TAXATION

Taxation during the Great Depression is confusing enough without the two competing narratives that historians have imposed on it. The more familiar, accessible narrative follows the storyline Franklin D. Roosevelt himself sought to project: noble democratic efforts to lift up the "forgotten man at the bottom of the economic pyramid" through whatever progressively redistributional tax reform could overcome the constraints of congressional special interests, corrupt "economic royalists," and financial exigencies. Like most myths, this first narrative reveals a great deal, but unfortunately obscures the second narrative on the fundamental ways in which the tax system evolved during the Depression.

The root of misunderstanding lies in certain peculiarities of the U.S. tax system. At the center of the standard twentieth-century tax reform story is the personal income tax. Today, that tax is an accoutrement—albeit an often-resented one—of citizenship. But, in the United States far more than anywhere else in the world, this tax emerged from a populist/progressive "soak-the-rich" tradition that exempted "the people" and specially targeted "surplus" incomes of privileged outlanders and plutocratic "malefactors of great wealth." Thus, between 1929 and 1939, upwards of 95 percent of Americans did not pay a dime of federal income tax, until World War II transformed it from a "class tax" to a "mass tax" through a 1,500 percent jump in the number of citizens covered by taxable returns. This narrowly-based "class tax" extracted most of its revenue in the 1930s from the tiniest fraction of 1 percent of Americans, the fewer than 20,000 tax returns reporting over $50,000. With so few shouldering this tax, the New Deal income tax collected only about 1 percent of the nation's total personal income, as opposed, for example, to over 12 percent today. New Deal revenue yields relied far less on politically and historically celebrated "progressive" rate hikes on upper incomes than on "regressive" levies, which claimed larger shares of incomes from the bottom of the economic pyramid than from those nearer the pyramid's top.

The economic collapse of 1929 to 1933 was bad enough, but fiscal collapse made it worse. With upper tax brackets decimated by the stock market crash and vanishing profits, federal government tax collections halved. This fiscal crunch came at the worst possible time, amidst desperate citizen needs and demands, New Deal commitments, state and local government debt limits, and reigning dictates of fiscal orthodoxy.

The government's response to this crisis went through three phases: economic heavy lifting between 1932 and the spring of 1935, a tax reform thrust between June 1935 and 1937, and an antitax reform parry in 1938 and 1939. The first phase opened during the Herbert Hoover administration with the Revenue Act of 1932, the nation's largest peacetime tax increase and the dominant tax legislation of the Great Depression. Though an insurgent congressional revolt blocked its most regressive sales tax formulation, the legislation still targeted consumers with new federal manufacturer's excise taxes on such widely-used items as cars, tires, gasoline, and electricity, while slicing exemptions and more than doubling most income and estate tax rates, restoring a gift tax, and hiking taxes on corporate profits.

Depression program costs, however, made it impossible simply to coast on these new revenues. At least until Roosevelt acquiesced to what came to be seen as a Keynesian policy of economic stimulation through deliberate deficits in the wake of the 1937 recession, Roosevelt was in principle a budget balancer, pledging fealty to fiscal responsibility by excluding what he labeled "emergency" expenditures while "balancing" the "regular" budget. But as total federal spending doubled in his first term, even creative accounting could not erase the rising federal debt, as deficits at times exceeded tax collections. Seeking to minimize controversy and to pursue a "concert of interests" with corporate leaders positioned to spearhead economic recovery, the administration took a path of least resistance. Instead of offering a tax reform program between 1933 and the spring of 1935, it used a financial Trojan horse, bringing in regressive taxes as subordinate financial provisions of popular programs. It celebrated its reimposition of alcohol taxes as part of prohibition repeal in 1933. Redirecting grateful imbibers' money from bootleggers to the government was easy pickings. Its agricultural recovery program, the 1933 Agricultural Adjustment Act (AAA), was funded by processing taxes (e.g., imposed on millers of wheat, but then passed along to consumers of bread). And most important to the future of the U.S. tax system, at the insistence of Roosevelt and Secretary of the Treasury Henry Morgenthau in January 1935, its old-age insurance program was financed entirely by a tax (1 percent each for employees and—nominally—employers) on the first $3,000 paid annually to workers qualifying for the program. Casting Social Security taxes in private insurance terms—as "premiums" that established an "earned right" to future pensions—made them a comparatively painless way to narrow New Deal deficits and to assure the program's permanence. Decision makers and economists widely recognized that these taxes would ultimately either be subtracted from wages or added to prices. Yet a more progressive scheme—even general revenue subsidies used in social insurance programs elsewhere in the world—might have incurred unwelcome political costs.

