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Tax History: Austerity, Not Overspending, Is the Real Danger

Posted on May 25, 2020

The American economy has been in free fall for two months, thanks to the coronavirus shutdown. The country has shattered one record after another in the annals of economic disaster, some on the way down, others on the way up: plunging retail sales, collapsing industrial production, and maybe worst of all, skyrocketing unemployment. At least 36 million Americans have filed unemployment claims since the shutdown began, pushing the unemployment rate toward heights not seen since the Great Depression.

It’s hardly surprising, then, that many people are looking to the 1930s for lessons. How did the nation respond during the greatest economic disaster in its history — before this one? More specifically, how did the federal government respond? Is there something our political leaders can learn from their predecessors? Does Franklin D. Roosevelt have any useful advice to offer President Trump?

We could take many lessons from the 1930s, not all of them inspirational. Indeed, the most useful is negative — a lesson about the biggest mistake of the 1930s that policymakers should try hard to avoid today. And that lesson is simple: The real danger, in the face of economic collapse, is timidity, not audacity.

Framed in more policy-specific terms, austerity, not profligacy, is the biggest threat to the nation’s short- and long-term prosperity.

An Apt Comparison?

Not everyone thinks we should be mining the 1930s for policy inspiration. “Clearly people have made comparisons to the Great Depression,” former Federal Reserve Chair Ben Bernanke told NPR. “It’s not a very good comparison.”

Bernanke is one of the nation’s leading experts on the Great Depression, so his complaint should be taken seriously. So should the objection of current Fed Chair Jerome Powell, who recently observed that while the 1930s downturn was rooted in a financial collapse, this one was sparked by something else entirely.

“This is an outside event — it is a natural disaster, in effect,” Powell told 60 Minutes in a recent interview. In origin and cause, it bears no resemblance to the Great Depression. That means we shouldn’t expect it to unfold similarly — and shouldn’t necessarily be trying to recycle 75-year-old policy responses.

And yet many of the policy responses Powell outlines in his 60 Minutes interview (somewhat gently and elliptically, because the chair of the Federal Reserve isn’t in the business of offering direct policy advice to Congress) sound remarkably similar to the policy advice people were offering Roosevelt in the 1930s: Spend more, spend quickly, and lift the country out of the Depression with a quick injection of Keynesian fiscal stimulus.

Except that’s not really what happened in the 1930s. Or even the advice Roosevelt was getting from most of the members of his famous “Brains Trust.”

Reluctant Keynesian

In popular memory, the New Deal and Keynesian economics are inextricably linked. And not without cause. But historians have been trying to pry the two apart for decades, insisting that Roosevelt was a reluctant Keynesian or — at best — a Keynesian-come-lately.

During his first run for the White House, Roosevelt actually campaigned on a plan for austerity, promising to slash federal spending by 25 percent. That austerity pledge was more than a little halfhearted, shot through with caveats and loopholes.

“There can be no extravagance when starvation is in question,” Roosevelt warned. “If starvation and dire need on the part of any of our citizens make necessary the appropriation of additional funds which would keep the budget out of balance, I shall not hesitate to tell the American people the full truth and recommend to them the expenditure of this additional amount.”

That’s a pretty big loophole in the midst of an economic calamity. Still, even this watered-down pledge underscored the non-Keynesian start to Roosevelt’s presidency: He didn’t come to the White House convinced that he could spend the nation into prosperity.

And why would he? John Maynard Keynes himself had yet to clearly make the case for expansionary, countercyclical fiscal policy; he didn’t publish his magnum opus, The General Theory of Employment, Interest and Money, until 1936. To be sure, Keynesian ideas existed before Keynes published the General Theory. And there were Keynesians (or at least proto-Keynesians) working for Roosevelt in the early years of his presidency. But as an intellectual movement, countercyclical fiscal policy was still a new and untested idea at the start of the Great Depression — and hardly the foundation for FDR’s plan of governance.

Keynesianism didn’t rise near the top of the New Deal agenda until at least 1936. And it remained there only briefly before Roosevelt demoted it again; in 1937 he embraced an ill-considered austerity drive that tipped the incipient recovery into a new “Roosevelt Recession” — the often forgotten contraction-within-a-depression that deeply scarred FDR’s second term.

Ultimately, the Keynesianism that we typically associate with Roosevelt is the military Keynesianism of World War II. Peacetime Keynesianism, while the subject of increasing interest among New Deal advisers over the course of the 1930s, never got a full-fledged trial before the war made it a practical necessity.

That fact hasn’t been lost on economic historians. The great MIT economist E. Cary Brown made the point quite nicely in a 1956 article taking stock of the New Deal’s fiscal record. Countercyclical fiscal policy “seems to have been an unsuccessful recovery device in the ‘thirties — not because it did not work, but because it was not tried,” Brown observed dryly (“Fiscal Policy in the ‘Thirties: A Reappraisal,” 46 Amer. Econ. Rev. 857 (1956)).

By implication, of course, Brown’s assessment suggests that expansionary spending (or, arguably, expansionary tax cuts) should have been tried. By the time Brown was writing, Keynesianism was ascendant in academic circles. It was even more deeply entrenched in Washington, where both parties had embraced it either explicitly or tacitly during the 1950s. By the 1970s, it seemed hardly surprising that a Republican president would casually acknowledge that “I am now a Keynesian in economics.”

(For the record, Richard Nixon never uttered the famous phrase often attributed to him: “We are all Keynesians now.” That observation was made by the economist Milton Friedman — and was actually taken out of context. Friedman’s complete comment, reported by Time magazine in 1966, was “In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian.” The full quotation obviously carries a somewhat different connotation than the truncated one.)

