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Hugh D. Galusha, Jr.

In a previous incarnation, I was, as some of you m a y know, a
tax lawyer.

I made m y living, such as it was, advising m y clients how

they might pay less in taxes and still stay out of jail.

It m a y there

fore seem a little strange that I come before you tonight to explain
w h y you should all be paying more in taxes.
clients of mine.

And you are in a way all

South Dakota is part of the Ninth Federal Reserve

District; and in m y present incarnation, as President of the Federal
Reserve Bank of Minneapolis, I have a certain responsibility for the
economic well-being of the district and its residents.
Y ou will perhaps take what I have to say tonight as an
elaborate plea on m y own behalf.

In part, it is.

If Congress passes

the P r e s i d e n t ’ tax proposal, I too shall have less m o ney to spend;
but for reasons I shall get into presently, m y life will be a lot

There is, however, more at stake than a relatively easy life

for me.

In some measure, the economic future of the United States

hangs in the balance.

Originally, I had thought I would begin my remarks by summar
izing the economic outlook, but I decided I should begin with a justi­
fication for beginning a talk on the need for increased taxes with a
summary of the outlook.

In Congress and elsewhere there has been a

good deal of criticism of the administration for having based its call
for higher taxes, not on present economic conditions, but on what it
expected future economic conditions would be.




It is not clear what those who have criticized the a d minis­
tration for forecasting the economic future would have had it do.
Possibly wait until a truly damaging inflation had emerged as a reality
before calling for an increase in taxes.

I would remind you, though,

that a change in economic policy, whether mone t a r y or fiscal, affects
the shape of things, not immediately, but only after some considerable
amount of time has passed.

There is, as it were, a time lag in economic

When taxes are changed, months pass before the full effect is
But then to put off increasing taxes until inflation has become

a reality is to be too late.
If the government is to do its job, which involves preventing
inflation and keeping unemployment down to an acceptable level, it
must forecast the future.
m a y be a sad truth.

Only by doing so can it act in time.


It is still, though, a truth.

It makes no sense to argue, as some have, that because the
administration urged a tax increase to curb future inflationary
pressures, its call for higher taxes should not be heeded.
this w a y is to get caught up in a logical snare.

To argue

By opposing the tax

increase, one makes a forecast of one's own--that there is no more
inflation looming down the road.

Let us be quite clear; those who

have opposed the a d m i n i s t r a t i o n ’ call for higher taxes have made a
forecast, even if only implicitly.
* * * * *
What is truly at issue then is the accuracy of the forecast
which government economists,

including those in the Federal Reserve

System, made late last spring, or just before the request for the
imposition of an income surtax was sent to Congress.

It is obviously




too early to be sure, but the indications are, I believe, that the
g o v e r n m e n t ’ economists correctly guaged the course of the economy.
Last spring, you will recall, the economy was languishing.
The recession expected by some observers had not come, but the economy
was hardly buoyant.

Even so, the prediction was made that it would

soon pick up steam, and that upward price pressures would reappear.
And consider what has happened.

Over the first half of 1967 Gross

National Product, measured in current dollars, increased on average
$7 billion per quarter at an annual rate.

But we are expecting the

third quarter increase in GNP to be $15 billion, at an annual rate,
that is, and unless the auto strike goes on and on, an even larger
increase in the fourth quarter.


in the second quarter of

1967 our most broadly based price index, the so-called GNP deflator,
increased about 2 per cent at an annual rate.

But the deflator will

likely increase nearly 4 per cent at an annual rate in the third
quarter, and again in the fourth.
Developments since late spring suggest then that the forecast
made by government economists is being borne out.

And this forecast is

for more, not less, inflation if there is no tax increase.

I shall not

bore you by reciting a long string of statistics, but let me sketch out
in broad strokes what is likely to happen if the a d m i n i s t r a t i o n s call
for higher taxes goes unheeded.
It seems reasonably clear that even without a tax increase
there are going to be machines idle during 1968.

Over recent years

we have added enormously to our capital stock, so much that not all of
it will be employed even if demand for final output increases beyond
what we believe it will.

It m a y puzzle you that I say this; a forecast




of manufacturers having idle productive capital on hand is hardly one
which argues for a tax increase.

And, indeed, that there will be idle

productive capital in 1968 should moderate such upward pressures on
prices as develop.

There is, however, another productive resource,

labor; it is in short supply presently, and if taxes are not increased
it will be in much shorter supply during 1968.

But as the unemployment

rate decreases, wage settlements get bigger and prices tend to increase.
This is what our postwar history suggests.
The trend of recent months has been to larger and larger
wage settlements.

