Monday, December 11, 2017

Lessons from the Great Depression: Government Stimulus Spending Made Things A Lot Worse

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10 MIN READ - An important in depth analysis from the Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff

Real federal spending nearly doubles 1929-1933

This month we focus on the historical lesson of government spending (more or less?) during an economic slump—the correlative to last month’s discussion on Herbert Hoover’s destructive 1932 tax hike (from a top marginal rate of 25% to 63%) and FDR’s nearly equally detrimental 1936 increase from 63% to 79% and new “undistributed profits” tax.

Mainstream Great Depression histories and the economics columns of America’s major newspapers have been mostly silent on Hoover’s massive revenue measures that sent the economy plunging to its worst levels in American history the following year—opting instead to criticize his laissez-faire approach. But what have they said about spending?


Well Herbert Hoover’s 1929-1933 spending policy is one subject the press and academia were certainly not silent on. During the Great Recession the New York Times, Washington Post, Boston Globe, the Guardian, Atlantic, and other more liberal outlets like Salon, Slate, Vox, Huffington Post, etc… were virtually unanimous in their endless bemoaning of government austerity—primarily in Europe—and repeatedly cited their own “lessons” from the Great Depression: that Herbert Hoover slashed federal spending at a time when the economy needed expansionary stimulus in the form of enlarged budgets and fiscal deficits. The examples are virtually endless, but here are just a few to illustrate:
“The nation will be reeling from the actions of 50 Herbert Hoovers — state governors who are slashing spending in a time of recession” 
-Paul Krugman, “Fifty Herbert Hoovers,” New York Times, Dec 28, 2008
“Virtually all the deterioration in the US debt position from 1929 to 1939 took place under the tight-fisted Hoover rather than under FDR… …the Hoover experience also provides a nice illustration of self-defeating austerity… …It’s too bad that people who don’t understand any of that seem to have the upper hand in policy.”
-Paul Krugman, “Debt Depression,” New York Times, July 20, 2010
“World Leaders Heed Herbert Hoover, Opt for Belt-Tightening Over Economic Stimulus”
-CBS News, June 7, 2010
“[Nobel Laureate economist Joseph] Stiglitz believes the world is in danger of repeating U.S. President Herbert Hoover's mistakes in 1929 of slashing spending. ‘There is ample evidence on this,’ Stiglitz said. ‘We call these Hooverite policies (government austerity measures) in honor of Herbert Hoover.’”
-CNN, “Depression, Double-Dip, and Deficits: Economists Speak Out,” July 9, 2010
“But one of the most basic principles of economics is that when an economy is anemic, governments should use deficit spending as a fiscal stimulus, even though that means an increase in debt. If Senator Rubio believes that the response to a weak economy is to slash spending, he is embracing the approach that Herbert Hoover discredited 80 years ago.”
-Nicholas Kristof, “Why Pay Congress?”, New York Times, April 6, 2011
“That‘s a bad thing. Hoover is a political epithet in bad economic times because his response to the depression—was to, first do nothing and then do stuff that made it worse. The country needed massive federal spending to stimulate demand and keep people working. Hoover? Cut spending… …I‘m Herbert Hoover. I can‘t do anything helpful. How about I hurt the economy some more instead because of my dumb, moralistic, ideologically-driven, ignorant, short-term, self-serving bad ideas? I‘ll take this depression and make it not just good but great. That‘s the ticket, the Great Depression.”
-Rachel Maddow, “The Rachel Maddow Show,” December 12, 2008
Regarding the Maddow quote: to anyone who knows anything about government spending under the Hoover administration, you can only shake your head in disbelief at the awesome ignorance of such a self-righteous commentary. OK I know, Rachel Maddow is no economist. She’s not even a good economics commentator. But she did at least get the part right about Herbert Hoover turning a recession that started in 1929 into the Great Depression.

But for the opposite reason. Herbert Hoover was actually a runaway spender. As you’ll see it’s not even up for debate.


Which leads us away from the New York Times, CBS, CNN, and Rachel Maddow back to economic reality on planet Earth. Since Krugman, Stiglitz, Kristof, or Maddow have for good reason never produced any actual 1930’s budget numbers to back up their assertions, let's discuss the important details that they never will:

1) In response to the 1929 stock market crash, Herbert Hoover launched the largest peacetime percentage expansion of federal spending in American history—then or ever since. From Calvin Coolidge’s last budget (FY29) to Hoover’s last budget (FY33), federal spending rose 47% from $3.127 billion to $4.598 billion (source: historical budget tables—although any 1930’s budget source will confirm the same).

2) But that’s just the beginning. During the same 1929-1933 period rapid deflation boosted the dollar’s purchasing power due to the failure of nearly 10,000 commercial banks and credit contraction by highly stressed surviving banks. The money supply fell by nearly a third as did prices. So an inflation-adjusted dollar spent in 1933 was worth almost 1.5 times its 1929 value. Adjusting Hoover’s FY33 budget for deflation, spending swelled by 93.5% in real terms. In fact, calculating the hike from the nadir of the monetary contraction in the late spring of 1933 federal spending rose briefly by over 100%. Yes, you read that correctly. Herbert Hoover nearly doubled real government spending. Not quite the “draconian cuts” you may have read about?

3) As if it couldn’t get any worse, as a percent of GDP federal spending rose from 3.64% to 8.92%--due to a combination of real spending hikes and the shrinking economy. So as a share of the economy, Herbert Hoover ballooned federal spending by 145% or to about 2.5 times its original size.

