Taxing the Rich Is an Idea Whose Time Has Come — and Gone

(Bloomberg Opinion) -- If you wait long enough, every past fad makes a comeback. And so it is with taxing the rich, an idea that has a long history of ups and downs in the U.S., but has for many decades been anathema to politicians eager to avoid accusations of “class warfare.”

Yet it has popped up again. Seizing on a broader discussion about income inequality, prominent liberals like Representative Alexandria Ocasio-Cortez and Senator Elizabeth Warren have proposed eye-popping increases in the top marginal tax rate. The elites gathered at the World Economic Forum in Davos denounced the idea, naturally, but among the hoi polloi, there’s a willingness to contemplate a notion that would have been unthinkable just a few years ago.

If history is any guide, proponents of confiscatory taxes probably face an uphill battle: Over the course of the nation’s history, flareups of rising inequality have sparked calls for such taxes and ignited furious fights. In the past, as now, opponents have denounced levies targeting the rich as inimical to America’s entrepreneurial spirit; advocates have argued that they’re necessary to level the economic playing field, given that the wealthy have far greater resources for avoiding taxation.

The idea of soaking the rich first come into fashion in another era of rising inequality and extremes of wealth and poverty: the Gilded Age. In the 1870s and 1880s, a growing number of radical reformers advanced tax proposals aimed squarely at the growing number of plutocrats and “monopolists” who ruled the economy.

Most prominent, perhaps, was Henry George, who proposed a “land tax” that sought to deprive the wealthy of reaping rents from their ownership of real estate; his manifesto, “Progress and Poverty,” published in 1879, sold millions of copies, and arguably launched the Progressive Era, the first great period of liberal reform in the U.S.

But a tax on land is a property tax, which the Constitution forbids the federal government from collecting (these are the exclusive province of local government). Instead, reformers embraced the income tax to reach the rich on a national level. The idea gained currency during the economic calamities of the 1890s, when the existing tax regime -- tariffs on imported goods, or what was effectively a regressive consumption tax –- sparked cries for change.

Under pressure from both Populists and reform-minded Democrats, Congress passed the Revenue Act of 1894. It was rather modest, a mere 2 percent tax on income. But it contained the germ of the idea of shifting some portion of the burden onto the wealthy: the personal deduction was $4,000, which meant that only high-income earners would be hit. (An equivalent annual income today would top out at around $1 million).

The law wasn’t the worked of crazed radicals, but the Supreme Court struck it down a year later, declaring the income tax unconstitutional. This was but the first salvo in a longer battle. In the succeeding decade, support for some kind of progressive income tax, however modest, gained traction. Eventually, the passage of the 16th Amendment opened the door to a permanent levy.

That came to pass in 1913, when Democrats and enough insurgent Republicans joined together to create the modern income tax. It, too, was exceedingly modest in its ambitions. It set a high exemption of $3,000, and then hit high-income earners with marginal tax rates ranging between 1 percent and 7 percent.

Critics of the legislation derided the new income tax. The New York Times claimed: “the law was deliberately designed … to tax the rich for the benefit of the poor.” This was a gross overstatement. As the historian Joseph Thorndike has argued, the first iterations of the tax may have been progressive, but they hardly represented a massive redistribution of resources away from the wealthy.

In fact, while Congress soon approved far higher rates on the rich during World War I, it quickly rescinded them after the conflict was over. Soaking the rich was a wartime exigency, not a permanent policy.

The Great Depression changed that calculus. That story, according to Thorndike, began during the early years of the New Deal. President Franklin Roosevelt asked his Treasury secretary for ideas on how to make the tax system less regressive. Two groups -- economists and lawyers -- came up with distinctly different proposals.

Economists didn’t want to raise taxes on the rich; rather, they wanted to lower taxes on the poor. This would require higher income taxes on everyone else, not just the rich. Lawyers, particularly those working in the Bureau of Internal Revenue (the predecessor to the Internal Revenue Service), wanted to make the tax system more progressive (or merely less regressive) by raising revenue from the rich.

Lawyers at the BIR gathered some powerful ammunition to make their case, assembling eye-popping case files on some of the nation’s wealthiest taxpayers, and demonstrating that even though some of these Americans earned staggering amounts of income, they managed – usually legally, sometimes less so – to avoid paying much in the way of taxes. Not coincidentally, some of these same people were among FDR’s most vocal critics.

Tax-exempt securities, trusts and other legal contrivances severely limited how much the wealthy paid relative to their gross income. Less wealthy individuals didn’t have these advantages. This meant that even though the existing income tax structure was progressive on its face, effective tax rates were often regressive. One Treasury lawyer summed up the situation this way: “It is an unsportsmanlike advantage which certain large taxpayers have taken.”

As the lawyers prepared their brief, Roosevelt faced growing pressure on the political left, as insurgent populists like Huey Long argued for radical caps on wealth. Even members of the president’s party, like the progressive Robert La Follette, pushed for “drastic increases in taxes levied upon wealth and income.” Eager to shore up his base, Roosevelt seized on the Treasury proposals. In an address to Congress in 1935, the president advocated steep hikes in taxes aimed at individual incomes and corporate profits. Soaking the rich suddenly went mainstream.

The arguments of the tax’s opponents, including the nation’s wealthiest families and business interests, are the same ones deployed against similar proposals today. One industrialist who testified against the idea in Congress declared: “We are attempting to tax people who work, who create wealth and distribute wealth – we are attempting to tax them to support the incompetents and the ne’er-do-wells, and the will-nots, and it is time we stopped it.”

But they couldn’t stop it. After months of political horse-trading, FDR signed the Revenue Act of 1935, which raised rates on taxpayers earning more than $50,000 a year, with punitive rates reaching as high as 75 percent on incomes over $500,000.  In reality, though, the legislation was more symbolic than real: For the first three years after passage, the very highest income bracket hit one taxpayer – John D. Rockefeller Jr. – and no one else.

But Roosevelt was after something bigger. He wanted to break the taboo against going after the rich. The idea found resonance in popular culture. A year after the new tax, Hollywood released a screwball comedy entitled “Soak the Rich,” which told the story of a self-pitying plutocrat named Humphrey Craig, who believes that FDR is “blind to the wounds of a millionaire.” Craig spends the movie fighting a tax bill that looks suspiciously like the Revenue Act of 1935, while simultaneously trying to protect his dippy daughter from the influence of campus radicals preaching confiscatory taxation.

The film bombed at the box office. But soaking the rich remained a winning political formula for the Democratic Party for years afterward. It may become one again.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stephen Mihm, an associate professor of history at the University of Georgia, is a contributor to Bloomberg Opinion.

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