Question #1:As demonstrated in the course readings, President Kennedy referred to the dangers of deficit spending triggered by tax cuts a “myth.”
What is deficit spending?
How do tax cuts trigger deficit spending?
Does the use of tax cuts to trigger deficit spending actually result in economic stimulus and growth?
Is there a negative economic impact?
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Rev. February 8, 1984
The Tax Cut of 1964
Economics has come of age in the 1960s ….
The paralyzing grip of economic myth and false fears on policy has been
loosened, perhaps even broken. We at last accept in fact what was accepted in law 20
years ago in the Employment Act of 1946, namely, that the federal government has
an overarching responsibility for the nation’s economic stability and growth. And we
have at last unleashed fiscal and monetary policy for the aggressive pursuit of those
objectives.
These are profound changes. What they have wrought is not the creation of a
“new economics,” but the completion of the Keynesian Revolution—30 years after
John Maynard Keynes fired the opening salvo.1
The Evolution of the “New Economics”
In January 1961, the Kennedy administration had begun the New Frontier with a promise to
“get the country moving again.” For the previous eight years, the Eisenhower administration had
argued for a return to economic orthodoxy, which, it believed, would reduce inflation. To
Eisenhower, orthodoxy meant minimal government involvement in the economy by reducing
government spending, reducing taxes and balancing the budget. During its two terms of office, the
Eisenhower administration was plagued by two major recessions, in 1953–1954 and in 1958. In both
cases, Eisenhower resisted attempts to stimulate the economy through fiscal policy. The Eisenhower
administration left office with a legacy of unemployment and unused industrial capacity.
The “new economics” of the Kennedy administration, as it was later called by the media, was
the product of a complex political evolution involving much infighting and competition for the ear of
John F. Kennedy. Walter Heller, Chairman of the Council of Economic Advisers, developed a
two-stage economic recovery plan in late 1960 and early 1961. The first stage sought to promote
recovery by establishing incentives for business investment and by raising confidence in the dollar.
An expansionary monetary policy might have helped investment and growth, but fears of inflation
and lower interest rates would have weakened the dollar. The Council of Economic Advisers
therefore opted for investment incentives to improve the business environment without harm to the
1 Walter W. Heller, Chairman of the Council of Economic Advisers under President John F. Kennedy, New
Dimensions of Political Economy (Cambridge, MA: Harvard University Press, 1966), pp. 1–2.
This case was prepared by Assistant Professor Michael G. Rukstad as the basis for class discussion rather than to illustrate
either effective or ineffective handling of an administrative situation
Copyright © 1982 by the President and Fellows of Harvard College. To order copies or request permission to
reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to
http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system,
used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying,
recording, or otherwise—without the permission of Harvard Business School.
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balance of payments. This first stage terminated with the passage of the Revenue Act of October
1962—a fiscal incentive package including a 7% investment tax credit among other reform provisions.
The second stage, which was much more important, was designed to close the “production
gap” (the difference between real and potential GNP) and reduce unemployment by means of an
aggressive fiscal policy. The administration did not publicly commit itself to such a course until the
summer of 1962, though the basic idea had been discussed since before the inauguration. This stage
culminated in the passage of the tax cut of February 1964 entitled the Revenue Act of 1964.
Political, Economic, and Foreign Policy Considerations
In the early days of the administration, Kennedy received conflicting advice regarding the
probabilities of economic recovery and the need to take drastic action. The assault for a major tax cut
was initiated by his pre-inaugural Task Force on Economics. The task force proposal was supported
by Walter Heller’s Council of Economic Advisers and by Budget Director David Bell. They argued for
an immediate cut in order to preempt a recession, lower the current unemployment rate and close the
“production gap.”
In the opposing camp were Treasury Secretary Douglas Dillon and Commerce Secretary
Luther Hodges, who supported the orthodox budget-balancing philosophy. They urged delay of a
major tax cut because of fears over the gold outflow (which would be aggravated if the tax cut ignited
domestic inflation) and predictions of recovery which some foresaw on the horizon.
At this time, the attention of the nation and the new administration was focused primarily on
foreign policy problems in Berlin, Cuba, Laos, and the Congo. But the economic advice of Kennedy’s
cabinet officers in Treasury and Commerce, who warned against moving too quickly on a large tax
cut, was evident in the president’s speeches and news conferences through most of 1961. In fact the
low point in launching the second stage occurred during the Berlin Crisis in the summer of 1961.
Despite the sagging economy, President Kennedy considered a $3 billion tax increase to offset the
increased military expenditures prompted by the U.S.-Soviet confrontation. Even though the tax
increase had the support of Kennedy’s political advisers and the Treasury, Heller was able to
persuade him at the last minute before his televised speech on Berlin to table plans for additional
taxes.
