The weekly column from Clark Judge:
We Can’t Go Back Again (to 1950s Tax Rates)
By Clark S. Judge: managing director, White House Writers Group, Inc.; chairman, Pacific Research Institute
In an article in yesterday’s Wall Street Journal, Lawrence Mone, president of the Manhattan Institute, took on the leftist contention that a return to prosperity requires returning to the high marginal tax rates of the 1950s – 91 percent for top earners.
In an article full of telling points, for me the most telling point was that “thanks to globalization, domestic capital and corporate earnings are no longer a ‘captive’ source of revenue that one nation can easily tax away.” (Much of what follows comes from an essay of mine published in the Claremont Review of Books’ Spring 2011 edition.) Mone offered the observation in passing. I want to give it a little more attention.
Leftish advocates of the “go back to the good old 1950s tax rates” school have totally missed what to me is one of the essential economic questions of the last half century: Why did the policies of the post-war Eisenhower era of good feeling stop working?
On the day that Ronald Reagan took office in 1981, U.S. inflation had reached 13%; interest rates, 21.5%—numbers not seen since the Civil War. Since the mid-1960s, most American economists had believed that unemployment and inflation seesawed against each other. If prices rose, joblessness would drop, and visa versa. But by January 1981, with unemployment at 7.5%, both were high, a phenomenon dubbed “stagflation,” that is, stagnation combined with inflation.
Looking back, the source of America’s late ’70s economic malaise seems simple: putting Mr. Mone’s point in more historical terms, the post-World War II period was over.
For all their success providing a foundation for the U.S. postwar boom and the reemergence of Europe and Japan, the expansive monetary practices, wide-reaching economic regulation, and redistributionist taxing and spending born of the Great Depression and the war could no longer be sustained.
Taken together, U.S. post-World War II policies sharply favored consumption over investment. The U.S. came out of the Second World War with a tremendous amount of under-employed industrial capacity. The tax rates and other policies of the period combined to pull in global goods and push out American capital, in the process restoring global and, in particular, European and Japanese liquidity. And for that reason, one unappreciated in any quarter, they worked for the U.S. economy, too. Real incomes increased; real personal wealth expanded.
But by the early 1970s, Europe and Japan had recovered. Other regions had not yet adopted the secure, easily established and readily transferable rights of property, impartial rule of law, and deference to free markets that would have allowed them to ingest and digest excess American liquidity. So formerly successful policies turned corrosively inflationary.
In 1972, President Richard Nixon reacted to the resulting turbulence in the currency markets and cut the dollar free from gold. Within two years, the oil exporting countries, attempting to protect their real incomes in their dollar-denominated trade, imposed steep spikes on crude petroleum prices. Their actions signaled the start of the nearly decade-long inflation crisis of the 1970s, the only peacetime inflation crisis in U.S. history.
Meanwhile, even after the Kennedy income tax cut of the early ’60s, both personal and corporate tax rates remained near historic highs. But following the unprecedented upheavals of the Depression and the war, the U.S. domestic market was still expanding back into itself. It required much more demand than investment, in keeping with the policies of the period. Meanwhile, 19th- and early 20th-century large-scale manufacturing techniques and processes still dominated the productive scene.
In this almost ideal environment for relying on big, long-established corporations to fuel growth, high tax rates produced less drag than in other periods. When tax rates are elevated, it is smaller and younger companies, with their more expensive cost of capital, that are priced out of the financial markets. Heavy economic regulations work the same way. Big companies can afford them. Smaller companies cannot. But by the mid-‘70s, reliance on established enterprises was no longer sufficient. Impressive yet inagile firms faltered in the unstable environment. More adaptive entrepreneurial companies became an increasingly essential driver of national economic growth. High taxes and New Deal-era economic regulations turned increasingly dysfunctional.
Ronald Reagan understood the emerging entrepreneurial economy before almost any major political figure. As president, he recast American policy to foster the developing metamorphosis.
The subsequent change has been profound. According to a recent study from the Ewing Marion Kauffman Foundation, in the quarter century after 1980, five-year-old or younger companies created all of the nation’s net new jobs. It would not be too much to say that the reason for the failure of the Obama administration’s economic policies to date is that they do not fit this new world. The reason for the success of the Reagan administration’s policies was that they did—and in fitting it, helped to create it.
In short, times have changed. We can’t go back. Progressives, who pride themselves in always being on the right side of history, should surely understand that.