Greenbook/Tealbook

Prefatory Note The attached document represents the most complete and accurate version available based on original copies culled from the files of the FOMC Secretariat at the Board of Governors of the Federal Reserve System. This electronic document was created through a comprehensive digitization process which included identifying the bestpreserved paper copies, scanning those copies, 1 and then making the scanned versions text-searchable. 2 Though a stringent quality assurance process was employed, some imperfections may remain. Please note that some material may have been redacted from this document if that material was received on a confidential basis. Redacted material is indicated by occasional gaps in the text or by gray boxes around non-text content. All redacted passages are exempt from disclosure under applicable provisions of the Freedom of Information Act. 1 In some cases, original copies needed to be photocopied before being scanned into electronic format. All scanned images were deskewed (to remove the effects of printer- and scanner-introduced tilting) and lightly cleaned (to remove dark spots caused by staple holes, hole punches, and other blemishes caused after initial printing). 2 A two-step process was used. An advanced optical character recognition computer program (OCR) first created electronic text from the document image. Where the OCR results were inconclusive, staff checked and corrected the text as necessary. Please note that the numbers and text in charts and tables were not reliably recognized by the OCR process and were not checked or corrected by staff. Content last modified 6/05/2009. CONFIDENTIAL (FR) SUPPLEMENT CURRENT ECONOMIC AND FINANCIAL CONDITIONS Prepared for the Federal Open Market Committee November 17, 1972 By the Staff Board of Governors of the Federal Reserve System SUPPLEMENTAL NOTES The Domestic Economy GNP Revisions. Third quarter current dollar GNP rose $24.6 billion according to revised Commerce Department estimates. Real GNP increased at an annual rate of 6.3 per cent--up slightly from the preliminary estimate of 5.9 per cent; the implicit price deflator rise of 2.4 per cent was also up a bit from the preliminary indication. The private product fixed weight deflator is now estimated to have risen at a 2.9 per cent annual rate. Major elements in the $1.8 billion upward revision in current dollar GNP were nonfarm business inventories now estimated to have been accumulated at a $7.9 billion annual rate rather than the earlier indicated $5.3 billion rate and personal consumption expenditures which revised upward by $0.5 billion. On the minus side, Federal nondefense purchases were revised down by $0.8 billion and total Federal purchases are now estimated to have declined by $2.7 billion in the quarter. Preliminary figures are now available for third quarter corporate profits and the Federal budget surplus on an N.I.A. basis. These show that before tax profits rose at a $4.2 billion annual rate from the second quarter. The Federal, N.I.A., budget was in deficit by $11.6 billion in the third quarter as compared with $21.6 billion, annual rate, in the second quarter. The improved deficit position re- flected both a substantial decline in expenditures and an increase in revenues. -2 CONFIDENTIAL - FR GROSS - November 17, 1972 NATIONAL PRODUCT AND RELATED ITEMS 1972-III 1972 I II 1109.1 1108.6 859.2 863.8 1139.4 1134.4 880.3 Personal consumption expenditures Durable goods Nondurable goods Services 696.1 111.0 288.3 296.7 713.4 113.9 297.2 Gross private domestic investment Residential construction Business fixed investment Change in business inventories Nonfarm 168.1 51.6 116.1 0.4 0.1 -4.6 70.7 75.3 Net exports of goods & services Exports Imports Rev. 11/15/72 Change from 72-II Prel. Rev. (Billions of Dollars) Seasonally Adjusted Annual Rates---------- ---------Gross National Product Final purchases Private Excluding net exports Prel. 10/17/72 1162.2 1156.6 900.0 903.4 1164.0 1156.0 900.4 903.8 22.8 22.2 19.7 17.9 24.6 21.6 20.1 18.3 728.1 118.4 301.4 308.3 728.6 118.6 302.0 308.0 14.7 4.5 4.2 5.9 15.2 4.7 4.8 5.6 177.0 52.8 181.0 119.2 5.0 4.3 121.1 5.7 5.3 163.2 54.4 120.7 8.0 7.9 4.0 1.4 1.9 0.7 1.0 6.2 1.6 1.5 3.0 3.6 -5.2 70.0 75.2 -3.4 75.0 78.4 -3.4 74.4 77.8 1.8 5.0 3.2 1.8 4.4 2.6 885.5 302.4 54.2 Gov't. purchases of goods & serv. Federal Defense Other State and local 249.4 105.7 76.7 28.9 143.7 254.1 108.1 78.6 29.6 146.0 256.6 106.2 75.2 31.0 150.4 255.6 105.4 75.1 30.2 150.2 2.5 -1.9 -3.4 1.4 4.4 1.5 -2.7 -3.5 0.6 4.2 Gross National Product in constant (1958) dollars GNP implicit deflator (1958=100) 766.5 144.7 783.9 145.3 795.3 146.1 796.1 11.4 12.2 Personal income Wage and salary disbursements Disposable personal income Personal saving Saving rate (%) 907.0 608.0 770.5 55.7 7.2 922.1 620.5 782.6 50.1 6.4 939.5 630.4 798.7 51.3 6.4 939.9 630.8 17.4 9.9 16.1 1.2 17.8 10.3 16.2 0.7 88.2 85.9 91.6 90.8 97.31/ 93.71/ 95.8 93.0 5.7 2.9 4.2 2.2 224.9 246.5 -21.6 230.21/ 230.0 241.6 -11.6 5.3 -3.4 8.7 5.1 -4.9 10.0 Corporate profits before tax Corp. cash flow, net of dividends Federal gov't. receipts and expenditures (N.I.A. basis) Receipts Expenditures Surplus or deficit (-) 221.4 236.3 -14.8 243.1 -12.91/ 146.2 798.8 50.8 6.4 --Per Year CentChange Per from Preceding Prio2/ --Per Cent Per Year Change from Preceding Period- -Gross National Product Current dollars Constant dollars Implicit price deflator 3/ Fixed wieght price indexPrivate product 12.0 6.5 5.1 6.1 4.5 1/ Preliminary Commerce figurers not available; 2/ Figures for quarter are at compound rates. 