Tax Policies and Redistribution: What Does History Tell Us?

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Do tax policies really matter when it comes to economic growth, job-creation, government debt, government spending, and wealth creation? Yes. I believe tax policies do matter and we have history to provide instructive data as proof. Since our progressive tax code is redistributive as a matter of practice, our nation has clearly been using tax-policy as a form of redistribution for more than a century.

[I apologize that I cannot insert the charts I am using to make my points into the correct places in this blog. I can only place the charts/images at the top or bottom of the post in the format allowed. I am therefore going to place them at the top and bottom of the blog so you can see the charts; however it is going to be a bit of a scavenger hunt for you to properly relate the specific chart to the specific paragraph. I have also left the name and source of the chart creators on the chart image so they receive the proper credit. All of the charts shown here are easily available on the internet. If you want to see this post with the correct chart placement, please send me your email address and I will send to you in a simple WORD file or as a PDF.]

Does history always repeat itself? Are there lessons from the decades of the 80’s and’ 2000’s that can instruct America during this election cycle? Yes and Yes. We should decide which history we want. Let’s look at historical tax cutting policies to see if any lessons can be gleaned that will be useful in the current election cycle.

In 2000 we created a very interesting challenge for ourselves. We made a early decision in March 2000 to cut taxes in a number of categories for three reasons:
1. The government had a current-year surplus and was coming off a balanced budget from 1999.
2. If the Treasury had a surplus and the budget was balanced, the Gov’t must have over-collected taxes and taxes should be decreased.
3. Return taxes to the people and jobs would be created, businesses would grow, individual spending would increase, government spending would decrease, equity- markets would grow, and the national debt would fall.

Many, many Americans agreed with the logic and tax-policies were implemented to support an economic theory that would drive the nation’s fiscal health for the next decade.

There we clues that 2008 would be the year of economic implosion because we had previously seen a similar economic situation back in 1914 that was solved using very similar tax-policy tactics. As you can see from the chart above, in 1914-1930, we were experiencing an imbalance not seen in the country previously – a significant rise in taxation followed by a very steep drop in taxation. This tax policy would have a far-reaching economic impact in 1929. Why? It seems the nation did not get the economic benefit promised when the tax cutting policies of 1920 were implemented. What was supposed to follow the tax reductions of 1919 – 1927 was explosive economic growth, swelling wages and massive infrastructure investment. Wealth was accumulating yet too few seemed to participate and to a large degree, demand began to contract. Result: The Depression arrived with a thud!

We all know what followed from 1930 – 1944. A massive increase in taxation along with massive contraction in every economic category.

By the time FDR began to right the nation’s ship, the country would inject massive public-sector investments into the economy. Taxes increased, spending increased, debt increased.

From the period 1946 – 1980, marginal tax rates held between 90% – 70% with moderate adjustments over that period. Tax rates, incredibly high by 2012 standards, were considered normal, necessary and fair during this period by many. This period has also been called the greatest period of economic growth in our history. Wages grew for all Americans, unemployment moderated , business expansion was dynamic, large infrastructure projects were built. During this period, social entitlements also grew. America was considered the World’s economic juggernaut. America thrived.

Yet in the decade of the 70’s, America developed a chink in its inflation armor. Interest rates spiked, and our reliance on oil led to a fiscal disaster – the 1970’s oil embargo. All of the sudden Americans wondered how they would get to work because of gasoline rationing. Inflation began to cripple the economy. Something had to be done.

Therefore in the 80’s a new theory was introduced with the promise of economic growth. A new theory on taxation was presented by a new President and what began in 1980 changed America forever. The theory: Dramatically reduce marginal taxes on everyone, especially high wage earners. Create new deductions for investment. Dramatically reduce taxes on Inheritance, Capital Gain, and Dividend Income.

During the 80’s, the nation saw the second largest reduction in tax rates – the largest of course being the period that preceded the great Depression. We introduced significant tax reductions for marginal rates, dividend and capital gains rates, yet the nation continued to spend. We did not drastically cut spending while cutting tax rates. However,we did see significant increases in debt. The theory was the economy would grow so much as a result of our tax policies, we would have sufficient revenues to pay for the spending and eliminate the debt at the same time.
Predictably, spending never fell. Debt grew.

As you can see, from the chart spending from 1980 followed the same spending trend-line as every other period year since 1947. As a simple matter of fact, spending increased not decreased. As is common of any party in government, spending goes up because people always choose to ADD but rarely subtract when it comes to spending.

Although there were two instances over the past 80 years where spending did go down (year-over-year -after WW2 and I am going to let you guess the only other period.

The last spike in spending followed by a reduction in spending was between the periods 1941 – 1946. Interestingly enough, the only other times spending fell were in 2009 and 2011. If the economic theory of the 1980 was based on the assumption spending would be cut in a meaningful way, it should have been clear from a reading of history that the theory was not a valid concept. Some politicians just want to spend as they wish.

