Friday, April 30, 2010

The Great Tax Wars

Income Tax

“The Great Tax Wars”

By Steven R. Weisman

Book Review

By Richard E. Noble

“Politics: a strife of interests masquerading as a contest of principles; the conduct of public affairs for private advantage.” Ambrose Bierce.

Considering the above cynical definition as accurate, it is difficult then to imagine under what circumstances any democratic nation would ever agree to an “income tax” burdening a majority of citizens. If self-interest and perverse private advantage were the goals then a general income tax would certainly appear to be convoluted.

On one particular occasion I was talking to a “better off’ friend of mine and he informed me that he and the majority of his friends were not opposed to paying income tax but, on the contrary, considered it a “privilege.” On another occasion I heard Steve Allen, the comedian, say that he felt that he wasn’t paying enough taxes when he considered all of the benefits that he was receiving from this society. I wasn’t sure whether he was serious or making a joke.

Other than those two individuals what I have heard from Americans with regards to income tax – and taxes in general – has not been so gracious.

If I had been forced to guess under what presidential administration the nefarious “income tax” was enacted, I would have guessed that it happened under the Franklin D. Roosevelt administration – and probably in his first term. I would think this because in 1932 the nation was in big trouble – the Depression was raging. With a Great Depression raging one could presume that there would be a great majority of lesser-off when compared to better-off and in such a situation it would not be surprising that the majority of lesser-off in a democracy would vote themselves a share of what made the “better off” better off. But I was wrong.

Income Tax found its first proponents in Abraham Lincoln and his Treasury Secretary, Salmon Chase – Republicans. The bottom line was that there was a war going on and somebody had to pay for it. The Federal Treasury was dwindling, gold reserves were being depleted and the banks were beginning to wonder who was actually going to win this war – banks want to side with the winners of wars not the losers. Some type of tax was necessary. On July 1, 1862, Lincoln signed the first income tax in the History of the United States.

In the 1850s 92% of the Federal governments revenue came from tariffs placed on imported goods. The logic was that tariffs placed on imported goods not only protected and encouraged domestic industry but in addition protected American workers – there were even surpluses during times of high tariffs.

But as war costs escalated and tariffs grew, the price of goods skyrocketed and even with no Ralph Nader, the consumers began to scream.

Now the tariff argument took on a negative spin – tariffs were filling the pockets of the super wealthy and the war profiteers. Consumer prices were rising, manufactures’ profits were rising, and wages were not. The workers and the poor were fighting the war; spilling their blood on the battlefields and being worked to death in the factories while the rich industrialists and capitalist were raking in huge profits. Lincoln “the rail splitter” was also a railroad lawyer for the new corporate America and was filling the pockets of the wealthy with railroad track bonuses, cheap government land and no bid contracts.

The Federal government tried every way to raise money but the poor didn’t have any; the workers were earning so little that they couldn’t buy anything and pay the tariffs; the businessmen and bankers didn’t want to make loans or buy bonds being issued by a country that was at war with itself and so the income tax was looking better and better.

The first year of the war had cost 530 million. In February of 1862 The Legal Tender Act was passed and the Federal Government began issuing “greenbacks” – paper money with no gold backing – though most agreed that it was unconstitutional because printing paper money had nothing to do with Congress’s right to “coin money.” Prior to the Revolutionary War, there had been paper money failures that turned the colonialists against paper money and supposedly this precipitated the “coin money” clause in the Constitution. But Constitutional or not it was deemed necessary.

When an income tax was finally passed it was 3% on incomes over 600 dollars per year and 5% on incomes over 10,000 dollars per year. Even with a bottom of $600 very few Americans had to pay this new tax. It was primarily a tax on the wealthy and the super wealthy. The idea that the rich should pay higher income taxes was a first in U.S. tax law.

The argument against the income tax and especially the progressive nature of the tax was that it was merely a confiscation of the wealth of the minority on behalf of the more populous majority; it was a tax on the rich to punish the rich for being rich. The rich liked the tariff much better – everybody paid the tariff.

Those who favored income tax and its progressive nature “saw wealth less as the product of hard work and conscientious ingenuity but as a product of good luck, exploitation of others, political favoritism, and predatory conduct toward rivals. The income tax could be used as a tool to promote equity and curb the power of great wealth over government.”

The Civil War had cost both sides nearly 5 billion and left the new nation with a National Debt of 3 billion.

After the war the opposition to the income tax did not arise from the “masses” but from the ranks of the super wealthy. By the 1870 less than 100,000 Americans paid the income tax and by 1872 the income tax was gone.

It is estimated that the income tax during the Civil War never affected more than 10%of the Union population and some estimates as low as 1%.

The war had enhanced the ranks of the super wealthy a hundred fold or more but the debt would be left to the citizens who would pay the tariffs and whatever other taxes of a less progressive nature the government could devise.

“…the income tax was gone. Its abolition had one more important and lasting effect. That was to guarantee that the Federal Debt, which had been incurred to preserve the Union for all citizens, would now have to be retired largely by the working classes and farmers. The fact that the American debt – its bonds, notes and other forms of loans – was owned by the wealthiest Americans meant that the taxpayers of modest means were working to pay off the investments of the richest taxpayers. As the tax historian Sidney Ratner notes, the Civil War debt ‘became one of the most powerful instruments in America for the enrichment of the rentier class, the leading capitalists.’ For the next forty years, farmers, workers, small merchants and other working class Americans carried this debt burden, to the benefit of the rich.”
Ah yes, and it does seems that nothing has changed.

After the war and the removal of the income tax, the tariff came back with a vengeance. But as the rich grew richer and the poor grew poorer the debate of tariff vs. income tax became prevalent once again.

