Carnegie: An Income Tax will Create a Nation of Liars

Exactly a century ago in October 1913 President Woodrow Wilson signed the first modern federal income tax into law. The sky did not fall. That may have surprised the eminences of the American plutocracy. For years they had predicted the most dire of consequences should the federal government begin taxing the incomes of America's most comfortable.

Those warnings took a shriller turn in 1909. A flurry of cynical congressional maneuvers sent the states a constitutional amendment, ostensibly designed to allow a federal income tax. Conservatives in Congress felt confident that the amendment had no chance of gaining enough state support to be ratified. To clinch the amendment's defeat, they unleashed a fierce rhetorical fusillade.

Friends of grand fortune would reserve a special venom for the notion of "progressive" taxation — the idea that high incomes should face the highest tax rates. They characterized a "graduated" tax on the incomes of America's affluent as "extortion," a "penalty upon ability and intelligence" and an imposition on a "small class of people powerless to defend itself." Taxing the wealthy, they contended, would be "killing the goose that laid the golden egg."

In the Virginia House of Delegates, Speaker Richard Byrd predicted that an income tax would put freedom itself in jeopardy. Any new income tax law, Byrd charged, "will of necessity have inquisitorial features." He forecast: "Under it men will be hailed into courts distant from their homes. Heavy fines imposed by distant and unfamiliar tribunals will constantly menace the taxpayer. An army of federal inspectors, spies and detectives will descend upon the state."

An income tax, Andrew Carnegie summed up, would simply destroy initiative and create a "nation of liars."

Americans ignored these admonitions. In 1910 and 1912, new progressive state legislative majorities across the nation endorsed the income tax amendment. Early in 1913, final ratification gave Congress a green light to add an income tax to the tax code. Months of congressional debate culminated eight months later with a new revenue act that featured a modest income tax.

How modest? The top tax rate would sit no higher than 7 percent on income higher than $4,000 — the equivalent of slightly more than $94,000 today.

That top rate would soar higher in the decades to come — much higher. In the 1940s, during World War Two, income above $200,000 faced a 94 percent tax rate. America's top marginal federal income tax rate would hover around 90 percent into the early 1960s.

These high-tax years — for the rich — should have been a time of economic calamity. At least according to the critics of progressive income taxation. But real life proved these critics wrong. Commerce did not cease when the tax code levied steeply graduated rates on U.S. incomes. The wealthy did not flee. The entrepreneurial spirit did not evaporate.

Quite the contrary. The United States thrived throughout the mid-20th century heyday of high taxes on the rich. We became the first mass middle-class nation in the history of the world, the first industrial nation ever where the majority did not live in poverty.

The progressive income tax was a key pillar of this middle class "golden age." Fiscally, the nation's steeply graduated tax rates raised the revenue that bankrolled new programs and services that opened doors into middle-class life. Culturally, these same steeply graduated rates sent the message that American society frowned on incomes that towered too high over the nation's economic and political landscape.

Looking back on those years now, the historical record is clear: America works best when we tax progressively — and significantly so. History hasn't been kind to all those who sought to prevent progressive income taxation a century ago. None of their dire predictions have come true.

This is the great irony of federal income taxation's first 100 years. Our contemporary political movers and shakers go about their business as if history had vindicated those shrill critics of income taxation in the early 20th century. Pols and pundits today have swept off our political center stage any serious consideration of the stiff progressive rates that even moderate Republicans, like President Dwight D. Eisenhower, once accepted as political and economic common sense.

Economists like Emmanuel Saez, the University of California, Berkeley (the scholar who rates as the leading authority on high incomes) points out that this refusal to revisit stiff top marginal rates makes no sense. Top tax rates today could double, Saez and his colleagues say, without jeopardizing our economic health.

The top 1% earns most of their income from capital gains with stocks (and stock-option grants), real estate and SWAG investments. They avoid taxation with gifts and inheritances, and by hoarding cash in offshore bank accounts. They also use a myriad of tax loopholes that primarily benefits the wealthy. At 23.8%, the capital gains tax rate for these high-income earners is lower than someone who earns an hourly middle-class wage --- which is 25% and higher on taxable incomes over $36,250 a year. The rich like to say they pay "more taxes" (because they earn more), but they usually won't tell you that they pay far less "as a percentage" of their income in taxes. And unlike regular wages, capital gains are also exempt from any Social Security taxes. The current tax code, with the capital gains tax, flies directly in the face of what is supposed to be a progressive tax system.

In 1909, former Attorney General Wayne MacVeagh asked "Why should the colossal incomes and the colossal accumulations of the possessors of what Mr. Carnegie himself calls surplus wealth continue to be exempted from proper taxation?"

"Gigantic fortunes," MacVeagh said, serve as "serious obstacles to the contentment, the peace and the healthy growth of the community as to call for their abatement."

(* Most of us have our taxes directly deducted from our paychecks by our employers. With rampant tax evasion and offshore banking, it seems that our "nation of liars" are primarily rich liars.)

* First posted at Reuters by John Buenker and Sam Pizzigati, Wed Oct 2, 2013- Edited and excerpted from "IRS at 100: How income taxation built the middle class"