I Like Ike’s Restrained Spending

There has been a lot of talk lately about the “good ‘ol days” in the 1950s, when we had good economic growth, strong labor unions and high top marginal tax rates. One of my favorite blogs, Cafe Hayek, has done a number of posts regarding this. I would recommend that you take a look.

Just the other night I saw a new version of this as a meme on Facebook. It showed a picture of President Eisenhower with the following information:

ike“The Last Republican” – Dwight David Eisenhower
Was the last Republican to balance a budget
Refused to lower taxes
Paid down the national debt
Spent money to create jobs
Interstate highway he built returned $6 for each $1 it cost
He did not lower taxes, cut spending, kill jobs or increase the debt
He was the last fiscal conservative

Some of this is factually true. He was the last Republican President to have a balanced budget and did pay down the national debt. Other items I think are less clear cut, such as spending money to create jobs which is not something the government can actually do. One item is actually false and is mentioned below. Also, it leaves aside just how much role the president has in any of this list as it requires Congress to actually do them.

As it is mentioned twice, I get the sense that the taxes are meant to be the main focus here, and if we’d only go back to such higher rates, the economy would be strong, we’d be paying down the debt, creating jobs and more. I believe there are a number of factors that would tend to indicate that the prosperity of the 50’s was in spite of the higher tax rates rather than because of them, but for this post I want to look at the implicit claim that if we’d just raise taxes, everything would be fine.

The graph below shows the top marginal income tax rate (the pink line) as well as federal revenue (purplish line) and expenditures (dark green line) as a percentage of GDP. The blue line is a simple trend line for federal revenue over time. I’ve also added a couple other bits of data as well. The green vertical bands indicate major wars: Korea, Vietnam, Gulf War, War on Terror (working left to right). The pinkish vertical band marks the period of Eisenhower’s presidency.
So there are a couple of interesting things to see in the graph. The first is that for the first 20 years indicated on the graph, federal expenditures as a percentage of GDP stayed fairly constant. Something that wasn’t mentioned in the list of Ike’s virtues, and in fact is falsely stated as something he didn’t do, is that he was the only president since 1950 to actually cut government spending, and not just in the modern sense of spending less than an automatically increased baseline spending. Between 1953 and 1954 it appears that federal spending decreased in real (inflation adjusted) dollars by about 4% and was essentially flat between 1954 and 1955.

The second interesting point is that the line indicating federal revenues runs pretty consistently around 18% of GDP. There are a few years when it gets higher, near or slightly above 20%, but it tends to drop back down to the 18% range. This consistent level of income is despite the wide range of top marginal tax rates. So not only do higher rates not result in increased long term revenue, they are also likely to reduce economic growth. According to Tax Foundation chief economist William McBride, “Nearly every empirical study of taxes and economic growth published in a peer reviewed journal finds that tax increases harm economic growth.”

Also note that as rates have come steadily down, the trend of federal revenues has risen slightly, seeming to indicate that over the long term, lower tax rates can lead to higher revenue as a percentage of overall GDP.

If we were currently spending the same percentage of GDP as Eisenhower did during his 8 years in office, 16.6% on average (as opposed to the current ~25%), our current deficit would be something like $190 billion instead of the $1100 billion it actually is. If in addition revenues were at the long term trend line, we’d have a surplus of about $200 billion. So maybe the reason Ike was able to pay down the debt was because he restrained spending rather than kept taxes high?

[Please do not assume that I think the government should be spending 16.6% of our GDP, as I believe that a lot (most?) of what the government does today it actually does not have any business or authority to do.]

One final note from the graph which doesn’t have anything to do with Eisenhower is marked by the red vertical line indicating 1971. I noticed that prior to this, the lines for federal revenues and expenditures track pretty closely together, with revenue being higher than expenditures most of the time. After 1971, these lines diverge quite a bit and in general expenditures are always higher.

The most likely event to have caused this was that in 1971 President Nixon took the United States off the last remnants of a gold standard, making the dollar a fiat money. Since fiat money is not connected to any objective standard of value, governments can create as much of it as they might want. Not surprisingly this results in higher inflation. In the 40 years prior to 1971 inflation averaged about 2.5% while in the 40 years since, it has averaged about 4.4%.