What The Great Depression Can Teach Us About Taxes

Fixed income strategist at eBooleant Consulting LLC, independent academic providing unbiased policy analysis at Micro Macro Infinity.


Taxes are going up. The Great Depression shows they will not likely come down soon.

For the CEO and CFO, tax uncertainty is a constant in their personal lives and businesses. And recent political events have elevated tax uncertainty to a generation high. With proposals to increase taxes across a wide swath currently under consideration, there is good justification for concern. But as important as the ultimate terms of a new tax bill like the Build Back Better Act are, the longevity of any tax increase is just as important. How long will tax increases survive?

Tax Policy Is The Driver

For asset valuation purposes, the primary consideration is often the duration of the tax increase. How long the increased taxes stay in force is a key parameter in any valuation. Taxes proposed today are not unprecedented, but factored with state and local taxes, approach a similar level of increase as in wartime (paywall) but without a war. The duration of a tax increase is almost purely a matter of tax policy. With the current focus on fairness and not tax efficiency, Americans can expect taxes to go much higher and stay there for years.

History Is The Teacher

The current tax system bears the mark of the U.S. Depression from almost a century ago. No historical comparison is ever exact but the same forces that helped forge extremely high rates in the 20th century are at work in the 21st century: wealth concentration and progressive politics.

You can get a very real sense of the trajectory of tax rates in the next few years from a quick look at the past. Here are three things that we have learned, without regard to politics.

• There is no natural tax rate.

• High tax rates tend to be “democratized” or applied broadly.

• High rates are sticky.

This is what history shows.

Income taxes have never been popular. Originally, they were unconstitutional. The first one was allowed during the Civil War, but it took a constitutional amendment in 1913 to clear up the legal issues.

The constitutional amendment did not set the tax rate and there is no natural rate for taxes. They have varied widely. Many leading economists have favored very high rates but there is no consensus.

Tax rates are set by policy, not underlying economic rules. There are no simple statistical rules to apply. Tax rates are not mean reverting, meaning they do not go back to the average over time. But tax rates are sticky. What goes up in taxes, does not need to go down, at least for a long time.

The high-top rates are not the only problem. High tax rates have gotten democratized. Taxpayers should know that millionaire’s and billionaire’s taxes are likely to affect everyone’s taxes. History has shown this very clearly that when Congress raises taxes for the top earners, it can ultimately impact people in the lower tax brackets. During the Depression, Congress raised taxes for top earners and later applied them to virtually all earners. The top tax rates eventually came down, but the democratization of taxes did not. They still apply to nearly all earners.

Let us look at a bit of history. The tax code started with very low rates in 1913, but tax rates popped to pay for World War I, leaping from 7% in 1915 to 73% in 1919 before crashing to 25% in 1925.

The Depression was different from the early years of the tax code with World War I and the Spanish Flu. In the Depression years, the budget problems were not even the main reason for tax increases. Rather, it was the drive to have the rich pay their “fair share,” which pushed the top marginal rate to 94% by 1944 and kept it over 90% for two decades. President Roosevelt’s belief captured it best: “Here is my principle: Taxes shall be levied according to ability to pay. That is the only American principle.”

Once Congress raised taxes to extremely elevated levels, it applied new, higher rates to all taxpayers. This took a variety of forms but ultimately resulted in 90% of all Americans filing taxes. Progressive tax policies led to a wide range of new taxes, including a wealth tax. The New Deal required vast amounts of income and Congress was creative in generating it.

With this in mind, I believe corporate tax planners should not view any jump in taxes this year as short term. I believe we should not expect that Congress will quickly reverse any new legislation. History shows us when Congress raises taxes, you can expect those new tax rates to live with us deep into our future.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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