Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy Summary

  • Last updated on November 10, 2022

On February 26, 1964, President Lyndon B. Johnson signed the Revenue Act of 1964, which was the first deliberate attempt to stimulate the U.S. economy by reducing taxes.

Summary of Event

In the early 1960’s, the U.S. economy was experiencing problems in many areas. These problems included recurring recessions, high rates of unemployment, excess productive capacity, inadequate profits, and lack of business investment. Because of the sluggishness of the economy, the federal budget ran a deficit, an unusual occurrence in peacetime. The country had experienced five recessions since the end of World War II. The annual economic growth rate was down to 3 percent, and unemployment was above 6 percent. For 1963, President John F. Kennedy originally projected a $500 million surplus, but as a result of the stagnating economy, a $9 billion deficit was projected by mid-year. Revenue Act (1964) Kennedy-Johnson Tax Cuts[Kennedy Johnson Tax Cuts] Economic policy;United States Taxation;United States [kw]Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy (Feb. 26, 1964)[Kennedy Johnson Tax Cuts Stimulate the U.S. Economy] [kw]Johnson Tax Cuts Stimulate the U.S. Economy, Kennedy- (Feb. 26, 1964) [kw]Tax Cuts Stimulate the U.S. Economy, Kennedy-Johnson (Feb. 26, 1964) [kw]U.S. Economy, Kennedy-Johnson Tax Cuts Stimulate the (Feb. 26, 1964)[U.S. Economy, Kennedy Johnson Tax Cuts Stimulate the] [kw]Economy, Kennedy-Johnson Tax Cuts Stimulate the U.S. (Feb. 26, 1964)[Economy, Kennedy Johnson Tax Cuts Stimulate the U.S.] Revenue Act (1964) Kennedy-Johnson Tax Cuts[Kennedy Johnson Tax Cuts] Economic policy;United States Taxation;United States [g]North America;Feb. 26, 1964: Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy[07970] [g]United States;Feb. 26, 1964: Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy[07970] [c]Economics;Feb. 26, 1964: Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy[07970] [c]Laws, acts, and legal history;Feb. 26, 1964: Kennedy-Johnson Tax Cuts Stimulate the U.S. Economy[07970] Kennedy, John F. [p]Kennedy, John F.;taxation Johnson, Lyndon B. [p]Johnson, Lyndon B.;economic policy Keynes, John Maynard Mills, Wilbur Heller, Walter W. Dillon, C. Douglas

Walter W. Heller, chairman of the Council of Economic Advisors Council of Economic Advisers, U.S. , was a key proponent of a tax cut. He believed that the structure of high tax rates, which dated back to World War II, was acting as a brake on the economy. Whenever the economy went into an expansion, the high tax rates slowed it down.

What Kennedy proposed was a tax bill that contained both a tax cut and tax reform. The original proposal was for a $13.6 billion reduction in taxes. Key reforms included an end to the dividend credit exclusion and changes in deductions for charitable contributions, home mortgage interest, and casualty losses. For corporations, he proposed both a reduction in rates and changes in the tax payment dates that in effect speeded up the receipt of corporate tax payments. The focus was on helping small business by reducing the corporate tax rate from 30 percent to 22 percent on the first $25,000 of corporate income. The surtax on earnings in excess of $25,000 would be 30 percent, later reduced to 28 percent.

Capital gains tax rates would be reduced from 25 percent to 19.5 percent. The required holding period for an asset would change from six months to a year. Executives with restricted stock option plans would not be able to use capital gains rates. A big change was proposed in the treatment of real estate tax shelters. Investors had been using accelerated depreciation methods and then selling properties for a profit. Under the proposed change, part of the gain would be taxed as ordinary income rather than as capital gains, which were taxed at lower rates. This caused concern among Realtors, who argued that the tax advantage had been built into real estate prices and that an increase in taxes would deflate prices in the real estate market.

Business was cool to the Kennedy administration for two major reasons. After the Bay of Pigs invasion, the government paid ransom to Cuba to release American prisoners. Since government funds could not legally be used for ransom, corporate donations were solicited. Companies with large government contracts or with pending hearings were particularly hard hit for contributions. In addition, in the spring of 1962, Kennedy had pressured the steel industry to reduce its proposed price increases.

Overall, businesspeople and workers were concerned about the power of government and how its use affected business in both positive and negative ways. There was not as much concern about the size of government, with business accepting the necessity of a large federal bureaucracy. In one example of a challenge to the government’s use of power, the administration was charged with pressuring aerospace firms and other large contractors to accept union shop clauses, which mandated union membership for company workers.

The investment community favored the idea of the tax cut but was cautious about what might happen to the bill as it made its way through Congress. Wall Street liked the planned corporate tax reduction but was concerned about budget deficits and the potential for inflation. American business as a whole initially opposed the plan because of concern about the effect that financing the deficit would have on the credit markets and interest rates.

The proposed tax cuts primarily benefited lower income groups. Business advocates argued that spending by the lower income groups would not be sufficient to stimulate the economy. Business liked the cut in corporate tax rates and the decrease in rates for the upper tax brackets but was concerned about the acceleration of corporate tax payments.

