__. .- .

134

February 2 7 , 1 9 8 1

AN ANALYSIS OF, THE

REAGAN ECONOMIC PROGRAM

,
.
INTRODUCTION
President Reagan's economic program, unveiled February 1 8 ,
is remarkably c o n s i s t e n t in both its p r a c t i c a l and philosophical
r e l i a n c e on the free market. The tax package, based on the
b e l i e f t h a t individuals and corporations will respond t o a l t e r e d
incentives, does not attempt t o channel resources i n t o favored
a c t i v i t i e s , b u t i n s t e a d relies on the market t o d i r e c t the funds
t o the highest uses. Many o f the spending c u t s were advanced t o
eliminate or. reduce f e d e r a l programs which are properly i n the
province o f t h e p r i v a t e sector: f o r example, the Export-Import
Bank, ilmtrak, the synthetic f u e l s program. Following a dictum o f .
A d a m S m i t h , the Administration a l s o advocates reducing f e d e r a l
spending $2 b i l l i o n by assessing users fees f o r inland waterways
a i r p o r t s and Coast Guard services.
A more s u b t l e , b u t equally important affimation o f the
market is the Reagan Administration's decision t o take a longer
tenn perspective. The taxing and spending powers o f t h e federal
government will not be used i n attempts t o counter short-term
economic f l u c t u a t i o n s . :Rather, the i n t e n t - is t o c r e a t e a climate
i n which t h e government minimizes the d i s t o r t i o n a r y e f f e c t o f tax
and spending, regulatory, and monetary p o l i c i e s on economic
decision-making.
There a r e e s s e n t i a l l y t w o avenues o f c r i t i c i s m o f the Reagan
proposals. The f i r s t is t h a t the s h i f t i n perspective is ill-
advised. Ogponents would argue t h a t t r a d i t i o n a l denand managenent
p o l i c i e s a r e b o t h adequats and necessarI7. Due i n part t o the
dismal economic perfomance o f t h e 1970s, t h i s v i t w is h e l a 517 3
r a p i d l y dwindling minority. The p o s i t i o n taken i n this paper is
t h a t the p r i v a t e sector is i n h e r c n t l y , s t & l e and t h a t the longer
term perspective is the c o r r e c t one.
 .'. ,: r ..
. . .'... .,..
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I
. I .
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2
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The second major a r e a o f inquiry conce.rns the composition,

mix, and .timing of spending and t a x c u t s . A t i s s u e a r e : 1)
s p e c i f i c elements o f budget and, more p a r t i c u l a r l y , t a x c u t s and
2 ) the r e l a t i v e s t r e n g t h of the two forces, t h e i r e f f e c t on t h e
d e f i c i t , and its effect on the economy. T h i s paper addresses
these questions.

THE REAGAN PROGRAM

President Reagan c a l l s for FY 1982 outlays o f $ 6 9 5 . 5 b i l l i o n ,

r e c e i p t s of $ 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 . Included
within 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 i n d i v i d u a l and corporate tax c u t s , and $2 b i l l i o n
i n proposed users fees. Another $ 5 . 7 b i l l i o n i n off-budget c u t s
are outlined.
The program a l s o contains $ 4 . 4 b i l l i o n i n c u r r e n t f i s c a l
year budget c u t s and $8.9 b i l l i o n i n tax c u t s . F i s c a l year 1981
spending would t o t a l $ 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 1
CURRENTLY ESTIMATED BUDGET OUTLOOK
WITE PRESIDENT'S BUDGET SAVINGS AND TAX REDUCTION PROGRAM
(dollar amounts i n b i l l i o n s )

' Target outlay c e i l i n g s 654.7 695.5 733.1 771.6 844.0 912.1

Estimated receipts a f t e r tax reduction
plan -
600.2 - 710.2 ---
650.S - 772.1 850.9 942.0

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

Share of GNP
Outlays 23.0 21.8 20.4 19.3 19.2 19.0
Receipts 21.1 20.4 19.7 19.3 19.3 19.6

I t 1s not c o r r e c t t o compare the Carter Administration's TI

1982 budget numbers, submitted i n January, w i t h t h e Reagan propo-
s a l because the l a t t e r was based on decidedly more o p t i m i s t i c
economic assumptions. The variance i n f o r e c a s t s a f f e c t s t h e base
from which the changes a r e c a l m l a t e d .
Because the Reagan program depends so much on supply-side
t a x c u t s and changes i n expectations, concepts which a r e over-
looked o r more d i f f i c u l t t o measure i n most econometric models,
there was some disagreement within the Administration about t h e
impact o f the economic package. In a compromise, t h e f o r e c a s t
 3

anticipates real growth rates of 4..2 percent, 5 . 0 percent, 4.5

percent, 4.2 percent, and 4.2 percent from 1982 through 1986.
The consumer price index will fall from 11.1 percent this year to
8.3 percent in 1982 and 6.2 percent in 1983.
Table 2
ECONOMIC ASSUMPTIONS
(Calendar Years)

1981 1982 1983 1984 1985 1986

Nominal Gross National
Product ( b i l l i o n s ) $2,920.0 $3,293.0 $3,700.O $4,098.0 $4,500.0 $4,918.0
('Percent Change) 11.1 12.8 12.4 10.8 9.8 9.3
Real Gross National
Product (billions,
1972 dollars) 1,497.0 1,560.0 1,638.0 1,711.0 1,783.0 i;ssa.o
(Percent Change ) 1.1 4.2 5.0 4.5 4.2 4.2
Implicit Price
Deflator 195.0 211.0 226.0 240.0 252.0 265.0
(Percent Change) 9.9 8.3 7.0 6.0 5.4 4.ij

Consumer Price Index*

1967 = 100 274.0 297.0 ._ 315.0 333.0 348. o 363.0
(Percent Change) 11.1 8.3 6.2 5.5 4.7 4.2

Unemployment Rate
(Percent) 7.8 7.2 6.6 6.4 6.0 5 .G

%PI for urban wage earners. and c l e r i c a l workers (CPI-W) .

