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[COMMITTEE PRINT]



ANALYSIS OF THE HOUSE VERSION

OF THE TAX REDUCTION ACT OF 1975

(H.R. 2166) AND POSSIBLE ALTERNATIVES



Prepared for the Use of the
COMMITTEE ON FINANCE

BY THE STAFF OF THE

JOINT COMMITTEE ON INTERNAL REVENUE
TAXATION




MARCH 13, 1975



U.S. GOVERNMENT PRINTING OFFICE
48-579 WASHINGTON : 1975 JCS-8-75



CONTENTS



Pare

I. The current economic situation 1

Some factors contributing to the current recession 5

The outlook without a tax cut 6

II. Summary of administration proposal and House bill 8

III. Economic effect of an individual income tax reduction 10

IV. Duration of the tax reduction 12

V. Size of the tax reduction 14

VI. Distribution of the tax reduction 18

VII. Alternative ways to reduce individual income taxes 20

A. Tax refunds for 1974 tax liability 20

B. Changes in the standard deduction 30

C. Earned income credits : 32

D. Optional tax credit in place of the personal exemption 34

E. Rate reduction 36

F. Increases in the personal exemption 40

G. Tax credits for purchases of durable goods 41

VIII. Alternative ways to reduce corporate taxes 44

A. Increase in investment tax credit 44

B. Corporate tax rate reductions 49

C. Net operating loss carrybacks and carryovers 51

IX . Repeal of percentage depletion for oil and gas 54

(m)



I. THE CURRENT ECONOMIC SITUATION

The year 1974 was marked by both inflation and recession. After
moving ahead vigorously since the close of 1970, output and employ-
ment moved downward during the j^ear while prices continued to rise
sharply.

In 1974, real gross national product (that is, GNP in constant
prices) registered the largest annual decline since 1946. (See table 1.)
For the year as a whole, money GNP rose to $1,397 billion — 7.9 per-
cent over 1973, but this increase merely reflected higher prices. After
taking into consideration a 10.3-percent increase in prices (as measured
by the GNP implicit price deflator which is the broadest measure of
inflation), real GNP fell 2.2 percent. The decline in output and the
rise in prices was especially marked in the fourth quarter of 1974 when
real GNP fell at an annual rate of 9.1 percent and prices rose at a rate
of 14.4 percent.

TABLE 1.— GROSS NATIONAL PRODUCT 1929-74
[In billions of dollars]





Gross national


Gross national




Gross national


Gross nationa'




product in


product in




product in


product in


Year


current dollars


1958 dollars


Year


current dollars


1958 dollars


1929


103.1


203.6


1956


419.2


446.1


1933


55.6


141.5


1957


441.1


452.5


1939


90.5


209.4


1958


447.3


447.3


1940


99.7


227.2


1959


483.7


475.9


1941


124.5


263.7


1960


503.7


487.7


1942 _______


157.9


297.8


1961


520.1


497.2


1943 ______


191.6


337.1


1962


560.3


529.8


1944


210.1


361.3


1963


590.5


551.0


1945


211.9


355.2


1964


632.4


581.1


1946


208.5


312.6


1965


684.9


617.8


1947


231.3


309.9


1966


749.9


658.1


1948


257.6


323.7


1967


793.9


675.2


1949


256.5


324.1


1968


864.2


706.6


1950


284.8


355.3


1969


930.3


725.6


1951


328.4


383.4


1970


977.1


722.5


1952


345. 5
364.6


395.1
412.8


1971


1,054.9


746. 3.


1953


1972


1,158.0


792.5-


1954


364.8


407.0


1973


1,294.9


839.2


1955


398.0


438.0


1974 p


1, 397. 3


821.1



p = preliminary.

Source: Department of Commerce.



