U.S. Tax Hikes of the 1930s
June 27, 2010
Usually, nobody has a cabinet meeting and decides: "our recession
strategy will be to spend more money and raise taxes." I don't think
anyone, Keynesian or classical, would put that on the top of their
policy dream list. It just happens that way -- the policy cycle of
"stimulus" and "austerity."
June
21,
2010:
The
Deadly
Cycle
of
"Stimulus" and "Austerity"
I make a big deal of the tax hikes of the 1930s -- first the Smoot
Hawley Tariff, and then the Hoover tax hike of 1932 -- mostly because
they are largely ignored by economists who would rather believe that it
was all a mysterious aftereffect of a decline in stock prices. Stocks
go down, and everyone loses their "animal spirits," and poof! -- ten
years of tragedy leading to a World War. You would think that people
would find that a little simplistic.
(On
the
other
hand, I think economists like it because it places no
blame on the government. Economists know on which side their bread is
buttered.) Also, it was not just U.S. policy, but very similar policy
around the world. Virtually all countries had tariff hikes of a similar
scale as the Smoot Hawley Tariff (60% tariff on just about everything),
and also many countries had domestic tax hikes on the scale of the 1932
Hoover hike. In fact, Hoover was imitating policies in Britain and
Germany, who were really the first with the big domestic tax hikes.
I would love to get more details on the British tax hike of 1931, and
also the final Weimar tax hike, which was so unpopular that it led
directly to the rise of the National Socialist party in Germany. I
actually asked a professor of British tax history about this, and got
... nothing. He didn't know. Eh? So, if you know of a source with this
info, let me know.
Instead, this week we will look a little more closely at U.S. tax
policy during the 1930s. I think you will end up with an idea of why
the Great Depression dragged on and on into the 1940s.
The Smoot-Hawley Tariff
The Smoot-Hawley Tariff began as an agricultural tariff. Farmers
weren't participating in the great economic boom of the 1920s. Indeed,
it appears that the introduction of motorized tractors resulted in
agricultural overcapacity. About 1/3rd of farmland, in those days, was
set aside for horse pasture. The horses then pulled the plows and
wagons. When horses were replaced with motorized tractors and trucks,
the farmland available for growing crops increased by 50%. At least,
that is one story -- there is a slight decline in corn, wheat and
soybean prices toward the end of the 1920s, but not a lot. To gain
congressional support for the tariff, however, the supporters started
to add products from other Congressmen's districts. This all began in
1920s -- Herbert Hoover campaigned on an increased tariff for
agricultural products in 1928. After his victory, in 1929 Hoover asked
Congress for a new tariff in which rates for agricultural products rose
and rates for industrial products declined.
In May 1929, the House passed a tariff in which rates for both
agricultural and industrial good increased. This went to the Senate,
which then debated the tariff. The initial stock market decline in 1929
lines up exactly when tariff supporters in the Senate got enough votes
to pass the tariff -- by adding more and more items to the list of
goods subject to the tariff. In May 1930, the House passed the new
bill. At first, Hoover opposed the bill, calling it "vicious,
extortionate, and obnoxious." However, in U.S. history, the Republican
party has typically been tariff supporters, while the Democratic party
has been in favor of lower tariffs. Republicans have often seen tariffs
as a type of economic support, as it protects existing businesses from
foreign competition. In the initial downturn of 1929-early 1930, the
tariff was then seen as an additional economic booster. Hoover was
pressured by his own party to pass the tariff into law, and he did so
in June 1930. The new tariff applied to over 20,000 goods and imposed a
60% rate on more than 3,200 products, quadrupling previous rates.
Between 1929 and 1934, with tariffs blasting higher worldwide, world
trade decreased by 66%.
