Bailouts and Taxes: Behind the Modern Economy

On this day in economic and financial history...

Europe is in trouble and may not recover. How did it get itself into this situation? To understand Europe's present, it's important to learn from its past. In many ways, the European Union as we now know it began taking shape on Oct. 3, 1990, the day Germany once again became whole.

The fall of the Berlin Wall in 1989 was followed by a tumultuous period of protests and free elections in East Germany, which led to the two Germanys signing a reunification treaty May 18, 1990. East and West united on Oct. 3. The healing process, and the rebuilding of a ruined East Germany, would take years. In many ways, that process is still ongoing.

The costs of reunification have been staggering. More than 20 years on, the price tab has been estimated at a net $1.9 trillion in transfers to rebuild the former East German territory, much of it designated for welfare payments to long-impoverished residents.

The East remains less prosperous even today, its shrinking economy limping along with per-capita GDP levels 29% lower than those of the western regions. One in five East Germans still lives in poverty, and the two halves of the country look at each other still and see something unfamiliar -- only a quarter of East Germany felt like "ein Volk" (one people) with the West, and under half of the West feels that way about the East, after two decades of supposed unity.

The size of Germany's economy has doubled since reunification. This, shockingly, is not near Europe's best growth rate. Of the five largest European economies, only Italy has grown at a slower pace since 1990. Spain, before its recent troubles, saw its GDP nearly triple over the same time frame.

Was it worth it?

Norquist's nightmare
The Revenue Act of 1913 was signed into law on Oct. 3, reinstating income taxes for the first time since they had been declared unconstitutional in 1895. Backed by the newly ratified Sixteenth Amendment, 1913's Revenue Act ushered in the modern era of income taxation, which has continued uninterrupted to the present day.

The lowest amount of income subject to tax was $20,000, on which was imposed a 1% tax rate. Few people had incomes high enough to be taxed, as $20,000 in 1913 would be equivalent to $465,000 today. The highest tax rate of 6% was reserved only for those making more than half a million dollars, or about $11.6 million in modern terms. The Los Angeles Times estimated that only 4% of the country's population would be subject to the tax in its first year.

Bailout day, part 2
Reunification Day isn't the only bailout that effectively began on Oct. 3. The Emergency Economic Stabilization Act was enacted four years ago today, authorizing the transfer of $700 billion to distressed financial institutions during the depths of the financial crisis. It created the Troubled Asset Relief Program, which has thus far disbursed $431 billion, generating an estimated $32 billion loss for American taxpayers.

The bailout did nothing to stop a worldwide market slide that continued into the following year. The Dow Jones Industrial Average (INDEX: ^DJI  ) fell below 10,000 on its next trading day and would set records that week for the largest single-week decline in history, both in terms of point values (1,874 points lost) and percentage declines (the index finished that week 18% lower).

Of the many banks participating, Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) received the largest bailouts from the program. Both required two TARP payments, adding up to $45 billion per bank, which have both since been repaid in full, with interest. General Motors (NYSE: GM  ) received over $50 billion, of which $27 billion remains outstanding, the most of any non-government-sponsored enterprise. Its finance arm, Ally Financial, still owes the Fed nearly $11 billion.

The Dow's since rebounded and is 31% higher four years on. The same can't be said of Citi or Bank of America, which have since lost 82% and 73% of their value, respectively.

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Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights.

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