by Mike Kimel
Recently I had the opportunity to speak to Professor David Cohen’s class on the US Presidency in the Political Science department at the University of Akron.
My talk was structured around three questions involving some extremely simple recent economic history. None of the questions were trick questions.
The questions appear below.
Question 1. From 1980 to 1992, the top marginal tax income tax rate was:
-70% in 1980
-69.125% in 1981
-50% from 1982 – 1986
-38.25% in 1987
-28% from 1988 – 1990
-31% in 1991 and 1992
Given this pattern, which of the two graphs that follows do you expect shows the growth rate in real GDP over that period?
Option A: A few years after the first tax cuts, there was one year of unusually strong growth. Subsequent growth slowed a lot, and continued slowing as tax rates fell further.
Option B: The more tax rates were cut, the faster the economy grew. And then Bush I broke his “read my lips, no new taxes” promise and the economy slowed again.
The following is the list of eight year administrations since 1929:
-FDR (1933 – 1941)
-Truman (1945 – 1953)
-Ike (1953 – 1961)
-JFK/LBJ (1961 – 1969)
-Nixon/Ford (1969 – 1977)
-Reagan (1981 – 1989)
-Clinton (1993 – 2001)
-Bush 2 (2001 – 2009)
(FDR’s first 8 years are included, but the War years are left out. Also, Truman took over a few months into the term.)
It turns out that the degree to which each administration cut the tax burden (i.e., current tax receipts/GDP) during its first two years in office seems to strongly affect the growth rate in real GDP in the subsequent six years in office. (E.g., the amount by which Reagan cut the tax burden from 1980, Carter’s last year in office, to 1982 seems to strongly affect the annualized growth rate in real GDP from 1982 to 1988.)
Which of the following two graphs do you think best explains the relationship that was observed between the change in the tax burden in the first two years of the administration and the subsequent growth in real GDP over the remaining six years?
Option A: Administrations which reduced tax burdens early on enjoyed rapid growth later. Administrations which increased tax burdens early had poor growth later.
Option B: Administrations which lowered tax burdens early on suffered through poor growth later. Administrations which raised tax burdens early had strong growth later.
Reaganomics involved cutting taxes and reducing regulation. The New Deal (for our purposes, not including World War 2 years) involved tax hikes and increased government control over the economy. Which of the following two graphs shows the growth rate in Real GDP over the Reagan and FDR years?
Option A. Growth was faster under Reagan than under FDR.
Option B. Growth was faster under FDR than under Reagan
1. Option A: A few years after the first tax cuts, there was one year of unusually strong growth. Subsequent growth slowed a lot, and continued slowing as tax rates fell further.
2. Option B: Administrations which lowered tax burdens early on suffered through poor growth later. Administrations which raised tax burdens early had strong growth later.
3. Option B. Growth was faster under FDR than under Reagan. Quite a bit faster, in fact.
By the way… in each of the questions, the data for both options A and B was “real.” Its just the wrong answer, in each case, the growth rates did not match the taxes for any given year, but rather were sorted in order to fit the story line that everyone seems to believe. Also, for Question 2, I could have used the first year, the first three years, the first four years, the first six years, or the first seven years rather than the first two years of the administration v. the remaining years of growth and gotten similar graphs. Using the tax change for the first five years v. the annualized change in growth fro the subsequent three years shows almost no correlation whatsoever. My guess is that’s the outlier, given every other combination shows a recognizable story.
Its also worth noting… the three questions I picked are not “gotcha” questions or special cases. They’re central to the macroeconomic theory that has prevailed in the United States for the past few decades, and which American economists have managed to sell to the rest of the developed world since about 1990. The Reagan tax cuts are usually presented as exhibit A that tax cuts “work.” But I could have used Exhibit B (the so-called Kennedy tax cuts) instead. It wouldn’t have made a difference. The second question is an attempt to show how policies affect the economy the entire time they are in effect. Essentially, all the data available since the BEA began computing GDP is there, except the Hoover years, the Bush 1 years, the Carter years, and WW2. The third question compares what are often referred to as the worst economic policies this country enacted in the past 100 years to what are often referred as the paragon of economic policies in the same period.