On a side note Keynesian economists argue “You can’t measure federal spending as a percent of GDP because the economy was collapsing from 1929-1933 which distorts the calculation. It’s an unfair metric.” To which there are at least two valid responses: First, even ignoring government spending as a share of GDP, real spending itself nearly doubled which is already high enough to kill the “austerity” myth. But second, Keynesians always argue huge boosts in government spending are precisely what prevent recessions/depressions from getting worse in the first place. So if Herbert Hoover oversaw the largest peacetime spending expansion in American history, why was the economy even collapsing? Shouldn’t his near-doubling of real government spending have saved America, or at least prevented the calamity of the Great Depression instead of delivering… well, the Great Depression?

Or is it just possible that there's something wrong with their theory, and that all this profligate government spending is precisely what made things worse? The data sure fits the alternate theory a lot better than theirs.

Incidentally, if we account for all levels of government and include state and local spending—the hike as a share of GDP, while still enormous, wasn’t quite as dramatic: up “only” 98%. But other than some aid to state and local governments, Herbert Hoover had much less of an effect on their budgets than Washington’s. And of course the main target of the media’s Great Recession criticism was Hoover’s austerity, not the states'. But the evidence that total government spending at all levels by 1933 had doubled up to 22% of GDP also establishes that government spending was by no means insignificant by then, and was in fact a record at the time. By contrast, during America’s second worst depression, the Depression of 1893, total spending at all levels of government tallied at only 7-8% of GDP. And not coincidentally the Depression of 1893 ended in less than half the time as the Great Depression.

4) When confronted with the folly of austerity claims—a rare occasion in and of itself—Keynesian economists will sometimes focus on a single year: FY33 where federal spending dipped slightly from the previous year—from $4.659 billion to $4.598 billion, a decline of 1.3%.

But to call a 1.3% cut “draconian” or characterize it as “slashing spending” is not only an anemic argument, it once again ignores the impact of deflation. One dollar in 1932 was worth $1.11 in 1933, so in 1932 dollars the FY33 budget was not $4.598 billion but instead $5.104 billion, yet another hike—this time up 9.6% in real terms. Pointing to FY33 as the year of tragic austerity is just a fool’s errand.

5) One more legend of Hooverian austerity is his Treasury Secretary Andrew Mellon’s advice in the early days of the downturn to “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate…” which Hoover has recounted in his memoirs (available online at the Hoover Institution). Paul Krugman has also resurrected the quote in his April 2011 column “The Mellon Doctrine”—the insinuation being that Mellon’s quote is proof that Hoover stood by and allowed the economy to collapse in the mistaken belief that liquidation and adjustment were the proper policy response.

Well if only Hoover had really believed that. Americans might have been spared a lot of pain and suffering! The problem is two paragraphs later in the same memoirs Hoover describes his reaction to Mellon—which unsurprisingly Krugman, Delong, Stiglitz and others have chosen not to tell their readers about:
“Secretary Mellon was not hard-hearted. In fact he was generous and sympathetic with all suffering. He felt there would be less suffering if his course were pursued… ...But other members of the Administration, also having economic responsibilities—Under Secretary of the Treasury Mills, Governor Young of the Reserve Board, Secretary of Commerce Lamont and Secretary of Agriculture Hyde—believed with me that we should use the powers of government to cushion the situation… …The record will show that we went into action within ten days and were steadily organizing each week and month thereafter to meet the changing tides— mostly for the worse. In this earlier stage we determined that the Federal government should use all of its powers.”
-Hoover memoirs, p. 31
6) Finally the last demand-side line of defense usually goes something like “Well, Hoover tried but his spending programs weren’t big enough” and the standard corollary of “The Great Depression would have been worse were it not for his half-measures.” Of course every time the Keynesian prescription has all-too-often failed (think Obama’s $800 billion 2009 ARARA stimulus, bloated European budgets in the initial post-2008 crisis years, and multiple Japanese stimulus packages) the “not big enough” card is dusted off and played, almost as if on an automated script.

But America experienced major depressions in 1837, 1873, 1893, 1907, and 1920, the first four in particular with major financial/banking panics. Not only were federal stimulus spending programs “not big enough” then either, they were completely nonexistent since demand-side economic policies hadn’t been invented yet. In fact, the federal government’s standard response prior to 1929 was to cut the budget during slumps to compensate for falling tax revenues.

According to the Paul Krugmans of the world, those downturns should have deteriorated into “Greater Great Depressions,” lasting entire generations. But the opposite happened: the slumps were over in a year or two and full employment was restored in anywhere from two years (Depression of 1907 and 1920) to at most seven (Depressions of 1873 and 1893), instead of the eleven years required after 1929, or more accurately sixteen years if you exclude World War II when the US military conscripted 12 million men, sent them overseas, and counted them as “employed.”

It’s also worth noting that early 1930’s federal spending increases were not on liberal bĂȘte noires like military budgets, but rather for standard New Deal type programs: The Resolution Finance Corporation to bail out railroads, politically connected banks and businesses. Compensation to state governments for falling tax revenues. The Federal Farm Board to buy up crops in an attempt to prop up produce and livestock prices, and eventually pay farmers directly to stop growing food. Public works programs building roads, bridges, parks, buildings and large jobs projects such as Mount Rushmore and the Hoover Dam. So no one can argue Hoover’s budgets weren’t “demand boosting” in the longstanding conventional sense.


But back to what we now know is, to borrow a line from economist Lawrence Reed, one of the Great Myths of the Great Depression: that Herbert Hoover was a tight-fisted budget cutter. The countless claims in America’s newspapers and among academics that Hoover was a small government austerian is an openly categorical falsehood. Herbert Hoover launched tax hikes and spending increases that, measured as percentage gains, were and still remain records for American peacetime. The top tax rate rose by 150%, real federal spending rose by nearly 100%, and federal spending as a percent of GDP rose by nearly 150%.

