Has the Kemp-Roth 30 percent tax cut become too little?

If there is a single lesson we have learned about taxes in the past four years, it is this: Only a change in marginal tax rates has any direct effect on the real economy.m

Economic stagnation is the failure of our economy to produce more this year than last year. If we want our economy to grow, we have to increase the incentive for producing an additional unit of goods, effort, or saving -- that is, lower the marginal income tax rate. Nothing else will affect the behavior of individuals and businesses.

The Kemp-Roth package would do three things: cut all marginal income tax rates for individuals by 10 percent a year for three years; index the new tax rates for inflation after the third year; and limit federal spending to a share of GNP which declines from 21 percent the first year to 18 percent by the fourth year.

The Kemp-Roth bill is startling in its modesty. For the first two years, it does not provide any tax reduction at all in dollar terms. The net impact on the budget never exceeds $21 billion. . . .

These numbers mean that a 30 percent cut in marginal income tax rates would do nothing, in dollar terms, but keep effective or average tax rates on individuals from increasing. Luckily for the American people, however, the economic effect of a tax cut depends on marginal, not effective tax rates.

I would like to submit data from three studies of the economic effect of the Kemp- Roth package, which were presented recently to the Joint Economic Committee.

The first study, by Data Resources Inc. (DRI), analyzed what would happen if Kemp- Roth were a tax rebate of the same dollar size, instead of a cut in marginal tax rates. The DRI model shows conventional effects of an increase in aggregate demand. Despite a rise in employment, there is little revenue feedback, although, interestingly enough, the same study showed that the personal savings rate would double to 8.1 percent. Essentially, the increase in government borrowing is merely offset by an increase in private saving.

Evans Economics Inc. estimates that the Kemp-Roth tax-rate reduction alone, without any spending restraint, would substantially reduce unemployment and increase real growth. There is a negligible increase in the rate of inflation over five years. The same study shows that the whole Kemp-Roth package, including both tax-rate reduction and spending restraint, would balance the budget in two years, reduce the unemployment rate to 4.3 percent and, most significantly, reduce the inflation rate by 5.1 percent by 1985.

The third study is by Dr. Norman B. Ture, of the Institute for Research on the Economics of Taxation (IRET). The IRET's econometric model is known as the ATIM (Analysis of Tax Impacts Model). This study shows even larger increases in employment than the Evans model. It also shows that as much as three-quarters of the increase in real GNP is due to added investment; the remainder, additional consumption.

Unless Congress cuts tax rates, taxes will increase drastically. The Kemp-Roth bill would barely offset the aggregate real tax increase on personal income which will take place under curent law. If we cut marginal tax rates 30 percent, even ignoring revenue feedback, the net effect will be merely to keep effective or average tax rates the same.

The administration has failed in its attempt to balance the budget through across- the-board increases in tax rates. In fact, the deficit has steadily widened. This casts doubt on the administration's contention that cutting tax rates across the board would lead to larger deficits.

Only a cut in marginal tax rates -- not a tax rebate -- will have the effect we desire on employment, saving, investment, and real economic growth. With a sound monetary policy, we can substantially reduce the inflation rate at the same time.

The situation we face was described accurately 17 years ago by President Kennedy, when the country faced a similar economic and financial problem.

He said: "Our true choice is not between tax reduction, on the one hand, and the avoidance of large federal deficits on the other. It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenue to balance the budget -- just as it will never produce enough jobs or enough profits. . . . In short, it is a paradoxical truth that tax rates are too high today and tax revenues are too low -- and the soundest way to raise revenues in the long run is to cut rates now."

And he said: "The purpose of cutting tax rates, I repeat, is not to create a deficit but to increase investment, employment, and the prospects for a balanced budget."

I have been pushing for across-the-board tax-rate reduction for individuals for almost four years now, and I have only one reservation about the Kemp-Roth bill. Because of the extraordinary magnitude of the tax increases which have occurred, and which are projected to continue, I am afraid that a 30 percent tax-rate reduction over the next three years may have become too modest.

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