Colbeck Capital Management Takes A Brief Look at the History of Tax Reform

tax

When Benjamin Franklin said that nothing was certain in life but death and taxes, he was clearly correct. Taxes are a certainty almost wherever you live but particularly in the United States. From tossing tea into Boston Harbor to corporations sheltering billions in offshore accounts to avoid paying their share, America’s history with tax reform is as fascinating as it is tenuous.

An exploration of the complicated history of tax reform in the U.S. can give us a better understanding of how and where we find ourselves with taxation today.

Regressive Taxation and Social Justice

The origin story for taxation in the U.S. begins in the first century of the nation’s existence. During this period, the federal government relied on high tariffs, public land sales and sales taxes. One critical component of modern taxation was notably absent. Income taxes were not introduced until the Civil War, and at a rate of just 3%.

While Abraham Lincoln was a beloved leader, his position as the first president to impose a Federal Income Tax was significant throughout the country. Lincoln and Congress agreed to tax incomes that exceeded $800 annually.

Pervasive taxes would become normalized during this period in American life. Some of the most popular products that experienced heavy taxes included tobacco, rum and sugar. Citizens were required to keep an exhaustive and extensive list of their property and possession to satisfy new taxation requirements. This new and overbearing tax obligation would lead to the rise of William Jennings Bryan as a tax crusader.

Bryan stood up against income taxes in the late 1890s, objecting largely to excise taxes that targeted the poor. He made the argument that taxation at existing levels and requirements was akin to imprisonment. While his stance achieved popularity, Bryan fell short in his objective to implement a progressive income tax. The Supreme Court struck down Bryan’s efforts in 1895, silencing the matter for nearly two decades.

Mark Twain said of taxation in 1906, “I don’t know of a single foreign product that enters this country untaxed… except the answer to prayer.”

Taxes, Vietnam, and Inflation

As the years went by, the likelihood addressing gaps and inequities in taxation lessened. Progressive and conservative parties agreed that taxes were a hard sale to the American people. This became further exacerbated by America’s participation in both World War I and World War II. The U.S. would watch the marginal tax rate soar as high as 94% to fund wartime efforts, leading to more than 90% of the labor force submitting tax returns.

While taxes continued to rise, they retained a baseline level of support as personal income also increased. This net positive momentum came to an end in the 1970s by way of inflated oil prices, the inflated dollar, and the war in Vietnam. To make matters worse, Congress had been slowly but steadily grinding away the tax base, implementing loopholes that would give rise to a world of tax shelters.

The situation deteriorated so drastically that U.S. vacation spots began offering tax shelter seminars as part of vacation packages. Alan Murray, historian and editor for the Wall Street Journal, said of this phenomenon, “Skiers could drop by the seminars, fix a cocktail and watch a videotape telling them how to make tax shelter investments.”

As mass inflation careened out of control in the mid-to-late 1980s, more Americans were living below the poverty line. Simultaneously, the wealthiest earners in the country with annual incomes exceeding $250,000 paid less than 5% on their income taxes.

Ronald Reagan and Tax Reform

New Jersey Senator Bill Bradley and Merrill Lynch CEO Donald Regan united to champion the Tax Reform Act of 1986. As described on Colbeck Capital Management‘s Medium blog, the typically liberal-minded Bradley’s partnership with Regan’s conservative leaning policies made for an unlikely pairing.

Bradley had previously played professional basketball in the NBA. During that time, he was one of the highest-paid rookies in the league, earning him the nickname Dollar Bill. At the start of his rookie season, Bradley had an unforgettable experience when his attorney asked him, “How much do you want to pay in taxes?”

The question burst open the world of tax loopholes and evasion to Bradley, and he knew he wanted to do something about it. At the same time, Donald Regan established himself as a Wall Street companion and an anti-establishment conservative. Regan had wanted to take down the nation’s tax code for decades, an idea only popularized by the wolfish lobbyists blacking out the halls of Congress with their contributions.

Regan and Bradley approached a receptive President Ronald Reagan with what they termed BBLR, Broad Base, Low Rates. They had crafted a plan to cut the top tax rates down to 30% or potentially even lower. President Reagan liked the idea after experiencing high taxes during his career as a high-earning actor. He had famously declined work that would have raised his tax bracket, saying, “What good would it have done me?”

To accommodate the lower tax rates of BBLR, Reagan would have to go after deductions. Deductions for IRA deposits, charity, mortgage interest, auto loans and credit cards were seemingly gone with the scrawl of a pen. Loopholes were closed,deductions had vanished, but top-level earners were paying less than ever before.

The positive benefits promised by the BBLR model did not last long despite being lauded as one of the most ambitious tax reform efforts in the history of the nation. The attempt wasn’t ignored by international audiences as countries including Ireland and Canada were quick to follow suit.

What’s To Come?

It is highly unlikely that the United States can ever return to the BBLR model that Reagan originally popularized. The issue largely is that taxes comfortably shielded the welfare state from the eyes of everyday taxpayers. As it turns out, taxpayers would rather pay for welfare through hidden taxes than through the issuance of a benefit check.

As new discussions develop surrounding welfare and the government’s role, how the tax system reacts and adjusts will be fascinating to observe. One thing we do know for sure is that death and taxes will continue to plague us.

Colbeck

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The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.