Economic Report of the President

induce an increase in labor supply between 0.3 and 1.0 percent. Accordingto past relationships between labor and production, such anincrease in labor supply would lead to the modest increase in potentialGNP mentioned above.The Supply of SavingA reduction in personal income tax rates increases both the incomeout of which an individual worker can save and the after-tax returnto saving. It would also tend to discourage borrowing by reducingthe value of the income tax deduction for interest payments. If theincreases in personal saving find their way into additional businessinvestment, productivity will rise.Most empirical studies have concluded that changes in personalincome tax rates would have only a small effect on personal saving.At best, a 10 percent reduction in tax rates would increase personalsaving less than 3 percent. This means that the saving rate—the averageshare of personal saving in disposable income, which over thelast 5 years has averaged 5.7 percent—would rise by no more than0.2 percentage point. The additional saving would at most be equivalentto only about 0.2 percent of GNP.Even if every dollar of personal saving that resulted from a 10 percenttax cut were invested in business plant and equipment—andsome, in fact, would flow into housing—the effects on output and onproductivity would be small. If the tax cut and the higher saving continuedfor 5 years, the additional saving and investment would increasepotential GNP by less than 0.3 percent and lead to a negligibleincrease in the annual rate of productivity growth.This examination of likely responses thus suggests that even underthe most optimistic circumstances, a 10 percent reduction in tax rateswould not induce enough additional work, saving, or investment tooffset more than a fraction of the 2 percent increase in aggregatedemand that would accompany the tax cut.BUSINESS TAX CUTSIt was pointed out earlier that a tax cut that liberalized the businessdepreciation allowance or increased the investment tax creditcould, after a time, have a fairly substantial effect on the Nation'sproductive potential. Such a tax cut, amounting to 1 percent of GNP,could raise potential output by perhaps \ x k percent over a 5-yearperiod.This would still be less than the 2 percent rise in aggregatedemand that would also be generated, however. More important, theincrease in demand would come relatively quickly, most of it withinlVa to 2 years. The increase in supply, on the other hand, wouldoccur very gradually. As a consequence, the tax cut would tend to82