Economic Report of the President

higher after-tax return on saving may induce still further increases insaving. This is more likely to occur if the personal tax cuts are directedat higher-income individuals who tend to save relatively more oftheir additional after-tax income. But there is substantial evidencethat, in any case, the personal saving rate responds very little tochanges in rates of return or in the tax structure. A large part of thepersonal tax reduction would therefore go toward increasing consumption.The most effective avenue at the disposal of the Federal Governmentto increase the volume of saving is to reduce taxes on businessincome. Cuts in business taxes would lower government saving, but alarge part of the tax cut would flow into business saving. Businessafter-tax cash flow would be increased. In time, part of the increasedcash flow would lead to higher corporate dividends. A very largepart, however, would be allocated to an increase in retained earnings—i.e.,saving. Evidence suggests, for example, that corporationssave more than 50 cents from every additional dollar of after-taxincome. Furthermore, some portion of any dividend increase wouldfind its way into personal saving. By contrast, giving the tax cut directlyto households would have a smaller effect on saving becausehouseholds are likely to save a much smaller fraction of every dollar ofadditional disposable income.It seems wise, then, to focus government efforts on the sector mostlikely to allocate a large part of any tax relief to saving—business. Abusiness tax cut would result in relatively large saving, and incentivesto expand investment demand would simultaneously be improved. Itis this approach that lies at the heart of the President's Economic RevitalizationProgram.THE INTEGRATION OF DEMAND-SIDE AND SUPPLY-SIDEPOLICIESTax reductions which induce additional saving and investment willcontribute to faster productivity growth, and this in turn will helpreduce inflation. A number of critical questions arise, however, in determiningthe appropriate type, magnitude, and timing of any tax reductions.First, what kind of an increase in productivity might reasonablybe expected from investment-oriented tax cuts of various sizes,and what would be the associated reduction in inflation? Second, towhat extent would the improvements in productivity and othersupply-creating aspects of a tax reduction offset the increase in aggregatedemand they would cause? More generally, how would taxcuts aimed at increasing supply fit into the framework of fiscal restraintthat is required to reduce inflation?78