Taxes Are High On The Little Guy—Thanks, FDR

In a Tax Notes review of our Taxes Have Consequences: An Income Tax History of the United States, tax history project director Joseph Thorndike writes that the book is a history of income tax rates, not the income tax itself. Income tax rates are not the income tax? The rate schedule does not apply? How scandalous.

Harvard law’s Stanley S. Surrey before Congress in 1959:

“The income tax provisions of the Internal Revenue Code begin with sweep and power. The very first section of the code goes straight to the rates of tax and prescribes a rate schedule that is severe and steep—starting at 20 percent with low exemptions, rising to 50 percent at $16,000, on to 75 percent at $50,000, and finally to 91 percent at $200,000. The code then proceeds to a definition of ‘gross income’—the starting point in any income tax base—that is as broad as any to be found: ‘all income from whatever source derived.’”

The courts, Professor Surrey?

“The courts have given the term ‘income’ an expansive scope in keeping with the statutory thrust. [C]apital gains, illegal gains, windfalls, receipts in kind, indirect receipts, and cancellation of debts have all been held to constitute taxable income. It is difficult indeed to find any reliable judicial precedents which would deny income classification to an admitted gain.”

“Thus the tax law in its initial sections presents a picture of an income tax of extremely wide sweep applied at the most severe rates”—up to 91 percent at the time—“especially in the upper brackets….”

But then this:

“[T]he power and sweep of the initial sections”—the first two pages of the tax code—“are not matched by the end result. The intervening technical provisions”—now of 70,000 pages— “severely dilute the initial sections and leave the income tax a far different levy than is presented in the initial picture.”

Surrey showed that earners subject to high rates up to 91 percent in 1959 generally topped out at rates about 46 percent. The “paper rates”—Surrey’s term—saying the rich were dunned past 90 percent were nonsense. High earners paid in the 1950s such that about 16 percent of GDP went to government. High earners facing tax rates up to 91 percent paid about 20 percent of their income in taxes, if about double that at the margin.

Surrey thought it was a scandal. The tax code said one thing at the fore about rates and then took everything back in the immense back pages. Richies got to take all sorts deductions so they could claim that they were assaulted by a 91 percent rate while paying at about a quarter of that. As a result, the hoi polloi were content to face a bottom rate at the elevated level of 20 percent (cf. 10 percent today).

The tax system of the mid-twentieth century was a sham, a central point of Taxes Have Consequences. The left, led by Thomas Piketty, says that that tax system soaked the rich and brought income equality. We disprove this contention with extreme prejudice. Taxes Have Consequences is indeed a history of income tax rates. Therefore, it is also a history of legal income tax avoidance of high rates. My, did the rich enjoy tax avoidance when rates were high—and submit to tax rates at the top when they were low.

The high income tax rates of the golden era of American prosperity—the 1950s—were utter fiction. The illustrations, the ample evidence, we offer of this reality find their pinnacle in Tom Wolfe. Writing of top 1 percent untaxable income of that time he put it this way:

“The restaurants in the East and West Fifties of Manhattan were like something from out of a dream. They recruited chefs from all over Europe and the Orient. Pasta primavera, saucisson, sorrel mousse, homard cardinal, terrine de legumes Montesquieu, paillard de pigeon, medallions of beef Chinese Gordon, veal Valdostana, Verbena roast turkey with Hayman sweet potatoes flown in from the eastern shore of Virginia, raspberry soufflé, baked Alaska, zabaglione, pear torte, creme brulee; and the wines! and the brandies! and the port! the Sambuca! the cigars! and the decor!”

All the bucks that went to feeding that executive compensation, these big boss and client lunches that lasted for three hours multiple times a week? The company picked up the tab. The consumption, meaning income, was untaxable to the execs, and deductible to the corporation at a 52 percent rate. The big shots got income not only untaxed in the 1950s, but income furnished half by the federal government.

The left’s love affair with high tax rates trades in fraud: the idea that the high tax rates of the past were not an excuse to tax the little guy at elevated rates. This was the essence of high tax rates from the 1930s through the 1970s. They enabled the rich to sustain their livelihoods while conning the working class into forking over a fifth of their income. Thanks, FDR.