Being anti-income tax was a bipartisan issue – both wealthy Democrats and wealthy Republicans were against it. Today we know that one sixtieth of the population in those days owned over two thirds of the wealth and three quarters of American families were not worth more than $600. In another estimate it was suggested that only 9 families owned 71% of America’s wealth.

William Jennings Bryan, “the Great Commoner” spoke for the income tax and Burke Cockran and Senator Nelson Aldrich and a host of others from the ranks of the rich and famous spoke against the income tax. Senator David Bennett Hill, a democrat from New York submitted a list of 23 amendments to modify or defeat the tax. “The income tax,” he said, was a product of little squads of anarchists, communists and socialists bringing their pernicious ideas from across the ocean to American shores.” We were already into the “Cold War” mentality.

The argument was put to rest temporarily when the Supreme Court decided that an income tax law passed by the legislature of Massachusetts was unconstitutional. The case that came before the Court was Pollock v. Farmers’ Loan and Trust Co. On this particular issue Conservatives were not against “legislating from the Bench” but the Liberals were.

But with the onset of America’s next war at the turn of the century the need for money and the demand for sacrifices from the wealthy was renewed. McKinley’s Treasury was once again depleted due to shenanigans of J. P. Morgan and friends manipulating a gold crisis during the Cleveland administration. Tariffs were taken to a new high – averaging 57%. The new higher tariffs only succeeded in stifling imports and lowering federal revenues but nevertheless all attempts at reinstituting an income tax failed.

The argument raged on through McKinley, Teddy Roosevelt and Taft. The progressives along with labor and the new socialists argued for the income tax. They claimed that the wealthy and the super wealthy were being exempted from paying their fair share while the poor and middle class were picking up the whole burden via conventional taxing policies and inflation. The rich and wealthy argued that the whole idea was nothing but Anarchism and Socialism. Income tax was a singling out and a punishment on the few for working hard and becoming prosperous – it was simply social prejudice.
By the time we get to Wilson the arguments had gotten more sophisticated. Senator Borar suggested that the rich needed to understand that a more equitable tax system would protect their own livelihoods against the dangers of class resentment. On the other side men like John D. Rockefeller argued that “... when a man has accumulated a sum of money within the law, that is to say, in the legally correct way, the people no longer have any right to share in the earnings resulting from the accumulation.” Another interesting argument against the income tax was that taxing the rich inhibited their desire to contribute to charitable causes.

Even though the Federal Supreme Court had ruled against the income tax, they nevertheless left that option open to the individual states. And the income tax was then pursued on a state level by legislation and by amendment to state constitutions if necessary.

Wisconsin was the first to adopt a permanent income tax in 1911. A corporate income tax – interpreted by the Supreme Court to be an excise tax on the privilege of doing business in a corporate capacity and not an income tax – was passed and several states passed estate taxes. The national mood was changing.

It wasn’t until the controversial election of 1912 and the success of Woodrow Wilson and a Democratic takeover of both houses that an amendment permitting income taxes was ratified. Wyoming in February of 1913 became the thirty-sixth state to ratify the sixteenth amendment. On Feb. 25, 1913 the Sixteenth Amendment was added to the U.S. Constitution:

“The Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Though it was now legal to pass a federal income tax it was left up to the Wilson administration and the legislature to devise one that was acceptable. The first income tax passed affected less than 4% of all Americans. It began with a 1% tax on incomes above $20,000 and climbed to 6% on income above $500,000.

Before the outbreak of World War I the U.S. still collected more than 90% of its revenues from tariffs and excise taxes but with the spending on the war that would change.

With the war, imports plummeted and federal revenues went into the red. But as the war progressed exports skyrocketed and profits went through the roof. But wages didn’t follow with the raging profits and the soaring prices. The workers became resentful, agitated and rebellious. Some called the situation “industrial feudalism.”
Countries involved in the war even began adopting an “excess profits” tax – in Briton the excess profits tax actually reached a rate of 60%. Business was seen on the positive as the driving engine of military might but on the negative as a vicious bloodsucker squeezing unreasonable profits out of the horrible struggle of war.

With the advent of World War I and then with American participation, the tax arguments took a patriotic twist. It was commonly accepted knowledge that the rich had profited from the Civil War and that the American people had picked up the bill via national debt and inflation. There was a strong push to change this situation in World War I – with income taxes on the wealthy, excess profit taxes on the corporations an the general population supposedly ready to “bear any burden and undergo any sacrifice” according to president Wilson.

The reality was that World War I had greater resistance than any war yet in American History. As during the Vietnam Era the country became divided against itself. But the basic argument that the rich and prosperous should, at the least, pay while the poor and average fought was fairly standard among the overall population. Of course the rich saw it otherwise. Conservatives screamed of communism and socialism “... we shall no more hear the nonsense that this is a ‘capitalistic’ war, waged for the benefit of the men of capital. It is a poor man’s war, waged at the expense of capital, and one of its collateral efforts will be to diffuse wealth.”

Income taxes soared up to as high as 77% and excess profit taxes up to 65%. The new war had been waged and funded with taxes and bonds sales to the general public –“Liberty Bonds.” The taxes paid for about a third of the cost of the war. Selling bonds to the middle class was considered to be fairer than had been the case during the Civil War and with this new tax system the tariff system disappeared.

Out of a work force of 106 million in 1920 only 5.5 million paid income taxes – and only a fraction of the wealthiest of these accounted for a majority of the revenue received. By 1930 two thirds of federal revenue came from income and corporate taxes. The fairness or unfairness of this system has been one of the main points of controversy in the American economic philosophy ever since.

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