Nearly a month ago Michigan Rep. Dave Stockman, with the backing of New York Rep. Jack Kemp, drafted a Republican economic and political manifesto for President-elect Ronald Reagan. This is an excerpt from that document, originally titled "Avoiding a GOP Economic Dunkirk," by the man Reagan named last week to head the Office of Management and Budget. I. The Gathering Storm
THE MOMENTUM OF short-run economic, financial and budget forces is creating the conditions for an economic Dunkirk during the first 24 months of the Reagan administration. These major factors threaten: 1. A Second 1980 Credit Crunch .
President Reagan will inherit thoroughly disordered credit and capital markets, punishingly high interest rates, and a hair-trigger market psychology.
The preeminent danger is that an initial economic policy package that includes tax cuts but does not contain decisive, credible elements on matters of outlay control, future budget authority reduction, and a believable plan for curtailing the federal government's massive direct and indirect credit absorption will generate pervasive expectations of a continuing "Reagan inflation." 2. A Double-Dip Recession in Early 1981 .
This is now at least a 50-percent possibility. Stagnant or declining real GNP growth in the first two quarters would generate staggering political and policy challenges. These include a further worsening of an already dismal budget posture and a profusion of "quick fix" remedies for various "wounded" sectors of the economy. The latter would include intense pressure for formal or informal auto import restraints, costly housing bailouts, accelerated draw-down of various lending and grant aids, a further 13-week extension of federal unemployment benefits, etc.
There is a further danger; the federal budget has now become an automatic "coast-to-coast soup line." For instance, the estimates for FY 81 [fiscal year 1981] trade adjustment assistance [to auto workers or others who lose jobs due to imports] have exploded from $400 million in the spring to $2.5 billion as of November.
For these reasons, the first hard look at the FY 81 and 82 budget posture by our own OMB [Office of Management and Budget] people is likely to elicit coronary contractions among some. An internecine struggle over deferral or temporary abandonment of the tax program could ensue. The result would be a severe demoralization and fractionalization of GOP ranks and an erosion of our capacity to govern successfully and revive the economy before November 1982. 3. Federal Budget and Credit Hemorrhage .
The latest estimates place FY 81 outlays at nearly $650 billion. That represnts a $20 billion outlay growth since the August estimates; a $36 billion growth since the First Budget Resolution passed in June; an outlay level $73 billion above FY 80; and a $157 billion growth since the books closed on FY 79 just 13 months ago.
The following table illustrates the full dimension of the coast-to-coast soup line problem and the manner in which it drives outlays upward at mind-numbing speed.
Sources of $36 Billion Growth in FY 81 Outlay Estimates Between June and November (TABLE) Program(COLUMN)Excess Cost Over June (COLUMN)(in billions) 1.Due to Higher Inflation:(COLUMN) Indexed Benefits:(COLUMN) Social Security(COLUMN)$0.75 Pension Benefits(COLUMN)0.40 Specific Price Reestimates:(COLUMN) Defense Fuel Costs(COLUMN)1.20 Medicare(COLUMN)1.90 Food Assistance(COLUMN)1.65 Subtotal(COLUMN)5.90 2.Due to Higher Interest Rates:(COLUMN) Student Loans(COLUMN)0.40 Interest on the Debt(COLUMN)1.30 Rural Housing Programs(COLUMN)0.15 FSLIC Outlays(COLUMN)0.15 Subtotal(COLUMN)2.80 3.Due to Higher Unemployment:(COLUMN) Medicaid(COLUMN)0.60 Assistance Payments(COLUMN)0.75 Unemployment Insurance(COLUMN)4.70 Trade Readjustment Assistance(COLUMN)2.10 Food Stamps(COLUMN)0.30 Federal Supplemental Unemployment Insurance Benefits(COLUMN)0.70 Subtotal(COLUMN)9.15 4.Due to General Economic Conditions:(COLUMN) Defense Department Procurement(COLUMN)3.35 Nondefense Procurement(COLUMN)3.25 Corps of Engineers(COLUMN)0.10 EPA Sewer Construction(COLUMN)0.10 VA Construction(COLUMN)0.10 SBA Disaster Loans(COLUMN)1.35 Subtotal(COLUMN)8.25 Grand Total(COLUMN)$26.10(END TABLE)
(The $9.2 billion increment for trade adjustment assistance, food stamps, cash assistance and unemployment benefits represents a revised assumption about the expected duration of high unemployment during calendar 1981. Category 4 presents still another example of the soup-line dynamic: When private sector orders soften, federal defense and "brick and mortar" contractors tend to speed up delivery on contract work, increasing the spend-out rate against obligated authority in the pipeline -- in this case by about $5 billion.)