Wikipedia on the
Smoot-Hawley Tariff
The 1932 Revenue Act
This was followed in 1932 by the Revenue Act of 1932. This raised the
top income tax rate from 25% to 63%, with increases on all incomes
above $6,000. The estate tax rose to 45% from 20% and the corporate tax
rate rose from 12% to 13.75%, and exemptions were reduced. Exemptions
for individuals were reduced, with the basic exemption for a married
couple falling from $3,500 to $2,500. This was aimed at bringing 1.7
million new taxpayers into the income tax system. However, the big
increases were in excise taxes, which were expected to raise 51% of the
$912m in increased revenue expected by the tax hike. (In actuality,
revenue declined as the economy imploded.) This was the result of a
debate that began with the idea of introducing a new national sales
tax, in an effort to "broaden the tax base." Ultimately, the national
sales tax idea was abandoned with the argument that tax rates should
fall higher on luxuries than on necessities.
Wikipedia on
the Revenue Act of 1932
More
on
the
Hoover
excise taxes
More on the 1932 tax
hike, including history of debates
The "Hoover New
Deal" of 1932
The 1934 Revenue Act
In 1934, tax rates were adjusted slightly to put higher rates on lower
incomes. The top rate remained at 63%. However, the rate on $10,000
rose to 11% from 10%, and the rate on $50,000 rose to 34% from 31%. The
estate tax rose to 60%.
Wikipedia on the Revenue Act of 1934
The Revenue Act of 1935
Yet more tax hikes. Rates on incomes over $50,000 were raised, with the
top rate going to 79%. Corporate taxes were increased, and the estate
tax rose to 70%. "We have not yet weeded out the overprivileged,"
Roosevelt told Congress.
Social Security Act of 1935
In addition, 1935 saw the introduction of the Social Security system,
along with the first payroll tax. The original rate was 1%, on both
employer and employee (2% total). It was raised to 3% (1.5%+1.5%) in
1950.
Wikipedia
on
the
Social
Security system
History
of
U.S.
payroll
tax rates
The Revenue Act of 1936
The Revenue Act of 1936 established an "undistributed profits tax" on
U.S. corporations. The normal rate on corporations was 15%. However,
there was a surtax of up to 27% on undistributed profits, producing a
combined rate of 42% on undistributed income of more than 60% of total
net income. It appears that personal income taxes were increased
slightly. The top rate remained 79%, and the rate on income of $50,000
was 35%.
Wikipedia on
the Revenue Act of 1936
The Revenue Act of 1938
There was another Revenue Act in 1938. Personal income tax rates
remained unchanged. It is not clear what happened in this act. The full
text is available here:
Full text
of the Revenue Act of 1938
The Revenue Act of 1940
In the Revenue Act of 1940, income tax rates rose again, and exemptions
fell. The basic exemption for married couples fell to $2,000 from
$2,500. The basic corporate tax rate rose from 19% to 22.1%. The income
tax rate on income of $8,000 rose to 12% from 10%; the rate on income
of $50,000 rose to 48% from 35%. The top rate remained unchanged at 79%.
Wikipedia on
the Revenue Act of 1940
The Second Revenue Act of 1940
Once wasn't enough? The Second Revenue Act of 1940 created a corporate
excess profits tax of 50%, and increased the basic corporate tax rate
to 24% from 22.1%.
Wikipedia on the Second Revenue Act of 1940
This is only a rough outline of tax policy in the 1930s. We could use a
lot more info on excise taxes (which were big), plus more info on
exemptions and other quirks of the tax code besides just the simple
rates.
State Taxes
However, we should add to this the rather dramatic concurrent
developments in state-level taxes. Here is a good primer on state
taxes, many of which increased dramatically during the 1930s:
Dates
of
Adoption
of
Major State Taxes
Click on it and read it. It is only one page. You can see a great many
new state income, sales and excise (liquor, cigarette) taxes were
imposed during the 1930s.
Some Conclusions:
As you can see, taxes headed significantly higher through the 1930s.
