Marginal Tax Rates, Tariffs and Outcomes
Few Presidents have attempted to lower both taxes, on highest earners, and tariffs at the same time. Despite the evidence that lowering both levies has been economically beneficial, after the implementation of the Constitutional income tax in 1913, only two Presidents would significantly cut taxes and not increase tariffs.
While lower income taxes do lead to prosperous periods of domestic economic growth, growth is often inhibited by higher tariffs. Often higher tariffs have caused economic hardship, or at least have exacerbated difficult economic times.
Hereafter “taxes” references the highest marginal tax rate; the highest tax rate applied to the last dollar earned. This is a vital rate for two reasons: one, it determines the incentive to increase income, and two, the effected individuals are responsible for much of new investment and business creation. Historic tax rates are from the National Taxpayers Union.
1913 to The Crash of ‘20
When Woodrow Wilson assumed office, the income tax was new and tariffs were generally high,
being kept that way out of fear of losing the domestic competitive advantage over imports. According to the Encyclopedia of the New American Nation, Wilson used free trade policies as a political tool to keep the peace with Europe. Prices began to drop on many goods as imports increased, which perhaps shielded the effect and awareness of slowly accelerating income tax rates (the tax rate that began at 7% in 1913 had reached 15% by 1916.) When the U.S. entered World War One, Wilson’s attempts to lessen economic protectionism ended and income taxes increased rapidly (highest rate 77% in 1918) with only slightly lower taxes after the war (73% in 1921.)
Near the end of Wilson’s Presidency, after World War I, most of his effort was spent promoting his World Peace initiatives as laid out in his Fourteen Points delivered to a joint session of Congress in 1918. Much of his program was met with skepticism domestically. However, it is fair to believe that many people in the country didn’t buy much of what Wilson was selling. This includes more open trade policies. Point III calls for;
“The removal, so far as possible, of all economic barriers and the establishment of an equality of trade conditions among all the nations consenting to the peace and associating themselves for its maintenance.”
This quote is “free trade” in a nutshell. Then Wilson adds other all inclusive points in his speech such as point XIV
“A general association of nations must be formed under specific covenants for the purpose of affording mutual guarantees of political independence and territorial integrity to great and small states alike.”
So the idea of “free trade,” is tied to grandiose ideas of a world peace council, or the “The League of Nations,” which was widely unpopular, as was Wilson in the end.
From Normalcy to Depression
In 1920, near the end of Wilson’s Presidency, a combination of “war fatigue,” Wilson’s utopian ideas, high taxes and one of the worst recessions in our nation’s history were all easily lumped together. Is there any doubt that Warren G. Harding ran his campaign a “Return to Normalcy,” as a full rejection of all things Wilson? Unfortunately, “Return” was also a return to protectionism. The Republicans had a long standing platform of higher tariffs and protectionism. Harding would continue this pattern, if on smaller scale than other Republican predecessors. This line from a Harding campaign speech is indicative,
“American’s present need is not heroic, but healing; not nostrums, but normalcy; not revolution; but restoration; not agitation, but adjustment; nor surgery, but serenity; not the dramatic, but the dispassionate; not experiment; but equipoise, not submergence in internationality; but sustainment in triumphant nationality.”
Harding would also tie protectionism to isolationism.
The State Department Office of the Historian, records, Harding pushes for the “Emergency Tariff Act” in 1921 followed by the “Fordney McCumber Act.” Both of these tariffs were intended to help struggling farmers who had lost much of their income due to the emergence of European farm markets. Harding did, however, lower tax rates significantly. Income tax dropped from 73% to 56% in 1921-22. With the lower tax rates and other pro-business policies Harding, with the help of Congress helped end the severe early ‘20s recession.
The “Roaring Twenties” started in 1921. According to writer Michael Medved, this period will have economic growth, low unemployment and lower yet taxes rates. Harding’s unexpected death in ’23 elevated the Vice President, Calvin Coolidge to the presidency. Under Coolidge, the income tax rate dropped further to 25% and bottomed out at 24% right after Coolidge left office. This was the lowest rate the nation would ever see.
Regarding tariffs, Coolidge was a somewhat typical protectionist Republican. While domestic farming still struggled, Coolidge made no attempt to add further tariffs than those imposed by his predecessor and he makes no effort to eliminate the scheduled drop in tariffs near the end of his second term. Coolidge is remarkable in this way. While he recognizes many of the problems the farming sector faces, his first State of the Union Speech puts the brunt of the responsibility on the farmers themselves;
“No complicated scheme of relief, no plan for Government fixing of prices, no resort to the public Treasury will be of any permanent value in establishing agriculture. Simple and direct methods put into operation by the farmer himself are the only real sources for restoration.
Indirectly the farmer must be relieved by a reduction of national and local taxation…He must have organization…business is organized, and there is no way for agriculture to meet this unless it, too, is organized. The acreage of wheat is too large. Unless we can meet the world market at a profit, we must stop raising (the crop) for export.”
While not lowering tariffs, Coolidge is clearly agnostic on them.
