Economics help requested

On my “real” facebook page, I posted a link to Laffer’s article arguing in favor of lower taxes on the rich.  A liberal friend posted a reply that pointed out that, during the 1950s, which was a time of tremendous US economic strength, the top bracket was taxed at a marginal rate of up to 90%. By contrast, the top bracket today is taxed at something approximating half that, but the economy is weak. From that he concludes that Laffer is dead wrong.

Is my friend right? I believe as a matter of principle that money should be in the hands of the people and not the government, and I believe as a matter of principle that government redistribution of wealth is wrong, but I am incapable of explaining in economic terms why high taxes worked in the 1950s — or, at least, didn’t seem to have stifled the economy — while the lower tax rate now doesn’t seem to have stemmed the recession.  One of my more conservative friends suggested that the answer might lie in the fact that the post-war US economy, unlike the rest of the world’s, wasn’t lying in ruins, which certainly helped.  Is that it, or is there more to the story?

I trust that many of you, more sophisticated about economics and taxes than I, can either set me right — or, possibly, confess that my friend has a point.

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  • Steamboy

    There were many and sundry tax shelters, the most prevalent was in real estate.  In 1954 Congress passed accelerated depreciation for real estate,  allowing rapid write offs.   I think this lasted until reagan’s tax reforms in the 1980’s.
    Every Doctor, Dentist, Lawyer and Accountant built their own buildings to shelter income and the landscape was littered with small office buildings and complexes.
    Yes there was a high marginal rate, but it could not work so tax breaks and shelters had to be enacted to keep things moving.

  • richlud

    Hi, this is my first comment, but read your site pretty much everyday and really enjoy it. About this topic, one thing that I do know is that JFK lowered taxes when he took office and at that point our economy really took off. He cut the top tax rate by at least half, maybe more. Keep up the good work.

  • Danny Lemieux

    Hi Book:
    Not only is your friend comparing apples to oranges, but they are also mistaken.
    The argument against high taxes is that they suck away disposable income from productive private sector activity into low productivity government activity. People stimulate the economy in three ways:
    1) By spending money to buy goods and services, thereby stimulating jobs to provide the goods and services.
    2) By saving money, thereby providing the investment capital to support business development activity that create wealth.
    3) By creating wealth (defined as profit over and above the costs of inputs), thereby providing employment and stimulating demand.
    As you other friends pointed out, WWII left the U.S. and Sweden as pretty much the only intact and standing First World economies. There was a tremendous business development boom going on worldwide of which the U.S. was the prime beneficiary. Much of that international growth was also stimulated by the Marshall Plan, which gave the rebuilding economies of the world access to cheap capital whereby to purchase goods and services from the U.S. The U.S. was also reabsorbing huge numbers of soldiers into the workforce (from WWII and Korea), so wages didn’t need to be high but the numbers of people pumping cash into the rebuilding economy were huge. In sum, the economy didn’t need the disposable income of the middle and upper classes to stimulate economic activity.

    All that being said, like that famous Sam Cook song put it, your friend “don’t know much about history”, thinking about that wonderful mythical world of the 1950s. Where does your friend get their information…Hollywood?
    There were three recessions during this period, all very painful and all very deep.
    1) The recession of 1953-1954 was marked by inflation, heavy unemployment, severe restrictions on credit, and very heavy government spending on defense (the Cold War build-up) and very real infrastructure projects (Interstates, not local dance theater groups and unemployment benefits, such as with the current stimulus).
    2) Shortly thereafter, there arrived the 1957-1958 recession, marked by very high unemployment (20% in Detroit) and high inflation (stagflation).
    3) Shortly after the end of the 1958 recession, the recession of 1960-1961 was marked by very high inflation and unemployment. It was in this recession that a Democrat president, JFK, set the foundation for Reagan /Laffer economics by significantly cutting taxes, ending the recession by the end of that very same year the tax cuts were enacted. Then, as during the Reagan years, Federal revenues actually increased as the tax rate was decreased.

    So, think about it: the 8 years between 1953 and 1961 were marked by three very deep recessions totaling 6 years. You might want to point out to your friend that, by contrast, Pres. G.W. Bush presided over only 4 months of recession (3 months in 2001…economists dispute whether it should even be called a recession… and 1 month, Dec. 2007, at the very end of his term) during his 8-year term in office. So much for “the worst economic record in modern history”.

    Then, fix yourself a nice drink and sit back and watch their heads explode.

    Hope that helps clear things up.

  • phillips1938

    This to confirm that every thing Danny said is accurate.

  • Bookworm

    Thanks!  I’ll drop that in the mix.

  • Bookworm

    Well, it’s done — I edited Danny’s incredibly lucid little economics essay into a polite facebook response.  We’ll see now if it garners any counter information.

  • Bookworm

    With cosmic perfect timing, I found in my mail today a “save the date” from the Pacific Research Institute (a conservative think tank in SF, of all places), telling me that Arthur Laffer will be speaking at the gala on November 11 this year.

  • Ymarsakar

    The production came from war production and individual American initiative, namely in the introduction of millions of women into the work force. That was the “golden goose”, not “government policies” like Social Security. Which, coincidentally, FDR rammed through using threats against the SC.
    John Kerry, Soros, and all the other Leftist rich boys don’t pay much of any taxes. They dodge them like crazy. What’s the use of raising taxes on the rich, when the people who need to be paying their fair share, can get out of it?

  • suek

    I know you check AT regularly…did you see this one?  Don’t know if it would be of any help, but maybe…

  • Zhombre

    Tell your friend he is free to voluntarily impose Fifties tax rates on his own income and make payment to the United States Treasury, to set a good example.

