‘Tax’ Cut vs. Rate Cut

November 19, 1962

Last summer Mr. Kennedy let it be known that he favored a tax cut of “at least $7 billion a year.” “Our present tax system,” he declared on Aug. 13, “is a drag on economic recovery and economic growth. . . . Our tax rates . . . are so high as to weaken the very essence of the progress of a free society—the incentive for additional return for additional effort.”

Everybody agrees that present taxes are too high. But a cut of the dimensions indicated, without a corresponding cut in spending, would touch off a new spiral of inflation and endanger the dollar. We have already had 26 deficits in the past 32 years. The Council of State Chambers of Commerce, before the Cuban crisis, estimated that the deficit in the current fiscal year would reach $7.7 billion. A tax cut of $7 billion could mean an annual deficit of $15 billion. Yet in despair of the political prospect for any cut in spending, groups and institutions ordinarily deeply concerned about inflation now advocate a tax cut even without a spending cut.

The latest example is the First National City Bank of New York. After an instructive comparison of the American tax system with that of other nations, its November letter concludes: “Our present tax system is bankrupt. It deters effort and progress. It has not succeeded in balancing the budget. We desperately need an imaginative new fiscal combination, even at the initial cost of some continuance of deficits. Easier taxes on enterprise could invigorate the economy [and] build a bigger base of taxable income.”

1 PERCENT OF REVENUES

May it not be possible, however, to reform our tax system without plunging into still bigger deficits in the hope that lower taxes will themselves restore a balanced budget in some sweet by-and-by? We need merely recognize that the greatest harm is being done by the excessive tax rates on the higher personal incomes. All U.S. personal income-tax rates above 50 percent yield less than $1 billion, i.e., less than 1 percent of total Federal revenues. The experience of other countries also shows that such punitive rates produce negligible yields. Yet such confiscatory rates immensely discourage effort, siphon off most of the very funds otherwise available for risk capital, and undermine the incentive to invest what is left.

If we stopped our income-tax progression at the 50 percent rate there can hardly be any doubt that this would result in an actual increase in governmental revenues. It would certainly result in an increase of economic growth from increased effort, increased capital accumulation, increased investment, increased job opportunities, and higher real wages.

DO HIGH RATES PAY?

The City Bank comparisons show that our top rate at 91 percent is the highest of any important country in the world. As the bank points out:

“It is sometimes thought that high rates and heavy reliance on income taxation necessarily go together. Such is not the case. The bulk of the revenue from the tremendously productive Federal individual income tax is derived from the initial 20 percent rate. In 1960, 86 percent of receipts came from this first bracket rate, to which all taxpayers are subject, while the entire progressive portion up to 91 percent produced only 14 percent of the yield. Collections were 23.3 percent of the total taxable income reported in 1960, which implies that a flat tax of 23.3 percent would produce the same revenue as the present steeply graduated schedule.”

To raise the individual exemption by even $100 would cost some $3 billion in revenues. But to lower the 20 percent rate to 19 percent on the first $1,000 of taxable income, or alternatively, to continue the 20 percent rate (which now applies only to taxable incomes of $2,000 or less for single persons) through the $2,000 to $4,000 bracket (which now pays 22 percent) would mean a revenue loss of only about $750 million.

With such changes at the top and bottom of the rate scale, the complexity of the income-tax schedule would be enormously reduced—from 24 tax rate brackets to eight or nine. This could be a cautious start toward further tax reduction spread over the following years.