• Some price advance was the inevitable cost of the adjustments required in recovering from a decade of slack:

-Wages had to be raised sharply in underpaid occupations,

which previously held their labor only because the alternative was no job at all.

-Producers in once stagnant, low-profit industries saw opportunities for expansion and found it possible to raise prices and earnings in order to attract needed capital.

-Demand pressed harder on skilled occupations and professional services where we had trained too few persons to

meet the needs of a high employment economy.

Some price increases would still have occurred had we moved at a steadier pace.

But these price increases could have come slowly enough and have been small enough not to threaten a chain reaction of wages chasing other wages-wages chasing prices-prices chasing wages and prices chasing other prices.

It is this spiral we must and can avoid. But it will require responsible action on the part of all.

3. Achieving equilibrium in our balance of payments remained a problem, in spite of strong new measures.

The costs of Vietnam required us to spend many more hundreds of millions of dollars beyond our shores. At the same time, the spurt of demand caused our imports-especially of capital goods—to soar.

We are determined to continue our progress toward equilibrium.

4. Tight money and high interest rates concentrated the burden of restraint on housing.

Interest rates in 1966 were as high as at any time in 40 years. They were pushed there by an insatiable demand for credit, straining against a deliberately restricted supply. Monetary policy in 1966-like tax policy-was properly aimed at slowing down an economy expanding too fast.

The brakes applied last year worked. worked. But tight money worked painfully and inequitably. It cut construction by more than $8 billion during 1966. Its impact was equivalent to a heavy across-the-board tax increase, but with most of its effect concentrated on a single industry.

FINDING SOLUTIONS

We will move this year toward solutions for these problems and others. But they cannot all be completely solved in 1967.

Lifting the Burden on Housing

Now that the economy's advance is again more moderate, the burden of tight money is being lifted. Interest rates are still extremely highbut they are moving down from their peaks. Credit is still not readily available to all who can make sound and productive use of it—but it is becoming easier to get. More savings are flowing into our thrift institutions and are beginning to be available to builders and homebuyers.

The steps we took last year and those I am now proposing, the steps the Federal Reserve has recently taken and is continuing to take to increase credit availability and lower interest rates, should have our housing industry moving smartly forward by the end of 1967, and ready for one of its best years in 1968.

Restoring Price Stability

The advance of prices has already begun to slow. Wholesale prices in December were below their levels of August.

The more moderate pace of economic advance now underway, which the policies I am recommending are designed to maintain, should further diminish inflationary pressures.

We cannot rescind all of last year's increases in costs, some of which are still spreading through our structure of prices. Price stability cannot be restored overnight. But we will be making good progress toward price stability this year.

Improving Our International Payments

We have recently announced stronger voluntary balance of payments programs for 1967. Our policies to constrain economic expansion to a sustainable pace should permit an improved export surplus.

I am now recommending further steps to strengthen our external payments. Yet so long as we remain heavily engaged in Southeast Asia, we will have a balance of payments problem.

Combating Poverty

We will continue to attack poverty and deprivation through such weapons as

-Community Action and Head Start;

-rent supplements and child nutrition;

-aid to elementary and secondary education in poverty areas and the Teachers Corps;

-the Manpower Development and Training Act, the Job Corps, the Neighborhood Youth Corps;

-Medicare, Medicaid, and neighborhood health centers;

-measures to end discrimination in jobs, education, and public facilities;

-the expanded coverage enacted last year for a higher minimum wage.

I am proposing that our attack be reinforced with new weapons in 1967.

Yet, with old weapons and new, the war on poverty will not be won in 1967 or 1968. There is no wonder drug which can suddenly conquer this ancient scourge of man. It will be a long and continuing struggle, which will challenge our imagination, our patience, our knowledge, and our resources for years to come. Our capacity to stay with the task will be a test of our maturity as a people.

USING THE GAINS OF GROWTH

From early 1961 to the end of 1966, our GNP rose an average of $44 billion a year. About $9 billion a year was price increase. Of the

balance

• An average real gain of $10 billion a year (in 1966 prices) came from putting idle men and machines back to work.

• An average real gain of $25 billion a year (in 1966 prices) came from the growth of our resources: a larger work force, more and better capital and management, higher productivity.

Further gains from putting idle resources to work will now be harder to achieve.

But our annual dividend from growth has meanwhile become more generous. In 1967 it will add $30 billion at today's prices to our potential output.