The falling GNP figures for 1974 reflect widespread declines in both
consumption and investment. Instead of registering their customary
gains, personal consumption expenditures (measured in constant 1958
dollars) for both durable and nondurable goods fell. The decline was
particularly sharp for durable goods expenditures which dropped
almost 9 percent for the year. About 8.9 million new cars were sold
during the year— 22 percent less than in 1973. The leading reasons for
the weakness in consumer expenditures were falling disposable income,
inflation, and lack of consumer confidence.

In contrast with 1973, when it rose 10 percent, real gross private
investment fell 8.2 percent in 1974. Housing starts totaled only 1.4

(i)



million compared with 2.4 million in 1972 and 2.1 million in 197.3. By
January 1975, housing starts were running at an annual rate of
well under 1 million.

As the economic situation deteriorated, unemployment rates rose —
from 5.2 percent in January 1974 to 8.2 percent in February 1975.
This compared with average unemployment rates of 4.9 percent in
1973, 5.6 percent in 1972, 5.9 percent in 1971, and rates averaging
3.8 percent or less from 1966 through 1969. The February unemploy-
ment rate was the highest since 1941. In addition, discouraged workers
have withdrawn from the labor force (and are not counted as unem-
ployed in the statistics) and employed workers have been forced to
reduce their hours.

Despite the recession during the year, the consumer price index was
12.2 percent higher at the end of 1974 than at the start of the year.
This was the highest rate of increase since 1946 when the index shot
up 18.2 percent, reflecting the removal of wartime price controls.
(However, for December 1974, the increase in the consumer price index
declined to an annual rate of 8.4 percent.) Although the wholesale
price index dropped slightly in December, for the year as a whole it
rose even faster than the consumer price index, shooting up 23.5
percent.

Interest rates rose during most of the year, but declined toward the
latter part of the year. Short-term rates have fallen considerably, but
long-term rates are now still at high levels, reflecting anticipations of
continuing inflation. In March 1975, the prime rate fell to 7% percent
after having reached 12 percent in 1974. As of the end of January, the
Treasur}^ bill rate (91 days — mew issues) was 5.61 percent, long-term
government bonds yielded 6.67 percent and AAA corporate bonds 8.74
percent. (See tables 2 and 3.)

Corporate profits for 1974 were high in money terms, totaling $141.0
billion before taxes. However, $35.6 billion of these profits were due
to the effect of higher prices in raising inventory values. After the
inventory valuation adjustment, profits amounted to $105.4 billion,
about the same as profits in 1973 but higher than profits of $78.7
billion in 1971 and $92.2 billion in 1972. Most analysts anticipate a
substantial decline in corporate profits in 1975.



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5

Some Factors Contributing to the Current Recession

No attempt is made here to enumerate all the causes of the current
economic downturn. However, the factors outlined below appear
worthy of note.

The money supply. — The Federal Reserve Board slowed down the
rate of increase in the mone}^ supply in 1974 in an attempt to keep
strong inflationary pressures under control. In 1974, the money stock
(currency plus demand deposits) increased 4.4 percent compared with
an average of 6.7 percent over the previous 5 years. Since the implicit
GNP deflator rose 10 percent for the year, the money supply in real
terms declined by over 5 percent during the year. Nonborrowed
reserves, an indicator of the direction of monetary policy, failed to
grow at all between November 1973 and August 1974. This un-
doubtedly has had an important influence in slowing down the
economy.

Fiscal situation. — As noted in table 4, the administration estimates
deficits in the unified budget of $35 billion for fiscal 1975 and approxi-
mately $52 billion for fiscal 1976. These figures assume that the Con-
gress will adopt the tax cut proposed by the administration and $17
billion of spending cuts proposed by the administration, including a
5-percent ceiling on Federal pay and social security benefit increases.
These anticipated deficits amount to a 1975 deficit of 2.48 percent of
GNP in 1974 and a 1976 deficit of 3.5 percent of estimated GNP in
1975.