And the Depression continued. The Depression is commonly considered to
have ended with World War II, but this is not really the case. What
happened is that unemployment declined, and production increased, due
to astronomical levels of government spending. In 1943, the U.S.
federal government spent 43% of GDP. This decline in unemployment was
welcome, since it is not the average decline in income that is really
the problem, but rather the large numbers of people who have no income
at all. Or, at least, it was welcome until you died on some foreign
battlefield. Most of World War II was fought by the Russians vs. the
Germans on the eastern front in 1941-1943, with the U.S. eventually
joining Britain to harass Germany's western flank. The U.S. did not
participate in the European war in size until the invasion of Italy in
September 1943, followed by the landing in northern France in June
1944. Some people today think that the U.S.'s involvement in World War
II was not really necessary. In the summer of 1941, public opinion was
70% opposed to becoming involved in the European war. Whatever supposed
good came from killing people and blowing stuff up in Europe and the
Pacific -- arguably, a more violent version of Keynes' "digging holes
and filling them back up" -- the result was increased hardship for most
U.S. citizens. Wartime meant little availability of consumer goods.
Statistics on consumption of basic supplies like butter show a dramatic
falloff during the 1940s during wartime, even compared to the depressed
1930s. In short, people were poorer -- as one would expect if the
government is directing 43% of the economy to something like waste. The
government's fiscal path was also unsustainable. The 30%-of-GDP federal
deficit of 1943 couldn't go on forever. As it was, the U.S. ended the
war with a federal debt/GDP ratio of about 120%.
In 1930, federal tax revenue amounted to 4.2% of GDP. It was probably a
little higher than that in 1929, as recession tends to depress this
figure. In 1934 -- after all the tax hikes -- it was 4.8% of GDP. It
then rises to 7.6% of GDP in 1941. We have seen that often, the
government doesn't really decide how much tax revenue it receives. The
people have an idea of how much they want to pay the government, and
that's how much they pay, no matter if tax rates are high or low.
Although the much higher taxes accounts for some of this rise in
revenue, I also think it reflected the increased government services
provided by the New Deal. The fact of the matter is, many of
Roosevelt's policies were popular, and were perceived as a long-awaited
solution not only to the immediate problems of the 1930s, but also the
long-standing problems of 19th century capitalism. Even libertarians
today don't complain too loudly about things like unemployment
insurance or even Social Security, certainly not at 1930s rates of 1%.
We like to have a bit of a safety net, and recognize the advantages
even to capital and businesses of such an arrangement -- in principle,
if not always in exact implementation. Thus, I think we can see some of
this tax revenue rise as a reflection of a greater willingness to pay
taxes, to fund a greater range of government services. Today, even
libertarian Hong Kong has a revenue/GDP ratio of 12.8%. (I think Hong
Kong has about the best balance of government services, sensible tax
policies and libertarian principles in the world today.)
During World War II, U.S. citizens got used to a much larger
government, and tax revenue as a percentage of GDP rises to a peak of
20.9% in 1944. There was a sort of step-function, from the roughly
4%-of-GDP level of the 1920s to the roughly 18.5%-of-GDP average that
has persisted since World War II, whether tax rates go up or down. A
basic principle of the Laffer Curve is that people will not resist
paying taxes if they feel that this
is the highest and best use of their money. Thus, taxes won't
have that much of a negative economic effect. For example, if the
government provides health care services that are better (because
universally available) and cheaper (just look at any developed country
outside the U.S.) than private-sector options, it makes sense that the
taxes to fund this health care wouldn't be perceived as a burden.
The U.S. economy did not immediately revive after the end of World War
II. Indeed, it was rather moribund all the way until 1950, a good five
years later. In 1948, it probably appeared that the Great Depression
was still dragging on much as it had in the late 1930s, punctuated
rather unpleasantly by a World War. The change around 1949-1950 was due
to a lot of things, notably developments on a global basis. It seems to
me that the boom of the 1950s and 1960s began with the big tax cuts in
Germany and Japan, but that in turn reflected a broader policy shift --
from one of crushing the war's losers into oblivion (the Morgenthau
Plan), while communism spread in China and eastern Europe, to a happier
policy (the Marshall Plan) of rebuilding the capitalist economies of
Germany, Japan, Italy and so forth. Everything looked a lot brighter on
a global level, and not just because of tax rates.
