[Economic Report of the President (1996)]
[Administration of William J. Clinton]
[Online through the Government Publishing Office, www.gpo.gov]

[DOCID: f:erp_c1._]
Economic Report of the President - - - - - - - - - - - - H. Doc. 104-161
[From the online service of the U.S. Government Printing Office]
[wais.access.gpo.gov]

CHAPTER 1

Economic Policy for the 21st Century

The American economy has performed exceptionally well over the past
3 years. The combined rate of unemployment and inflation fell to its
lowest level since 1968. Productivity in the manufacturing sector has
increased by an average of 4 percent per year. Investment has soared,
laying the basis for increased productivity in the future, while exports
have boomed: equipment investment and merchandise exports both have
climbed more than 25 percent since the beginning of 1993. Yet despite
these encouraging developments, many Americans remain concerned about
the state of their own economic affairs. Their dissatisfaction reminds
us of the many challenges that remain.
In 1992, more than 9 million Americans were unemployed, and the
unemployment rate was above 7 percent. In parts of the country, such as
California, nearly one-tenth of the labor force was without a job. By
late 1995, however, the unemployment rate had dropped to 5.6 percent,
and the economy was poised to reach the target the Administration had
set for it: 8 million new jobs in 4 years.
Before the Administration could move ahead with its own positive
economic agenda (which this Report describes), it had to address some of
the economic problems it had inherited. The economy suffered from
multiple infirmities--a weakened banking system, increasing poverty, and
lackluster overall performance--but the most visible problem was the
soaring budget deficit. The first step required to set the economy on
the right course was to reduce the Federal budget deficit. By cutting
the Federal Government's borrowing needs, deficit reduction has
contributed to lower interest rates for businesses and consumers,
thereby spurring investment and growth.
The Omnibus Budget Reconciliation Act of 1993 (OBRA93), which
embodied the President's deficit reduction plan, put the country solidly
on the road to fiscal responsibility. For over three decades the country
had been gradually reducing the burden of the debt that had financed
victory in World War II: the ratio of debt to gross domestic product
(GDP) fell from 82 percent in 1950 to 27 percent in 1980. Within 12
years much of this progress was lost, and the debt to GDP ratio soared
to 50 percent by 1992 (Chart 1-1). Following passage of OBRA93, the debt
to GDP ratio has stabilized.



Since OBRA93, the deficit has been cut nearly in half, from $290
billion in fiscal 1992 to $164 billion in fiscal 1995. The drop is even
more dramatic when compared with the deficits that would have occurred
without OBRA93 (Chart 1-2). The deficit has been reduced in dollar terms
for 3 consecutive years for the first time since the Truman
Administration. The decline in the deficit as a percentage of national
output has been particularly striking: at 2.3 percent of GDP, the fiscal
1995 deficit is the lowest since fiscal 1979 and less than half the
fiscal 1992 level of 4.9 percent. The Federal Government is now running
a primary budget surplus: in other words, were it not for the interest
payments on the inherited debt, there would be no deficit. And the
general government deficit is now a smaller percentage of GDP than in
any of the other major industrial economies (Chart 1-3).
This restoration of fiscal responsibility, achieved without
sacrificing crucial investments in our Nation's human, physical, and
natural resources, provided the background for the current bipartisan
resolve to eliminate the deficit within 7 years. A later section of this
chapter discusses the right way and the wrong way to elimi-



nate the deficit, and Chapter 2 of this Report examines budgetary issues
in more detail.

ECONOMIC CHALLENGES

The economy's recent performance notwithstanding, pressing
challenges remain. In the short run, as discussed in Chapter 2, the
principal economic challenge is to maintain full employment with low
inflation. In the long run, the two paramount challenges are to increase
productivity growth and to ensure that all Americans share in the
benefits of a stronger economy. Since 1973, productivity growth has been
relatively sluggish: its pace in the economy as a whole is significantly
slower than it was during the two and a half decades immediately
following World War II. Output per hour grew by an average of 2.9
percent per year between 1960 and 1973, but has grown by only 1.1
percent per year since then. The cumulative impact of this productivity
shortfall, compounded over decades, is dramatic: output per hour would
be over 40 percent higher today if the pre-1973 rate of productivity
growth had been maintained. Slower productivity growth since 1973 has
resulted in stagnating real wages. Because of the difficulties in
measurement, the extent of the weakness in wages may be overstated, but
concern over slow wage growth is genuine and cannot be ignored.
Some evidence suggests that the tide may now be turning. In 1994
real median family income rose for the first time since 1989. But a 20-
year trend cannot be corrected in one year. Indeed, even with the 1994
improvement, real median family income was just 2.5 percent above its
1973 level. More needs to be done. The Administration's economic
policies are intended to boost growth and living standards well into the
21st century.
The negative effects of slower productivity growth have been
sharpened for low-income Americans by a marked increase in income
inequality. Between 1966 and 1979 Americans all across the income
distribution enjoyed the benefits of economy-wide growth in real
incomes: families in the poorest fifth of the population saw their real
incomes grow by 20 percent, while families in the top fifth experienced
real income growth of 28 percent. But since 1979 family incomes have
grown apart. Between 1979 and 1993 real family incomes in the bottom
fifth fell by 15 percent, while the incomes of the top fifth rose by 18
percent (Chart 1-4).
It is too soon to tell for sure, but we may be beginning to succeed
in sharing the benefits of growth and reducing poverty. The poverty
rate, for example, fell in 1994 for the first time in 5 years. But we
must do more to reduce inequality and poverty: despite an improvement in
1994, over one-fifth of American children still live in poverty.



