Be suspicious whenever you hear pundits proclaim that some change in taxes or regulation will cause either disaster or stupendous success in our economy.
These factors of tax laws and varied government regulation of economic activity are important to how a nation’s economy performs. But economies are complex, and many other factors — historic, demographic, social and cultural — play influential roles. Moreover, economies often are remarkably resilient, surviving policies that horrify economists of one persuasion or another.
Substantial changes in taxes or regulation often don’t show up in basic indicators of economic performance such as gross domestic product or unemployment rates.
Consider the U.S. economy over the past 60 years, from 1950 to 2010. Over that time, the value of everything the nation produces in a year, adjusted for inflation, grew 6.6 times over. Since the population also grew, output on a per-capita basis grew by a factor of 3.4.
Converted to average annual rates of increase, total output grew by 3.8 percent and per capita output by 2.1 percent per year over these six decades.
But the rate of growth was not uniform. From 1950 to 1980, total output grew about 3.8 percent a year. From 1980 to 2010, the rate of growth was 2.8 percent. On a per-capita basis, it was 2.4 percent for the first three decades and a bit under 1.8 percent for the most recent three.
Yet according to many contemporary economists, we were doing many things wrong. The top marginal rate of personal income tax was first 90 percent and then 70 percent. Transportation and telecommunications were highly regulated. So were banking and the securities industry. The Justice Department aggressively prosecuted antitrust cases. Import tariffs had dropped from 1930s levels but were higher than in the subsequent years. Yet, real output per person was doubling every 30 years.
Then we started to do things right in the view of these same economists. The Carter administration oversaw deregulation of airlines, trucking and railroads.
Telecommunications regulation decreased as result of Nixon-era court decisions and subsequent legislation. The Reagan administration cut personal and corporate tax rates.
George H.W. Bush and Bill Clinton ushered in NAFTA and the WTO. All presidents, 1980-2009, oversaw decreases in regulation of banking and finance.
All of these changes, many economists argue, make an economy more efficient and capable of better growth. But that did not occur. Instead of per-capita output doubling every 30 years under the old overtaxed and overregulated economy, it would take 40 years to double at the average rate of increase since 1980.
This is not an argument that lower taxes and deregulation made the economy grow more slowly.
That would be the sort of post-hoc fallacious reasoning that would earn an F in a freshman logic course. The economy is far more complex than just these two factors. Many other changes were occurring.
However, if these policy changes did have positive effects on creation of wealth, they apparently were not large enough to overcome forces moving in the opposite direction.
And yes, there were increases in other kinds of regulation. Prior to 1970, there was little regulation concerning the environment, racial or gender discrimination or occupational safety and health. So the deregulation of transportation, telecommunications and financial services may have been countered by environmental and anti-discrimination legislation.
The baby-boom generation changed the makeup of the work force. Economic policies of China and Mexico saw dramatic shifts. Oil prices fluctuated. And a cycle of tight money while Paul Volcker headed the Federal Reserve eventually yielded to excessive loosening under Alan Greenspan. Then there were two wars in Iraq and one in Afghanistan.
However complicated the factors that determined fluctuations in the performance of the U.S. economy over these six decades, the fact remains it did quite well, thank you, when we followed policies that horrify some economists. And it did not perform as well when we did what these economists think wise. That should give one food for thought when hearing some politician saying the sky will fall if raising taxes is part of deficit reduction or if we reverse some of the deregulation of financial firms that has occurred since the late 1970s.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.