Friday, December 9, 2011

FDR's Class Warfare: A Tutorial For Obama

Not that he needs any further lessons from the master of confiscatory taxation.

"It's only right that we ask everyone to pay their fair share," President Obama has declared, while calling for higher taxes on the group he refers to as "millionaires and billionaires." Redistribution is the key concept--President Obama again and again demands that the U.S. redistribute wealth from one group of Americans to another.

Where does this emphasis on redistribution come from? Not from the Founders. The Constitution mandates that "all duties, imposts and excises shall be uniform throughout the United States." The Declaration of Independence entrenches the right to life, liberty, and the pursuit of happiness for all citizens. And once slavery was abolished, the 14th Amendment required that no state deny "equal protection of the laws" to "any person."

In fact, the Founders, and the American leaders of the 1800s, disdained the income tax. In 1872, President Grant rid the nation of the Civil War income tax; two decades later, the Supreme Court struck down another attempt at an income tax. If we must have taxes, the Founders urged, let them be consumption taxes--a luxury tax on imports, for example, or a vice tax on whiskey. As Alexander Hamilton said in Federalist 21 of such taxes: "The amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources." He added, "If duties are too high, they lessen the consumption; the collection is eluded; and the product in the treasury is not so great.…This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them."

In other words, if the government taxes whiskey, tobacco, or imported French wine at too high a rate, people will drink less and smoke less--and revenue will go down. That is "a natural limitation" on the greed of politicians. Thus, a system of tariffs and excise taxes formed the basis of U.S. revenue collection from Presidents Washington to Teddy Roosevelt.

In the early 1900s, the progressives argued that more power needed to be centralized in the executive branch, and more money should be spent by government to attack social problems. But where could the money be found to pay for such huge government bureaucracies? Progressives had a solution: tax the rich and regulate their income. On August 31, 1910, Teddy Roosevelt, who became a key progressive spokesman, announced: "The really big fortune, the swollen fortune, by the mere fact of its size, acquires qualities which differentiate it in kind as well as in degree from what is possessed by men of relatively small means. Therefore, I believe in a graduated income tax on big fortunes." In other words, uniform taxes, equal protection of the laws, and full property rights do not apply to those people with fortunes that are swollen. "A graduated income tax on big fortunes" is needed, Roosevelt insisted, as part of society's right to "regulate the use of wealth in the public interest."

But who is to determine how much money constitutes a swollen fortune? And what will the proper tax on it be? Under an income tax, politicians are the ones who judge ability to pay, and they choose the rates they think rich people can afford. And here, unlike with a consumption tax, there is no real check on the greed of politicians. If politicians choose rates too high they may lose the support of the rich, but they may gain support of those larger groups receiving subsidies from the redistributed swollen fortunes.

The income tax became law in 1913 through constitutional amendment, and immediately politicians enacted a progressive tax and began the arbitrary process of setting rates. Over time, politicians discovered incentives to increase taxes on the small group of rich people and redistribute their wealth to the larger group of voters. In 1913, for example, the original top tax rate was 7 percent on all income over $500,000. Three years later the top rate was 15 percent. During the 1920s, the top rate became 25 percent on all income over $100,000, but in 1932, during the Great Depression, it was hiked to 63 percent on incomes over $1,000,000. In 1935, President Franklin D. Roosevelt raised the top rate to 79 percent on multimillionaires. Thus, even before the income tax was 22 years old, politicians had steadily jacked up the top rate from 7 to 79 percent. FDR had no experience running a profitable business, but his cries for the rich to pay their "fair share" profited his political career.

FDR USED THE CRISIS of World War II to do three things: first, to tax the rich even more; second, to begin taxing the majority of Americans; and third, to introduce "withholding" to get cash immediately and guarantee a regular flow of revenue into the federal treasury. These three changes were dramatic events in U.S. history, and few historians have studied them. Rows of books have been written on the bombing of Pearl Harbor and on the dropping of the atomic bomb, but little is known of how 39 million Americans suddenly had to pay income taxes and why the cash was withheld from their monthly pay envelopes. In our new history FDR Goes to War, we tell the story of these three dramatic changes.

On the first point, FDR hiked tax rates even further on the rich because he wanted more of their money to fight the world war. In the 1940s, he gradually boosted marginal rates on top incomes to 94 percent on all income over $200,000. But even at those high rates, he ran out of rich people before he ran out of places to spend the money. As Senator Tom Connally complained, "We cannot get much more from the very high brackets, because as to them we have already reached the point of unproductiveness."

