[Economic Report of the President (1998)]
[Administration of William J. Clinton]
[Online through the Government Printing Office, www.gpo.gov]

[DOCID: f:erp_c1._]
Economic Report of the President - - - - - - - - - - - - H. Doc. 105-176
[From the online service of the the U.S. Government Printing Office]
[wais.access.gpo.gov]



CHAPTER 1 -- Promoting Prosperity in a High-Employment Economy

The past year saw the Nation's economy turn in its best performance in
a generation. Over the course of 1997, output growth and job creation
remained vigorous while inflation declined. Real (inflation-adjusted)
gross domestic product (GDP) grew 3.9 percent, and employment rose by
3.2 million, for an average rate of 267,000 jobs per month. The
unemployment rate dropped below 5 percent for the first time in 24
years, yet core inflation (as measured by the consumer price index,
excluding its volatile food and energy components) averaged only
2.2 percent, its lowest rate in over 30 years. This exceptional
economic performance occurred during a period of historic deficit
reduction: the Federal budget deficit, which reached $290 billion in
the 1992 fiscal year, declined to only $22 billion in fiscal 1997. And
the Administration has submitted a budget for fiscal 1999 that
projects a balanced budget for the first time since 1969.

As 1998 begins, the prospects for continued growth with high
employment and low inflation remain excellent. The economy is
remarkably free of the symptoms that often presage an economic
downturn--such as an increase in inflation, an accumulation of
inventories, or evidence of financial imbalance. Inflation fell in
1997, and developments in East Asia, by reducing U.S. import prices,
are likely to exert additional downward pressure on U.S. inflation in
1998. Economic turmoil in East Asia could affect the global economy,
but if international efforts to restore stability there succeed, the
main effect on the U.S. economy could simply be to allow continued
growth and job creation with a more moderate outlook for interest
rates. Another sign that an expansion is nearing its end would be a
sudden accumulation of inventories, as businesses find their sales
falling short of production. Yet sales were strong in 1997, and
inventory-sales ratios are near historical lows. Financial imbalances
can also threaten to disrupt an expansion. But today banks and other
financial institutions do not appear overextended, as they did in the
late 1980s and early 1990s, and the stock market shrugged off a
one-day plunge in October (although its continuing high valuation
relative to earnings is a source of concern to some). Although the
business cycle may not have been vanquished, the economy is in
fundamentally sound shape and well-equipped to handle any unexpected
bouts of rougher weather.

A principal force behind the current expansion has been private fixed
investment. Almost none of the growth in GDP over this expansion has
come from increased government spending, whereas close to one-third
has come from greater private fixed investment (Chart 1-1). Because of
the Administration's deficit reduction efforts, the contribution of
government spending to overall growth has been much lower than in most
previous postwar expansions (real Federal Government spending has
actually declined), while that of private fixed investment has been
substantially higher. One benefit of this burst of investment has been
a rapid expansion of industrial capacity: over the past 3 years
average annual capacity growth has exceeded every previous growth rate
since 1968.

Policies such as deficit reduction have contributed to an
investment-led recovery and a climate conducive to sustained economic



growth. But the lion's share of the credit for the economy's
performance goes to American workers and firms, who have risen to the
challenges of a competitive global economy and rapidly changing
technology. The role of government in such an economy is not to prop
up economic growth with government spending but, more subtly, to
provide individuals and businesses with the tools they need to
flourish through their own efforts. The range of appropriate
government policies in such an economy includes promoting private
investment through sound macroeconomic policies, encouraging the
formation of skills through training and education, securing
opportunity for the marginalized members of our society, and--where
necessary--providing assistance to the most vulnerable. Using
government to complement, not replace, the market and the private
sector has been a fundamental, guiding principle of this
Administration's economic strategy from the very beginning. And it is
this strategy that has borne fruit over the last 5 years.

Despite the economy's recent exemplary performance, a number of
challenges remain. The first is to preserve and nurture the successes
achieved so far. And although progress has been made in addressing the
longer term problems that have affected the economy since the
productivity slowdown of the early 1970s--problems like slow growth in
wages and incomes and widening income inequality--more needs to be
done. This chapter describes the principles and policies of this
Administration for achieving its two basic, overarching goals:
securing high and rising living standards now and in the future, and
ensuring that the benefits of a higher standard of living are extended
to all Americans.

THE ADMINISTRATION'S ECONOMIC STRATEGY

The Employment Act of 1946 (which created the Council of Economic
Advisers), together with its later amendments, gave the Federal
Government responsibility for stabilizing short-run economic
fluctuations, promoting balanced and noninflationary economic growth,
and fostering low unemployment. This Administration's strategy in
pursuing this mandate has focused on getting the fundamentals right:
reducing the budget deficit, investing in technology and the American
people, and opening markets at home and abroad. These were the right
policies for encouraging the job creation needed to move the economy
to full employment, and they are the right policies for attacking the
longer term problems of sluggish productivity growth and widening
income inequality that began to afflict the economy in the early
1970s.

But there is more to the Administration's policy agenda than can
be measured by aggregate economic statistics alone. Getting the
fundamentals right means removing the barriers that block people from
realizing their potential; it means promoting their sense of
individual responsibility and giving them the tools to succeed.
Getting the fundamentals right also means fostering a personal
commitment by all Americans to help others, a sense of shared
responsibility for our Nation's children, and a sense of community in
an increasingly multiethnic society.

A CREDIBLE PLAN FOR DEFICIT REDUCTION

The policy course set in 1993 has contributed to the Nation's recent
economic health and strength. In 1993 the economy was still recovering
from the 1990-91 recession, and it labored under the burden of a
Federal budget deficit that had ballooned to $290 billion, an all-time
record. The linchpin of the Administration's economic strategy was a
credible budget plan that could achieve substantial deficit reduction
over the longer term, yet be balanced and gradual enough to allow the
economy to gather strength and move toward full employment in the
short term. The success of this program rested on achieving an
interest rate environment conducive to investment, which would allow
the economy to grow in the face of a contractionary fiscal policy.
This in turn required that financial markets correctly anticipate an
appropriately accommodative monetary policy. In large measure, that is
exactly what happened. Long-term interest rates fell to 25-year lows
in 1993, spurring a pickup in economic growth.

