The Economy Needs A Psychological Jolt

The US economy remains in a tepid stage at best – subject to a multiple dip recession at worst. Unemployment is high and private sector jobs are taking longer than usual to rebound. Even the Obama Administration is forced to admit unemployment will be high for a long time to come. Starting two years ago this July, I said if Obama was elected President, we would have a difficult economy, at best, for at least six years. Unless our governments, federal and state, make a concerted effort to change the economic psychology facing Americans today, that prediction can’t help but come true.

There is no question that the American economy is in bad shape. Unemployment has only been this high one other time since World War II, i.e. in the 1980’s. Recessions similar or deeper than this recession occurred in 1918, the Great Depression, the 3 recessions of the 1950’s, and the stagflation of the late 1970’s and early 1980’s.

Recessions of this magnitude take on a life of their own because both businesses and consumers are plagued with doubts – doubts about future government policy, doubts about consumer spending, doubts about the prospects for future investments. Those doubts literally diminish future economic activity as investors and consumers favor caution over investing and spending. The psychology of larger recessions exaggerates downturns as fears mount. That Psychology of Doubt delays recoveries in ways that cannot be measured by statistics alone.

In order to break that Psychology of Doubt, it takes bold action on the part of governments – not half measures or technical adjustments. Indeed, each of those recessions did not end until there was a dramatic change in the government policy – usually a change to the very policies that drove our economy into the ditch in the first place – excepting only World War II’s effect on the Great Depression.

In the 1920’s, facing unemployment nearly as high as today, Secretary of the Treasury, Andrew Mellon, noted that “The history of taxation shows that taxes which are inherently excessive are not paid. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business.” Seeking to reverse that gun-shy mindset, Mellon was influential in crafting a bold break from the tax policies of President Wilson which featured a 77% marginal tax rate. The top marginal tax rate was slashed to 25% – a move that dramatically changed the psychology at the time. In doing so, investors were convinced the prospects for risking capital were bullish, they moved money out of tax-free, low-risk municipal bonds, among other things, and the Roaring ’20s ensued.

After the 3 recessions of the 1950s under Eisenhower, which featured a top marginal tax rate of 91%, the economy did not make a significant move until the top rate was cut to 70%. The proponent of that big rate cut, President Kennedy, argued that: “Our practical choice is not between a tax-cut deficit and budgetary surplus. It is between two kinds of deficits: a chronic deficit of inertia, as the unwanted result of inadequate revenues and a restricted economy; or a temporary deficit of transition, resulting from a tax cut designed to boost the economy, increase tax revenues, and achieve–and I believe this can be done–a budget surplus.”

Similarly, the mounting stagflation of the 70’s and early 80’s, which convinced President Carter and others that there was a crisis of confidence, was not reversed until a bold and dramatic change in government policy was enacted by President Reagan, i.e. a cut in marginal tax rates from 70% to 28% among other deregulations.

Long before that, our Founding Fathers recognized that the high tax, and debt burdened, post revolutionary economy needed a bold measure to reverse the psychology of doubt plaguing investors and traders. In addition to high taxes and debt, the economy was at risk because states were passing a dizzying array of laws that harmed creditors and investors. In order to break the prevailing Psychology of Doubt, and to bring certainty to our economy, they literally made a push for a new Constitution with a central feature – the “Contract Clause.” That clause prohibited states from retroactively impairing contract rights – a serious problem which fed the Psychology of Doubt. That dramatic move paved the way out from one of the deepest recessions in our nation’s history.

Perhaps it may be helpful to think of the economy as a huge boulder. The faster it moves in one direction, in case of a deep recession downhill, the greater force which must be applied to it to reverse its course – a force greater than if it was on level ground. Presidents Coolidge, Kennedy and Reagan – and our Founders – well understood that to break the negative psychology of a bad recession, bold action was necessary.

By contrast, fiddling on the margins with targeted tax breaks, swelling the ranks of bureaucrats, increasing spending and therefore exacerbating our already serious debt crisis, will do nothing to cure our current “chronic deficit of inertia.” Bold action is needed to convince investors that tomorrow will certainly – not maybe – but certainly will be better than today.

It is no secret that US debt, regulatory and tax burdens (combining, state, local and federal taxes) are at or near all time highs and rising. That is the very source of our current problems. Now, as before, the bold break we need is away from government responses and in favor of private enterprise, freedom and the lower tax and regulatory rates that foster sustainable recoveries.