Between the summer of 1961 and the summer of 1962, political considerations dominated the
discussion of whether and when to announce a second stage program of fiscal stimulus. The key
element according to Kennedy’s political advisers was the issue of timing of the tax cut. The
memoranda by Under Secretary of Treasury Henry Fowler (Appendix A) and Special Presidential
Adviser Ted Sorensen (Appendix B), outline some of these considerations.
At the same time that presidential advisers were debating the timing of a major stimulative
tax cut, the Revenue Act of 1962 began its 18-month political odyssey. In an important tax message to
Congress on April 20, 1961, Kennedy formally proposed a $1.7 billion investment incentive program.
Tax revenues lost as a result of this measure would be offset, as he saw it, by the closing of loopholes
on business expense accounts, the creation of withholding tax on dividends and interest, and
additional taxes on business overseas. At this time, Kennedy was still concerned with “fiscal
responsibility,” which meant the avoidance of additional deficits. By October 1962, when the
Senate-House Conference Report was issued, all of the original proposals had been scaled down and
the withholding tax had been eliminated from the plan. The result was that the $1 billion of tax
credits which remained would only be partially offset by the revenue-raising reforms.
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Business-Government Relations
In January 1962, the stock market started to decline. This was caused in part by the mediocre
performance of the economy and in part by the poor relationship between business and government.
That same month, Kennedy had announced wage-price guideposts in order to jawbone labor and
business into holding wage-price increases in line with productivity. In April, U.S. Steel raised its
prices $6.00 per ton in direct challenge to the president’s injunction. In the famous confrontation
between Roger Blough of U.S. Steel and Kennedy, Kennedy charged that a $6.00 per ton price hike
was socially irresponsible and not consistent with his guideposts.
In the ensuing weeks, business-government relations ebbed to a new low, with fears that
mandatory wage-price controls might be instituted in order to combat anticipated inflation caused by
the perception of larger deficits. At this point, Treasury Secretary Dillon was still denying any need
for an immediate tax cut. Secretary of Commerce Hodges, however, had been won over to the side of
the CEA tax-cut advocates.
The headlines were dominated by news of further stock declines. From the record high of
734.91 on December 13, 1961, the Dow-Jones fell 200 points in the next half year. Kennedy was
concerned about the lack of confidence in his economic management on the part of business. Heller
tried to dismiss the market slide as caused by irrational fears on the part of business, and emphasized
the underlying strength of the economy.
The Dow-Jones Industrial Average
Source: The Wall Street Journal, July 2, 1962.
In subsequent months, Kennedy succeeded in restoring business confidence by initiating
three actions favorable to business. The first, in July 1962, was to issue new depreciation schedules
which affected 70% to 80% of all business equipment, resulting in a tax savings of $1.5 billion during
the first year it was in effect. The second was the Investment Tax Credit bill (described above) which
was passed in October 1962, as was Kennedy’s third confidence-winning measure, the Trade
Expansion Act of 1962.
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Kennedy’s Public Commitment to a Tax Cut
In June 1962, the administration had reached a decision to seek large, across-the-board cuts in
personal and corporate income taxes to begin sometime in 1963—thereby intentionally running a
fiscal deficit. The turning point in Kennedy’s mind and in the eyes of commentators occurred in a
Yale Commencement speech in the same month. Kennedy decided to abandon his attempts to
conform to traditional notions of “fiscal responsibility” and instead to attack directly the “persistent,
persuasive and unrealistic myths” surrounding deficit spending.
The myths were particularly threatening to the administration’s proposal. Former President
Eisenhower, for one, objected to the increased deficits and national debt in the pages of the Saturday
Evening Post:
I say that the time-tested rules of financial policy still apply. Spending for
spending’s sake is patently a false theory. No family, no business, no nation can
spend itself into prosperity…. They or their children will pay and pay and pay. In
effect, we are stealing from our grandchildren in order to satisfy our desires of
today…. But all of us would feel more comfortable and secure if our national
leadership exercised the foresight and self-discipline to balance its budget and to
begin paying back something on the national debt …. Imagine how much better the
country would feel if it had no debt at all but a healthy surplus!
While most of the public and private discussion centered on tax cuts as a means of stimulus,
this was hardly the only suggestion in the air as a vehicle for restoring prosperity. Professor John
Kenneth Galbraith, then ambassador to India, and Leon Keyserling, former chairman of the Council
of Economics Advisers under Truman, both strongly advocated a deficit generated not by tax cuts but
by increased public expenditure. Kennedy himself often had the same thought. “You know,” he once
remarked, “I like spending money.” Political pressures, however, dissuaded him from this course in
the 1962–1963 period.