3/ Using 1967 expenditures as weights. 11.4 9.4 1.8 3.0 2.9 11/15/72 staff projection. -- - -3- Housing starts. Seasonally adjusted private housing starts rose 2 per cent in October to an annual rate of 2,410 thousand units. Although single-family structures declined 6 per cent from the advanced September rate, multifamily starts increased by more than a tenth to the highest rate since February. Starts rose in all regions except the West where they dropped 5 per cent. Unlike starts, seasonally adjusted building permits edged off 2 per cent in October from the peak September rate, primarily reflecting a 15 per cent drop in 5-ormore family permits. PRIVATE HOUSING STARTS AND PERMITS October 1972 (Thousands of Units) 1/ Per cent change from: September 1972 October 1971 Starts 2,410 + 2 + 18 1-family 2-or-more-family 1,288 1,122 - 6 +13 + 12 + 27 Northeast North Central South West 368 483 1,096 463 + + + - + 52 + 11 + 22 Permits 2,218 - 2 7 1 4 5 + 12 +18 +10 1,071 1-family + 7 -11 1,147 2-or-more-family 1/ Seasonally adjusted annual rates; preliminary. 2/ Not included in starts are mobile home shipments for domestic use, which in September--the latest month for which data are available-were at a seasonally adjusted annual rate of 502 thousand units-6 per cent below the August rate, and 8 per cent below the year earlier level. -4The Domestic Financial Situation Corporate profits. According to preliminary estimates released on Friday, November 17, by the Bureau of Economic Analysis aggregate corporate profits before tax increased by $4.2 billion in the third quarter to a level 15 per cent over a year ago. While earn- ings of financial institutions and of investments abroad were up somewhat over both the year and the preceding quarter, most of the dollar increase represented improved earnings of domestic nonfinancial business, whose earnings were 16 per cent greater than a year ago. Comparisons with the second quarter are somewhat misleading, since additional capital consumption charges from the floods of almost $2 billion reduced profits by a corresponding amount. If second quarter earnings had not been reduced for this accidental damage to fixed capital, a comparison of quarterly rates of change would indicate a deceleration in the quarterly rate of growth of earnings. Repatriated earnings of foreign subsidiaries and dividends on portfolio investments abroad amounted to $5 billion, up 16 per cent from a year ago. Earnings of private financial institutions were $15 billion, up ten per cent from a year ago; earnings of the Federal Reserve were at $3.4 billion, unchanged from a year ago. Within manufacturing, preliminary data from the Federal Trade Commission indicate substantial increases in both profits and in profit margins for primary metals manufacturers. Although the steel strike did not materialize in July of 1971, anticipatory stockpiling -5- reduced demand in the latter part of the year. Both motor vehicles and petroleum experienced reduced earnings and lower margins profit in comparison with last year. Indeed the reduced earnings of General Motors depressed durable manufacturing as well as total manufacturing. Evidence is scanty for non-manufacturing. The earnings of regulated industries appear to be recovering less rapidly than those of other sectors. Reported increases in the earnings of trade, services, and construction probably containing substantial amounts of inventory profits. In the aggregate, the rate of increase in earnings is almost a full percentage point higher when account is taken of the inventory valuation adjustment. For manufacturing in particular the inventory component of 1971's third quarter profits was larger both in relative and in absolute terms than it was this year. Taxes and dividends have not risen as fast as have profits, though the tax rate seems to have stopped its long decline. Retained earnings and cash flow have, there- fore, increased more rapidly than profits. CORPORATE PROFITS: PRELIMINARY All corporations 1/ 1972-III Percentage change from $Billion 1972-II 1971-III SAAR Domestic nonfinancial corporations 1972-III Percentage change from $Billion 1972-II 1971-III SAAR Profits before tax and inventory valuation adjustment 89.7 14.6 4.2 65.6 16.5 4.5 Profits before tax 95.8 13.9 4.6 71.7 15.5 4.8 Profits tax liability 42.0 12.0 4.7 33.7 14.2 5.0 Profits after tax 53.7 15.2 4.3 37.9 16.3 4.4 Dividends 26.5 3.9 1.2 20.5 2.5 1.0 Undistributed profits 27.2 29.5 7.5 17.4 38.1 8.8 Cash flow 2/ 95.6 16.3 2.5 82.9 16.1 2.0 43.8 -1.8 .0 47.0 -1.1 .2 49.4 -9.7 -3.0 54.1 -11.9 -3.2 Effective tax rate (per cent) Payout rate (per cent) 4/ 1/ 2/ 3/ 4/ 3/ Includes both foreign and domestic profits. Capital consumption allowances plus undistributed profits. Profits tax liability/profits before tax. Dividends/profits after tax. - 77-Corporate security issues. Because of a shift in the scheduling of a $500 million debt offering by AT&T, the staff estimates of November and December public bond volume have been revised to $1.3 billion and $500 million, respectively. This revision affects only the timing, not the total volume of corporate securities offerings during the last 2 months of 1972. - 8 - INTEREST RATES 1972 Highs Lows Oct. 16 Nov. 16 Short-Term Rates Federal funds (wkly. avg.) 5.25 (11/8) 3.18 (3/1) 5.09 (10/11) 4.89 (11/15) 4.84 5.25 5.50 6.12 2.99 (2/11) 3.75 (2/29) 3.75 (2/23) 4.62 (3/8) 4.80 5.25 5.50 6.00 4.76 5.13 5.38 5.38 (10/25) 3.50 (2/23) 5.38 (10/11) 5.12 (11/15) 5.26 (9/25) 5.38 (10/25) 5.51 (9/25) 3.35 (1/10) 3.88 (3/3) 3.79 (2/17) 5.13 5.25 