A key feature of the Administration's deficit reduction plan was its
credibility. A credible and realistic program for deficit
reduction--one that observers and financial markets judged likely to be
fully implemented--was a precondition for the reduction in interest
rates that spurred investment-led growth. Fundamental to the plan's
credibility was the adoption of a set of economic projections that
represented conservative, mainstream forecasts of future growth and
inflation. These projections eschewed the ``rosy scenarios'' of previous
budgets, which invariably fell short of reality; they were not meant
to indicate the best that the economy could do, but rather how the
economy was most likely to perform given past experience. In fact, the
economy's performance has been stronger than the Administration
projected.

In the 1980s expansive fiscal policy required relatively tight
monetary policy in the form of high interest rates to prevent the
economy from overheating. This policy mix is particularly unfavorable
from the standpoint of fostering longer term growth: high interest
rates impede capital formation, while burgeoning government deficits
depress national saving and contribute to more borrowing from abroad.
The net result of deficit reduction in the 1990s has been to promote a
more balanced mix of fiscal and monetary policy. Deficit reduction has
also had an important collateral benefit, namely, a restoration of
Americans' confidence in the ability of their government to manage its
own affairs.

INVESTING IN PEOPLE AND TECHNOLOGY

The primary purpose of deficit reduction, however, is to encourage
investment. Hence, this Administration recognized from the outset that
a plan that balanced the budget at the expense of the government's own
productive investments would ultimately be self-defeating. Far from
curtailing public investment, the Administration has given investment
in people and technology a major place in its economic agenda.

Government invests in people by promoting public health and safety,
encouraging opportunity and individual responsibility, and assisting
in the formation of human capital through education and training. This
last function is especially vital in today's high-technology economy,
where a skilled work force is an essential condition for future
growth. Education is critical if Americans are to capitalize on the
opportunities created by new technologies and more open global
markets. And education and training programs are of particular
importance in the present economic environment as a means of
preventing poverty and ensuring opportunity for all. The return to
education has risen dramatically since the late 1970s; today, highly
skilled workers command a large premium in the labor market over their
less skilled counterparts. This rising skill premium is an important
reason why earnings inequality is greater today than it was in the
late 1970s. Governments have an important role to play in ensuring
that all Americans have the opportunity to accumulate the skills
necessary for economic success. This requires initiatives to improve
public education at the primary and secondary levels, as well as
programs to make higher education more accessible. It also requires
recognizing that learning must be a lifelong activity in an economy
where technological change is ongoing.

Investing in basic research and the development of new technologies is
another important function of government. The private sector spends
billions of dollars every year on research and development. But
economists have long recognized that private sector spending alone in
these areas will be less than the optimum. Since the fruits of a new
scientific discovery, for example, are enjoyed not merely by the
discoverer but by society as a whole, the private incentive for
pursuing scientific research falls short of the total social benefit.
Moreover, new theories of economic growth place a special emphasis on
advances in knowledge through research and development as the motive
force behind long-run increases in living standards. This analysis
implies that the return to government investment in basic research and
technology is likely to be especially high.

OPENING MARKETS AT HOME AND ABROAD

A third major component of the Administration's economic agenda is the
promotion of freer and more competitive markets at home and abroad.
Domestically, this has involved the pursuit of initiatives directed at
enhancing competition--particularly in such industries as
telecommunications, electric power, financial services, and health
care--and a vigorous approach to antitrust enforcement. It has also
meant addressing market failures in such areas as health care and
environmental protection. In some cases the effect of these
initiatives is a one-time boost to the level of output, through
greater efficiency and lower costs. But these policies can also
sometimes lead to a faster rate of economic growth. For example, past
experience provides evidence that sensible deregulation can not only
help raise efficiency, but also spur continued innovation through
greater competition. Moreover, some benefits of these policies are not
captured in the GDP statistics at all, but rather take the form of
improvements in our quality of life.

The Administration is also committed to reducing the burden of
government regulation and ensuring that the benefits of new
regulations justify their costs. Many government regulations apply to
industries in which technological change is rapidly altering the
nature of market competition. A key precept of this Administration's
approach to regulation, therefore, is that the regulatory process must
be dynamic, with regulatory policies under constant review so as to
minimize their burden on consumers and businesses. Another important
precept is to refrain from policies that regulate through government
fiat in favor of policies that use market-based incentives to attain
the desired outcome. Experience with such policies as permit trading
for sulfur dioxide emissions suggests that this approach can help
ensure that compliance with socially beneficial goals is achieved
efficiently and cost-effectively.

This Administration has also worked hard to open markets abroad by
encouraging fairer and freer international trade. From his earliest
days in office, the President has advocated an outward-looking,
internationalist trade policy. During the Administration's first 4
years the United States concluded over 200 trade agreements with other
countries. Some of these agreements, such as the North American Free
Trade Agreement (NAFTA) and the Uruguay Round agreement of the General
Agreement on Tariffs and Trade, were comprehensive in scope, whereas
others had much more limited aims--but all are vital to our Nation's
competitive future.

Economists generally recognize that an open economy offers both static
and dynamic advantages. First, trade benefits an economy by allowing
it to specialize in what it does best--a point that economists have
made since the early 1800s. Even if a country is more efficient than
its neighbors at producing every good it consumes, it can still
benefit from trade by specializing in the production of goods in which
it is relatively more efficient, and then trading its surplus
production for whatever else it wants to consume. In addition, a new
view of international trade argues that increased trade actually
raises an economy's rate of growth, because increased competition and
larger markets spur the acquisition of new skills and the development
of new technologies. If so, the case for trade liberalization becomes
even more compelling, since raising the economy's growth rate--even by
a few tenths of a percentage point per year--has vastly more
significance for long-run living standards than even a relatively
large one-time increase in the level of output.

