Back to the Future?

by Thomas Sowell

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Those who are impressed by words seem to think that President Barack Obama made a great speech to Congress last week. But, when you look beyond the rhetoric, what did he say that was fundamentally different from what he has been saying and doing all along?

Are we to continue doing the same kinds of things that have failed again and again, just because Obama delivers clever words with style and energy?

Once we get past the glowing rhetoric, what is the president proposing? More spending! Only the words have changed – from "stimulus" to "jobs" and from "shovel-ready projects" to "jobs for construction workers."

If government spending were the answer, we would by now have a booming economy with plenty of jobs, after all the record trillions of dollars that have been poured down a bottomless pit. Are we to keep on doing the same things, just because those things have been repackaged in different words?

Or just because Obama now assures us that "everything in this bill will be paid for"? This is the same man who told us that he could provide health insurance to millions more people without increasing the cost.

When it comes to specific proposals, President Obama repeats the same kinds of things that have marked his past policies – more government spending for the benefit of his political allies, the construction unions and the teachers' unions, and "thousands of transportation projects."

The fundamental fallacy in all of this is the notion that politicians can "grow the economy" by taking money out of the private sector and spending it wherever it is politically expedient to spend it – so long as they call spending "investment."

Has Obama ever grown even a potted plant, much less a business, a bank, a hospital or any of the numerous other institutions whose decisions he wants to control and override? But he can talk glibly about growing the economy.

Arrogance is no substitute for experience. That is why the country is in the mess it is in now.

Obama says he wants "federal housing agencies" to "help more people refinance their mortgages." What does that amount to in practice, except having the taxpayers be forced to bail out people who bought homes they could not afford?

No doubt that is good politics, but it is lousy economics. When people pay the price of their own mistakes, that is when there is the greatest pressure to correct those mistakes. But when taxpayers who had nothing to do with those mistakes are forced to pay the costs, that is when those and other mistakes can continue to flourish – and to mess up the economy.

Whatever his deficiencies in economics, Barack Obama is a master of politics – including the great political game of "Heads I win and tails you lose."

Any policy that shows any sign of achieving its goals will of course be trumpeted across the land as a success. But, in the far more frequent cases where the policy fails or turns out to be counterproductive, the political response is: "Things would have been even worse without this policy."

It's heads I win and tails you lose.

Thus, when unemployment went up after the massive spending that was supposed to bring it down, we were told that unemployment would have been far worse if it had not been for that spending.

Are we really supposed to fall for ploys like this? The answer is clearly "yes," as far as Obama and his allies in the media are concerned.

Our intelligence was insulted even further in President Obama's speech to Congress, when he set up this straw man as what his critics believe – that "the only thing we can do to restore prosperity is just dismantle government, refund everybody's money, and let everyone write their own rules, and tell everyone they're on their own."

Have you heard anybody in any part of the political spectrum advocate that? If not, then why was the President of the United States saying such things, unless he thought we were fools enough to buy it – and that the media would never call him on it?

Some people are hoping that President Obama's plan will get the economy out of the doldrums and start providing jobs for the unemployed. Others are hoping that the Republicans' plan will do the trick.

Those who are truly optimistic hope that Democrats and Republicans will both put aside their partisanship and do what is best for the country.

Almost nobody seems to be hoping that the government will leave the economy alone to recover on its own. Indeed, almost nobody seems at all interested in looking at the hard facts about what happens when the government leaves the economy alone, compared to what happens when politicians intervene.

The grand myth that has been taught to whole generations is that the government is "forced" to intervene in the economy when there is a downturn that leaves millions of people suffering. The classic example is the Great Depression of the 1930s.

What most people are unaware of is that there was no Great Depression until AFTER politicians started intervening in the economy.

There was a stock market crash in October 1929 and unemployment shot up to 9 percent – for one month. Then unemployment started drifting back down until it was 6.3 percent in June 1930, when the first major federal intervention took place.

That was the Smoot-Hawley tariff bill, which more than a thousand economists across the country pleaded with Congress and President Hoover not to enact. But then, as now, politicians decided that they had to "do something."

Within 6 months, unemployment hit double digits. Then, as now, when "doing something" made things worse, many felt that the answer was to do something more.

Both President Hoover and President Roosevelt did more – and more, and more. Unemployment remained in double digits for the entire remainder of the decade. Indeed, unemployment topped 20 percent and remained there for 35 months, stretching from the Hoover administration into the Roosevelt administration.

That is how the government was "forced" to intervene during the Great Depression. Intervention in the economy is like eating potato chips: You can't stop with just one.

What about the track record of doing nothing? For more than the first century and a half of this nation, that was essentially what the federal government did – nothing. None of the downturns in all that time ever lasted as long as the Great Depression.

