Question

TAX CUT OF 1964

Was there a production gap when Kennedy assumed the presidency in January 1961? How large was it? Assume a GNP growth rate of 3.3% (approximately the U.S. long-run average real GDP growth rate) starting in 1955 and project forward using a Google Docs spreadsheet or Excel document.

What were the critical economic issues (and assumptions) of the tax cut debate?   

Was the Tax Cut of 1964 a supply-side or demand-side tax cut?

How successful was the Tax Cut of 1964? What general lessons do your conclusions suggest regarding use of fiscal policy as a macroeconomic management tool?

Answer 1

Production Gap is an economic term which shows us the deviation of actual industrial production in a country from the expected potential production . It occurs when there is under utilization of resources in the economy . Yes there existed a production gap when Kennedy assumed the presidency in January 1961 .

As per the historical data , GNP in 1955 was 438 billion dollars . Potential GNP with 3.3% growth rate anually . There was also recession and unemployment in the economy . If we see the growth rate of 3.3% , then after 6 years in 1961 potential GNP = 515 billion dollars ( approx) . The real was about 487 billion dollars .

Hence cearly there was a gap of 27 billion dollars ( approx) .

The critical issues and assumptions of tax cut debate are : a) with existing deficits , tax cuts will widen the fiscal deficits . Tax cuts would be a riskier method to balance the budget .

b) The purpose of this tax cut endeavour was to allure business investments . This would ultimately boost production and reduce unemployment . But if the businness firms did not invest as expected then such tax cuts can be a burden on the government trasury .

c) If high income groups are taxed then it would not be much effective . This is because high income groups already can afford all their needs , so the excess mney due to tax cuts will be saved . This will not create aggregate demand in the economy to rise .

It was a supply side tax cut . According to supply side theory , the purpose of a tax cut is to induce investment in production of goods and services . The production gap was tried to be recovered by tax cuts .