And given the prescriptions liberal economists, journalists, and policymakers have been pushing since 2009—more taxes on the rich and more government spending—well, Hoover has already generously given us all the greatest experiment in American history of that very same prescription; by ballooning the federal budget and soaking the rich. Was the result an energetic recovery achieving full employment in record time? No, it was the Great Depression; delivering peak unemployment rates double that of the nearest slump (also the Depression of 1893) and lasting two-and-a-half times longer than the next longest downturn (tie: Depression of 1873, Depression of 1893, and 2008 Great Recession—as measured by number of years to return to full employment).

So what’s our Great Depression’s great lesson for this month? More government spending makes recessions longer and worse (for a modern-day example, see Japan’s nearly three decades of government stimulus spending). Multiple articles have been written about the Hoover myth and the real lessons of early 1930’s fiscal policy, but they have been confined mostly to conservative and libertarian outlets such as the Mises Institute, CATO, and Mercatus Center. Most of America simply isn’t aware that Hoover the tightfisted miser is a complete myth, because if you watch or read mainstream media you’d probably never know either.

Sunday, December 10, 2017

MiG Pilot Defector Viktor Belenko Visits a Virginia Grocery Store

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2 MIN READ - From the desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff; following up from last post on the world of Marxism.

PVO Lieutenant Viktor Belenko before his spectacular defection to Japan

And not to limit our history lessons to the Chairman of the Supreme Soviet Presidium and Politburo party bosses, everyday Soviet MiG-25 pilot-defector Viktor Belenko had his own observations about the suburban Virginia supermarket he visited with his CIA handlers.

"Thirty or forty different varieties; milk, butter, eggs, more than he had ever seen in any one place; the meat counter, at least twenty meters long, with virtually every kind of meat in the world-wrapped so you could take it in your hand, examine, and choose or not; labeled and graded as to quality. A date stamped on the package to warn when it would begin to spoil!..."

“…Never had Belenko been in a closed market selling meat or produce that did not smell of spoilage, of unwashed bins and counters, of decaying, unswept remnants of food. Never had he been in a market offering anything desirable that was not crowded inside, with lines waiting outside. Always he had been told that the masses of exploited [U.S. citizens] lived in the shadow of hunger and that pockets of near starvation were widespread, and he had seen photographs that seemed to demonstrate that.”

“If this were a real store, a woman in less than an hour could buy enough food in just this one place to feed a whole family for two weeks. But where are the people, the crowds, the lines? Ah, that proves it. This is not a real store, The people can't afford it. If they could, everybody would be here. It's a showplace of the Dark Forces. But what do they do with all the meat, fruit and vegetables, milk, and everything else that they can't keep here all the time? They must take it away for themselves every few nights and replace it.”

(to read more of this amusing story, click and download the PDF link)

Saturday, December 2, 2017

A Houston Randall’s Grocery Store Convinces Boris Yeltsin to Leave the Soviet Communist Party

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1 MIN READ - An offering from the Cautious Optimism Correspondent for Economic Affairs (and other Egghead stuff).

Before we say goodbye to the November 100th anniversary of the communist Bolshevik Revolution, CO has decided to take a slightly different path from recounting the deaths, suffering, and famine under the early Lenin regime and nightmarish Stalin dictatorship. Instead we ask "How were things going in the Soviet Union near its end--after the Communist Party had spent over 70 years ironing out the details of the Workers’ Paradise utopia?"

Boris Yeltsin certainly formed his own opinions about how the Soviet economic model was performing in 1989—right after he visited NASA’s Johnson Space Center in Houston. But it wasn’t the American space age technology that impelled him to leave the CPSU but an impromptu visit to the nearby Randall’s supermarket afterwards.

The frozen Jell-O pudding pops in the ice cream aisle woke Yeltsin up to hard truths about communism and economic central planning—lessons that thousands of Marxist and communist university professors in the USA and Europe still haven’t grasped today.

Read the Houston Chronicle story at...

Great photo slide show to boot!

Thursday, November 16, 2017

Lessons from the Great Depression: Taxes

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6 MIN READ - An important dispatch from the Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff
CO has been watching with great interest the Republican Congressional and Trump White House tax proposals. Predictably, critics have again complained that cutting taxes for the largest taxpayers—the wealthy and corporations—is not only unfair to the bottom 80% of Americans who pay just 5% of income taxes (source: OMB via Washington Examiner), but that it will bring harm to what was until recently a very slowly recovering economy.

Meanwhile the financial crisis and worst of the Great Recession are fading in the rear-view mirror, even as tax policy was also a heated topic of discussion then, and pundits, politicians, and academics persistently invoked the Great Depression as their guide—arguing the critical importance of understanding the fiscal mistakes of the 1930’s if we were to avoid another Great Depression or Japan-style malaise. Well it’s true a great deal can be learned from the tax failures of the 1930’s, so what exactly are those lessons?

The prevailing story for decades has been that in the wake of the October 1929 stock market crash, Herbert Hoover stubbornly clung to a dogmatic policy of laissez-faire, refusing to intervene and even slashing the federal budget at a time when the country needed (according to Keynesian economists) expansionary stimulus. As early 1930’s budget cuts dominated the post-2008 conversation and taxes weren’t discussed as much, the constant barrage of stories about Hoover’s alleged refusal to involve the federal government strongly suggested he was motionless on taxes as well or even cut them. The conclusion, we are told to accept, is Hoover’s refusal to recruit the powers of the federal government tragically and avoidably transformed the Recession of 1929 into the Great Depression. That’s the New York Times/CNN/education system version.

