Great Depression Income Tax Hikes

In my last blog, I discussed how government inaction concerning bank failures helped to turn the recession of 1929-30 into a Great Depression. This time I want to focus on how tax hikes helped that occur.

Nowadays, almost everyone recognizes that the last thing you want to do in the middle of a recession is raise taxes. However this is exactly what occurred in the 1930s and helped prolong the Great Depression.

With one or two brief exceptions, the income tax only got started in 1913. It started with a top marginal tax rate of 7%. It went much higher during WWI to fund the war, but dropped to 25% throughout the economic boom of the 20s.

In 1932, Hoover and a Democratic Congress raised the top marginal income tax from 25% to 63%, more than a double increase. In addition, the income tax was increased at all marginal rates on everyone. The idea was to increase revenues to meet the increased spending the government undertook to meet the economic crises. It didn't do that - as government revenues went down, government spending went up, and the deficit continued rising.

Roosevelt with a Democratic Congress raised the top marginal in 1936 to 79%. This meant if you were in the top income tax bracket, for every extra dollar you made, you had to pay 79 cents to the federal government. In addition, corporate tax rates as well as capital gains rates were raised in drastic measures. An investor has to consider all of these taxes, as well as taxes on the state level, which were also raised during the Great Depression, before making investments.

When the government raises top marginal to such rates, it makes investors much more reluctant to invest in economically efficient investments. Instead, they tend to spend their time and money hiring tax lawyers and accountants to find economically inefficient investment tax shelters so they don't have to pay such high taxes.

Capitalism needs investors who invest capital in economically efficient investments that create wealth, jobs, and goods for the general economy. When the government raises taxes to high rates, it discourages these kinds of investments, and an economy stagnates, eventually hurting everyone in the economy. While the government had good intentions to balance the budget, because of the increased spending to meet the needs generated by the economic downturn, I believe the extraordinary tax increases in peace time helped to turn the recession, along with other government actions or inactions I discussed in this blog, into a Great Depression and prolong it.