Merry Christmas

The Holy Family by Henry Ossawa Tanner

The Mellon Tax Cuts of the 1920s

Opponents of tax cuts claim that the large income tax cuts in the 1920s caused increased inequality and the Great Depression. For instance, Robert S. McElvaine writes in “I’m a Depression historian. The GOP tax bill is straight out of 1929” Washington Post’s PostEverything Perspective that

The crash followed a decade of Republican control of the federal government during which trickle-down policies, including massive tax cuts for the rich, produced the greatest concentration of income in the accounts of the richest 0.01 percent at any time between World War I and 2007 (when trickle-down economics, tax cuts for the hyper-rich, and deregulation again resulted in another economic collapse).

In 1926, Calvin Coolidge’s treasury secretary, Andrew Mellon, one of the world’s richest men, pushed through a massive tax cut that would substantially contribute to the causes of the Great Depression.

In that decade, the mass-production American economy became dependent on mass consumption. For it to work, the masses need a sufficient share of the national income to be able to consume what is being produced.

Republican policies in the ’20s instead pushed to concentrate more of the income at the top.

On the other hand, proponents of tax cuts have used the 1920s tax cuts (sometimes referred to as the Mellon after the Secretary of the Treasury Andrew Mellon) to illustrate how tax cuts can fuel so much economic growth that they generate increases in revenue. For instance, back in 2003, Veronique de Rugy argued that

The decade of the 1920s had started with very high tax rates and an economic recession. Tax rates were massively increased in 1917 at all income levels. Rates were increased again in 1918. Real GNP fell in 1919, 1920, and 1921 with a total three-year fall of 16 percent. (Deflation between 1920 and 1922 may also help explain the drop in tax revenues in those years, evident in Table 1).

As tax rates were cut in the mid-1920s, total tax revenues initially fell. But as the economy responded and began growing quickly, revenues soared as incomes rose. By 1928, revenues had surpassed the 1920 level even though tax rates had been dramatically cut.

She also notes that Between 1922 and 1929, real gross national product grew at an annual average rate of 4.7 percent and the unemployment rate fell from 6.7 percent to 3.2 percent. 

I am not persuaded that either of these stories clearly establishes connections between cause (tax cuts) and effect (inequality, economic growth, Great Depression).

Both stories attribute a great deal of economic influence to a relatively small federal government. Prior to the Great Depression, the federal revenue typically accounted for less than 5% of GDP. 

Moreover, income taxes accounted for only about half of federal revenue (Statistical Abstract of the United States for 1926 Table No. 169) Neither opponents or proponents of tax cuts explain  how changes that are so small relative to the whole economy could have effects as large as they suggest.

In addition, many of the changes during the 1920s were part of a reversion to pre-War patterns.The federal government lowered income tax rates during the 1920s, but it lowered them from the rates that had been imposed during World War I. By the end of the 1920s the top marginal rates were still almost double what they had been before the War.

Source: http://eh.net/encyclopedia/the-u-s-economy-in-the-1920s/

Likewise, the available evidence suggests that inequality of both income and wealth increased during the 1920s, but they were also moving back toward the rates that had existed before the war.

Source Piketty, Thomas, and Emmanuel Saez. "Income inequality in the United States, 1913–1998." The Quarterly journal of economics 118, no. 1 (2003): 1-41.

From a longer run perspective, the rapid decline of World War I and increase in the 1920s was a blip in a trend of decreasing inequality that was not isolated to the U.S.

Source: http://voxeu.org/article/american-growth-and-inequality-1700

Moreover, taxes were cut for all income groups and both the amount and the share of taxes paid by lower income groups decreased.

Source: de Rugy

Even if there is not a clear connection between tax cuts and inequality, inequality did increase. Could that increase in inequality have led to underconsumption as an important cause of the Great Depression? It seems unlikely.

Although inequality increased during the 1920s, it was not immiserating working class people. After the recession of the early 1920s, real wages generally increased until the Great Depression.

Source: http://eh.net/encyclopedia/the-u-s-economy-in-the-1920s/

Dramatic decreases in consumption expenditures were certainly a cause of the severity of the Great Depresion, but they were not an initiating factor. Consumption fell after a tightening of monetary policy and the stock market crash. Consumption fell because of decreases in wealth and income, but also because of increases in uncertainty about the future (Romer 1990, Romer and Romer 2013) and because of the need to reduce current consumption to make installment payments and avoid repossession (Olney 1999). The initial problems were exacerbated by continued bank failures and decreases in the money supply. Economic historians continue to explore the extent to which the problems in money and banking were the result of Federal Reserve failures or problems with the international gold standard. Given the small initial size of the federal government it should perhaps not be surprising that economists tend to find the causes of the Great Depression in monetary rather than fiscal policy.

 What about the alternative argument that the Mellon tax cuts spurred economic growth. Higher income individuals did pay a larger share of income tax after tax rates decreased, but it is not clear that this was because tax cuts spurred rapid economic growth? Here too, I'm skeptical.