PRINCIPLES FOR RAISING LIVING STANDARDS

The Administration's economic policies address the twin problems of
slow productivity growth and rising income inequality. Three principles
guide the Administration's efforts to solve these long-run problems:
embracing change, creating opportunity, and promoting personal
responsibility. These principles reflect core American values, and as
such they provide the basis for a national consensus for addressing our
economic challenges.
Putting this consensus into practice requires a variety of
partnerships--between workers and firms, between the public and the
private sector, between individuals and their communities, and between
the Federal Government and State and local governments. Competition is
the driving force of a market economy, but companies compete more
effectively when workers and managers cooperate. The public and private
sectors can cooperate in solving environmental problems and in meeting
skill shortages. And the Federal Government can work with the States to
meet the need for infrastructure investment and a social safety net.
Much of the current debate over the economy and the budget stems
from different conceptions of the roles that markets, governments, and
individuals should play in improving our society. Private enterprise
lies at the very heart of our modern economy. Individuals and
corporations provide the initiative and innovation that have enabled the
market economy to bring unrivaled prosperity to our Nation, and the
underlying dynamism of markets is fundamental to continued improvements
in living standards.
Yet unfettered markets occasionally fail to yield desirable outcomes
or to meet important national objectives. For example, in a completely
unregulated marketplace, firms may produce too much of some ``goods,''
such as pollution, and too little of others, such as basic research and
development. This failure to produce the ``right'' amounts of certain
goods and services is due to the presence of externalities.
Externalities arise when the actions of one firm or individual produce
costs or benefits for others without that firm or individual being
charged for the costs or compensated for the benefits. In such cases the
government has a special role. The government has an obligation to
perform that role as efficiently as possible, minimizing the burden on
the economy and the intrusions in the lives of its citizens. Not every
market ``problem'' calls for government action. In order to raise living
standards, government actions therefore must meet two criteria: they
must address some serious imperfection in the private marketplace, and
they must be designed so that their benefits outweigh their costs.
A variety of government programs have proved extremely successful in
raising living standards. We take for granted many of the government
services--such as retirement and disability benefits (Social Security),
health insurance for the aged (Medicare), and unemployment insurance--
that the market had failed to provide (Box 1-1). Before Medicare was
enacted in the 1960s, for example, many elderly Americans lacked health
insurance, whereas today almost all have it.
Medicare is a good example of a government program that filled a gap
in the range of services provided by the private sector. But government
programs can and do go awry. Indeed, government is sometimes part of the
problem, not part of the solution. For example, the construction of
high-density public housing projects may have contributed to some of the
problems facing America's inner cities. Chapter 4 of this Report
describes some of the efforts the Administration has made to make
government work better, while Chapter 5 examines the role of policy in
making markets work better.
In sum, government has a place, but government must know its place.
We now turn to exploring what government's place should be with regard
to the three principles enunciated above: embracing change, creating
opportunity, and promoting personal responsibility.

Box 1-1.--Programs That Raise Living Standards

Many public sector programs have been extremely successful in
improving living standards:
 Social Security. The Social Security system, created in
1935, provides monthly benefits to retired workers and their
dependents and to survivors of insured workers. The program has
dramatically reduced old-age poverty: only 12 percent of elderly
Americans now live in poverty, down from almost 30 percent in
1966. The Social Security Administration is also remarkably
businesslike. A leading financial news publisher recently ranked
the quality of the agency's telephone customer service above
those of several private companies renowned for their excellent
customer service. And administrative costs only amount to about
1 percent of Social Security outlays.
 The G.I. bill. The first G.I. bill of rights, signed by
President Franklin D. Roosevelt on June 22, 1944, transformed
American society. It provided education benefits for all
honorably discharged World War II veterans who had served at
least 90 days during the war. Almost 8 million received
education benefits under the first G.I. bill; more than 10
million veterans have received benefits under its extensions.
The G.I. bill also provided loan guarantees for veterans to buy
a home or a farm.
 Student grants and loans. The government provides various
forms of financial assistance to students. Pell grants provide
aid to financially needy students for educational costs at
participating postsecondary institutions. Under the Perkins loan
program, the Federal Government contributes the capital for
qualifying institutions to make long-term, low-interest loans to
needy students. Under the Stafford loan program, commercial
loans to students are backed by the government. And the new
direct lending program for college students is designed to
provide educational finance in a less costly, less cumbersome
fashion. Under the program, the government provides loans to
students directly, rather than guaranteeing loans from financial
intermediaries, and offers a variety of repayment schemes
(including a new option to link repayments to students'
incomes). Chapter 7 discusses the role of government in
education.

