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current problems

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V.USOSKIN, R.ENTOV, S.TARASENKO

__TITLE__ US Budget and Economic Policy __TEXTFILE_BORN__ 2007-04-05T10:12:21-0700 __TRANSMARKUP__ "Y. Sverdlov"

COPY 15

PROGRESS PUBLISHERS

MOSCOW

[4]

Translated from the Russian by Leo Lempert

Edited by Mike Davidow

VCOCKHH B. M., SHTOB P. M., TapaceHKO C. M.

EIQZOKET H 9KOHOMHMECKA3 HOJ1HTHKA CIIJA

Ha

__COPYRIGHT__ First printing 1973
© Ttranslation into English. Progress Publishers 1973 [5] CONTENTS Chapter I. THE BUDGET IN THE AMERICAN ECONOMIC STRUCTURE 7 1. The Budget and the Public Sector of the Economy ... 7 2. Government Interference and Inefficiency of the Market Mechanism................... 19 3. Structure of Public Finance............ 36 4. The Budget-Making Process............ 43 Chapter II. FEDERAL BUDGET EXPENDITURE..........56 1. Military Spending of the Federal Government.....59 2. Needs of Economic Growth and the System of Civilian Spending.................... 71 Chapter III. TAX REVENUE OF THE FEDERAL BUDGET .... 83 1. The Individual Income Tax System........ 85 2. Federal Tax on Corporation Incomes......... 92 3. The Structure of the Federal Tax System and the Problem of Erosion of the Tax Base.............. 102 Chapter IV. ``THE PURE THEORY" OF PUBLIC FINANCE: A CRITICAL ANALYSIS....................108 1. ``Pure Theory of Public Expenditure": Main Ideas . . . Ill 2. The Pure Theory of Public Finance: An Analysis of Some Premises . :.................114 3. Mechanism of Choice of Public Goods........120 Chapter V. THE PUBLIC DEBT AND MONETARY SYSTEM.....126 Chapter VI. FINANCES OF STATES AND LOCAL GOVERNMENTS . . 146 1. Expenditures of State and Local Budgets....... 154 2. Revenue of State and Local Budgets........ 167 3. Federal Grants to States and Local Governments .... 180 4. Borrowing Operations and the State-Local Debt .... 188 CONCLUSION...................198 [6] ~ [7] __NUMERIC_LVL1__ CHAPTER I __ALPHA_LVL1__ THE BUDGET IN THE AMERICAN
ECONOMIC STRUCTURE __ALPHA_LVL2__ 1. THE BUDGET AND THE PUBLIC SECTOR
OF THE ECONOMY

Every January the President of the United States transmits to the Congress a series of economic documents which evaluate the current state of economic activity, forecast developments in the forthcoming period and chart the course of government actions in the economic sphere. These documents are: the State of the Union Message, the Economic Report of the President with the Annual Report of the Council of Economic Advisers and the Budget Message. The American press regards these documents as the ``national economic plan" which, however, essentially differs in content and nature from directive plans of national economic development. The President and his economic staff merely indicate specific directions and set some general goals and guideposts for the Administration in performing its economic functions. But these recommendations are not binding on the private sector of the economy. Correspondingly, the final results of economic activity as a rule essentially differ from official outlines and forecasts.

The budget occupies a unique place among the governmental economic documents. Since the main part of the national output in capitalist countries is produced by private enterprises the budget serves as one of the few channels through which the government is able to exert purposeful 8 influence on different spheres of economic activity. At present the budget has been elevated to the rank of the most important instrument of macroeconomic control and regulation. Being a condensed expression of the government's policy, the budget reflects as a mirror the changing pattern of socio-economic priorities and preferences, and the arrangement of the Administration's economic and political objectives from the viewpoint of their urgency and importance. The character of the allocation of the budget appropriations for various programmes and categories of expenditure, shifts in the relative significance of individual budget items, changing structure of tax receipts---all these express in a specific manner the peculiarities of economic growth, the acuteness of class and social conflicts, government policy and the state of relations with theh outside world. In brief, the government budget reflects the most profound economic and political changes under way in the country.

The steady absolute growth of the government budget and its rising share in relation to the national income has become an essential characteristic of the capitalist economy at a high level of its development. This process is by no means accidental: it expresses the immanent laws of capitalism. Enhancement of the role of the budget is a reflection of the profound changes in the functions of the capitalist state which have occurred in the last half a century. These functions have become a serious factor which exerts a many-sided influence on all spheres of economic decisionmaking.

Engels pointed out that as the productive forces of capitalism grow ``... the state will ultimately have to undertake the direction of production".^^1^^ This development confirms the fact that production which is social in its nature requires social regulation for normal functioning. At the same time the tendency towards centralisation of economic management is displayed under capitalism in specific and contradictory forms. State guidance of the economy, while preserving _-_-_

~^^1^^ Karl Marx and Frederick Engels, Selected Works in three volumes, Vol. 3, Moscow, Progress Publishers, p. 144.

9 private ownership in the basic sectors of the means of production, is inevitably of a restricted, fragmentary nature and affects only separate spheres of productive economic activity. Moreover, the state does not compete with the private sector, seeks to supplement it and ultimately ensures the interests of the ruling upper crust of the capitalist class.

Nor is it accidental that the state began to play a special, exceptional role in the economic process only in the 20th century. At the threshold of our century deep-going shifts took place in the economic pattern of capitalism. There developed a network of large corporations, which concentrated a substantial part of national financial and material resources. The free competition of producers began to give way to various forms of monopoly competition. At the same time the amplitude of cyclical fluctuations of output widened, the crisis of overproduction became particularly destructive, encompassing simultaneously many countries and shaking the capitalist economy to its foundations. Under these conditions the state was compelled to assume an ever increasing share of the economic, organisational and ideological functions.

The process of restructuring the capitalist economy inevitably leads to interlocking and merging into one mechanism of the activity of large corporations with the economic power of the state. This process which is.now clearly observed in the economy of all developed capitalist countries is characterised as state-monopoly capitalism in Marxist economic literature. State-monopoly capitalism, as a special form of socio-economic relations, was profoundly analysed in the works of Lenin.

Capitalist economy changes and the growing complexity of the state functions have exerted a significant influence on economic theory. This was expressed in the crisis which jolted traditional concepts and doctrines of classical political economy in the West. The laissez-faire philosophy which propounds the concept of reducing to a minimum the participation of the state in the economic process, has lost its significance. It has been replaced by a directly opposite thesis embodied in the doctrine of Keynes and developed by his followers. It proclaims that, as a result of peculiar features 10 of the ``mature'' capitalist economy, stable economic development cannot be achieved without systematic and energetic government action designed to eliminate the adverse consequences of the uncontrolled market mechanism. Today the overwhelming majority of economists, with the exception of the most conservative wing, admit that the market mechanism of economic activity under capitalism in principle cannot ensure either an adequate (optimal) distribution of resources and incomes or a solution of other important problems which arise in the course of economic and social development. Only the government, it is asserted in most of the economic works, is the sole instrument with the help of which it is possible to ensure relative stability of production, mitigate social conflicts stemming from economic and political inequality, and impart to capitalism the stability, dynamism and vital force it lacks. State-monopoly capitalist regulation makes it possible to impose on the entire society economic decisions which are especially beneficial in the first place to the capitalist class.

The strongest impulse for revising the doctrine of noninterference by the state in economic processes was given by the chronic disequilibrium of the capitalist economy in the 20th century. The disastrous consequences of fluctuations in economic activity culminated, at the beginning of the 1930s, in what is known as the Great Depression. The programmes of state financial aid to the biggest companies hit by the crisis of those years facilitated the development of the theoretical concepts of permanent government intervention in the economic sphere. This greatly influenced the approach to problems of economic policy, including (in the first place), government fiscal policy. The sphere of public finance turned gradually into one of the main channels of the economic expansion of the state. Correspondingly, a huge budget and a growing public debt began to be regarded by Western theoreticians and political leaders not as an anomaly or a flagrant violation of all the canons of ``sound finance" but as a necessary condition for balanced development. The fact that a considerable part of the country's productive and financial resources are systematically removed from private economic circulation in order to undergo distribution and redistribution along government 11 Chart I Money Flows in the United States Economy -2- 099-2.jpg 1. Personal Consumption Expenditure 11. Personal Income 12. Corporate Income and Social Security Tax 13. Personal Taxes 14. Government Borrowing 15. Personal and Corporate Gross Saving 16. Disposable Income 17. Corporate Saving 18. Personal Gross Saving 19. Bank Credit 2. Government Purchases 3. Gross Private Investment 4. Gross National Product 5. Net National Product 6. Government 7. Indirect Business Tax 8. National Income 9. Capital Consumption Allowance 10. Transfers 12 budget channels in accordance with special criteria and purposes, is now regarded as a normal economic procedure (see Chart I).

The above chart shows that the government draws into the budget part of the incomes of the private sector in the form of taxes, payments and loans and then returns these financial resources into the income circuit in the form of expenditures for the purchase of goods and services, transfers and grants. Participating in the redistribution of the national product and income, the government thus exerts an important influence on production, consumption and saving. This makes it clear why the sphere of public finance has become an active area of theoretical studies and practical policy.

The position of a budget in a country like the United States influences not only the domestic economic situation but international economic relations as well. The United States is the most powerful capitalist country in the world, and its budget includes huge amounts which are spent by the government for rendering diverse forms of aid ( including military) to other capitalist countries, for the maintenance of armed forces and military bases abroad.

The US Government budget is exerting a serious impact on the international monetary relations of capitalist countries. The dollar performs the role of an international reserve and means of payment and settlements in the capitalist world. To perform these functions stability of the purchasing power of the dollar is essential. But the latter is systematically undermined by the process of inflation affecting the American economy. And one of the serious factors spurring on the inflation process is that of the government budget, to be more exact, its chronic imbalance and the methods of deficit financing. It is not by chance that the condition of the American financial system is being closely watched by economic experts and government officials in other capitalist countries. A large deficit in the US federal budget serves as a sign of the further worsening in the international position of the dollar and aggravates the international monetary crisis.

For several decades the enhanced economic role of the government has been the object of intensive study by 13 Western economists. On the theoretical side great attention has been paid to the nature and causes of the rise of a public sector in the capitalist economy.

Many problems of public finance and fiscal policy are raised from this angle. At the same time there is also the statistical aspect of the problem linked with the quantitative evaluation of the scale of government economic operations and their influence on the economic system.

Data on the amounts of money drawn into the national budget, government expenditures and the public debt to the private sector are among the main parameters which characterise the level of economic activity of the state. We show the change of these indicators at three main levels of government in the USA---federal, state and local (see p. 14).

The data of the table cover a period of 40 years. They demonstrate the substantial growth of government activity financed through the budget channels. Thus, between 1927 and 1968 government revenue increased (in current prices) from $12,200 million to $265,600 million, i.e., almost 22 times, and the expenditure 25 times (from $11,200 million to $282,600 million). The public debt (at all levels) amounted to $33,400 million in 1927; in 1968 it reached the astronomical figure of $468,700 million (an increase of 14 times).

It goes without saying that an appraisal of government operations is also influenced by an external factor---the change in the purchasing power of money linked with the change in prices of goods. If the budget revenue and expenditure were expressed in base year prices, the figures denoting increase would be more modest. Thus, using as an indicator of price changes the deflator employed by the US Department of Commerce in calculations of the national product and income (1958 = 100), we obtain the following picture: the revenue of government institutions at all levels in the USA in constant prices rose 9 times between 1927 and 1968, the expenditure---10.5 times and the public debt (including that of state and local governments)---5.8 times. Nevertheless even these figures demonstrate the rapid expansion of the state economic activity. For comparison let us point out that the key indicator of economic development, the

14 Table 1-1 Revenue, Expenditure and Debt of All Governments, 1927--1968 (million dollars) Fiscal year All governments Federal State and local Amount Percentage distribution Amount Percentage distribution Budget revenue 1927 12,191 4,469 36.6 7,722 63.4 1940 17,804 7,000 39.3 10,804 60.7 1944 64,778 51,399 79.3 13,379 20.7 1950 66,680 43,527 65.6 23,153 34.4 1955 106,404 71,915 67.6 34,489 32.4 1960 153,102 99,800 65.2 53,302 34.8 1965 202,585 125,837 62.1 76,748 37.9 1968 265,639 165,239 62.2 100,400 37.8 Budget expenditure 1927 11,220 3,410 30.4 7,810 69.6 1940 20,417 3,177 45.0 11,240 55.0 1944 109,947 99,448 90.5 10,499 9.5 1950 70,334 42,429 60.3 27,905 39.7 1955 110,717 70,342 63.5 40,375 36.5 1960 151,288 90,289 59.7 60,999 40.3 1965 205,550 118,996 57.9 86,554 42.1 1968 282,645 166,411 58.9 116,234 41.1 Debt outstanding 1927 33,393 18,512 55.4 14,881 44.6 1940 63,251 42,968 67.9 20,283 32.1 1944 218,482 201 ,003 92.0 17,479 8.0 1950 281 ,472 257,357 91.4 24,115 8.6 1955 318,641 274,374 86.1 44,267 13.9 1960 356,286 286,331 80.4 69,955 19.6 1965 416,786 317,274 76.1 99,512 23.9 1968 468,736 347,518 74.2 121,158 25.8

Note: Revenue and expenditure as of the end of the respective fiscal year; exclude intergovernmental transfer of funds; amount of debt outstanding as of the end of the fiscal year.

Sources: Statistical Abstract of the United States 1970, p. 403; Historical Statistics of the United States, Colonial Times to 1957 ( hereafter Historical Statistics... to 1957), Washington, 1960, pp. 722--30.

15 gross national product of the USA, during the same period rose (in constant prices) only 3.8 times.^^1^^

The figures show that the greatest increase was registered by indicators characterising the activity of the federal government: revenue rose 23.6 times; expenditure, almost 50 times and the debt, 18 times.

Military spending and related types of budget expenditures (payments to veterans of war, military aid to other countries, payment of interest on public securities, and so on) are the main factors responsible for the rise in spending by the federal government.

Revenue and outlays of the state and local governments are important components of the general system of public finance. A detailed analysis of these activities is given in Chapter VI. At this point we shall merely indicate the general tendency. In the 1920s the state and local governments accounted for the main part of all budget revenue and expenditure; in 1927 they represented 63.4 per cent of the entire revenue and almost 70 per cent of the expenditure. Then, in the 1930s, the role of federal finance began to rise until it reached its peak during the war. The comparative decline in the financing of state and local governments also continues in the post-war period, but their share in revenue and expenditure rose somewhat, to 37--42 per cent.

Lastly, there are other indicators characterising the growing influence of the state. Among them is the number of persons engaged in the public sector. Thus, the total number of government employees in the USA (excluding the personnel of the armed forces) was 13.0 million in 1970 as compared with 4.5 million in 1940. Of this number about threefourths were employed by state and local agencies and a little less than one-fourth, by the federal government. The tendency towards a rise in the relative importance of the federal government is also reflected in employment figures. Prior to the mid-1940s the share of federal employees _-_-_

~^^1^^ The calculation was made on the basis of data of Table 1-1 and the Survey of Current Business, July 1971, pp. 13, 46. The value of the deflator of prices for 1927 was obtained by extrapolation, taking into account the change of the wholesale price index in 1927--1929.

16 steadily increased. But then an opposite tendency emerged---the proportion of employees in the states and municipalities began to rise (chiefly due to those engaged in education).

Table 1-2

Government Employment in the USA, 1940--1970

(thousands)

Total Federal State and local total stale local 1940 1950 1960 1970 4,474 6,402 8,808 13,028 1,128 2,117 2,421 2,881 3,346 4,285 6,387 10,147 1,057 1,527 2,775 3,228 4,860 7,392 As a percentage of the total 1940 1950 1960 1970 100 100 100 100 25.2 33.0 27.5 22.1 74.8 67.0 72.5 77.9 16.6 17.3 21.1 50.4 55.2 56.8

Note: Figures include all persons in government employment except for the armed forces.

Sources: Statistical Abstract of the United States 1971, p. 420; Historical Statistics... to 1957, p. 709.

It is also interesting to note the steady increase in the proportion of government employees to the number of persons engaged in the process of production and distribution. In 1929 government employees (excluding the armed forces) amounted to 6.5 per cent of the total number of persons engaged in civilian production and in 1969, to 15.6 per cent.^^1^^

Another widely used indicator of state activity is the proportion of government purchases of goods and services to GNP.

_-_-_

~^^1^^ Calculated according to the Handbook of Basic Economic Statistics, June 1971, pp. 12--17. On this question see also S. Fabricant, The Trend of Government Activity in the United States Since 1900, National Bureau of Economic Research, New York, 1952, Appendix B; pp. 161-- 203.

17

The share of government purchases which during the Second World War reached up to one half of the GNP stabilised during the last 20 years at the level of one-fifth of the GNP. This shows that a huge and to a certain extent stable market for many enterprises of the private sector ensured by government orders, has arisen in the USA. It is difficult to overestimate the importance of this market in conditions of the dominance of market spontaneity. At the same time it is necessary to note that government-generated demand is largely of a one-sided, specific character. Its very uneven impact on different sectors and geographical regions gives rise to disproportions in the economy. A considerable part of the purchases is connected with unproductive expenditures by the government, specifically the purchases of armaments and supplies for the armed forces. The struggle for a share in the governmental ``pie'', which is unfolding both among big corporations and geographical regions, is an important factor in US political life.

At the same time the data supplied in Table 1-3 underestimate the extent of state influence on economic activity because they do not include transfer payments. These payments, as we shall see later, play an important role in the

Table 1-3 Government Purchases of Goods and Services ('000 million 1958 dollars) Government purchases of goods and services Amount Per cent of GNP Years GNP Total Federal State and local Total Federal State and local 1929 203.6 22.0 3.5 18.5 10.8 1.7 9.1 1939 209.4 35.2 12.5 22.7 16.8 6.0 10.8 1944 361.3 181.7 165.4 16.3 50.3 45.8 4.5 1950 355.3 52.8 25.3 27.5 14.8 7.1 7.7 1955 438.0 . 85.2 50.7 34.4 19.5 11.6 7.9 1960 487.7 94.9 51.4 43.5 19.4 10.5 8.9 1965 617.8 114.7 57.9 56.8 18.6 9.4 9.2 1970 720.0 139.4 65.4 74.0 19.4 9.1 10.3

Note: Excluding purchases of goods and services within the public sector.

Source: Economic Report of the President 1972, pp. 196--97.

__PRINTERS_P_17_COMMENT__ 2---62 18 redistribution of incomes among various groups of the population and they affect the functioning of the economy as a whole. Thus the relationship of all government spending to the GNP is often used as an indicator of the scale of governmental operations. In the 1969 fiscal year this ratio was 21 per cent for the federal sector (with the share of purchases of goods and services amounting to 11.4 per cent).

Many other statistics could be cited demonstrating the high level of economic power and, correspondingly, the influence of the government in the USA. Thus, the federal government owns over one-third of the 2,300 million acres of land occupied by the United States. Governments at all levels own nearly 20 per cent of the total stock of accumulated wealth (in the form of tangible assets) which is estimated at $3,000,000 million. Government-owned electric power stations generate from one-fourth to one-third of all the electricity consumed in the country; 30 per cent of total annual new construction in the United States is accounted for by public buildings and other structures (highways, dams, and so on). Lastly, about two-thirds of the total annual expenditures for research is financed by the federal government.^^1^^

By comparing the public sector in the USA with that of other developed capitalist countries certain essential differences are revealed. The scale of direct participation by the US government in the organisation of productive activity is relatively small. The state primarily owns enterprises in the military sector, the atomic energy industry and space exploration, these enterprises constitute an insignificant group of all the companies in the country. The influence of the state on the private sector in the United States is expressed not so much in the form of direct nationalisation of industrial companies, as has been the case in France, Italy and Austria, but primarily in direct and indirect financing, subsidising and regulating of various sectors (railways, agriculture, and so on).

These special distinctions in the development of the public sector in the USA substantially enhance the role and importance of budgetary channels of government influence _-_-_

~^^1^^ Robert H. Haveman, The Economics of the Public Sector, John Wiley & Sons, Inc., New York, 1970, p. 8.

19 in the economic sphere. It is not by chance that as regards the level and ratio of the budget expenditures (including local government budgets) to the GNP, the United States holds one of the first places in the capitalist world. Studies of the economy of the US public sector are largely devoted to an analysis of budget problems.

__ALPHA_LVL2__ 2. GOVERNMENT INTERFERENCE AND INEFFICIENCY
OF THE MARKET MECHANISM

The present volume of government activity in the economic sphere of capitalism bears no comparison to the situation which prevailed some 30--40 years ago. The significance, however, lies not only in the degree and scale of government interference but in the essence of this process. In principle the element of state coercion can be traced at all stages of capitalist development. In the era of the dominance of free competition, in conditions of the atomistic economic structure, the interference of the state was not only reduced to a minimum but was also of an auxiliary, ``external'' nature with regard to the ``basic'' economic process. The functions of government agencies were limited to maintenance of the general conditions of ``aw and order" and the protection of capitalist property.

Today in the period of the dominance of large industrial corporations which monopolise the production and marketing of major goods and services, the state directly interferes in the reproduction process and tries to exert a purposeful influence on it. A big corporation requires for its normal functioning stable economic activity, stable prices, guaranteed markets, i.e., conditions incompatible with the spontaneous, uncontrolled market mechanism.^^1^^ David T. Bazelon, an American economist, rightly remarks that modern gigantic capitalist enterprises would perish without such federal governmental activities as taxation, expenditures, grants, guarantees, organisation, aid, regulation and the ensuring of a proper level of the national income.^^2^^

_-_-_

~^^1^^ John K. Galbraith, The New Industrial State, Houghton Mifflin Co., Boston, 1967, p. 193.

~^^2^^ David T. Bazelon, The Paper Economy, New York, 1965, Chapter X.

20

Today a capitalist state not only openly proclaims its responsibility for eliminating the strongest cyclical fluctuations of economic activity. It sets itself the aim of guiding long-term trends, seeks to influence the historically shaped rates of economic growth and national economic proportions, create conditions for the acceleration of scientific and technological progress, plan programmes of ``social services'', and so on. The state is firmly ``built into" the system of economic relations and a sudden stoppage of its activity would most seriously derange the entire capitalist economy.

The increased role of the state in the economic life of capitalist countries is an objective and irreversible process. It takes place in all highly developed capitalist countries, although it develops, as we pointed out, at different tempos and in different forms. The opinion is at times voiced that the degree of intervention by the state is determined by conscious factors: the expression of the will of the masses, collective opinion about the ``permissible level" of the development of the public sector. Naturally, historical conditions and traditions, local distinctions, and so on, play a certain part, are superimposed on the general tendency. But the roots of the process of the augmentation of the power and influence of the state should be sought in the objective laws of capitalism's development, in the chronic instability of an uncontrollable economy and in the desire of the capitalist elite to utilise the state machine for consolidating its power. Explanation of the phenomenon of ``state capitalism" in Western literature is usually reduced to demonstrating the limited nature of the market mechanism, its inability to ensure the efficient functioning of the system and to solve important problems of social development. Indeed, such a limited nature is inherent in the capitalist market. But to reduce to it the entire problem of present-day state intervention means to ignore the chief thing. State-monopoly capitalism is the stage of highly developed capitalism which is characterised by the emergence of close and diverse ties between the big corporations and the state. This alliance ultimately aims at protecting the interests of the ruling class. Not to consider this primary factor, to reduce the role of the state to the position of a ``neutral and unbiased arbiter" guided by the interests of all sections of society would mean to bar 21 the road to an objective study of the nature and phenomena of contemporary capitalism.

At the same time an analysis of different manifestations of the inefficiency of the market mechanism, made by Western researchers, is by itself of undoubted interest. These phenomena speak of the transitory nature of capitalism, the inevitability of transition to another economic system based on social ownership of the means of production and managed in a planned way. These principles of organisation of the economy are more adequate to the high level of development of the productive forces.

The tendency towards extension of public operation is most distinctly displayed in spheres of the economy where private capitalist enterprise cannot or does not consider it profitable for itself to produce definite types of goods and services and to perform functions of vital importance for society. The development of the economic infrastructure, the educational system, a wide range of ``public services" (public health, pension system), the financing of long-range projects, the organisation of fundamental scientific research ---such is the most general and by far not complete enumeration of spheres in which the state tries to fill the ``vacuum'' created by private business. Here we have a clear example illustrating the point: the aims and interests of social development come into contradiction with the chief criterion of capitalist enterprise---the principle of profit maximisation. The public sector of the economy serves as a kind of `` safety-valve" which makes it possible, within certain bounds and for a certain time, to resolve emerging contradictions, to smooth over conflicts, to ensure society a minimum of major services for satisfying collective needs.

There are many facts demonstrating the inability of the market economy to ensure an adequate volume of production of goods and services of importance from the national economic viewpoint. Equally, the purely market form of economic organisation contains no regulators restricting the development of such types of productive activity which, although they bring a profit to the individual producers, directly or indirectly inflict harm on society. These features in the functioning of the market mechanism are specifically reflected in the problem of external or spillover effects. 22 There are many spheres of economic activity which, aside from the direct results paid for by the consumer, exert an indirect influence of a positive or negative nature. The person receiving the indirect benefit of this influence makes no payment to the producer for this service. On the other hand neither is the consumer compensated for by those guilty of inflicting harm upon him.

It is known, for example, that education, besides affording direct benefit to the student, is of use to entire society. But this effect of education is not considered in the payment for tuition, and the scale of this sort of activity ensured by the private sector is obviously inadequate.^^1^^

Here is another example. Many types of industrial production are linked with the pollution of the environment. But this effect, adverse from the viewpoint of society, is not reflected in the production costs. The state is urged to help increase the volume of services of the first type and reduce activity of the second type. Guided by considerations of the ``public good'', the state should stimulate education and introduce various types of free tuition, in other words, reduce the total cost of education; and it should restrict the activities of companies which pollute the air with production wastes through a system of fines, and so on (i.e., by increasing production costs).

Robert Dorfman, a well-known American economist, points to the existence of a large gap between the public interests and the criteria of private capitalist enterprises. He points out that there is a growing number of enterprises which are justified from the public viewpoint, but are regarded by businessmen as unprofitable. At times they do not bring in a profit because of the conditions under which the product is distributed or consumed (for example, ``collective'' goods, conveniences and services available to all comers), or because their payment is too burdensome or unjustified (street patrolling service); at times owing to production conditions (only the government can buy lands needed for the building _-_-_

~^^1^^ In conditions of the contemporary scientific and technological revolution and the economic rivalry of big powers, there are also other reasons which compel a state to step up the development of the educational system.

23 of highways or the reconstruction of cities); at times owing to the fact that the market undervalues some things which in the long-range aspect are highly valued by society (for example, preservation of natural wealth.)^^1^^

What are the most general illustrations of the inefficiency of the market mechanism? A logical scheme, presented with various modifications in many Western textbooks, is given in the book, Government Finance. An Economic Analysis by John Due.^^2^^ Due formulates a number of general conditions, the existence of which he regards as of exceptional importance for the proper functioning of the capitalist economy and the absence of which makes government intervention necessary. Among them are: = ``1. Maximum individual freedom of choice; = 2. optimum standards of living, in terms of available resources and consumer and factor-owner preference; = 3. distribution of income in conformity with currently accepted standards of equity."^^3^^ In real life, according to Due, these purposes are seriously distorted as a result of adverse influences arising in the course of market decisionmaking. Thus, the tendency to monopolise resources, capital markets, and so on, distinctly displayed in the course of the development of capitalism, reduces to naught the `` individual freedom of choice''. The optimum standard of living (under which Due implies the most efficient use of the available resources of society from the viewpoint of the public good) cannot be achieved because of the operation of such elements as restriction of competition in the markets of consumer goods and factors of production; capitalism's inherent hindrances to achieving full employment of manpower and productive resources; the gap between marginal benefits and costs as regards private individuals and society as a whole (the problem of external effects earlier mentioned).

As for the third important condition, more equitable distribution of income, Due confines himself to the following cautious statement: ``The market economy, even with _-_-_

^^1^^ Measuring Benefits of Government Investments, Ed. by Robert Dorfman, The Brookings Institution, Washington, B.C., 1965, Introduction, pp. 3-4.

~^^2^^ John F. Due, Government Finance. An Economic Analysis, Richard D. Irwin, Inc. Homcwood, Illinois, 1954, Chapters 1 and 2.

~^^3^^ Ibid., p. 5.

24 relatively free competition, has resulted in a pattern of income distribution among families, which opinion in society has typically regarded as inequitable, because of the high degree of inequality. The degree of inequality has been increased still more by the development of monopoly power."^^1^^

Due's laconic manner of speaking about the third condition is understandable. The uneven distribution of incomes is an eternal and the most acute problem of capitalism, the source of social conflict and class struggle. But the method of distribution is determined by the entire system of capitalism's production relations and can be changed only through transition to another, higher socio-economic formation. Palliative measures of the state in this sphere merely emphasise the pressing need for a cardinal solution of the problem.

An economic analysis of state intervention, as a rule, is not limited to a description of government activity or an explanation of the reasons for the growth of the public sector. One of the trends of study is an attempt to ascertain the ``optimum boundaries" of this sector, utilising for this purpose an apparatus of highly abstract models. The latter, as a rule, are divorced from the real conditions of the political process which determines the volume and composition of the government expenditure. It is a matter not of observing developments in real life but of what ought to happen given certain assumed conditions for the functioning of the system.

This problem is studied by a special branch of economic analysis---welfare economics. With its help a technique is being devised for evaluating alternative situations from the viewpoint of satisfying to the maximum individual needs within the limits of the examined collective or group. The proponents of such an approach are trying to employ the techniques of marginal evaluations elaborated in microeconomic analysis for weighing the public benefits and costs linked with government operations.^^2^^ But a study of government activity on the basis of market economy criteria is _-_-_

^^1^^ Ibid., p. 10.

~^^2^^ William J. Baumol, Welfare Economics and the Theory of the State, Harvard University Press, Cambridge, Mass., 1952.

25 exceedingly difficult. The point is that many types of government services do not have a ``price'' determined by market forces (for example, judiciary functions, defence, and so on). The absence of objectively formed evaluations essentially hampers (and in a number of cases completely excludes) the measurement and comparison of costs and effects. At the same time the existence of a considerable external effect in many services of the public sector creates a gap between the marginal evaluations from the viewpoint of the individual and society as a whole. This again complicates the application of the principles of marginal analysis to the study of government operations. For all the attractiveness of a study of the optimum limits of state activity, which is ``strict'' from the viewpoint of ``pure theory'', the apparatus of welfare economics, in the opinion of many theoreticians, is poorly suited for the study of concrete processes and situations. Let us refer in this connection to a statement made by Jan Tinbergen, an eminent economist: ``The problem of finding the optimum regime is the central problem of welfare economics. ... This means that we assume knowledge about two things: first, about the preferences of the individuals constituting the economy and, second, about how to weigh the interests of different individuals in determining social wellbeing or social welfare. In customary economic language this means, first, knowledge about the utility functions of the individuals and, second, about the social utility function. These are far-reaching assumptions because our knowledge about individual utility functions is very limited, and the social welfare function depends on how we compare utilities of different persons."^^1^^

A zealous custodian of the traditions of free enterprise Eugene Rostow writes: ``It [the problem of planning.---The Author] is inescapable because a capitalist economy doesn't keep itself at high levels of employment, nor can it accomplish unaided certain other economic goals of the community. And there are no institutions, apart from those of government, to carry out the essential preliminary function of planning---that of seeing to it that the aggregate _-_-_

~^^1^^ Jan Tinbergen, Central Planning, Yale University Press, New Haven, London, p. 82; see also Kenneth J. Arrow, Social Choice and Individual Values, John Wiley & Sons, Inc., New York, 1951.

26 of all spendings in the economy is high enough to ensure full employment, and not so high as to produce inflation."^^1^^

The term ``planning'' is employed by Western authors in the most diverse interpretations and aspects. It encompasses a motley range of concepts---from indicative planning of the French type to imperative or directive planning, from the compilation of the most general---long-range forecasts to projects and programmes elaborated in detail.^^2^^ At the same time, in evaluating planning methods, it is considered ``the proper thing" to regard with disapproval the system of planning existing in socialist countries, putting up in contrast to it ``capitalist planning'', ``liberal planning" and even ``planning for freedom".^^3^^

Terminology by itself hardly improves the forms and methods of planning. It seems, however, that planning, by its very nature as an instrument of co-ordinating different economic elements and subordinating them to a single social goal, must be of an all-round and binding nature and must not be confined to general evaluations and recommendations which are not binding on anyone.

We find a more pragmatic approach to the problem of the limits and intensity of state intervention among followers of the Keynesian theoretical scheme. Keynes formulated a number of causal and functional links between key macroeconomic factors (consumer spending, savings, investments, the interest rate, money, and so on) and tried to develop them into a single system. In current variants of the Keynesian scheme government spending and taxes perform the role of ``adjusting elements" which rectify discrepancies in the dynamics of the major national economic variable---the aggregate demand for goods and services presented by the private sector of the economy. The shortage of private demand (and Keynes-proceeded from the premise that the shortage _-_-_

~^^1^^ Eugene V. Rostow, Planning for Freedom. The Public Law of American Capitalism, Yale University Press, New Haven, Connecticut, 1960, p. 23.

~^^2^^ Andrew Shonfield, Modern Capitalism. The Changing, Balance of Public and Private Power, London, Oxford, New York, 1969, Chapter 2.

~^^3^^ Eugene V. Rostow, Op. cit., p. 22.

27 of demand is inherent in the economy of mature capitalism) requires additional government investments financed by the selling of public securities.The excess of demand beyond the level dictated by the available resources of society must be accompanied by government measures for curtailing demand (through an increase of taxes, and so on).

Hence the tremendous significance attached in the West to measures of government fiscal policy as an instrument of economic stabilisation and control. In its simplest form the general ways of influencing the economy with the help of budget instruments can be demonstrated in the following model:

C = C 4 cYd 0<c<l 0<x<l (1) (2) (3) (4) (5) (6) where C is consumption expenditure by households; c is marginal propensity to consume; Y is the gross national product; Yd: is disposable income (i.e., disposable income after taxes); T is total tax collections from households, x is marginal propensity to pay taxes under the existing tax structure; I is investment expenditure by firms and G is government purchases of goods and services. Index ``o'' denotes the initial level of the variable introduced into the model from the outside. From the given system of equations there directly follows: --------^---(7) AG I---C(I---X) \'> AY________~C (Q} A To 1 - C (1 - X) W

Equation (7) gives the multiplier applicable to government purchases and equation (8)---the multiplier for a change in taxes. In the first case the formula shows how the GNP changes with the change in government spending; here the multiplier is positive and equals, let us assume, 3. This 28 means that a change in the government purchases of goods and services by $1,000 million ultimately leads, through the given chain of dependence and effects, to an increase of the GNP by $3,000 million. In the second case the multiplier is negative (let us say minus 1.8); an increase in tax receipts by $1,000 million will bring about a reduction of the GNP by $1,800 million.

Government policy in various economic situations is based on these propositions: in conditions of a depression it is advised to increase budget spending and reduce taxes so as to bring about a growth in effective demand; on the other hand, in conditions of an inflationary boom it is advised to reduce demand by curtailing government spending and raising taxes.

But even quite incomplete, selective and poorly co-- ordinated measures of centralised regulation of economic activity have been arousing vociferous protests of the defenders of free enterprise. The general point in their works is the thesis concerning the need to restrict state action within narrow and strictly delineated bounds.

Contemporary capitalist economy is conceived as some kind of a ``private-collectivist'' system in which elements of centralised guidance should be administered in ``doses'' and combined in definite proportions with private decisions on questions of production and consumption. A bitter polemic is being waged over the ``best'' combination of these two opposite elements---centralised regulation of the economy and the spontaneous functioning of the market. Most economists are of the opinion that in the absence of sizable and systematic governmental actions modern capitalist economy would be subjected to disastrous fluctuations of economic activity. At the same time there is a large group of economists and political leaders in the United States who characterise the process of increasing the role of the state and growth of the public sector and the budget as ``creeping socialism" which endangers the ``freedom'' and the very existence of American society. The arguments of this group usually boil down to an apology for the ``classical'' forms of capitalist activity, the apologists claim that capitalism is a ``basically sound'', ``stable'' system in which the operation of internal self-regulating mechanisms is effective and charge 29 that deep disproportions arise precisely as a result of ``excessive'' intervention of the state in the reproduction process.^^1^^

A vast area of intermediate, at times eclectical and contradictory views lies between these polar positions. Moreover, there are periodic changes in the relationship of forces between the supporters of, and opponents to, energetic government action, largely determined by changes in economic situation. A decrease of output, increase of labour unemployment, rise of underemployment of productive capacities and other symptoms of a depressed condition of the economy are usually accompanied by a drive in favour of extending state intervention. Conversely, in periods of accelerated economic growth, widespread opposition is expressed against any increase in government spending and more people voice the opinion that it is necessary ``to slow down the growth" and ``to balance the economy".

These tendencies were clearly revealed in the USA in recent years when the Republican Party came into office. The Nixon Administration put forward as its paramount aim the slowing down of economic growth in order to restore the economic proportions distorted during the preceding years. Inflation became the main target of government economic activity. The Administration proposed: a reduction in the scale of government stimulating measures, limitation of the budget deficit, stepping up the use of traditional tools of monetary policy and the ``balancing'' of growth by curtailing excessive demand.

But the hope placed in the self-regulating mechanism underlying the government's policy was not justified. The sharp worsening of major indicators of production and employment early in 1970 forced the Administration hastily to revise its entire economic programme. This was also spurred on by criticism of the Republican Party leadership by advocates _-_-_

~^^1^^ M. Friedman, Capitalism and Freedom, Chicago University Press, Chicago, 1962; F. A. Hayek, The Road to Serfdom, Chicago University Press, Chicago, 1944; F. A. Hayek, The Constitution of Liberty, Chicago University Press, Chicago, 1960; Ludwig von Mises, Human Action, Yale University Press, New Haven, 1949; Henry G. Simons, EconomicPolicy for a Free Society, Chicago University Press, Chicago, 1948.

30 of ``activism'' and energetic interference in the economy. The Government had to launch large-scale stimulating budget measures which, in turn, resulted in a huge unplanned budget deficit in the 1971 fiscal year and largely reduced to naught the effect of former restrictions designed to curb inflation. As a result, the first postwar attempt to reduce the scale of state stimulation of the economy actually ended in failure.

Thus far we discussed the reasons for the origin and development of a large public sector and the economic policy of the state as an instrument of rectifying the defects of the market mechanism. To what extent do governmental actions ``correct'' the course of social development and improve the ``general welfare"? An answer to this question is given in subsequent chapters of this book. But already at this point it is possible to draw some general conclusions. The chief conclusion is that despite increased government activity, despite the greater use of methods and forms of regulation and control in the economic sphere, the state cannot alter the nature of capitalism which daily, hourly reproduces all disproportions in production and distribution which the state is trying to eliminate or mitigate.

Numerous facts reveal that in the richest capitalist country in the world with its powerful productive capacities and enormous redistribution of incomes conducted through government budget channels, obvious social contrasts, material and political inequality, far from being abolished, on the contrary, tend to grow sharper in the course of economic development.

The system of socio-economic priorities operating in the United States does not ensure the satisfaction of many urgent needs of society. In the short-term aspect it is the prime task of government economic policy to ensure stability of economic growth and maximum employment. At the same time it is gradually becoming clearer that an increase of national output and a rise in the level of money incomes do not automatically lead to a solution of the problem of social inequality and other pressing problems of capitalism. The changing composition of social needs has no adequate mechanism for their satisfaction.

Edward S. Mason, Professor of Harvard University and well-known American economist, in his analysis of the 31 features of a ``mature society" (he places contemporary American capitalism in this category)^^1^^ points out that recent experience shows how much easier it is to regulate the world of things than to effect even moderate shifts in the way of life of people and civilisations.