  • Allen

    Laffer developed an optimization method for revenues versus economic growth. His main hypothesis is that there is some optimal level of taxation that would not hinder economic growth while maximizing revenues to the Treasury. This hypothesis can be extended across all income brackets. For example, no level of taxation would bring in any significant revenues from the lowest income brackets, but low income people do spend what money they have which supports the economy. Thus, lower income people should have few taxes. The economy is like an ecosystem in that stress at one point may lead to a collapse at other points. The system itself has feedback in it that prevents this collapse. The classic example of this is Volterra’s work. He mathematically described the predator-prey relationship and it’s feedback. So, if you overtax a bracket that bracket will adjust it’s behavior (lower income/tax shelters) so revenues will correspondingly drop. The levels of taxation are fluid though. A healthy robust economy will absorb higher taxes in some brackets then a moribund one, i.e. don’t raise taxes in a recession.

  • jj

    One of the things that everybody forgets (and I forget it too, exact numbers are long gone, though I suppose findable online somewhere) is that there were a hell of a lot fewer – and I mean a HELL of a lot fewer people who were “rich” in the fifties.  In the fifties, a million dollars, total net worth, was a LOT of money.  There were something like 20,000 people who were worth that much in 1959, which is the year I seem to remember.  Net worth, a million bucks: 20,000 in this whole country.  That’s not many.
    And, of course, that 1959 million dollars had the purchasing power, in today’s monopoly money, of about ten times as much.  The “worth” of the dollar was pegged, for a goodly piece of my life, to the 1957 dollar.  By the mid-seventies that had become such an embarrassment that they changed it to the 1975 dollar.  Now of course they don’t announce that kind of stuff at all any more, because even a 1975 dollar is currently worth about 20 of today’s dollars.  They just don’t make those comparisons any more – it’s too damned embarrassing.  The 2010 dollar is worth about a fifteenth of a cent in 1957 money,and worth about two and a half cents in 1975 money.
    This is measures of buying power, which is the only real way to measure the value of money.  It isn’t flattering to our government.

  • JKB

    Did you happen to catch Victor Davis Hanson’s essay at Pajamas Media?  Works and Days » A Weird Sort of Depression In it he contrasts the well to do state of the present day poor compared to the upper middle class of 1965 and that goes as well for the 1950s.

    “On the face of it, here in one of the most impoverished areas of a bankrupt state, things are not going well. But yet, by any abstract measure, we are far wealthier than, say, in the mid-1960s when things were booming.”

  • Spartacus

    You, Mrs. Bookworm, take comfort in the consistency and predictability of junk novels, their lack of intellectual rigor notwithstanding.  I have begun to take comfort that any comment I leave after Mr. Lemieux may simply say, “Um, yeah, what Danny said,” and be assured of giving good and correct advice, the lack of intellectual rigor of my approach notwithstanding.
    I will only add two things, both of which are links.  The first, and more quickly digested, is Kevin Williamson over at NRO arguing for some limits on (Laffer-inspired) supply-side theory, which is worth knowing when heading into an argument over Laffer, lest a leftist leap on it first.  The second is the utter treasure trove of raw economic data of all sorts over at the site of the St. Louis Fed.  Most numbers you might ever want are right here, in graph form, and straight from the Fed, so they’re not likely to be casually swatted away in debate.  Some of the graphs are really quite scary, and would make good campaign posters in and of themselves (“Had enough change yet?” printed below the federal deficit graph, “FYFSD,” or federal net outlays, “FYONET”) so I’m a bit suprised that the Fed has retained enough independence to continue displaying them, but hey, make hay while the sun shines.

  • Ymarsakar

    I read your article, Suek. I would feel better if Krugman gave up all of his bank assets to me, however.

  • BombthePeasants

    All of this makes me depressed. I’m only 35, and my daughter is 1-1/2. She will never have the life we had growing up, it seems sometimes. I’m going home to make more ammunition, and await the zombie apocalypse.

  • Danny Lemieux

    Don’t be depressed.
    We can never see the future but we can help make it.

  • garyp

    Just because two facts exist at the same point in time does not make them related.  Many other, much more plausible explainations, spring to mind before “90% marginal tax rates lead to high economic growth.”  The Left seems to relish “just so” stories because they satisfy the “children” (meaning the mass of humanity–as that’s how they see us) and don’t require much thought or effort (probably because if you think about this issues very long, it becomes obvious that the Left’s entire world view–including solutions–is silly).  Marx opined that all wealth came from “labor” and that capital played no role in economic growth.  This thinking lead directly to “workers should be in charge” and “property is theft” but gave no insight in how to build a better, more prosperous world (quite the opposite).   In fact, by ignoring the obvious fact that work is, for the most part, only undertaken to get “stuff,” the Marxists were forced to try to create the “New Socialist Man” that took only what they needed and gave whatever was asked.  Since real people don’t work that way, the asking turned to beatings and the beatings turned to executions until the entire sick system collapsed. The more sophisticated discussion provided above may be of value to your conservative friends but I doubt will have any impact on your Lefty pals.  If Leftists could (or more accurately, wanted to) think things through and really come to grips with the reality of how the economy works, they would not be Leftists.  They like a worldview where analysis is on the level of “two legs bad, four legs good.”   I have tried to convince some of my well-meaing, kind relatives that their “NPR” view of the world is not just wrong but destructive as it leads us to apply solutions that make the problem worse.  However, they refuse to make the effort to try to learn how the world really works and prefer to stick with the simple platitudes that yield pat, but incorrect, solutions rather than expending the effort to develop remedies that might actually work. 

  • Danny Lemieux

    You are way to kind, Spartacus. Hold my feet to the fire. It’s good for me.

  • Danny Lemieux

    That’s “too” kind.