Why Republican Tax Cuts Always Cause A Financial Crash and Economic Disaster
This is the third edition of this post. I first wrote most it when Obama thought he had achieved the golden unicorn of a bipartisan tax reform deal that included big cuts in the deferred earned benefits programs of Social Security and Medicare. I posted it again in January of this year when it was rolled out as Trump's tax cuts accompanied by a "big" infrastructure spending program. (Don't look for the previous two editions here at C99%, because I posted them over at Real Economics and cross posted them to DK, aka TOP, aka, "Jeebus what cretinous chowderhead excreted this steaming pile of rightwing crap here?". Jon Larson, who keeps Real Economics up and running, told me that since the Rethuglicans passed the Senate version of their tax deform yesterday, my January post there has been reposted on Facebook by some wonderful soul, and over 1,000 people have hopped on over to take a look.
Basically, I try to explain how the Republican tax cuts of Coolidge, Reagan, and Bush the Dumber created cumulative microeconomic effects which led to the macroeconomic crises marked by the financial crashes of 1929, 1987, and 2007. But you don't have to take my word for it. This time around, even the stuffed shirts of America's executive suites are flat out telling anyone who will listen that, no, tax cuts are not going to lead them to invest more in the American economy: from bloomberg.com no less, Trump's Tax Promises Undercut by CEO Plans to Help Investors.
Why Republican Tax Cuts Always Cause A Financial Crash
Tuesday, January 24, 2017
One of the centerpieces of Trump’s economic plan is to, once again,
try the Republican experiment of cutting taxes. Now, I know it is hard
to argue against cutting taxes, but Democrats have really dropped the
ball by not pointing out the amazing historical fact that every single
time the Republicans have cut taxes, a financial crash and economic
depression followed within a few years. This time, Trump wants a
trillion dollar increase in spending on infrastructure that will boost
the economy. But increased infrastructure spending will probably not
make this experiment work better, because it does not address the
microeconomic factors which cumulatively cause Republican tax cuts to
create macroeconomic disasters.
There have been three grand
multi-year national experiments with Republican / conservative tax
cutting over the past century. All three experiments resulted in the
average American becoming poorer, the real (industrial) economy in
tatters, and spectacular financial crashes.
Tax Cut Experiment Number 1
1921, President Warren G. Harding proposed ending the wartime excess
profits tax which had been imposed during World War I. When Harding died
during a speaking tour in California in August 1923, Calvin Coolidge
became President, so it was Coolidge who actually signed into law the Revenue Act of 1924, which lowered personal income tax rates on the highest incomes from 73 percent to 46 percent.
Two years later, the Revenue Act of 1926
law further reduced inheritance and personal income taxes; eliminated
many excise imposts (luxury or nuisance taxes); and ended public access
to federal income tax returns. The tax rate on the highest incomes was
reduced to 25 percent.
The result was a speculative frenzy in the
stock markets, especially the application of structured leverage in what
were called at the time "investment trusts." In September 1929, this
edifice of false prosperity began to wobble, and finally crashed
spectacularly in October 1929.
Coolidge did not seek
re-nomination in 1928. Faced with a wildly gyrating stock market, a
worsening collapse in farm incomes, and faltering industrial orders, the
new Republican President, Herbert Hoover, responded with more tax cuts.
Personal income tax on income under $4,000 was cut by two thirds;
personal income tax on income over $4,000 was cut in half. The tax rate
on corporations was cut by a full percentage point.
How did the economy respond to these tax cuts? It sunk further and faster into the First Great Depression.
Tax Cut Experiment Number 2
1981, Ronald Reagan reduced the top marginal income tax rate, which
affects the very wealthy, from 70% to 50%. In 1986, Reagan convinced
Congress to reduced the top tax rate yet again, to 28%. Contrary to the
Reagan / Republican / conservative argument that the tax cuts would pay
for themselves by boosting economic activity, the budget deficit and
federal debt exploded. Federal government debt grew from 33.3% of GDP in
1980 to 51.9% at the end of 1988.
