By Joseph J. Thorndike
As Buffett pointed out, rich people -- especially investors -- get a relatively easy ride under the current tax law. Much of their income comes in the form of capital gains and dividends, both of which are usually taxed at a maximum rate of 15 percent.
By contrast, most people who depend on wage income to buy groceries face higher rates. According to the Tax Policy Center, an independent think tank, most people making more than $12,500 annually will pay higher effective rates than Buffett and his fellow billionaires.
Rich wage earners will pay a lot more: a salary man making $500,000 can face effective rates near 38 percent, much more than someone making the same amount from investments.
This discrepancy strikes many people as unfair -- and it always has. The tax preference for capital gains dates to 1921, and complaints about its fairness are almost equally as old. For decades, critics have argued that income from labor, rather than income from wealth, is the better target for preferential treatment.
Perhaps the most curious champion of taxing labor lightly was Andrew W. Mellon, the Treasury secretary and banking baron of the 1920s. Best known for his relentless campaign to reduce taxes on the rich, Mellon also fought for lower taxes on the “earned” income of working people (as opposed to the “unearned” income of the investing class).
“The fairness of taxing more lightly income from wages, salaries or from investments is beyond question,” Mellon wrote in his popular book, Taxation: The People’s Business, in 1924. “In the first case, the income is uncertain and limited in duration; sickness or death destroys it and old age diminishes it; in the other, the source of income continues; the income may be disposed of during a man’s life and it descends to his heirs.”
Mellon was no fan of taxing capital gains in the first place, suggesting that the effort probably cost the government money in the long run since it allowed investors to deduct losses in bad years. But as long as lawmakers were intent on taxing gains, he felt, they should ensure that labor income enjoyed preferential treatment.
In 1924, Mellon proposed a 25 percent tax credit for earned income, and he found plenty of support. His boss, President Calvin Coolidge, endorsed the idea in his first annual message to Congress.
Many lawmakers, too, lined up behind it. Politicians had been swayed, according to William R. Green, chairman of the House Ways and Means Committee, by “every argument in the way of reason and justice supporting it.”
Congress included Mellon’s earned-income credit in the Revenue Act of 1924. In operation, it proved troublesome, accounting for more than its share of filing errors. But lawmakers valued its contribution to fiscal equity, and they clung to it for years. Only after the Great Depression strained federal finances to the breaking point did they agree to repeal it.
To be fair, a tax credit for labor income is probably unaffordable today, too. But as lawmakers cast about for ways to shrink the long-term budget gap, Mellon’s insight on the moral status of labor income remains relevant.
If we can’t afford a tax break for work, how can we still afford tax breaks for wealth?
(Joseph J. Thorndike, a contributor to the Echoes blog, is the director of the Tax History Project at Tax Analysts and a visiting scholar in history at the University of Virginia. The opinions expressed are his own.)
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