Our economic policies must assure that we realize this potential dividend and use it wisely.

REALIZING THE GROWTH DIVIDEND

To ensure our full dividend from economic growth requires that markets for goods and services expand steadily and adequately-but not excessively. In recent years, we have tested and refined the power of fiscal and monetary policy to stimulate or moderate the expansion of total demand.

During 1966, Federal expenditures were expanding rapidly. But tax policy worked to counter their impact.

Federal expenditures in our national income accounts grew $19 billion in calendar year 1966, reflecting the step-up in national defense; in Social Security, Medicare, and related payments; and in grants to State and local governments. They added strongly to private pur

chasing power. They would have added more but for the substantial expenditure cutbacks put into effect during the year.

On the other side, taxes restrained demand. Higher payroll taxes, the restoration of some excise taxes, the institution of graduated withholding, and the suspension of tax incentives to investment all represented new measures that were draining off more than $9 billion of spendable incomes by year-end. In combination, and for the full year, these measures and an expanding economy produced $18 billion more in revenues than in 1965. Prompt action by Congress in response to my tax proposals of January and September made tax policy an important force for economic restraint.

Taking the two sides together, our national income accounts budget was in surplus in the first half and in balance for 1966 as a whole.

But as private investment threatened to outrun private saving, sharp monetary restraint was also applied. In response to both fiscal and monetary restraints, the economy shifted gears from excessive speed to a moderate advance.

FISCAL POLICY FOR 1967

In the year ahead we are determined to maintain that moderate advance; we need no further slowdown; we can tolerate no new spurt of demand. After midyear, the tax increase I have proposed and a more moderate growth of Federal spending will increase the freedom of monetary policy to support expansion. I am confident that the opportunity will be used.

The specific fiscal program I am recommending includes

-a surcharge of 6 percent on the tax liabilities of individuals, exempting persons in the lowest income brackets;

-the same 6 percent surcharge on the tax liabilities of corporations. Here are some examples of the effect of this proposal, as applied to a married couple with two dependents, using typical deductions:

• With $5,000 income, their tax will be unchanged still $130 lower than they would have paid in 1963.

• With $10,000 income, their tax in 1968 will rise $67, or $1.30 a week. Their annual tax will still be $190 less than they would have paid in 1963.

With $20,000 income, their tax in 1968 will rise $190, or $3.65 a week. But their annual tax will still be $450 less than they would have paid in 1963.

A corporation with profits before tax of $100,000 will pay an extra $2,490. It will still pay $2,510 less than it would have paid in 1963.

One with profits of $1,000,000 will pay an extra $28,410, still $12,590 less than it would have paid in 1963.

The surcharge will provide for $5.1 billion of extra revenues in fiscal year 1968 on a national income accounts basis, substantially offsetting the expansion of $5.8 billion in defense purchases.

The national income accounts budget will also be affected by my proposals for Social Security benefits and taxes.

After allowance for these changes, the national income accounts deficit for fiscal year 1968 is now estimated at $2.1 billion, compared with $3.8 billion in fiscal year 1967.

I am also recommending two further accelerations of corporate tax payments, to begin in 1968:

-requiring quarterly payment of estimated tax on the basis of 80 percent rather than 70 percent of liability;

—requiring, over a 5-year period, that small corporations, as well as large, become current in their tax payments, in the same way as individual proprietors.

We have fashioned a fiscal program for sustainable expansion. With that program, we now see a rise of about $47 billion in our GNP in 1967-a growth dividend close to 4 percent in real terms.

USING THE GROWTH DIVIDEND

The first priority for the use of our growth dividend must, as always, be the defense of freedom. But it will take only a small part of our $47 billion of added production.

These will be the public claims on our growth dividend:

$10 billion more of our output in 1967 will go for the support of our men in Vietnam and other urgent needs of defense.

$12 billion will go for the expansion of other Federal purchases, including adjustments in Federal civilian and military pay.

• State and local governments will use about $8 billion more of the Nation's resources in 1967. In this, they will be aided by Federal grants totaling nearly $15 billion.

The remaining $272 billion of our GNP gain in 1967-nearly 60 percent of it—will be used in the private sector. And the flow of goods and services to consumers will expand this year by even more than that.

In the past several years, an unusually large part of our output growth has gone to expand the productive capacity of business and to build up inventories to support high and growing production and sales. On balance, a slightly smaller portion of our resources will be used for these purposes in 1967 than in 1966.