You can see here that the bull market of the 1950s and 1960s did not
begin until the end of 1949, coinciding exactly with the change from
the Morgenthau Plan framework to the Marshall Plan framework. Until
then, stock prices remained roughly where they were in 1937.
Not only did stock prices not go up, but 1949 was the peak of the Great
Bond Bull Market of the 1930s and 1940s. Prospects for business looked
so crappy that people were happier with a "safe, secure" 2.0% yield on
the ten-year Treasury bond than they were with the 6% dividend of U.S.
stocks.
In short, people in the U.S. got used to a bigger government, and
higher taxes. The adjustment period of the imposition of the new taxes
was over. It didn't bother them anymore, and indeed it probably seemed
necessary to fund the military (protect us from communism!) and the
various social services that had emerged as a result of the New Deal.
Not to mention that immense wartime debt. Diverting roughly 18.5% of
GDP to the federal government now seemed
acceptable. Thus, although tax rates in the 1950s and 1960s (and today)
were in fact much higher than in the 1930s, this provided a tolerable
environment for growth and prosperity.
This hypothesis does not imply that further tax hikes from here will be
ultimately met with open arms. Going from a federal government of 4% of
GDP (more like 1% before 1913) to 18.5% was perhaps an acceptable path,
but that doesn't mean that U.S. citizens will accept a government that
intends to increase its tax revenue to 25% or 35%. Depending on how the
government behaves, it is possible that people will conclude that even
18.5% is much too high a figure for this collection of liars, criminals
and thieves, and we could see revenue/GDP fall to 10% even as tax rates
rise, as tax evasion becomes commonplace. As I mention in my book,
citizens will accept even astronomical tax rates if they believe "it's
worth it." In the ultimate crisis -- typically a military invasion by a
foreign power that is perceived to be tyrannical, such as the German
invasion of Russia in 1941 -- citizens will sometimes give up
essentially everything they have in the defense effort, a "tax rate "of
90% if you want to put it in those terms. Of course, this willingness
to be taxed disappears immediately after the danger is passed. On the
flip side, people may not accept any taxes at all if they feel that
they get nothing out of the deal, and that the government has no
legitimacy. The American Revolution represented a tax revolt against
taxes that were very modest by today's standards.
Thus, I think a "spend more money and raise taxes" approach would
probably be even more of a failure today than in the 1930s. There is
nothing that we particularly need to spend money on today, not even a
national health care system in the U.S., which could easily be funded
out of the 7.5% of GDP that U.S. governments (all levels) are already
spending on healthcare. If anything, we should be spending less money
on the military and all forms of waste and graft, with various
"bailouts" on the top of the list.
September
25,
2009:
Does
Hong Kong Have the World's Best Health Care
System?
June
9,
2010:
The
Coming
Keynesian
Catastrophe
Lastly, I would point to the "stimulus/austerity" cycle as it has
played out in Japan. It's still going on there, with taxes rising ever
higher, accompanied by many plans to reduce spending, which go out the
window and are replaced by new "stimulus" plans as soon as the economy
begins to groan under the new taxes.
November
1,
2009: Japan's New Government
May
26,
2009: The Japan Baloney
May
24,
2008: Japan: Silly Self-Destructive Behavior
May 18, 2008: Japan: Tax Hikes are No Fun
May 11, 2008: Japan: Now What Are We Going To Do?
And of course the Japanese economy continues to stink, just as the U.S.
economy stank in the late 1930s -- this even after the big problem of
the 1990s, monetary deflation, has largely been relieved. Just as is
the case for the 1930s, people still blame this stagnation on the
decline in asset markets in the early 1990s, about 17 years ago. You
would think that 17 years would be enough time to figure out what is
happening right under their noses.
