By Barry Ritholtz
The GDP data this morning was a deep sigh of relief for those people who fear a recession may be coming. I don’t have that sense of relief. Perhaps its my own bias, but the details of the GDP report reveal not an organic growth period in a healthy recovering economy, but rather a tepid post-credit crisis expansion highly dependent on government largesse and Federal Reserve accommodation…..
By Tim Harford
Economic growth is a modern invention: 20th-century growth rates were far higher than those in the 19th century, and pre-1750 growth rates were almost imperceptible by modern standards. Many have seen this as an encouraging trend, but [economist Robert Gordon] draws a different lesson: growth is a recent phenomenon, so why assume that it will last?
……Demographics and debt accumulation have both speeded up growth in the past and, as the pendulum swings back, demographics and debt repayment will reduce it in the future…….
President Francois Hollande recently increased the top income tax rate in France to 75 percent — for incomes in excess of €1 million. This is part of a wider trend with President Obama targeting the wealthy in his election campaign, promising to raise taxes on incomes in excess of $1 million. Shifting the tax burden onto the wealthy might be clever politics, but does it make economic sense? To gauge the effectiveness of this strategy we need to study tax rates and their effect on incomes in the 1920s and 1930s.
By the end of the First World War, Federal government debt had soared to $25.5 billion, from $3 billion in 1915. Income taxes were raised to repay public debt: 60 percent on incomes greater than $100,000 and a top rate of 73 percent on incomes over $1 million. When Andrew Mellon was appointed Treasury Secretary in 1921, he inherited an economy in sharp recession. Falling GDP and declining income tax receipts led Mellon to observe that “73% of nothing is nothing”. He understood that high income taxes discourage entrepreneurs, leading to lower incomes and lower tax receipts — what we now refer to as the Laffer curve. By 1925, under President Coolidge, Mellon had slashed income taxes to a top rate of 25 percent — on incomes greater than $100,000. The economy boomed, tax collections recovered despite lower rates, and Treasury returned budget surpluses throughout the 1920s.
Interestingly, Veronique de Rugy points out that taxes paid by those with incomes over $100,000 more than doubled by the end of the decade.
Andrew Mellon was a wealthy banker and investor: in the mid-1920s he was the third highest taxpayer in the US. His strategy of cutting income tax rates may appear self-interested, but showed an understanding of how taxes can stimulate or impede economic growth, and succeeded in rescuing the economy from prolonged recession in the 1920s.
A decade later, President Herbert Hoover spent liberally on infrastructure programs in an attempt to shock the economy out of recession following the 1929 Wall Street crash. By 1932 Hoover and Mellon raised income taxes to rein in the growing deficit. Tax on incomes greater than $100,000 was increased to 56 percent and the top rate lifted to 63 percent — on incomes over $1 million.
The budget deficit continued to grow. Higher tax rates were maintained throughout the 1930s, under FDR, but failed to achieve their stated aim and may have contributed to the severity of the Great Depression.
GDP rose steeply after 1934. Income tax receipts recovered to pre-crash levels but declined again after 1937, when President Roosevelt introduced payroll taxes. Increased taxes reduced the fiscal deficit but caused a double-dip recession: GDP contracted, income tax receipts fell and the deficit grew.
Comparing the 1920s to the 1930s it is evident that Barack Obama and Francois Hollande threaten to repeat the mistakes of the 1930s. Increasing taxes in the middle of a recession does not reduce the deficit. It merely prolongs the recession.
Sources:
Cato Institute: 1920s Income Tax Cuts Sparked Economic Growth and Raised Federal Revenues by Veronique de Rugy
National Debt History
Wikipedia: Andrew W Mellon
Wikipedia: Laffer Curve
The Politically Incorrect Guide to the Great Depression and the New Deal by Robert Murphy
An excellent historical analysis of this issue can be found in the working paper, “Debt Overhangs: Past and Present”, which was published by the National Bureau of Economic Research in April, 2012. Authored by Carmen Reinhart, Vincent Reinhart and Kenneth Rogoff, it examines 26 different “debt overhangs” that have occurred around the world since 1800, with “debt overhang” being defined as public debt exceeding 90% of GDP for at least five years…..What Reinhart, Reinhart and Rogoff found was that the average duration of a debt overhang was 23 years, and that the end result was a 24% reduction in the size of national economies, compared to what they would have been if they had grown at their average growth rates when not crippled by large government debts.
via Three Converging Factors May Slash Economic Growth By 71% | Daniel Amerman | Safehaven.com.
For the first time in eight years, the Chinese government’s annual growth target has been lowered, to 7.5 per cent GDP growth for all of 2012…..
The new number represents Beijing’s recognition that the investment-driven, export-dependent growth model that has propelled it from an impoverished backwater to the world’s second-largest economy in just three decades is running out of steam……
The goal is to shift growth away from investment in polluting, energy-intensive, unsustainable industries and towards domestic consumption, particularly of services and “green goods”, such as energy-efficient vehicles and environmentally friendly building materials.
“We will move faster to set up a permanent mechanism for boosting consumption,” Wen Jiabao, the premier, said at the opening session of China’s rubber stamp parliament on Monday. “We will vigorously adjust income distribution, increase the incomes of low- and middle-income groups and enhance people’s ability to consume.”
via China’s growth model running out of steam – FT.com.
Comment:~ The trap China faces is that raising wages in order to promote domestic consumption will reduce competitiveness in export markets and harm its current export-driven growth model. Not only are exports likely to fall but, with a high propensity to save, there is no guarantee that Chinese consumption will rise as fast as wages.
Prior to 2000, world real GDP (based on USDA Economic Research Institute data) was indeed growing faster than energy use, as measured by BP Statistical Data…… Since 2000, energy use has grown approximately as fast as world real GDP–increases for both have averaged about 2.5% per year growth. This is not what we have been told to expect.
Why should this “efficiency gain” go away after 2000? Many economists are concerned about energy intensity of GDP and like to publicize the fact that for their country, GDP is rising faster than energy consumption. These indications can be deceiving, however. It is easy to reduce the energy intensity of GDP for an individual country by moving the more energy-intensive manufacturing to a country with higher energy intensity of GDP.
What happens when this shell game is over? In total, is the growth in world GDP any less energy intense? The answer since 2000 seems to be “No”.
It seems to me that at least part of the issue is declining energy return on energy invested (EROI)–we are using an increasing share of energy consumption just to extract and process the energy we use–for example, in “fracking” and in deep water drilling. This higher energy cost is acting to offset efficiency gains.
via The Oil Drum | Is It Really Possible to Decouple GDP Growth from Energy Growth?.
Take a look at the [Chinese] Leading Index’s sharp deterioration recently – there has been a clear and material deterioration in the leading index over the past couple of months. This suggests to us a substantial further fall in Chinese GDP. The last release of a week or so ago showed Chinese GDP growing at 9.1% against expectations of 9.1%. This leading index to us suggests that this growth rate will fall to 8% which is getting dangerously close to the “hard landing” territory.
via China’s leading indicators head south – macrobusiness.com.au | macrobusiness.com.au.
