By Burton Folsom, Jr. & Anita Folsom from the December/January issue
Not that he needs any further lessons from the master of confiscatory taxation.
"It's only right that we ask everyone to pay their fair share," President Obama has declared, while calling for higher taxes on the group he refers to as "millionaires and billionaires." Redistribution is the key concept--President Obama again and again demands that the U.S. redistribute wealth from one group of Americans to another.
Where does this emphasis on redistribution come from? Not from the Founders. The Constitution mandates that "all duties, imposts and excises shall be uniform throughout the United States." The Declaration of Independence entrenches the right to life, liberty, and the pursuit of happiness for all citizens. And once slavery was abolished, the 14th Amendment required that no state deny "equal protection of the laws" to "any person."
In fact, the Founders, and the American leaders of the 1800s, disdained the income tax. In 1872, President Grant rid the nation of the Civil War income tax; two decades later, the Supreme Court struck down another attempt at an income tax. If we must have taxes, the Founders urged, let them be consumption taxes--a luxury tax on imports, for example, or a vice tax on whiskey. As Alexander Hamilton said in Federalist 21 of such taxes: "The amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources." He added, "If duties are too high, they lessen the consumption; the collection is eluded; and the product in the treasury is not so great.…This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them."
In other words, if the government taxes whiskey, tobacco, or imported French wine at too high a rate, people will drink less and smoke less--and revenue will go down. That is "a natural limitation" on the greed of politicians. Thus, a system of tariffs and excise taxes formed the basis of U.S. revenue collection from Presidents Washington to Teddy Roosevelt.
In the early 1900s, the progressives argued that more power needed to be centralized in the executive branch, and more money should be spent by government to attack social problems. But where could the money be found to pay for such huge government bureaucracies? Progressives had a solution: tax the rich and regulate their income. On August 31, 1910, Teddy Roosevelt, who became a key progressive spokesman, announced: "The really big fortune, the swollen fortune, by the mere fact of its size, acquires qualities which differentiate it in kind as well as in degree from what is possessed by men of relatively small means. Therefore, I believe in a graduated income tax on big fortunes." In other words, uniform taxes, equal protection of the laws, and full property rights do not apply to those people with fortunes that are swollen. "A graduated income tax on big fortunes" is needed, Roosevelt insisted, as part of society's right to "regulate the use of wealth in the public interest."
But who is to determine how much money constitutes a swollen fortune? And what will the proper tax on it be? Under an income tax, politicians are the ones who judge ability to pay, and they choose the rates they think rich people can afford. And here, unlike with a consumption tax, there is no real check on the greed of politicians. If politicians choose rates too high they may lose the support of the rich, but they may gain support of those larger groups receiving subsidies from the redistributed swollen fortunes.
The income tax became law in 1913 through constitutional amendment, and immediately politicians enacted a progressive tax and began the arbitrary process of setting rates. Over time, politicians discovered incentives to increase taxes on the small group of rich people and redistribute their wealth to the larger group of voters. In 1913, for example, the original top tax rate was 7 percent on all income over $500,000. Three years later the top rate was 15 percent. During the 1920s, the top rate became 25 percent on all income over $100,000, but in 1932, during the Great Depression, it was hiked to 63 percent on incomes over $1,000,000. In 1935, President Franklin D. Roosevelt raised the top rate to 79 percent on multimillionaires. Thus, even before the income tax was 22 years old, politicians had steadily jacked up the top rate from 7 to 79 percent. FDR had no experience running a profitable business, but his cries for the rich to pay their "fair share" profited his political career.
FDR USED THE CRISIS of World War II to do three things: first, to tax the rich even more; second, to begin taxing the majority of Americans; and third, to introduce "withholding" to get cash immediately and guarantee a regular flow of revenue into the federal treasury. These three changes were dramatic events in U.S. history, and few historians have studied them. Rows of books have been written on the bombing of Pearl Harbor and on the dropping of the atomic bomb, but little is known of how 39 million Americans suddenly had to pay income taxes and why the cash was withheld from their monthly pay envelopes. In our new history FDR Goes to War, we tell the story of these three dramatic changes.