But even a passive glace at 1929-1933 tax policy reveals that narrative is a baseless myth. What really happened was quite different:

In 1932, with the economy reeling and a combination of falling tax receipts and profligate spending (more on spending in another CO installment on the Great Depression) Herbert Hoover was confronted with the problem of growing deficits. For every dollar of federal revenue, Washington was spending $2.47 and deficits were reaching 4.5% of GDP. By comparison, during the worst budgets of the George W Bush administration, the annual deficit peaked at 3.5% of GDP. And during the 1930’s a deficit of either magnitude was considered inconceivable and alarming.

Hoover felt strongly the deficit had to be closed. But instead of urging Congress to pull back on spending (as we’re told to believe by most newspapers and economists) he attempted to bridge the gap by signing the Revenue Act of 1932—the greatest peacetime percentage tax hike in American history, then or ever since.

For starters, Hoover targeted the rich. The top marginal income tax rate was raised from 25% to 63%. Yes, you read that correctly: the top rate surged from 25% to 63% or a tax liability increase of 150% in the middle of a depression (see link or pretty much any online historical table of marginal tax rates).

The working and middle classes weren’t spared either. Although their 1930’s tax brackets were very low by today’s standards (1.5% to 5%) the Hoover hike to a range of 4% to 8% inflated Americans’ tax bill by  60%-166% depending on which bracket they had previously populated.

Furthermore, as Murray Rothbard recounts in his classic book “America’s Great Depression”:
“The corporate income tax was increased from 12 percent to 13 percent, and an exemption for small corporations eliminated; the estate tax was doubled, and the exemption floor halved; and the gift tax, which had been eliminated, was restored, and graduated up to 33 percent.”
…and furthermore…
“Many wartime excise taxes were revived, sales taxes were imposed on gasoline, tires, autos, electric energy, malt, toiletries, furs, jewelry, and other articles; admission and stock transfer taxes were increased; new taxes were levied on bank checks, bond transfers, telephone, telegraph, and radio messages… … The raising of postal rates burdened the public further and helped swell the revenues of a compulsory governmental monopoly. The letter rates were raised from 2¢ to 3¢ despite the fact that the Post Office’s own accounting system already showed a large profit on first class mail. Postage on publishers’ second class mail was raised by about one-third, and parcel post rates on small parcels were increased by 25 percent.”
It's no wonder then that the year following the Revenue Act of 1932 was the worst in American economic history—then or ever since as well. The bottom figuratively fell out from under the country, with real GDP plummeting to 1922 levels and the unemployment rate rising nearly eight points in a single year, from 18% to nearly 26%. By comparison in the twelve months following the October 2008 financial crisis unemployment rose by 3.5 points to its peak of 10.0% in October 2009 (source: Bureau of Labor Statistics).

So while Hoover has been roundly criticized by mainstream economists and the media for years for closing the deficit at a time when (according to them) deficits were a necessary stimulus, they almost never criticize him for the record tax hike. In fact, not only are they not critical of the tax hike, they’re virtually silent on it which should make us all a bit suspicious about the motives behind such a glaring omission. After all, a 60%-160% tax hike on all of America during a deep recession isn’t some insignificant fiscal move unworthy of discussion. Do they really want us to learn the lessons of the Great Depression or just the ones they like?

Now to the extent that today’s left-leaning economists are ever forced to acknowledge Hoover’s tax hikes (which is rare), a common fallback to the next line of defense goes something like this: “Well a lot of other things were happening after the 1932 Revenue Act that caused the fallout in 1933. There was a major banking crisis early that year for example.”

And that’s true. However even if you suspend disbelief momentarily and accept that the huge tax hikes of 1932 contributed very little to the 1933 plunge, all one has to do is fast forward to 1936 for more evidence. Franklin Roosevelt enacted another large tax increase that year with the Revenue Act of 1936. The “Soak the Rich” tax was introduced, raising the top tax rate to 79%. Capital gains taxes were hiked from 17.7% to 22.5%. Corporate taxes were raised from 13.75% to 15%. And a new “Undistributed Profits Tax” of up to 27% was levied on corporations.

So it’s not surprise that the following year America fell into depression again, the Depression of 1937-38 (also referred to as “America’s only depression within a depression”) which was the third worst dip of the 20th century. Unemployment, which had been slowly recovering due to the stabilizing banking system, about-faced and rose six points in a single year (14% to 20%).

So it seems unlike progressive claims that massive tax hikes, especially on the wealthy, ushers in rapid recovery and quick prosperity, history and reality show instead that it creates worsening and prolonged depression.

And despite the ongoing myth that Herbert Hoover’s stubborn adherence to laissez-faire policy and tax cuts caused the Great Depression, the truth is the opposite. Hoover launched record tax hikes, and as we will cover in the next installment on the Great Depression, was also a profligate spender. In other words: he ballooned the size of government both in the tax and spending columns, not to mention also with wage, trade, and regulatory policy. Not only are the myths myths, they frame a diametric opposite portrait of what really happened.

So when the next recession comes to America—or even while politicians, academics, and journalists argue the merits of the current Trump tax package—remember the real lessons of the Great Depression. Double-digit tax hikes on the rich and higher federal spending, aka. bigger government, while a drag in a growing economy, leads to extended and more painful slumps when applied during recessions or fragile recoveries. We know because it happened in the real world—outside the halls of academia and CNN’s editing room.

Note: For those interested in demolishing more longstanding myths about Herbert Hoover’s lack of depression-fighting policies, CO’s Economic Affairs Correspondent highly recommends reading Part III of Austrian economist Murray Rothbard’s masterful “America’s Great Depression,” available free in PDF format.