Having decided on a tax cut, Kennedy next struggled with the issue of timing. In a
nationwide TV and radio speech on August 13, 1962, he claimed that an immediate cut was
unnecessary according to his reading of the current economic statistics, but pledged his commitment
to a tax cut package which he would present in detail in January 1963. By December 1962, Kennedy’s
CEA had prepared extensive briefs on tax cuts, deficits, the debt, the budget, and other economic
issues as background for a major speech to the Economic Club of New York. A summary
memorandum dated December 16, 1962 (Appendix C), outlines the motives and rationale of the
administration as well as the wide political support for a tax cut prior to its public presentation.
Kennedy’s Case for Tax Reduction
On January 21, 1963, Kennedy presented his Economic Report to Congress. This document
elaborated on the reasons for advocating tax cuts and reforms:
Let me make clear why, in today’s economy, fiscal prudence and
responsibility call for tax reduction even if it temporarily enlarges the federal
deficit—why reducing taxes is the best way open to us to increase revenues.
Our choice is not the oversimplified one sometimes posed, between tax
reduction and a deficit on the one hand and a budget easily balanced by prudent
management on the other …. If we were to try to force budget balance by drastic cuts
in expenditures—necessarily at the expense of defense and other vital programs—we
would not only endanger the security of the country, we would so depress demand,
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production, and employment that tax revenues would fall and leave the government
budget still in deficit. The attempt would thus be self-defeating.
So until we restore full prosperity and the budget-balancing revenues it
generates, our practical choice is not between deficit and surplus but between two
kinds of deficits: between deficits born of waste and weakness and deficits incurred
as we build our future strength….
I pledged last summer to submit proposals for a top-to-bottom reduction in
personal and corporate income taxes in 1963 for reducing the tax burden on private
income and the tax deterrents to private initiative that have for too long held
economic activity in check. Only when we have removed the heavy drag our fiscal
system now exerts on personal and business purchasing power and on the financial
incentives for greater risk-taking and personal effort can we expect to restore the
high levels of employment and high rate of growth that we took for granted in the
first decade after the war.
In order to enlarge markets for consumer goods and services and translate
these into new jobs, fuller work schedules, higher profits, and rising farm incomes, I
am proposing a major reduction in individual income tax rates. Rates should be cut
in three stages, from their present range of 20% to 91% to the more reasonable range
of 14% to 65%. These revisions would directly increase the annual rate of disposable
after-tax incomes of American households by some $8 billion when the program is in
full effect, with account taken of both tax reductions and tax reform. Taxpayers in all
brackets would benefit, with those in the lower brackets getting the largest
proportional reductions. American households as a whole regularly spend between
92% and 94% of the total after-tax (disposable) incomes they receive. And they
generally hold to this range even when income rises and falls; so it follows that they
generally spend about the same percentage of dollars of income added or subtracted.
If we cut about $8 billion from the consumer tax load, we can reasonably expect a
direct addition to consumer goods markets of well over $7 billion….
Even if the tax program had no influence on investment spending—either
directly or indirectly—the $8 billion to $9 billion added directly to the flow of
consumer income would call forth a flow of at least $16 billion of added consumer
goods and services. But the program will also generate direct and indirect increases
in investment spending. The production of new machines, and the building of new
factories, stores, offices, and apartments add to incomes in the same way as does
production of consumer goods. This too sets off a derived chain reaction of consumer
spending, adding at least another $1 billion of output of consumer goods for every $1
billion of added investment.
To raise the nation’s capacity to produce … we must invest, and we must
grow…. As a first step, we have already provided important new tax incentives for
productive investment. Last year the Congress enacted a 7% tax credit for business
expenditures on major kinds of equipment. And the Treasury, at my direction,
revised its depreciation rules to reflect today’s conditions. Together, these measures
are saving business over $2 billion a year in taxes and significantly increasing the net
rate of return on capital investment.
The second step in my program to lift investment incentives is to reduce the
corporate tax rate from 52% to 47%, thus restoring the pre-Korean rate. Particularly
to aid small businesses, I am recommending that… the rate on the first $25,000 of
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corporate income be dropped from 30% to 22%…. These changes will cut corporate
liabilities by over $2.5 billion before structural changes ….
The third step toward higher levels of capital spending is a combination of
structural changes to remove barriers to the full flow of investment funds, to sharpen
the incentives for creative investment, and to remove tax-induced distortions in
resource flow. Reduction of top individual income tax rates from 91% to 65% is a
central part of this balanced program.