In Roosevelt's first two terms, collections from manufacturer's excise taxes, alcohol taxes, the AAA processing tax, and Social Security taxes each separately peaked at over 12 percent of annual federal revenues—a regressive influence at odds with New Deal images of democratically redistributional taxation. State and local tax shifts only heightened this tilt toward taxes that exacted proportionately more from lower-income Americans. Local governments, primarily reliant on property taxes that squeezed farmers, home owners, and landlords whose Depression-wracked incomes could no longer cover their property tax bills, faced tax defaults, popular tax revolts, and reduced revenues that forced contraction at the very time when needs were most dire. State government spending rose substantially despite debt ceilings, partly in order to participate in shared federal/state welfare, public works, and unemployment insurance programs. But new regressive state retail sales taxes, along with the nonprogressive state unemployment insurance payroll taxes generated by the Social Security Act, carried a much greater portion of this new load than the personal or corporate state income tax.

Not all Americans took the regressive elements of this first phase of Depression taxation policy lying down. The Treasury, flexing its growing economic and legal expertise, relayed the broader conclusion of the economics profession and a few progressive political leaders, such as Senator Robert La Follette, Jr., that the New Deal tax system too heavily burdened the "forgotten man" while undertaxing—especially in comparison with European rates—lower and middle income tax brackets, where the real money was. Noting the New Deal's failure to rectify "our fundamental malady, the maldistribution of wealth and income," left-wing critics declared taxation to be "the weakest link in the Roosevelt program." Millions scapegoated wealth concentration as "the greatest menace this country faces," and gravitated toward plans such as those of Senator Huey Long's share-the-wealth movement, formed in 1934 to confiscate or heavily tax the fortunes of multimillionaires. Pressures from congressional progressives, with measured support from the Roosevelt administration, resulted in minor antiplutocratic initiatives in the Revenue Act of 1934, which boosted estate taxes and tightened several upper-income and corporate tax loopholes, such as preferential rates on capital gains. Congressional pressure only increased with the 1934 elections, as extraordinary gains by liberal Democrats and left-wing third parties left Republicans outnumbered by three-to-one in Congress. Some conservatives now cast Roosevelt as "the bulwark between the country and the 'wild men' of Congress."

Just as the thunder on Roosevelt's left made problematic any strategy of business conciliation, conservative opposition erupted. Earlier in the New Deal, with economic survival and political stability hanging in the balance, businessmen had reason to go along with the New Deal's "concert of interests" theme. But rising economic indicators quelled their desperation. In May 1935, the U.S. Chamber of Commerce stingingly condemned the New Deal, and the Supreme Court found unconstitutional the National Industrial Recovery Act, the New Deal's main institutional vehicle for partnership with business interests.

Roosevelt responded to this new balance with a political masterstroke. His June 19, 1935, message to Congress spearheaded a strategy that durably cast the New Deal on the side of the common people against "entrenched greed," "economic tyranny," and other evil "forces of selfishness and of lust for power" that his upcoming reelection campaign famously portrayed as "unanimous in their hate for me—and I welcome their hatred." Noting that the tax system had "done little to prevent an unjust concentration of wealth and economic power," he called for "very high taxes" on "vast fortunes" and "inherited economic power." This was a message very much in the "anti-bigness" mold of Roosevelt adviser Felix Frankfurter and his patron Louis Brandeis: scaling down the over-concentrated power of big business and the bloated super-rich to safeguard democratic institutions and foster economic opportunity.