In Mason's opinion only some chronic disproportions inherent in the American economy can be eliminated `` automatically" if full employment is maintained over a sufficiently large period. These are: the ``farm problem" revealed in the relative overproduction of agricultural commodities and the systematic decline in the incomes of farmers; the problem of distressed areas, i.e., entire geographical areas suffering from chronic mass unemployment and low level of production; and, lastly, questions connected with industrial automation and better technology. The latter creates a real threat of ``structural unemployment" which cannot be eliminated by the simple ``creation'' of an additional demand for goods. Mason admits the acuteness and complexity of these problems but considers that the process of economic growth will ultimately eliminate them.

This confidence can hardly be shared. The solution of the long-standing ``farm problem'', the elimination of ``distressed areas'', eradication of the causes of ``structural unemployment"---all these require a broad comprehensive programme of socio-economic changes connected with shifting of resources and populations among regions and sectors, a planned change in the pattern and volume of production, regulation of economic proportions, and so on. Neither the market nor the capitalist state can undertake the implementation of such programmes on a sufficiently wide scale. Only the socialist system where production is organised in a planned way on a nation-wide scale can cope with such programmes.

Skirting round the serious problems related to inflation and balance of payments, Mason turns his attention to another group of questions which, as he admits, cannot be _-_-_

~^^1^^ Edward S. Mason, ``Objectives of Mature Society" in The Nations Economic Objectives, Ed. by Edgar 0. Edwards, Chicago University Press, Chicago, 1964, p. 2.

32 solved by a mere expansion of production. Among them are:

1) the change in the proportions between urban and rural populations;

2) the change in the age distribution of the population;

3) shifts in the pattern of consumer demand as per capita incomes rise.

The first point leads to one of the most acute problems of present-day America---the city crisis. According to census statistics, 63 per cent of the entire population in 1960 lived in metropolitan areas. Thus, not only has the rural population moved to the cities but the urban population has shifted from small communities to the very large cities. Not less than 20 million people will be concentrated within the New York metropolitan area in 1985.^^1^^ ``... Close to three-quarters of our people are destined to live in metropolitan areas and over a third in metropolises of more than a million, affected by what happens to our cities. And American cities, to speak bluntly but truthfully, are a mess."^^2^^

The second question raised by Mason is also quite urgent. It is a matter of the ``ageing population'', i.e., a comparative increase of percentage of the population in the age of 65 or older. This requires the development of pension and medical care systems which, according to the admission of specialists, are at present in an entirely unsatisfactory condition. And again the question is linked with the need to redistribute the financial resources on a nation-wide scale.

Lastly, there is the third question, concerning a change in the structure of wants. This, in turn, is reflected in a greater demand for some types of services and the stepped-up development of a number of sectors. The conglomerate sector called ``service industries" in the United States (and statistics include in it a very wide range of economic activities) exceeds the similar sector in any other capitalist country. More than 50 per cent of the entire labour force is employed here _-_-_

~^^1^^ Robert H. Connery and Richard H. Leach, The Federal Government and Metropolitan Areas, Harvard University Press, Cambridge, Mass., 1960.

~^^2^^ Ibid., p. 6.

33 and there is a tendency for a further rise of employment in this sphere. Moreover the demand grows particularly quickly in such areas as education, medical care and the recreation industry.

The more far-sighted economists, sociologists and political leaders are deeply concerned over this situation and are urging the government to take determined measures to increase spending for social needs. Of interest in this respect is the concept of ``social balance" advanced by John Kenneth Galbraith in his book The Affluent Society which gained wide renown in the United States and other countries. Galbraith considers that one of the chief factors contributing to the disproportionate development of capitalism lies in the upsetting of the balance between the so-called ``public goods" provided by the state outside the market for satisfying collective and individual needs of society's members and `` privately produced goods" distributed through the market. Galbraith notes that in contemporary capitalist society there is a serious shortage of goods of the first kind and an excess of goods of the second group. He cites in his book numerous and quite impressive examples of the ``crisis'' of the supply of public goods: the overcrowded and decrepit school buildings, antisanitary conditions of city streets, inadequate medical service, pollution of the environment, and so on. ``Failure to keep public services in minimal relation to private production and use of goods is a cause of social disorder or impairs economic performance,"^^1^^ Galbraith writes.

He cites as one of the reasons for this imbalance, the psychology of the man in the street who succumbs to the stultifying influence of modern advertising and buys vast quantities of goods he often does not really need but at the same time completely ignores urgent social requirements. That is why Galbraith advocates a further increase in taxes, and greater redistribution of incomes through the state budget for satisfying public needs.

This recommendation is hardly feasible in conditions when the tax burden reaches a very high level and the further increase in tax rates will merely produce a negative effect on _-_-_

~^^1^^ John K. Galbraith, The Affluent Society, Houghton Mifflin Company, Boston, 1958, p. 259.

__PRINTERS_P_33_COMMENT__ 3---62 34 the living standard of the poorest strata. Yet Galbraith's work indicates another, more realistic way of eliminating the catastrophic deficiency in public services---a change in the structure of government spending, a reduction of the military expenditure which absorbs a great part of federal appropriations.^^1^^

The ``social balance" theory reflects the real contradictions of capitalist development but in a distorted, irrational way. The stresses have been shifted and the real causes remain undiscovered. The chief conflict lies not in the sphere of `` relations of things" (this is merely the outward display of the disproportion) and not in the wrong psychology of the consumer. A powerful sector has arisen in the United States which ex-President Eisenhower very aptly named the military-industrial complex, for which the maintenance of military appropriations at a stable high level is of vital importance. Robert Haveman points to the pressure brought to bear on the budget by the interconnected aggregate of military men and political representatives of regions with large military bases, war industry corporations and also scientists and analysts working on military projects and the development of new types of weapons. Every member of this interconnected aggregate, often named the military-industrial complex, according to Haveman, thinks that an increase in military spending is in his personal interests.^^2^^

Thus, the US government budget is far removed from the idyllic picture portrayed which presents it as a mirror-like reflection of the ``collective expression of will" of American citizens. Its structure, and the priorities given to particular programmes are determined in accordance with the desires of powerful ``pressure groups" which at times gain great influence. The widely advertised projects for improving the distribution of incomes by creating a ``welfare state" _-_-_

~^^1^^ ``In the mid-fifties defense expenditures were rather more than half of all the expenditures of the federal government and rather more than the total expenditures of states and localities combined. Were these sums to become available in any considerable part for the civilian services of Governments in the years ahead, social balance could be quickly restored.'' (Ibid., Cambridge, 1958, p. 312.)

~^^2^^ See Robert H. Haveman, The Economics of the Public Sector, John Wiley & Sons, Inc., New York, 1970, p. 220.

35 which spends a substantial part of the budget revenue for satisfying the needs of the poorest groups of the population as a rule, fail to achieve a set objective. In princple ``the welfare state" is in duty bound to maintain a ``minimum standard" of income, health and education of the population and to rectify by its actions the most glaring disproportions in these spheres. Occasionally, the functions of ``the welfare state" are more widely interpreted and they include general regulation of economic activity.^^1^^

Opposition to increasing government spending for social needs is very strong in certain political circles of the United States. As will be subsequently shown, these expenses are usually the first to be cut as soon as the need arises to increase the military, foreign aid and other related expenditures which in present-day conditions have unchallenged priority over everything else. Nor is it accidental that for many years spending for social needs in relation to total budget expenditures as well as to national income has been considerably lower in the United States than in other developed capitalist countries.'^^2^^

The characterisation given by the American economist, Harold L. Wilensky, is quite apt: ``Ours is a reluctant welfare state."^^3^^ Such a situation cannot be regarded as accidental. The public sector ``built into" the capitalist economy is subordinated to the general laws of this socio-economic formation. In the ``private''-``collective'' policy mix, private interests dominate. Moreover, social groups possessing wealth and power are exerting a great influence on the real political process which ultimately determines the economic measures of government agencies.

The inability of the capitalist state to solve urgent problems of economic and social development are sharply criticised by various sections of American society. Professor Martin Bronfenbrenner, chairman of the Department of Economics of the Carnegie-Mellon University, sums up the views of radically-minded circles in the US concerning the _-_-_

~^^1^^ Alfred J. Kahn, Theory and Practice of Social Planning, Russel Sage Foundation, New York, 1969, pp. 42, 43.

~^^2^^ See Richard A. Musgravc, Fiscal Systems, Yale University Press, New Haven and London, 1969, pp. 95, 360--61.

~^^3^^ Quoted after Albert J. Kahn, op. cit., p. 51.

36 capitalist system. He points to the equal distribution of income, wealth, and power within individual countries. In many countries too many resources are allocated to private goods consumed by the upper and middle classes, and to military goods, too little to public goods and services, used by the poor as routes to equalisation of income and wealths. Another aspect of misallocation is the ignoring of the set of social costs (externalities) involved in the term 'quality of life'---pollution, alienation, over-population, and resources exhaustion. He also mentions failure either to eliminate or greatly mollify racial discrimination.^^1^^

As we see, all this is linked to one degree or another with the budget, its structure, the dynamics of its main items and government fiscal policy. These specific ``financial'' questions which represent a definite aspect of the more general problems of development of capitalism are examined in subsequent sections of the book.

__ALPHA_LVL2__ 3. STRUCTURE OF PUBLIC FINANCE

Formally, the budget represents a group of tables which outline in smaller or greater detail the different items of revenue and expenditure. But, as pointed out earlier, these tables conceal the real mechanism of state power and the determination of the most important political decisions. No government programme can be implemented without appropriating the necessary funds. Aaron Wildavsky, a specialist on problems of political decision-making, offers the following characteristic of the US budget: ``Taken as a whole the federal budget is a representation in monetary terms of governmental activity. If politics is regarded in part as conflict over whose preferences shall prevail in the determination of national policy, then the budget records the outcomes of this struggle. If one asks, 'who gets what the government has to _-_-_

~^^1^^ See Martin Bronfenbrenner, ``Radical Economics in America: A 1970 Survey'', journal of Economic Literature, September 1970, Vol VIII No. 3, p. 749.

37 give?' then the answers for a moment in time are recorded in the budget. If one looks to politics as a process by which the government mobilizes resources to meet pressing problems, then the budget is a focus of these efforts."^^1^^

The government functions are thus specifically reflected in the budget structure. We shall analyse these functions in more detail in later chapters but shall confine ourselves in this section to a general characterisation of the features of the U.S. system of public finance.

The state financial system in the USA corresponds to the three-level structure of organisation of political power: the federal government, the state governments and the local governments. Correspondingly there are three levels of financial organisation---federal finance, state finance and local finance.

According to census statistics, the United States has more than 92,000 various government units, the overwhelming majority of which belongs to the lower, local level. Thus in 1962 total number of 91,158 government units included 3,040 counties, 17,144 towns and townships, 17,956 municipalities of big cities, 34,668 school districts and 18,301 other units (rural districts, police precincts, fire protection districts). Territorially the boundaries of these units do not coincide. Thus the residents of one county may belong to different municipalities, school districts, and so on. All these units secure their financing through taxes and excises, appropriations from higher level government, and the like, and they allocate these resources in the course of performing various functions within their jurisdiction. Each unit thus has its own financial draft plan which is included in the general category of local budgets. Units at a higher level---the state governments and the Federal Administration---also perform the full range of budget functions: collect taxes, spend money, issue loans. Such a structure of the financial system gives rise to the vast complex of intergovernmental financial relations and in addition requires considerable effort to co-- ordinate operations at different levels. Moreover, the relations between the financial system of the state, on the one hand, _-_-_

~^^1^^ Aaron Wildavsky, The Politics of the Budgetary Process, Little Brown and Company, Boston, Toronto, 1964, p. 4.

38 and the population and capitalist enterprises, on the other, are quite complicated.

Duplication of functions, multistage system of taxation, absence of precise criteria for the separation of financial functions of various governmental units---all this makes the USA financial system inflexible and leads to the lack of coordination in the work of separate parts of the state financial mechanism.

The principles governing the proportional distribution of tax receipts, collected by the state, among the various financial levels have become a most urgent political and social problem. The historically developed proportions, together with the steadily increasing share of the federal government, have ultimately led to a chronic financial crisis of the state and local governments and seriously restricted the possibilities of performing important social functions.

The growth of military spending at the end of the 1960s caused by the participation of the United States in the war in Vietnam had much to do with the origin of the crisis of state and local nances. Walter W. Heller, an American economist, notes that ``Vietnam, of course, has postponed the happy day when the hopes of the states for some new and generous form of federal financial support can be realized".^^1^^ The financial base of the state and local governments is extremely weak because of the specific tax structure which ensures a much smaller influx of revenue at the lower levels in comparison to the expanding requirements in additional funds for spending. ``At the Federal level,'' Heller writes, ``economic growth and a powerful tax system, interacting under modern fiscal management, generate new revenues faster than they generate new demands on the Federal purse. But at the state-local level, the situation is reversed. Under the whiplash of prosperity, responsibilities are outstripping revenues. As Galbraith has suggested, prosperity gives the Federal government the revenues, and the state and local governments the problems."^^2^^

The leading place occupied by the federal budget is _-_-_

~^^1^^ Walter W. Heller, New Dimensions of Political Economy, Harvard University Press, Cambridge, Mass., 1966, p. 120.

~^^2^^ Ibid., p. 118.

39 determined not only by the high share in revenue and expenditure operations but by the nature of the governmental programmes financed under this budget which exert a profound and multifarious influence on the country's economy, national economic policy and living standards of various groups of the population. The specific nature of the expenditure of the federal budget is shown in the following table (see p. 40).

Military spending occupies the leading place in federal expenditures. Together with US government spending of an international nature, it comprises 52 per cent of all the federal government expenditures and more than one-third of the total government spending at all levels. The second big item in the federal budget is interest payments on the general debt. As for education, public health and other social needs, their share in the federal budget is relatively small.

The multiplicity of functions of the contemporary state leads to multiplicity of fiscal operations. Correspondingly there are in use various budget concepts.^^1^^

For many years the term ``Federal Budget" was associated with the concept of the Administrative Budget. This concept is reflected in the Budgeting and Accounting Act of 1921 which authorised the US President to regularly submit to the Congress a bill on the allocation of the federal financial resources among the various governmental departments and agencies. The Administrative Budget consequently reflected the operations of institutions for which the US Congress regularly makes appropriations. At first this form of the budget fully embraced all types of governmental activity. But the situation changed in the 1930s when the so-called ``self-financing programmes" appeared which are not approved by Congress and are not included in the Administrative Budget. These programmes, most of which are covered by specially designated taxes and loans, include government social insurance funds and financial operations of a number of institutions controlled by the federal government. In the budget for the 1970 fiscal year these programmes were _-_-_

~^^1^^ The Federal Budget as an Economic Document. Prepared for the Subcommittee on Economic Statistics of the Joint Economic Committee, Congress of the United States, US Government Printing Office. Washington, 1962, Chapter Seven, pp. 109--28.

40 Table 1-4 Expenditures of the Federal, State and Local Governments, by function, for 1968 fiscal year Amount, million dollars Percentage distribution Function All governments Federal State Local All governments Federal State Local National defence and international relations 83,874 83,874 --- --- 35.5 55.2 --- --- Space research and technology 4,645 4,645 --- --- 2.0 3.1 --- --- Postal service 6,485 6,485 --- --- 2.7 4.3 --- --- Education* 43,614* 7,184 24,279 30,237 18.5 4.7 40.2 47.0 Highways 14,654* 4,464 1 1 ,848 4,713 6.2 2.9 19.6 7.3 Natural resources 9,200* 7,001 2,005 522 3.9 4.6 3.3 0.8 Health and hospitals 10,580* 3,751 4,203 3,806 4.5 2.5 7.0 5.9 Public welfare 11,245* 6,794 8,649 4,828 4.8 4.5 14.3 7.5 Housing and urban renewal 2,841* 1,995 103 1,614 1.2 1.3 0.2 2.5 Air transportation 1 ,360* 917 96 448 0.6 0.6 0.2 0.7 Social insurance administration 1 ,378* 1,363 606 --- 0.6 0.9 1.0 --- Interest on general debt 14,873 11,607 1,128 2,138 6.3 7.6 1.9 3.3 Other and combined 31,601* 11,909 7,478 16,087 13.4 7.8 12.4 25.0 Total 236,348* 151,990 60,395 64,393 100.0 100.0 100.0 100.0

* Aggregates exclude duplicative transactions between levels of government. Source- Statistical Abstract of the United States 1970, p. 407.

2 3 41 estimated at $54,900 million, that is, they made up more than cne-fouth of the entire expenditure of the federal budget.

The desire to more fully encompass and forecast government budget operations led to the employment of a wider concept, Consolidated Cash Budget. It registers all money receipts and payments between the federal government and the rest of the world, including operations not shown in the Administrative Budget. The specific feature of the Consolidated Cash Budget, besides fully encompassing financial operations, is that its combined totals (the excess of revenue over expenditure or deficit) determine changes in government borrowings.

A third concept of the federal budget became popular in the 1960s. It is connected with the analysing of the public sector as an integral part of the entire economic system. We refer to the National Income Account Budget which includes only the operations of the federal government connected with the current production of goods and services. For its range this concept of the budget is close to the Consolidated Cash Budget but has a number of specific features.

The parallel use of different budget concepts had great inconviniences. After working for several years a special body appointed by the President proposed an improved form, a Unified Budget.^^1^^ It is under this title that the federal budget has been compiled since the 1969 fiscal year.

The Unified Budget contains a considerably greater volume of information than the previous budgetary documents. It indicates the sums of new appropriations approved for the current year and the balance of appropriations remaining from earlier years; data on governmental credits to local authorities and foreign borrowers, the deficit of the budget and sources of covering it, changes in the cash balances of the Treasury, government loans. In size it is close to the Consolidated Cash Budget. Thus, in the 1969 fiscal year the Unified Budget revenues totalled $149,600 million, the Consolidated Cash Budget $153,600 million, the Administrative _-_-_

~^^1^^ Report of the President's Commission on Budget Concepts, US Government Printing Office, Washington, 1967.

42 Table 1-5 Federal Budget Receipts and Outlays, 1929--1973 (million dollars) 43 continued Fiscal year Receipts Outlays Surplus or deflci t 1965 116,833 118,430 -1,596 1966 130,856 134,652 -3,796 1967 149,552 158,254 -8,702 1968 153,671 178,833 -25,161 1969 187,784 184,548 3,236 1970 193,743 196,588 ---2,845 1971 188,392 211,425 -23,033 1972 197,827 236,610 ---38,783 1973 220,785 246,257 -25,472 Fiscal year Receipts Outlays Surplus or deficit Administrative Budget 1929 3,862 3,127 734 1930 4,058 3,320 738 1931 3,116 3,577 -462 1932 1,924 4,659 -2,735 1933 1,997 4,598 -2,602 1934 3,015 6,645 -3,630 1935 3,706 6,497 -2,791 1936 3,997 8,422 -4,425 1937 4,956 7,733 -2,777 1938 5,588 6,765 -1,177 1939 4,979 8,841 -3,862 Consolidated Cash Budget 1940 6,879 9,589 -2,710 1941 9,202 13,980 -4,778 1942 15,104 34,500 -19,396 1943 25,097 78,909 -53,812 1944 47,818 93,956 -46,138 1945 50,162 95,184 -45,022 1946 43,537 61,738 -18,201 1947 43,531 36,931 6,600 1948 45,357 36,493 8,864 1949 41,576 40,570 1,006 1950 40,940 43,147 ---2,207 1951 53,390 45,797 7,593 1952 68,011 67,962 49 1953 71,495 76,769 ---5,274 Unified Budget 1954 69,719 70,890 -1,170 1955 65,469 68,509 -3,041 1956 74,547 70,460 4,087 1957 79,990 76,741 3,249 1958 79,636 82,575 -2,939 1959 79,249 92,104 -12,855 1960 92,492 92,223 269 1961 94,389 97,795 -3,406 1962 99,676 106,813 -7,137 1963 106,560 1)1,311 -4,751 1964 112,662 118,584 -5,922

Note: For the 1971 fiscal year the table contains preliminary data on the actual fulfilment of the budget and for the 1972 fiscal year the draft.

Source: Economic Report of the President 1972, p. 269.

Budget $115,900 million; the expenditures respectively were $158,400 million, $155,100 million and $125,700 million; the budget deficit was $9,300 million, $1,500 million and $9,800 million.

With the introduction of the new category of the budget, the financial operations of the government were recalculated for a number of years including 1954 in accordance with the new system. For earlier years data of the Administrative and the Consolidated Cash Budget are used.

4. THE BUDGET-MAKING PROCESS

Before going over to a detailed analysis of budgetary revenue and expenditure and the long-range shifts in the structure of the major financial operations of the federal government (Chapters II-1V) and state and local authorities (Chapter VI), it is necessary to discuss in brief the budgetary process or the ``budget cycle" in the United States, i.e., the procedure of drafting, discussing and approving the budget. It would be wrong to think that this is a purely technical question. Here we deal with the essence of the intricate 44 mechanism employed in the making of political decisions in the USA. In the course of drafting the regular budgetary document, which takes many months, the aims and principles of the Administration's policy, its programme on major problems of development are clearly revealed. During this period various political forces and groups manoeuvre and clash. ``The size and shape of the budget,'' Wildavsky writes, ``is a matter of serious contention in our political life. Presidents, political parties, administrators, Congressmen, interest groups, and interested citizens vie with one another to have their preferences recorded in the budget. The victories and defeats, the compromises and the bargains, the realms of agreement and the spheres of conflict in regard to the role of national government in our society all appear in the budget. In the most integral sense the budget lies at the heart of the political process."^^1^^

In some American publications and textbooks on governmental finance the budgetary procedure in the USA is pictured as an integral part of the ``democratic system of government''. It is asserted that the budgetary document, elaborated in this way, best reflects the ``collective interests" of different groups and sections of American society. The authors of such works contend that only through political bargaining, conflict and compromise is it possible to assure ``equal representation" of different social groups and thus bring about a situation in which not one of them can impose its will and decisions on the majority. The budgetary procedure in the United States is held up in contrast to other budgetary systems, including the planned principles of determining the budget structure, as an expression of the supreme values of bourgeois society---competition and free, enterprise.

The question arises, whether the extremely cumbersome and time-consuming procedure of drafting the budget ensures the making of truly unbiased and rational decisions equally acceptable to all or at least to a majority of American citizens? Is the most efficient allocation of the financial resources accumulated by the government thus attained? Does the system of numerous hearings and discussions of the _-_-_

~^^1^^ Aaron Wildavsky, Op. cit., pp. 4-5.

45 budget by tens of Congressional committees and subcommittees effectively control the actions of the Executive? In other words, does all this ensure the checks-and-balances of the government, the system so much praised in textbooks, wherein the financial decisions of governmental agencies are controlled by the President, the operations of the President checked by Congress and the actions of Congress determined by the American people?

A discussion of these questions in the American press shows that it is impossible to give an affirmative answer to any of these questions. The American system of drafting and approving the budget is extremely wasteful in the sense of spending time and effort of governmental personnel; it in no way guarantees the economic rationality and the ``just and equal representation" of all sections and groups of American society. Moreover, this system creates the ground for abuses and is exceptionally beneficial for powerful Big Business groups. The inexpediency of the budgetary system and the scandalous cases of abuse have been so widely publicised in the press that the question of a major reform of budgetary procedure has for many years been repeatedly raised and discussed by financial experts and political leaders.^^1^^

And now a few words about the existing system. Under the American Constitution, the President has no right to spend a single cent before the sum is approved by a corresponding legislative act which provides for the appropriation of money for some concrete government programme. The budgetary process is divided into two big cycles: 1) Drafting of the budget document which is entrusted to the US President but is practically prepared by the staff of his economic advisers; 2) examination and approval of the budget by the US Congress.

_-_-_

~^^1^^ See on this question Jesse Burkhead, Government Budgeting, New York, John Wiley & Sons, Inc., London, 1956; Arthur Smithies, The Budgetary Process in the United States, New York, 1955; Charles E. Lindblom, ``Decision-Making in Taxation and Expenditure'', in Public Finances: Needs, Sources and Utilization. A Conference of the Universities---National Bureau of Economic Research, Princeton, 1961, pp. 295--334; Charles E. Lindblom, ``Policy Analysis'', The American Economic Review, Vol. XLV1II, No. 3, June 1958, pp. 298--312.

46

The American budgetary procedure differs essentially from that of other capitalist countries in that in the United States the original draft of the budget, as a rule, has very little in common with the finally accepted version. In Britain, for example, Parliament does not intervene in the budget-- making process---it either approves or rejects the bills submitted by the government, expressing in the latter case a vote of no confidence in the government. In the United States, however, the budget bill submitted by the President is repeatedly redrafted in Congressional committees and subcommittees.

The drafting of the budget starts long before the fiscal year begins (usually 18 months in advance).^^1^^ The heads of the government agencies and departments submit at the beginning of the preparatory period estimates of the material and manpower resources they need, and, on this basis, calculations are made of the necessary money appropriations. At this stage an important role is played by the Bureau of the Budget which is part of the Executive Office of the President. The main function of the Bureau of the Budget (in July 1970 it was renamed the Office of Management and Budget) is to evaluate the needs of departments, determine the necessary sums and draw up a draft of the planned budgetary expenditures. The head of this Office keeps in constant contact with the President and his economic advisers. That is why the final version of the budget bill reflects the President's ideas and preferences, his evaluation of political aims and of the prospective economic development. As for budget revenue, it is forecast by the Council of Economic Advisers on the basis of the prospects of change in economic activity. In January of every calendar year the President submits to Congress a Budget Message which sums up the main trends and features of financial activity of the government in the forthcoming fiscal year. The detailed budget document is attached to the President's Message.

The serious imperfection of the budgetary procedure is revealed already at this stage. Since the budget is not a part of a national economic plan in which the major elements _-_-_

~^^1^^ In the United States the fiscal year begins on July 1 of the current year and ends on June 30 of the next year, its name corresponding to the calendar year in which it ends. Thus the fiscal year beginning July 1, 1971, and ending June 30, 1972, is called the 1972 fiscal year. '

47 and proportions of the economic process are balanced and mutually linked together, co-ordination of different government programmes is exceedingly difficult. Departments do not have precise objective criteria and guidelines for determining the prospects for the development of various programmes.

In submitting applications for appropriations, the heads of departments follow the practice of ``squeezing out" as much money as possible. Congress, on the other hand, tries to curtail to the utmost appropriations for needs which are considered secondary. This bureaucratic game, in which the departments try to get more and the Congress to give less, does not ensure the best procedure for the allocation of financial resources. The entire budgetary cycle ultimately is linked with the making of three major decisions at the three main levels: how much to ask (departments and government agencies), how much to recommend (the Office of Management and Budget) and how much to approve (the respective committees in the Senate and the House of Representatives).

In principle the problem of evaluating and allocating budgetary appropriations is very intricate in itself. But under capitalism it is further complicated by the spontaneous nature of the production processes, the absence or a sufficient degree of coordination in the development of individual economic sectors, enterprises and regions. The lack of coordination is not eliminated and at times is even accentuated because of the employment of bureaucratic methods to coordinate the decisions of participants in the economic process. This is revealed with particular clarity during the allocation of budget appropriations when the purely mechanical procedure of curtailing programmes causes, in turn, a series of defensive measures by government departments and agencies designed to outwit the distributors of the government financial resources.

In these conditions the calculation process loses the nature of an economic process and assumes the character of a political game. In setting the requested sums the heads of departments are usually least of all guided by considerations of economic rationality, comparative costs and effectiveness, rather they act on the principle of ``what will go''. The general ``rules of the game'', elaborated by practical experience, 48 are usually taken into account. It is known, for example, that new programmes pass through Congress with much difficulty. Jf a programme, however, has been launched and is handed down from budget to budget over a number of years it is much easier to get appropriations for it even if its inefficiency has been revealed. An ``irrefutable'' argument usually employed is: so much has already been spent on the programme that its closing would mean an admission that the amounts spent had been wasted. At the same time it is very difficult to convince Congress to accept some new, perhaps even very important, programme. That is why departments resort to various artifices. For example, the real cost of a programme is originally underestimated in the hope that once it is accepted it will be possible in future endlessly to ``squeeze out" money from the Treasury for it. Thus Congress is deliberately misled as to the actual cost of a programme.

The situation in the Office of Management and Budget, whose staff sees its major task in reducing appropriation requests by departments and agencies of the Government, does not improve the efficiency of the present fiscal system. The true character of calculations made in this Office is clearly revealed by Wildavsky who cites in his book excerpts from his conversation over appropriations for the National Institute of Health (NIH). A Bureau of the Budget official admitted that there were no precise schemes for evaluating the needs of medical institutions. On the question of criteria by which the Bureau of the Budget determines appropriations, the official stated that a kind of mechanical approach was taken, such as leaving it at the same level as last year or last year's budget plus 10 per cent of new grants or simply a 10-per cent increase against last year.

When the President transmits the proposed budget to the Congress, each item of expenditure is examined by the House and the Senate twice. The first round is called `` authorisation" and means the approval of the programme itself; the second round is called ``appropriation'', that is, the allotment of necessary funds to fulfil the programme. Approval of the programme by no means implies that the appropriations will be automatically assigned for it. Strategic positions are held by the respective subcommittees in the House and the 49 Senate which ultimately make the major decision providing the programme with the necessary financial funds. Examination of the budget by Congressional committees ends with the adoption of the respective legislative acts (at present 13 regular appropriation bills are adopted). Each of them provides for the allocation of funds for implementing certain government functions (national defence, military construction, foreign aid, agricultural price support, etc.). Only after approval of the bill can the government department or agency write checks against the Treasury balances with the Federal Reserve System to make payments to its suppliers.

The procedure of examining and approving the budget in the US Congress was developed over a long period of time. It was elaborated in expectation that people through its representatives in Congress would effectively supervise government spending. Realities, however, proved to be far removed from these expectations. American writers often characterise the budget-making process as ``wasting time'', ``archaic'' and ``ineffective''.

Let us merely enumerate some of the most serious defects of this system.

1. Congress discusses not the budget as a whole but its separate sections or parts. Neither the House nor the Senate examine the budget in its entirety.

Thus recommendations on the structure of budget revenues are examined by three committees: the Committee of Ways and Means of the House of Representatives, the Senate Finance Committee and a Joint Committee on Internal Revenue composed of a few leading members of these two committees. The work of all these bodies is considerably hampered by the customary delay in approving appropriation bills which are examined in other Congressional committees. Changes in tax rates and the introduction of new taxes is a very difficult and long process. So the work of the committees approving budget revenues is practically unco-ordinated with the planning of budget expenditures. The task of financial planning is further complicated by the practice of approving only new appropriations for the forthcoming fiscal year, whereas the Administration can utilise unspent balances of appropriations approved from previous years.

The budget expenditure programmes are discussed in __PRINTERS_P_49_COMMENT__ 4---62 50 each chamber in two rounds in a fragmentary way. Initially, specific programmes are discussed at the hearings of the respective legislative committees of Congress. Altogether there are 33 such committees (18 in the House and 15 in the Senate). In addition each committee has numerous subcommittees where the main work of examining the programmes is done.^^1^^ Bills on specific appropriations are examined by full committees.

Finally all the differences between the House and the Senate are resolved through ad hoc conference committees. The discussion and approval of programmes takes many months.

The second round leads to the approval of appropriations. The bills are discussed at the hearings of the Appropriation Committees of the House and the Senate, which have 13 subcommittees in the House and 14 in the Senate. Each bill may be repeatedly discussed from subcommittee to committee and the final joint conference of the committees of the two Houses for the settling of differences is repeated.

It is clear that the fragmentary character of approving expenditures, and the lack of co-ordination in planning revenue and expenditure preclude a comprehensive approach to the budget as a single document.

In this connection plans to reform the budgetary procedure have been repeatedly proposed in order to improve co-ordination of action by different committees of Congress. As early as 1946 the Reorganisation of the Legislature Act contained a proposal for setting up a Joint Budget Committee composed of members of the revenue and appropriations committees of both Houses. But a year later this committee failed to function: powerful forces in Congress (especially in the House of Representatives) were opposed to this committee and paralysed its work. Heads of the subcommittees, who held key positions and disposed of appropriations, did not wish to lose their influence in the US political scene by transferring some important functions to the Joint Committee.

2. Discussions of appropriations are usually limited to one fiscal year, thus blurring the legislators' vision. Programmes _-_-_

~^^1^^ Committee for Economic Development. Making Congress More Effective, New York, September 1970, Appendix.

51 designated for many years operate chiefly in the military establishment. The result is that attention is concentrated primarily not on programmes in their entirety, nor on the fulfilment of a definite long-range economic task, but on the estimates of expenses of one or another government department for one year. It is clear that such an approach is by no means efficient.

3. Many American writers expose procedures which operate under the veil of a ``democratic discussion" of the budget and ``consideration of public interests''. The subcommittees discuss bills behind closed doors. Moreover, the process of decision-making in many of the subcommittees takes place under the dominating influence of the chairman or a group of members who hold their posts for many years. These legislators are often connected with ``pressure groups'', with powerful lobbies, and they are able to push through decisions they want or to block for many years the passage of unwanted bills. Here for example is what Jacob Viner, a well-known American economist whom it is difficult to suspect of a biased attitude to the US Congress, has to say on this point: ``There is ... the almost promiscuous and haphazard dispersal of power within each branch of the legislature, where the weakness of party discipline and the possession of nearly unlimited veto power and delaying power by the committee chairman, who acquire their posts by seniority regardless of the degree and quality of their ability, ... result in the process of legislation being largely subject to the idiosyncrasies and the special interests of a small group of men whose qualifications for meeting the heavier responsibilities they bear [whether it be qualities of ability or of character.---The Author.] are even more subject to the hazards of chance than the outcome of a horse-race or a football match. .. . The run-of-the-mill congressman or senator in initiating, delaying or modifying specific legislative proposals, which results in making extremely difficult and even impossible the attainment of coherence, timeliness, and self-consistency in the legislative processes as a whole and in making unduly important the role of the lobbyist for special interests, private or regional, who to attain his objectives, good or bad, often needs not the approval of the President or of the administration or

52

of the majority party as a whole or of national public opinion or of the press, but only the dedicated and not necessarily disinterested support of a small handful of free-- wheeling legislators."^^1^^

4. The central function of Congress as the ``controller of public funds" is undermined by the fact that a substantial part of the resources can be spent by government departments essentially without any control. This applies to many categories of ``self-financing programmes''. Furthermore, a discussion of the budget bill for the next fiscal year is only linked with approval of new obligational authority which do not contain the obligations of departments to spend this money and, what is most important, do not regulate the use of the ``outstanding balance" of unutilised appropriations of previous years. This not only reduces to naught the control functions of Congress but also prevents the ``closing out" of inefficient programmes approved by preceding Congresses. William Henderson and Helen Cameron point out: `` Congress may never really know how much money in toto it has appropriated for a particular function or agency and obviously cannot know the effects of an unknown expenditure pattern."^^2^^ The authors cite the following example: In the 1968 fiscal year with the administrative budget totalling $135,000 million, only $61,000 million (45 per cent) of all appropriations could be placed in the category of `` controlled''. Among the appropriations not subject to control are outlays under unutilised appropriations for previous years, expenditures under permanent programmes, expenditures of Government-owned enterprises, open programmes, liquidation of contracts, payments to trust funds and other operations.

5. What extremely complicates the procedure of adopting the budget in the Congress and results in a waste of time is the fact that at the beginning of the fiscal year government departments and agencies as a rule do not know what sum will be allotted to them for the coming year. Thus, by _-_-_

~^^1^^ Jacob Viner, ``The United States As a 'Welfare State' '', The Nation's Economic Objectives, Chicago University Press, Chicago, 1964, pp. 165--06.

~^^2^^ William L. Henderson, Helen A. Cameron, The Public Economy: An Introduction to Government Finance, New York, 1969, pp. 85--86.

53 July 1, 1969, that is, at the beginning of the fiscal year, not one of 13 regular appropriation bills was approved by Congress. At the beginning of August 1969, six bills passed through the House, two through the Senate, but not one was approved at the joint conference of committees where final agreement between the two Houses of Congress is reached. At the beginning of October, 1969, only one bill, covering altogether two per cent of the appropriations, was enacted and became law. Lastly, in March 1970, only four months before the end of the fiscal year, one bill, amounting to $19,000 million, was still not approved (it was vetoed by the President).^^1^^ The passage^of bills, requiring additional appropriations including expenditures for purposes not envisaged in the major bills, is even more delayed. One bill of this kind was signed by the President on July 22, 1970, i.e., three weeks after the end of the fiscal year.^^2^^

6. The President has the right to veto a bill and return it to Congress for repeated examination. But the peculiarity of this action is that a veto can effect only the entire bill and not some specific part or item. This creates another loophole for various abuses and the railroading through of appropriations beneficial for definite groups, corporations or individuals. Various items which obviously run counter to the public interest but which the President, as individual Congressmen hope, will be forced to accept in order not to reject the bill as a whole, are tacked on to a general bill that includes hundreds of items. Usually these hopes are justified.^^3^^

These and many other defects of the budgetary procedure are targets of withering criticism. But the fact that they are preserved shows that the complexities of this procedure are of advantage to some forces in American society and are products of the pattern and peculiarities of the entire political system. Attempts to improve the efficiency of the _-_-_

~^^1^^ Committee for Economic Development. Making Congress More Effective, p. 24.

~^^2^^ Ibid.

~^^3^^ Such a supplement to a bill is known in the lobbyist language as a ``rider'' (Troy J. Cauley, Public Finance and the General Welfare, Columbus, Ohio, 1960, pp. 17--18).

54 budgetary procedure by adopting and applying in practice normative criteria, are doomed because they irreconcilably contradict political reality, the system of organisation of political power in the United States. ``The budget,'' Wildavsky writes, ``is the lifeblood of the government, the financial reflection of what the government does or intends to do. A theory that contains criteria for determining what ought to be in the budget is nothing less than a theory stating what the government ought to do....

``A normative theory of budgeting would be a comprehensive and specific political theory detailing what the government's activities ought to be at a particular time. A normative theory of budgeting, therefore, is Utopian in the fullest sense of that word."^^1^^

Wildavsky lays bare the essence of the budgetary process, seeing it as an answer to the question, ``whose preferences are to prevail in disputes about which activities are to be carried on to what degree, in the light of limited resources. The problem is not only 'how shall budgetary benefits be maximized?' as if it made no difference who received them, but also 'who shall receive budgetary benefits and how much?'~"^^2^^ The author correctly points to the impossibility of finding a satisfactory solution to the problem of allocating budgetary funds in the conditions of the socio-political system existing in the USA. It is impossible to treat as a single collective with common aims, a society, in which classes and social groups are divided by irreconcilable contradictions. It is impossible to find ``a purely economic solution to the question" and to try to maximise the budgetary benefits irrespective of the problem of distribution of income, that is, without furnishing an answer to-the political question: for what groups (to be more exact, classes) one or another governmental measure is of benefit, who will gain and who will lose by its implementation?

In the early 1960s, a budget programming was for the first time instituted by the US Department of Defence on the initiative of Robert McNamara who was at that time Defence Secretary. A programme of long-term planning of the _-_-_

~^^1^^ Aaron Wildavsky, Op. cit., pp. 128--29.

~^^2^^ Ibid., pp. 129--30.

55 military expenditure was formulated at two levels: first, the drawing up of a five-year plan of the basic programmes and second, the planning of departmental weapons systems within each programme. The direct and indirect expenses for each section were calculated and the ``benefits'', if they can be called such, from the application of different alternative ``systems'', were evaluated.

In 1965 President Johnson decided to extend the planning-programming-budgeting system (PPB) to other governmental departments.^^1^^

Budget programming can promote a more precise determination of the efficiency of various programmes and thereby eliminate the most glaring absurdities of the present budgetary process. But it in no way changes the system of priorities and the existing procedure upon which the main political decisions are based: the chief criteria of the budgetary structure are already determined from the outside, regardless of the ``scientific'' recommendations and conclusions of experts. Behind-the-scenes pressure of powerful ``interest groups'', linked with the Congressional `` appropriation machine'', definitely precludes any possibility of optimising the US budgetary procedure.

_-_-_

~^^1^^ See Committee for Economic Development. Budgeting for National Objectives, A Statement by the Research and Policy Committee, January 1966, New York, 1966, pp. 21--22.

