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

[DOCID: f:erp_p5._]
Economic Report of the President - - - - - - - - - - - - H. Doc. 104-161
[From the online service of the U.S. Government Printing Office]
[wais.access.gpo.gov]



CONTENTS

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Page
Chapter 1. Economic Policy for the 21st Century...................    19
Economic Challenges...........................................    22
Principles for Raising Living Standards.......................    23
Embracing Change..........................................    26
Creating Opportunity......................................    27
Promoting Personal Responsibility.........................    28
The Administration's Economic Policies........................    29
Expanding Markets.........................................    29
Investing in Physical, Human, and Technological Capital...    31
Making the Government More Efficient......................    33
Reducing the Deficit......................................    37
Approaching the 21st Century..................................    39
Chapter 2. Macroeconomic Policy and Performance...................    41
The Twin Roles of Macroeconomic Policy........................    42
Implications of the Policy Mix............................    43
Overview of 1995: Returning to Potential Growth...............    45
Explaining the Moderation in Growth During the First Half
of 1995.................................................    46
Consumption Expenditures..................................    47
Business Fixed Investment.................................    48
Inventories...............................................    49
Residential Investment....................................    51
Net Exports...............................................    51
Inflation.................................................    51
Employment and Productivity...............................    53
Incomes...................................................    59
Monetary Policy and Interest Rates in 1995................    59
Fiscal Policy in 1995.....................................    63
What Causes Economic Expansions to End?.......................    65
Economic Symptoms Preceding a Downturn....................    67
Short-Run Macroeconomic Effects of Reducing the Budget Deficit    69
Forecast and Outlook..........................................    72
Conclusion....................................................    74
Chapter 3. Making Fiscal Policy Choices Within and Across
Generations.....................................................    77
The Structure of the Tax System...............................    78
Characteristics of a Well-Designed Tax System.................    83
Fairness..................................................    84
Efficiency................................................    85
Simplicity................................................    88
Assessing the Current Tax System..............................    89
Evaluating Reform Proposals: The Flat Tax.....................    91
Long-Term Demographic Challenges..............................    95
Demographic Trends........................................    95
Economic Effects of an Aging Population...................    98
Effects of Demographic Change on the Federal Budget.......   101
Maintaining Valuable Programs.............................   106
Chapter 4. Devolution.............................................   107
Facts on Federalism...........................................   108
Trends over Time..........................................   108
Composition of Spending...................................   108
The Rationale for a Federal Role..............................   110
The Need for Uniformity...................................   111
Direct Spillovers.........................................   111
The Effects of Policy-Induced Mobility....................   111
Inequality of Resources...................................   112
Devolution of Policymaking Responsibility.....................   112
Ensuring Government Accountability............................   113
Devolution and the Provision of Public Services...............   116
Matching Grants...........................................   117
Public Services and Differences in Local Resources........   118
Better Government Through Community and Individual
Empowerment.............................................   119
Devolution and the Safety Net.................................   120
The Federal Role in the Safety Net........................   123
Moving Forward: Welfare Reform............................   125
Moving Forward: Medicaid..................................   127
The Challenges of Devolution..................................   128
Chapter 5. Economic Efficiency and Regulatory Reform..............   131
Rationales for Government Regulation..........................   132
Evaluating Regulatory Performance: Principles and Practice....   133
Setting Regulatory Priorities.............................   133
Designing Effective Regulatory Policies...................   134
Regulation and Devolution.................................   135
Regulatory Assessment in Practice.........................   136
Setting Regulatory Priorities for the Environment and Natural
Resources...................................................   138
The Safe Drinking Water Act...............................   140
Hazardous Waste...........................................   141
Agricultural Land Retirement Programs.....................   143
Creating Cost-Effective Policies: Economic Incentives for
Environmental Protection....................................   146
Air Pollution Trading.....................................   148
Tradeable Fishing Quotas..................................   149
Technology Diffusion for Pollution Control in Agriculture.....   151
Conclusion....................................................   152
Chapter 6. Promoting Competition in Traditionally Regulated
Industries......................................................   155
From Regulated Monopoly to Competition........................   156
Adapting Regulation to Increase Competition...............   158
Deregulation is Not Enough: Challenges to Regulatory
Reform..................................................   162
Promoting Competition in Telephone Service....................   167
Unbundling Potentially Competitive Services from Regulated
Monopoly Services.......................................   168
Entry by the Regional Operating Companies into Long-
Distance................................................   171
Implementing Local Competition............................   174
Replacing Cross-Subsidies and Promoting Universal Service.   176
Promoting Competition in Electricity..........................   181
Unbundling Generation from Transmission and Distribution..   183
Stranded Costs............................................   186
Competitive Parity, Universal Service, and Environmental
Protection..............................................   188
Conclusion....................................................   189
Chapter 7. Investing in Education and Training....................   191
Americans are Responding to the Demand for Skills.............   194
Do Education and Training Lead to Higher Earnings?............   196
Comparing the Earnings of Similar Workers with Varying
Educational Attainment..................................   197
Studies Using Twins.......................................   198
Natural Experiments.......................................   199
Random Assignment Experiments.............................   200
Learning or Sorting?......................................   200
The Payoff to Public Investment in Education..................   202
The Federal Role in Education and Training....................   205
Ongoing Efforts in Education and Training.....................   209
Early Childhood Education.................................   210
Elementary and Secondary Education........................   211
Postsecondary Education and Training......................   216
Better Options for Those Already in the Labor Force.......   222
Conclusion....................................................   223
Chapter 8. The United States in the World Economy.................   225
The Benefits of Outward-Looking, Market-Opening Policies......   226
The Evidence on Open Economies................................   230
Trade and Wage Inequality.....................................   231
U.S. Trade Policy in the 1990s................................   232
The Administration's Trade Strategy.......................   233
Measuring the Success of Trade Policy.....................   249
Causes and Consequences of the Trade Deficit..................   250
Sources of the U.S. Trade Deficit.........................   250
Consequences of the Current Account Deficit...............   257
Policy Options to Reduce the Current Account Deficit......   259
Conclusion....................................................   260

