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More on Occupy Wall Street–Stiglitz and Madrick add their voices

by Linda Beale

More on Occupy Wall Street–Stiglitz and Madrick add their voices

Jim Swan, the Not-an-economist blogger who writes about “economics and the economy in the wake of the financial crisis”, is definitely a supporter of the Occupy Wall Street protest movement.

In an earlier post, I noted the addition of labor concerns to the voices supporting the movement–important, because so much of the impact of financialization of the economy has been to create a two-tiered social structure of privileged banker/investor/managers versus marginalized worker. Decades-long actions have undermined unionization–by limiting secondary strikes, by empowering employers to dominate workplace discussions, by weakly enforcing labor laws, by disempowering workers from forming unions, and now by the right’s efforts in the states to gut collective bargaining by public workers, in the process using a divisive technique of pitting private workers whose efforts to unionize have been hardest hit by the weakening of labor protections against public workers whose unions have given them more ability to claim decent wages. As a result, the vast majority of Americans find themselves with declining standards of living as wages stagnate or decline, while heads of big business rake in a bigger and bigger share no matter how the company actually fares, resulting in ridiculous golden parachutes for failed executives.

Notaneconomist notes the importance of progressive economic thinkers paying attention to the Occupy Wall Street group: see Occupy Wall Street? It’s About Time!, providing video and transcript links covering progressive economist Joe Stiglitz and economic historian Jeff Madrick addressing the group October 2. Part of the post follows.

Two excerpts from the Wall Street event (October 2):

Stiglitz: Our financial markets have an important role to play. They’re supposed to allocate capital and manage risk, but they’ve misallocated capital and created risk. We are bearing the cost of their misdeeds. There’s a system where we’ve socialized losses and privatized gains. That’s not capitalism! That’s not a market economy. That’s a distorted economy, and if we continue with that, we won’t succeed in growing, and we won’t succeed in creating a just society….

Madrick: The FBI actually told the powers that be that there was an epidemic of fraud in 2004 in the mortgage market. Washington and the Federal Reserve had the power to do something about that. They did not. The more bad mortgages went on, the predatory lending got worse, and the powers that be—in particular and let me name names, Alan Greenspan, the Chairman of the Federal Reserve—was able to retire in glory. Is there something with this picture? There sure is…

My only question is why the demonstrations didn’t happen sooner. Perhaps it has taken this long for it all to sink in. Not only did Wall Street recklessness create the crisis as government regulators looked on, but now bankers are back playing the same game and complaining of government interference, with no acknowledgment of the bailout that pulled them back from the brink.

Speaking of the bankers lack of acknowledgement of the bailout, Swan goes to NPR’s interview a year ago with Wall Street bar patrons (an investment banker, an institutional investor, a credit rating agency quant). That’s definitely worth reading in full at NotanEconomist (linked again in case you want to), but here’s the key part. After the interviewer suggests that the interviewees should acknowledge that all three benefited from the massive government intervention to protect the financial system, one of them says that the reason he still had a job was “because I’m a smart person”, not because Wall Street was bailed out. They view the fact that the industry was bailed out as irrelevant to their situation–they just used their smarts to take advantage of the situation and land well-situated.

originally published at ataxingmatter

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Basic Macroeconomics

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?

Figure 1 Option A

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.

or…

Figure 1 Option B

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.

Question 2.
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?

Figure 2 Option A

Option A: Administrations which reduced tax burdens early on enjoyed rapid growth later. Administrations which increased tax burdens early had poor growth later.

or

Figure 2 Option B

Option B: Administrations which lowered tax burdens early on suffered through poor growth later. Administrations which raised tax burdens early had strong growth later.

Question 3
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?

Figure 3 Option A.

Option A. Growth was faster under Reagan than under FDR.

Figure 3 Option B.

Option B. Growth was faster under FDR than under Reagan

(ANSWERS AFTER THE JUMP)

The answers…
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.

