Echoes Dispatches From Economic History
In 1939 as now, the battle over the income tax raged. Source: Library of Congress.
Soak-the-Rich Tax Policies Never Even Got Them Damp
The president denounces the tax code as “an outrage, one riddled through with special privileges and inequities, that violates our most fundamental American values of justice and fair play.”
His Treasury secretary agrees that the tax system is “too complicated, it’s grotesquely unfair, and it’s a drag on the economy because it discourages competition.”
Sound familiar? Those words were uttered by President Ronald Reagan and his Treasury secretary, Donald Regan. Similar sentiments have been repeated since the first modern income tax became law in 1916.
For years, the federal government obtained most of its revenue from a tariff supplemented by some excise taxes. The income tax came into being for an obvious reason: The federal government needed more money for an emergency. It was first imposed during the Civil War and phased out afterward. It was revived in 1894, only to be struck down by the Supreme Court. The 16th Amendment took care of that objection.
From the very beginning, there were two opposing camps. One school viewed the tax as strictly a revenue vehicle and argued that it should be spread evenly across the broadest-possible base. A second group argued that industrialization had created a dangerous chasm between the rich and everyone else, and that the income tax could reduce that gap by placing the major burden on the wealthiest citizens and the big corporations.
Thus began the fight over a policy we know by the cliche “soak the rich.” This clash extended to virtually every form of taxation, including sales, estate, corporate and excise levies.
President Woodrow Wilson opened the battle in 1916 by supporting a highly progressive income tax to pay for preparedness and later the fighting of World War I. His backers also hoped to attack the deep-rooted problems of special privilege, corruption and especially the concentration of wealth. The Revenue Act of 1916 concentrated on the wealthiest taxpayers and doubled the tax on corporate incomes (to a whopping 2 percent).
The Republican Party returned to power in the 1920s. Treasury Secretary Andrew Mellon, one of the richest men in the U.S., spearheaded a rollback of taxes on corporations and wealthy individuals. By 1928, the top marginal rate had been cut to 25 percent from 73 percent and new loopholes favored the rich.
The onset of the Great Depression in 1930, followed by the election of Franklin D. Roosevelt in 1932, gave the debate fresh impetus. Even before he took office, Democrats shoved through the Revenue Act of 1932, which increased the marginal rate to 63 percent from 25 percent. The Revenue Act of 1935 raised the effective rate on the rich by 50 percent. Then came World War II, which required huge sums of money.
The Revenue Acts of 1942 and 1943 revolutionized the tax system. They broadened the base by lowering exemptions and increased marginal rates to the highest level in history. A surtax was imposed that rose from 13 percent on the first $2,000 to 82 percent on income exceeding $200,000. In 1945, the richest 1 percent of Americans paid 32 percent of the income taxes collected.
A dramatic shift had occurred. By 1950, the income tax accounted for 51 percent of all taxes collected compared with 16 percent a decade earlier. During the 1950s and ’60s, Congress gradually lowered the rate on top incomes. Prosperity coupled with a growing population kept revenue high despite a proliferation of tax deductions. The onset of stagflation during the 1970s ended this period of relative calm as President Jimmy Carter denounced the tax system as “a disgrace to the human race” and renewed the fight for a more progressive approach, though he couldn’t budge Congress.
A growing national movement against taxes found its champion in Reagan. For a time, the idea of a “flat tax” -- eliminating all deductions, exemptions and credits in favor of one single low rate -- gained currency. Instead, the Reagan administration produced the Economic Recovery Act of 1981, which reduced rates by 25 percent, slashed the top rate to 50 percent from 70 percent, indexed tax brackets and accelerated depreciation rates for businesses.
In 1986, Reagan and Congress thrashed out a bill that cut individual rates across the board; lowered the marginal rate on the highest incomes to 28 percent from 50 percent; increased personal exemptions and deductions enough to remove about 6 million poorer Americans from the tax rolls; and reduced the top corporate rate to 34 percent from 48 percent.
Subsequent administrations retreated from Reagan’s bold approach. By 1994, antigovernment sentiment dominated in Congress, and the fight over taxes became entangled with the demand to reduce the deficit while somehow keeping the deductions, exemptions and loopholes. George H.W. Bush offered several proposals to cut taxes. There was renewed talk of abolishing the income tax in favor of a national sales tax, but deficit reduction remained the primary target until the Taxpayer Relief Act of 1997, which contained the deepest cuts since 1981.
The act didn’t cost the government much revenue because it was offset by spending cuts. Strong economic expansion enabled President Bill Clinton in 1998 to present the first balanced budget in almost three decades.
Enter George W. Bush. His Economic Growth and Tax Relief Reconciliation Act of 2001 included 10 percent reductions for the lowest bracket and 35 percent for the highest one.
How badly did the rich get soaked in all this? The top marginal rate reached 77 percent in 1918, dropped to 24 percent in 1929, shot up to 63 percent in 1932, and climbed to 79 percent by the eve of World War II. It soared to 94 percent in 1944 and 1945, and never fell below 91 percent through 1963. For most of the 1970s, it hovered at 70 percent, then declined to 50 percent for the first half of the 1980s. In 1987, it reached 38.5 percent, dropped to 28 percent the following year, rose to 31 percent in 1990, and settled at 39.6 percent in 1993. In 2001, it slipped to 38.6 percent, then fell to 35 percent, where it has remained ever since.
It seems that the wealthy hardly got damp. From 1979 to 2007, according to the Congressional Budget Office, the income of the 60 percent of Americans in the middle of the income ladder rose 40 percent compared with an average 275 percent increase for the top 1 percent. During that time, the top 400 incomes increased 392 percent while their average tax rate fell 37 percent. By 2007, the top 1 percent held a larger share of total income than at any time since 1928, and that gap is growing.
(Maury Klein is a professor of history emeritus at the University of Rhode Island and the author of 16 books on American history. The opinions expressed are his own.)
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