A RECORD OF ACCOMPLISHMENT

Focusing on the fundamentals in shaping economic policy has paid off
by helping to produce an economy that is stronger than it has been in
decades. This past year alone saw a drop in the unemployment rate to
its lowest level in a generation and the forging of a budget agreement
that promises to bring the Federal deficit under control for the first
time in decades. Last year also saw significant advances in this
Administration's economic agenda along other fronts.

BENEFITS OF A HIGH-EMPLOYMENT ECONOMY

Driven largely by strong growth in business fixed investment, growth
in real GDP and employment picked up in the second half of 1993 and
persisted in 1994. This robust growth led to a series of monetary
policy tightenings over the course of 1994, which resulted in more
moderate growth in 1995. In retrospect, 1995 may have been the pause
that refreshes. Economic growth exceeded expectations in 1996, and
strong growth continued through 1997. The result has been a
high-employment economy with the potential to overcome some of the
longer term problems of productivity growth and income distribution
that built up in the 1970s and 1980s.

A high-employment economy brings enormous economic and social
benefits. Essential to personal economic security is the knowledge
that work is available to those who seek it, at wages sufficient to
keep them and their families out of poverty. A tight labor market
increases the confidence of job losers that they will be able to
return to work, lures discouraged workers back into the labor force,
enhances the prospects of those already at work to get ahead, enables
those who want or need to switch jobs to do so without a long period
of joblessness, and lowers the duration of a typical unemployment
spell. Returning the economy to full employment yields a direct
benefit by ensuring that the economy's resources--human and
material--are not squandered by needless cyclical unemployment. On
average, reducing the unemployment rate by a percentage point raises
output by approximately 2 percent; in 1997, 2 percent of GDP was $160
billion, or roughly $600 for every American man, woman, and child.
Wasted resources from not producing at potential, together with the
human cost of unemployment, are intolerable; the elimination of this
waste is the principal benefit of a sustained return to full
employment.

But a high-employment economy in which jobs are plentiful and labor
markets tight yields other benefits as well. Short-term economic
conditions can affect long-term structural unemployment. A tight labor
market encourages participation by those who might otherwise be forced
to sit on the sidelines, and makes it easier to absorb less skilled or
younger and more inexperienced workers into the labor force. These new
labor market entrants gain much-needed job experience, building the
skills they will need to hold down a job in the future. The importance
of this can be seen from the experience of some European countries:
prolonged stagnation or recession may have led to a permanent increase
in unemployment there, as the unemployed and the never-employed have
seen their skills atrophy or become obsolete. Running a
high-employment economy, then, may be one of the surest ways to ensure
that an unacceptably large fraction of our citizens are not consigned
to long-term joblessness and economic marginalization.

From the 1980s until the early 1990s, the economy's ability to reduce
poverty through growth alone was hampered by a strong headwind:
sustained declines in wages at the low end of the earnings
distribution that offset the benefits of an expanding economy for the
poorest Americans. As a result, holding a job no longer ensured that a
less skilled worker would be able to lift his or her family out of
poverty. This adverse secular trend raises even further the stakes of
maintaining a high-employment economy.

Keeping the unemployment rate low and job growth high is also
necessary if we are to move current welfare recipients into the work
force. Early, indirect evidence here is encouraging: employment and
labor force participation rates among single women who maintain
families--about two-thirds of whom have children under 18--have
increased in the past few years. This is probably in part the result
of recent welfare reform: the greatest acceleration in employment
rates has occurred among those single women most likely to be affected
by welfare reform, namely, those with young children. Nevertheless, it
is obvious that fostering an economy in which job opportunities are
plentiful plays a crucial part in aiding the transition from welfare
to work.

We have begun to see heartening signs that the current expansion is
yielding gains in living standards for all Americans, especially those
at the bottom of the income distribution. The poverty rate fell to
13.7 percent in 1996, from 15.1 percent in 1993; the poverty rate for
black Americans is at a historical low, and in 1997 unemployment among
blacks fell to its lowest rate since 1973. Since 1993, household
income has grown in each quintile of the income distribution, with the
largest percentage increase going to the poorest members of our
society (Chart 1-2). Maintaining a full-employment economy is
essential if this progress is to continue.

DEFICIT REDUCTION: COMPLETING THE TASK

The most significant economic policy event of 1997 was the passage of
a deficit reduction package that will finish the task of balancing the
Federal budget by 1999. This will be the first balanced budget since
1969, and only the ninth since World War II (Chart 1-3).

Some have claimed that the expanding economy, not government policy,
deserves all the credit for vanquishing the deficit. It is certainly
true that ups and downs in the business cycle have an important effect
on both revenues and outlays, leading to fluctuations in the deficit.
But even when cyclical factors are thus accounted for, it





is evident that policy has played a major role in bringing the deficit
under control. It is also worth noting that in January 1993, before
the 1993 deficit reduction package was adopted, the Federal deficit
was projected to reach $350 billion in fiscal 1998 and to rise to $650
billion in fiscal 2003, even when the economy was projected to be at
full employment. Finally, it is difficult to imagine that the
economy's performance would have been anywhere near as strong as it
has been without a credible and successful attempt to put the
government's fiscal house in order. Improvements in economic
conditions have played a part in reducing the deficit, but a balanced
budget would not now be in sight had the Nation remained on the fiscal
course in place in 1992.