EMBRACING CHANGE

Our continued prosperity and well-being depend on our embracing, not
retreating from, the constant succession of new opportunities and
challenges of an ever-changing world. During the past few years American
firms have been through a technological revolution. They have taken a
hard look at what they do, how they do it, and what they must do
differently. The result: in many sectors American firms are the most
competitive in the world. U.S. computer firms continue to lead the
industry at a breakneck pace of technical innovation, of which the
explosive growth of the Internet and the increasing popularity of the
World Wide Web are merely the newest manifestations. When firms and
workers embrace change as these industries have done, the economy as a
whole benefits in the form of higher real incomes, lower prices for
goods, a wider variety of products, and enhanced opportunities.
But while embracing change raises growth and average living
standards, not everyone is made better off. In a rapidly changing
economy some will find themselves without the skills required for the
new jobs being created. When workers with outdated skills lose their
jobs, they face the threat of prolonged unemployment or reemployment at
much lower wages. Estimates suggest that about one-third of full-time
workers who lose their jobs and are subsequently rehired at another
full-time job take a pay cut of 20 percent or more. By providing
retraining, and by establishing one-stop career development centers
where workers can find out about both training and job opportunities,
the government can increase the efficiency of the economy even as it
reduces the burden on those who otherwise would be harmed by economic
change.
This Administration has actively promoted change, by opening up
markets here and abroad, by sponsoring research and development, by
devising tax policies to stimulate the growth of new enterprises, and by
easing the burden of government regulation. Critics sometimes claim that
open trade and investment harm the economy. But as Chapter 8 of this
Report argues, outward-looking trade and investment policies remain the
best choice for America. They boost living standards by encouraging
firms to innovate and become more competitive, by stimulating the flow
of ideas across national borders, and by providing a wider variety of
goods--at lower prices--to consumers and firms.
This Administration has not only promoted change for others--the
workers and firms affected by its policies--but has embraced it in its
own practices. The Administration recognizes that what the Federal
Government does, and how it does it, is sometimes the result of a
seemingly haphazard accumulation of functions rather than a coherent,
concerted response to a present need. Programs inaugurated yesterday
with great optimism in response to yesterday's exigencies too often
survive long after their usefulness has passed. In an era of difficult
budget choices, those programs that have outlived their purpose, or
whose benefits no longer justify their costs, have to be cut back or
eliminated to make room for programs that may be needed for success in
the 21st century. Efforts to reinvent government over the past 3 years
are explored in more detail below.

CREATING OPPORTUNITY

The Administration is committed to extending opportunity to all
Americans. Opportunity means allowing each individual to live up to his
or her full potential, and ensuring that those who suffer temporary
setbacks have a chance to bounce back. The commitment to opportunity is
not only a fundamental American value; it is also necessary for
achieving faster growth rates and higher standards of living.
Education and training are essential tools for expanding
opportunity. Educational opportunities must be available at all stages
of a person's life: from the preschool years through high school or
college, and continuing through one's career. But these opportunities
are not universally available. Children from low-income families, for
example, do not enter formal schooling with the same readiness as their
more economically advantaged peers--a disparity that Head Start (a
government program that provides a range of preschool services to young
children and their families) helps redress. And the difficulties
involved in borrowing against future income highlight the importance of
government student loan programs. Although college is an investment that
usually pays high returns to the student and to society, private lenders
view these loans without collateral as simply too risky. Chapter 7 of
this Report examines the government's role in the student loan market.
Opportunity entails more than just education and training: having
learned the requisite skills, Americans should have the opportunity to
obtain jobs. During the Great Depression, when the unemployment rate
soared to over 25 percent, our economy failed to offer the opportunity
to work to millions of Americans, unemployed through no fault of their
own. The Employment Act of 1946 committed the government to combating
unemployment. The act declared that ``it is the continuing policy and
responsibility of the Federal Government to use all practicable means .
. . to foster and promote . . . conditions under which there will be
afforded useful employment opportunities, including self-employment, for
those able, willing, and seeking to work. . . .'' The Administration's
macroeconomic policies, described in Chapter 2, have provided
opportunity to millions of Americans by fostering job growth and
reducing unemployment.
Opportunity in the labor market requires much more than active
education, training, and macroeconomic policies. It also requires
policies that make work pay for low-skilled workers and eliminate labor
market discrimination for all. Today a full-time, year-round minimum
wage worker with a family does not earn enough to stay out of poverty.
To help these low-income working Americans and their families, in 1993
the President and the Congress expanded the Earned Income Tax Credit
(EITC), and the President has since proposed an increase in the minimum
wage from $4.25 to $5.15 an hour.
All forms of discrimination contradict a fundamental tenet of
American society: that every American should have a fair chance to
succeed. Our Nation has made tremendous strides in reducing
discrimination, but the job is not finished. ``Audit'' studies, in which
white and minority job seekers are given similar resumes and sent to the
same sets of firms for interviews, indicate that discrimination remains
a problem in the labor market. Our civil rights statutes and affirmative
action programs combat such discrimination and seek to ensure equal
opportunity, and the Administration is fully committed to promoting
opportunities in employment, education, and government contracting for
Americans subject to discrimination or its lingering effects.
Finally, opportunity also means that those who suffer temporary
setbacks have the ability to put themselves back on the right track. The
EITC can help, and it does more than help those who directly benefit: it
also provides an enhanced sense of security to the millions of other
Americans who know they might need assistance at some time in their
careers.