Roosevelt’s Lesson for Today

By almost any measure, then, Roosevelt was an indifferent Keynesian. He embraced Keynesianism tentatively during his second term, only to abandon it when politics made that seem prudent. Later, during the war, he embraced Keynesianism only to the extent that it was a necessary element of wartime mobilization.

And during the war, the element of Keynesianism that was getting the most conscious attention from fiscal policymakers wasn’t expansionary spending (which was happening automatically because of military spending) but contractionary taxation designed to limit inflation — the element of Keynesianism that politicians typically like to forget.

If Roosevelt was a poor excuse for a Keynesian, it seems churlish to fault him too seriously for it. In 2008 I offered an excuse by way of analogy:

Indicting Roosevelt for that failure — so obvious in retrospect — is a cheap shot. We might just as well complain that doctors weren’t treating infections with penicillin after it was invented in 1928 (it didn’t come into widespread use until the 1940s). In politics, as in medicine, it takes time to translate theory into practice. [Prior analysis: Tax Notes, Dec. 8, 2008, p. 1189.]

I still believe that’s true. But we can learn from Roosevelt’s “mistake,” even if it wasn’t much of a mistake when viewed in historical context. If Roosevelt has anything to teach contemporary policymakers, it’s this: Resist the instinct for austerity.

Now let’s be honest — austerity isn’t the strongest of impulses in Washington these days. If one thing has been made blindingly obvious over the past 40 years, it’s that fiscal responsibility is a policy agenda without a durable constituency.

Sure, budgetary responsibility gets some lip service — from both parties, at various points. But responsibility is the prerogative of the opposition party: a convenient weapon with which to beat the governing party until you have supplanted them in the seat of power. At which point, you, the new ruling party, can lose interest in responsible budgeting.

Still, when numbers get big enough, even spendthrift politicians seem to become nervous. And the numbers these days are very, very big. Two months ago, the fiscal outlook was bad enough, and it’s quickly gotten much worse. A few months ago, the Congressional Budget Office was predicting a 2020 deficit of roughly $1 trillion. Now, it’s expecting something like $3.7 trillion (almost 18 percent of GDP). Before the pandemic, the outstanding public debt was projected to be 81 percent of GDP by the end of the year. It’s now expected to reach 101 percent — and 108 percent next year.

Those numbers, which William G. Gale of the Brookings Institution outlines in a helpful litany of disaster, aren’t an excuse for panic. “This is not the time to get wobbly,” he writes. “Additional federal relief would produce substantial benefits at low costs. We can learn from history and avoid policymakers’ knee-jerk tendency to cut off stimulus too quickly after a recession.”

Indeed, we should learn from history. Roosevelt’s panic in 1937 brought a premature end to the recovery that the rest of the New Deal had helped spark between 1933 and 1936. A similar case could be made that premature panic about stimulus spending slowed recovery from the Great Recession after the initial burst of expansionary fiscal policy in 2009.

Powell has been making this case in his steady, measured manner. He has been careful to praise lawmakers for their swift action in the face of calamity, and I think he’s correct in his positive assessment:

The Congress has done a great deal and done it very quickly. There is no precedent in post-World War II American history that’s even close to what Congress has done. They have passed $3 trillion in stimulus, which is 14 percent of GDP. It is vastly larger than anything they’ve ever done. And also very, very quick.

All that is true. To be sure, there are many problems with the stimulus and economic support legislation passed over the last two months, which is hardly surprising, given the speed and scale of the effort. But we can’t ask for speed, scale, and perfection all at the same moment. Perfection is a legislative process, not a characteristic of actual legislation.

In Powell’s view, Congress should resist its early inclination (however tepid) to worry about all the recent spending and associated borrowing. More spending and borrowing could well be necessary:

It may be that Congress has to do more. And the reason we’ve got to do more is to avoid longer-run damage to the economy. If we let people be out of work for long periods of time, if we let businesses fail unnecessarily, waves of them, there’ll be longer-term damage to the economy. The recovery will be slower. The good news is we can avoid that by providing more support now.

Someday, the nation will need to get its fiscal house in order, Powell declared. But that day isn’t now. “The time to deal with that is when the economy is strong. When unemployment is low, when economic activity is high, that’s when you deal with that problem. This is not the time to prioritize that concern,” he said.

If only someone had told Roosevelt something similar in 1937. (Actually they did — he just chose to ignore them.)

Looking Forward

The argument over further support for the pandemic-stricken economy isn’t yet partisan. To be sure, some partisan divisions are beginning to materialize. Republicans seem increasingly uneasy with all the spending and borrowing, which is hardly surprising and generally on brand for the party. The GOP is also clearly more sympathetic to the idea of “reopening” the country as a path to economic recovery, although the divisions in that debate seem exaggerated — the argument is really over matters of degree.

Moreover, some reluctance when it comes to spending and borrowing is reasonable. As Powell noted, policy formulation has moved quickly in Washington, reflecting the swift pace of the virus. If Republicans are interested in gauging the effects of recent legislation before embarking on new ventures, that’s understandable. But I suspect that some of this caution is more performative than substantive — designed to convey the impression of fiscal responsibility amid the necessity of continued spending.

Ultimately, what matters most is that lawmakers not lose their nerve should events demand further legislation. If the 1930s hold any meaningful lesson for the 2020s, it’s about courage. Fiscal policy in an emergency can be scary — and it’s scarier today than ever before, given the numbers we’re talking about.

But timidity in the face of disaster is the real threat.

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