5.44 5.08 5.25 5.50 (10/11) 5.38 (11/15) 3-month Treasury bills (bid) Comm. paper (90-119 day) Bankers' acceptances Euro-dollars (10/13) (10/26) (11/2) (10/10) 5.81 CD's (prime NYC) Most often quoted new 6-month Treasury bills (bid) Comm. paper (4-6 mo.) Federal agencies CD's (prime NYC) Most often quoted new 1-year Treasury bills (bid) Federal agencies CD's (prime NYC) Most often quoted new Prime municipals 5.50 (10/25) 3.88 (2/23) 5.24 5.55 (9/22) 5.80 (10/16) 3.57 (1/8) 4.32 (1/17) 5.40 5.80 5.17 5.75 (11/15) 3.20 (9/14) 4.62 (1/19) 2.35 (1/12) 5.75 (10/11) 3.15 (10/12) 5.75 (11/15) 2.90 Treasury coupon issues 5-years 20-years 6.32 (9/14) 6.22 (4/14) 5.47 (1/13) 6.17 5.71 (11/15) 6.01 6.08 5.73 Corporate Seasoned Aaa Baa 7.37 (4/24) 8.29 (1/3) 7.12 (11/16) 7.22 8.01 (11/16) 8.06 7.12 8.01 7.60 (4/21) 7.08 (3/10) 7.48 (10/12) 7.12 Municipal Bond Buyer Index 5.54 (4/13) 4.99 (1/13) 5.16 (10/12) 5.01 Mortgage--implicit yield in FNMA auction 1/ 7.72 (10/30) 7.54 (3/20) 7.72 7.71 (11/13) 5.57 Intermediate and Long-Term New Issue Aaa Utility 1/ Yield on short-term forward commitment after allowance for commitment fee and required purchase and holding of FNMA stock. Assumes discount on 30year loan amortized over 15 years. APPENDIX A: THE STATE AND LOCAL GOVERNMENT SECTOR* Since World War II, State and local government purchases of goods and services have increased at a 50 per cent faster rate than GNP as a whole. Education, welfare and health services, public safety, sanitation, recreation and the environment have been matters of continuing public concern and these functions have traditionally been provided by State and local government, and their growth has oeen assisted by increasin Federal financial grants-in-aid. Demand for most of these services has been little affected by cyclical considerations. In fact, growth in the State and local government sector has contributed an important element of stability during recessive periods in the rest of the economy. Thus, during the latest recession, the State and local government sector registered an increase in purchases in real terms between the fourth quarter of 1969 and the fourth quarter of 1970 but in the private sector only residential construction expenditures moved ahead--even personal consumption expenditures registered hardly any real gain. Although growth of State and local outlays has continued to be a stimulating factor in the past several years, its performance has been less spectacular than in the past. In constant dollars, after 1968, the rate of growth of State and local government outlays has been below the longer term trend and since the end of 1970 its growth has even failed to match that of the economy as a whole. * Prepared by Peter Wagner, Senior Economist, National Income, Labor Force and Trade Section, Division of Research and Statistics. A - 2 TABLE 1 STATE AND LOCAL GOVERNMENT EXPENDITURES, 1950-1972-QIII (SELECTED YEARS) Total purchases ---.-----.--. Expenditures for structures -Billions Total purchases as a per cent of gross national product of 195P Dollars-----------7.7 7.9 8.9 9.2 9.3 1950 1955 19'0 195 196( 27.5 34.4 43.5 5:.3 1.1 7.0 10.4 12,4 1C.1 16.8 1967 (5.5 17.6 9.7 19.C 69.C 18.4 9.4 19(9 1970 1971 72.4 74.3 7(.8 17.4 IC.0 15.4 10.0 10.3 10.4 1972:1 79.4 14.8 10.4 80.3 81.9 14.3 14.2 10.2 10.3 II IIIp --- Structures The principal factor in the recent sluggishness of State and local expenditures has been the decline in construction outlays despite the substantial easing of money market conditions. In the first two quarters of this year, such outlays in constant dollars have run about 9 per cent below the corresponding period of 1970 when the economy was approaching its cyclical trough. Several factors may be responsible: in education, school construction needs have become less ur,ent because of the declining number of children of elementary school age, and these outlays have still not regained their 1970 levels. Perhaps even more surprising has been the lack of strength in highway expenditures which are also still slightly Such expenditures have below their 1970 levels in real terms. apparently been restrained by the tight controls exercised by the Federal Highway Administration over releases from the Highway Trust A - 3 Fund. The failure of most other types of public construction to show increases has in part been due to conservative spending limits imposed by many states and localities. However, it is anticipated that expenditures on structures may be a principal beneficiary after the receipt of recently enacted revenue-sharing payments from the Federal government. TABLE 2 EXPENDITURES FOR STATE AND LOCAL GOVERNMENTS FOR NEW CONSTRUCTION IN MILLIONS OF 1967 DOLLARS Total Highways Education Water supply and sewerage Other 1969 (1st half) 9,818 3,169 2,450 1,232 2,967 1970 (1st half) 8,681 3,063 2,129 927 2,562 1971 (1st half) 8,773 3,243 1,923 999 2,608 1972 (1st half) 7,887 3,038 1,697 929 2,223 A -4 PERCENTAGE DISTRIBUTION OF STATE AND LOCAL GOVERNMENT PURCHASES (Quarterly figures at annual rates) 1950 Total purchases of goods & services Compensation Structures Medical vendor payments Other purchases 10 51.8 27.2 1967 1969 1970 1971 1972II 100.0100.0 100. 0 100. 