Researcher Talk: Making the Modern American Fiscal State

Researcher Talk: Making the Modern American Fiscal State


McCulley: Thank you for attending today’s
Researcher Talk. I’m Richard McCulley, historian at the Center for Legislative Archives which
host this series. Today’s talk is the last of 2014, a year when we’ve really been treated
to some splendid presentations by some of the Center’s most significant researchers.
That said, we end the year with a bang by hosting today’s guest, Ajay Mehrotra, who
will discuss his very significant and timely book, Making the Modern American Fiscal State:
Law, Politics, and the Rise of Progressive Taxation, 1877 to 1929, published by Cambridge
University Press. We will resume these talks, on January 15th when we host Rebecca Edwards,
Professor of History and Department-Chair at Vassar College. Her talk is titled Sex
on the Frontier: Fertility in America’s Antebellum Empire. Well, Rebecca Edwards is a very eminent
historian who would be expecting quite a draw from, but a presentation of that title I think,
this is something not to be missed. Professor Mehrotra is the Associate Dean for
Research, Professor of Law, and Louis F. Niezer Faculty Fellow Adjunct Professor of History
in Indiana University. He received his J.D. from Georgetown University Law Center and
his PhD in History from the University of Chicago. He has served as the co-director
of the Indiana University Center of Law, Society, and Culture. Before arriving at Indiana University,
he was a Doctoral Fellow at the American Bar Foundation in Chicago. After law school and
prior to his graduate training in history, he was an associate in the Structured Finance Department of the New York office of JP Morgan. Ajay must be among the very, very small group of
individuals who have left Wall Street to pursue a degree in history. He is co-editor of the
New Fiscal Sociology: Taxation in Comparative and Historical Perspective, published also
by Cambridge University Press. We should have time for Q&A afterwards. If you have questions,
please raise your hand so we can pass around the microphone. Then, after that, there are
copies of Ajay’s book for purchase at the back of the room.
Mehrotra: Thank you – Well, thank you all for coming so let me begin actually by saying
thank you to Richard, for inviting me to this. We met at the Policy History Conference last
summer. He was kind enough to come to one of the panels where I was presenting some
recent research, that is an outgrowth, an elaboration of some of the work from the book
project and we got to talking about how important the National Archives were to my project,
and my entire research agenda, and many other people – there’s a real revival in political
history. Rebecca Edwards is, is certainly one of those pioneers and I think you’re going
to have a great talk when she’s here next week, and Richard was kind enough to invite
me out here and so thank you all for coming out here and let me also take this moment
to really thank the Archives and archivists everywhere. I mean, historians cannot do what
we do without the great work of the archivists and staff members of a place like National
Archives and Library of Congress and other places. We know that, I know we, we try to
make acknowledgements in our books for all the great archivists out there but really,
is it the fodder for, for all of history and it is the primary sources you all put together
that are very important to our profession so I want to take a moment to thank you for
that. So I thought I’d take about a half hour, forty
minutes or so, to go over the general outlines of the book. Before I do that, I want to give
some background in how I became interested in writing about US fiscal policy, particularly
during this particular period. As Richard mentioned, the book that I’m going to discuss
today, that is The Making of the Modern American Fiscal State: Law, Politics, and the Rise
of Progressive Taxation, from 1877 to 1929. I thought I would spend some time going over
what the main arguments and claims I try to make in the book, and then I really want to
focus on the sources of historical evidence and as I do so I want to weave some of the
very valuable sources I have found here in this building as well as NARA 2 and Library
of Congress and in, in some of the other places where, again this, the primary, these unpublished
primary sources that are a historian’s true desire for getting to the sort of unmediated
past and there are a lot of important sources in this building and I’ll try to weave those
into my presentation. As Richard mentioned, I’m a legal historian
and I’ve been in, so I’ve been trained as a lawyer and as a historian. But I also teach
and write about a topic that most historians do not want to focus on and that’s tax law
and policy. I think tax is one of those areas that, at least for the American historical
profession, has been neglected, at least in this country. It’s quite surprising. I’m actually
in town for a conference the next couple of day of the German Historical Institute and
every couple of years the GHI puts together this terrific conference on taxation and all
these folks from Europe, Germans and they – And for them, fiscal history is it. I mean,
there’s so many people doing it, they have so much vast knowledge and they kind of come
over here and go, “What’s wrong with you Americans? How come you don’t pay enough attention to
these issues of fiscal policy?” And we try to say “Well, we’re getting there, the sources
are here, give us a chance, we’re catching up in a sense.” And so, this has been my research
agenda from the very beginning, so this book project has been part of a larger agenda.
When I’ve looked at the political causes and consequences of changes in American tax policy.
And so, at its core, my book is really about the intellectual, legal and administrative
foundations of what I refer to as our current system of direct and progressive taxation.
Right, those two key words, are direct and progressive are really important. Like all
historians though, my motivations aren’t just based on the historiography. They’re really
shaped by our own present social and political climate. Arthur Schlesinger once famously
said that all historians are prisoners of their own generation. So as much as they want
to write about different generations, we are of course impacted by what’s going on around
us. And so I’ve working on this book for longer than I care to remember from the dissertation
to the transformation of the book process and during that time we’ve heard from many
social commentators and scholars that the United States has entered a new Gilded Age
and this is, of course not, not tremendous news, we, as I’ve said lots of scholarly commentary
about this, lots of books about the growing inequality and the concentration and maldistribution
of wealth that’s occurred. Not just the United States but in the Western industrialized world
since about the 1970s to the present. All you have to do is read Paul Krugman every
other day and know that you’ll be reminded of that of course, he’s been writing about
this for quite a lot of time. And of course the sensational reception of Thomas Piketty’s
Capital is just yet another example of how this has really become a very important issue
not just for scholars but, but for social commentators and for all concerned citizens.
