January 23, 2018


Growth, Not Equality : American history shows that expanding the economy benefits everyone. (Amity Shlaes, Winter 2018, City Journal)

The modern American economic story starts with the 1920s, a decade worth dwelling on at some length because of the stunning evidence that it offers of growth's power. The winners of the 1920 election were two Republicans, Warren G. Harding of Ohio and his vice presidential candidate, Calvin Coolidge of Massachusetts. Confronting these men and, indeed, Congress, was the same pressure to prioritize redistribution that weighs on us today. In the aftermath of World War I, commodity prices had plummeted; farmers could not pay the bills for equipment and land that they'd purchased in better years. The farmers demanded agricultural subsidies from Washington; veterans sought a federal pension, an early version of Social Security. Harding and Coolidge's 1920 opponent from the Socialist Party, Eugene Victor Debs, won only 3.5 percent of the popular vote. But the dignified Debs, in prison for noncompliance with the wartime draft, was becoming a national martyr to progressivism. An even greater force was the progressive wing within Harding and Coolidge's own party, the Republicans, led by Robert La Follette, senior senator from Wisconsin. La Follette advocated massive redistribution, including not only farm aid but also government seizure of national resources. Politically, La Follette was gaining in strength, looking to a 1924 presidential run. Dramatic moves by Woodrow Wilson's administration during the war, including the suspension of trading on the New York Stock Exchange and the nationalization of the chief means of transportation, the railroad, had strengthened the case for a big-spending government. Perhaps what had worked in war would also work in peacetime.

Meantime, however, business was slow--the early 1920s experienced a significant recession. At the end of World War I, the top income-tax rate stood at 77 percent. Business was accustomed to extraordinary burdens in war. But in autumn 1920, two years after the armistice, the top rate was still high, at 73 percent. The government's lack of clarity over the tax treatment of capital gains was also roiling markets. An official capital-gains tax rate had yet to be established. It was unclear whether, in the future, gains from the sale of equities would be taxed as income, or taxed at all. If capital gains were taxed as income, Americans would be trapped in an economy where it was almost impossible to make money legally.

In response, Wall Street and private companies mounted a "capital strike," dumping cash not into the most promising inventions but into humdrum municipal bonds. Bootlegging and any other illicit activity outside the purview of the Treasury's Bureau of Internal Revenue, the ancestor to our Internal Revenue Service, grew abnormally attractive. The high tax rates, designed to corral the resources of the rich, failed to achieve their purpose. In 1916, 206 families or individuals filed returns reporting income of $1 million or more; the next year, 1917, when Wilson's higher rates applied, only 141 families reported income of $1 million. By 1921, just 21 families reported to the Treasury that they had earned more than a million. This was ironic, for, as the financial titan Andrew Mellon would comment, the effect of tax progressivity was: "The idle man is relieved. The producer is penalized." The perverse situation contributed to public disillusionment, the kind captured by F. Scott Fitzgerald in The Great Gatsby, published in 1925--not, as commonly assumed today, after the crash of 1929.

Against this tide, Harding and Coolidge made their choice: markets first. Harding tapped the toughest free marketeer on the public landscape, Mellon himself, to head the Treasury. This was the 1920s equivalent of choosing a Warren Buffett, a hedge-fund star, or Peter Thiel of PayPal, rather than a more standard figure from, say, Goldman Sachs. From his railroad experience, Mellon had seen that high rail-freight charges drove businesses to find other means to transport their goods. To attract maximum business, a railroad could charge, Mellon said, only "what the traffic will bear." With a low enough freight rate, the railroad could even become popular, making up in volume what it lost when it lowered price. (Mellon spoke of railroads because that was what he knew; today we would use the Walmart example.) The Treasury secretary suggested applying the same theory to taxation: a lower rate, perhaps 25 percent, might foster more business activity, and so generate more revenue for federal coffers.

This figure drove Progressives wild. How could 25 percent for the rich be "good for the country as a whole?" demanded James Couzens, a maverick senator from Michigan. Couzens and others demanded that the amount of all taxpayers' payments be posted on the walls of town halls or post offices--the "Peeping Tom" provision, as it came to be known. Harding and Mellon got the top rate down to 58 percent. When Harding died suddenly in 1923, Coolidge promised to "bend all my energies" to pushing taxes down further. In a second round, stewarded by Coolidge, a bitter deal was cut: Mellon and conservatives would get a (somewhat) lower tax rate of 46 percent, and the Peeping Tom provision would become law--gossip for a thousand headlines.