The mere reading of this speech, confessed one corporate lawyer, practically left him "frothing at the mouth." But at first no draft legislation accompanied it. Would the speech itself suffice as a campaign document to preempt such critics as the flamboyant Huey Long, a likely third-party presidential candidate? Roosevelt was ambivalent, but a revolt of progressive senators forced his hand. By summer's end, the Revenue Act of 1935, popularly known as the wealth tax, entered the statute books. More a "hell-raiser" than a "revenue raiser," it institutionalized Roosevelt's oratory by strafing mammoth incomes, estates, and corporations, while only augmenting tax collections by $250 million. Contrary to conventional historical wisdom, this paltry yield—a fraction of collections from New Deal taxes disproportionately shouldered by ordinary Americans—cannot be attributed to congressional foot-dragging. Congress did reshuffle rates to dilute certain anti-bigness features of Roosevelt's proposed inheritance tax on legatees (replaced by a reduced exemption and higher rates for existing estate and gift taxes), graduated corporate income tax (which now favored small companies instead of specially penalizing giant ones), intercorporate dividend tax, and personal income tax. Yet that original incarnation would have collected even less than the final law. Even in the revenue-enhanced but "diluted" final income tax schedule, increases only kicked in at $50,000. Net incomes over five million dollars faced a 79 percent rate (up from 63 percent)—an onerous-sounding top bracket, though it applied only to John D. Rockefeller, Jr.

The Wealth Tax established Roosevelt's tax credentials for the 1936 presidential campaign. But early in 1936 the Supreme Court invalidated the AAA processing tax and Congress overrode Roosevelt's veto of a budget-busting "bonus" for veterans of World War I. Into the breach came the undistributed profits tax. The Roosevelt administration dusted off a boldly innovative tax proposal to replace existing corporate taxes with a graduated levy on corporate profits not distributed to stockholders. Roosevelt, as was his wont (particularly in circumstances of high political visibility), joined the Department of the Treasury in casting the tax as a moral question of "fundamental equity" and "ability to pay." Undistributed corporate profits, he said, were a haven for what would otherwise have been the taxable dividends of wealthy stockholders. Others, such as Brain Truster Rexford Tugwell, conceived of the tax as a tool of economic planning, transforming idle surpluses into needed consumer buying power, while reducing the use of retained earnings for redundant expansion by diverting them into more competitive investment markets.

Thanks in part to the Treasury's inept defense of the tax (including a meltdown of its claim that the undistributed profits tax would reduce corporate concentration and empower smaller stockholders) and in part to corporate outrage over the government's intrusion into investment decisions, the Revenue Act of 1936 retained existing corporate taxes while introducing a supplementary 7 percent to 27 percent tax on undistributed corporate profits. Still, this tax promised to yield far more added revenue from corporations and the wealthy than the more symbolic assault upon the super-rich in the 1935 wealth tax or in the upcoming Revenue Act of 1937, which penalized tax dodges of the super-rich, especially "personal holding companies." The 1937 law—passed after genuinely indignant presidential denunciations of tax lawyers' "clever little schemes" to help millionaires avoid their "fair share" of taxes—followed Roosevelt's lead in targeting smaller, flagrantly sensational loopholes as opposed to more financially significant ones, such as oil depletion allowances.

Symbolic or not, New Deal tax reform of 1935 to 1937 infuriated congressional conservatives and business leaders, who bristled at New Deal campaigns that vilified them and denigrated their economic contributions. Rocked both politically and economically by the precipitous "Roosevelt Recession" of 1937 to 1938, the New Deal could not fend off these attacks. In 1938 and 1939, Congress onesidedly gutted and then eliminated the undistributed profits tax, while slashing capital gains tax rates on the wealthy. This victory, however, came at a price to the resurgent congressional conservative coalition. Forced to recoup these cuts by raising the standard corporate income tax rate several points above its previous high, it left unscathed more fundamental New Deal transformations, such as in employment and labor policy. New Deal taxation, arguably a bane of the "forgotten man" in the 1930s, was a political masterpiece.

TAXATION

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