Monday, October 30, 2017

Is Connecticut’s Slanted Tax Structure Inviting Crony Capitalism?

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From the ornate mahogany desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff.

As CO has recently reported, Connecticut is losing population due to the burden of heavy taxation and over-regulation.

Adding fuel to the fire is Connecticut’s heavily progressive and relatively new tax structure. After having no income tax until 1991, Connecticut’s current lowest income bracket has since reached 3% while the tax rate on single earners making over $500,000 has quickly risen to effectively 7% (6.99%). 

Taxes on estates of over $10 million is 12% (on top of the federal estate tax rate of 40% for an effective rate of 52%). In addition to property taxes, the corporate state tax rate is among the nation’s highest at 9% (source:

All this adds up to a huge share of Connecticut’s tax revenue stemming from a small number of wealthy taxpayers, many of whom own businesses in Connecticut and several of whom have made high profile departures in the last few years. For example, (from the Yankee Institute):

"Connecticut faces an outmigration trend in which higher-earning individuals are leaving the state, with Florida being one of the primary beneficiaries."

"Florida, with no income tax, has been attracting wealthier individuals as Connecticut passed two of its largest tax increases in history in 2011 and 2015. Notably, Florida has siphoned off some of Connecticut’s wealthiest people. In 2015, hedge fund manager Paul Tudor Jones moved from Greenwich to Florida, taking with him nearly $30 million in income tax revenue."

And the two historic tax hikes in 2011 and 2015, combined with the wealth exodus, has put further pressure on the remaining rich. The result has been greater and greater budget dependency on a shrinking and evermore exclusive club of well-to-do citizens. Also from the Yankee Institute:

"A 2014 study by the Connecticut Department of Revenue Services found that 357 families account for 11.7 percent of the total Connecticut income tax burden. Those 357 families paid $682.5 million in income tax in 2014, so minor fluctuations in the number of high wealth families and their income levels can have big consequences for balancing the budget."

Connecticut’s dependence on this dwindling pool of wealthy taxpayers has propelled officials to keep a very close eye on them, even meeting with one personally to discuss what accommodations might convince him not to leave. As the Hartford Courant reports:

“Two years ago, tax officials were alarmed that a super-rich hedge fund owner might leave and reduce the state's income tax revenue. They met with the unidentified taxpayer. The effort was partly successful, with the taxpayer's leaving Connecticut but agreeing to keep the hedge fund here.”

Which raises an interesting question: If government tax policy makes it so dependent on a handful of taxpayers to fund its operations that officials meet personally with them to keep them in Connecticut, is the same tax policy making the same officials vulnerable to political influence?

Or put another way, despite all the grumbling by progressive leftists about the rich “buying” government, does their vaunted progressive taxation actually enable more “government buying” and crony capitalism? Is corruption built into state-level “soak the rich” policies?

When officials rely so heavily on a handful of residents to pull the entire budget wagon, it empowers that exclusive club to exert enormous influence over them. Politicians can more easily be talked into compensatory forms of accommodative policy to keep their sponsors happy. 

Perhaps progressive taxation through democratic government produces more undemocratic results than voters and politicians would like to believe—another example of government policy producing the opposite results it was intended to.

Source stories:

Monday, October 23, 2017

Some Famous Macroeconomic Predictions from 1929-2009

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4 MIN READ - From the desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff 

2005-2009: More recent macroeconomic predictions

As we approach the 88th anniversary of 1929’s Black Thursday stock market crash, here are some predictions by several famous economists and policymakers.

"We will not have any more crashes in our time"

-John Maynard Keynes (Keynesian School), 1927

"There will be no serious consequences in London resulting from the Wall Street slump. We find the look ahead decidedly encouraging.”

-John Maynard Keynes (Keynesian), November 1929

"Stock prices have reached what looks like a permanently high plateau"

-Irving Fisher (Quantity Theory School), October 17, 1929

“The end of the decline of the Stock Market will probably not be long, only a few more days at most”

-Irving Fisher (Quantity Theory), November 14, 1929

"[The economy is] in its 150th month of unparalleled, unprecedented, and uninterrupted economic expansion" and has taken a 'dramatic departure' from the past."

-Arthur Okun (Keynesian), LBJ Council of Economic Advisors, from “The Obsolescence of the Business Cycle" in his book "The Political Economy of Prosperity," 1970. Over a decade of stagflation would follow

“Meanwhile, economic policy should encourage other spending to offset the temporary slump in business investment. Low interest rates, which promote spending on housing and other durable goods, are the main answer.”

-Paul Krugman (Keynesian), Nobel Laureate, October 2001

“The good news about the U.S. economy is that it fell into recession, but it didn’t fall off a cliff. Most of the credit probably goes to the dogged optimism of American consumers, but the Fed’s dramatic interest rate cuts helped keep housing strong even as business investment plunged.”

-Paul Krugman (Keynesian), Nobel Laureate, December 2001

"On the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero."

-Joseph Stiglitz (Keynesian), Nobel Laureate, 2002

"The stability of our economy is greater than it has ever been in our history. We really are in remarkable shape... The United States is at the peak of its performance in its history... I think monetary policy is primarily responsible for it."

-Milton Friedman (Monetarist School), December 2005

“The United States economy has never been in better shape… … monetary policy is spectacular.”

-Arthur Laffer, August, 2006

“To be honest, a new bubble now would help us out a lot even if we paid for it later. This is a really good time for a bubble… There was a headline in a satirical newspaper in the US last summer that said: 'The nation demands a new bubble to invest in,' and that’s pretty much right.”

-Paul Krugman (Keynesian), Nobel Laureate, May, 2009

“A great crash is coming, and I don't want my name in any way connected with it."

