Taxes in our country have increased tenfold since Herbert Hoover was President. We now pay out $110 billion a year—30 per cent of our personal income—to the Federal, state, and local governments. The rising costs of defense ($40 billion), foreign aid, veterans’ benefits, farm subsidies, interest payments, roads, schools, and social services have kept taxation in the political headlines from coast to coast. Nevertheless, though there is considerable talk of balancing budgets, there has been little discussion of taxation as a social policy—a means of redistributing the national income, limiting the share of the rich and increasing the share of the poor and the middle-income groups.
Yet, fifty years ago, when the modern era of American taxation began, the power to tax was clearly recognized as the power to preserve equality of opportunity by curtailing the growth of private fortunes and assisting the lower classes. It was in 1909 that Congress passed the resolutions which led four years later to the adoption of the historic Sixteenth Amendment, giving the Federal government the power to tax personal incomes at “progressive” rates (the higher the income, the higher the tax rate). Such a progressive income tax had been on the priority last of social reformers in Europe and America for many decades; not only the English Chartists and Karl Marx had advocated it as the best means of redistributing wealth—Populists and Progressives in the United States did strenuous battle for a progressive income tax in the courts and legislative assemblies. But because the Supreme Court had struck down previous Congressional enactments, a constitutional amendment was finally necessary. In 1909, too, Congress first enacted a tax on the incomes of corporations, and in 1911 Wisconsin led in establishing the first successful state income tax. In 1916, the Federal estate tax was added to the battery of progressive taxes.
Behind these changes in tax policy moved a vigorous spirit of protest against the increasing concentration of wealth which had marked American social development after the Civil War. The reformers pointed to the emerging family dynasties and the threat of oligarchy, and declared that equality of opportunity was a delusion so long as economic status was so grossly unequal. By the time of the Wilson administration, the reformers had established the principle of taxation as an equalizing device.
Before 1909, the local property tax had been all-important, with the Federal government meeting its modest needs almost entirely by customs duties and excise taxes on liquor and tobacco. After the progressive Federal income tax had demonstrated its utility in meeting the costs of World War I, even Andrew Mellon, the reactionary Secretary of the Treasury during the 20’s, could only get it modified; he could not secure its repeal. By 1929, a fourth of all tax revenues was derived from personal and corporate income taxes. Now they produce more than half, and the fulminations of the outright opponents of the income tax—like the Connecticut industrialist Vivian Kellems, the former Governor of Utah, J. Bracken Lee, and the States’ Rights Presidential candidate, T. Coleman Andrews—more and more have an irrelevant and crackpot sound.
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Contrary, however, to a popular assumption, the over-all U.S. tax pattern became less, rather than more, progressive during the New Deal period. Even though the Federal government began taking close to half of all taxes, the Roosevelt administration was compelled to depart from the progressive tax policies of the Wilson era. With the economy in a state of near collapse, Roosevelt did not wish to discourage business; and when World War II broke out, the White House felt that defense production might be impaired unless “Dr. New Deal” gave way to “Dr. Win the War.”
Even before the international emergency, the Roosevelt administration had lowered the personal exemption for a married couple from $3,500 to $2,500. In this manner, the number of income-taxpayers was raised by half, from 2.5 million in 1929. to 3.9 million in 1939. During the war, exemptions were lowered again, this time to $500 per person. At war’s end they were raised to $600, where they stand today. Meanwhile, the postwar inflation not only qualified many more people for the income-tax rolls (inflation cut the real value of the exemption in half) but it pulled many “middle-income” families into the reach of the higher rates which formerly affected only the top-income families. Today, income taxes are paid by 46 million families—including 80 per cent of all earners. And four-fifths of the revenue comes from the very first tax bracket, the 20 per cent tax which is levied on “net taxable income” under $5,000 for a family.