The deficit and total federal credit activity figures are even more alarming. When the "cut-off budget" deficit (reflecting borrowings for agencies whose spending is not included in the unified federal budget) is included, the pre-tax-cut deficit for FY 81 ranges between $50-60 billion. The vigorous tax cut package required to spur the economy could raise the total deficit to the $60-80 billion range.
Moreover, new federal loan and loan guarantee activities during FY 81 are now estimated at $150 billion , with only $44 billion of this amount included in the official on-budget accounts. Thus, federal credit agencies will absorb an additional $100 billion in available funds beyond the Treasury's requirements for financing the official deficity.
4.Commodity Shocks and the Destruction of Monetary Policy.
The U.S. economy is likely to face two serious commodity price run-ups during the next 5-15 months. First, if the Iran-Iraq war is not soom terminated, today's excess worldwide crude and product inventories will be largely depleted by February or March. Under those conditions, heavy spot market buying, inventory accumulation and eventually panic bidding on world markets will once again emerge. Indeed, unless the way combatants exhaust themselves at an early date and move quickly back into at least limited production, this outcome is almost certain by spring.
Similarly, the present rapid draw-down of worldwide grain and protein oil reserves could turn into a rout by the fall of 1981, if the Soviets have another "Communist" (i.e. poor) harvest and production is average-to-below-average elsewhere in the world.
Demand for these basic commodities is highly inelastic in the very short run; and this generates strong credit demands from both the business and household sectors to finance existing consumption levels without cutting back on other expenditures. If the Federal Reserve chooses to accomodate these credit demand shocks, as it has in the past, then in the context of the massive federal credit demand and financial market disorders described above, only one result is certain: The credibility of monetary policy will be destroyed.
The Federal Reserve will subsequently succumb to enormous internal strife and external pressure, and the conditions for full-scale financial panic and unprecedented global monetary turbulence will be present.
5.Ticking Regulatory Time Bomb.
Unless swift, comprehensive regulatory policy corrections are undertaken immediately, an unprecedented, quantum scale-up of the much discussed "regulatory burden" will occur during the next 18-40 months.
In the auto sector, for example, new or substantially tougher regulations in the following areas will impact the industry during 1981-84: passive restraint standard (airbags) . . . 1981 passenger tailpipe standards . . . 5 mph bumper standards . . . final heavy duty engine emission standards . . .vast new audit, enforcement and compliance procedures, and a new performance warranty system . . . heavy duty truck noise standards . . . model year 83-85 light duty truck emission standards . . . MY 83-85 light-duty truck fuel economy standards . . . bus noise standards . . . ad infinitum. These measures alone qill generate $10 to $20 billion in capital and operating costs while yielding modest to nonexistent social benefits.
Similarly, a cradle-to-grave hazardous waste control system will take effect in 1981 at an annual cost of up to $2 billion. Multi-billion overkill has bloomed in the regulatory embellishment of the Toxic Substances Control Act. Three thousand pages of appliance efficiency standards scheduled for implementation in 1981 threaten to create multi-billion-dollar havoc in the appliance industry. All told, there are easily in excess of $100 billion in new environmental safety and energy compliance costs scheduled for the early 1980s. II. The Threat of Political Dissolution
This review contains an inescapable warning: Things could go very badly during the first year, resulting in incalculable erosion of GOP momentum, unity and public confidence. If bold policies are not swiftly, deftly, and courageously implemented in the first six months, Washington will quickly become engulfed in political disorder commensurate with the surrounding economic disarray. A golden opportunity for permanent conservative policy revision and political realignment could be thoroughly dissipated before the Reagan administration is even up to speed.
