The Bear’s Lair: The missed Eisenhower opportunity

U.S. lovers of high taxes frequently refer nostalgically to the glories of the Eisenhower years, when the top rate of tax was 91%, claiming their prosperity proves there to be no negative supply-side effects from high income tax rates. But if you look at the data more closely, the U.S. economy of the Eisenhower years was surprisingly unimpressive, while the supply-side Kennedy tax cuts of 1963-64 actually did “get America moving again.” Viewed from the light of 2013, with what we now know about taxes, the Eisenhower years become ones of enormous missed opportunity, with no supply-side incentives, very little entrepreneurship and abysmal growth in per capita income.

The excessively high tax rates of the 1950s derived initially from one of the most foolish policy moves in history, when Herbert Hoover in 1932, the worst year of the Great Depression, increased the top rate of income tax from 25% to 63%, thus substantially deepening what was already the deepest depression in U.S. history, losing the election the following November to Franklin Roosevelt, and giving Roosevelt an excuse to increase income taxes still further.

This he did with gusto. In 1936, the top rate was raised to 79% on incomes over $5 million (about $76 million in 2011 money) with Roosevelt insulting his victims further (if there were any of such exalted incomes in the middle of the Depression) by calling them “malefactors of great wealth.” World War II raised rates further, so that at the peak in 1944 the top rate of tax was 94%, incident at an income of $200,000 ($2.5 million today.)

Taxes came down only marginally after the war; the top rate of tax was set at 91% from 1946 to 1964, its incidence at $200,000 being worth less and less in today’s money as the inflationary years wore on. However in the early post-war years this did not matter. With two decades of technological advances since the 1929 crash and only modest peacetime recovery in 1939-40, the economy was running far below its technological capacity and a mass of capital and consumption investment was needed before it started hitting up against its technological limits. Then when those limits might have been approaching, the Korean War intervened, which unlike World War II did not involve the conversion of much peacetime production capacity. In 1951-53, while inflation was rampant, so were prosperity and increases in living standards.

When President Dwight Eisenhower assumed office in January 1953, bringing the Korean War to a conclusion shortly thereafter, the U.S. economy was thus at a crossroads. One alternative would have been to use the “peace dividend” from ending the Korean War as an opportunity for an early form of supply-side Reaganomics, reducing the top rate of federal income tax from 91% to 50% or so. That could easily have been afforded; government consumption expenditures as a percentage of GDP fell by 6% in 1953-55, which would have paid for a massive tax cut.

The other alternative was what actually happened. A tight control was kept on non-military expenditure, at least until Eisenhower’s last two years when he was faced with an overwhelming Democrat majority in Congress, but income tax rates were left at their absurdly high levels.

Contrary to current rose-tinted leftist memory (which rose-tinting they don’t accord to the Eisenhower years on cultural or social issues) the result was a period of remarkably slow economic growth, with no fewer than three recessions in eight years, in 1954, 1957-58 and 1960 – the last of which probably cost Richard Nixon the 1960 election. GDP per capita, the best measure of economic performance, rose at only 0.96% per annum during the 7 years 1953-60, or 0.92% per annum during the 8 years 1953-61, depending on how you want to count the Eisenhower administration’s period of economic control.

This was far below comparable growth rates since. The boom of 1960-68, combined with the Kennedy/Johnson tax cuts of 1963-64 (which reduced the top rate of tax to a more reasonable though still extortionate 70%) brought annual growth in GDP per capita of 3.5%. The allegedly sluggish 1970s from 1968 to 1980 still produced growth in GDP per capita of 1.9% (1.7% during the Nixon/Ford administrations, accelerating marginally under Jimmy Carter.) The Reagan growth years produced per capita GDP growth of 2.4%, which slowed somewhat to 2.2% in 1988-2000, including the supposed miracle growth of the Clinton second term. Only in the ineptly governed 2000s, also including two major recessions, did the growth rate per capita slow to 0.64% in 2000-11, but it must be remembered that this is a somewhat unfair comparison, tracking growth between the peak of a fabulous boom to a year still mired in the deepest recession since World War II. It won’t take much growth in 2012-13 to push post-2000 per capita growth above the feeble Eisenhower level, even with the current very poor macroeconomic management.