And so my goal in this book though, of course, is to take us back to the first Gilded Age.
Right, if we’re in the Second Gilded Age there was clearly an earlier period in which there
was this massive inequality, this, this sort of incredible concentration of wealth symbolized
by such mansions as this one. Right, this is of course the Vanderbilt’s Biltmore Estate
in Ashville. Some of you may have visited. It is of course now a big tourist attraction
but this two hundred and fifty room home, a nice humble abode for a summer home for
the Vanderbilt’s, is just one example of some of the opulence and, of this massive inequality.
And of course, contrasted against that was the ravages of industrialism. The late nineteenth
century is of course the period when massive urbanization, migration and industrialization
has the other end of the spectrum. This of course from the 1930s, this is a famous Dorothea
Lange photo from the Great Depression but you get the point with the massive inequality
that existed in the Gilded Age, was a fundamental part that’s kind of driving my concerns about
this book. And so the puzzle that drove me when I first started thinking about this,
thinking about the first Gilded Age and what was the response, what was the economic, political,
and social reaction to this kind of inequality. Well, I noticed that there’s was a fundamental
fiscal transformation in the United States at the turn of the twentieth century and its
best seen, I think, with some quantitative data. I teach tax law so I think the numbers
are every, we can talk about tax and, and fiscal policy about these numbers, and you
can see that there’s this dramatic transformation from the late nineteenth century and the sources
of revenue for the federal government. You see that its custom duties, it’s indirect
and ostensibly regressive taxes, right, the excise, consumption tax, what we would call
today consumption taxes, that fuel about 90 percent of government revenue in 1880. And
that if you scan up -I don’t know if this is a scanner clicker her, but if you go up
to 1930s you see that the income tax picks up, up almost 60 percent, 66 by 1920 as a
legacy of World War I of course. This is a fundamental transformation in the way our
federal government finances itself. And so this was the real puzzle, how did we make
this shift, how did we go from this indirect and highly regressive system of consumption
taxes to a more direct system, the income tax is a direct tax as we would say, and as
what we referring to the base, and its graduated rates. Not dramatically graduated as we would
expect, though during World War I there is quite a spike of which the top rate does goes
up to 77 percent. How do, how did this shift occur? What was the driver behind it?
Part of it, of course, is geopolitical. So this another version of this. . . the yellow
is the income tax. You can see World War I is the pivot upon which this transformation
occurs. And I have a separate chapter on World War I and World War I plays a very crucial
role but much of the historiography and much of the historical-social science literature
gives a lot of emphasis to war – war and state-building go hand in hand and tax is sort of the hand
maiden that gets us there. Except that the chronology doesn’t quite work for the US because
our income tax is well before World War I. Right, so 1913, a year before the war even
starts in which we have the 16th amendment and then the first set of federal income tax
laws. So it’s, so part of my contribution to the literature is to challenge a little
bit the sort of the Charles Tilly view of the world, that war, that states make war
and war makes states, that it’s all about war as the independent variable. This is sort
of an old parlor trick among historians. We go to the social scientists, we tell them
that it can’t be just one variable. There’s lots of variables, right, it’s not just one
independent variable that explains such fundamental structural changes in society.
And so I wanted to ask myself, what were the motivations for this fiscal transformation?
What were its consequences? That was what I was really trying to get in this book. And
so there are, there are really five. I am not going to spend the entire time going over
all five. Let me go over the main, sort of what I see as the consequences ‘ what I see
not just the transformation of public finance but how that itself leads to a new fiscal
polity, a new kind of statecraft. And it’s driven by and contained within sort of five
different elements. One of course is this desire to reallocate the fiscal burden. So
moving it away from regressive consumption taxes towards direct – it’s really about reallocating
the burden of how you finance what at this time is the emergence, burgeoning modern,
regulatory, administrative, social welfare state. The roots are all there in this, this
Progressive Era period. The question becomes how are you going to finance it and are we
going to do it in a more equitable and effective manner. And this is not all that new, the
literature has talked about how the rise of income tax and a graduated direct tax has
had this effect but what has been underestimated, I think, is how this also had a sort of social
and cultural implication. So I argue in the book, the second element of this new fiscal
policy is how it created this new sense of civic identity and national, what was referred
to as “fiscal citizenship” and that’s not a term I’ve coined but it’s a very important
term to my book and it’s become more popular to tax reform debates. The tax lawyer by the
name Larry Zelenak who has a new book out called Learning to Love Form 1040 in which
he advocates for the maintenance of the return- based income tax system and part of it is
this notion of fiscal citizenship – that the actual process of paying taxes actually engages
citizens with the state in a positive kind of way, or at least it potentially can be.
And so certainly in my period that’s certainly one of the drivers of this move away from
a hidden, sort of regressive consumption taxes to a more direct, visible, transparent kind
of tax system. So that’s a really important part of the book.
And then also third, I am at heart a legal and political historian and I think that when
one thinks about the turn of the twentieth century in American political historiography
at least, this is the time when we see a transformation away from what’s known as the “party period”
– the period when things like the tariff are the defining issues that separate Republicans
and Democrats to the move to what’s known more as – I don’t know if this is the exact
term but the “post-party period” is certainly one in which special interests rise and there
is a more fractured sense of politics and how, how law-making occurs. And of course
fiscal policy is at the center of that. The move away from the tariff and customs and
excise taxes to an income tax is part of this shift, this alteration in political arrangements.
