Chapter 1 of Taxation: The People’s Business
By: Treasury Secretary Andrew Mellon
New York, The Macmillan Company, April 1924
Chapter 1: Fundamental Principles
The problem of the Government is to fix rates which will bring in a maximum amount of revenue to the Treasury and at the same time bear not too heavily on the taxpayer or on business enterprises. A sound tax policy must take into consideration three factors. It must produce sufficient revenue for the Government; it must lessen, so far as possible, the burden of taxation on those least able to bear it; and it must also remove those influences which might retard the continued steady development of business and industry on which, in the last analysis, so much of our prosperity depends. Furthermore, a permanent tax system should be designed not merely for one or two years nor for the effect it may have on any given class of taxpayers, but should be worked out with regard to conditions over a long period and with a view to its ultimate effect on the prosperity of the country as a whole.
These are the principles on which the Treasury’s tax policy is based, and any revision of taxes which ignores these fundamental principles will prove merely a makeshift and must eventually be replaced by a system based on economic, rather than political, considerations.
There is no reason why the question of taxation should not be approached from a non-partisan and business viewpoint. In recent years, in any discussion of tax revision, the question which has caused most controversy is the proposed reduction of the surtaxes. Yet recommendations for such reductions have not been confined to either Republican or Democratic administrations. My own recommendations on this subject were in line with similar ones made by Secretaries Houston and Glass, both of whom served under a Democratic President. Tax revision should never be made the football either of partisan or class politics but should be worked out by those who have made a careful study of the subject in its larger aspects and are prepared to recommend the course which, in the end, will prove for the country’s best interest.
I have never viewed taxation as a means of rewarding one class of taxpayers or punishing another. If such a point of view ever controls our public policy, the traditions of freedom, justice and equality of opportunity, which are the distinguishing characteristics of our American civilization, will have disappeared and in their place we shall have class legislation with all its attendant evils. The man who seeks to perpetuate prejudice and class hatred is doing America an ill service. In attempting to promote or to defeat legislation by arraying one class of taxpayers against another, he shows a complete misconception of those principles of equality on which the country was founded. Any man of energy and initiative in this country can get what he wants out of life. But when that initiative is crippled by legislation or by a tax system which denies him the right to receive a reasonable share of his earnings, then he will no longer exert himself and the country will be deprived of the energy on which its continued greatness depends.
This condition has already begun to make itself felt as a result of the present unsound basis of taxation. The existing tax system is an inheritance from the war. During that time the highest taxes ever levied by any country were borne uncomplainingly by the American people for the purpose of defraying the unusual and ever-increasing expenses incident to the successful conduct of a great war. Normal tax rates were increased, and a system of surtaxes was evolved in order to make the man of large income pay more proportionately than the smaller taxpayer. If he had twice as much income, he paid not twice, but three or four times as much tax. For a short time the surtaxes yielded a large revenue. But since the close of the war people have come to look upon them as a business expense and have treated them accordingly by avoiding payment as much as possible. The history of taxation shows that taxes which are inherently excessive are not paid. The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business and invest it in tax-exempt securities or to find other lawful methods of avoiding the realization of taxable income. The result is that the sources of taxation are drying up; wealth is failing to carry its share of the tax burden; and capital is being diverted into channels which yield neither revenue to the Government nor profit to the people.
Before the period of the war, taxes as high as those now in effect would have been thought fantastic and impossible of payment. As a result of the patriotic desire of the people to contribute to the limit to the successful prosecution of the war, high taxes were assessed and ungrudgingly paid. Upon the conclusion of peace and the gradual removal of war-time conditions of business, the opportunity is presented to Congress to make the tax structure of the United States conform more closely to normal conditions and to remove the inequalities in that structure which directly injure our prosperity and cause strains upon our economic fabric. There is no question of the fact that if the country is to go forward in the future as it has in the past, we must make sure that all retarding influences are removed.
Adam Smith, in his great work, “Wealth of Nations,” laid down as the first maxim of taxation that ”The subjects of every state ought to contribute toward the support of the Government, as nearly as possible, in proportion to their respective abilities,” and in his fourth and last maxim, that “Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state,” citing as one of the ways by which this last maxim is violated a tax which “may obstruct the industry of the people, and discourage them from applying to certain branches of business which might give maintenance and employment to great multitudes …. While it obliges the people to pay, it may thus diminish, or perhaps destroy, some of the funds, which might enable them more easily to do so.”
The further experience of one hundred and fifty years since this was written has emphasized the truth of these maxims, but those who argue against a reduction of surtaxes to more nearly peace-time figures cite only the first maxim, and ignore the fourth. The principle that a man should pay taxes in accordance with his “ability to pay” is sound but, like all other general statements, has its practical limitations and qualifications, and when, as a result of an excessive or unsound basis of taxation, it becomes evident that the source of taxation is drying up and wealth is being diverted into unproductive channels, yielding neither revenue to the Government nor profit to the people, then it is time to readjust our basis of taxation upon sound principles.