Reagan's tax cuts failed to
revive American industry, which was also being hammered by the Reagan /
Republican / conservative blind faith in free trade. A number of
American industries actually disappeared. By the end of
Reagan’s presidency, the American textile, apparel, and footwear making
industries had been reduced to less than one tenth the size and sales
they had just two decades earlier. During Reagan’s tenure, the U.S.
lost its trade surplus in consumer electronics, and began to also lose
its advantage in industrial electronics.
the average American family began working more hours to maintain its
standard of living. The phenomena of latch-key kids took hold as mothers
sought jobs to help keep their family afloat. Wikipedia notes that
the number of Americans below the poverty level increased from 29.272
million in 1980 to 31.745 million in 1988, increasingly slightly as a
percentage of total population, from 12.95% in 1980 to 13.0% in 1988.
The number of people in poverty under the age of 18 increased from
11.543 million in 1980 (18.3% of all child population) to 12.455 (19.5%)
The most important industry of all, the machine tool
industry—which is needed to make all other production equipment—slipped
into a death spiral from which it has never really recovered. At the
beginning of the 1980s, the ten largest machine tool makers in the world
were all American. By 1997, only one of the top ten was, and it was ranked seventh by sales. In 2009, China became the world’s largest producer of machine tools.
In industry after industry, under Reagan, the U.S. lost its world lead: steel,
auto, printing equipment, construction equipment, farm equipment, power
generating equipment. Only the aerospace industry, the key component of
the American empire’s military-industrial complex, managed to maintain
its world lead.
Oh, and the banking and financial sector? In
October 1987, the worst stock market crash since the First Great
Depression shook Wall Street.
Tax Cut Experiment Number 3
and conservatives of course contend that the two Bush tax cuts of 2001
and 2003 created the economic boom of 2002-2006. But they prefer we not
remember the financial crash of 2007-2008. As discussed below, the
financial crash is actually the inevitable result of cutting taxes the
way Republicans do.
But first I want to expose the “economic boom of 2002-2006” for what it was: a frenzy of borrowing based on the rise in home value that was largely speculative. The amount Americans borrowed against their homes more than doubled from $627 billion in 2001 to $1.428 trillion in 2005. From 2001 to 2005, the cumulative amount of home equity extraction totaled just under $5 trillion. This was more than double the total $2.3 trillion growth of GDP in this same 2001-2005 period.
Economist Paul Krugman wrote in December 2008:
"The prosperity of a few years ago, such as it was — profits were
terrific, wages not so much — depended on a huge bubble in housing,
which replaced an earlier huge bubble in stocks."
Meanwhile, U.S. industries continued to weaken and falter. Even the semiconductor and computer industries—the crown jewels of the American industrial economy in the late 1980s—collapsed
under Bush, fleeing offshore. As the late Andy Grove, one of the
founders and former chairman of semiconductor pioneer Intel wrote in
July 2010 (How to Make an American Job Before It's Too Late):
manufacturing employment in the U.S. computer industry is about 166,000
-- lower than it was before the first personal computer, the MITS
Altair 2800, was assembled in 1975. Meanwhile, a very effective
computer-manufacturing industry has emerged in Asia, employing about 1.5
million workers -- factory employees, engineers and managers.
largest of these companies is Hon Hai Precision Industry Co., also
known as Foxconn. The company has grown at an astounding rate, first in
Taiwan and later in China. Its revenue last year was $62 billion, larger
than Apple Inc., Microsoft Corp., Dell Inc. or Intel. Foxconn employs
more than 800,000 people, more than the combined worldwide head count of
Apple, Dell, Microsoft, Hewlett-Packard Co., Intel and Sony Corp.
important to note, wages and earnings for all but the richest Americans
continued to stagnate, and actually declined for the bottom quintile of
And, in late 2006, the sub-prime mortgage crisis
began to unravel the very fabric of the world financial system, leading
to the crashes of April and September 2008.
The failure of our national debate on tax cuts
discouraging about this entire national debate on taxes, has been the
complete failure of Democratic Party leaders to point to these clear
facts, and ask the obvious question:
Why do Republican tax cuts lead, counter-intuitively, to industrial decline, stagnant wages, and finally financial collapse?
