Examining Socialist Myths: Tax Cuts Don’t Stimulate the Economy

Aw Hell. It’s election season again. As someone posted, “It’s a great time to pare down my Facebook friends.” I’m sure a fair amount of that goes on. As an acquaintance of mine recently described it, “Political beliefs are largely an echo chamber. Election season is an invitation to everyone else to enter your personal echo chamber.”

I’ve gotten better about things. I enter fewer political discussions on Facdbook and have greatly reduced my objectives. The truth is that as a Libertarian, I disagree politically with well over 90% of the voting public. So if I responded to every invitation to enter a political argument, I’d never have any to time to myself.

And some arguments are really subjective and not worth discussing. If you think Obama’s the best President in history, good for you. If you think Mitt Romney is the voice of sanity in the political wilderness, good for you. I’m not here to debate things like that. I’m never going to win the argument, first off, because these beliefs are not subject to change. They are part of political identity that people have absorbed and they’re sure as hell it giving them up for me.

But then, sometimes, I just can’t help myself. Sometimes political beliefs are so out there that I just can’t help myself. If a NeoCon is arguing that invading the entire Middle East will usher in a new American Golden Age, I just have to wade into the fray. I can’t say I have any success in converting people, but occasionally people do tell me that they find discussing things with me enlightening.

Which brings us to today’s political Facebook discussion, “Do tax cuts stimulate the economy?” I find it strange that this is a real question, but I am going to treat it as legitimate and go forward from there. Mark Sumner for DailyKos.com writes a piece which then really just cites another government study from the the Congressional Research Service which says, according to Sumner, that the lower rate of taxes at the top, the slower the economy grows.

That’s certainly a surprising finding. Let’s see how they got it. Well, according to the report, the top bracket income tax rate during the 1950s was above 90% (the US government was valiantly attempting to pay back all the money it borrowed to fight the second World War) and the economy grew just fine. Then as time progressed and taxes lowered, our growth rate came down. Fair enough. So the more money the government takes from rich people, the better off we are.

Does that seem right to you? It seems a bit counter-intuitive to me. As a thought experiment, let’s take this to it’s logical conclusion. Let’s say we simply have the government confiscate all wealth over a certain level. Sounds like a recipe for an econcomic boom, right? The government comes in and takes all the money those miserly rich people have and spends it to build roads, pay for medical care, and invade those countries that desperately had it coming. Now we’re growing! If those misers won’t spend their money, we’ll do it for them.

If we are to take this study at face value, then we would believe that a simple policy of wealth confiscation would increase strangely increase savings rates and economic growth. Wow. Who wudda thunk it? But if this policy is so awesome, why stop at rich people? Let’s get everyone in on the act. Let’s confiscate the wealth of everyone, and spend it for their own good. After all, what’s good for the goose is good for the gander, right?

What would this lead to? Well, other than Communism. I find it hard to believe that this policy would grow anything. In fact, the history of the Great Depression shows two instances where increasing taxes was a disaster: the Smoot Hawley tariff of 1930 and Recession of 1937. The Smoot Hawley tariff was a massive tax increase on imports that ushered in a trade war and is commonly cited as one of the variables that helped to turn the market crash of 1929 into a full blown depression. The second, tax increase in 1937, at the request of the US Treasury squashed the economic recovery which was underway and tacked on a few more years to The Great Depression.

So it would seem our Communist notion of wealthy confiscation being an economic panacea is not universal. This might seem curious except that it’s common sense. When people discuss stimulating the economy, they discuss putting money into private hands. Why? Presumably because they feel that private hands are superior to public hands when it comes to Economic stimulation. What kinds of people make these arguments? Well Barack Obama certainly seemed to feel that government money needed to go to General Motors to keep them in business because it would otherwise be adversely effect the economy. I guess he hadn’t read the DailyKos article saying that more money the government takes the better off we all are. John F. Kennedy similarly argued that the notion that cutting taxes would lead to economic growth was simple. “Don’t you remember your Economics 101?” he asked.

The thing is, at this point we’re attacking an absurd argument. No one is really advocating full blown Communism. At least, not openly. What they are suggesting is that rich people don’t stimulate the economy and are, therefore, not as deserving as keeping their wealth as poor or middle class people. So it’s OK to soak the rich, because those bastards don’t spend enough to really stimulate the economy. Most people probably don’t know where this logic comes from, but I do. These are the arguments of John Maynard Keynes who argued that it was the “Paradox of Thrift” that lead to economic collapse. Except that the government study cited even suggests that no one was saying, because savings rates declined from the 1950s on.

Say, let’s take a look at that study. As I already cited, the Great Depression has two very good examples of where an ill-times tax increase can exacerbate and already fragile economic climate. For that matter, the most explosive economic growth in our history was the Industrial Revolution, which has a tax rate of zero across the board. How did the study reconcile these facts?

Well, since it only considered 1950+, it didn’t. The study nicely chose a time period whereby these “inconvenient truths” would not be an issue. Instead, the history of the American Economy exists from the end of World War II. But the 1950s was a rather exceptional time for two reasons. The first is rather obvious: the 1940s featured a tremendous destruction of wealth and industrial capacity during World War II that left the United States relatively unscathed. Suffice it to say that when we have factories and you have rubble, we’re going to be doing pretty well. The second is the Bretton Woods Convention whereby the United States basically became the issuer of the World’s Reserve Currency. A privilege it enjoys to this day.