And so those are sort of the three main elements. The other two that I don’t sort of tease out
in the book but that I allude to that are more consequential. The fourth is really how,
at the end of the day, the income tax becomes a fiscal work horse. It doesn’t happen in
my period. It’s really in World War II when we move from a class tax to a mass tax – that
it generates the kind of revenue that’s important for us today. But the foundations again, the
intellectual, legal, administrative foundations, are all there in the Progressive Era. It just
gets accelerated, I argue, in World War II when it really- it underwrites this modern,
as I’ve said, modern administrative, regulatory, social welfare state. You have to have the
revenues to do these kinds of things and it’s at this early stage, this early Progressive
Era stage that the foundations are built. And then the fifth, which is a little more
provocative perhaps, or a little more presentist, as some of my historian friends always push
me a little on this, but I try to make the argument that – the foundations are, there’s
also a paradox, or an unintended consequence that comes from this kind of move to, towards
direct and progressive taxation and away from consumption taxes and that, that is, I argue,
it kind of exacerbates what I describe as a fiscal myopia that Americans might have.
And this comes from some of my comparative historical work I’ve done looking at, for
example the value-added tax in Europe for example. Right, if one looks at OECD data
today, it, I think, shows us two things. One, there’s a myth that there’s an undertaxed
American, right, I mean that we’re overtaxed, pardon me, right. If you look, at we don’t
pay as much as other OECD but we not, it’s not as if we’re overtaxed in that sense. But
more importantly, what’s missing is – almost all modern industrial countries have some
kind of consumption tax that, in the form, some kind of form, something like a value-added
tax. The conspicuous absence of a value-added tax in the United States is really kind of,
at least for someone of a more presentist tax law policy perspective, is really sort
of jarring. And in some ways, the presentist [sic] punch I’m trying to make in this book
is not to explain why, that would take another book all by itself, but at least as to gesture
that this fixation on a progressive income tax may have foreclosed the opportunity for
other kinds of taxes, possibly the movement to a VAT. And so in some ways, no VAT in the
United States, the question of why no VAT in, is sort of like Werner Sombart’s question
about why no socialism in America. I think the two kind of go hand-in-hand. And so I’ll
talk a little bit at the end about my current research and so I think I’m going a little
bit more in that direction but, what, at least one of the consequences I see is how this
foundational period really kind of narrowed the imagination and vision of tax reformers
when they thought about the income tax versus consumption tax and what was possible. And
I’d be happy to talk this more in the Q&A. As I said I don’t think I can prove this point
but I certainly I think there are, there is evidence to suggest that this foundational
period had this unintended or paradoxical consequence.
So let me get to the first three claims because they really are the most important. First
of course, is this notion about shifting the tax burden. Right, so we saw here this move
again away from regressive tariffs associated with the tariff and excise taxes on alcohol
and tobacco to really taxing individual income, business profits, and wealth transfers and
intergenerational wealth transfers, direct taxes. So it’s about shifting the base. This
was certainly, clearly part of it. And so that meant targeting wealthy individuals and
corporations in the northeast. So there’s clearly a sectional story to this. And this
has been told again by others so I am sort of weaving and synthesizing some of the historiography
that exists. But one thing I really focus on is this notion of “ability to pay.” So
these three words, these really curt words at this time become very powerful tools. This
is where my book is more kind of a combination of intellectual and political history. I look
at the reformers who initially are populists farmers in some sense up from, part from,
up to intellectuals. So key, some of the key protagonists in my book are political economists.
We’d today call them economists but back then themselves called political economy. I think
the distinction is very important. They were thinking about the economy in a much broader
way than economists think of today. And it was these political economists, led by people
like Edwin Seligman who was probably the leading tax theorist of his time, the Colombia University
political economist Richard Ely, the labor activist from the University of Wisconsin,
Henry Carter Adams, and the University of Michigan, these sort of, what I argue, are
the pioneers of American public finance, at least theoretical finance. And they pushed
this, they’re all German-trained and so there’s a trans-Atlantic story to be told as well
that I use in my book, and they focus this notion of ability to pay – that our tax system
should have as its fundamental cornerstone the notion that those who earn more have a
duty, have a social obligation to contribute more. Not just proportionally more but progressively
more. So this notion of graduated rates fits into this idea and is driven by this concept
of ability to pay. And of course, it’s no coincidence that these
economists are writing at a time when things like marginal utility analysis is taking over
the United States – coming you know again from a trans-Atlantic story from Europe. But
it’s people like Seligman’s colleague at Colombia, John Bates Clark, who are talking about notions
of marginal utility and how the last dollar to the Vanderbilt’s means a lot less than
the last dollar to a local New York laborer. And so this very important phrase,”ability
to pay,” I trace this language from the political economists, their writings and their treatises,
and again, this is a time when these political economists are progressive reformers too.
They’re not just writing for a specialized audience of intellectuals. They’re actually
trying to write for broad audiences. So Edward Seligman writes just as many articles in the
North American Review as he does in the Journal of Political Economy – and he’s really trying
to reach a broader – And what I argue they’re doing is harnessing a social response or social
reaction against the existing ancien regime of regressive, indirect taxes and they’re
using this language of “ability to pay” not just as an intellectual tool but as a political
tool, as a way to galvanize a movement. And so they, their ideas are picked up by politicians
and so this is where the lawmakers come in and this is where the National Archive story
has been very important to me, to trace how this language of ability to pay moves from
the halls of academic seminars and journals and popular magazines to what lawmakers are
saying actually on, in the halls of Congress. And so this is clearly one of the main points
about this. And the other main thing that Seligman and others are pushing is that they’re
not trying to radically redistribute wealth. Okay, that’s never been the goal of sort of
shifting the tax burden. Alright, and I think we sometimes forget what the origins of our
tax system are about. In some ways, our historiography, at least what’s the current existing historiography,
I’m thinking here of the work of the legal historian Morton Horwitz as well as the political
and economic historian Robert Stanley who’s also written about the rise of the income
tax. It’s this view, that you know, that this was a lost opportunity – that, you know, this
instance was co-opted, the income tax was really co-opted by conservatives who really
averted what really could have been a really, we could have been Scandinavia is sort of
the premise. Right, we could have had this really radical change in this progressive
era and we missed out. And so it’s really this conservative ploy to just kind of silence
the masses, we’ll have this token income tax is sort of the argument that Horwitz and others
have made. And I think that’s just wrong because if you, if you take a look at the primary
sources, yes there were some people so it’s not completely wrong, there were some people.