But Coolidge was not satisfied. After winning election in his own right in 1924, Coolidge joined Mellon, and Congress, in yet another tax fight, eventually prevailing and cutting the top rate to the target 25 percent. Earlier, Mellon had managed to establish "his" capital-gains tax at a substantial but still reassuringly low 12.5 percent. Just in case there was any doubt about what he and Mellon were doing by putting business first, Coolidge underscored it in a 1925 speech to the American Society of Newspaper Editors: "The chief business of the American people is business," Coolidge said, adding that "the chief ideal of the American people is idealism."

Several features of the 1920s events deserve note. The first is the unapologetic tone of the pro-markets campaign. The leaders ignored their own Pikettys, and prevailed: in the 1924 presidential campaign, the Progressive La Follette did take a disruptive 16.6 percent of the vote. But the "icy," pro-business Coolidge took an absolute majority, beating La Follette and the Democratic candidate combined. Second, the tax-cutters did not back down--though several rounds of legislation were necessary. Third, and most important, the tax cuts worked--the government did draw more revenue than predicted, as business, relieved, revived. The rich earned more than the rest--the Gini coefficient rose--but when it came to tax payments, something interesting happened. The Statistics of Income, the Treasury's database, showed that the rich now paid a greater share of all taxes. Tax cuts for the rich made the rich pay taxes.

There were other positive outcomes. Today, politicians speak of 4 percent growth, but that's a frankly aspirational number; 3 percent growth is the goal that most policymakers hope for. In the 1920s, though, the United States did average 4 percent real growth. What's more, the quality of growth improved: money flowed no longer to war or tax breaks but rather to products with the most economic potential. The great signal of economic hope is the patent: the investment by an individual or a team in the future profitability of an idea. In the 1920s, patent applications for inventions exploded, reaching 89,752 in 1929--a level that they wouldn't see again until 1965.

Patent data can seem obscure to everyday Americans, but all that innovation resulted in productivity increases, which meant that factory employees could work five days a week, not six. Thus did Americans receive something new to them: Saturday. Luxuries became cheaper to make as new equipment came on line, and therefore more affordable: homes got electricity, most homes got indoor plumbing, and people could afford automobiles. Mellon budgeted so well that he made wartime inflation a memory; consumers found that their dollar went further. Finally, the 1920s economy gave workers something far more important than notional wage equality: a job. Unemployment averaged 5 percent or lower. Putting markets before equality had done much to improve the lives of regular Americans. This may be one reason that no one appeared to notice when Congress, in 1926, repealed the Peeping Tom provision in the tax code. Prosperity tastes better than envy.

The 1930s tell the opposite story. When the market crashed in 1929, Coolidge's successor, Herbert Hoover, was caught off-guard. So was everyone else, including Corrado Gini, who concluded that the worldwide slump that ensued was due to workaholic Americans--the American worker, the New York Times reported Gini saying, "does not know when to stop," resulting in the oversupply of goods and the ensuing slowdown. We don't know what Hoover made of Gini himself, but we do know that Hoover responded differently from the way predecessors had responded to previous crashes: he intervened. The monetary nature of the initial collapse would have been hard for him to address, though Hoover did recognize it. In every other area, Hoover changed policy to focus on social equality: "a chicken in every pot." Key was Hoover's emphasis (new for those times) on raising the labor price. Rather than allow prices to find their own level--in particular, wages--as presidents had in the past, Hoover hauled business leaders to Washington and bullied them into sustaining high wages, and he cajoled Congress into passing laws that pushed up compensation as well, the best-known being the Davis-Bacon Act of 1931, which boosted pay for all employment under government contract. The Norris-La Guardia Act likewise institutionalized higher wages by limiting recourse to the courts of employers who could not afford what unions demanded. In addition, Hoover bullied a rueful Mellon into undoing the tax cuts, raising the top rate to 63 percent. Finally, Hoover thoroughly intimidated business and markets, blaming them for hogging too much of the money.

He gets blame he doesn't deserve, for the Crash, but not "credit," for the New Deal.  Of course, the reality is that his massive interventions were no more successful than FDR's.

Posted by at January 23, 2018 9:16 AM