There is one mitigating factor, but it shrinks on closer examination. The 1950s were the years of the “baby boom” in which a historically high birthrate brought a massive increase in young people, stressing school facilities and lowering per capita growth, since most of them were not yet working. Conversely, the 1950s, before the liberalized 1965 Immigration Act, saw very little immigration of unskilled workers tending to bring down average productivity, but instead a modest flow of very highly qualified people fleeing the tyrannies of the Soviet bloc or the poverty of East Asia. However even with immigration low the slack Eisenhower-era labor market affected African-Americans disproportionately, slightly reversing their long-term improvement in relative incomes compared to whites and worsening their disadvantage in unemployment rates.

The Eisenhower years were a period of remarkable scientific advance, from the Salk polio vaccine to the space program. Furthermore, during those years U.S. industry was almost without serious competition in world markets, a technological leader in almost all fields, except a very few such as jet aircraft where the enfeebled Britain clung to a modest pre-eminence. Macroeconomic policy was sound and monetary policy, in the early years of William McChesney Martin at the Fed, was even sounder. Inflation was gradually declining and budgets were close to balance.

The 50s had massive expenditure on the Cold War, but much of that spending was highly productive by government program standards, producing weapons systems that remained viable for decades into the future and rarely suffered intolerable budget overruns. Meanwhile the private sector was almost unhampered by excrescences like the EPA and the OSHA and so was able to produce the magnificent automobiles of the tailfin era without government interfering in the process – or wanting to; opposition to tailfins was at that time confined to a tiny minority of pointy-headed intellectuals and Beat poets.

It was the Golden Age of science fiction, when a superb honor roll of authors produced Hugo awards during the Eisenhower years for Robert Heinlein, Poul Anderson, Fritz Lieber, James Blish, Robert Sheckley, Kurt Vonnegut, Clifford Simak, C.M. Kornbluth, Arthur C. Clarke and Daniel Keyes (for “Flowers for Algernon”) with Isaac Asimov, John Wyndham and Frederic Pohl also active but neglected by the Hugo jury during these years. The period thus represented a peak in thinking about the future and imagining technology that the future would contain. According to 1950s science fiction, we should by now be colonizing a rapidly expanding interstellar empire while at home robots would cater for our every need, eliminating poverty and drudgery.

Yet economic growth in the Eisenhower years was pathetic, around the levels of our own far more troubled years. Very little of the intellectual ferment represented by science fiction translated itself into entrepreneurial activity. Venture capital was in its infancy; the first such fund American Research and Development was founded by Harvard Business School professor Georges Doriot in 1946, but made its signature investment of a mere $70,000 in Digital Equipment Corporation only in 1957. Most technological activity took place in large companies, with the transistor invented by William Shockley at A.T. & T.’s Bell Laboratories in 1948 and the integrated circuit at Texas Instruments in 1958. The era’s leading technological thinkers were probably Richard Feynman and Shockley; Feynman remained in academia throughout his career, while Shockley’s attempt at entrepreneurship was a dismal failure.

One can’t help thinking that Feynman, Shockley and the more scientifically capable of the science fiction writers would today be spinning off start-ups, aided by massive Silicon Valley funding. Shockley was arrogant and a poor manager, but these qualities would hardly have held him back from success and wealth in the era of Peter Thiel and Mark Zuckerberg. Part of the change is technological – 1950’s industry lent itself to mass standardization in very large units, since with only primitive information systems costs could not be reduced to competitive levels by any other means.

Yet you have to come back to the fact that a 1950s Peter Thiel, perhaps juggling advances in semiconductors, would have had great difficulty in getting going, since there were almost no venture capital sources. His own earnings, even if at the top end of what was available in U.S. industry, would after the punitive Eisenhower-era taxes not have enabled him to pull together the necessary entrepreneurial grub-stake. After all Ken Olson and Harlan Anderson, the founders of Digital Equipment, had to sell 70% of their company to AR&D to raise a mere $70,000, equivalent to less than $600,000 today – the after-tax bonus of a mid-level employee of Goldman Sachs. In such an environment, why would the 1950s Thiel have bothered with entrepreneurship? – so maybe the world would have gained some incomparable science fiction!

Eisenhower was an admirable man, and in many ways a good President. But one can’t help feeling that a more free-market President, maybe Robert Taft, would have produced a much more dynamic U.S. economy, with faster growth in living standards. Far from being a paradigm to follow in economic policy, the Eisenhower years were a waste.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations—8% versus 46.5%, according to recent research. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)