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(Continued from previous article) By March 1917, Congress had made some pretty big changes in the federal tax system, one of which is the corporate excess profits tax. The corporate excess profits tax essentially taxed any profit or income generated by a corporation that is greater than what is deemed reasonable in terms of return rates. When this tax law was first passed and then implemented, the reasonable return rate was determined to be eight percent – meaning that if corporate owners’ return rate was eight point five percent or even eight point one percent, they were required to pay taxes “according to a steep rate schedule”. The corporate excess profits tax also taxed individuals who are in professional positions requiring high education and intelligence; those who earn six thousand dollars annually are required to eight percent of the earnings.

This particular tax actually generated the most money for the cause of the war, even though businessmen were very much against the law because it threatens the way businesses were managed – and with good reason, as the tax was also used by the government at the time to control and regulate businesses. Other critics of this tax law termed the taxes levied on the individuals as a “tax on brains”. The tax had many supporters, however, and there have been some plans to retain this tax law even after the war has ended.

Regular income tax also hiked up that year – the War Revenue Act of 1917 stated that a two percent tax would be imposed on annual incomes that were in excess of one thousand dollars (or two thousand dollars for married couples). The 1917 War Revenue Act also included graduated surtaxes that could go as high as sixty percent, and four percent more on the corporate income tax at the time.

The big changes in the tax system unsurprisingly caused a lot of problems for the Bureau of Internal Revenue – after all, the Federal revenues suddenly shot up and averaged at almost three billion dollars worth within the 1915-1926 period. In order to deal with the sudden influx of tax to be collected, the agency had to hire more people to process the taxes relating to the areas of estate, munitions, and capital stock taxes on top of expanding the staff to a number in the thousands, in order to manage war taxation. This sudden expansion almost destroyed the Bureau of Internal Revenue as it was flooded with paperwork – not only were the new income tax returns coming in in 1918, but the 1916 and 1917 papers were far from being fully processed. And the tax increases just made it worse – the returns increased by one thousand percent between 1916 and 1921.

1918 and 1919 saw very little major change in the tax system of America, although for corporate and individual income, estates and corporate excess profits, the rates were raised. Normal and surtax rates at that point could go up to seventy-seven percent for incomes that are considered among the highest. Corporate bodies had to pay twelve percent of their net taxable income and were given an exemption of two thousand dollars. All in all, there were attempts to fix any mistakes in tax laws that were placed without due consideration.

At this point, the federal revenue system has come to rely on income tax, turning it into the most important source of federal finance. And the Bureau of Internal Revenue struggled to try and keep up with the changes, hiring thousands of personnel and attempting making up for the late printing of tax forms and instructions by extending the filing deadlines. Eventually, it was deemed that the incredibly high taxes that were prompted by the war cannot at all be sustained anymore. President Woodrow Wilson and tow of his Treasury secretaries – Carter Glass and David Houston – began working on the possibility of lowering the taxes.

There were many supporters of the wartime tax reforms, however, proving that the tax may not be as easy as one would hope. After all, the progressive nature of the revenue policy back then had beneficial aspects; progressive Republicans and Democrats rather liked certain policies, even the excess profits tax. One of the main arguments for the retention of the profits tax (which imposes a graduated levy on profits that exceed the “normal” return rate on capital) is a good way to fight egalitarianism (the idea that everyone should be treated as equal from birth, which, at certain times, could be ironically unfair); at the time, egalitarianism is seen as a threat to certain American ideals.

Despite the contentions, tax cuts and reforms were still made and implemented. The tax cuts and changes started in 1921, and this included many changes like the removal of the excess profits tax from the system, a slight increase in the corporate income tax and some decrease in personal income tax rates. Much of the wartime excise levies, however, were retained. There were also changes that increased exemptions for dependents and heads of the family, allowing middle class earners some relief, and preferential treatment was introduced to capital gains income.