Meanwhile, other forms of taxation have been undergoing broad changes. In examining the over-all tax pattern from Hoover to Eisenhower, we find that the big shift has been away from state and local property taxes toward the Federal income taxes. The share of sales and excise taxes were reduced in the last thirty years from 36 to 24 per cent; but if we add to the last figure the flat-rate social security assessments which now account for 13 per cent of all revenue, we see that the share of such “regressive” taxes (levies which hurt the poor more than the rich) was remarkably alike in 1929 and 1958—more than a third of all taxes collected. State and local property taxes have actually doubled, in dollar figures, over the last three decades, from $5 billion to about $11 billion. But their share in all taxation has decreased, from 41 per cent to 11 per cent, as the main burden of government has shifted to Washington. Thus, the great increases in spending during the 40’s and 50’s were mostly financed out of Federal personal and corporate income taxes.
Since the personal income tax is collected at progressive rates, and the corporate income tax is levied on profits, in theory the changes of the last three decades should have made the national tax pattern more progressive, equalizing incomes in a more decided way than did the taxes of the 20’s and 30’s. In fact, however, today’s taxes are no more equalizing than they were under Andrew Mellon, although they are much, much higher. The explanation of this seeming paradox lies in the understanding of a recondite phrase called the “tax base,” which means the amount and kind of income which is subject to be taxed. Changes in the base of the personal income tax have enormously reduced its equalizing effect over the years. These changes involved (1) a “widening” of the base at the bottom, among the poor, and (2) a “narrowing” at the top, among the rich.
The bottom was widened by the lowering of personal exemptions in the 30’s and 40’s together with the inflation of the 40’s and 50’s. To exempt today the same purchasing power that was exempt in 1929, the exemption would have to be $7,000 per married couple, instead of $1,200 as at present. Moreover, the growth in average real incomes brought more relatively low-income families into the reach of the tax. Hence, while the personal income tax was strictly a “rich man’s tax” in 1929, it is now “every-man’s tax.”
Meanwhile, at the top, a decided “narrowing” has been effected. Ever since the war, and certainly in the Eisenhower administration, fewer categories of income have been taxed at progressive rates. Today, only 40 per cent of the income received by persons is subject to personal income tax. What are euphemistically called “loopholes” have enabled wealthy people to avoid the full impact of the progressive tax schedule. These “loopholes” are not illegal dodges on the part of the taxpayer; they are deliberate social policy, written into the tax laws by Congress, mostly on the recommendations of the administration. Tax experts cynically observe that while the tax rates are legislated progressively to please the poor, the tax base is legislated to please the rich.
In theory, the tax rate is supposed to go as high as 91 per cent for the very richest taxpayers. In fact, thanks to deductions, exemptions, exclusions, and income-splitting, the maximum effective rate in virtually all cases is only 50 per cent. A married taxpayer with two dependents earning $100,000 should theoretically be taxed at an average rate of 52 per cent; in fact, the typical taxpayer in these circumstances pays something less than 30 per cent of his total income in tax. The rich man pays lower taxes on income derived from capital gains, stock dividends, or interest from tax-exempt bonds than a man who earns all his money from wages or salary. The well-to-do executive can do considerable juggling with his expense account; his firm may provide him with many personal services which are written off as business expenses. The homeowner can make profitable deductions if he pays interest on a mortgage; the man who pays rent gets no such tax benefit. Often, the wealthy can actually save money by making just the right amount of contributions of money, securities, or real estate to charitable organizations.
A major change, making the tax even less progressive, was enacted by the 80th Congress in 1948; married couples were permitted to split their income-tax base in two. Such splitting brought considerable tax relief to high-income families; a $100,000 income, for example, was thenceforth taxable only at the top rates for $50,000. Lower-bracket taxpayers received no comparable benefits—or nothing like what they would have received had the personal exemption been raised to pre-war levels. All these special provisions and loopholes help explain why the tax system does no more to redistribute wealth than it did twenty and thirty years ago; why in fact, it affects the broad distribution of income and wealth in the American population in only a minimal way.
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Senator Paul Douglas, commenting some time ago on John Kenneth Galbraith’s The Affluent Society, remarked that today’s urban family of four needs an income of $10,000 a year to maintain itself decently and can hardly be considered “affluent” until it earns more than $15,000. President Truman once described the “middle income” group as those earning between $10,000 and $20,000 a year. A strange “middle,” certainly, for these incomes are enjoyed by only the top 5 per cent of the population.