However, the growth in spending was not the only disappointment to come from the 80’s economic theory although it would not reveal itself fully for a few decades after.

During the 80’s, the nation did see direct revenue flowing into the treasury. Whether the direct result of lower taxes is unsure, however when measured against historical revenue, the growth in revenue was consistent with the revenue growth trends of the 70’s as well. Oddly enough, early 2000 and 2008 saw a double-dip decline in revenue even as tax rates were at lower levels than even 1980.

Many have opined on the question of 80’s revenue growth. Some say revenue to the Treasury dramatically increased, others say revenue growth was similar to the previous decades. What the chart demonstrates is one truth, 80’s revenue growth was good yet was not explosive, chart popping, or historic – especially when contrasted with the 90’s.

However, the debt genie continued to grow in the 80’s as a result of increased spending and reduced revenue to match. The debt that had accumulated after World War 2 did decline dramatically after 1946, yet began a rapid new rise from 1980 to 2010. Interestingly enough, debt was falling in the 60’s and 70’s. It was during the 80’s that debt began to rise after 40 years of debt reduction. As a matter of fact, debt accumulation only dipped between 1993-1999 before beginning a new meteoric rise in the 2000’s that continues today.

If economic growth is strong, job creation constantly improving, businesses expanding, wages growing and tax collection is growing at a sustainable level, debt should be shrinking not growing. An economic philosophy that causes debt to grow, wages to contract, spending to increase, revenue to stall, and U.S. job creation to shrink is a failed economic philosophy. There is strong evidence that America experienced these economic outcomes in 1929 and the ground work for a repeat performance began again in 1980. By 2008, the ultimate economic end-game was revealed to the entire world.

There were a number of bright spots in the 80’s. Historically the equity markets always grew. As the chart below demonstrates, the market seems to grow consistently over time. As a matter of fact, prior 2000, the market never had a decade of negative returns, even after the Great Depression led by the 1929 implosion.

In the 80’s, record growth in the markets continued. This chart shows the market over a 100 year period. Although the print is small, the graphical illustration tells a undeniable story; markets grow but the last 2 declines you see are 1987 and 2008. Without doubt $100 invested in 1980 would have more than tripled by 2006 but $100 invested in 2006 and sold in 2010 would have gained $0.
Wage growth was another promise of lower marginal tax rates. Specifically middle-to-lower wage earners were promised increased wages as a result of an improving economy. As you can see from the chart below, the positive trend-lines for wage growth did not eventuate as promised. Although hourly wages had grown drastically during the 60’s and continued to rise in the 70’s, hourly wages began a dramatically negative trend in the 80’s. The working class lost income during the 80’s. Even by 1994 when the decline in wage growth stopped, the previous decade of wage decline would negatively impact consumer purchasing power and broad-based economic prosperity for years into the future.

What happens in a capitalism-based, free-market economy when consumers have constricted wages and minimal purchasing power – especially when consumption represents 70% of economic growth? The answer: Low demand, low employment.

The belief that new businesses would flourish under the 80’s economic theory turned out to be a mixed bag. Many companies did experience positive economic growth, however a troubling reality emerged. Although start-up businesses expanded and contracted during the decade, they ended the decade lower – a trend that continues.

If the phrase: “inside every small business is a large business waiting to get out”, is true, America was previewing the shrinking of business growth that would reveal itself fully in the coming decades.
Any economic theory that results in fewer start-up companies is bad policy.

Obviously if the country is in a recession or depression, all business will contract and growth will stagnate. However, in a period like the 80’s where the country was on the move, it is not good news that the policies produced fewer start-up businesses as a percentage of all business. It is a demonstrated fact that before you can become a large business enterprise you have to start as a small enterprise. Google started in a garage. As a matter of fact, today many have begun to argue that small businesses are NOT the engine for job creation simply based on the fact that they produce fewer employees at a given point in time than a large company does. This analogy is ludicrous! It is silly to forget that if a small business becomes a large business, their employment growth is no longer calculated in the small business category, therefore skewing the positive impact of small business job creation.

Starting up a business is surely something elected leaders would want to encourage if America really wanted to see large businesses grow. As I often say, “inside every small business is a large business waiting to get out”.

Prior to 1980, employment growth was considered good but the economic theory put into action in 1980 promised Americans that the US could do better and produce even more jobs. It was posited that the high taxes of the 70’s were stifling employment and opportunity, therefore reducing taxes would unleash pent up demand for jobs. As you can see in the chart below, employment did grow in the 80’s however the growth was weaker than the 70’s and not stronger than the 90’s.

