Low Taxes Don't Cause Recessions: Part II

We were previously talking about the comparison between this politically manipulated chart (above) and this more complete one (below), along with some relevant history.

http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=213

We had gotten to pretty much the middle of the Great Depression—the big blank part on the propaganda chart. What we know about that time was that taxes were high and wages were kept artificially high—both contributing to extended high unemployment and a sluggish economy stuck in a trough, instead of bouncing back. Added to this were seemingly arbitrary regulations interfering with various sectors of the economy. Unpredictability is another factor that prevents investment and job growth.

These things look familiar because we’re seeing them, close up, right now. And the administration just scratches its collective head and says, “We just need to keep doing more of the same until it works.” Please insert definition of insanity here.

Back to the timeline. Some people assume that the Great Depression ended with the outbreak of WWII in 1941. What happened then was that FDR stopped some of the micromanaging of the economy to focus on the safety of the nation in a dangerous world. (We can thank him for that; at least he valued the nation enough.) Resources had to go to military. Many workers, including the unemployed, went into the military, leaving openings in manufacturing and elsewhere that needed filling. So by some definitions, the Depression did end.

Are you familiar with the broken glass example? A vandal comes and breaks a baker’s window. The baker then employs a glazier to replace the window, so the glazier has more income, which he spends to by a suit. And so on, implying that the economy is better off because of the broken window. But this looks only at what is seen, not what is unseen. The baker was building up capital to buy a larger oven and hire more workers. But he had to use the capital on the window, which he wouldn’t have had to do without the breakage. So there was a loss in the economy to the baker, to his possible employees that didn’t get hired, and to the manufacturer of the new oven that didn’t get purchased. Those losses are unseen. The economy is actually worse off because of the unnecessary glass breakage. Thomas Sowell describes seen vs. unseen in his piece this week called “Jobs Versus Net Jobs.”  

The point here is that, while there was visible economic activity caused by WWII, the capital spending didn’t really grow the economy. Spending for the war was necessary, just as repairing the window would be once it was broken. But what helped the economy was getting FDR to stop getting in the way of it.

Progressives being what they are, they were merely more dormant during the war. What you have following the war is still extremely high marginal tax rates and more government interference. This is the period where people used the phrase, “To err is Truman.”

Right after the war the top marginal rates were dropped slightly, from an insane 94% to 86.45%, and then to 82.13%. Let’s be honest; a drop to 82.13%, while better than 94%, is still so confiscatory that no one capable of making the top level of income would pay it. Such a person would find the numerous loopholes placed there specifically for the purpose of avoiding payment. (Lobbying for specific favors was pretty much as described in the fictional version, Atlas Shrugged.) Or that person would set aside money in places that would not be considered income (trusts, investments, or just a jar buried in the yard), rather than keep earning income without getting to enjoy it.

The rate bounded up again to 91% and stayed there for a decade. There’s something to be said for stability. But, again, no one paid this rate. It brought in essentially no revenue. The data missing from the chart is what the rates were for the next couple of tiers lower, and how those near top earners responded to them; also missing is information about other government interference affecting stability in the market. As a rule, the more profit an earner can count on using, the more the earner is likely to risk it as capital investment—leading to economic growth.

You can see a steady and slightly lower 70% marginal tax rate from 1965 through the last Carter budget of 1981. (Back in the 73-74 recession, in those Republican years before Carter, unemployment was a painful 4-6%; yes, that was considered high back then, before Carter suggested we get used to a different version of normal.) Steadiness is a good thing. But, again, high rates mean high avoidance. And other government interference, such as price controls and regulation in chosen sectors, equals economic drag.

Then, under Reagan, despite a Democrat Senate and House, we see a drop in marginal tax to 50% then 38%, and further under Bush 41 to 28%. Recovery and economic growth ensued, disrupted only when Bush reneged on the “no new taxes” pledge. Revenues also went up, even with the much lower rates, offering evidence that Laffer is right. (Read about the Laffer Curve here and my piece on it here.) Rates went up under Clinton, but then they steadied with the coming of the election of a Republican House in 1994 (first time in 40+ years).

We had some recessions, and burst bubbles, during the last three post-Carter decades. But there is no evidence of any recession taking place because top marginal tax rates were too low. In fact, it is harder for Federal Reserve interference and federal government over-regulation to do their damage when the rates are kept low enough. That’s why it took until after 2006, when Democrats took control of Congress, before the build-up of meddling in the housing sector finally resulted in that bubble bursting.

