Reusing New Deal Tactics

The Trade and Tax Doomsday Clocks

 

By Donald L. Luskin

 

The nearby chart is an update of one I showed on this page in early July. It depicts how the stock market over the last year and a half has followed a path eerily similar to that of 1937. This week corresponds on the chart to mid-August 1937, when the cumulative effects of massive hikes in personal and corporate tax rates, severe monetary tightening, and aggressive business-bashing by the Roosevelt administration tipped the economy into the "depression inside the Depression." From there, stocks were in for the longest and second-deepest bear market in history.

 

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Thankfully, we're not repeating all the mistakes of 1937. But Congress and the Obama administration are flirting dangerously with one of them by failing to extend the expiring low tax rates for all Americans. What's worse, we're close to repeating the mother of all policy errors, the one made not in 1937 but in 1930—the one that started the Great Depression. We're on track to resurrect the 1930 Smoot-Hawley Tariff Act.

 

Let's start with taxes. If today's low rates expire at year-end per current law, that would at a stroke reduce after-tax income for every working American, the average reduction being 3.3% according to the Tax Policy Center. Do the math: 94% of income goes to consumption, and consumption is 70% of gross domestic product. All else being equal, if the Bush tax cuts don't get extended, that's a 2.3% hit to 2011 GDP. That means instant double-dip recession, starting at midnight, Dec. 31.

 

Why won't the Democrats who control both houses of Congress switch off this doomsday clock? It's because Democratic leaders and the Obama administration want to roll the dice for the sake of ideology, by giving tax relief only to the middle class while letting rates rise for higher earners. A growing number of Democratic dissidents have joined with Republicans in insisting that, in this weak economy, it's more prudent that relief be given to all Americans.

 

Some have even undergone a supply-side conversion. Forty-seven Democrats have sent a letter to House Speaker Nancy Pelosi citing the urgency of preserving low tax rates on dividends and capital gains for the sake of more job-creating capital formation.

 

Democratic leaders blocked Congress from taking up the matter before the October recess, fearing a humiliating defeat. Last Wednesday a resolution permitting the House to adjourn without dealing with the doomsday clock passed by a single vote, over unanimous Republican opposition and nays from 39 Democrats.

 

When a bill comes before the House in the lame-duck session later this year, the games will really begin. House rules allow Mrs. Pelosi, as speaker, to offer legislation under what's known as "suspension of the rules," which limits time for debate but requires a two-thirds majority to pass, rather than a simple majority. If Mrs. Pelosi offers a bill under suspension that excludes the highest earners, there's little chance she'll get enough GOP votes for the supermajority she needs. That way she can blame Republicans for the defeat of an already doomed bill many Democrats oppose, shaming the GOP for "voting against middle-class tax cuts."

 

Now to protectionism. Last week the House passed the Currency Reform for Fair Trade Act. It's an amendment that gives dangerous new protectionist powers to the notorious Smoot-Hawley Tariff Act, the proximate cause of the global Great Depression, which after all these years is still on the books. Democrats—all but five of whom voted in favor of the bill last week—would do well to remember that in 1932 Franklin Delano Roosevelt ran as a free-trader, pledging to lower Smoot-Hawley's tariff walls. The 99 Republicans who voted aye should know that Herbert Hoover's name lives in infamy for erecting them. Instead, Wednesday's vote was a bipartisan move to build those walls higher using currencies as the bricks and mortar.

 

(continued)

 

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The one major difference is the movement of the money supply. Ironically, it is the Fed's expansion of the money supply that could trigger a trade war.

The one major difference is the movement of the money supply. Ironically, it is the Fed's expansion of the money supply that could trigger a trade war.

 

Let me correct myself; another major difference is the world did not have the high deficits as a legacy of the 75 years of Keytnesianism that the Great Depression gave rise to. Fortunately, there is one positive difference and that is productive output is much higher today. We are much more likely to go into a Japan style economy of no growth for decades.