ANALYSIS
The following analysis will be divided in two parts. The
first will be an examination of the program elements designed to
alter the economic incentives to work, save, and invest. These
consist primarily of tax cuts and changes in programs, such as
unemployment insurance and trade adjustment assistance. The
second portion of the analysis will focus on the proposed spending
cuts, their efficacy, and completeness.

ECONOMIC INCENTIVES
The T a x Proposal
President-Reagan's tax proposal is a sweeping p l a n to return
much economic decision-making to the purview o f the free m a r k e t .
The proposal differs from tax cuts o f recent years in that it is
not aimed at stimulating aggregate demand through changes in the
average tax rates. Rather, it is designed to increase work,
 4

savings, and investment through changes i n the marginal t a x .

r a t e s . The general philosophy behind this type o f t a x c u t is
t h a t the many a r t i f i c i a l r e l a t i v e p r i c e d i s t o r t i o n s make it
b e t t e r t o l o w e r marginal r a t e s and decrease a l l biases r a t h e r
than attempt t o chip away s t r u c t u r a l l y a t each one i n d i v i d u a l l y .
If t h e p l a n is adopted,. marginal tax r a t e s f o r personal
income w i l l be c u t by 5 percent, s t a r t i n g on J u l y 1, 1981. In
1982 and 1983, these w i l l be c u t by an a d d i t i o n a l 1 0 percent p e r
year, and i n 1984 the p l a n c a l l s f o r a f i n a l S percent c u t .
There w a s debate as t o whether t h e m a x i m u m t a x on unearned
income should be dropped immediately from 70 percent t o 50 percent.
Due t o p o l i t i c a l circumstances, the decision was made not t o
e f f e c t t h a t change immediately. However, when the plan i s fully
implemented, marginal tax r a t e s w i l l range from 1 0 percent t o 50
percent.

Table 3
THE ADMINISTRATION'S PROPOSED TAX RATE SCHEDULES
FOR 1981, 1982, 1983, AND 1984
JOINT RETURNS

Administration Proposal
Taxable Present Law 1981 . 1982 1983 . 1984
income Tax Rate Tax Race Tax Rate Tax Rate Tax Rate
bracket on income on income on income on income on income
i n bracket in bracket i n bracket in bracket i n bracket
(dollars) (percent) (percent) (percent) (percent) (percent j.

$ 0 - 3,400 0% 0% 0%
I

0% 0%
3,400 - 5,500 14 13 12 11 10
5,500 -
'

7,600 16 15 14 12 11

7,600 - 11,900 18 17 15 14 13
11,900 - 16,000 21 20 18 16 15
16,000 - 20,200 24 23 21 19 La
20,200
24,600
-- 24,600
29,900
28
32
27
30
24
27
22
24
21
23
29,900 - 35,200, 37 35 31 28 27

35,200 - 45,800 43 41 37 33 32
45,800 - 60,000 49 47 42 3a 36
60,000 - 85,600 54 51 47 lr2 60

85,600 - 109,400 59 56 50 45 43
109,400 - 162,400 64 61 55 G9 47
162,400 - 215,400 68 65 58 52 $9

215,400 and over 70 66 60 53 50

 . 5

The depreciation propogal i s a s l i g h t l y revised version of

t h e Capital C o s t Recovery A c t of 1 9 7 9 , introduced by Congressmen
Barber Conable (R-New York) and James Jones (D-Oklahoma). Under
the P r e s i d e n t ' s plan t h e useful l i f e concept is scrapped and t h e
following c a t e g o r i e s and write-off periods would be established.
Category Write-off Periods

0 Automobiles and l i g h t trucks 3 years I

0 R & D capital 3 years

0 A l l other machinery 5 years

0 Public u t i l i t y capital with a previous

guideline l i f e o f under 18 years 5 years

0 Owner-occupied non-residential structures 10 years

0 Public u t i l i t y c a p i t a l with previous
guideline l i f e o f over 18 years LO years
0 Other nou-tesidential structures 15 years

0 Low income rental housing 15 years

0 Residential rental buildings 18 years

The 3 o f S o f and 10-year categories q u a l i f y for a super-

accelerated write-off method involving an optimal cbmbination of
t h e l'double declining balance1' and Ifsum o f t h e years d i g i t s "
methods of depreciation. The '15- and 18-year categories must u s e
" s t r a i g h t l i n e " methods.
The 3-year category q u a l i f i e s f o r a 6 percent Investment Tax
C r e d i t (ITC) and t h e 5-year category q u a l i f i e s f o r a 1 0 percent
ITC as does p u b l i c u t i l i t y c a p i t a l i n t h e 10-year category.
S t r u c t u r e s i n t h e lO-year category a r e considered t o be
s e c t i o n 1245 property f o r purposes of recapture, b u t t h e 15- and
18-year categories a r e considered t o b e s e c t i o n 1250 property.
This p e r m i t s t h e l a t t e r two categories t o be subject t o some
c a p i t a l gains t a x a t i o n , as opposed t o ordinary income t a x a t i o n a t
t h e p o i n t of s a l e . '
The Individual C u t s
The d i s t i n c t i o n between personal and business cuts is an
a r t i f i c i a l one. Individuals own a l l businesses and all business
income accrues t o individuals i n one form o r another. Thus, any
tax change ,that a f f e c t s personal saving a f f e c t s businesses and
any business t a x c u t w i l l have an e f f e c t on personal w e l l being.
 \ '

