Economic Review
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The U.S. Congress is considering several strategies to reform the federal income tax system. The most widely discussed strategy, a flat tax, would tax income received by businesses and individuals at the same low, flat rate. Flat tax proposals would eliminate most tax deductions and tax credits but would increase the personal exemption for individual taxpayers. While the debate continues over whether a flat tax would be fair to individual taxpayers, assessing the effect of a flat tax on economic growth and business activity is also important. Most economists who analyze tax incentives conclude that a flat tax would encourage economic growth, which would have a positive effect on businesses in general. The effects on businesses would not be uniform, however, and many small businesses would be affected differently than large businesses. Small businesses are an important component in the U.S. economy, producing about half of private sector output and employing over half of the work force, so tax reformers need to understand how a flat tax would affect the small business sector of the economy. Golob examines the effects of a flat tax on businesses in general and on small businesses in particular. He concludes that businesses in general are likely to benefit from a flat tax and that small businesses are likely to benefit more than large businesses. Most businesses would benefit from higher economic activity associated with a flat tax. Small businesses would benefit even more than large businesses, due in part to reduced compliance costs. In addition, a flat tax would eliminate tax deductions and tax credits less widely available to small businesses, thereby leveling the playing field between large and small businesses. Moreover, lower interest rates under a flat tax would offset more of the loss of interest deductibility for small businesses than for large businesses. Back to top Economic Review home
Public sector debt in the industrialized world has increased dramatically over the last 15 years. At the June 1996 Economic Summit in Lyon, France, leaders of the seven major industrialized democracies discussed the problems posed by large budget deficits and debt, as well as the potential benefits of regaining fiscal balance. The G-7 leaders agreed that while economic fundamentals in their countries are sound, investment growth, income growth, and job creation all depend on enacting credible fiscal consolidation programs and successful anti-inflationary policies. While there is general agreement that cutting budget deficits and debt will lower interest rates, debate persists over the effects on a country's exchange rate. Unfortunately, the evidence on the relationship between budget deficits and the exchange rate does not readily resolve the debate. In the early 1980s, the rising U.S. budget deficit was associated with dollar appreciation, while in the 1990s rising deficits in Finland, Italy, and Sweden were associated with currency depreciation. Hakkio analyzes the effects of budget deficit reduction on a country's exchange rate. First, he shows the evidence on the relationship between budget deficits and exchange rates is not clear-cut and explains why the theory that underlies the relationship is ambiguous. To sort out the ambiguity, he provides new empirical results indicating that deficit reduction through tax increases tends to weaken the exchange rate of countries with good records on inflation and debt, while deficit reduction through spending cuts tends to strengthen the exchange rate of countries with poor records on inflation and debt. Back to top Economic Review home
With the current U.S. economic expansion now in its sixth year, the economy appears to be on a path of stable growth. Such a development would be beneficial because it would foster steady gains in employment, income, and investment, all of which would help boost the overall standard of living. To maintain such a healthy course, most sectors of the economy need to be solid performers. The housing sector is an especially important component of the economy, having generated $1.5 trillion in output in 1995, or one-fifth of the nation's gross domestic product. Whether housing activity will continue to perform well in the 1990s will depend in part on two key factors. First, will demographic factors, such as the aging "baby-boom" generation and the smaller "baby-bust" generation, lessen the demand for housing and thereby imperil the health of housing activity? And second, will cyclical factors enable housing activity to sustain its solid performance as the economy moderates to a stable growth path? Filardo explores whether housing will continue to perform well in the rest of the decade. He concludes that favorable demographic trends and stable cyclical forces will lay the foundation for healthy housing activity for the rest of the decade. Back to top Economic Review home
The banking industry has undergone substantial consolidation during the last 15 years, and that process has accelerated in the 1990s. One effect of this consolidation has been to greatly reduce the number of independent and locally owned banks. Some banks have been acquired by distant banking organizations, and some have been acquired by banking companies that were nearby but very large, causing the banks to become junior partners in the new organization. Since independent and locally owned banks have been important sources of funds for local businesses and farmers, concern has arisen that such borrowers will now find it harder to obtain credit. In principle, the extra safety and liquidity that newly acquired banks enjoy from belonging to a larger, more diversified banking organization could enable the banks to lend more to local farms and businesses. But some analysts worry that banks acquired by large or distant organizations will lend less to local borrowers because the parent company cannot make credit decisions as efficiently or has other preferred uses for the banks' funds. Is this concern warranted? Keeton finds that recent bank mergers in Tenth District states provide partial support for the claim that banks acquired by large or distant organizations reduce lending to local farms and businesses. Back to top Economic Review home
A recent surge in U.S. agricultural exports has triggered a wave of optimism about the industry's prospects in the world food market. At the root of the industry's recent export gains are rapidly growing populations and incomes across Asia and Latin America. Adding fuel to U.S. agriculture's newfound optimism is the recent emergence of China--the world's most populous nation and most rapidly growing economy--as a net importer of food. The world food market may not live up to current expectations, however, without substantial investment in food processing and distribution infrastructure in developing countries. Much of the developing world has limited capacity to process and distribute food, whether imported or produced domestically. For example, in China and Mexico--two of U.S. agriculture's most promising markets--the existing transportation and distribution systems are inadequate to meet current food system needs. Such infrastructure limitations could become a crucial bottleneck for exports of some U.S. farm commodities. At the same time, however, exports of other kinds of products, including U.S. farm and food technology, could be strengthened by efforts to upgrade the infrastructure supporting the food systems in the developing world. Barkema and Drabenstott examine how an inadequate food system infrastructure in the developing world may affect U.S. agriculture's prospects in the world food market. They conclude that inadequate infrastructure could tilt U.S. exports toward food technology and products and away from traditional bulk commodities. |