How to Squelch an Economic Recovery
Kurt Brouwer August 27th, 2008
If history is any guide, screwing up the economy has been a bipartisan effort — Republicans and Democrats have done things that do not make economic sense. Have our political leaders learned anything from the mistakes of the past? This Washington Post piece points out some mistakes to avoid [emphasis added]:
Five Ways to Wreck a Recovery (Washington Post, August 18, 2008, Amity Schlaes)
Perverse monetary policy was the greatest cause of the Great Depression. But five non-monetary missteps were important in making the Depression great, and the same missteps damaged the global economy as well. While many are thinking about the Depression, few seem concerned about replicating these Foolish Five today:
- Giving in to protectionism. In Herbert Hoover’s time, Sen. Reed Smoot and Rep. W.C. Hawley proposed a tariff that was to raise effective duties by as much as half. More than a thousand economists signed an open letter warning that the duties would “raise the cost of living and injure the great majority of our citizens.”
But Hoover’s Republican Party didn’t much care. In its 1928 platform, the GOP had pledged to “reaffirm our belief in the protective tariff.” Ambivalent, Hoover signed the bill. An irate Canada and many other nations retaliated. At a time when the United States was begging for foreign markets, it lost them. The selfish signal discouraged an already unstable Europe.
Today, international trade claims a sizable share of our economy. Bilateral free-trade agreements with Colombia or Panama are good insurance — cheap steps that might prevent an expensive loss, that of the Western Hemisphere to Venezuela’s Hugo Chávez.
Yet again, one party — the Democrats, this time — is cavalier. House Speaker Nancy Pelosi is blocking passage of these bilateral agreements. And another ambivalent politician — Sen. Barack Obama — has sent mixed messages to Canada about just how much he wants to roll back the North American Free Trade Agreement…
Free trade has been one of the chief engines of global prosperity. It would be a huge mistake to adopt protectionism as the Smoot-Hawley legislation did prior to the Great Depression. There is plenty of disguised protectionism going around today in the form of misleading claims about America’s manufacturing output. In fact, though employment in manufacturing is dropping due to improvements in productivity, manufacturing output has never been higher.
There is also plenty of obstructionism about trade agreements as well. The Colombia free trade pact is a perfect example. Colombia’s goods can now come here largely without restriction. But, there is a bill that would give U.S. exporters improved access to Colombian markets. That seems unambiguously good for us, yet Congress is holding it up due to opposition primarily from U.S. labor unions. Big mistake.
The Washington Post continues with a second point on how we could squelch the recovery:
- Increasing taxes in a downturn. Hoover more than doubled income tax rates, taking the top marginal rate to 63 percent from 25 percent. FDR hiked the top rate to 90 percent. Perhaps worse, Roosevelt’s Treasury crafted taxes to punish business, including an undistributed profits tax and an excess profits tax, that ultimately sucked cash from a capital-starved economy.
Today, Democrats are planning tax increases that make Bill Clinton’s hike look mild. The proposals start with lifting the cap on Social Security payroll taxes — an effective increase in the top marginal tax rate of 6.2 percent, or for some 12.4 percent, all by itself. Add in the promised repeal of the Bush tax cuts and you have an additional 4.6 percent increase. Effective top rates approach 50 percent. There are also proposed increases for dividends and capital gains. Taken together, these will make the U.S. economy sluggish and more like that of Europe…
As we pointed out in a recent post (California Taxes Going Up), there is a strong movement to raise taxes in California. Tax revenues have been going up for years, but politicians have simply spent far more than we raised. Now, rather than slowing the growth of spending, they want to raise taxes. Higher taxes often backfire though because taxpayers change their behavior and the expected revenues gains fall short. For more on what the proposed tax increases would mean, see Largest Tax Increase Since World War II.
We do not need to repeat the mistakes of the Great Depression by raising taxes or adopting protectionist trade policies. That will only slow down the recovery. And, as we pointed out in a recent post, there are clearcut, proven ways to encourage prosperity as pointed out in this article from The American Magazine:
The Path to Prosperity (The American Magazine, August 7, 2008, Amela Karabegovic and Alan W. Dowd)
A new report confirms that low taxes, limited government, and flexible labor markets help to spur economic growth.
There are times when common sense is not so common. We may be in one of those times, which is why a new report on the power of economic freedom is so important.
Common sense tells us that low taxes, limited government, and flexible labor markets will help to spur economic growth. The Fraser Institute’s 2008 Economic Freedom of North America (EFNA) report offers a striking, yet unsurprising, picture of the benefits that flow from such policies.
In 2005, the most recent year for which data are available, Colorado, Georgia, Delaware, North Carolina, New Hampshire, Tennessee, and Texas-states with consistently strong records of promoting economic freedom-had an average per capita GDP that was more than $4,300 above the U.S. average. Their total growth from 1981 to 2005 was nearly 20 percentage points higher than the U.S. average.
