Tuesday, December 2, 2008

Room to Maneuver?

That the march by the world's central banks to what seems to be an inevitable zero interest rate policy leaves very little room to maneuver for these institutions has not gone unnoticed or uncommented on. Many others have covered that ground already.

A couple of weeks ago, I read The Great Crash of 1929 by John Galbraith. It's as light a read as possible considering the topic. There were a lot of details that warranted close attention but one thing that struck me as interesting was Hoover's decision to cut tax rates on both individuals and corporations. This was ineffectual due to the fact that the cuts (at least for individuals) were basically insignificant. Galbraith cites a man earning $5000 received a tax cut from $16.88 to $5.63. While these cuts were well-received, they did little to actually help the problems.

This got me thinking about the latest tax rates and how much room there is to maneuver for the Federal government in terms of economic stimulus via tax cuts as opposed to outright cash returns.

The chart here shows a few things from 1975 to 2008. The bars indicate median household income in nominal dollars, the upper limit of the tax bracket for a married couple filing jointly of the median income, and the lower limit of the maximum tax bracket. The lines indicate the marginal tax rates (MTR) for this median household and for the maximum tax bracket.

Two major things stick out. First, the significant drop in the highest MTR from 70% in 1975 to 35% in 2008. Second, the MTR for the median household income has not changed since 1987. There is also the fact that the lower limit of this maximum tax bracket has increased considerably from $250k/year in 1993 to $357k/year in 2008.

Considering the very large annual deficit already run by the Federal government, it seems difficult to imagine further tax cuts on what are already low rates by relative standards. Even if tax cuts were made it seems unlikely that they will be significant enough to kick start spending or borrowing again anyway.