-Ludwig von Mises (Austrian School), summer 1929, to his wife when asked why he turned down a lucrative job at Austria’s largest bank, the Kreditenstalt, which failed spectacularly in 1931.

“Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans...

...However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing...”

...Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever.”

–Ron Paul (Austrian School), Congressional Testimony 2002

…and a few bonus quotations!

“The Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive.”

-Paul Samuelson (Keynesian and Nobel Laureate), in the 1989 version of his textbook “Economics.” The Soviet Union collapsed that same year.

“[i]t is a vulgar mistake to think that most people in Eastern Europe are miserable.”

-Paul Samuelson, in the 1976 version of his textbook “Economics”

“Can economic command significantly accelerate the growth process? The remarkable performance of the Soviet Union suggests it can. Today it is a country whose economic achievements bear comparison with those of the United States.”

Lester Thurow, MIT economist, and Business School Dean, in 1989. Also co-founder of the progressive Economic Policy Institute. Again, the Soviet Union collapsed two years later.

“What counts is results, and there can be no doubt that the Soviet planning system has been a powerful engine for economic growth. . . . The Soviet model has surely demonstrated that a command economy is capable of mobilizing resources for rapid growth.”

Paul Samuelson (Keynesian), 1985

“I fear that those who think the Soviet Union is on the verge of economic and social collapse are kidding themselves.”

Arthur Schlesinger, famous liberal historian, “court historian” to John F Kennedy White House, social critic, and public intellectual, in 1982.

“A Messiah rather than a dictator.”

Joan Robinson (Keynesian), about North Korean leader Kim Il-Sung from her report “Korean Miracle.”

“[o]bviously, sooner or later the country [Korea] must be reunited by absorbing the South into socialism."

Joan Robinson (Keynesian)

"As the North [Korea] continues to develop and the South to degenerate, sooner or later the curtain of lies must begin to tear.”

Joan Robinson (Keynesian)

“moderate and humane"

Joan Robinson (Keynesian), regarding Chairman Mao Zedong’s intentions in her 1969 book “The Cultural Revolution in China.” Robinson was both an admirer of Mao and of his Cultural Revolution.

Thursday, October 5, 2017

Trump Suggests Clearing Puerto Rico’s Debt, But Will Puerto Rico Rein In Its European Levels of Spending?

Click here to read the original Cautious Optimism Facebook post with comments

3 MIN READ - Thoughts on Puerto Rico from The Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff.

As CO has recently reported on Puerto Rico’s post-Hurricane Maria debt position, it’s helpful to look at some numbers that explain why the Commonwealth’s fiscal situation got so desperate in the first place.

When Puerto Rico’s debt crisis made headlines in 2014 and into 2015 most major US newspapers were full of columns blaming low taxes and tax cuts for the Commonwealth’s accumulated budget shortfalls. Meanwhile more conservative/free market outlets blamed out-of-control government spending.

So which narrative was right?

Well it happens that very same year the New York Federal Reserve published its own report on Puerto Rico’s economic competitiveness...

The comprehensive paper analyzed many economic indicators such as GDP, unemployment, private debt, labor markets, regulations, etc… but also included the all-important metrics on tax/fee revenue and government spending.

Despite progressive claims that Puerto Rico’s debt crisis was the product of tax cuts, Puerto Rico ranked #1 for government revenues as a percent of GDP (38.65%) among all 50 states plus District of Columbia plus itself (see page 14, figure 10). 

However, unlike the continental United States, Alaska, and Hawaii the Commonwealth government owns and operates sizable state-owned enterprises (SOE’s) delivering services such as electric power, health insurance, and transportation to the island. And a significant share of its revenue comes from SOE’s.

Yet even after removing SOE revenues, Puerto Rico tax revenues still ranked #2 out of 52 states/districts at 14% of GDP. As the New York Fed report states:

“Puerto Rico’s overall state and local tax burden, at 14 percent of GDP, is heavy compared with that of most mainland states. Among the fifty states plus the District of Columbia, Puerto Rico would rank second in terms of total tax burden.”

Furthermore Puerto Rico residents enjoy the advantage of paying no federal income tax to Washington, DC (except for federal employees) and the island receives Medicare and Social Security payments as well as continuous federal aid. So with the second highest tax revenues in the United States plus sizable intergovernmental transfers it’s hard to see insufficient revenues or tax cuts as a problem.

But what about spending? The New York Fed report did not tally spending minus SOE’s, but when including all government spending Puerto Rico not only exceeded every other state at a mindboggling 50.1% of GDP, its total expenditure ranked it sixth highest out of 31 OECD countries (see page 17, figure 12). 

Let me repeat that. Puerto Rico’s government spends more as a percent of GDP than the overwhelming majority of OECD countries. 

That means more spending than not only the United States itself, but also most European social democracies including Spain, Portugal, the Netherlands, Norway, the UK, Germany, and more—many of which also have their own SOE’s, an amazing display of government inefficiency and largesse. Although in fairness they were still beat out by Greece, a country that was allegedly suffering from “austerity” and draconian spending cuts during the same period (restrain laughter).

Now one important factor to consider is that Puerto Rico is responsible for funding a greater share of its  own highway construction than most states—although it still receives some financial assistance from the federal government—which would necessitate marginally higher spending levels than most states. 

However the island also enjoys the benefit of military protection from the United States while paying no income taxes to Washington, much like the European countries it emulates. Given that total public construction spending (above and beyond just roads and highways) in the United States is less than half that of defense spending (source: St. Louis Federal Reserve), the Commonwealth enjoys a considerable net benefit from the pay-for-highways/free-defense tradeoff. And sharing some of the road transportation costs with Washington is not going to account for the difference between, say… Texas and Norway levels of spending.

