<html> <head><style type ="text/css">body { font-family: "Bloomberg Prop Unicode I", Verdana, sans-serif; font-size:125%; letter-spacing: -0.3pt; color: #FF9F0F; background-color: #000000; text-align: left; } p {line-height: 1.25em; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" );} h1, h2, h3 { text-align: left; font-weight: normal; color: #FFFFFF; } h1 { font-size: 130%; } h2 { font-size: 115%; } h3 { font-size: 100%; } #bb-style { font-size: 90%; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" ); } b, strong { font-weight: bold; } i, em { color: #FEC54A; } pre { font-family: "Andale Mono", "Monaco", "Lucida Console"; letter-spacing: -0.3pt; line-height: 1.25em; } table { border: 0; font-size: 90%; width: 100%; margin-left: auto; margin-right: auto; } td, tr { text-align: left; } td.numeric { text-align: right; } a:link { color:#53B2F5; text-decoration: none; } a:visited {color:#53B2F5} a:active {color:#53B2F5} a:hover {color:#53B2F5} </style> </head> <body> <p>By John Steele Gordon</p> <p>The idea that the rich aren't paying their "fair share" of taxes isn't exactly a new beast in the zoo of American politics. It has been around since the Civil War ended 150 years ago.</p> <p>To fund the war, the federal government taxed as it had never taxed before. The tariff, long the main source of government revenue, was raised sharply. So were excise taxes on commodities such as liquor. The government also instituted the country's first income tax, which imposed a 3 percent levy on incomes above $800. It was soon raised to 3 percent on earnings of more than $600 and 5 percent on those that exceeded $10,000.</p> <p>In the mid-19th century, anyone would have considered a person with a $10,000 annual income "rich."</p> <p>With the war's end, government outlays declined sharply. In 1865, they had been almost $1.3 billion, the first time any government anywhere had spent more than $1 billion in a year. By 1870, they had declined to $309 million.</p> <p>The income tax was allowed to lapse in 1873, and excise taxes were lowered as well. What remained very high was the tariff. But the purpose of a high tariff wasn't solely to fund federal operations; it was so high that the government ran budget surpluses for 28 straight years, from 1866 to 1893.</p> <p>Rather, the tariff was kept high to protect the booming industrialization of the American economy in the postwar years. That was very popular in the Northeast and Midwest, where the industry was concentrated, but deeply unpopular in the South and West.</p> <p>The problem was that the tariff is a consumption tax. It is simply built into the price of imported goods and paid by the purchaser. (It also, of course, allows domestic producers to raise prices.) And consumption taxes are inherently regressive. They fall more heavily on people of low income, who must spend most of their earnings to buy necessities. The rich usually bank most of their incomes and thus largely escape consumption taxes.</p> <p>Not surprisingly, many thought that a federal tax system based mostly on the tariff was unjust: The rich weren't paying their fair share. One way to make them do so was an income tax.</p> <p>In 1894, with the economy in deep depression, Congress, with a Democratic majority, passed a revenue act that slightly lowered tariffs and imposed an income tax to make up the lost revenue. The tax amounted to 2 percent on incomes above $4,000.</p> <p>That was a comfortable upper-middle-class income in the 1890s (only about 85,000 households would have been subject to the tax). So this was explicitly a tax on the rich.</p> <p>Naturally, a lawsuit ensued. The plaintiff's argument was that an income tax was a "direct tax" and the Constitution requires that all direct taxes laid by the federal government must be "in proportion to the census." In other words, direct taxes must be apportioned among the states according to population, not income, something obviously impossible with a personal income tax.</p> <p>The case, Pollack v. Farmers' Loan and Trust, reached the Supreme Court in 1895. Joseph Choate, an eminent Wall Street lawyer, argued for the plaintiff. He had a tough case to make. The court had ruled as early as 1796 that a direct tax was, simply, any tax that could be apportioned among the states according to population. In 1881, it had ruled that the Civil War income tax, which had already expired, was an indirect tax.</p> <p>With precedent against him, Choate demagogued, calling the act socialistic, communistic and populistic. He argued that the income tax endangered "the very keystone of the arch upon which all civilized government rests."</p> <p>This approach proved good enough to get a tie vote in the court, 4-4. But a tie in a case that had generated such national attention would never do.</p> <p>Justice Howell Jackson of Tennessee had been absent from the argument due to illness. Although he was dying of tuberculosis, he managed to return to the court for a rehearing. As one journalist wrote, "He interested the crowd more than all the rest of the bench; that his life can last but a short time and that it will probably be shortened by the effort which he has made to attend the hearing."</p> <p>Advocates for the income tax were confident that, with Jackson's known political sympathies, the tax would be upheld 5-4.</p> <p>The vote was indeed 5-4 when the decision came down on April 8, 1895. But it went against the income tax. One of the other justices -- which one isn't known to history -- had switched his vote. Jackson could only write a stinging dissent, calling the decision "the most disastrous blow ever struck at the Constitutional power of Congress." He then returned to his bed, where he died four months later.</p> <p>The rich would go undertaxed a while longer.</p> <p>(John Steele Gordon is the author of numerous books, including "Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt." The opinions expressed are his own. This is the first in a two-part series.)</p> <p>To read more from Echoes, Bloomberg View's economic history blog, <a href="http://www.bloomberg.com/view/echoes/">click here</a>.</p> <p>To contact the writer of this blog post: John Steele Gordon at jsg@johnsteelegordon.com.</p> <p>To contact the editor responsible for this blog post: Timothy Lavin at tlavin1@bloomberg.net.</p> </body> </html>