How the Tax Dilemma Abroad Is Tied to Regressive Policies at Home
December 10, 2019
By Todd Tucker
In response to “The Starving State: Why Capitalism’s Salvation Depends on Taxation” by Joseph E. Stiglitz, Gabriel Zucman, and Todd Tucker for Foreign Affairs, the Roosevelt Institute is hosting a blog symposium to further examine the history of international tax rules and the path ahead toward more inclusive and fair international tax policies.
Read the other posts:
The Future of Global Corporate Taxation Is More Uncertain Than Ever
Corporate Tax Negotiations at the OECD: Shifts to Ensure Symmetry and Equity
We are anchoring our blog symposium around the release of “The Starving State: Why Capitalism’s Salvation Depends on Taxation,” an essay by Joseph E. Stiglitz, Gabriel Zucman, and myself for Foreign Affairs. In it, we discuss the disaster that is current international tax rules.
In this blog post, I want to give the backstory; namely, how these rules grew out of institutional racism and pro-plutocratic government over centuries of US history.
Much of the current state of affairs on tax is rooted in centuries-old policy choices that allowed elites to limit the capacity of government to do much of anything, including the ability to effectively use sovereign taxing power to restrain the growth of inequality. In order to guarantee that corporations and the wealthy paid little in taxes—indeed, at lower rates than those less well-off—the rich ensured that government was designed and operated in as counter-majoritarian a fashion as possible, positioning powerful unelected judges and malapportioned Senate seats.
For the US story, the constraints on taxation came early on and were intertwined, from the beginning, with the country’s history of racism. In order to appease Southern slave states, the founders agreed to the infamous compromise whereby slaves would be counted as three-fifths of a person for purposes of representation in the people’s House and the Electoral College. It’s easy to see why Southern elites liked this deal: Slaves did not get a vote, but they did count towards population totals. This inflated the South’s power beyond what it would have otherwise been, and it took a Civil War to have the clause excised through the Fourteenth Amendment to the Constitution in 1868. But less commonly acknowledged and understood is that the three-fifths clause also constrained federal power to institute direct taxes unless on a by-population basis, on the same formula. This greatly limited the scope for progressive taxation, whereby those with greater ability to pay—the rich—contribute a larger share of their income.
For the first century of American life, the stricture on taxation mattered little, simply because of the limited role of government in a highly agrarian economy. Tariffs—which did a double duty of raising revenues and protecting the fledging Northern manufacturing industry against competition from abroad—sufficed. And though the founders neglected to define “direct”—as opposed to “indirect”—taxation over the course of the 19th century, Congress would regularly pass—and the Supreme Court would often uphold—a wide array of federal taxes, duties, imposts, and excises, including income taxes, stamp taxes, special taxes on holders of bank shares and insurance companies, and more.
But with the rising inequality of the Robber Baron Era, the Supreme Court suddenly flipped. In 1895, in Pollock v. Farmers’ Loan & Trust Company, the court, by a slim 5-4 majority, threw out previous precedents and deemed an income tax (approved to help the nation recover from the depression brought on by the Panic of 1893) as a prohibited “direct tax.” As labor organizers and socialists agitated across the country for factory safety standards, an abolition of child labor, and the eight-hour workday, Associate Justice Stephen Field offered the following reasoning for the reversal: “The present assault upon capital is but the beginning. It will be but the stepping stone to others, larger and more sweeping, till our political contests will become a war of the poor against the rich; a war constantly growing in intensity and bitterness.” Ironically, Field had originally been appointed when the Lincoln administration expanded the court from nine to ten seats as a way to dilute the votes of conservatives. In 1881, he had joined a unanimous court in upholding income taxes used to finance Reconstruction. In dissent to the Pollock decision, Associate Justice John Marshall Harlan painted the majority decision “as a disaster to the country …. It so interprets constitutional provisions, originally designed to protect the slave property against oppressive taxation, as to give privileges and immunities never contemplated by the founders of the government.”
