New Deal Laffer Curve


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?