Higher education costs are extremely high right now, without an equivalent payoff to consumers (students). Government interference has led to both the higher costs and the lower quality and value. Health care costs rise the more government interferes as well—which is why we must repeal the monstrosity so untruthfully titled the Patient Protection and Affordable Care Act. Both of these are likely to become bubble bursts rippling into recession conditions. No level of top tax rates, either high or low, would prevent the eventual bursts of any bubbles.

It comes down to this: if someone thinks low taxes cause recessions and high taxes are good for the economy, would you want such a person to get near any sector of the economy that you care about? Smart people just say no.

Low Taxes Don't Cause Recessions: Part I

There are some things that are just not worth bothering to answer. But sometimes I get goaded into it, because of timing, or exasperation.

I, like you too, probably, have people on Facebook I’m connected to, but not because of politics, and yet we tolerate their posts for the sake of other reasons. There’s one of these in particular whose life I want to keep up with, but whose politics—especially the steady stream of everything put out by the Obama campaign website for minions to pass along—just causes a roll of the eyes.

Among the continual propaganda (alongside my care not to let politics be intrusive on my wall), this post came a few days ago:

It is apparently a characteristic of Obama minions that they have a moat and beam problem (and probably aren’t even familiar with the source of that imagery: Matthew 7:3-5).

The steady stream of posts has continued since that one a few days ago. This one came on Monday, with the comment, "Very sad. We need to fix this."

So, let’s see if I catch the message: low tax rates cause recessions and depressions. If only government would confiscate more money, then businesses would hire more workers and create more wealth. I’m not imagining that message, am I?

And the data verifies it, right? Well, not exactly. There is data shown here that implies a cause/effect relationship, but there are some really big gaps in the data as well as the surrounding history—which you have to be ignorant of in order to believe this implication. It is similar to noticing that 95% of obese people eat tomatoes either frequently or occasionally; ergo, eating tomatoes causes obesity. Well, not really. Even if the data is true, there’s a whole lot of data missing that would give a better picture of the causes of obesity. With the additional data we might find not only that eating tomatoes does not cause obesity, but we might find it’s a good food to help avoid obesity. So to give the limited data with the causal implication is pretty much—a lie.

One thing noticeable on the Obama-provided chart is a lack of data for the Great Depression. No problem; I can Google. I easily found the Historical Highest Marginal Income Tax Rates from 1913 (the first year they were imposed) through 2012.

Here’s a little history. When the income tax was proposed, it was pressed through as the 16^th Amendment over more than half a decade, based on the promise that the rate would never rise above 7% and would only be imposed on the very wealthy. That held for three years. Then in 1916 it more than doubled to 15%. But that wasn’t sufficient for Woodrow Wilson; he more than quadrupled it in a year to 67%, and the following year to 77%. Good for the economy? Not really. But there was a world war on, so maybe  there was a temporary need? But it was maintained at 73% for the next three post-war years.

Then in 1921 there was a stock market crash—every bit as severe as the 1929 crash. But government didn’t interfere, and the market corrected. According to the historical chart, one change from 1921 to 1922 was a decrease in the marginal tax rate. And those rates continued to be lowered down to a steady 25% for the rest of the decade. The Roaring 20s. A prosperous decade.

Yes, those rates were still low when the stock market crashed. Was that the cause? Most people look at overspeculation during the inflationary policies caused by the Federal Reserve failing to return to the gold standard following WWI. Related to the top marginal tax rate, there was a belief that rates would stay low, or even drop lower, up through 1929, when it had been dropped to 24%. But then, in 1929 the rise back up to 25% was passed. Those speculating because of reliably low rates would see that as a signal to get out of the market. After the legislation was passed to slightly raise the rate, but before the rise shows up on the historical chart, the 1929 crash happened. Was that change in rates the cause? Not enough data here, and this certainly isn’t the full picture. You have to include artificially low interest rates manipulated by the Fed. But we can be pretty sure it wasn’t the lower rate voted for in 1928 that caused the crash in October 1929.

Following the crash, the market began to recover, signaled by significant return growth in employment—until the government started interfering. That was Hoover, a Republican, but a "progressive," not a conservative. The interference halted the nascent recovery, and every interference caused further hindrance. Then, in 1932 the rate is drastically raised to 63%. Did this lead to an increase in employment? Of course not. It did lead to Hoover being voted out of office, and rightly so.

Unfortunately, the alternative was the even more “progressive” FDR. He held the rates at 63%, while interfering in various other government intrusions, though 1935. Then in 1936 he jumped the top tax rate to 79%. Coincidentally, 1936-1937 was a serious downturn in the economy. That’s when the word “recession” was invented, because it sounded less dire than “depression.”

But wait! There’s more! We’re only a third of the way through the timeline. So the rest of this will have to be continued in Part II in a couple of days.