Wednesday, September 01, 2010

Recession, Depression, Heil Obama!

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The road map to disaster that Der Feuhrer Osama is following has been travelled before. Travelled by FDR, and by Woodrow Wilson. Every time it is taken, it leads to unmitigated disaster. So why, then, does Il Duce wish to follow it again, eh?

For a complete expose of what REALLY happened during the Great Depression of FDR and Hoover, read these two sources:

1 - New Deal or Raw Deal?: How FDR's Economic Legacy Has Damaged America - by Burton Folsom

2 - Liberal Fascism - by Jonah Goldberg


FDR and the Lessons of the Depression
Higher taxes on capital and increased union power led to the 1937 economic slide.

In 1937, after several years of partial recovery from the Great Depression, the U.S. economy fell into a sharp recession. The episode has become a lightning rod in the ongoing debate about whether the economy needs further increases in government spending to keep employment from declining even more.

Christina Romer, the outgoing chair of the President's Council of Economic Advisers, started this debate last year in The Economist by drawing a parallel to 1937 for anyone getting cold feet about increased government spending and soaring deficits. New York Times columnist Paul Krugman chimed in by claiming that the economy will repeat the experience of the 1930s if government spending is not increased.

The economy did not tank in 1937 because government spending declined. Increases in tax rates, particularly capital income tax rates, and the expansion of unions, were most likely responsible. Unfortunately, these same factors pose a similar threat today.

Here are the facts: Real government spending, measured in 1937 dollars, declined by less than 0.7% of GDP between 1936 and 1937, and then rebounded in 1938. It is implausible that such a small and temporary decline reduced real GDP by nearly 3.5% in 1938 or reduced industrial production by about one-third.

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Associated Press
.But in 1936, the Roosevelt administration pushed through a tax on corporate profits that were not distributed to shareholders. The sliding scale tax began at 7% if a company retained 1% of its net income, and went to 27% if a company retained 70% of net income. This tax significantly raised the cost of investment, as most investment is financed with a corporation's own retained earnings.

The tax rate on dividends also rose to 15.98% in 1932 from 10.14% in 1929, and then doubled again by 1936. Research conducted last year by Ellen McGratten of the Federal Reserve Bank of Minneapolis suggests that these increases in capital income taxation can account for much of the 26% decline in business fixed investment that occurred in 1937-1938.

Meanwhile, after the 1935 National Labor Relations Act, union membership rose to about 25% in 1938 from about 12% in 1934. The increase in unionization was fostered by the sit-down strike.

In late 1936 and early 1937, for example, members of the United Auto Workers (UAW) occupied a General Motors auto body plant in Flint, Mich. Without auto bodies, production plummeted, and the company was forced to settle the strike and recognize the union.

The GM strike effectively unionized the auto industry, as UAW membership rose more than 15-fold the following year to about 500,000 members. Just the threat of a sit-down strike by steelworkers led to a unionized U.S. Steel in 1937. An unprecedented increase in union power increased manufacturing wages by nearly 10% between 1936 and 1938, which increased costs and reduced employment.

There are important parallels between the tax and labor policies of FDR and those of President Obama. As in the 1930s, tax rates on capital income will be rising sharply with the expiration of the 2001 and 2003 tax cuts. Beginning in 2011, dividends will be taxed as ordinary income with rates increasing up to 39.6% for many taxpayers, more than double the current 15% rate. The capital gains tax rate will rise to 20% from 15%.

And like FDR, Mr. Obama has advanced unionization through his recess appointments to the NLRB and his support for "card check," a provision in the controversial Employee Free Choice Act that would allow unions to organize without holding a secret ballot vote.

FDR eventually abandoned the excess profits tax and decreased the tax rate on dividends, but only after they significantly damaged an already weak economy. He also reduced union bargaining power in the 1940s as the National War Labor Board struck down union wage increases that exceeded the increase in the cost of living. This promoted wartime economic expansion.

There are lessons to be learned from the history of 1937-1938 but they are not the ones being taught. The Obama administration should consider these: Raising business costs by increasing capital income taxes and promoting higher unionization is a mistake that will hurt most those who they should want to help—workers who have lost jobs during this recession.

Mr. Cooley teaches economics at New York University's Stern School of Business. Mr. Ohanian teaches economics at UCLA.
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