Business roundtable; Do we need a federal income tax increase?

The following program is made possible through a grant from nation's business. This is business roundtable a program of current comments from leading members of America's business community. Today. Dr. Roland Hi Robin son professor of financial administration Graduate School of Business Administration Michigan State University and Dr. Paul E. Smith assistant professor of economics also of the Graduate School of Business Administration at MSU. Well explore the question do we need a federal income tax increase now with series host Alfred L. Seeley dean of the Graduate School of Business Administration at Michigan State University. In January of this year President Lyndon B Johnson recommended to Congress a tax increase of 6 percent. As a

surcharge on taxes paid by corporations and on personal income. Congress took no action on this request. Subsequently in August the president again strongly called for a tax increase. This time he recommended 10 percent. He based the request on the need to dampen what he called the increasing threat of inflation and an estimated budget deficit for the fiscal year ending in June of 1968. Twenty nine to 30 billion dollars. The deficit for the past year was just short of 10 billion dollars. The president's request for a tax increase as the strong support of the Treasury Department. The Council of Economic Advisors and the Federal Reserve System. Today. On Business Roundtable we examined this important issue affecting the nation's economic health.

Do we need a federal tax increase now. Dr. Smith what are the basic basic causes of inflation that the president feels that we need a tax increase to combat. Well perhaps the two most common ones the ones we would first be best described one as an excess demand inflation or what we sometimes call a demand pool inflation. This arises simply because the. Combined economic sectors of the government sector the private sector including both consumers and investors simply want more goods and services and they are able to buy them than are available. As the price goes up. You know that I was equally as any schoolboy was I hope at least mine had better know. That an increase in the demand for commodity is going to raise prices. Now. Perhaps the greatest source of increases in demand in the last two years and will begin to notice is price

increases going to be more. Versus better. What you say is perfectly true and I have no quarrel with it but I feel that there is an element of urgency about this situation that requires a little bit more than the sort of pedantic explanation. We live in a circumstance in which inflationary expectations have been built up by virtue of inflationary experience and these inflationary expectations have come to the point. Where real estate people are selling houses on the basis of the true costs are going to go up 5 percent every year. That at the same time common stocks have been have been sold to investors on this basis and we're building into our economy something that I doubt it can last in other words while what you say is quite true someway After all it doesn't give us a sense of urgency that this problem really deserves. There is a serious situation which has been brought about not. Do we need a tax increase now but we've needed one for two years.

In my opinion are the prices the price of oil has been going up as a Doctor Robinson. Well the the price level is there are several ways of measuring the price level as measured by wholesale prices was very stable until about a year and a half ago and then it has been going up. Now this the Consumer Price Index which measures the basket of commodities that we buy is has been going up for a long time and then it started to go up rather more rapidly. But I repeat that the thing that sheens was in place in our expectations and that is what is is creating an atmosphere in terms of bargaining. And that was very in terms of a raise was in our economy that I believe is not tenable that it creates a situation that will get worse before it gets better. What are some of the other other causes of inflation besides this excess demand in relation to the quantity of goods or services available. Well first let me say that I entirely agree with Dr. Robinson that the time to take action would have been two years ago. I might argue now that it's a little late.

And that perhaps expectations being what they are. There might be a few danger signals in the economy where we wouldn't want to be too hasty. Now the other major source of inflation is the so-called wage price spiral or sometimes referred to as cost push inflation. Where we might initially say get an increase in wage rates perhaps due to union activity or minimum wage legislation or something of the story. Which would be in excess of that. Which might be associated with the increase in the productivity of labor. Consequently the cost to producers and firms have risen. So then the manufacturer has to increase his price to cover is increased labor costs right now it should be pointed out here that there are two other factors to be considered. One that this requires some degree of market imperfection in both the labor market and the product market in order to make these price increases in wage increases possible.

Secondly. That there may be another adverse effect in that once a price increase occurs this can only be done perhaps at the expense of lower sales for business firms. So we may have a side effect and that. There can very well be a decrease in output and employment associated with the rise of gravity would you agree with that. Well I shan't quarrel with that. But in this world who sometimes want to balance things a little differently and let me say it words that that that say the same story but perhaps give a different tune to it. It is quite right. That under circumstances in which people feel that they can improve their income bargain that they feel that they can do it. That is it. That is it is not only that Labor good raises prices but doctors can raise their fees. I'm afraid the professors can sometimes bargain to DMD's a little more advantageous way if you can answer to that point. I have a feeling that this goes down to the point of whether they bid on little jobs for paving your driveway