On the first point, FDR hiked tax rates even further on the rich because he wanted more of their money to fight the world war. In the 1940s, he gradually boosted marginal rates on top incomes to 94 percent on all income over $200,000. But even at those high rates, he ran out of rich people before he ran out of places to spend the money. As Senator Tom Connally complained, "We cannot get much more from the very high brackets, because as to them we have already reached the point of unproductiveness."
FDR's solution was to convert the income tax from a class tax to a mass tax. Before World War II, fewer than 5 percent of Americans paid income taxes. "Too many people," Roosevelt lamented, "are earning money and not contributing to the government." When a Treasury official suggested lowering personal exemptions, Roosevelt was delighted. "Of course I want that. I have been trying to get it for years but nobody will help me do it." From 1939 to 1944, with Roosevelt's blessing, the amount of money families could earn before they had to pay income taxes declined from $2,500 to $1,000 for married couples. That meant that from 1940 to 1942, the number of Americans paying income taxes jumped almost tenfold, from 4 million to 39 million. Furthermore, the starting tax rate skyrocketed from 4 percent to almost 24 percent. The government used the wartime emergency as a tool to encourage tax payments. "Taxes to Beat the Axis" became the slogan of the day. Songs on the radio, speeches by movie stars, and even Walt Disney cartoons in movie theaters urged all Americans to pay their income taxes.
Just as 1942 was the year of the first mass tax in U.S. history, 1943 would be the year of withholding taxes at the source. The case for withholding was simple: the war was expensive, and FDR wanted to get more revenue more quickly from the tens of millions of new taxpayers. To sell the idea of withholding to Americans, the government called the practice "pay as you go," which made higher taxes sound more like payments on layaway merchandise in a store. "Pay as you go" also subtly implied that everyone was paying a debt that they owed, when in reality, most Americans had never paid an income tax before. But if employers could be forced to extract pay from their workers' wages each week or month, and then send that cash to Washington, the government could secure a steady flow of revenue--not only for the rest of the war, but for generations to come.
The campaign for withholding, however, hit a snag: Tax payments in the United States were not on a current basis. The 1942 tax bill, for example, was not due until 1943, and there was no system of withholding. That system of earning revenue in one year and paying nothing until the next year started with the first income tax law passed in 1913. Congress did not pass that tax until October and, to extract instant cash from wealthy people, made the tax retroactive. To ease the pain, Congress allowed taxpayers to pay their 1913 tax in 1914, and that practice had continued for the next 30 years. Thus, the more than 30 million new taxpayers in 1942 could delay their payments to Uncle Sam until 1943. But since FDR wanted withholding immediately in 1943, that meant most taxpayers would be subject to "double taxation," in 1943--they would be paying withholding tax immediately, and they would still owe their 1942 taxes on top of that.
Some observers favored the government forgiving people of their 1942 taxes in return for withholding, but FDR insisted on "double taxation" even if it meant that rich people owed more than 100 percent of their 1943 income to pay both years' taxes all at once. The Current Tax Payment Act of 1943, passed on June 9, forced millionaires to pay some double taxation--one-fourth of their 1942 tax bill was due in 1943, and they also had to pay withholding on 1943 income immediately. Married people with no dependents who annually earned $500,000, for example, would have to pay a 98.7 percent tax rate in both 1944 and 1945. Those who earned $1 million each year of the war would owe a whopping $1,006,750 in both 1944 and 1945. When asked how some people, admittedly a small minority, could pay more than they earned in taxes, Senator Allen Ellender (D-LA) responded, "I submit that the [rich] taxpayer is likely to have accumulated sufficient assets with which to make the necessary income payments."
THE PROGRESSIVE IDEA that income should be limited by law raised profound questions for American society. Do rights, such as the right to property, come in a natural way from God--as stated in the Declaration of Independence--or do they come from government? If Americans have a natural right to life, liberty, and property, then high progressive taxes violate that right. If, instead, rights come from government, then the leaders of government have the legitimate authority to confiscate wealth, or redistribute it from one group to another. In time of war, Roosevelt argued, and perhaps afterward, government had the right to most, if not all, income of wealthy citizens in the national interest.