TABLE 4.— UNIFIED BUDGET TOTALS
[Fiscal years; in billions of dollars]

1974 1975 current 1976 current

Description actual estimate estimate



Budget receipts 264.9 278.8 297.5

Budget outlays - 2614 3114 349^4

Deficit (— ) -3.5 -34.7 -51.9

Sourcs: The Budget of the U.S. Government for Fiscal Year 1976.

Despite the large actual deficits that are anticipated, many econ-
omists maintain that the Federal budget will be contractionary in
1975 unless offsetting action is taken. This is because the Federal
budget when measured on a full employment basis (which assumes
that potential real GNP grows 4 percent per year) is expected to have
a much larger surplus this year than in the past. (The full employ-
ment budget differs from the actual budget because when the economy
is at full employment, tax receipts are larger because the tax base is
larger and certain expenditures, such as expenditures for unemploy-
ment insurance and food stamps, are smaller.) In recent years, the
administration has used the full-employment surplus rather than the
actual surplus or deficit as the measure of the effect of fiscal policy
on the economy .

In the first quarter of 1973, the Federal budget deficit on a full
employment basis ran at an annual rate of $5.1 billion. In the third
quarter of 1973, the full employment budget swung from a deficit to
a surplus which continued through 1974. By the third quarter of 1974,

4S - 579— 75 2



6

the full-employment surplus was $30.4 billion. During 1975, the sur-
pluses on a full employment basis are expected to increase further
unless taxes are reduced or spending is increased. In addition, the full
employment surpluses of State and local governments are increasing.

Oil. — The sharp increase in the price of imported oil which has
resulted from the actions of the OPEC cartel now involves an annual
cost to the United States of approximately $25 billion, or about $18
billion more than in 1973. This has not only added to our balance-of-
payments problem; it has also acted to dampen our economy since the
outflow of such large funds siphons off purchasing power from the
domestic economy. Some part of this resulting deflationary effect is
(or will in the future) be offset by increased U.S. exploration for oil
and gas, but the net dampening effect is still very large.

Inventories. — In 1973 and early 1974, the fear of shortages en-
couraged firms to accumulate more inventories than they normally
hold in relation to their sales. Now, firms are trying to liquidate their
excess inventories, so that production is declining by more than the
decline in final sales.

Automobiles. — Sales of new U.S. autos have fallen from a rate of 10.5
million in the first quarter of 1973 to a rate of 5.8 million in the last
quarter of 1974. They have picked up recently as a result of price
reductions. While some of this decline in autos resulted from the tight
monetary and fiscal policies pursued in 1974, the depressed state of
the auto market is also a result of uncertainties about the price and
availability of gasoline and the sharp auto price increases that
occurred in 1974.

The Outlook Without a Tax Cut

Economic forecasters are practically unanimous in predicting that
in 1975 and 1976 the economy will continue to operate far below its
potential. Real GNP in 1975 is likely to be 3 or 4 percent below 1974,
which will mean a 5>or 6 percent decline from its 1973 level. Even if
there is no tax reduction, the economy should reach bottom sometime
in 1975, although forecasters disagree over whether this would be in
the middle or at the end of the j^ear. The recovery should occur because
some, but not all, of the economic forces that caused the recession
have reversed themselves. Firms are now liquidating their excess
inventories, and the completion of this process later in the year will
strengthen the economy. Most important, there has been a significant
easing of monetary policy in the past several months, which will
increase housing starts and business investment. (Nonborrowed re-
serves grew at a rate approaching 7 percent in the past six months.)
This recovery, however, is not likely to be strong enough to reduce
unemployment below 8 percent by the end of 1976 unless there is
additional fiscal stimulus.

With this pattern of forecasts for 1975 and 1976, the actual GNP
for this year will fall considerably short of the potential GNP. Table 5
presents data on actual and potential GNP and staff projections which
suggest that actual GNP during 1975 may be as much as 14 percent
under the potential GNP assuming the present budgetary picture
with no tax cut. This gap Mall be over $200 billion, or SI, 000 per capita.
This is significant for two reasons: first, it indicates that in the absence
of remedial action, there will be a large loss of economic goods and
services; and second, it suggest that tax reductions could be employed



to stimulate the economy without creating substantial additional
inflation in view of the large amount of available unused resources.