[56] __NUMERIC_LVL1__ CHAPTER II __ALPHA_LVL1__ FEDERAL BUDGET EXPENDITURE __ALPHA_LVL2__ [introduction.]

The enumeration of budgetary appropriations serves, as it were, as a distinctive mirror, in which the interrelations of the different political, economic and social functions of the federal government receives a precise quantitative reflection. Of interest in this respect are the changes in the structure of governmental spending in recent decades.

Throughout the post-war period the expenditures of the federal government linked with current military spending and past wars have, as a rule, exceeded the entire sum spent for civilian purposes. At present, as shown by Table II-1, more than two-fifths of the federal budget goes directly for military purposes. Another one-eighth of the budgetary appropriations is spent on benefits to war veterans and interest on the federal debt. Of the federal government's total debt of $367,000 million (at the end of the 1969 fiscal year) more than $220,000 million are for the period of the Second World War (1939--1945 fiscal years). Therefore not only veteran benefits and services but the bulk of the expense on the federal debt, represent financial burden connected with the military preparations in the preceding period. Thus, more than half of the total expenditure of the US federal budget is allocated for military purposes.

Until now periods of a steep rise in the federal budget were invariably marked by an increase in appropriations for military purposes. Thus, during the years of the Second 57 __MISSING__ Table. II-1 58 World War alone, budgetary spending greatly exceeded the total sum of military and civilian spending under the federal budget throughout the preceding history of the United States.

At the same time in the last 100 years the following feature of the federal budget was clearly revealed: in the peaceful periods which set in after the First and Second world wars military spending was invariably stabilised at a level which substantially exceeded the previous pre-war scale. Thus, after the First World War (1921--1925), the average of the US armed forces personnel was twice as high and the average annual military spending (calculated in unchanging, 1945, prices) was almost three times as much as before the war (1909--1913). After the Second World War (1947--1949), the strength of the armed forces increased almost six times and the current military expendinture, seven times as compared with the pre-war period (1935--1939). In the subsequent period this tendency was further accentuated. During the period of the escalation of the war in Indochina the total sum of military spending (taking into account the depreciation of the dollar) exceeded the expenditure of the federal government in waging the First World War. Mr. Dwight Eisenhower, who directly led the operations of the American forces during the Second World War and later became President of the USA, subsequently noted the tendency towards the steady growth of military preparations in peaceful years and pointed to the danger of the gradual conversion of the United States into a ``garrison state''.^^1^^

It goes without saying that to maintain the country's military preparedness at the same level in conditions of steadily developing inflation more money is needed. But the growth rate of the military expenditure is much higher than the growth rate of inflation. This is in the first place linked with the further build-up of the military potential. Thus, according to data of Professor Melman, in the 1964 fiscal year, close to two-fifths of the money spent for the purchase of armaments represented expenditures for the maintenance of military preparations at the former level, while three-- _-_-_

~^^1^^ New York Times, March 12, 1959, p. 12.

59 fifths were utilised for building up the striking power of the US armed forces.^^1^^ The swift stockpiling of weapons has always been fraught with the danger of truly disastrous consequences in the even of the unleashing of another way. Within the limits of the present chapter, primary attention is given to the sources and stimuli for increasing direct military spending. At the same time certain aspects of the spending policy of the federal government are examined. These aspects are linked with the needs of long-range economic growth.

__ALPHA_LVL2__ 1. MILITARY SPENDING
OF THE FEDERAL GOVERNMENT

The growth of US military spending throughout the 20th century has been determined above all by the system of priorities applied by the Administration in its activity, and the generally aggressive line of its foreign policy. Characteristically, programmatic statements made by the US Government in the first postwar years most often link Washington's role in settling disputed international questions with its increasing military might and the application of the policy ``from position of strength''. The military preparations of the US Government in recent decades have served as an important activator of a cumulative process in which every step toward more military spending is not only a consequence but also the cause of the further intensification of international tension.

In present-day conditions war and preparations for war make new demands on the national economy. The greater scale and intensity of the armed struggle dictate not only an increase in the numerical strength of the armed forces but also their equipment with increasingly more sophisticated weapons. The rapid development of research in the armaments industry enhances the dependence of a country's war potential riot only on the quantity of weapons but also on their quality.

_-_-_

~^^1^^ A Strategy for American Security. An Alternative to the 1964 Military Budget. Submitted by a Group of Independent Specialists, April 1963, p. 4.

60

The process of ever faster obsolescence of weapons is playing a particularly important role. Some studies and calculations show that no other sector of production is subjected to such frequent renewal and improvement as the manufacture of modern weapons.

The periods for the large-scale re-equipment of the armed forces are also being reduced. Thus, a special study made in the USA in 1955, revealed that the cycle for the complete re-equipment of armaments is on the average 14 years. A similar study made in 1959 disclosed a reduction of up to 10 years in the average life span of weapons.^^1^^ In view of this, the cost of armaments, annually written off by the military establishment as obsolete, is swiftly mounting. In present-day conditions various weapons and strategic materials are annually written off to the tune of $8,000--10,000 million annually. The prices of ``surplus'' stocks sold by the US Department of Defence, as a rule, amount only to 1-2 per cent of the price the Government originally paid for these materials.^^2^^

An increase in prices is one of the major factors making for the absolute growth in the scale of the budget. But, if prices of goods and services paid for by the government rise at the same rate as the general price level, all other conditions being equal, this cannot bring about a growth in the relative share of government spending.

Of interest in this respect, therefore, is a comparison of the dynamics of prices of purchased armaments with the general price index. In a period of 40 years after 1929 the deflator of prices of elements of the gross national product increased by 153 per cent, while the index of prices of goods and services bought by the federal government rose by 273 per cent. But, of the mass of goods and services paid for by the government, we are interested above all in the prices of armaments. For the period of the Second World War we can use data of S. Kuznets which relate directly to prices of war output. The index of prices for these goods rose by 62 per cent, while the general index of prices of all durable _-_-_

~^^1^^ Military Review, Vol. XLI, Number 6, June 1961, p. 6.

~^^2^^ Ladislas Farago, It's Your Money. Waste and Mismanagement in Government Spending, New York, 1964, p. 115.

61 goods rose by 36 per cent.^^1^^ After the conclusion of the war in Korea, between 1953 and 1969, prices of consumer durable goods in the United States rose on the average 12 per cent, of durable goods purchased by entrepreneurs, 38 per cent, and durable goods bought by the government, 43 per cent.^^2^^ At the same time the general level of prices of armaments in the United States is now considerably higher than that in Western Europe.

The particularly swift growth of armament costs is explained by a number of factors. First of all, armaments which are products of prolonged research and development, are characterised by ever greater sophistication and require increasing inputs of skilled labour. For example, to develop the B-17 military plane, used in the Second World War, 200,000 engineer man-hours were needed; to develop the B-52 bomber, 4.1 million hours were already required and the B-58, 9.3 million hours. As for the XB-70 (work on this bomber was completed in the mid-1960s), the input reached about 15 million hours.^^3^^ The amount of labour of engineers and technicians required for the development of missiles on the average is twice as high as that needed for the development of aircraft.^^4^^

The intricate nature of the scientific and technological problems which have to be solved in creating new types of weapons determines the long periods of their development. To this often are also added long debates in Congress concerning appropriations, the bureaucratic procedure in the military establishment, and so on. At the beginning of the 1960s, the period between the conclusion of a contract for the study of the possibilities of producing new aircraft and their regular manufacture, was about 11 years.^^5^^

_-_-_

~^^1^^ Simon Kuznets, National Product in Wartime, New York, 1945, p. 49.

~^^2^^ Calculated according to data of U.S. Income and Output, Washington, 1958; Survey of Current Business, July 1970.

~^^3^^ Aviation Facts and Figures, 195S, Aircraft Industries Association of America Inc., p. 48.

~^^4^^ See Business Week, January 10, 1959, p. 111.

~^^5^^ Merton J. Peck, Frederic M. Scherer, The Weapons Acquisition Process: An Economic Analysis, Harvard University Press, Boston, 1962, pp. 53--54.

62

At the same time the swift advance of science entails the rapid obsolescence of the developed weapon systems. As a result more and more models of weapons already become obsolete at the stage of research and development. According to spokesmen of the US Air Force, of each three elaborated projects ot new weapons, two are obsolete before their production is launched.^^1^^ Consequently, ever greater resources are spent for the development of weapons which turn obsolete even before they become operational.

Government contractors widely exploit these features of the manufacture of modern weapons for additionally raising the prices of goods sold to the government. The increase of prices is also facilitated by the fact that the military establishment, seeking to achieve better tactical and technical properties of new weapons, is little concerned with additional expenses. This further weakens the economic ``brakes'' which restrain the essentially endless process of development of new weapons. One scientific consultant of the US Air Force wrote that ``too much effort is being spent in getting a one per cent greater improvement at a 20 per cent increase in cost".^^2^^

In addition to these technico-economic factors, it is necessary to consider the structural characteristics of the arms market. The point is that the share of governmental enterprise in the production of weapons in the United States is very small: during the 1950s only 2 per cent of the primary military contracts issued by the US Government were filled at state-owned enterprises.^^3^^ This inevitably gives rise to the problem of enlisting private businessmen in sectors servicing the war industry.

In view of intensive scientific and technological progress as well as a number of political factors, the government's demand for specific types of weapons is marked by growing instability. In conditions of increasing uncertainty and risk, _-_-_

~^^1^^ See Department of Defense Appropriations for 1957. Hearings before the Subcommittee of the Committee on Appropriations, US Senate, 84th Congress, Second Session, Washington, 1956, p. 243.

~^^2^^ George E. Vallev, ``Pentagon Profile'', Armed Forces Management, Washington, April 1958, p. 19.

~^^3^^ Planning and Forecasting in the Defense Industries, Ed. by J. F. Stockfish, Belmont, Calif., 1962, p. 145.

63 large corporations undertake the development of a new weapon and its manufacture only when the prices seem sufficiently profitable to them. Moreover, in view of the swift change of weapon models, private firms refuse to make big investments in the most specialised parts of the productive machine of the war industry, in highly capitalised factories of its new branches, and so on. Large corporations in respective industries usually possess sufficient resources for buying all the necessary equipment.^^1^^

But they prefer to shift to the government (that is, ultimately on the taxpayers) most of the increasing commercial risk. Specialised re-tooling at the expense of the government is now becoming one of the main conditions for the migration of capital into the war industries.

While during the First World War approximately onetenth of the expense for building industrial enterprises was financed by the state, during the Second World War already about two-thirds of the total sum of investments in manufacturing industry were made with the government's money.^^2^^ During the post-war years the US Department of Defence financed the building of a number of new specialised productive units. The government's property leased to private contractors working for the US Department of Defence was valued at about $15,000 million in the mid-1960s.

The role which productive units, leased from the federal government, play for some private companies can be judged by the following data. A group of contractors, 12 aerospace companies, utilise government plants worth $895 million, possessing their own facilities with an original cost of $395 million.^^3^^

_-_-_

~^^1^^ ``Though much of this equipment has been special-purpose equipment, contractors might well have purchased it with their own funds if they had had a positive incentive [!] to make the investment" ( Harvard Business Review, January-February 1958, Vol. 36, No. 1, p. 134).

~^^2^^ See John M. Blair, Harrison F. Houghton, Matthew Rose, Economic Concentration and World War II, Washington, 1946.

~^^3^^ Aircraft Production Cost and Profits, Hearings before the Subcommittee for Special Investigations. Committee on Armed Forces, House of Representatives, 84th Congress, Second Session, Washington, 1956, p. 3114. Cited from Merton J. Peck, Frederic M. Scherer, 'The Weapons Acquisition Process: An Economic Analysis, Boston, 1962, p. 166.

64

The very terms of military contracts promote concentration in war production. Thus, in the atomic industry, only 1-3 contractors had a production potential for performing the required technical tasks.^^1^^

In shipbuilding only three or four private firms could, from the viewpoint of the military establishment, undertake to develop nuclear-powered submarines. In the production of missiles the main stages of manufacture are monopolised by two to four of the biggest companies.^^2^^

This procedure can also be observed in the market for the sale to the government of some goods which are not of an exclusively military purpose, for example, strategic raw materials. Thus, one company supplied nickel and two companies provided 85 per cent of all the lead to the federal government.^^3^^

A total of 50 biggest private concerns received from the government about 58 per cent of all the military contracts during the Second World War (1940--1944); over 56 per cent during the war in Korea (1950--1953) and 63--65 per cent in the first half of the 1960s.^^4^^

The specific structure of the arms market imparts a definite imprint on the forms of contracts concluded by the big corporations with the government. The 1947 Act gave the military establishment broad powers as regards the choice of the form of agreement with contractors.^^5^^

_-_-_

~^^1^^ Richard A. Tybout, Government Contracting in Atomic Energy, The University of Michigan Press, Ann Arbor, 1956, p. 98. Let us confine ourselves to the following example: at the beginning of the 1960s bids were called for the manufacture of an atomic reactor. After a preliminary ``screening'' of the 28 companies which offered their services, only three were left: Lockheed, General Dynamics, and Martin-- Marietta, which are among the biggest governmental contractors (See Wall Street Journal, January 30, 1962; ibid., May 18, 1962).

~^^2^^ See Planning and Forecasting in the Defense Industries, p. 152.

~^^3^^ Richard L. Worsnop, ``Government Stockpiling'', Editorial Research Reports, Vol. II, No. 8, 1962, Aug. 22, p. 622.

~^^4^^ William L. Baldwin, 'The Structure of the Defense Market, 1955-- 1964, Duke University Press, Durham, N.C., 1967, p. 9.

~^^5^^ Having signed this Act President Truman remarked that it permitted the armed forces in peacetime ``to use any form of negotiated contract''. See Arthur Smithies, The Budgetary Process in the United States, New York, 1955, p. 298.

65

The spread of new forms of contracts, associated with large-scale research and development work, essentially restricted the traditional process of contract-bidding through free competitive bids. At present military products are overwhelmingly purchased by the government without any competitive bidding, by way of direct negotiation with the largest corporations. Thus, in the 1968 fiscal year as a result of negotiations with only one firm, military contracts were awarded totalling 57.9 per cent of the value of all contracts; moreover, 30.6 per cent were placed through negotiations in which several firms could participate and only contracts comprising 11.5 per cent of the total value were awarded on the basis of free competitive bids.^^1^^

Among the barriers preventing the entry of new companies into weapons production are a number of governmental provisions for the conclusion of contracts along ``package deal" lines, the limited circle of companies given permission to do classified work and the role of preliminary contracts for the development of new types of weapons.^^2^^

Professor Lanzillotti, a well-known expert on industrial organisation, points out that there is a ``defense contract policy which leans heavily on oligopolistic firms'',^^3^^ and B. Cochran notes that in the sphere of weapons production monopoly relations are more fully realised than in the civilian economy.^^4^^

The scale of overpayments linked with the restriction of competition and the spread of the oligopolistic practice in _-_-_

~^^1^^ New York Times, November 12, 1968.

~^^2^^ ``Once a contractor has been selected to develop a new weapons system or subsystem, it is in an extremely advantageous position with respect to receiving subsequent contracts to produce the system. . . . The practise of eliminating some firms from consideration on the basis of past experience or existing capabilities, either before or after bids are requested, constitutes a potential barrier to entry into the weapons industry" (Merton J. Peck, Frederic M. Scherer, The Weapons Acquisition Process: An Economic Analysis, pp. 325, 355).

~^^3^^ Robert F. Lanzillotti, ``Some Characteristics and Economic Effects of Pricing Objectives in Large Corporations. The Relationship of Prices to Economic Stability and Growth'', Compendium of Papers Submitted by Panelists Appearing before the Joint Economic Committee, March 31, 1958, Washington, 1958, p. 453.

~^^4^^ Bert Cochran, The War System. An Analysis of the Necessity for Political Reason, New York, London, 1965, p. 142.

66 price formation is demonstrated by the following fact: surveys have shown that free competitive bids enabled the government to buy weapons 32--46 per cent cheaper than in the case of direct negotiations with only one company.

Thus, in weapons production highly contradictory processes are revealed. The specific features of the manufacture and sale of modern arms facilitate the development of the distinctly pronounced oligopolistic tendencies. On the other hand, intensive research and development in this sphere and the exceedingly dynamic process of renewal of weapons gives rise to the possibility of competition by a considerable number of big industrial corporations, including companies which formerly did not engage in the manufacture of the given type of arms.

Oligopolistic tendencies in the development of the production and sale of armaments inevitably give rise to an increase in prices (as compared with the level of competitive prices) and predetermine considerable overpayments on military contracts. Instances of this kind have been repeatedly reported in the American press.^^1^^ Similar examples may be found in almost every report of the General Accounting Office.

Until recently prices for new articles of a specifically military nature have been most frequently established on the basis of production costs (``costs-plus fixed fee'', `` costsplus incentive fee'', and so on). Moreover the big corporations can more fully utilise in war production than in civilian, all the priviliges in writing off depreciation, exorbitant salaries which are allowed by law to be included in the cost of production and so on.^^2^^ As was pointetd out in one of the _-_-_

~^^1^^ In carrying out the programme of stockpiling strategic materials the US Government bought titanium at a price of $4.5 per pound, while the price in the free market at that time did not exceed $2.25; similarly it purchased tungsten at $55 per pound with a price of no higher than $35 in the free market (see Wall Street Journal, October 14, 1957).

~^^2^^ A considerable part of the income is not counted as profit but is directly distributed among the higher managerial personnel. Thus, in 1953--1959 salaries of top executives of aircraft companies rose much faster than in other industries. See Arch. Patton, ``Trends in Executive Compensation'', Harvard Business Review, September-October 1960, pp. 144--54.

67 Congressional committees, military departments rarely attempt to restrict this tendency to conceal part of the profit through higher salaries paid to top executives.^^1^^

In the first half of the 1960s the US Government tried to somewhat restrict the size of such overpayments by opening the door to free competitive bidding and widely introducing contracts based on a ``fixed price-plus incentive''. But the reorganisation of the government's system of contracts could not radically alter the existing situation. Let us merely mention here some of the obstacles this reform encountered. In the first place, the sphere of free competitive bidding is restricted by the very process of research and development of new types of weapons and the uncertain character of this process, the need to utilise complex technologies, specialised costly manufacturing equipment. To this must be added the oligopolistic position occupied by a number of large corporations which refuse to supply the government with the necessary materials at prices which they consider insufficiently profitable. Second, in a private enterprise economy the maximisation of profit inevitably remains the chief stimulus for fulfilling military contracts. Thus, in most cases the state does not attempt to seriously curtail the profits of most of the big war industrial companies. Robert McNamara, former Secretary of Defence, stated: ``I want to emphasize, that our objective here is not to cut the profits of Defense contractors. I am not at all concerned with cutting the profits of the average Defense contractors."^^2^^

At the same time the following point should be emphasised. Even in those cases when free competitive bidding is formally practised, prices offered by participating corporations actually reflect the oligopolistic processes of price formation. The US press has repeatedly cited instances when a number of different companies participating in bids offered absolutely identical prices (coinciding to a cent),^^3^^ and the _-_-_

~^^1^^ See Aircraft Production Costs and Profits, pp. 2744, 2747.

~^^2^^ Impact of Military Supply and Service Activities on the Economy. Hearings before the Subcommittee on Defense Procurement of the Joint Economic Committee, Congress of the United States, 88th Congress, First Session, Washington, 1963, p. 25.

~^^3^^ See, for example, Administered Prices. Hearings before the Subcommittee on Antitrust and Monopoly of the Committee on the __NOTE__ Footnote cont. on page 68. 68 Defence Department was compelled to accept this price. In this respect let us quote a characteristic excerpt from a dialogue between Senator Proxmire and an executive of the Defence Department Captain T. M. Malloy at a hearing of one of the subcommittees of the Joint Economic Committee of Congress: ``Senator Proxmire: Do you have any method to determining whether the so-called, what might be called the General Electric-Westinghouse pattern, in other words, the dividing up of the market where firms come in and seem to rotate in their procurement bids for armament materials? Is there any method that the Defense Department has of coping with this kind of situation or being alert to it, being aware of it? Captain Malloy: Senator, this is, of course, one of the most difficult things to detect."^^1^^

The budget expenditure, which assumes the form of overpayment on military contracts, is transformed into profits for the big war-industry corporations. As pointed out earlier, a considerable part of the profits of these companies is listed among other items of the Balance sheet, by putting these sums into the various items of production costs. But even the figures officially listing these profits speak for themselves. The ratio of net profit to the invested capital of fifteen of the biggest military contractors in 1960 was 21 per cent higher than the average for 500 of the largest industrial corporations; in 1961 the figure was 31 per cent higher.^^2^^ Professor Murray L. Weidenbaum showed that in 1962--1965 six big corporations engaged in filling military contracts had a return on net worth (net profits as a per cent of stockholders' investment) of 17.5 per cent, while six companies of approximately the same size which had no big military contracts received a return of only 10.6 per cent. He rightly _-_-_ __NOTE__ Footnote cont. from page 67. Judiciary, United States Senate, 86th Congress, First Session, Part 13, 1959, Washington, 1960, pp. 6684--6685.

~^^1^^ Progress Made by the Department of Defense in Reducing the Impact of Military Procurement on the Economy. Hearings before the Subcommittee on Defense Procurement of the Joint Economic Committee, Congress of the United States, 87th Congress, First Session, June 12, 1961, Washington, 1961, p. 24.

~^^2^^ Calculated on the basis of data in fortune, July 1961; ibid., July 1968.

69 concludes that military business is much more profitable than ordinary commercial business.^^1^^

Lastly, we can refer to a survey of the biggest military contractors of the state (the 12 surveyed corporations received more than half of all the contracts in the aircraft industry, rocketry and space vehicles): the rate of profit in the manufacture of the latest weapons was 29 per cent, while profit on the output of civilian group only 17.4 per cent.^^2^^

The large sums officially listed, and the hidden profits combined with the steadily mounting demand for armaments by the government, make it possible to assure a comparatively higher rate of accumulation for companies which have large military contracts. A study made by the Stanford Institute compares a change of balance-sheet data of 400 big companies between 1948--1950 and 1956--1958. The results of the analysis show that 100 companies with the highest rates of capital accumulation and expansion of production had a share of military contracts amounting up to one-third of their turnover, while 100 companies with the lowest growth rates had contracts of only 2.5 per cent. These facts give a good idea of the reasons for the frenzied activity of some war-industrial companies during the Congressional procedure of authorisation of appropriations for military purposes.

At the same time the increased arms race leads to a growth in the economic and political influence exerted by the brass hats. In these conditions ``the tasks which military leaders perform tend to widen. Their technological knowledge, their direct and indirect power and their heightened prestige result in their entrance, of necessity, into arenas that in the recent past have been reserved for civilian and professional politicians".^^3^^ The growth of militarism involves ever closer contact and interlocking relations between the most powerful representatives of the war industry and the _-_-_

~^^1^^ American Economic Review, May 1968, Vol. LVIII, No. 2, p. 434-- 35.

~^^2^^ R. Kaufman. ``MIR Ving the Boondoggle: Contracts, Subsidies and Welfare in the Aerospace Industry'', American Economic Review, Papers and Proceedings, May 1972, p. 290.

~^^3^^ Morris Janowitz, Sociology and the Military Establishment, New York, 1959, p. 17.

70 top group in the military and political machine. As a result, a real danger arises of increasing the economic and political might of the military-industrial complex.

Military preparations divert resources and energies that could serve purposes of construction and the progress of all mankind into channels for production of weapons of destruction. In the 1967 fiscal year the production of armaments absorbed 59 per cent of all the labour inputs in the aircraft industry; 33 per cent in the radio, television and communication equipment; 26 per cent in electronic components and accessories; 23 per cent in other transportation equipment; 11 per cent in metal-working machinery and equipment; 11 per cent in electrical equipment and apparatus and 10 per cent in nonferrous metal ores.^^1^^

The steep growth of military spending may impart an unbalanced character to country's economic growth. It will be shown in other chapters that the rapid increase in the military expenditures inevitably increased the tax burden, the government debt and stimulated inflation, that is, it ultimately brought serious hardships to the overwhelming majority of the American people.

At the same time the huge military spending of the United States has accelerated the increase of the balance-of-- payments deficit and weakened the position of the dollar in the world. In this sphere the adverse effect of the large military expenditures abroad stands out particularly.

The growth of military spending by its very nature involves a waste of national wealth. That is why at some stage of the arms race the huge military expenditures inevitably begin to retard the growth of the country's economic potential. Japan, the Federal Republic of Germany and Italy have registered the highest economic growth rates and for a longer period among Western countries throughout the post-war period. It goes without saying that there are many complex factors explaining their advance but it is indicative that in these countries the arms race until now has been conducted on a comparatively smaller scale.

_-_-_

~^^1^^ Monthly Labor Review, Vol. 90, No. 9, September 1967, pp.

71

The only alternative to the arms race is general and complete disarmament. Today mankind has no more pressing task than to curb the policy of escalating militarism and international tension; this task can be accomplished only by energetic and consistent struggle for disarmament and the peaceful settlement of outstanding international issues, only by struggle against the forces of militarism and aggression.

This steadfast and hard struggle is yielding ever more tangible results with each passing year, helping to normalise the entire international climate. Significant changes have taken place in the world scene in recent years. Suffice it to refer to the end of the war in Vietnam, the wide international recognition of the German Democratic Republic, the conclusion of a number of important political and economic agreements between socialist countries and the Federal Republic of Germany, the preparation of the European conference on security and co-operation, cessation of the armed conflict in the Indochina Peninsula and the emergent steps towards normalising relations between India and Pakistan. All these and many other events attest to a substantial improvement of the international political climate in the world.

A big part in implementing a peace-loving policy has been played by constructive meetings and negotiations between leaders of the socialist and capitalist countries and particularly the Moscow (1972) and Washington (1973) talks of General Secretary of the CPSU Central Committee Leonid Brezhnev and US President Richard Nixon. Among the major results of these negotiations are the conclusion of the Treaty on the Limitation of Anti-Ballistic Missile Systems and the Interim Agreement on Certain Measures with Respect to the Limitation of Strategic Offensive Arms and the elaboration of the Basic Principles of Negotiations on the Further Limitation of Strategic Offensive Arms. Of truly historic importance is the Agreement on the Prevention of Nuclear War signed in the summer of 1973. For the first time in history the two strongest powers in the world reached understanding, according to which both parties assumed the commitment to prevent situations capable of causing a dangerous aggravation of relations and to avoid military confrontations and the outbreak of a nuclear war.

All these changes in political, economic and cultural 72 relations between states create new conditions for revising, from realistic positions, priorities in budget appropriations of the federal government.

__ALPHA_LVL2__ 2. NEEDS OF ECONOMIC GROWTH AND THE SYSTEM
OF CIVILIAN SPENDING

Among the unfavourable consequences of the huge growth in military spending are also the limited possibilities of increasing federal appropriations for civilian needs. The general tendencies of the dynamics of military and civilian spending in recent decades have been marked by a close interdependence between the two: a substantial expansion of military outlays has invariably been accompanied by a decrease in the share of the civilian expenditure. Inasmuch as the expansion of military spending during the last 35 years has greatly exceeded the expansion of the expenditure for civilian purposes, the share of the latter in the total expenditure (both in relation to the federal budget and state and local expenditures) has been substantially reduced. In 1938 civilian spending amounted to about nine-tenths and in 1970, to over half of the total expenditures by federal, state and local governments.

Moreover, the civilian expenditure during this period increased more slowly than the growth of the entire economy, specifically at a lesser rate than the growth of the GNP. Thus, during this period the GNP increased annually (in current prices) 8 per cent on the average, while civilian spending rose approximately 6 per cent. As a result, this expenditure which totalled 16.4 per cent in 1938, was only 10.2 per cent of the GNP in 1970.^^1^^ At the same time, as statistics reveal, the proportion of purchases of goods and services of a civilian character, made by the federal government, states, and local authorities, were considerably lower in the GNP of the United States during the 1950s _-_-_

~^^1^^ Calculated from data in U.S. Income and Output, Washington, 1958; Survey of Current Business, July 1971.

Civilian spending includes the entire budget expenditure minus the military spending, interest on the national debt, veterans' benefits and foreign aid.

73 than in many West European countries; for example, it was smaller than in the Federal Republic of Germany, Britain, Sweden and Belgium.^^1^^

The overwhelming part of the civilian expenditures are disbursed by states and local governments.^^2^^ In this chapter we examine only the civilian spending under the federal budget.

The limited scale of the budget resources remaining after military spending leaves only appropriations sufficient for satisfying the most pressing economic and social needs. The nature and scope of these appropriations is illustrated by the figures given earlier in Table II-l. In the 1930s expenditures for relief and public works held first place in civilian spending. At the same time since the 1930s expenditures for large-scale agricultural programmes of the federal government have significantly expanded. At present about half of all the expenditures in the federal budget for civilian needs goes for various income security payments and agricultural programmes.

The serious aggravation of the problem of surplus productive capacity in agriculture and the consequent elimination of a large number of farmers resulting in the intensification of social friction and conflict, demanded substantial budget appropriations for federal agricultural programmes. Among the major structural changes in the mechanism of the functioning of American agriculture in recent decades is undoubtedly the development of a government market for the sale of farm produce. The size of the purchase of agricultural surpluses depends on a number of natural and economic factors. The federal expenditures for these purposes are among those items characterised by the greatest fluctuations. The purchasing role played by the main government agency, the Commodity Credit Corporation (CCC), can be judged by the following data: in the second half of the 1950s and the first half of the 1960s, the CCC removed from the free market and handled the sale of one-fourth to one-half of the total wheat harvest, one-seventh to two-- _-_-_

~^^1^^ See Francis M. Bator, The Question of Government Spending. Public Needs and Private Wants, New York, 1962, pp. 45--46.

~^^2^^ See Chapter VI.

74 thirds of the cotton crop and so on.^^1^^ Operations on such a scale demanded considerable appropriations. To this must be added the cost of storaging the stockpile of commodities accumulated at government warehouses: in 1960 alone, these expenses including the interest paid by the CCC on respective loans reached $1,000 million.^^2^^

The increasing gap between the production potential of US agriculture and the existing possibilities for utilising that potential, is demonstrated by the substantial increase in the cost of financing federal agricultural programmes. Suffice it to say that in the 1970 fiscal year these expenses were approximately ten times greater than in the 1951 fiscal year and 6-8 times above the level of the period following the Great Depression in the mid-1930s.

A substantial part of this money goes directly for various programmes designed to restrain the increase of agricultural output (an acreage restriction, and so on). The programmes for diverting land from productive use were always regarded as temporary measures, but most of them in one form or another have been continued up to the present. In the 1969 fiscal year about half of all the budget appropriations for the Department of Agriculture were used to pay for reductions in the planting of cotton, wheat and feed grains on the basis of annual programmes and programmes for the long-range removal of the land from use.

The purchase of a tremendous amount of agricultural commodities and the removal of ever larger areas from cultivation constituted an indispensable condition for the development of US agriculture in the post-war period. But even all these measures could not ensure a solution to the problem. Clifford M. Hardin, former US Secretary of Agriculture, in remarks made in 1969 before a subcommittee of the House, referred to a number of studies which ``showed that excess capacity to produce will continue through 1980 even with the most favourable assumptions".^^3^^

_-_-_

~^^1^^ Calculated after Agricultural Statistics 1966, United States Department of Agriculture, Washington, 1966.

~^^2^^ D. Hathaway, Problems of Progress in the Agricultural Economy, Chicago, 1964, p. 42.

~^^3^^ Department of Agriculture Appropriations for 1970, Hearings before a Subcommittee of the Committee on Appropriations, House of __NOTE__ Footnote cont. on page 75. 75

Another category of civilian expenditures consists of transfer payments related to federal public welfare programmes. Some of these programmes were previously inaugurated by the Roosevelt Administration during the years following the Great Depression when the inadequacy of all kinds of private charity programmes was fully revealed.^^1^^ But payments under the social security system in the United States thus far remain quite limited as compared, for example, to expenditures by many West European countries. Thus, in 1960 in the USA expenditures under the social security system amounted to 5.3 per cent of the national income, while in Britain they were 9.6 per cent, Italy 14.9 per cent, France 16.2 per cent and the Federal Republic of Germany 17.0 per cent of the national income. At the same time the American social insurance system places a comparatively heavier tax burden on the workers in the form of insurance payments made by factory and office workers themselves: in the United States they contribute 41.0 per cent, in the Federal Republic of Germany 37.3 per cent, Britain 27.0 per cent, France 19.2 per cent and Italy 15.2 per cent of all the resources which make up the respective funds.^^2^^ Professor Musgrave believes that in respect to governmental welfare programmes, the United States lags behind Europe by a quarter of a century.^^3^^

The war on poverty programmes announced by the Johnson Administration were even more modest in real life. Little more than half of all the spending under public welfare programmes are financed through federal budgetary channels. Escalation of the war in Indochina sharply increased tensions in the federal financial system and led the federal government to whittle down the modest appropriations used for increasing relief to the poorest families. ``The `unconditional war on poverty' declared by the President has proved to be highly conditional, dependent on _-_-_ __NOTE__ Footnote cont. from page 74. Representatives, 91st Congress, First Session, Part 1, Washington, 1969, p. 5.

~^^1^^ ``Private philanthropy ... is virtually bankrupt in the face of great disaster,'' wrote B. Mitchell: Depression Decade. From New Era through New Deal 1929--1941, New York, Toronto, 1947, p. 101.

~^^2^^ The Banker, June 1963, London, p. 413.

~^^3^^ Richard A. Musgrave, Fiscal Systems, p. 86.

76 limited annual appropriations,'' remarks James L. Sundquist. Total appropriations for these purposes were inadequate ``and, under the pressures of Vietnam spending, are not rising".^^1^^ The government welfare programmes which rest on extremely curtailed appropriations simply cannot dig up or even shake the roots of poverty, roots which extend deep into the economic and socio-political fabric of contemporary American society. Moreover, it should be noted that a number of procedures in the war on poverty programmes are based on bureaucratic practices degrading to the human dignity of thousands of Americans. The emergency nature of many programmes, their brief duration and the ``piling up" of one programme on top of another impart to the entire public welfare system an extremely confused and contradictory nature. That is why, according to the popular Newsweek magazine, welfare itself ``is a maddening mix of compassion and callous bureaucracy, penny-pinching and shocking waste---the shame of a nation. And the problem is growing at an alarming rate."^^2^^

The forced nature of the federal budget expenditures on agriculture, welfare and relief and their connection with the sharply conflicting nature of economic and social development of contemporary capitalist society are obvious and hardly require any special comment. One need merely note that the prime reason compelling the federal government to decide on increasing these expenditures has been the increased activity of the mass movement directed against the serious material privations suffered by millions of American families.

At the same time, lately, as a result of the widening of the range of government policy and above all as regards ensuring conditions for long-term economic growth, there have been increases in some other budget appropriations. Basic shifts in contemporary economic theory and practical financial policy are being disclosed with particular clarity in the federal government's changing approach to expenditures for education and vocational training. Formerly it _-_-_

~^^1^^ Perspectives on Poverty, Vol. II. ``On Fighting Poverty'', Ed. by James L. Sundquist, New York, London, pp. 31--32.

~^^2^^ Newsweek, February 8, 1971, p. 26.

77 was assumed that intensive accumulation of capital utilised by private entrepreneurs was a necessary and sufficient condition for economic growth. Particularly strong emphasis on the role of increasing investments was reflected in some neo-classical models of economic growth which became widespread in the literature of the first post-war decade. But an analysis of aggregate production functions shows that in these models the main role is played not by an increase in the size of capital but by a change in the form of the production function itself. Many authors associate these changes above all with investments in ``human capital" and improvement of the quality of manpower.^^1^^

But the private enterprise principle, because of its nature, cannot ensure an adequate development of the system of general and special education. Nevertheless, even in present times, the most consistent supporters of the neo-liberal concept continue to defend the system of private schools and higher educational establishments, in other words, the financing of education from private sources, as one of the major prerequisites for the existence of a ``free and democratic society".^^2^^

The contradictions between the potentialities of the richest country in the world and the backward educational system became glaring at the threshold of the 1960s. The country lacked 600,000 classrooms.^^3^^ The system of educational establishments, as pointed out in one of the Presidential messages to Congress, was absolutely inadequate for ensuring universal literacy.^^4^^ The results of a survey showed that in some areas more than half of the population could not pass the test of so-called functional literacy, in other words, could not read, write and make elementary mathematical calculations.

_-_-_

~^^1^^ See, e.g., Edward F. Denison, The Sources of Economic Growth in the United States and the Alternatives before U.S. Committee for Economic Development, New York, 1962, pp. 68--70.

~^^2^^ See, e.g., Milton Friedman, ``The Role of Government in Education'', Economics and the Public Interest, Ed. by R. A. Solo, New Brunswick, N. J., 1955; Milton Friedman, Capitalism and Freedom, Preface, Chicago, London, 1962.

~^^3^^ Seymour E. Harris, The Economics of the Political Parties, New York, 1962, p. 256.

~^^4^^ New York Times, February 21, 1961.

78

The requirements of economic growth in conditions of the rapidly spreading scientific and technological revolution are coming into ever sharper conflict with the restricted possibilities of the private educational system. This is reflected in the ``human capital" concept which became especially widespread recently. ``Human capital,'' says Nobel Prize Winner Professor Samuelson, ``has a profit yield like that of material capital, but our market system does not carry investment to an optimal point.^^1^^ This gives rise to demands for the extension of government investments in ``human capital".

Under conditions of intensive military and technological progress and the re-equipment of the army with new sophisticated weapons, even representatives of the military establishment call for a substantial increase of government appropriations for general and special education.^^2^^

The concept of the need to increase ``investment in human beings" is also gradually making its way into Congress. Let us refer to the following example. Not so long ago the financial burden for education was almost entirely placed upon state and local governments. For many years the coalition of conservative forces in Congress blocked all bills which called for increasing federal appropriations for education. But in recent years the blowing of ``new winds" has been felt here as well. In 1965 the US Congress for the first time passed an Elementary and Secondary Education Act which substantially extended the financing of school education from federal sources. In the following four years federal budgetary expenditures on education more than doubled. In assessing^ these changes one should take into account the fact that the increased skill of workers is reflected in increased efficiency of production and, consequently, _-_-_

~^^1^^ Paul A. Samuelson, ``Fiscal and Financial Politics for Growth'', Economic Growth. An American Problem, Ed. by Peter M. Gutmann, Englewood Cliffs, N. J., 1964, p. 156.

~^^2^^ Thus, Donald Quarles, former Deputy Secretary of Defence, asserted that the inadequate training of technical specialists, from the viewpoint of the country's defence, represented ``potentially a greater threat to national security than any aggressor weapons known" (Fortune, December 1957, p. 150).

79 in the first place, in a growth of the profits of employers.^^1^^

At the same time, it would be obviously wrong to exaggerate the practical role of this re-evaluation of priorities. In a private enterprise society the dominant ideology, as previously, views the main purpose of all economic activity as the accumulation of material wealth. The functions of the state, too, are evaluated accordingly: in its simplest form such conception regards the government's function as one of merely promoting an increase in the supply of automobiles and other durable commodities for people possessing the adequate financial means. But this in essence is the orientation for the entire system of priorities of most persons participating in the process of economic decisionmaking. That is why some of the big employers are especially vocal in their opposition to programmes for extending the government's role in public spheres like education, social insurance, etc. ``When a Galbraith or Myrdal suggests a greater concentration on the public sector, the automatic response of businessmen is---'socialism'~".^^2^^

This tendency stands out clearly in the position held by Congress: in recent years most Senators and members of the House, at best, agreed to allocate for education and other ``investments in human beings" a certain part of the additional tax revenue in periods of intensive economic growth; but they flatly refused to radically revise the entire structure of governmental spending or to finance these programmes by increasing taxes on large incomes and correspondingly reducing private spending.^^3^^

The limited nature of the federal programmes of `` investment in human beings" is seen especially in medical care.