There are about 50 million “consumer units” (families and unattached individuals) in the United States. If we rank them by income and divide them into five equal groups, we find that in 1954 the poorest fifth (earning under $2,200 a year) received less than 5 per cent of the total income. The richest fifth (with incomes over $7,000) received more than 45 per cent. At the very top, the highest 2.5 million consumer units (enjoying incomes over $12,350, and an average income of $21,761) got 20 per cent of the total. In other words, the richest twentieth of our population had four times as great a share as the poorest fifth.
Although the Federal income tax is the most progressive of all taxes (its effective rates range from 2.4 per cent in the lowest fifth of the population to 18.7 per cent in the top 5 per cent of families), it did little to modify this pattern of income distribution. The under-$2,200 group, which had 4.8 per cent of the total income before paying the Federal tax, had 5.2 per cent after it. The highest fifth, the over-$7,100 group, had 45.2 per cent of the income before the tax and 43.2 per cent afterward. And the top 5 per cent of income earners, who had 20.3 per cent of the income before the tax, still had 18.3 per cent afterward.
Moreover, the Federal personal income tax raises only a third of all tax revenues. When all other taxes have been collected, the pattern is even less progressive. The poorest fifth (the under-$2,200 group) pays out 24 per cent of its income in taxes of all kinds; the richest fifth (over $7,100) pays 36 per cent; the top 5 per cent (over $12, 350) pay 42 per cent. Of course, low-income groups spend a higher proportion of their earnings on the necessities of food, clothing, and shelter; and it may well be argued that it is more difficult for a man earning $40 a week to give up $9 in taxes than for a man earning $400 a week to surrender $170. In any case, these rates (which we have adapted from the studies of Professor Richard A. Musgrave of Johns Hopkins University) do not appreciably reduce the share of the top 5 per cent in the total personal income of the country:20.3 per cent before all taxes, 17 per cent after all taxes. This is about the same as before the war; few realistic observers would call it “confiscatory taxation.”
As far as the lower and middle income groups are concerned, taxes are demonstrably higher than they were twenty years ago. To maintain his purchasing power, a person with a $2,500 income in 1939 would have had to earn $5,000 in 1954. If he did so (many did, though others did not), his overall tax rate would have changed over those years from 22 to 27 per cent. If he maintained a constant income of $2,500, his rate would have risen from 22 to 26 per cent.
Economic inequality, it should be observed, can never be adequately portrayed by the facts on distribution of income. The distribution of wealth is in some ways more revealing. In 1953, for example, the top one per cent of adults owned 27 per cent of all personally held wealth in the country. Certain types of wealth were even more concentrated. This top one per cent, for example, held over 75 per cent of the corporate stock, corporate bonds, and tax-exempt state and local government bonds (although only 13 per cent of real estate and 12 per cent of life insurance).
Much political capital has been made out of the fact that the share of the richest families in personal income took a sharp fall in the war years, that is, between 1938 and 1945. (The share has remained constant since then.) But the distribution of national income, which allots corporate income to the various income groups on the basis of their stockholdings, did not change either during the New Deal or during the war. The share of wealth held by the top 2 per cent of families was slightly reduced between 1922 and 1953, from 33 to 29 per cent. But their share of producer-assets, notably corporate stock, has remained rather constant, fluctuating between 65 and 75 per cent throughout these three decades. In addition, the top 2 per cent of families stand in a position to control or benefit by the roughly $75 billion of wealth now held in title by personal trust funds and foundations.
The trend since 1949 has been toward an increasing concentration of wealth, largely because corporate stock, the chief asset of the rich, has risen four times in price while the general price level has only doubled. The pattern of investment of the rich in 1953 suggests how well they were hedged against inflation and the stock market boom of 1954-59. Close to half the estate value of the top wealth-holding families was in corporate stock, about a fifth in real estate, and about a tenth in business equities—and all of these tend to rise with the general price level.
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A part from the Federal personal income tax, the only other major tax in the American system for which progressive features are claimed is the tax on corporation profits. Some scholars have come to the conclusion that, because stock ownership is so concentrated, this is the most equalizing of all taxes. Professor Musgrave, for example, assumes that two-thirds of the tax is borne by the stockholders and, allocating the tax to the income groups known to own most of the stock, he estimates that the tax has effective rates of about 4 per cent up to $10,000, and 14 per cent over $10,000 of income.