Although a balanced budget is often taken as the goal of fiscal
policy, from an economic standpoint the motivation for deficit
reduction is to raise national saving, thereby augmenting society's
future consumption possibilities. When the government's budget is in
surplus, in the sense that revenues exceed outlays, the government
makes a positive contribution to national saving. As discussed in
Chapter 2 of this Report, a case for higher national saving can be
based on the high return on saving in the United States and the fact
that private saving remains low. A higher rate of national saving now
would lead to a larger economy when the baby-boom generation retires,
thus making it easier to provide for their retirement without imposing
undue burdens on younger generations. Although a balanced budget does
not add to the government's outstanding debt to the public, which past
deficits have ballooned, it does not subtract from it either. Leaving
a large public debt in place implies that a sizable portion of
existing government resources will continue to be absorbed by interest
payments, leaving less for all other spending. Indeed, one legacy of
the runup in the national debt that accompanied the deficits of the
1980s and early 1990s has been a sharp increase in the share of total
outlays that must be used to make interest payments on the debt (Chart
1-4).

POLICIES TO RAISE GROWTH, REDUCE INEQUALITY, AND INCREASE OPPORTUNITY

A significant part of the Administration's economic agenda also
involves investment in people: in a broad sense, this encompasses
education and training, measures to promote health, and policies that
extend opportunity to all Americans. A number of policies have been
put in place to ensure that these investments are made.

Education

The 1997 balanced budget agreement included the largest Federal
investment in education in a generation, in the form of initiatives to
improve the quality and accessibility of primary, secondary, and
higher education.



Higher education is a particular priority. The earnings of college
graduates have risen sharply relative to those of workers with only a
high school education; in today's economy, a college degree has become
as vital for success as a high school diploma was a generation ago.
Even post-high school education that does not lead to a bachelor's
degree (such as an associate's degree program or vocational or
technical training) boosts earnings substantially over just completing
high school (Chart 1-5).

Moreover, learning must be a lifelong process. A fundamental
characteristic of our economy is constant technological change. Such
progress holds the promise of higher living standards for all, but it
also requires workers to adapt to employers' demands for a
well-trained, highly skilled work force. It is therefore critical to
provide all individuals--including those not traditionally thought of
as ``school age''--with access to additional education or training.

The President's higher education initiatives reflect these principles.
Specific measures include:

 The largest Pell grant increase in 20 years. The balanced budget
agreement raises the maximum Pell grant by over 10 percent, to $3,000.
Approximately 3.7 million students receive Pell grants, and close to a
quarter of a million families will become eligible for the grant for
the first time.



 HOPE scholarships for post-high school education. In his 1997
State of the Union address, the President called for making the 13th
and 14th years of education as universal as a high school education is
today. The HOPE scholarship program accomplishes this by providing a
tax credit for higher education expenses of as much as $1,500, enough
to cover tuition at a typical community college.

 A tuition tax credit for Americans of all ages. A 20-percent tax
credit for post-high school tuition expenses will be available for the
first $5,000 (and after 2002, $10,000) of qualified education
expenses. This tax credit is offered not just to school-age Americans
but to those already working as well, to permit workers to upgrade
their skills at any time during their life.

 Tax exemptions for employer-provided education benefits. The
budget agreement extends Section 127 of the tax code for 3 years,
allowing workers to exclude up to $5,250 of employer-provided
education benefits from their taxable income.

 A tax deduction for interest on student loans. Up to $1,000 of
interest payments on loans for higher education expenses will be
tax-deductible in any given tax year, starting in 1998. This deduction
will rise by $500 each year until 2001.

Because public education in the United States is largely administered
by local authorities, the Federal Government's ability to influence
primary and secondary education is somewhat less direct. Nevertheless,
this Administration recognizes that there is much that the Federal
Government can do to improve our public schools, and has worked to
enact programs that will ensure that our children have access to the
best possible primary and secondary education. These initiatives
include:

 Establishing national standards. Research shows that students in
countries that have standardized, mandatory examinations do better
than students in countries that do not. The Administration's voluntary
national testing program has received full funding; this will allow
for the development of national fourth-grade reading and eighth-grade
mathematics examinations.

 Expanding Head Start. The balanced budget agreement raised
funding for Head Start by $374 million, to $4.4 billion, to reach the
Administration's goal of having 1 million children in the Head Start
program by 2002. Since 1993, funding for this program, which has shown
great success in preparing low-income preschoolers to enter school,
has increased by 57 percent. The program will serve over 830,000
children and their families in 1998, including 40,000 infants and
toddlers in the Early Head Start program.

 Establishing a comprehensive literacy strategy. Every child
should be able to read by the third grade. To meet this basic goal,
the President's comprehensive literacy strategy will receive nearly
$46 million in new funding in 1998 for State teacher training, family
literacy, and tutoring efforts; $210 million was provided in an
advance appropriation to be available in 1999, contingent on
authorization of a literacy initiative such as the America Reads
Challenge.

 Increasing funding for charter schools. The President set a goal
of having 3,000 locally designed public charter schools in operation
by early in the next century. Funding for charter schools is increased
by over 50 percent in the balanced budget agreement, to allow the
Department of Education to support nearly 1,000 charter schools by the
end of 1998.

Health

This Administration has made promoting health, increasing access to
health insurance, and improving the functioning of health insurance
markets a major priority. The Balanced Budget Act of 1997 allocates
$24 billion over 5 years to assist States in providing health
insurance for up to 5 million children through Medicaid or State
programs. This represents the single largest investment in children's
health since Medicaid was begun in 1965. The Administration's 1999
budget proposes to expand access to health insurance further by
allowing uninsured Americans between 62 and 65 years old, as well as
55- to 61-year-olds who have been laid off or displaced from their
jobs, to buy into the Medicare program. These measures are fully
offset so as not to increase the cost of Medicare to the government.

The Balanced Budget Act also takes important steps toward ensuring
that Medicare itself remains viable. Structural reforms--such as
expanded choice among health care plans and the restructuring of
payment systems--will help save $115 billion over 5 years. Recently
passed legislation also provides additional funding for preventive
care, such as mammograms, which can help keep health care expenses
down by catching and treating health problems before they become
serious. These and other measures will keep the Medicare trust fund
solvent for at least the next decade. The Balanced Budget Act also
created a commission to examine long-term solutions to the problems
that will face Medicare as a result of the demographic changes coming
in the 21st century.