PROMOTING PERSONAL RESPONSIBILITY

It is each individual's responsibility to make use of the
opportunities that society offers, and not to abuse the protections that
society affords. The Administration is firmly committed to designing
policies and programs to bolster personal responsibility. But ultimately
it is up to each and every American to assume responsibility for his or
her own life.
Policies must encourage people to assume responsibility for their
own lives, not discourage them from it. And policies intended to address
other challenges--for example, ensuring equity--must be carefully
designed to minimize any adverse impact on individual incentives. A
number of government programs provide, or can be thought of as
providing, insurance. Yet a problem common to all types of insurance is
moral hazard: having the insurance makes the insured-against event more
likely to occur. For example, fire insurance reduces the incentives for
homeowners to take precautions against fire, and thus may make fires
more likely. In the policies they write, private insurance companies
include mechanisms, such as deductibles and copayment provisions, aimed
at minimizing moral hazard. Similarly, government programs that
compensate for misfortune--such as employment and disability insurance,
and welfare programs--must be designed so as to promote responsibility,
minimize adverse incentive effects, and diminish moral hazard, including
dependence on government programs.
In summary, an appropriate role for policy--an effective partnership
between the public and the private sector--is crucial to raising living
standards. Markets are the engine of prosperity, but sometimes
government must help markets to work more efficiently.

THE ADMINISTRATION'S ECONOMIC POLICIES

Embracing change, creating opportunity, and promoting personal
responsibility--these principles are a common thread running through the
Administration's economic policies. Those policies are intended to
bolster, not replace, the underlying strength of markets in building a
better society and raising living standards. Raising living standards
entails more than just raising incomes; it also includes providing
educational opportunities for our children, protecting the environment,
and supplying security against devastating adversity. The
Administration's economic policies include expanding markets; investing
in human, physical, and technological capital; making government more
efficient; and reducing the budget deficit.

EXPANDING MARKETS

Promoting Competition

Competition is the driving force of efficiency and innovation. But
as we all know, life is often more comfortable with less rather than
more competition. Over 200 years ago, Adam Smith recognized that,
``People of the same trade seldom meet together, even for merriment and
diversion, but the conversation ends in a conspiracy against the public,
or in some contrivance to raise prices.'' It is all too easy to advocate
competition for others while seeking protection from competition for
oneself. Such protection is often rationalized by claims of ``unfair''
competition. Economists have long criticized such self-serving arguments
and have advocated strong antitrust laws to secure the advantages of
effective competition: lower prices, greater efficiency, increased
output, more rapid growth, and enhanced innovation. Under the leadership
of the Justice Department's Antitrust Division, the Administration has
implemented an aggressive policy to prevent unhealthy concentrations of
market power and promote competition.
Competition policy issues in telecommunications provide a trenchant
example of how ongoing change in the economy necessitates change in
economic policies. The telecommunications sector not only has grown by
leaps and bounds during the past 3 years, but has also provided a spur
to changes in other sectors. Government has played a long and useful
role in telecommunications, from its financing of Samuel Morse's first
telegraph line between Baltimore and Washington to the development of
what has become the Internet. But the 60-year-old legislation that
regulated the industry until this year was out of tune with the times
and stifled innovation. Passage of the new telecommunications bill in
February 1996 is expected to stimulate competition and ease access to
the information superhighway.
Most analysts agree that the telecommunications regulatory structure
needed reform. But effective reform proved more complicated than simply
repeating a mantra of deregulation: an unregulated private monopoly can
be just as stifling, if not more so, than a regulated one. Deregulation
done the wrong way could result in the growth of firms with market power
that suppress competition and innovation; equally important,
deregulation that permitted excessive media concentration could hamper
the public's access to the full panoply of viewpoints. To avoid these
pitfalls, the new legislation is designed in a way that fosters
competition, recognizing that today's bottlenecks to competition might
be removed in a few years. Chapter 6 details the constructive approach
the Administration has taken to regulatory reform in this and other
areas.

