Tax Cuts and the American Economic Boom
To the Editor:
In his article “How America Got Rich” [September], Arthur Herman mischaracterizes the United States as it was both before and after World War II. He calls the prewar U.S. economy “strong.” Not so; it was weak. It was the idle manufacturing capacity and the unemployed people that enabled the United States to shift to a war economy without excessive difficulty.
He tells only half the story of the postwar years, omitting the fact that the United States had a strong manufacturing base, trade surpluses, and strong unions. In addition, the peak income tax rate was 90 percent until 1963 and 70 percent until 1981.
The flood of cheap imports destroyed the manufacturing base and the related unions. The reduction of the income tax rate to 35 percent for the super rich contributed to the budget deficit, especially in the eventual face of the Iraq and Afghanistan wars.
What can we learn from this? Free trade does not work. We need sufficient tariffs to bring U.S. trade into balance and restore manufacturing. We need a return to greater progression in the income tax with rates of at least 70 percent for the very wealthy. The super rich must pay their fair share of the tax burden.
To the Editor:
I appreciate Arthur Herman’s insight into America’s postwar recovery. He seems to forget, however, two elements that were key to our robust economic activity during that period.
First, there was very limited international competition for products. I recall when the words Made in Japan produced more laughter than a willingness to spend. China was not even on the consumer radar screen.
Second, regulatory restrictions were very different. For example, New York Mayor Fiorello La Guardia was frustrated that he was unable to access New York City by air. After he made the decision to reconstruct a new airport, it was completed two years later. That’s virtually impossible in today’s regulatory environment.
Mr. Herman is certainly correct about the role of tax rates in economic growth. But the lack of red tape and competition from abroad cannot be discounted.
To the Editor:
I read with great interest Arthur Herman’s article on “How America Got Rich” and was pleased to see that Keynesian economics were not credited. But what spoiled the article, and what has again highlighted to me the failure of even those who see the dangers of Keynesian economic theory is his argument that “what turned the United States into the world’s most affluent society after 1945 [were] entrepreneurship, innovation, cheap and readily available raw materials, a built-in bias toward competitive production, and a voracious consumer demand—made more voracious by the deprivation of the Depression years and restrictions of World War II.”
With this sentence, and the emphasis put on increased demand as a stimulus to recovery, Mr. Herman completely sells the pass. The fact is that the demand side of the economy has no bearing whatsoever on the level of activity or the number of people with jobs.
The innovation Keynes brought to economic theory was aggregate demand, which had never been part of mainstream economic theory until then. Effective demand had, of course, a long and important history, but it explained what was necessary to allow demand to occur at all—what turned a desire to buy into an ability to buy. Aggregate demand, however, was about the totality of demand in relation to employment, something entirely different. Aggregate-demand failure was the supposed cause of large-scale unemployment and therefore, according to Keynes, only an increase in aggregate demand could lead to recovery.
Keynes’s General Theory of Employment, Interest and Money intended to remove an entity known as Say’s Law from economic discourse. And while economics has since 1936 been burdened with Keynes’s definition of Say’s Law as “supply creates its own demand”—the actual significance of Say’s Law was that it specifically denied the possibility of demand deficiency as a cause of recession, and ruled out demand stimulation as a means to bring recessions to an end.
Classical economists were very clear on this question. Demand is constituted by supply. The ability to buy is determined by an economy’s ability to produce. To describe “voracious consumer demand” as one of the reasons for the strength of the American economy after 1945 is to put the cart before the horse. There is always a voracious desire to buy, but as anyone who thought in terms of Say’s Law would understand, it is first necessary to raise productivity, in this case through “entrepreneurship, innovation, cheap and readily available raw materials, a built-in bias toward competitive production,” as Mr. Herman wrote.
Aggregate demand does not cause an economy to grow. It is the consequence of getting everything else right first. To think of demand as some kind of independent element is to accept the fundamental premise of Keynesian economic theory. Until aggregate demand and demand deficiency are dropped from our macroeconomic theories, we are never going to get our economic policies right.
Melbourne, Victoria, Australia
To the Editor:
It appears that in his article Arthur Herman forgets to include a contributing factor to the postwar industry boom: an interstate highway system built and maintained by those loathed government-spending programs implemented by Franklin Roosevelt as WPA projects. It was precisely those infrastructure projects that directly contributed to America’s ability to go forward in manufacturing, get raw materials to factories, and move finished products to store shelves.