Fourth, apart from direct measures to encourage investment, the tax program
will go to the heart of the main deterrent to investment today, namely, inadequate
markets. Once the sovereign incentive of high and rising sales is restored, and the
businessman is convinced that today’s new plant and equipment will find profitable
use tomorrow, the effects of the directly stimulative measures will be doubled and
redoubled. Thus—and it is no contradiction the most important single thing we can
do to stimulate investment in today’s economy is to raise consumption by major
reduction of individual income tax rates.
Fifth, side-by-side with tax measures, I am confident that the Federal Reserve
and the Treasury will continue to maintain, consistent with their responsibilities for
the external defense of the dollar, monetary and credit conditions favorable to the
flow of savings into long-term investment in the productive strength of the country.
Congressional Politics
Throughout 1963 the administration was under pressure from both ends of the political
spectrum. Liberals wanted more stimulus directed to the lower income levels. Conservatives argued
for more tax incentives focused on business investment and for reductions in public expenditures as
well. The support of Wilbur Mills (D., Ark.) who was the powerful chairman of the House Ways and
Means Committee would be essential. Ever since the inauguration Kennedy had actively courted his
favor.2 Kennedy’s Chief Congressional Liaison, Larry O’Brien, outlined Mills’s position at the end of
1962 for the president in a memorandum reproduced in Appendix D.
In order to facilitate progress of the tax bill through the House Ways and Means Committee,
the administration initially emphasized the tax reforms and played down the tax cut. Gradually the
emphasis changed as the lackluster performance of the economy continued. One inside observer
recounted the Kennedy-Mills courtship:
Initially Mills agreed to a major tax reform bill, with a little tax reduction to
help pass it. When presented, it was a tax reform and tax reduction bill. In testimony,
it became a tax reduction and tax reform bill. And when it was finally reported by
Mills, the president had his major tax cut bill with a little tax reform.3
In September 1963, after seven months of hearings and deliberations, the House Ways and
Means Committee issued its favorable report on the bill. A week later the House Rules Committee
reported the tax bill to the floor for two days of debate. By this point, Mills was an avid supporter of
the tax cut, arguing that a temporary deficit now would aid in achieving a balanced budget later. This
made the bill more palatable to those who were concerned with fiscal responsibility.
2 Theodore Sorensen, Kennedy (New York: Harper & Row, 1965), p. 432..
3 Ibid.
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Once the bill had received the approval of Mills and his colleagues in the House, it faced
similar challenges from the Senate Finance Committee, which opened hearings on October 15, 1963.
The objective of the administration was to appease both the conservative and liberal interests to the
extent necessary in order to secure a majority of the political center. The influential chairman of the
committee, Senator Harry Byrd (D., Virginia), was expected to oppose the intentional deficits
generated by the proposed tax cut and to spearhead the conservative opposition. The liberals still
maintained that the proposed fiscal stimulus was inadequate in size and inequitable in distribution.
Senator Byrd explained his objections to the administration proposal to Leon Keyserling (the liberal
chairman of the Council of Economic Advisers under Truman) during the Senate hearings:
… [T]here is not a single president in the history of the United States who has
ever deliberately urged a tax reduction on the basis of planned deficits. I think it is
even more dangerous to do it at this time because, as you know, Doctor, we have had
deficits for three previous years. Now, even the administration admits that, if this bill
is passed, there will certainly be deficits for six consecutive years. To my way of
thinking, a deficit is bad enough, but when it becomes a habit, when it becomes a
custom, it is even worse and may lead to serious consequences. … I am anxious to see
a tax reduction, but expenditures should be reduced first. I point out repeatedly
where these reductions could be made; each year I prepare what I call a Byrd Budget
….
Keyserling also wanted to modify the administration proposal with “a few broad
suggestions, keeping within the ambit of the about $11 billion which represented the size of the tax
proposal.”
First, … [a] general corporate tax reduction at this time is unnecessary and
wasteful. More than enough was done on this score in 1962. Second, … the allocation
of about 45% of the proposed personal tax cuts to taxpayers with incomes of $10,000
and above, who constitute only about 12 ½ of all taxpayers, is wasteful on economic
grounds and indefensible on social grounds. I submit that about half of this amount
could most usefully be diverted to tax reduction of a more useful and efficient sort.
The two foregoing suggestions come to a total of about $4.2 billion. Third, I
respectfully suggest that the exemptions be lifted enough to absorb this $4.2 billion
amount. The current customary exemption of $2,400 for a family of four has 67% less
purchasing power than the 1939 exemption. The families benefiting most by the
exemptions are even now hard-pressed to make ends meet. Helping them more will
help the economy most, and be a most worthy human and social gain.
What I am trying to show and prove, if I can, is that this $11 billion of tax
reduction at this time, in its nature, in its composition, is such that a large part of it
would be wasted and will do no good, and that part of it is distributed in a way that
is socially inequitable and unjust.