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The Effect of Individual Income Tax Rates on the Economy, Part 7: 1988 – 2010

by Mike Kimel

[UPDATE: Graphic title corrected below. h/t Eric Whitaker]

This post is the seventh in a series that looks at the relationship between real economic growth and the top individual marginal tax rate. The first looked at the period from 1901 to 1928, the second from 1929 to 1940, the third from 1940 to 1950, the fourthh looked at 1950 – 1968, and the fifth from 1968 to 1988. Because the Reagan era is so pivotal in the American psyche, it was also covered again in the sixth post, which looked at the period from 1981 to 1993. This post will look at the period from 1988 to the present.

Before I begin, a quick recap… both the 1901 – 1928 period and the 1929 – 1940 failed to show the textbook relationship between taxes and growth. In fact, it seems that for both those periods, there was at least a bit of support for the notion that growth was faster in periods of rising tax rates than in periods when tax rates were coming down. It is worth noting that growth from 1933 to 1940 was generally quite a bit faster than at any other peacetime period since data has been available, both on average and for individual years. Not remotely what people believe, but that’s what it is.

In the 1940 – 1950 period, we did observe slower economic growth following a tax hike and faster economic growth followed a tax reduction. However, that happened when the top marginal tax rate was boosted above 90%.

Interestingly enough, though the so-called “Kennedy Tax Cuts” are often used as one of the prime exhibits on the benefits of cutting taxes, a look at the 1950 – 1968 period yields no such conclusion. Growth rates were already rising before the tax cuts occurred in 1964 and 1965, reached a peak when the tax cuts took place, and started shrinking immediately afterwards. The other period that is always pointed to as evidence that tax cuts spur growth is the Reagan years, which showed up in the 1968 – 1988 and the 1981-1993 posts. It turns out that put into context, the Reagan years produced one year of rapid but not particularly extraordinary growth a few years after tax cuts began. That’s it. In fact, its worse than that… during the Reagan Bush 1 years, aside from that one good year, growth tended to shrink as tax rates were slashed.

Real GDP figures used in this post come from Bureau of Economic Analysis. Top individual marginal tax rate figures used in this post come from the IRS. As in previous posts, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate. Let me stress this point again as I’ve been getting people e-mailing me to tell me I’ve got the growth rates shifted a year. That is correct, and is being done on purpose (and is shown on the graph labels). To avoid questions of causality, the growth rate in year X used in this post is the growth rate from year X to year X+1. And when I say “to avoid questions of causality” – you’d be amazed at how many people write me when I don’t do this and insist that sure, higher tax rates seem to be correlated with faster growth, but that’s because when growth is faster governments feel more willing to charge higher tax rates.

So here’s what the period from 1988 to the present looks like [update: Graphic Title Corrected; h/t Eric Whitaker)

Once again, the data fails to show anything resembling the old “lower taxes = faster growth” story. In fact, once again, it kind of looks like things go the other way. The two biggest dips in the graph occur when tax rates are at low points (28% and 35%). The highest tax rates also coincide with the fastest overall growth. But no doubt next week’s post looking at the next period will be the one that finally shows what everyone believes is there. Oh wait, we’ve run out of years.

Now, I’m sure someone will bring up the fact that there was a tech boom and the internet in the late 1990s. And no doubt there was some of that. But that doesn’t explain why only once did the graphs appear to show that cutting tax rates correlates with faster economic growth, and that one time occurred in the middle of WW2 during what was essentially a command economy when tax rates were above 90%. Talk about a special case. Conversely, most of the other graphs that we’ve seen in this series have not shown any relationship between tax rates and economic growth. And then there were a few, such as those showing the Reagan era, that seem to at least suggest that faster growth was more likely when tax rates were higher. None of this matches what we hear in the liberal (ha ha) media. None of this matches what I see in econ textbooks. It doesn’t match what I read in economics journals. But anyone, and I mean anyone, can do these graphs. Not sure many people can replicate Barro.

Next post in the series… what it all means.

As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel (note that I’m not from the wealthy branch of the family that can afford two “m”s – make sure you only put one “m” in there) at gmail period com.

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Speaking engagement

by Mike Kimel

Speaking Engagement

If anyone is in the Akron, Ohio area and has any interest, I will be giving a guest lecture at David Cohen’s American Presidency class on Monday Sept. 19. The class runs from 12:05-12:55 in Leigh Hall 510.