The Administration has also promoted policies to improve the
functioning of health insurance markets, increase consumer protection,
and improve access to new pharmaceuticals. The Health Insurance
Portability and Accountability Act of 1996 helps workers who change
jobs by making it easier to carry their health insurance with them to
the new job. In 1997 the President's Commission on Consumer Protection
and Quality in the Health Care Industry, established to advise the
President on changes in the health care system, responded to the
President's request to develop and recommend a ``Consumer Bill of
Rights and Responsibilities.'' The President urged the Congress to pass
appropriate and necessary legislation to ensure that a range of
protections are extended to all Americans. And the Food and Drug
Administration Modernization Act of 1997, which codifies a number of
initiatives taken by this Administration as part of the reinventing
government initiative, will help ensure the timely availability of
safe and effective new drugs. These policies and others are considered
in greater detail in Chapter 5 of this Report.

Finally, teenage tobacco use is one of the most important public
health concerns that the Nation faces, and it has been rising in
recent years. The increase in the tobacco tax passed last year not
only will help fund the expansions in children's health insurance
coverage described above, but also will help reduce teen smoking. The
rise in the tax complements recent Food and Drug Administration rules
to limit advertising targeted at youth. Finally, the Administration
has indicated its support for national legislation designed to achieve
large reductions in teen smoking, with strict financial penalties on
the tobacco industry if specific targets in this effort are not met.

Welfare Reform and Poverty Alleviation

Welfare reform presents an ongoing challenge: to ensure that our
neediest citizens can maintain a decent standard of living without
creating incentives that encourage a life of dependency. This
Administration has committed itself to a policy that combines work
incentives and community efforts to move people off of welfare and
into employment. This has contributed to the largest reduction in
welfare rolls in history.

The same long-term changes in the wage structure that give greater
rewards to education and skill also imply that some workers will find
it difficult to raise themselves and their families out of poverty,
even with a full-time job. To make work pay, all those who work must
be guaranteed a minimum level of earnings. The Administration has made
an expansion of the earned income tax credit (EITC), which raises the
take-home pay of eligible low-income workers, a cornerstone of its
strategy to promote work and reduce poverty (Box 1-1). This expansion
has occurred alongside two increases in the minimum wage (the second

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Box 1-1.--Poverty Alleviation, the Earned Income Tax
Credit, and the Minimum Wage

A typical cash assistance program guarantees its maximum
benefit to those who receive no income, then phases out this benefit
as the recipient's income from other sources (usually labor)
rises. The disincentive to work that such programs create has
been a major concern--perhaps the major concern--of policy-
makers with regard to welfare policy. These disincentives will
persist so long as we confine ourselves to considering policies
with this structure.

One way to avoid these work disincentive effects is to design
programs that add to the wages of low-income workers. One
such program, the earned income tax credit, was expanded substantially
in 1993. Under the EITC, eligible low-wage workers receive a credit
against their income and payroll tax liability; this credit is
rebated in cash if the worker's income tax liability is zero. The EITC
differs from the typical cash assistance program in that no benefits
are paid to those who do not work, and benefits rise as earnings
increase (up to some threshold earnings level). It therefore largely
eliminates the typical program's work disincentive effects.

The minimum wage complements and enhances the EITC. When used
by itself to guarantee a subsistence level of income, the minimum
wage must be set very high. But an excessively high minimum wage
(that is, substantially above the current one) could discourage
hiring. On the other hand, using the EITC alone to guarantee an
income floor would require payment of a large subsidy, which would
then have to be phased out slowly to minimize the disincentive to
earn additional income. This makes the program much more costly.
Hence, the minimum wage and the EITC are best employed jointly in
designing an optimal assistance package.
-------------------------------------------------------------------------

of which, in September 1997, raised the minimum wage from $4.75 to
$5.15 an hour).

In August 1996 the President signed into law a comprehensive,
bipartisan welfare reform bill, which established the Temporary
Assistance for Needy Families program. This created a new system of
block grants to States and dramatically altered the nature and
provision of Federal welfare benefits in America. This legislation has
changed the Nation's welfare system into one that requires work in
exchange for time-limited assistance and provides support for families
moving from welfare to work.

Although these policies have helped shrink the welfare rolls
significantly since 1993, much remains to be done. To that end, two
additional initiatives have been put in place to advance this
Administration's strategy for moving welfare recipients into
employment. The first is a tax credit for employers who hire long-term
welfare recipients; the credit rebates to employers up to $3,500 in
wages paid in the first year and up to $5,000 in the second. The
second initiative is the Welfare to Work Job Challenge Fund, which
will assist States and communities in moving long-term welfare
recipients into lasting, unsubsidized employment. A hallmark of this
fund, for which $3 billion has been earmarked, is that it is targeted
to those areas of the country most in need of poverty alleviation.

The Child Tax Credit

The Administration proposed a tax cut to help working families with
the expense of raising their children. The Taxpayer Relief Act of 1997
will reduce taxes for 26 million families by providing a tax credit of
$500 per child. This credit will benefit over 40 million children
under age 17, including over 10 million children from working families
with incomes below $30,000. Because the credit is partly refundable,
large families who have paid significant out-of-pocket payroll taxes
can benefit even if they have little or no income tax liability.

STRENGTHENING CITIES AND COMMUNITIES

This Administration has worked to make Federal resources available for
investment in our Nation's cities and communities. First, the
Administration has sought to expand the number of Empowerment Zones
and Enterprise Communities. The initial round of competition, in 1994,
led to the establishment of 95 Enterprise Communities and 9
Empowerment Zones; both urban and rural areas were represented. The
Taxpayer Relief Act of 1997 established 22 additional Empowerment
Zones. To compete for these designations, communities submitted
strategic plans for revitalization; this requirement is intended to
mobilize local communities and encourage them to harness their talents
and resources in framing a plan for local economic development.
Designated zones and communities receive tax benefits and flexible
grants and are entitled to apply for waivers of certain Federal
regulations; the underlying principle of the program is that
communities know best how to solve their own problems but may lack the
necessary resources.