Promoting Exports

Both theory and evidence demonstrate that outward-looking trade and
investment policies raise wages and living standards: jobs supported by
merchandise exports pay 13 percent more than the national average.
Chapter 8 of this Report presents the rationale for the Administration's
continued support of ``compete, not retreat'' trade policies. It also
explores what trade policy can achieve (higher living standards) and
argues that the trade balance is not the proper measure by which to
judge the success of trade policies.
The Administration's trade policy record includes several historic
trade agreements that have opened foreign markets. Over the past 3 years
the Administration has brought the Uruguay Round to a successful close;
created the North American Free Trade Area with our largest and third-
largest trading partners; reached agreement with 33 other countries to
seek a Free Trade Area of the Americas by 2005; set the vision for
achieving free trade and investment in the Asia-Pacific by 2020;
concluded 20 bilateral trade agreements with Japan; and promoted
macroeconomic and trade policies that have contributed to strong export
growth (Chart 1-5). The Administration's aggressive support of
intellectual property rights has benefited not only American firms,
which lead the world in research and innovation, but also other
innovative firms throughout the world, providing a spur to innovation
everywhere. U.S. living standards have benefited and will continue to
benefit from the Administration's efforts to promote trade.



INVESTING IN PHYSICAL, HUMAN, AND TECHNOLOGICAL CAPITAL

Increases in productivity are largely the consequence of investment:
in physical capital (plant, equipment, and infrastructure), human
capital, and in the development of new technology. Government can
promote all three. Through the sound macroeconomic policies of the kind
pursued during the past 3 years, the government can create an economic
climate conducive to physical capital investment. But the government
must play an even more direct role in making investments in people and
in technology.

Investing in People

Preserving and extending lifelong investments in people has been
central to the Administration's economic strategy. Investments in people
are estimated to account for approximately a fifth of the annual
increase in productivity achieved over the past three decades, and
economic studies have demonstrated the high returns of public
investments in this area. As Benjamin Franklin once put it, ``An
investment in knowledge pays the best interest.'' Early childhood
programs such as Head Start, seem to produce fewer repeated grades, a
lower likelihood of being assigned to special education classes, and a
higher likelihood of graduating from high school.
The Administration has expanded investments in education and
training not only as a pro-growth policy, but also as an essential
ingredient in breaking the vicious cycle of poverty. As Chapter 7 of
this Report argues, past cutbacks in public support for education have
aggravated trends in inequality. Between 1980 and 1994 the average
tuition at public 2-year colleges increased by 70 percent, and that at
public 4-year colleges by 86 percent, while the value of the maximum
Pell Grant--the primary Federal program for low-income students--fell by
more than 25 percent in real terms. The results of these changes are not
unexpected. Returns to education have risen sharply in the past 15
years, but the expected response--increased enrollments--has occurred
disproportionately among the children of the better off: over the same
time period, the gap in enrollment rates between high-income and low-
income children has actually increased.
This Administration is working to revitalize the Federal role in
education and training. It has supported rigorous academic standards and
comprehensive school reform through the Goals 2000: Educate America Act,
which provides funding for the implementation of voluntary content
standards and local educational innovation; created a new direct lending
program for college tuition, to reduce costs and inefficiencies and make
the terms of repayment less onerous; and encouraged a smooth transition
from school to the workplace through the School-to-Work Opportunities
Act. That piece of legislation is especially important because it funds
programs to prepare high school students for today's careers. The
Administration has also begun to transform the Nation's unemployment
system into a reemployment system, by creating one-stop career centers
and proposing a system of skill grants (job training vouchers) for low-
income and dislocated workers. The Administration's policies to improve
both the quantity and quality of expenditure on education and training
are examined in more detail in Chapter 7 of this Report.

Investing in Research and Development

The Federal role in research and development and technology--both in
conducting research and in disseminating the ideas that research
generates--dates back to the 19th century. That investment has produced
impressive returns: from a more productive agricultural sector to the
underpinnings of what is today one of America's largest export sectors,
aeronautics, and to the basic science that has given rise to one of
America's most prominent high-technology sectors, biotechnology. Recent
studies suggest that half or more of all increases in productivity are
due to improvements in technology, and these studies have verified the
high total returns to such investments--returns far in excess of those
from investments in plant and equipment. As the 21st century approaches,
our technology programs must be both strengthened and reoriented to
emerging sectors. The Administration has promoted public sector
investments in technology through programs such as the Advanced
Technology Program and the Manufacturing Extension Partnerships (at the
Department of Commerce's National Institute of Standards and Technology)
and the Technology Reinvestment Project (at the Department of Defense's
Advanced Research Project Agency).

MAKING THE GOVERNMENT MORE EFFICIENT

The Administration recognizes the need for change not only in what
the government does, but also in how it does it.