The fact is that high marginal tax rates strongly correlate with economic growth. In December 2010 Mike Kimel examined the effects of cutting the top marginal tax rate:
GDP also grew faster under Bill Clinton, who raised taxes, than it did
under Ronald Reagan. In fact, from 1981 to the present, the period in
which Reagan’s philosophies have reigned triumphant, the correlation
between the top marginal tax rate and the annual growth in real GDP has
been positive. That is to say, higher top marginal tax rates have been
associated with faster, not slower real economic growth. Conversely,
lower top marginal tax rates have coincided with less economic growth.
positive relationship between the top [higher] marginal tax rate and
the growth in real GDP is very nearly bullet-proof. For instance, it
extends all the way back to 1929, the first year for which the
government computed GDP data. Additionally, higher marginal tax rates
are not only correlated with faster increases in real GDP from one year
to the next, but also with increases in real GDP over the subsequent
two, three, or four years. This is as true going back to 1929 as it is
for the period since Reagan became president. In fact, since the Reagan
Revolution took hold, similar relationships have existed between the top
marginal rate and several other important variables, like real median
income, real private investment, consumer sentiment, the value of the
dollar relative to other major currencies, and the S&P 500. Lower
tax rates in any given year are associated with slower growth rates for
each of these variables, whether those growth rates are measured over
periods of one, two, three or four years.
If you look under the hood of the industrial economy, you can see why there is this counter-intuitive relationship between tax rates and economic growth . With
high taxes, the only way to retain the bulk of the wealth created by a
business is by reinvesting it in the business -- in plants, equipment,
staff, research and development, new products and all the rest. But
if tax rates are low, then there is more incentive to pull the wealth
out, by declaring it as profits that are taxed at what turns out to be
too low a rate. In other words, low taxes create an incentive for profit
taking, not for business expansion and capital investment.
in turn creates an incentive for short-term horizons in business
planning. If you’re going to be taking all the profits out of a company,
and take home a few million a year, why bother to reinvest anything in
the business? You’re going to be rich, and never have to work again, even if the business goes bust. Or gets packed on a boat and shipped to China. Or goes "virtual" and lets all the hard work, like, you know, actually making something, be done by the lowest bidder. Employees? Don’t need them.
employees are also customers. If enough businesses "take profits",
after some length of time, the former employees also become former
customers. Meaning, they stop buying. As economists phrase it, the
economy's aggregate demand generation is crippled. From examining the
effects of the three Republican tax cut experiments this past century,
it appears the length of time for this to happen is five to seven years.
tax rates are high enough to discourage profit taking, the best way for
investors and owners to keep the profits created by a business, is to
invest those profits back into the business: buying new plant and equipment that will be used for many years, and hiring and training new employees.
This in turn pushes businesses toward longer-term planning, beginning to
counteract the infamous quarter-to-quarter short term fixation of the
financial markets. And you do not get the absurd situation you have now,
where companies are posting record breaking profits, but are not buying new equipment, nor hiring new employees.
tax rates encourage taking wealth out of industrial companies; the
wealth taken out must then be "put to work." That means more money
chasing "investment" opportunities (instead of real investment in
capital goods and employees), leading to price increases in financial
capital or real estate or some other asset. In other words, an asset
bubble. The rise in prices of an asset bubble has nothing to do with the
creation of real wealth. It all looks like prosperity—until the asset bubble bursts.
The virtuous economic cycle that was destroyed by Reagan
The central economic assumption of Reagan’s economics is the same as that of neoliberalism: the people in the private sector who have become rich by profitably “investing” do
a much better job allocating society’s financial resources than the
federal government. Reagan flatly asserted that , "government is the problem." Bill Clinton signaled his acceptance of this assumption by declaring that the “era of big government is over.” Bush Jr. of course imitated Reagan by cutting taxes. And Barack Obama declared “I am a pro-growth, free-market guy. I love the market."
the Republican Party, and American conservatives in general have
developed a simple-minded faith in tax cuts, especially in reducing
taxes on the highest incomes. The rich, according to their assumption,
are the people in the private sector who supposedly do a better job
investing than the government can do by planning. Not unreasonably, therefore—given the assumption of their economic thinking—their major goal is to get as much of society’s financial resources into the hands of the rich.
reality, as shown by the three Republican experiments in the past
century, is much different. Tax cuts only work to build bubbles that
enrich mostly the financial sector. Tax cuts do nothing to help the
real, industrial economy. Judged from the perspective of long-term
national interests, the rich have proven that they are not very good at
investing: they prefer credit default swaps over investing in
sustainable energy start-ups. The major political-economic challenge of
the past three decades has been to create a new economy that is not
dependent on burning fossil fuels so as to halt climate change. Measured
against this challenge, the Reagan / Republican / conservative /
neoliberal theory that the rich are best at allocating our society's
financial resources has been a disastrous failure. Scientists working on
climate change have concluded that we have passed the tipping point, so
it is more accurate to write “catastrophic failure” than “disastrous failure.” We have wasted thirty years testing the Reagan / Republican / conservative / neoliberal theory. We are about to waste at least another four years under Trump.
reason tax cuts do not create economic growth has to do with the
distribution of income in the economy. The Republican / conservative
religious belief that "tax cuts create jobs" has become so shallow and
so insipid, that they don’t even understand the actual process of job
creation contained in their own lousy theory. Tax cuts do NOT create
jobs. It is the response of business to growth of aggregate demand in the economy that creates jobs.