The Administration has also worked to promote fair access to loans and
investment capital for residents of low- and moderate-income areas.
Reform of the Community Reinvestment Act regulations required banks to
focus on performance--actual lending, investments, and services--rather
than paperwork. Since 1993,
conventional home mortgage lending to black Americans has increased by
67 percent, lending to Hispanic borrowers is up nearly 50 percent, and
lending activity in low- and moderate-income communities has risen by
37 percent. The Administration also obtained $80 million in funding
for Community Development Financial Institutions, which make
investment capital and other financial products available to low- and
moderate-income communities. The President's 1999 budget requests an
additional $45 million for this program.

In addition, the President signed into law the ``brownfields'' program,
which will provide tax incentives for the restoration of urban land
contaminated by pollution. These incentives will leverage more than
$6 billion for nationwide private sector cleanups and the
redevelopment of 14,000 contaminated and abandoned sites in
economically distressed urban areas.

Several basic principles inform these policies. First, they seek to
equip communities with the tools they need in order to flourish--they
are helping hands, not handouts. Second, they place the principal
responsibility for community development with the communities
themselves, because they are closest to their problems. Third, they
emphasize private sector engagement rather than government mandates.
And finally, they stress results over process: the Enterprise
Communities/Empowerment Zones program, for example, gives communities
broad scope to determine for themselves the best path for development;
similarly, the reformed regulations implementing the Community
Reinvestment Act use criteria based on actual outcomes to judge
compliance with its provisions.

STRENGTHENING THE PERFORMANCE OF DOMESTIC MARKETS

As part of this Administration's commitment to free and open markets,
the Antitrust Division of the Department of Justice has worked
together with the Federal Trade Commission to vigorously enforce the
Nation's antitrust laws. Recent cases and investigations reveal that
the Department of Justice and the Federal Trade Commission have both
pursued an aggressive but balanced approach in enforcing antitrust
law; in particular, both agencies have sought to ensure the continued
growth and competitiveness of high-technology industries. Chapter 6 of
this Report describes how the antitrust agencies have worked to attain
these goals in several recent cases.

OPENING FOREIGN MARKETS

Progress was also made in 1997 toward opening foreign markets to U.S.
goods, as a number of important international trade initiatives were
made final. Trade agreements affecting three important sectors were
reached, concluding some unfinished business from the Uruguay Round of
multilateral negotiations. The first of these agreements, the
Information Technology Agreement (ITA), will eliminate tariffs on a
large array of information technology products, in which U.S. firms
tend to be highly competitive. Also successfully concluded were an
agreement covering financial services, which will foster broad
liberalization of banking, securities, and insurance markets, and a
key agreement to liberalize basic telecommunications services
(including telephone services). Chapter 7 of this Report considers the
Administration's trade policies in more detail.

These negotiations illustrate an important point about trade
liberalization. Even though all three agreements involved sectors in
which the United States is generally thought to have a competitive
advantage, other countries were willing nevertheless to agree to their
liberalization. They did so because they recognized that the entry of
efficiently produced foreign products in these markets would improve
the competitiveness of their own economies: securing goods of the
highest quality at the lowest possible price is good for any economy.

PROMOTING AN ECONOMICALLY SOUND ENVIRONMENTAL AGENDA

The Administration took several important steps in 1997 to protect the
environment. These included efforts to address global climate change
and to improve air quality. In December representatives of the United
States and some 160 other countries, meeting in Kyoto, Japan, agreed
to establish binding limits on industrial countries' greenhouse gas
emissions. These limits are intended to stem the disruptive effects of
climate change by stabilizing atmospheric concentrations of greenhouse
gases. (Because developing countries will emit an increasing share of
global greenhouse gases, the President has indicated that the Kyoto
agreement will not be submitted for ratification without meaningful
developing-country participation.)

The Administration has proposed several market-based approaches to
meeting the Kyoto limits. Domestically, tax incentives for
energy-efficient technologies and research and development will spur
early efforts to reduce emissions. A national system of tradable
permits for greenhouse gas emissions, patterned after the successful
permit trading program for sulfur dioxide emissions, will be
implemented later under the President's proposal. In addition, the
Kyoto agreement allows for trading in greenhouse gas emissions permits
on an international scale, as well as opportunities for firms in the
industrial countries to receive emissions credits for investing in
climate-friendly technologies in developing countries. All of these
efforts will help the United States attain its greenhouse gas
emissions target in a cost-effective way.

In July 1997 the Environmental Protection Agency (EPA) issued a
significantly more stringent standard for ground-level ozone and a new
standard for fine particulate matter in the atmosphere. Although the
Clean Air Act does not allow for the consideration of costs in setting
these standards, under the President's policy the EPA must implement
these health-based standards in a cost-effective manner. The
Administration's plan for achieving the new air quality standards
departs from traditional command-and-control approaches by designing
regional strategies that will complement local efforts, and
encouraging the development of trading programs for emissions of
nitrogen oxides, which are ozone precursors. The nitrogen oxide
trading program, like the acid rain program and the trading program
envisioned for greenhouse gas emissions, enlists market incentives in
controlling pollution and should reduce pollution more cheaply than do
traditional regulatory approaches. Chapter 5 of this Report provides a
detailed assessment of the Administration's environmental policies.

FACING THE CHALLENGES AHEAD

In many ways the U.S. economy today is very different from that in
which our parents and grandparents lived and worked. Today, 24 percent
of families are headed by a single parent, compared with 14 percent 25
years ago. And three in five married mothers with children under 6 are
in the work force--twice as large a share as in 1970. This makes
affordable, quality child care a pressing concern for most families.
Meanwhile the nature of the labor market has changed significantly:
few American workers expect to be working for the same employer--or
even to be in the same career--when they retire. Industry has also
changed radically: in the 1950s the information technology industry
barely existed; today it employs a larger share of the labor force
than the automobile industry did in the 1950s and 1960s. And the U.S.
population is aging, implying that in the next century there will be
fewer workers for every retiree.