Given that Puerto Rico has been devastated by Hurricane Maria, the verdict is still out as to whether or not wiping out its debt obligations is a good idea. Will it encourage other disaster prone states to practice fiscal moral hazard in the hopes of a federal bailout? Or is it simply the humanitarian thing to do?

But one thing is certain: Puerto Rico got into its fiscal mess with European-level taxes, European-level spending, and the burden of vast and expensive government enterprises. No one can pin their fiscal problems on tax cuts.

Monday, September 18, 2017

The 1950’s Weren’t America’s Most Prosperous Decade: It’s Not Even Close

Click here to read the original Cautious Optimism Facebook post with comments

4 MIN READ - From the desk of the Cautious Optimism Correspondent for Economic Affairs and other Egghead stuff

In the recent crusade against “income inequality” it has become fashionable to cite the 1950’s as America’s greatest decade of economic growth—and then credit it almost exclusively to the period’s 91% top marginal income tax rate (the idea being that soaking the rich somehow promotes growth). 

In distant second place is crediting Dwight D Eisenhower’s push for the Interstate Highway System as a giant Keynesian government stimulus thus championing the virtues of large federal spending programs. 

In either case, the correlation of big-government interventions with an affluent decade is used to justify steeper taxes and higher government spending today with the promise of reliving the riches of the fifties.

But even though a multitude of deductions allowed nearly everyone to avoid paying the 91% rate, the larger fallacy in both arguments is that the 1950’s simply weren’t America’s greatest growth decade.

For one, the USA experienced two recessions during Happy Days (1953-54 and 1957-58) with two more bookending the decade (one bottoming in October 1949 with America just beginning a recovery in 1950, and another recession beginning in April 1960. Source: NBER). So the slightly longer 10-1/2 year period October 1949-April 1960 encompassed part or all of four recessions.

Second, based on real GDP growth the 1950’s decade barely ranks in America’s top five. Although no government figures exist before the 1930’s, academic estimates show without a doubt that America’s greatest decades of growth were during the post-Civil War era of the late 1800’s—when by the way there was no giant government spending program on interstate highways and federal peacetime spending was typically only 2-4% of GDP. 

And ironically by the income inequality crusader’s logic, the growth of the Gilded Age must have been fueled by the top marginal tax rate of zero since, with the brief exception of the Civil War, the federal income tax didn’t even exist until the passage of the 16th Amendment in 1913. So will the income inequality warriors now call for abolition of the income tax?

Statistics can be boring, but in this case a little slogging tells quite the compelling story. Using FRED/BEA figures for 1950-1960 and Johnston/Williamson numbers from for the 19th century we can compare the 1880’s, the decade when America emerged as the world’s largest economy, and the 1950’s real GDP and per-capita GDP growth rates:

Real GDP: 1950-1960. +42.3% ($2.184T to $3.108T, 2009 dollars)
Real GDP: 1880-1890. +66.7% ($207B to $345B, 2009 dollars)

Real per-capita GDP: 1950-1960. +20.1% ($14.4K to $17.3K, 2009 dollars)
Real per-capita GDP: 1880-1890. +32.6% ($4,123 to $5,467, 2009 dollars)

Real GDP sources: 
As you can see, it isn’t even close.

1850-1860 and 1870-1880 (even with the Depression of 1873) also outperform the golden 1950’s in both categories.

Real GDP gains for the Gilded Age decades were +65.5% and +70.8% respectively ($53.6B to $88.7B and $121.3B to $207.2B, 2009 dollars).

And real per-capita GDP gains were +22.2% and +35.7% respectively ($2,303 to $2,815 and $3,039 to $4,123, 2009 dollars).

Even the destitute 1980’s—when we’re told the great riches of the postwar era were squashed under heartless Ronald Reagan’s iron boot when he cut the top marginal rate from 70% to 28%—outperforms the 1950’s on a per-capita basis. 

Although real GDP grew by a slightly lower 38.9% ($6.45T to $8.96T, 2009 dollars), slower population growth translates to a superior real per-capita increase of 26.3% ($28.5K to $36.0K, 2009 dollars).

Third and finally, what growth came out of the 1950’s isn’t explained by 91% high tax rates, wealth redistribution or the Interstate Highway System at all, but rather by the very unsexy, boring, and little-understood international monetary arrangement of the time. 

Under the postwar Bretton-Woods agreement the US dollar served as the world’s anchor-reserve currency due to its peg to America’s vast gold reserves, and other member nations’ currencies were convertible to US dollars at fixed exchange rates. However, America’s low money stock-to gold reserves ratio in the first 15-20 years of Bretton Woods undervalued the dollar via its trading partners’ currencies—the exact opposite phenomenon of the overvalued British pound during the interwar gold-exchange standard. 

Unlike Britain, which during the 1920’s suffered from chronic trade deficits and gold outflows due to its overvalued currency, the US experienced an export boom during the 1950’s and most of the 1960’s due to the undervalued dollar.

With the exception of the US having already been a developed economy during the 1950’s, strong American exports were driven much the same way China’s deliberately undervalued yuan—pegged at fixed exchange rates to the US dollar by the People’s Bank of China—has stimulated its current export boom. 

But the party came to an end in the late 1960’s when aggressive money creation by the Federal Reserve to finance deficits for Lyndon Johnson’s Great Society and the Vietnam War reversed the dollar’s undervalued status to overvalued. America’s trade surpluses turned to chronic trade deficits and the late 1960’s Fed-induced stock market bubble popped, leading America into the stagflation era of the 1970’s.