Unit labor costs have increased considerably, although

in part because, with the slow-down in the economy, productivity has
been increasing only slowly.

Fortunately, we can look forward to

productivity increasing much more rapidly than it has been.

But even

so, it is not going to increase anything like enough to offset the
increase in m o ney wages which is going to come if taxes are not increased.
What we are expecting, then, should the a d m i n i s t r a t i o n s call for a tax
increase go unheeded, are very strong cost pressures, or in other words
a good deal of cost-push inflation.
Before going further, let me sound a cautionary note.


if the a d m i n i s t r a t i o n s call is heeded, we likely will have some
inflation in 1968.

Having failed to increase taxes in 1966, we are

bound to see prices increase some more yet.

It would take an unt h i n k ­

ably disruptive dose of deflation to prevent the large m o n e y wage
settlements of the past twelve months from being passed on in the form
of higher prices.

But if there is a tax increase, there will be less

inflation than there otherwise would have been.

It is important to




recognize that an increase in taxes will not prevent further price

This is hardly an argument, though,

for not increasing

4c 4c 4c 4c *

Nor can we afford to be casual about the prospect of more

In a sense, the choice before us is not whether to increase

taxes, but what kind of tax increase to impose.
a form of taxation.

Inflation is after all

But it is a poor form, m o stly because it is

capricious and cruel in its incidence.
I would also stress, however, that we take grave risks if we
allow further increases in prices.

Despite all we have done, our

international balance of payments still is in deficit.

We have gotten

by, although largely because we have been able to maintain a margin of
exports over imports.

Indeed, this margin was larger in 1966 than in

But it was smaller in 1966 than in, say, 1964.

smaller if we do not keep our prices down.
Kingdom are just emerging from recessions,

And it will get

Since Germany and the United
it is unlikely that European

prices are going to increase much over the coming year.

Thus, if ours

do, we are going to lose part of the competitive advantage we sacrificed
so to achieve.
But there is more at stake than whether we lose some export

There is the risk that if we do not soon improve our balance

of payments position,

foreigners are going to lose confidence in the

dollar and we are going to lose more gold.

If we do, the whole inter­

national payments mechanism could break down, and we would end up back
in the 1930s, with every country imposing trade restrictions or short­
sightedly interrupting the free flow of international trade.


4c k

4c 4c




Strictly speaking, the prospect of inflation suggests, not
ne cessarily that taxes be increased, but only that total demand for
the n a t i o n ’ output be reduced.

And there are various ways of doing

Thus, the Federal Reserve might increase m o n e t a r y restraint,

which as we all know substitutes for fiscal restraint.
Think back, though, to 1966--the year of the great credit

Perhaps you will recall what the summer of 1966 was like.

Interest rates rose to levels not reached since 1921.
of an impending financial crisis.

The talk was

Still, this was the fear of those

who operate in the n a t i o n ’ financial markets.
There can be no doubt that 1966 was, over its first nine
months, a year of increasing m o netary restraint.
this increasing m o n etary restraint produce?

And what effects did

Inflationary pressures

were checked; let there be no mistake about this.

But the m o n e t a r y

restraint which the Federal Reserve had to impose because there was no
tax increase had a wrenching effect on the economy.

It is only a slight

exaggeration to say that the residential construction industry was
wiped out.

You are perhaps aware that housing starts, seasonally

adjusted, declined from about 1,500,000 in March 1966 to a little more
than 800,000 in November.

Housing starts totaled over 1,500,000 in 1965,

and in 1966 a little less than 1,200,000.
over year is pretty impressive.

A 20 per cent decline year

Or as those in the residential

construction industry might prefer to say, depressing.
W h y this sharp decline in the output of housing is easily

With the increase in market interest rates, funds were

directed from savings and loan associations and mutual savings banks.
And those two groups of institutions bulk large as mortgage lenders.




For a variety of reasons, they could not raise their share and deposit
rates sufficiently to prevent customers from turning to bonds and stocks.
Or from turning to commercial banks, which through the first nine months
of 1966 did all they could to get consumers*

savings dollars.

I might add here that in increasing interest rates the Federal
Reserve, although justified in doing so, nevertheless risked undermining
confidence in the financial system.

There were some savings and loan

associations, for the most part among the less well managed, which
almost went under during 1966.

As a group, though, savings and loan

associations are now in mu c h better financial shape than they were at
the beginning of 1966, and could withstand increased m o n e t a r y restraint
better than they did in 1966.

