March 18, 1966
Vol. V, No. 1

Does the 'New Economics' Work Both Ways?




When I was discussing the subject of this newsletter with colleagues here in the House, one of them suggested I entitle it "Election Year Memo from a Political Lunatic." As you can see, I thought better of that suggestion. However I expect some of my colleagues will insist the title was appropriate.

What this newsletter contains is a prediction and a recommendation:

The prediction: Federal taxes will go up in 1966. They will go up in one of two ways -- through inflation, a cruel, senseless, unequal and damaging way; or through a deliberate and, I think, sensible decision of Americans through their Congress to enact a moderate tax increase to head off inflation and keep our economic growth sound and healthy.

The recommendation: Let's do it by a tax increase and not by inflation. Let's do it even in the face of the national myth that voters in an election year invariably rise in indignant wrath if their taxes are raised as they are heading for the polls.

GROWTH WITHOUT INFLATION -- FIVE YEARS OF SUCCESS

Between 1963 and 1965 we challenged and overcame a basic economic and political myth -- the one that says you never cut taxes in times of prosperity and an already unbalanced budget. During those years we cut federal taxes by a staggering $20 billion. We did so because our economy, while prosperous, was lagging behind its potential and -- more importantly -- because we needed to create more jobs for our growing work force. The experiment was a tremendous success:
 

** Because these tax cuts were timely we have marked up an unprecedented five straight years of economic expansion -- the longest such period in our nation's history. The 1965 growth rate in the United States was 5%, greater than that of any other major nation -- and this after our lagging behind for many years.

** Last year's $47 billion increase in our Gross National Product -- just the increase, mind you -- was larger than the total Gross National Product of all but 12 countries of the world.

** Corporate profits in 1965 were up another 20%, bringing the total growth to more than 60% since 1960. Personal income rose $39 billion during the year, making a 40% gain since 1960.

** During 1965 alone we created 2.4 million new jobs, and unemployment has now dropped to 3.7%, a goal many said could not be reached.

** In spite of dire warnings from opponents of the "new economics" inflation has been held in check through all these years of unprecedented growth. The average decline in the value of the dollar has been about half the rate of the preceding decade.

'NEW ECONOMICS' HAS TWO SIDES

I'm sure we all will agree this is a record of success. The picture is a bright one. But, at the risk of being called a wet sponge, I want to remind my readers that this "new economics", about which I wrote in three newsletters last summer, has two sides. And I think the time is approaching when we must put it to work, not to stimulate our economy, but to hold it somewhat in check.

As I explained in those reports, most economists now believe that, in times of a slack economy, with under-employment and under-utilization of our industrial capacity, you should cut taxes or increase spending (even in the face of an existing deficit in the budget). You can expect these results:
 

** You stimulate production, increase employment, and head off the recession that otherwise might be expected as a period of advance "runs out of steam."

** Government income won't decrease with the lower tax rates but, on the contrary, will increase because of higher incomes and increased business volume.

** Because of the slack in the economy -- and, more particularly, because there are people waiting for jobs and factories waiting for orders --


 
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wages and prices are likely to remain in the "normal" range of growth (something like 1% to 1 1/2% per year).

That 1963-65 experiment has made "New Economic Christians" out of a lot of unbelievers like Wall Street bankers, the titans of industry and leading conservative business writers. Most of them are convinced the prescription set forth above actually works. It passed the test. But now a bigger test is standing outside our front door -- or at least heading up the walk -- and I hope we don't flunk it.

A prescription for low blood pressure won't work for high blood pressure, and we now must examine the other side of the "new economics." Here's what it says on the label: When the economy is operating at near-capacity, when unemployment is down and labor shortages are imminent, when you begin to see "too many dollars chasing too few goods", you put on the fiscal brakes. You raise taxes or cut spending (even in the face of an existing surplus in the budget). The expected result:
 

** If this is done promptly and moderately -- if the brakes aren't applied too hard -- the economy will continue to expand, but less rapidly and within manageable limits.

** If it is not done, if the first signs of excessive demand are ignored, if shortages of raw materials, goods and workers start to develop, the gains of economic growth can be lost through a spiralling of prices and wages, a burst of overproduction which cannot be maintained -- and an eventual downward adjustment or recession.