_-_-_

~^^1^^ ``The material benefits of education are felt most by employers, and therefore the largest user in the economic sense _ is not the individual who receives the education but his employer" (J. M. Pargeter, ``Ad Hoc or Cost-Based Pricing in the Public Sector'', Essays in the Theory and Practice of Pricing, London, 1967, p. 298.). The final division of these benefits between the employer and the wage worker depends on a number of factors but there are reasons for assuming that in most cases a considerable share is appropriated by the employer.

~^^2^^ Hobart Rowen, The Free Enterprisers: Kennedy, Johnson and the Business Establishment, New York, 1964, p. 18.

~^^3^^ See American Fiscal Policy: Experiment for Prosperity, Introduction, Ed. by Lester C. Thurow, Englewood Cliffs, N. J., 1967, p. 16.

80 Throughout the post-war years the number of doctors per 1,000 of population, far from increasing, even somewhat decreased.^^1^^ There is an acute shortage of disease-prevention measures, above all for children. At the beginning of the 1960s, 20 per cent of all children under the age of five, were not given any prophylactic treatment against poliomyelitis.^^2^^

One of the main factors tending to make private medical care less accessible is its increasing cost. The total sum of money spent by Americans to pay for doctors' fees, medicines and hospital care is rapidly mounting: in 1950 these expenses totalled $11,000 million and in 1970, according to estimates, about $60,000 million. But not less than half of this increase was caused by inflation; people are compelled to spend an ever larger proportion of their income to pay for the higher cost of hospital care, doctors' services and so on.^^3^^ The higher cost of medical service outstripped not only the rise of retail prices of consumer goods but the increase in rates for other services purchased by people.

``For growing numbers of Americans,'' it is pointed out in the President's Message to Congress of February 18,1971, ``the cost of care is becoming prohibitive and even those who can afford most care may find themselves impoverished by a catastrophic medical expenditure."^^4^^ The position of the American people is steadily growing worse because of the specific features of market relations in the private system of medical service. ``As a purchaser of medical services, the patient is usually in no position to choose how to spend his medical dollar. ... Doctors are forbidden under rules of medical ethics to advertise fees, and the subject is rarely raised during doctor-patient interviews. Few patients are capable of judging the relative qualifications of local doctors, and many fear a low fee indicates lack of competence."^^5^^

_-_-_

~^^1^^ See Rodney M. Coe, Sociology of Medicine, New York, 1970, pp. 353, 356.

~^^2^^ Congressional Record, February 9, 1961, p. 1905.

~^^3^^ Fortune, January 1970.

~^^4^^ New York Times, February 19, 1971, p. 17.

~^^5^^ Helen B. Schaffer, ``Medical Costs and Medicare'', Editorial Research Reports, Vol. I, No. 20, May 24, 1967, Washington, p. 390.

81

The inadequacy of medical service and its rising cost disastrously affect the position of the poorer American families. Half of all the children of poor families receive no inoculations against ordinary children's diseases. Paid medical care is becoming less and less accessible. In the 1960s paid visits to a doctor by persons of families with annual incomes up to 2,000 dollars were half as many as in families with an income of $7,000 and more. The number of visits to a dentist in families with a higher income are approximately three times greater than the same figures for families with low incomes.^^1^^

Yet it is the poorest sections of the working people that are in the greatest need of medical care. A survey showed that child mortality from influenza and pneumonia in what are known as poverty areas was 3.5 times greater than similar figures in other districts.^^2^^ Another survey reveals that the mortality rate (calculated per 100,000 population), as a rule, increases as the income of the families decreases: among the most propertied sections of the population the rate was 6.17 and among the poorest sections, 9.91. In the poorest families the cause of death more frequently is a disease like tuberculosis. Particularly high is the mortality rate among the Negro population. Deaths during childbirth among non-white women are four times higher than among white women.^^3^^

All this no doubt reveals the limited possibilities of capitalist society's public health system. In the richest country in the world it is impossible to satisfy the most urgent needs for medical and other services. In February 1971 President Nixon stated: ``Nineteen months ago I said that America's medical system faced a 'massive crisis'. Since that statement was made, that crisis has deepened."^^4^^ The federal government's expenditure for the health service system which now _-_-_

~^^1^^ Forrest E. Linder, ``The Health of the American People'', Scientific American, June 1966, p. 28.

~^^2^^ Chicago Board of Health, Preliminary Report on Patterns of Medical and Health Care in Poverty Areas of Chicago and Proposed Health Programs for Medical Indigent, Chicago, 1966.

~^^3^^ Social Security Bulletin, Vol. 26, No. 5, May 1963, p. 8.

~^^4^^ New York Times, February 19, 1971, p. 17.

__PRINTERS_P_81_COMMENT__ 6---02 82 amounts to only 7 per cent of the total does not cover even one-third of the increased cost of medical care.

In conditions when a substantial part of the national income is redistributed through governmental budgetary channels, the majority of the population cannot be indifferent to the government's financial policy. With every passing year the American people feel more and more the adverse consequences of the policy which devotes the main share of the resources of the federal budget to military preparations and increasingly realise the inadequacy of social and cultural appropriations.^^1^^

Today it is clearer than ever before that the factors which facilitated a growth in military spending and restricting the scale of social and cultural appropriations were closely linked with the entire economic, socio-political and ideological structure of contemporary American society.

_-_-_

~^^1^^ The results of Harris Survey are indicative. In 1969, 26 per cent of the people regarded curtailment of the military expenditure as the primary task of the federal government's financial policy; in 1970 the number increased to 27 per cent, while in 1971 already 30 per cent stated that it was necessary, in the first place, to cut the expenditure on the war in Vietnam and on foreign aid and to curtail socio-cultural spending only as a last resort.

Number of Persons Who in 1971 Favoured a Reduction of Certain Budget Expenditures (percentage of polled) Type of expenditure | Cut first | Cut least Vietnam spending 64 8 Foreign aid Space programme Poverty programmes Aid to cities 6i 50 13 9 3 13 34 30 Aid to education 4 66 Pollution control 3 57

(Washington Post, August 5, 1971, p. E3.)

[83] __NUMERIC_LVL1__ CHAPTER III __ALPHA_LVL1__ TAX REVENUE OF THE FEDERAL BUDGET __ALPHA_LVL2__ [introduction.]

Expansion of the economic functions of the state has been followed, as shown in the preceding chapters, by a swift increase in federal government spending. Taxation is inevitably the main source of financing governmental spending. It, as it were, embodies the economically expressed existence of the state. ``Taxes,'' according to Karl Marx, ``are the source of life for the bureaucracy, the army ... for the whole apparatus of the executive power."^^1^^

Throughout the 20th century the financial operations of the state and, consequently, also the scale of taxation have been growing much faster than the indices characterising the general economic process (the GNP, national income, and so on). In view of this an increasing share of the GNP has been drawn into redistribution along the channels of the government's financial system. Some indicators illustrating the development of this process are given in Table III-l.

In examining data on the increase in the federal budgetary tax revenue we at once notice the following point. The tax burden has been increasing steadily, but very unevenly. The curve characterising this process resembles a ladder, moreover, every rung of this ``ladder'' (i.e., the part of the curve which illustrates the leap-like growth of taxes), as a rule, coincides with the participation of the United States in world wars and in the period after the Second World War, with the military hostilities in Korea and _-_-_

~^^1^^ K. Marx and F. Engels, Op. cit, Vol. 1, p. 482.

__PRINTERS_P_83_COMMENT__ 6* 84 Table III-1 Tax Revenue of the Federal Budget, 1800--1970 fiscal years 1800 fiscal year 1850 fiscal year 1900 fiscal year 1940 fiscal year 1970 fiscal year Total taxes, million dollars, current prices 10 40 528 5,696 195,705 Per capita sum of taxes 2 2 7 43 955 Taxes, percentage of gross national product * * 3 6 20 * No data.

Source: Annual Report of the Secretary of the Treasury on the State of the Finances for the respective years.

Indochina. Thus, tightening the screws of the taxation press is inseparably linked with the growth of militarism. The gigantic sums of money extracted from the many millions of taxpayers were used for financing a number of unproductive operations and first of all the further stepping up of the arms race. It is clear that real progress in the international disarmament negotiations now underway, accompanied by a substantial reduction of military appropriations, could bring substantial alleviation to the American taxpayer. Thus, the steeply rising financial needs of the state dictated a reconstruction of the entire taxation system. In the 19th century indirect taxes---customs duties (which ensured up to half of the entire sum of budgetary revenue), liquor and tobacco excises as well as the income of the post office--- played a dominant role in the system of budgetary revenue. But a large share of these taxes displayed comparatively little elasticity with the change in the national income.^^1^^ That is why, notwithstanding the general tendency towards

_-_-_

~^^1^^ Comparing the role of indirect taxes in the fiscal system of capitalist countries with different levels of per capita national income, R. Musgrave obtained the following results. The coefficient of the rank correlation between the share of indirect taxes in the total sum of tax __NOTE__ Footnote cont. on page 85. 85 extending the range of goods and services which are taxed, and a growth of excise duties, the share of indirect taxes in the GNP of the USA increased much slower than the share of other fiscal revenues throughout the 20th century.

At present indirect taxes play, in fact, a secondary role in the federal tax revenue system. More than four-fifths of the total revenue comes from direct taxes and above all from individual income taxes and the corporate tax. That is why attention in this chapter will be paid mainly to problems of direct taxation.

__ALPHA_LVL2__ 1. THE INDIVIDUAL INCOME TAX SYSTEM

The introduction of an individual income tax was an important landmark in the development of the fiscal system. The history of its introduction in the United States is indissolubly linked with a sharp aggravation of the political struggle. The government utilised this tax for financing expenditures during the Civil War. But subsequently the collection of an income tax was discontinued. In 1895 the US Supreme Court ruled as ``unconstitutional'' the income tax law enacted in 1894.^^1^^ At the beginning of the 20th century the federal government had no income tax and only one state (Wisconsin) had direct income taxes. But the increasing strain of the financial situation of the federal government and democratic pressure compelled the legislative authorities to adopt in 1913 the 16th ammendment to the US Constitution, according to which Congress was empowered to introduce a federal income tax. Since then the income tax has become a consistent component of the _-_-_ __NOTE__ Footnote cont. from page 84. revenue and the average size of the per capita GNP is 0.46 (t = 3.33), and one of the equations of the regression is as follows: Tid/t = e 4.99. Yc-o.is Ra=0.43, (25.3) (---5.3) where Tid = indirect tax receipts, T = total sum of taxes and Yc = per capita GNP. These calculations show that indirect taxes have less elasticity in relation to income increase than other forms of taxation. (See Richard A. Musgrave, Fiscal Systems, Yale University Press, New Haven, London, 1969, pp. 116, 144--45.)

~^^1^^ Pollack v. Farmers Loan and Trust Co.. 157, US 429 (1895)' 158, US 601 (1895).

86 US financial system and its role in the revenue of the federal budget has been more or less steadily rising.

From its very inception, the income tax structure bore an internally contradictory nature. On the one hand, the introduction of this tax was directly linked, as pointed out earlier, with the struggle for a more equitable fiscal system, somehow commensurating the size of the tax with the economic possibilities of the taxpayer. It is not accidental that the decision of the Ways and Means Committee gave as one of the reasons for introducing the income tax the ``general demand for justice in taxation".^^1^^ According to the idea of a number of liberal political leaders, an individual income tax had to embody the principle which in modern financial literature has become known as the ``ability-to-pay approach".^^2^^ The spread of the money economy relations made the money income (and not, for example, real property) a universal indicator of the material possibilities of the taxpayer.

Accordingly, income taxation at the first stage affected only persons who received big incomes. During this period the tax-exempt minimum was above the incomes of the overwhelming majority of American families. It should be noted that the rate of the tax for the big income was quite modest. The maximum rate (on incomes in excess of $500,000 annually) did not exceed 7 per cent. That is why a progressive tax on the income of capitalists was playacting, according to Lenin; the entire income tax paid by the American bourgeoisie, together with payments in the form of indirect taxes, did not exceed 1.5 per cent of their income.^^3^^ At the same time the very structure of the federal taxation system, introduced in the USA in the first third of our century, contained elements making it possible to sharply expand the sphere of compulsory taxation. Moreover the further development of state-monopoly capitalism facilitated the utilisation of these possibilities.

The main method of expanding the federal tax base was through a reduction of the minimum tax exemptions. The _-_-_

^^1^^ Internal Revenue Bulletin, Cumulative Bulletin, January-June 1939, pp. 1-3.

~^^2^^ See Richard A. Musgrave, The Theory of Public Finance. A Study in Public Economy, New York, Toronto, London, 1959, Chapter 5.

~^^3^^ See V. I. Lenin, Collected Works, Vol. 19, p. 199.

87 development of this tendency was directly linked with the system of financing the governmental countercyclical measures in the 1930s and especially with the steep rise in budgetary appropriations during the Second World War.

In post-war years the level of the minimum tax exemptions continued to decline but the forms of development of this process were somewhat different. The nominal sum of the income tax exemptions has remained unchanged in recent decades (as compared with 1944 it was even somewhat raised). But the inflationary rise of prices results in the gradual erosion of the real non-taxable minimum. The sum of the non-taxable minimum expressed in constant (1970) prices, in 1970 was for a family of two only onetwelfth and for a single taxpayer one-seventeenth of what it was in 1913 and correspondingly from 33 to 41 per cent lower than at the end of the Second World War.

Thus the burden of inflation and the almost steadily rising cost of living, as it were, are intertwined with a further increase in the tax load.

As a result the non-taxable minimum is now much lower than the average level of income in the United States and the tax burden extends to the poorer sections of the population.^^1^^ Whereas in 1913 the federal income tax was paid only by a very small part of the population (less than 1 per cent) now about four-fifths of all Americans have to hand over to the federal government a substantial part of their incomes. As a result, the share of the taxes contributed by those in the lower income brackets is rapidly rising: in 1929 persons with the lowest incomes, up to $3,000 annually, paid only 0.2 per cent of the total individual income tax, while in the mid-1950s taxpayers with incomes of up to $5,000 annually (the size of income of the given group of the population was changed in order to take into account the _-_-_

~^^1^^ A trade union representative, speaking before a Congressional subcommittee, stated: ``Proposed tax changes in the richest country in the world still require millions of American citizens whose earnings are below the standard judged adequate for decent living to continue to pay Federal income taxes.'' (Fiscal Policy Implications of the Economic Outlook and Budget Developments, Hearings before the Subcommittee on Fiscal Policy of the Joint Economic Committee, Congress of the United States, 85th Congress, First Session, Washington, 1957, p. 169).

88

Table III-2

Expansion of the Sphere of Federal Taxation 1913--1970

1913 1939 1950 1970

Sum of minimum* tax exemptions (dol-

lars, current prices)

3,000

1,000

600 600

Real purchasing power of minimum tax
exemptions (dollars, 1960 prices)

8,982

2,128

716 444

Number of individual income taxpayers,

per cent of total US population

1.0

5.0

72.6

80.2

Tax paid, per cent of total individual
income

0.1

1.2

8.0

11.9

* For a single taxpayer.

Sources: Historical Statistics ... 1957; Richard Goode, The Individual Income Tax, Washington, 1965.

factors linked with the approximate depreciation of the dollar) accounted already for more than 30 per cent.^^1^^

The system of income tax rates contains an internal contradiction. The existing progressive tax rates^^2^^ above all reflect the pressure of the struggle for a more just taxation system. But it should be noted that periods marked by a serious rise in taxation of large personal incomes have invariably coincided with a sharp expansion of the tax base and an increase in the financial burden borne by the mass of the population. Thus, just prior to the Second World War, the tax rate on an income of $200,000 and more was 66--79 per cent and at the end of the war it reached the record figure of 94 per cent. But during the same period the minimum of tax exemptions was sharply reduced and the rate of taxing the less well-to-do taxpayers was raised from 4 per cent to 23-- 25 per cent. The overwhelming share of the additional _-_-_

~^^1^^ Tax Revision Compendium, Hearings before the Ways and Means Committee, House of Representatives, US Congress, Vol. 1, Washington, 1959, p. 509.

~^^2^^ According to the 1964 Act, persons in the lowest tax brackets pay an individual income tax amounting to 14 per cent, while the richest (with an anual income of 100,000 or more---70 per cent of their taxable income.

89 budget revenue came from an increase in the taxation of the less prosperous sections of the population.

In such a situation one gets the impression that the basic change in the system of individual income tax rates, dictated by the tremendous growth of the military expenditure, adds up to increased taxes paid by the mass of working people, while the rise in taxes on big incomes performs the function of a political ``safety valve''. It is indicative that the ruling class resorts to the use of this safety valve above all in periods of sharpening socio-political conflicts and intensified movement by the working people against a steep increase in the tax burden.

At present the bulk of the income tax revenue in the federal budget comes from taxation of the lower rates. At the end of the 1950s the entire progression of tax payments (above the lowest rates) ensured only about 13 per cent of this revenue. As for the highest rates, 50 per cent of the income and more, they constituted only one-sixtieth of the taxable income and brought into the federal budget less than one per cent of the total tax receipts.^^1^^ Moreover the lowest tax rates in the United States are (in respect to their absolute level) by far not so low. Comparison with the taxation system in other countries reveals that in the USA the groups with the lowest incomes contribute a much larger share of the tax than taxpayers with approximately the same incomes in France, Great Britain, Japan or Italy.^^2^^

Reference to high tax rates on big incomes is often utilised as one of the main points in discussions on more general ideological questions.^^3^^ The much publicised high _-_-_

~^^1^^ The Federal Revenue System: Facts and Problems. 1959, Materials Assembled by the Committee Stuff for the Joint Economic Committee, 86th Congress, First Session, Washington, 1959, p. 185; Tax Revision Compendium, Vol. 1, p. 197.

~^^2^^ See, for example, L. Needleman, ``The Burden of Taxation: An International Comparison'', Economic Review No. 14, National Institute of Economic and Social Research, London, March 1961; R. Musgrave, Fiscal Systems, pp. 182--87.

~^^3^^ Executives of the US National Association of Manufacturers, for example, were able to detect in the existing tax progression even an ``air of radicalism" (See A. E. Holmans, United States Fiscal Policy, 1945--1959, Its Contribution to Economic Stability, Oxford University Press, Oxford, 1961, p. 143.

90 level of nominal individual income tax rates actually proves to be quite modest. Assertions that the individual income tax actually absorbs more than half of the rich taxpayer's income are characterised as naive by many financial experts like Professors Richard Musgrave, Robert Lampman, and many others.

While the nominal rates of the federal individual income tax are characterised by a quite steep progression, from 14 to 70 per cent of the entire income, the real rates change little as the size of the taxed income increases. This is demonstrated in particular by the results of investigation made by R. Herriot and H. Miller, some of the figures are given in Table III-3.

Table 111-3 Real Rates of the Federal Individual Income Tax, 1968 Annual income of taxpayers (thousand dollars) up to 2 2-4 4-6 6-8 8-10 15--25 Real tax rate (per cent of income) 25.6 24.7 27.9 30.1 19.9 31.1 Source: Wall Street Journal, May 9, 1972.

There is also the following regularity: as the size of the income grows so does the gap between the nominal and the real tax rates. Thus, according to data of the US Treasury Department, the wealthiest families with incomes of $1,000,000 and higher, paid in 1968, 38 per cent of their income as the federal income tax.^^1^^ But these data by no means cover the entire income of the rich taxpayers. According to estimates of J. Pechman and B. Okner, financial experts of The Brookings Institution, the individual tax on incomes of $1,000,000 and more actually does not exceed _-_-_

^^1^^ Statistics of Income. Individual Income Tax Returns. 1968, Department of Treasury, Internal Revenue Service, Washington, 1970, p. 98.

91 32 per cent^^1^^ (at the highest nominal rate of 70 per cent). It is easy to see that such a gap between the nominal and real tax rates spells the biggest benefits for the wealthiest taxpayers. Pechman and Okner made a number of interesting calculations, trying to pinpoint the difference between the actually paid tax and the sums which individual groups of taxpayers would have to pay in accordance with the rates officially fixed by law. Here are some results of these calculations: taxpayers with an income of up to $3,000 can ``save'' $16 annually on tax payments; those with incomes of from $3,000 to $5,000, $48; incomes from $5,000 to $10,000, $340; from $25,000 to $50,000, $4,000; from $100,000 to $500,000, $41,000; from $500,000 to $1,000,000, $202,000 and with incomes above $1,000,000, $720,000.^^2^^ These figures require no additional comment.

Thus, nominal and real tax rates of the top incomes are separated by a gulf, which largely makes the entire tax progression a fiction. The actual progression of tax rates can be and in many cases is not so much a result of legislative decisions as, according to Richard Musgrave, an ``accidental (or worse: intentional, but hidden) result of legislation for loopholes in the tax base and tricks. .. ."^^3^^

The rising cost of living which has become a chronic affliction of the American economy, inevitably gives rise to a number of additional problems linked with progressive rates of taxation and increasing nominal incomes. In such a situation a rise in the general level of prices, all other conditions being equal, inevitably increases the tax burden. Let us illustrate this point with the following hypothetical example. Let us assume that the nominal taxable annual income at the initial moment, say, 1965, was $5,600 and, consequently, under the existing law, 22 per cent had to be paid as the income tax. If in the next two years prices, say, rose by 10 per cent, and the level of real wages remained unchanged, then the nominal wages at the end of the period _-_-_

~^^1^^ Washington Post, February 15, 1972.

~^^2^^ See P. Stern, ``Uncle Sam's Welfare Program---For the Rich'', New York Times Magazine, April 16, 1972.

~^^3^^ Richard A. Musgrave, ``How Progressive Is the Income Tax?'', Tax Revision Compendium, Vol. Ill, Washington, 1959, p. 2230.

92 had to be $6,160 and, according to this scale the tax rate had to rise to 25 per cent.

Let us sum up in brief. The introduction of a progressive income tax system was a definite gain for the democratic movement. But this system by itself cannot ensure a true conformity or even a preservation of the former proportions between the amount of taxes paid and the ability to pay. Objective tendencies and contradictions inherent in the capitalist taxation system transform this system into a burden, the main brunt of which is borne by tens of millions of US working-class families. That is why the redistribution effect, connected with the existence of a progressive tax and calculated, say, for every million dollars of budget revenue, is today much lower than before the Second World War.

__ALPHA_LVL2__ 2. FEDERAL TAX ON CORPORATION INCOMES

Together with personal incomes, the net incomes of capitalist enterprises, organised in corporations, are also taxed in accordance with the Payne-Aldrich-Tariff Act (1909). In the 1910s-1920s receipts from the tax on corporate incomes, as a rule, exceeded the sum of federal taxes paid by the population. However, after the Second World War, the considerable expansion of the individual income tax base changed the relationship between these elements of the taxation system: at present the individual income tax accounts for more than two-thirds and the corporation income tax for less than one-third of the total federal income tax revenue.

The rates of the corporation income tax and its progression are much lower than those of the individual income tax.^^1^^ But even in taxing the net income of corporations the level of nominal rates cannot give an exact picture of the size of the actual taxes paid.

Thus, prior to 1964, the nominal rate at which the _-_-_

~^^1^^ Wilfred Lewis ironically characterises the progression of these tax rates as ``rudimentary'' (see Wilfred Lewis, Jr., Federal Fiscal Policy in the Postwar Recessions, The Brookings Institution, Washington, 1962, p. 35).

93 overwhelming part (about nine-tenths) of the entire net profits of corporations was taxed, was 52 per cent and after 1964, 48 per cent.^^1^^ But corporations actually pay a considerably smaller share of their profits. The real size of the tax on profits of American companies in the mid-1960s did not exceed 37 per cent. It was 21 per cent in the oil industry, 24 per cent in some other sectors of the extractive industry and of commercial banks, and so on.^^2^^ According to other calculations the real rate of the corporate income tax did not even amount to 30 per cent in the mid-1950s.^^3^^

The total sum of taxes paid by corporations in the postwar period is marked by extreme instability. Any slowing down in economic growth rates or a recession was reflected in a much greater reduction of the share of corporate taxes. The particular sensitivity of this tax to cyclical fluctuations is explained by a number of reasons. First of all corporation incomes are sensitive to changes in the scale of production and sales, the degree of utilisation of productive capacity, and display a much greater degree of fluctuation than personal incomes.

Besides a change in current incomes, a number of other additional factors influences the decline in tax payments. Cyclical fluctuations are revealed by the share of corporation incomes in the entire economy.^^4^^ Moreover, in the preceding period US industry had a particularly widespread system of bookkeeping which based the valuation of inventories in the balance sheets of enterprises at the price at the time of purchase (known as the Fifo, i.e., first-in, first-out system). Therefore during a depression and the ensuing drop in prices, a corporation employing this bookkeeping system _-_-_

~^^1^^ A tremendous number of small corporations was taxed at the lowest rate of 22 per cent, but their share in total profits was very small.

~^^2^^ Calculated according to Statistics of Income 1966: U.S. Business Tax Returns, Washington, 1969.

~^^3^^ See A. Haberger, ``The Corporation Income Tax: an Empirical Appraisal'', Tax Revision Compendium, Vol. 1, pp. 240--41.

~^^4^^ Thus, according to calculations of Ch. Schultze, with a reduction in the gross income of the entire private sector (measured at unchanged prices) by 1 per cent, the output of corporations declined by about 1.4 per cent in the post-war period (see Ch. Schultze, ``Short-Run Movements in Income Shares'', The Behaviour of Income Shares. Studies in Income and Wealth, Vol. XXVII, Princeton, 1964, p. 157).

94 usually showed large additional losses on items of working capital.^^1^^ Lastly, besides these factors, which ``automatically'' reduced the effective corporation income tax rates, in 1948 and 1954 the Federal Government resorted to a `` discretional reduction" of nominal tax rates.

Thus corporations gained the opportunity to curb the decline in their profits. This chiefly benefited the biggest companies since the bulk of the taxed income---more than 70 per cent---is earned by a small group (0.6 per cent of the total) of corporations, each of which has an annual income of $1,000,000 and more.^^2^^

Table 111-4 Change in Corporation Profits~rin Periods of Post-War Depressions ('000 million dollars) 4th quar-- 2nd quar-- 3rd quar-- 2nd quar-- 4th quar-- ter 1948-- ter 1953-- ter 1957-- ter 1960-- ter 1969-- 2nd quar-- 2nd quar-- 1st quarter 4th quarter 4th quar-- ter 1949 ter 1954 1958 1960 ter 1970 Drop of profits be-- fore the payment of taxes 2.5 2.0 3.0 1.0 2.0 Reduction of the corporate income tax 0.9 1.3 1.6 0.5 1.4 Drop in profits after the payment of taxes 1.6 0.7 1.7 0.5 0.6

Sources: Survey of, Current Business for the respective years.

Data in Table III-4 show that private corporations were able to shift to the federal budget, that is, ultimately to other taxpayers during the period of the 1948--1949 depression, 36 per cent of their losses connected with the cyclical reduction in the size of their profits; in 1953--1954, it was _-_-_

~^^1^^ This mechanism is examined in greater detail by J. Keith Butters in his Effects of Taxation: Inventory Accounting and Policies, Harvard University Press, Boston, 1949, Chapter III.

~^^2^^ The Federal Tax System: Facts and Problems 1964, Washington, 1964, p. 48.

95 65 per cent; in 1957--1958, 49 per cent; in 1960, 50 per cent and in 1969--1970, already 70 per cent. The downward tendency in the movement of private profits is substantially restrained by increased fluctuations in government revenue. Thus, such a reduction in the losses of private capital signifies an increase in the losses on the opposite side---in the government budget. The present structure of federal taxation contributes to a situation wherein a greater strain is placed on governmental finance even during not-so-deep economic recessions or stagnations of business activity.

A number of Western scientists are trying to find some sort of economic justification for this process of shifting losses, regarding it as one of the ``built-in stabilisers" which help to reduce the spontaneous cyclical fluctuations of the capitalist economy. But it is difficult to accept this viewpoint. The point is that in the short-term aspect, the money put back by the big corporations into further economic circulation (capital investments and dividends paid to shareowners) in present-day conditions apparently do not greatly depend on the size of the profit remaining after the deduction of taxes.

The investment policy of corporations during periods of an economic depression thus depends, above all, on the scale of the over-accumulation of fixed capital and the prospects existing in the major commodity markets. It is a rare situation when, in conditions of a substantial underutilisation of its productive capacity, a large corporation attempting to sharply expand its investments, cannot carry out this programme solely as a result of the removal of part of the current profit in the form of income taxes.^^1^^ As for that part of the profit going to dividend payments, the amount of taxes on corporate incomes according to data of special statistical studies, exerts a very small influence on these payments.^^2^^

_-_-_

~^^1^^ Factors influencing investments of private corporations are examined in greater detail by Robert Eisner and Robert H. Strotz in `` Determinants of Business Investments'', Impacts of Monetary Policy, Englewood Cliffs, N. J., 1963, pp. 60--338.

~^^2^^ See, for example, John Lintner, ``Distribution of Income of Corporations among Dividends, Retained Earnings and Taxes'', American Economic Review, Vol. XLVI, No. 2, May 1956, pp. 97--113; John A. __NOTE__ Footnote cont. on page 96. 96

Thus, fluctuations in the amount of taxes paid by corporations, can hardly restrain cyclical fluctuations of production to any considerable degree. Professor Joseph Pechman, Director of Economic Studies at The Brookings Institution and Executive Director of Detailed Studies of Government Finances, had every right to state that ``the corporation income tax is not regarded as one of the significant built-in stabilizers, despite the fact that it contributes heavily to the large swings in federal surpluses and deficits during business cycles".^^1^^

In post-war years the opinion has been repeatedly voiced in Congress and in the American press that the tax rates on corporation incomes are so high that they reach a ``level of confiscation'', and therefore this situation exerts an extremely unfavourable impact on the processes of economic growth.^^2^^ ``We have in this country people anxious to work and capital seeking investment opportunities. We have a need for many things.... But we have erected a high wall between these resources and these needs, in the form of high rates of profits taxation,'' it is claimed in one of the publications of the US Committee for Economic Development.^^3^^

Discussion of this question has become particularly lively _-_-_ __NOTE__ Footnote cont. from page 95. Brittain, ``The Tax Structure and Corporate Dividends Policy'', American Economic Review, Vol. LIV, No. 3, May 1964, pp. 272--87.

Gary Fromm, utilising the calculations of Lintner, shows that only 5 per cent of the changes in the paid dividends could be attributed to the influence of changes in the size of profit after the deduction of taxes in 1953--1960 (Gary Fromm, ``Inventories, Business Cycles and Economic Stabilization'', Inventory Fluctuations and Economic Stabilisation, Joint Economic Committee, Congress of the United States, 87th Congress, Second Session, Part IV, Supplementary Study Papers, Washington, 1962, p. 86).

~^^1^^ Joseph A. Pechman, Federal Tax Policy, The Brookings Institute, Washington, 1966, p. 114; see also Richard Goode, ``The Corporate Income Tax in a Depression'', Policies to Combat Depression, Princeton, 1956, pp. 149--70.

~^^2^^ See, for example, Tax Revision Compendium, Vol. Ill, p. 2267; Review of Report of the Commission on Money and Credit, Hearings before the Joint Economic Committee of the US Congress, p. 193, and others.

~^^3^^ Reducing Tax Rates for Economic Growth, A Statement on National Policy by the Research and Policy Committee of the Committee for Economic Development, December 1962, p. 24.

97 since the beginning of the 1960s. The incoming Democratic Administration began to pay more attention to problems of economic growth and after an initial leap-like increase in governmental appropriations, emphasis was shifted from the Keynesian compensatory finances to the concepts of economic growth through manoeuvring with tax rates influenced by neo-classical concepts. Moreover, a change in the tax rates was regarded as one of the most operational tools for counter-cyclical regulation. Speaking in Congress, R. Nathan, Chairman of the Commission on Money and Credit, stated: ``More and more economists have tended to come around to the view that for short-term stabilization purposes, the revenue side is a more important and more potent stabilization force than the expenditure side."^^1^^

An analysis of the measures taken in the sphere of taxation (revision of the rates of depreciation allowances and the consequent reduction of the rate of corporate taxes, the law on the 7 per cent investment credit for corporations, etc.) reveals that the profit tax plays a key role in this programme. Since the rate of profit is a basic factor in the decision-making of a businessman, particularly on the question of expansion or reduction of production, government regulation of business activity is first of all directed toward stimulating a growth in the profits remaining at the disposal of corporations. The government recognised that the shortest road to achieving this lay in reducing the effective tax rate on the profits received by private corporations.

Needless to say, the spokesmen of Big Business were very vocal, and continue to be so, in defending this policy. Thus, Robert Tyson, Chairman of the Finance Committee of the United States Steel Corporation, stated: ``I believe that the present-day taxation of corporate income is inequitable and adverse to investment and to economic growth.... Taxes, by their very nature, are disincentives, and the greater the tax the greater the disincentive."^^2^^ William Hogan of Fordham _-_-_

~^^1^^ Review of the Report of the Commission on Money and Credit, Hearings before the Joint Economic Committee, Congress of the United States, 87th Congress, First Session, August 14--18, 1961, Washington, 1961, p. 169.

~^^2^^ Robert C. Tyson, ``Business Capital Spending and Investment Decisions'', Fiscal Policy and Business Capital Formation, A Symposium __NOTE__ Footnote cont. on page 98. __PRINTERS_P_97_COMMENT__ 7---62 98 University asserts that ``high taxes are making it hard for us to maintain the profitability---the survivability and growability---of our business firms".^^1^^

Recent tax reforms, including those enacted in 1964, bear obvious traces of Big Business influence. Thus, at the beginning of the 1960s, the National Association of Manufacturers demanded that the corporate tax rate be reduced from 52 to 47 per cent,^^2^^ while the bill in Congress provided for a reduction of these rates from 52 to 48 per cent.

Actually all efforts to connect movement of investments with changes in the corporate tax rate fail to disclose the existence of a simple and stable dependence between these magnitudes. Throughout the post-war period the investment process developed more intensively than prior to the Second World War, although in the war years and in the subsequent period, tax rates on net profit of corporations were essentially raised. Surveys specially made in the United States (as well as in a number of other capitalist countries) did not reveal that existing tax rates exercised a distinctly pronounced unfavourable influence on the initiative of businessmen or corporate businessmen.^^3^^

Nor has there been any sign indicating that the financial position of corporations was being undermined. The share of borrowed funds in the operations of non-finance corporations throughout our century has remained more or less stable. Moreover, the share of long-term loans in their total debt has been reduced.^^4^^ This is apparently linked with an increase in the role of their own funds in financing the biggest capital investment programmes. Notwithstanding the higher tax rates, accumulation within the sector of non-- _-_-_ __NOTE__ Footnote cont. from page 97. Sponsored by the American Enterprise Institute for Public Policy Research, Washington, 1967, p. 15.

~^^1^^ Thomas F. Patton, Business Survival in the Sixties, New York, 1961, pp. 13--14.

~^^2^^ See Taxation, Capital and Economic Growth, National Association of Manufacturers, November 1961.

~^^3^^ See, for example, the review in Royal Commission on the Taxation of Profits and Income, 2nd Report, Presented to Parliament by Command of Her Majesty, April 1954, London, Cmd 9105, Chapter 4, pp. 27--31, Chapter 5, pp. 31--34.

~^^4^^ Raymond W. Goldsmith, The Flow of Capital Funds in the Postwar Economy, New York, London, 1965, p. 112.

99 finance corporations developed at a faster rate than the increase in the GNP. As a result the share of accumulation of private corporations in the GNP rose from 7.3 per cent in 1929 to 8.7 per cent at the end of the 1960s.^^1^^

Together with huge investments and substantial reserves formed on the basis of undistributed profits, private corporations used a considerable part of their income, remaining after the deduction of taxes, to pay dividends to shareholders. It is remarkable that the share of dividends in profits after the deduction of taxes was particularly large in rapidly developing US industries: at the beginning of the 1960s about 70 per cent of the profit after deduction of taxes was distributed in the form of dividends in the electrical equipment industry, 64 per cent in the chemical industry, 55 per cent in the automobile industry, while in the steel industry it was 47 per cent and in other industries 37 per cent.^^2^^

In assessing the thesis that high tax rates on corporate profits are an obstacle to economic growth, one can point to the following. In most West European countries as well as in Japan, the tax rate on company profits is not smaller than in the US. Thus, the real tax rates on undistributed profits of corporations were 67 per cent in the Federal Republic of Germany and 46 per cent in France at the beginning of the 1960s. In the United States (after the tax reform of 1964) they were 43 per cent, while the taxes on the distributed part of the profit were correspondingly 44, 46 and 43 per cent.^^3^^ The maximum tax rate on the net profits of corporations in Japan in the mid-1960s was also higher and the tax on corporations played a greater role in the budgetary revenue system than in the United States. Nevertheless in both Japan and the Federal Republic of Germany industrial production during the period under review developed considerably faster than in the USA.

_-_-_

~^^1^^ Survey of Current Business, Vol. 45, No. 8, August 1965, p. 25.

~^^2^^ Ray M. Powell, ``Management Views of Tax Depreciation'', Bureau of Business Research, Indiana Business Report, No. 34, Indiana University, 1962, p. 10.

~^^3^^ Richard A. Musgrave, Peggy Brewer Richman, ``Allocation Aspects, Domestic and International'', The Role of Direct and Indirect Taxes in the Federal Revenue System. A Conference Report of the National Bureau of Economic Research and The Brookings Institution, Princeton, 1964, p. 128.

100 Emacs-File-stamp: "/home/ysverdlov/leninist.biz/en/1973/USBEP201/20070405/199.tx" __EMAIL__ webmaster@leninist.biz __OCR__ ABBYY 6 Professional (2007.04.06) __WHERE_PAGE_NUMBERS__ top __FOOTNOTE_MARKER_STYLE__ [0-9]+ __ENDNOTE_MARKER_STYLE__ [0-9]+

The influence of tax rates is inseparably linked with the problem of incidence of the corporate income taxes. Within the framework of the present work it is impossible to examine in detail all aspects of this problem, which in a theoretical sense is quite complex. Let us confine ourselves to the following points: an increase in the tax on corporation incomes did not lead to any substantial reduction in the rate of profit after tax deductions. Thus, the rate of profit on the capital of corporations in the US manufacturing industry in the period of the cyclical advance of the 1920s (1927-- 1929), fluctuated around the level of 8 per cent and in the cyclical advance of the 1950s (1955--1957), around 9 per cent, although the nominal rates of corporate taxation during this period rose 4-5 times.

Martin Krzyzaniak and Richard Musgrave in a special study dealing with the problem of the shifting of the corporation income tax, arrive at the following conclusion: ``An increase in the tax is shifted fully through short-run adjustments to prevent a decline in the net rate of return, and ... these adjustments are maintained subsequently..."^^1^^ Since one of the major forms of shifting the corporation income tax is to raise the price of the goods they sell, this process promotes an increase in prices and a general rise in the cost of living.

In conditions of monopolistic competition when an important role is played by non-price aspects of the competitive process, the shifting taxes may assume somewhat different forms: the price would remain more or less stable but the quality of the goods is worsened, the volume of after-sale services is reduced, and so on. This process can be distinctly noted when rates on corporate taxes are raised in conditions of a war economy. But a study made by the Consumers Union in the post-war period shows that this process can also take place in conditions of a peacetime economy and the absence of government price control.

The US federal financial system is distinguished by a comparatively smaller share of indirect taxation.^^2^^ That is _-_-_

~^^1^^ Martin Krzyzaniak, Richard A. Musgrave, The Shifting of the Corporation Income Tax, Baltimore, 1963, p. 65.

~^^2^^ In 1960 indirect taxes in Italy amounted to 50 per cent of total tax revenue of the central government; in Britain, 40 per cent; France, __NOTE__ Footnote cont. on page 101. 101 why programmes for reducing corporate taxes often contain proposals for compensating the resulting fiscal losses by extending indirect federal taxes.^^1^^

The connection between an increase in indirect taxes and the rise in consumer goods prices is evident. At the end of the 1950s, D. Davies published a study demonstrating the influence which taxes on foodstuffs can exert on the living standards of various groups of the population. For families with incomes under $1,000 annually, the actual rate of taxation is 2.14 per cent of their incomes; $1,000 to $2,000, 1.43 per cent; $3,000 to $4,000, 1.33 per cent; $5,000 to $6,000, 1.26 per cent; $7,500 to $10,000, 1.04 per cent and above $10,000, 0.69.^^2^^ Consequently the system of actual rates of indirect taxation is marked by a distinctly pronounced regression: the burden of these taxes borne by the poorest population is 2-3 times heavier than by rich families. Particularly high are the actual rates of indirect taxation on poorer families with a large number of dependents.