Nelson Aldrich is a very far-right, the very famous conservative Republican from Rhode
Island who actually says that he’s going to agree for the income tax to stop the socialists.
I mean that’s a claim he makes quite explicitly. And so there is some evidence of that but
that’s not wha’s going on elsewhere and that’s, he’s not the only lawmaker who has influence
on this. So I think we lose sight of this in historiography by thinking that our income
tax was meant to radically redistribute wealth. And it’s not just in the historiography. I
think in popular political discourse sometimes, folks on the right think we have, had a goal
of using it to radically redistribute wealth. So our modern Tea Party in a sense, has this
sense that our tax system is about somehow punishing capital or punishing wealth. Or
you see these kinds of posters about “Taxed Enough Already.” Right, this is one of the
chords, continues to be one of the core elements, I think, of our modern Tea Party. And so there’s,
of course, a huge cognitive dissonance to some of the Tea Party. And this is my favorite
poster from the Tea Party, right, “Keep Government Out of My Medicare,” right – People are odd
– Again, going back to those salient, lot of people, lot of people really understand
is the public versus the private in all this. So I am trying to address, again going back
to Schlesinger’s point about being a prisoner of our own generation, I am trying to address
both the kind of New Left historiography that wonders why we’re not Scandinavia and the
kind of current political dialogue that thinks that we’re radically redistributing wealth
or that we wanted to at one point. That was never the goal in any of this.
And so if you go back to this, what the goal really was, it was really about reallocating
the financing. How are we going to support a modern industrial state? And so it wasn’t
just the intellectuals. In fact, it starts, I argue with a sort of social history. And
here’s a source that I found in this building. And so you have, I hope it’s not too small,
but this is a letter, a petition from the secretary of the Massachusetts Grange movement
to, to his Congressman which I found here in the Petition and Ways and Means Box, Box
180, folder tax – It’s upstairs somewhere, right, I imagine, right. And this is the quote
that’s in, in the book: “That the American farmer in here fore and is now paying more
than his just proportion of taxation and believing than an internal revenue tax upon incomes
will tend to equalize the burden of taxation.” I want to draw your attention to that phrase,
right. It’s about equalizing the burden of taxation. It’s not about radically redistributing
wealth in any sense. And so the resolution they come up with is that the members of the
Grange request our representative in Congress and also our Senators – best efforts to place
such a law upon the Statute. This is in1893-94, when the first income tax is introduced and
eventually struck down by the court. And so this is a social movement. It starts with
this kind of populist and it spreads, of course, politically through the People’s Party. So
you can actually see this, it’s not just the Granges. There’s actually some political voice
for this in the political parties. And then later you actually, this becomes a resounding
theme that the, again, the intellectuals kind of harness but the – My story kind of moves
from the social movement to the intellectuals who harness that social movement. They become
the kind of bridge between the people on the ground and then the lawmakers cause, of course,
what I’m trying to write about is ideas in action – not just the ideas of intellectuals
talking among intellectuals, but how they-re trying to influence lawmakers. And so, one
of the most important lawmakers in this period is Cordell Hull who is, in many ways, the
political father of the income tax. And here too, Hull, I think, suggests it-s not about
any kind of notion of radically redistributing wealth. He says here: “I have no disposition
to tax wealth unnecessarily or unjustly. But I do believe that the wealth of the country
should bear its just share of the burden of taxation and it should not – shirk that duty.”
Now of course – just share – is a protean concept, right. Everyone has a different vision
of what “just share” is. But there was, at least at this point, at this time, a sort
of bi-partisan, at least initially, and slowly, gradually, a sort of bi-partisan notion about
a shift from a regressive and indirect system to a progressive and direct system was at
least one way to ensure that kind of, that kind of just share. And then again you saw
this, again, back in, in the popular culture. So there’s this terrific little cartoon that
is the cover of my book. I just, this is here in the Library of Congress that I stumbled
upon. And you can see here the title of the cartoon is “The New Man on the Job.” The treadmill
is “Governmental Expenses.” Right, so again this is about – it’s going, and we’ve got
this modern, burgeoning, regulatory, administrative, social welfare state. It’s the working class
that’s been on top of the treadmill, doing all the work and finally, the heavy set iconography
– this is the “Idle Rich,” it’s what he’s labelled at. And the collar you can’t see,
but the collar is the income tax. It’s the collar that’s bringing the rich onto the treadmill.
Again, not to radically redistribute – not to turn, not to equalize all wealth and income
but to get them onboard with doing their fair share. This, I think, image really, powerfully
captures what’s going on. And then this quote from George Owens who’s a government statistician
at the time, talks about this concern, right, -That there is always a danger the rich will
get too large a hold upon the wealth, the resources, the labor of the country. In which
case, the most effective and practical remedies are progressive taxes on incomes, gifts, and
inheritances. – Right, so we’ve moved to a direct and graduated tax system and moving
away from indirect and regressive to this is what’s really driving at. And I think we
still hear echoes of this today. So if you think back to just a couple of years ago when
Warren Buffet was talking about his own tax liability compared to his secretary’s, right,
so this is an example of this concern about “ability to pay.” I also think we also saw
it in California for example which, people often written, they’ve raised their taxes
in California – so tax – People often think I imagine this time in particular, you can’t
talk about tax increases, you can’t talk about tax hikes, it’s completely off the table.