The critical assumption here is that the corporate profits tax reduces profits and is largely borne by the stockholder. A good case can be made against the soundness of this assumption, however. Particularly in the recent years of inflationary pressure, and particularly among the “blue-chip” corporations in non-competitive industries, companies have been able to pass a large share of the tax on to the consumers in the form of higher prices. Thus, many corporation executives have boasted of their record in maintaining “stable” profit rates, after taxes. Meanwhile, those who buy corporate stocks buy them at prices which reflect the capitalized value of earnings per share after taxes; they thus “buy free” of the tax. Finally, leaders of small business maintain that the corporate tax rates, which are not graduated in the manner of the personal income tax, do little to disrupt the growing concentration of wealth among the giants of American industry.
In any event, if some case may be made for the progressiveness of the corporate profits tax, all the other Federal taxes (aside from the personal income tax) and the state and local taxes taken together are regressive. Sales and excise taxes yield two-thirds of state revenues; property taxes produce nine-tenths of local revenues. Social security contributions are also regressive; they are partly shifted in the form of higher prices or rents, and thus take a larger part of the income of the poor than of the rich.
The trend in the Eisenhower administration has been toward a less equalizing tax system. The 1954 Revenue Act introduced the special allowances for dividend income. The 1958 act liberalized depreciation allowances. In line with the administration’s belief in local initiative, regressive state and local taxes have been assuming a larger share of all taxes. Excises and sales taxes are increasingly being used by the Federal government—e.g., for the highway program—as well as the states and localities. (The share of excises and sales taxes in all taxes has risen almost 10 per cent in the last five years.) Moreover, state and local governments have more and more been using “charges” as substitutes for taxes; these charges, generally regressive, take the form of fees, tolls, public prices, and tuitions. Finally, inflation continues to dilute the progressiveness of the income tax itself. For when money incomes rise through inflation, the lower-income groups are caught by a greater increase in effective rates than are the wealthy.
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It may seem a piece of outmoded radicalism to talk about taxation as a way to narrow the distance between the rich and the poor. The inherent purpose of taxation is to raise revenue for government, and conservatives have always argued that taxes should not impose any changes on the “natural” social fabric. Yet, when taxes take as large a share of the national income as they do at present, the tax system unwittingly becomes a massive engine which can increase the income share of either the rich or the poor.
The customary liberal argument is to justify progressive taxes on the grounds of “fairness” in sharing governmental burdens; the “ability to pay” principle is held to be most fair. But it is obvious that this argument leads quickly to value judgments about what the ability to pay really is, and these value judgments ultimately involve the question of equalization.
The case for reduction of inequality may be said to have two parts: one developed in terms of preferences, the other in terms of social consequences. Henry Simons, the renowned University of Chicago spokesman for free enterprise who supported progressive taxation, stated the first position well. “The case for drastic progression in taxation,” he said, “must be rested on the case against inequality—on the ethical or aesthetic judgment that the prevailing distribution of wealth and income reveals a degree (and/or kind) of inequality which is distinctly evil or unlovely.”
But the consequences of failing to equalize may include more than an injured psyche or a guilty conscience. The hope of a democratic capitalism rests on a limited inequality of income and widespread ownership of capital. An informed and responsible electorate and a well-motivated laboring class cannot be expected to develop in a society of increasing economic inequality. The social costs of accommodating concentrated wealth and power, on the one hand, and poverty, on the other, may far outweigh the gains which ensue from encouraging the economic activity of the rich. These social costs include the effects which flow from poverty on the health, morals, and safety of the whole community. They also include some loss of energy and undiscovered talent from that part of the population which is raised in the mire of economic inadequacy.
The leading argument against “over-zealous” progressive taxation is that discouragement of the rich and those who would like to be rich (“abolition of incentive”) will result in a loss of total income and production. It used to be argued that high taxes on the poor made them work harder, but few today would agree with Patrick Colquhoun, who wrote in 1806 that poverty is “a most necessary and indispensable ingredient in society.” Surely, there has also been some modification in our thinking about how socially necessary are great riches in the hands of a few. The experience of the last five decades with some degree of progressive taxation has hardly inhibited the growth of American income and production, whereas it has made possible some degree of social protection for the poor.
