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GNP blues: a tax cut may be the cure.

The recovery from the 1990-91 recession has bogged down. The economy is adrift with an excess of industrial capacity and high unemployment. Without added fiscal stimulus, prospects for an economic uptick are dim (see BE Economists' Report, "Achieving Growth In A Slowly Reviving Economy," January 1992). But spending and growth can be boosted--if there is a cut in federal individual income taxes.

The recession, which ran roughly from July 1990 to May 1991, depressed real GNP--gross national product corrected for inflation--by $51.1 billion or 1.2%, a smaller drop than the postwar recessionary average of 2.6%.

The 2% third quarter economic rebound stemmed from several factors. These included increases in consumer spending, automobile sales, residential fixed investment (up 21%), and plant and equipment purchases. Companies also slowed cutbacks in inventory levels. They had been liquidating stocks rapidly over the past nine months.

But the rebound fell flat. It is estimated that real GNP rose only .9% in fourth quarter 1991, and may grow by only 1.5% by April. In previous post World War II recoveries, real GNP rose at an annual rate of 7% during the six months after a recession and averaged 6.7% in the first year (see chart).

Between June 1991 and December 1991, real GNP rose at an annual rate of 1.5% and may grow less than 2% before July. Whole year projections show growth of 1.6% in 1992, 2.2% in 1993, and 2.5% in 1994. If these projections are right, real GNP over the next three years may run 6% to 6.4% below potential. By contrast, if the recovery followed the 45-year average, real GNP would be 4.3% above the expected 1992 level; and for 1993 and 1994, the levels would be 6.8% and 7.9% higher, respectively.

These GNP gaps reflect a projected shortfall in industrial output and the persistence of high unemployment. For example, at full employment, about 87% of the nation's industrial capacity would be used. But at the recession's bottom, capacity utilization fell 10.5% below this level. By the end of 1991, this had shrunk to 9.7% and may fall to 9.4% in 1992, 6.2% in 1993 and 6.7% in 1994.

A Tax Cut Will Promote Growth

The American economy is mired well below its long-run potential to grow. This is the result of a vicious cycle: The slow expansion of real GNP reflects sluggish growth of consumer spending (which is roughly 66% of GNP). American shoppers are restrained by the dilatory rise in disposable personal income as well as high consumer debt. Personal income is held in check by high unemployment and the slow increase in jobs. The latter, in turn, are being held back as retail sales stagnate and firms continue to trim staff in efforts to improve efficiency. The result is an economy that drifts.

A personal tax cut is required to jump-start the economy. A federal income tax reduction would lift disposable income and stimulate consumption leading to increased output and higher employment.

The tax reduction should take the form of a 10% rebate of 1991 individual income taxes. It is estimated that, in 1991, federal income tax liabilities amounted to roughly $527.5 billion. A 10% rebate would equal $52.8 billion. If the rebate were adopted early in 1992 (before the April 15 deadline for payment of 1991 taxes), 1992 disposable income might rise to $4,128.6 billion--a gain of 13%. To assure that the tax stimulus is effective, a further 10% tax rebate in 1992 would add an additional $60 billion to disposable income in the following year.

Disposable income increases would eventually boost consumer spending by a multiple of the gains in after-tax income. The net result would be a major lift narrowing the gap between potential and actual output. Jobs would be created and unemployment would decline.
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Article Details
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Author:Brimmer, Andrew
Publication:Black Enterprise
Article Type:Column
Date:Mar 1, 1992
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