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The Obama Tax Hike and Lessons from 1937

Posted By Guinevere Nell On October 6, 2010 @ 12:00 pm In Economics | Comments Disabled

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Raising taxes on successful businesses is one thing we cannot afford to do [2]. Large, successful businesses that create jobs would be hit the hardest, but small businesses would also be hurt by such a tax increase [3]. Although economists disagree on many aspects of economic growth and recession, there is near-unanimity on at least one issue: raising taxes during a recession is a bad idea. It seems clear then, that a jobs-killing tax increase, such as the one planned by President Obama, is a bad idea.

Of course, Obama has argued that repealing the Bush tax cuts would not cause job loss. Because small business owners often earn a portion of their income from other sources, some commentators have argued that they are not real businesses and therefore a tax increase would not cause job losses. This is simply not true: many of these businesses have employees. The businesses most likely to have employees are the most successful ones, and therefore would face very large tax increases; but a significant portion of small businesses at every income level report having paid employees.

Many small business owners face high tax rates even if they are currently reporting business losses. For example, a small business owner may hedge against losses, and also earn income to invest in expansion, by supplementing business revenue with another source of income such as interest or capital gains. In fact, businesses filers in every earning category will face a tax increase if Obama’s tax hikes are enacted. While some commentators suggest that it is only a tiny fraction of businesses that have enough income to face a tax increase under Obama’s plan, it simply is not true.

Meanwhile, there are fears of a “double-dip” recession. Keynesian advocates of government spending like Paul Krugman [4] argue that reducing government spending during a recession is dangerous, and was a big part of what caused the “recession within the depression” in 1937. Not all economists agree with this analysis, for good reason.

For one thing, the evidence simply does not support Krugman’s version of history [5]. Government spending only fell by 1 percent of GDP in 1937 preceding the “double dip” – hardly enough to account for the fall in GDP of 4.3 percent that occurred the next year, even if you believe in his high “multiplier” numbers. Instead, as a recent Wall Street Journal article explains, it was tax hikes on businesses, along with union wage demands [6], that most likely caused the dip. Today, it is quite clear that government spending is not what lifted (to the extent we have been lifted) out of this recession, because we’d barely opened the purse before the recession officially ended [7]. But, tax hikes could once again prevent recovery.


Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2010/10/06/the-obama-tax-hike-and-lessons-from-1937/

URLs in this post:

[1] Image: http://www.foundry.org/wp-content/uploads/Obama-tax-hike-projections.jpg

[2] we cannot afford to do: http://blog.heritage.org../2010/08/27/biden-wrong-obama-tax-hike-is-only-thing-we-can%E2%80%99t-afford/

[3] small businesses would also be hurt by such a tax increase: http://www.heritage.org/Research/Reports/2010/09/Obama-Tax-Hikes-The-Economic-and-Fiscal-Effects

[4] Keynesian advocates of government spending like Paul Krugman: http://www.nytimes.com/2010/01/04/opinion/04krugman.html?_r=1&ref=opinion

[5] the evidence simply does not support Krugman’s version of history: http://www.forbes.com/forbes/2010/0809/outfront-economy-taxes-krugman-barro-avoid-double-dip.html

[6] tax hikes on businesses, along with union wage demands: http://online.wsj.com/article/SB10001424052748703461504575443402028756986.html

[7] we’d barely opened the purse before the recession officially ended: http://www.aolnews.com/opinion/article/opinion-a-tale-of-two-economic-recoveries/19641455

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