SENATOR GORE (Democrat, Tennessee): What do you mean by wasted?
MR. KEYSERLING: I mean that it will not be spent, it will be saved.
SENATOR GORE: You mean, then, insofar as being stimulative of the
economy—is that what you mean by waste?
MR. KEYSERLING: That is right. When our large corporations sit around a
table to determine their rate of investment, the first thing that they consider is
whether investment in plant and equipment will improve their technology and
productivity and thus give them a competitive advantage over those who cannot
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afford to make that investment. The second thing they consider is whether the
current and prospective demand for their products justifies the increase in their
productive capacity. The argument I am making is that, if our corporations now
answer these two questions in the affirmative, there is no problem of a barrier to
investment in the form of a lack of funds. Their after-tax profits are very high. Their
retained earnings are very high. There is such a prolixity of savings that even the
Secretary of the Treasury admits it.
After Keyserling’s testimony, the committee heard from Dan Throop Smith, a professor of
finance at the Harvard Business School at the time:
The tax bill before you, though it contains several good features, seems on
balance to be a bad piece of legislation. [A] deliberate increase of a large existing
deficit in relatively good times, with a prospect of continuing deficits for a long
period seems foolhardy. The country cannot afford economic experiments which are
almost certain at some time or other to weaken confidence in the dollar, both
internally and externally…. [D]eficit spending … was tried and presumably
discredited in the 1930s, when after a decade of deficits, we had over 10 million
unemployed just before World War II ….
Not only is a large tax reduction foolhardy, it is also likely to be futile in
dealing with the most serious aspects of our very real problem of unemployment. In
recent months there has been increasing recognition of the fact that unemployment is
concentrated in particular groups of the population…. The distinction between
general and structural unemployment has by now become familiar ….
Monetary and fiscal measures cannot solve the problems of structural …
unemployment. Increases in the general availability of credit or artificial increases in
general demand will not seek out the pockets of unemployment and unutilized
productive equipment. Rather, attempts to reach the pockets of unemployment by
artificial increases in total demand will lead to bottlenecks, to shortages, and to
increases in costs and prices in areas where there are no significant shortages ….
Undue reliance on general remedies distracts attention from the need for specific
cures and may actually weaken a general system. [For example] an attempt to relieve
a deficiency of a particular vitamin in a diet simply by eating more will probably
continue the deficiency and weaken the patient by obesity….
Our tax structure, however, is very bad. It represses and distorts effort and
investment…. The discouragement and distortion of taxation arise primarily from
excessive tax rates [which occur only in the top income brackets] …. Reduction in the
bottom-bracket rate increases purchasing power and is, of course, welcome on
personal grounds. But on economic grounds it is hard to see how it can do anything
more than increase purchasing power…. The combined effect of rate and structural
changes gives a reduction of tax liability of 39% in the bottom bracket, decreasing to
a reduction of 27% for incomes of $3,000 to $5,000, 20% for incomes of $5,000 to
$10,000, 17% for incomes of $10,000 to $20,000, 15% for incomes of $20,000 to $50,000,
and 13% for incomes above $50,000. Thus the relief at the bottom is three times as
much as that for the larger incomes. This discrimination makes our tax system
commensurately more progressive ….
[Finally] the proposed reduction in the corporation income tax is eminently
desirable. This tax is coming to be recognized, regardless of its incidence, as a penalty
on efficient producers. As international competition becomes more severe, the
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adverse effects of this penalty on efficiency becomes more serious. The tax rate
should be reduced as far as possible in view of revenue requirements.
*****
In response to the testimony of Keyserling and Smith, Secretary of the Treasury Douglas
Dillon sent a memorandum to Kennedy on the following day, October 24, 1963. This memorandum is
included as Appendix E.
After Kennedy’s assassination on November 22, 1963, President Lyndon Johnson pushed the
compromise tax proposal to a rapid vote in February 1964. There were several explanations for
Johnson’s ability to overcome the strong ideological debates that entangled Kennedy in 1963.
Undoubtedly aided by the sympathy for the slain president, Johnson also relied on his long working
relationship with influential senators to expedite the bill. In addition, Johnson’s projected 1965 budget
spending figure was below the 1964 outlay, which Senator Byrd supported. Finally, the Senate
appeared eager to complete action on the tax bill before the upcoming civil rights legislation began in
the spring.
The Revenue Act of 1964, signed into law on February 26, 1964, contained the following
provisions:4
!
Individual tax liabilities were cut $6.1 billion in 1964 and $9.1 billion in 1965. Rate
reductions and reforms combined were expected to cut tax liabilities an average
of 19.4% in 1965, with the new rates ranging from 14% to 70% after 1964, down
from the 20% to 91% range before the act. (For details on the distribution of the
tax cut, refer to Appendix F.)
