thanks for your response.

one additional comment re: “. . do we credit higher taxes with growth . . ”

i certainly didn’t mean to imply that raising taxes was the cause of the GDP growth after 1932. i only wanted to make the point that raising taxes doesn’t preclude growth.

what actually caused the growth after 1932? i don’t know. there are just too many variables.

i enjoy your blog. best of luck to you.

bob

It’s still a good point, about the dangers of bad p.r., and I do think the message to Congress couldn’t have helped things. So much of the marketplace is driven by perception, how could it not cause a panic to some degree?

But I’m not sure what else could have been done. They needed the money and the authority from Congress to stop a looming crisis. They had to convey a strong message to Congress, and they couldn’t do it privately. It was a dire situation, and glossing over the depth of the potential downside … well, it might have keep the Libor-OIS spread from continuing up, or it might not have. But it certainly would have impacted their ability to get the unprecedented amount of money and power from Congress.

In the end, of course, it’s really unknowable, unless you are truly well-versed in these things, which I am not. And even with a deep understanding, it rises to merely educated guess-work.

That’s the problem with preventing a crisis, I suppose … you only know it worked if nothing happens. Which is exactly the same result as if there isn’t a crisis in the first place.

Cheers.

-Ted

After the tax hikes of the Hoover administration, unemployment hit nearly 25% the following year; that was the peak. But it averaged 20% or so through 1935 and remained in the high teens through 1939. 1940 was the first year of single-digit unemployment — 9.9%.

So this gets back to the comment from tedsaid: do we credit higher taxes with growth (as per your chart) or with punishing the stock market and wage earners? And let’s not forget about the central bank induced inflation that probably had a role to play in those GDP numbers.

Thanks for the contribution.

First, I think you’re right that it was a “combination of government taxes, debt, and spending” that contributed to the deepening and extension of the Great Depression. The Laffer OpEd caught my eye because I feel we are on the cusp of a big spending program just as we have building deficits to bail out the economy. Taxes probably need to rise to lower the deficit as well as to pay for what has been; I shudder to think about paying for new programs at this juncture. Debt as a percent of GDP has been rising relentlessly (my last post) which makes this downturn more difficult to manage in terms of government spending. (And, BTW, The Economist has an excellent roundup this week on the struggles Great Britain is having in managing its programs, deficits, and taxes. A good read: http://www.economist.com/opinion/displaystory.cfm?story_id=14505529)

Lehman was an important event in terms of helping to shift market sentiment. But I think memory has altered the role of Lehman vs the pre-TARP testimony on the Hill. I find the course of the Libor-OIS spread most interesting: It tells you how banks feel about lending to one another. And it wasn’t until Paulson and Bernanke presented their case for TARP that the bottom nearly fell out. I object to the role Lehman has assumed in the economic crisis narrative. But that doesn’t mean I don’t think it was important. I would write a different lead to the story and it would be about the p.r. blunders of the politicians in D.C. It’s funny, I was recently at an exhibit about the history of money and the controversy over funding the Civil War. In the exhibit, it became abundantly clear that even back then Lincoln understood his p.r. role. He didn’t have Twitter (or True/Slant) to promote his views, but he still understood the power of the pen.

As for causality, you’re right that some numbers can be coincidental (Libor-OIS happened to gap out when Paulson/Bernanke said we were on the edge of catastrophe). In this case, I think it’s fair to link the two. And thanks for finding my typo — I fixed it.

As for my background? I don’t have enough training to blow up a global economy — only the real experts can do that!

laffer has a great theory there about the effects of raising taxes. but look at what actually happened to GDP before and after tax rates were raised in 1932.

http://2.bp.blogspot.com/_otfwl2zc6Qc/SSnGcXaRkfI/AAAAAAAAH1M/Kbneap1nrCw/s1600-h/depression.bmp

Most people would argue that the late 1950’s and early 1960’s were some sort of acme of economic growth and vibrancy for the US and the world. However, the top personal tax bracket was a staggering 91% and the top business tax bracket was 50%. In contrast, in the last 1920’s and early 1930’s tax rates were very similar to what they are now. The tax rates begin increasing under the Roosevelt administration and peaked under the Eisenhower administration. I would suggest that taxes, might actually stimulate the economy if structured and spent correctly. So perhaps this exactly the right time to raise taxes.

I’m not sure what your economic background is, but there are a couple pretty major fallacies in this post, I’m afraid.

First, the easy one: it’s not Luigi Gonzales at the University of Chicago, but Luigi *Zingales.* But that’s merely a quibble. I’ve probably mispelled a few things myself.

Second, Zingales and Cochrane didn’t “demonstrate” that Paulson and Bernanke caused the financial crisis of last fall; rather, they *opined* that this was the cause. I.e., they wrote an opinion, in the Wall Street Journal Opinion page, rather than publishing peer-reviewed research that would demonstrate this connection.

Third, the logical fallacy of their opinion, and yours, is that correlation = causality. It does not. You might as well say that a man running from his house yelling “fire” is the cause – moments later – of his house being engulfed in flames. If you, and Cochrane and Zingales, want to play “shoot the messenger,” I suppose that’s up to you. But it is merely an opinion, I’m afraid, and a rather weak one.

Fourth, Cochrane and Zingales present a rather stunning “straw man” argument: that all our financial troubles were the result of Lehman Brothers being allowed to fail. No one is arguing that. The most anyone is saying about letting Lehman Brothers go under is that it aggravated the systemic problems more than anticipated, and that the damage done was worse than the positive benefits of letting an over-leveraged entity suffer the consequences of imprudent risk.

[BTW - I'm not saying I agree or disagree with that opinion; rather, I'm just clarifying it as being much less dramatic than how Cochrane and Zingales characterize it.]

The fifth logic problem accounts for the rather strong headline. Of course, Arthur Laffer popularized the famous Laffer Curve in the 1980’s, arguing that – past a certain point – raising taxes decreases federal revenue. But this depends, of course, on which side of the Laffer curve we are on. I think it is clear that with our tax rates – particularly those on the highest margins – being so historically low, we are on the safe side of the Laffer curve, in terms of tax increases on revenues.

But the main lesson of the Great Depression is not tax policy, but rather a combination of government taxes, debt, and spending. When Hoover and Roosevelt were raising taxes, it was because they were desperately trying to balance the budget. They also, at first, cut quite a bit of spending. This is unwise, during a deep recession. Instead, we should promote counter-cyclical policies, such as increasing spending, to off-set the damage a deep recession can do to even well-managed companies.

That’s why the stimulus package was passed, and why it has so far been successful.

The final problem with your logic – and Laffer’s, perhaps – is the simplistic idea that the issue of taxes is binary: raising taxes will choke the economy and lowering taxes will save it. It is not a binary choice … there are a wide variety of possibilities, such as small tax hikes on certain segments of the population a year or two from now. This, by the way, is all that is currently being argued, even from the most inflation-panicked segment of economists and pundits.

Furthermore, most economists agree that cutting taxes is a poor stimulus measure, and does not “pay for itself” in the current low-tax environment. Tax cuts haven’t paid for themselves with increased revenue for – literally – decades. Probably not since the Kennedy Administration; or during the Thatcher years in England, where the highest rates were greatly lowered from the exorbitant 98% (for capital gains) and 83% (for income).

The reverse is also true: small, prudent tax increases – after the recovery is well under way – will lower the deficit without “choking” growth. This would be, in fact, a responsible hedge against future inflation that may come soon, due to the high costs of the stimulus package, the bailouts, the war in Iraq, and the irresponsible deficits of the Bush years.

Anyway, that’s my view of things. Cheers.

-Ted