For the first time in U.S. history, the redistributionists dominated political life. For example, on the Senate floor on May 14, 1943, Senator Happy Chandler (D-KY) said, "All of us owe the government; we owe it for everything we have--and that is the basis of obligation--and the government can take everything we have if the government needs it." Chandler wanted to be clear on this point. "The government," he added, "can assert its right to have all the taxes it needs for any purpose, either now or at any time in the future." Chandler, however, did not redistribute much of his own income. Already investigated in 1942 for accepting large gifts from war contractors--including a 60-foot in-ground swimming pool--Chandler had a history of securing government contracts for friends and donors, and then reaping rewards for himself.
Not all congressmen agreed with Chandler. Many opposed Roosevelt's "capital levy," as Senator Robert Taft (R-OH) called it. Senator Arthur Vandenberg (R-MI) called it "prejudicial class baiting." During the congressional debate, Rep. Charles Gifford (R-MA) said, "The administration [has] set loose the forces of prejudice and disunity." Rep. John Jennings (R-TN) said of the American taxpayer, "Heretofore, we have sheared him annually--now it is proposed to skin him." Jennings added, "I do not hold any brief for Henry Ford, but I am glad that he started life with a pair of blue overalls and a monkey wrench and the genius that God Almighty put into his brain, and became a millionaire, because he made other men rich and paid the highest wages that up to that time had ever been paid to the American workingman and covered this whole country with a network of highways."
Jennings concluded, "The time will come if we continue on down the slippery, steep road we are now on to the precipice that leads to the bottomless pit, the abyss of financial bankruptcy and ruin, the time will come when we can put a taxpayer on exhibition and make money charging admission for people to see him."
FDR, however, clearly wanted Congress to pass a tax bill that gave him withholding and double taxation on the rich. When the Senate refused to pass such a bill, FDR threatened a veto. "The Senate bill," the president wrote, "would result in a highly inequitable distribution of the cost of the war and in an unjust and discriminatory enrichment of thousands of taxpayers in the upper income groups." Yet this "unjust" Senate bill already taxed large incomes almost 90 percent. The Senate-House conference committee, however, under threat of an FDR veto, turned out a bill that taxed million-dollar incomes at 100.6 percent per year for 1944 and 1945. Six months later, however, when Congress refused to raise those rates further in the Revenue Act of 1943, FDR vetoed it and called it "not a tax bill but a tax relief bill providing relief not for the needy but for the greedy."
FDR's ACTIONS SEEM PUZZLING. Why "soak the rich" for 100 percent of their income (more or less) when they already face rates of 90 percent in both income and corporate taxes? He knew that rich people would shelter their income in foreign investments, tax-exempt bonds, or collectibles if tax rates were confiscatory. In fact, he saw it happen during his early New Deal years. When he raised the top rate to 79 percent in 1935, the revenue into the federal government from income taxes that year was less than half of what it was six years earlier when the top rate was 24 percent. After that, FDR admitted privately, "Barney Baruch has been saying right along that you have got to reduce the top taxes and that if you do that people will take chances." But he refused "to pay usury in order to get recovery," and he kept rates high. Why?
Three points are important here. First, FDR, as a progressive, believed with his cousin Teddy that "swollen fortunes" needed to be taxed at punitive rates to redistribute wealth. In fact, as we can see, redistributing wealth was more important to FDR than increasing it. FDR was the first U. S. president to take redistribution that far.
Second, high taxes on the rich provided excellent cover for his having made the income tax a mass tax. How could a steelworker in Pittsburgh, for example, refuse to pay a new 24 percent tax when his rich factory owner had to pay more than 90 percent?
