Tuesday, September 22, 2009

Real Lesson from Great Depression: Tax Damage


Arthur Laffer in today's Wall Street Journal ("Taxes, Depression, and Our Current Troubles") writes:

In 1930-31, during the Hoover administration and in the midst of an economic collapse, there was a very slight increase in tax rates on personal income at both the lowest and highest brackets. The corporate tax rate was also slightly increased to 12% from 11%. But beginning in 1932 the lowest personal income tax rate was raised to 4% from less than one-half of 1% while the highest rate was raised to 63% from 25% (see charts above). (That's not a misprint!) The corporate rate was raised to 13.75% from 12%. All sorts of Federal excise taxes too numerous to list were raised as well. The highest inheritance tax rate was also raised in 1932 to 45% from 20% and the gift tax was reinstituted with the highest rate set at 33.5%.

But the tax hikes didn't stop there. In 1934, during the Roosevelt administration, the highest estate tax rate was raised to 60% from 45% and raised again to 70% in 1935. The highest gift tax rate was raised to 45% in 1934 from 33.5% in 1933 and raised again to 52.5% in 1935. The highest corporate tax rate was raised to 15% in 1936 with a surtax on undistributed profits up to 27%. In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years. Finally, in 1937 a 1% employer and a 1% employee tax was placed on all wages up to $3,000.

Because of the number of states and their diversity I'm going to aggregate all state and local taxes and express them as a percentage of GDP. This measure of state tax policy truly understates the state and local tax contribution to the tragedy we call the Great Depression, but I'm sure the reader will get the picture. In 1929, state and local taxes were 7.2% of GDP and then rose to 8.5%, 9.7% and 12.3% for the years 1930, '31 and '32 respectively.

The damage caused by high taxation during the Great Depression is the real lesson we should learn. A government simply cannot tax a country into prosperity. If there were one warning I'd give to all who will listen, it is that U.S. federal and state tax policies are on an economic crash trajectory today just as they were in the 1930s. Net legislated state-tax increases as a percentage of previous year tax receipts are at 3.1%, their highest level since 1991; the Bush tax cuts are set to expire in 2011; and additional taxes to pay for health-care and the proposed cap-and-trade scheme are on the horizon.

20 Comments:

At 9/22/2009 2:18 PM, Blogger 1 said...

Funny how this opinion piece (mind you its a good one) forgot to mention that quasi-marxist, thoroughly Keynesian argument of the New Dealers the undistributed profits tax...

 
At 9/22/2009 2:42 PM, Anonymous Junkyard_hawg1985 said...

"In 1936 the highest personal income tax rate was raised yet again to 79% from 63%—a stifling 216% increase in four years."

Laffer says that top marginal tax rates increased by 216% (25% vs. 79%). This is a generously low assessment of the increase in the top marginal rate. People don't care how much there tax rate is as much as how much money that get to keep when trhey look at doing some economic activity. At a 25% tax rate, a person must earn $1.33 to keep $1.00. They pay $0.33 in taxes for each dollar they keep. At a 79% tax rate, they must earn $4.76 to keep $1.00 ($3.76 in taxes). For each dollar people got to keep, their taxes went from $0.33 to $3.76. Their taxes on each dollar they got to keep went up by 1039%! This is a major factor into the reason the Great Depression was not just another depression - stupid government by both Hoover and Roosevelt. They destroyed the incentive to work and invest.

 
At 9/22/2009 2:50 PM, Blogger 1 said...

Junkyard_hawg1985 there's absolutely nothing wrong with your comment but people are indeed tired of paying at the higher rate today...

Why?

Because there are still other taxes and fees (that weren't there for the most part during FDR and Hoover before him) that come out of the net dollars left over from the initial federal extortion of earned income...

I really did like this part of your comment: "Their taxes on each dollar they got to keep went up by 1039%!"...

Nailed it sir!

 
At 9/22/2009 3:17 PM, Anonymous Junkyard_hawg1985 said...

1 said, "Because there are still other taxes and fees (that weren't there for the most part during FDR and Hoover before him) that come out of the net dollars left over from the initial federal extortion of earned income..."

You are absolutely correct. In 1929, total government spending (Fed, state, local) was 11.27% of GDP. By 1939, government had grown to 20.66% of GDP. In 2009, total spending is up to 45.19% of GDP. To support this spending, we get taxed well beyond our income tax. I pay income tax, social security taxes, medicare taxes, property tax, sales tax, multiple government fees like car tags, license renewal fees, etc. Some people just don't realize how much this tax creates a drag on the private economy.