This shift fueled a populist backlash that took square aim at the court as a guardian of plutocratic privilege. The platforms of the Democratic and Socialist parties criticized the decision and called for income taxes and structural reforms. Even Republicans, such as Theodore Roosevelt and William Taft, conceded the necessity of income and even corporate taxes. In a special session of Congress in 1909, it became clear that a coalition of Democrats and insurgent Republicans had the votes to pass a progressive income and corporate tax, with the leaders assuming that the brinksmanship would pressure the court to reverse its Pollock position. The newly elected President Taft was aghast; unsure that the court would back down, he feared that a repeat of 1895 would give ammunition to progressive reformers who wanted to weaken the judiciary. As a former judge, he would not countenance that. Working with anti-tax Senate leaders, he nixed the income tax and instead called for a constitutional amendment strategy—which tax opponents assumed would never attract the necessary three quarters of state votes. Instead, tax advocates exceeded the required 36 states, making it to 42 by 1913. Congress promptly enacted a law that imposed a 1 percent tax on incomes above $3,000 per year and a top tax rate of 6 percent on those earning more than $500,000 per year. Only the top 3 percent richest Americans owed any tax under these rules, which today translates to around $77,000 and $13 million, respectively.
In the years since, wealthy Americans used our country’s unrepresentative small-r republican structures to fight back, pushing for a more regressive tax code that disproportionately disadvantaged non-white groups. At the state level, racists enacted tax codes that shifted taxation from property owners (who were disproportionately white) to consumers, shifting more of the tax share onto Black Americans and poor white individuals through sales taxes—a pattern that persists today.
Throughout the 1920s, a Treasury Department led by the uber-wealthy Andrew Mellon presided over a reduction of taxes and the development of capital-friendly international tax rules, approved in due course by a Senate with minimal dissent and sometimes without oversight hearings. These actions instituted the transfer price system that prevails today, whereby corporations, in moving goods across borders, from say one subsidiary to another, pretend that they sell the good at “arms-length prices.”
When the Franklin D. Roosevelt administration proposed various measures to use the tax code to restrain executive compensation, disincentivize mergers, shrink firm size, and stop corporations from hoarding income, he often found that a strong House majority was not enough. After the Supreme Court struck down early New Deal policies, FDR proposed a bill to overhaul corporate taxes in order to achieve some of these objectives. Despite sailing through the House on a 267 to 93 vote, a mere nine Democratic senators (the majority from the South) defected—stopping the proposal dead.
And thus, unable to overcome the Senate, the 1920s Gilded Age rules are essentially still on the books today. Multiple generations of US policymakers then imposed similar strictures on the rest of the world through an expansive set of treaties and norms, as my forthcoming working paper with Martin Hearson shows.
So, what do we do about these tax rules—both the domestic and international? Check out my piece with Stiglitz and Zucman for ideas.
But here, let me just dwell on one point. Namely, would America’s history of racist legalism pose an insuperable hurdle here at home?
The short answer is, most of the reforms we propose could be done within existing constitutional constraints. There is, however, a debate about the wealth tax. While conservatives have claimed that a wealth tax will run up against constitutional strictures on direct taxation, legal scholar Bruce Ackerman has compellingly argued that changes to the Constitution are unnecessary. Under his reading, the Fourteenth Amendment severed not only the racist three-fifths compromise but also the strictures on taxation that went along with it. For him and other scholars, the Sixteenth Amendment, which allows income taxes, was a legally unnecessary political gambit by the Taft administration: Congress can and always could impose wealth taxes, financial transaction taxes, or nearly any other impost that they can conceive of.
Nonetheless, the conservative Roberts Court is unlikely to be sympathetic to that argument, and Mitch McConnell’s Senate is likely to see any of the ideas above as unthinkable, “full-bore socialism.”
The path forward is to pass the wealth tax, alongside other progressive measures, and pair it with judicial and institutional reforms to undo Senate Republicans’ hard-right court-packing after the Merrick Garland episode and overhaul the Senate itself. Ultimately, so long as our government has a structural counter-majoritarian bias, a pro-majority tax structure will be difficult to institute.