The proposal also called for a reduction in the oil depletion allowance. In addition, foreign tax credits would be limited. Companies would be prohibited from using foreign development costs to offset U.S. taxable income. These changes would hit the oil and gas industries hard, and industry leaders predicted a substantial decrease in domestic drilling.

The home building industry was concerned about the proposed reduction in the mortgage interest deduction, as were homeowners. The auto industry, on the other hand, favored the tax cut, seeing a potential increase in the number of two- and three-car homes as the tax cut would likely encourage car purchases. Federal Reserve Board chairman William C. Martin, Martin, William C., Jr. Jr., clearly favored the tax cut and indicated that he would not let interest rates rise if the tax cut passed.

Goals of the tax cut were to achieve economic growth of 4.5 percent per year and to bring unemployment down from 5.8 percent to 4 percent. By April, 1963, the unemployment rate was 6 percent. There was concern over the impending entrance of the baby boom generation into the workforce and the need for significant job expansion to meet that challenge. There was equal concern about the loss of jobs resulting from automation. The Council of Economic Advisors estimated that two million new jobs would be needed each year to offset jobs lost to automation. Walter Heller estimated that the tax cut would create two to three million new jobs. At first, Kennedy tried to boost the economy by increasing government spending, but concern over the resulting deficits caused him to turn instead to the use of the tax cut strategy.

As the bill made its way through Congress, many of the tax reform items were dropped. Capital gains rates stayed at 25 percent. Individual marginal tax rates were cut from 91 percent to 70 percent for the highest tax brackets. Long-term capital gains rules would apply after only six months. A one-time tax exemption was offered for the sale of a personal residence. Stock options held for more than three years would still qualify for capital gains treatment. No change was made to the deductibility of mortgage interest. Changes were made to the deductibility of casualty losses, charitable contributions, and sick pay. There was a new increased standard deduction.

At the time of President Kennedy’s assassination, the tax bill had not yet passed the Senate. President Lyndon B. Johnson supported the tax cut and was opposed to increased government spending as a way to stimulate the economy. Johnson was perceived to be more friendly to the business community.

In the Senate, Russell Long Long, Russell , chair of the Committee on Finance, amended the bill, extending the benefits of the investment credit and adding leased equipment to the list of qualified investments. Real estate tax shelters held for less than ten years were taxed at a higher rate. In the final version of the bill, few of the original tax reform items remained. On February 26, 1964, President Johnson signed the Revenue Act of 1964. It had taken thirteen months for the bill to pass Congress.

Significance

The Revenue Act of 1964 cut taxes by $11.6 billion, with individuals receiving $9.2 billion and corporations receiving $2.4 billion. There was a major reduction for people with annual incomes below $3,000; they would no longer pay taxes. Tax cuts for individuals slightly favored the higher income brackets. The 15 percent of taxpayers at the highest brackets received 40 percent of the tax-cut money. The remaining 85 percent of taxpayers received 60 percent of the benefit. In total, an estimated 90 percent of taxpayers received some benefit from the tax cut.

The impact was felt immediately because of prompt changing of payroll withholding rates, which pumped an additional $800 million into the economy monthly. That additional money would prompt extra purchases and lead to a chain reaction of increased economic activity. It was expected that the gross national product would increase by $30 billion. The hope was that investment spending would increase as firms saw that investment was profitable because of the increased consumer spending.

Concerns of business after the tax cut focused on inflation. Productivity was rising 2.6 percent per year in the nonfarm sector and 6.1 percent in the farm sector. Unions pushed for wage increases to match productivity increases. There was concern that increased costs would create an inflationary spiral.

There was also concern about the nation’s balance of payments. The fear was that in order to alleviate the trade deficit (an excess of imports relative to exports), interest rates would be raised, and that the higher interest rates would dampen the effect of the tax cut within the U.S. economy. President Johnson was also concerned about the federal budget deficit, which could also result in higher interest rates. He cut spending—primarily in defense—in order to reduce the deficit. The budget request for the War on Poverty was modest because of the size of the deficit. Few people believed that the tax cut would reduce poverty rates measurably.

The effects on business occurred over a longer period, through the accelerated corporate tax payment schedule. Prior to the bill’s passage, corporations estimated their taxes in September and paid half of that amount at year end. Corporations with tax liabilities in excess of $100,000 would have to pay earlier and eventually would pay in quarterly installments. The most immediate positive impact on business was increased inventory investment, as firms prepared for increased consumer spending. The other major direct benefit for business was the change in the investment credit. The anticipated benefit from that change was a $160 million reduction in corporate taxes in 1964 and $195 million in 1965.

While the tax bill was making its way through Congress, the economy was well into a recovery. In 1963, steel production rose 11 percent over 1962. During the fourth quarter of 1963, 2.2 million new cars were produced, setting a record. Construction increased. Retail trade, business investment, and consumer spending all rose throughout 1963, before the tax cut was passed.