I’m sad to say I’m confident most economics professors in the United States would get the three questions wrong. I’m also sad to say, I think it is no more possible to explain the US economy without knowing these facts than it is to produce a useful theory of the solar system assuming turtles all the way down.
And since most economics professors wouldn’t get it right, that’s what they’ve been teaching. I would venture to guess, in fact, that a student at, say U of Chicago or George Mason University (to use the flagships for two of the more popular “schools of thought”) is more likely to get these questions wrong after taking an economics course than before. And now, after a few decades, its now popular wisdom and the foundation of our economy. If you’ve been wondering what caused The Great Stagnation and the mess we’re in now, look no farther.
As always, if anyone wants my spreadsheets, drop me a line. I’m at my first name (mike) period my last name (kimel – one m only!!) at gmail.com.
Ok, so what was the class response? I mean, don’t leave us hanging.
They got it all wrong, but that’s forgiveable – it was a poli sci class. Economic policy and its outcomes isn’t a focus of the course. So these students were answering the question based entirely on what they had picked up elsewhere (i.e., the media, economics courses).
The blame lies with the economists who spread these erroneous ideas and the media that doesn’t check any of it. I figure journalists have no idea what happened. None. Most economists ditto. But there are some that do. Take a guy like Barro – he’s a great numbers guy. But his approach is always just a bit too tortured. I have to believe he knows what the data would show if it wasn’t tortured.
In any case, the end result is that for a long time, we’ve been collectively creating and implementing theories that are based on turtles all the way down. And that school of thought has spread in the 1990s across the developed world. If you want to know why we are where we are, this is it.
During the Reagan years I was living in Germany and what sticks in my mind is the surge of the $$, it went way up against the DM and other currencies. It felt as unreal as the housing bubble and the stock market bubble and all the day time traders getting rich over night coming down fast when the bubble burst.
I believe Obama made his biggest mistake last Dec. when he did not let the Bush tax cuts expire. He could have financed a recovery instead of focusing on the deficit. He made a poor choice picking his cabinet. He would have been crucified in the beginning until the economy would have improved and unemployment would have gone down at least some. The government would have invested at home, the corporations don’t invest at all as it is.
the real question is how much of that lesson sticks with them, & how likely they are to drift back to previously held beliefs, no matter how wrong…
I’m not even as concerned with the students. People absorb what they see all the time. The problem is, conventional wisdom spits out the wrong answer. Most people don’t have the time to check things outside their field… you take the word of doctors on medicine, you take the word of civil engineers about the stability of a bridge, and you take the word of economists about the economy. So the problem is with economists.
The question is, why does a smart guy like Tyler Cowen believe what he does? And if he stopped believing and stopped peddling the line he does, can he still make a living?
I think Obama’s biggest mistake came before he took office. By December 2008, it was already clear the “bazooka” wasn’t working as advertised, and there were even plenty of indications that it wasn’t even intended to do its stated purpose anyway. He should have said, “I would like to sign a law dismantling this monstrosity on Day One of my administration.” Instead, like a lemming, he went along. And he’s gone along ever since, with the tax cut extension being more going along, nothing more.
While your point about media not checking what they’re told is dead on, I think a large part of what’s going on is that evidence is being ignored in favor of ideology.
A very long time ago a good friend told me the secret to life: “Don’t confuse me with the facts, just dazzle me with the bullshit.” And we’ve been allowing ourselves (many, not all of us) to be dazzled for 30 years.
It’s not for nuthin’ that the public schools have been dumbed down over the same period.
Mike, don’t we face the same problem concerning SS? We have journalists who don’t know enough about SS and make no effort to find out by asking people with expertise?