Here is the link on government spending (it is a pretty good resource):

http://www.usgovernmentspending.com/downchart_gs.php?year=1900_2014&units=p&chart=F0-total&title=Total%20Spending#copypaste

 
At 9/22/2009 3:36 PM, Blogger 1 said...

Now this site: US Government Spending.COM sure does have all the earmarks of being interesting and seriously educational...

Thanks Junkyard_hawg1985 for that link...

Speaking of taxation and how it drags down the economy, George Gilder writing in the City Journal this incredibly interesting article: Silicon Israel
How market capitalism saved the Jewish state
...

Its an incredible story about the influx of some very smart people and the dumping of the very socialist government that Israel saddled itself with after the '48 war...

Note the following which has Netanyahu's finger prints all over it: 'In under 25 years—starting from those first modest tax reforms of the mid-1980s—Israel has accomplished the most overwhelming transformation in the history of economics, from a nondescript laggard in the industrial world to a luminous first. Today, on a per-capita basis, Israel far leads the world in research and technological creativity. Between 1991 and 2000, even before the big reform of 2005, Israel’s annual venture-capital outlays, nearly all private, rose nearly 60-fold, from $58 million to $3.3 billion; companies launched by Israeli venture funds rose from 100 to 800; and Israel’s information-technology revenues rose from $1.6 billion to $12.5 billion. By 1999, Israel ranked second only to the United States in invested private-equity capital as a share of GDP. And it led the world in the share of its growth attributable to high-tech ventures: 70 percent.'...

 
At 9/22/2009 7:12 PM, Anonymous Benny "Just Calling It Like I See It" Man said...

Odd, how the U.S. enjoyed very strong GDP growth and low inflation through the 1950s and 1960s, with that 90 percent top tax rate.

 
At 9/22/2009 8:11 PM, Blogger Craig said...

"Odd, how the U.S. enjoyed very strong GDP growth and low inflation through the 1950s and 1960s, with that 90 percent top tax rate."

The fact that Europe, China and Japan had been destroyed in the 1940s had quite a lot to do with that. As the only one's left standing, we could do no wrong. It all started to slow down by 1960, though.

Thus, JFK's tax cut.

 
At 9/22/2009 10:17 PM, Blogger Colin said...

What's hilarious is that FDR criticized Hoover for engaging in similar policies:

http://en.wikipedia.org/wiki/Herbert_Hoover#Economy

Franklin D. Roosevelt blasted the Republican incumbent for spending and taxing too much, increasing national debt, raising tariffs and blocking trade, as well as placing millions on the dole of the government. Roosevelt attacked Hoover for "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible," and of leading "the greatest spending administration in peacetime in all of history."[37] Roosevelt's running mate, John Nance Garner, accused the Republican of "leading the country down the path of socialism".

 
At 9/22/2009 10:26 PM, Blogger Colin said...

Odd, how the U.S. enjoyed very strong GDP growth and low inflation through the 1950s and 1960s, with that 90 percent top tax rate.

In 1951 the top tax rate of 91% was applied to taxable income of $400,000, where it remained until 1964.

Using this inflation calculator:

http://www.westegg.com/inflation/infl.cgi

that $400,000 figure in 1951 is the equivalent of $3,160,918 in 2007 dollars. In 1963 it would be 2,682,087.

Now the top rate kicks in at something like $320,000 I believe.

Using the top marginal rate as a proxy for the tax burden is folly.

 
At 9/22/2009 10:44 PM, Anonymous Anonymous said...

Adding a bit: the Tax Foundation says that in 1951 the 39% bracket started at $10,000, so that applying the same inflation factor for the as noted for the top rate the 39% bracket started at around 80,000 which is a long way from 320,000.
Hidden in the argument is the issue of what motivates people money or something else. On Wall Street the answer is money, in a lot of other places it is not.

 
At 9/22/2009 11:17 PM, Blogger bobble said...

"The damage caused by high taxation during the Great Depression is the real lesson we should learn."

i'm not in favor of high marginal tax rates either. but, it astounds me how you can ignore what actually happened after taxes were raised.

it appears from your chart that between 1933 to 1937 marginal tax rate went from 25% to 75%.

looking at a chart of GDP growth you posted last november we see that:

- GDP was contracting at about a 10% Y/Y rate from 1930 to 1932.

- in 1933 it contracted a a 1.3% rate.

-from 1934 thru 1936 GDP expanded at about a 10% rate Y/Y.

sorry, going from 3 years of 10% GDP contraction to 3 years of 10% GDP growth is NOT "damage".

 
At 9/23/2009 1:25 AM, Anonymous Bennt The Puzzled Free Marketeer said...