The next President, Republican Herbert Hoover, is elected partially on his promise to aid the struggling farmer. At this time many tariffs, including the “Emergency Tariff Act” and the “Fordney McCumber Act.” were expiring. In an attempt to reinstate perceived protection for farmers Congress passed the “Smoot-Hawley Tariff.” These tariffs dwarfed the earlier Fordney McCumber Act. While income taxes stayed very low, temporarily, Smoot (1930) included duties on nearly every industry’s imports, which caused prices to rise and created shortages. While Fordney McCumber, and other tariffs had already made it difficult for European economies emerging from World War I to pay war reparations, Smoot made things worse and severely contracted international trade. It is widely believed that the tariff act greatly accelerated the growing economic depression. To make matters worse, Hoover leaves office in 1933 with the income tax rate back up to the highest levels since 1921 (63%).
Democrat Franklin Roosevelt’s first two years in office (1934-1935) will mark the lowest rate (63%) the national will see until 1981, and he will gradually increase rates throughout his presidency. FDR advocated more open trade policies with the passage of Reciprocal Trade Agreements Act in 1934, but his “New Deal” will see stiflingly high tax rates (79% by 1939). The “Great Depression” is often seen as lasting until 1941 with the introduction of the “War Economy,” with massive domestic spending in World War II. The economic growth of the 1920’s will remain elusive for sixty years.
A recent Wall Street Journal essay (April 11, 2010, Burton Folsom Jr. and Anita Folsom) reaches this conclusion:
“FDR did not get us out of the Great Depression—not during the 1930s, and only in a limited sense during World War II”
“Let's start with the New Deal. Its various alphabet-soup agencies—the WPA, AAA, NRA and even the TVA (Tennessee Valley Authority)—failed to create sustainable jobs. In May 1939, U.S. unemployment still exceeded 20%. European countries, according to a League of Nations survey, averaged only about 12% in 1938. The New Deal, by forcing taxes up and discouraging entrepreneurs from investing, probably did more harm than good.”
“What about World War II? We need to understand that the near-full employment during the conflict was temporary. Ten million to 12 million soldiers overseas and another 10 million to 15 million people making tanks, bullets and war materials do not a lasting recovery make. The country essentially traded temporary jobs for a skyrocketing national debt. Many of those jobs had little or no value after the war.”
“No one knew this more than FDR himself. His key advisors were frantic at the possibility of the Great Depression's return when the war ended and the soldiers came home. The President believed a New Deal revival was the answer—and on Oct. 28, 1944, about six months before his death, he spelled out his vision for a postwar America. It included government-subsidized housing, federal involvement in health care, more TVA projects, and the "right to a useful and remunerative job" provided by the federal government if necessary.”
“Roosevelt died before the war ended and before he could implement his New Deal revival. His successor, Harry Truman, in a 16,000 word message on Sept. 6, 1945, urged Congress to enact FDR's ideas as the best way to achieve full employment after the war.”
“Congress—both chambers with Democratic majorities—responded by just saying "no." No to the whole New Deal revival: no to a federal program for health care, no to the full-employment act, no to increases in the minimum wage or Social Security benefits, and only a limited federal housing program. Instead, Congress reduced taxes. Income tax rates were cut across the board. FDR's top marginal rate, 94% on all income over $200,000, was cut to 86.45%. The lowest rate was cut to 19% from 23%, and with a change in the amount of income exempt from taxation an estimated 12 million Americans were eliminated from the tax rolls entirely.”
“Corporate tax rates were trimmed and FDR's "excess profits" tax was repealed, which meant that top marginal corporate tax rates effectively went to 38% from 90% after 1945.”
“Georgia Sen. Walter George, chairman of the Senate Finance Committee, defended the Revenue Act of 1945 with arguments that today we would call "supply-side economics." If the tax bill "has the effect which it is hoped it will have," George said, "it will so stimulate the expansion of business as to bring in a greater total revenue."
“He was prophetic. By the late 1940s, a revived economy was generating more annual federal revenue than the U.S. had received during the war years, when tax rates were higher. Price controls from the war were also eliminated by the end of 1946. The U.S. began running budget surpluses.”
“Congress substituted the tonic of freedom for FDR's New Deal revival and the American economy recovered well. Unemployment, which had been in double digits throughout the 1930s, was only 3.9% in 1946 and, except for a couple of short recessions, remained in that range for the next decade.”
“The Great Depression was over, no thanks to FDR. Yet the myth of his New Deal lives on.”
(Wall Street Journal essay (April 11, 2010, Burton Folsom Jr. and Anita Folsom)
Post World War II to Stagflation.
The post World War II period saw minor growth and recession, rising and lowering tariffs, and taxes remained high (Between 70% and 92%). In fact, this is the longest period, from the creation of the income tax, that taxes remained at such a high level.
