There is an old saying that those who fail to learn the proper lessons from history are doomed to repeat them.  So in this time of economic uncertainty what lessons can we learn from history as to how to escape from this current economic turmoil?

During the early part of the Great Depression, FDR's administration kept coming up with public works projects designed to keep Americans busy. It was not until after the United States was drawn into World War II, that the United States and much of the rest of the world experienced the prosperity that came afterwards.  So what are the lessons waiting for us to learn that we should have learned?

In the early 1980's, Ronald Reagan inherited a stagflation that had crippled many businesses, saw high unemployment and had people waiting in long lines for rationed gasoline.  However, by the end of his administration Ronald Reagan could rightfully boast about how strong the economy of the United States had become under his tenure as President.  What happened on his watch to change the economic circumstances of the United States?

In both cases, the new President inherited an economic mess from his predecessor, but their initial reactions in how to get out of it were different.  While FDR's inherited mess lasted for over a decade, Reagan was able to get the economy running efficiently again within 3 years, why?

To answer these questions we have to take a look at what actions each of these Presidential Administrations took and what impact they had on the American economy of their time.

Let's first revisit the Administration of FDR and see what actions the Administration took and what impact those actions had on the economy.  FDR was elected in 1932 and was sworn into office in March of 1933.  From March of 1933 until December of 1941, the Administration of FDR was consistently creating and repackaging programs and agencies with what some called an alphabet soup of agencies.  The primary purposes of these agencies were to keep the American public busy and paid from government coffers until the economy turned around.  Most of the jobs were one time projects that once they were finished another project, whether it was needed or not, had to be created to keep these folks employed and happy.  However, the Great Depression continued and in some areas of the country became even worse.

Then Pearl Harbor was bombed and America declared war on first Imperial Japan and then Nazi Germany and Fascist Italy, after they declared war on us.  In response to this war the economic policies of the United States also changed.  Instead of funding an alphabet soup of Federal Agencies that thought up projects to keep Americans from complaining, the Federal Government started buying from private businesses, temporarily relaxing of federal regulations to help keep costs low and among other things started selling war bonds to help pay for the costs.  By buying the products from private businesses in order to fight the war, the Administration of FDR stumbled out of the Great Depression and gave us a historical clue in how to get out of similar economic tough times.  What they did was they invested in businesses by purchasing products from private businesses. This both kept Americans busy in jobs with businesses that could become self sustaining after the Federal dollars went away and gave businesses money.  This money gave these businesses the ability to pay off their debts, become more efficient, develop new techniques & technologies and reinvest in other businesses through the purchasing of their products.

Fast forward to 1980, in November of that year Ronald Reagan was elected President of the United States and like FDR he inherited an economic mess. In January of 1981 he was sworn in and he surrounded himself with economists who were of the Monetarist school of economic thought.  These men included Milton Friedman, Arthur Laffer, Alan Greenspan, and George Schultze.  Among their recommendations was that Reagan needed to cut taxes, thereby allowing the American businesses and the American public to keep more of their income property, and that both the size and scope of government had to be reduced.  In the next couple of years Reagan's Administration closed down government agencies, slashed government regulations and enacted a huge tax cut to both businesses and to individual Americans.  By allowing American businesses and individuals to keep more of their hard earned money, Reagan created a long and sustained time of economic good times that made him one of the most popular Presidents at the time of his leaving office. He was so popular that the voting public decided his Vice-President was a good choice to keep "the good times rolling".

Again fast forward to today, economists tell us that the present economic crisis started in January of this year a little over a year after the Democrats took control of both Houses of Congress from a Republican Party that got too comfortable and was reeling from numerous scandals involving corruption and/or incompetence (i.e. Jack Abramoff/Duke Cunningham/Mark Foley/Hurricane Katrina).  We have a new President who is proposing to create projects that will keep the American public busy through the duration of those projects and he has assembled around him a team of individuals from the Keynesian school of economic thought.  But are the remedies these folks are currently putting forth going to work or will this become a repeat of the early years of FDR, which made the economic problems even worse in some areas of the country?

No, this is not the path to economic prosperity for our nation, but a path towards a depression rivaling the Great Depression. Why? These proposed remedies in their current form are neither helping businesses become self sustaining by purchasing products from them such as what FDR did for the war effort, nor are these proposed remedies reducing the government imposed costs of doing business or living as Reagan did in the early 1980's.  Instead what these proposed remedies are doing is essentially giving taxpayer dollars to temporary projects that will not become self sustaining nor help businesses to grow and innovate, despite whatever spin comes from the dais.

What do we need to do?

In order to get out of this current economic mess we need to remember what Thomas Jefferson once wrote to James Madison in 1784 and apply it to our current situation: "The simplest system of taxation yet adopted is that of levying on the land and the laborer. But it would be better to levy the same sums on the produce of that labor when collected in the barn of the farmer; because then if through the badness of the year he made little, he would pay little. It would be better yet to levy it only on the surplus of this produce above his own wants. It would be better, too, to levy it, not in his hands, but in those of the purchaser; because though the farmer would in fact pay it, as the purchaser must deduct it from the original price of his produce yet the farmer would not be sensible that he paid it...What a comfort to the farmer to be allowed to supply his own wants before he should be liable to pay anything, and then to pay only out of his surplus."  Both Jefferson and Madison lived in an agrarian society, and today we do not, but from this bit of wisdom we can apply it to the businesses and our individual taxpayers of today, substituting them for the farmer and their income property for the produce.