!
Corporate tax liabilities were cut $1.6 billion in 1964 and $2.4 billion in 1965,
representing a 7.7% reduction when fully effective. The maximum corporate rate
was reduced to 48% from 52%. The rates also were revised to give special benefit
to small businesses.
!
A minimum standard reduction aided lower income families and removed 1.5
million persons from the tax rolls. Broader tax deductions were authorized for
medical expenses of persons 65 or older, for dependent care expenses, for the
cost of moving to a new job location, and for some types of charitable
contributions.
!
Various other provisions, including a significant broadening of the value of the
7% investment tax credit, which was enacted initially in 1962.
4 These excerpts may be found in the 1964 Congressional Quarterly Almanac.
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Appendix A
The Tax Cut of 1964
Tuesday, Nov. 13, 1961
Dear Mr. President,
At the last Cabinet meeting, you suggested that the various departments submit their
suggestions on the program promptly for the coming year.
This is not an official or departmental response. It is a personal letter written in an unofficial
capacity to introduce a memorandum I hope you will find useful.
The subject of the memorandum is one to which I have given considerable attention since the
first flowers of recovery bloomed in the spring. I did so because the history of our business cycle
suggested that the period of early recovery provides the best opportunity to act so as to sustain an
economic advance for a long period and prepare to meet effectively and overcome rapidly at some
future unpredictable point, the tendency to a recession.
A concern with the subject—”Sustaining Recovery, Avoiding Recession, or Minimizing a
Decline in the National Economy”—involves both politics and economics.
The politics are better disposed of in this personal vein in a few lines: the economics, or some
aspects of it, are much more complicated. They are treated in the attached memorandum.
Your Administration should be inextricably associated with “good times” in the minds of the
people.
This is a rare political asset.
Much has been done to capture it by your Administration.
Ten days after taking office, you announced your program to restore momentum to an
economy in recession. Shortly thereafter, a recovery was underway. In a few short months, the
economy had recovered its losses in gross national product and industrial production and was
breaking new ground.
Can that rare political asset—Kennedy prosperity—be preserved until November 1964?
There is a general consensus that the current economic advance will continue until at least
the latter part of 1962 or early 1963.
The odds are better than two-to-one in past performance of the business cycle (as described
in the attached memorandum), that there will be a recession in 1963. They (the odds) lengthen very
substantially that one will occur by sometime in early 1964.
Playing the averages, the recovery might end in March or April 1963, and the following
recession end in June or July 1964. Taking the last short recovery and recession as a pattern (1958–
1961) would show a new recovery in January 1964. Recoveries similar to the 1945–1948 and 1954–1957
patterns would give rise to recession around the turn of the year 1963–1964, with the likelihood that
the election of 1964 would occur in an atmosphere of economic decline.
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A forty-four-month recovery would carry through November 1964, putting the election in a
frame similar in some ways to the 1936 one, when FDR and the 1933–1937 recovery left the
opposition Maine and Vermont.
Sometimes it requires some months to detect and confirm a recovery and memories of recent
misery and anxiety do not quickly abate. Therefore, the next best ride on the cycle to a
forty-four-month upswing or longer, from a political point of view, would be a healthy recovery of
average duration (twenty-five or twenty-six months) followed by a short recession (nine months or
less). This would suffuse both the summer and fall months, when most of the voters make up their
minds, and November, when they vote, with the glow of a well-confirmed recovery.
Thus, the political implications of the subject of the attached memorandum are self-evident
and simple.
The answers to the question raised: how do we keep “good times” or see that they prevail in
1964—are neither self-evident nor simple. They require our best thought in the weeks and months
ahead—and a combination of rare economic wisdom and political skill.
I hope you will excuse the handwritten character of this letter, in view of its somewhat
delicate nature.
Respectfully,
Henry H. Fowler
P.S. Secretary Dillon is aware of the general tenor of the enclosed memorandum as we have discussed
the problem many times. I am sending him a copy and holding it to that. I did not want to disturb
him on his vacation to review the memo in all its detail. HHF
11
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The Tax Cut of 1964
Appendix B
The Tax Cut of 1964
July 12, 1962
MEMORANDUM FOR THE PRESIDENT
Subject: Tax Cut
A tax cut is a massive economic weapon. It can only be used once. It has not been used in any
previous recession in my memory. We have promised a tax cut effective January 1; a bill this year
could hardly be effective before October 1—and we may therefore be undertaking a major battle for a
3-month difference. You did not want us to overreact in Berlin with a national emergency—I do not
want us to overreact now. I do want us to act when we are certain action is required, even if
unprecedented.