I’ll be talking about Presimetrics, the book I co-authored with Michael Kanell. I’ve prepared a few slides which I’ll make into a post after the lecture.

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The Effect of Individual Income Tax Rates on the Economy, Part 6: 1981 – 1993

by Mike Kimel

The Effect of Individual Income Tax Rates on the Economy, Part 6: 1981 – 1993

This post is the sixth in a series that looks at the relationship between real economic growth and the top individual marginal tax rate. The first looked at the period from 1901 to 1928, the second from 1929 to 1940, the third from 1940 to 1950, the fifth looked at 1950 – 1968, and the sixth from 1968 to 1988. Because the Reagan era is so pivotal in the American psyche, though it was covered in the last post, I intend to focus on it again. The last post included the lead in to Reagan’s term, this post contains the follow-up to his term. In this post I’ll look at the period from 1981 to 1993.

Before I begin, a quick recap… both the 1901 – 1928 period and the 1929 – 1940 failed to show the textbook relationship between taxes and growth. In fact, it seems that for both those periods, there was at least a bit of support for the notion that growth was faster in periods of rising tax rates than in periods when tax rates were coming down. It is worth noting that growth from 1933 to 1940 was generally quite a bit faster than at any other peacetime period since data has been available, both on average and for individual years. Not quite quite what people believe, but that’s what it is.

In the 1940 – 1950 period, we did observe slower economic growth following a tax hike and faster economic growth followed a tax reduction. However, that happened when the top marginal tax rate was boosted above 90%.
Interestingly enough, though the so-called “Kennedy Tax Cuts” are often used as one of the prime exhibits on the benefits of cutting taxes, a look at the 1950 – 1968 period yields no such conclusion. Growth rates were already rising before the tax cuts occurred in 1964 and 1965, reached a peak when the tax cuts took place, and started shrinking immediately afterwards. The other period that is always pointed to as evidence that tax cuts spur growth is the Reagan years, which showed up in the 1968 – 1988 post. It turns out that put into context, the Reagan years produced one year of rapid but not particularly extraordinary growth a few years after tax cuts began. That’s it.

Real GDP figures used in this post come from Bureau of Economic Analysis. Top individual marginal tax rate figures used in this post come from the IRS. As in previous posts, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate. Let me stress this point again as I’ve been getting people e-mailing me to tell me I’ve got the growth rates shifted a year. That is correct, and is being done on purpose (and is shown on the graph labels). To avoid questions of causality, the growth rate in year X used in this post is the growth rate from year X to year X+1. And when I say “to avoid questions of causality” – you’d be amazed at how many people write me when I don’t do this and insist that sure, higher tax rates seem to be correlated with faster growth, but that’s because when growth is faster governments feel more willing to charge higher tax rates.

With the preliminaries out of the way, let’s get started. The first graph shows the tax rates from 1981 to 1993 along with the t to t+1 real GDP growth rates.

Figure 1.

It goes without saying that what the graph does not, repeat, does not show is that lower tax rates have much to do with faster economic growth. In fact, some of the slowest sustained economic “growth” that occurred during the Reagan-Bush years coincided with the lowest tax rates: 28% and 31%. The one standout year occurred when tax rates were at 50%, and had been at 50% for a few years. And yet, somehow this period has entered the public consciousness as Exhibit A that Tax Cuts Work.

That said, I’d like to point out that unlike the folks who venerate Reagan today, Reagan himself did have a reason, an excellent reason, in fact, to try tax cuts… at least the first round of tax cuts. Looking back from the vantage point of 1980 and leaving out the WW2 years, real economic growth when tax rates were in the 90% + range was lower than it was when tax rates were in the 80% to 89.9% range, and that was slower than when tax rates were in the 70% to 79.9% range, and that in turn was slower than when tax rates were in the 60% to 69.9%. That is shown in the graph below.

Figure 2.

Note that all the information contained in Figure 2 was available by the time Reagan took office. If the information in Figure 2 is all you have, it isn’t unreasonable to wonder whether further reductions in the tax rate will lead to faster economic growth. Of course, Reagan did have a bit more information available. He also had growth rates from the last time tax rates were in the 24% and 25% range (i.e., the start of the Great Depression) which were negative… and which might have tipped him off that the relationship between tax rates and growth is actually quadratic. But I guess its a bit much to expect any of Reagan’s advisors to consider anything like a quadratic relationship.