It seems difficult for some to understand that high rates of taxation do not necessarily mean large revenue to the Government, and that more revenue may often be obtained by lower rates. There was an old saying that a railroad freight rate should be “what the traffic will bear”; that is, the highest rate at which the largest quantity of freight would move. The same rule applies to all private businesses. If a price is fixed too high, sales drop off and with them profits; if a price is fixed too low, sales may increase, but again profits decline. The most outstanding recent example of this principle is the sales policy of the Ford Motor Car Company. Does any one question that Mr. Ford has made more money by reducing the price of his car and increasing his sales than he would have made by maintaining a high price and a greater profit per car, but selling less cars? The Government is just a business, and can and should be run on business principles.
Experience has shown that the present high rates of surtax are bringing in each year progressively less revenue to the Government. This means that the price is too high to the large taxpayer and he is avoiding a taxable income by the many ways which are available to him. What rates will bring in the largest revenue to the Government experience has not yet developed, but it is estimated that by cutting the surtaxes in half, the Government, when the full effect of the reduction is felt, will receive more revenue from the owners of large incomes at the lower rates of tax than it would have received at the higher rates. This is simply an application of the same business principle referred to above, just as Mr. Ford makes more money out of pricing his cars at $380 than at $3,000.
Looking at the subject, therefore, solely from the standpoint of Government revenues, lower surtax rates are essential. If we consider, however, the far more important subject of the effect of the present high surtax rates on the development and prosperity of our country, then the necessity for a change is more apparent. The most noteworthy characteristic of the American people is their initiative. It is this spirit which has developed America, and it was the same spirit in our soldiers which made our armies successful abroad. If the spirit of business adventure is killed, this country will cease to hold the foremost position in the world. And yet it is this very spirit which excessive surtaxes are now destroying. Any one at all in touch with affairs knows of his own knowledge of buildings which have not been built, of businesses which have not been started, and of new projects which have been abandoned, all for the one reason–high surtaxes. If failure attends, the loss is borne exclusively by the adventurer, but if success ensues, the Government takes more than half of the profits. People argue the risk is not worth the return.
With the open invitation to all men who have wealth to be relieved from taxation by the simple expedient of investing in the more than $12,000,000,000 of tax-exempt securities now available, and which would be unaffected by any Constitutional amendment, the rich need not pay taxes. We violate Adam Smith’s first maxim. Where these high surtaxes do bear, is not on the man who has acquired and holds available wealth, but on the man who, through his own initiative, is making wealth. The idle man is relieved; the producer is penalized. We violate the fourth maxim. We do not reach the people in proportion to their ability to pay and we destroy the initiative which produces the wealth in which the whole country should share, and which is the source of revenue to the Government.
In considering any reduction the Government must always be assured that taxes will not be so far reduced as to deprive the Treasury of sufficient revenue with which properly to run its business with the manifold activities now a part of the Federal Government and to take care of the public debt. Tax reduction must come out of surplus revenue. In determining the amount of surplus available these factors control: the revenue remaining the same, an increase in expenditures reduces the surplus, and expenditures remaining the same, anything which reduces the revenue reduces the surplus. The reaction, therefore, of the authorization of extraordinary or unsound expenditures is twofold–it serves, first, to raise the expenditures and so narrow the margin of available surplus; and, second, to decrease further or obliterate entirely this margin by a reduction of the Treasury’s revenues through the disturbance of general business, which is promptly reflected in the country’s income. On the other hand, a decrease of taxes causes an inspiration to trade and commerce which increases the prosperity of the country so that the revenues of the Government, even on a lower basis of tax, are increased. Taxation can be reduced to a point apparently in excess of the estimated surplus, be- cause by the cumulative effect of such reduction, expenses remaining the same, a greater revenue is obtained.
High taxation, even if levied upon an economic basis, affects the prosperity of the country, because in its ultimate analysis the burden of all taxes rests only in part upon the individual or property taxed. It is largely borne by the ultimate consumer. High taxation means a high price level and high cost of living. A reduction in taxes, therefore, results not only in an immediate saving to the individual or property directly affected, but an ultimate saving to all people in the country. It can safely be said, that a reduction in the income tax reduces expenses not only of the income taxpayers but of the entire 110,000,000 people in the United States. It is for this basic reason that the present question of tax reform is not how much each individual taxpayer reduces his direct contribution, although this, of course, is a powerful influence upon the individual affected; the real problem to determine is what plan results in the least burden to the people and the most revenue to the Government.