Cross-posted at Angry Bear.
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.)
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.
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 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.