What I am proposing as the fastest way out of this economic mess is to change the tax code in such a manner as to allow businesses and individuals to keep in their pockets more of their own money.  This way would make deflation come from a reduction in the cost of doing business & the cost of living, as opposed to the devaluation of our currency (which is happening right now).  To do this without any more economic dislocation than is absolutely necessary, we must transition away from the current taxation of income property to a consumption tax of some sort.  Of the various sorts of consumption taxes to transition to, the sales tax is the least complicated to comply with and the least costly to enforce.  Of the various types of sale taxes, a "progressive" sales tax with at least 3 rates is probably the type most likely to be passed by Democrat controlled legislatures. Add in a gaming tax similar to those charged in Nevada on winnings before the winner of a prize can collect it (thereby treating winnings as a product purchased rather than as income) to keep the "progressive" sales tax rates lower and the bill creating this change probably has a greater chance of passage.

So what sort of rates of taxation would be in a "progressive" sales tax? To some degree in California we already have a "progressive" sales tax of two rates, where certain products and all services are not taxed, while other products are.  So, a "progressive" sales tax would definitely have a zero percent rate on such things as necessities for survival (i.e. groceries, certain medicines & medical care, rent), certain business to business transactions (to keep the final product cost small), government mandated costs (i.e. auto insurance, smog checks, licenses), and investments for future needs (i.e. medical care, retirement, education).  A "progressive" sales tax would also have a luxury rate on products like yachts, private airplanes, elective plastic surgery, hard liquor, caviar, etc... Then at least one middle rate on other products &/or services.

By moving from an income tax to a progressive sales tax rather than a two rate tax, the normal opposition put forth by lobbyists is reduced due to the fact that most lobbyists rely on the tax code to drive to them business and this would not eliminate that source of business.  Furthermore it reduces opposition from Democrats, who want a certain amount of "fairness" in any tax structure. The trade-off to this will be that a significant number of Republicans will be resistant to anything with a "progressive" label attached to it or will reflexively be for only an increase to the current two rate system.

How would it be best implemented?

In order to get the recovery to happen as quickly as possible with minimal or even no economic pain, the income tax system needs to be phased out starting with at least the withholding tax while the higher or new "progressive" sales tax rates are phased in over a few years.  In order to get enough Republican votes to get passage, there has to be an assurance that the income tax won't be resurrected.  Therefore, an amendment to the Constitution is needed, that permanently eliminates at least any type of income tax that will not be returned at some later date to the taxpayer. This amendment probably also must include protections making it much more difficult to raise the rates on the items in the zero percent category.  On the federal level, the option of whether or not to eliminate those payroll taxes that by law are suppose to be returned back to the taxpayer should be explored, because this action will raise the sales tax if they are also eliminated or keep the new rate(s) low, if not. In order to pass the 3 out of 4 state legislatures for ratification purposes, this amendment must also give collection power to the states with them keeping at least 10% as a collection commission.  This commission probably could pass with some broad strings attached like restricting the commission to paying for collection, education, medical care, &/or transportation funding.

If the withholding and income taxes are phased out from the bottom up by increasing each year the initial amounts of income spared from taxation, this provides an almost instantaneous stimulus to the economy by allowing individuals and businesses to keep more of the income property they earn.  This money will probably go towards paying off debts and increasing savings initially, but over time as debts are paid down this will lead to greater economic activity and the creation of more private businesses.  The paying off of debts will also free up liquidity in the markets as banks recoup money they thought they had lost, see the amount loaned to individuals and businesses decrease, and then turn around and become more willing to loan out the money.  This freeze in liquidity of money is one of the major problems keeping our economy from recovering and this reform addresses much of the debt left over from the bursting of the credit and housing bubbles.

As for the sales tax implications, in the short term it is difficult to say whether this will reduce sales as the sales tax rises or increase them as people find they are keeping more of their paycheck.  However, in the long run, there is good reason to believe that sales of most items will increase once the system changes permanently.  This reason is based on the fact that as businesses pay off their debts, while keeping more of their income they will lower their prices, so as to be more competitive.  This will take place simultaneous as individual taxpayers pay off their debts and increase their savings, which will give them more confidence to go out and spend their hard earned income property on goods that they are currently refraining from purchasing. The reduction in the cost of doing business and cost of living may also limit the out migration of jobs to foreign countries or at least remove one of the reasons used by companies that move their jobs overseas.

More needs to be done, such as address the causes that created the housing bubble, reducing medical care costs, reducing those regulations that are unnecessary and reducing the size and scope of the federal and state governments. However, this one step would jump start the recovery sooner than anything currently being discussed by the talking heads in Sacramento and Washington, D.C.  And it would do it in a manner that would make the economy more stable over time.