As you can see in the 70’s, 19.6 million net new jobs were created – nearly 1.2 million more than were produced during the 80’s. As a matter of reality 21.6 million net new jobs were created in the 90’s under a different economic theory – over 3.2 million more than were created during the 80’s.
Unfortunately, employment growth actually cratered in the decade of 2000 which I will discuss later.

I discuss the economic theory of 1980 because America tried the same economic theory again in 2000. Back were the provocateurs of the theory that low taxes would come first, economic growth would come second, wage increases would follow quickly, and spending cuts – which would be the product of leadership and make tough decisions- would come next . Yet this time there was an addition to the theory. This time a sitting Vice -President would tell the nation that debt DID NOT MATTER. Everyone knew the country had heard this economic theory before – George Bush 41 even called it Voodoo-Economics back in 1979 – but the new debt element should have been most troubling to the deficit hawks. If we cut taxes, increased spending and froze wages, what might the likely impact be for the economy?

Where was Ross Perot when the country needed him?

Unfortunately the results for the decade of 2000 would prove to be so negative the policies would actually crash our entire economy and the world economic itself. Although there would be economic peaks during the 2000’s, the valleys would create a historically negative bottom. Growth would not just stagnate, the country would freeze to a level of entropy not seen since 1930. Not only were the results not promising, as a matter of fact that they were worse …. catastrophic would be the more correct term.

If America were in fact a corporation, in 2000 the new CEO inherited an America with a balanced budget, a budget surplus, record revenue, and a preceding period of record job growth. You would think success would be a slam dunk. If America was a Corporation with this type of performance, America, Inc. would be flying high. With a single party Board of Directors, (Congress) for 6 years and an MBA educated CEO at the helm (President), everyone anticipated stellar results from this team in 2000. Unfortunately, the management team of America, Inc. screwed the pooch. The Board of Directors and the President, its CEO, took over America Inc. and produced a stunningly negative fiscal record. In the private-sector these folks would have been fired and would never serve on another board. The CEO would have been fired and shamed for losing jobs, running up debt, killing the stock market, and driving down wages for 98% of all American consumers.
America actually went in reverse in the decade of 2000.

The chart below is sobering. For 30 years, net job creation was considered normal in America. It was unheard of to have an entire decade of no net job creation. However this is exactly what happened in the decade of 2000. America lost 1.5 million jobs during the decade of 2000, 5 million of which were lost from January 2008 to January 2009 alone. Even the first 8 years produced much weaker job growth when compared to the prior 3 decades. America produced ZERO net new jobs in the decade of 2000.

How can a country allow itself to have policies in place that encourage ZERO net new jobs for its citizens, especially when working people pay taxes? Jobs equal revenue – we lost millions of jobs for real people. This chart below will be studied for decades in Economic’s Classes to illustrate what not to do in a free-market, capitalistic society.

* Thank goodness we have at least produced 4 million net jobs from 2010 to-2012, though not nearly enough to create the economic growth we need. *

Let’s ask ourselves this question: If the economic theory practiced in 2000 worked, how did America fare in its mission to increase the income and wealth of all of its citizens? Not so good. Results :too many, earning too little, unable to create demand.

Spending? How well did America fare on its mission to cut spending?

As you can see, 2000 spending increased at a greater rate than the 70’s, 80’s or 90’s.
We simply spent too much from 2000-2009 even though revenue was going the other way and debt was exploding. Although some want to caveat spending increases as the result of wars, every decade had wars so war spending is an invalid excuse.

The reality is spending increased broadly in almost every single spending category.

How did the markets fare in the decade of 2000?

[The charts I wanted to show here would not load but are easily available online from NYSE, Google Finance or Bloomberg]

Let’s look at what happened to the US stock market during the period 2000- 2011. During this decade, the stock market went on a roller coaster ride that destroyed investor wealth at a level never seen before. The steep valleys you see are the crashes of 2002 and 2008.
Seniors saw their nest-eggs wiped out from 2000-2009 .., nearly everyone did.

The fact that the Dow began the 2000 at 11,773 and ended the decade below 10,000 should be a statistic that will forever shock the senses. A decade of zero net equity appreciation had rarely occurred in our history. As a matter of fact, if you ask equity market professionals, they would tell you it is nearly impossible to have 5 years of stagnant market appreciation … 10 years is absolutely unheard of. Someone screwed up.

If the plan was to reduce taxes so people could put that money back into investing in the economy, what we saw was if they put their cash in the market, many would have either lost their initial investment or worse yet, many would have lost money all-together.

The economic philosophy of 2000 which worshiped equity, capital and the financial services industries was built on a house of cards. In reality those industries took much more from American prosperity than they ever produced. Worse yet, we never got the jobs we were promised.