0 1 52.5 55.5 56.7 55.0 30.2 26.9 26.4 25.0 00.0 55.4 22.5 100.0 56.7 20.5 100.0 100.0 57.2 57.5 19.4 17.6 1955 1960 1965 21.0 17.3 17.6 17.3 2.7 17.3 4.2 17.9 4.6 18.2 5.2 18.2 5.7 19.2 Exhibit: Transfer payments to persons as per cent of total purchases and transfer payments 15.2 10.9 10.0 9.1 8.9 9.4 10,3 10.9 11.0 Employment and Compensation State and local governments have provided a consistent source of expanding employment for the last 20 years and today one-seventh of all employees work for these governments whereas in 1950 the proportion only amounted to one-eleventh. During these two decades employment in this sector has been growing at an average annual rate of 4.7 per cent as compared to an increase in total employment of 2.0 per cent annually. Growth slowed somewhat following the recent peak rate in 1966 but has picked up sharply during the last year. In the year ending with the third quarter of 1972, State and local government employment increased by about half a million workers (see Table 4). This compares with average annual gains of about 380,000 between 1967 and 1970 and approximates the higher rates of increase which ruled during the mid-sixties. However, to some extent the recent gain is exceptional, in that about one-third of the increase consists of persons working under the Public Employment Program, which was established to provide jobs for unemployed workers unable to find work elsewhere. This program is not permanent and almost entirely funded by the Federal government. A -5 Employee compensation accounts for close to 60 per cent of all State and local government purchases, (see Table 3) and slightly more than half of all compensation is spent in the field of education. Despite the considerable employment growth, the increase in wage and salary payments has been dampened during the last 12 months by the success of anti-inflationary policies in moderating per capita salary increases to around 5-1/2 per cent compared to a rate of 7-1/2 per cent in the corresponding 1970-71 period. However, inclusion of generally lower-paid employees hired under the Public Service Employment Program may have contributed to the slower rate of increase. TABLE 4 INCREASES IN NON-AGRICULTURAL PAYROLL EMPLOYMENT AND STATE-LOCAL GOVERNMENT EMPLOYMENT 1950-1972-III Selected Years Increase from previous year Total State-local employment employment (000) State-local government employment as a per cent of total employment 1950 1955 1960 1965 1,444 1,653 921 2,484 150 164 233 448 9.1 9.3 11.2 12.7 1966 1967 1968 1969 1970 1971 3,140 1,902 2,058 2,369 309 52 531 452 430 335 386 361 12.9 13.2 13.4 13.4 13.9 14.4 1972:I II IIIp 1,470 1,953 2,313 390 406 513 14.6 14.6 14.9 Other Purchases Among other expenditures, shown in table 3, medical vendor payments (mostly Medicaid) have shown some extraordinary increases and now represent close to 6 per cent of the value of all purchases. Other A -6 miscellaneous purchases have also gained in relative importance and currently account for nearly 20 per cent of total. Transfer Payments Transfer payments to persons, comprising pension-related outlays as well as expenditures for a multiplicity of relief and welfare programs continue to show a rising trend. However, they still account for only about 11 per cent of total State and local government outlays (see Table 3) and are in large part financed from Federal grants-in-aid. The Fiscal Position Despite steadily rising expenditures, the fiscal position of most State and local governments has become a good deal more comfortable during the last two years. Receipts from their own tax and other revenues have been rising, reflecting a generally improving economy and the imposition of higher tax rates or entirely new taxes and other imposts in a large number of jurisdictions. Such revenues have risen by about 25 per cent between the second quarter of 1970 and the second quarter of 1972. Personal tax and other receipts, corporation profits taxes and indirect business tax and other receipts as well as contributions for social insurance all showed substantial increases. In addition to their own efforts, State and local governments have continued to benefit from increasing amounts of Federal grants. Second quarter 1972 receipts from this source were distorted by an advance receipt of about $4 billion in Federal grant payment, but after adjustment, total Federal grants-in-aid were still up around 40 per cent from the corresponding quarter of 1970. The adjusted level of Federal rants accounted for about 20 per cent of all State and local government receipts, and this proportion is bound to rise with the revenue-sharing funds which will add over $5 billion annually to Federal cash distributions to State and local governments. This combination of favorable factors on the receipts side and some slowing in the rate of increase of purchases has resulted in a steadily improving fiscal position which has yielded small but increasing surpluses ever since 1968. Even after deducting the requirements of pension fund surpluses which cannot be used for other purposes, income and outgo of all State and local jurisdictions were almost in balance during the first quarter of this year and recorded a substantial surplus during the second quarter although this was largely due to special factors. A - 7 State and local governments have also improved their liquid position considerably during the last two years through record amounts of bond financing in addition to their improving revenue position. In the light of current fiscal prospects, their demand for additional loan funds may be expected to moderate somewhat from the near-record amounts floated through the second quarter of 1972. Of course, the overall figures conceal wide differences in the experience of individual governments. A number of states are running sizable surpluses whereas other states and many central cities are in a less enviable financial