TABLE 5.— ACTUAL AND POTENTIAL GNP
[Billions of dollars, seasonally adjusted annual rates]



Year and quarter



Actual
GNP



Potential
GNPi



GNP gap

(potential

less actual)



1971-1
1971—1
1971—1
1971— IV
1972— I _.
1972-1
1972—1
1972— IV
1973-1 ..
1973-1
1973—1
1973— IV
1974— L.
1974—1
1974—1
1974— IV
1975— I..
1975-1
1975—1
1975— IV



1, 027. 2


1,081.4


54.2


1, 046. 9


1, 105. 2


58.3


1, 063. 5


1,126.0


62.5


1, 084. 2


1,141.0


56.8


1,112.5


1, 164. 3


51.8


1, 142. 4


1, 182. 9


40.5


1,166.5


1, 202. 6


36.1


1, 199. 2


1, 223. 8


24.6


1, 248. 9


1,258.3


9.4


1,277.9


1, 293.


15.1


1,308.9


1, 332. 1


23.2


1, 344.


1, 373. 2


29.2


1, 358. 8


1, 427. 7


68.9


1, 383. 8


1, 474. 3


90.5


1,416.3


1, 532.


115.7


1, 430. 2


1, 599. 1


16S. 9


2 1, 432. 5


s 1, 642.


209.5


2 1,454.0


» 1, 686. 9


232.9


2 1, 483. 5


» 1, 727. 7


244.2


2 1,520.3


3 1, 770. 3


250.0



1 The increase of potential GNP assumes a growth rate in real terms of 4 percent each year, composed of an increase in
the labor force of 1.8 percent, a decline in hours worked of 0.3 percent and a rise of output per man-hour of 2.5 percent.
These trends may not be an accurate reflection of conditions during the oil embargo of I ate 1973 and early 1974. Like all
measures of capacity, these are subject to a wide margin of error.

- Forecasts of Chase Econometrics, Inc., assuming no tax reduction.

3 Staff estimates using the methodology of the Council of Economic Advisers.



Source: Business Conditions Digest.



II. SUMMARY OF ADMINISTRATION PROPOSAL AND

HOUSE BILL

Administration proposal. — In his State of the Union message, the
President announced his economic, tax, and energy programs designed
to deal with the problems of recession, inflation, and energy de-
pendence. The tax proposals, which have been reaffirmed by the
administration in its testimony before the committee, include a
temporary tax cut for individuals based on 1974 tax liabilities and a
temporary increase in the investment credit for businesses. The
proposals also include permanent tax reductions for individuals and
corporations, and payments to nontaxpa3^ers, which are to be financed
by "energy conservation" taxes and fees.

The temporary tax cuts in the administration's anti-recession pack-
age amount to $16 billion. This consists of a $12 billion refund to
individuals of their 1974 income taxes and a $4 billion increase in the
investment tax credit for businesses. These two proposals for the
temporary tax cut are as follows:

(1) A cash refund for individuals of 12 percent of a taxpaA^er's 1974
income tax liability, up to a maximum refund of $1,000.

(2) A temporary increase in the investment credit (from 7 percent
to 12 percent general^, and from 4 percent to 12 percent for most utilities)
for businesses, effective for property placed in service in 1975 (with an
additional 2-year period for certain utility property) and covering
binding contracts in effect at the end of 1975 if the property is placed
in service before the end of 1976. In addition, with respect to utilities,
the limitation on the amount of investment credit which may be
claimed in a year would be temporarily increased.

The permanent tax reductions and payments to nontaxpa}^ers
proposed by the administration are to be financed by the energy
conservation taxes and fees as part of the administration's overall
energy program. In the case of individuals, these permanent tax
reductions are as follows:

(1) An increase in the low income allowance from the present
$1,300 to $2,600 for joint returns ($2,000 for single persons).

