Avoiding "Overcure"

The U.S. economy is facing its most perplexing situation of the fabulous 1960s. Production, profits and personal income are at record highs and still rising. Yet last week the auto industry, at least temporarily, cut back production because of disappointing sales, and the stock market shuddered through its worst fall since 1962. Amid these conflicting currents, Lyndon Johnson continued to ponder one of the toughest decisions of his presidency: whether to raise taxes to forestall the kind of inflation that would inevitably lead to a downturn later or to avoid a tax hike for fear that it would hurt business this year.

Washington's Dilemma. The advocates of a tax rise last week picked up such prominent recruits as Walter Heller, former chairman of the President's Council of Economic Advisers; Pierre-Paul Schweitzer, chief of the International Monetary Fund; and most important, William McChesney Martin.

The Federal Reserve chairman said out loud what he has long argued privately:

"The logical way to fight inflation is to put through a simple, clean-cut, across-the-board increase in taxes that would be both temporary and moderate."

Martin is the first top Government official to call for a tax increase.

Johnson's other advisers responded to Martin's words by calling on business men for even more acts of self-denial.

Gardner Ackley, chairman of the Pres ident's Council of Economic Advisers, told businessmen that they have no reason to raise prices, because they are earning so much already (see following story). Pointing out that profits after taxes jumped 88% between early 1961 and late 1965, he said: "It is time to ask whether a further rise in the share of profits in the national income is in the interest either of the health of the nation's economy or in the interest of business itself." Treasury Secretary Henry Fowler declared that the economic outlook is so uncertain that to battle inflation by boosting taxes now "might present some danger of 'overcure.' "

Detroit's Downturn. Even if Johnson eventually calls for a tax hike, he will have trouble selling it to Congress during an election year. So far in 1966, Congress has aggravated the inflationary danger by appropriating $3 billion more for nonwar spending than Johnson asked for. House leaders contend that they will not support a tax hike unless Viet Nam spending swells enormously--which it may well do. Appropriations Chairman George Mahon believes that Viet Nam "is going to cost us many billions more than asked for in the fiscal 1967 budget."

How then to avoid inflation? Last week men who presumably know business best, 543 executives at the annual meeting of the U.S. Chamber of Commerce, voted by an 18-to-l ratio to urge a slash in federal spending instead of a tax rise.

The obvious argument against higher taxes is that business is already beginning to hurt from the labor shortage and from tight credit. Reflecting the auto industry's concern last week were General Motors' announcement that it was putting at least four of its 23 car-assembly plants on three-day or four-day work weeks and Ford's decision to eliminate Saturday overtime at four of its nine assembly plants. Auto sales in April were off almost 5% from last year's record, and the inventory of unsold cars swelled to 1,582,000 compared with 1,337,500 a year ago. All the publicity about the industry's safety record has begun to damage the automakers, notably General Motors, whose Corvair sales are off 53.4% from last year's rate and whose entire Chevrolet division is down 6.6% .

G.M.'s Announcement. The news from Washington and Detroit gave Wall Street's nervous investors an excuse to sell more furiously. The Dow-Jones industrial average worried off ten points after Ackley's critique of profits, continued down after Martin's endorsement of higher taxes, plunged another 26 points in 1 1/2 trading sessions after G.M.'s disclosure of a production cutback, falling to an intraday low of 889.

Then the Dow-Jones ticker carried a strategic and slightly curious G.M. announcement that all of its plants would resume normal operations this Monday, and the market--again overreacting--rallied 131 points in the final hour of trading, closing at 903. Actually, General Motors said only that its plants would work Monday but was obscure about whether they would work full weeks. Later, G.M. said that eight of its assemby plants, rather than the previously announced four, will skip between one day's and three days' work before the end of this month.

Wall Street's Outlook. The stock market's bulls have been frustrated for more than a year because every substantial rise has been nipped by scare talk fanning fears of a business downturn in the months ahead. A year ago, the market was sent tumbling from 940 to 841, after the Fed's Bill Martin compared the modern economy with that of the giddy 1920s. Last February, the market climbed to a record 995 and seemed headed toward 1,000, but talk of tight money and tougher taxes again sent it down.

Though the market will quite possibly go lower still, this very fact carries a potential of strength for the future. Prices have been falling while corporate earnings have been rising, with the result that the important "price-earnings ratio" of stocks in the Dow-Jones industrial average is down to 14.85 times this year's expected earnings, compared with ratios of 19 to 1 in each of the last two years. Moreover, plenty of big buying power is waiting on the sidelines. Brokers are holding $1.8 billion in unused cash for their investors and large institutions have plenty of money in reserve. They may well come in and pick up bargains when and if the Johnson Administration finally decides what economic policy to follow. When Washington does clear the air, even by raising taxes or boosting interest rates, the oversold and underpriced stock market will very likely rise.

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