6
.
The c u r r e n t t a x code contains s e r i o u s d i s t o r t i o n a r y f a c t o r s
which lead t o e f f i c i e n c y losses. t o s o c i e t y . Because o f i t s
m u l t i p l e t a x a t i o n of income from personal saving, the . t a x systen
c r e a t e s a b i a s i n favor o f consumption and a g a i n s t saving. Less
saving means less investment, which hampers economic growth.
High marginal tax r a t e s on labor income a r t i f i c i a l l y penalize
the work e f f o r t . Once again, this causes an e f f i c i e n c y loss t o
s o c i e t y because the c o s t o f working r e l a t i v e t o l e i s u r e o r non-
market a c t i v i t y is d i s t o r t e d .
A l l economic decisions a r e made a t the margin. That i s , a
worker makes h i s decision t o work o r not t o work based on the t a x
treatment o f a d d i t i o n a l d o l l a r s o f labor income, not on the
treatment of d o l l a r s earned i n the p a s t . I f r e l a t i v e p r i c e s a r e
d i s t o r t e d , it is only through changes i n mirginal t a x r a t e s t h a t
the d i s t o r t i o n s w i l l be minimized.
What w i l l the 30 percent across-the-board c u t i n marginal
r a t e s accomplish? Since the p r i c e of labor r e l a t i v e t o l e i s u r e
is exactly the a f t e r tax r e a l wage r a t e , a c u t i n marginal t a x
r a t e s on labor income w i l l increase the marginal wage r a t e ,
thereby making work more p r o f i t a b l e and l e i s u r e more c o s t l y .
The proposed individual c u t s a l s o i n d i r e c t l y a t t a c k the
anti-saving b i a s i n the tax code.- In a manner s i m i l a r . t o the
effect on the work-leisure choice, the c u t s i n marginal r a t e s
w i l l advantageously a f f e c t the save-consume decision. For example,
t h e present tax r a t e on income from savings f o r a j o i n t r e t u r n o f
$ 1 0 , 0 0 0 is 54 percent. By 1984, t h a t w i l l b e reduced t o 40
percent. Thus, f o r each one hundred d o l l a r s of savings incurred,
the individual w i l l r e t a i n an additional 14 percent.
D i s t o r t i o n s , however, w i l l s t i l l e x i s t . There i s still a
multifold t a x a t i o n o f income from c a p i t a l , including the t a x a t i o n
of i n t e r e s t income, dividends, and c a p i t a l 'gains. Since the t o p
marginal 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 s
may be s i z a b l e .
A p r i v a t e investor i n this bracket is taxed a t the r a t e o f
50 percent on new income. I f he decides t o i n v e s t some o f h i s
a f t e r - t a x d o l l a r s , the r e t u r n on h i s investment w i l l a l s o be
taxed at the r a t e o f 50 percent. Thus, the inherent b i a s a g a i n s t
saving and investment continues, a l b e i t a t a diminished r a t e .
T h e individual c u t s proposed by President Reagan a r e a good
s 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 e
done. Had t h e maximum tax on unearned income i n the proposal
been dropped imqediately t o 50 gercent and had t h e r e d u c t i o n s
proceeded f r o m t h e r e , the e f f e c t s would be more p o s i t i v e .
The Depreciation Program
The P r e s i d e n t ' s proposed depreciation system is very close
t o being an i d e a l system. I t accomplishes two things: . 1) it
 7

- l o w e r s the o v e r a l l marginal tax r a t e on income from c a p i t a l , and