Appendixes

A. Report to the President on the Activities of the
Council of Economic Advisers During 1995...........   261
B. Statistical Tables Relating to Income, Employment, and
Production.........................................   273

List of Tables

2-1.    Measures of Inflation...............................    52
2-2.    Accounting for Growth in Real GDP, 1960-2002........    58
2-3.    Administration Forecast.............................    73
3-1.    Selected Consumption Tax Elements of the Income Tax.    81
3-2.    Tax Share of GDP in Selected OECD Countries, 1994...    81
3-3.    Composition of Federal Receipts.....................    82
3-4.    Projected Distribution of Income and Federal Taxes,
1996............................................    83
4-1.    Composition of Government Spending, 1993............   110
4-2.    Typical AFDC Payments for a Family of Three.........   125
5-1.    Atmospheric Emissions of Lead, by Source, 1970-94...   139

List of Charts

1-1.    Federal Debt-to-GDP Ratio...........................    20
1-2.    Federal Budget Deficits.............................    21
1-3.    General Government Deficits of the Group of Seven
Countries in 1994...............................    21
1-4.    Changes in Average Real Family Income by Quintile...    23
1-5.    Merchandise Exports.................................    31
2-1.    Real Business Fixed Investment......................    49
2-2.    The Sustainable Rate of Unemployment in the 1980s...    54
2-3.    Labor Force Participation Rates.....................    56
2-4.    Women's Labor Force Participation Rate, Child
Dependency Ratio, and Birth Rate................    57
2-5.    Actual and Trend Labor Productivity.................    58
2-6.    Measures of Real Compensation and Labor Productivity    61
2-7.    The Yield Curve.....................................    62
2-8.    Federal Funds Rate..................................    62
2-9.    Federal Budget Outlays and Receipts.................    64
2-10.    Federal Budget Deficit..............................    64
2-11.    Length of Economic Expansions.......................    66
2-12.    Probability that an Expansion or a Contraction Will
End.............................................    67
2-13.    Changes in Core Inflation...........................    68
2-14.    Core Inflation Rate.................................    69
3-1.    Gini Indexes for Before- and After-Tax Income of
Households......................................    83
3-2.    Past and Projected Population Shares by Age.........    96
3-3.    Past and Projected Fertility Rates..................    97
3-4.    Past and Projected Elderly and Youth Dependency
Ratios..........................................    98
3-5.    Elderly Dependency Ratios in Europe, Japan, and the
United States...................................   101
3-6.    Poverty Rate of the Elderly.........................   102
4-1.    Expenditures by All Levels of Government............   108
4-2.    Federal Expenditures as a Share of Total Government
Expenditures....................................   109
5-1.    Air Quality in Urban Areas..........................   139
6-1.    Growth in the Cellular Communications Industry......   161
6-2.    Telephone Industry Revenues in 1994.................   169
6-3.    Potentially Stranded Costs of Investor-Owned
Electric Utilities by Region....................   186
7-1.    College Enrollment Rates of Young High School
Graduates.......................................   193
7-2.    Mathematics Proficiency of U.S. and Foreign Students   195
7-3.    Percent Differences in Annual Earnings for College
