While Andrew Mellon and presidents Warren G. Harding and Calvin Coolidge are rightly credited with proposing and shepherding through Congress tax reform legislation in the 1920s that radically reduced marginal tax rates on wealthy individuals from WW I highs, it is less well known that a similar change very likely would have occurred even under Democratic administrations. Basically, the Mellon plan was originally authored by former and holdover Treasury officials from the Wilson administration, who fully intended to formulate a permanent peacetime taxation system that would best serve a modern industrial society.
The income tax had constituted an insignificant source of revenue from its inception in 1913 through 1916, and only the unprecedented war expenditures enabled progressives to exploit a combination of antiwar and redistributionist sentiment to enact a significantly more confiscatory income tax. After the war, tax reform was all but inevitable – with two opposing forces committed to different tax systems. Some conservative Republicans hoped to roll back the income tax and relegate it to an inconsequential supplementary tax in a system dominated by tariffs and excises. Progressive elements in both parties sought to keep the income tax as redistributive as possible as a means of fighting moneyed privilege and of nationalizing what they perceived as excessive war profits.The Treasury Department’s team of tax policymakers, mostly culled from the ranks of Wall Street law firms and educated at the best universities, represented a third position. While committed to the principle of progressive taxation, they nevertheless were also fully committed to corporate capitalism. Their goal was to utilize economic analysis to arrive at a system of income tax rates that would yield a maximum of revenue with the least possible interference with business activity. Championed by Wilson’s assistant Treasury Secretary Russell C. Leffingwell and his protégé S. Parker Gilbert, they called their program scientific taxation. Secretary Mellon wholeheartedly endorsed the tax reform developed by Leffingwell and Gilbert, and he was identified with the program to such an extent by media and public alike that it came to be called the Mellon Plan. Still, Mellon insisted that “the Mellon Plan might better have been called the Treasury Plan, or, perhaps, the TaxReform Plan, because since 1919…one Democratic President and two Democratic Secretaries of the Treasury have offered Congress exactly the same recommendations that I suggested.”
The plan’s implication, explicitly stated in the following excerpt from the 1924 annual Treasury report, was that tax reduction was not the primary goal:
“Taxation should not be used as a field for socialistic experiment, or as a club to punish success, but as a means of raising revenue to support the Government…The purpose of taxation is to raise money, not only in the year in which it is assessed, but to leave the source from which the revenue is to be derived permanently unharmed, so that in the next year and in the years following, similar taxes will produce adequate revenue from this source… The enemies of the income tax are not those seeking to reduce its excessive rates but those who insist that the high taxes, which have proved economically incorrect, shall remain.”
Ultimately enacted in 1926, the Mellon plan completed the change from a nineteenth-century government revenue regime of national tariffs and state general property taxes to a twentieth-century regime dominated by an (originally) moderate national income tax. The intense debate pitted mostly rural, agrarian, Southern and mid-Western small-producer proponents of the old regime against urban, Eastern and industrial proponents of the new regime. Redistribution for its own sake was rejected, but moderate redistribution accepted as a tolerable side effect; for a while, the consensus held that it was acceptable for the rich to get richer as long as they invested their wealth in a socially beneficial way. While tax rates surged post-Mellon, and did not return to Mellon Plan levels until the 1980s, the basic structure and philosophical underpinnings of the tax system first articulated in the Mellon Plan enjoys public support to this day.
Based on and adapted from: M.Susan Murnane (2004): Selling Scientific Taxation: The Treasury Department’s Campaign for Tax Reform in the 1920s, Law & Social Inquiry,pp 819 – 854; and Lawrence L. Murray (1978): Bureaucracy and Bi-Partisanship in Taxation: The Mellon Plan Revisited, Business History Review 52 (2), 200-225.