IWF published this article in The Women’s Quarterly in 1999. It is as relevant today as it was then, and will be even more relevant if John F. Kerry were to become president. It is an excerpt from Shlaes’s book The Greedy Hand.
In August 1966, George Harrison led the album Revolver with a song about a new presence in his life — “Taxman.” The lyrics were simple. “Let me tell you how it will be. There’s one for you, nineteen for me. ‘Cos I’m the taxman.”
1966 was exactly the right time for the Beatles to discover “Taxman.” This was the period when they were just settling into the notion of their stupendous success. In the Britain of the 1960s, that meant they were taxed like lords and dukes, at confiscatory rates ranging far above half their incomes. No matter how much they earned, and they were earning more than they had ever dreamed, it seemed the government took more.
Older Americans may no longer identify quite so much with the Beatles’ music. But they can identify, more than ever, with George’s shock. This is because, in some sense or another, we are all Beatles now: people in the process of achieving more than we thought we could.
With our achievement comes the George Harrison experience. Suddenly we — little me! — are paying taxes in the 30, 40 or even 50 percent range. Even if we aren’t yet confronting such rates, we are aware that our work may soon get us to that territory. We look around, stunned, for we don’t really feel rich. In fact, we may feel tired because we have been working harder than ever to make the progress we’ve made. So we wonder: Why is it that my effort earns a bonus from my employer and punishment from my government?
This is a fundamental moment in our relationship with government. When we struggle with taxes that come with our new prosperity — call them “success taxes” — we are struggling not with some peripheral tax pitfall but with the core principle of the code — progressivity. Progressivity is a success tax, but it is also the mother of all taxes, the tax that dominates our lives like no other. Progressivity institutionalizes the class warfare that politicians tell us they are waging on our behalf.
Yet progressivity is not an intuitive thing: As we look at our tax bills, we find we are forced to explain exactly how it works. Many of us simply fall back to assuming that progressivity is what makes rich people pay more taxes. That’s not right. When the tax rate is 25 percent, a person who earns $100 pays $25. A person who earns $200 pays more. He pays $50. That’s called a proportionate system, and it’s not what we have.
What we have is progressivity, a system that taxes people more the higher up the income scale they go. Our first dollars are taxed at lower rates: nothing at all, or 5 or 20 percent. But the last dollar we earn is taxed at higher rates, rates that, on the federal level, currently range up to 39.6 percent. Medicare drives that rate up to over 40 percent. Some states push that figure toward 50 percent by applying their own progressive tax structure. We encounter the progressivity problem at many points in our lives. But only with significant achievement, only when we actually come dose to managing the seemingly Herculean feat of actually doing in life what we set out to do, do we move up the tax brackets toward the 39.6 percent, or 45, or 50 percent zenith; only then do we know progressivity’s full damage.
Today Washington talks as if progressivity was etched in stone — no reform plan, not even the intrepid flat taxers, dares offer a program totally devoid of progressive elements. Yet when pollsters ask Americans how they feel about progressivity, different answers emerge. In 1995, for example, the Reader; Digest published the results of a poll by Everett Ladd, director of the Roper Center for Public Opinion Research at the University of Connecticut. The poll showed that a broad majority of people felt that 25 percent was about the share of their money Americans should pay in all their taxes. It also showed that Americans earning less than $30,000 agreed, along with all other earners, that 25 percent should be the top tax burden for families with incomes of $200,000. That’s well below the average taxes many such families actually confront.
What those laboring in the trenches of everyday life have sensed is that progressivity doesn’t do what it says it does: Tax the rich. Indeed, the secret of progressivity, and all the other little success taxes we have constructed over time, is that they aren’t really success taxes. They are taxes on becoming successful, or merely improving one’s lot. Those who are truly successful, the superrich, get to stay that way and even build their wealth. Those who aren’t, or aren’t yet, get the following message: Stay where you are. When you move upward, you will start to lose a lot of breaks that are valuable to you.
How America, land of strivers, came to target those strivers like so many Iraqi chemical-weapons factories is an instructive story. Certainly, the nation’s founders never advocated “success taxes.” Thomas Jefferson ran for office in 1799 on a plan to ban all internal taxes — and won. One of Jefferson’s promises was that a “wise and frugal government” would not “take from the mouth of labor the bread it has earned.”
Every time the nation’s leaders doubted their convictions, they had only to look at Europe. There, numerous success taxes and big, rigid government killed enterprise and dampened free spirits.
De Tocqueville, a French nobleman whose family had barely made it through the French Revolution, knew all too well what damage could be wrought in the name of punishing the wealthy. In the same years that he was traveling in America, one of his more gifted countrymen, the economist Frederic Bastiat, unfurled perhaps the best explanation ever on why governments favor success taxes.
Lower earners who would not normally tolerate a tax, Bastiat noted, will do just that when they believe that the rich are being taxed even more. “People are beginning to realize that the apparatus of government is costly. But what they do not know is that the burden falls inevitably on them. They have been led to believe that if their share has been heavy until now the Republic has a means, while increasing the general burden, of shifting at least the larger part of it onto the shoulders of the rich. Fatal Illusion!”
For 50 years after Bastiat sketched it, most Americans still retained their understanding danger of his fatal illusion. America’s bedrock principle was still that people should be able to keep the fruits of their own labor. Bourke Cockran, the Democratic leader in the House of Representatives before the turn of the century, thought that installing a progressive tax was a terrible plan. He noted such a tax would fall heavily on a crucial group: younger people starting out, first-generation arrivals, average Americans who might have little but who hoped to one day make a success of their lives. “The hope of wealth, which is universal, is a greater force for order than the possession of wealth, which is confined to a few.”
In those years William Jennings Bryan campaigned on a Democratic Party platform that explicitly rejected progressivity.