At the same time, as pointed out in the subsequent chapter on local finances, the distribution of a number of state and local taxes is also of a regressive nature. The cumulative effect of these factors results in that the highest rates (as compared with their income) are paid by the poorest American families. R. Herriot and H. Miller have calculated the effective rate of taxation which would take into account all types of federal and local taxes. Some of the results of their estimates are given in Table III-5. Thus the actual tax burden more often does not increase but decreases as the economic possibilities of the taxpayers rise. Such a structure of the tax rates merely intensifies the inequality in the _-_-_ __NOTE__ Footnote cont. from page 100. 39 per cent; the Federal Republic of Germany, 37 per cent; Japan, 33 per cent; and in the United States only 14 per cent (O. EcEstein, ``Comparison of European and United States Tax Structures and Growth Implications'', The Role of Direct and Indirect Taxes in the Federal Revenue System, Princeton, 1964, p. 234). Indirect taxes, in accordance with the classification of UN statistical agencies, include customs duties, excises, the sales tax and property tax.

~^^1^^ Herbert Stein, ``What's Wrong with the Federal Tax System?" Tax Revision Compendium, Vol. 1, Washington, 1959, p. 116.

~^^2^^ David G. Davies, ``An Empirical Test of Sales-Tax Regressivity'', 'The Journal of Political Economy, Vol. LXVII, No. 1, February 1959, p. 74,

102 Table 111-5 III. TAX REVENUE 01' FEDERAL BUDGET Burden of Federal and Local Taxes Annual incomes less from from from from from from from from of taxpayers than 2 to 4 to 6 to 8 to 10 to 15 to 25 to 50 and (thousand 2 4 6 8 10 15 25 50 above dollars) Effective tax rate, per cent of income 5.0 34.6 31.0 30.1 29.8 29.8 30.0 32.8 45.0 Source: American Economic Review. Papers and Proceedings, May 1972, p. 320. distribution of incomes and property between various classes and social groups of American society.

__ALPHA_LVL2__ 3. THE STRUCTURE OF THE FEDERAL TAX SYSTEM
AND THE PROBLEM OF EROSION OF THE TAX BASE

Examining the contemporary taxation system in the United States one cannot fail to note that the numerous laws, regulations and addenda in the whole make up an extremely intricate and cumbersome system. Thus in filling out a tax declaration it is necessary to make ``upwards of 500 entries . .. and as many as 200 additions, substractions, multiplications and divisions".^^1^^ ``Thousands of people,'' the Wall Street Journal writes, ``...can't understand the tax forms."^^2^^ Practically only experts in taxation can understand all the fine points of this legislation.

The inequitable demands made by the government on different taxpayers and the diverse opportunities for evasion are accentuated by the existence of a ramified network of tax loopholes. The increasingly intricate system of relations existing between the Treasury Department and the big _-_-_

~^^1^^ Monthly Economic Letter, First National City Bank of New York, August 1963, p. 92.

~^^2^^ Wall Street Journal, April 9, 1959, p. 8.

103 taxpayers can nonplus even the most experienced officials of that department.

It would perhaps be too naive to see in the tax loopholes only a result of machinations by taxpayers or even of some or other pressure groups. The existing system, with its loopholes, is a manifestation of the functioning of the statemonopoly economic mechanism. With the extension of the economic functions of the state and the growth of taxation, the government must make ever wider use of changes in the structure of the taxation system as an important instrument of economic policy. It gives ``selective'' tax concessions to employers in some sectors of economy or to capitalists who perform definite commercial operations in order to stimulate the flow of capital into some or other sectors and thereby achieve a restructuring of the economy.

At the same time the government from time to time also offers general tax concessions, recognising in them one of the principal means for stimulating economic activity.

The system of tax concessions is being steadily widened and is becoming more ramified. The concessions and allowances introduced as temporary measures most often become irreversible.^^1^^

Here we encounter another specific feature of the mechanism of creating tax loopholes. While emphasising the role of the objective processes in the development of state-monopoly capitalism, we naturally must not discount the political forces which act as the chief dramatis personae in this process. Different groups of the capitalist class actively attempt to influence the choice of various forms of tax regulation, upholding the privileges most advantageous to themselves. ``Not more than one out of every 100 citizens actively . working on a tax bill is trying to represent the general interest,'' noted Paul H. Douglas, Chairman of the Joint Economic Committee of Congress who took part in the drafting of many tax bills. ``And in the halls outside the hearing rooms the lobbyists are as thick as flies. . . ."^^2^^ In those cases where _-_-_

~^^1^^ ``To attempt to close any one of even the major 'loopholes' would be a formidable political undertaking,'' Professor David B. Truman writes on this score (Trends in Modern American Society, Ed. by Clarence Morris, Philadelphia, 1962, p. 138.)

~^^2^^ Paul H. Douglas, In Our Time, New York, 1968, pp. 24--25.

104 the government decides to put forward proposals to restrict tax loopholes, big business representatives utilise their influence in Congress to have these bills rejected.^^1^^ The development of the US taxation system in recent decades shows that defenders of tax loopholes, who form a bloc, usually succeed in fully or partly frustrating reforms.

Consequently, the use of tax concessions as an instrument of economic policy ultimately gives rise to a spreading labyrinth of tax loopholes. But beside general economic functions, the taxation system must perform fiscal functions ``properly'' linked with the need to finance the growing governmental expenditure. These functions increasingly clash with the network of tax concessions. The internal contradictions between the general economic and fiscal technical functions of the tax system thus come to the foreground.

The various forms of tax concessions have been examined in detail in a number of special studies.^^2^^ Let us merely point to the financial importance of the tax concessions given to corporations. Data in Table III-6 illustrate the process of the gradual increase of the non-taxable incomes of corporations.

If we also add the rough estimates of the expenditures of executives of corporations for their own consumption which are entered under different items of costs,^^3^^ it will turn out that the total sum of actual profit exempted from taxation _-_-_

~^^1^^ This mechanism is examined in greater detail in Chapter I, in analysing the procedure of budget decision-making.

~^^2^^ See, for example, Norman B. Ture, Accelerated Depreciation in the United States 1954--1960, New York, 1967; Lawrence H. Seltzer, ``Nature and Tax Treatment of Capital Gains and Losses'', Fiscal Studies, No. 3, New York, 1951, and others.

~^^3^^ Materials submitted by the Department of the Treasury to Congress enumerate the following expenses usually entered as production costs: ``Country club and athletic club dues and charges; travel expenses of wives, children and relatives ... particularly when visits are made to resort or vacation areas... . Maintenance, operation or rental of automobiles, yachts, hunting lodges, fishing camps, resort properties, houses, apartments, hotel suites, etc. .. .Gifts to members of the taxpayer's family.'' Revenue Act of 1962, Hearings before the Committee on Finance, US Senate, 87th Congress, Second Session, April 2, 1962, Part 1, Washington, 1962, pp. 280--81.

105 Table III-6 Structure of Tax Concessions Given to Corporations, 1953--1959 fiscal years Form of exemptions and concessions Sums of corporation incomes exempted from taxation (million dollars, in current prices) Accelerated depreciation Depletion allowances Research and development Contributions or gifts Exclusions Preferential rates on capital gains 1953 fiscal year 1959 fiscal year 3,120 2,300 1,100 500 1,300 2,500* 3,550 3,000 1,750 500 1,600 3,500 * Estimates based on data of the 1956 fiscal year. Sources: William F. Hellmuth, ``Erosion of Federal Corporation Income Tax Base'', Federal Tax Policy for Economic Growth and Stability, November 9, Washington, 1955, pp. 914--15; Tax Revision Compendium, Vol. 1, Washington, 1959, p. 313. mounts up to one-third of the officially declared taxable profits.

Many loopholes are also contained in the system of taxation of individual large incomes. Let us refer in this connection to the earlier mentioned privilege of taxing incomes in the form of a preferential rate on capital gains: if these incomes were taxed at the ordinary rate, federal budget revenue in 1955 would increase, according to calculations of Professor Goode, by 10 per cent.^^1^^ The bulk of the benefits from these tax concessions accrues to the receivers of the biggest individual incomes: in families with the annual income of up to $5,000 the capital gain amounts to 2 per cent; in families with an annual income from $50,000 to $100,000, to 18 per cent and in families with an annual income of $1,000,000 and more, to 64 per cent of their total income.^^2^^

_-_-_

~^^1^^ See Richard Goode, The Individual Income Tax, Washington, 1964, p. 194.

~^^2^^ Calculated from data in Statistics of Income, Individual Income Tax Return, 1960.

106

Moreover, as a result of a number of officially permitted tax deductions, the Treasury Department loses about onefourth of the individual income tax receipts. In the case of families with incomes of $500,000 annually and over, these deductions added up to 21.5 per cent of the gross income in 1960, while in families in the lower income brackets (with an income of up to $3,000 annually) the deductions amounted to only 12.9 per cent of the gross income.^^1^^ Professor Lampman, analysing different forms of tax loopholes, declares that the ``income tax is full of rich man's subsidies".^^2^^

The development of various forms of tax concessions is gradually undermining the entire federal tax system, giving rise to the problem of so-called income tax base erosion. The extension of the network of loopholes reduces the efficiency of the entire fiscal mechanism since these processes, in the first place, curtail the basis of taxation, driving ever new breaches in it. Second, they widen the gap between the official and effective rates of taxation, thereby reducing to naught in a number of cases the system of progressive taxation envisaged by law. The federal tax system is especially vulnerable in this sphere because it is based on a higher proportion of personal income taxation (as compared with the financial system of local governments and the national budgets of other capitalist countries).

At the same time this process of erosion is gradually undermining the very principles of taxation, deepening property inequality and social injustice. The fiscal mechanism existing in the United States today is, less than ever before, based on the principle of equitable taxation of equal incomes. While those who receive modest incomes have to pay their taxes in full, in the 1960s 155 taxpayers with an income of more than $200,000 annually (among them 21 with an annual income of more than $1,000,000) did not pay a single cent in taxes.

Yet the taxation system is closely linked with the general system of the socio-political relations and this connection between them is two-sided. The structure of the existing _-_-_

~^^1^^ Calculated from data in Statistics of Income, Individual Income Tax Return, 1960.

^^2^^ Tax Revision Compendium, Vol. 3, Washington, 1959, p. 2243.

107 taxation system always reflects the dominant socio-political pattern of society.^^1^^ At the same time the contradictions and conflicts engendered by such a redistribution of the national income through the channels of the financial system which increases property and social inequality, in turn, actively influences the course of the socio-political movements developing in the country. The steady growth of the tax burden, coupled with the extension of the maze of tax loopholes utilised by Big Business, inevitably increases tensions within the economic and social system of contemporary capitalism.

_-_-_

~^^1^^ A number of interesting views on this question are voiced in an article by J. Schumpeter ``The Crisis of the Tax State'', International Economic Papers, No. 4, 1954.

[108] __NUMERIC_LVL1__ CHAPTER IV __ALPHA_LVL1__ ``THE PURE THEORY'' OF PUBLIC FINANCE:
A CRITICAL ANALYSIS __ALPHA_LVL2__ [introduction.]

Ever since the Great Depression of 1929--1933 the centre of emphasis in the theories and practices of economic regulation has gradually been shifted from measures of monetary policy to operations in the sphere of public finance. This is a reflection of definite structural changes in the development of the capitalist economy. Expansion of the economic functions of the government and the effecting of numerous state-monopoly measures presupposed a sharp rise in the share of the national income going into the channels of public finance. After a number of unsuccessful attempts to eliminate the Great Depression of the 1930s with the help of the policy of cheap money, faith in the possibility of influencing the course of economic growth through monetary policy was undermined. Keynesian concepts of economic regulation, widely disseminated during this period, were assigned a decisive part in operations in the sphere of government finances.

In the post-war period the discussion on the choice (and/or proper combination) of individual forms and methods of economic policy flared up with fresh force in Western economic literature. Today in almost all these discussions the financial operations of the state are regarded as a direct and efficient instrument and, in the opinion of some opponents of financial regulation, even ``excessively powerful" (from viewpoint of the general proponents of the private enterprise economy) for influencing the economy. Of late, 109 budget policy has been attracting the particular attention of Western theoreticians in connection with mounting military expenditures and the need for financing an ever wider range of government measures to stimulate economic growth, accelerate the development of many sectors of economy and so on.

A solution to a major question of financial theory, the optimal size of government consumption, has always been closely linked with the dominant general economic concept. Since the days of Adam Smith and David Ricardo an adverse attitude to big government spending has been quite firmly entrenched in Western economic literature. Exponents of the classical political economy emphasised the unproductive nature of government spending and assumed that in ordinary conditions it must be kept down to a minimum.

The extensive spread of the microeconomic marginalistic theories, which imparted a universal nature to elementary relations of the purchase and sale of goods, also left a definite imprint on the development of financial science. The gradual ousting of the methods of study employed by classical political economy and the wide introduction of the apparatus of .microeconomic analysis ushered in a new approach to the problem of government spending.

The category of ``services'' the government renders to the individual is gradually assuming a central place in financial theory. The demand for these ``services'' is presented, according to the new financial concept, not by society as a single political and economic entity but by every member of society; in this connection the demand for governmental services from the very beginning is considered an individual demand. The relations between the consumer of government services and the state are analysed in accordance with the partial equilibrium method. Since government expenditures represent simply a specific form of goods, the nature of government spending is determined solely by the composition of the effective demand of the population.

This concept gained dominant positions in Western financial literature at the end of the 19th and early 20th centuries. It was most consistently expounded in Germany by Friedrich von Wieser; Austria, Emil Sax; Italy, Maffeo 110 Pantaleoni and dc Viti de Marco; and in the Scandinavian countries, by K. Wicksell and Erik Lindahl. The proponents of this concept see, as one of its major advantages, that it makes possible the linking of the theory of public spending and taxation. Budget appropriations and taxes become one and the same act of exchange, the purchase and sale effected between the private buyer and the government.

The central role in this transaction is played by the subjective evaluations of the utility of governmental spending, on the one hand, and the similarly subjectively evaluated burden of tax payments, on the other. Thus in their relations with the state, consumers are guided by the same principles as in buying other commodities in the market: they buy the services only so long as the marginal utility of these services still exceeds the marginal disutility ( subjective burden) of the paid taxes. If the further development of the transaction proves disadvantageous for the taxpayer he refuses to shoulder the additional expenses of the state. Given such a premise, the precondition for the optimum financial activity of the government is the equal valuation by every consumer of the marginal utility of government services and the marginal utility of the money paid in the form of taxes. Provided this condition is observed the sum of the budget expenditure can ensure the maximum utility of the services from the point of view of the population.^^1^^

With such an approach, the financial activity of the state does not enter into contradiction with the processes of price formation on other markets: on the contrary, it fully meets the requirements of commercial accounting and forms an important component of the entire market mechanism.

In the financial literature of Anglo-Saxon countries, ``most of their ideas about the subject, and even their prejudices,'' as John Maynard Keynes pointed out, ``are traceable to the contact they have enjoyed with the writings and lectures of the two economists who have chiefly influenced Cambridge thought for the past fifty years, Dr. _-_-_

~^^1^^ One of the first models of this type is given in the work of Erik Lindahl, Die Gerechtigkeit der Besteuerung, Lund, Gleerug, 1919.

111 Marshall and Professor Pigou."^^1^^ After the publication of the Principles of Economics by A. Marshall and especially Economics of Welfare by A. Pigou, the academic theory began to link the financial activity of the state above all with the effect which Marshall designated as ``external economy or diseconomy".

The substance of this effect can be expressed as follows: in real economic life the production (or consumption) of one or another commodity within the bounds of one firm often exerts an essential influence on the nature of production functions of other firms (or correspondingly on the utility of commodities purchased by other consumers). In conditions of the dominance of private property such an interdependence inevitably assumes the form of an external economy (or diseconomy). The existence of this effect can undermine the conditions of ``normal'' competition. From this follows, as assumed by the proponents of these concepts, the need for financing governmental activity aimed at regulating the ``external'' conditions of production and consumption.

In modern economic literature we can find the most diverse schemes in which the financial operations of the state are deduced from the existence of one or another externality as well as numerous interpretations of government spending which link it first of all with the sociopolitical functions of the state. Any attempt to classify all these schemes and describe their approach to the question of the optimal level of government spending would lead us far beyond the bounds of the present chapter. Therefore we shall confine ourselves to a brief discussion of one of the presently most widespread and influential theories---the socalled ``pure theory of public finance".

__ALPHA_LVL2__ 1. ``PURE THEORY OF PUBLIC EXPENDITURE'':
MAIN IDEAS

The pure theory of public expenditure was first expounded in a consistent form in the 1950s in three articles by _-_-_

~^^1^^ John M. Keynes, Preface in M. E. Robinson, Public Finance, New York, 1922, p. VI.

112 Professor Samuelson.^^1^^ In the subsequent period the pure theory of public expenditure gained wide renown in Western economic and financial literature; it is part and parcel of courses on the theory of public finance.^^2^^

The ``pure theory of public expenditure" fully preserves the category of governmental services but emphasises the specific forms of the consumption of these services. For this a special theoretical construction is introduced, the concept of the ``public good''. The main feature, distinguishing a public good from a private one, is that consumption of a public good by a member of society does not entail any harm for other persons, the scale of their consumption remaining unchanged.

It is not difficult to see that when a good possesses such properties all usual principles of commercial activity simply lose their meaning. Let us, for example, turn to the usual technique of the microeconomic theory, a comparison of the marginal rates of substitution in the production of goods. In elementary models of perfect competition it is assumed that in the production of a given assortment of goods an equilibrium and simultaneously an optimal use of resources is achieved at that point where the marginal rate of substitution of any pair of resources in the production of any pair of goods is equal.^^3^^ But as soon as a public good is included, the conditions of equilibrium essentially change: _-_-_

~^^1^^ Paul A. Samuelson, ``The Pure Theory of Public Expenditure'', Review of Economics and Statistics, Vol. XXXVI, No. 4, November 1954, pp. 387--89; Paul A. Samuelson, ``Diagrammatic Exposition of a Theory of Public Expenditure'', Review of Economics and Statistics, Vol. XXXVII, No. 4, November 1955, pp. 350--56; Paul A. Samuelson, ``Aspects of Public Expenditure Theories'', Review of Economics and Statistics, Vol. XL, No. 4, November 1958, pp. 332--38; and also Paul A. Samuelson, ``Pure Theory of Public Expenditure and Taxation'', Public Economics. An Analysis of Public Production and Consumption and Their Relations to the Private Sectors. Proceedings of a Conference Held by the International Economic Association, London, 1969, pp. 98--123.

~^^2^^ See, for example, Richard A. Musgrave, The Theory of Public Finance. A Study in Public Economy, pp. 61--89.

~^^3^^ For a description of such models and conditions for the achievement of an equilibrium see Samuel Karlin, Mathematical Methods and Theory in Games, Programming and Economics, Addison-Wesley Publishing Co., Inc., Palo Alto, Mass., London, 1959.

113 the marginal rates of substitution of private resources in the production of private goods, as before, must be equal to the marginal rates of substitution of private resources in the production of public goods. But substitution between the public and private resources is regulated by entirely different interrelations. Let us assume, however, that these conditions are met. Then a more general question arises, namely, the criteria for the choice between public and private goods, and, together with this, the distribution of private goods among members of society. It can be demonstrated that there is a set of solutions which satisfy the criterion of optimality usually employed in microeconomic models (the Pareto criterion).^^1^^ To choose from this abundance of alternative decisions the best one, it is necessary to introduce into the model a macroeconomic choice function or, following the terminology accepted in Western economic literature, the ``social welfare function''. The entire presentation of this problem in essence differs little from the presentation of other problems in the welfare theory---the ensuring of maximum utility of public goods with a simultaneous minimising of the burden of tax payments.

The usual market operations in this system are inadequate even for achieving the Pareto optimum. As soon as public goods are introduced into the model the former mechanism of marginal analysis and equalisation of marginal rates of substitution is undermined.

In ordinary models supply of an additional good presupposes some cost of its production. In a model which includes a public good everything is different: as long as such a good is already produced the increase in the number of its consumers is not linked theoretically with any additional expenditures and so the marginal costs, and consequently, the prices may be equal to zero. Therefore, even some of those authors who energetically defend the principles of private enterprise and the ``sovereignty'' of individual needs, note that the efficient management requires other, non-market, methods of satisfying the individual needs _-_-_

~^^1^^ A detailed exposition of these problems in a formalised way can be found in Paul Samuelson's latest work mentioned above which was issued in 1969.

__PRINTERS_P_113_COMMENT__ 8---62 114 in goods possessing the properties of a public good. This, in turn, may give rise to the necessity of government financial activity.

__ALPHA_LVL2__ 2. THE PURE THEORY OF PUBLIC FINANCE:
AN ANALYSIS OF SOME PREMISES

The extensive dissemination of the ``pure theory of public finance" in Western economic literature in recent years is quite indicative. The marginalist methods were utilised until recently only for an analysis of market transactions between owners of private goods. But the development of the scientific and technological revolution and the attendant progress in technoeconomic and social interdependence demonstrate, with increasing clarity, the limited possibilities of private capitalist enterprise. The role played by fundamental theoretical studies in the natural sciences, for example, is sharply rising. But the results of such research, which often demands considerable expenditures, cannot serve as the object of an ordinary purchase-and-sale transaction: these results sooner possess the properties of a ``public'' rather than a private good. As Marx once remarked, the discovered natural law cost never a penny.^^1^^

Much of what has been said applies, as pointed out earlier, also to the flow of general technical, economic and other information. Can information about the movement of air masses, obtained with the help of space vehicles or the weather forecasts elaborated on this basis, serve only as the object of private market transactions?

In a number of cases personal consumption, too, acquires features which are not intrinsic in ordinary individual consumption. For example, as soon as at least one man begins to ``consume'' radio and TV programmes, any neighbour who has his own set can receive the same programmes free of charge. The forms of acquisition of such services already do not coincide (or at least only partly coincide) with usual purchase-and-sale operations. At the same time, as applied to them, the principles of private capitalist economic activity _-_-_

~^^1^^ Karl Marx, Capital, Vol. I, Moscow, 1969, p. 386.

115 lose their meaning; a need arises in other measures (criteria) and forms of distribution of society's resources.

The conversion of a public good into an object of study has one more quite important aspect. The goods, which could to the utmost degree satisfy the theoretical definition of a public good, could be, for example, pure air, pure water, sufficiently large tracts of forests and parks, and so on. So far the quantity of some of these resources were not strictly limited. So, in accordance with the usual concepts of non-Marxist economic theory, they generally cannot be regarded as an ``economic good''. But the numerous works, published in recent years on the problem of cities, demonstrate that questions of the pollution of the atmosphere and water reservoirs, the impermissible level of noise, the rapacious use of land, the disposal of the products of disintegration and combustion, and so on, constitute acute problems in the development of modern soceity. Special (and often considerable) governmental expenditures are required to ensure the general physical conditions for the existence and development of society---pure air, drinkable water, land suitable for life, forest tracts and so on.

In the pure theory of public expenditure, some of these problems are reflected in quite a peculiar form. At the same time the extension of this theory attests to a certain crisis in traditional microeconomic theory. As compared with the latter, the ``pure theory of public expenditure" makes an essential step forward, admitting the inadequacy of private enterprise methods of operating the economy.^^1^^

That is why, alongside numerous models of perfect and oligopolistic competition, other sharply differing concepts arise. The new models at the very outset proceed from the need for definite state regulation in the supply of public goods, trying to find criteria of the efficiency of such regulation and specifically to establish the optimal magnitude of government spending.

It is characteristic that economists adhering to positions _-_-_

~^^1^^ ``No decentralized pricing system can serve to determine optimally these levels of collective consumption" (Paul Samuelson, ``The Pure Theory of Public Expenditure'', Review of Economics and Statistics, Vol. XXXVI, No. 4, November 1954, p. 388.

116 of the unrestricted market economy, at once have perceived in the new theory a threat to the fundamental principles of the capitalist economy. Any attempt to replace market processes by state regulation ``would necessitate'', an opponent of Samuelson writes, ``a direct frontal attack on a vital institution of capitalism---the productivity principle as a basis for income distribution. This principle cannot be scrapped without a social revolution."^^1^^

It is indicative that in subsequent articles on this problem Samuelson hastened to make a reservation, assuring his opponents that he by no means is the proponent of a fully state-directed development of the economy.

For all the ambiguity of the described models, the formal methods of study employed in them are of definite interest. Some methods of such analysis can be utilised (naturally given a critical analysis of their genuine economic content), for the purpose of illustrating interrelations arising in the most general theoretical models of a national economic optimum.

At the same time any attempt to go beyond the bounds of the general conclusions and to lead the ``pure theory of public expenditure" to any practical conclusions, inevitably brings out the internal weaknesses of this concept.

Complications arise from the very beginning---from the moment the category of a public good is introduced. The point is that the overwhelming majority of goods and services provided by governmental spending actually do not satisfy (or in any case satisfy to an insufficient degree) the general terms of the model. Thus, transfer payments ( pensions, benefits and others) cannot be included among them in general. As for other governmental expenditures, they, as a rule, have sufficiently narrow limits of effective functioning and do not permit an unlimited increase in the number of consumers. Therefore a public good actually turns out to be an abstract theoretical concept which only in very rare cases can be adequately reflected in reality. After the publication of Samuelson's first article critical remarks _-_-_

~^^1^^ Julius Margolis, ``A Comment on the Pure Theory of Public Expenditure'', Review of Economics and Statistics, Vol. XXXVII, No. 4, November 1955, pp. 348--49.

117 were immediately forthcoming which pointed to the artificiality of such a theoretical construction as a public good.^^1^^ Noting that ``very few pure public goods exist'', some authors concluded ``that the theory based on the concept therefore has very limited applicability".^^2^^

In subsequent articles Samuelson partly admitted the complete conventionality of the mechanical division of goods into public and private categories. At the same time, replying to his opponents, he voiced a fully grounded thought: a private good, which plays such an important role in models of perfect competition, is also quite rarely met in pure form in practical life. Somewhat softening former conclusions, Samuelson proposed that the properties of public and private goods be regarded as some kind of ``opposite poles" in the total diverse spectrum of goods and services.

Such an approach undoubtedly makes the theory under examination somewhat more realistic. But its link with the theory of public finance is consequently eroded and the practical conclusions from this concept are even more shaky. If in every good we can find the properties inherent in a private good and at the same time the properties of a public good, why then is a consumer able (and, as assumed by the traditional microeconomic theory, must) buy some goods in the market, while he has to receive others in the form of governmental services? When can a good be regarded as primarily public and where is the divide, beyond which the intervention of the state in the processes of production and distribution of a good becomes an economic necessity?

Demonstrating the impossibility of ensuring public goods on the basis of voluntary private economic transactions, the new concept of government spending signified an evident step forward as compared with the earlier mentioned interpretation of financial operations as acts of voluntary _-_-_

~^^1^^ See, for example, Stephan Enke, ``More on the Misuse of Mathematics in Economics: a Rejoinder'', Review of Economics and Statistics, Vol. XXVII, No. 2, May 1955, p. 132.

~^^2^^ Albert Breton, ``A Theory of the Demand for Public Goods'', The Canadian Journal of Economics and Political Sciences, Vol. XXXII, No. 4, November 19<>6, p. 45S.

118 exchange. ``Much of what goes by the name of the Voluntary exchange theory of public finance' seems pure obfuscation,'' Samuelson remarks.^^1^^

But casting aside former concepts and going over from primitive equilibrium models to an optimisation model, the ``pure theory" in general prefers to avoid questions connected with the characteristic of the concrete mechanism which ensures the maximum production and distribution of public goods. The main information which can be gained from these models does not go beyond the bounds of a peculiar ``collective Robinsonade": the initial premises assume the existence of a number of rational consumers and a definite stock of production resources. The whole point is limited to this.

As for processes which characterise the mechanism of the functioning of the system itself, its economic and political structures, they are completely ignored. To achieve an optimum within the bounds of the model it is only necessary that the government possess sufficient information, first, about the social welfare function and, second, about the system of preferences of society's every member (the individual consumer appears in this model, according to Samuelson, as a parametrically decentralised bureaucrat). Moreover, the question does not arise, that the government may pursue some tasks which do not coincide with one definite solution of the system. At such a level of abstraction the initial premises of the model resemble, as G. Colm caustically remarks, ``the marriage between the ghost of the long-time buried homo economicus with an equally sterile mulier politico".^^2^^ The paucity of the initial premises inevitably imparts to the conclusions of the ``pure theory" an excessively general and in a number of cases rather arbitrary character.

Former theories presupposed that, if prior to effecting governmental financial operations some kind of a ``fair'' _-_-_

~^^1^^ Paul A. Samuelson, ``Diagrammatic Exposition of a Theory of Public Expenditure'', Review of Economics and Statistics, Vol. XXXVII, No. 4, November 1955, p. 355.

~^^2^^ Gerhard Colm, ``Comments on Samuelson's Theory of Public Finance'', Review of Economics and Statistics, Vol. XXXVIII, No. 4, November 1956, p. 409.

119 distribution of personal incomes had been achieved, government spending (and the respective tax collections) would not be able to impair it. The ``pure theory" has elaborated an apparatus which makes it possible to demonstrate evidently the untenability of such assertions. Distribution and redistribution of incomes (effected either directly in the form of a change in money payments or transition to a new structure of prices) represent for the ``pure theory" one of the important aspects of the optimisation process itself.^^1^^ But the extremely abstract nature of the model permits of no answer to the question, how in practice to redistribute the national income and what sections of the population are interested in one or another government expenditure. The ``pure theory" in fact also avoids these questions, imparting to the entire problem a strictly normative nature, and simply relegates it to another sphere---the sphere of analysis of the social welfare function. However not only the practical elaboration but even the most general theoretical definition of the social welfare function encounters exceedingly serious difficulties.

There is just as little clarity on the question, how a government can obtain information about the system of individual preferences. The point is that because of the specific properties of a public good the process of ``revealing preferences" in the course of market exchange becomes impossible. At the same time, here, the ordinary methods of polling the consumers cannot be successful.

Since every consumer in any case can obtain an equal share of a public good, it is to his benefit to minimise his needs (and correspondingly, the money evaluation of this good). After all, these evaluations must be taken into _-_-_

~^^1^^ Thus, in the examined model there existed, as pointed out earlier, a whole area of solutions, each of which ensures an improvement in the welfare of one group of consumers, without worsening the position of other groups. A stricter formulation of the problem makes it possible to show that within the limits of such models, determination of the optimal size and structure of the product and distribution of incomes represent two sides of one and the same process. This is especially seen in the study of the system of differential equations in an analogous model of R. Strotz (see Robert H. Strotz, ``Two Propositions Related to Public Goods'', Review of Economics and Statistics, Vol. XL, No. 4, November 1958, pp. 329--31).

120 account, in one or another way, in distributing the burden of taxation and there is every reason for assuming that the biggest contribution will have to be made by those groups of the population whose revealed needs are more urgent.

These features impart to the ``pure theory of public expenditure" the nature of an insufficiently elaborated formal hypothesis. Notwithstanding Samuelson's two repeated attempts at explaining his concept the ``pure theory" ``is still . . . something of an enigma to most economists, though it is nevertheless felt to be of considerable importance'', one of the active proponents of this theory admits.^^1^^

__ALPHA_LVL2__ 3. MECHANISM OF CHOICE OF PUBLIC GOODS

We already pointed earlier to one of the most vulnerable points in the pure theory of public finance. This theory essentially goes beyond the bounds of the examined models in the solution of any essential socio-economic problems: their ``strictly scientific" solution is fully dependent on the social welfare function and the latter, as Western authors unanimously admit, belongs among the least elaborated categories of economic theory.

That is why some economists are trying to save the model of the ``pure theory of public finance" along the following lines: the decisive role is assigned not to the social welfare function but to the political mechanism of decision-making. Thus, Professor Musgrave in his book, The Theory of Public Finance, states: ``Political action is needed to translate individual preferences for social wants into a specific budget program. Since the responsible organs of government in a democratic society are the electorate and their representatives, budget determination by these responsible organs is determination through the democratic process."^^2^^

_-_-_

~^^1^^ J. C. Head, ``Public Goods and Public Policy'', Public Finance, No. 3, 1968, pp. 197, 198.

~^^2^^ Richard A. Musgrave, The Theory of Public Finance. A Study in Public Economy, p. 87.

121

Thus, as can readily be seen, many formerly rejected premises about the ``purchase'' of public expenditures are again introduced. The role of ordinary competitive bids is performed here by the mechanism of voting and rivalry of different political groups and parties.^^1^^

In such an interpretation, the pure theory of public finance finally loses its reality. The entire complexity of the proposed mechanism of the social system is completely ignored. Let us refer merely to one of these problems---the problem of every taxpayer being sufficiently informed. Anthony Downs, the author of a number of works on the theory of the political process, characterises as follows the real state of affairs in this field: ``It becomes harder and harder for even experts to keep well-informed on possible benefits to be gained from government policies. . .. Society's complexity demands more government action, but it also makes each field of action more remote from the ken of the average man. Faced with gigantic maze of government agencies, each grappling with incredibly intricate problems, a normal citizen . . . wraps himself in a mantle of rational ignorance. .. ."^^2^^ Moreover, it is because of the negligible influence exerted by individual consumers on the general policy of government spending that the consumer has no sufficient stimuli for accumulating such information.

The nature of state power and the processes of centralised administration are given an extremely primitive interpretation. W. Ehrlicher in his review of financial theories remarks on well-founded grounds: ``Such theories have recently been reviving the former notion of 'natural right' stemming already from the idea of the social contract: the _-_-_

~^^1^^ Lindahl already noted that the totality of individual preferences concerning one or another governmental activity could be adequately expressed in a system which assigns each political grouping equal rights and ensures the possibility for the practical exercise of these rights. In subsequent years, G. Myrdal and other economists demonstrated the inconsistent nature of such theoretical constructions (see, for example, Gunnar Myrdal, The Political Element in the Development of Economic Theory, Cambridge, Mass., 1955, p. 182).

~^^2^^ Anthony Downs, ``Why the Government Budget Is Too Small in a Democracy?" World Politics, A Quarterly Journal of International Relations, Princeton University Press, Vol. XII, No. 4, fuly 1960, pp. 561--62.

122 state is a result of individual efforts, its operations are determined by the members of society and the economy of the state is nothing else but a single economy among other ( private) economies."^^1^^ Such notions cannot withstand criticism even from the viewpoint of the modern Western political science. Thus Anthony Downs, Fred Harding and other authors have shown that even given the full equality of political rights of voters, time and again situations arise when governmental policy does not reflect the real preferences of the population.^^2^^

The greatest objections, however, are naturally aroused by the too formal, non-social approach to the concept of democracy and the ignoring of the sharp contradictions which characterise the antagonistic political structure of contemporary capitalism.

The exacerbation of these contradictions is also reflected in the positions of ``academic'' financial science. One of the reports on public expenditure points out that the Western democracies show a tendency to be displayed in a system of corporative pressures which express only their own interests.^^3^^

Of definite interest in this respect is the interpretation of public expenditure in the concept of Albert Breton.^^4^^ Like Musgrave, Breton seeks to develop the pure theory, linking the economic and political factors of determining government spending with factors of political influence and pushes to the background all the theoretical constructions connected with the social welfare function.

Moreover, an analysis of the political factors is of a somewhat more realistic nature: instead of general, declarative statements about ideal democracy there figures the activity _-_-_

~^^1^^ W. Ehrlicher, ``Finanzwissenschaft'', Kompendium der Volkwirlschaftslehre, 2. Band, Gottingen, 1968, S. 364.

~^^2^^ See Anthony Downs, An Economic Theory of Democracy, New York, 1957; Fred O. Harding, Politisches Modell zur Wirtschaftstheorie. Theorie der Bestimmungsfaktoren finanzwirtschaftlicher Staatstdtigkeit, Freiburg, 1959.

~^^3^^ W. Drees, ``Efficiency in Government Spending. General Report'', The Public finance Nos. 1-2, 1967, p. 9.

~^^4^^ See Albert Breton, ``A Theory of the Demand for Public Goods'', The Canadian Journal of Economics and Political Sciences, Vol. XXXII, No. 4, November 1966.

123 of political groups, which could unite to represent common interests, engage in lobbying, organise representations and demonstrations, bring pressure to bear on senators and congressmen, organise protests, send their statements to the appropriate organisations, render financial and other support to political action groups and also employ many other means. A mere enumeration of these means could serve as a good commentary on the ``idyllic'' schemes for determining the range of public goods in conditions of some kind of an ``abstract perfect democracy".

Efforts to take into consideration the influence of different political groups with the aid of elementary equilibrium models lead Breton to the conclusion that the scale and composition of government spending in conditions in which the equilibrium is being formed, will ultimately reflect not so much the system of society's ethical values as the concentration of political power in the hands of one or another group of the population.

At the same time it should be noted that Breton's arguments are too general in nature. For example, he enumerates the various instruments of political pressure accessible in fact only to Big Business. But he carefully avoids any concrete answer to the question, what class forces and social groups directly influence the mechanism which determines government appropriations. Yet Breton's conclusions could acquire a more concrete content if he were to introduce into the model at least the most elementary terms that the majority of the population has very limited, if any, access to pressure groups, lobby organisations, and so on, terms mentioned in many works on political theory.^^1^^

An analysis of the models of decision-making within the bounds of the pure theory of public finance leads to the conclusion that all efforts to solve the problem of the optimal size of a budget, proceeding from the premises of socalled ``ideal democracy'', are characterised by deep inner contradictions. Borrowing premises of atomistic models of perfect competition and equilibrium models of self-- regulation, the authors of the models apply these premises to a _-_-_

~^^1^^ See, for example, E. Schattschneidery, The Semisovereign People. A Realist's View on Democracy in America, New York, 1961.

124 characteristic of a fundamentally different social process which develops as a negation of former commercial operations and goes beyond the bounds of the ordinary market equilibrium.

__*_*_*__

The pure theory of public expenditure from the very beginning was constructed as an abstract model, proceeding from a number of purely formal premises and hypotheses. Not one of its subsequent interpretations has succeeded in linking this concept with the real policy of governmental appropriations. It is not by chance that immediately after the publication of Samuelson's first article, Stephan Enke, an American economist, noted: ``One might expect that an article on public expenditure (however 'pure') might throw out a few hints to responsible government officials (or at least to the economists on their staff) on how policy implications (if any) might conceivably be derived. Not to do so is to imply that there will be none."^^1^^ Many West European economists assessed the possibilities for the practical application of this theory in a similarly sceptical vein. Thus, K. Hauser, Professor of Frankfurt University, the Federal Republic of Germany, remarks: ``For such an imposing integrity and completeness of this theory a high price has to be paid because the theory obtained in this way is extremely impractical and is as good as unsuitable for the solution of real problems."^^2^^

Thus far, all the interpretations of the pure theory of government expenditure and the practical financial policy are divided by a deep abyss. Among the numerous theoretical models of government spending it is impossible to find one which could concretely show the optimum size and structure of appropriations for the given conditions or, at least, the tendencies of their development. As for the models of an optimum budget which gained currency recently, they are abstract and schematic to the utmost---that is why _-_-_

~^^1^^ Stephan Enke, Op. cit, p. 133.

~^^2^^ K. Hauser, Ober Ansdtze zur Theorie der Staatsausgaben. Beitrage zur Theorie der offentlichen Ausgabcn von Clemens-August Andrcac, Berlin, 1907, S. 48.

125 such models simply cannot be utilised in the real processes ol planning and allocating budget appropriations.^^1^^

Such a gap between the theory and practice of government financial policy cannot be considered accidental. Relegating to the background a concrete socio-economic study of tendencies and processes which characterise the development of capitalism's financial system and seeking only to construct the ``most general" deductive theories, Western financial theory thereby develops first of all formal, logical methods of analysis which are divorced from a penetrating institutional and other studies.

