Grover Norquist, the longtime conservative activist, was our guest on The Daily Ticker Monday. And as might be expected from the president of Americans for Tax Reform, a big chunk of our discussion centered around taxes.
"As for increasing economic growth, Republicans have boatloads of policies: cut marginal tax rates -- for starters take the American corporate income tax rate from today's 35% to the European average of 25%. Reduce the individual income tax rate to 25%. Abolish the death tax which double and triple taxes income earned and taxed already."
By contrast, he noted: "Democrats have no ideas that will increase your 401(k) or the general economy."
For Norquist it's a very simple matter: if you want better performance in the economy and the stock market, cut taxes. Raise taxes, and you'll get a poor, pathetic performance. End of story.
For many people, views of the relationship between the levels (and changes in levels) of taxes and the correlation and causation of market and economic performance are akin to theology. People have faith in their positions, almost regardless of the evidence.
The last 20 years have served as something of a controlled experiment. There was a roughly 10-year period, in the 1990s, during which taxes on the wealthy were raised twice — by President George H.W. Bush and a Democratic Congress in 1990 and by President Clinton and a Democratic Congress in 1993.
Read My Lips
The warnings came fast and furious: these increases would bring on lengthy recessions, condemn the U.S. stock and job markets to a decade of underperformance, and lead to subpar economic growth. Oops! Instead, in the 1990s the economy enjoyed its longest peacetime expansion, and the employment and stock markets turned in extraordinary performances.
In 2001, President George W. Bush and his economic advisers (along with Norquist) promised that cutting marginal taxes on income, capital gains, and on dividends would usher in a period of economic nirvana that would make 1990s growth rates seem positively Soviet. Double Oops!
The U.S. economy enjoyed a long expansion. But many of the gains, it turned out, were borrowed. Incomes stagnated. By January 2009, there were only 1.1 million more payroll jobs than there were in January 2001. The markets? Forget about it. Stocks in the oughts had one of their worst decades on record. Analysts may fret about the possibility of a Japan-style lost decade. But as I've argued elsewhere, we've already had one.
So what are we to conclude about the vastly different performance in the two decades, under significantly different taxation regimes?
Cracks in the Ironclad Rule
Well, it could be that the iron law that Norquist and others posit about the relationship between policy, politics, and economic performance just doesn't hold. Many people believe — no, know -- that the economy and markets always do well when Republicans control the White House and always do poorly when Democrats occupy 1600 Pennsylvania Avenue. These people are wrong. Timing the market this way would have meant an investor would have held on for an 80 percent decline during the Hoover years, missed out on a massive rally in Roosevelt's first term, held on for eights year of pain in the Nixon-Ford years, missed out on much of the 1990s bull market, then allocated capital to the stock markets for the lost years of the two Bush terms, and then missed out on the gains the market has racked up since January 2009. (This long-term chart of the S&P 500 tells the story in graphic form.)
Or it could be that tax rates just don't matter that much. The U.S. economy has thrived and done poorly in periods when taxes were comparatively high, and it has thrived and done poorly in periods when taxes were comparatively low. Much as it may pain CNBC's Larry Kudlow to hear it, there is much more to life — and to the economy -- than marginal tax rates. Taxes are just one factor among many that affect market behavior and trends in the global economy.
All things being equal, higher taxes on wealthy people enacted in 1993 might have been expected to dampen economic growth. But broad economic developments, like the rise of the Internet, the advent of China as a source of cheap labor, were much more powerful forces in propelling the markets, job creation and investment in the 1990s.
All things being equal, lower taxes on capital gains and dividends would tend to boost investment in the stock market. But broad economic developments, like the stagnation of wages and poor jobs growth (leaving people with less money to invest) and the housing bubble (which sucked in lots of capital that might otherwise have gone to stocks) proved to be more powerful. Tax policies were never more friendly to investors and the wealthy than they were during the years from 2001-2009. But for some reason, investors didn't respond to these incentives. According to the securities industry's Equity Ownership in America 2008 report, the proportion of the population that owned stocks or bonds fell from 57 percent in 2001 to 48 percent in 2008. In 2008, 45 percent of U.S. households owned stocks—inside retirement programs and in brokerage accounts—down from 49 percent in 1998.
This dynamic, whereby global trends outweigh the impact of policy, cuts both ways. The boom in stocks since March 2009, when economist Michael Boskin penned a now-famous Wall Street Journal op-ed entitled "Obama's Radicalism is Killing the Dow," has less to do with Obama's economic management and more to do with the global boom/corporate cost-cutting mania that has boosted profits massively.
In theory, this year's payroll tax cut should free up more cash for spending and investing. In reality, higher gas prices have the potential to eat up most of this stimulus.
Of course, political investors come up with all sorts of contortions to justify their continued faith. Norquist, for example, argues that the boom of the 1990s didn't really begin until the Republicans took control of the House in the 1990s, and all the gains were the retrospective result of the capital gains tax cut in 1997. Other say the poor performance of the economy and the markets in 2001-2008 was the fault of Barney Frank, or Fannie Mae, or the Community Reinvestment Act. Or something.
Making predictions about the performance of the stock market and the economy is very difficult. But political ideology doesn't help much.
Daniel Gross is economics editor at Yahoo! Finance: email him at firstname.lastname@example.org; follow him on Twitter @grossdm
- marginal tax rates
- capital gains
- President George H.W. Bush
- Grover Norquist
- individual income tax rate
- death tax