are a number o f o i l companies, 'oreven entrepreneurs, it is very l i ke ly t h a t t h e i r summed expecta-t ions regarding a future embargo ana its sever i ty , w i l l be moreaccurate than the gove-rllment's. Thus, the s tockpi le w i l l b e moreef f i c i en t l y main tained by the pr iva te sec to r .

St re tch Out and Retarget P u b l i c Sector Capital ImprovementProgramsThe c r i t i c a l elements of this s e c t i o n are an 11 percentreduction i n planned water resources p roj ect s , def err ing municipalwater t reatment gran ts, cu tt i ng urban mass t r a n s i t grant s, andslowing down highway construction grants.The cr i t ic ism i s not w i t h what i s c u t b u t r a the r w i t h whatremains. Sewage treatme nt pl an ts , mass t r a n s i t gr an ts , and even

water resource proj ects are local and regional re sp on si bi l i t ie s . 'Rather than defe r o r s t r e t c h o u t these programs, an o r d e r l ytermination should be enacted.Improve Fisca l Res t ra in t on Other Proqrams .of NationalI n t e r e s t 'The $3.2 b i l l i o n i n FY 1982 savings contained i n this sec t ionis derived from a large number o f re la ti v e ly small cu ts . Some o fthe more prominent in clu de impact.. a id , vo ca tio na l edu cation,NASA, and f,o reign a id programs, such as PL 480 and mult i lateraldevelopment banks.T h e programs contained within this heading offer a uniqueopportunity for experiments designed t o increase b o t h pr iva tesector contributions and more desirable outcomes. For ins tance,i n s c i e n t i f i c r e s e a r c h the federal government could promoteprivate involvement by changing the ru les o f appropr iab i l i ty ,encouraging research ass oc iat i on s, engaging i n inter nat ion al co stsharing, and even offering a retroactive prize program.s Agreater reliance on market mechanisms could considerably enhancethe ef f ic iency of such programs while permitting reduct ions i nfederal spending.Consolidate Categorical Grant Programs i n to Block GrantsTo reduce administrative expenses and promote g r e a t e r s t a t ed i scre t ion , the Reagan Adminigtration proposes t o consolidate 45education programs into t w o block grants, one t o t h e s t a t e , t h eo t h e r t o the local education agencies. I t i s a l s o proeosed t h a t40 federal heal th and s o c i a l searvices programs be consolidatedinto one or more b lock gzants t o the s t a t e s .

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See Richard Speier "General Science , Space., and Technology, in 3cAl l i s t eop. c i t : , p . 63.


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Reduced' verhead and Personnel CutsTo attain greater personnel and management efficiency, theAdministration has proposed a number of cost savings measures.In defense, these include the increased use of contracting ser-

vices, multi-year procurement, and annual cost of living adjust-ments for federal retirees. Also expected to offer substantialsavings are the ceiling on federal civilian employment, andoverhaul of the federal pay comparability standard.Another defense efficiency measure would be to increase theterm of first enlistment and curtail re -e nli ~t me nts .~accessions, the training costs could be reduced. In addition,.less retention of first-term enlistees would reduce the retire-ment liability.

By reducing

CONCLUSIONThe Reagan program embodies the changes in economic perspec-tive, tax policy, and federal spending necessary to bring about amore efficient and productive economy. There are two caveats,however. The f irs t is that regardless of how Congress alters theplan or how it fares in the short run, the Administration shouldcontinue to pursue the current course. The reason is not onlythat the program is sound, but that consistency is essential toaltering expectations.The second warning is that should Congress

to be too large, it should cut spending even moReagan proposals, rather than drastically alterIt is critical that the marginal tax rate cutsdepreciation schedule remain intact.

fear the tax cutre deeply than thethe tax proposal.and the accelerated

Peter G. GermanisPolicy Analyst/EconomicsEugene J. McAllisterWalker Fellow in EconomicsDavid G. RaboyInstitute f o r Research on t h eEconomics of Taxation

Documents

1981 - An Analysis of the Reagan Economic Program (for the Policies Inscribed)