America's Forgotten Depression, and roaring recovery

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America’s Forgotten Depression... and Roaring Recovery February 24, 2010

 

Ever hear of the Great Depression of 1920? No, me either. Do you know why? Because the recession that began shortly after World War I ended never deepened and never became “great” (as though any depression is great). There is a history lesson in that story that our leadership in Washington should keep in mind today.

 

As the United States, and the world, came out of World War I, the economies of the warring powers had been cranked up to full production to meet wartime demands. Suddenly, in 1918, the Armistice was announced, and within a year, troops began returning to civilian life. The influx of millions of soldiers worldwide introduced sudden unemployment, and thousands of farmers came back to farms that were already at or near full capacity, causing farm prices to fall. In the United States, Woodrow Wilson’s hand-picked successor, James Cox, the newspaper magnate from Dayton, Ohio, ran on a platform of reducing America’s wartime debt through a policy of maintaining Wilson’s outrageously high wartime tax rates.

 

The Progressive President Wilson had been in office when the Income Tax Amendment was passed—a story in itself. While the goal of the Progressives who favored an income tax was first and foremost wealth redistribution (not raising money to run the government), the income tax itself was largely sold to the American people on two major positive features. First, its rates were (by current standards) ridiculously low. Most people paid no income taxes at all, the bottom bracket paid only about 1%, and the very richest Americans paid only 6% (today, many states have higher income tax rates than that!). As a Vegas comedian would say, “What’s not to like?”

 

But it only took Wilson a couple of years of war to jack up the top rates to an astounding 73% (near confiscation) and hike the bottom rate to 25%.

 

Now for a little sidebar: how often have you heard that “World War II got us out of the Great Depression?” Probably more times than you can count. What is often forgotten is that when your very survival is at stake, as it was from 1941 to 1945, people will submit to most anything—rationing, confiscatory tax rates, muzzling of civil liberties. This is laudable and natural. But it is wholly unnatural and oppressive for a government to seek to maintain wartime tax levels and intrusions on civil liberties in peacetime. Hence, to return to our story, Wilson “got away” with the outrageously high tax rates during the war because . . . it was a war! Once the threat was over, however, Americans expected their country back.

 

Cox’s opponent, Warren Harding, also of Ohio, ran on a platform of returning the country to its pre-war “normal” economy and freedoms. While he didn’t explicitly endorse a tax cut, voters rightly inferred that’s what he meant, and sent him to the White House instead of Cox. In perhaps his shrewdest move, Harding asked Pittsburgh millionaire Andrew Mellon to be the Secretary of the Treasury. When Mellon told him he “didn’t want the job,” Harding knew he had the right guy. Mellon finally gave in, and immediately studied the recession, which was severe.

 

Various estimates of the 1920-1921 recession suggest that Gross National Product fell anywhere from 2.4% to a whopping 6.9%. Estimates of unemployment put the rate at between 7% and 8%. Interestingly, while most economists correctly identify the issue of returning troops as a “shock,” few note that the extremely high tax rates dragged the economy down faster than “Bernie” behind the boat (reference to “Weekend at Bernies,” if you haven’t seen it).

 

Mellon performed a review of another phenomenon: even though Wilson’s boys consistently pushed up tax rates, the relative return from those rates fell steadily. Without knowing it, Mellon had come up with an early version of the “Laffer Curve,” which says that at a certain point, raising taxes will result in less revenue to government, because people will silently revolt and either cease work or go into the black market. Mellon convinced Harding to ask Congress for a radical tax cut. Of course, many in government opposed. In a stunner, the New York Times of 1909 had actually warned that “when men get in the habit of keeping themselves to the property of others, they cannot easily be cured of it.”[1] Harding died in office, but his successor, the great Calvin Coolidge, remained committed to steeply reducing tax rates. Mellon, Harding, and Coolidge succeeded in reducing the top rate from 73% to 25%, and the bottom rate from 25% to 5%. There are two observations one can make: a) that’s an astounding drop, and all three men are to be commended, and it was still many times higher than the pre-war rates!