Democrat Harry Truman opposed traditional domestic protectionism and instituted the Marshal Plan for European Reconstruction. The Marshal Plan created a new protectionism of allies, so to speak, with 13.3 billion dollars of funds being transferred to European countries. The Congressional act that authorized the Marshal Plan was know in Congress as the Economic Cooperation Act. The U.S. and her closest allies worked more or less cooperatively against the rising Soviet, Chinese communist threat. Both Republican Dwight Eisenhower and Truman kept taxes high, between 80% and 90%, and Eisenhower’s record on trade policy is mixed.
John F. Kennedy is unique among Democrats, by promoting significant tax cuts (Johnson’s signed them after Kennedy’s assassination) which brought income tax rates down, eventually, by over 20% (1963-91%, 64-77%, 65-70%), and promoting less protected trade. In his speech before signing the “Trade Expansion Act” of 1963, Kennedy compared the bill to the Marshal Plan.
Democrat Lyndon Johnson, “Great Society” policies increased taxes by the time he left office (1968-75.25%, 1969-77%). Meanwhile the “Cold-War” era free-trade, started by the Marshal Plan continued at a lesser level.
The Richard Nixon cut taxes again (1969-77% 1970-71.75%, 1971-70%), like many Republicans and lowered oil tariffs (news clip from Lundington Daily News.) Nixon’s overall trade record, however, is mixed. The “Trade Act of 1974” was implemented to protect a shrinking manufacturing sector from imports.
An article from Time Magazine April 18th 1977, states that Democrat Jimmy Carter remained a free trade president while manufacturing struggled. From 1971 to 1980 income tax rates remained at 70% until Carter relented to a tax cut of less than 1% in 1981 (69.125%). The first time taxes dropped below 70% since FDR initiated increases in 1936. Carter leaves office with a recessionary period known as “Stagflation.”
1982 to 2000 Peacetime Expansion
Free trade positions dramatically shift starting in the ’80s with Republican Ronald Reagan. According to Dinesh D’Souza, while Reagan sympathized with many in the industrial sector and farming, he would not resort to higher tariffs. In fact he worked for Free Trade with Canada. When talking of protectionist policy Reagan would say, “Just because one partner shoots a hole in the bottom of the boat, does it make sense for the other partner to shoot another hole?”
Remarkably, despite positive evidence, lower income tax rates combined with free trade was seldom pursued regularly until 1981. The Coolidge era of a combination of agnostic trade policies combined with low taxes is unique. However after Reagan free trade policies became more common. And under Reagan the highest marginal tax rate dropped 28% and remained below 31% for nearly a decade. During this period (’88-‘92) free trade agreements were at a level that even the Wilson Administration would have envied. Interestingly, while Democrat Bill Clinton administration raised some taxes, taxes remain relatively, indeed starkly low historically. Clinton would increase the highest earner rates from 31% to 39%., while advocating free trade agreements. According to the exports.gov list, there was a remarkable expansion in free trade. Israel Free Trade Agreement 1985, Jordon 2001 and NAFTA (North American Free Trade Agreement) 1994. The Heritage Foundation deems the time from 1982 to 2000 as the “longest and strongest expansion in our history back to back.”
The Bush Administration will have small tax cuts (2000-39.6, 2001-39.1, 2002-38.6, 2003-35%) and the most aggressive expansion of free trade agreements. Republican George W. Bush’s era seemed to reflect the Republicans of the early Twentieth Century in the first year by imposing Steel Tariffs. George Will, a conservative, warned in Jewish World Review in March of 2002 that the Steel Tariffs would be damaging to other industries while attempting to protect steel manufacturers. Will was right. The Detroit Chamber of Commerce in October of the same year notes the damage done to vehicle manufacturing, automotive parts manufacturing and machine shops and other industries who use steel. The tariff was rescinded in late 2003 as reported by The American Enterprise Institute. The Bush Administration would later see an aggressive expansion of free trade agreements. The Bush era is not peace time growth, as the administration will be at war most of his term in office. And of course Bush will leave office during a severe recession.
The Obama Administration would break new ground in Democratic policy by espousing protectionism. Business Week reported in early 2009, vague protectionist language in the 2009 “Stimulus Package” requiring steel, iron and other manufactured goods must be domestically produced, no matter how expensive those goods may be. Then later in 2009 a tariff was placed on Chinese low cost tires. Many of the free trade agreements that were initiated under his predecessor also lay dormant. Obama seems to have a blank understanding of economic history, being the first President to raise taxes and increase protectionist policies since Herbert Hoover, who did both during economic hardship.
Too often Presidents raise both taxes and tariffs with a short sighted view, and in an attempt to stop natural economic cycles. Two of the most prosperous periods in our nation’s history, under Reagan and Coolidge, occurred when income taxes are dramatically cut and the protectionist urge is resisted. Hoover, Wilson, FDR and certainly Obama can’t resist the tendency to raise taxes and Hoover, Nixon/Ford (and Obama) exacerbate economic troubles with their protectionism. Lastly, the Presidents in the middle, those who raise taxes, leave taxes high, cut taxes in single digits or push a level of protectionist policy see anemic, and often short-lived economic growth.
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