What Obama Didn’t Learn From the 1990s

by alexvanbuskirk

What Obama Didn’t Learn From the 1990s: The economic growth of the 1950s, the ’60s and the Clinton years had many causes. But one of them wasn’t high marginal tax rates

By Edward Conard @ WSJ (August 2, 2012)

With the prospects for a postrecession economic rebound fading, it has grown increasingly obvious that the United States must eventually raise taxes or cut spending. President Obama claims we can raise taxes on those earning over $250,000, to avoid spending cuts with little, if any, effect on growth because growth was faster in the 1990s and in the 1950s and ’60s when marginal income-tax rates were higher.

The evidence doesn’t support Mr. Obama’s conclusion.

President Clinton raised taxes in the 1990s and the economy grew. So does that mean it would grow today if we did the same thing?

Commercialization of the Internet lifted the Nasdaq from 800 in 1995 to 4,500 in 2000, the largest five-year gain of any major index in American history. Put bluntly, increased payoffs for successful investment and rising equity values simply dwarfed offsetting increases in marginal tax rates. The taxes themselves didn’t increase growth.

The story is similar for the Eisenhower and Kennedy eras, when top marginal rates were high. The economy rebounded from two decades of underinvestment, first from the Great Depression and then from World War II.

Large corporations like General Motors raced to capitalize on markets unleashed from wartime rationing and controls. A postwar increase in college graduates raised productivity and opened new avenues for investment. Dramatic improvements in agricultural productivity lowered the cost of food to 10% of GDP from 25%. Oil was a fraction of today’s price and dollar-an-hour offshore labor was inconsequential. Mass markets were fostered by TV and interstate highways.

Meanwhile, weakened by the war, slow to educate their workforces, and fragmented into smaller markets, Europe and Japan remained weak economic competitors until the 1970s.

No such favorable circumstances lie on the horizon today. Rising real-estate values prior to the 2008 financial crisis accelerated economic activity just as a 30% drop afterward decelerated it. Without a foreseeable rise in asset prices, high taxes and government spending will have a more dampening effect on growth.

Today, federal, state and local spending has reached 38% of GDP. In the late 1990s, it was only 33%. Throughout the 1950s and ’60s, it was only 28%. The notion that the robust economy of the 1950s, ’60s and ’90s proves that historically high government spending and taxes have little, if any, negative effect on growth is naïve.

Public investment might increase productivity in theory—the GI Bill and investment in the federal highway system, for example, helped make Americans more productive. But today’s endless increases in government spending with no discernible improvement in our infrastructure or educational outcomes makes it painfully obvious that politics and special interests have undercut its benefits.

Higher taxes on the most productive workers to fund increased government spending reduces incentives, and redistributes and consumes income that would otherwise fund private investment. Expectations of lower investment and slower growth lower asset values and slow economic activity. Until circumstances improve, lowering the trajectory of unproductive government spending provides our best opportunity for growing economic activity today.

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