Reinventing Government

The reinventing government initiative was undertaken to improve the
efficiency of government, learning from the private sector wherever
possible, while acknowledging the differences between public and private
sector activities. The National Performance Review, headed by the Vice
President, has focused on making government agencies more performance-
and customer-oriented, developing performance measures, and ensuring
that those measures are used for evaluation. These efforts are already
beginning to bear fruit, in the form of better customer service and
greater efficiency.
The Administration is committed to continuing the reinvention of the
Federal Government, eliminating outmoded programs designed for the 19th
and 20th centuries, and promoting new ones designed for the 21st. For
example, the Department of Agriculture has reduced the number of its
agencies from 43 to 29 and is in the process of closing or consolidating
1,200 field offices. It has also plowed under a bumper crop of
paperwork: America's farmers this year will fill out 3 million pages
fewer of government forms than in years past. Meanwhile the
Administration has cut the overall Federal workforce by 200,000
positions. As a percentage of total employment in the United States,
Federal employment is smaller today than at any time since the early
1930s.
In its efforts to reinvent regulation, the Administration has
attempted to ensure that each regulation it reviews is consistent with
its identified objectives, and that the benefits from the regulation
justify its costs. Many of the proposals for reinventing government are
intended to reduce those costs by fundamentally changing our regulatory
philosophy. In its regulatory role, government should seek to facilitate
compliance, not to act as a disciplinarian. And regulations should be as
market-friendly and performance-oriented as possible. They should
encourage innovation and cost-effective ways of achieving the objectives
of the regulation. They should take advantage of incentives and market
mechanisms, rather than try to suppress them.
One set of regulations that the Administration has examined is those
affecting some private sector pensions. Two objectives of these
regulations are to prevent pension plans from becoming a vehicle for tax
evasion, and to keep them from discriminating against low-wage workers.
But in the aggregate these provisions have discouraged firms from
offering pensions, thus failing to encourage national saving. The
Administration therefore proposed simplified pension arrangements. The
proposal would provide substantial safe harbors from nondiscrimination
rules if employers match employee contributions; this should reduce the
costs to small businesses of administering pension plans.
Other strides have been made in reducing the burden of environmental
regulations and those affecting the banking and telecommunications
sectors. The proposals recognize the fundamental changes in the economy
that call for reform of regulatory structures, but also the need for
real safeguards to be kept in place to promote competition and
innovation, and to protect consumers and the environment. These reforms
are described in greater detail in Chapters 5 and 6.

Protecting the Environment

Americans want to know that the air they breathe, the water they
drink, and the rivers and lakes in which they swim and fish are safe.
They want to be sure that the places where they live and work do not
harbor threats to their health from contamination by dangerous
chemicals, and that the Nation's natural resources are properly
protected and managed. Protecting the environment is one of the best
investments we can make on behalf of our children. Preserving and
improving our environmental heritage is an essential part of maintaining
and raising overall living standards.
The country has made enormous progress in this area. The air we
breathe today is cleaner than before the Clean Air Act was passed.
Substances that pose real dangers to human health and the environment,
such as lead and DDT, have been eliminated or their use sharply reduced.
Rivers and lakes have been restored to health: 25 years ago Lake Erie
was all but dead; today life thrives in it again. With U.S. leadership,
the international community has made considerable progress in phasing
out substances that damage the earth's stratospheric ozone layer, which
shields us from dangerous radiation.
But the battle is far from over. Air quality in some locations
remains unacceptably poor. The outbreak of water poisoning in Milwaukee
in 1993, and other episodes in which drinking water in our major cities
has failed to meet quality standards, do more than just raise anxiety.
Chemical runoff from cities, subdivisions, and farms into our rivers and
lakes is a constant challenge. Pressures from economic development and
increased demand still threaten the Nation's wetlands, fisheries, and
other natural resources.
Although we all enjoy the benefits of cleaner air and cleaner water,
as individuals--whether managers of steel companies or of oil
refineries, or the producers or the drivers of automobiles--we have
little incentive to spend our own money to make these things happen. Few
are willing to shoulder all the costs of something for which all share
the benefits. Acceptable environmental quality cannot be achieved
without collective action. With appropriate policies--including
cooperation with States and localities, partnerships with the private
sector that engender creative solutions as well as set standards, and
careful assessment of the advantages and disadvantages of alternative
government action--environmental protection can be secured at an
affordable cost.
The Administration is improving the way in which we protect the
environment, making government a partner rather than an overseer. The
Environmental Protection Agency is eliminating 1,400 pages of obsolete
regulations and revising 9,400 more. In the process it is cutting
paperwork requirements by 25 percent, saving private industry about 20
million hours of labor per year. Chapter 5 of this Report examines
environmental policy in more detail.