The tax cut was hailed as a monument to the ideas of economist John Maynard Keynes and as a significant shift in economic policy. President Franklin D. Roosevelt had used fiscal policy favored by Keynes to pull the country out of the Depression, but he favored increased spending as a tool rather than tax policy. The belief in a balanced budget was commonly held, in opposition to Keynesian economics. The significance of the tax cut was in the use of tax rather than spending policy and the use of planned budget deficits. The Kennedy-Johnson tax cut was more closely aligned to Keynes’s theory than was the New Deal.

By June, 1964, the economy had been growing for forty months, in the longest period of economic growth since World War II. Prices remained stable. The Federal Reserve Index of Industrial Production was up 25 percent from the base period of 1957-1958. Production costs were stable. The Census Bureau’s Index of Unit Labor Costs of Manufacturing showed that labor costs had actually fallen slightly from the same base period. According to the McGraw-Hill Capital Spending Survey, business planned a 14 percent increase in capacity over the next three years and expected a 19 percent increase in sales volume. Stock prices held steady, and consumer spending grew, as did the level of consumer debt.

In October, 1964, a major strike Labor;and the economy[economy] Strikes at General Motors idled 265,000 workers. The strike caused a reduction in auto production in the last quarter of 1964 and reduced projections for 1965. There was fear of a steel strike, and manufacturers began stockpiling steel in anticipation. A contract settlement at Chrysler exceeded the administration’s wage guidelines and fueled fears of inflation. Raw material prices rose. By August, there was a 7 percent drop in construction contracts and an increase in home mortgage foreclosures. There was growing concern about business failures and the increase in consumer debt.

By 1965, the gross national product had increased 25.3 percent since 1961. Industrial production was up 27 percent. Personal income was 21.5 percent higher than in 1961, and corporate profits had risen 64 percent in the four-year period. The unemployment rate was still above 5 percent, and there remained concern over structurally endemic unemployment and poverty. Credit remained available, because the Federal Reserve System increased the money supply as interest rates increased.

The impact of the tax cut was felt both before and after the legislation was passed. The congressional debate increased consumer and business expectations. Passage of the legislation then secured a recovery that was already well under way. The importance of the tax cut has more to do with the essential change in government policy that occurred. For the first time, tax policy was used deliberately to manipulate the economy. The government’s role as economic manipulator was firmly accepted. The Keynesian concept of planned deficits took root. The ideal of a balanced budget remained, but the business community, voters, and Congress became willing to accept budget deficits as part of the economic picture. Revenue Act (1964) Kennedy-Johnson Tax Cuts[Kennedy Johnson Tax Cuts] Economic policy;United States Taxation;United States

Further Reading
  • citation-type="booksimple"

    xlink:type="simple">Bernstein, Irving. “Keynesian Turn: The Tax Cut.” In Promises Kept. New York: Oxford University Press, 1991. A history of the Kennedy administration, with detailed description of the political process involved in the tax cut legislation. Good discussion of the relationship between the administration and business at the time.
  • citation-type="booksimple"

    xlink:type="simple">Evans, Rowland, and Robert Novak. “Taming the Congress.” In Lyndon B. Johnson: The Exercise of Power. New York: New American Library, 1966. An interesting narrative description of how President Johnson maneuvered the tax bill through Congress. Shows Johnson’s struggle to come to terms with the new economics represented by the tax cut proposal.
  • citation-type="booksimple"

    xlink:type="simple">Hughes, Jonathan, and Louis P. Cain. American Economic History. 5th ed. Reading, Mass.: Addison-Wesley, 1998. Concludes with a chapter on the development of the U.S. economy and governmental economic policy from the 1960’s through Reaganomics. Bibliographic references and index.
  • citation-type="booksimple"

    xlink:type="simple">Solow, Robert M., and James Tobin. “The Kennedy Economic Reports.” In Two Revolutions in Economic Policy, edited by James Tobin and Murray Weidenbaum. Cambridge, Mass.: MIT Press, 1988. Compares economic policy changes that occurred during the Kennedy administration and during the Reagan administration. A highly readable explanation of economic issues of the time and reasons for the tax cut proposal. The text also includes the presidents’ economic reports for readers who want detailed statistics and data.
  • citation-type="booksimple"

    xlink:type="simple">Sorensen, Theodore C. “The Fight Against Recession.” In Kennedy. New York: Harper and Row, 1965. An insider’s view of the thinking and discussions within the Kennedy administration that led to the tax cut proposal. The chapter provides detail regarding the economic problems of the time and why the tax cut proposal was considered to be the best option.
  • citation-type="booksimple"

    xlink:type="simple">“Tax Cut: Triumph of an Idea.” BusinessWeek, April 11, 1964, 180-182. Excellent synopsis of economic thought. Contains anecdotes about Keynes’s thinking and shows the policy shift represented by the tax cut and its importance in the evaluation of economic theory. The style is informative and clear. A good background source for readers without training in economics.

Value-Added Taxes Begin in Europe

Congress Gives Tax Breaks to Financiers of Small Businesses

Service Economy Emerges in the United States

President Kennedy Is Assassinated

Johnson Announces War on Poverty

Johnson Signs the Interest Equalization Tax Act

Johnson Restricts Direct Foreign Investment

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