Third, and possibly most important, class warfare was the major campaign strategy for FDR during his whole presidency. He believed he won votes when he attacked the rich, or they attacked him, and he discussed that with Ray Moley, his speechwriter, and later with Henry Morgenthau, his secretary of the treasury. During the 1936 campaign, when FDR still had double-digit unemployment, he used the rich again and again as scapegoats. Two weeks before the election, FDR announced that wealthy people had long been refusing "to pay a fair share" of the cost of government. Therefore, he boasted, "we increased still further the taxes paid by individuals in the highest brackets--those with incomes over one million dollars a year. Wasn't that the American thing to do?" Later, when those millionaires sheltered their income to escape the high new rates, Roosevelt publicly denounced them for "tax avoidance" and for not paying their "fair share." In 1937, perhaps thinking of his next reelection campaign, he told two prominent Democrats, Senator Pat Harrison and Rep. Robert Doughton, that if they would form a "subcommittee to investigate tax avoidance," that the Democrats would gain "at least 10,000,000 [votes]" by publicly exposing those who sheltered income.
FDR won his long-term battle to retain the withholding tax and keep a large percentage of Americans paying incomes taxes. But in the next generations, Presidents Kennedy and Reagan were each able to slash the top rates; Presidents Clinton and Bush were able to cut the capital gains tax as well. Because these rate cuts created more revenue, and sparked economic growth in the U.S., the old campaign for redistribution slowed down until the arrival of Barack Obama on the political scene.
NO POLITICIAN SINCE FDR has locked into the campaign for redistribution as faithfully or as enthusiastically as Barack Obama. He clearly admires FDR and compares himself to FDR. Perhaps tongue-in-cheek, Obama said FDR was "pretty fiscally conservative," but in practice Obama has copied Roosevelt's tax strategy, using his main tactics and even some of his words.
During the 2008 campaign, we saw Obama parallel FDR's commitment to the principle of redistribution -- even if it reduced wealth in society. In an ABC News segment, for example, on April 16, 2008, Obama said he wanted to raise the capital gains tax. Interviewer Charlie Gibson asked:
George Bush has taken it down to 15 percent. And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28 percent, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?
Obama replied, "Well, Charlie, what I've said is that I would look at raising the capital gains tax for purposes of fairness...." When Gibson retorted, "But history shows that when you drop the capital gains tax, the revenues go up," Obama said, "Well, that might happen, or it might not."
Thus, whatever the impact on revenue, Obama has fought during his presidency to raise the capital gains tax. Not only is it a matter of principle, it is for Obama, as it was for FDR, a useful campaign strategy. Both FDR and Obama had huge spending programs that resulted in high unemployment, increased national debt, and a stagnant economy. The class warfare theme that worked so well for FDR is a major part of Obama's campaign for reelection. Regardless of whether massive federal spending and high taxes hurt the economy, the political point is that few Americans earn $1 million a year and those who don't can be riled up at those who do. That's how, as FDR showed, an incumbent campaigning for reelection can win and win again during hard times.
Republicans put "party over country," Obama said during an October 6, 2011 press conference. "Millionaires and billionaires…have lower tax rates in some cases than plumbers and teachers." True, capital gains taxes at 15 percent are lower than income taxes for some middle-class Americans, but that is because the capital gains tax is, in a real sense, a second tax on top of the income tax. All cash invested toward capital gains has already been shrunk by the income tax (and possibly the corporate tax as well). But census data reveal that the top 1 percent of income earners pay 38 percent of the federal income tax; and the bottom 50 percent shoulder less than 2 percent of that total tax burden--which is not a statistic shared by the president. Instead, Obama promotes his new surtax on millionaires, thus "making our tax system fair and just and promoting growth."
Those who thrive on class warfare, like FDR and Obama, seem to have insurmountable advantages. They can divide America, demonize the rich, and fish for votes among the middle-class and poor. But, as FDR and Obama have discovered, when you penalize the rich, they shelter their wealth, or take it elsewhere. That makes an already depressed economy even more stagnant. Ronald Reagan, by contrast, slashed tax rates on incomes and corporations, and then watched as unemployment and inflation plummeted. The U.S. dramatically expanded its industrial hegemony in the world. Along the way, Reagan carried 49 of 50 states when he ran for reelection. What's more, when the economy opened up, the poor really did get something from the rich--computers, iPhones, Garmins, the Internet, and flat-screen TVs, for starters. That beats the WPA, the OPA, cash for clunkers, and Obamacare. And it gives those who believe in freedom hope that the votes for President Obama will be redistributed in 2012.
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