In 1924, Secretary of Treasury Andrew Mellon began to argue for more tax cuts (he has made himself a name in the defense of lowered tax rates), insisting that they could actually increase revenue that way because fewer people would be avoiding the payment of taxes. His proposals, which involved dropping the top rate of taxes to twenty-five percent, a twenty-five percent reduction for wage and salary income, and a decrease in excess taxes, were of course met with significant and sometimes harsh resistance. His opposition, for the most part, won – the 1924 Act got the top marginal income tax rate down to forty percent (less than the cut Mellon wanted), and a fifteen percent rise in estate tax rates even though he was allowed the twenty-five percent earned income credit.

Two years later, another attempt to lower the taxes was mobilized. This time, Mellon suggested that the estate tax be gradually be eliminated, that the gift tax be removed, and that individual income taxes by broadly reduced in order to lower the top marginal rate to twenty percent. The new proposal Mellon presented was supported by a lot of lobbying and, eventually, Congress. So this time around, Andrew Mellon managed to score a significant victory over his opposition. While it was true that the estate tax remained in place, it suffered a fifty percent cut in rates and Mellon’s opposition had to agree to a credit for state inheritance taxes.

However, income tax exemptions were also raised at this point, and more people were removed from the tax rolls. Unfortunately for Mellon, this was something that he vehemently opposed since the tax base was too small as it was and the whole point of his argument for change was to get more people to pay their taxes. He firmly believed that by getting people to pay their taxes, they will feel that they are responsible for what happens to the revenues – placing their eyes on the government and ensuring little corruption. Mellon’s critics, particularly those in the lower classes, were offended at the suggestion that the sales taxes levied on ordinary men’s and women’s consumer products were not enough to generate their interest in the usage of government revenue.

Still, 1926 heralded a host of tax cuts that included the exemptions, which Mellon eventually accepted with resignation. The tax cuts continued well into 1928, which the year when Mellon once again made an attempt to get the estate tax repealed on top of cutting down rates of corporate income tax. While many liked the idea of making corporate income tax cuts, but they were once again reluctant to remove the estate tax from lawful taxation. Nevertheless, the overall state of taxation at the time was satisfactory: less Americans were burdened by taxes, and income tax became the most important central source of federal income.

In 1929, however, the Great Depression claimed the United States of America. A year later, the dwindling state of the revenues was alarming enough to make lawmakers realize that they will be soon suffering from a significant deficit and a fiscal gap to rival the extent of Grand Canyon. Strangely enough, President Herbert Hoover and Andrew Mellon were very much reluctant to increase taxes until the national income met with so much trouble that they had no choice in the matter any longer.

In 1932, Mellon himself asked for a tax hike, a very painful decision for a man of his reputation. It was also at this point that Mellon had decided to end his service in the Treasury, becoming an ambassador to London. His replacement, Ogden “Little Oggie” Mills, was a known tax expert who immediately assessed the several problems with not only the collection of taxes, but also the expenditures on which the budget was being spent on. He concluded that the major problem really lies on the fact that the revenue system was functioning on a depressingly narrow base, and that tax receipts tend to vary according to a myriad of business conditions. The fact that income tax at the time was progressive (that is, the tax rate increases as the income increases) apparently just made things worse – because large incomes, which supported the revenue, tend to be more sensitive to the economy, they crash when the economy crashes just as quickly as they hurtle upwards in times of prosperity.

After determining this, Mills advised against radically increasing the rates, since they would probably not raise enough revenue anyway. He acknowledged that there would indeed be the need to raise rates on the richer Americans, but also pointed out that more people should actually be paying the taxes – meaning, of course, less exemptions. Broadening the tax base is, in his opinion, a priority, and citizens should thus be duly encouraged to contribute to the federal revenue – of course, with their ability to pay taken into consideration. To this end, Mills suggested that they restore the 1924 tax rates, increase the surtax (topping at forty percent) and, most importantly, reduce the tax exemptions.

Still, the new Democratic Congress decided not to pursue the decreased exemptions and instead went with a new federal sales tax. The move inspired a rebellion among the Democratic masses, forcing the Congress to scrap the idea and instead go with largely relying on excise taxes, and raised rates of estate taxes and income taxes. This was reflected on the Revenue Act of 1932, which relied heavily on new or increased excise levies and only fractionally on steeper rates and lower income tax exemptions. (To be continued)