I know it is a mute point, but I do wonder what the world would be like now if Gore would have been president? Hillary was my first choice, I believe she would have put up a fight and asked something in return if the GOP wanted bi-partisan ship.
He like many believe what they do because they never questioned the apriori’s of the reasoning they were taught to use when going beyond their apriori’s and leasons taught.
Which also means they were never taught, or never caught on to that part of the education that would allow them to be the scientist they believe themselves to be.
Agree about Hillary.
About SS… yes, it is. But there is a difference. That’s Bruce Webb’s and Dale Coberly’s crusade, this one is mine. And from what I can tell, they have what should be the harder load to carry… its harder for most people to see what is going on in SS. With taxes and growth, it seems it should be fairly obvious. After all, most of us lived through the Reagan years. We remember what was supposed to happen when Clinton raised taxes and what was supposed to happen when GW cut taxes, and we were there for the aftermath. And yet despite having been there, having lived through it, people are still dead wrong. With SS there isn’t the memory aspect. Those who Webb and Coberly are arguing with don’t even have to contradict what people remember.
But every so often one of those guys is confronted with the facts. Megan McArdle (granted, not the same league as Cowen) will simply say something that translates as, “well that ‘s an artifact of the data” and insis you need X number of observations or whatever she misremembers from a long ago stastistics class. And as I said, its clear that Robert Barro knows what the untortured data looks like given the cleverness with which he tortures the data. But what about the middle ground… its hard to believe a Tyler Cowen nevr had the interest or curiosity to actually look at data and graph it. What could he possibly be teaching his students without using graphs?
This is a bogus methodology, examining just one factor while so many other factors remain.
Household leverage jumped 25% during the Reagan years . . .
Corporate leverage was probably more.
Troy if you meant that it is bogus to claim that tax cuts for high earners spurs economic growth, and tax hikes for high earners harms economic growth, then I agree with you.
1. Are you saying that when household and corporate leverage increased, it decreased growth? I note that leverage often leads to problems later, but I was under the impression that it takes a while for those problems to arrive. Which means that household leverage should have increased growth under Reagan and decreased it under Clinton, right?
2. Of course other things matter. But let me see if I understand your point. Tax cuts are good, but by coincidence, every time they happen, other factors creep in and overpower the good effect of the tax cuts (and the good effect of Reagan’s leverage). And tax hikes are bad, but everyt time they happen, other factors creep in and overpower the bad effects of the tax hikes.
Its like God or the Universe or some other force is out there sabotaging tax cuts.
I got them all right (but I’ve seen the answers before…), but I was surprised that even a PolySci class got the Reagan vs. FDR one wrong. The Carter ‘malaise’ and Reagan/Volker’s led recovery were not even comparable to what the country went through during the Great Depression/WWII. As PolySci majors I would at least expect them to guess correctly just based on the state of the US during those two times. I would have gotten that one right in ’85.
Not only did this show great ignorance of economics, but a corresponding ignorance of history. How do you do Political Science without history???? I can sort-of understand being light on economics – though considering Clinton’s “It’s the economy stupid.” I’m a little surprised about that also.
Islam will change
I’d throw out four things:
1) Almost every President in history, or at least since FDR, has grown the size and scope of the Fed US Government. (I think – not sure, but I think even Reagan grew it). Thus the ones who raised taxes at the start to pay for the expansion had the smallest deficits and thus kept the government intake = to outflow the best. The ones who didn’t, or cut revenues, caused a mismatch betwen revenues and expenditures, cuasing a deficit, and then putting an artificial break on growth. Deficits do matter.
(That was a wild thought, but who knows it may give you real economist a ‘real’ thought to chew on)
2) As always, correlation does not mean causation. The world and US economy were so different between what FDR faced vs. Reagan as to make GDP growth comparisons meaningless.