Therefore, I am for a tax cut only when we can be certain (as certain as such matters can be certain) of
the following:
1. That both employment and production are on a decline that will be both
substantial and continuing;
2. That a cut in income taxes (which directly helps only those with earned income)
will not go largely into savings instead of consumption;
3. That the resultant deficit will not be as large as Eisenhower’s $12.4 billion in fiscal
1959;
4. That the tax cut bill we submit will pass both Houses of Congress in the form in
which it is submitted, with no danger of a defeat or its being amended so badly it
might have to be vetoed;
5. That the economy will not be sufficiently stimulated by the deficit now
predicted, by the tax credit, public works, and other spending bills we expect to
get, and by existing spending authority (and that we have no chance of getting
the stand-by tax authority);
6. That the situation is sufficiently serious to warrant giving up the likelihood of
passing our tax reform plans for next year;
7. That the cut we are able to propose, within political and budgetary limits, will
earn business confidence and not be attacked as the wrong size or in the wrong
brackets; and,
8. That the gains made by a tax cut will not be wiped out by more expensive
monetary and debt management policies—but that, on the contrary, everything
possible is being done in these two areas to make a tax cut unnecessary (see
12
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The Tax Cut of 1964
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memo from Senator Douglas, a long-time advocate of tax cuts to fight recessions,
who opposes a cut now).
Conclusion: Once you are able to go to the Congress and country with positive answers to these items,
such a move will be both right and successful. Until then, it is likely to be neither.
Theodore C. Sorensen
13
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The Tax Cut of 1964
Appendix C
The Tax Cut of 1964
December 16, 1962
MEMORANDUM FOR THE PRESIDENT
Subject: Recap of Issues on Tax Cuts (and the Galbraithian alternative)
A.
The Economic Case for Fiscal Action
1.
The cost of a slack economy
a. The $30-$40 billion loss of potential output in 1962 alone is:
–
8 times our total foreign aid,
equals total public and private expenditures on health and medical
care
well exceeds total expenditures on education
is almost equal to the total GNP of Italy.
b. Similar losses have occurred in each of the past five years. Next year, without a tax
cut, we would face a loss of the same order:
–
Normal growth of the labor force plus growth in productivity add
more than $20 billion to our productive potential next year,
Optimistic forecasts of actual GNP growth for 1963 without a tax cut
is of roughly this magnitude.
c. We do not predict a recession in the first half of 1963, but there is still one chance in
four or five that it will occur. And as expansion continues at a slow pace, the chance of
a recession steadily increases.
d. These are avoidable losses. Economics is no exact science; but economists are almost
unanimous in holding that an active fiscal policy can prevent this waste. And
experience in other countries, where popular and parliamentary devotion to outworn
fiscal doctrine is less rigid, provides impressive evidence to support them.
2.
The danger of too little and too late
a. This is a big country. For example: A budget deficit of $15 billion:
–
would be about 3% of potential GNP in 1963.
is equivalent to a deficit of $1–$1/2 billion in 1933 (when GNP was
1/10 of its present level).
is less as a percentage of GNP than Ike’s record deficit of $12.5
billion, which translates into $16.5 billion in today’s GNP.
14
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The Tax Cut of 1964
382-078
Our economy is basically healthy, but one doesn’t treat an elephant’s earache with an eyedropper.
(This metaphor has not been certified by Galbraith.)
b. Fiscal medicine is reasonably sure in its effects, but it takes time to work. Even the
Treasury’s initial proposal of a two-stage net cut of around $10 billion would probably
not achieve 4% unemployment (our interim target), until 1965. But we would be well
on our way by November 1964 not only to full employment, but to that 4 or 4–1/2%
growth rate to which we are pledged both at home and in OECD.
B.
C.
The Political Case for Fiscal Action
1.
Congress may be lukewarm, but powerful groups throughout the country are ready
for action. When the Chicago Board of Commerce, the AFL-CIO, the CED, and the
U.S. Chamber are on the same side—when repeated editorials in Business Week are
indistinguishable from those appearing in the Washington Post—the prospect for
action cannot be wholly dim. Can 3,000 members of the N.Y. Economic Club be
wrong?
2.
To be sure, the supporters of action do not agree on the details. But there seems
adequate room for compromise, and the Treasury proposals are superbly conceived
to provide something for everyone, and in a way that is solidly defensible on
economic grounds.
3.
Our world leadership—brilliantly asserted only a few weeks ago in the political
field—would be strengthened by vigorous expansion of our economy. Continued
economic slack saps our prestige and weakens the dollar. One looks for economic
miracles today not to the homeland of revolutionary economic expansion, but to
Western Europe and Japan. A booming U.S. economy can do more to cure economic
sickness in Latin America—and other primary producing areas—than all our foreign
aid.