It is not likely that the Federal Reserve

would have to run the risk it did in 1966.

Also, we have a law passed

in September 1966 which in essence prevents financial institutions
from competing much with each other, so if there were to be increased
mo n e t a r y restraint in 1968, savings and loan associations would not
have to suffer the same intense competition from banks that they had
to suffer in 1966.

There is therefore reason to believe that even with

increased m o n e t a r y restraint, housing output would not decline as much
in 1968 as it did in 1966.
It would, though, decline, and sharply.

There is no getting

around that housing output is affected most by m o n e t a r y restraint.
And next in line, one suspects, is output of investment goods, which
the country needs if it is to increase its productive capacity.


point, then, is that m o n etary restraint alters adversely the composition
of output.

This is no argument for not using m o n e t a r y restraint.





is an argument, however, for not using only m o n e t a r y restraint.


is what we have been doing.





We would then be poorly advised to increase m o n e t a r y restraint
instead of increasing taxes.

But what about cutting government e x p e n d i ­

There is no denying that insofar as preventing inflation is the

problem, cutting current expenditures--not appropriations, but current
expenditures--is in theory as good a solution as increasing taxes.
Whether expenditures are cut or taxes are increased, total demand for
the n a t i o n 1s output decreases.
Cutting expenditures is not, however, an easy task.

We are

perhaps all agreed that, as a cab driver in Rome put it to me, lThe
government, she eats too m u c h . 1 But going beyond this to agreement on
which government programs to cut back is very difficult.

I am simply

saying we are not all agreed on our social priorities.
I too am for cutting expenditures, but I see this nation as
beset by terribly serious social problems.

And although I would admit

that these problems will not be solved simply by spending money, I
would add that I find it hard to understand how we will solve them
without doing so.

To me, then, it would seem to make sense to cut

government programs designed to solve problems which no longer exist,
or are nowhere as acute as they once were.

Doing this, we could expand

programs designed to solve emerging problems, and still perhaps reduce
total government expenditures.
And yet is it not in the nature of democratic government that
when expenditures are cut, new programs, not old ones, suffer?
m a y not, though, be inevitable.


If expenditures are cut in haste, it is.




But what about a detailed study of federal expenditures?

It is surely

worth a try.
Fearful as I am of what programs will suffer if government
expenditures are cut substantially, I would prefer for now to increase
taxes and over a longer period of time work hard--and I would stress
this, "work hard"--to eliminate low-priority spending.

But this is,

as I would admit, a matter of preference, and I should not abuse the
honor of being asked to speak to you by running on any longer with a
description of mine.
I would, however, add this note of warning.
would prefer to see expenditures cut, be realistic.

Even if you
In the end, there

are not going to be sufficient cuts in current expenditures.

Is there

anyone here who believes that nondefense expenditures will be cut enough
to make a tax increase unnecessary?

As an abstract possibility, they

perhaps could be, although even this is doubtful.

But even if they

could be, will they?
It is tempting to look at government expenditures of $135
billion and say "Surely this total could be cut by $8 to $10 billion!"
(This $8 to $10 billion is about the increase on tax receipts that can
be expected if Congress imposes an income surtax.)

But remember that

discretionary expenditures do not amount to anything like $135 billion.
Taking out defense expenditures, interest payments, expenditures on
veterans* programs, etc., one ends up with a discretionary spending
total of $21-23 billion.

And $8 or $9 or $10 billion seems an awfully

big share of even $23 billion.
It would be foolish, I believe, to quarrel for long about
which expenditures to cut, or about who should take responsibility for




cutting expenditures, and thereby delay until too late the passage of
a bill to increase taxes.
• * k k k
Let me now before stopping recount m y argument.
outlook is bullish.

The economic

It suggests an intensification of inflationary

pressures, and therefore that something be done to restrain total demand
for the n a t i o n ’ output.

The Federal Reserve could perhaps shoulder

the entire burden, as it did in 1966.

But this would be good neither

for the Federal Reserve nor, more importantly, for the country.


would be better to increase taxes or cut government expenditures.
Which would it be better to do?

This depends on o n e ’ prejudices, or

more k i ndly on o n e ’ judgment of how pressing our social problems are.
Realism would suggest, though, that expenditures are not going to be
cut sufficiently, and that therefore we would be well-advised to pass
a bill temporarily increasing taxes.
In conclusion, I can only add that I would sleep a lot better
if I were sure a tax bill is going to be passed soon.

And I would

emphasize that word "soon.” A tax bill passed next April, say, will
do precious little good.