Fist Of History

1920s Federal Government and Taxation…a quiet revolution

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The period from 1920 through 1929 represents an unusual shift in the operations and nature of the federal government, one that can be best considered a “quiet revolution” in federal government in which both the principles behind taxation, and the principles behind expenditure, were quietly changed to reshape the government into a leaner structure which can still be seen in the foundations of the modern federal government currently operating within the United States.  The core of this change took place under President Warren G. Harding in 1921 with the passage of the Budget and Accounting Act – a new legislation that required that President to submit an annual budget to Congress for approval which would encapsulate all the revenues and expenditures of the federal government.  It also created the Office of Budget Management (OMB, it’s modern name) and the Government Accountability Office (GAO) – all institutions designed to make the federal government operate more like a modern corporation in its handling of income and expenditures.  The immediate result was increased government efficiency in cost-management and the opportunity for the government to reduce some of its expenditures overall.  By 1922 the federal government had reduced its overall spending by nearly half, from roughly six billion to only three billion in total costs.

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Harding also appointed Andrew W. Mellon to the office of Secretary of the Treasury, where he served from 1921 to 1931 under Presidents Harding, Coolidge, and Hoover.  Mellon was responsible for drastic modifications to the United States federal tax code, implementing vast reductions in tax rates on the theory that reduced income tax rates would capture more wealth overall for the federal government by encouraging wealthier individuals to bring their fortunes out of hiding from tax rates and into the productive economy.  During the 1920s his policies worked well overall, calling his efforts “scientific taxation” he oversaw Congress gradually reducing top-tier tax rates from 73% in 1921 to 24% by 1929.  During that same period federal tax receipts went up as well, however Mellon had some unusual ideas that shaped his policy of “scientific taxation” that make it stand out from more modern efforts to reduce tax rates.

  • Mellon believed that lower income tax brackets should be reduced as well, the lowest income tax rate was cut from 4% to 0.5% during the same period
  • Mellon oversaw estate tax rates being cut while also quietly ending policies that encouraged investments into tax shelters to hide wealth from taxation
  • Mellon pushed for the tax rate on “unearned income” – income from investments – to be taxed at a higher rate than that earned by direct labor – arguing that the inherent instability in income earned from wages and salaries needed to be sheltered from the hazards of life

The biggest part of Mellon’s revolutionary idea though was the goal of fine-tuning the income tax rate on the highest earners in society to a point where the government would gain maximum efficiency in returns by getting the most wealth into circulation against revenue generated for federal needs and then locking the tax rate down at that level.  He resisted calls during 1929 to further cut the income tax rate or other tax rates, arguing that peek efficiency had been gained and the wealthy needed no further incentives to get their money into circulation.  Mellon believed in squeezing those who could pay – his major goal was to find just the right squeeze to get the maximum revenue possible for the federal government that it needed, no more, no less.

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This aspect of the “quiet revolution” came to an end in the whirlwind of the 1930s and the global economic downturn now known as the Great Depression.  The population of the United States swept the Republican party from power in 1930 and 1932, putting the Democratic party into power and ending the era of a tight federal government and diminished federal spending.  The citizens demanded a more active role from the federal government in combating the problems of the Great Depression and this lead to the end of Mellon’s influence and an end to the idea of the federal government operating as a “business” rather than as a government.  But legacies from this carry on – in the modern United States tax policy is still guided by the goal of setting tax rates that will encourage money to stay in the system rather than hide and the federal budget is an annual event which Congress wrangles over even in the 21st century.

A final note to those who might argue that Mellon’s model, and the tight federal spending efforts by Harding, Coolidge, and Hoover are a more “proper” path for the federal government need to know a key detail, although the spending and role of the federal government declined in the 1920s the role of state governments expanded, including spending to pick up more social programs.  So the overall level of expenditure during this period on social infrastructure is a more complex topic than presented here.

Sources:  Wikipedia entries on Warren G. Harding, the Budget and Accountability Act of 1921, Calvin Coolidge, and Andrew W. Mellon

 

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