As I explained in my "Silent Revolution in Economics" series, the prescription for a slack economy bordering on recession is for government to put more money into the economy than it takes out. In other words, you either increase expenditures or cut taxes. Conversely, you check an over-heated economy bordering on inflation by having government take more money out of the economy than it puts in. In other words, you cut expenditures or raise taxes.

To recall my earlier metaphor, when water is everything you act to meet a drought, but you also plan ahead to prevent a damaging flood.

IS THIS THE TIME TO ACT?

A high-level economic debate is now raging in Washington. The question is whether the time has come to put on the economic brakes. A few economists argue that there is still slack in the economy, that deflationary action is not yet indicated. A majority, however, including some of the leading advocates of the "new economics", see these signs indicating action:
 

** It was estimated that the Gross National Product would climb this year from $676 billion to about $720 billion. It now appears headed toward $728 billion, and most of the difference is of the unhealthy sort associated with a mere bidding up of prices and wages.

** Whereas inflation has been held within manageable or "normal" bounds for several years (average of 1.3%, 1960-64), we ended 1965 with a 1.7% rise in the Consumer Price Index.

** Whereas the Wholesale Price Index has been almost static since 1959, it started to rise slightly last year and has spurted nearly 1/2% per month for the past four months. This index is probably the best indicator of supply-demand pressures in the economy.

** Whereas we were using only 82% of our industrial potential in 1961, we're now using 91% -- close to the optimum businessmen shoot for. Beyond about 92% efficiency drops off.

** Wage and price pressures are mounting, and the Administration's "voluntary" guidelines and guide posts are meeting increasing resistance from industry and labor unions.

** While the gain in consumer prices has been only 4/10 of a percent greater than that of recent years, the trend appears to be upward. And while our economy certainly can live with a 2% annual rate of inflation (the average for the years 1955-60), anything much over that could be serious.

** It seems that an inflation psychology is developing. Plants are building up inventories of supplies, thinking they will cost more very soon; decisions to expand plants or machinery are being accelerated for the same reason; and all of these things feed on each other, pushing up the prices of supplies, equipment, building materials and services.

** The war in Viet Nam is throwing many plans out of kilter. In just two years defense spending has increased from $46 billion to $60 billion -- roughly a one-third increase. A big chunk of this boost has occurred in the last few months.


 
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With indicators such as these to draw on, it seems clear to me that time is important; if we're going to act, we ought to act with dispatch. And I am convinced that action is needed to head off the excesses of inflation.

I might say that this same view is held by most of the economists who advocated the tax cuts of recent years -- and, in particular, by Dr. Walter Heller, former chairman of the Council of Economic Advisers and chief architect of the "new economics" which has so advanced our economy since 1961.

WHY NOT CUT SPENDING INSTEAD?

But, wait, you say, aren't you overlooking something? Why not cut spending instead of increasing taxes? This would appear to be the easiest and quickest course: we have a war on; domestic needs can wait.

Perhaps so, but I am frank to say that I don't think this is a live possibility. In fact, we are applying far more of a pinch on domestic programs than people realize right now. And further cutting back could have serious effects on many problem areas.

In this connection, I was interested in a survey reported March 5 by the Saturday Review. Prominent businessmen, financial leaders and economists for large corporations were asked what steps they would take to meet mounting war costs. Only 15% specifically advocated curtailing domestic programs. The main thrust of their responses was toward increased taxation if war expenditures rise.

What we must remember is that 80% of our federal budget is virtually untouchable. We certainly can't cut defense spending. If anything, we should be spending more on international affairs. Perhaps we could cut some funds from the space program, but as our competition with the Soviet Union is growing more intense I don't think we will. The cost of veterans' benefits is as fixed as anything can be. We can't cut the interest on the federal debt, and the basic, housekeeping costs of the government must go on, no matter what happens. This leaves just 20%, or about $21 billion, to run every other department, agency and activity of the federal government and pay out over $8.5 billion in grants-in-aid to the states. There simply aren't many places to cut without endangering programs needed by the 195 million Americans who are not in Viet Nam.