It doesn’t have to be, right, it doesn’t – it hasn’t always been that way. I mean that’s
one, that’s one of the things I’m trying to show, or I guess presentist concerns today.
I guess you could label the, my book as a neo-Progressive kind of assault to remind
us that Americans have not always and everywhere been anti-tax and anti-statist. I think too
often people draw a direct linear line from say, the revolution and the initial Tea Party
to Newt Gingrich. Right, that’s how American political culture has always been. That’s
just not right and so that’s part of the upshot of this book and I think we see echoes of
that today. We saw it all throughout when I was in watching some of the Occupy Movements
and some of the other things that were going. I think we actually see it in law. I mean,
the Obama administration’s sort of partial victory in raising taxes on the high end,
not as high as they wanted too, not the same threshold levels but certainly that movement
up, that partial victory a couple years, all suggest that this notion of ability to pay
is still has resonance today. Now the other claims that I would mention,
I’ll try to run through relatively quickly so we’ll still have time for Q&A. I mentioned
already this notion of forging a new civic identity. And so, reformers during this Progressive
era really believed that you could use taxes to reconstitute or reinvigorate the social
contract, the relationship between citizens and the state and you could use taxes in a
sense to help citizens re-envision or reimagine their ethical or social obligations to the
broader community. That’s what taxation was about, giving back to a larger, broader community,
a state that could help with things like crisis management, economic development, and all
the things the public sector does for us. And so this is really at heart what, in many
ways, the historiography tells us what Progressivism was all about. Right, this was an age when
the social dimensions of American democracy were the key concept, right. – The identification
with the common lot, – as Jane Adams put it, “is the essential idea of democracy,” right.
This was clearly the Progressive Era notion. And that’s why it’s this time that we see
this structural transformation that leads to the fiscal state. And I think we also see
it in the sense of replacing what they saw as an old and outmoded notion, that taxes
were based on government benefits. And that was a sort of ideological rationale used for
much of the existing tax system. Certainly at the state level, the property tax for example,
and even the tariff and to a lesser extent the excise. It was this notion that there
was this kind of quid pro quo, that people paid taxes for the direct benefits the government
gave them, protecting their property for example, right. But the, the intellectuals I look at,
in particular the political economists, really attack benefits theory and say that’s really
an outmoded notion, that there is no real such thing as a kind of isolated one-on-one
relationship. And so they use this notion of “ability to pay” as a counter to the benefits
theory. This suggests that there’s a social obligation that comes with a, taxation is
one way to fulfill that obligation. And then the third thing that I try to stress
in the book is how this movement to the income tax, or direct tax – it’s not just income,
it’s also corporate profit taxes and as well as wealth transfer, the estate tax of course,
also has its origins in this time period – it also transforms politics, or political arrangements,
institutions, of course. We get new tax laws, policies, and regulations that are very different
from the tariff. So it’s no longer about log rolling, about what’s going to be on the duty
list or how much it’s going to be, but it’s about how do we define something called income.
Which to this day is an important concept. It continues to be litigated and discussed
for which there’s regulations and other things. And in that since, this move to a different
base, of graduated rates, I argue, really becomes, in that sense, tax law becomes the
vanguard for our proto-administrative state. I think the New Deal still becomes the high
water mark for a lot of those changes with all the other – But a lot of the agencies
that follow up are really following along what, a lot of what Treasury is doing. So
the Treasury regulations that come up in this time period, to help us define what counts
as income, what counts as a taxable unit. All these things are really important in developing,
I say this really, this new sense of politics. And so now we’re less beholden to the Party
period, the politics of horse trading over which items to put on the duty list and how
much and who to be appointed to the custom houses, these were all part of the Party period.
And now it’s about bureaucratic experts and so I have a separate chapter on the critical
role that Treasury lawyers play, during World War I in particular, in building the administrative
infrastructure of this fiscal polity. That spills over into other aspects of the modern
state. And so another example of, of this is, you know, we see in the earlier part of
[inaudible] it’s all about partisan politics, relatively simple collection methods during
the custom houses, to this much more, much more detailed and the need for professional
knowledge about the tax maze and the process of remittance. This is no coincidence that
this is a time when the modern corporation plays an important role. So the paper I presented
when I first met Richard was about how important the corporate tax is in all this. It’s less
about taxing corporations than it is about the knowledge, the information that corporations
start to accumulate in this period. That becomes very important through the process of withholding.
Withholding is this very important cornerstone to our system of taxation and it’s the modern-Richard
Berg, who’s a well-known public finance figure who has this terrific line and he says that
if the custom house was the locus of tax power in the 19th century, the tariff, it’s the
modern corporation that’s become our custom house of today because it’s the know- it – s
the information that corporations contain that allows us to, to do all the kind of third
party reporting through withholding other things that leads to this kind of change in
political arrangements. Now I’ve used up a lot of our time. I want
to conclude though, just a couple of quick slides, on the importance of, sort of, constitutional
law in all this because the 16th amendment is what allows for the creation of income
tax. It’s a sort of response to the Pollock Case which strikes down that 1894 income tax
that I marked. And it was again here that I found some terrific information. So there’s
this very important role that the New York Senator Elihu Root played in actually drafting.
And so Richard and I were talking earlier about how important it is to demonstrate to
grad students and junior scholars about what the archives can tell you. I spent several
weeks here looking through a lot of the cool papers and I stumbled upon in Record Group
56, this is up in NAR 2 up in College Park, this sort of back and forth between Root and
the Treasury Department about how to actually write the actual language of the 16th Amendment.