In any case, we can combine Figures 1 and 2 to put the Reagan – Bush rates into context:

Figure 3.

If you’re wondering, during seven of the 12 Reagan-Bush years, growth rates were actually below the average rate observed when top marginal tax rates were above 90%… and the really slow growth during the Reagan – Bush era occurred disproportionately when tax rates were at the 28% and 31%. That is to say, when tax rates were at their lowest levels in the Reagan – Bush era, growth rates were also at their lowest. And as the graph also shows, every single year, repeat, every single year of the Reagan Bush had a lower average growth rate than when tax rates were in the 60% to 69.9% range.

So… what we don’t from the Reagan – Bush era is anything that supports the notion that lower tax rates correlate with faster economic growth. (Note… correlation does not imply causality, but lack of correlation certainly does imply lack of causality.) We do see that it could have been a rational experiment for Reagan to cut tax rates from 70% to 50%. It was not a rational experiment, based on what happened at 50%, to cut rates further, and the result was easily predictable.

And speaking of rational… the story the data tells is strongly at odds with what is commonly believed. And this isn’t ancient history. Most of us lived through this. It isn’t rational for us to believe things that aren’t true. But collectively, we do. And its leading to crummy growth rates. What a surprise.

Next post in the series… 1993 to the present.

As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel (note that I’m not from the wealthy branch of the family that can afford two “m”s – make sure you only put one “m” in there) at gmail period com.

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The Effect of Individual Income Tax Rates on the Economy, Part 5: 1968 – 1988

by Mike Kimel

The Effect of Individual Income Tax Rates on the Economy, Part 5: 1968 – 1988
This post is the fourth in a series that looks at the relationship between real economic growth and the top individual marginal tax rate. The first looked at the period from 1901 to 1928, the second from 1929 to 1940, the third from 1940 to 1950, and the fifth looked at 1950 – 1968.

Before I begin, a quick recap… both the 1901 – 1928 period and the 1929 – 1940 failed to show the textbook relationship between taxes and growth. In fact, it seems that for both those periods, there was at least a bit of support for the notion that growth was faster in periods of rising tax rates than in periods when tax rates were coming down. In the 1940 – 1950 period, we did observe slower economic growth following a tax hike and faster economic growth followed a tax reduction. However, that happened when the top marginal tax rate was boosted above 90%. Interestingly enough, though the so-called “Kennedy Tax Cuts” are often used as one of the prime exhibits on the benefits of cutting taxes, a look at the 1950 – 1968 period yields no such conclusion. Growth rates were already rising before the tax cuts occurred in 1964 and 1965, reached a peak when the tax cuts took place, and started shrinking immediately afterwards.

Real GDP figures used in this post come from Bureau of Economic Analysis. Top individual marginal tax rate figures used in this post come from the IRS. As in previous posts, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate. Let me stress this point again as I’ve been getting people e-mailing me to tell me I’ve got the growth rates shifted a year. That is correct, and is being done on purpose (and is shown on the graph labels). To avoid questions of causality, the growth rate in year X used in this post is the growth rate from year X to year X+1. And when I say “to avoid questions of causality” – you’d be amazed at how many people write me when I don’t do this and insist that sure, higher tax rates seem to be correlated with faster growth, but that’s because when growth is faster governments feel more willing to charge higher tax rates.

So let’s get started below the fold:

Let’s put up a diagram showing growth rates and tax rates for the period from 1968 to 1988. But we almost don’t have to do it. We all know what happened. We’ve been told so many times. Tax rates were very high in the late 60s and 70s. And then came the Lone Ranger Reagan, and, and lo, Reagan cut taxes. The result is that the economy began to grow like never before. Sure, the story is strikingly similar to the one about the tax cuts in the 1960s, and we know from the last post how that turned out. But still, the Reagan story is even more widely accepted, so here’s the graph that accompanies the story:

Figure 1.

