Herbert Clark Obama Raises Taxes to Cure a Recession

For all the comparisons of Obama to FDR, the latest budget proposal contains at least one really important analogy to a Depression-era President.  It's not FDR though, it's Hoover.  In 1932, Hoover pushed for and Congress passed the Revenue Act of 1932 that raised taxes significantly as part of Hoover's push to balance the budget.  Obama is proposing over a trillion dollars in new taxes over the next decade as part of his budget proposal recently released.

Hoover's Revenue Act of 1932 was, at that point, the largest peacetime tax increase in US history.  It revived a number of excise taxes that were in place in World War I, it imposed a variety of sales taxes, and it raised/added a number of taxes on financial market dealings.  Of course it raised income taxes significantly:  almost doubling the basic income tax rate, reducing personal exemptions, and raising the maximum rate (surtax) from 25% to 63%.  It also increased the corporate tax rate as well as estate and gift tax rates.

There's no need to discuss what followed and it was hardly recovery.  How much those tax increases contributed to the deepening/lengthening of the Great Depression remains a matter of debate, but there's no doubt that they did not help and the real debate is over how much they undermined the private sector's attempts to recover. 

Raising taxes during a recession is, shall we say, a dangerous business.  And even if the first of Obama's new taxes don't kick in until 2011, the reaction of investors today is what matters and they know those higher taxes mean trouble and that will mean a recovery sooner is that much less likely.

So the next time someone invokes the ghost of Hoover to explain why we must, as the President said the other night, do "whatever proves necessary. Because we cannot consign our nation to an open-ended recession," you can feel free to point to ol' Herbert Clark Hoover as your example of "doing whatever proves necessary" and how the President is imitating that example at his and our peril as he raises taxes $1.3 trillion over the next decade.  The ghost of Hoover is alive and well, but not among those of us saying that the economy needs to heal itself.  It's walking the halls of the White House and Congress as the new Administration repeats the errors of the past.

Comments

[Rafe Champion]

On the topic of bad policy, Jevons described the Morrill Tariff Act of 1861 as the most retrograde piece of legislation of the century (reported by Stigler http://www.tannerlectures.utah.edu/lectures/documents/stigler81.pdf ). Makes you wonder what Jevons might have said about Hoover's program.

[MattYoung]

According to Wiki on the Great Depression, the Hoover tax hikes were immediately followed by one of the largest growth periods in history. From 1932 to 1937 industrial production rose to the previous peak.

[Scott]

"as the new Administration repeats the errors of the past"

That's just what I've been thinking, Prof - that not only are today's recycled politicians economically ignorant, they've combined it with an ignorance of history and the ability to learn from past mistakes to create a fine mist of combustible stupidity that's going to burn the remaining wealth and freedom of this country to the ground.

[Steve Horwitz]

Throughout that period, unemployment remained at 10% or higher, which was above the rate for 1930. GDP rose of course, mostly due to increases in G, and it's a matter of debate whether that constitutes real recovery. Gross private investment was 1.3b for 1932 and 1.7b for 1933 and 3.7b for 1934, and stayed below its 1930 levels for every year until 1940 except 1937. Compare those 32-34 numbers with the 1929 level of 16.5b and the 1930 10.8b. I suggest you also compare the speed of recovery in the GD to the speed of recovery in prior recessions where tax increases weren't on the agenda.

Bottom line: government spending can always improve GDP numbers, but if the question is causing sustainable recovery in the private sector, tax increases didn't do the trick.

[M]

I have another narrative.

The 1932 tax hikes was a result an Austrian triumph engineered by Secretary of Commerce Hoover some eight years earlier. He standardized our roads, pursued suburban housing, fixed local federal partnership in road building, tried to get commercial radio on a sound footing and prepared the economy for the new mass markets, in Austrian fashion. After the crash, the readjustement to the new order was established, winners were sorted from losers in optimum equilibrium time. Hence it was time for the winners and government to reach equilibrium.

The relapse came from FDR misguided policies. Up to the arrival of FDR, Hoover had engineered one of the greatest productivity enhancements of all time.

[greg ransom]

We've got a "Hoover" out here in California as well.

Schwarzenegger is telling us the tax hiking budget provides "stimulus" for the economy ...

[Josh Hendrickson]

Steve,

This is sure to generate snide remarks from fellow commenters, but allow me to play devil's advocate here. I would agree with you that increases in taxes do not help the economy. However, we have already increased spending substantially via the bailouts and the stimulus [I feel like I am repeating myself :-)]. Thus, if Ricardian equivalence holds, the increased spending through borrowing is no different than through taxation.

In other words, if the government is going to increase spending in the manner in which it has demonstrated, doesn't the debate about taxes become a moot point?

BTW, for detractors on Ricardian equivalence, I have recently written a post on this topic that discusses the literature on RE. The literature suggests that although there are many practical reasons to reject RE, the empirical evidence suggests that it is a good approximation. The link is here:

http://everydayecon.wordpress.com/2009/02/09/the-stimulus-will-fail/

[James]

Josh,

Since this site is called "The Austrian Economists," I'm curious why you're touting empirical evidence as corroboration for a theory that, in your view, fails on its own merits. If Ricardian Equivalence doesn't hold up to scrutiny as a theory, then how can it be corroborated by empirical observations? Clearly some other theory must be devised in order to explain observed behavior.

Isn't your argument a classic case of "saving the phenomena"? Or maybe I'm missing something about the assumptions made in Ricardian Equivalence...