This Administration's economic agenda is designed to deal with these
changes and the challenges they pose. If the American economy is to
maintain its preeminence as the strongest and most dynamic in the
world, both policymakers and citizens will have to meet and overcome a
number of challenges in the 21st century.

Several such challenges already loom large for this Administration and
Congress. Perhaps the most important is preparing for the aging of the
population, which requires reforming Medicare and Social Security and
promoting retirement security more generally. As reported above, some
progress was made in addressing Medicare's immediate problems, but
comprehensive reforms are still needed to ensure the program's
long-term viability. Likewise, steps will have to be taken to
strengthen the finances of the Social Security system.

For almost 60 years Social Security has provided Americans with income
security in retirement and protection against loss of family income
due to disability or death. A large share of elderly Americans,
particularly those with low incomes, rely on Social Security as their
primary source of pension income in retirement. The system has enjoyed
dramatic success in reducing poverty rates among older Americans.
However, many Americans now fear that Social Security will not be
there for them when they are ready to retire. This concern reflects
the widespread recognition that, under current ``intermediate''
projections of the Social Security trustees, the system faces a
long-term funding gap: beginning in 2012, unless the system is
reformed by then, the government will be unable to pay current Social
Security benefits in full out of current payroll taxes; it will then
have to draw down the system's trust fund, and by 2029 those funds
will be exhausted. If still nothing has been done, the government
would then face several options which it could adopt singly or in
combination: it could reduce benefits until they are in line with
collections, raise payroll taxes to cover an unchanged level of
benefits, or finance the shortfall from other parts of the budget, by
raising other taxes, cutting expenditures on other programs, or
borrowing and allowing the budget deficit to increase. One or more of
these measures will have to be taken so long as no changes are made to
the present system.

Although the seriousness of the financial imbalance facing Social
Security should not be downplayed, its magnitude is not so large as to
be insurmountable, particularly if early action is taken. For example,
even if nothing is done and the trust fund is exhausted, payroll taxes
will still be sufficient to permanently finance roughly 75 percent of
benefits. Put another way, the difference between the anticipated
income and the anticipated expenditures of the Old Age, Survivors',
and Disability Insurance program over the next 75 years amounts to
around 2G percentage points of taxable payroll, or approximately 1
percent of GDP. (The imbalance is somewhat larger when viewed over a
longer horizon.) These facts suggest that the problem of placing
Social Security on a sound financial footing can admit of eventual
resolution, and the President has proposed a process to devise an
appropriate solution over the next 2 years. The President has also
proposed that any budget surpluses should be reserved until Social
Security reform is achieved.

Medicare reform presents a somewhat thornier problem, in terms of both
its complexity and its scale. Unlike Social Security, Medicare
promises not just the payment of a sum of money but the delivery of a
service: health insurance. The government has little influence over
the rate of increase in the cost of providing this service, which has
been rising faster than general inflation for decades, largely driven
by technological advances in medical care. Higher costs for medical
care are projected to account for the bulk of the increase in Medicare
expenditures for the next 25 years or so, after which the aging of the
baby-boom generation will act to raise expenditures still further
through increases in program enrollment. Hence, any long-term reform
will have to involve slowing both the rise in health care prices and
the growth in volume and intensity of use of covered services. Neither
will be accomplished easily.

Before last year's budget legislation was enacted, the trust fund for
the component of Medicare that covers hospital costs was projected to
fall to zero in 2001. The 1997 reforms will delay the trust fund's
depletion until 2010. The legislation also calls for the establishment
of a bipartisan commission to assess and recommend the structural
changes that will be needed to ensure Medicare's long-term viability.
A second major policy challenge involves continuing the drive for more
open international markets. Preferential trade agreements are being
negotiated among countries around the world at a rapid pace, and the
United States could easily be left behind through inaction. Since
1992, countries in Latin America and Asia have negotiated 20
preferential trade arrangements that exclude the United States. One of
these is MERCOSUR, a customs union among four South American
countries. The European Union has begun a process intended to
culminate in a free trade agreement with Brazil, Argentina, and the
other MERCOSUR nations; the President of one European nation has even
gone so far as to declare that the economic interests of Latin America
lie with Europe, not the United States. Meanwhile the MERCOSUR nations
are attempting to extend their preferential trade arrangement to the
entire continent. It is clear that now, more than ever, continued
engagement with the world trading system will require an active effort
on the part of the United States.

In 1997 the Senate voted to move forward on extending the President's
so-called fast-track negotiating authority. This authority allows the
President to negotiate trade agreements and submit them to the
Congress for a yes-or-no vote, without amendments. However, in the
House of Representatives the vote to renew fast-track was postponed.
Some have voiced concern that free trade hurts American workers and
contributes to the U.S. trade deficit. As discussed in Chapter 7,
however, market-opening initiatives do not cause net job losses to the
U.S. economy as a whole, although they do result in a reallocation of
jobs into expanding, export-oriented industries. As the chapter
documents, the jobs created by increased trade are good jobs, offering
high pay. But some workers are indeed hurt by more open markets, just
as some workers are harmed by technological innovation, even though
market-opening initiatives unambiguously benefit the economy as a
whole.

This Administration has realized from the beginning that the
government can minimize the impact of dislocations affecting workers
who lose their jobs, by speeding the adjustment process. For example,
one of the key provisions of NAFTA involved monitoring those
industries that were in danger of being adversely affected by the
agreement, and the Administration committed itself early on to
providing for dislocated workers through retraining programs. The
President's 1999 budget includes proposals to expand the scope of
trade adjustment assistance and to increase funding for these
programs. More generally, the Administration's commitment to investing
in people through education and training serves as a strong complement
to its policy of trade liberalization.

