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May 10, 2012
News Analysis: Are You Sure? Uncertainty, Taxes, and Recovery
Joseph J. Thorndike

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Over the course of the Great Recession, we've heard a lot about business confidence and uncertainty. The meaning of these words isn't always clear, and neither is their relationship to one another. But one thing is certain: They are proxies for a broader argument over Keynesian economics.

The confidence debate is highly politicized. Conservatives generally insist that business confidence is vital for recovery because it spurs investment. Liberals, on the other hand, ridicule the "confidence fairy," especially when it's used to buttress calls for fiscal consolidation. The problem isn't sagging confidence and a consequent dearth of investment, but rather a shortfall in aggregate demand, best remedied through fiscal stimulus, they say.

These days, arguments about confidence center on disagreements over European fiscal policy, including the austerity measures forced on countries like Ireland and Greece. But history also looms large in the confidence debate, as policy wonks on both sides marshal evidence from the 1930s to support their positions.

So what can history tell us about the role of business confidence in the 1930s? Did sagging confidence prolong the Great Depression? Or was low confidence a symptom, rather than a cause, of the economic slump?

The unsatisfying answer? Both.

Confidence and Uncertainty

Confidence and uncertainty are often linked in political debate, but the connection between the two concepts isn't always obvious. Historian Robert Higgs, a leading critic of the New Deal, has clarified matters by introducing the notion of "regime uncertainty," which he describes as "more definite than the hoary but vague idea of 'business confidence.'"1

For Higgs, regime uncertainty describes "a pervasive uncertainty about the property-rights regime -- about what private owners can reliably expect the government to do in its actions that affect private owners' ability to control the use of their property, to reap the income it yields, and to transfer it to others on mutually acceptable terms." Regime uncertainty can be profound or subtle. On the one hand, it might reflect worries that government will simply expropriate private property. This is the socialism bugaboo.

Alternatively, regime uncertainty can describe a fear that government will leave intact the trappings of private property but strip owners of "real control and profitable use of their properties," Higgs writes. This weaker version of regime uncertainty can encompass numerous issues of economic policy, including regulatory, monetary, and tax policies.

In the 1930s, regime uncertainty took both extreme and subtle form. Some business leaders worried publicly about the rise of socialism. Franklin Roosevelt was a dangerous man in their eyes, and a threat to the most basic American rights of political freedom and private property.

Other critics were less worried that FDR would dismantle private property wholesale and were more concerned that he would take it apart piecemeal. New Deal regulation of the labor market was a leading complaint, but taxes loomed especially large in the indictment offered by these critics. The Wealth Tax Act of 1935 was an obvious problem, especially because the rhetoric used to defend it made broad claims about the social origin of private wealth. As FDR said:

    In spite of the great importance in our national life of the efforts and ingenuity of unusual individuals, the people in the mass have inevitably helped to make large fortunes possible. Without mass cooperation great accumulations of wealth would be impossible save by unhealthy speculation. As Andrew Carnegie put it, "Where wealth accrues honorably, the people are always silent partners."2

Such sentiments worried the "unusual individuals" in possession of great wealth. But the undistributed profits tax of 1936 posed an even more serious threat. This novel levy challenged the managerial and ownership prerogatives of American business by stripping corporations of their freedom to dispose of profits as they saw fit. The undistributed profits tax, in other words, challenged the very essence of American capitalism: the right of business owners to control their own property.

FDR's tax rhetoric served to underscore such fears. His loose talk about "economic royalists" fostered a sense of alienation and persecution among business leaders. As a result, those leaders refused to invest in productive enterprise. In his article on regime uncertainty, Higgs describes the long-term shortfall in business investment during the Depression decade. Between 1930 and 1940, he reports, net private investment totaled negative $3.1 billion; only in 1941 did private investment surpass what it had been in 1929. "The data leave little doubt," Higgs concludes. "During the 1930s, private investment remained at depths never plumbed in any other decade for which data exist."