2 ) it removes a very s e r i o u s b i a s a g a i n s t investment i n long-lived
a s s e t s . F u r t h e r , it diminishes much o f the complexity and admini-
s t r a t i v e burden .associated w i t h the present depreciation system.
By allowing firms t o recover their c a p i t a l more quickly, t a x
payments a r e deferred. Thus, the discounted value o f these tax
payments is lessened. For the same reason that double t a x a t i o n
o f personal saving i s d i s t o r t i o n a r y , high marginal t a x r a t e s on
the income from physical c a p i t a l i s d i s t o r t i o n a r y . The c u r r e n t
tax treatment poses a r e l a t i v e d i s i n c e n t i v e t o investment i n
physical c a p i t a l . Only the immediate expensing of c a p i t a l a s s e t s
w i l l provide a climate i n which investment decisions w i l l be made
i r r e s p e c t i v e of the tax system --the desired, ''neutral" r e s u l t .
Given p o l i t i c a l r e a l i t i e s , the P r e s i d e n t ' s d e p r i c i a t i o n proposal
approximates this desired n e u t r a l i t y .
I t is f i n n l y e s t a b l i s h e d i n the economic l i t e r a t u r e t h a t
businesses a r e quite respons,ive t o changes i n marginal t a x r a t e s
on income from c a p i t a l . As a r e s u l t of the new depreciation
system w e can expect new investment i n productive, physical
c a p i t a l . A second major e f f i c i e n c y gain w i l l come from the
removal of a present-law b i a s a g a i n s t c e r t a i 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 c u r r e n t tax code i s
the b i a s towards investment i n short-lived assets a t the expense
o f long-lived a s s e t s . By c l i n g i n g t o the "useful l i f e " concept,
p r e s e n t law i n s u r e s that the r e l e v a n t p r i c e of a long-lived a s s e t
r e l a t i v e t o a s h o r t - l i v e d a s s e t is higher than would b e the case
i n a non-tax world. This f a c t o r has contributed t o a tax-induced
s h i f t of resources i n o u r economy. I t cannot b e claimed t h a t a l l
the woes o f the steel i n d u s t r y , for example, a r e t o be blamed on
this 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 c o n t r i b u t i n g f a c t o r .
This obsession with the useful l i f e concept stems from the
b e l i e f t h a t depreciation for tax purposes must be matched w i t h
a c t u a l economic depreciation or the loss of value an a s s e t s u f f e r s
p e r accounting p e r i o d . The t r a d i t i o n a l wisdom holds t h a t such a
system would b e n e u t r a l w i t h respect t o assets o f d i f f e r i n g
d u r a b i l i t i e s . Recent, more s o p h i s t i c a t e d a n a l y s i s has shown t h a t
i n the context of developments over t i m e , the t r a d i t i o n a l wisdom
is f a l s e and i n f a c t discriminates a g a i n s t long-lived a s s e t s .
T h e proposed depreciation system will r e t u r n the r e l a t i v e
p o s i t i o n s o f s h o r t - and long-lived assets t o t h e i r proper place.
No longer w i l l t h e r e a tax-induced incentive t o favor investment'
i n s h o r t - l i v e d assets.
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 returning so
much money t o the p r i v a t e sector, w i l l c r e a t e a demand p u l l
i n f l a t i o n . However, i n f l a t i o n occurs' o n l y if the r a t e o f growth
i n the money s u p p l y exceeds the ra.te o f growth o f goods and
s e r r i c e s . Therefore, w e need only worry a b o u t i n f l a t i o n i f
whatever d e f i c i t e x i s t s is funded t h r o u g h monetary expansion by
 ~ . ..... . ... .. .. - .

the Fed. As long as t h e Fed holds the l i n e and f o l l o w s a r a t i o n a l ,

steady, monetary policy, t h e r e w i l l b e no infclationary e f f e c t s .
The Reagan program s p e c i f i e s a d e s i r e for a gradual reduction i n
the money supply and c r e d i t growth r a t e t o one-half the c u r r e n t
l e v e l s by 1986.
The Administration a l s o has indicated i t s support f o r the
Federal Reserve policy of t a r g e t i n g money aggregates r a t h e r than
i n t e r e s t r a t e s . W i t h d e f i c i t s o f $ 5 4 . 5 b i l l i o n i n FY 1 9 8 1 and
$45 b i l l i o n i n E'Y 1982, c r i t i c s charge i n t e r e s t r a t e s w i l l skyroc-
k e t , thereby negating the b e n e f i c i a l e f f e c t s of the t a x c u t .
The unprecented change i n the tax treatment o f a l l forms of
savings w i l l , however, c l e a r l y increase t h e supply o f loanable
funds. Treasury Secretary Regan has estimated t h a t as much aq
two-thirds of the tax reduction w i l l be saved. The demand for
loanable funds w i l l a l s o increase. I t is possible t h a t t h e r e
might be some i n i t i a l pressure on the c a p i t a l markets. I t s h o u l d
b e noted t h a t as i n t e r e s t r a t e s rise, saving w i l l become more
attractive.
A s new productive capacity comes on stream, output w i l l
expand and r e a l i n t e r e s t r a t e s w i l l s t a b i l i z e . Of course, i f
government spending is successfully c u t , t h e r e would n o t be any
i n i t i a l pressure i n c a p i t a l markets. The b e s t way t o guard
a g a i n s t any short-run. increases i n i n t e r e s t r a t e s is t o be v i g i -
'

l a n t on the spending side.

UNEMPLOYMENT COMPENSATION
Unemployment compensation has been designed t o replace
. approximately 50 percent o f a worker's former average weekly
wage. The Federal-State Extended Unemployment A c t o f 1 9 7 0 , .
enacted t o give a d d i t i o n a l a s s i s t a n c e t o unemployed workers
during p e r i o d s of high s t a t e o r n a t i o n a l unemployment, authorizes
the extension o f b e n e f i t s a t the regular weekly amount f o r an
a d d i t i o n a l 13 weeks whenever the unemployment r a t e among insured
workers ( I U R ) rises above some s t a t e o r n a t i o n a l I'triggeringl'
l e v e l . T h e s t a t e t r i g g e r t a k e s . e f f e c t when the s t a t e ' s IUR
equals o r exceeds, for a 13-week p e r i o d , 120 percent o f the
average r a t e f o r the corresponding p e r i o d i n each.of t h e p r e v i o u s
two years and when such a r a t e is a l s o a t l e a s t 4 percent. A
s t a t e a l s o has the option t o extend b e n e f i t s i f the s t a t e ' s
.
o v e r a l l unemployment r a t e is a t l e a s t 5 percent f o r 13 weeks.
When t h e n a t i o n a l IUR reaches 4 . 5 percent, t h e national t r i g g e r
is and a l l s t a t e s , even those w i t h r e l a t i v e l y low unemploy-
ment r a t e s , become e l i g i b l e for the. extended b e n e f i t s .
Unemployment compensation o f t e n has the adverse e f f e c t o f
making l a y o f f s d e s i r a b l e f o r . b o t h employees and employers.
Generous b e n e f i t s and added l e i s u r e t i m e often c r e a t e s i g n i f i c a n t
work d i s i n c e n t i v e s . An employer may b e induced i n t o laying o f f
more workers during an economic downturn than he o t h e r d i s e would
 .-