A widespread misconception is that one of the benefits of increased
trade comes in the form of an improved balance of trade. Economic
policies do indeed affect the current account (the broad measure of
U.S. international transactions that includes investment income and
transfers as well as trade in goods and services), but it is budget,
saving, and investment policies, not trade liberalization policies,
that do so. The Nation's current account deficit equals its borrowing
abroad to finance any excess of investment over domestic saving. The
current account is therefore a macroeconomic phenomenon that mirrors
the gap between what we as a Nation invest and what we save. The large
Federal budget deficits of the 1980s and early 1990s were a form of
negative saving, or dissaving, which reduced the total amount of
national saving available to cover the Nation's investment in plant
and equipment. In an important sense, the Nation was overconsuming in
the 1980s, financing its consumption binge by borrowing from
foreigners. The result was a large and persistent current account
deficit.

We still have a current account deficit today, but for a very
different reason. The near elimination of the budget deficit has left
more saving available for investment in plant and equipment by the
private sector. National saving has risen. But because of the
investment boom during this expansion, the gap between investment and
saving has persisted. Once again, this shortfall is made up by
borrowing from abroad, and the result is a current account deficit.
But there is a big difference between borrowing to invest--as the
Nation is doing now--and borrowing to consume, as it did in the 1980s.
In fact, running a trade deficit in order to expand the Nation's
productive capacity is not new to American history--we did much the
same thing in the last century, to build up the Nation's
infrastructure, most notably during the railroad construction boom.
Ironically, therefore, today's trade deficit reflects the economy's
current success in growing more rapidly than our trading partners and
investing so much--and not our free trade policies.
It is always difficult to explain this macroeconomic perspective on
the trade deficit to those who are primarily concerned with the
microeconomics of their daily lives. But making the case in favor of
trade is particularly important now, because real danger threatens
should countries turn their backs on a progressive and integrated
world economic order. Besides postponing the renewal of the
President's traditional trade-negotiating authority, the Congress
chose not to support the sort of financial participation in
international institutions that is vital for the sound functioning of
the international system. Meanwhile financial crises in East Asia have
made U.S. international engagement more important, rather than less.
Other emerging-market countries are themselves in danger of reacting
to the East Asian crises by turning inward. It is important for their
economic well-being, as well as our own, that they continue along the
path toward an outward-oriented market system, on which they had until
recently been making such astonishing progress. This will require
difficult macroeconomic and structural adjustments on their part,
including reducing their dependence on foreign borrowing. As a result,
these countries will have to reduce their trade deficits, and in some
cases even turn them into trade surpluses. This will inevitably  lead
to an increase in U.S. bilateral trade deficits with some East Asian
countries. Again, however, such deficits are not the proper gauge of
the success or failure of U.S. trade policy.

The Nation faces other, broader challenges in shaping economic
policies for the 21st century. First, we must act to help families
address the problems they face in today's economy. More American
workers today are faced with the need to juggle the demands of the
workplace with the demands of family and home. Government must act to
ease this burden by ensuring that families have access to quality
child care and health care. For this reason the President's 1999
budget includes a $21 billion increase in funding for child care, to
make it accessible to more families and raise its quality. An
important part of this proposal is increased tax credits for 3 million
working families to help them pay for child care, as well as an
increase in block grants to States that will directly subsidize child
care for low-income families. In addition, the proposal calls for a
new Early Learning Fund, along with support for the enforcement of
State child care health and safety standards, scholarships for up to
50,000 child care providers per year, and funding for research and
consumer education.

We must also continue to invest in our Nation's children. Chapter 3 of
this Report shows that the last 3 years have witnessed notable
improvements in children's well-being along several fronts, including
decreases in child poverty, increases in consumption of basic health
care services, and improvements in health status and in some measures
of educational achievement. However, many children remain economically
vulnerable. One in five children in the United States lives in a
family whose income is below the poverty line, one in seven does not
have access to health insurance, and a large proportion of children
fail to achieve basic levels of proficiency in science, mathematics,
and reading. Chapter 3 considers ongoing and proposed Administration
initiatives that address these problems.

Finally, this country's longstanding goal of achieving equality of
opportunity among racial and ethnic groups has not yet been attained.
Chapter 4 of this Report reviews differences in economic status among
blacks, Hispanics, non-Hispanic whites, Asians, and American Indians.
Although there has been progress in narrowing these gaps in the
postwar period, it has been very uneven, with rapid progress in the
1960s and early 1970s followed by 20 years of stagnation from the
early to mid-1970s to the early 1990s. For example, since the
mid-1970s the wages of young black college graduates have fallen
relative to those of their white counterparts. Although the current
expansion has brought signs of renewed progress, substantial
disparities in economic status persist. For example, the median wealth
of white families is by some estimates 10 times that of black and
Hispanic families. More needs to be done to promote equality of
opportunity for all Americans. Many of the Administration's current
and proposed policies, such as those that encourage community
empowerment and education, are intended to address these disparities.
And this Administration has pledged itself to furthering a dialogue on
race in America.

CONCLUSION

The United States today enjoys some of the most favorable economic
conditions in a generation: high growth and low unemployment combined
with low and stable inflation. And the success of Americans in
adapting to the new economy in which they find themselves has been
truly remarkable. But that success--and the economy's present
strength--cannot be taken for granted. Recent developments do not
herald the end of inflation, the conquest of the business cycle, or
the permanent reversal of such secular trends as weak productivity
growth and rising income inequality. Rather, there are still long-term
changes at work that demand action by individuals, businesses, and
governments alike. This Administration has put in place a set of
policies that has allowed the economy to grow and to flourish--in
particular by putting the Nation's fiscal house in order. But we must
continue to pursue sound policies aimed at opening markets at home and
abroad, promoting private and public investment, and ensuring that all
Americans, regardless of age or origin, have the skills they need to
prosper in a world of change and opportunity.