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David Shreve's op-ed column on the fiscal cliff
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This explains why the tax increases of 1942, 1990, and 1993 helped to lift the American economy and why the notable tax cuts of the 1920s--the only major federal reductions in the modern era not accompanied by equal or greater deficit spending--contributed greatly to one 13-month recession (1926-27), and to the onset and awful persistence of the Great Depression.
It also explains why we have gotten less bang for our deficit buck in recent decades. The general theory Keynes underscored remains simple and instructive: A low monetary threshold for investment and a progressive fiscal policy to re-seed the demand on which new investment always depends. Astoundingly, the applicable tax and fiscal policy effects rely on principles we learned long before Keynes; Adam Smith highlighted them in Book Five of the "Wealth of Nations" and Alexander Hamilton urged them in Federalist No. 36.
For reasons related to the effects cited above, capitalism depends upon progressive taxation, and this is dependent upon the nation's entire tax structure. The golden age of American capitalism, for example, was built largely on the effects of three key tax policy changes: the 1910s to 1960s adoption of moderately progressive state income taxes, the decreased dependence on archaic and regressive local taxes that accompanied this state-level trend, and the World War II-era adoption of the first broad and progressive federal income tax.
The reversal of all three of these changes--in modest ways since the 1960s, and in much less modest ways in recent years--helps to explain much of our current predicament. Recognition
Unless we lessen again the regressive character of state and local taxes (currently accounting for approximately half of the nation's fiscal weight), or lessen our dependence upon them by increasing federal aid to states, our federal tax structure must be at least as progressive as it was in the 1960s, after which we began this Great Reversal.
While other related myths abound--shaping our tendency to equate fewer tax brackets and flatter rates with simplicity, for example, or to tax blindly with regressive proxies in the name of "balance"--those deflecting us from progressive taxation, in general, are likely the most debilitating we possess, making a return to widely shared capitalist prosperity well near impossible.
David Shreve is an economist and former professor of economic history at the University of Virginia.