These features in the evolution of the theory of finance are widely utilised for apologetic purposes by the defenders of the aggressive imperialist policy. From the viewpoint of the pure theory of public finance, the difference between appropriations for the intensification of the arms race and, say, expenses for improving the medical service system may be inessential. Utilising the extremely abstract nature of such a category as the social welfare function or replacing the antagonistic political structure of contemporary capitalist society by models of ``ideal democracy'', a number of economists are trying to portray appropriations for an aggressive policy as financing some kind of an `` optimum range" of public goods. It is clear that vulgar concepts of this kind actually conceal the mounting social conflicts within capitalist society, the exacerbation of the contradiction between the government's policy, effected in the interests of the military-industrial complex, and the vital interests of the working people.

_-_-_

~^^1^^ ``Major allocative decisions involve such questions as, should more resources be employed in national security in the future, or in national health programs, or in preservation and development of natural resources, etc.? .. .In the main, the analytical tools now available--- particularly the quantitative ones---are just not very helpful in dealing dirccly with such problems. Intuition and judgment are paramount.'' (G. Fisher, ``The Role of Cost-Utility Analysis and Program Budgeting'', Program Budgeting, Washington, 1965, p. 35.

[126] __NUMERIC_LVL1__ CHAPTER V __ALPHA_LVL1__ PUBLIC DEBT AND MONETARY SYSTEM __NOTE__ Only chapter without ALPHA_LVL2's.

The problems of raising additional funds in the money and capital markets to cover the excess of budget expenditures over receipts occupies an important place in the fiscal strategy of the US Government. The problem became very acute during the Second World War when the US public debt annually increased by tens of thousands of milions of dollars. After the war there appeared a new problem of managing the huge debt. At the same time the chronic deficit of the federal budget, which was largely due to preserving military spending at a high level made impossible any substantial reduction of the government debt. At the beginning of June 1972, the total amount of federal securities outstanding reached an all-time peak in the history of US public finance---$427,300 million. Together with the issues of government agencies the debt outstanding amounted to $438,200 million. On March 17, 1971, the US Congress enacted Public Law 92-5, which raised the statutory federal debt limit to $400,000 million and the temporary limit (up to October 1972) by another $30,000 million. Then the temporary maximum limit was raised by another $20,000 million, i.e., to $450,000 million.^^1^^ This is more than 40 per cent above the record figure reached during the Second World War.

_-_-_

~^^1^^ Treasury Bulletin, August 1972, pp. 22, 28.

127

The practice of fixing the maximum volume of the federal debt was introduced in the United States in 1917 on the basis of the Second Liberty Bond Act.^^1^^

The purpose of fixing a debt limit was to give to the legislative authority means of control over the total borrowings of the government. But gradually this procedure became a mere formality. This was clearly revealed during the last 15 years when Congress almost automatically satisfied all the requests of the Treasury to raise the federal debt limit. During this period the limit was increased 17 times, following the steady growth of the federal debt.

The increase of the public debt in the USA indicates the serious financial difficulties faced by the federal authorities. Although the long-term historical tendency, outlined earlier, consists in the increase of the tax rates, as a result of which an ever growing share of the national income was placed at the disposal of the government, the revenue failed to keep pace with expenditure. The point is that at any time the possibility of mobilising part of the money income into the budget through the tax channels is limited by a number of economic and social factors. Tax increases reduce the purchasing power of the population and exacerbate the most ``painful'' problem of capitalism, that of marketing the produced goods. At the same time, the tax burden, shifted chiefly onto the population in the lower brackets, is a constant source of social conflicts and growing intensity of the class struggle. That is why a substantial (and in some periods even the bigger) part of the expenditure has to be financed by the government in a more costly way, by the issue of securities and their sale in the money and capital markets.

Table V-I shows that the present federal debt is a product of Treasury operations carried out over a long period of time.

The First World War increased the federal debt by more than eight times. Budget revenue covered only part of the tremendous military expenditure. The deficit reached up to 70 per cent of the expenditure. After the end of the war _-_-_

~^^1^^ Until then Congress instructed the Treasury as to the type of securities, the sum and terms of each separate issue.

128

Table V-1

Federal Debt of the USA, 1917--1972 (million dollars) End of fiscal year Total outstanding Increase (+) or decrease (---) 1917 2,976 1919 25,482 + 22,506 1929 16,931 ---8,551 1939 40,440 + 23,509 1946 269,422 +228,982 1950 257,367 ---12,065 1955 274,374 + 17,017 1960 286,331 + 11,957 1965 317,274 + 30,943 1970 370,919 + 53,645 1972 427,260 + 56,341 Sources: Historical Statistics of the United States, Treasury Bulletin, August 1972, p. 22. the debt was reduced ($16,900 million) as a result of the relatively stable economic activity.

The Great Depression of 1929--1933 marked a kind of a turning point in the history of US public finance. A deficit has become a regular feature of the budget since the 1931 fiscal year and there has been, since then, a chronic imbalance of the federal budget in non-war years. Although the budget deficit of that period was largely determined by uncontrolled economic factors (specifically, the sharp decrease in taxable incomes of the population and corporations), the government by its ``anti-depression'' actions initiated a policy of a ``deliberately unbalanced" budget. We have referred in earlier chapters to a basic shift in the function of the capitalist state which changed the strategy and forms of economic policy. Perhaps in no other sphere has the shift been so pronounced as in governmental financial operations.^^1^^ Prior to the outbreak of the deep economic crisis in _-_-_

~^^1^^ See Herbert Stein, The Fiscal Revolution in America, Chicago University Press, Chicago, London, 1969, chapters 2-4; Lewis H. Kimmel, Federal Budget and Fiscal Policy, 1789--1958, The Brookings Institution, Washington, B.C., 1959, chapters III-IV.

129 the 1930s, the concept of ``sound finance" and of an annually balanced budget dominated US academic circles, public opinion and governmental policy. US presidents, Coolidge (1923--1929) and Hoover (1929--1933), consistently supported the principles of a ``cheap government" and a small public debt. Lewis Kimmel writes in his study of the historical aspects of fiscal policy that ``when the depression began in 1929, federal budget policy was firmly anchored to the idea that the budget should be balanced annually. A balanced budget was regarded as the principal test of sound fiscal management."^^1^^

A sharp change in budgetary concepts and, accordingly, in the nature of governmental actions, occurred during the Administration of President Franklin Delano Roosevelt, although even before that time a number of US and West European authors voiced ideas justifying the violation of ``fiscal discipline" in conditions of deep depression.

The initial budgetary measures of the Roosevelt Administration (1933--1934) and the ``pump-priming'' policy it conducted, had no consistent theoretical foundations. It was assumed that large budget appropriations for public works and other programmes were of strictly temporary nature. They were viewed as emergency measures which would be phased out with the economy's transition to the stage of recovery and growth. The budget appropriations for these purposes were called emergency expenditures which were placed in opposition to general expenditures.

The situation, however, changed at the end of the 1930s after the publication of The General Theory of Employment, Interest and Money (1936) by John Maynard Keynes and the works of Alvin Hansen, a leading defender of Keynesian ideas in the United States. The fiscal policy received justification within the limits of a more general theoretical concept. Popularity was gained by Hansen's thesis on the capitalist economy's tendency towards secular stagnation, and also by his notion of the governmental fiscal policy as the chief and, in fact, the only method for _-_-_

~^^1^^ Lewis H. Kimmel, Op. cit., p. 143.

__PRINTERS_P_129_COMMENT__ 9---02 130 eliminating the chronic lack of effective demand.^^1^^ According to John Williams, deficit spending gained recognition in academic circles, and considerations of a balanced budget were relegated to the background in elaborating government measures.^^2^^

As a result of the chronic imbalance of the US budget in the 1930s the federal debt in the 1941 fiscal year was three times as large as in 1930.

The public debt mounted tremendously during the Second World War. The screws of the taxation press were tightened to the utmost and even that, by far, did not cover war expenditures. The total budgetary deficit in the fiscal years between 1941 and 1946 reached $204,900 million. During this period the increase in the debt amounted to $220,500 million. Governmental borrowings were the main method for financing the cost of the war. They covered, in some years, more than 50 per cent and in the 1943 fiscal year, more than 70 per cent of the budget expenditures.

After the end of the Second World War, the size of the US budget deficit decreased. But instances of an excess of revenue over expenditure were merely episodic. The US budget is influenced to a decisive degree by the cyclical process of reproduction as well as by militarism and the arms race.

The forms and operational principles of fiscal policy have changed in recent decades. Although the sharp increase in inflationary pressure has moderated the predilection for deficit financing, the release of the government from the duty to fit expenditures in the budget to the amount of tax collections, is now regarded as a prerequisite for a modern fiscal policy.

A deliberately unbalanced budget serves as a practical expression of neo-Keynesian concepts of a ``high-pressure economy" and ``activism'', where big government spending is regarded as an indispensable stimulus for maintaining stable economic growth rates. The principles of a ``free'' _-_-_

~^^1^^ Alvin H. Hansen, Fiscal Policy and Business Cycles, W. W. Norton, New York, 1941.

~^^2^^ John H. Williams, ``Deficit Spending'', American Economic Review, Vol. XXX, No. 5, February 1941, pp. 52--56.

131 and flexible budgetary policy were revealed most clearly in the 1960s under the Kennedy and Johnson administrations.

The influence exerted by professional economists on the process of government decision-making rose sharply during those years. Among President Kennedy's closest advisers were such well-known proponents of ``activism'' and expansionist measures as John Galbraith and Seymour Harris of Harvard University, Paul Samuelson of the Massachusetts Institute of Technology and James Tobin of Yale University.

``The Kennedy economists,'' Herbert Stein wrote, ``like most American economists of 1960, believed that the chief economic problem of the country was to achieve and maintain high and rapidly rising total output. That is, the problem was full employment and economic growth. The keys to the management of that problem was fiscal policy and monetary policy, with fiscal policy being the senior partner in the combination. Full employment---or economic stabilization---and economic growth were the main objectives and guides of fiscal policy; budget-balancing was an irrelevancy."^^1^^

This brief historical survey shows that in conditions of the contemporary American economy a budget deficit is in effect a constant feature of federal finance. The result is that the government piles up a huge debt.

Let us examine in greater detail the composition of the US public debt. All the issues of the US Treasury Department are divided into three big categories: 1) marketable securities; 2) nonmarketable securities; 3) special issues.

Marketable securities can be freely bought and sold in the public securities market but cannot be presented for redemption prior to maturity. Nonmarketable securities cannot be sold or transferred by their original holders but, with some exceptions, can at any time be presented for redemption.

Special issues are designated in each case for placement among definite government institutions and funds. They cannot be sold at the market either.

_-_-_

~^^1^^ Herbert Stein, Op. cit., p. 381.

132 Table V-2 Composition of the Public Debt in the USA (end of selected fiscal years, in '000 million dollars) 1938 1946 1950 1960 1972 Marketable securities Nonmarketable securities Special issues Others 32.3 1.6 2.7 5.4 189.6 56.2 22.3 1.8 155.3 67.5 32.4 2.1 183.8 54.5 44.9 3.1 257.2 78.6 89.6 1.9 Total amount of the public debt 42.0 269.9 257.3 286.3 427.3 Percentage of the marketable debt in the total 76.9 70.2 60.4 64.1 60.2 Source: Treasury Bulletin, various issues.

The tendency to reduce the share of marketable securities and to increase the share of nonmarketable and special issues reflects the desire of the Treasury to utilise accumulations of different population groups and to extend to the utmost the number of holders of the public debt. Fourfifths of all the issues which do not circulate in the market are US savings bonds which are designated especially for small bondholders and savings institutions.

Special issues are placed among government institutions, government pension and insurance trust funds. Their sum is steadily rising---$2,700 million in 1938; $32,400 million in 1950; $89,600 million in 1972. Large amounts are invested in government securities by federal employees pension funds, federal old-age insurance fund and other trust funds. So a considerable part of the money mobilised through the channels of the social security system are used for Treasury financing.

The huge size of the US public debt extremely complicates the offering of the new issues of securities. The main difficulties are connected with the marketable part of the debt which is quite mobile and sensitive to changes in the 133 money market. Of interest in this connection is the change of the maturity distribution of the marketable part of the debt during the post-war years.

Table V-3 Maturity Distribution and Average Length of Marketable Public Debt (1939--1972) Maturity classes 20~ End of fiscal Amount outstand-- within 1 year 1-5 years 5-10 years 10--20 years years and more Average length year ing Sum at the end of the fiscal year. '000 million dollars 1939 32.8 4.3 9.3 8.8 9.9 1.5 no data 1946 189.5 62.0 35.1 32.8 37.2 22.4 7 years 11 months 1955 155.2 49.7 39.1 34.3 28.6 3.5 5 » 10 » 1960 183.8 70.5 72.8 20.2 12.6 7.7 4 » 4 » 1965 208.7 87.7 56.2 39.2 8.4 17.2 5 » 4 » 1972 257.2 121.9 89.0 26.9 9.3 10.1 3 » 3 » Percentage, distribution 1939 100.0 12.7 27.6 26.0 29.3 4.4 1946 100.0 32.7 18.5 17.3 19.7 11.8 1955 100.0 32.0 25.2 22.1 18.4 2.3 1960 100.0 38.4 39.6 11.0 6.8 4.2 1965 100.0 42.0 26.9 18.8 4.0 8.3 1972 100.0 47.4 34.6 10.5 3.6 3.9 Source: Treasury Bulletin, various issues.

At the end of the war the most mobile part of the debt (issues with a maturity up to one year) amounted to onethird of the entire debt. Subsequently their share continued to rise, reaching 47.4 per cent in 1972. The share of the next maturity group (1-5 years) has also been steadily rising. In 1972, the part of the debt subject to repayment in the next five years, exceeded four-fifths of the entire marketable debt (in 1946 it equaled one-half). On the whole the average length of the entire marketable public debt decreased in the post-war period from nearly 8 to 3 years and 3 months.

134

Such a shortening of the average maturity of indebtedness created exceedingly difficult problems for the Treasury. The higher the share of the short-term issues the more often the need arises for ``refinancing'' (refund or rollover), i.e., for redeeming the old issues by placing new securities on the market. This greatly hinders the management of the public debt, especially in view of the keen competition which has been existing in the capital market during the last twenty years.

Since the 1950s, the Treasury has been unsuccessfully trying to change the composition of the debt, to raise the share of securities with a longer term to maturity. The report of the Commission on Money and Credit contains a special recommendation which requires ``that we arrest the shortening of the outstanding publicly held marketable debt___The Treasury should pursue a program which over a period of time would lead to a more balanced maturity structure for the debt."^^1^^ But the share of short-term issues continues to rise. The adverse consequences of this shift are felt not only by the Treasury: as a result of greater liquidity of the economy the possibilities for monetary and credit management are consequently hindered, particularly, the struggle against inflation.

Many difficulties in respect to placing marketable issues are linked with the fact that the government, acting as a borrower in the money and capital markets, competes with numerous groups of private investors. The degree of this competition is particularly demonstrated by the comparative growth of the public and private debt.

While in 1950 the federal debt approximately equalled the debt of the private sector, in 1971 the latter exceeded the amount of the federal debt almost four times. The result was stiffer competition in the credit market. Moreover, the Treasury's interest payments on the new issues are steadily increasing.

Who are the holders of government securities? What changes occurred in the post-war period in the ownership of the federal debt?

_-_-_

~^^1^^ The Report of the Commission on Money and Credit, PrenticeHall, Inc., Englcwood Cliffs, N.J., 1961, p. 103.

135 T a b l e V-4 Public and Private Debt in the USA, 1929--1971 (in '000 million dollars) Public debt End of Total out-- Private year standing Total Federal* State and local Other debt 1929 214.4 34.8 17.5 17.2 179.6 1939 208.9 70.1 50.1 20.0 --- 138.9 1945 464.2 309.2 292.6 16.6 --- 155.0 1950 561.1 290.6 266.4 24.2 --- 270.5 1960 997.0 372.1 296.6 72.0 3.5 624.9 1965 1,401.8 442.7 330.7 103.1 8.9 959.1 1970 2,104.3 591.5 401.6 151.1 38.8 1,512.9 1971 2,276.2 646.7 435.2 171.7 39.8 1,629.6 * As of the end of calendar year. Source: Survey of. Current Business, September 1957, May 1969, May 1972.

An answer to this question is given in Table V-5.

It is interesting to point to the steady rise in the share of the federal debt distributed among government agencies, government pension and insurance trust funds and Federal Reserve Banks. In 1946 this group accounted for 17.5 per cent of the debt, whereas in 1972 it increased to 42.8 per cent. An especially noticeable change occurred in the last decade when the security holdings of these institutions doubled. Changes of the securities portfolio with each of the two main categories of this group influence the economy in different ways. Particularly adverse effects result from the purchase of government securities by the Federal Reserve Banks. This point will be examined in greater detail later on.

Essential shifts have also occurred among the groups of private investors. The part of the debt held by credit institutions has been reduced.^^1^^

_-_-_

~^^1^^ It should be noted that in the rapidly expanding group of other investors there are concealed such financial institutions as savings and loan associations, corporate pension trust funds, dealers and brokers.

136 Table V-5 Distribution of the Public Debt by Classes of Investors (in '000 million dollars) Holders of securities 1946 1960 1972 amount per cent amount per cent amount per cent Official Institutions US Government agencies and trust funds 27.4 23.4 10.6 9.0 55.1 27.4 19.0 9.4 111.5 71.4 26.1 16.7 Federal Reserve Banks Total 50.8 19.6 82.5 28.4 182.9 42.8 Private Investors Commercial banks 74.5 28.8 62.1 21.4 59.9 14.0 Mutual savings banks Insurance companies Corporations State and local governments 11.8 24.9 15.3 6.3 4.5 9.5 5.9 2.4 6.3 11.9 19.7 18.7 2.2 4.1 6.8 6.4 2.7 6.2 10.4 21.8 0.6 1.4 2.4 5.1 Individuals 64.2 24.8 65.0 22.4 77.8 18.2 Foreign and international Other investors 2.1 9.3 0.8 3.6 13.0 11.2 4.5 3.8 50.0 16.7 11.7 3.8 Total 208.3 80.4 207.9 71.6 244.4 57.2 Total public debt outstanding 259.1 100.0 290.4 100.0 427.3 100.0 Note: The holdings of commercial banks do not include securities kept in their trust departments. The figures for all years are as of December, for 1972 as of June. Sources: Federal Reserve Bulletin, February 1963, p. 264; August 1972, p. A 44.

Federal securities holdings of state and local governments are steadily rising. Lastly, in recent years the share of the federal debt distributed among foreign investors has sharply increased.

137

Between 1960 and 1969, the total amount of US government securities held by foreigners fluctuated around $11,000-- 17,000 million. But in recent years foreign security holdings more than trebled. By mid-1972 foreigners held US government securities for $50,000 million, which amounted to 11.7 per cent of the entire federal debt.

It sounds as a paradox that the increase in US government securities held abroad is connected with the massive ``flight from the dollar" which started in 1970--1971 due to fear of its devaluation. The chronic deficit in the US balance of payments and the depreciation of the dollar in the US domestic market prompted foreign dollar holders to ``switch over" to other, relatively more stable currencies. But the central banks, tied to the International Monetary Fund through the system of foreign exchange parties, were compelled to buy dollars offered by private holders to prevent a sharp rise in the exchange rates of their own national currencies. As a result the huge mass of dollars in international circulation began to shift from private holders to official institutions, central banks, treasuries and directly to the governments of foreign states. Thus, in May 1971 the dollar holdings of this group rose to $31,300 million as compared with $11,100 million at the end of 1969. Correspondingly, private dollar holdings during this period decreased from $28,700 million to $17,300 million.^^1^^

This change led to an increased demand by foreign governments and official institutions for US government securities which this group of holders regarded as the most safe and profitable means for investing the accumulated dollars. As a result, the US Treasury was able to sell abroad large sums of short-term issues, treasury notes and nonmarketable bonds specially designated for sale to foreign official institutions. Between June 1970 and June 1971 the holdings of American short-term treasury notes and certificates in foreign official institutions (including the Bank for International Settlements) rose from $7,000 million to $20,100 million and up to $33,000 million at the beginning of 1972. The amount of nonmarketable bonds and notes sold directly to foreign official institutions did not change _-_-_

~^^1^^ Federal Reserve Bulletin, October 1971, p. A 80.

138 throughout 1970 and the first months of 1971. But after the May international monetary crisis of 1971 it sharply increased from $3,500 million at the end of May to $8,600 million at the end of July. The growth in these category of securities held by foreigners continued and the figure reached $15,900 in June 1972.^^1^^ The purchase of US government bonds by foreign holders, in principle, was advantageous for the United States because this made it easier for the Treasury to finance the tremendous budget deficit resulting from the emergency economic measures of the Nixon Administration. But the extremely speculative nature of the demand for securities creates the threat of a sharp change in the situation in the future.

Credit and financial institutions, and the banking system in the first place play an important role in the functioning of system of US government borrowings. In 1972 financial institutions (including Federal Reserve Banks) held government securities totalling $140,200 million, more than onethird of the total federal debt. Although the role of commercial banks and other private financial institutions as holders of federal securities decreased somewhat, the banks provide a unique mechanism which ensures `` administration" of the debt and the placing of new issues in the market. All operations for the subscription and primary offering of government securities are performed by the Federal Reserve Banks. This is closely linked with another of their functions, that of cash payments and settlements of Treasury accounts. A considerable part of the new issues of government bonds are bought by commercial banks for their own account and for subsequent redistribution among the ultimate holders.^^2^^ Here are some figures illustrating the scale of these operations. According to materials submitted at the beginning of the 1960s by the American Bankers Association to the Commission on Money and Credit, between February 1953 and July 1960, the sum of the new issues of government bonds with a maturity of more than _-_-_

~^^1^^ Treasury Bulletin, August 1972, p. 81.

~^^2^^ Commercial banks are the only type of credit institutions (together with several big investment banks) which are permitted to receive subscriptions from other institutions and individuals.

139 one year, exceeded $250,000 million. Of them, securities for $165,000 million (65 per cent of the entire subscription) were purchased by commercial banks.^^1^^ These figures do not include subscriptions for short-term (3- and 6-months) treasury notes and certificates which are issued to the amount of $130,000--150,000 million annually.

The purchase and sale of government securities in the United States is not made at the stock exchange. The ``market'' for them is formed by a small group of dealers which includes six large commercial banks (in New York--- The Morgan Guaranty Trust Company, Bankers Trust Company, Chemical Bank New York Trust Company and the First National City Bank; in Chicago---The Continental Illinois National Bank and the First National Bank). There are also 13 investment houses (Blyth and Co., The First Boston Corporation and others).^^2^^ Formally, any firm can announce itself to be a dealer in federal securities, that is, it undertakes the obligation to buy and sell systematically these securities at the prices prevailing in the market. But practically only the biggest commercial and investment banks which have the necessary staff of specialists, free money resources and are closely connected with government circles, are able regularly to engage in such operations. All buyers and sellers of government securities (banks, specialised credit institutions, industrial corporations and private individuals) have to resort to the services of dealers.

Until recently, operations of dealers with government securities were made in conditions of absolute secrecy. Dealers published no statistics and their activity in fact was uncontrolled. After the sudden stock-market drop of government securities in 1958, largely as a result of speculative buying and selling, the demands of US public opinion for an investigation of dealer operations became very strong. Many economists pointed out that these operations increased _-_-_

~^^1^^ The Commercial Banking Industry, American Bankers Association, Prentice-Hall, Inc., Englewood Cliffs, N.J., 1963, p. 368. The banks absorb 90 per cent of all the subscription for cash and 53 per cent of the issues exchanged for redeemed bonds.

~^^2^^ American Banker, June 20, 1961.

140 stock-market fluctuations of government securities and often aimed at ensuring the selfish interests of a narrow group of big banks to the detriment of the country's interests. During a stock-market drop of government securities prices, dealers instead of ``supporting'' the market by buying additional securities, tried to quickly unload their own holdings. This naturally intensified the instability of the market. Moreover, since dealer profits rise with the expansion of the gap between price quotations of their purchase and sale, dealers are interested in sharp changes. Thus, they often deliberately advise their clients to buy or sell securities to manipulate quotations in a way advantageous to them. The results of a special joint study made by the US Treasury and the Federal Reserve System at the end of the 1950s, proved that these charges against US government securities dealers were justified.^^1^^

Thus, the government securities market has been monopolised by a small group of banks which gain large profits from the fluctuations of the market prices. At the end of the 1950s the income of a dealer from the resale of the ordinary lot of short-term government securities ($10,000,000) was in the range of $1,000 to $6,000 and from the transaction with the lot of medium-term securities ($3-5 million)---$1,300 to $2,500. The average daily turnover of dealer operations amounted to $600-2,000 million and for the entire year of 1958 up to $350,000 million.^^2^^

Banks not only perform the functions of dealers in government securities but also provide tremendous resources for financing these operations. Major New York commercial banks regularly offer loans to dealers.

Government financing is a profitable business for the big banks. Each stage in the issuance and subsequent resale of government securities brings millions with it in profits. We pointed out earlier how dealer banks make money on the resale of treasury issues. Moreover, the procedure of paying for purchased securities permits dealers to make entries to the Treasury's tax and loan account without immediate _-_-_

~^^1^^ Treasury-Federal Reserve Study of the Government Securities Market, Parts I---III, Washington, 1959.

~^^2^^ Ibid., Part I, pp. 78, 82--83.

141 transfer of funds. This is one of the ways of getting an additional profit. Ronald Robertson, a well-known banking specialist, cites the following example: ``An eighteen-day delay in paying for a $1,000 bond with a 3 per cent coupon is worth about $1.50-----At this rate the profit is $1,500 per million bought and paid for in the tax and loan account."^^1^^ If we consider that operations of this kind are made by the banks every day with securities which amount to hundreds of millions of dollars, it is clear that this is a source of considerable income.

The banks also receive large amounts in the form of interest payments on the government debt. Between 1950 and 1970 the annual income from the investments in US government securities of the members of the Federal Reserve System increased from $1,015 million to $3,067 million and the total interest paid to the banks during this period only on federal securities (not including securities of government agencies and state and local authorities) to $49,200 million dollars. Three-hundred of the largest banks regularly receive from 50 to 60 per cent of the entire income which the US banking system yields on government obligations.

In the light of these facts the claims of banking circles that servicing of the US Treasury operations is `` disadvantageous" for them can hardly be taken seriously.

Under certain conditions government borrowings tend to stimulate inflation. A decisive role in this process is played by the offering of government issues through the banking system, especially if these operations are conducted systematically and on a large scale.

The purchase of government securities by the central bank directly from the Treasury or US government securiities dealers leads to inflationary results. In buying securities from a dealer the Federal Reserve Bank credits a corresponding amount to the reserve account of the bank in which the deposit account of the dealer is maintained. Deposits and the circulation of cheques based on them are enlarged without any additional need in the exchange media.

_-_-_

~^^1^^ Roland I. Robinson, Money and Capital Markets, McGraw Hill Book Company, New York, 1964, pp. 142--43.

142

The Federal Reserve System was prepared for wide operations in the purchase of government securities long before the beginning of the Second World War. When the United States entered the war the task of ``maintaining the market of government securities" became the main task of the Federal Reserve policy. In 1942, the Federal Reserve System and the Treasury reached an agreement to maintain stable interest rates on the new government issues. The Federal Reserve System undertook to buy government securities not placed among ordinary holders. This enabled the owner of government securities to convert them into cash at any time. The influence of these operations on money circulation can be judged from the following data.

Table V-6 Open Market Operations of the Federal Reserve System and the Federal Reserve Notes in Circulation (million dollars) US Government securities holdings with the Federal Reserve System Federal Reserve notes in circulation Years Sum at the end of the Increase during the year Sum at the end of the Increase during the year 1941 2,254 +70 8,192 +2,261 1942 6,189 +3,935 12,193 +4,001 1943 11,543 -1-5,354 16,906 +4,713 1944 18,846 +7,303 21,731 +4,825 1945 24,262 +5,416 24,649 +2,918 Source: Federal Reserve Banks. Supplement to Banking and Monetary Statistics, Board of Governors of the Federal Reserve System, Washington, 1965, p. 5.

An increase by $22,000 million of the Federal Reserve holdings of government securities during the war years had its counterpart in the increase of the Federal Reserve notes outstanding by $16,500 million. The Federal Reserve notes were backed by government securities and issued in amounts greatly exceeding the needs of circulation. This led to inflationary consequences.

143

After the war, the practice of ``pegging'' the government securities prices did not stop. With some modifications it continued up to 1951. The Treasury objected to the introduction of the free market for its obligations, fearing this would cause serious difficulties in placing new issues and would raise the cost of servicing the government debt.

But the preservation of inflationary methods of financing the Treasury aroused wide opposition.

After a number of meetings, in which the US President participated, an agreement was reached on March 4, 1951, between the Treasury and the Federal Reserve System to stop ``pegging'' US government securities prices and release the Federal Reserve System from unconditionally buying government securities which find no buyers in the market. Two years later, in March 1953, the Federal Open Market Committee of the Federal Reserve System adopted a decision to confine its activity to the purchase and sale only of short-term bills and to render assistance to the Treasury only if abnormal conditions threatened the government securities market.^^1^^ The US press proclaimed the agreement of March 4, 1951, a ``new landmark" in the history of interrelations between the Federal Reserve System and the Treasury. Many commentators assessed this measure as the complete triumph of the principle of ``absolute independence" of the Federal Reserve System and its transformation from an ``engine of inflation" into a powerful instrument of credit control. Later events demonstrated that this conclusion was wrong. The US Government, as before, was greatly in need of attracting capital through the credit system. In these conditions the purchase by the Federal Reserve Banks of treasury bills served as a kind of valve which enabled it over a definite period to prevent a panic on the oversaturated government securities market. So the support given by the Federal Reserve System to Treasury operations cannot be regarded as a temporary phenomenon determined by emergency wartime conditions. The interest of the Treasury, as hitherto, remained one of the primary criteria in decisionmaking by the Board of Governors of the Federal Reserve System.

_-_-_

~^^1^^ See Marcus Nadler, Sipa Heller, Samuel Shipman, The Money Market and Its Institutions, New York, 1955, p. 235.

144

Differences between the Federal Reserve System and the Treasury pertain not to the substance of the principle of supporting the government securities market, but to the forms and timing of this support. The inflationary consequences of buying of government securities by the Federal Reserve Banks became particularly pronounced in the 1960s. Federal Reserve holdings rose steadily from $27,200 million at the end of the 1950s to $40,900 million in 1965 and $71,400 million in June 1972. At the initial stage, the price index was stable, but then the purchase of government securities by the banking system and the resulting growth in the money stock, combined with other factors of an economic and political nature, led to a dangerous escalation of prices. The rate of money depreciation in the United States measured by the consumer price index averaged 2.6 per cent annually in the decade of 1960--1970. Moreover, the process became more intense at the end of this period. In 1970 prices rose 5.6 per cent and in 1971, 4.4 per cent.^^1^^ In recent years, rates of price growth in the United States outstripped those of many West European countries, especially the Federal Republic of Germany, France and Italy.

When the Nixon Administration came into office, an attempt was made to break the vicious inflationary circle by utilising deflationary measures for this purpose. In 1969, the Federal Reserve System sharply slowed the rate of credit expansion by restricting the amount of securities bought at the open market from the member banks. While from December 1966 to May 1969 Federal Reserve credit to member banks increased at an annual rate of 9.3 per cent, the growth slowed down to 2.9 per cent^^2^^ from May 1969 to February 1970. The brief period of decline in the growth of the money stock did not exert a noticeable influence on the price level. On encountering serious economic difficulties, the Nixon Administration carried out a new series of expansionist measures in 1970--1971. An active part in financing these measures was taken by the Federal Reserve System which bought government security. From April 1970 to July _-_-_

~^^1^^ First National City Bank of New York, Monthly Economic Letter, September 1971, p. 10.

~^^2^^ Monetary Trends, September 15, 1971, pp. 8-9.

145 1971 government securities holdings of the Federal Reserve System increased by $10,000 million or 18 per cent, which undoubtedly increased the economy's inflation potential.

The introduction of price and wage controls slowed down somewhat but did not halt the rise of prices. The consumer price index rose by 3.2 per cent during the year ending August 1972. But the credit expansion maintained by the Federal Reserve System continued: since the mid-1971 the Federal Reserve Banks bought government securities for another $6,000 million and the money stock increased by 6-7 per cent in 1972.

[146] __NUMERIC_LVL1__ CHAPTER VI __ALPHA_LVL1__ FINANCES OF STATES AND LOCAL GOVERNMENTS __ALPHA_LVL2__ [introduction.]

The bulk of spending for civilian purposes in the United States is made through state and local budgets, as pointed out in the preceding chapters. Current and capital outlays on education, health and social welfare are mainly financed from state and local budgets, including money received from the federal budget as subsidies for these purposes.

In contrast to most West European capitalist countries where the system of local budgets was shaped under the influence of central legislation, in the United States local legislation arose before federal. This is one of the reasons for the diversity of forms of the budgetary structure of states and local administrative units as well as the intertwining of many functions performed at the federal and state-local level.

In the course of the country's economic and socio-political development, the organisation and structure of local finance gradually changed. But these changes were not aimed at creating a single unified budgetary system. On the contrary, the financial relations of the states and the federal government were constantly complicated and differences between states increased.

The 1787 Constitution provided for contributions of the states to the budget of the federal government in proportion to the value of land and improvements.^^1^^ The states _-_-_

~^^1^^ Davis R. Dewey, Financial History of the United States, New York, 1928, p. 49.

147 independently looked for sources to satisfy their own needs and to make payments to the federal authorities. They practically felt neither direct nor indirect influence of the federal government on their financial policy as regards budget revenue and expenditures in their territory.

But under the Constitution proclaimed in September 1787 the rights of Congress were greatly extended. It was given the right ``to lay and collect taxes, duties, imposts and excises, to pay the debts''. Moreover, direct taxes and duties per capita were spread among the states in proportion to the size of population. The federal government still could not introduce direct taxes.

At the same time, this Constitution, which in effect initiated the delimitation of financial functions between the federal government and the state and local governments, did not establish precise boundaries. Moreover, they subsequently became much more blurred.^^1^^

Throughout the 19th century the budgetary duties of the federal government and the states changed slowly and only after the Civil War were essential shifts initiated. States were exempt from contributing for defence expenditures which became the exclusive function of the central government.

With the introduction of an income tax in 1913 and an inheritance tax in 1916, the federal government received the most effective taxation sources. In the meantime the rights of the states in tax legislation were steadily restricted. The introduction of progressive taxes on property, duties on interstate trade, and so on was specifically prohibited.

The concept of a division of governmental functions based on state interests was replaced by a new ``federalism of co-operation" which signified the dominant position of the federal government in solving all general national financial problems, including questions of the financial position of the states. It enabled the federal authorities, within constitutional bounds and legal restrictions, to actively intervene in the financial activity of states and local administrative bodies through the system of government-controlled grants. _-_-_

~^^1^^ James A. Maxwell, Financing State and Local Governments, The Brookings Institution, Washington, D.C., 1969, p. 24.

__PRINTERS_P_147_COMMENT__ 10* 148 Studying the consequences of federal grants-in-aid, Murray Weidenbaum noted: ``This results in the federal government's not only reviewing the use to which its funds are put by the states but also reviewing the matching funds which the states put up themselves."^^1^^ Thus the central government concentrates in its hands greater financial resources than the states and local authorities. Under the existing structure of the distribution of functions, the budgets of state and local governments are charged primarily with the responsibility of financing the numerous current and long-term civilian needs. They are linked both with general national needs and with tasks inherent in state and local government functions embodying a great variety of requirements. These needs flow from general economic growth as well as the peculiarities of particular areas, their geographical location, density and concentration of population, local traditions, economic trends, transport facilities, and so on.

While the federal government in allocating financial resources encounters a great number of alternatives in making political and economic decisions, the sphere of financial decision-making of state and local authorities is much more limited. They have to solve urgent current problems which can no longer be deferred.

Referring in this sense to the question of allocating financial resources, Arnold Cantor pointed out: ``It cannot be assumed that 50 state legislatures and some 81,000 localities are in a better position than the federal government to weigh and balance these critical national priorities and spend accordingly."^^2^^

But insufficient financial resources place the states and local governments in a difficult position in respect to securing funds for even the most essential needs.

Pointing to the significant role played by state and local budgets in meeting the needs of the population, Frank Fernbach, Assistant Director of the AFL-CIO Department of Research, writes: ``When it comes to providing for the _-_-_

~^^1^^ Murray L. Weidenbaum, The Modern Public Sector, New Ways of Doing the Government's Business, New York, 1969, pp. 14--15.

~^^2^^ Arnold Cantor, ``Revenue Sharing: Passing the Buck'', The American Federationist, Vol. 77, No. 11, November 1970, p. 3.

149 civilian public services the American people need, it is the states and localities---not Washington---that shoulder most of the load."^^1^^

The structural shifts in economic development, the movement of large masses of the population from rural areas to cities and the reorganisation of industry, research and education under the impact of the scientific and technological revolution, are constantly raising the role of public services. The state and local authorities are faced with new problems linked with the spending of funds.

One of the main features in the evolution of the financial position of state and local governments at the present stage is the rapid rise in financial needs and the relative curtailment of their own sources.

Notwithstanding the sharp increase in the absolute expenditures within state and local budgets after the Second World War, their ratio to the GNP decreased as compared with the 1930s.

Comparing the sources of revenue of the federal government and the state and local governments, Joseph Pechman draws the conclusion: ``Most federal revenues come from income taxes that rise at a faster rate than income as income grows. By contrast, state-local revenues barely increase in proportion to income."^^2^^

The widening gap between the swiftly growing demands made on the volume and quality of public services and the limited finance from their own sources has predetermined another important feature of state and local budgets--- dependence on federal government grants. Moreover, the central government finances national programmes through the states, partly also enlisting local money resources as a condition for providing grants-in-aid.

Thus, with the high level of administrative independence proclaimed by the US Constitution, state and local governments are subject to strong direct and indirect restrictions of their freedom in financial activity by the federal government. Referring to the distribution of revenues by the _-_-_

~^^1^^ Frank Fernbach, ``The Financial Crisis of State and Local Governments'', The American Federationist, October 1965, p. 7.

~^^2^^ Joseph A. Pechman, ``Money for the States'', The New Republic, April 8, 1967, p. 15.

150 central government, Benjamin Masse pointed out: ``That the power trend over the past 40 years has been toward Washington and away from the states is obvious."^^1^^

While seeking to get maximum help from federal funds, states and localities are often compelled to reduce spending for the most urgent needs because grants-in-aid almost always presuppose the participation of the states in financing such programmes.

The state dependence on the federal government is also increased by the fact that in allotting them grants the use by states of their own sources is taken into account. That is why, notwithstanding the fact that the states independently enact, execute and control their own budgets, they have to take into consideration the main finance-management principles of the federal authorities.

The historically shaped uneven economic development of the country's individual regions in conditions of considerable administrative state autonomy, has resulted in sharp differences in the structure of revenue and expenditures of particular states and local governments. Their budgetary procedures, classifications, forms and types of reports, are characterised by great diversity, including the types and rates of taxes, relationships of items of expenditure, the size and purpose of loans and the distribution of functions between states and the local administrative bodies under their jurisdiction.

This makes it exceedingly difficult to analyse local budgets and to compare specific revenues and expenditures by state and local governments. As a result, it is impossible to determine, with sufficient accuracy, the actual degree of the states' needs in allotting federal grants for levelling out state and local differences. ``Comparisons of state government expenditures are treacherous,'' Maxwell says, referring to the problem of comparisons between states. ``In State A the government may perform functions that in State B are left to localities."^^2^^ He suggests using per capita revenues and expenditures in the states and localities as a more proper basis for comparisons.

_-_-_

~^^1^^ Benjamin L. Masse, ``Some Pros and Cons on Revenue Sharing'', America, February 27, 1971, p. 200.

~^^2^^ James A. Maxwell, Op. cit., p. 2.

151

A study of summary data on state and local finance cannot compensate for this structural defect because it produces only average figures.