Inequality tends to feed on itself, to be cumulative over the generations. The maintenance of equality of opportunity may require a steady tax pressure against this “natural” growth in inequality. Galbraith has called attention to the failure of governmental social services in the fields of health, education, transportation, and welfare to keep pace with the growth of the population and of private consumption over the last two decades. The money to finance the needed expansion of such services must obviously come from taxes; bond issues merely add higher fixed interest charges to Federal, state, and local budgets, charges which themselves must ultimately be paid for out of taxation.
The question, in the last analysis, is what kind of taxes can raise the necessary revenue while maintaining or extending the equalizing characteristics of the tax system. The assumption among conservatives in Congress and the state legislatures has been that progressive taxation has gone as far as it should, and that new sources of income can best be tapped by sales and excise levies or various kinds of charges. Yet economic research shows that a liberal tax program, based on extension of the progressive principle, would raise more money without increasing rates, while acting to reduce inequality of income and wealth.
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On the Federal level, it seems to me, three lines of action should be pursued. First, the Federal personal income tax can be vastly improved by restoring the base. At present, with three-fifths of the income received by persons not subject to this tax, there is a widespread belief that the tax law encourages speculative gains and property incomes at the expense of salaries and wages. The task here is to remove the advantages which accrue to those better-off taxpayers who get most of their income from other sources than wages, who own rather than rent their homes, and who are able to manipulate charitable contributions for tax benefits. We can have all the present equalizing results of the income tax with a much lower schedule of rates simply by restoring the tax base. By narrowing the definition of a capital gain (by cracking down on “collapsible corporations,” for example), by revising the formula for oil-depletion and other natural resource allowances, and by abolishing the exemption for state and local government bond interest, we could add at least $4 billion to the tax base, and about $1 billion to the tax yield. Putting strict limits on expense accounts might add several billion more dollars to the base.
Joseph A. Pechman of the Committee for Economic Development has estimated that by tightening up on all types of deductions, exclusions, and credits and by removing the split-income provision for married couples, we could increase the tax base by a full third, or $40 billion. We could thus get the present tax yield with tax rates one-third lower (that is, a set of rates from 13 to 61 per cent instead of 20 to 91 per cent); or we could retain the present rates and spend the $10 billion of added revenue for needed social services; or we could raise personal exemptions and readjust the rates in favor of lower-income families.
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A second line of action on the Federal level is to place corporate income on the same basis as personal income. A major aim of the corporate income tax has been to prevent the use of the corporation as a tax-free avenue to the accumulation of personal wealth. Most capital gains (which are taxed at a long-term rate of 25 per cent) arise out of stock transactions, so this avenue is still being used. (Indeed, to pursue the metaphor, it is the scene of a veritable traffic-jam.) However, if all corporate income were made subject to personal rates and the corporate income tax abolished, the tax system would be both simpler and more equalizing. It would be more equalizing because the progressive rates of the personal income tax would be applied, instead of the flat 25 per cent capital-gains rate and the 52 per cent rate at which the major corporations are taxed. This change would mean tax relief for the low-income stockholder, because the first personal-income bracket is only 20 per cent; it would mean higher rates of taxation for the big stockholders, who are (as we have seen) concentrated in the top one per cent of the population.
One way of bringing this about would be to compel or induce corporations to pay out all profits to the stockholders (in theory, the owners). This was tried out in the so-called undistributed profits tax of 1936, and repealed during the recession of the following year. Corporations objected to this law because of its limitation on re-investing profits; under its provisions, companies could expand only by selling new stocks or bonds. Any new law on this principle would have to take this objection into account. However, there are other ways of achieving the same object. One could subject corporate earnings to personal rates by taxing stockholders on the basis of their share of corporate earnings, whether or not these earnings are distributed. A subsidiary consequence of such a reform might be to restore to the stockholders some measure of control over the price, profit, and expansion policies of the large corporations.
