While Raising Taxes . . . .

An Administration economist observed last month that if there were no Vietnam war the Federal government would have a budget surplus rather than a deficit. But there is a Vietnam war, and as military expenses grow interminably, the government anticipates a deficit of $29 billion for fiscal 1968. A deficit this large causes an excessive stimulus on the economy, and for that reason President Johnson asked Congress in early August to approve a temporary 10 per cent surcharge on income taxes for both individuals and corporations. He hopes this surcharge and other fiscal proposals will reduce the deficit by $11 billion.

Under the 10 per cent surtax plan, a taxpayer would calculate his tax in the normal manner under the existing rate. He then would calculate 10 per cent of the tax and add it to the tax to obtain the amount which he owed the government.

Opponents of the tax hike have two arguments: that sharp spending cuts should take priority over higher taxes, and that the economic conditions do not warrant the increase. In the first case, any spending cuts would come in non-defense areas which have the most pressing needs. Therefore to oppose the tax hike in protest to the war in Vietnam serves merely to desert vital programs. The President has made his opinion clear that the war, though costly, is vital to American interest. To disagree with this priority is admirable; but to disregard it is unrealistic and stupid.

The second argument concerns the economy. If the economy advances rapidly, a large Federal budget deficit helps create inflationary pressures because the government is putting more funds into the economy than it is taking out. The tax increase tends to slow the economy by restricting the ability of individuals and corporations to spend. In the absence of an economic boom, however, a tax increase tends to further depress economic conditions. In an economy operating at a slower pace, less consumer spending would result in lower tax revenues, thereby negating the beneficial effect of any tax increase.

The nation's sluggish economic activity from January to June this year has led critics to fear the recessive potential of a tax hike. But Gardiner Ackley, chairman of the Council of Economic Advisers, has said recently that there was "no longer a significant risk" of recession to block a tax hike. Rather, he added, an income tax increase has become essential to hold down prices and interest rates.

A $29 billion deficit, coupled with the built-in cost-push inflationary pressures of wage and price increases, will probably bring about a return to excessively high interest rates and tight money conditions from the Federal Reserve Board (Fed)--if Congress does not act quickly on the proposed tax increase. A delay in the hike would permit inflationary forces to gain momentum, and then the Fed would use its monetary device of tightening money--clearly, only a second best choice.

It was the Fed in December 1965 and 1966, in the absence of a major tax increase by the Administration, which took steps to increase interest rates and make money more difficult to borrow in order to reduce inflationary pressures. The result was the tightest credit situation in the U.S. in 40 years; the housing industry was particularly hard hit by the absence of mortgage money. This approach hurt the sections of society which were least able to bear it economically: small businessmen, farmers, and homebuyers.

The man who authorized the Fed action, Chairman William McChesney Martin, has recently stated that the "main need of the economy" is prompt action by Congress on the Administration's tax plan. Because there is always considerable opposition in Congress against such unpopular tax proposals, it is one that much be hard pushed. Otherwise, the Fed will have to depend on its own monetary solutions. No doubt Congress will reduce the 10 per cent figure to six or eight per cent before voting on it; even at 10 per cent it is no panacea: the tax hike will not eliminate the deficit, it will just reduce it. Nor will it stop inflation; the surtax will be a brake to help slow the economy down. Fiscal policy, such as the tax hike, is effective only when employed at the first signs of an economic trend, not six months later. The signs are clear now.