Growing the Economy: Three Models of Failure, Three Models of Success

From Americans for Tax Reform:

There’s a debate raging in Washington over how to improve economic growth.  On the one side, the liberal establishment wants to “stimulate” the economy by stealing money from taxpayers and giving it to unionized government make-work projects.  On the other side, free market conservatives favor lower marginal tax rates, full business expensing, tax-free savings, free trade, sound money, and lower government spending.  In the recent past, there have been three models of “stimulus” failure, and three models of free-market success.

Failed “Stimulus” Plans

  • In 1997, Argentina’s economy began to worsen.  In response, Argentine non-interest government spending grew from 23% of GDP in 1997 to 25% of GDP by 2001.  The equivalent in the U.S. would be an immediate increase in government spending of nearly $300 billion. Despite this, average real GDP growth in the period was just 0.7%
  • In the 1990s, Japan tried to grow government to “prime the pump” of the economy.  Government spending grew from 32% of GDP in 1991 to 38% of GDP in 2000. The equivalent in the U.S. would be an immediate increase in government spending of nearly $900 billion. After this experiment, Japan’s per-capita national income fell from 86 percent of the U.S. level in 1991 to only 74 percent in 2000.  The people of Japan became poorer after this massive government “stimulus”
  • In 1929, the U.S. entered the Great Depression.  In the decade following, a Republican failed president (Herbert Hoover) and a Democrat failed president (FDR) increased federal spending from 3.4% of GDP in 1930 to 10.3% of GDP in 1939.  The equivalent today would be an immediate increase in government spending of $1 trillion. Despite all the spending of the New Deal, the U.S. economy actually shrank from $97.4 billion to $89.1 billion, or nearly 10 percent in 10 years

Successful Growth Models

  • In late 1963, Congress implemented the Kennedy tax cut, which lowered the top marginal personal income tax rate from 91% to 70%.  Until LBJ raised taxes to pay for the Vietnam War and Great Society, average annual real GDP growth from 1964-1966 was 6.2%.
  • In 1983, the Reagan tax cuts were fully implemented.  They reduced the top marginal income tax rate from 70% to 50%, and also cut the corporate income tax rate.  The top personal rate was reduced to 28% in 1986. Average annual real GDP growth from 1983 to 1989 (the last year before the George H.W. Bush tax hike) was 4.3%
  • In 2003, President George W. Bush cut the top personal rate from 38.1% to 35%, the dividend rate from 38.1% to 15%, and the capital gains rate from 20% to 15%.  Until Democrats took over Congress in 2006 and announced the imminent end of these lower tax rates, real GDP growth averaged 3.0% per year

There are two models at work here:

  • Keynesian Stimulus.  The government spends taxpayer money on projects to “create jobs.”  The only jobs that are created are in the sprawling government bureaucracies.  Because the government cannot spend any money on the economy it did not first take from the economy, this model cannot create economic growth.  It failed in Japan and Argentina in the 1990s, and right here in America in the 1930s.  Economic growth was stagnant or negative in all three cases.  The government purely and simply wasted taxpayers’ money
  • Growth Economics. When marginal tax rates on work, saving, and investment are cut, incentives to produce more work, savings, and investment go up.  The Kennedy tax cuts worked.  The Reagan tax cuts worked.  The Bush tax cuts worked.  In all three cases, lowering marginal tax rates caused economic growth to rise and for all Americans to be better off.

How to Grow the Economy Now and Permanently

  • Cut the top personal income tax rate from 35% to 25%
  • Cut the corporate income tax rate from 35% to 25%
  • Cut the capital gains and dividends rate from 15% to 0%
  • Move to full business expensing of all business investments
  • Stop double-taxing U.S. employers on their income earned overseas
  • Kill the Death Tax
  • Kill the Alternative Minimum Tax (AMT)
  • Cut the payroll and self-employment tax rate in half, from 15.3% to 7.5%
  • Cap government spending to the pre-Bush level of 18% of GDP
  • Require full government transparency to ensure that taxpayer money is not wasted

All real GDP growth figures in the successful models taken from U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Account

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6 Responses to “Growing the Economy: Three Models of Failure, Three Models of Success”

  1. Trout Says:

    A few points:

    – I have no knowledge whatsoever on the Argentina case, but the facts you presented don’t really tell us anything. “…average real GDP growth in the period was just 0.7%”. So what? Without some sought of estimate of what real GDP growth would have been without the stimulus package, this fact tells us nothing. It may be the case that the fiscal package saved the economy from negative growth in real GDP.

