Aftermath. Thomas E. Hall

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СКАЧАТЬ It was also the era when the income tax replaced excise taxes on tobacco and alcohol as the major source of federal revenue.⁸

       Changing of the Guard

      World War I and its aftermath cost the Democrats dearly in the 1918 and 1920 elections. They lost control of Congress in the 1918 elections, and incurred further damage by losing more congressional seats along with the White House in 1920. The Republicans assumed control of the government in March 1921 and held power for the remainder of the decade.

      A major economic policy figure during the 1920s was Pittsburgh industrialist Andrew Mellon, who served as U.S. treasury secretary from 1921 to 1932. Mellon agreed with Woodrow Wilson’s and Carter Glass’s claim that high income tax rates reduced the incentive to earn taxable income, but Mellon took the argument a step further. He believed that if the disincentive to earn income was strong enough, then high tax rates could yield less revenue than if rates were lower. In other words, lowering income tax rates might cause people to earn enough additional income to cause an increase in tax revenue. This view was an important part of Mellon’s case about why income tax rates should be reduced, and congressional Republicans and Presidents Warren Harding and Calvin Coolidge were amenable to it.

      The result was a series of tax laws passed during the 1920s that reduced income tax rates, including lowering the top rate from 73 percent to 24 percent. Many economists consider these lower tax rates to be one of the reasons that the U.S. economy performed so well during the decade. The income tax was also made more broadly based by reducing the income exemption so as to raise the number of taxpayers (although the tax was still directed at high incomes). In the early 1920s, the income exemption for married couples was reduced from $4,000 to $2,500.⁹ Given the tremendous economic growth that took place during the decade (per capita income rose about 30 percent from 1920 to 1929), ever-increasing numbers of Americans paid taxes.¹⁰

      Meanwhile, the federal government was shrinking in relation to the overall economy. In 1920, federal outlays were $6.6 billion, which represented 7.3 percent of that year’s economic output. By 1929, federal outlays were $3.8 billion, or 3.5 percent of economic output.¹¹

       Raising Taxes during the Depression

      The Great Depression (1929–1941) ranks among the most significant events ever to occur in the United States. The severity of the initial economic recession (1929–1933) is important to the history of the income tax because it caused plummeting incomes, which resulted in a huge decline in tax revenue. Consequently, the federal government experienced sizable budget deficits. The prevailing view at the time was that budget deficits should be avoided, and one way to balance the budget was to raise revenue. Mellon’s idea that lower tax rates could yield more revenue was thrown out the window. The government instead opted for higher tax rates.

      President Herbert Hoover started the tax increase ball rolling in 1932. Figure 2.1 shows the top and bottom federal income tax rates from 1913 to 2011. The budget deficit was a major issue in the 1932 presidential election between incumbent Herbert Hoover and challenger Franklin Roosevelt, and both men pledged to balance the budget. In 1932, before the election, Hoover supported higher tax rates as a way to raise revenue, and Congress passed the tax increase in June. Figure 2.1 shows that tax rates rose substantially for high-income taxpayers as the top rate went from 24 percent to 63 percent. The corporate profit tax rate was increased as well. These higher tax rates, however, did not eliminate the budget deficit because the economy continued to plunge in 1932, in part because the higher tax rates reduced both spending and the incentive to earn income.

Figure 2.1 TOP AND BOTTOM FEDERAL MARGINAL TAX RATES ON INCOME, 1913–2011

      SOURCES: 1913–2002, IRS, www.irs.gov; 2003–2011, Tax Foundation, www.taxfoundation.org.

      The 1929–1933 recession had a huge impact on the fortunes of the country’s two major political parties. The Republicans went from enjoying substantial congressional majorities in the late 1920s to very thin margins (one seat in the Senate, two in the House) following the 1930 elections. The coup de grâce came in 1932, when the Democrats gained 12 Senate seats and nearly 100 House seats. The Democrats also won the presidency that year when Franklin Roosevelt scored a landslide victory over Hoover. The incoming president’s plans for economic stimulus included various New Deal programs for work relief and welfare that would require significant funding. Since the government’s budget was already in deficit and Roosevelt intended to spend even more, the plan was to raise tax rates to generate additional revenue. The public, many of whom blamed the Great Depression on a failure of capitalism, supported higher taxes so long as the increases were targeted at the upper-class capitalists.

      Figure 2.2 shows federal revenue and spending data from 1929 to 1940. Roosevelt’s New Deal began in March 1933, and during the next few years, the programs required ever more funds. The economic recovery combined with the higher income tax rates that took effect in 1932 caused revenue to rise, but not fast enough to eliminate the federal budget deficit. So beginning in 1934, Congress passed and President Roosevelt signed a series of tax laws that substantially raised rates on personal income, corporate income, and inheritances. For example, the 1936 Revenue Act maintained the $2,500 exemption for a married couple, but raised tax rates to a maximum of 79 percent on incomes above $5 million. Corporate income was taxed at a maximum rate of 15 percent, plus a tax was instituted on undistributed profits. Francois Velde estimates that for households earning more than $4,000, this law nearly doubled the average tax rate from 6.4 percent to 11.6 percent (2009, 19). Another major tax change during the decade was the institution of the Social Security tax in 1937.¹² The Social Security Act (1935) imposed a 2 percent payroll tax on the first $3,000 of wage income beginning in 1937. That year, the new tax accounted for 10.5 percent of federal tax revenue (Velde 2009, 19).¹³

Figure 2.2 FEDERAL RECEIPTS, SPENDING, AND BUDGET SURPLUS, 1929–1940

      SOURCE: Economic Report of the President (1963, p. 238). Data are for fiscal year July 1–June 30.

      Except for the Social Security levy, taxes assessed on income during the Depression were directed at high earners. This feature of the tax laws provided the upper class with a strong incentive to avoid paying taxes. After all, these income tax increases were not temporary war-funding measures; instead they were peacetime measures that might be in place for a long time. Wealthy Americans—some of whom considered Roosevelt (who was descended from an upper-class New York family) a “traitor to his class”—hired lawyers and accountants to figure out ways to avoid paying.¹⁴ For example, business owners could compensate themselves in the form of nontaxable fringe benefits instead of taxable wages and business profits. Corporations did similar sorts of things; one common method was to move operations offshore to avoid paying taxes. During congressional hearings in 1937, members of Congress were shown photographs of small shacks on Caribbean islands that served as corporate headquarters for tax purposes (Carson 1977, 120).

      High tax rates also increased the opportunity for politicians to hand out more political favors in the form of tax breaks. Taxpayers subject to high rates had a strong incentive to appeal to their political representatives for relief. Members of Congress were able to hand out benefits in the form of tax exemptions for various activities, the implied quid pro quo being that the beneficiaries would lend СКАЧАТЬ