Federal Taxation in America: A Short History (2004) by W. Elliot Brownlee

Writing on New Year’s 2013, this whole “fiscal cliff” mess and the hullabaloo with the “Buffett rule” on taxing the wealthy got me curious about federal taxation in America. Not just where we are today, but where we’ve been and what the second and third order consequences have produced. It’s all well-and-good for Paul Krugman to remind us incessantly that the top income earners in this country once paid a marginal tax rate of 90% in the 1950s (relative to 35% today) and that the overall economy did just fine. But for most of our nation’s history no one paid any income tax at all. If you looked at all the data from 1781 to the present, what story would it tell? Surely, we must have some insights that would allow us to create a responsible and effective federal taxation policy, one that is both socially progressive and commercially aggressive. Or so that was my assumption. I was hoping that W. Elliott Brownlee’s “Federal Taxation in America: A Short History” would help answer some of these questions, and do so in an objective, thoughtful, nonpartisan manner.

I learned quite a bit from this tight, unadorned little history. Brownlee’s central argument is that dramatic change to American federal taxation policy is relatively common, but it has always been associated with a serious national crisis: 1) the founding of the republic; 2) Civil War; 3) World War I; 4) Great Depression; and 5) World War II. He argues that the preceding tax regimes were incapable of meeting the fiscal requirements of the latest crisis, while the unifying influence of the crisis allowed for political objections and obstacles to new federal taxation to be overcome. Moreover, each successive tax regime retained features of the one that preceded it, giving U.S. taxation a diversified, layered feel. The enhanced power of the federal government to tax has thus never taken a step backward after a serious crisis has passed – tax powers just continue to “ratchet upwards” as politicians embrace the new fiscal power that major crisis tax change brings them in peace time.

For the first century of American history the federal government collected 90% of federal revenue from import duties. These taxes were easy to collect (most imports entered through a handful of ports) and were politically popular and perceived as just. Nevertheless, Article I, Section 8, of the U.S. Constitution gave the federal government the power to collect indirect sales tax, such as the Whiskey Tax, although Section 9 explicitly prohibited the government from collecting direct taxes, such as income taxes.

The Civil War changed the game on federal taxation, Brownlee writes. The government employed the full gamut of taxes available to them and the citizens of the North readily complied as demonstration of their loyalty. Only 20% of the Union war effort was financed by taxes — the majority of those were levied on consumption, particularly luxury (perfume, carriages) and vice (alcohol, tobacco)– but 30% were still from tariffs and 20% from a revolutionary new income tax (although only about 10% of the northern population had to pay it).

By the 1890s, the tax on the sale of alcohol and tobacco accounted for half of all federal revenues, and financed nearly all of the Spanish-American War when those taxes were doubled. To this point federal taxation was not a controversial issue, according to Brownlee. The rise of industrial monopolies and their associated titans would change all of that. Brownlee writes that progressive taxation was an issue that the long downtrodden Democratic Party identified as an issue to reclaim national electoral competitiveness. By 1896 a federal income tax appeared in the Democratic national platform. It remained a priority that continued to gain public support but made little progress until World War I provided the galvanizing event to push through new federal income tax legislation.

Brownlee uses the term “Democratic statist” (in a generally neutral sense) to describe the tax policies stretching from Wilson to FDR. During WWI, Wilson and his Treasury secretary, McAdoo, focused on “soak-the-rich” policies of progressive income tax and corporate taxation (top 1% of earners paid 80% of income tax at 15% effective rate), but the really big innovation was a corporate “excess profits” tax of 60% on profits of greater than 20%, which accounted for 2/3 of federal tax revenues during the war. This shift from the tariff to the income tax as the main source of federal revenue was revolutionary. In 1902 the tariff accounted for 75% of federal revenue and income tax 0%; by the 1920s the tariff had fallen to 25% and income tax had grown to 50%.

The author stresses that both parties entered the Depression believing that federal deficits needed to be closed and were prepared to raise taxes to do so. But FDR focused on taxing corporate retained earnings and publicly shaming wealthy tax evaders, including former Treasury secretary Mellon and GM executive Alfred Sloan. Brownlee writes that FDR’s tax policy up to WWII was not so much progressive as simply heavier: higher taxes on the rich, social security taxes for everyone, and new consumption taxes to boot.

Brownlee contends that strong political leadership guided primarily by political ideology and powerful agency leadership were decisive to the tax regimes that emerged from WWI and Great Depression (Wilson & McAdoo; FDR & Morgantheau). Taxation was broadly distributed (60% paid income taxes) but still progressive; in fact, the most progressive income tax scheme ever: top 1% paid 32% of all income tax at an effective rate of a whopping 60%.

The final half of the book is an in-depth exploration of Reagan era tax policy and the tax regimes of Clinton and George W. Bush. Much of it reads as tired, yesterday’s news, with far too much detail.

In closing, the first section to “Federal Taxation in America” offers a sharp and readable summary of the U.S. government’s experience with taxation from the 1780s to the Cold War. For anyone looking for a general overview, that should suffice. However, for someone looking for a more insightful, data-driven perspective of federal taxation, showing how federal tax policies and income tax rates have impacted and influenced core economic growth, productivity and competitiveness, which it what I was hoping for, will likely be disappointed.