The basis for comparing the revenue and expenditure of individual states and local governments, which Maxwell recommends, that is, money receipts from their own sources (per $1,000 of personal income), has a drawback. In a situation of regressing local taxes this indicator conceals the degree of influence exerted by existing taxes on budgets of families in the lower and middle income brackets.

The situation is also complicated by the fact that no firmly fixed criteria exist for fixing the size of federal grants to states and local governments.

Martin McGuire and Harvey Garn, comparing various proposals in respect to the choice of criteria in determining federal grants, note: ``First, one is obliged to deal with the fact that no single unambiguous measure of 'poverty' or 'community need' exists. Often, a single government program may be directed against diverse, more or less uncorrelated conditions of economic (or social) distress."^^1^^

This specific feature of state and local budgets is determined by the extremely uneven development of the capitalist economy, in which attempts at governmental regulation come into contradiction with private production, whose main stimulus is the maximum increase in profits and not equalisation of the socio-economic conditions of the population of individual regions and different sections of society. On the other hand, the private sector yields to state regulation only indirectly and on an insignificant scale.

The functioning governmental financial system cannot be quickly adapted to the constant economic shifts, as a result of which a gap arises between current needs and the possibilities of satisfying them.

While all states require increased revenue for public needs, the position of individual states, especially of their local subordinate units, have reached a critical point.

The big differences in per capita income levels in individual _-_-_

~^^1^^ Martin C. McGuire, Harvey A. Garn, ``The Integration of Equity and Efficiency Criteria in Public Project Selection'', The Economic Journal, Vol. LXXIX, No. 316, December 1969, p. 883.

152 states, especially between industrial and agricultural areas, also largely determine the financial possibilities of the respective authorities.

The state of Mississippi which had the lowest per capita income, for example, is trying to compensate for this by high tax rates. But this measure brought the state and local authorities only $204.41 per capita in budget revenue in 1969, while per capita revenue of $356.59 is obtained in Connecticut at lower tax rates.

Under a unified financial system, it would be obvious that states and local governments with a higher level of individual and corporate incomes, have greater possibilities of spending money for public needs. But in reality some of the states which have a low tax base spend considerably more money than the ``richer'' states.

This is explained by other factors which dictate greater spending of resources from public funds. The expansion of metropolitan areas because of the outmovement from rural localities, intensive concentration of industry, the creation of new scientific centres, the greater mobility of the population resulting from improved transport facilities, the change in the population age composition, and many other factors have engendered demands for a higher level and a wider scale of public services. To this should be added the point that the carrying out of a number of public measures was delayed by the Second World War and the war in Korea and in Vietnam.

Rapid urban development and the rise of urban conglomerates in recent decades have seriously influenced the general financial position of states and especially of municipalities and counties. The scientific and technological revolution has accelerated this process. A steep increase in local resources has become necessary for such purposes as the building and maintenance of hospitals, sewage installations, parks, schools, water supply systems, libraries, airfields, housing, maintenance of police and fire protection and the social welfare system.

Since the cost of public services to the urban population is much higher than to the rural, there is an increased utilisation of federal, state and local governmental resources by the cities. The situation in metropolitan areas reveals 153 the aggravation of the extremely acute deficiency of resources for meeting pressing needs and budget deficits.

Frank Fernbach who made a study of urban problems, concludes: ``For example, the crisis of transportation---of moving goods and people into and out of the core city--- must be met. The never-ending task of finding enough revenue to meet educational and recreational needs, provide adequate water for human and industrial consumption, cope with air pollution, combat delinquency and crime, clear slums and assure decent housing and neighborhoods besets every metropolitan area."^^1^^

Fernbach describes the dynamic processes under way in US society and the gap between the measures which are being taken and the ever growing needs. He emphasises that already in 1960, according to the official census, almost 16 million dwelling units in the main metropolitan areas were substandard because they either were dilapidated or lacked running water or other basic plumbing facilities, and so on.^^2^^

Such a situation also prevails in other spheres of public services to the urban population---education, social welfare, public utilities.

The social and geographical polarisation of the population tends to exacerbate the financial problems of urban municipalities. The poor, specifically the Negro, population, is concentrated in dilapidated houses in the old central districts of a city, while the more prosperous inhabitants move to the suburbs.

The process of geographical disunity arising between the populations of urban centres and the suburbs is being consolidated through administrative organisation of the latter into self-administering communities, vested with the rights of urban municipalities. The fragmentation of the suburbs, which creates certain obstacles to the most rational planning and use of government resources on a metropolitan wide scale also tends to deepen social inequalities. But, as demonstrated by US realities, the capitalist economic system based on private property is becoming increasingly incapable of coping with the socio-economic problems it faces.

_-_-_

~^^1^^ Frank Fernbach. Op. cit.. p. 9.

~^^2^^ Ibid.

154

Anthony Downs, a specialist on urbanisation problems, arrives at the conclusion that sooner or later Americans would face the dilemma: it was impossible to preserve individual freedom of property and control over land use and simultaneously achieve the desired results in planning the development of US cities. To think that both were possible would mean to ignore realities and present the wish for reality.^^1^^

__ALPHA_LVL2__ 1. EXPENDITURES OF STATE AND LOCAL BUDGETS

The system of state and local finance in the 20th century, as pointed earlier, is marked by the continuous growth of expenditures. In contrast to federal spending, the expenditures of state and local budgets are relatively more static. They react less to the fluctuations within the economy even in periods of a sharp decline in business activity. The revenue sources of state and local budgets, based on regressive taxation, display less susceptibility to changes in the economy. This enables state and local authorities to keep expenditures at relatively high levels.

Table VI-1 Expenditures of State and Local Budgets in Relation to the Expenditures at All Government Levels (million dollars) State and local Fiscal At all go-- Per Per Per years vernment levels Total cent of total State cent of total Local cent of total 3 : 2 5 : 3 7: 3 1942 45,576 10,914 23.9 3,563 32.6 7,351 67.4 1950 70,334 27,905 39.6 10,864 38.9 17,041 61.1 1960 151,288 60,999 40.3 22,152 36.3 38,847 63.7 1968 282,645 116,234 41.1 44,304 38.1 71 ,930 61.9 1969 308,344 131,600 42.7 49,448 37.6 82,152 62.4 Source: Statistical Abstract of the United States 1971, p. 399. _-_-_

~^^1^^ Anthony Downs, Urbanization Policies Recommended by the National Commission on Urban Problems Planning, 1969, p. 2082.

155

But in comparison with the increase of the GNP the growth rates of expenditures of state and local authorities have slowed down in recent years. Between 1957 and 1962 the GNP increased by 20 per cent and the expenditures of state and local budgets, by 48 per cent. In the next four years the GNP rose by 33 per cent, while the state-local expenditures rose only by 35 per cent.^^1^^

The larger increase in nominal expenditures in the postwar period is partly explained by rising inflation and the consequent substantial increase in the cost of measures financed by state and local governments.

The deflator of prices of goods and services bought by state and local governments rose during this period by 3.5 per cent annually on the average as compared with the 1.5-per cent deflator for the GNP. In the opinion of Lawrence R. Kegan and George P. Roniger, the main factors of growth in prices of government purchases will also be preserved in 1965--1975 and will amount to 40.8 per cent as compared with 17.8 per cent for consumer goods prices.^^2^^

If we consider the natural increase in population, the real rise in expenditures after the Second World War was even smaller and was close to that of 1913--1938.

Yet a number of objective factors, determined by general economic development and demographic changes, dictate the need for increasing state and local expenditures. While formerly vital public welfare programmes were financed largely by the federal Treasury, in recent years an increasing part of spending for these purposes has been shifted to state and local authorities.^^3^^

The federal government, however, continues to take an active part in grant-aiding these measures, thus exercising its influence on the allocation not only of federal but state and local resources. The increase in spending after the war _-_-_

~^^1^^ Impact of the Properly Tax; Its Economic Implication for Urban Problems, 90th Congress, Second Session, May 1968, Washington, 1968, p. 2.

~^^2^^ Lawrence R. Kegan and George P. Roniger, Fiscal Issues in Future of Federalism, p. 252.

~^^3^^ The Burden of Taxes, by Labor Research Association, New York, 1956.

156 by state and local governments was facilitated by the big decline in construction during the war, especially of public utilities. Subsequently this demanded substantial expenses both for reconstruction and expansion of public utilities and the building of new ones.

The main expenditures of state and local budgets are the general expenditures which cover all types of public services except the outlays for public utilities and government security funds. In 1968, of the total sum of $116,234 million for all expenditures, general expenditures amounted to $102,411 million or 88.7 per cent.

Table VI-2 General Expenditures for Civilian Purposes for Selected Years from 1902 to 1969^^1^^ (million dollars) Fiscal year At all government levels State and local Per cent of state and local to all 4 : 2 1902 1,243 1,013 81.5 1927 8,631 7,210 83.5 1938 13,397 8,757 63.4 1948 26,397 17,684 67.0 1966 108,607 82,843 76.3 1968 152,474 102,411 67.2 1969 171,428 116,728 68.1

The biggest items in the general expenditure of state and local governments are education, highways, public welfare, health and hospitals. They accounted in 1969 for 73.5 per cent of the total as compared with 64 per cent in 1942.

The expenses for building highways were kept at a high level but after the peak reached in the mid-1950s a downward tendency emerged.

The large share of expenses for specific social measures is the result of the imposition of this type of expenditure on state and local budgets in the distribution of financial competence between the federal government and the state _-_-_

~^^1^^ Statistical Abstract of the United Stales 1971, p. 399.

157 Table VI-3 Direct General Expenditures of State and Local Governments^^1^^ for Selected Years from 1902 to 1968 1902 1927 1938 1942 1948 1960 1968 Total (million dol-- lars) 1,013 7,210 8,757 9,190 17,684 51,876 102,411 Per cent of total Education 25.2 31.0 28.5 28.1 30.4 36.1 40.2 Highways 17.3 25.1 18.8 16.2 17.2 18.2 14.1 Public welfare 3.7 2.1 12.2 13.3 11.9 8.5 9.6 Health and hospi-- tals 5.9 4.9 6.3 6.4 6.9 7.5 7.4 All others 47.9 36.9 34.2 35.9 33.6 29.9 28.7 authorities. The total share of the expenditure for education and public welfare and health and hospitals is not indicative of the distribution of the corresponding appropriations on the wide scale of government spending. Thus, in 1969, the outlays for education through state and local budgets amounted to $47,238 million out of the entire state expenditure ($50,377 million) for this purpose. In local and state budgets they amounted to 40.5 per cent of all the direct general expenditures and in the federal budget only to 3.7 per cent.

The expenditure for education is the biggest item in state and local budgets and their share in the general expenditure is steadily rising. In the last 15 years, beginning with 1955, the expenditure of state and local governments for education (including federal grants) fluctuated between 93.7 and 97.4 per cent of the entire government spending for this purpose. Practically all governmental appropriations for elementary, secondary and higher education go through state and local budgets.

In recent years the expenditure for education amounted to more than 40 per cent of the total general expenditure of state and local budgets.

_-_-_

~^^1^^ Historical Statistics ...to 1957, pp. 722--39; Statistical Abstract of the United States 1971, pp. 399, 403, 373.

158 Expenditure for Education^^1^^ Table VI-4 State and local Fiscal year At all government levels (million dollars) Sum (million dollars) Per cent of expenditure at all government levels 1902 258 255 98.8 1927 2,243 2,235 99.6 1942 2,696 2,586 95.9 1950 9,647 7,177 74.4 1960 19,404 18,719 96.5 1968 43,614 41,158 94.4

The increase in the education expenditure in the last decade is determined by the specific features in the economic development of the United States linked with the scientific and technological revolution---the accelerated conversion of scientific and technological achievements into an important element of the productive forces. A certain role in this respect has been played by the economic competition with the Soviet Union which registered impressive successes in education and in a number of fields has arreatly outstripped the USA.

The guided system of education offered a possibility to regulate the long-term development of individual sectors of the economy and research through the training, selection and placement of personnel.

A change in the quality of education, the use of new organisational forms adapted to the demands on narrow specialisation together with the general inflationary tendencies, raised the cost of training per student.

The objective factors which dictated a general increase in expenditures for education have been: a) an increase in population; b) growth of the urban population engaged in industry, management and the service spheres which demand a higher level of general and vocational training as compared with rural localities; c) the need for reducing the _-_-_

~^^1^^ Historical Statistics ...to 1957, pp. 722--30; Statistical Abstract of the United Slates 1970, p. 411.

159 cost and improving the quality of export goods as a result of greater competition in foreign markets from European countries and Japan; d) a narrowing of the technological gap which for a long time created favourable conditions for US foreign trade.

Thus, the general increase in the expenditures of state and local governments for education has been the result of economic and demographic changes in the country as well as increased state-monopoly influence on the development of individual sectors of the economy, including the armaments industry and the training of personnel.

But education expenditures have proved to be inadequate for achieving the specified aims. On the contrary, funds for specific educational programmes have been very unevenly allotted and in a number of regions, particularly in cities, the situation has become extremely unsatisfactory. Many states and cities are urgently in need of school buildings and there is a shortage of teachers. Kenneth A. Gibson, the Mayor of Newark, declared that education was Priority Number One. He stated in a report submitted to Congress of January 22, 1971: ``We are saddled with an ancient physical plant and an inadequate per pupil municipal expenditure.'' He further noted: ``Our physical structures were allowed to deteriorate for many years---between 1930 and 1955, for instance, only three new elementary schools were constructed. Of Newark's 84 schools almost half were built over 60 years ago."^^1^^

Increase of appropriations directly for educational needs cannot fully solve the problem of improving education, even if sufficient funds are provided. Other conditions, linked with the material position of the population, especially low-income families, are required for a thorough-going improvement in the quality and scale of education. `` Increasing concern with school dropouts, the quality of education in slum areas, and the interrelationships of social and economic circumstances with educational aspirations and _-_-_

~^^1^^ ``Prepared Testimony of the Honourable Kenneth A. Gibson, Mayor of Newark, New Jersey, Before the Hearings of the Joint Economic Committee of the 92nd Congress of the United States'', January 22, 1971, p. 10.

160 achievements, however,'' Ida C. Merriam writes, ``again point up the relevance of education to social welfare."^^1^^

Solution of the financial aspect of the educational problem is negatively affected by the limits imposed by the federal government on states in utilising the federal resources allotted them. The numerous federal grant-aided educational programmes have a narrowly designated character, specifically for the development of specialised research in space exploration and the development of new weapons which meet above all the interests of the federal government. Such utilisation of financial resources is hardly relevant to social needs.

Both the state and local authorities are unable to utilise the grants for education to meet the most urgent needs in this field. Moreover, they point out that depreciation of the dollar and population increases reduce to naught the absolute rise in expenditures for these purposes.

A characteristic feature of state-local expenditures for education, as is the case, incidentally, for other sociocultural functions, is their uneven distribution among individual states and counties. In 1969, with an average per capita expenditure for education of $234 in state and local budgets, in some states this sum exceeded $300, while in others it was less than $200. In Wyoming the per capita expenditure was $336, Alaska $390, Utah $312, New Mexico $295, Arkansas $157, Mississippi $173, Tennessee $175 and the District of Columbia $225. Such fluctuations are also registered in other states.^^2^^ These statistics reveal that with the generally inadequate resources provided for education in all areas, individual states are in particularly difficult positions, spending for educational programmes much less per capita than the average and half as much as states with maximum funds. Moreover, within states there are wide differences in expenditures between individual counties, municipalities, townships and school districts.

The absence of nation-wide unified standards of expenditures, the differences in incomes and resources at the _-_-_

~^^1^^ Ida C. Merriam, ``Social Welfare Expenditures. 1964--1965'', Social Security Bulletin, October 1965, p. 4.

~^^2^^ Statistical Abstract of the United States 1970, p. 415; 1971, p. 407.

161 disposal of state and local authorities, contribute to the uneven public services and education provided for the people.

There are noticeable differences in the share appropriated for education in states with an approximately the same level of expenditure per 1,000 dollars of personal income. In Connecticut, with a $188 expenditure per $1,000 of personal income in 1968, $69.77 per capita was spent for education with the per capita expenditure for this purpose being $167. In Minnesota with an expenditure on education of $83.25 per cent $1,000 of personal income, the per capita figure was $255. Naturally such a system of allocation of public funds creates the preconditions for population migrations and the future shortage of skilled personnel. On the other hand, this further widens the gap in the economic and social positions of the population in different parts of the country.

Expenditures for public welfare occupy a leading place in the general expenditure systems of state and local budgets. In 1969, they amounted to $12,110 million or 9.2 per cent of the entire general expenditure of state-local governments and about 82.2 per cent of all government appropriations for public welfare. A large part of the expenditures for different forms of relief and services to the aged and the needy, the maintenance of orphanages, and so on, is met by state and local governments from their own sources. The share of federal aid in public welfare is comparatively small.

The bulk of all government resources allotted for public welfare are spent through the budgets of state and local governments. In the post-war period almost all the expenses for public welfare were made through the state and local budgets and only beginning with 1967 has their share in the general national expenditure somewhat declined as a result of an increase in outlays by the federal government for benefits and services to war -veterans and their families. In 1942 they amounted to 13.3 per cent of the general expenditure of state and local budgets; in 1950, 13 per cent; in 1955, 9.4 per cent and in 1966, only 8.2 per cent.^^1^^ But since 1968 the share of the expenditure for public _-_-_

~^^1^^ Statistical Abstract of the United States 1971, pp. 403, 399; Historical Statistics: Governmental Finances in 1965--66, pp. 22--24.

162 welfare has begun to rise again and in 1969 it reached 10.4 per cent of the general expenditure of state and local budgets.

Expenditure for Public Welfare^^1^^ (million dollars) Table VI-5 At all government levels State and local Per cent of state and local in total 1902 41 37 90.2 1927 161 151 93.8 1942 1,285 1,225 95.3 1960 4,462 4,404 97.0 1968 11,245 9,857 87.7 1969 14,730 12,110 82.2

Intergovernmental spending includes grants to state and local governments.

Simultaneously the ratio between the state and local governments' expenditures for public welfare has been changed in the direction of increasing the share of state expenses. In 1950, of the $2,940 million used for public welfare, $2,358 million (80 per cent) was spent through the states; in 1969 of the $12,110 million, $10,866 million or 89.7 per cent was spent through the budgets of states, including help by states to local authorities. The slow but steady increase in the role of states in respect to expenditures formerly made through budgets of local bodies attests to the concentration of finances in the hands of higher administrative agencies.

Yet big differences in expenditures for public welfare between states remain. For example, in 1969 Massachusetts, California and New York spent more than $100 per capita, while Wyoming, South Carolina and Indiana, less than $25 per capita.^^2^^ The disproportion in expenditures is noticeable in other states as well. In 1968, nine states spent _-_-_

~^^1^^ Statistical Abstract of the United States 1971, p. 399.

~^^2^^ Statistical Abstract of the United States 1970, p. 415; 7.977, p. 407.

163 for public welfare less than $30 per capita and nine other slates and the District of Columbia about $55 or more.^^1^^

The expenditure for health and hospitals occupies fourth place in general expenditures of state and local budgets and in recent years amounted to just over 7 per cent. In view of the fact that in the United States medical service is paid for by the individual, only a small part (about one-fourth) of all expenses for these purposes are financed by government funds. In 1969 $8,520 million was spent for health and hospitals through state and local budgets (states, $4,703 million and local governments, $3,817 million) or 65.9 per cent of all government spending. The outlays for building, repairing and maintaining hospitals totalled $7,011 million and for other medical services, $1,509 million.

Notwithstanding the swift rise in medical care needs, the share of expenditures for health in state and local budgets decreased in the last 20 years. In 1950, expenditures for health and hospitals amounted to 7.7 per cent of the general expenditure under state and local budgets and in 1967 they dropped to 7 per cent. In 1968 they rose by 0.4 per cent, and then again declined by 0.1 per cent in 1969.

Health and hospitals have been a sector of public services with a very low level of investments. In 1969, out of the total expenditure of $8,520 million for health and hospitals, investment appropriations from state and local budgets amounted to $761 million, i.e., less than 10 per cent. The outlays for construction were $622 million or less than 8 per cent. Moreover, federal appropriations for the construction of medical institutions amounted to only $83 million, in other words, the bulk of these expenses was borne by state and local budgets.

Per capita expenditures by state and local governments for health and hospitals are small---an average of $42 per annum. But some states spend considerably less. In 1969, 14 states spent less than $30 per capita; North Dakota and South Dakota, $21 and $19 respectively. At the same time, five states and the District of Columbia spent from $50 to $118 per capita. On the whole, however, fluctuations in expenditures by states are somewhat smaller here than in _-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 415; 1971, p. 407.

164 Expenditure for Health and Hospitals^^1^^ (million dollars) Table VI-6 At all government levels State and local Per cent of state and local to total 1902 63 60 93.7 1927 431 355 82.4 1942 714 591 82.8 1960 5,244 3,794 72.3 1968 10,579 7,546 71.3 1969 12,930 8,520 65.9 public welfare appropriations. There are greater differences in the outlays for health and hospitals per $1,000 of personal income. With an overall average of $12.46, 15 states spent less than $10, two states (North Dakota and South Dakota) less than $8, while 9 states and the District of Columbia spent from $15 to $26 per $1,000 of personal income.^^2^^

As a result of the rapid development in motor transportation after the Second World War, expenditures of state and local governments on the building, repairing, and maintenance of highways sharply increased. The high economic value of motor transportation, as well as its military strategic significance, predetermined the federal government's interest in expanding the network of highways mainly in interstate commerce.

Thus, the Federal-Aid Highways Act of 1956^^3^^ provided for the building of national systems of interstate highways and roads of military significance totalling 41,000 miles. Under this Act, states in part had to allot funds from their own sources in financing this programme.

Other Congressional acts for highway building programmes also envisaged the participation of states and their subordinated administrative units in financing these _-_-_

~^^1^^ Historical Statistics: Governmental Finances in 1965--66, pp. 22--24; Statistical Abstract of the United States 1970, p. 415; 1971, pp. 403, 399.

~^^2^^ Statistical Abstract of the United States 1971, p. 407.

~^^3^^ Arnold Cantor, Op. cit, pp. 3-4.

165 programmes. Between 1946 and 1969 the outlays in state and local budgets for building, repairing and maintenance of highways increased from $1,672 million to $15,417 million and in 1969 comprised 13.2 per cent of their entire general expenditures.^^1^^ Although funds appropriated for building and maintaining highways are constantly 'increasing, their share in the general expenditures of state and local governments has decreased somewhat in recent years. This is explained by two main reasons: 1) the need to re-allocate expenditures in favour of items for which a minimum of appropriations is not ensured and 2) by the very high cost of road construction as compared with other civilian functions.

Table VI-7 Expenditure of State and Local Governments on Building, Repair and Maintenance of Highways^^2^^ (million dollars) Sum Per cent of the direct expenditure 1902 175 16.3 1927 1,809 25.1 1942 1,490 16.2 1950 3,803 16.7 1960 9,428 18.2 1968 14,481 14.1 1969 15,417 13.2

In the $15,417 million spent by state and local governments for the building and maintenance of highways, a considerable part was played by federal subsidies. In 1969 they amounted to $4,162 million, and were somewhat smaller than in 1968---$4,196 million.

In contrast to the outlays on education and public welfare and health, more than half of the expenditure for building and maintaining highways goes for capital investments. In 1969 they totalled $10,273 million,^^3^^ of which $8,827 million _-_-_

~^^1^^ Historical Statistics: Governmental Finances in 1965--66, pp. 22--24; Statistical Abstract of the United States 1970, pp. 407, 411; 1977, pp. 404, 403.

~^^2^^ Historical Statistics: Governmental Finances in 1965--66, pp. 22--24; Statistical Abstract 1971, pp. 403, 399.

~^^3^^ Statistical Abstract of the United States 1971, p. 402.

166 was for construction, i.e., about 39 per cent of the entire expenditure on construction allotted within state and local budgets. Naturally, such a distribution of appropriations for investments over long periods freezes the funds obtained from the taxpayers and adversely affects the ability of state and local bodies to meet other needs. Funds for building and maintenance of highways are largely spent through state budgets, under programmes of interstate construction. In 1969 $12,522 million was spent from state budgets and only $5,045 million from local budgets, chiefly for the building and maintenance of highways connected with the development of cities.

Thus, the present system of financing highway construction is such that the biggest part of the outlays and administrative responsibility is assumed by the states, while the federal government determines the size and geographical location of construction sites.

The share of all other general outlays under state and local budgets is comparatively small. But combined they make up substantial sums. In 1969 they added up to $33,443 million or 14.4 per cent of all direct expenditures and 28.6 per cent of the general expenditures.

Table VI-8 1950 1969 Million dollars Million dollars Per cent of total general expenditures Police protection 776 3,901 3.0 Local fire protection 488 1,793 1.4 Natural resources 670 2,552 1.9 Sanitation and sewerage 834 2,969 2.3 Housing and urban renewal 452 1,902 1.4 Local parks and recreation 304 1,645 1.3 Financial administration and gene-- ral control 1,041 4,105 3.1 Interest on general debt 458 3,738 2.8 Source: Statistical Abstract of the United States 1971, pp. 402, 403, 399.

Of all these items the biggest are for maintenance of the police and payment of interest on the debt. Moreover 167 these items grow at higher rates---the interest on the general debt rose 7 times between 1942 and 1968, maintenance of the police, 4.4 times and financial administration, including general control, 3.5 times.^^1^^ But it is housing reconstruction, the maintenance of cities in an adequate condition that demand ever greater resources in view of the continued urbanisation process. Demands for considerable increase in appropriations for urban improvements in view of the critical situation in many cities are steadily becoming more urgent.

__ALPHA_LVL2__ 2. REVENUE OF STATE AND LOCAL BUDGETS

While a description and analysis of the state and local expenditures basically revolves around the question of establishing the relationship between current and long-term needs on a satisfactory basis, a study of the composition and scale of revenue largely makes it possible to pinpoint the factors determining this relationship.

Efforts of state and local governments to increase pressure through their own sources, chiefly through taxes, invariably affect the material condition of the people who are themselves compelled to pay for public services, including those they do not directly use.

This applies in the first place to metropolitan districts, the public services of which are enjoyed by the inhabitants of suburbs and other cities.

The revenue of state and local governments can be listed in three main groups, according to their sources: a) revenue from own sources; b) federal or state grants and c) loans.

These groups of revenue can, in turn, be broken down into smaller subgroups, the examination of which will make it possible to analyse in detail the system of state and local budget revenues.

Revenue from their own sources comprises the main part of budget receipts of states, counties, municipalities, townships, school and special districts. In 1968 they exceeded 85 per cent of all receipts.

Tax receipts make up the overwhelming part of revenue _-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 411,

168 Table VI-9 Distribution of State and Local Revenue by Sources in 1969^^1^^ (million dollars) Total state-local State Local Total revenue From own sources Intergovernmental revenue 132,153 113,001 19,153 77,584 59,809 17,775 79,274 53,192 26,082 from their own sources. In 1968 they amounted to more than 80 per cent of the general revenue of state and local governments. Table VI-10 Distribution of State and Local Budget Revenue by Sources in 1969^^2^^ (million dollars) Total State Local All revenue 132,153 77,584 79,274 Total revenue from own sources 113,001 59,809 53,192 General revenue from own sources 95,397 49,537 47,861 Taxes 76,712 41,931 34,781 Charges and miscellaneous general re-- venue 18,689 7,606 11,080 Utility revenue 5,931 --- 5,931 Liquor stores revenue 1,909 1,663 245 Insurance trust revenue 9,764 8,609 1,155 Intergovernmental revenue 19,153 17,775 26,082

Total revenue from own sources consists of taxes and charges and miscellaneous revenue, and revenue from utility, liquor stores, and insurance trusts. General revenue from own sources is limited to taxes and charges and miscellaneous revenue.

Pressed by circumstances demanding an increase in expenditures, state and local governments are trying to find additional financial sources. They resort both to improved _-_-_

~^^1^^ Statistical Abstract of the United Stales 1971, p. 400.

~^^2^^ Ibid.

169 administration and to legislative action affecting the size of the tax base and the rates of the operating taxes.

In some cases new taxes are introduced if this does not lead to obvious adverse consequences. At times such measures prevent further economic growth and undermine the base for a further increase in revenue.

State and local governments utilise more than 15 types of taxes, of which the most widespread are the following: sales and gross receipts; motor fuel; individual income; corporation income; automobile licences; tobacco; alcoholic beverages; property tax; insurance company gross premium tax; the use of natural resources; corporation licences; public utilities; and estate and gifts tax.^^1^^

The role played by specific taxes varies from state to state and in administrative districts under their jurisdiction. But a number of major taxes are practically applied in all states. These taxes are: property, individual income, general sales, corporation income and indirect taxes added to the prices of goods and services.

Together with states, the general sales tax has been widely utilised by many local bodies since 1934 when it was inaugurated in New York and then, in 1938, in New Orleans. In 1968, about 3,000 local governments had general sales taxes, introducing them directly or administratively through the financial agencies of states.

Taxation of goods at the level of production is not practised for fear of lowering the competitive position of companies within the state and for fear of losing them to other states.

The distribution of revenue from interstate commerce remains an intricate problem. Many industrial companies which send their goods to other districts are located on the territory of several states. As a result direct taxation on retail sales and the siphoning off of revenue by the taxing state could have a distorting effect on the distribution of incomes to the detriment of states which produce the commodities.

The interstate distribution of revenue from general sales _-_-_

~^^1^^ State and Local Finances. Significant Features 1966 to 1969, pp. 49--53.

170 taxes was the subject of long discussions, and thus far a single distributive formula with unified criteria has not been devised. Since more than 120,000 firms have commercial relations beyond the borders of a single state, this remains an extremely important issue.

The general sales tax, affecting most consumer goods including prime necessities, remains regressive because it absorbs a higher share of the incomes of the poor than of the rich whose proportional expenditures on the taxed goods are lower.

The most important social aspect in the taxing of prime necessities is ultimately their higher cost and a corresponding reduction in effective demand and consumption.

The tax on corporation incomes introduced for the first time in Wisconsin in 1911, is now applied in 40 states and the District of Columbia.^^1^^ Most states utilise rates within a range of from 2 to 11.33 per cent. Moreover, in 25 states the net income is taxed; nine utilise excises and a tax for the privilege of doing business in the state, and six employ both types. In 1968 these taxes yielded $2,518 million or about 7 per cent of all the tax revenue of states.

Table VI-11 Revenue of State and Local Governments from the Corporation Income Tax^^2^^ State and local Sum (million dollars) Per cent of all taxes 1942 272 3.2 1950 593 3.7 1960 1,180 3.3 1968 2,518 3.7 1969 3,180 4.1

In view of the different tax rates employed by states, the uneven level of concentration of industry and trade, there _-_-_

~^^1^^ State and Local Finances. Significant Features 1966 to 1969, pp. 49--53.

~^^2^^ Statistical Abstract of the United States 1970, p. 406; 1971, p. 398.

171 are big differences in the share of the corporation income tax in individual states.

In New York, California, Connecticut, Michigan, Massachusetts, Pennsylvania and some other states this revenue is essential (from 11 to 16 per cent of all tax receipts), while in states like New Mexico, North Dakota, South Dakota, West Virginia, Indiana and Nebraska they practically play no part at all, amounting to from 1 to 3 per cent of all tax receipts (according to data for 1969).

The tax rate scale is a wide one, ranging from 8 per cent in South Dakota to 15.4 per cent in Connecticut.^^1^^

But there is a definite tendency to equalise the tax rates in proportion to federal income tax rates. At the same time the differences in the proportions of specific kinds of taxes in state budget revenues make it impossible to effectively equalise rates.

A more or less proper distribution of revenue demands consideration of a big number of interconnected factors such as property, productive assets, size of sales, expenditures of firms, security holdings, the size of sales within the state, and so on. These factors are evaluated in various forms; moreover, the method of calculating the quantitative values of specific factors differs in many states.

Individual income taxes occupy third place in state-local taxes and second in state taxes. The share of this tax in budgets of state and local governments amounted to 10.8 per cent in 1969 and reached $7,308 million. Paralleling the Federal Government's taxation on personal incomes, begun in 1913, states also started to gradually introduce these taxes. By 1938, already 32 states and the Hawaii had made this tax a permanent source of revenue. By 1968, their number had reached 35.^^2^^ About one-third of the population living in other states is not subject to this tax. However, they levy other types of direct and indirect taxes which are sufficiently high.

The introduction of individual income taxes very likely will arouse a sharply negative reaction from taxpayers. Total taxes per capita in states which do not utilise _-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 420.

~^^2^^ State and Local Finances. Significant Features 1966 to 1969, p. 49.

172 Table VI-12 Revenue of State and Local Governments from Individual Income Taxes^^1^^ State and local, million dollars Per cent of all taxes State, million dollars Per cent of all state and local taxes Local, million dollars Per cent of all state and local taxes 1942 276 3.2 249 2.9 27 0.3 1950 788 4.9 724 4.5 64 0.4 1960 2,463 • 6.8 2,209 6.1 252* 0.7 1968 7,308 11.1 6,231 9.2 1,077* 1.6 1969 8,008 11.6 7,527 9.8 1,381* 1.8 * Corporation tax included with individual Income tax collections. individual income taxes are approximately the same as in states which do. Thus, in 1968 taxes in Connecticut, Illinois, Ohio and Pennsylvania were respectively $357, $330, $277 and $298, with this figure fluctuating in all states from $200 to $503, and averaging $338.^^2^^

The role played by this tax in all tax receipts of states is steadily rising: in 1950 they collected $724 million out of $7,930 million received from all taxes, or about 9 per cent; in 1960, $2,209 million out of $18,036 million, or approximately 12 per cent, in 1968, $6,231 million or 17 per cent, and in 1969, $7,527 million or 18 per cent of all tax revenue.^^3^^

In some states receipts from the individual income tax comprise more than one-third of all tax receipts while in Oregon they exceeded 50 per cent in 1969.

The most important characteristic of this tax is the level of rates and criteria for tax-exemption employed in individual states.

In 1970, the minimum rate fluctuated between 0,75 (Iowa) and 4 per cent (Oregon and Utah); the maximum rate ranged from 4 per cent (Missouri and Mississippi) up to 14 per cent _-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 406; 1971, p. 398.

~^^2^^ Statistical Abstract of the United States 1970, p. 414.

~^^3^^ Statistical Abstract of the United States 1971, p. 398.

173 Table VI-13 Receipts from the Individual Income Tax in Selected States in 1969^^1^^ All tax Individual receipts, income tax Per cent of million receipts, mil-- all tax revenue dollars lion dollars Oregon 405.8 204.3 50.3 Wisconsin 1,090.8 461.9 42.3 New York 5,329.0 2,151.6 40.3 Minnesota 914.6 304.2 33.2 Massachusetts 1,232.0 452.6 36.7 Maryland 917.2 365.8 39.9 Connecticut 157.0 61.4 39.1 (New York and New Jersey). Moreover, the rate of progression of taxes on incomes above $15,000 slows down. Some states use a steady rate---Michigan 2.6 per cent, Indiana 2 per cent, Illinois 2.5 per cent and Massachusetts 4 per cent.^^2^^

Many states apply a maximum tax rate to comparatively small incomes of $3,000---$7,000 (Maryland, Mississippi, Oregon and Utah). It is clear that such regressivity of taxes, with small differences between minimum and maximum rates as, for example, from 3 to 4 per cent in Mississippi, benefits persons with high incomes.

States which apply high rates, as a rule, have also a larger percentage of receipts per capita, such as Delaware, Wisconsin, Oregon and New York.

The minimum level of tax-exempt incomes in 1968 also ranged widely from $370 per person to $5,000 and from $740 to $7,000 for a family of two. Moreover, the most widespread tax-exempt incomes were $600 and $1,200 respectively (14 states), i.e., at the same level as exemption from the federal income tax.

Twenty-eight states apply tax exemptions depending on age and also other types of exemption as, for example, for blind persons, disabled, and so on.

_-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 406.

~^^2^^ Ibid., p. 421, Data as of January 1, 1969.

174

Some states provide tax exemptions through tax credits (Arkansas, California, Iowa, Kentucky, Louisiana, Minnesota and Wisconsin) , as a result of which the tax-exempt minimum is raised.

Higher tax rates, together with the extension of the tax base, have ensured a very strong reaction on the part of taxes to the rise or drop in the GNP in a ratio of approximately 1:1.7. While such a situation is exceptionally favourable during the rise in the GNP, it has a very negative effect in periods of recession, especially when the predicted dynamics of the GNP were optimistic in comparison with the actual situation. State governments are unable to issue loans on an unlimited scale and, since they lose a considerable part of the revenue, may find themselves in difficult positions.

Sharp fluctuations of tax rates in individual states are likewise an adverse feature of the existing system. This creates definite conditions affecting individual groups of the population and persons engaged in certain vocations who in order to evade a loss of an essential part of their incomes migrate to states with more favourable taxation terms.

The property tax is now the chief source of tax revenue of local governments. In 1969 it totalled $30,673 million, of which $29,692 million or 96.8 per cent were receipts of local governments.

But notwithstanding the exceptionally high share of the

Table VI-14 Revenue of State and Local Governments from the Property Tax^^1^^ State and local, million dollars Per cent of all tax revenue State, million dollars Per cent of all state and local tax Local, million dollars Per cent of all local tax revenue revenue 1942 4,537 53.2 264 3.0 4,273 91.6 1950 7,349 46.2 307 1.9 7,042 88.2 1960 16,405 45.4 607 1.7 15,798 87.4 1968 27,747 41.1 912 1.3 26,835 86.1 1969 30,673 40.0 981 1.3 29,692 85.4 _-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 406; 1V71, p. 398.

175 property tax in revenue of local governments, its role is gradually declining.

While the role of the property tax in all federal and state tax receipts is declining quite rapidly as a result of the introduction and spread of other taxes, it remains dominant in local budget receipts. State governments are orienting themselves on more effective taxes, responsive to economic growth, population increase and a rise in incomes.

The main reason for the almost complete dependence of local governments on the property tax is the absence of other large revenue sources, including taxes, which could provide sufficient budget resources, without detriment to the tax base. At the same time, the property tax, chiefly on real property, within certain limits (when its rates are not too high), does not stimulate population migrations to other areas, and local governments can utilise it as a permanent financial source.

Existing regulations for applying the property tax in most states provide for the inclusion of practically all types of property, both real as well as personal movable property, including automobiles, furniture, jewellery, and so on.

At present more than 85 per cent of the taxable property consists of real property. Non-material property is almost not taxed because of the difficulty of evaluating such property. Local governments use various forms of exempting personal property from taxation, such as household property, whose value it is extremely difficult to assess. The importance of the property tax for various types of local administrative units is not everywhere identical, because, with the exception of municipalities with substantial nontax revenue sources, all the others, especially school districts, depend almost entirely on this tax.

The role of the direct property tax in the budgets of cities is noticeably declining, however. In 1968, of the $11,291 million in tax receipts collected by cities, $7,769 million came from the property taxes, i.e., 68.8 per cent.^^1^^ In that year, all local governments received $26,835 million from property taxes out of the $31,171 million collected from all tax receipts, i.e., 86.1 per cent.

_-_-_

~^^1^^ Statistical Abstract of the United States 1970, p. 423.

176

A characteristic feature of property taxation in the United States is the great diversity in methods of valuation, the list of taxable property and the terms of exemption. On the one hand, this is a consequence of big differences in the financial position of individual state and local units as regards the need for solving urgent problems, which, in turn, tells on the degree of pressure exerted on the taxpayer. On the other, we have the structure of the financial base which is capable of reacting differently to the introduction of some or other taxes. This, of course, does not rule out the subjective initiative of financial agencies and respective government bodies in finding new or tapping more intensively the existing revenue sources. Thus, personal household property is exempted from the property tax in 30 states and personal automobiles in 21 states.

Personal material property which yields a commercial income is taxed by 46 states. Ownership of a car formally is not subject to the property tax in some states but practically is subjected to other additional duties. Partial exemption from the personal property tax is applied in most states.