and High School Graduates.......................   197
7-4.    Real Change in Maximum Pell Grant, Loan Limit, and
Tuition, 1980-1994..............................   217
8-1.    Merchandise Exports to Japan........................   246
8-2.    Export and Import Volumes...........................   249
8-3.    Employment Growth and the Trade Deficit.............   252
8-4.    Economic Growth and Changes in Trade Balances in the
G-7 Countries, 1990-94..........................   253
8-5.    Private Saving and Investment, the Fiscal Balance,
and the Current Account.........................   254
8-6.    Growth of Real GDP in the United States and Abroad..   255
8-7.    U.S. Dollar Exchange Rates..........................   256

List of Boxes

1-1.    Programs That Raise Living Standards................    25
2-1.    Microeconomic Policies Can Improve Long-Run
Macroeconomic Performance.......................    43
2-2.    The Comprehensive Revision of the National Income
and Product Accounts............................    48
2-3.    New Measures of Government Investment...............    50
2-4.    Has the Sustainable Rate of Unemployment Fallen?....    53
2-5.    Macroeconomic Policy and the Sustainable
Unemployment Rate...............................    55
2-6.    New Productivity Estimates..........................    59
2-7.    Productivity and the Real Wage......................    60
2-8.    Duration Analysis of Business Cycles................    66
3-1.    Taxation of Capital Gains Income....................    80
3-2.    Family Economic Income..............................    82
3-3.    Did the 1993 Tax Rate Increases Raise the Revenues
Predicted?......................................    92
3-4.    Tax Proposals in the Middle Class Bill of Rights....    93
3-5.    Changes in Fertility Over Time......................    96
3-6.    Will Increases in Longevity Permit Increased Work
Effort..........................................    99
3-7.    Linking Productivity Growth to Demographics.........   100
3-8.    Demographic Changes Around the World................   101
3-9.    Gauging the Accuracy of the Consumer Price Index....   105
4-1.    Federal Grants and the ``Flypaper Effect''..........   114
4-2.    The Unfunded Mandates Reform Act....................   115
4-3.    Rethinking Devolution: The Job Training Partnership
Act.............................................   121
4-4.    Rethinking Devolution: The Case of Public Housing...   122
5-1.    Natural Resource Damages............................   144
5-2.    Land Trusts and the Tax System......................   147
5-3.    Protecting the Stratospheric Ozone Layer: An
Incentives-Based Approach.......................   150
6-1.    The Telecommunications Industry.....................   157
6-2.    The Electric Power Industry.........................   158
6-3.    The Structure of the U.S. Telephone Industry........   168
7-1.    Is a College Education a Worthwhile Investment?.....   198
7-2.    New Opportunities for Potential Dropouts............   201
7-3.    Raising the Stakes for Students.....................   206
7-4.    Income-Contingent Student Loans as Forward-Looking
Means Testing...................................   220
8-1.    Comparative Advantage and Living Standards..........   227
8-2.    The New Trade Theory................................   228
8-3.    The Administration's Trade Achievements.............   235
8-4.    Trade and Intellectual Property Rights..............   236
8-5.    Mexico's Financial Stabilization....................   240
8-6.    The APEC Action Agenda..............................   244