Effects of the Tax Hike

THE ECONOMY

The outlines of the deal had been clear for some weeks. In exchange for the tax increase that he believes essential to save the economy from inflationary chaos, Lyndon Johnson would submit to massive budget cuts, despite pressing domestic needs. Last week when the package finally came to a vote, the House passed it by a surprisingly comfortable margin of 268 to 150, and only 16 1/2 hours later the Senate, by an even cushier 64-to-16 vote, rushed the measure to the White House, where it awaited certain approval.

What effect it will have on the economy is less sure. At best, it will ease inflationary pressures. But there is also a danger that the combined restraint of higher taxes and reduced spending will prove too powerful a brake, throttling expansion rather than merely controlling it.

Up, Up & Away. The tax increase was long overdue. Johnson requested a 6% surcharge on personal and corporate income taxes as far back as his 1967 State of the Union address, then failed to press for it. Ten months ago he demanded a 10% increase, but a recalcitrant House coalition, led by Ways and Means Chairman Wilbur Mills, would not yield without parallel cutbacks in Government outlays. Meanwhile, consumer prices were advancing at an annual rate of 4%, more than twice the average of the early '60s. The gross national product was bubbling toward the $850 billion level, up some $65 billion from last year. Interest rates soared. On top of a $20 billion-plus federal-budget deficit in the fiscal year ending this month, the new year was expected to bring as much as $30 billion in red ink. So huge a deficit, in turn, threatened to reduce confidence in the already shaky dollar. His back to the wall, Johnson finally met Mills's price for a tax increase, and the influential chairman, together with the House Democratic and Republican leadership, combined to assemble a large majority for the bill.

The Bite. Most taxpayers will begin to feel the measure's impact by mid-July. Because the increase for individuals is retroactive only to April 1, the increased bite for 1968 will really amount to 7 1/2% (example: the $10,000-a-year man with wife and two children who paid $1,100 in taxes last year will pay an added $83.25 in 1968). Corporations, liable for the increase as of last Jan. 1, will pay the full additional 10% in taxes. Though the surcharge is supposed to run to next June 30, nobody would be surprised if it were prolonged. In return for the surcharge and some relatively minor revenue measures--which together will yield an estimated $15 billion in the next year--the Administration reluctantly accepted a mandatory $6 billion spending cut by agreeing to a $180.1 billion limit on federal outlays in the new fiscal year.*

Where will the cuts come from? House committees last week sliced into foreign-aid funds and into the proposed budgets of the Department of Health, Education and Welfare and the Office of Economic Opportunity. Congress thus showed an alarming eagerness to chop hardest at politically vulnerable programs despite their proven value--one in furthering U.S. policy abroad, the others in coping with urgent problems at home. Military spending not directly related to Viet Nam will likely be reduced as well, along with the space program and such public works as highway construction and waterway improvement. The Federal Aviation Agency, the Atomic Energy Commission, the Post Office and other agencies also stand to lose some money.

Putting on the Brakes. Though many economists and businessmen considered the drastic measure necessary to check the speed of economic expansion, it has several negative aspects--apart from the extra tax wallop. At a time when job opportunities for the poor must be broadened, unemployment may increase as a result of belt tightening by both Government and private enterprise. With contracts in the steel, shipping and aerospace industries due to expire in the next few months, a wave of serious strikes could brake the economy further. Nor is the rate of consumer-price increases likely to decline for several months.

Nonetheless, the potential long-term benefits are obvious. The federal deficit for the next fiscal year is now estimated at about $7.5 billion, as much as $22.5 billion less than it might have been without the tax bill. As a result, Washington will not have to borrow as much money --good news for those seeking home mortgages or other forms of credit. The entire economy could ease into a more stable growth pattern than has prevailed for the past two years. There may be some disconcerting bumps as things decelerate, but they are likely to be gentle compared to the inflationary bang that would almost surely have resounded without the tax bill.

* Congress exempted certain categories from the restraint: Viet Nam, federal-debt service, veterans' benefits, social security, and the Commodity Credit Corporation.

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