FEDERAL SPENDING IN ARIZONA

Of course, spending cuts are always more attractive when they occur in other states and other regions of the country. But I think we ought to take a look at what's happening in our own backyard before we talk about sweeping reductions in domestic programs:
 

** For example, recall what a storm was raised when the Defense Department announced deferral of $3.8 million in hospital and other construction at Davis-Monthan Air Force Base in Tucson. The message was clear: this cut in anticipated spending was a blow to Tucson's economy.

** Similar protests went up over the deferral of a $320,000 bachelor officers' quarters at Ft. Huachuca.

** Even louder objections were raised when we learned that the new federal building for Tucson had "gone to war" -- or at least been put off to some later time.

** Right now I'm hearing from school boards, educators and parents all over Arizona who are alarmed about cutbacks in the school lunch program, special milk program and federal impact aid to local schools.

** Arizona has been hoping to get a big new federal facility -- a proton accelerator of the Atomic Energy Commission costing $350 million and forming the nucleus of a new scientific community. If that project, too, "goes to war," it's going to be a blow to those communities counting on the benefits it would bring.

** On top of all this, reflect for a moment on the Central Arizona Project -- the reclamation project so desperately needed to bolster our sagging water supply. Right now we are in our most favorable position in 15 years to see that project authorized. But we can be very sure that a decision to slash federal spending would put it in limbo for some time to come.

Thus, when we talk about spending cuts as the way to deal with the threat of inflation, I think we had better think carefully about what this would mean to Arizona. And if this is true of Arizona, it's true of vitually every other state of the union. In my judgment, while some cutbacks might be possible, I don't believe the country will let us make them or that they are necessarily the best solution to the problem.


 
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BEST BET -- A TEMPORARY TAX INCREASE

Instead, I think we ought to have an immediate, moderate tax increase for individuals and corporations. I would suggest that it have two features:
 

** An immediate increase in all brackets of about 5% in federal tax liability (that is, 5% of the tax we're now paying).

** After one year a return to present tax rates.

Maybe I'm wrong, but I think thoughtful citizens would accept this modest sacrifice at a time when our troops are heavily engaged in Viet Nam and when the people at home have earnings and incomes at all-time highs. At the end of the year, the situation could be reviewed, but in my judgment the immediate inflationary crisis might well have passed and the need for the special tax have ended.

Here is what the temporary tax increase might mean:
 

** A wage earner who received $6,000 last year and paid $400 in taxes would pay $420 next year. In exchange, he might find his $6,000 depreciated $60 during the year instead of, perhaps $120 or $150.

** An executive who earned $20,000 and paid $2500 in taxes would pay $2625 in taxes next year. In turn, he might find his $20,000 depreciated $200 instead of $400 or $500.

** Pensioners and people on fixed incomes, perhaps noting no great change in their taxes, would be saved from the greater loss of real income that would result from a burst of inflation.

LET'S DISCARD SOME POLITICAL MYTHS

I give our citizens credit for a lot more sense and willingness to make tough decisions than do some of my colleagues. One of the oldest rules of "practical" politics is: "Vote for all tax cuts and all spending bills." Another is: "If you must vote for a tax increase, never do it in an election year." I reject these old myths. I think that people want leadership and want their leaders to talk sense and explain unpleasant truths when they exist. And this is what I'm trying to do in this newsletter.

The unpleasant truth I began with is clear to me: Taxes will go up this year -- either by plan or by inflation. There is good reason to believe that the "new economics" -- the most successful approach yet of what is certainly an inexact science -- can give us even more of the remarkably stable, long-term growth we have had in the past five years. But this is possible only if we recognize that this machine comes with both an accelerator and a brake. I think the time has come to put on a little brake.

I don't like the thought of higher taxes any more than I like our being in a war. But I'd prefer higher taxes to the even higher costs of inflation or the sacrifice of needed programs.


Previous Report: August 9, 1965 -- The Silent Revolution in Economics: III--A River Called Money
Next Report: September 20, 1966 -- 'Wait 'Til Next Year' -- Old Tune, New Verse


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