For example, unless the whole remaining system of crude oil price controls, refiner entitlements, gasoline allocations, and product price controls is administratively terminated "cold turkey" by Feb. 1, there is a high probability of gasoline lines and general petroleum market disorder by early spring. These conditions would predictable elicit a desultory new round of Capitol Hill-initiated energy policy tinkering reminiscent of the mindless exercises of summer 1979.
The administration would lose the energy policy initiative and become engulfed in defensive battles. In short, if gas lines are permitted to erupt due to equivocation on revocation of controls, debilitating legislative and political distractions will be created.
Similarly, failure to spur early economic expansion and alter financial market inflation expectations will result in a plethora of Capitol Hill initiatives to "fix up" the housing, auto, and steel sectors, hype up exports, provide municipal fiscal relief, etc. Again, the administration would be thrown on the defensive. Finally, persistence of budget deficits, high interest and inflation rates, and monetary policy vacillation at the Fed would quickly destroy the present GOP consensus on economic policy.
To prevent early dissolution of the incipient Republican majority, only one remedy is available: an initial administration economic program that is so bold, sweeping and sustained that it -- -- totally dominates the Washington agenda during 1981; -- holds promise of propelling the economy into vigorous expansion and the financial markets into a bullish psychology; -- preempts the kind of debilitating distractions outlined above.
The major components and tenor of such an orchestrated policy offensive are described below. III. Emergency Economic Stabilization and Recovery Program
To dominate, shape and control the Washington agenda, President Reagan should declare a national economic emergency soom after inauguration. He should tell the Congress and the nation that the economic, financial, budget, energy and regulatory conditions he inherited are far worse than anyone had imagined. He should request that Congress organize quickly and clear the decks for exclusive action during the next 100 days on an Emergency Economic Stabilization and Recovery Program he would soon announce. The administration should spend the next two to three weeks in fevered consultation with congressional leaders and interested private parties on the details of the package.
Five major principles should govern the formulation of the package:
1. A static "waste-cutting" approach to the FY 18 fiscal hemorrhage will hardly make a dent in the true problem. Persisting high "misery index" conditions in the economy will drive the soup-line mechanisms of the budget faster than short-run, line-item cuts can be made on Capitol Hill.
Elimination of deficits and excessive rates of spending growth can only be achieved by sharp improvement in the economic indicators over the next 24 months. This means that policy initiatives designed to spur output growth and to lower inflation expectations and interest rates must carry a large share of the burden.
2. For this reason, dilution of the tax cut program to limit short-run revenue losses would be counterproductive. Weak real GNP and employment growth over calendar 1981 and 1982 will generate soup-line expenditures equal to or greater than any revenue gains from trimming the tax program.
3. The needed rebound of real GNP growth and especially vigorous expansion in the capital spending sector cannot be accomplished by tax cuts alone. A dramatic, substantial rescission of the regulatory burden is needed both for the short-term cash flow relief it will provide to business firms and the long-term signal it will provide to corporate investment planners.
4. High, permanent inflation expectations have killed the long-term bond and equity markets that are required to fuel a capital spending boom and regeneration of robust economic growth. The Reagan plan must seek to restore credit and capital market order and equilibrium by supporting monetary policy reform and removing the primary cause of long-term inflation pessimism: the explosive growth of out-year [future year] federal liabilities, spending authority and credit absorption.
This points to the real leverage and locus for budget control: severe rescission of entitlement and new obligational authority in the federal spending pipeline, which creates outlay streams and borrowing requirements in FY 82, FY 83 and beyond.
5. Certain preemptive steps must be taken early on to keep control of the agenda and to maintain Capitol Hill focus on the Stabilization and Recovery Program. Foremost, all remaining petroleum product controls and allocations should be cancelled on day one. This will prevent a "gasoline line crisis," but will permit retail prices to run up rapidly if the world market tightens sharply as expected. This prospective price run-up can be readily converted into an asset: It can provide the political motor force for a legislative and administrative program to step up U.S. energy program production.