Not all economic historians agree with that assessment.3 But for what it's worth, many New Dealers did. In particular, Treasury Secretary Henry Morgenthau fretted constantly that FDR's attacks on business were impeding recovery. To be fair, Morgenthau was never much of a New Dealer, but rather a Roosevelt loyalist. Still, as the Depression wore on, he became a consistent voice for easing the antagonism between FDR and the business community. In a 2010 article, columnist Amity Shlaes related a conversation between FDR and Morgenthau that made clear the latter's worry about business confidence. "You can do something about public utilities," Morgenthau told his patron. "You can do something about the railroads. You could do something about housing. Above all, you must do something to reassure business." Publicly, Morgenthau was even more outspoken, emphasizing the role of business investment in spurring recovery. "We want to see private business expand," he said. "We believe that much of the remaining unemployment will disappear as private capital funds are increasingly employed."4

Morgenthau's pro-business comments were part of a larger business appeasement campaign unveiled by the Roosevelt administration in the midst of the 1937-1938 recession. This so-called Roosevelt Recession figures prominently in today's arguments about the slow recovery from the 2008 financial crisis, which both conservatives and liberals use to buttress their arguments. Conservatives point to FDR's anti-business animus leading up to the 1937 recession, arguing that it helped derail the incipient recovery. By extension, the slow recovery from the 2008 crisis can be explained by Obama's ostensibly anti-business governance.

Liberals, by contrast, insist that the history of the 1937 recession vindicates Keynesian explanations for the Depression generally and the Roosevelt Recession in particular. The 1937 slump followed close on the heels of a major fiscal contraction, as FDR pushed through large cuts in spending precisely when new Social Security taxes were kicking in, they argue. Together, these measures depressed aggregate demand and prompted a new recession.

For liberals, sagging business confidence was a reflection of this broader economic phenomenon, not its cause. No one expressed this point better than Marriner Eccles, Federal Reserve chair in the 1930s and an early convert to Keynesianism. "What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed," he wrote.5

Ultimately, while Keynesians have the better of this argument, both sides have a point. The sharp fiscal contraction of 1937-1938 seems more than adequate to explain the Roosevelt Recession, especially because it coincided with newly tightened monetary policy at the Federal Reserve. Indeed, even many conservatives have granted as much.

But business uncertainty still played a role, even if it was not the primary explanation for the 1937 recession -- or the long duration of the Great Depression itself. Aggregate demand is the big story of the 1930s, but business confidence is part of the tale, too. To believe otherwise is to dismiss not simply the sincerity of business critics, but the worries of New Deal loyalists, too.

Uncertainty in 2012

Today, conservatives still worry incessantly about business confidence and economic uncertainty. Scholars affiliated with the American Enterprise Institute (AEI) have even developed a new "uncertainty index" to measure the harm caused by economic anxiety among business leaders and the general public.6

"Economists have long known that uncertainty can have large negative effects on economic activity," notes AEI scholar Kevin Hassett in a discussion of the new index. "If a business does not know what its tax rates will be next year, it will have a hard time getting excited about a big expansion."7

Such sentiments seem reasonable, especially in light of the looming Taxmageddon scheduled to arrive at the end of 2012. But the economic destruction likely to result won't be a simple function of failing confidence or even business underinvestment. The gigantic fiscal contraction baked into our existing tax laws will confirm Keynesian analyses of our current economic doldrums -- as well as the economic cataclysm yet to come.

Moreover, it's worth recalling who's to blame for the current climate of tax uncertainty. Hassett fingers the Democrats exclusively. "Taxmageddon is the result of the extreme shortsightedness of President Obama and the Democrats, who extended current tax policies for only two years back in 2010," he writes. "The latest research suggests that the economy will suffer severely this year for that shortsightedness."

That's fair, as far as it goes. Democrats are certainly complicit in this looming disaster. But Republicans voted for it, too. And if we're in the market for original sins, let's remember that it was the Republicans who started us down this road to uncertain disaster when they enacted their "temporary" tax cuts of the early 2000s.


1 Robert Higgs, "Regime Uncertainty, Then and Now," The Freeman, Jan./Feb. 2012, available at

2 Franklin D. Roosevelt, "Message to Congress on Tax Revision," June 19, 1935, the American Presidency Project, available at

3 In a 1985 article, for instance, Thomas Mayer and Monojit Chatterji conclude that political shocks in the 1930s did not frighten off business investment. See Mayer and Chatterji, "Political Shocks and Investment: Some Evidence From the 1930s," Journal of Economic History, Vol. 45, No. 4 (Dec. 1985), 913-924.

4 Amity Shlaes, "FDR, Obama and 'Confidence,'" The Wall Street Journal, July 13, 2010, available at

5 Marriner S. Eccles, Beckoning Frontiers; Public and Personal Recollections, 78 (Knopf, 1951). Also quoted on the Naked Keynesianism blog, "The Inflation Expectations Fairy," Apr. 26, 2012, available at

6 Steven J. Davis, Scott R. Baker, and Nicholas Bloom, "Measuring Economic Policy Uncertainty," Feb. 3, 2012, available at

7 Kevin Hassett, "The New Age of Anxiety," National Review, Apr. 27, 2012, available at