because the tax used t o finance unemployment compensation i s n o t

always d i r e c t l y r e l a t e d t o the unemployment experience o f t h e
firm: T h e extinded b e n e f i t s program adds t o these d i s t o r t i o n s
and generates even g r e a t e r i n e f f i c i e n c y .
The Reagan Administration has proposed r e s t r u c t u r i n g the
extended b e n e f i t s program so t h a t it would provide r e l i e f o n l y t o
those areas plagued by high unemployment. T h e changes suggested
' a r e meant t o achieve r e s u l t s analogous t o t a x c u t s
work incentives by making employment r e l a t i v e l y more a t t r a c t i v e
-- t o restore
than UnemplOyInent. S p e c i f i c a l l y , the Administration's proposal
would: 1) eliminate the n a t i o n a l t r i g g e r ; 2 ) change the way the
s t a t e t r i g g e r s a r e c a l c u l a t e d ; 3 ) r a i s e the s t a t e t r i g g e r l e v e l
from 4 t o 5 percent of the I U R a n d , . a t s t a t e option, t o 6 percent
of the o v e r a l l unemployment r a t e ; and 4 ) s t r i c t l y enforce the new
r u l e r e q u i r i n g claimants t o accept any reasonable j o 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 the
minimum wage and can replace the i n d i v i d u a l ' s c u r r e n t unemployment
insurance b e n e f i t s . The f i r s t two changes w i l l become e f f e c t i v e
J u l y 1, 1981, while the third change would take e f f e c t only on
October 1, 1982, thereby allowing necessary changes i n s t a t e law.
The 1980 Reconciliation A c t already r e q u i r e s t h a t the work t e s t
b e a p p l i e d t o a l l extended b e n e f i t s r e c i p i e n t s a f t e r A p r i l 1,
1981. These modifications would.'save $523 million i n FY 1 9 8 1 and
$1.2 b i l l i o n i n EY 1982.
Abolishing the nation'al t r i g g e r would reduce c o s t l y unemploy-
'merit insurance b e n e f i t s i n states t h a t would otherwise n o t q u a l i f y
f o r extended b e n e f i t s . In addition, e f f i c i e n c y i n the l a b o r
market would be enhanced by eliminating one of the sources c r e a t -
ing. work d i s i n c e n t i v e s . when the n a t i o n a l t r i g g e r is Ifon,'I
b e n e f i t s a r e extended i n a l l s t a t e s , even those w i t h r e l a t i v e l y
low unemployment r a t e s . Despite the c o n s i d e r a b l y b e t t e r j o b
o p p o r t u n i t i e s i n such s t a t e s , unemployment may rise as a r e s u l t
of increased work 'disincentives associated w i t h the a v a i l a b i l i t y
o f more b e n e f i t s .
The proposal would a l s o exclude extended b e n e f i t s r e c i p i e n t s
from the c a l c u l a t i o n o f the IUR. The problem w i t h using the I U R
as a mea,sure o f unemployment f o r t r i g g e r i n g purposes is t h a t it
c r e a t e s an extended b e n e f i t s program which becomes s e l f - p e r p e t u a t -
ing. When the t r i g g e r i s IIon,tf a l l persons f i l i n g claims f o r
b e n e f i t s a r e included i n t h e IUR. T h i s r e s u l t s i n exhaustees
t h a t normally would no longer be considered p a r t o f the labor
force t o b e included i n the IUR f o r an a d d i t i o n a l 13 weeks. On
the other hand, when the t r i g g e r i s IIoff,If t h o s e same workers a r e
excluded; Making this fundamental change would save s u b s t a n t i a l
b e n e f i t payments i n s t a t e s t h a t have already reached t h e i r t r i g g e r -
i n g . l e v e 1 . An even b e t t e r approach, however, would b e t o use t h e
o v e r a l l unemployment r a t e i n c a l c u l a t i n g the trigger because it
. would more accurately r e f l e c t job 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 v e l i s desirable'because it
would ensure t h a t o n l y t h o s e i n genuine need receive a s s i s t a n c e .
.. . .. - ..
. . . - .. -. .- - . . -. . .. ..

10

This, i n p a r t , is necessary t o compensate f o r the changing compo-

s i t i o n of the labor force, which over the years has r a i s e d the
'/. n a t u r a l r a t e o f unemployment. F i n a l l y , strengthening the work
t e s t can eliminate much o f the waste and fraud i n the program.
Although the changes proposed a r e a l l d e s i r a b l e from an
e f f i c i e n c y and equity standpoint, they do not go f a r enough. The
extended b e n e f i t s program should b e eliminated e n t i r e l y . The
o r i g i n a l purpose of unemployment compensation was t o provide
temporary r e l i e f . The program i s not s u i t e d t o c o r r e c t long-term
s t r u c t u r a l problems.

