by Steven R. Weisman, Peterson Institute for International Economics
Op-ed in U.S. News & World Report
October 23, 2008
© U.S. News & World Report
It is one of the abiding traditions of American politics, at least since the era of Ronald Reagan. In the final weeks of the 2008 presidential campaign, Senator John McCain's campaign is taking a leaf from the Republican playbook and suddenly suggesting that Senator Barack Obama is a closet socialist who wants to "spread the wealth" by taxing the rich and providing tax breaks and spending for the poor.
It was exactly 95 years ago this month that the income tax as we know it today was signed into law by President Woodrow Wilson as part of the Underwood-Simmons Act lowering tariff barriers. In the process, Wilson also established the pattern of how Americans would debate the tax in coming decades.
On one side in 1913 were the populist Democrats who argued that the income tax was the only fair way to ensure that the wealthiest Americans paid their fair proportion of the burden. "I have no disposition to tax wealth unnecessarily or unjustly, but I do believe that the wealth of the country should bear its just share of the burden of taxation and that it should not be permitted to shirk that duty," said one of the tax's most eloquent proponents, Representative Cordell Hull of Tennessee, a future secretary of state under President Franklin Roosevelt.
On the other hand were those who charged that the tax was a socialist or even communist plot. "What these people want to do," said Senator Elihu Root, a New York Republican, who had served as secretary of war under Teddy Roosevelt, "is to take away the money of the rich, and then pass laws distributing it among their people at home."
The income tax was a centerpiece of Wilson's "New Freedom," which included establishment of the Federal Reserve, lower tariffs, and a more muscular prosecution of trusts and monopolies. But Wilson was not one of the tax's biggest advocates. In fact, as it headed toward approval, he told lawmakers not to raise rates so high as to anger the public and make the Democrats look like they favored confiscation of wealth.
The income tax was actually enacted three different times in American history. First, it was imposed during the Civil War. Lincoln's treasury secretary, Salmon Chase, worked with Republican congressional leaders to pass a tax that helped assuage popular discontent over the huge new class of wealthy Americans who were making money from the war. The tax was repealed in stages after the war.
It was reenacted in 1894 at a time of the biggest economic crisis—bank runs, unemployment lines, homeless people riding the rails—faced by the United States until that time. The main proponent was Representative William Jennings Bryan of Nebraska, more famous for his opposition to the gold standard. The following year, the Supreme Court threw the tax out, saying that it violated the Constitution's requirement that direct taxes be paid proportionate to their populations. (The income tax meant that rich states of the North paid more taxes per capita than poor states of the South and West.)
Throughout the 19th and early 20th centuries, however, the tariff was a far bigger issue than the income tax. That is because the tariff rose as high as 50 percent on many household goods, and it favored the manufacturing states that produced these goods over the farming states of the South and West. It is worth noting that in those decades, Republicans were the party of protectionism, advocating high tariff walls to protect big business, whereas Democrats favored lower tariffs because they argued that the tariff forced consumers to pay higher prices for clothing, household goods, and other necessities.
In the Progressive Era after the turn of the 19th century, the Republican Party split over the issue. In 1909, President William Howard Taft was unable to heal the party's disagreements on the issue, but he agreed to congressional passage of a constitutional amendment allowing the income tax as a price for getting a tariff bill through Congress. He and others were secure in the feeling that such an amendment would never be ratified by three quarters of the state legislatures, as the Constitution requires.
Then in the 1910 election, the Republicans completely split apart. Teddy Roosevelt had returned from his Africa safari to rebuke Taft and lay the groundwork for his 1912 presidential race. Democrats swept into office in 1910, remaking statehouses across the country. Wilson, a president of Princeton, was elected governor of New Jersey that year. The 1912 election saw an even deeper Republican split, as Taft and Roosevelt both ran for the White House. Democrats turned to the relatively untested Wilson as its nominee. By early 1913, the 16th Amendment permitting the tax was ratified and adopted, and Wilson was president.
The first priority of Congress was to lower tariffs. That fight was led by Representative Oscar W. Underwood of Alabama, chairman of the Ways and Means Committee and a former rival of Wilson's for the 1912 Democratic presidential nomination. In the Senate, the probusiness Finance Committee chairman, Furnifold M. Simmons of North Carolina, an ultraconservative (and white supremacist), went along with it under pressure from Wilson. The tariff was lowered from about 40 percent to about 28 percent. The question was: Where would the money come from to make up for lost tariff revenues?
That was when Hull seized the moment. Son of a farmer, logger, and whiskey still operator from the Tennessee backwoods, Hull had long admired Bryan and the populists. He had pushed for an income tax for years and lobbied Wilson at the Jersey shore before Wilson took office. "Here at last was fruition to my work and study of twenty years," Hull later wrote in his memoirs, referring to his accomplishment of adding the tax to the tariff bill.
Would the income tax encourage more spending in Washington? Hull argued no. In fact, he asserted, an income tax would actually restrain spending because Congress would recognize that it was spending money directly taxed from Americans. (That is one argument you are unlikely to hear today.) But opponents used words we would find familiar. A Kentucky congressman, William Murray, said it would tax "the surplus" of income that the rich had available. Senator Henry Cabot Lodge of Massachusetts called the tax "the pillage of a class" whose only sin was to be rich.
The law imposed a 1 percent income tax on all Americans making more than $3,000, with exemptions for married couples. Additional rates went higher, depending on a family's income, the highest rate being 7 percent for incomes of $500,000 or more. The revenue yield was projected at $70 million, but it ended up bringing in only $28 million in the first year. Prophetically, Hull and others had warned that the tax was a necessity in case of a national emergency that no one could foresee. That emergency came the following year, in 1914. By the end of World War I, the top rate of the tax was raised to an extraordinary 77 percent.
Since World War I, the tax has remained, but its amount has gone up and down, along with the tariff. The economic downturn that began in 1929 led Republicans to raise the tariff. By World War II, the tax was raised to ever higher rates and its rate came down gradually after the war with the efforts of such disparate tax cutters as John F. Kennedy and Ronald Reagan. There is little doubt that the tax is here to stay. But so also are the arguments that, on the one hand, it stifles economic activity and, on the other hand, that it is the only fair way to make Americans pay for the government they need. Whoever is elected president, Congress will be channeling the likes of Elihu Root and Cordell Hull in the coming year.
Policy Brief 11-16: US Tax Discrimination Against Large Corporations Should Be Discarded October 2011
Policy Brief 11-2: Corporate Tax Reform for a New Century April 2011
Policy Brief 10-10: Higher Taxes on Multinationals Would Hurt US Workers and Exports May 2010
Congressional Testimony: Tax Reform and the Tax Treatment of Debt and Equity July 13, 2011
Book: US Taxation of Foreign Income October 2007
Book: Reforming the US Corporate Tax September 2005
Op-ed: America Badly Needs a Value Added Tax April 21, 2005
Paper: Tax Policy in a Global Economy Revised February 2000