Various types of property which bring commercial benefits such as cars, equipment and implements, are difficult to valuate because of the unequal purchase prices, the degree of wear and tear, the type of production, and so on. This applies especially to the valuation of implements, which is practically impossible.

The absence of a single system for determining the tax base, the methods of valuation and the unequal distribution of the mass of property in individual states and local administrative units, have resulted in big differences in respect of the burden borne by individual states.

Thus, the per capita receipts from the property tax in state-local budgets fluctuated in 1969 from $36 (Alabama) to $246 (California).

The chief difficulty in applying the property tax lies in valuating property. This depends not only on the regulations and procedures established through legislation but on a number of subjective factors in respect to the owners and the estimators.

Notwithstanding the existence in many states of quite 177 Table VI-15 Per Capita Property Tax Revenue^^1^^ (dollars) States with the highest per States with the owest per capita incomes capita incomes California 249 Alabama 36 Connecticut 210 Arkansas 58 New Jersey 227 Louisiana 60 Massachusetts 225 Mississippi 60 definite criteria for valuating property, actually there is an underassessment almost everywhere. A comparison of the estimated values with the market prices shows that on the average, the estimated tax value of property was about 33 per cent of the market price. Moreover, in some states, these fluctuations are even more striking. Although the laws of 17 states provide for a specific ratio of the assessed and market values, it is clear that this relationship cannot be maintained because of the above-mentioned reasons. The assessed value calculated by the tax officials ranges from 5 per cent of the market price (South Carolina) to 84 per cent (Kentucky).^^2^^

Divergences in the level of underassessment of property during valuation are inevitable in the absence of a strictly unified system of taxation and results in an unjust distribution of the tax burden borne by individuals and groups of the population. Moreover, property owners try to get a maximum lowering of the estimated value because they know that there is no firmly fixed practice of valuation.

Another serious shortcoming in the system of valuating property lies in the terms of financial allocations between state and local governments. The latter have to collect taxes for the states but in accordance with their own evaluations.

The interest of the local authorities in reducing the tax base in such cases is obvious. This circumstance has had _-_-_

~^^1^^ Statistical Abstract of the United States 1971, p. 406.

~^^2^^ Ibid.

__PRINTERS_P_60_COMMENT__ 12---62 178 much to do with the refusal of a number of states to collect the property tax in their favour.

In part, estimated value also plays a role in the distribution of state aid when the per capita property value is employed as a criterion for estimating the financial potentialities of a local administrative unit.

Such an approach is utilised particularly in determining grants for education.

Analysing the system of valuating taxed property, Maxwell says that ``a locality is tempted to set a low valuation in order to reduce its share of county tax assessment and to set a high valuation in order to secure larger shares of state grants or of state distributions of taxes".^^1^^

The desire of states to unify, to some degree, the system of local tax valuations thus far does not go beyond efforts at comprehensively assessing property in specific localities for the purpose of establishing a more just intrastate reallocation of resources. But there still exist various valuations of individual property in each administrative unit and this naturally tends to deepen the differences in their financial situation in the allocation of state aid.

The process of establishing comprehensive and equitable valuations by states is very inaccurate and is based on subjective decisions by state tax agencies.

State re-evaluations of property, as a rule, encounter the energetic resistance of local financial agencies which at times succeed in getting a second re-evaluation in their favour.

Yet the question of valuating taxable property goes beyond purely tax relations when the size of the utmost limit of the debt on local loans is based on the ability of a corresponding administrative unit to collect the property tax. Thus, the evaluators, within certain limits, can influence the size of local loans to which they, in respect to their purposes, have no relation whatsoever.

Another adverse aspect of the imperfect system of valuation is the application of privileges for exempting property from taxation when it depends upon the estimated value of property whether the local government unit will receive some tax from the owner or not.

_-_-_

~^^1^^ James A. Maxwell, Op. cit., p. 142.

179

The glaring shortcomings in property taxation are constantly criticised and various reforms are proposed. But at the local level no sufficiently effective substitute for this tax has been found which could ensure similar budget revenue and would not suffer from still greater shortcomings.

The widening gap between the value of property owned and the income which this property brings, makes it increasingly difficult to find an efficient and justified application of the tax, and very often its size exceeds permissible limits.

Moreover, the property tax is regressive and does not conform to the incomes of the owners. It prevents commercial enterprise from withdrawing taxable property. This is most strikingly revealed in metropolitan areas where businesses move from the central urban districts to suburbs, increasing the financial difficulties of central districts. To a certain extent private investments in housing construction are being decreased and unemployment is rising. This, in turn, places new demands on the budget expenditure of municipalities.

Commercial firms try to compensate for their tax payments by raising prices for the goods they sell. This, in turn, leads to a rise in the cost of municipal services.

The taxes on estates and gifts supplement each other and in a number of cases are ineffective, although an opinion is current that they prevent huge accumulations of wealth and promote equal opportunities.

Summing up this brief review of sources and methods of financing state and local budgets, one can conclude that the general financial resources at their disposal are no longer sufficient to ensure meeting growing needs.

Yet the taxation system itself proved inflexible and as a result of this was not sufficiently adapted to rising expenditures without resorting to assistance from higher government bodies. On the other hand, the system cannot ensure a fair distribution of the tax burden on individual sections of the population and, on the contrary, promotes the deepening of social disunity vividly revealed in metropolitan areas. Comparing the efficacy of the taxation system of states and local governments with that of the federal government, 180 Cantor noted: ``Their tax revenues have not grown in line with public-service needs and their methods of taxation seldom result in a fair sharing of the tax burden."^^1^^

He, however, does not explain this as the result of complex and contradictory socio-economic processes in US society, in which the concentration of state-monopoly power which determines national priorities runs counter to the interests of the overwhelming majority of the population. In this sense the budgets of state and local governments reflect the wide gap that exists between the federal government's priorities and the needs of society as a whole. For the latter a solution of urgent domestic problems is immeasurably more necessary than the purposes for which federal resources are largely used.

__ALPHA_LVL2__ 3. FEDERAL, GRANTS TO STATES
AND LOCAL GOVERNMENTS

In the United States, local governments, just as in most of highly developed capitalist countries, receive grants from the national budget for covering part of their expenditures. This is a reflection of the centralisation of government finance inherent in the present level of development of statemonopoly capitalism. This is one of the reasons for the widening gap between the rise in expenditures for public needs of state and local authorities and their own financial resources. Simultaneously the more centralised form of financial relations between the federal government and localities is developed to the utmost, through allotments from the national taxes in the form of grants for definite purposes. The size of grants significantly affects the scope of state and local budgets and the character and proportions of specific budgetary items. This, as will be subsequently shown, undermines the economic independence of state and local governments which become increasingly dependent on the aid of the federal government.

The process of state-monopoly regulation of the economy, combined with centralisation of financial resources in the _-_-_

~^^1^^ Arnold Cantor, Op. cit., p. 2.

181 hands of the federal government, increased noticeably in the 1960s. This development affected intergovernmental budget relations.

Table VI-16 Federal Grants to State and Local Governments in Relation to Their Revenue^^1^^ Total revenue of state and local budgets, million dollars Sum of federal grants, million dollars Per cent of federal grants in total revenue 1942 13,148 858 6.5 1950 25,639 2,486 9.7 1955 37,619 3,131 8.3 1960 60,277 6,974 11.6 1965 87,777 11,029 12.6 1968 117,581 17,181 14.6 1969 132,153 19,153 14.5

Murray Weidenbaum, characterising the relations of the federal government and state-local authorities, notes: ``There is a widespread tendency to think of these grants as gifts and thus to assume that they merely add to the financial resources of the recipients. Such is hardly the case."^^2^^ He points to the conditions for providing such grants, with the help of which the central authorities gain the opportunity to control and direct state and local budgets, and declares: ``The question arises inevitably as to the extent the grant-in-aid system is converting the states into veritable agents of the federal government. Is there the possibility that the states may become the civilian counter-parts to the arsenal-like, government-oriented corporations in the military sphere?" He arrives at the conclusion that the total effect of federal influence through grants given to state and local governments is considerable.^^3^^

_-_-_

~^^1^^ Statistical Abstract of the United States 1965, p. 426; 1970, p. 411; 1971, p. 403.

~^^2^^ Murray I,. Weidenbaum, The Modern Public Sector. New Ways of Doing the Government's Business, Basic Books, Inc., New York, London/1969, p. 15.

~^^3^^ Ibid.

182

In nine years direct federal grants to states, counties, municipalities and school districts more than trebled---from $6,974 million in 1960 to $20,255 million in 1969.

In the main, federal grants are provided for public works, trade, transport and means of communication, for financing anti-crisis measures; for the needs of education, health and public welfare, benefits and services to war veterans and for financing some administrative agencies and private enterprise connected with public services.

Though states and local governments continuously obtain more revenue, federal grants are becoming an increasingly significant source of their budget receipts as a result of the more rapid rise in the size of grants as compared with the increase in the state incomes from their own sources.

The first large programmes of grants to states and local governments, envisaged by the US Constitution, arose during the crisis of the 1930s with the need to provide subsidies for stabilising the economic situation. In the course of 10 years of depression 13 main aid programmes were initiated as compared with 10 programmes implemented in the years prior to 1930.

The financial position of states and local authorities became the most acute problem: as a result of the sharp drop in employment and population incomes they were badly in need of resources for social welfare. The aid programmes therefore concentrated grants in this sector of government spending. Their purpose was to cope with pressing current problems and did not aim at long-range consolidation of the financial position of states and local governments.

After the Second World War, the inadequacy of the funds of states and local authorities received from their own sources was revealed more clearly. The limited nature of tax resources in contrast to the rapidly rising needs, made it necessary for the federal government to come up with more effective financial support. In 1950, federal grants to states and local administrative units reached $2,486 million. By that time not a single substantial part of state and local expenditures could be fully financed through their own resources. Federal grants were mainly directed at helping states and local governments in health, education, highway 183 construction and restoring the natural environment in cities.

The 1958 National Defense Education Act provided for federal aid in the form of grants and loans to states and local governments for special educational purposes. It envisaged the adaptation of educational programmes to purposes of a military nature.

Simultaneously federal funds were allotted for the clearing of slums, urban renewal and planning, and combating pollution of the environment. These programmes, including public welfare, amounted to about 70 per cent of all federal grants in 1955.

With the passage of the Federal-Aid Highway Act, grants-in-aid for commerce and transportation exceeded other types. In 1960, after the adoption of programmes on education, personnel training, economic opportunities and similar purposes, the share of such grants again rose. At the same time the increase in federal aid did not keep pace with the growth in needs, and the financial difficulties of the local authorities continued to mount.

This period was marked by big budget deficits of municipalities, especially in large metropolitan areas. The constant growth in the urban population demanded expansion of costly public services, linked with current needs and investments requirements for housing, public works and urban reconstruction. Of the total appropriations grants-in-aid, about 70 per cent were allotted for metropolitan areas. In 1964, these areas received only 55 per cent; moreover, the total sum was much smaller.

At present the system of federal aid to states and local bodies consists of three main elements: grants-in-aid, shared revenue and loans.

The grants-in-aid programmes allot resources of the federal government (Congress) to local governments for definite purposes. As a rule they are made conditional on state and local participation in their financing.

Conditional grants, as pointed out earlier, are above all provided for purposes arising from priorities set by the federal government. They thus do not always coincide with the primary tasks of states and local governments. The purposes of aid, formulated by Congress, are determined 184 by certain factors which do not directly concern the interests of states and local authorities.

Among them are questions of defence, the geographical location of the productive forces, the priority development of individual industries and lines of production.

Arnold Cantor, examining the use of federal grants, wrote that ``the aid programs must meet the test of aiding in the provision of a public facility or service that is in the national interest and in accordance with national priorities. The state and local government receiving the funds must use the money for the purpose intended by Congress and must agree to certain performance conditions such as civil rights and labor standards."^^1^^

It is clear that what is meant here are priorities put forward by the central government and not by the states and local authorities which have their own pressing needs.

States and local governments who receive aid of this type are forced to accept definite terms, including those which do not coincide with their direct interests as well as to take part in financing the subsidised measures.

James Henderson, studying some aspects of the influence of federal -grants-in-aid on different types of local governments, specifically counties, metropolitan areas and other administrative units, proves that the local budget receipts from the central government inevitably cause additional outlays by the recipients from their own sources. ``These revenues,'' he points out, ``are less than perfect income substitutes.... An intergovernmental revenue increase also leads to increases of local taxes and debt, and a reduction of private expenditures for both groups of counties."^^2^^

Though all grants-in-aid are made conditional on specific terms of financing, there are several varieties which can be grouped in two main types.

There are what are known as categorical grants allocated among the states or indirectly among local governments in accordance with the terms provided for in the relevant act _-_-_

~^^1^^ Arnold Cantor, Op. cit, p. 5.

~^^2^^ James M. Henderson, ``Local Government Expenditures. A Social Welfare Analysis'', The Review of Economics and Statistics, Vol. L, No. 2, May 1968, p. 159.

185 (formula-allocated grants). They take as a basis factors determined from statistical information for the district, such as the size of the population or per capita income.

A distinctive feature of this type of grant is that it determines in advance the sums which can be taken into account by state and local governments in planning budget items, specifically for education.

The manpower potential, unemployment level, the amount of welfare provided, and so on are taken as criteria.

Grants of this kind are more convenient forms of aid to state and local authorities than project grants which are of a more general, national significance.

Examples illustrating this type of conditional grant are those provided for under the Manpower Development and Training Act.

Project grants are given for strictly defined purposes. These programmes make up the majority and they absorb the main part of the aid. In awarding them, federal agencies take into account not only the concrete socio-economic statistics of individual states and their subordinate administrative units but other considerations which follow from accepted economic principles. At the same time to receive these grants, states must display initiative in solving local and regional tasks. Moreover, they must be ready to finance, in part, their implementation. In some cases, as for example, in low-cost housing construction programmes, participation is natural and the states, in fact, receive the opportunity to facilitate the accomplishment of primary tasks. The participation with their own funds in other programmes is less favourable for states. Inadequacy of state financial resources undermines their initiative in securing project grants. To a certain extent, this applies to grants for building highways, airfields and other projects where the principle of sharing the cost between the federal and the state-local contribution is applied.

With the exception of grants for highway construction, the distribution of financing, as a rule, is made in accordance with the ``equalisation'' principle or a 50:50 ``sharing of costs".

Individual grants, under the Elementary and Secondary Education Act of 1965, were provided directly for local 186 governments, in particular school districts, without making them conditional on their participation.

Other aid programmes, for example, the construction of health facilities, presuppose a fluctuating participation of the recipients, depending on the size of the project and their financial resources.

The federal share in financing varies, usually from onethird to two-thirds of the total cost of the project. Thus, even assuming a smaller part of the expenditure, the central authorities are given the possibility to practically fully determine the nature of the expenditures made by states and their subordinate administrative units.

A less important form of federal support to state and local budgets is shared revenue. It represents direct financing of states and localities from of a definite type of income---the sale or rent of certain federal property.

This type of financial aid, as a rule, contains certain terms, set by the federal government, which in this sense brings it closer to grants-in-aid.

President Nixon in his message to the Congress of February 4, 1971, officially proposed an expansion of shared revenues. The principle of ``new federalism" he formulated presupposes definite decentralisation of state administration, including finance. It proceeds from the need to transfer all responsibility for public services from the centre to the localities.

This decision, possibly of a temporary nature, adopted in the period of a critical condition of states and local finances, apparently was designed to give local governments greater independence in manoeuvring with financial resources so as to utilise them more rationally.

At present the proportion of aid in the form of shared revenue is insignificant, although state and local governments are interested in them more than in conditional grants.

Shared revenues on a larger scale were also proposed to the Johnson Administration in 1964 by Walter Heller, who at that time was Chairman of the Council of Economic Advisers to the President. His proposals encountered strong opposition and were not adopted. This happened at a time when all official organisations, representing state and local governments, called for unconditional shared revenues.

187

Analysing the economic and administrative terms of federal aid to states, B. Masse noted that the National Governors Conference, the US Conference of Mayors, the National League of Cities, the National Association of counties, the City Managers Association and the Council of State Governments, Democrats and Republicans equally, all were in favour of snared incomes.^^1^^

But, notwithstanding the position taken by the US President as regards increasing the financial independence of state and local governments, their dependence on federal aid continues to grow. This applies above all to conditional grants which carry rigid terms in respect to their use.

Apparently centralised government administration of local finances is supported by the private sector which receives big orders through the system of federal grants to states.

The dependence of state and local governments on federal grants, which has been increasing in recent years, is arousing growing dissatisfaction among official agencies of the recipients and a number of economists. Three main features of the system have become the object of sharp criticism: 1) loss of financial independence by states and their subordinate administrative units; 2) the general inadequacy of federal aid for coping with urgent tasks and 3) the frequent discrepancies between federal aims and local priorities.

Other aspects of the system of federal grants-in-aid are also criticised, for example, the advantages given to individual states, direct financing of measures in local governments, the impossibility of planning allocation of their own resources on a long-term basis as a result of the absence of information concerning future size of grants.

A most detailed analysis of the influence of federal grants-in-aid has been given by Murray Weidenbaum in his monograph The Modern Public Sector. The author examines the economic and social consequences not only in respect to goal-oriented redistribution of national resources, but also in connection with the influence they exert on the entire system of the private-monopoly economy. He _-_-_

~^^1^^ See America, February 27, 1971, Vol. 124, No. 8, p. 2007.

188 demonstrates the widespread impact grants have on the economic pattern of states and localities and draws the conclusion that ``the shift in the location of the actual conduct of government programs gives the rise to more than just administrative and managerial repercussions. It strongly influences the role of the states and cities in our federal form of government. It affects the size and strength of the business sector and of other nongovernmental institutions in our economy which has been primarily geared to corporate enterprise and private initiative."^^1^^

One can hardly disagree with this conclusion because this situation follows from the main terms on which grants are given. They are to be used for special purposes, recipients have to match federal funds, and controlling agencies or some other federal bodies have to approve in advance detailed plans for which the money will be used.

__ALPHA_LVL2__ 4. BORROWING OPERATIONS
AND THE STATE-LOCAL DEBT

Inadequacy of the funds from their own sources and federal aid is compelling state and local governments to constantly resort to various loans for covering primarily capital investments. Aggravation of the financial difficulties of state and local governments, especially after the Second World War, brought about a systematic increase in the

Table VI-17 A Comparison of State and Local Government Nonfinancial Expenditures to Gross National Product (1890---1938)^^2^^ Periods (annual average) Annual average of GNP, million dollars Ratio of total nonfinancial expenditures to GNP, per cent 1890 12,400 4.6 1909--18 40,120 6.3 1914--23 61,900 6.6 1919--28 81,200 8.2 1924--33 79,130 10.9 1929--38 69,950 14.2 _-_-_

~^^1^^ Murray L. Weidenbaum, Op. cit, p 5.

~^^2^^ Data given by Morris A. Copeland in Trends in Government Financing, Princeton University Press, Princeton, 1961, p. 47.

189 issuance of bonds and the growth of the debt. The tendency to increase the debt on state and local loans has been observed for several decades. But its manifestations vary from period to period, reflecting the cyclical nature of the development of the capitalist economy.

During the years of crisis (1930--31) expenditures which led to a deficit rose steeply. But in the subsequent years of the depression the expenditures were cut more rapidly than the revenue and in 1934 some of the receipts were partly used for repaying the debt. This was facilitated by federal grants which reached $1,600 million in 1934 as compared with $500 million in 1933. Notwithstanding the consequences of the depression, the level of state and local expenditures remained high in relation to the GNP which dropped sharply during the crisis. This position could not continue for long and a reduction of the ratio of expenditures to the GNP started at the beginning of the 1940s.

In the 1920s the growth of the state and local debt outstripped the increase of the GNP almost 10 times, which pointed to an obvious discrepancy in the scale of financial operations, specifically investments and the economic activity. Morris Copeland, examining the structure, aims and consequences of state and local loans, arrives at the conclusion: ``In general we have not inquired whether the borrowings governments have engaged in have been justified. But it has seemed necessary to note that there have from time to time been various instances of clearly unjustified deficits and thoroughly disorderly finance. And in some of these there has been outright corruption. Among the most extreme instances of the disorderly finance during the last 50 or 60 years are those that accompanied the Florida land boom of the 1920s; and the Coral Gables case stands out as one that was clearly characterised by corruption."^^1^^

The general drop in the level of employment and incomes, accompanied by the crisis reduction of prices, increased the tax burden in the 1930s. Measures to raise tax rates did not produce the expected effect and tax receipts in 1930--1934 were cut by 17 per cent. This was partly a result of failure to collect the expected taxes in a number _-_-_

~^^1^^ Morris A. Copeland, Op. cit., p. 170.

190 of municipalities; in 1934 it reached 20 per cent in 150 cities with a population of more than 50,000.

Thus, all attempts of state and local authorities to balance their budgets, ensuring a minimum of expenses for current needs on the basis of their own revenue, were unsuccessful. Yet borrowing on extremely disadvantageous terms presupposed, in future, a substantial burden on their budgets, through debt and high interest repayment.

It was becoming clear that state and local governments were unable to reasonably adjust their financial resources to the expenditures when dealing with questions even relating to the immediate future. The measures they adopted were dictated not by needs for capital investment for the future and current expenditure but by circumstances connected with spontaneous development of capitalist economy. And on the contrary, when decisions were made on big programmes, involving large outlays, it often turned out that resources for implementing them were inadequate.

Samuel Jackson, Assistant Secretary for Metropolitan Development, characterising the existing situation in planning the financial sources of investments, writes: ``... Communities delay needed improvements until crisis develops. Others permit popular or large projects to drain off all available funds. Inadequate planning also results in the poor location of public facilities and the unrealistic expenditure of public funds."^^1^^

The post-depression period was characterised by relatively favourable economic and financial activity. By 1944, nonfinancial receipts in state and local budgets exceeded the 1939 level by about 26 per cent, which enabled them to reduce the general debt by 15 per cent in 1946 as compared with 1939.

However, as the economy developed and incomes of corporations and private individuals grew, a greater interest arose in buying bonds issued by state and local governments because the interest on them was exempt from federal taxes. This factor became even more pronounced after the _-_-_

~^^1^^ Samuel C. Jackson, Capital Improvements Programming in Local Government. US Department of Housing and Urban Development. Urban Management Assistance Administration. Office of Metropolitan Development, Revised Edition, October 1969, p. iii.

191 Second World War when federal tax rate increased and became more progressive.

The distribution of the state and local debt over a number of years tended towards a relatively swifter growth in state indebtedness, the result of the transfer of a number of functions from local to state governments. During the depression, states were compelled to assume a number of tasks beyond the capacity of local authorities. This process did not have an identical ``feed-back'' and states largely preserved duties they assumed. This notwithstanding the fact that in 1966 the debt of states was still only one-third of that of the local debt.

Table VI-18 Outstanding State and Local Debt Selectively by Years 1902---1969^^1^^ (million dollars) Fiscal years State and local State Local 1902 2,107 230 1,877 1913 4,417 379 4,035 1927 14,881 1,971 12,910 1932 19,205 2,832 16,373 1938 19,436 3,343 16,093 1946 15,917 2,353 13,564 1950 24,115 5,285 18,830 1960 69,955 18,543 51,412 1966 107,051 29,564 77,487 1968 121,158 35,666 85,492 1969 133,548 39,553 93,995

These characteristics do not fully correspond to the situation in individual states and local government bodies but they adequately reflect the general tendencies.

The growth of the GNP and the consequent increase in receipts for state and local budgets are major factors for achieving financial stabilisation. The GNP rose from $211,100 million in 1945 to $743,300 million in 1966.

_-_-_

~^^1^^ Historical Statistics ... 1957, pp. 728 and 730; Government Finances 1960--66; Statistical Abstract of the United States 1970, pp. 417, 411; 1977, p. 396.

192

At the same time, tendencies toward consistent price increases, preserved throughout the post-war period, contained socio-economic prerequisites for future budget difficulties. These were expressed specifically in the constant rise in the cost of state-local programmes.

The composition of loans utilised by state and local authorities for capital investments is characterised by great diversity in the forms of placement, purpose, maturity and financial terms: these factors determine their expediency and economic effects.

General principles determining placement and terms of borrowing are based on the desire of the respective authorities to ensure easiest redemption with a maximum economic effect. But the desire to achieve these aims runs counter to a number of objective and subjective factors which operate in the opposite direction. Among them are the enhanced interest of private corporations in buying government bonds to secure tax privileges.

The most widespread form for determining the terms of loans at present is the redemption of the total debt and interest in equal parts throughout the period of maturity from current revenue. This relieves respective local governments from the need to accumulate resources for a single redemption, as was the case with loans in the 1920s and the 1930s. But the constant increase in the debt leads to steadily growing current outlays for interest payment. This adversely affects the financing of non-capital needs.

Table VI-19 Interest on the General Debt^^1^^ (million dollars) 1902 1927 1934 1948 1960 1966 1968 1969 68 584 739 399 1,670 3,268 3,889 4,403 _-_-_

~^^1^^ Historical Statistics ... 1957, pp. 139, 178; Government Finances 1960--66; Statistical Abstract of the United States 1970, p. 411; 1971, p. 403.

193

Long-term bonds issued by state and local authorities are usually for 20--30 years, in the course of which, repayment of the debt, including interest, must be fully ensured.

At the comparatively low interest paid on state and local debts private corporations, which buy their bonds, receive an income that was officially exempt by the federal government from the income tax by Congressional decision in 1913. This makes attractive the placing of capital in securities of this type.

At the same time, interest rates on taxable bonds, all other conditions being equal, are always higher.

This, in turn, makes such loans disadvantageous for local financial agencies.

To prevent the accumulation of an excessive debt and possibility of default on loans, most states, as was the case after the crisis of 1873, set limitations on the rights of states to issue loans. Everywhere all restrictions in principle pursued one aim. However, in character and effectiveness they are not identical. As early as 1941, Professor Ratchford classified limitations on state and local borrowing into three main groups: I---borrowings must be authorised by Constitutional amendments; II-^the legislature enacts borrowing proposal but they must be approved by popular referendum and III---legislatures themselves make the borrowing decisions.

The most effective barrier is the first category of restrictions which, according to an analysis of the debt made by Maxwell, showed that states which apply them have the smallest per capita debt.

States which utilise restrictions on borrowing by subordinate local administrative bodies, chiefly municipalities, have, in turn, been suffering from an acute shortage of fund for capital outlays in recent decades.

The economic basis for loan restrictions is usually taxable property with a definite percentage as the limit.

The necessity to secure approval of bond issues through popular referendums is also regarded as a restrictive measure. But with appropriate advertising and promotion by local authorities and corporations this type of restriction has little effect.

The purpose for restricting local borrowing basically __PRINTERS_P_193_COMMENT__ 13---62 194 coincides with that for restricting state borrowing---to protect the financial position of corresponding governmental units as well as the bondholders from default.

The gradual widening of the gap between property ownership and profitability makes these restrictions insufficiently justifiable economically and in some cases they are already incapable of preventing an excessive issue of bonds.

A widespread means for avoiding restrictions on statelocal borrowing are bonds guaranteed by the incomes of the credited enterprises which largely compensate the principal and the interest from their own sources. Such operations are not limited by legislation, as is the case with bonds guaranteed by governmental units. But the money received from nonguaranteed borrowing cannot be used for capital investments not ensured in the established periods by incomes for redeeming the debt. They are used for financing public utilities and other public institutions yielding a regular income.

Nonguaranteed bonds had already become widespread in the 1930s as a means of stimulating public works. By 1940, as many as 40 states had already utilised nonguaranteed bonds and the number of projects financed by them was steadily growing.

Subsequently nonguaranteed bonds continued to increase at an accelerated pace. In five years, between 1957 and 1962, the total long-term debt ensured by the credit of cities rose 35 per cent, while the nonguaranteed long-term debt of municipalities rose 44 per cent.^^1^^

The system of issuing nonguaranteed bonds is now marked by diversity of forms in individual states which, basing themselves on different local methods of financial and economic organisation, set the legal regulations for placing, approving and using the funds.

Self-financing projects, implemented through credits, in the final account include the cost of the debt and the interest on the volume of the collected duties which, in respect to guaranteed bonds, is somewhat lower than non-guaranteed ones.

_-_-_

~^^1^^ Census of Governments. Finances of Municipalities and Township Governments, US Department of Commerce, Bureau of the Census, Washington, August 1964, p. 2.

195

Non-self-financing projects, which use nonguaranteed issues, create additional financial burdens for state or local governments which annually must allot money from their own funds for redeeming the bonds.

The employment problem which is growing sharper and the search for ways to expand the tax base have promoted states and local government units to issue interest-bearing bonds for the purchase of land, buildings and installations. These are leased to private industrial corporations as a means for stimulating the expansion or retaining industrial enterprises within the territories under their jurisdiction.

The fact that private corporations can obtain taxexempt incomes throughout the country leads to competition between local authorities, which ultimately benefits private and not public interests.

Yet the additional incomes obtained by private companies in the form of exemption from taxes, under other conditions, could return to the state and local authorities in the form of grants via the federal budget.

Thus, local and state governments who provide loans to aid industry and do not bear either financial or administrative responsibility for their redemption, practically become simple intermediaries, with the help of which private individuals derive an additional profit.

Maxwell, who analysed the economic content of credit aid to industry, correctly noted: ``This cost advantage means that tax exemption serves to raise the rate of return earned by firms so that the direct benefits of the exemption accrue to individuals."^^1^^

Expansion of borrowing operations to aid industry attests to the increasing ``official'' evasion of income taxes by private corporations which are oriented not on solving state and local problems but on deriving additional profits practically financed by the federal government.

At present almost all states have given their subordinate local governments the right to issue aid-to-industry bonds. In 1960, the debt on these bonds amounted to $56.4 million, _-_-_

~^^1^^ James A. Maxwell, Op. cit., p. 203.

196 while in 1967 the issue of such new loans reached $1,400 million.

The debt on nonguaranteed bonds rose from $2,500 million in 1949 to $41,200 million in 1966.^^1^^ Cantor regards the exemption of state and local bonds from federal taxes as a form of grants to the former, the size of which can be calculated through the difference between the interest rates on the market value of credit and on state-local bonds containing tax privileges.

He points out that the difference represents a federal subsidy, which costs the US Treasury about $1,800 million in income lost on taxes, and gives the states and local governments $1,200 million annually. The sum of about $600 million accrues chiefly to rich investors who gain the benefit from tax exemptions.^^2^^

If we consider that in conditions of an unfavourable situation in the capital market, state and local authorities are willing to pay higher interest rates on bonds, since they have no alternative, the advantages accruing to private buyers of their bonds are, most likely, even greater.

Thus, in an effort to extend the tax base, raise employment and this way solve their problems, state and local governments facilitate the transferring to the private sector of part of the government funds they need.

Together with these shortcomings in the issuance of aidto-industry bonds, they, to a certain extent, limit the financial means of states for satisfying their own primary needs and make them even more dependent on the situation in the money market.

On the other hand, the expanding process of issuing nonguaranteed bonds affects projects which do not ensure complete financing. This leads to the formation of a type of debt which superficially does not appear to be dangerous but which in reality proves to be a heavy burden on state and local governments.

The general rise in the level of state-local needs, resulting from expanding urbanisation, has also been reflected, to a certain extent, in the distribution of the debt. The tendency _-_-_

~^^1^^ A. Cantor, Op. cit., p. 5.

~^^2^^ Government Finances, 1949--1966.

197 for the sum of the debt to vary in accordance with the population size of an area, is obvious. But differences in economic development, geographical location and population density have made this tendency less noticeable in recent decades. Capital investments, which mainly create debts, have a higher share in the per capita expenditure in big cities and industrial areas. As their level of incomes is higher, this, in itself, presupposes a higher level of financial operations.

The choice of rational solutions in the spheres of borrowing and utilising available resources has become an exceptionally complex problem for state and local governments. Frequent changes of the situation in the money market, in the growth rate of the economy, in the level of employment and other factors make successful long-term planning impossible. In this sense, budget planning, as a rule, is confined to the solution of problems as they arise and to ensuring (if this is possible) the financing of operating programmes.

Analysing the existing system of drawing up municipal budgets, John Crecine, a budget modelling specialist, stated: ``It is quite clear (from interviews) that the decision-makers do not see the problem as one of optimally balancing community resources, allocating funds among functions to achieve overall community goals, and the like."^^1^^

_-_-_

~^^1^^ John P. Crecine, Government Problem-Solving: A Computer Stimulation of Municipal Budgeting, University of Michigan, Rand McNally & Co., Chicago, 1969, p. 38.

[198] __ALPHA_LVL1__ CONCLUSION

Our analysis of various aspects of the US government budget and financial policy fully confirms the conclusion that the contemporary state has become a powerful and constant factor in the economic life of capitalist countries. The budget is one of the most potent instruments of state intervention in economic processes. The structure of the budget is shaped to coincide with the interests and demands of powerful influence groups and above all of Big Business. This ultimately increases disproportions in economic growth and exacerbates social contradictions.

The inoptimal allocation of the huge money resources obtained by the American Government via taxation channels and the credit system, is most glaringly displayed in the general orientation of the budget and the system of national priorities expressed in it. The high share of the military expenditure, which after the Second World War became a permanent feature of US financial policy, is a heavy burden for the country's economy. The influence of the big budget expenditure is exerted along many lines: it constantly affects the structure of production, money circulation and the credit system. The adverse consequences of the arms race are manifested in intensified inflation and in such a seemingly remote and specific sphere as monetary relations. In this area the United States and other capitalist countries have been harassed by chronic difficulties in recent years.

As far as the civilian expenditure of the budget, and, 199 more specifically, expenditure for social needs, is concerned, its general increase is dictated by the specific features of economic growth, by the aggravation of the class struggle, and in no way eliminates the contradictions of American society. This is shown by the quite modest results of the vaunted programme of the ``war on poverty'', the ever increasing shortage of the supply of ``public goods'', and by the chronic inadequacy of spending by state and local governments. The reorientation of the budget, with a view to increasing the share of some civilian items, to making higher expenditures on education, manpower retraining, etc., is primarily designed to accelerate economic development, improve the competitiveness of the US companies in foreign markets and to increase the profits of the biggest corporations, and is by no means motivated by concern for the welfare of the working people. The same conclusion is also suggested by an analysis of tax receipts and of the process of forming the financial resources of state and local governments.

Despite the keen opposition of radical sections of US society, the arguments and conclusions of many financial experts and realistically minded political leaders, the structure of the budget is changing very slowly. This suggests that powerful institutional and class forces in the United States are preventing any serious restructuring of government finance. This is once again proved by the latest (1973) Presidential Budget Message setting forth the main items of the federal budget for the 1973--1974 fiscal year.^^1^^

At the beginning of the 1970s the federal budget resulted in a big deficit. Unceasing inflation and the sharp decline of the position of the dollar in the world money markets prompted the federal government to resort to more rigid regulation of the financial system. But, the main method proposed by the Federal government of reducing the budget deficit boils down, above all, to cuts in appropriations of social needs. To this end the most primitive neo-liberalist arguments are mustered: each person must not count on government relief, but must secure an income by his own labour. But the extolling of an economic system which purportedly _-_-_

~^^1^^ New York Times, January 29, 1973.

200 Emacs-File-stamp: "/home/ysverdlov/leninist.biz/en/1973/USBEP201/20070405/201.tx" __EMAIL__ webmaster@leninist.biz __OCR__ ABBYY 6 Professional (2007.04.06) __WHERE_PAGE_NUMBERS__ top __FOOTNOTE_MARKER_STYLE__ [0-9]+ __ENDNOTE_MARKER_STYLE__ [0-9]+ is capable of ensuring affluence to any energetic American seems so much more unconvincing against the background of five million unemployed, against the persistence of large ``islands of poverty" and the steadily mounting cost of living. In his Message to Congress of March 2, 1973, President Nixon admitted the existence of a deep abyss between abstract ``equal rights" and the concrete economic opportunities of many Americans.

Nevertheless the federal government is out to cut the programmes of aid to the poorest sections of the population. In the face of the acute crisis of the private medical service system and of the waning accessibility of some forms of paid medical care federal support in building medical institutions and in implementing regional medical programmes is proposed to be stopped. Just as previously, a very small share (less than 1.5 per cent) of government appropriations is to be spent for the preservation of natural resources and the environment; moreover their share in the federal budget is even somewhat lower than in the mid-1960s.

On the other hand military spending continues to grow. This expenditure, according to the projected budget, is to rise from $76,400 million in the 1973 fiscal year to $81,100 million in the 1974 fiscal year and to $85,500 million in the 1975 fiscal year. Such an expansion of these appropriations holds out the promise of new, highly profitable contracts for the largest military industrial corporations. The new budget specifically calls for the purchase of five nuclear submarines, the modernisation of three missile-carrying ships, and so forth.

Yet the agreements between the USSR and the USA on the limitation of strategic defensive and offensive arms and the general improvement of the international climate open up a real way for a substantial reduction of military appropriations and radically altering the entire structure of government spending. The interest paid to financial institutions and to money capitalists, the owners of federal government securities, will attain astronomical sums. The total to be paid in interest in the 1974 fiscal year will reach $24,700 million as against $18,300 million in 1970. Throughout the last 20 years spending under this item grew faster than total budget expenditure.

201

Another salient feature of the programme for reducing the budget deficit is the further growth of taxes paid by the population. The biggest increase, about 45 per cent in the 1973--1974 fiscal year, will be registered in one of the most regressive forms of taxation---social insurance taxes and contributions. The rates of this tax on wages were raised from 5.2 per cent to 5.85 per cent as of January 1, 1973; simultaneously the minimum wage exempted from this tax was reduced. An increase of these taxes and contributions will provide about half of the general growth in budget revenue in 1973--1974.

In addition, receipts from the personal income tax will also go up substantially: the figure planned for the 1974 fiscal year will be almost one-fourth higher than in the 1972 fiscal year. Of all the forms of income taxation corporate taxes will rise least of all: during the period in question they will increase by about 15 per cent. The experience of preceding cyclical development shows that in the period following a recession the share of the national income appropriated by corporations in the form of net profit grows especially fast. But the burden of the bigger tax receipts in the 1973--1974 fiscal year is to be shouldered not by the private corporations, but, above all, by the main mass of the population.

The Presidential Budget Message contains a significant admission: for almost two postwar decades the US economy had been unable to achieve the goal of high employment and prosperity for American citizens without inflation and war. A financial policy which provides for a restraint or even direct cut of appropriations for social needs and for an increase in the tax burden borne by the working people can only further exacerbate socio-economic antagonisms.

__ALPHA_LVL0__ The End. [END] [202]

REQUEST TO READERS

Progress Publishers would be glad to have your opinion of this book, its translation and design and any suggestions you may have for future publications.

Please send your comments to 21, Zubovsky Boulevard, Moscow, U.S.S.R.

[203]

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IN THE ``PROGRESS
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The origin and causes of integration are some of the problems over which a sharp struggle is being waged between representatives of bourgeois and Marxist thinking. Singling out of the general and of the particular in the processes of economic integration, elucidation of differences of principle that exist between its main types, and definition of its specific features connected with regional aspects help to clarify the role and importance of different factors underlying integration. The authoress deals with the essence of economic integration, its main forms, private-monopoly and state-monopoly mechanisms. In the focus of attention are such problems as the interaction of monopolies and the state, internal contradictions of integration processes and specifics of inter-imperialist contradictions brought about by integration. Extensive concrete data are used to analyse economic ana social consequences of capitalist integration.

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[208] LAPL 336.73 U86 CM Usoskin, 201-1.jpg

This monograph by three Soviet economists is a study of US public finance, the main trends of fiscal operations of the federal, state and local governments as well as of activities in the sphere of public borrowing. The antagonistic nature of the socio-economic and political processes in the United States and the role of the federal budget in militarising the economy are revealed by the voluminous statistics, official documents, quoted works of American scholars and other materials. An analysis of bourgeois theories of the public sector in general and of the budget in particular brings out their main purpose---that of justifying the existing system.

201-2.jpg ____ ;320W«t Ohio Street Chicaw. Illinois 60610 current international problems 201-3.jpg V.USOSKIN, R.ENTOV, S.TARASENKO US Budget and Frrmnmir PrJi/-w