Devolution

The Administration has been examining not only what roles government
should play, but also at what level--Federal, State, or local--
government should play its role. It has reexamined the partnership
between the Federal Government and the States and localities, to ensure
that public funds are used most efficiently. In some areas, such as
national defense, the Federal Government has a clear responsibility that
cannot be delegated. Other areas have traditionally been matters of
local responsibility. Chapter 4 of this Report reviews the basis on
which different responsibilities should be assigned to different levels
of government, and stresses that what is usually required is a careful
balancing of roles and responsibilities between the different levels.

Redesigning Welfare Policies

The government has a crucial role to play in increasing economic
independence, rewarding work, and ensuring that children are not trapped
in poverty. This is important not only for social cohesion; it is an
economic imperative as well. Each year that a child spends in poverty
raises the probability of that child later dropping out of school. And
dropouts tend to contribute less to national income: in 1994, mean
annual earnings for a full-time, year-round worker aged 25 to 34 who had
dropped out of high school were $18,679. Mean earnings for high school
graduates in that age range were $23,778.
Although individuals must ultimately be responsible for their own
actions, opportunities at least partially affect our behavior. The
limited economic opportunities available to dropouts make recourse to
antisocial behavior all the more likely. On any given day in 1992, 25
percent of men aged 18 to 34 who lacked a high school diploma were in
prison, on probation, or on parole, compared to only 4 percent of high
school graduates. This is not merely a tragic outcome for those young
men: increased crime imposes a wider social cost, in the form both of
greater expenditure by the criminal justice system and of reduced
personal security for all of us.
The policies adopted in the past to reduce income inequality and
poverty are in need of reform. Everyone agrees that the current welfare
system is broken. Welfare dependency does enormous harm to individuals
and families, by discouraging work and undermining personal
responsibility. Welfare recipients are robbed of their dignity, and
administrators spend too much time determining eligibility and to little
time helping families get back on their feet.
Figuring out how to fix the welfare system, however, is a great
challenge. With no easy answers, the Administration has worked to give
States the flexibility they need to experiment with new approaches to
welfare. As of February 1996, 37 States have received waivers allowing
them to pursue a wide range of reforms. For example, Wisconsin has
received a waiver to impose stringent work requirements and time-limited
benefits.
In order to help move parents from welfare to work, the
Administration has proposed to impose a time limit nationwide. Within 2
years, parents would be required to work. Within 5 years, they would
lose their benefits. Children would receive vouchers for support if
their parents' benefits were terminated. Chapter 4 of this Report
discusses many of these issues in more detail.

REDUCING THE DEFICIT

Before it could pursue the rest of its economic agenda, the
Administration had to bring the Federal budget deficit under control.
One of the most detrimental legacies left by previous Administrations
was the perilous state of public finances. The large budget deficits run
up during the 1980s and early 1990s, and the associated increase in
public debt, were restricting the private investment that is so crucial
to growth and were deepening our indebtedness to foreigners.
Borrowing to finance the deficit absorbs funds that could otherwise
be used to finance investment in plant and equipment--investment that
would increase the productivity of the American economy. Combined with a
low rate of private saving, government borrowing forces America to
borrow more abroad, increasing our indebtedness to foreign countries. As
discussed in Chapter 8, one of the fallouts from previous
Administrations' economic policies was that the United States went from
being the world's largest creditor country to being the world's largest
debtor country in the space of a few years.
Deficit reduction can right many of these wrongs and provide the
springboard for faster economic growth. But throughout the recent debate
over the budget, the Administration has stressed that there is a right
way and a wrong way to reduce the deficit. Deficit reduction is not an
end in itself, but a means to the end of higher living standards for all
Americans. How the deficit is cut may determine whether or not those
ends are accomplished.
Deficit reduction done the wrong way will reduce living standards
and worsen inequality. Cutting spending to reduce the deficit requires
hard choices. In making these hard choices, we must assess what the
government does now and what it should do in the 21st century. The
Federal budget is not just a bland accounting statement--it is an
expression of the Nation's priorities and values and should reflect a
vision of where the country is going and the problems it faces. Some
proposed budget cuts, such as those that would reduce equality of
educational opportunity, represent attacks on fundamental American
values. Others, such as in programs that protect the environment and
Americans' health and safety, would have adverse effects on living
standards in the future, and thus undermine the very purpose of deficit
reduction.

Deficit Reduction and Public Investment

Investment is a key factor in stimulating growth. Reducing the
deficit should lower interest rates and stimulate private investment.
Cutting the deficit by cutting high-return public investments makes
little sense: it merely substitutes one worthwhile investment for
another. Indeed, deficit reduction that reduces high-return public
investments--like those in research and development, technology,
education, and training--may compromise long-term economic growth.
Deficit reduction should not be achieved by running down our public
infrastructure, by failing to invest in research and development, or by
neglecting education and training.