I am not a fan of taxes, and less a fan on noisome regulations.
But the fact is, high tax rates in the United States, at least at the federal level, appear nearly positively correlated with higher GDP growth.
The high-tax 1950s and 1960s are often cited by right-wingers as a halcyon apex of American economy and society. And GDP growth was strong.
The crushed nature of Japan and Europe after WWII explains nothing--indeed, if anything, was a drag on growth. If you believe free trade spurs growth, then you must believe having such shrimpy trading partners decreased growth.
It is a riddle. Why did such high federal tax rates seem, if anything, to boost GDP growth?

 
At 9/23/2009 2:42 AM, Blogger 1 said...

"But the fact is, high tax rates in the United States, at least at the federal level, appear nearly positively correlated with higher GDP growth"...

Bennt the pseudo free marketeer what didn't you understand colin's comment replete with link to inflation calculator?

Just curious...

 
At 9/23/2009 8:57 AM, Blogger Colin said...

I think that taxes play an important, but not decisive role, in economic growth. Just look at the Nordic countries (although they have lower corporate tax rates than the US).

Far more important in my opinion is the role played by regulation, which throws up any number of barriers in the way of those wishing to start a business or hire more workers. I suspect the regulatory state was greatly reduced in the 1950s and 60s relative to where it is today.

I also think that the vast new regulations imposed by the Roosevelt administration during the 1930s explains much of the sluggish economy during that period, with price controls and other central planning mechanisms the order of the day.

We also need to keep in mind other policies enacted later on during the 1960s such as welfare, which reduced incentive to work and be a productive member of society.

Economic growth has many causes. While taxes certainly play a role, it is not nearly as simple as high taxes=low growth while low taxes achieve the opposite. One needs to look at the big picture and overall business environment.

 
At 9/23/2009 10:47 AM, Anonymous Brad S said...

"The fact that Europe, China and Japan had been destroyed in the 1940s had quite a lot to do with that. As the only one's left standing, we could do no wrong. It all started to slow down by 1960, though."


Shhhh! Don't say that! You'll ruin the template that the '50s and '60s were the economic gold standard. Can't have that.

 
At 9/23/2009 10:49 AM, Anonymous Brad S said...

"The high-tax 1950s and 1960s are often cited by right-wingers as a halcyon apex of American economy and society."

The Left does plenty of harkening back to those bygone days as well. So why don't we just man up and call the '50s and '60s an economic bubble. After all, Europe and Asia couldn't stay destroyed forever.

 
At 9/23/2009 8:30 PM, Blogger Richard Rider said...

I think what is missed is in all probability few actually PAID the 90% tax. There are MANY ways to avoid that tax -- from not working at that marginal bracket, to barter, to tax dodges. Back then the tax dodges were more varied, and there was no AMT. A simple "dodge" was tax free muni bonds, but it got a lot more sophisticated than that.

I'd like to see some data showing how much of the total income tax collected during this period came from the 90% tax bracket.

Unfortunately with the tax dodges we get considerable misallocation of resources, as people make less sensible (in a low tax environment) investments with lower, less pretax returns.

I remember well in the 1970's as a stockbroker when we came up with all sorts of schemes to avoid our clients paying taxes at what was then the 70% maximum rate.

Leveraged oil deals, bogus art evaluations for charity donations, wild real estate deals offering 300% to 500% writeoffs.

Lord knows what extremes people went on to avoid a 90% tax.

 
At 9/23/2009 8:57 PM, Blogger Richard Rider said...

There's a little story that illustrates how high the 90% tax would have been, and one way how it could be dealt with.

A well-to-do "90%" doctor goes to a well-to-do 90% dentist to get a filling. The dentist tells the doc that it will cost $1,000. The doc is aghast -- "I have to earn $10,000 to net the $1,000 to pay you."

The dentist responds that "I have to charge $1,000 to net the $100 real value for my work."

After mulling it over, a deal is struck -- the doc gives the dentist $100 worth of booze and the transaction is completed without records, of course).

BTW, this is not all fiction. In England when they were indeed in the 90% bracket (actually 94%, if I recall correctly), there developed an active substitute monetary system -- booze. Bottles were traded in lieu of cash.

 
At 9/24/2009 9:19 AM, Blogger bix1951 said...

so how can we balance the budget?

is there some efficiency being overlooked?

I hear we are headed for a real collapse when the government will be borrowing just to pay the interest.

that may be the tipping point

some combination of higher taxes and lower spending is needed

 
At 9/26/2009 3:35 AM, Blogger 1 said...

"so how can we balance the budget?

is there some efficiency being overlooked?
"...

Dumping ALL entitlements is the only way to balance the budget...

 

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