Posted by: The Dauntless Conservative | December 1, 2010

Dynamics of tax policy during 1920s through 1940s


Much as been written and debated on tax policy during the Great Depression years and continues today. While this post is not all-inclusive of what happened during this time period, my objective here will be to dispel the myths that democrats and liberals claim that the tax increases during the depression years caused unemployment to go down and GDP to go up. The problem is that they are not looking at the data very closely. Today, obama and company are trying use it to justify in their arguments to let the current tax rates expire. They are wrong, so let’s analyze the data a little more closely.

Andrew Mellon, became Secretary of the US Treasury in the 1921 in the Harding administration, and then on to Coolidge and Hoover administrations, wanted to prove cutting tax rates can decrease unemployment and raise federal revenue faster and GDP. Prior to 1929, there is not much reliable unemployment data that I can find beyond what the Bureau of Labor Statistics (BLS) have. According to the BLS, the unemployment rate was 5.2% in 1920, 4.2% in 1922 and 3.2% in 1929. Note that according to the BLS,  the unemployment rates prior to 1948 included citizens 14 years old and older.  See Table 2. However, note the tax rates in the chart below and notice both of the Taxable Income columnsThis metric is often ignored, but it is very important factor. The economy during this time was stagnating along with a high national debt load. I am sure much of this debt could have been accumulated from WWI war effort, but I have no reliable data to discuss. See Table 1

Data from the IRS:

Table 1

Tax year Personal exemptions [1] Tax rates for regular tax  
Lowest bracket Highest bracket  
Single
persons
Married
couples
Dependents Tax rate [2]
(percent)
Taxable
income
under [3]
Tax rate [2]
(percent)
Taxable
income
over [3]
 
 
 
  (1) (2) (3) (4) (5) (6) (7)
1913 3,000 4,000 N/A 1.0 20,000 7.0 500,000
1914 3,000 4,000 N/A 1.0 20,000 7.0 500,000
1915 3,000 4,000 N/A 1.0 20,000 7.0 500,000
1916 3,000 4,000 N/A 2.0 20,000 15.0 2,000,000
1917 1,000 2,000 200 2.0 2,000 67.0 2,000,000
1918 1,000 2,000 200 6.0 4,000 77.0 1,000,000
1919 1,000 2,000 200 4.0 4,000 73.0 1,000,000
1920 1,000 2,000 200 4.0 4,000 73.0 1,000,000
1921 1,000 [4] 2,500 400 4.0 4,000 73.0 1,000,000
1922 1,000 [4] 2,500 400 4.0 4,000 58.0 200,000
1923 1,000 [4] 2,500 400 [5] 3.0 4,000 [5] 43.5 200,000
1924 1,000 2,500 400 [6]1.5 4,000 46.0 500,000
Mellon proposed a series of tax cuts in the form of the Revenue Acts of 1921, 1924, and 1926. See Table 3.  As I mentioned above, according to the BLS, the unemployment rate (UNRATE) was 5.2% in 1920, 4.2% in 1922 and 3.2% in 1929. Notice the unemployment rate going down?  It seems logical that Mellon’s idea holds true.
Table 2
1920 1922 1929
5.2%UNRATE 4.2% UNRATE 3.9% UNRATE
Data from the IRS:  Table 3
Tax year Personal exemptions [1] Tax rates for regular tax
Lowest bracket Highest bracket
Single
persons
Married
couples
Dependents Tax rate [2]
(percent)
Taxable
income
under [3]
Tax rate [2]
(percent)
Taxable
income
over [3]
1925 1,500 3,500 400
[7] 1.125
4,000 25.0 100,000
1926 1,500 3,500 400 [7] 1.125 4,000 25.0 100,000
1927 1,500 3,500 400 [7] 1.125 4,000 25.0 100,000
1928 1,500 3,500 400 [8] 1.125 4,000 25.0 100,000
1929 1,500 3,500 400 [8] 0.375 4,000 24.0 100,000
1930 1,500 3,500 400 [8] 1.125 4,000 25.0 100,000
1931 1,500 3,500 400 [8] 1.125 4,000 25.0 100,000
Notice in the chart below as tax rates increase, debt goes up and as the rates go down, the debt goes down. Changes in marginal income tax rates cause individuals and businesses to change their behavior. As tax rates rise,
taxpayers reduce taxable income by working less, retiring earlier, scaling back plans to start or expand businesses, moving business activities to the underground economy, restructuring companies, and spending more time and money on accountants in order to minimize taxes. Notice in the chart below how the debt gradually drops an as tax rates drop. High tax rates caused the tax base to contract. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business and revenue streams contract as well. Progressive tax systems as we have today, narrows the tax base. The tax base needs to expand so that everyone pays.