FDR's solution was to convert the income tax from a class tax to a mass tax. Before World War II, fewer than 5 percent of Americans paid income taxes. "Too many people," Roosevelt lamented, "are earning money and not contributing to the government." When a Treasury official suggested lowering personal exemptions, Roosevelt was delighted. "Of course I want that. I have been trying to get it for years but nobody will help me do it." From 1939 to 1944, with Roosevelt's blessing, the amount of money families could earn before they had to pay income taxes declined from $2,500 to $1,000 for married couples. That meant that from 1940 to 1942, the number of Americans paying income taxes jumped almost tenfold, from 4 million to 39 million. Furthermore, the starting tax rate skyrocketed from 4 percent to almost 24 percent. The government used the wartime emergency as a tool to encourage tax payments. "Taxes to Beat the Axis" became the slogan of the day. Songs on the radio, speeches by movie stars, and even Walt Disney cartoons in movie theaters urged all Americans to pay their income taxes.

Just as 1942 was the year of the first mass tax in U.S. history, 1943 would be the year of withholding taxes at the source. The case for withholding was simple: the war was expensive, and FDR wanted to get more revenue more quickly from the tens of millions of new taxpayers. To sell the idea of withholding to Americans, the government called the practice "pay as you go," which made higher taxes sound more like payments on layaway merchandise in a store. "Pay as you go" also subtly implied that everyone was paying a debt that they owed, when in reality, most Americans had never paid an income tax before. But if employers could be forced to extract pay from their workers' wages each week or month, and then send that cash to Washington, the government could secure a steady flow of revenue--not only for the rest of the war, but for generations to come.

The campaign for withholding, however, hit a snag: Tax payments in the United States were not on a current basis. The 1942 tax bill, for example, was not due until 1943, and there was no system of withholding. That system of earning revenue in one year and paying nothing until the next year started with the first income tax law passed in 1913. Congress did not pass that tax until October and, to extract instant cash from wealthy people, made the tax retroactive. To ease the pain, Congress allowed taxpayers to pay their 1913 tax in 1914, and that practice had continued for the next 30 years. Thus, the more than 30 million new taxpayers in 1942 could delay their payments to Uncle Sam until 1943. But since FDR wanted withholding immediately in 1943, that meant most taxpayers would be subject to "double taxation," in 1943--they would be paying withholding tax immediately, and they would still owe their 1942 taxes on top of that.

Some observers favored the government forgiving people of their 1942 taxes in return for withholding, but FDR insisted on "double taxation" even if it meant that rich people owed more than 100 percent of their 1943 income to pay both years' taxes all at once. The Current Tax Payment Act of 1943, passed on June 9, forced millionaires to pay some double taxation--one-fourth of their 1942 tax bill was due in 1943, and they also had to pay withholding on 1943 income immediately. Married people with no dependents who annually earned $500,000, for example, would have to pay a 98.7 percent tax rate in both 1944 and 1945. Those who earned $1 million each year of the war would owe a whopping $1,006,750 in both 1944 and 1945. When asked how some people, admittedly a small minority, could pay more than they earned in taxes, Senator Allen Ellender (D-LA) responded, "I submit that the [rich] taxpayer is likely to have accumulated sufficient assets with which to make the necessary income payments."

THE PROGRESSIVE IDEA that income should be limited by law raised profound questions for American society. Do rights, such as the right to property, come in a natural way from God--as stated in the Declaration of Independence--or do they come from government? If Americans have a natural right to life, liberty, and property, then high progressive taxes violate that right. If, instead, rights come from government, then the leaders of government have the legitimate authority to confiscate wealth, or redistribute it from one group to another. In time of war, Roosevelt argued, and perhaps afterward, government had the right to most, if not all, income of wealthy citizens in the national interest.

For the first time in U.S. history, the redistributionists dominated political life. For example, on the Senate floor on May 14, 1943, Senator Happy Chandler (D-KY) said, "All of us owe the government; we owe it for everything we have--and that is the basis of obligation--and the government can take everything we have if the government needs it." Chandler wanted to be clear on this point. "The government," he added, "can assert its right to have all the taxes it needs for any purpose, either now or at any time in the future." Chandler, however, did not redistribute much of his own income. Already investigated in 1942 for accepting large gifts from war contractors--including a 60-foot in-ground swimming pool--Chandler had a history of securing government contracts for friends and donors, and then reaping rewards for himself.

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