Wait. That can’t be right. Something is wrong with the data because it doesn’t match the narrative!!! Yes, there was a tax cut and the economy started growing. But the only growth that was unusually strong for the time period occurred in one single year, from 1983 to 1984. And immediately afterwards it dropped and kept dropping.

In 1987, there was a small pickup in growth which accompanied a further tax cut (50% to 38.5%), but the year after, when the top marginal tax rate dropped further (to 28%), growth fell again.

Strip away the rhetoric, and it would seem the “evidence” for the benefits of Reaganomics, for the most part, are that following the small tax cut in 1981 (70% to 69.25%) and the bigger one in 1982 (69.25% to 50%), there was one seemingly extraordinary year of growth from 1983 to 1984. I could swear the narrative usually isn’t stated in this way.

But let’s take a close-up of the Reagan years and put them (and the one extraordinary year) in perspective. In the next graph we have the 1980 -1988, but for comparison, I’ve included the growth rate from 1938 to 1939. That happens to be the third slowest year of the pre-WW2 New Deal era. Here’s what it looks like:

Figure 2

Now, you may be able to noodle out why I picked the third slowest year of FDR’s first 8 years from the graph – see, it turns out that Reagan’s best year was faster than FDR’s worst, and FDR’s second worst pre-WW2 years, but that’s about it.

Redoing Figure 2 and adding in FDR’s best pre-WW2 New Deal year: 1940 to 1941, produces this graph:

Figure 3.

Doesn’t look at all like what you learn in school, eh? How about what you hear on Fox? Or from El Rushbo? What about from Rick Perry? Heck, you don’t even hear about this from liberals.

What you will hear is denial, and on the rare occasions where someone is willing to accept the data, excuses. Now, I’m sympathetic to the idea that FDR and Reagan were Presidents at very different times, that perhaps FDR had higher potential growth due to a bounceback effect (I don’t buy it, but I’m sympathetic to the idea). I also don’t find it offensive if someone states that times and laws were different, and even if Reagan had FDR’s approach to government in mind, he could never have enacted the same policies that FDR applied. What I am not sympathetic to are people who tell us about how well Reagan’s policies worked and who also insist that FDR ruined the economy or made it worse. People who make such claims can only fall into two categories, the “good” one being the misinformed.

So to sum up… so far in this series… it seems the evidence has been at least weakly against the idea that tax cuts lead to faster economic growth in the 1901 – 1928, 1929 – 1940, and 1950 – 1968 periods. The 1940 – 1950 period does seem to behave consistently with that notion, though it is worth noting that it happened when tax rates were above 90%. The period from 1950 – 1968, despite the frequent obfuscatory comments from certain sectors, also completely fails to support the notion that lower tax rates are followed by faster economic growth. And frankly, the 1970s and 1980s don’t help the cause either.

Because the Reagan years play such an important role in the way we do economic policy in this country, we’ll revisit them in the next post in the series.

As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel (note that I’m not from the wealthy branch of the family that can afford two “m”s – make sure you only put one “m” in there) at gmail period com.

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The Effect of Individual Income Tax Rates on the Economy, Part 2: The Great Depression and the New Deal, 1929 – 1940

by Mike Kimel

The Effect of Individual Income Tax Rates on the Economy, Part 2: The Great Depression and the New Deal, 1929 – 1940

This post is the second in a series that looks at the relationship between real economic growth and the top individual marginal tax rate.

Last week I had a post looking at the relationship between the state of the economy and the top individual marginal tax rate from 1913, the first year for which there were individual income taxes, to 1928. Because there is no official data on GDP for that period, I used recessions as a proxy for how well (or poorly) the economy was doing. I note that there was no sign whatsoever that the economy did better during periods when income taxes were non-existent (the post also looked back to 1901), or were low, or were falling, than when tax rates were high or were rising between 1901 and 1928.

This post extends the analysis to the period from 1929 to 1940, 1929 being the first year for which official real GDP data is available from the Bureau of Economic Analysis. 1940 is the end of FDR’s first eight years in office, and serves as a decent bookend to the New Deal era given America’s entry into WW2 in 1941. Top individual marginal tax rate figures used in this post come from the IRS.