Note the chart below that as the TMTR (top marginal tax rate) increases or decreases, so does the debt as percent of GDP follows the trend with TMTR. Left hand column is in millions of dollars and right hand column is TMTR.

Next, the Great Depression Years and some analysis as to the causes. There is much information and debate about it, but I only will focus on the points to prove my objective. It was NOT Wall Street as we have been led to believe that caused the crash by the revisionist liberals and democrats. The crash on Wall Street was it’s REACTION to mostly the Federal Reserve’s monetary policy. When government inflates the money and credit supply, as it did in the 1920s, interest rates at first fall. Businesses invest this “easy money” in new production projects and a boom takes place in capital goods. As the boom matures, business costs rises, interest rates readjust upward, and profits are squeezed. This easy money effects thus wear off and the monetary authorities fearing price inflation, slow the growth of, or even contract, the money supply. Substantial cuts in high marginal income tax rates starting in 1925 certainly helped the economy. The Federal Reserve oversaw a dramatic contraction of the money supply that began late in the late 1920s. Milton Friedman argued conclusively that the contraction of the nation’s money supply by one-third between August 1929 and March 1933 was an enormous drag on the economy and largely the result of gross incompetence by the Fed. In the Hoover administrations, the Smoot-Hawley Tariff passed in June 1930, which virtually closed the borders to foreign goods and ignited a vicious international trade war, was passed on top of the already protectionist Fordney-McCumber Tariff of 1922, which had already put American agriculture in a tailspin during the preceding decade. Tariffs on linseed oil, tungsten, and casein pounded the U.S. paint, steel and paper industries, respectively. More than 800 items used in automobile production were taxed by Smoot-Hawley. Most of the 60,000 people employed in U.S. plants making cheap clothing out of imported wool rags went home jobless after the tariff on wool rags rose by 140 percent. Congress then passed and Hoover signed the Revenue Act of 1932. The largest tax increase in peacetime history, it doubled the income tax. The top bracket actually more than doubled, soaring from 24 percent to 63 percent. Exemptions were lowered; the earned income credit was abolished; corporate and estate taxes were raised; new gift, gasoline and auto taxes were imposed; and postal rates were sharply hiked. This exacerbated an already bad situation. Welcome to the Great Depression. Let’s take a closer look at Hoover’s new tax higher tax rate, the Revenue Tax Act of 1932.