    – Japans a unique case. Basically, the reason behind Japans poor performance in the 1990’s was the fact the economy was caught in a deflationary spiral. Also, it could be argued that if they’d acted with expansionary fiscal policy prior to being caught in this spiral, they may have avoided deflation altogether. The main problem in this case was the governments inaction early on in the crisis. Nonetheless, I think quantitative easing would have been more appropriate, rather than direct government spending.

    – The great depression started in 1929. Not knowing how to deal with such a complex problem, it took several years before the government started significant expansionary fiscal policy. In fact, it wasn’t until 1933 that massive government intervention was initiated by Franklin Roosevelt. After this intervention, things started to improve quite dramatically.

    And finally: Keynesian models and growth theory models are not in competition with one another. Keynesian stimulus is appropriate as a response to short term swings in the business cycle. Growth theory is appropriate for long term growth. Also, growth theory doesn’t necessarily emphasize tax cuts as a means to achieve its goal.

    With regards marginal tax rate cuts on work providing more incentive for individuals to work… not exactly true. Think about the supply curve for labour and its pretty obvious why this is the case.

  2. Trout Says:

    With regards to my point on the depression, I have found the following quote from then Treasury Secretary, Andrew Mellon, made in 1930. His suggestion as a means to deal with the great depression was for the Fed to: “Liquidate labor, liquidate stocks, liquidate real estate… values will be adjusted, and enterprising people will pick up the wreck from less-competent people.” In other words, leave it to the market. As can be seen, this failed miserably, with improvement only really occurring around 1933 when government action was taken.

  3. Tim Says:

    Right. So while the factual evidence shows that the crash of 29 was caused by the Smoot-Hawley Tariff Act (government intervention), was turned into a depression by the disastrous intervention re constricting the money supply of the Federal Reserve (government intervention) and was prolonged through almost a decade of FDR’s wasteful spending (again, government intervention – which contrary to your post did NOT lead to any remarkable recovery), you conclude that the market failed miserably on the basis of… one quote.
    Right.

    I’ll address the substance of your first comment in a proper post shortly.

  4. Trout Says:

    Ha, yeah. The Smoot-Hawley Tariff Act was the sole cause of the great depression. Although a generally shit piece of policy that by no means helped the situation, I think you may have made a bit of an overstatement there. Have a read on institutional arrangements of the time, such as the gold standard and bank lending margins.

    I agree completely, they should have increased the money supply.

    I agree, spending did not lead to a remarkable recovery. It did, however, lead to a short term recovery. The problem is they carried on the spending way too long, and initially didn’t complement the policy with sufficient changes in institutional arrangements to address the underlying problems.

  5. Stimulus Spending « The musings of an Australian classical liberal in Washington DC Says:

    […] Trout, hailing from the bastion of freedom and rationality that is the UQ Liberal Club, made the comment here that: “With regards to my point on the depression, I have found the following quote from then […]

  6. Sean Says:

    Stimulus spending is always overemphasised in its positive impact. If you look at Japan which was caught in a debt-deflation spiral they spent trillions of Yen on infrastructure projects but after a “lost” decade they have very little to show for it other than bridges to nowhere.

    What are the two key aspects of ensuring a renewed economic growth: credit and confidence. Credit flows must be resumed and this can only come from banks admitting to the real values of the underlying assets. This will free up credit for business after another recapitalisation of the retail banks (due to the losses from impairments). The second part is confidence. If people are confident about the future then they will spend and invest rather than save and repay debt (Keynes’ Paradox of Thrift). Sudden action, with resolute rhetoric rather than hasty and continuous action which dimishes the public’s perception of the effectiveness of government action.

    Animal spirits is more important than pump priming.

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