(2) A cut in the schedule of tax rates.

(3) A 15-percent tax credit on the first $1,000 of expenditures for
thermal efficiency improvements in residences, effective January 1,
1975.

(4) An $80-per-adult payment to nontaxpayers and a lesser amount
for certain low income taxpayers who receive less than $S0 in tax
reductions, so their refund and tax reduction together equal $80.

The administration also proposed permanent tax cuts for corpora-
lions by a reduction in the corporate surtax rate of 6 percentage
points (reducing from 48 percent to 42 percent the total tax on
income over $25,000), effective for 1975.

House bill. — The Committee on Ways and Means decided to deal
with the temporary anti-recession tax reduction package first and then

(8)



9

take up the administration's energy program and permanent tax
reductions. In the House tax reduction bill, the size of the tax cut
proposed by the administration was increased from $16 billion to
$20 billicn. (Both the administration proposals and the House bill
would involve some additional revenue losses for 1976.) The tax
reduction for individuals was increased from the proposed $12 billion
to $16 billion while the business tax reduction was decreased slightly.
(The administration proposals would reduce 1975 business taxes by
$4.1 billion; the House bill would reduce them by $3.6 billion.)

The 1974 refund was reduced in the House bill from $12.2 billion in
the administration proposal to $8.1 billion, and its structure was
changed to concentrate more of the reduction on low- and middle-
income taxpayers. In addition, the House bill includes $8.1 billion of
tax cuts for 1975 that are to be reflected in lower withholding. These
are a $5.1 -billion increase in the standard deduction (including the
low-income allowance) and a $3.0-billion refundable credit for low-
income people based on earned income.

The House bill raises the investment credit to 10 percent, instead
of the 12 percent proposed by the administration. The House bill also
liberalizes the extent to which most utilities may use the investment
credit to offset their tax liabilities. In addition, the House bill provides
in the case of long lead time property (that is, property that requires
at least 2 years to construct) that the investment credit is to be avail-
able to the extent that progress pa3^ments are made during the con-
struction period, rather than the year wheri the property ultimately
is placed in service. This new feature of the investment credit, which
is permanent under the House bill, is to be phased in over a 5-year
transitional period.

The House bill reduces taxes for small business by increasing the
limit on the amount of used equipment that can qualif} 7 ' for the in-
vestment credit from $50,000 to $75,000 and by raising the corporate
surtax exemption from $25,000 to $50,000.

The investment credit provisions provide for $2.4 billion reduction
for businesses in 1975 and $1.5 billion in 1976; the increase in the surtax
exemption is expected to reduce revenue by $1.2 billion for 1975, of
which $730 million (or about 60 percent) is expected to go to businesses
with incomes under $100,000.

The House bill also repeals percentage depletion for oil and gas,
effective January 1, 1975, except for regulated gas (which retains
percentage depletion for 18 months) and gas sold under a pre-existing
fixed price contract. This provision (sponsored by Congressman
Green) was added to the bill on the House floor and is expected to raise
$2.2 billion in 1975 and $2.7 billion in 1976.



III. ECONOMIC EFFECT OF AN INDIVIDUAL INCOME TAX

REDUCTION

Most economists believe that an individual income tax reduction at
a time when there is excess capacity in the economy will increase the
level of real income and emplo3anent. People will spend a fraction of
their tax cut on consumer goods, which will create jobs and increase
incomes. The individuals who receive these increases in income (as
wages and profits) will spend some fraction of the increase, thus creat-
ing more jobs and still further increases in income. Businesses will
respond to higher demand for their products by increasing their in-
vestments which will also expand the econonry. There is some dispute
about the precise magnitude of the "multiplier" — the increase in


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Online LibraryUnited States. Congress. Joint Committee on InternAnalysis of the House version of the Tax reduction act of 1975 (H.R. 2166) and possible alternatives (Volume JCS-8-75) → online text (page 1 of 7)