August 2002

The Great Tax Wars

By Steven R. Weisman
Simon and Schuster (September 2002); $27; ISB 0-684-85068-0

Reviewed by Robert H. Colson, Editor-in-Chief, The CPA Journal

Although we accept the income tax as a fact of life, it exists because of fierce political battles and violent class confrontations over money and power that gripped the nation from the Civil War through World War I. In the 19th century, income taxes were commonly viewed as an extraordinary measure to be adopted only during times of war. Not until February 25, 1913, when Secretary of State Philander C. Knox applied the Great Seal of the United States to the Sixteenth Amendment to the Constitution, did the income tax become the primary means for financing the federal government. Even then, financing the government was only an important side issue to the growing political concerns about impending social instability given the vast disparity in the distribution of wealth and income and the shift in political power from New York and the manufacturing centers of the East to the more agrarian Midwest and South.

The United States and the Roman Empire are the only major states to tax their citizens on all income regardless of source. The modern income tax in the U.S. dates from the Civil War. President Lincoln and his Treasury Secretary, Salmon Chase, sought to raise money for the Union war effort and to address extreme popular resentment against wealthy industrialists who were seen to be profiting excessively from the conflict. The tax, which applied to individuals with what were very high incomes for the times, never raised as much as was hoped, and Congress rescinded it after the war. Congress re-enacted the income tax in 1894 in response to what was then the worst economic collapse in American history, the Panic of 1893. A year later, the U.S. Supreme Court declared the tax unconstitutional, calling it a direct tax, which the Constitution would allow only if proportional to the populations of the states. Because citizens of wealthy states would pay more than citizens of less wealthy states, such a direct tax on income would have been unconstitutional. Although members of Congress considered various ways of getting around the direct tax and proportionality constraints and did not think that a Constitutional amendment was necessary, a deal between Congress and President William Howard Taft in 1909 led to a Congressional resolution to amend the Constitution. The new income tax was quickly enacted when Woodrow Wilson became president in 1913 and became a means for financing the country’s effort in World War I, during which the top tax rate in the progressive tax system was 77%.

Weisman’s focus on the development of the income tax provides insights into current debates over trade, investment, the taxation of income, stock option compensation, wealth transfers, and America’s role as a global power. In the nation’s infancy, the goal of fostering economic growth was pursued largely through the protective tariff, which also provided the federal government with whatever money it needed. Reaching 50% on imports of clothing, machinery, and manufactured goods, the tariff disproportionately consumed the resources of Americans with modest means while the owners of protected industries became extremely rich. The high tariffs were successful in establishing American industry in the 19th century, and Americans began to become more sensitive to the competing economic interests of protecting industry and lowering the costs of their purchases.

The political and historical chronicle of The Great Tax Wars provides an opportunity to compare and contrast two fundamentally conflicting principles that characterize the American experience with taxation in general, and income taxation in particular. On one hand is the principle of fairness, which Weinstein refers to as “justice.” On the other hand is the principle of incentive, which Weinstein calls “virtue.” Both have had their day in the national debates over taxation since 1913, and one or the other prevails in our national subconscious at any given time.

Opponents of the income tax see it as constraining virtue: If wealth is a product of hard work, thrift, ingenuity, and risk taking (all the foundation of the American economic system), then taxing income and wealth at excessive rates distorts the incentives that make our economy thrive. In an epilogue, Weinstein relates a story about Ronald Reagan that reveals the essence of American virtue. Reagan saw excessive marginal rates of taxation as goads to laziness and a punishment of virtue because of his own experience after World War II, when he stopped working once his income hit the 90% bracket.

Proponents of the progressive income tax believe that people should fund the government in proportion to the income and wealth that they have generated from the economic system. In this view, the progressive income tax serves somewhat as a leveler, preserving the incentive to work toward wealth for those that currently are not wealthy. The income tax demonstrates a national commitment to justice in the distribution of rewards and sacrifice in our society, as well as the potential for upward mobility.

Weisman has covered politics, international affairs, and economics for The New York Times for over 30 years, and he delivers a compelling history that should interest everyone who deals professionally with income taxation, handled in a credible and entertaining fashion. The story of the clash of the ideals of virtue and justice—and the personalities embodying them, from Lincoln to Wilson—that framed the debate over income taxation from 1860 to 1918 illuminates contemporary issues about our future and how to finance it.

The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.

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