Professor's Perspective: Precedents set by previous tax breaks show…

President Bush has proposed a $674 billion tax cut to be spread
over the next 10 years. The major goal of this proposal is an
improvement in job growth and elimination of the 3 million
shortfall in jobs. This has significance for graduating UCLA
students who will find it especially difficult to get jobs come
June.

The job shortfall is the result of one million layoffs over the
past two years, plus the annual one million increase in the number
of persons reaching labor force age.

Lowering tax rates gives more money to the public, which
consequently enables the public to spend and invest more. Increases
in spending and investing often leads to job growth, so it is
reasonable to expect that lower tax rates will contribute to job
growth.

Having served as an economist in the administration of President
John F. Kennedy, I was able to observe at close range the effect of
tax cuts on job growths. In the three years prior to the Kennedy
tax cuts, annual job growth was about 900,000. In the three years
after the cuts, annual job growth increased to 1.3 million.

Similarly, in the 20 years following the tax cuts in the early
’80s, job growth was 3.5 million (1982-2002), the largest
expansion in employment in U.S. economic history. Again, with the
tax reduction in 2001, the recent recession showed a drop of only
0.6 percent in real gross domestic product. In the previous 10
recessions since the Great Depression, all of the declines were
more than 1 percent. Credit is given to the 2001 tax cuts for
keeping the recession mild. In addition, during the 1991 recession,
tax rates were not cut and the recession was deeper.

The most dramatic improvement in employment in U.S. history came
when the deficit spending increased the most. From 1940 to 1943,
the national debt expanded from $50 to $150 billion. In this same
period the rate of unemployment decreased from 15 percent to 2
percent. Correspondingly, the failure to pursue a strong
expansionary fiscal policy in the 1930-1940 period contributed to
the 18 percent average rate of unemployment for that decade. Thus,
the 70-year history of fiscal policy shows remarkable consistency.
When stimulus is used, the economy responds in a favorable way.

Tax rate reductions, along with steadily increasing government
spending, cause the U.S. Department of the Treasury to operate at a
deficit. This means the treasury must supplement its tax receipts
with the sale of bonds to the public. This is not new for the
treasury because over the past half century, it has operated at a
deficit in four out of every five years. Over this period of time,
the economy has performed well, and the ratio of the national debt
to gross domestic product has declined from 85 percent to about 60
percent. Except for the period of OPEC oil price increases,
inflation has generally been at a low rate, as have interest rates.
In the recent shift from treasury surplus to deficit, the corporate
bond rate decreased from 7.6 percent to 6.3 percent.

In evaluating the proposed $647 billion tax cut over the next 10
years, it should be recognized that this sum is only about one-half
of 1 percent of the expected aggregate gross domestic product for
the 10 year period. So in economic terms, it is a relatively small
cut. Furthermore, the goal is to put idle economic resources back
to work, something that is very much in the public interest.

The more difficult issue is how the tax cut should be
distributed among the various economic groups. If the recipients of
corporate dividends will no longer have to pay taxes on such
income, they will have more funds to spend and invest, thereby
stimulating job growth. Other groups slated for tax relief include
parents who will receive an increase in the child tax credit from
$600 to $1,000. The marriage penalty will be reduced, as well as
the alternative minimum tax. Small business would get more liberal
write-offs for new investment. A laid-off employee could get as
much as $1,000 for training and expense. A married couple with two
children and income of $40,000 would see their tax bill go down
from $1,178 to $28, or 98 percent.

For those with $300,000 of income the bill would go from $71,000
to $64,000, a decrease of 9.8 percent. While some would argue that
those with incomes of $300,000 do not need tax relief, the fact
remains that the secondary effect of this relief is likely to have
a positive impact on the economy. This is because the tax savings
are likely to be invested and thereby contribute to job growth.

There are of course other ways to allocate the tax relief in the
search for an optimal distribution of relief. At the same time,
primary recognizability should be given to the importance of
eliminating the three million shortfall in jobs and the roles that
tax relief can play in achieving such progress.