Hillary Parties Like It’s 1938 by Alan Reynolds in The Wall Street Journal:
Hillary Clinton’s most memorable economic proposal, debuted this summer, is her plan to impose a punishing 43.4% top tax rate on capital gains that are cashed in within a two-year holding period. The rate would drift down to 23.8%, but only for investors that sat on investments for six years.
This is known as a “tapered” capital-gains tax, and it isn’t new. Mrs. Clinton is borrowing a page from Franklin D. Roosevelt, who trotted out this policy during the severe 1937-38 economic downturn, dubbed the Roosevelt Recession. She’d be wise to consider how it played out.
Yet since the capital-gains tax rate grew in tandem with income-tax rates, the top income-tax bracket increased to 79% in 1936, while the capital-gains tax rate jumped to 63% for assets held one year, 47% after two years, 32% after five and 24% after 10. Even worse, the 1936 law added a surtax on “undistributed profits”—those not paid out as dividends but kept to finance business investment.
It didn’t take long for economic consequences to bubble up: In the 12 months between February 1937 and 1938, the Dow Jones Industrial stock average fell 41%—to 111 from 188.4. That crash presaged one of the nation’s worst recessions, from May 1937 to June 1938, with GDP falling 10% and industrial production 32%. Unemployment swelled to 19% from 14%.
Harvard economist Joseph Schumpeter, in his 1939 opus “Business Cycles,” noted that “the so-called capital gains tax has been held responsible for having accentuated, if not caused, the slump.” The steep tax on short-term gains, he argued, made it hard for small or new firms to issue stock. And the surtax on undistributed profits, Schumpeter wrote, “may well have had a paralyzing influence on enterprise and investment in general.”
More recent research confirms these insights. A 2011 study from the Federal Reserve Bank of St. Louis reported that monetary policy tightening, contrary to received wisdom, can’t explain the 1937-38 recession. “The 1936 tax rate increases,” they concluded, “seem more likely culprits in causing the recession.” Higher taxes on investors tended to fall on the more affluent individuals that supply capital to new firms.