So let’s recap. From 1870-1910, the United States Economy doubled in terms of GDP per capita. The poverty rate declined from roughly 45% in 1870 to 30% in 1910- a remarkable feat economic feat that has not continued nor been duplicated. The personal savings rates over this period was close to 20%. So it seems that a tax rate of zero was working out OK for us. Then we are introduced to tax rates in 1913, and from there things get kind of strange. Truthfully, the strangeness is probably due more to what came along with income tax in 1913, the Federal Reserve Act. But after these two institutions we get World War I, the roaring 20s, the Great Depression, World War II, the reconstruction of the 1950s, the Vietnam War and Great Society programs of the 1960s, the economic malaise of the 1970s, the expansionary boom of the 1980s and 90s, and then the very troubled 2000s. Each of these time periods is rather exceptional, but the one thing that they all have in common is that the money supply was being inflated thanks to the Federal Reserve and the huge amount of government spending.

What happens during inflationary times? Well, savings rates go down because people see no incentive to save money that will be worth less when they go to take it out. So it kind of makes sense that we see a decline in savings rates over this period. What about economic growth during this time? Well, American Economic growth has greatly slowed down as the century progressed. We also have tax rates introduced during 1913, brought up sharply in 1917 to 73% at the top to pay for World War II, cut during 1920s back to a more reasonable 20% or so, then increased sharply in 1932 to 62%…

Wait, a tax increase in 1932 to 62%? That coincides with The Great Depression. So if we were to include the 1930s in our Economic sample, it would clearly show a negative correlation to Economic Growth. I guess it’s a good thing that the authors of our Economic Study chose not to do so. Which leads me to believe the entire study had a predetermined conclusion which they needed to arrive at, so they cherry picked the right times to include in the study. A government study with a predetermined conclusion? Would the folks in Washington do that? You bet your life.

3 thoughts on “Examining Socialist Myths: Tax Cuts Don’t Stimulate the Economy”

  1. “So let’s recap. From 1870-1910, the United States Economy doubled in terms of GDP per capita. The poverty rate declined from roughly 45% in 1870 to 30% in 1910- a remarkable feat economic feat that has not continued nor been duplicated. The personal savings rates over this period was close to 20%. So it seems that a tax rate of zero was working out OK for us.”

    Goodness knows I’m no historian, but a quick search netted me the remembered fact that the exact period you mentioned was also a period in which the US Government was busy confiscating lands from the natives and handing them over to any and all comers. This was known as “homesteading”. It was a perfectly massive redistribution of wealth from one group of people to another.

    http://en.wikipedia.org/wiki/Homestead_Act

    It seems sensible to say that we were “taxing” the Native Americans in order to pay for our own economic boom. Poverty is bound to go down dramatically when you give everyone who wants it a big piece of land and the opportunity to grow crops on it and sustain oneself and one’s family. Even immigrants, slaves, and single women could qualify! Talk about economic stimulus! But it wasn’t tax-free. The Indians paid for it.

    “The nation had few taxes in its early history. From 1791 to 1802, the United States government was supported by internal taxes on distilled spirits, carriages, refined sugar, tobacco and snuff, property sold at auction, corporate bonds, and slaves.”

    http://www.infoplease.com/ipa/A0005921.html

    I think you can’t call those anything except a luxury tax on the wealthy.

    “The high cost of the War of 1812 brought about the nation’s first sales taxes on gold, silverware, jewelry, and watches. In 1817, however, Congress did away with all internal taxes, relying on tariffs on imported goods to provide sufficient funds for running the government.

    “In 1862, in order to support the Civil War effort, Congress enacted the nation’s first income tax law. It was a forerunner of our modern income tax in that it was based on the principles of graduated, or progressive, taxation and of withholding income at the source. During the Civil War, a person earning from $600 to $10,000 per year paid tax at the rate of 3%. Those with incomes of more than $10,000 paid taxes at a higher rate. Additional sales and excise taxes were added, and an “inheritance” tax also made its debut.”

    During the time period you mentioned, the source I linked above says that the income tax was 3%, not zero. These taxes also targeted wealthier people for higher taxation in order to finance a war.

    “In 1866, internal revenue collections reached their highest point in the nation’s 90-year history—more than $310 million, an amount not reached again until 1911.”

    You cherry-picked your time period, too, because income tax wasn’t abolished until 1872. It came back a couple times in the intervening period, then was ruled unconstitutional, then the Constitution was amended to allow it.

    No real point I’m making here, except that nothing is ever as simple as “compare historical tax rates to economic growth and extrapolate to modern times”. Surely the US Government giving all takers a lot of extremely valuable farmland it had taken from somebody else had something to do with how awesomely Americans did around the 1900’s.

    1. Hey Cathy,

      Good to hear from you again. Remember that people in favor or heavy government involvement and higher taxes often cite the 1950s as a great time of high taxes and productivity growth. However, as you well know, this is in large part because we spent the 1940s destroying the productive capacity of most of our competitors- which, as you can imagine, would dramatically impact our economy.

      Cheers,
      Preston

  2. Though I understand your point of view, I am way too close to the edge to not know that that, “free,” money is going to be a life saver for those who are out pnoduing the beat looking for jobs from shop to factory and have nothing to feed our family with these days. I know…we support my son and his family while they wait for SSD after a horrendous accident that left him unable to work. His wife works at Micky Ds since she lost her job.We are thankful this Christmas that my husband is still working and that I am available to be grandma after school and some evenings. God has given us thatgift.

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