4.
A limping economy in November 1964 would be a greater liability than a near-record
deficit.
Why Cut Taxes Rather Than Go the Galbraith Way?
The case for bold fiscal action seems inescapable. But why rely primarily on the
“conventional wisdom” of tax cuts? The economic effect of a $10 billion tax cut could, after all,
be achieved by an extra $9 billion increase in expenditures.
1.
But how could we spend an extra $9 billion in a year or two? This would be a
40 percent increase over FY 1963 Federal nondefense expenditures(excluding interest,
agriculture, and social security). True, our cities need renewal, our colleges and
universities have no place for the flood of students about to inundate them, our mass
transport system is in a sad state, our mental health facilities a disgrace, our parks
and playgrounds inadequate, housing for many groups unsatisfactory. But even if
Congress would appropriate the added billions, how could they be spent—in time?
Attempts to enlarge spending at the rate required to do the economic job would lead
to waste, bottlenecks, profiteering, and scandal.
2.
Politically, the case for tax rather than expenditure action is strong:
!
An expansion of spending would bring all of the charges of “fiscal
irresponsibility” that attach to tax cuts—after all, deficits would be
practically the same either way.
15
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382-078
The Tax Cut of 1964
!
But on top of this would be all of the opposition to expansion of
government, to over-centralization, to a “power grab” and a “take-over”
of the cities, the educational system, the housing market.
3.
Tax-cut-induced deficits are also far more acceptable to the world financial
community than expenditure-induced deficits, i.e., far less likely to touch off new
gold outflows.
4.
In the not-too-long run, the tax cut route is likely to bring us closer to our
government program goals than an immediate attempt to push the budget up by $10
to $15 billion a year—a vigorous economy, stimulated by tax cuts, will provide a
broader economic base and an atmosphere of prosperity and flushness in which
government programs can vie much more successfully for their fair share of a bigger
pie.
Walter W. Heller
16
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The Tax Cut of 1964
382-078
Appendix D
The Tax Cut of 1964
December 5, 1962
MEMORANDUM FOR THE PRESIDENT
During a telephone conversation with Wilbur Mills, he brought up the subject of the Tax Bill.
He made the following points:
1. Tax cuts, if any, should not be effective until January, 1964.
2. Objects strongly to deficit increase, and stated initial tax cut discussions in
August were based on the assumption we would now be in economic difficulty.
Feels this has not occurred and alters the situation.
3. Tax cut reform should be a package with proviso that if reform delayed in
Congress, the cut would be then treated separately. (I suggested to him that this
might bring about delay in reform if the Members would realize the cut was
forthcoming in any event. He agreed this might cause a procedural problem.)
4. Feels his Committee is impressed with the need for reform and therefore its
accomplishment is possible.
5. Repeatedly emphasized that spending cannot be allowed to rise faster than
revenue—the reverse must be achieved in the legislation to guarantee the
claimed ultimate goal of balance.
Concerning your New York speech of next week, he suggested you hedge on specifies—not get into
proposals for the Congress but rather emphasize economic progress from January, 1961—feels this
real progress has been lost to the public because of the constant tax cut discussions.
Claims he finds no public interest in a cut and others he has talked to agree—in his view, little or no
political plus and serious possibility of extremely adverse reaction to deficit increase …
Larry O’Brien
17
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382-078
The Tax Cut of 1964
Appendix E
The Tax Cut of 1964
October 24, 1963
MEMORANDUM FOR THE PRESIDENT
Testimony completely opposite to that of Leon Keyserling was presented to the Senate
Finance Committee yesterday when the bill was attacked by Professor Dan Smith of Harvard, who
had been in charge of tax policy during the Eisenhower administration. He vigorously attacked the
bill on economic grounds as giving too much relief to consumption, and not enough to investment,
and called for sharply lower taxes in the higher brackets.
Similar, but less extreme views were also expressed in the testimony of Roswell Magill, who
was in charge of tax policy during the second Roosevelt administration, and is now a lawyer in New
York. He called for considerably greater reductions in the higher rates of income tax, advocating a
50% top rather than the 70% in the current bill.
All of this indicates that the bill, as presently drafted, is pretty squarely in the middle and
subject to cross-fire from extreme elements on both sides. It is for this reason that we feel it is the only
type of bill that can be passed, and it is probably about right in its effects ….
Douglas Dillon
18
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382-078
Appendix F
The Tax Cut of 1964
Distribution of Personal Income Tax Rates Under 1964 Act
Source: Joint Committee on Internal Revenue Taxation, 1964 Congressional Quarterly Almanac.
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