Data from the IRS: Table 4

Tax year Personal exemptions [1] Tax rates for regular tax
Lowest bracket Highest bracket
Single
persons
Married
couples
Dependents Tax rate [2]
(percent)
Taxable
income
under [3]
Tax rate [2]
(percent)
Taxable
income
over [3]
(1) (2) (3) (4) (5) (6) (7)
1932 1,000 2,500 400 4.0 4,000 63.0 1,000,000
1933 1,000 2,500 400 4.0 4,000 63.0 1,000,000
1934 1,000 2,500 400 [9] 4.0 4,000 63.0 1,000,000
1935 1,000 2,500 400 [9] 4.0 4,000 63.0 1,000,000
To exacerbate an already bad economy, Roosevelt’s fascist policies such as the National Industrial Recovery Act of 1933, which was nothing more than a massive government bureaucracy with overwhelming regulations, was passed in June 1933. The Agricultural Adjustment Act of 1933 levied a new tax on agricultural processors and used the revenue to supervise the wholesale destruction of valuable crops and cattle and Federal agents oversaw the destruction of perfectly good fields of cotton, wheat and corn. The NRIA and AAA were declared unconstitutional by the US Supreme Court in 1935 and 1936 respectively. Afterward the Supreme Court ruling, signs of economic recovery were beginning to show; the unemployment rate dropped to around 18% in 1935 and around 14% in 1936 and even lower in 1937. FDR’s tax increases in the form of the Revenue Tax Act of 1935 and the Undistributed Profits Tax of 1936 did not help this situation either. As a result, the UNRATE goes from 14.3% in 1937 to 19% in 1938 which led to a little known recession in 1937-1939. The onset of WWII created high demand for goods and services and war material which contributed to a lower unemployment rate. See Table 5.
Data from the IRS: Table 5
Tax year Personal exemptions [1] Tax rates for regular tax
Lowest bracket Highest bracket
Single
persons
Married
couples
Dependents Tax rate [2]
(percent)
Taxable
income
under [3]
Tax rate [2]
(percent)
Taxable
income
over [3]
(1) (2) (3) (4) (5) (6) (7)
1936 1,000 2,500 400 [9] 4.0 4,000 79.0 5,000,000
1937 1,000 2,500 400 [9] 4.0 4,000 79.0 5,000,000
1938 1,000 2,500 400 [9] 4.0 4,000 79.0 5,000,000
1939 1,000 2,500 400 [9] 4.0 4,000 79.0 5,000,000
1940 800 2,000 400 [9,10] 4.4 4,000 [10] 81.1 5,000,000
1941 750 1,500 400 [9] 10.0 2,000 81.0 5,000,000
1942 500 1,200 350 [9] 19.0 2,000 88.0 200,000
1943 500 1,200 350 [9] 19.0 2,000 88.0 200,000
1944 [11] 500 [11] 1,000 [11]   500 23.0 2,000 [12] 94.0 200,000
1945 [11] 500 [11] 1,000 [11]   500 23.0 2,000 [12] 94.0 200,000
It must be emphasized that tax increases or decreases affect economic behavior, a concept that democrats/liberals cannot seem to grasp. When tax rates increase, the rich look for tax shelters and tax-free havens. They put their money in, for example, tax exempt bonds, because taxpayers change their behavior according to what the tax rates are. To illustrate, when one of the Rockefeller’s died, his estate included $44 million in tax-exempt bonds. This example proves that huge amounts of money were diverted to avoid tax and not being invested in productive capacity, such as manufacturing but was instead being made available for local political pet projects, because this money was put into tax-exempt state and local bonds. So, it would behoove the democrats and liberals to examine history a little bit closer see that tax increases did not help the Depressions, but exacerbated the problem along with the Federal Reserve’s monetary policy and legislation like NRIA and AAA. If the US ever had a fascist president, it was Roosevelt. So, lets summarize. Here is a brief chart that displays a timeline of events.
Table 6: Summary of Events
YEAR UNRATE Top Marginal Tax Rate
1929 3.20% 24.00%
Wall Street Crashes; Herbert Hoover, president 1929-1933
1930 8.70% 25.00%
1931 15.90% 25.00%
Hoover raises taxes effective 1932. UNRATE increasing.
1932 23.60% 63.00%
FDR elected 1932; assumes office 1933
1933 24.90% 63.00%
NRIA of 1933
AAA of 1933
1934 21.70% 63.00%
1935 20.10% 63.00%
Revenue Tax Act 1935 also known as the Wealth Tax or “Soak the rich” act.
FDR raises taxes effective 1936; Supreme Court rules NRIA unconstitutional which eases NRIA overwhelming regulations; UNRATE drops.
1936 16.90% 79.00%
Undistributed Profits Tax of 1936-1937
Supreme Court rules AAA unconstitutional which contributed to drop in UNRATE.
1937 14.30% 79.00%
FDR’s recession follows as a result of tax increases.
1938 19.00% 79.00%
Effects of FDR’s tax increase show UNRATE going up; recession follows.
1939 17.20% 79.00%
1940 14.60% [10] 81.1%
1941 9.90% 81.00%
Japanese bomb Pearl Harbor; US enters WWII. With high demand for goods and services for the war effort, It is logical to conclude the UNRATE is going down.
1942 4.70% 88.00%
1943 1.90% 88.00%
1944 1.20% [12] 94.0%
1945 1.90% [12] 94.0%
1946 3.90% 86.50%
Truman lowers the tax rate.
1947 3.90% 86.50%

Note that according to the BLS,  the unemployment rates prior to 1948 included citizens 14 years old and older

The effects of Hoover and Roosevelt’s tax increases did contribute to the drop in GDP as show in the graph below.

The effects of the tax increases of Hoover in ’32 and Roosevelt’s tax increases in 1936-37  also caused federal revenue to drop.

In summary, this notion that FDR saved us from the Great Depression is nothing more than a democrat party lie and revisionist history. As I have illustrated, a combination of irresponsible legislation, an incompetent Federal Reserve with their contracting and expanding of the currency and high tax rates that forced private investment capital out of the marketplace kept the Great Depression going until the end of the New Deal.
Sources:
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