It’s hard for you to see here but this is Root’s handiwork. I mean he really, he’s a
very clever Wall Street lawyer who’s really thinking carefully about how the language
of the resolution needs to be worded in this particular way and I, so there’s like seven
or eight drafts that go back and forth about how exactly we are going to have things like
“from whatever source derived.” Right, that very key word, that’s not only part of the
16th Amendment but becomes part of our income tax law – I mean, you can’t get that from
a published source and this is why the archives are so important. I probably don’t make enough
of it in my book and so my next project I’m thinking about doing another book, a second
book, on the Pollock Decision. There is no, at least not since Twist I think, that we
have had a book that really takes a closer look at the income tax, the Supreme Court
income tax case, the Pollock Decision and the rise of 69. It plays an important part
in my book and I do have two chapters to it, but I’m thinking about going in that direction
to talk a little bit more about how important that Constitutional Amendment really has been.
And so let me conclude now with just, you know, sort of, present day implications. You
know, when I give this talk, especially to an audience not familiar with archives or,
or scholarship they kind of go, “What, what are you talking about? That period’s gone.
I mean civic identity, you know ability to pay. No one really believes that.” I have
to concede that times have changed. There’s no doubt about that. But, I would also state
that even today’s revolts against taxation, even the Tea Party, share a very important
link with this roots of our modern fiscal policy. They’re responding. This is, that
has set the agenda. The Progressives, the Progressive period, the New Deal, the elaboration
of it, really continue to set the political and I would argue, intellectual agenda of
our modern fiscal polity. So in that sense, it’s really long history that I’m talking
about, this long history about the making of the modern state, I think continues to
press upon thinking today. And let me end there. Thank you very much for your attention.
I’m happy to take questions. Thank you again and –
Audience Member #1: So – my experience has been that in developing federal policies,
very often state governments test out interesting ideas first. So could you describe the history
of direct taxation and income taxes at the state level and kind of how that influenced
the federal government. Mehrotra: Yes. Thank you. Great segue. Wisconsin
is the answer in some ways, the short answer. During the Progressive Era, Wisconsin is really
the incubator. To use Brandeis’ term the “laboratory of democracy,” it’s one of those states. And
it’s there, in 1911, where we see the first state level income tax. And so it’s, a lot
of the law-, it’s no coincidence that Lafollette, Robert Lafollette, becomes a very important
proponent of the income tax at the federal level. He sees it work at the state level.
And it also has a very important role in convincing the reformers, the intellectuals. So, Edward
Seligman, before Wisconsin actually implements it, says it’s not possible, states can’t do
this because too many things are national now, even in the early 20th century, that
the states are kind of kidding themselves, it really has to be at a national level which
states shouldn’t even bother cause it’s administratively too difficult is Edward Seligman’s argument.
And Richard Eily, who’s in Wisconsin, doubts him, and there is, I have, I have an entire
chapter in fact on what’s going on at the sub-national level, and it’s Wisconsin that
becomes a leader. There’s other states that do other things on the administration, but
on the actual development and effective implementation of income tax, it’s Wisconsin that becomes
the bellwether, not just for other states but for the national government. And one of
the important innovations they have is this third party reporting. So they have this very
crude form of withholding where it’s not the modern day notion of withholding but it’s
reporting, requiring banks and other financial institutions which are remitted that are paying
interests and dividends and things of that sort to actually report what they’re paying
and to whom. And so that becomes a very important administrative innovation at the federal level
and picks up on it as well. So there is very much a story about both states experimenting
with things. Ohio does some very interesting things administratively, so does Indiana – and
then the actual implementation of a direct and progressive taxation successfully at Wisconsin,
I think, emboldens national lawmakers to do it themselves just a few years later. So there’s
very much a state to national story. Does that help?
Yeah. And, and was it – was limited just to the rich in Wisconsin?
Mehrotra: Yes, very much so. That’s one of the keys to this is it allowed those Social
Democrats in Milwaukee, for example, to galvanize support for, because it requires a constitutional
amendment in Wisconsin as well, a state constitutional amendment. And part of the argument is that
we’re going to keep rates high and this is again meant to, in a sense, ameliorate the
existing dysfunction of the state level property tax, for example. So the property tax in theory,
ought to be this sort of graduated since people who have more property should be paying more.
But at this time we see a radical transformation of the notions of property and wealth. It’s
no longer about land and real estate, it’s about intangible wealth, it’s about stocks,
it’s about securities, it about, in Wisconsin, it’s about mortgages to large farmers that
have mortgages that are not being taxed. So the argument at the state level is well our
property tax, which may have functioned fine in a sort of pre-industrial, pre-financial
capitalist world, was okay. Now that we have all of this intangible wealth, our property
tax isn’t getting to it. It’s supposed to – on the books it’s supposed to – but in effect
it’s not. How do we counter that? We come up with another tax as a sort of counterbalance
to that and it’s aimed at the elite. That’s exactly how it’s pushed through – The states
– story is very important. I have a whole chapter, probably too long a chapter, but
I found it very interesting. Audience Member #2: You made one point early
on that was that developments in your period maybe exacerbated fiscal myopia and so I’ve
begun wondering, what was happening on the spending side during your period – I guess,
a couple questions. Number 1, just empirically, to what extent was government spending growing
and what was government spending its money on to then change during your period? And
then two, and this I guess is motivated from sort of observations about our current politics.
