What 'stimulates' American commerce?

If Republicans can modify or delay the “stimulus” package, we might be in the midst of a debate over whether our economic woes can be overcome with government policies that encourage production or consumption. That is not likely for, as “post-partisan” President Barack Obama let slip, “We [meaning Democrats] won.” There has been a major divide between parties over this question at least since the Great Depression, and especially since President Reagan led a successful charge for cuts in income tax rates that gave rise to a 25-year boom.

The two opposing views are supply-side and demand-side political economy. The first holds that prosperity is driven by business enterprise, facilitated when income and other tax rates are low. The second maintains that the cause is consumers with spending power, boosted when federal spending “primes the pump” with new government programs.

Let us admit that supply and demand are as inseparable as the concave and convex sides of a curved line. No one can buy what is not for sale and nothing can be sold when there are no customers. But bearing in mind that commercial republics like the United States are vastly more prosperous than primitive societies largely dependent upon agriculture, we must consider that something accounts for the difference.

That “something” is the entrepreneur, who neither commands wealth nor depends upon the beneficence of others. Unlike landed aristocrats or powerful oligarchs, those in business for themselves provide a good or service which a sufficiently profitable number of people need or want, and freely choose.

The supply-side approach demonstrated its capacity for fostering national prosperity when Congress in 1981 reduced the highest income tax rate from 70 to 50 percent, and decreased the number of brackets from 14 to five. Double digit inflation, unemployment and interest rates all fell to lower levels.

In the early 1960s President Kennedy effectively made the case that the existing top tax rate of 91 percent on incomes of $200,000 yielded little revenue to the government because wealthy persons legally shielded their income in ways Congress had made possible with tax breaks.

Why is this? The explanation lies in a combination of human nature and mathematics. High tax rates are, to say the very least, burdensome. So if they can avoid it, people will find ways around them. If someone earns a million dollars and is taxed at 91 percent, that only theoretically (but not actually) nets the government $910,000 . For if he reduces his taxable income through various tax shelters to, say, $500,000, the government gets only $455,000. And even this is fanciful.

On other hand, if the income tax rates are lowered, the enterprising businessman is more likely to invest more and earn more on his money. If he then makes two million dollars under a more favorable tax regime, at 50 percent that yields a million dollars, or more than twice as much as he actually paid under the higher tax rate.

Thus, not only did this policy revive stagnant commerce, it yielded more revenue for the government than ever. Indeed, even substantial federal deficits each year during the Reagan years put no drag on our growing prosperity. We had high defense spending to face down the Soviet military threat along with increases in social welfare spending, but lowered tax rates kept commerce humming.

The demand side approach was first implemented in the administration of Franklin Roosevelt. Income tax rates, which already had risen in the previous administration, went even higher, causing the recession inherited from Herbert Hoover to expand into a Great Depression as the government added agencies and bureaus on an unprecedented scale.

Deflation and high unemployment plagued us during FDR’s first two terms, and only World War II’s demands for armaments and supplies turned the corner. Then, for the first time, income tax was withheld from pay checks to ease the pain of taxing not just the wealthy (who can’t pay it all) but everybody else with any income.

Currently, Democrats are saying that the failures of the New Deal were due to the federal government not spending enough money fast enough. But that is just so much blowing of smoke, for even the government cannot spend money fast enough to stimulate anything except a passion for the political power made possible by enlargement of government beyond its constitutional functions.

The government cannot spend us into prosperity and certainly cannot pay for it with confiscatory tax rates which free people will always find ways to avoid, if they do not move their enterprises elsewhere. Real political economy consists in restraining the government, not unleashing it.