Forty Centuries of Wage and Price Controls

Appendix D

An Analysis of President Carter’s Wage-Insurance Plan

On October 24, 1978, President Carter announced the latest phase of his anti-inflation campaign. In doing so, he sketched the outline (without precise details) of a new proposal. This was his wage-insurance plan, which would have to be enacted into law by the Congress since it would alter current tax laws. Two Walker Fellows in Economics at The Heritage Foundation (Eugene McAllister and Andrew Chalk) have written a brief analysis of this plan which appears below.

On the evening of October 24, 1978, President Carter introduced Phase II of his battle against inflation. The program consists of voluntary wage and price guidelines, a pledge to reduce the 1980 budget deficit, a promise to investigate the inflationary impact of government regulations, and a proposal for “real wage insurance.”

Real wage insurance, conceived by Arthur Okun of the Brookings Institution, is designed to offer workers accepting wage contracts below a target some protection should inflation exceed the anticipated rate. Under the Carter proposal workers settling for an increase of less than 7 percent would receive a tax rebate based on the difference between the actual inflation rate and 7 percent. For instance, with an inflation rate of 9 percent, workers might expect a 2 percent rebate.

Prior to its announcement, much of the anti-inflation program had been reported and discussed by the press. This had provided organized labor ample opportunity to express its displeasure. The inclusion of real wage insurance was a bid by the President to overcome the expected ennui and to make the program more palatable to labor.

Skepticism of real wage insurance is based on a variety of factors. The cost of the program and barriers to its administration have been criticized. The selling point of the program is that it offers an incentive to comply with the guidelines. This, however, is a questionable assertion. In addition, concerned observers have asked: what is the value of real wage insurance when past wage and price controls have failed?

A major objection to the program is its cost. Current estimates vary from 5 to 10 billion dollars. These totals appear even more substantial in light of the pledge to lower the 1980 deficit to 30 billion dollars. The final cost will depend on who is included and to what extent coverage is provided.

Nearly two months after the announcement the Carter Administration has failed to answer several criticial questions. Does the program cover all workers accepting a wage increase of less than 7 percent? If so, the real wage insurance might become a general tax reduction. If not, the program would aid the urban worker but ignore the rural or self employed worker.

Is there to be a limit to the amount of coverage provided? For instance, are rebates to be limited to 3 percent regardless of the rate of inflation? Are fringe benefits to be included, and if so to what extent?

Finally, what is the time frame for the real wage insurance? New wage contracts are often negotiated several years into the future. An insurance program which covers only the first year will afford little protection and little incentive to comply. The actual life of the insurance program is critical, yet extremely difficult to determine.

These unresolved questions are merely samples of the administrative difficulties raised by any real wage insurance program. The uncertainty is heightened upon realization that the program must receive congressional approval.

The purpose of the real wage insurance is to offer labor an incentive for wage demand restraint. The effectiveness of such a policy, however, is doubtful.

For example, under a 7 percent guideline a union correctly anticipates a 9 percent rate of inflation. The members will be better off accepting a 9 percent contract than settling for 7 percent initially and later a 2 percent rebate. The reason for this is that under a 9 percent contract the member receives the inflation adjustment in his weekly paycheck rather than through a rebate in the next year. A dollar in the present is worth more than one in the future. This is particularly true in an inflationary environment.

In addition, the previous wage increase often serves as the basis for current or future negotiations. A smaller percentage increase not only lowers the range of future percentage increases, but also makes the wage base for future considerations smaller. Thus, there would seem to be an incentive to ignore real wage insurance from the standpoint of both present return and future gains.

Real wage insurance does not directly reduce inflation. Rather it is designed as an enhancement to wage and price controls. The feasibility of real wage insurance should be judged not only on its own merits, but also on the effectiveness of the wage and price controls. These considerations make the impact of the real wage insurance program extremely dubious.

ANDREW CHALK AND EUGENE McALLISTER