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Twice during the 20th century, the U.S. federal government had huge
reductions in expenditures. Once was after WWI, and once was after WWII.
In the 1919 fiscal year, the federal government spent $18.493 billion. In
1920 this fell to $6.358 billion, in 1922 to $3.289 billion and in 1924 to
$2.908 billion. The government ran a budget surplus every year from 1920 to
1930.
In the 1945 fiscal year, the government spent $92.712 billion. This fell to
$55.232 billion in 1946, $34.496 billion in 1947, and $29.764 billion in
1948. The government ran a budget surplus in 1947-1949.
These cuts were accompanied by large layoffs of government employees, or
"demobilization" as it is known. This was probably the primary
reason for economic recessions in both cases.
Ideally, the natural recessionary effect of such dramatic changes in spending
would be offset by some sort of positive action. To put it a little more
bluntly: big tax cuts.
This is what happened in the early 1920s. Woodrow Wilson managed a minor tax
cut, lowering the top income tax rate to 73% from 77% in 1919. Brackets also
rose, so the 25% rate applied to income of $36,000, up from $28,000
previously.
Warren Harding followed up with a cut in 1922 that lowered the top rate to
58%, and the 25% rate applied to $38,000 of income. In 1923 the top rate fell
to 50%, and in 1924 to 46%. The 25% rate now applied to $52,000 of income.
Then came the big tax cut of 1925, in which the top
rate fell to 25%, on income of $100,000. Businessmen would be able to see
these cuts passing through the political process, and would actually react
before their formal enactment.
The recession of 1920 was intense, but quite brief. The economic boom that
followed was one of the best of the 20th century.
Some tax cuts followed the end of the war in 1945, but they were relatively
minor. In the Revenue Act of 1945 the excess profits tax was repealed, the
top income tax rate fell to 86.45% from 94%, and the corporate tax rate fell
to 38% from 40%.
The Revenue Act of 1948 reduced individual income tax rates by another 5% to
13%, and increased the personal exemption. However, taxes were raised again
in the Revenue Act of 1950, which roughly coincided with another recession.
That wasn't the only factor: 1949 was a scary time for business, as that year
had both the first successful Soviet nuclear test and the Communist
Revolution in China.
Eventually the situation stabilized, and the 1950s were quite productive.
This may have been due in part to tariff reductions worldwide, beginning with
the first round of the General Agreement on Tariffs and Trade in 1947, which
involved 45,000 tariff concessions.
In 1949 another round of talks managed an additional 5,000 tariff
concessions, and another 8,700 concessions followed in 1950. Although the
U.S. had to wait until the 1964 Kennedy tax cut for another major reduction
in rates, huge tax cuts in Germany and Japan beginning in 1950 probably
helped the worldwide situation.
The successful solution was huge spending reductions, and, ideally, huge tax
reforms with lower rates to allow greater economic activity.
This strategy--less spending, lower taxes--should be familiar as the
"Reaganomics" plan of the early 1980s. In practice, little was
accomplished in terms of spending reductions during the 1980s, in part
because Congress was then dominated by Democrats. Republicans also wished to
increase military expenditures at that time.
Margaret Thatcher had the same strategy. She is well-known for her rollback
of the socialist state in Britain during the 1980s. Strangely, she is less
well-known for her tax reforms, in which the top income tax rate fell to 40%
from 83% and the corporate rate fell to 35% from 53%. Both Thatcher and
Reagan were hugely popular.
This strategy is completely opposite of today's "austerity" plans,
which seek spending reductions and tax hikes. This piles one recessionary act
upon another, guaranteeing miserable economic performance. Not surprisingly,
this strategy is not very popular, so in practice little is accomplished on
either front, and the offending government is typically replaced as soon as
possible.
One often finds that reducing spending is politically impossible when the
private economy is being pummeled by higher taxes. Everyone feeding from the
government trough sees the private economy slashing its investment plans and
laying off workers, and decides that they will do everything possible to
prevent being thrown into that pit of despair. Meetings are held, people are
paid, and nothing is accomplished. Thus, I would say that providing a major
tax reform push to the private economy also helps grease the political wheels
of spending reduction, in addition to its positive economic effects.
Our recent experience, as well as that of Japan in the 1990s or the U.S.
during the Great Depression, is that wasteful government spending is mostly a
waste. Government spending can be reduced by enormous amounts without serious
consequences, and long-term beneficial effect, but in the short term this can
result in an adjustment period with recessionary implications. Ideally, these
recessionary factors should be overcome with positive tax reforms, which
would also set the foundation for the economic expansion to follow.
Nathan Lewis
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