position. However, all State and local governments will have considerably more flexibility in their future fiscal and financial planning as a result of these recent developments. TABLE 5 STATE AND LOCAL GOVERNMENT FINANCES ($ billion at seasonally adjusted annual rates) "Overall" surplus 1968 1969 1970 1971 -0.3 1972-I 0.7 2.8 4.8 7.1 5.0 5.7 6.5 7.5 8.1 -5.3 -5.0 -3.7 -2.7 -1.0 1972-II 14.8 Surplus social insurance funds 8.4 All other State and local funds 6.4 A - 8 TABLE 6 LIQUID ASSETS OF STATE AND LOCAL GOVERNMENTS on June 30, 1970, 1971, 1972 $ Billion June 30, Demand deposits and currency 1970 June 30, 1971 June 30, 9.5 10.8 10.8 Time deposits in Commercial banks 17.1 26.2 33.3 Short-term U.S. government securities 17.8 22.6 26.3 44.4 59.4 70.4 Total 1972 TABLE 7 STATE AND LOCAL GOVERNMENTS LONG-TERM BOND OFFERINGS AND CHANGES IN NET INDEBTEDNESS (Quarterly 1970-72-II) $ Billion I II 1970 III IV Gross long-term bond offerings 4.1 3.7 4.5 Net new debt (unadjusted) 2.6 4.0 2.4 I II 1971 III IV 5.9 6.8 6.1 6.0 6.1 6.0 6.3 4.9 6.4 5.4 4.6 3.9 4.5 3.8 I 1972 II III 5.4E Appendix B: PROVISIONS OF TITLE I OF THE NEW REVENUE SHARING LAW Revenue sharing is a major new undertaking by the Federal Government.1/ Previous Federal aid to State and local governments has been limited to specific programs, but this new program provides aid with very few restrictions on how State and local governments use the funds. Payments are retroactive to January 1, 1972 and are appropriated through 1976. Total appropriations in each period are as follows: Period Appropriation (billion $) Jan. 1 - June 30, 1972 2.652 July 1 - Dec. 31, 1972 2.652 Jan. 1 - June 30, 1973 2.990 Fiscal 1974 6.055 Fiscal 1975 6.205 Fiscal 1976 6.355 July 1 - Dec. 31, 1976 3.327 Thus, the total for calendar year 1972 is $5.3 billion; the amount increases steadily to $6.4 billion by 1976, an increase of 20 per cent over a five year period. The payments are scheduled to start before the end of 1972. The original proposals for revenue sharing did not provide restrictions on the ways in which the funds could be spent. The law as passed, however, does restrict State and local governments to use the money on "priority expenditures." These include current and operating expenditures for: 1. 2. public safety environmental protection (includes sewage, and sanitation) * Prepared by Albert Teplin, Economist, Division of Research and Statistics. 1/ The new law has three parts. Title I is concerned with revenue sharing appropriations and allocations to the States. Title II sets out provisions for the Federal Government collection of State income taxes. Title III amends the Social Security Act in order to place a $2.5 billion limitation on Federal matching grants for social services. The discussion here is restricted to Title I, which has the official title "State and Local Fiscal Assistance Act of 1972." B - 2 3. 4. 5. 6. 7. 8. public transportation (includes road maintenance) health recreation libraries social services for poor and aged financial administration. The law also allows the funds to be used for all capital expenditures. It is clear, therefore, that the bill allows the funds to be spent on almost all the traditional functions of State and local governments. The category most noticeably left out of the priority expenditure list is education.2/ At present education accounts for over 40 per cent of local expenditures and over 30 per cent of State expenditures. It will be interesting to see if this restriction in the revenue sharing law results in a lowering of these percentages or just a reshuffling of funds such that the States and local governments do not change their own priorities. States are restricted from decreasing the State tax revenues they return to local governments. If the dollar value of State aid to localities falls below the fiscal 1972 amount then the State's revenue sharing funds are reduced. This does not apply if the States grant new taxing authority to the local governments. The law also provides that a Treasury trust fund be set up for distribution of the funds on a quarterly (or more often) basis. Each State is to create a special fund for its shared revenues and this fund is subject to Treasury audit. Allocation formulas Different formulas were developed in the Senate and House for allocating funds to the States. The Conference Committee did not change these formulas but instead decided that the formula giving the highest amount to each State would be used for that State. The allocations are then scaled proportionately to the appropriation total. After the allocations to the States are determined the funds are again divided. One third of each State's allocation goes directly to the State government. The remaining two-thirds of each State allocation is divided (again by a formula) among the local governments within the States. For example the State of Maryland will receive $107 million in calendar 1972. Of this $35.7 million (or one-third) will go directly to the State to be used for the "high priority" expenditures 2/ It is not clear what capital expenditures dealing with education Final regulations on this issue have not been will be allowed. completed. B- 3 described above. Two-thirds or $71.3 million will go directly from the Federal government to the localities such as the City of Baltimore and Montgomery County. The way this local share is divided between each locality is based on a formula that is similar to the Senate formula (described below). The difference between using the Senate formula to find the local share instead of the