The 4.7 percent rate of growth from 1922 to 1929 that de Rugy mentions is very sensitive to beginning and end dates. Much of it comes from very high rates at the beginning and the end. The annualized growth rate from 1923 to 1928 was a much less spectacular 2.8%.

https://measuringworth.com

It seem likely that the lower rates simply meant it was no longer worthwhile for high income earners to incur the costs associated with tax avoidance. This was primary the reason that Mellon gave for the tax cuts. 

I'll try to keep an open mind, but I am not yet persuaded that the Mellon tax cuts were able to generate very large macroeconomic economic effects despite the relatively small role of the federal government generally and the federal income tax specifically prior to the Great Depression.

Clegg on Capitalism and Slavery

I just ran across John Clegg’s  "Credit Market Discipline and Capitalist Slavery in Antebellum South Carolina." Social Science History (2017): 1-34. Clegg got a lot of attention a couple of years ago for "Capitalism and Slavery." in which he criticized the approach of New Historians of Capitalism, especially Edward Baptist. Clegg’s critique was based in part on work that he had done on the role of credit among slaveholders in South Carolina, and that work is presented more fully in this new paper.

Clegg follows Robert Brenner in terms of focusing on competition for the means of production as the driving force behind capitalist growth. Capitalists are forced to increase productivity to survive as capitalists. Clegg’s twist is to add the need to use credit to finance the purchase as land and slaves as the mechanism that drove this competition in the South. He has interesting information about the development of debtor creditor law and the extent to which slaveholders experienced foreclosure.

Clegg explains that

I claim that the ability of creditors to seize the land and slaves of insolvent debtors compelled slave owners to specialize for the market and increase productivity. It did so because most slave owners were in debt, and those who failed to repay their debts at the going rate would end up losing their land and slaves, and thus cease to be slave owners.

He concludes that

if the debt constraint I am describing was operative, then identifiably capitalist outcomes—market orientation, profit maximizing, technical innovation—are in an important sense independent of mentality. This is because slave owners who were not interested in specializing for the market, maximizing profit or adopting cost-reducing innovations would end up losing their slaves to those who were. On this view, capitalist patterns of behavior can be the unintended consequence of competitive selection operating via credit markets

That description made me think of Armen Alchian’s Uncertainty, Evolution and Economic Theory, which made essentially the same argument in defense of economic theory.  I should also mention John Nye’s "Lucky fools and cautious businessmen: On entrepreneurship and the measurement of entrepreneurial failure." The Vital One: Essays in Honor of Jonathan RT Hughes. Research in Economic History 6 (1991): 131-52 which makes a similar sort of evolutionary argument regarding entrepreneurship. 

P.S. If you weren't paying attention when Clegg's first paper came out you might to check out the Junto for some of the discussion it generated.

Our Lady of Guadalupe

Hartman on Public Choice

Andrew Hartman has an essay at The Baffler arguing that “libertarianism is a political philosophy shot through with white supremacy. Public choice theory, a technical language nominally about human behavior and incentives, helps ensure that blacks remain shackled.”

I have pointed out before that I am not a libertarian. I have been critical of libertarians on several occasions (for instance, here and here) . I am not associated with George Mason, not paid by the Koch brothers, and not really a big fan of James Buchanan. So why bother writing this? I do have an interest in public choice, and I find the recent attempts to bind racism, Buchanan, public choice, libertarianism, and the Koch brothers into  a neat little bundle ridiculous.

Below are quotes from Hartman’s essay (in bold) and my responses to them.

IN DECEMBER 1992, AN OBSCURE ACADEMIC JOURNAL published an article by economists Alexander Tabarrok and Tyler Cowen, titled “The Public Choice Theory of John C. Calhoun.” Tabarrok and Cowen, who teach in the notoriously libertarian economics department at George Mason University, argued that the fire-breathing South Carolinian defender of slaveholders’ rights had anticipated “public choice theory,” the sine qua non of modern libertarian political thought.

That obscure academic journal is The Journal of Institutional and Theoretical Economics. While it may not be The Baffler, it has been around for over 150 years, and Nobel prize winners, such as Oliver Williamson, Douglass North and Ronald Coase have published in it.

Public choice theory, which grew in stature across the late twentieth century and is now a bedrock conservative doctrine marketed to right-wing policymakers by the billionaire Koch brothers, has indeed tilted the scales of justice in favor of the white, rich, and powerful.

Libertarians seem unaware that Buchanan’s public choice theory is the thing without which their philosophy cannot exist. Milton Friedman does not refer to Buchanan or public choice in Capitalism and Freedom. Robert Nozick does not mention Buchanan or public choice in Anarchy, State and Utopia. David Boaz can put together a 600 page Libertarian Reader that has just a handful of references to public choice and no readings from Buchanan or Tullock. On a personal note, I was once invited to a lunch where John Allison former head of BB&T and a well-known libertarian spoke. I remember him talking a lot about Aristotle, but I don’t recall any mention of Buchanan or any other public choice theorists. I’m not suggesting that there are not libertarians who like Buchanan’s work, but I don’t see a case for the claim that it is regarded as an essential ingredient.