but all the way around that there is this feeling that you can get away with it and so that that what Professor Smith has described this cost Bush and I think correctly nevertheless is given a push and it's given a rather sharp push when there is a belief that it can be made to stick and that you can get ahead of the other guy a little bit. In other words your sales don't go down that you get that you can you can see what's going to happen earn terms of some of the recent contract negotiations between business and labor where apparently two very large ones. The rubber industry and the recent Ford contract appear to give labor a wage increase considerably in excess of the productivity increase that has taken place. I don't want to debate this but matter in terms of equity it to try to get back of each of these bargains because each of these represent many complicated issues that in our time we couldn't possibly deal with. But

it is clearly true that in every case whatever the bargain was settled I am sure that the employer had back in his mind that even though it was a pretty high demand that he could pay it because he could pass it along. That is this is a part of this of this problem which I described as inflationary expectations are such that we expect that we can get away so that when you ask your question do we need a tax increase. I really could only answer it by saying what we really need is something that will break this chain of inflationary expectations. I hope it isn't a great traumatic event. I hope we can do it gently. I hope we can do it in a sense put on the brakes nicely and neatly. But this is a problem of economic statesmanship which in my opinion we have failed on rather badly. In other words you are in agreement we need to do something to slow down the price rise. I certainly am and from what Dr. Robinson It seems to me that he has made an argument for that.

We have got both kinds of inflation going on and I think that's very true and one of the problems here is is it's really difficult to say just which is happening. The. Last two years we've had perhaps a rate of increase in the consumer price levels 3 percent a year maybe a little less. There's no way that we can say 2 percent of this is due to excess demand inflation the other 1 percent is due to cost push inflation. And you know maybe making an exhibition of our ignorance at this stage. Now if we've had as you mention 3 percent rise in price levels during the past few years. And the current year we're having one of approximately the same magnitude. What do we do to combat this. How do we come back at this kind of price inflation. In other words what can the federal government do about it. Well we have two broad classifications of policy one which we can call

general controls and that they do not discriminate between demand for one type of commodity as opposed to another. Subdivided these can be broken down broadly into fiscal policy which relates to manipulating local government expenditures and taxes and secondly monetary policy which is designed to control the volume of credit. And the Grahams were the most effective. I wish I could answer that question. I wish I could tell you exactly what it is that is effective in combating complacent and particularly how we haven't put out a brushfire of it. I think rather than that I'm doing what I can't really do honestly though that maybe we can we can put the problem in better perspective if we if we said this that strictly speaking all of the policies of government should be harmonious. I think the first place that the policy is a government with respect to expenditures. The policies of government with respect to taxes.

The policy of government with respect to its money system. And I would say that the policy of government will respect him to many things that lie about this regulation of financial institutions. I think the policy of government with with respect to the bargains that it makes all of these things need to be a part of a harmonious whole. And I think in many ways our failures there and I think it a serious failure that we have we have for example in 1946 depended on one line of policy money. Recently recently we have changed and money has been rather free and there has been. I hope it isn't because it's an even numbered year. Odd numbered year I should say a push for taxes in this year. But nevertheless I don't believe that our expenditure policy and our monetary policy and our taxing policy have have been well coordinated so that when you ask the simple question should taxes be increased. I really

believe it should be rephrased. Should all of the powers of government be harmoniously used to fight inflation and I can only say the very heartfelt way. Yes yes yes. I take it that your reference to the odd numbered years has something to do in this country with the elections that we have. Let me say it honestly. I not sure. I am not sure that I would have the courage if I were in office to always act absolutely fearlessly and face the public because taxes are not popular. I might add that expenditure cuts are unpopular but we have at the present time. A rather serious conflict in which on one side our present record present is recommended a tax increase. Congress I don't know whether it is really failing in its duty but is turning to the president not its own function which is normally constitutional reforms saying to the president cut expenditures and so the two of them face each other like angry children and we get no

action whereas we really need action both ways that is I feel that this is where the where we should place the problem that we are failing and getting the full package of action of government that we need. But your reaction to this question document form certainly in accord with Professor Robinson I think we mine and two we have the Federal Reserve system sitting back and saying Let Congress and the president do it. It seems to be largely a matter of after you Alfonse. This may have been for working over hard in the year 1946 in which we didn't have a stoppage of the creation of money and a stoppage it was so abrupt and so sharp. That we had what is called a credit crunch but the fact is that there's generally been associated weather with it and that year we suddenly had such a sharp change that there was very little credit for housing. We had an unusually sharp I think and to sharpen impact in one narrow segment so that in the year