3) If you are truely interested in keeping US combat related deaths to a minimum you should always vote republican. The correlation between high US combat loses and Dems as President is much better than the one between taxes and GDP growth. So only a war-monger would ever vote D…
4) And last:
Buff it might be ignorance of 1980s history combined with ignorance of 1930s history. Everybody knows that the Reagan years were the best we’ve ever had; it’s popular knowledge that the depression didn’t end until we went to war; and we’ve been told many times about how FDR screwed-up with all his misguided programs. To students around 19-20 years old, anything before W is ancient history. During W, they were old enough to begin hearing all of the above messages and not a lot of people were talking about the Clinton years. I am not at all surprised by what Kimel heard.
Buff & PJR,
I don’t think this about 20 year olds. My guess is that few professors at U of Chicago and even fewer at George Mason would get any of them right without some prepping. I’d guess that nationally the rates aren’t much better. As to why you (Buff) got it right… you’ve been reading this blog for a long time. We’ve been covering this issue many different ways at this blog. (And I don’t mean just me, though the focus on the Presidency tends to be more my schtick.)
I’ve read a number of your posts in which you discuss these (or similar) charts regarding the relationship between economic growth and marginal tax rates. In one very good series of comments you were asked “so what is the implication?” to which you linked your attempt at explaining the connection between higher rates and icnreased investment.
It seems to me like, as inoccuous as your “undermine the common beleif” goal seems here you are directly (whether deliberately or not) implying that growth results from high rates.
In fact you know that the data doesn’t support this correlation either. It’s true that there is no correlation between *cuts* and *increased growth* but neither is there a strong correlation between *hikes* and *increased growth*.
In particular your point regarding the possibility of a correlation between marginal tax rates and increased business investment seems lost here. How do you propose to use marginal rates to encourage capital investment if effective rates are raised on the backs of capital gains taxes?
Are we to believe that fiscal policy changes have no impact on the use of income?
I think we are chasing our tails and becoming victim to bad stats and defunct spinsters trying to correlate tax rates to growth. I’d contend that there are plenty of other multicolinearities between factors of GDP growth regardless of marginal tax rates. As I’m sure you have found studying the data, correlation between marginal rates and GDP growth are tenuous at best… the better arguments for limited fiscal policy are to mitigate government paternalism and inhibit the growth of a central-planning authority…. unless you’re advocating for a central planner?
A poli sci professor’s blog today took me to an analysis that attacks a recent Heritage Foundation attempt to keep the myth alive: http://www.americanprogress.org/issues/2011/09/supply_side_debate.html does a good job of “calling out” conveniently faulty, misleading data analysis to show, for the past 20 years, that tax hikes hurt economic growth and tax cuts increased economic growth.
I agree with you and Lys on SS and also Hillary.
Thanks for saying this:
“The point I made was that up until a certain point, higher tax rates incentivize me to keep my profits in my company, reinvesting them and generating more growth. Lower tax rates incentivize me to remove my profits from my business and spend it on frivolities. (I.e., if I’m going to get taxed at 75% if I take money out, I’m going to keep money in the business. If I’m going to get taxed at 25% if I take money out, woo-hoo, its yacht time.) “
Mike you really really need to do an experiment on most economists. Someone call the AEA.
It might be worth a try. On the other hand, there’s a problem. Imagine if most civil engineers involved in bridge construction thought that popsicle sticks make great rebar for bridge construction under cold conditions. If that were the case, showing up at the Bridge Engineering Association with three questions involving the failure rate of popsicle stick rebar would get you chased off the premises. Fortunately, I have every confidence that the members of Bridge Engineering Association actually know what they’re doing. Unfortunately, I think economists’ ignorance of the three questions I described has caused more damage than civil engineers would have had they been using popsicle sticks as rebar.
Robert – that would, of course, be most American economists. As we point out in Presimetrics, studies show that 95% of the world’s population is foreign. Its not a fair test for people who can’t be expected to be familiar with basic American macro data. The point of the questions is that American economists aren’t familiar with basic American macro data.