In marking Calhoun’s political philosophy as the crucial antecedent of public choice theory, Tabarrok and Cowen unwittingly confirmed what critics have long maintained: libertarianism is a political philosophy shot through with white supremacy. Public choice theory, a technical language nominally about human behavior and incentives, helps ensure that blacks remain shackled.

Cowen and Tabarok did not mark Calhoun as a crucial antecedent of public choice. To the contrary, they argue that economists have ignored Calhoun. It would be more accurate to say that they argue that although Calhoun did not influence the development of public choice theory, there are some interesting similarities. They note some of these similarities, but also point to significant differences. Including the differences that enabled him to include support for slavery in his philosophy.

The sheer volume and intensity of these protests suggest that MacLean’s observations have hit a nerve. And by historicizing the putatively neutral and scientific character of Buchanan’s research, MacLean has apparently shaken the pediment supporting the altar of this libertarian saint. 

Apparently, Hartman regards it as noteworthy that calling someone’s friend a racist would strike a nerve. I’m not sure what to make of that. As for neutral. I don’t know of anyone who would argue that Buchanan’s work was neutral. Buchanan had values that he argued for throughout his career. There is just no evidence that racism was one of them.

Just as Calhoun developed his novel political philosophy in response to the growing fear among his class of southern slaveholders that a Northern majority might seek to abolish slavery, Buchanan’s public choice theory was an innovative approach to resisting federal enforcement of civil rights in the South.

Hartman simply parrots MacLean here. They use innuendo to create a link between Buchanan and segregation, while ignoring the well documented intellectual context in which Buchanan was working. Buchanan was one of a number of people in the 1950s and 1960s working on applying economic or rational choice methods to the analysis of politics.

Buchanan saw his work as part of this broader movement. The following quotes are from a talk he gave on public choice theory at Hillsdale College in 2003

“Public choice should be understood as a research program rather than a discipline or even a subdiscipline of economics. Its origins date to the mid-20th century, and viewed retrospectively, the theoretical “gap” in political economy that it emerged to fill seems so large that its development seems to have been inevitable. Nations emerging from World War II, including the Western democracies, were allocating between one-third and one-half of their total product through political institutions rather than through markets. Economists, however, were devoting their efforts almost exclusively to understanding and explaining the market sector.” He goes on to explain that he “entered this discussion with a generalized critique of the analysis generated by the Arrow Black approach.” He also describes the 19^th century thinker who influenced his work. No, it was not Calhoun. It was Knut Wicksell.

Oddly, Hartman cites S.M. Amadae, but seems to have missed Amadae’s description of this broader context, Amadae describes Buchanan’s early essays as responses to the work of Ken Arrow and his Calculus of Consent (with Gordon Tullock) as “a new analysis of the rapidly forming study of politics that had been articulated by John von Neumann and Oskar Morgenstern, Duncan Black, Arrow, and Arrow’s student Anthony Downs.” (Amadae 136)

Buchanan was part of a movement to develop a rational choice approach to politics. He also had normative views about what government should do. These beliefs were essential to James Buchanan, but not central to public choice.  Being interested in a rational choice approach to politics does not require that one hold any specific set of normative beliefs. A rational choice approach to politics has been followed by people as disparate views of what should be as James Buchanan, Amartya Sen, Howard Rosenthal and Jon Elster.

Other people involved in the development of a rational choice approach to politics, such as Anthony Downs,  Amartya Sen and Mancur Olson, also viewed Buchanan’s work as part of this broader movement and engaged his arguments in their work.

If Hartman is right, then he and MacLean have seen through a false facade that fooled all of these other scholars. Buchanan somehow managed to hide his true motives from all of them, tricking them into believing that, like them, he was  trying to understand collective decision making, when in fact he was simply working to preserve race based segregation.  

As opposed to wishing to free the masses from a state controlled by the capitalist elite, Buchanan wished to free the capitalist elite from a state controlled by the unruly masses. And this returns us, suitably enough, to John C. Calhoun.

Public choice theory is interesting and important because recognizing that the state is composed of human beings means that the state can be controlled by an elite that oppresses the masses or a majority that oppresses a minority.  The outcome depends upon the institutions for making public choices. Some of us hope that it is possible to have institutional arrangements that protect the majority from a despotic elite and protect minorities from the tyranny of the majority.

In the end, there is no evidence for Hartman’s argument and considerable evidence against it. Public choice theory did not develop out of the work of Calhoun nor was it an outgrowth of attempts to preserve segregation in Virginia. Buchanan was influential in the development of public choice, but public choice theory is not synonymous with the thought of James Buchanan.  Buchanan and public choice theory are not the sine qua non of modern libertarianism. In fact there is no necessary connection between public choice and any set of normative beliefs.

In the end, I am puzzled why Hartman would choose to write an essay about something that he obviously has so little interest in? He doesn’t appear to have made any attempt to learn anything about the history of public choice theory beyond reading MacLean.  He could have written a better informed essay if he had read the Wikipedia page on public choice.