1946 too much now not enough. You mean the amount of money available to the commercial banks from our Federal Gas Gas is the whole harness of money creation process. That was that was abruptly changed to slow down in 46 or 60 secs and then speeded up and 67 well attacks in Greece now slow down the rate of inflation. Well sir. You think it will. Yes if you concur Yes. But I believe that the answer I would still have to give is that it really is one of a number of steps that should be taken and which we should have a. All of these powers that Professor Smith described brought into a harmonious application. And it is it is this problem of trying to marshal all of the forces of government it is the problem of its more than cored nation. Its really getting together the forces on an agreed policy within the federal government. I know you have been talking today about the increase in taxes which

pulls money away from consumers and corporations so they dont have as much buying power and therefore tends at least to dampen prices and not being able to increase them and still sell the same amount of goods. Youve mentioned some of the monetary policy of the restriction of the amount of dollars available through our banking system for the same reason. Now isn't there a third possibility that has been mentioned by many people and these are some form of direct control. Now we've had two periods of real direct wage price controls in the United States during World War Two and for a brief interval during the Korean War. What's your reaction to the imposition of utilization of wage price controls. Well in my mind and to this the attempt and recent years to impose wage price guidelines which certainly are not direct controls but an attempt at moral suasion perhaps a little course to prevent price and wage increases from exceeding productivity increases. Generally. The

Economist as far as direct controls is concerned would disagree violently with imposing except and yet most emergency and then wouldn't hunt awfully hard for a better alternative. In other words you say nothing in the current picture that would lead you to suggesting any direct wage and price controls. We tried direct wage and price controls and even in war times as I believe you yourself know they have worked with with very mixed and uncertain success and certainly in peacetime not only on the score that I think that they're philosophically objectionable but I believe that they're not very practical I I believe that that we have to recognize. That in a society in which freedom is widely practiced and which we believe in and. That rather than having controls that bear directly on the individual that these generalized controls

which have to do with the spending and the taxing and the money system are controls which are acceptable in peacetime and that there are very few other. That that are acceptable in fact the effective are these tools. I wish I could answer with more affirmation than I can. I would have to admit I would have to admit that when you get as strong a degreed of inflationary expectations as we are now suffering from. That is a kind of a momentum that our brakes will hold immediately that if you should ask me Will a tax increase really solve our problems I'd have to say that it's like applying a brake. It'll slow us down but I'm not sure that it will that it will be completely effective. And I I would only I would only say that we need to do something because the car is going too fast.

Reduction in my Or maybe I interpret incorrectly. I interpret from your remarks that you don't think that a tax increase now will have much impact on slowing down the rate of the price rise. For Hap's I should rephrase that a little. The assumption here is that this inflationary pressure is going to continue. I'm not entirely certain that our forecasting tools are not that accurate yet and there has been in just the last month or two some signs of a slowdown in the economy. A slight increase in the rate of unemployment. Profit levels are dropping in some firms in the third quarter statements of the recent we've been issued. And I think you are taking to severe policy. Making. At one time. Me just I think it is true that the advocates their immediate tax increase pred. this on the assumption. That next year

1968 is going to be a very prosperous year with continued economic expansion. I take it that you would question this fundamental or basic assumption. I wouldn't question the continuous economic expansion perhaps a rate of continuous economic expansion. What would you then think that the price rise next year might be. Or. I think perhaps at the same rate as this year. If you can't make any other day readers and always say things next year will be about pulling up 3 percent probably. I would like to let you would you lead with this kind of a percentage over a period of time. Or do you think this is bad for the economy. I hate to make a value judgement here I would like to point out however that there is a cost and price level stability and apparently there is some relationship between the rate of increase in prices and the level of unemployment. So we may have a trade off here we may have to decide whether we would prefer what you

might call relatively full employment whatever that may be in complete price level stability or on the other hand to some inflation. And at the same time have full blown doctor absent would you live with a 3 percent price rise year after year or do you think. Take a look at this one. Sally. I don't mind a bit making a value judgment perhaps. I leave my role as a as a professional economist and simply become a private citizen expressing my view at this stage. But I bloomed first as an economist. That to talk about a continuous 3 percent increase in prices is simply not possible. Either we will have more or we will have less. I believe that there is built into our bargaining system as we were talking before the fact that when we start to have. A system in which people expect this much of it increase everybody's going to try to beat the

God that this is a part of the bargains and once this sort of expectation is building it either gets faster or gets slower. One of the things that makes me very unhappy because if I can revert to my role as a professional economist I would hope seriously in earlier years that we had learned enough about the process that we could manage it that we could some way a balanced economy and that we could stay reasonably on an even keel. I think maybe it is still possible. But I believe that we are more seriously in jeopardy of something like this that we could have both inflation and still not a full use of resources. That is that we could have a case and what's there. There would there would be this. This building I had and still at the margin of our economy not a full use of resources because while this is a complex question. This has happened some times in the past this is not without precedent and this is my fear.

