New Deal Laffer Curve

Tim Cavanaugh | September 23, 2009

Arthur Laffer, in a Wall Street Journal op-ed arguing against the tight-money explanation for the Great Depression, gives some tax and tariff history:

The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy's relapse in 1937.

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%. (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.

As Jerry Lewis told Martin Short, that hurt.

Laffer ends by acknowledging that he's worried about similar behavior in the current Decession (is that term ok with everybody?), but doesn't give much evidence that the states or the feds have begun actually increasing tax rates (or even tariffs) to these suffocating degrees.

In fact, I'm fairly certain a new approach to government has taken hold in the 21st century: a relic of dotcomonomics, in which revenues don't matter and instead you pursue "mindshare" or "first mover status" or some other phantasm. The genius of the Bush and Obama administrations has been to deny that the question "how are you going to pay for all this" exists at all.

Consider, Reason's excellent October roundup of dismal scientists, in which there are several references to a post-TARP policy that allows the Federal Reserve Bank to pay interest on bank reserves. From the Silicon Valley's own Jeffrey Rogers Hummel:

This seemingly technical change not only gives banks an incentive to hold reserves rather than make loans; it also essentially converts reserves into more government debt. Fiat money traditionally pays no interest and therefore allows the government to purchase real resources without incurring any future tax liability. Economists refer to this revenue from creating money as seigniorage. Federal Reserve notes will continue to earn no interest. But now the seigniorage that government gains from creating bank reserves will be much reduced, if not entirely eliminated.

If the government is cutting itself off from free money, I ain't complaining. But as a former dotcommer and a dedicated servant to our president, I have to ask, Boss, how are you monetizing this economic-savior business?

Comments

|9.23.09 @ 3:12PM|#

Oh... "doTComonomics" -- that makes more sense. I was ready to look up what the hell "doctomonomics" was.

Docto, Docto, it hurts when I do this...

Stop doing that.

Tim Cavanaugh|9.23.09 @ 3:16PM|#

Fixt.

Joe M|9.23.09 @ 3:27PM|#

Decession (is that term ok with everybody?)

I'd prefer to call it a Repression.

Invisible Finger|9.23.09 @ 3:49PM|#

but doesn't give much evidence that the states or the feds have begun actually increasing tax rates (or even tariffs) to these suffocating degrees.

They don't have to actually enact the taxes to have a chilling effect. If people fully expect increased taxes to be enacted, or in the case of health care the mandatory purchase, people will decide to put off financing that LCD TV they always wanted (aka continuing the deleveraging). If your business might be subject to some new cap-and-trade rules, you might decide to put off that IT project until you see how things shake out.

Michael Ejercito|9.23.09 @ 3:50PM|#

The Smoot-Hawley tariff of June 1930 was the catalyst that got the whole process going. It was the largest single increase in taxes on trade during peacetime and precipitated massive retaliation by foreign governments on U.S. products. Huge federal and state tax increases in 1932 followed the initial decline in the economy thus doubling down on the impact of Smoot-Hawley. There were additional large tax increases in 1936 and 1937 that were the proximate cause of the economy's relapse in 1937.

President Hoover really screwed things up.

Barack Obama|9.23.09 @ 4:45PM|#

"President Hoover really screwed things up."

You ain't seen nothin' yet. B-b-b-baby, yeah you ain't seen nothin' yet.

Tim Cavanaugh|9.23.09 @ 5:11PM|#

They don't have to actually enact the taxes to have a chilling effect. If people fully expect increased taxes to be enacted, or in the case of health care the mandatory purchase, people will decide to put off financing that LCD TV they always wanted (aka continuing the deleveraging).

Comprendo. A question:

Could the increases in tax hits Laffer describes be accounted for in part by the decline in GDP? I don't think it can, because taxes are mostly collected as percentages. However, in cases where you have a static sum that has to be paid every year, that will increase as a percentage when your income goes down. The only example I can think of is the £142.50 telly license, but I'm sure we have plenty of examples in the good ol' USA, and I'd know about them if I were in broadcast communications, import/export or some other fee-burdened industry. (Aren't a lot of the cigarette excises just flat $2-a-pack arrangements unrelated to whether you're buying Rothmans or GPCs?)

So if there were enough of these flat fees, the percentage of GDP that gets taxed would go up, right? I still assume there weren't enough even in the thirties, but I don't know how they taxed stuff back then.

|9.23.09 @ 5:31PM|#

The only example I can think of is the £142.50 telly license, but I'm sure we have plenty of examples in the good ol' USA, and I'd know about them if I were in broadcast communications, import/export or some other fee-burdened industry. (Aren't a lot of the cigarette excises just flat $2-a-pack arrangements unrelated to whether you're buying Rothmans or GPCs?)

Yes. And in most states, gasoline excise tax is a flat per-gallon fee. New York is an exception; there may be others. Though when the price of gas goes up, that means that the tax is smaller as a percentage of money spent on gas.

Sean W. Malone|9.23.09 @ 6:51PM|#

After spending a great deal of time looking into the history of monetary policy recently for my various charts & essays - including the one that the Mises institute published (hi res here if anyone missed it and cares - I've been completely and utterly convinced that Milton Friedman & Anna Schwartz' explanation of tight money being the cause of the great depression is quite wrong.

The Federal Reserve added roughly $10 Billion to M2 between 1923 and 1929, taking the money supply from around $35 Billion to $45 billion in 6 years... And surprise, surprise, we had a massive boom during that time. The boom was, as they all are, quite unsustainable - fueled not by savings & smart investment, but cheap credit based on printed money. Laffer misses the point if he thinks that tariffs were the cause as well (which it doesn't seem like he really does).

1929's crash was inevitable given what the government had done with the money supply in the preceding years. Whether or not it was precipitated by stupid tariffs or a monetary tightening, both of which assuredly had a negative effect - and both of which contributed significantly to the pain experienced at the time - neither is the root cause.

We really need to start learning this as a nation... At the risk of going all Peter Schiff, the problem is the boom, not the bust.

Invisible Finger|9.23.09 @ 7:17PM|#

but I don't know how they taxed stuff back then.

There were possibly more flat taxes back then; I know such things as kegs of beer were heavily taxed. (As high as $60 a keg. In 1930's dollars. Which would be about $500 per keg today.) Also remember that there were no (or very few) sales taxes.

So it is possible that some of the increases in percentage taxes were a result of reducing/eliminating the flat-charge taxes, probably to make the revenue expectations more predictable. I'd bet a good portion of the flat taxes could be avoided - if you didn't drink alcohol you never paid the tax. I suppose the reason my grandparents never drove cars was because automobile taxes were prohibitive. Eliminate the excessive car taxes and then driving becomes an affordable proposition - if you have money left over after paying income taxes.

I think the more important point is that the tax rates may have gone through the roof, but the number of people subject to the taxes was much larger. Income taxes initially were only on the top 1% of earners - the tax was eventually levied on the top 10%, then the top 20%, eventually the top 80% (and that could be done via inflation rather than changes in law, ala the Alternative Minimum Tax today)... Taxation without voting rights is what led to people like Susan B. Anthony getting pissed off - if she didn't have to pay taxes she probably wouldn't have given a shit about not being allowed to vote. The whole taxation without representation shtick.