In August 20109, Dave Johnson explained
a crucial flaw in the economic assumptions behind the Obama /
Republican / conservative deal that made over 80 percent of the Bush tax
Tax Cuts Are Theft
The American Social Contract is supposed to work like this:
beneficial cycle: We invest in infrastructure and public structures
that create the conditions for enterprise to form and prosper. We
prepare the ground for business to thrive. When enterprise prospers we
share the bounty, with good wages and benefits for the people who work
in the businesses and taxes that provide for the general welfare and for
reinvestment in the infrastructure and public structures that keep the
We fought hard to develop this system and it worked for
us. We, the People fought and built our government to empower and
protect us providing social services for the general welfare. We,
through our government built up infrastructure and public structures
like courts, laws, schools, roads, bridges. That investment creates the
conditions that enable commerce to prosper – the bounty of democracy.
In return we ask those who benefit most from the enterprise we enabled
to share the return on our investment with all of us – through good
wages, benefits and taxes.But the "Reagan Revolution" broke the contract. Since Reagan the system is working like this:
Since the Reagan Revolution with its tax cuts for the rich, its anti-government policies, and its deregulation of the big corporations our democracy is increasingly defunded (and that was the plan), infrastructure is crumbling, our schools are falling behind, factories and supply chains are being dismantled, those still at work are working longer hours for fewer benefits and falling wages, our pensions are gone, wealth and income are increasing concentrating at the very top, our country is declining.
This is the Reagan Revolution home to roost: the social contract is broken.
Instead of providing good wages and benefits and paying taxes to
provide for the general welfare and reinvestment in infrastructure and
public structures, the bounty of our democracy is being diverted to a
So, what about Trump’s infrastructure investment?
time around, Trump wants a big tax cut, but at the same time, he wants a
massive boost in spending on infrastructure. It appears to me unlikely
that this increase in infrastructure investment will counteract the ill effects of any tax cut.
it is not certain that the Republicans in Congress will give Trump what
he wants. While they will happily cut taxes yet again, they are
ideologically opposed to increasing government spending of any kind
unless it is to help USA military and CIA kill non-white people
Second, much of the increase in spending
is supposed to come from private investors. Trump's plan is actually not
an increase in government spending at all, but giving $140 billion in tax credits to construction companies.
We have yet to see to what extent Trump and the Republicans in Congress
change government policies so that investors actually have incentives to invest $140 billion in tax credits and
their new tax-cut windfall in infrastructure rather than financial
speculation. There is also the question of whether any new investment in
infrastructure actually adds new productive capacity to the economy, or
merely becomes another form of economic rent seeking. For example, if
new investment takes the form of privatizing already existing
infrastructure, there will be no net national economic gain. Even if
that existing infrastructure is repaired or even upgraded, the economic
gain will be limited only to whatever increase in employment occurs. In a
program constrained by the ideology of Republicans in Congress, that
employment bump will be minimal.
Third, outcomes also greatly depend on how much, and how soon, Trump changes U.S. trade policy.
Ian Welsh, who has been consistently accurate about economic and
political developments in USA since editing FireDogLake over a decade
ago, explained years ago that a large portion of tax cuts end up outside the U.S. economy:
past 30 years, and the past 10 years in particular, have been a huge
experiment in tax-cutting, and for ordinary people, the result has been
stagnation and now an absolute decline. Because ordinary people do not
have pricing power, either as workers for their labor (since there are
plenty of people who need jobs) or as consumers (because the oligopolies
who sell food, energy, telecom and so on know you must have their
services) every single red cent of tax cuts which go to the middle and
lower class will be taken away by corporations and the rich. Those
corporations and rich will then use that money to either play leveraged
financial games or to offshore jobs to low cost, low regulation
domiciles. Not only do tax cuts not do any good, they accelerate the
loss of US jobs. No, this isn’t what you’ve been told, indeed
propagandized, for the last thirty years. But how has trickle down
economics worked out for you? Are you going to believe your lying eyes,
or the talking heads who tell you that tax cuts create jobs?
will obviously change as Trump discards TPP and renegotiates NAFTA. The
former will have no real impact, because TPP was never approved, let
alone implemented. But renegotiating NAFTA and other other free trade
deals will take time, probably a couple years minimally. The leaves
Trump with the power of the bully pulpit—which he has twitterized—and which he is already claiming has forced some American companies to keep jobs in USA or even start bringing them back.