 

Nevertheless, the economy quickly recovered. Unemployment rates fell, down to 5%, then 4%, then finally, in 1926, to 1.6% according to one study. Even more shocking, the share of taxes paid by the rich . . . skyrocketed. Those earning over $50,000 (a “supermillionaire” back then) had only paid 45% of the total taxes when the rates were sky-high, but after the Mellon cuts paid 62%. Those in the “Bill Gates” category of “so-rich-they-wouldn’t-pick-up-a-$100-bill-on-the-sidewalk” rich ($100,000 at the time), saw their share of taxes paid almost double, from 28% to 51%.

 

We call what happened next the “Roaring ‘20s,” because the economy absolutely went nuts. Average Americans came to own cars, radio, have appliances and the electricity to power them (electricity use rose by almost 300% between 1899 and 1929), telephones, and a myriad of other products once considered luxuries.[2] Ford’s Model T, once considered revolutionary for its low cost and simplicity, now was out; General Motors, with its different car line for every income class was in. And they say tax cuts don’t work? Tell that to the Americans of the Roaring ‘20s.”

 

Larry Schweikart

 

Professor of History, University of Dayton

 

co-author, http://www.amazon.com/Patriots-History-Uni.../dp/1595230327/

 

A Patriot’s History of the United States

[Mr. T]

“Laffer Curve,” something that the earlier republicans used to increase taxes while later they used it to cut taxes.

 

 

Inframarginal?

 

Yeah, the nonmarginal tax rate. Let's say you make $100,000 and let's say we're talking just about you, Justin Fox, and let's say there's no chance on earth your income would fall as low as $50,000. All those tax cuts we do on Justin Fox up to $50,000 for sure are dead-weight revenue losers. You just lose the money from now until the cows come home. That's clearly true. I don't think you'll find many people who disagree with that. So the lowest end of the rate cuts, what I call inframarginal, those things do lose the money.

 

So you talk about a Bush tax cut, he had two sets, the first one I wrote not only wasn't going to pay for itself, but probably wasn't going to stimulate anything. The second one was a lot better. The second one was when he got panicked, as he probably should have.

 

Now there are parts of the tax cut he did, for example child-care tax credits, those are dead-weight revenue losses. There is no feedback effect on those at all, because they don't effect the marginal rate at all.

 

The ones that have the feedback effect the most are those at the highest bracket. I can give you an example of this. Let me use Kennedy, so I can get away from current politics.

 

Kennedy cut the highest federal marginal income tax rate from 91% to 70%, and he cut the lowest tax rate from 20% to 14%. He cut all the rates in the middle, too, but I'm just going to take the two extremes for you.

 

Before the tax cut, one second before the tax cut, a guy would earn a buck in that highest tax bracket, he would have to pay 91 cents in taxes, and he would be allowed to keep 9 cents after tax. That's his incentive for working. Now after the tax cut, the guy would earn that same pretax dollar, he'd now pay 70 cents in taxes and he'd now be able to keep 30 cents after taxes. The increase in that incentive for doing the exact same job for the exact same gross pay would be 233% .

 

Now let's take the lowest tax bracket guy. Let's assume that it's the guy that's on the margin. That guy makes a buck before tax, paid 20 cents in taxes, he got to keep 80 cents. That was his incentive on the margin for doing that work. Now Kennedy cut that from 20% to 14%. The guy went from 80 cents after tax to 86 cents for that exact same job. That's a 7.5% increase in incentives.

 

The top tax bracket he cut from 91% to 70%. That's a 23% cut in tax rates with a 233% increase in incentives. That's a 10-to-1 benefit-to-revenue-loss number.

 

Now you take the guy in the bottom bracket. The guy in the bottom bracket had a 30% cut in tax rates, from 20% to 14%, and he had a 7.5% increase in incentives. So that's a 1-to-4 benefit-to-revenue-loss calculation.

 

You can see why it's far more efficacious, why you'd far more expect revenue feedback to be positive in the upper brackets than in the lower ones.

 

 

 

Read more: http://curiouscapitalist.blogs.time.com/20.../#ixzz0gVOkJS9n

 

What politicians should really be looking at is if they raise taxes on the rich, (Like Obama letting the Bush tax cut go away) Why would the ones in charge (business owners) be interested in creating wealth? or say, stimulating the economy?

 

Will we see more jobs leaving this country over Obama's spread the wealth system?