Tuesday, February 25, 2014

The Secret History of the Income Tax

The 16th Amendment granted Congress the power to levy an income tax. This amendment continues to rankle tax-averse Americans. According to popular perception, progressives supported the income tax as a means of funding a raft of new, expensive social welfare programs. Some people link the income tax to war debt (the country was still paying off the Civil War). However, according to professor Philip Magness of George Mason University (source), there is a different explanation that is closer to the truth. He does an excellent job of citing the politicians who were involved in pushing the amendment and demonstrating the arguments they used in favor of it.

Joseph Weldon Bailey Senator from Texas, fat-cat
The little-known story of the 16th Amendment may be understood in the context of protective tariffs. In the early 1900s, the federal government acquired revenue by collecting taxes on imported goods. Many people supported the tariffs because they helped protect American farmers and manufacturers from foreign competition. Tariffs certainly did contribute to the great prosperity of the United States; tariffs meant higher wages for American workers.

But the point here is that there was a small number of business-owners who opposed the protective tariff. These business-owners made money by selling imported goods. If the tariff were lowered, they could increase their profits. These business owners made a lot of specious arguments in favor of so-called "free trade." They said that a tax on imports meant that American manufacturers could coerce consumers to choose American goods over foreign goods.

What free-traders neglected to mention was that federal revenue had to come from somewhere. If it didn't come from tariffs, it would have to come from other forms of taxation. One could either tax consumption, through the tariff, or one could tax income. And if the free-traders had their way, wages would go down, because it would place American workers in competition with lower-paid foreign laborers.

The free-traders threw their support behind the idea of an income tax. Amazingly enough, the efforts of these so-called "free traders" were ultimately successful. Tariffs were lowered and the lost revenue was recouped through a new income tax. 

Senator Joseph Bailey of Texas was an influential voice in favor of free trade, even though he had campaigned for office on a pro-tariff platform. Once he was safely in office, he declared, "I would make ... two propositions in one motion. I would provide for the reduction of the duties on articles of common necessity, and then I would supply the deficiency of revenue created by a remission of those duties to the people by the levy of an income tax."

Mr. Bailey helped ensure the passage of the 16th Amendment. Later it was discovered that Mr. Bailey accepted bribes and had a financial interest in Standard Oil. Interestingly enough, when the 16th Amendment passed, Standard Oil was no longer interested in selling oil drilled in America. It made its money in refining oil, and wanted to import oil from overseas (source).

1 comment:

  1. I just read this article to my 13 year old son. Thanks.