Echoes Dispatches From Economic History
Is Warren Buffett the New Andrew Mellon? Not Quite: Amity Shlaes
Andrew Mellon would back it. That's the recent analysis of the "Buffett Rule," a plan to reform the tax law that would require top earners, including those who make much of their money from investments, to pay the same percentage of their earnings as those in the middle class do.
The rule was suggested by Warren E. Buffett, the chief executive officer of Berkshire Hathaway Inc., this summer in an op-ed in the New York Times. "My friends and I have been coddled long enough by a billionaire-friendly Congress," the so-called Oracle of Omaha wrote. "It's time for our government to get serious about shared sacrifice." President Barack Obama has since endorsed the idea.
Many heard echoes of Mellon in Buffett's statement. While serving as Treasury secretary in the 1920s, Mellon led a campaign to end tax breaks for the rich. And if Buffett merely reprises Mellon, then his case, and the president's, starts to look politically feasible -- after all, Mellon is a Republican idol.
But a close read of both Buffett and Mellon makes clear that the two men differ in a subtle but key way: Buffett puts fairness of the tax code first. From fairness, he believes, follow other benefits. Mellon puts access to capital for business as the top priority. Call it the Mellon Rule.
Buffett is the Dumbledore of today's markets, a wizard who seems to know how to magically generate value. Mellon, in his time, also loomed mysteriously, conjuring whole new industries, from steel to railroads. All Mellon had to do was touch a tiny company like Pittsburgh Reduction with his wand to transform it into an industrial giant like Alcoa Inc. Buffett wants federal solvency. So did Mellon. Mellon ran the Treasury like a railroad: Taxes were tolls, and the government should set tax rates according to "what the traffic will bear."
It's at the proposal level that the two men differ. Buffett wants to curtail tax advantages for the rich, and has mentioned as an especial injustice the treatment of carried interest, the profits-based compensation of venture capitalists and managers of private-equity and hedge funds. Buffett would like them to pay the ordinary top income-tax rate of 35 percent on their investment profits rather than the capital-gains rate of 15 percent that currently holds.
The carried-interest equivalent of the early 1920s was municipal bonds. In Pollock v. Farmers' Loan & Trust Co., a landmark case in 1895, the Supreme Court had affirmed that such bonds enjoyed an exemption from federal tax. Coming out of World War I, the top tax rate was 73 percent. After taking the Treasury post in 1921 Mellon was able to reduce that rate to 46 percent by 1924. But the spread between the top rate and zero on muni interest rendered such bonds enormously attractive to higher earners.
Investors today would be taken aback at the zeal with which the etiolated secretary attacked the muni exemption. When a legislative effort to close the loophole failed, Mellon backed a constitutional change, the McFadden Amendment, that would have deprived munis of their status.
But Mellon was not anti-wealth. Rather, he disliked the way munis drew cash away from startups and innovation, the kind that could give the country another decade of strong growth. In "Taxation: The People's Business," published in 1924, Mellon painstakingly laid out the arithmetic: "an investor is offered a prospect of going into a business returning 11 percent. He also has the choice of buying a municipal bond paying 4 percent, which, to a man of large income, returns the same net income as the 11 percent business. No business returning 11 percent net is as sound as a municipal bond."
When the campaign for a constitutional amendment failed, Mellon attacked another way. He fought to lower the top rates on income taxes even further. That would erode the relative attractiveness of tax-favored bonds. Mellon quoted Henry Ford: "High taxes on the rich do not take burdens off the poor. They put burdens on the poor." At a high income-tax rate, Ford said, "we cannot do the great things we should do had we more money."
By 1925, Mellon got the rate down to 25 percent. He was a political realist, and allowed other changes in the name of fairness, but the lowering of the top income-tax rate was his centerpiece.
The Ford-Mellon prediction that reducing top rates would benefit the poor proved correct. Jobs proliferated, unemployment stayed at less than 5 percent, real wages grew and the federal budget was in surplus. By 1928, with the top rate still at 25 percent, those earning more than $100,000 paid 60 percent of all the tax. That same set of earners had paid only 30 percent of the income taxes in the early part of the decade, when the top rate had been 73 percent.
Taxes were needed for revenue, Mellon allowed, and the rich must pay their share. But he always stressed priority for capital, and even formulated a corollary to the Mellon Rule: "A decrease of taxes causes an inspiration to trade and commerce which increases the prosperity of the country so that the revenues of the government, even on a lower basis of tax, are increased."
Today, Obama and others are again proposing to erode municipal bonds' tax advantage, along with a host of other measures designed to get the rich to pay more. But the record of the 1920s suggests that when it comes to rules, Buffett has met his match.
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