full State allocation is that local shares are determined by comparing the different demographic and economic characteristics of the localities within the State. State allocations are determined by comparing each State to the rest of the U.S. States may vary the local share formula within certain bounds, but always two-thirds of the State allocation is sent directly to the local governments. Thus each year the Federal government will first make 51 calculations (D.C. is treated as a State) for the State allocations. Then based on the State's desires and within the limits of the formula in the law, the Treasury will calculate the local shares. In all more than 38,000 Revenue Sharing checks will be sent to either a State or a local government officer. The Senate formula (or "three-factor" formula) for finding the State allocations uses three measures--population of the State, a tax effort factor (own revenues divided by personal income) and a relative income factor (per capita national income divided by the State's per capita income). First a calculation for each State is made using these three factors: R. (1A) Pi = Ni . * where Pi, Ni, Ri, Yi, yi are the -i Yi 1 product, population, own revenues, personal income, and per capita income of the ith State. The y is per capita national income. Own revenues include all taxes collected by the State and its local governments. Thus, a reduction in State or local taxes without a reduction in personal income would result in a lower product, Pi. Note, too, that per capita national income appears in the numerator of the third factor. In this way the States with per capita incomes lower than the national figure have a higher Pi. Once each State's product is found the appropriation to any individual State is simply the ratio of the State's product to the sum of all States' products times the total congressional appropriation: P (1B) Si = A . EiP i where S is the States share, A is the B - 4 Congressional appropriation and EPi represents the sum of the products of each State. 3/ we can find its product Again using Maryland as an example, 3/ by multiplying its population (3.922 million) times the ratio of its $16.8 State and local revenues to its personal income ($1.9 billion billion) times the ratio of the national per capita income to its own per capita income ($3698 ÷ 3965). This gives a product of 408.9. The sum of such products for all States and the District of Columbia is about 22860.4. Thus the ratio of Maryland's product to the national sum is about .018. Maryland, therefore, would receive about 1.8 per cent of the revenue sharing funds under this formula, which would amount to $95.4 million for calendar year 1972. The House formula (or "five factor" formula) is additive. The total appropriation is first split such that approximately 2/3 is allocated on the basis of a State's total population, urban population, and per capita income. The remaining 1/3 is allocated on the basis of the relationship between total State and local income tax collections within the State and the national total and a measure of the State's 3/ The figures used here are approximate and not necessarily those used by the Treasury. B - 5 The five factors are defined as 4/ general tax effort. F1: 4/ Proportion of State's population to national population F2 : Proportion of State's urban population to the national urban population. F3 : A measure of relative per capita income in the State compared to the national per capita income. F4: Proportion of State and local income taxes to all State and local income taxes raised nationally. F5: A measure of total tax effort that relates the State's ratio of its total revenues to personal income to the national sum of the ratios of State and local revenues to total personal income. The mathematical formulation of these factors can be written as follows. (1) (2) (3) F 1 i N = -i N F 2i 2i (proportion of State population to national) (proportion of urban population to national) -- U N Y. F3 1i i Y E. N. (y) (relative per capita income measure) Yi I (4) F4i (5) F (proportion of State and local income taxes to national total) i E i * Ri = Ei Ei (Ei Ri) 1 1 (tax effort measure) 1 where Ni, Ui, yi, Ii, Ei, Ri are populations, urban population, per capita income, state income taxes, tax effort (defined above in the Senate formula) and own revenues for State i. N, U, y, and I are the corresponding national total for population, urban population, per capita income and State income taxes. B- 6 The above five factors are combined to give the State allocation (Si) from the total appropriation (A) in the following way: (2) S i - A = 3 3 li + 1 F 3 2i +1 3 F i1 3i 2 i + 1 F, 22I This formula gives Maryland 2.2 per cent of the revenue sharing appropriations--a somewhat higher percentage than provided by the Senate version. The reason Maryland is favored under the House formula helps explain the difference between the two approaches. Maryland is an urbanized State and it has a State and local income tax. In the House formula, these factors are given separate weights. They do not enter into the Senate formula. A rural State that does not raise any of its own revenues with an income tax would be favored under the Senate formula. Obviously if every State was to receive its share under the most favorable formula the shares would exceed the total appropriation of $5.3 billion. To scale the total appropriation down the procedure is to first find each State's most favorable share under the two formulas and sum them for a national total. In the case of Maryland this would be $117.5 billion under the House formula and the total for all States would be $5.821 billion. Maryland's share of this total is about 2 per cent. Thus Maryland receives 2 per cent of the $5.3 billion appropriated for calendar 1972, or $107 million. is that A popular misconception of the revenue sharing bill it will allow States to lower their taxes. However, if a State lowers its taxes and the other States do not it will receive less in shared funds. The debate on revenue sharing made it clear that the intent was not to reduce State and local taxes, although the new law may slow the growth of these taxes. Table 1 below gives the State and local government shares for the 1972 calendar year. It shows that 45 per cent of the funds California and New York together are concentrated in seven States. receive over twenty per cent of the money. However, the character of the redistribution is clearer from Table 2. There the per cent of revenue sharing funds going to each State is compared to its per cent of 1970 population and 1969 Federal individual income taxes. The difference between the per cent of shared funds and per cent of population is largest for New York (2.18) and smallest for Ohio (-1.34). Texas, too, has a small number (-.91), but the rest of the states seem to be between -.40 and .40. B - 7 TABLE 1--DISTRIBUTION OF FUNDS TO THE STATES FOR CALENDAR YEAR 1972 (In millions of dollars) State United States, Total .. Alabama . . Alaska . . . Arizona . . Arkansas. . California. Colorado. . Connecticut Delaware. . District of Florida . . Georgia . . Hawaii . .. Idaho . ... . . . .... . . . . . .. . . . . . . . . . . . . . . . . .... . . . . . . ... . ........ , . . . . . Columbia. . . . . . . . . .... . . . . . . . . . . . . .. . . . .. . . . . Illinois. . . . . . . . .. Indiana ...... .. Iowa. . . . . . . . . . . . Kansas. .. . . . Kentucky. . . . . Louisiana . . . . Maine . . . . Maryland . . . Massachusetts . . Michigan. . ......... Minnesota . . . . Mississippi . . . . . . . . . . . . . . . . . . .. . . . .... . . . . . . . . . . . . . . . . Total State State2 share- Local, 2/sha share- 5,303.9 1,767.8 3,536.1 116.1 6.350.2 55.0 556.1 54.6 66.2 15.8 23.6 146.0 109.9 23.81/ 19.9 274.4 104.3 77.0 52.8 87.3 113.6 31.1 107.0 163.0 221.9 103.9 90.7 38.7 2.1 16.7 18.3 185.4 18.2 22.1 5.3 7.9 48.7 36.6 7.9 6.7 91.5 34.8 25.6 17.6 29.1 37.9 10.3 35.7 54.3 74.0 34.6 30.2 77.4 4.2 33.5 36.7 370.7 36.4 44.1 10.5 15.7 97.3 73.3 15.9 13.2 183.2 69.5 51.4 35.2 58.2 75.7 20.8 71.3 IC8.7 147.9 69.3 60.5 After adjustment for noncontiguous States. 1/2 to State governments and 2/3 to local governments. Continued on next page. B - 8 TABLE 1--DISTRIBUTION OF FUNDS TO THE STATES FOR CALENDAR YEAR 1972 (In millions of dollars) (continued) Total State Missouri . . . . Montana... . . Nebraska . . . . Nevada . . . . New Hampshire.. New Jersey . . . New Mexico . . . . . . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . New York . . . . . . . 98.8 20.6 42.9 11.1 15.2 163.6 33.2 33.0 6.9 14.3 3.7 5.1 54.5 11.0 65.8 13,7 28.6 7.4 10.1 109.1 22.2 . 591.4 197.1 394.3 135.5 45.2 90.3 North Dakota . Ohio . . . . . . . . . . . . . . . . . . . . 19.7 207.0 6.5 69.0 13.2 138.0 Oklahoma . . . Oregon . . . . Pennsylvania . Rhode Island . South Carolina South Dakota . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59.4 56.2 274.0 23.6 81.5 25.1 19.8 18.7 91.3 7.9 27.2 8.4 39.6 37.5 182.7 15.7 54.3 16.7 Tennessee. . . . . . . . . . 98.4 32.8 65.6 . . 244.5 81.5 163.0 31.4 14.8 10.5 4.9 20.9 9.9 105.2 35.0 70.2 84.1 28.1 56.0 West Virginia.. . . . . . .. Wisconsin. . . . . . . .. . 52.3 133.9 17.4 44.6 34.9 89.3 .. 9.7 3.2 6.5 Utah . . . . Vermont. . . .. . . . . . . . .. . . . share . . . . . . Local Lo c a l 2/ . . . . . . . .. . 2/ share- North Carolina . Texas . . . State . .. Virginia . . . . . . . . . . Washington . Wyoming.. . . ..... . . . ... . . . . 1/ After adjustment for noncontiguous States. 2/ 1/2 to State governments and 2/3 to local governments. BTABLE 2: Per cent of 1972 revenue sharing per cent of population (1970) 9 REDISTRIBUTION MEASURES Per cent Per cent of of Feder- funds less al person- per cent al income population taxes (1969) funds (1) - (2) Per cent of funds less per cent of taxes Revenue sharing funds as a per cent (1)-(3) of taxes (1) : (3) *100 (2) Ala. Alas. Ariz. Ark. Cal. Colo. Conn. Del. D. C. Fla. Geo. Ha. Id. Ill. Ind. Ia. Kan. Ky. La. Me. Md. Mass. Mich. Minn. Miss. Mo. Mont. Neb. Nev. N. H. N. J. N. M. N. Y. N. C. 2.18 0.11 0.94 1.03 10.48 1.02 1.24 0.29 0.45 2.75 2.07 0.44 0.37 5.17 1.96 1.45 0.99 1.64 2.14 0.58 2.01 3.07 4.18 1.98 1.71 1.86 0.38 0.80 0.20 0.28 3.08 0.62 11.15 2.55 1.69 0.14 0.87 0.94 9.81 1.08 1.49 0.26 0.37 3.34 2.25 0.37 0.35 5.46 2.55 1.39 1.10 1.58 1.79 0.48 1.93 2.79 4.36 1.87 1.09 2.30 0.34 0.72 0.24 0.36 3.52 0.49 8.97 2.50 (3) (4) 1.04 .49 -.03 .07 .0 .67 -. 06 -. 25 .03 .08 -. 59 -. 18 .07 .02 -. 30 -. 59 .06 -.11 .06 .35 .10 .08 .28 -.18 .08 .62 -.44 .04 .08 0.17 0.72 0.52 10.83 0.96 2.37 0.34 0.44 3.05 1.77 0.40 0.22 7.07 2.51 1.14 0,92 1.07 1.21 0.36 2.35 3.27 5.02 1.64 0.46 2.13 0.25 0.61 0.34 0.32 4.49 0.31 11.33 1.73 -. 04 -. 