In the latest EFNA index, Delaware is the top-ranked state or province in all of North America while Texas is tied for second with the Canadian province of Alberta. And for good reason: Delaware has the smallest size of government at the subnational level and ranks first among U.S. states on key taxation measures; Texas ranks first in labor-market freedom at the all-government level and has a state top marginal income tax rate of zero. Delaware and Texas also rank high in the categories of government transfers and subsidies as a percentage of GDP at the all-government level.
By comparison, West Virginia, Hawaii, Maine, Montana, New Mexico, North Dakota, and Rhode Island-states with low levels of economic freedom-had an average per capita GDP that was more than $4,300 below the U.S. average. Their total growth from 1981 to 2005 was 10 percentage points below the U.S. average.
Again, this is predictable: all of these states rank in the bottom half of the nation on taxation at the all-government level, labor-market freedom at the state/local level, and size of government at the all-government level.
The benefits of policies that promote economic freedom extend far beyond good scores and bragging rights. For instance, a one-point increase in economic freedom results in an increase of $32.13 in venture capital investment per capita; an increase in the number of patents by 8.2 per 100,000 population; and an increase of 4.2 percent in the growth of sole proprietorships.
The encouraging news is that most states have maintained a high degree of economic freedom and embraced polices that nurture economic freedom. In fact, the 2008 EFNA report found that 20 states have improved their level of economic freedom since the last report, with Louisiana experiencing the greatest increase…
This is a case where putting in a blogging acronym, RTWT [that is, read the whole thing] is not a cliche. This article is important and well worth reading. The principles outlined in the article work at the national level, the state level and the local level.
If you improve and enhance economic freedom, more prosperity ensues. If you restrict economic freedom by increasing taxes or laying on more bureaucratic red tape, you inevitably reduce prosperity. Our economy is resilient, yet it should also be clear that people gain prosperity faster in areas with more economic freedom.
No matter what happens with this presidential election, it should be clear that we want to encourage — rather than squelch — economic growth. There is certainly room for disagreement on how to achieve growth, but let’s not lose sight of the goal — a strong, prosperous economy.
- Business , Economy , Geopolitics , Personal Finance , income taxes
- Comments(6)
Did you enjoy this article?
Thanks for this article! I even forwarded a copy to my congressman. I look forward to more of the same.
Gordie
Gordie — Thanks for the kind comment. I hope your Congressman gets the point. Some do, but many seem completely oblivious to the history of how politicians brought about the Great Depression with policies that were known to be dangerous by most economists.
‘Today, Democrats are planning tax increases that make Bill Clinton’s hike look mild. ‘ and ‘Effective top rates approach 50 percent.’ both are untrue statements. I expect nothing less from a complete simpleton like yourself - keep up the good work (NOT)!
Robert–We try to stay away from name calling here. So, if you want to comment critically, that’s great. Gratuitous insults are not.
Incidentally, the comment to which you objected was not mine, but rather that of the Washington Post author.
Kurt, the whole article bears your name, and the essence of your conclusion is: “We do not need to repeat the mistakes of the Great Depression by raising taxes or adopting protectionist trade policies. That will only slow down the recovery.” If you had done your homework properly, you would see that:
Sen. Obama….would repeal a portion of the tax cuts passed in the last eight years for families making over $250,000. But to be clear: He would leave their tax rates at or below where they were in the 1990s.
- The top two income-tax brackets would return to their 1990s levels of 36% and 39.6% (including the exemption and deduction phase-outs). All other brackets would remain as they are today.
- The top capital-gains rate for families making more than $250,000 would return to 20% — the lowest rate that existed in the 1990s and the rate President Bush proposed in his 2001 tax cut. A 20% rate is almost a third lower than the rate President Reagan set in 1986.
- The tax rate on dividends would also be 20% for families making more than $250,000, rather than returning to the ordinary income rate. This rate would be 39% lower than the rate President Bush proposed in his 2001 tax cut and would be lower than all but five of the last 92 years we have been taxing dividends.
- The estate tax would be effectively repealed for 99.7% of estates, and retained at a 45% rate for estates valued at over $7 million per couple. This would cut the number of estates covered by the tax by 84% relative to 2000.
Overall, in an Obama administration, the top 1% of households — people with an average income of $1.6 million per year — would see their average federal income and payroll tax rate increase from 21% today to 24%, less than the 25% these households would have paid under the tax laws of the late 1990s.
Robert — Thanks for improving the tone and adding some hard information. The post makes it clear that President Hoover, a Republican president, did raise income taxes considerably. That mistake was followed by a Democratic president raising them even more. Neither move was useful from an economic perspective and both increases exacerbated the economic downturn known as the Great Depression.
You are trying to obscure the point that Senator Obama would raise income taxes from their current levels. That’s a tax increase. It’s perfectly fine to advocate a tax increase, but you tried to skirt that point by referring to tax rates of the 1990s. We live in 2008, so a tax increase would be calculated from current income tax levels, not those of the 1990s.
I notice you also neglected to include the increase in Social Security and Medicare taxes being proposed.