The following graph shows the growth rate in real GDP from one year to the next (black line) and the top marginal tax rate (gray bars). In case you’re wondering, I’m using growth rate from one year to the next (e.g., the 1980 figure shows growth from 1980 to 1981) to avoid “what leads what” questions. If there is a causal relationship between the tax rate and the growth rate, the growth rate from 1980 to 1981 cannot be causing the 1980 tax rate.

Notice that tax rates fell from 77% in 1920 and 1921 to 24% in 1929, the year the Great Depression began. (As noted in the last post, the so called Roaring 20s was a period when the economy was often in recession.)

Figure 1

In 1932, tax rates rose to 63%, and by 1933, the economy was growing quickly. That doesn’t match with what people believe, I know. It seems these days its commonly accepted that FDR, who took office in 1933, created the Great Depression or at least made it worse, and that only WW2 saved us. In part to address that issue, the graph below shows growth only during the New Deal era, 1933 – 1940 (no WW2!!!). To put the growth in perspective, I’ve added two lines. One represents the fastest single year growth during the Reagan administration, and the other shows the average of the single year growth rates during the Reagan administration. I figured it would be a good comparison, the Reagan administration being today’s gold standard for all that is good and pure.

Figure 2.

As the graph shows, in all but two years from 1933 to 1940, the t to t+1 growth rate was faster than in every single year of the Reagan administration. In fact, the average of the yearly growth rates during this period was about a percent and a half faster than Reagan’s best year.

And yes, there was a sharp downturn shortly after the tax hike in 1935, but its hard to credit that tax hike with the downturn when immediately after the economy continued on a rocket trajectory.

Now, whenever I point something like this out, I get told the same thing (at least by folks who are smart enough not to argue with the data): the rapid growth in the New Deal era occurred simply because the economy was slingshotting back from the Great Depression, and if anything the New Deal policies slowed the recovery. The problem with that argument, of course, is that because the unfortunate events of 2007-2009 witnessed the biggest economic decline since the end of WW2, the economy should be primed for the fastest spurt of growth in the past 60 years. After all, the policies we’ve been following before, during and since that decline have not been very New Dealish at all: top marginal tax rates are 35%, not 63% or 79%, there are no work relief programs, and Glass Steagal Act, passed as part of the New Deal, borders on irrelevant. Yet I think its safe to say just about everyone is in agreement that sort of growth isn’t going to happen anytime soon.

It is also safe to say that for the first two periods covered in this series (i.e., 1901 – 1928 and 1929 – 1940), we once again haven’t seen any sign of the purported relationship between higher lower marginal tax rates and faster economic growth. No doubt that relationship shows up later on. Next post in the series: WW2 and the immediate post-War era.

As always, if you want my spreadsheets, drop me a line. I’m at my first name which is mike and a period and my last name which is kimel at gmail period com.

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A Post: Tax Burdens, Presidents, and Subsequent Economic Growth – A Few Pictures, Part

by Mike Kimel

A Post: Tax Burdens, Presidents, and Subsequent Economic Growth – A Few Pictures, Part 1

Last week I had a post looking at the relationship between the change in the tax burden in the first two years of a Presidential administration and the growth of real GDP during the remaining years of the administration. I’ve done variations of this exercise before. It turns out that the more an administration reduced the tax burden in its first two years, the slower the growth the in real GDP over the remainder of its term in office administration. Assuming the result is more than an artifact of the data (and it does seem to correspond with other results I’ve reported here over the years), it requires an explanation. While (I am not happy to report) an increased tax burden might in and of itself stimulate faster economic growth, I suspect a bigger effect is that a) the easiest way to move the tax burden is by increasing or decreasing tax regulation and b) there is a correlation between an administration’s views on tax regulations and its views on other regulations that are intended to prevent externalities. This theory is supported by the fact that the relationship between lower tax burdens and slower growth is strengthened by not including the administrations that served only four rather than eight years makes the relationship stronger.

As I keep noting, one doesn’t have to like the results. I personally would much prefer a world in which lower tax burdens do lead to faster economic growth. But the data doesn’t seem to show that. Still, every time I put up a post like this, I get a lot of flack. One thing people keep telling me is that the results are, at best, a coincidence. In their honor, in today’s post I’m going to describe a few more coincidences that the data shows in my next few posts. Some of these coincidences I expected to see, and some, to be frank, I did not. Today I’m going to stick with a few coincidences I expected.