The American consumer was also a different animal during that era; Americans actually believed that having money in savings was preferable to having a great deal of material items. Houses were smaller, most families had one vehicle, and eating a meal away from home was a luxury, not the norm. Compare that with the average American now: Most households have more than one car; a good amount have a motorcycle or a boat; they live in homes that are on average three times larger than homes in 1940; and they are in massive debt.
Most Americans today put very little of their after-tax income into savings. In 1940, the average American put nearly 25 percent of his net disposable income into savings—a high point, yes, but the average remained at around 10 percent from 1948 to 1985, and from there it declined steadily and by 2004 it trickled down to less than 0.6 percent. In 1940, average American family debt (other than a mortgage) was almost nothing, and most Americans used cash to make purchases. Today consumer debt (excluding mortgages) is an average of $15,000 per household, mostly held in credit-card debt. Consumer debt has consistently risen since the mid-80s. A tax cut will not help to increase savings and would probably just allow for an increased borrowing advantage.
Industry was also very different in the 1940s. In 1940, most manufacturing that contributed to the economic gains in the United States was performed in the United States by unionized American workers. American consumers purchased most of the items that were manufactured. Mr. Herman considers the ballpoint pen, which today is usually manufactured in China, by Chinese workers, and sold in the America. Even most of the products that are manufactured in the United States have a supply chain that leads to overseas companies.
A tax cut won’t change these things. It would actually decrease the money available to pay down the national debt.
Arthur Herman writes:
Scott Hunziker isn’t the first to suggest that America’s postwar economic success was due to a huge trade advantage, since its industrial rivals—Germany and Western Europe, Japan, and the Soviet Union—were still crippled by the effects of war. But America’s emergence as an economic superpower after 1945 was never export-driven, any more than its later decline was caused by cheap imports, as Lawrence Briskin seems to think.
In 1929, U.S. exports were 4.4 percent of GDP; in 1949 they were 4.6 percent. Likewise, steadily rising imports from Japan and then China in the 1970s and 80s were a symptom of declining American productivity, not its cause.
In the end, the best explanation for postwar prosperity remains the one in my article: the return of business investment and expansion thanks to the historic tax cuts of 1945 and 1948, and the elimination of wartime economic controls.
Wayne Fiskum has the right idea about savings, but doesn’t see that the goal of lowering marginal rates, as the 1945 tax cut did, was aimed precisely at increasing the kind of savings that wind up as capital investment, the rocket fuel of economic growth—and of rising government tax revenues.
Arguing this way, of course, makes me a dreaded supply-sider to critics like Messrs. Fiskum and Briskin. But not enough of one, it seems, for Steven Kates, who accuses me of having “completely [sold] the pass” by daring to mention consumer demand as a factor in economic growth—an unforgivable concession to Keynesian dogma.
Yet as Mr. Kates himself points out in his admirable 1998 book on Say’s Law, neoclassical economists such as Say always recognized that demand had its role to play in making societies prosperous—just not the only one, as Keynes later insisted. It was a failure in the structure of supply and demand, Say concluded, that brought economic dislocation and caused unemployment—as when producers guess wrong about what consumers want and overproduce goods which, to quote Mr. Kates directly, “remain unsold even at cost-covering prices.”
So it seems foolish to ignore the impact of private consumer demand on the economic picture in 1945, when Americans were starved for all the durable goods the war had denied them. Businessmen such as Alfred Sloan of General Motors, Henry Kaiser, and other industrial leaders knew there would be an eager market for the goods they would soon be producing, and that increased investment in their businesses would pay off—investment made possible by tax cuts.
Finally, Mr. Briskin’s account of the postwar economy has it exactly backwards. What wrecked America’s manufacturing was a combination of productivity-strangling government regulation (as Mr. Hunziker rightly notes), union demands for compensation unmatched by any increasing contribution to productivity to pay for them, and sagging private-capital investment under a regime of rising inflation and confiscatory taxes. By 1980, private savings sank to less than 4 percent of income, just as productivity growth in this country had come to a virtual halt.
This was no coincidence, as Jean-Baptiste Say would be the first to point out. He understood the importance of savings for future growth, just as he argued that “it is the aim of good government to stimulate production, of bad government to encourage consumption.”
We’ve endured the latter for the past four years, and seen the sorry result. By turning to the lessons of the postwar period, we can, and should, do much better.