A third area of Federal taxes, on estates, gifts, and inheritances, cries for reform. As with the personal income tax, the problem in this area is not so much the rates but the erosion of the base. The rates schedule itself is impressively progressive; marginal rates run up to 77 per cent on the Federal estate tax. But at present this tax collects only about 10 per cent of the aggregate gross estate of those decedents with estates worth over $60,000. A foresighted taxpayer may avoid the progressive rates by timely gifts. Moreover, the 1948 tax revision permitted married taxpayers to split the base for both estate and gift taxes.
Beyond this, the use of personal trust funds, insurance, and charitable contributions to avoid taxation has become a high art. Through personal trust funds, one may avoid death taxes through several generations, while at the same time keeping income from the property in the family. Life insurance and gifts of life insurance enable one to avoid many uncomfortable consequences of estate taxation. Charitable contributions to foundations help people to keep control of the assets of an estate even though some measure of income must be sacrificed. (The assignment of non-voting stock to the Ford Foundation enabled the Ford family to maintain control of the Ford Motor Company.)
It is probably fair to say that in no other area of taxation are we now falling so far short of the intentions of the earlier generation of liberals as in this field of estate, gift, and inheritance taxes. Reform in this field calls for some integration of the death and gift taxes, as well as limitations on the use of trust funds to avoid taxes. Also, it would be desirable to make capital gains realized at time of death, or on the occasion of making a gift, liable Kb personal income tax.
These are the three areas of Federal tax reform which would be most productive as well as equalizing. But there are many other individual taxes from which more progressive effects could be achieved. For example, social security taxes could be made less regressive if, instead of raising the rates, we increased the amount of income subject to the tax. At present, the Old Age, Survivors, and Disability Insurance contributions are calculated on the first $4,800 of income. This might be raised gradually to the first $10,000 of income, thus keeping rates at their present level for the lower-income wage-earners.
At the state and local level, the big struggle must be to reduce the regressive features of existing tax systems. Many states do not have personal income taxes or corporation taxes at all, and among those that do the rates are only faintly progressive. Ironically enough, the regressive effects of state and local taxes are multiplied because such taxes can be deducted in figuring Federal income tax; the higher the income, the more relief these state and local deductions afford from Federal tax.
From a political standpoint, it would be unrealistic to expect state or local governments to show much interest in trying to reduce inequality of incomes through taxation; the interstate and interurban rivalry for the location of industry makes state legislatures and city councils wary of antagonizing business interests through taxation. Nevertheless, it should be possible to provide state and local public services without grinding the face of the poor through heavy reliance on sales taxes. The burden of the lower-income families could be lightened by two steps: abolition of sales taxes on food, which are now levied in a number of states, and substitution of personal income taxes (even flat-rate income taxes) for retail sales taxes, excises, business gross income taxes, taxes on property, and “charges” for the use of public services.
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Such a program would err if it assumed that very great new revenues could thus be secured from the very rich. The total pre-tax income of those receiving more than $25,000 a year—the top one per cent of the people—is less than 10 per cent of all income, and their wealth is only a fourth of all personally held wealth. Since taxation has been absorbing nearly a third of all personal income in the last decade, the other 99 per cent of the population cannot possibly, even if that were desirable, be relieved of all taxation. The tax burden can, however, be substantially reduced for the lowest 20 per cent of families, who earn less than $2,200 a year, and perhaps lightened to some extent, too, for the lowest 60 per cent, who earn less than $5,120.
A dynamic capitalism will be refreshed, political democracy will be promoted, and the quality of civilization encouraged by a tax system which narrows the economic differences between the rich and the poor, and which assures the easy upward mobility which has characterized the America of past generations. An equalizing tax system is needed as part of a larger social policy which insists on the continual re-examination of the justification and functional necessity for every kind of inequality. As R. H. Tawney put it, the aim is to eliminate “capricious inequality and irresponsible power” and to overcome “a religion of inequality” which reveres, almost as ends in (themselves, social arrangements designed to provide differential opportunities. America can reaffirm and accomplish, if she will, the purposes of the generation which, fifty years ago, committed us to progressive taxation.
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