TRADE ADJUSTMENT ASSISTANCE

Trade Adjustment Assistance ( T U ) was introduced i n 1962 t o
a s s i s t workers s u f f e r i n g from increased imports, which were a
d i r e c t r e s u l t o f government p o l i c i e s aimed a t the l i b e r a l i z a t i o n
o f i n t e r n a t i o n a l trade. Today, however, the Secretary o f Labor
can declare workers e l i g i b l e i f imports have contributed signifi-
c a n t l y t o unemployment and t o a decline i n the s a l e s and/or
production of the f i n n ( s ) i n question. In other words, workers
no longer have t o prove t h a t they a r e h u r t by freer t r a d e o r t h a t
imports a r e the major cause o f t h e i r i n j u r y . The primary purpose
of t h e TAA program is t o h e l p workers a d j u s t t o changed economic
condi.tions by easing the t r a n s i t i o n period between j o b s . A s s i s t -
ance a v a i l a b l e t o workers c o n s i s t s o f : 1) t r a d e readjustment
allowances; 2 ) employment services; and/or 3 ) job search and
r e l o c a t i o n allowances. TAA b e n e f i t s supplement unemployment
insurance , b e n e f i t s by providing 70 percent of a worker's former
average weekly wage, up t o a maximum o f the national average
weekly manufacturing wage. Because unemployment insurance-replac e s
only about 50 percent of gross earnings, TAA can be s i g n i f i c a n t
t o the unemployed worker. In addition, these b e n e f i t s a r e a v a i l -
able f o r up t o a year. In FY 1980, outlays on the program had
grown t o 1 . 7 b i l l i o n d o l l a r s , which was more than s i x times a s
much as i n the preceding year.
The major problem w i t h TAA is t h a t it compounds a l l the
problems associated w i t h unemployment compensation. The more
gengrous b e n e f i t s and the l e n g t h i e r entitlement p e r i o d exacerbate
work d i s i n c e n t i v e s . Greater b e n e f i t s a l s o discourage workers
from seeking employment i n more stable i n d u s t r i e s . Since employ-
ers pay no supplemental t a x f o r laying o f f workers who would
receive TAA b e n e f i t s , an employer may find it p r o f i t a b l e t o lay
o f f workers during a p e r i o d o f s l a c k demand, assuming t h a t r e l a -
t i v e l y generous TAA b e n e f i t s will induce a worker t o wait t o be
rehired r a t h e r than a c t i v e l y search f o r a new j o b . F i n a l l y , T.U
c r e a t e s i n e q u i t i e s by discriminating i n favor o f a s e l e c t g r o u p
of unemployed workers, those a f f e c t e d by imports.
The Administration proposes t o extend TAA b e n e f i t s o n l y . t o
those workers who have exhausted t h e i r regular unemployment
compensation and t o l i m i t the s i z e o f these,benefits t o levels no
 ..... ...... ..
. . ... ---.... \

11

higher than those under unemployment insurance. An unemployed

worker will be allowed to receive benefits from T U and unemploy-
ment 1nsuranc.e for up,to a year. These changes will become
effective October 1, 1981, and could reduce spending by S1.15
billion in EY 1982 alone.
1

The limitations proposed bn the availability of TIW benefits

would improve efficiency within the program markedly. The results
of several studies seem to indicate that reducing the availability
of benefits would dramatically mitigate pernicious practices of
employees and employers alike. One such study found that TAA
recipients were much more likely to have experienced temporary
unemployment than their counterparts receiving only unemployment
insurance. Moreover, they were much less likely to have changed
their 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 no
incentive to adjust. The generous assistance payments seem to
act as a deterrent to workers from seeking employment in new
areas, thereby artificially generating too strong an attachment
to a vulnerable industry. The proposed changes are needed to
restore work incentives and to discourage misuse of the program.
Although the proposed changes in TAA would result in great
savings and lead to a more efficient allocation of resources, the
program would still have some eortcomings. Even greater savings
could be realized if t h e eligibility requirements were made more
stringent by requiring workers'not only to show that they were
displaced 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 determining
eligibility should be returned to the 1nternational.Trade Commis-
sion. The Department of Labor has all too often demonstrated a
bias in favor of organized lahor, many of whose members are T U
recipients. This is important because there often is only a very
tenuous link between layoffs and increased unemployment from
imports. Is greater compensation then justifiable f o r workers
who are laid off because their firms failed to modernize o r
because 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 amount
of supplemental benefits despite the ruling by the ITC that
imports were not a substantial cause or threat of serious injury
to the U.S. auto industry. Instead, the Commission found L5at
the recession, rising costs of credit, high gasoline prices, and
the resulting shift in demand for small cars harmed the industry
more than imports. Moreover, since workers produce goods and '

serrices f o r local, regional, national, and international markets,

J . D. Richardson, "Trade Adjustment A s s i s t a n c e Under the U.S. Trade Act

o f 1974: An .Analytical Examination and Worker Survey," National Bureau
- o f Economic Research, Working Paper 5 5 6 , September 1980.
 . . . - .. __ ... . .

