A Brief History of Taxes, Pt. 3

April 15th every year – a day that will live in infamy

Welcome back to the Tax Shack – I hope you had a great Thanksgiving weekend. Squanto never paid one cent in federal income tax, and for that I am thankful. You know who else didn’t pay income tax until 1933? That’s right, the President!

In the true American spirit, however, the President started paying income tax during the F.D. Roosevelt administration. After all, “Mr. President” is an American citizen just like you and me, right? Before you answer a resounding “NO,” just imagine Jimmy Carter trying to use TurboTax. You’re welcome.

Seriously though, the 1930s and ‘40s in America were a time of Depression, War, and the ever-expanding reach of the Bureau of Internal Revenue. Fresh off the Jazz Age and the theme-and-variation of rule codification and the legal challenges thereof, the Bureau of Internal Revenue was a lean, (less) mean, income taxing machine.

Franklin Roosevelt, meet the Taxman.

Between the World Wars

It is my personal experience that societal institutions (corporations, Bureaus, etc.) follow a similar lifecycle pattern. They are founded by a visionary leader who is primarily motivated by self-aggrandizement and/or zealotry, religious or otherwise. For this reason, the founder typically neglects the nuts and bolts of large organizations like recordkeeping or internal harmony in favor of his/her preferred end. Once the charismatic founder is out of the picture, caretaker leaders descend sensing the need for a steady hand. This goes on for as long as particular conditions hold and no Napoleon figure enters the scene. This is how we can think of the Bureau of Internal Revenue in the eras of Harding and Coolidge.

This is not to say, of course, that there is anything wrong with caretaker Presidents. For people like your humble correspondent who naively hope for stable and unintrusive government, caretakers can even be a much-needed respite. Either way, the Harding and Coolidge administrations saw a decreasing direct role for the Oval Office in the Bureau’s proceedings. Congress passed revenue bills at least annually to plug the “loopholes” (a new term then!) and the professions of tax preparer, tax lawyer, etc. continued to find lucrative employ. While Harding and Coolidge had no brief for the administrative state, they certainly believed in what we would now call “law and order” – resulting in ample punishment for tax cheats (Capone included).

Andrew Mellon deserves a mention here, as Treasury Secretary during both Harding and Coolidge’s administrations and the true shepherd of the Bureau during the ‘20s. Mellon was the original Tax Cut Guy and significantly broadened the base of taxpayers during this time. Put differently, Mellon championed the idea of taxing more people but at a lower rate. Marginal rates did in fact come down significantly, but the expansion of the tax base in peacetime made it clear the income tax was here to stay. While the Bureau’s role as Prohibition Enforcer would soon be stripped away, the Judiciary Branch and Treasury Department were hard at work cementing the “Taxman’s Do’s and Don’t’s.”

With a green light from the Powers That Be that would tempt Gatsby, the Bureau got down to business.

Depression and Security

Any plans Secretary Mellon might have had were cut short by the much-ballyhooed Great Depression. Whatever the merits of the attacks, Mellon-omics was partially blamed for driving the flawed financial system into the ground its adherents were summarily swept from office. For his troubles, Mellon was given a new deal as Ambassador to Great Britain (lucky guy) but history books have been less than kind to his job as Secretary. I don’t have an opinion because I was born almost 70 years later.

The Great Depression started in October 1929, and subsequent analysis pinned the blame on Republican tariffs (especially Hoover’s favored Hawley-Smoot tariff). This may have been the final nail in the coffin of tariffs as a major source of the U.S. Government’s revenue, and the income tax waited patiently to take the full measure of its power. The 1932 election of Franklin Roosevelt as President finalized this process, and during Roosevelt’s tenure the income tax would be imposed on a larger share of the population than ever before.

Roosevelt’s election also saw the end of Prohibition, an integral piece of the Taxman’s core set of responsibilities. While alcohol prohibition was replaced with taxation, primary enforcement was shifted over time to the newly-created Bureau of Alcohol, Tobacco and Firearms. Talk about a badass name, too. Eat it, Internal Revenue. Anyway, suffice it to say most of the things previously banned by Uncle Sam for Your Own Good were now viewed as valuable sources of Depression and Wartime revenue. “Be thankful I don’t take it all,” as George Harrison once said in a song about taxes, except about booze. We see a similar pattern in the 21st century with marijuana legalization – give Big Dog his taste and you’re free to blaze on to your heart’s content. The Pax Americana Model.

Uncle Sam’s New Deal

Once King Roosevelt II and his Court really got things rolling, the Taxman was given law enforcement authority over the majority of the American economy for a period. Laws like the National Recovery Act (NRA) and Agricultural Adjustment Act (AAA) were soon struck down by the Supreme Court on Constitutional grounds, but much like during the Wilson Administration the registration requirements were the true victory for the Bureau. Plus, because the Bureau was one of the better-organized agencies at the time, it got a valuable dry run enforcing laws like the NRA and AAA with a large civil service-led organization. The lessons learned undoubtedly informed future federal legislation and regulation that passed “Constitutional muster,” as the lawyers say.

Despite the short lives of some New Deal legislation, Roosevelt’s signature program drew up the detailed blueprints for the organizational infrastructure behind a new U.S. Government. Businesses, especially ones with forward-looking managers, got the message that regulation of their operations on a granular level was the wave of the future, at least at the federal level. Banks large and small (mostly small at the time) as well as financial institutions like brokerages and investment managers were put on notice that the government now had a vested interest in limiting future economic turmoil, and would vehemently pursue policy to that end.

