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Heed the Lessons of the 1930’s

Posted by Brian Garst on August 27, 2010

Economics professors Thomas Cooley and Lee Ohanian have found a significant parallel between the pending tax hikes and the 1930’s under FDR.  Roosevelt’s rate hikes on capital gains and dividends did considerable damage to the economy before being rescinded.  This lesson needs to be heeded:

…[I]n 1936, the Roosevelt administration pushed through a tax on corporate profits that were not distributed to shareholders. The sliding scale tax began at 7% if a company retained 1% of its net income, and went to 27% if a company retained 70% of net income. This tax significantly raised the cost of investment, as most investment is financed with a corporation’s own retained earnings.

The tax rate on dividends also rose to 15.98% in 1932 from 10.14% in 1929, and then doubled again by 1936. Research conducted last year by Ellen McGratten of the Federal Reserve Bank of Minneapolis suggests that these increases in capital income taxation can account for much of the 26% decline in business fixed investment that occurred in 1937-1938.

…FDR eventually abandoned the excess profits tax and decreased the tax rate on dividends, but only after they significantly damaged an already weak economy.

There is no reason why history must repeat itself.  The capital gains and dividends taxes should not be raised – they should be eliminated.

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