I think now there’s a great disjoint in discussions about taxing and discussions about spending,
and so I wondered whether the protagonists in your book, maybe other policy makers at
the time, were sort of similarly segmenting those discussions, or were they talking about
sort of taxing and spending together? Mehrotra: Yeah. So that really gets at this
point about fiscal myopia that I didn’t get a chance to elaborate on, but it’s in fact
– I try to suggest, one of the arguments I make, is it’s during this period that we actually
see that segmentation occurring much more explicitly. So part, and this is again not
an argument that I’m making innovatively, Richard Musgrave made this argument along
with Allan Peacock in the mid-twentieth century when he was sort of attacking ability to pay,
that notion as being too powerful. And so I’ve just taken Musgrave’s argument and kind
of putting it, put it back in historical perspective. And so what Musgrave and Peacock and what
I, I’m trying to say now is back when benefits principle was the ideology, the two were linked.
Spending and extraction were tied together. Ability to pay comes along, and I argue, and
it in a sense this is an unintended consequence because this is what reformers are responding
to. This is the deck–that the cards that have been dealt to them is this kind of regressive
system of consumption taxes, and they want to do away with it. It’s their foil, it’s
their bete noire, and so they do everything against it. And in that sense, by pushing
ability to pay as the counter, they focus exclusively on the extraction sideand they
sever the link between spending and government, and raising revenue. And that’s what I think
is myopic about this. And so the Musgrave argument that I’m trying to revitalize in
a historical frame is that might not have been such a great thing because if you take
a look at other countries, other industrialized countries in the world that are trying to
address poverty and inequality, it’s in fact through consumption taxes. So why aren’t we
Scandinavia? What is Scandinavia actually doing? I just use the idea of it, obviously,
as an example, as an illustration. It’s got an incredibly regressive VAT. That tax is
everything. As far, the last time I checked, it doesn’t have anything exempted. So it’s
an incredibly regressive tax system, but yet its spending side is incredibly progressive.
National health care, national education, all this, that ameliorates the regressivemess
of the extraction process. And part of the fiscal myopia that I’m suggesting is that
the reformers in this period were so fixated on ability to pay, were so obsessed with trying
to focus only on the extraction side, they severed that link between spending and revenue
extraction. And I think there’s a legacy, and I don’t want to make too much of this,
it’s not purely an intellectual story. And this actually picks up upon Sven Steinmo’s
argument in his classic work on comparative taxation and democracy. And his argument is
about political institutions, that Scandinavia’s got a parliamentary system and so it’s more
possible. The US has all these veto points and so either the US is never going to do
it. Roger Smith has a cultural argument about how notions of race and ethnicity have always
also influenced our policy. All those things are there. I’m just adding another layer to
suggest that this intellectual legacy is pretty strong too. And to get your other question
about spending, so there isn’t a lot of spending in this early period. There is the ratchet
effect of course. So, as soon as World War I comes along, even before that, the Civil
War, so you might, in the beginning of my period the one of the largest accounts for
federal spending is on Civil War and veterans pensions. I mean that’s the beginning of our
social welfare state, and it’s a pretty significant number in the late nineteenth century. It
starts to dwindle later on but in some ways, raising revenue isn’t the goal of the tariff
system. Right, so scholars sometimes say “Well, you know, look at the tariff system, it didn’t,
didn”t raise a lot of revenue.” And you sort of go, “Well that’s the point. It was a protective
tariff. ” It really wasn’t meant to raise a lot, so there wasn’t like there was a lot
of demand for federal revenue at that time period. Things change after World War I. So
the wars do become important, there is this ratchet effect, and so military spending stays
very high even during, it comes down but it never goes back to the pre-war period. There’s
spending on World War I veterans as well that leads to other social policy. This is also
the time, of course, where the regulatory state takes the Federal Trade Commission and
all these now federal agencies that didn’t exist in the late nineteenth century. So there
is this sort of incremental growth of federal spending that’s beyond national defense and
the question becomes, where is the revenue going to come from? And so part of my story
is describing the forces that led to it. Does that help? I mean that’s a very, very
good question. Audience Member #3: I have a question about
what you think of funding our transportation infrastructure. Our highway trust fund is
broken and that’s based on fuel taxes, gasoline, diesel fuel, but they have not raised, no
politician has had the guts including Obama, to raise our gasoline taxes. It’s been the
same since 1990. And should we pay for highway infrastructure out of the general fund or
should we, you know, how should we do this? Mehrotra: Wow. Well, so let me take the first
out and say I’m a historian and as a historian I study a lot of periods but the future is
not one of them so I’m not sure where we should be going. But at other times, if you take
history as an analogue, at other times when we’ve had these earmarked kind of taxes and
they’ve been insufficient, the response, when, the response in past times has been to increase
them’in some cases. But you’re right. In today’s political environment that seems unlikely.
And so the turn in other contexts have been to other sources. So maybe part of discretionary
spending ought to be going more towards transportation/infrastructure. I mean there is talk of it on occasion. I
mean, President Obama does talk about our dysfunctional infrastructure and how he can
do more about it. It’s mostly just rhetoric so I agree with your point in the current
environment. We don’t seem to be spending money in that sense. But if history is any
guide, there becomes a crisis moment – and I’m not sure what that, again future, you
don’t know- Audience Member #3: Well, we did have a crisis
in August, when they predicted the highway trust fund would be in the red so they took
money from the general fund but not the highway trust fund.
Mehrotra: Yeah, but that was a budgetary crisis. I mean the crisis that usually galvanizes
the kind of reform we’re talking about is more far reaching than that. When there’s
the next bridge catastrophe or something like that and human lives are taken, that might
be the moment. Fiscal history teaches us that there are these moments, these opportunities,
these kind of windows for reform, and that might be the time when progressive reformers
who want to, either increase the gasoline tax or find other funds for it, might be able
to use that. I mean what was the Rahm Emmanuel line, “it’s a shame to waste a crisis” or
something like that. There’s a lot of historical truth to that.