Sometimes sound answers to economic questions can be a little bit complicated, but Bretton-Woods and an undervalued dollar aren’t quite the progressive soundbite the “91% tax rates made us wealthy” forces are looking for. And certainly neither is “zero tax rates drove America’s truly most prosperous decades.”

Friday, September 8, 2017

The End of Canada's Zero Interest Rate Policy

2 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff reflects on Fed/Central bank policy/effectiveness across the US and The Great White North.

The Bank of Canada building has added floors since 1935
On Wednesday the Bank of Canada raised its overnight lending rate for the second time in two months to 1%--meaning its next rate hike will end over eight years of 1% or lower interest rate policy and signal the end of an unprecedented era of cheap money that many believe has fueled real estate bubbles in key Canadian metro areas.

By contrast, Canada's banking system going back to the late 18th century had been largely free of government control and nearly totally unregulated, functioning without a central bank all the way until 1935—well after the Great Depression had already bottomed out.

Lacking restrictions on branch banking that had plagued American unit banks for over a century, and free from distorting controls imposed on US banks by the National Bank Acts (1862-1913) and the First and Second Banks of the United States (1791-1811, 1816-1836), Canada never suffered a systemic banking crisis in its entire history versus the roughly fifteen that the United States has endured reaching back to 1797.

Under its freer and less regulated system, Canada also did not experience a single bank failure during the Great Depression compared to the nearly 10,000 failures the United States suffered from 1929 to 1933 under the watchful eye of the Federal Reserve.

(click here to read's report on the historical contrast between the Canadian and American systems

However, in the decades since the Bank of Canada opened its doors in 1935, Canada's banking system has increasingly mirrored its southern neighbor's with a powerful central bank issuing monopoly fiat money and centrally planning interest rates and monetary policy.

And while Canada has benefited from its citizens' traditionally conservative household finances and absence of the affordable housing crusades that flowed from Washington, DC during the 2000's, the Bank of Canada's ultra-easy money policy of the last eight years and the real estate bubbles it has blown in major metro areas raises doubts as to whether Canada can avoid its first full-fledged financial crisis.

Even if it survives this tightening cycle, is an end to Canada's remarkable lifetime streak of zero bank crises coming in our lifetimes given its abandonment of free banking policies for central planning in money?

Tuesday, August 15, 2017

Solar and Wind Energy Subsidies vs Oil and Natural Gas

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3 MIN READ - Fresh dispatch from the Cautious Optimism Correspondent for Economic Affairs and other Egghead Stuff. Here he drills into some Energy issues.

As CO has recently reported on solar energy’s cost inefficiencies against traditional natural gas or even coal, it’s helpful to take a closer look at the ugly subsidies side of the equation. How much government assistance does solar (and its little brother wind) receive to still remain uncompetitive?

It turns out according to the U.S. government’s own EIA report, solar receives over 1,600 times more subsidy dollars per KWh generated than traditional coal and petroleum (96.8 cents per KWh vs 6/100ths of a cent).

For the NCPA story which links to the U.S. Energy Information Administration's study go to...

The EIA study was conducted during FY10 at the height of the failed Obama green energy spending spree, but even today solar and wind still massively outcollect government money via their fossil fuel competitors per KWh generated.

And while solar and wind get direct government payments, fossil fuel “subsidies” are mostly writedowns on equipment depreciation—a form of “subsidy” that all companies take. Furthermore, these metrics exclude “reverse subsidies” (i.e. taxes paid).

For example, in the decade FY2005-FY2014 one petroleum company alone, ExxonMobil, paid over $250 billion in corporate income taxes, or over a quarter trillion (yes, trillion with a “T”, see links below to SEC filings) dollars. 

This also excludes the additional retail energy taxes collected on the energy the company sells, and ExxonMobil is just one payer alongside other giant energy companies like ChevronTexaco, BP, Total, ConocoPhillips, Schlumberger, Transocean, Baker Hughes, and literally hundreds of others.

Some critics argue that wind and solar costs are all up front—in the production and installation of the panels and windmills—and that the energy flows at much lower cost. But it's worth reminding such critics that traditional petroleum's costs too are very front-heavy with major capital expenditures in exploration, drilling, and infrastructure.

For example, contracting an offshore drilling rig that can cost half-a-million to nearly a million dollars per day to operate (during periods of high demand), petroleum companies can pay over $100 million for a single offshore drilling project and in most cases find nothing.

Once all the costly failures are logged and a rig finally hits an oil and gas field, production rigs move in and energy is extracted at much lower cost. But petroleum companies make enormous upfront capital investments just like renewables, usually to fail.

The same is true with the expansion of refineries or construction of pipelines with large upfront costs and much lower operating costs once they are built. Or as mentioned in one of CO’s previous articles, there are also upfront costs associated with building natural gas electric power stations.

Factoring in all the financials—direct federal subsidies to wind and solar and enormous taxes paid by traditional fossil fuels companies, green energy should easily have the upper hand. Government props it up heavily while simultaneously hobbling and handicapping its competition.

Yet even with all its state-support, the propaganda claims of “competitiveness” still fall flat. When government help is removed from the calculus, the claims appear downright absurd.

One of the common refrains from those advocating “green” energy is that we need to stop subsidizing coal, oil and natural gas. And while they admit, even advocate for, the existence of subsidies for wind, solar and the like, they imply that if only we got rid of subsidies for oil, those other forms of energy would lose their competitive advantage and the world would automatically move to green sources.

They're at best only 1/1600th correct.

To verify ExxonMobil's corporate taxes paid for the 2005-2014 period, check the company's SEC filings (pages 41, 56, 53, and 53 respectively) at...