Roaring twenties tax cuts.

[Mr. Wynand]

In the 1920's the highest tax bracket in the US was lowered from 73% to 25% (all other brackets were cut as well). Income tax receipts increased by 61% from around $700 million to over a billion throughout that decade. But what the supply siders neglect is that the money supply increased 60% during that period as well. Does this mean that real tax revenue remained the same despite the tax cuts? Or am I neglecting other factors, such as the effect of fractional reserve banking/trading on margin?

And yes, I realize that taxation is theft. Any thoughts would be appreciated.

[freestyle]

...at the money supply increased 60% during that period as well. Does this mean that real tax revenue remained the same despite the tax cuts?...

Maybe I'm not following... Are you suggeting that an increase in money supply somehow increases the demand for government services?

[Mr. Wynand]

Maybe I'm not following... Are you suggeting that an increase in money supply somehow increases the demand for government services?

No sorry if I was unclear. I'm suggesting that the tax cuts generated the same amount of revenue as before because the 60% expansion of the money supply led to the 61% increase in revenue. When the tax rate was 73%, the revenue was 700 million dollars, but when it was cut, revenue increased to over 1 billion dollars. This appears to be a result of the inflation, but the fact that real revenue remained constant is still incredible. My question was is there anything else to account for this besides the standard claims of the supply-siders that lower taxes bring more (or in this case equal) revenues? (By revenue, I mean government revenue from tax receipts.)

[Steve D'Ippolito]

Is it possible that the expansion of the money supply was actually more an indication of an increase in real wealth?

Assuming (for the moment) that the answer is yes (and I realize that's a big can of worms I just opened up, having to do with the nature of inflation, but let's try to stay on topic) could the growth be caused, or rather, enabled by the tax cuts? Or would it have happened anyway? Remember that the central claim behind the Laffer curve--that revenue can go up when tax rates are cut, because there will be more economic activity if the tax rate drops, would actually be evidenced by this history, if this is the case.

[softwareNerd]

In the 1920's the highest tax bracket in the US was lowered ... ... Income tax receipts increased ...

WW-I was a rare event that caused some "once in multi-generation" changes. For instance, it changed the U.S.A. from a "debtor nation" to a 'creditor nation", it ended London's primacy in financial affairs and moved that the NYC. The U.S. had financed part of the war through bonds, but had also shifted to war-time tax levels on the principle of paying for some of it as one goes. The War had seen all sorts of other temporary short-term changes: like forms of rationing that cut certain uses of resources, attitudes and contracts that restricted the amount of profit on war-production, and so on. The ending of the war -- at least in the case of the U.S. -- could be expected to unleash a boom. So, one has to be careful picking one aspect of the post-WW-I scene and naming it as the causal factor for the roaring twenties.

[Mr. Wynand]

Is it possible that the expansion of the money supply was actually more an indication of an increase in real wealth?

Assuming (for the moment) that the answer is yes (and I realize that's a big can of worms I just opened up, having to do with the nature of inflation, but let's try to stay on topic) could the growth be caused, or rather, enabled by the tax cuts? Or would it have happened anyway? Remember that the central claim behind the Laffer curve--that revenue can go up when tax rates are cut, because there will be more economic activity if the tax rate drops, would actually be evidenced by this history, if this is the case.

That's an interesting theory. Supply siders argue that people will hide their wealth to avoid confiscatory taxes. If the wealthy start releasing this wealth into use on the American market, perhaps an increase in the money supply would result. However it's difficult to say exactly how much money was "hidden" and where it was.

Also the federal reserve inflated the currency during the 1920s.

[Mr. Wynand]

WW-I was a rare event that caused some "once in multi-generation" changes. For instance, it changed the U.S.A. from a "debtor nation" to a 'creditor nation", it ended London's primacy in financial affairs and moved that the NYC. The U.S. had financed part of the war through bonds, but had also shifted to war-time tax levels on the principle of paying for some of it as one goes. The War had seen all sorts of other temporary short-term changes: like forms of rationing that cut certain uses of resources, attitudes and contracts that restricted the amount of profit on war-production, and so on. The ending of the war -- at least in the case of the U.S. -- could be expected to unleash a boom. So, one has to be careful picking one aspect of the post-WW-I scene and naming it as the causal factor for the roaring twenties.

Those are great points. Correct me if I'm wrong, but after WW2, wasn't there a boom despite extremely high taxes? (The highest bracket was about 90%.) Could decent regulatory and fiscal policies have partly led to this?

[agrippa1]

Decreasing taxes increases the profitability of lending money, thus incentivizing lending under higher risk scenarios. It was the expansion of credit that led to an increase in the money supply (we are talking M3/MZM here right?)

Likewise, the decrease in taxation leads to an increase in risky investments, which would not be risk-adjusted profitable given heavy taxation's squeeze on high-side expectations.

These factors, in addition to the technological boom of the 1920's acted as impulses to the system, which responded with an increase in wealth and a temporary bubble. The great increase in wealth during that time created the illusion of a decrease in lending risk, when in fact the bubble prices evidencing decreased risk were in fact winding up increased risk as they created opacity to the long-term value of collateral.

The adjustment to new conditions came in 1929, and instead of allowing markets to make their adjustment to the new conditions, the U.S. gov't drastically changed the conditions again and again, leading to and lengthening the Great Depression.

[dream_weaver]

Those are great points. Correct me if I'm wrong, but after WW2, wasn't there a boom despite extremely high taxes? (The highest bracket was about 90%.) Could decent regulatory and fiscal policies have partly led to this?

During the war, those who were being paid to produce the materials necessary for war saved much of their money.

The automobile industry converted much of their assembly lines to the manufacture of airplanes, bombs and tanks. Discretionary income went to the sidelines untill after the war.

The boom could be attributed to the return of manufacture to peacetime goods and services, as well as an increase of workers who were freed up from being overseas on military actions.