Deficit Reduction and the Social Safety Net

Deficit reduction financed through ill-conceived and excessive
cutbacks in social programs is also counterproductive. Reducing
inequality not only is essential to keep from shredding the common
fabric of our Nation, but may also be important in the more limited
objective of promoting economic growth.
Economic growth would suffer if opportunities were reduced for those
Americans--and especially the children--at the bottom of the income
distribution. We would only worsen the inequality in our society by
reducing support for the most vulnerable members of society while
handing out large tax benefits to the richest. The better course is to
ensure that all Americans who work hard and play by the rules have a
chance to escape poverty. To do so would increase national output at the
same time that it reduces inequality.

Deficit Reduction and Health Care

As the President has long emphasized, growth in health care
expenditures must be contained. Failing to do so would not only pose the
renewed threat of large budget deficits; it could also force
unacceptable cuts in other programs that are vital to the country. It
would be wrong, however, for the richest country in the world to abandon
its commitment to increase access to basic health care.
Ongoing changes in our health care system not only allow us to take
advantage of structural reforms (such as more extensive use of managed
care), but also offer the hope that market forces will help contain
rising health care costs. The restraint exercised by health maintenance
organizations, for example, should serve to increase the relative supply
of health care services in other segments of the market and, through the
usual workings of supply and demand, help bring down costs. But more is
needed, and experiments could provide the information required to
implement effective reforms in the coming decade--reforms that would
protect the elderly even as they reduce the growth rate of public
expenditures. Possible demonstration initiatives include reforming the
reimbursement system, developing a system of regional hospitals
specializing in certain high-cost treatments, and cutting administrative
costs at hospitals.

Deficit Reduction and Taxes

Fifteen years ago, marginal tax rates and the progressivity of the
tax system were dramatically reduced. Some suggested that these policies
would so spur economic growth that tax revenue would actually increase.
The outcome of that experiment is now a matter of record: not only did
this response not occur, but the national debt quadrupled in the span of
a dozen years. Chapter 3 of this Report reviews the arguments and
evidence concerning the efficacy of new tax proposals.
In developing its tax proposals, this Administration has emphasized
fairness. The Administration has proposed tax cuts for the middle class
and argued forcefully against increasing taxes on low-income families
through a reduction in the EITC. And the Administration objects to
proposals that would give a disproportionate share of tax relief to
upper income individuals.
At the same time, the Administration has argued that existing
expenditure and tax provisions that benefit particular sectors of the
economy, and that cannot be justified in terms of some market failure,
should be reduced. Although the Administration succeeded in persuading
the Congress to eliminate some of the most obvious examples--the
subsidies for mohair and honey, for example, and the tax deductions for
lobbying expenses--billions of dollars in corporate subsidies and other
loopholes remain.

APPROACHING THE 21ST CENTURY

The U.S. economy has changed profoundly in this century. It will
continue to change as we enter the 21st century. Advances in technology
will continue at a rapid pace. The globalization of economies will also
continue. American firms will face competition from abroad, and all the
evidence indicates that they can and will rise to the challenge. Lower
priced imports and increased export sales will play a role in increasing
living standards, as the United States is able to exploit its
comparative advantage on an increasingly global scale.
Some sectors of the economy, such as the services sector, will
expand, while others will contract. In 1850, the majority of Americans
worked on farms; by 1950 only 12 percent did. In 1900, 20 percent of the
workforce was employed in manufacturing; by 1950 this had increased to
24 percent. The manufacturing share has since declined and now stands at
16 percent. Today, the main growth sectors of the economy include
service industries such as telecommunications services. Service
industries in the private sector accounted for 46 percent of employment
in 1950; today they account for 63 percent.
People naturally tend to recall the past in a softened light that
obscures its blemishes, and to see in the future adversities that may
never materialize. For some, the prospect of a future in which the
service economy dominates even more than it does today is one that
raises anxieties. To be sure, some of the service sector jobs that are
being created are not good jobs. On the other hand, many new service
sector jobs--in computer programming and management consulting, for
example--are high-tech, high-wage jobs.
Markets and government will need to respond to ongoing changes in
the economy. For government, change will require rebalancing: more
emphasis on new problems, less emphasis on those of the past. The best
combination of policies to address the problems of 2030 will be markedly
different from those that got us through the problems of 1930 or 1830.
Ideological and extremist solutions reflect neither the realities of
today nor the tradition of American pragmatism. Rather, the problems of
the 21st century need to be addressed with a balanced perspective.
Markets are at the core of our economy, but they do not always operate
fully efficiently and do not adequately meet all the needs--even all the
economic needs--of Americans. It is then that the government can often
help. In the face of increased income inequality, for example, it can
make greater efforts to enhance educational opportunity so that the
vicious cycle of poverty is not perpetuated.
Government cannot solve all of society's problems, and it certainly
cannot solve the more persistent problems overnight. But even if the
benefits do not manifest themselves immediately, government must
continue to invest in the future. Only by making such investments can
the long-term problems of slow productivity growth and increasing
inequality be addressed. This Administration firmly believes that
government--through selective, focused, and well-designed policies--can
help American workers and families achieve higher living standards and
develop a more humane, more just society.