So… let’s go with coincidence number one. The graph below shows the change in the tax burden from Year 0 (i.e., the last full year of the prior administration) to Year 2 on one axis, and the growth rate in the last full year of each administration. (Only eight year administrations are included.) As an example, for Ronald Reagan, we see the change in the tax burden from 1980 to 1982 along one axis and the percentage change from the 1987 real GDP to the 1988 real GDP.


Figure 1

Notice that the relationship between the tax burden in the first two years of each administration and the growth rate in its last year is extremely strong. That’s consistent with what I wrote in my last post (and so many times before): most administrations do not change their tax policy very much, but tax policy (and other policies that correlate with tax policy) can take a while to have an effect on the economy.

Before I go on, a few ground rules for those who want to comment or send me e-mail:
1. If you really believe that the growth rate in the last year of an administration is “causing” the change in the tax burden in the beginning of the administration, I encourage you to seek psychiatric help. I can’t do anything for you.
2. US’ participation in World War 2 prior to 1940 is best described as peripheral. Growth in 1940, or 1939, or 1934 for that matter, is not due to World War 2.

(If you find my constant repetition of these ground rules funny, hazard a guess as to what creeps into my inbox.)

Now, another coincidence… the next figure shows the the change in the tax burden from Year 0 (i.e., the last full year of the prior administration) to Year 2 on one axis, and the growth rate in the fourth year of each administration.

Figure 2

Again… the picture looks an awful like Figure 1. The fit isn’t as good (consistent with the idea that it takes a while for policy to have a a very strong effect. Kind of odd for a coincidence.

Now… you may be wondering… what about other years. I’ll tell you flat out, the fits in years 1 and 2 are awful… consistent with the idea that it takes a while for policy to have a very strong effect. As to the rest, that will wait for the next post.

To close, nominal and real GDP come from the Bureau of Economic Analysis. GDP was first computed in 1929, so the first complete administration for which we have data is FDR I. Data on the Federal government’s tax receipts comes from the Bureau of Economic Analysis’ NIPA Table 3.2.

As always, if you want my spreadsheets, drop me a line at my first name (mike) period my last name (kimel – with one m only) at gmail period com. I should also point out, you can find a lot more of this sort of analysis in Presimetrics, the book I wrote with Michael Kanell.

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Optimal Tax Rates for Generating Economic Growth According to Barro-Sahasakul Tax Data

By Mike Kimel

Optimal Tax Rates for Generating Economic Growth According to Barro-Sahasakul Tax Data

This piece is a bit more wonky than what I normally post.

I recently re-read “Macroeconomic Effects from Government Purchases and Taxes” by Barro & Redlick. I was struck by how different the conclusions they make about taxes are from what you get if you simply make a bar chart of the top marginal rate at any given time versus the growth rate over the next year.

Now, obviously, Barro & Redlick take a completely different approach… but at the bottom of everything is the data set they use (see Table 1 of the above referenced paper and this explanation of the “Barro-Sahasakul” data set). To cut to the chase, they use estimates of the average marginal tax rates paid by taxpayers rather than the top marginal rate that I used in the bar chart referenced above. Their overall marginal rate is made up of not just federal tax rates, but also social security tax rates, and even estimates of the state tax rates. It should be noted the Barro is an average rate, and since the average includes non-filers (who pay zero), the Barro rate is often well below the top marginal rate. The top Barro rate is 41.8% which occurred in 1981 (compared to top marginal rates of 90%+ from 1951 and through 1963). The Barro rate is also not correlated with the top marginal income tax rate (correlation going back to 1929 is -30%).

A lot of work clearly went into producing this overall marginal rate (I’m going to call it the “Barro tax rate” for simplicity). But does it explain economic growth rates any better than the top marginal rate?