McCulley: Ajay, you said income is a slippery term. Another slippery term that’s used a
lot is direct tax. And – apparently to some
Supreme Courts, some things are direct taxes
and other Supreme Courts disagreed. Some apparently
questioned the Pollock decision and would
you elaborate on the use of this term, not
defined in the Constitution, and the political
repercussions that seem to have given some
momentum to the 16th Amendment.
Mehrotra: That’s a great question. So for
the direct tax clause that’s in the Constitution
from the Founding period requires that any
taxes that are- it doesn’t define “direct”
but the phrase is “a direct tax” has to be
apportioned by population. That”s the language
pre- before the 16th Amendment changed that.
But that’s not how the courts interpreted.
For many years before Pollock, an income tax
was not deemed to be a direct tax. There was
never a direct, there was never an explicit
challenge to that, but for the most part,
the way the court defined direct tax, it was
presumed that an income tax would be fine.
In fact, in my chapter on the lead up to the
Pollock decision, Seligman, who’s also a trained
lawyer, is consulted by both sides of the
Pollock decision. There’s a bunch of New York
Wall Street lawyers who are representing Pollock.
And they contact him as well as the government
lawyers to sort of get his consultation. He’s
the expert, he’s done all this historical
work on it, and he thinks this is a non-starter. The courts – this is not going to be challenged.
We’ve always had this. And he does an incredible study of colonial, from the colonial era Massachusetts
all the way up to all the cases, and tries to convince the Pollock lawyers in particular
that they’re wasting their time. In fact, he says that. And they, of course, are paid
lawyers so they’re going to do their job and they selectively use some of his research,
in not the way he was appreciative of. And so he writes an article in response, but it’s
all moot because to his surprise, to the surprise of every expert, they deem a tax on rental
income, that was the key part of the Pollock decision, a tax on rents, was a derivative
of a land tax and therefore was a direct tax and therefore had to be apportioned. The 1894
law was not apportioned so it was struck down. And the experts are all shocked by this. I
mean, the law reviews are all full of “What is the court doing?” And since that time there’s
been tons of historiography because the actual case is really tricky. They hear it once and
then there’s a missing justice. They hear it again, there’s a different justice who
votes a different way it appears, which is why a book on that might be interesting. So
that you’re right, the courts interpret direct, that the direct tax clause in the Pollock
case very differently than all the Supreme Court cases that have been at least similar
on that topic have before. And so the experts are shocked and in fact, when Taft is running
for president – I mean he’s a lawyer, he knows it – he thinks, I mean on the campaign trail,
he says we probably should have an income tax since the Court probably made- he doesn’t
say they made a mistake but he said we might be able to implement an income tax despite
the Pollock decision, which would suggest that he’s not in agreement with the Pollock
decision. When he becomes president, of course, he backs off, does not want to challenge the
integrity of the Court and push it. In fact, helps broker the compromise that leads to
the 16th Amendment. So the image I had here of Elihu Root is fascinating. When I stumbled
upon that. It’s Root going through each word, trying to figure out how he can write the
16th Amendment so there won’t be any future challenges. So the language of the 16th Amendment
says without apportionment, so he adds in there this is an income tax will be deemed,
it will not require apportionment, direct response to the actual, initial Constitutional
restriction. And so Root plays this very important role, the political economists play this very
important role, but at the end of the day it’s really about- social politics, it’s a
social movement. To ratify, I mean, a Constitutional amendment is not an easy thing to do and so
it really, it’s not surprising we go back to the Populist reformers. It’s not surprising
it’s the South. Alabama’s the first state’s to ratify the 16th Amendment, and there’s
this influx of Southern states because of what the income tax s going to do to the Northeast
industrial sector. It’s the South that’s being hurt by the tariff. And so the shift from
the tariff to the income tax has this very important sectional implication and so you
see this slowly going through. New York becomes a very crucial state in the 16th Amendment
battle and that’s where Seligman is. There’s, I just really riff off of John Bunker’s great
book on the 16th Amendment where Seligman is testifying before the New York Assembly
about the 16th Amendment and Charles Evans Hughes is the governor at the time. He actually
comes out against the 16th Amendment because he’s worried that it’s going to give the Federal
government too much power vis-a-vis the states, and he’s worried that means that they’re going
to tax state interest on bonds for example and things like that. And so he’s really worried
so he’s and Seligman comes out and says- Charles Evans Hughes is a classmate of his at Columbia,
they go to law school together and so they’re friends. He has this terrific presentation
before the New York Assembly where he says Governor Hughes doesn’t understand the economics
of taxation. “If he was a student of mine, I would have flunked him” – What he says is
not what’s going to happen. The equity, the capital markets will sort out, this is what
happens today. This is what we call an implicit tax. The markets will sort out what is the
exemption for certain kinds of rates and others and so Governor Hughes is going down the wrong
path. And I’m not saying that Seligman’s testimony was the lynchpin but New York – that’s where
80 percent of the income tax comes from New York, Pennsylvania, and Massachusetts. New
York is one of the states you’d expect to resist but in fact goes along with the 16th
Amendment as well. Does that help? I don’t know if I was sort
of a roundabout response to your question Richard but it gives you some flavor.
McCulley: Yes. Mehrotra: Okay, great.
McCulley: More questions? Well, if Ajay’s
presentation is really an example of why we
should purchase his book.. It was a great discussion, giving clarity on what can be
an intimidating and a difficult topic. Thankful so much for a wonderful presentation.
Mehrotra: Thank you. Thank you all for coming.

Leave a Reply

Your email address will not be published. Required fields are marked *