12

and a l l . o f these workers. may b e affected by unfavorable conditions,

why should import-affected workers receive p r e f e r e n t i a l treatment
s o l e l y because they happen to produce for an inte-mational market?
T h i s would b e e s p e c i a l l y t r u e if increased imports were a r e s u l t
o f g r e a t e r competition r a t h e r L!an t r a d e concessions granted by
.the government. Import-affected workers, however, a r e sometimes
considered more deserving because their layoff i s the r e s u l t o f
promoting a s o c i a l l y d e s i r a b l e policy, i . e . , one meant t o achieve
the g r e a t e r b e n e f i t s associated w i t h f r e e t r a d e . Although this
may be t r u e , workers i n other i n d u s t r i e s o f t e n are displaced f o r
'equally deserving causes. For example, s t r i c t e r environmental .
controls, more s t r i n g e n t s a f e t y standards, and deregulation a r e
just a few. Yet workers who become unemployed as a r e s u l t o f
these p o l i c i e s receive no supplements beyond unemployment cornpea-
sation.
Finally, 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-
ment compensation readers it more l i k e an extended b e n e f i t s
program. These payments should be reduced d r a s t i c a l l y , while
expanding the a v a i l a b i l i t y of the adjustment serrices.

SPENDING CUTS
The tax proposal, unemployment insurance, and t r a d e adjust-
ment a s s i s t a n c e programs a r e designed t o increase incentives t o
work and invest. 'To free theE-resources for the p r i v a t e sector
expansion, the AdministratiorI proposes $41.4 b i l l i o n in-on-budget
spending reductions, another .$S .7 b i l l i o n i n off-budget c u t s , ana
$2.0 billion i n usezs charges. while these c u t s a r e s i g n i f i c a n t ,
staggering t o some, there is considerable p o t e n t i a l ' f o r even
greater reductions. Following the Administration's breakdown,
t h e remainder of this paper w i l l examine the P r e s i d e n t ' s proposal
and suggest some additional reductions.
Revise Entitlements t o Eliminate Unintended Benefits
The major c u t s within t h i s section a r e reform o f the food
stamp 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 s o c i a l s e c u r i t y minimum payment (Sl.0 b i l l i o n )
and the a d u l t student payment (S700 m i l l i o n ) , and the e s t a b l i s h -
ment o f a cap on federal Medicaid payments t o the s t a t e s ( S l
b i l l i o n ) . The Administration also proposes t o l i m i t c o s t o f *-

l i v i n g adjustznents for the c i v i l service retirement systen t o

once a year ($SlO m i l l i o n ) .
Some additional changes n o t recommended by Reagan whlch'
could provide s-Jbstantial savings include l i m i t i n g veterans'
con7ensation payments
t i e s a r e traceable e i t ht oe 'r veterans and
t o combat o r s job-performance,
u n i v o r s whose a i sa--_.
a ibniilni -a
1
-
t-
ing a l l pensions for veterans and survivors which azc n o t ' ' s e nIce-
connected" ana dismantling the VA 'health care ~ g s t c m . ~Nany 0;'

, ' '2 See C o t t o n M. Lindsay, "Veterans' B e n e f i t s and S e r v i c e s , " in Eugene J.

tluSllister, e d . , Agenda for Progress: 'Examining Federal Spezdinq (Washing-
ton, D . C . : The Heritage Foundation, 198L), p . 286.
 13

those c u r r e n t l y receiving such a s s i s t a n c e would f a l l back on the

l e s s remunerative Medicaid system b u t , d e s p i t e t h a t s h i f t , the
changes o u t l i n e d above could save $8 b i l l i o n i n FY 1982.
Reduce Middle-Upper Income Benefits
The February 18 budget a l s o o u t l i n e s c u t s o f $ 1 . 6 b i l l i o n
tlkough the c h i l d n u t r i t i o n program and $800 m i l l i o n r e s t r u c t u ri n g
t h e Guaranteed Student Loan and the P e l 1 g r a n t programs. In
addition, t h e Student Loan Marketing Association ( S a l l i e Mae)
would no longer have access t o the Federal Financing Bank. The
l a t t e r would reduce f e d e r a l c r e d i t demands and promote approxi-
mately $15 b i l l i o n o f off-budget savings over the next f i v e
years. These t h r e e changes a r e d i r e c t e d a t b e n e f i t s received b Y
the middle and upper income l e v e l s .
Some a d d i t i o n a l policy changes which would reduce the bene-
f i t s received by t h e non-needy include introducing c o s t sharing
i n the Medicare pro.gram and lowering the payment l i m i t a t i o n f o r
a g r i c u l t u r a l deficiency payments from $50,000 t o $ 1 0 , 0 0 0 .
Recover Clearly Allocable Costs from Users
To achieve $2.0 b i l l i o n i n EY 1982 r e c e i p t s the Administra-
t i o n proposes t o charge inland waterway, a i r p o r t and Coast Guard
u s e r s fees through increases i n barge f u e l t a x e s , a v i a t i o n f u e l
t a x e s , and boat and yacht owner fees r e s p e c t i v e l y . Another fee
which would not .only r e l i e v e the f e d e r a l government o f f i s c a l
r e s p o n s i b i l i t y b u t , a l s o promotes g r e a t e r economic e f f i c i e n c y
would be t o incorporate e f f l u e n t taxes i n the 97th Congress'
r e a u t h o r i z a t i o n of t h e Clean A i r and Water A c t s .
Apply Sound C r i t e r i a t o Economic Subsidy Programs