I ran a quick and dirty regression…

Growth in real GDP from t to t+1 = f(Barro Tax Rate, Barro Tax Rate Squared, Top Marginal Income Tax Rate, Top Marginal Income Tax Rate Squared)

Data ran back to 1929, the first year for which real GDP was computed by the BEA. Top marginal rates came from the IRS Statistics of Income Table 23. And the Barro Tax Rate came from Table 1 of the Barro & Redlick paper. Since Barro rates are computed only through 2005, that’s when the analysis stops.

Results were as follows:

Figure 1

(Note… the errors got big during leading up to WW2, but I don’t think that invalidates this quick and dirty look.)

Here’s what I get out of this:

1. There is definitely a quadratic relationship between tax rates in one period and real economic growth the next.
2. If you’re going to pick either the Barro rate or the top marginal income tax rate, go with the latter. Its clearly better at explaining economic growth rates.
3. There may be something to be said about using the Barro rate and the top marginal income tax rate together. They do explain different things.

If you compute the “optimal tax rate” – the rate that maximizes economic growth implied by the regression – you get a Barro rate of 25% and a top marginal income tax rate of 64%. The optimal Barro rate was last seen in 1966, when the top marginal rate was 70% and the bottom rate was 14%. I’m guessing from this, and from looking at the Barro rate series, that this would imply that if you want to maximize growth, the top rate should be raised to about 64% and the tax burden on folks at the lower end of the income scale should be lowered. I’m not sure Barro would be pleased with these results.

I may return to this, but my next post should be the next in the series on GDP growth and the S&P 500.

As always, if you want my spreadsheet, drop me a line with the name of this post. I’m at my first name (mike), my last name (kimel – with only one m) at gmail.com. BTW… this spreadsheet contains a lot more wonky goodness!

Thanks to Sandi Saunders for getting me started wading through this particular pile of weeds.

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Four Graphs Looking at Real Economic Growth

by Mike Kimel

Four Graphs Looking at Real Economic Growth

This post contains four graphs looking at real economic growth, three of which also contain some tax information.

The first graph shows the five year annualized growth in real GDP for every five year period beginning the one ending in 1934. (I begin then simply because data on real GDP is only available from the BEA beginning in 1929.)

Figure 1.

I took the liberty of adding in two lines free-style. The first is my attempt to trace the high points over time, leaving out WW2. The second traces the low points, assuming the collapse from 1929 to 1932 and the post-WW2 drop are special cases. (That huge dip from 1945 to 1950, economic shrinkage and all, is what libertarian professors like David R. Henderson keep referring to inexplicably as a post-war miracle.) Those ad hoc lines seem to indicate that any “Great Moderation” in the economy – whether it began in the 1980s or earlier – is more due to a slowing down of the rapid periods of growth than to a reduction in the severity of downturns. Put another way… the Great Moderation = the Great Suckening (for readers who aren’t economists, that’s a technical term like “sterilizing monetary policy” or heteroscedasticity).

Figure 2 is similar to Figure 1, but it strips out the two ad hoc lines and adds in the five year average top marginal individual income tax rate.

Figure 2.

As Figure 2 shows, there doesn’t seem to be much of a relationship between the average top marginal tax rate in any five year period and the annualized growth in real GDP over that same period, and certainly there’s no sign from this graph that higher tax rates discourage economic growth. The fact that the correlation between the two series is positive indicates that if anything, in general real economic growth rates have tended to be higher when tax rates were higher.

Figure 3 is a scatter-plot version of the data in Figure 2.

Figure 3.

Notice that it kind of looks like you can put a quadratic curve to these points – at “low” tax rates, increasing tax rates are associated with faster economic growth. Only at very “high” tax rates – somewhere north of 70% or 80% – does it appear that reducing tax rates are associated with faster economic growth. Reminiscent of this graph, dontcha think? Another thing that’s noticeable… the greater variability in growth that accompanies higher tax rates, which was also visible from Figure 2.

Finally, Figure 4 is the same as Figure 3, but rescaled to leave out 1942-1945, which only makes the lack of a lower taxes = faster economic growth relationship more obvious.

Figure 4.

As always, if you want a copy of the spreadsheet where these graphs were produced, drop me a line. I’m at mike period my last name (that is “kimel” – one m only!) at gmail period com.

Cross posted at the Presimetrics blog.

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