08 -.44 .13 2.18 .05 (5) 1.14 - .06 .22 .51 - .35 .06 -1.13 - .05 .04 - .30 .30 .04 .15 -1.90 - .55 .31 .07 .57 .93 .22 - .34 - .20 - .84 .31 1.25 - .27 .13 .19 .14 - .04 -1.41 .31 - .18 .82 Continued on next page. (6) 12.9 4.2 8.0 12.2 5.9 16.6 3.2 5.4 6.2 5.5 7.2 6.8 10.3 4.5 4.8 7.8 6.6 9.4 10.9 9.7 5.3 5.8 5.1 7.3 22.5 5.4 9.3 8.1 3.7 5.4 4.2 12.1 6.0 9.1 B - 10 TABLE 2: CONTINUED Per cent Per cent Per cent Per cent of Per cent of Revenue of 1972 revenue sharing funds of population (1970) of Federal personal income taxes (1969) funds less per cent population (1) - (2) funds less per cent of taxes (1)-(3) sharing funds as a per cent of taxes (1) (3) *100 (1) (2) (3) N. Dak. Ohio 0.37 3.90 0.30 5.25 0.18 5.74 Okla. Ore. Pa. R. I. S. C. 1.11 1.05 5.16 0.44 1.53 1.25 1.02 5.80 0.46 1.27 0.93 0.94 5.98 0.44 0.75 (5) (6) .07 -1.34 .19 -1.84 12.7 4.2 - .14 .03 - .64 - .02 .26 .18 .11 - .82 .00 .78 7.4 6.9 5.3 6.1 12.4 (4) S. Dak. 0.47 0.32 0.18 .15 .29 15.5 Tenn. Tex. 1.85 4.60 1.93 5.51 1.41 4.79 - .08 - .09 .44 - .19 8.1 5.9 Ut. Vt. 0.59 0.27 0.52 0.21 0.34 0.17 .07 .06 .25 .10 10.5 9.9 Va. Wash. 1.98 1.58 2.28 1.67 2.08 1.78 - .30 - .09 - .10 - .20 5.9 5.5 W. Va. Wis. Wy. 0.98 2.52 0.18 0.85 2.17 0.16 0.61 1.96 0.13 .13 .35 .02 .37 .56 .05 9.9 7.9 8.2 Sources: (1) Congressional Record, Oct. 13, 1972, p. S 18016. (2) U. S. Bureau of the Census, Statistical Abstract of the U. S., 1971 pp. 12-13. (3) I.R.S., Statistics of Income 1969: Individual Income Tax Returns, Table 5.3, Col. (8), p. 250. B - 11 TABLE 3 STATES RANKED BY PER CENT OF 1969 FEDERAL INDIVIDUAL INCOME TAXES RETURNED THROUGH REVENUE SHARING Middle third Top third (22.5%-8.2%) (8.1%-5.9%) Lower third (5.9%-3.7%) Mississippi 18. Tennessee California South Dakota 19. Nebraska Massachusetts Alabama 20. Arizona Florida North Dakota 21. Wisconsin Washington South Carolina 22. Iowa Delaware Arkansas 23. Oklahoma New Hampshire New Mexico 24. Minnesota Missouri Louisiana 25. Georgia Maryland Utah 26. Oregon Pennsylvania Idaho 27. Hawaii Michigan Vermont 28. Kansas Indiana West Virginia 29. Colorado Illinois Maine 30. District of Columbia New Jersey Kentucky 31. Rhode Island Ohio Montana 32. New York Alaska North Carolina 33. Texas Connecticut Wyoming 34. Virginia Nevada Average per cent returned is 7.8. B - 12 An interesting pattern emerges when we subtract the per cent of personal income taxes from the per cent of revenue sharing funds. Money will be flowing to the South from the rest of the U.S. Alabama (1.14), Arkansas (.51), Mississippi (1.25), North Carolina (.82), and South Carolina (.78) are the chief gainers in the South. Whereas Connecticut (-1.13), Illinois (-1.90), Michigan (-.84), New Jersey (-1.41) and Ohio (-1.84) rank higher in per cent of taxes than in revenue shared funds. One final measure shows revenue sharing as a per cent of 1969 federal individual income taxes. Mississippi has the highest figure of 22.5 per cent. Several other Southern states as well as small states outside the South seem to have a higher percentage relative to the rest of the country. In Table 3 the states are ranked by this last measure. On the average 7.8 per cent of the 1969 taxes are returned. It is clear from this table also, that funds are going to be redistributed to the smaller rural states from the larger urban states. Furthermore, it is not totally a regional redistribution since the first column of Table 3 has states from all regions of the U.S. just as the third column does. Effects on State and local Finance Revenue sharing may prevent some tax increases, but it probably will not result in actual decreases in state and local taxes. There are three reasons why lower tax rates are not likely. The first is that, as mentioned above, a reduction in tax effort (either in rates or type of taxes) on the part of a State or local government may result in less funds in the future. Secondly, the budget surpluses for the State and local sector reported in the national income accounts are in large part due to surpluses in social insurance funds. Third, it should be remembered that Title III of this Act reduces the social service grants-in-aid program. In turn a restriction in Title I for using revenue sharing funds for social services was lifted in the conference report. Thus, there will be some substitution of revenue sharing funds for the lost categorical grants which State and local governments had already budgeted. It is important to note that block grants (such as revenue sharing) probably are less stimulative to State and local spending than other forms of Federal aid to lower level governments. Edward Gramlich and others 2/ have suggested that a dollar of block grants usually leads to an equal amount of State and local expenditure. The funds are just transfered from one level of government to another. This has not been true of conditional grants (such as highway funds). 2/ Most of these studies are listed and discussed in Edward Gramlich, "The effects of Federal Grants on State-Local Expenditures: A Review of the Econometric Literature," Papers and Proceedings of the National Tax Association, 1970, pp. 569-592. B - 13 For this type of aid the matching formula induces the State or local government to spend more than the Federal appropriation. Finally it should be pointed out that revenue sharing will raise the per cent of State and local revenues from the Federal government. In 1950, 10 per cent of State and local revenues came from the Federal level. In fiscal 1970 the per cent was about 18 per cent and with revenue sharing it will climb to about 20 per cent. 

Federal Reserve (1972, November 20). Greenbook/Tealbook. Greenbooks, Federal Reserve. https://whenthefedspeaks.com/doc/greenbook_19721121_part3

@misc{wtfs_greenbook_19721121_part3,
  author = {Federal Reserve},
  title = {Greenbook/Tealbook},
  year = {1972},
  month = {Nov},
  howpublished = {Greenbooks, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/greenbook_19721121_part3},
  note = {Retrieved via When the Fed Speaks corpus}
}