Taxing our way to prosperity

April 4, 2009

This is an odd post coming from somebody whose job it is to reduce individuals’ tax liability as much as possible. Still, in my studies of tax policy, combined with my fascination with history, I occasionally come across things I just have to comment on.

We hear it over and over again, “We can’t tax our way to prosperity.” It’s a mantra of the right. The left doesn’t seem to disagree…they just don’t even address it. Well, history has another message. We actually can tax our way to prosperity. And WWII is the proof.

We entered WWII with massive deficits and a terrible economy. Beginning in 1940, we raised tax rates to 23% on middle-income earners and as high as 94% on the highest earners ( We increased government spending to nearly 50% of GDP. And in well under a decade we had a booming economy ushering in one of the longest sustained periods of prosperity in American history.

What’s most amazing about this is the fact the government spending wasn’t even very productive. The popular mantra today is we can’t increase taxes because it will reduce consumer demand and further damage the economy. BS. What’s better for the economy, a smart energy grid or a new big-screen plasma TV in every household? I think the answer’s obvious. Both outcomes would cost tens of billions of dollars, possibly hundreds of billions, and therefore have roughly the same effect on demand. But one of the outcomes can be achieved by consumer spending, and one of them can be achieved by taxation and subsequent government spending. We’re obviously better off in the long-run if we are all taxed in such a way that generates sufficient revenue for a smart energy grid, even though it means giving up a big-screen plasma TV.

But this isn’t just theory. This is exactly the kind of thing that happened during WWII. Americans were asked to sacrifice and make do with less. With increased revenues, the government built lots of bombs and tanks and planes…mostly non-productive assets meant for almost immediate destruction. But part of that money also went to very productive assets, like factories and power plants and transportation networks. It also went to education in the form of the GI Bill. And after the war the government continued to spend on the Interstate Highway System. These productive assets were instrumental in the post-WWII boom that America experienced. And this was accomplished with only a small portion of government spending going into productive assets.

Today the need for military (economically non-productive*) spending is far less than during WWII. Despite our fears of terrorism, there is simply no threat to our national existence like there was during WWII. Our current defense spending is almost entirely discretionary. We could bring all our troops home, leave the terrorist networks alone, and face zero threat to our national existence. Of course, we might face an elevated threat of terrorist attacks. But these are entirely different from the existential threat posed by totalitarian national regimes during WWII. Our military spending today is out of a choice we make that we are willing to spend half a trillion dollars to potentially save a few thousand lives every year. And even making this choice, we are still spending a small fraction of what was spent fighting WWII, leaving a tremendous potential for spending on productive assets. If we spent four years devoting a quarter of GDP to creating productive assets (this would still be significantly less than the spending during WWII), we could probably afford to build a national smart energy grid, install renewable energy on a sufficient scale to power the nation, and build a better national transportation system far faster, safer, and cheaper than the Interstate Highway System. We would have to train people to install all of this, and at the end of four years of spending we could unleash our highly-trained workers and our technology on the rest of the world where we could make unimaginable sums of money bringing this technology to other developed and developing nations.

Of course, to accomplish all this would require Americans to temporarily cut back on big-screen TVs, designer clothes, luxury cars, and all the other perishable goods that we’ve come to love. And I guess maybe we can’t have that.

Of course there are limits to this kind of thinking. Government doesn’t always know best. After the overwhelming success of WWII spending, government tried to solve every problem…an approach that naturally led to problems of its own until the Reagan revolution took the pendulum back the other direction with considerable success for the better part of two decades. But now that the hands-off approach has run its course, and the pendulum seems naturally ready to swing back…it seems like most politicians are still afraid to learn history.

*I use the term “non-productive” in a very specific sense here. I’m not implying the military is not valuable. Providing for the national defense is a very valuable service. But generally speaking, money spent on the military goes to items that are quickly used up and do not produce other items. It’s basically the difference between a company investing in a security system for a factory, or state-of-the-art equipment to produce goods. Obviously, a factory needs security to protect the investment, but the security system doesn’t in itself produce anything of value. A smart company will spend as much as possible on equipment and as little as necessary on security. It’s the equipment that pays for the security, after all.