An economic downturn in 1920-21 sent unemployment up to 12 percent. President Warren Harding did nothing, except for cutting government spending. The economy quickly rebounded on its own.

In 1987, when the stock market declined more in one day than it had in any day in 1929, Ronald Reagan did nothing. There were outcries and outrage in the media. But Reagan still did nothing.

That downturn not only rebounded, it was followed by 20 years of economic growth, marked by low inflation and low unemployment.

The Obama administration's policies are very much like the policies of the Roosevelt administration during the 1930s. FDR not only smothered business with an unending stream of new regulations, he spent unprecedented sums of money, running up record deficits, despite raising taxes on high income earners to levels that confiscated well over half their earnings.

Like Obama today, FDR blamed the country's economic problems on his predecessor, making Hoover a pariah. Yet, 6 years after Hoover was gone, and nearly a decade after the stock market crash, unemployment hit 20 percent again in the spring of 1939.

Doing nothing may have a better track record in the economy but government intervention has a better political record in getting presidents re-elected.

People who say that Barack Obama cannot be re-elected with unemployment at its current level should take note that Franklin D. Roosevelt was elected a record four times, despite two consecutive terms in which unemployment was never as low as it is today.

Economic reality is one thing. But political impressions are something very different – and all too often it is the political impressions which determine the fate of an administration and the fate of a nation.

Ninety years ago – in 1921 – federal income tax policies reached an absurdity that many people today seem to want to repeat. Those who believe in high taxes on "the rich" got their way. The tax rate on people in the top income bracket was 73 percent in 1921. On the other hand, the rich also got their way: They didn't actually pay those taxes.

The number of people with taxable incomes of $300,000 a year and up – equivalent to far more than a million dollars in today's money – declined from more than a thousand people in 1916 to less than three hundred in 1921. Were the rich all going broke?

It might look that way. More than four-fifths of the total taxable income earned by people making $300,000 a year and up vanished into thin air. So did the tax revenues that the government hoped to collect with high tax rates on the top incomes.

What happened was no mystery to Secretary of the Treasury Andrew Mellon. He pointed out that vast amounts of money that might have been invested in the economy were instead being invested in tax-exempt securities, such as municipal bonds.

Secretary Mellon estimated that the amount of money invested in tax-exempt securities had nearly tripled in a decade. The amount of this money that the tax collector couldn't touch was larger than the federal government's annual budget and nearly half as large as the national debt. Big bucks went into hiding.

Mellon pointed out the absurdity of this situation: "It is incredible that a system of taxation which permits a man with an income of $1,000,000 a year to pay not one cent to the support of his Government should remain unaltered."

One of Mellon's first acts as Secretary of the Treasury was to ask Congress to end tax exemptions for municipal bonds and other securities. But Congress was not about to set off a political firestorm by doing that.

Mellon's Plan B was to cut the top income tax rate, in order to lure money out of tax-exempt securities and back into the economy, where increased economic activity would generate more tax revenue for the government. Congress also resisted this, using arguments that are virtually unchanged to this day, that these would just be "tax cuts for the rich."

What makes all this history so relevant today is that the same economic assumptions and political arguments which produced the absurdities of 1921 are still going strong in 2011.

If anything, "the rich" have far more options for putting their money beyond the reach of the tax collectors today than they had back in 1921. In addition to being able to put their money into tax-exempt securities, the rich today can easily send millions – or billions – of dollars to foreign countries, with the ease of electronic transfers in a globalized economy.

In other words, the genuinely rich are likely to be the least harmed by high tax rates in the top brackets. People who are looking for jobs are likely to be the most harmed, because they cannot equally easily transfer themselves overseas to take the jobs that are being created there by American investments that are fleeing from high tax rates at home.

Small businesses – hardware stores, gas stations or restaurants for example – are likewise unable to transfer themselves overseas. So they are far more likely to be unable to escape the higher tax rates that are supposedly being imposed on "millionaires and billionaires," as President Obama puts it. Moreover, small businesses are what create most of the new jobs.

Why then are so many politicians, journalists and others so gung-ho to raise tax rates in the upper brackets?

Aside from sheer ignorance of history and economics, class warfare politics pays off in votes for politicians who can depict their opponents as defenders of the rich and themselves as looking out for working people. It is a great political game that has paid off repeatedly in state, local and federal elections.

As for the 1920s, Mellon eventually got his way, getting Congress to bring the top tax rate down from 73 percent to 24 percent. Vast sums of money that had seemingly vanished into thin air suddenly reappeared in the economy, creating far more jobs and far more tax revenue for the government.

Sometimes sanity eventually prevails. But not always.

September 14, 2011

Thomas Sowell is a senior fellow at the Hoover Institution at Stanford University. His Web site is www.tsowell.com. To find out more about Thomas Sowell and read features by other Creators Syndicate columnists and cartoonists, visit the Creators Syndicate web page.

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