Learning Objective II
Discuss the Two Phases of the Republican domestic program from 1921-33
It is frequently said that the Republican administration of the 1920's favored laissez-faire.
This is true only if one defines laissez-faire as the absence of government restraint on business.
In many areas, Republican administrations used the power the federal government to aid business ·enterprises.
The "trickle down grassroots" theories:
- During bad times: Spend money to take care of people, cut taxes to create jobs.
- During good times: Gradually raise taxes as the economy improves to lower governments debt.
The "trickle down" theory provides financial incentives to business and wealthy individuals to invest in the economy. The direct benefits in the form of more wealth go to the wealthy and big business while the indirect benefits "trickle down" to the common man in the form of more jobs and thus more purchasing power.
he Internal Tax Structure--The Revenue Acts: 1921-1929
The Revenue Act of November , 1921, eliminated the wartime excess profits tax on business and reduced the maximum tax rates on personal income tax from 65% to 50%. Secretary of the Treasury Andrew Mellon wanted the maximum rate to be 32%. However, the law did raise the corporate tax rate from 10 to 12 1/2% while granting some relief to lower income groups with higher exemptions for dependents.
This act was the first step in Andrew Mellon's program of tax reduction for the wealthy.
Mellon argued that wealthy people would not invest in industry if income taxes took a large share of the return.
In 1924, the Revenue Act lowered the maximum rate to 40%.
The general prosperity of 1925-1929 brought increased tax revenues and surpluses to the federal government, thus helping Mellon in his program to reduce taxes on large incomes .
The Revenue Act of 1926 lowered the maximum tax on income down to 20%, reduced corporation taxes, cut the inheritance tax by half, and eliminated the gift tax.
This aid to the wealthy increased the marked inequality in wealth which was one of the major causes of the crash and depression in 1929.
In 1929, 5% of the population with the highest incomes received approximately one-third of all personal income. Thus, the lower classes had no purchasing power.
This highly uneven income distribution meant that the economy was dependent on a high level- of investment or on a high level of luxury consumer spending, or both.
The rich cannot buy great quantities of bread. Ifthey are to dispose of what they receive, it must be on luxuries or by way of investment in new plants and new projects.
Accordingly, costs fell; and with prices the same, profits increased. These profits sustained the spending of the well-to-do, and they also nourished at least some of the expectations behind the stock market boom . Most of all, they encouraged a very high level of capital investments.
The question is: who was to buy the products which these extra capital goods produced if the common man had no purchasing power to speak of? What happens after the common man's purchasing power is saturated and business keeps producing goods and building up inventories which cannot be consumed?
When people get laid off as a result of this over-production, they will have no purchasing power; in which case, a downward cycle for the economy will be accelerated .
The Revenue Act of 1928 left personal income taxes at the 1926 rate, but reduced corporation taxes still further.
One can make a strong argument that it was economically unwise to reduce taxes on high incomes at all. Much of the incomes thus saved from the tax collector went into land and stock speculation and contributed greatly to the crash of 1929. This tax policy also transferred much of the tax burden from the rich to the middle and poor classes.
If wealth had been taxed at the rate it had been during or soon after the war, more of the national debt could have been retired, or the higher revenues could have been used for a vigorous government farm program and an economically healthier distribution of income.
By cutting governmental expenses, the Republicans did balance the federal budget for a time. Governmental expenditures fell from $6.4 billion in 1920 to $3.4 billion in 1922, and to a low of $3 billion in 1927.
Hence, the Republicans were able to achieve a surplus every year until 1929 and were thus able to reduce the national debt from $25.5 billion in 1919 to $16.9 billion in 1929.
It is no wonder the business community asserted with one voice that Andrew Mellon was the greatest Secretary of the Treasury since Alexander Hamilton.
The Underwood Tariff (a low tariff) had never really been tried under normal conditions, for the war itself afforded protection to American manufacturers and fostered the establishment of new industries.
At the conclusion of the war, these infant industries -- chemicals, dyes, hardware, and so forth -- clamored for protection.
Wilson vetoed Congress's attempt to pass a protective tariff. Reason:
"If there ever was a time when America had anything to fear from foreign competition, that time has passed. If we wish to have Europe settle her debts, governmental or commercial, we must be prepared to buy from her."
Before World War I the United States was a debtor nation (we owed countries money), but during and after WWI, the United States became a creditor nation (countries owed the US money). When the United States was a debtor nation the surplus of US exports over our imports had paid the interests and principal on US loans from Europe. Now that the United States was a creditor nation the profits from its surplus exports were added to the debt that European countries now owed us. During the 1920s, the surplus of American exports over imports continued and European countries continued to get deeper into debt. The end result of this situation meant that European nations had to accomplish one of the following:
Presidents Harding, Coolidge, Hoover, and the Congress moved promptly to eliminate the first possibility -- that European accounts would be balanced by larger imports -- by sharply increasing American tariffs. Accordingly, debts (including war debts) went into default and there was a precipitate fall in American exports.
Nevertheless, in the early 1920's, the mood of Harding and the country was fear that the United States would be inundated with the products of depressed European labor. At the request of Harding, Congress pushed through a high protective tariff in September, 1922: the
The Fordney-McCumber Tariff established rates higher than ever before -- up to 400%.
The Fordney-McCumber act provoked a tariff war which cut briefly into our foreign trade, consequently persuading many manufacturers to establish branch plants abroad in order that they may compete more effectively.
The net result of this high protective tariff was that it made it almost impossible for many European nations to replenish their financial reserves and rebuild their economy when..the American market was sealed off by the tariff, thus making it difficult for them to pay on the $10.3 billion they had borrowed from the United States during the war -- a debt the Untied States refused to cancel
as her share of the war effort.
The high tariff thus encouraged (1) inefficient production, (2) allowed business to make artificial profits (profits based on inefficient production and an unstable corporate structure -
holding companies) and (3) gave people great faith in the economy.
This misdirected faith encouraged people to speculate in land and stock.
However, the stock market boom of the twenties had to come to an end sometime. This rise in the market could continue only as long as new people or new money was coming into the market. Once the supply of new customers began to falter, the market would cease to rise.
Once the market stopped rising , a good many would start to cash in and the market would tumble .
The market's crash is important because it revealed the other weaknesses in the economy.
The continued prosperity after the Fordney-McCumber tariff, however, confirmed the Republicans in their devotion to high tariffs.
In the campaign and election of 1928, Herbert Hoover stood on
Republican prosperity and reaffirmed his faith in a high tariff. The results: Hoover won an easy victory over the Democrats' Al Smith -- 444 to 87.
There was no urgent need for further tariff revision, but no sooner was Hoover inaugurated then he summoned Congress in a special session to consider farm relief and limited changes in the tariff.
Hoover felt America's continued prosperity was tied to protecting American industries.
The new Howley-Smoot tariff bill represented increases all along the line.
A vigorous protest from over 1,000 economists had no effect on the President, who signed the bill into law in June, 1930.
The reaction was immediate: Within two years, by 1932, 25 countries had established retaliatory tariffs and American foreign trade dropped off as America was facing a depression and suffering from over-production at home.
America's foreign trade declined from $9 billion in 1929 to $3 billion by 1932.