Farmers were also in on the economic New Deal action. Agricultural price supports, with the attendant reporting requirements, added a new dimension to the life of a midwestern whatever farmer – a life that probably seldom required much ‘rithmatic prior to the 1930s. Most farmers made out pretty good in this transaction with Uncle Sam. The rest, well, we can’t be too sure of their story. After all, as we previously established, they couldn’t read or write too good.

Make America Socially Secure

These days, Social Security is a fact so deeply-embedded in American life there’s even a lobbying organization dedicated almost exclusively to perpetuating it (AARP). However, the tradition goes back only as far as 1935 and Roosevelt. Most notably for our purposes, the Social Security Act created a new analog to the income tax – the payroll tax – in order to fund the old age pension program.

Payroll taxes fly under the radar because the employee percentage is relatively small and automatically deducted by the employer’s payroll system. Self-employed Americans certainly notice, however, when they pay the 15% combined “self-employment tax.” Payroll taxes, after all, are paid half by the employee and half by the employer. Heaven help you, then, if you are your own employer. No personal grievance has been stoked here.

We’ll dig into payroll taxes in a future Shack, but I would be remiss not to mention them as an overlooked part of the flurry of legislation during the New Deal. The original 2% payroll tax was a pittance, and arguably still is at 15%, but it wouldn’t be until Lyndon Johnson’s Great Society programs that payroll taxes would come to fruition and begin their steady northward climb. Overall pretty cleaver taxation scheme though, since people barely notice it but the amount adds up over a large U.S. population. Emphasis on scheme.

You Can’t Run a War on the Cheap

With apologies in advance to his myriad admirers, it can be said with justification that FDR’s economic agenda did more for the administrative state than for the Depression. World War II, after all, truly marked the dawn of an American era geopolitically and the U.S. economy responded in kind by firing on all cylinders. New markets, the demise of old markets, and decisive victory in the war itself juiced the adolescent nation with a two-ocean defensive moat to an economic output never seen before, anywhere. The government, income tax in-hand like a fork and knife, prepared to take its share.

World War II, both before and after Pearl Harbor, cost the United States over $300 billion ($4.1 trillion today) and that’s just the war itself. America’s military presence in Europe continues to this day, and costs some serious dough. And keep in mind, this is after the bulk of New Deal programs were in full swing. In 1936, mid-New Deal, the top federal tax rate was a staggering 79%. By 1944, mid-War, the top rate would be jacked up to 94% and stay in the 90s until the ‘60s.

Yes, that’s right, the top tax rate was 91% until 1964 when it was lowered to 77%. George Harrison wasn’t singing about the Obamacare 39.6% top rate on 1966’s Revolver, but he also wasn’t singing about America so whatever.

The Roosevelt Dynasty Begins

On April 12, 1945, Franklin Roosevelt gave up the Oval Office the only way possible – natural causes. Roosevelt’s stroke ended his record 3+-term reign, 4 Electoral College victories and one World War. Harry Truman knew he’d never outshine the supernova of FDR’s death, and he didn’t try. His slogan could have been Maintain the New Normalcy, and maintain he did. Even got a second term out of the deal.

One of the agencies at the forefront of the public’s collective mind was the Bureau of Internal Revenue. We can retire that term now, by the way, because it was Truman who renamed this organization the Internal Revenue Service (to emphasize its service, no I’m serious). Goodbye Bureau and hello, Service!

The 1952 Revenue Act, proposed by President Truman, was designed to address the myriad issues popping up at the IRS in the preceding decade. The largest and most obvious of these issues was a cascading series of scandals involving agents of the Bureau caught in all manners of corruption and personal tax evasion. A public besieged by wartime tax rates and goods rationing was in something of a “Drain the Swamp” mood when the big IRS scandals broke in the early ‘50s and the Taxman was subsequently taken down a peg and given a PR makeover. It was a Service now, you see? The agents knocking down your door are actually serving you, and not just with a subpoena this time!

Harry Truman’s reform of the Bureau set the tone for income tax collection in the United States going forward. Career civil servants adhering to a robust but strict code and challengeable in court replaced field agents with little training and much to gain through corruption. A Byzantine tax code would, over time, render the temptation of even the most remorseless tax collector inert. That same tax code would provide the basis for innumerable challenges (and victories) by average citizens with sharp lawyers. Despite its internal inconsistency, it likely remains one of the fairest and most efficient taxation systems in world history. Harry Truman deserves a solid share of the praise for that accomplishment, but paying taxes still blows.

Rolling, Rolling, Rolling

The Tax Shack won’t be rolling back the clock as next week we roll on into the 1960s. Walmart was founded on July 2, 1962 and we can probably agree that’s as fine a marker as any of the modern age – the American Age.

Men on the moon, Great Societies, and more cleaver tax schemes. Tune in next week to Jack’s Tax Shack, and have a great weekend.

References

“IRS Historical Fact Book: A Chronology” Compiled by the IRS.

https://en.wikipedia.org/wiki/Internal_Revenue_Service

https://online.norwich.edu/academic-programs/resources/cost-us-wars-then-and-now