Democrats have to oppose Trump from the left
TPP and economics generally, if Trump actually manages to force
companies to return production to USA, the Democratic Party is dead meat
if it continues to respond as it has. I’ve already seen people at
DailyKos regurgitate some “free trade” drivel from the Koch-funded,
market fundamentalist American Enterprise Institute. If Democrats are
going to oppose Trump by allying with market fundamentalists to defend
the tenets of conservative / neoliberal economics, then they will be
useless in opposition and voters will treat them accordingly. The only
way Democrats can successfully oppose Trump is from the left: by pushing
single payer health care; a tax on Wall Street speculation; and a
massive $100 trillion world-wide program to stop climate change by
building new energy, transportation, and industrial systems that do not
use fossil fuels.
The Democrats can wreak havoc on the
Republicans by repeatedly introducing a tax on Wall Street, and either
force Trump and Wall Street into each other’s arms, or driving Trump and
Wall Street further apart. If the former, the Tea Party base of the
Republicans will boil over in revolt; if the latter, the Democrats will
maneuver Trump and Wall Street to be at each other’s throats.
David Rolf, president
of one of the fastest growing union locals in USA, Seattle-based Local
775 of the Service Employees International Union, representing health
care workers, recently told Owen Jones of the London Guardian,
Democrats will only win if they embrace and promote “progressive
economic populism—they have to stand up for what’s good for the majority
of Americans even if it’s not good for the donor class of the
Democrats”. (Rolf is also an international vice president of SEIU, and was one of the organizing forces behind the successful ballot measure that dramatically raised wages and won paid sick leave for thousands of workers at Seattle’s airport, SeaTac.)
Besides a tax on Wall Street, Democrats should counter Republican proposals to “reform” the social safety net by introducing and pushing for expansions of existing programs. An excellent start, though much too small, is the ten-year $1 trillion infrastructure spending bill being prepared by eight Democratic Senators.
After posting this, I was gratified to follow a Tweet to this essay on the Washington Post website from five days ago: I’m a Depression historian. The GOP tax bill is straight out of 1929, by Robert S. McElvaine, professor of history at Millsaps College.
And I knew there were other articles of CEOs openly saying, "Tax cuts? Investment? Bah, humbug!"
CEOs agree: Corporate tax cuts won't trickle down, by Hunter Blair, 12-03-17.
Watch CEOs admit they won’t actually invest more if tax reform passes, by Matthew Yglesias, 11-15-17. Yeah, actual video footage of robber barons openly proclaiming their intent to rob more from the American people's Treasury.
Why A Corporate Tax Cut Won't Boost Economic Growth, by Patrick W. Watson, 11-27-17. This is in Forbes, no less. And, it has a truly remarkable quote from former Brightcove CEO David Mendels you should go read.
Finally, I fully agree with Ian Welsh's assessment a few days ago, of What the Republican Tax Bill Portends for the Future.
A lot of people in the US will suffer because of this. Some will die. All of it will most likely be repealed within eight years, because, as with the Tories in Britain completely destroying the economy for ordinary people, this will lead to a huge backlash.
It will stand only if “centrists” succeed in making sure that genuine left-wing principles are locked out of the Democratic party, as Blairites tried to do with Labour, only barely failing.
However, a genuine left-wing candidate on the Democratic ticket, with policies similar to Corbyn’s, will win in a landslide, because the youngs will vote for them in massive majorities (and, as Corbyn showed, the rule “young people don’t vote” isn’t true when someone champions their causes).
By 2024 at the latest, there will be enough of a generational shift, and enough people hurt badly enough and unable to pretend that the status quo ante was every good, that the Left, if not prevented by internal party politics, will win.
And they will win with a fairly radical agenda.
I would only add: What about the effects of climate change?