As has often been the case in our history, the Republicans ended up doing the dirty work. The Republican leadership in the House and Senate, and a Republican president, Taft, were the ones who began the institutionalization of class warfare. When they wrote the Sixteenth Amendment, the law that gave us the income tax, the Republicans went where the Democratic Party had refused to go. Their amendment said that “Congress shall have power to lay and collect taxes on incomes, from whatever source derived.”
This left the door open for progressivity and the income tax.
Scholars today often wonder whether the Republicans actually realized what they were setting in motion. Theirs was supposed to be a levy on the wealthy. When it did come, the new income tax, passed by a Democratic Congress in 1913 as part of the Underwood-Simmons Tariff Act, exempted all but two in a hundred of American households. Its top rate was 7 percent, less than what individuals pay today for their share of payroll taxes. It is fair to say none of the Republicans who laid the grounds for progressivity ever dreamed of income tax rates at 39.6 percent.
In fact, there was a floor debate at the time on whether to put a 10 percent cap in the constitutional amendment. The answer was no — largely because people thought the idea that the tax might ever rise that high too absurd to address.
But within a few very short years — the years that brought World War I — the first of these promises already lay broken. The Wilson administration didn’t just take something from the wealthy; it pushed top rates on the income tax up to 67 percent. It also loaded on corporate profits taxes — so-called “excess profits” taxes — of up to 60 percent. Progressivity was crucial to FDR’s mass tax. FDR made a big show of taxing the wealthy. And so, in the 1940s, average people began to pay taxes, including the success taxes of progressivity. They did so in part because they were promised that wealthier people were paying yet higher success taxes. Bastiat’s fatal illusion was up and running in the United States.
Government liked the fatal illusion. “We shall tax and tax, and spend and spend, and elect and elect,” said Roosevelt’s adviser Harry Hopkins in a merry moment.
Federal tax revenues jumped by tens of billions. There were those who questioned progressivity. But most economic thinkers and politicians, from left to right, embraced it. Even the most famous of the right-wing eminences, the Austrian economist Friedrich von Hayek, endorsed a progressive rate structure in those days.
Yet even in the 1940s and 1950s, what we know today was clear: The class-warfare part of progressivity didn’t really function as advertised. In the 1940s and 1950s most Americans were paying progressive taxes for the first time. They consoled themselves with the knowledge that the wealthy were paying the highest taxes in U.S. history. At one point, the top marginal rate on the income tax was 91 percent.
Even then, though, the rich had found a way to evade these taxes. They asked Washington for tickets out of this regime, and Washington handed out those tickets by inserting tiny favors to specific groups in the tax code. Eager to maintain its fatal illusion, Washington has come up with any number of justifications for its success taxes. After World War II, the foremost among these was something that seems surprising today: inflation. Later, Washington argued that we needed progressivity to obtain necessary revenue; as Eisenhower said at one point, “I need the money.”
World War II and its extensions — the Korean War, Vietnam War, and the cold war — generally meant that the nation needed resources available at any instant in case of war. Today these arguments have faded. Yet progressivity is still here — and doing even more damage, perhaps, than at other times.
Here’s why: We live in a watershed moment. The computer revolution has given enormous wealth to a small group of people-people whom the class-warfare sorts like to target. Even those who have never worried about such things before are now worried about a new, two-class society — the haves, who enjoy the technology bounty and the bounty of the market, versus the have-nots, the children of working people who never even got Intel stock options or bought a mutual fund. Starting new offices and new businesses, and buying home computers are things these people ought to be allowed to do. Progressivity is often what stops them.
GREEDY HAND, DEVIOUS MIND
The father of the modern American state was a pipe-smoking executive at R. H. Macy & Co. named Beardsly Ruml. Ruml, the department store treasurer, also served as chairman of the board of directors at the Federal Reserve Bank of New York and adviser to President Franklin Roosevelt during World War II. In 1942, not long after Pearl Harbor, lawmakers raised taxes radically, hoping to capture twice as much revenue as the previous year.
As March 15, 1943, neared, it became clear that many citizens were not filing tax returns. Enter Ruml, man of ideas. Like other retailers, he had observed that customers didn’t like big bills. They preferred making payments bit by bit, in the installment plan, even if they had to pay for the privilege with interest.
So Ruml dvised a plan, which he unfolded to his colleagues at the Federal Reserve and to anyone in Washington who would listen. The government would get business to do its work for it by collecting taxes for it. Employers would retain a percentage of taxes from employees every week — say, 20 percent — and forward it directly to Washington’s war chest. This would, among other things, hide the size of the new taxes from the worker.
Ruml hadn’t invented withholding. His genius was to make its introduction palatable by adding a powerful sweetener: the federal government would offer a tax amnesty for the previous year, allowing confused and indebted citizens to start on a new footing. It was the most ambitious bait-and-switch plan in American history.
Also from a recent Los Angeles Times column by Amity Shlaes:
George W. Bush has a war, and now John F. Kerry has one too — a class war. At Georgetown University this month, Kerry opened fire when he vowed to raise taxes on the top 2% of earners while cutting taxes on the other 98%. The idea is not only to create jobs — Kerry says he can get 10 million — but to create economic opportunity. Kerry wants to plow through class barriers like an Abrams tank. Or, as he put it, to reclaim America on behalf of those who seek “paths to a better life.”
Will it work? A short review of the program suggests otherwise.
Start with the Kerry plan for corporations. He says he wants to give advantages to firms that keep jobs at home. His critics have called Kerry inconsistent for bashing outsourcing even though his wife, Teresa, holds a great deal of stock in an international company, H.J. Heinz Co. But what is really important about the corporate tax plan is the way it shows that Kerry believes tax protectionism, rather than a free market, yields growth.
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