In addition, some informal agreement should be sought with Chairmen [Orin] Hatch, [Jake] Garn and others to defer the labor policy agenda [including proposals for a sub-minimium wage for youth and ending the "prevailing wage" requirement on federal contracts] until the fall of 1981. Both committees will have a substantial role in the stabilization program, and there is no point in antaganizing organized labor during this critical period. Similarly, the Moral Majority agenda should also be deferred. Pursuit of these issues during the 100-day period would only unleash cross-cutting controversy and political pressures which would undermine the fundamental administration and congressional GOP economic task.
The following includes a brief itemization of the major components of the Stabilization and Recovery Program: a. Supply-Side Tax Components.
The calendar year 1981 and 1982 installments of Kemp-Roth [a 10 percent tax cut each year], reduction of the top income tax rate on unearned income to 50 percent, further reduction in [tax rates on] capital gains, and a substantial reform of corporate [tax write-offs for] depreciation. b. Fiscal Stabilization Component.
This would consist of two parts. First, the cash outlay savings measures for the reminder of FY 81 would be aimed at holding outlays to the $635 billion range. A hiring freeze and a severe cutback in agency travel, equipment procurement and outside contracting would be the major areas for savings.
The second part would be oriented toward entitlement revisions and budget authority reductions in FY 82 and beyond. Some of this could be accomplished through budget authority rescissions included in the remainder of the FY 81 appropriations bill. This would have to be enacted before the continuing resolution [which continues spending for many agancies at last year's levels] expires. Expiration of the continuing resolution would provide strong leverage. Another part could be accomplished through the revised FY 82 budget and scaled-back requests for new budget authority. The remainder would require legislative committees to address a carefully tailored package of initial entitlement revisions.
Expressed in functional program and spending areas, the out-year [future-year budget] authority reduction package should address the following items, with a view to reducing federal domestic program levels by $30-$50 billion per annum in the FY 82-83 period:
1. Public sector capital investment deferrals. We are now spending about $25 million per year on highways, mass transit, sewer treatment facilities, public works, national parks and airport facilities. These are all necessary and productive federal investments, but their benefit stream will accrue over 20-40 years. In light of the current financial crisis, a modest deferral and stretch-out of activity rates (a 10-20 percent reduction) in these areas should be considered.
2. Non-Social Security entitlements. Current expenditures for food stamps, cash assistance, Medicaid, disability, heating assistance, housing assistance, WIC [Women, Infants, Children supplemental food program], school lunches and unemployment compensation amount to $100 billion. pA carefully tailored package to reduce eligibility, overlap and abuse should be developed fro these areas -- with potential savings of $10-$20 billion.
3. Low-priority program cutback. Total FY 81 expenditures for NASA, CETA [comprehensive Employment and Training Act], UDAG [Urban Development Action Grants], the Community Development Program, EDA [Economic Development Administration], urban parks, impact aid, ACTION, Department of Energy commercialization and information programs, arts and humanities, and the Consumer Cooperative Bank amount to $25 billion. Most of these programs are ineffective or of low priority and could be cut by at least one-third or $8 billion.
4. Federal credit, lending and guarantee reform. As indicated previously, concessional direct lending and loan guarantee activities by on-budget, off-budget and government-sponsored enterprises is now running rampant, absorbing ever bigger shares of available credit market funds. Controlling SBA [Small Business Administration] direct grant activities, for instance, will accomplish little if program activity is simply shifted to concessional loan authorities, with the resultant outlays laundered through the FFB [Federal Financing Bank.] c. Regulatory Ventilation.