I think it should be pointed out here incidentally with respect to the expectation's effect on rising price levels. If people in business firms in general believe that the government is willing to use these controls and especially if they believe that they will be effective announcement effects as we sometimes put it. The brakes will be put on and a lot of psychology kind of at work here when terms of consumer reaction to these. Let's look at another facet of the problem. A number of bad good cept that we've certainly got to cut government expenditure with the kind of deficit federal deficit we are running or we can't combat this rise in prices regardless of the tax increase. The answer that I would have to give you is a twofold answer. In the long run I would much prefer to have a system in which we make our judgments and we divided up between the private economy and the public economy and

we have some stability about this division of the use of resources and then that we are just up through the site of taxes and this is a point on which there could be different views and Professor Smith may differ but this is my is my feeling as a long matter but we're not. We don't live in the long run as Keynes said we're all dead in the long run and in the short run. So I want to survive but I want to survive in a viable economy. I believe that even if we give up some programs that we personally want that this is a time when we when we need to cut expenditures as well as raise taxes. And I would even admit to cutting some some expenditure I want I won't deny that there I have some peps but I'll keep the list of best private production it would you advocate cutting the federal budget at the present time in view of the magnitude of the deficit. Yes I think in conjunction with perhaps a mild tax increase or possibly something less than 10 percent it's been suggested she actually here we have a choice. Are we going to give up perhaps in the refrigerator or perhaps perhaps a little bit of a space

program. I'd rather give up a little of both of them than give up a big chunk of my own have you know what's been happening in other industrial countries of the world with regard to inflation and price rises in recent years not grubs and in spite of the rather alarmist tone that I've taken. I mean for one moment I speak a little more complacently and even a jingoistic fashion. The United States has done pretty well. There are very few countries of the world that have that have contained price rise in the post-war period as well as we have and this goes right to the present time. And I'm not talking about the extreme cases such as in South America or or in some of the underdeveloped nations where inflation has gone wild. I am comparing our experience with Western Europe all record is better than the average of Western Europe and it is better than almost any country within Western Europe. Well then let's look at another aspect of the problem. Let's assume for a minute that the Vietnam war should be ended with an old let's just pick a

figure here for discussion purposes of say 6 months. Because most of the federal budget deficit today is a result of the war expenditures. Now if it should end in six months where does this leave us on this question of inflation next month. I think under those conditions will better have another round table discussion or have you make buy out my heart jump with joy to raise this possibility of there being an end to the conflict and there is no doubt that if if we could we could we could then within the cutting of expenditures that would be a part of that. Make a very drastic change. The point however is that even though this is a real issue it is much easier. It is much easier to accomplish that side. And I have no no fear that that we could do what I do care is that we won't be able to take the better medicine of the other side raising taxes and cutting expenditures.

In other words this theory that we cut taxes when we have a slight downswing in our economy to pump money out in the hands of consumers to bring us back seems to work rather effectively. But at the time we need to take more restrictive measures such as increasing taxes or restricting the money supply that this is a much more difficult thing to accomplish. Yes and particularly with respect to adjusting government expenditures should know that during periods of inflation high income. Full employment that people typically want more government services. So the demand for public goods increases just like the demand for anything else. So when affecting stabilization policy at least through cutting expenditures in the public sector This may run counter to what a lot of us would like as private individuals. Everyone other thing that would work for us very strongly if we should have an end of the Vietnam struggle which I dearly hope that we would have and that would be the fact that not only would there be government expenditure that would be cut but we would have in a benefactor

in the private sector a very large number of plans but they carry in industrial plans that now they can see the longer term horizon much more clearly so that I have a feeling that here we can convert to peace peace is no threat that it is worth it as a threat and so it's a respectable question the fuel raised but it doesn't worry me the slightest bit. But we have converted to peace very gracefully. The last two times and there is no reason we can't do it again. But X-Men 2 I sum up your views correctly that you think we don't pacifically need a tax increase now and our crabs and you do. I don't believe you summarized quite correctly I would say a tax increase but I'm going to go anywhere in August and our time is up and I certainly thank you for appearing on the Business Roundtable and Dr. Robinson thank you very much for a most interesting discussion. Participating in today's business roundtable where DR ROLAND eye Robinson

Professor of Economics Graduate School of Business Administration and Michigan State University and Dr. Paul Smith assistant professor of economics also of the Graduate School of Business Administration at MSU post where the program was Alfred L. Seeley the dean of the Graduate School of Business Administration at and as you. See. This program was produced by the Graduate School of Business Administration and the Broadcasting Services of Michigan State University under a grant from nation's business a publication of the Chamber of Commerce of the United States. Business Roundtable is distributed through the facilities of national educational radio. This and he are the national educational radio network.