Interestingly enough, in the decade that began in 2000, there were jobs created by U.S. companies … just not in our country. Obviously very few of these jobs found a way to directly benefit the U.S. economy or create a positive U.S. job creation multiplier. By 2009 not only did the U.S. jobs contract in America, they contracted Internationally. In 2012, nearly every international economy is still contracting dramatically.

Conclusion
So what did we learn from our tour of America’s recent fiscal history. An economic theory that reduces taxes as its primary strategy while still increasing spending, slowing the growth of start-up businesses, and incurring unfunded debt does not work. An economic theory that does not adopt policies specifically aimed at increasing the health, wealth and well bring of all Americans – with a focused nod to the well being of the middle class and working class – will result in lower economic activity for the entire country. No American would want to embrace such a flawed strategy.
In life, you are not judged by how you start , you are judged based on how you finish. It’s not about effort, for a drowning person makes a monumental effort right before they drown; it’s about succeeding. Swimming is only successful if you don’t drown.

The same is true with economic leadership. If things are worse after you finish, you have failed. By any reasonable measure, the economic theory that began in 2000 and ended in 2009 was a failure. America lost a decade of prosperity. In a world governed by the laws of compounding, this lost decade may still be hurting our country for another 30 years. There is no reason to repeat such a failed economic strategy.

The 80’s produced outcomes that on-balance, were a mixed-bag. Equity market performance was outstanding, inflation and interest rates fell. Defense spending increased. Yet when measured against the stated goals of dramatically increasing revenue, lowering debt, reducing spending, increasing jobs, and increasing working class income, the 80’s was less successful than the 90’s.
If any future candidate for federal office presents as their economic plan, a plan similar to the 2000 economic plan, you need to ask them this question: Please tell me you have a back-up plan? Especially since we all know how the old plan worked out for the country the last time.

In 2013, we will need to put into action a plan that all Americans can agree will produce the right results. You get to decide which specific results you demand to see. You get to be very specific. Do not fall for promises. Don’t fall for failed theories that are too good to be true, because they are often just Bigfoot riding on a Unicorn. Study history and look for the plan that mirrors the historical performance you believe is best for your community and best for America. If you don’t understand plans that are presented to you, make the presenter produce a message that you do understand. Place the plans side-by-side and determine where they differ and exactly how those difference will impact fiscal performance.

Americans do not tolerate mediocrity or failure and we can no longer afford average outcomes. We demand excellence. Let’s make these same demands on our elected leaders especially when it comes to fiscal policy.

Let us decide which version of economic history we want to repeat itself.

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4 Responses to Tax Policies and Redistribution: What Does History Tell Us?

  1. btg5885 says:

    Vincent, excellent post and history lesson. If we don’t learn from our mistakes we are destined to repeat them. If the GOP wins the White House, we will repeat them. Yet, we need President Obama, if he wins and Congress to more dramatically deal with the deficit while continuing the job creation streak we have been on. Thanks, BTG

    • vincentmudd says:

      I learned quite a bit researching these tax policies. My thought was “how can we ignore history when it is clear what the outcomes have been”? Americans simply are not this stupid.

      One day, a strong free-market, smart government, socially sophisticated conservative will emerge from the Republican party. They will not trot out tax policies that have failed to produce the desired result. They will save their party.

      That individual has kept themselves out-of-sight up until now.

      Even the Dems learned their economic lessons and moved to policies that produced more jobs, smarter government, and more broad-based opportunity. They lost many on the left as a result yet they seem to have stuck to it anyway. However many on the left, right , and middle have joined them because of the consistency of their policies.

      Until the Republican party relocates their truly fiscal conservative soul and provide solutions that help all American’s equally, they are going to be on a path to 8 years of mediocrity.

  2. btg5885 says:

    I am hoping the Tea Party influence will decline, but they continue to be propped up by money. The GOP candidate who will save that party will have to have the courage to stand up against this divisive group. If he does not, the party will continue to retrench.

  3. vincentmudd says:

    I have met a number of folks in 2008 that considered themselves Tea Party members but they did not actually support the old tax policies. They were in fact disaffected mostly Republicans and some Libertarians and a few Democrats. Their real beef was with bail-outs, excessive spending, off-shoring, mounting debt, and corporate welfare. Those policies were born in 200 and burst in 2008, not 2010. It was an elected official on 2005 that said deficits do not matter , not 2009. I am convinced their original premise was correct: Why are we bailing out anyone? Why the giant tax deductions? Why the shrinking middle-class? Where are the jobs? Why so much debt and spending? Every American can understand and shared these sentiments.

    This is before the movement got co-opted by many others with many other agendas.

    Going back to the policies of 2000 would be going against the real Tea Party principles – if the current Tea Party was being completely honest and frank. There are politicians acting like they share the Tea Party cause, however they were in Congress when the votes we cast that the tea Party was formed to stop.

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