This component also has two segments. The most urgent is a well planned series of unilateral administrative actions to defer, revise or rescind existing and pending regulations where clear legal authority exists. The potential here is staggering, as this hastily compiled list of specific actions indicates: (TABLE) (COLUMN)Action Impact Grant model year '82 carbon monoxide waiver(COLUMN)$300 million auto industrysavings Rescind passive restraint standard(COLUMN)$300-600 million auto investment savingsover 3 years Relax 1984 heavy duty truck emission standard(COLUMN)Minimum savings of $100million Simplify auto emissions certification and testing(COLUMN)$80 million per year Modify ambient air standard for ozone to permit multiple exceedencesor higher standard value in conformanace with scientific evidence(COLUMN)$15 to $40billion in reduced compliance costs over next 8 years Eliminate unnecessary new source performance standards for small industrial boilers(COLUMN)$1-2 billion over next 5 years Cancel EPA fuel additive testing program(COLUMN)Savings of $90 to $120million Relax proposed light duty truck emission standards for post-1983(COLUMN)Savingswould be a substantial fraction of currently estimated $103 billion compliancecost Modify or defer EPA pretreatment standards for industrial waste-water(COLUMN)Savings of a substantial fraction of the $6 billion compliance cost for just3 sectors: utilities, steel and paper Cancel DOE appliance efficiency standards(COLUMN)Avoids multibillion havoc inan industry that is already improving product efficiency in response to marketpressure Eliminate building energy performance standards(COLUMN)Market forces are workinghere, too, but rigid BTU budgets for each new structure could cost billionsper year for non-cost-effective energy savings Modify Resource Conservative & Recovery Act to incorporate "degree ofhazard" and control system simplification(COLUMN)Savings would be some fraction of$2 billion a year Defer new OSHA workplace noise standards(COLUMN)Save $250 million a year Modify or defer pending OSHA standards on scaffolding, asbestos exposure,cadmium and chromium exposure and grain elevator dust control(COLUMN)More than$1 billion in annual combined savings(END TABLE)
On a second front, both temporary and permanent statutory revisions will be needed. There are literally dozens of rule-making and compliance deadlines on the statue books for the next 20 months that cannot be prudently met. An omnibus "suspense bill" might be necessary during the 100-day session to defer these deadlines and to implement the one-year moratorium on new rule-making proposed by Murray Weidenbaum [who heads the Reagan regulatory task force].
Finally, a fundamental legislative policy reform package to be considered after the 100-day period will have to be developed. This would primarily involve the insertion of mandatory cost-benefit, cost effectiveness and comparative risk analyses into the basic enabling acts -- Clean Air and Water, Safe Drinking Water, OSHA, etc. Without these statutory changes, administrative rule-making revisions in many cases will be subject to successful court challenge. d. Contingency Energy Package.
The probable 1981 "oil shock" could entail serious political and economic disruption. Therefore, the preemptive step of dismantling controls before the crisis really hits is imperative. (Incidentally, the combination of immediate decontrol and a $10 rise in the world price would increase windfall profits tax revenue by $20-25 billion during calendar 1981, thereby adding substantially to short-run budget posture imporovement, if not to long-run energy production prospects.)
But beyond this, a planning tream should be readying a package of emergency steps to increase short-run domestic energy production and utilization. The primary areas for short-run gains would include accelerated licensing of a half-dozen completed nuclear plants and removal of all end-use restrictions on natural gas. If the crisis is severe enough, rapid statutory revision of the natural gas decontrol program and modification of the windfall tax might be considered as part of the l00-day agenda. e. A Monetary Accord
President Reagan should meet with [Federal Reserve Chairman Paul] Volcker or the entire Federal Reserve Board at an early date and issue them a new informal "charter" -- namely, to eschew all consideration of extraneous economic variables like short-term interest rates, housing market conditions, business cycle fluctuations, etc., and to concentrate instead on one exclusive task: bringing the growth of Federal Reserve credit and bank reserves to a prudent rate and stabilization of the international and domestic purchasing power of the dollar.
The president and Congress would jointly take responsibility for ameliorating credit and capital market conditions through implementation of the Stabilization and Recovery Program and would stoutly defend the Fed from all political attacks. Insulation of the Fed from extraneous economic and financial preoccupations, political pressures, recalibration of its monetary objective, and restoration of its tattered credibility is the critical linchpin in the whole program.