The Administration a l s o a n t i c i p a t e s FY 1982 savings o f $10.3

b i l l i o n from changes i n subsidy programs. These include reductions
i n d a i r y price supports and Farmers Home Administration lending.,
elimination o f the Economic Development Administration, r e s t r u c t u r -
ing the s y n t h e t i c f u e l s program and c u t t i n g back a l t e r n a t i v e - - .
energy supply programs. Further reductions a r e proposed i n the
Amtrak, P o s t a l Service, and mass t r a n s i t operating subsidies and
Export-Import Bank d i r e c t lending. The l a r g e s t savings w i l l
r e s u l t from the phase-out o f T i t l e s 1 1 - D and VI o f CETA (S3.6
b i l l i o n i n FY 1982).
There a r e two c r i t i c i s m s o f the c u t s i n s u b s i d i e s . F i r s t ,
i n most instances the e n t i r e subsidy s h o u l d be eliminated.
Secondly, t h e r e were s e v e r a l programs which could have been
included. In the cut list the Overseas P r i v a t e Investment Corpo-
r a t i o n , a g r i c u l t u r a l deficiency payments, and U . S . flagship
subsidies a r e a l l e x c e l l e n t candidates for elimination.
Another p o s s i b i l i t y would be t o terminate the S t r a t e g i c
Petroleum Reserve. The immediate d e c o n t r o l o f o i l p r i c e s has
 14

c r e a t e d t h e necessary incentive for the p r i v a t e sector t o s t o c k -

p i l e reserves. Because t h e r e are a number o f o i l companies,'or
even entrepreneurs, it is very l i k e l y t h a t t h e i r summed expecta- .
t i o n s regarding a f u t u r e embargo ana its s e v e r i t y , w i l l be more
accurate than the gove-rllment's. Thus, the s t o c k p i l e w i l l b e more
e f f i c i e n t l y maintained by the p r i v a t e sector.
S t r e t c h Out and Retarget P u b l i c Sector Capital Improvement
Programs
The c r i t i c a l elements of this s e c t i o n a r e an 11 percent
reduction i n planned water resources p r o j e c t s , d e f e r r i n g municipal
water treatment g r a n t s , c u t t i n g urban mass t r a n s i t g r a n t s , and
slowing down highway construction g r a n t s .
The criticism is not w i t h what is c u t b u t r a t h e r w i t h what
remains. Sewage treatment p l a n t s , mass t r a n s i t g r a n t s , and even
water resource p r o j e c t s a r e l o c a l and regional r e s p o n s i b i l i t i e s . '

Rather than d e f e r o r s t r e t c h o u t these programs, an o r d e r l y

termination should be enacted.
Improve F i s c a l R e s t r a i n t on Other Proqrams .of National
Interest'
The $3.2 b i l l i o n i n FY 1982 savings contained i n this s e c t i o n
is derived from a l a r g e number o f r e l a t i v e l y small c u t s . Some o f
the more prominent include impact.. a i d , vocational education,
NASA, and f,oreign a i d programs, such as PL 480 and m u l t i l a t e r a l
development banks.
The programs contained within this heading o f f e r a unique
opportunity for experiments designed t o increase b o t h p r i v a t e
sector contributions and more d e s i r a b l e outcomes. F o r instance,
i n s c i e n t i f i c research the federal government could promote
p r i v a t e involvement by changing the r u l e s o f a p p r o p r i a b i l i t y ,
encouraging research a s s o c i a t i o n s , engaging i n i n t e r n a t i o n a l c o s t
sharing, and even o f f e r i n g a r e t r o a c t i v e p r i z e program.s A
g r e a t e r r e l i a n c e on market mechanisms could considerably enhance
the e f f i c i e n c y of such programs while permitting reductions i n
f e d e r a l spending.
Consolidate Categorical Grant Programs i n t o Block Grants
To reduce administrative expenses and promote g r e a t e r s t a t e
d i s c r e t i o n , the Reagan Adminigtration proposes t o consolidate 45
education programs i n t o t w o b l o c k g r a n t s , one t o the s t a t e , the
o t h e r t o the l o c a l education agencies. I t is a l s o proeosed t h a t
40 f e d e r a l h e a l t h and s o c i a l searvices programs be consolidated
i n t o one or more b l o c k gzants t o the s t a t e s .
~~

See Richard Speier , "General S c i e n c e , Space., and Technology, " in 3cAllis t e r ,

op. c i t : , p . 63.
 15

Reduced'Overhead and Personnel Cuts

To attain greater personnel and management efficiency, the
Administration 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 substantial
savings are the ceiling on federal civilian employment, and
overhaul of the federal pay comparability standard.
Another defense efficiency measure would be to increase the
term of first enlistment and curtail re-enli~tments.~By reducing
accessions, the training costs could be reduced. In addition,
.less retention of first-term enlistees would reduce the retire-
ment liability.

CONCLUSION
The Reagan program embodies the changes in economic perspec-
tive, tax policy, and federal spending necessary to bring about a
more efficient and productive economy. There are two caveats,
however. The first is that regardless of how Congress alters the
plan or how it fares in the short run, the Administration should
continue to pursue the current course. The reason is not only
that the program is sound, but that consistency is essential to
altering expectations.
The second warning is that should Congress fear the tax cut
to be too large, it should cut spending even mo re deeply than the
Reagan proposals, rather than drastically alter the t a x proposal.
It is critical that the marginal tax rate cuts and the accelerated
depreciation schedule remain intact.

Peter G. Germanis
Policy Analyst/Economics
Eugene J. McAllister
Walker Fellow in Economics
David G. Raboy
Institute f o r Research on t h e
Economics o f Taxation

See William Schneider, J r . , "Defense," in McAllister, o p . cit., p . I .