Thomas Woods and the Depression of 1920-21

Posted on March 25, 2010


My Stepson Luke sent me a link to an article by Thomas Woods.  It’s an interesting read, as it challenges conventional orthodoxy what the government should do to deal with a depression.  Unfortunately, I think the article is full of holes, cherry-picking of data and unreasonable prescriptions that simply won’t work.  Here was my answer to him.

The basic cause of the decline in GNP, increase in unemployment, and everything else in 1920-21 was the end of World War I.  Back then, the government was relatively small, and ending a war allowed the government to spend less.  And let’s be real clear about what they did.  They didn’t cut taxes for everyone; just the rich.  Here are the tax tables for 1920 (before Harding pushed through the Revenue Act of 1921, and 1922.

Remember that this is in a time when the median income is just slightly more than $1000.  So for most people, their taxes didn’t change at all.  But for the Rockefellers and others making $1,000,000 or more, they suddenly had 25% more money to spend.  Also note that the top marginal tax rate was 50% after Harding’s cuts.  Today, the top marginal rate is only 35%, starting at $374K and above.  In reality, very few people pay above 25% of their adjusted gross income (AGI) in Federal Income Tax.

A couple other facts that weaken his argument.  First, he implies that the economy quickly recovered.  In reality, this economic contraction was 1 month longer than the historical average (18 months compared to the average of 17 months) – see here  It’s also interesting to note that there was another business contraction from 1923-24, another from 1926-27 and of course the great depression from 1929-1934.   The point I’m making is that Harding didn’t introduce a magic bullet (cut government spending) that suddenly improved the economy.

He says that Harding cut government spending almost in half and that’s true, it dropped by 48% from 1920 to 1922.  Of course, I’d argue that what really happened was that we went from a wartime spending pattern to a peacetime spending pattern.  After World War II, the exact same pattern emerged, where government spending dropped by 47% from 1946 to 1948.  Unless you end a war, it’s very difficult to cut spending this much.  And by the way, he cut revenues by only about 39%, and a good bit of that was due to the contraction, not government action.  Also, if you compare pre-war spending, Harding’s reduced budget was still more than 4 times as large as the pre-war budget.

Bottom line – it’s not that simple.  Could we and should we  cut some government spending?  Yes, but it’s not easy.  Go study the Federal budget, and I challenge you to come up with a balanced budget that Americans could live with.

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