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Tuesday, June 10, 2014

American Fiscal State-Building, Crisis, and Contingency



In his sweeping and sophisticated new book, Making the Modern American Fiscal State, Ajay Mehrotra takes on a transformation of profound and enduring importance: America’s shift from a tax regime that was relatively regressive and indirect (centered on the federal tariff) to one that is relatively progressive and direct (centered on the federal income tax).  Chapter 1 of the book sets the stage by introducing us to the old tax regime that prevailed as of the 1880s, especially the tariff.  Chapters 2 through 5 explain how the new regime first gained a foothold in American government -- in the spheres of intellectual discourse, law, and government institutional capacity.  At the end of Chapter 5, the year is 1915: the Sixteenth Amendment has been ratified, Congress has enacted an income tax targeted at the highest earners and corporations, and the Treasury Department has begun its collections, using the crucial administrative technology known as “stoppage-at-source” -- a crude early form of withholding.  We can, at this point in the story, recognize the essential features of our present regime.  Yet they exist only in embryo: the income tax itself is still tiny, with a top rate of 7%, accounting for only 8% of federal revenue (p. 352).  It takes the crisis of the First World War -- with its tremendous revenue demands -- to cause the federal income tax to grow from a mere embryo into the workhorse of the American state.  The Great War takes up Chapter 6, and it is the climax of Mehrotra’s story.  The income tax's top rate skyrockets to 77%, and it ends up providing most federal revenue (p. 300, 352).  The revolution is locked in: even in the putatively reactionary 1920s, as Mehrotra argues in his concluding Chapter 7, the top rate doesn’t go below 25% (more than triple the prewar figure), and the tax accounts for about 50% of federal revenue (p. 352). 

Yet despite the centrality of the WWI crisis to the transformation Mehrotra chronicles, he is keen to resist a simple functionalist account in which (to paraphrase Charles Tilly) the war makes the state.  As Mehrotra insists: “the wartime fiscal revolution was not merely a functionalist response to the need for revenue ....  The wartime tax regime embodied, instead, a complex continuation of the conceptual shift in public finance advanced by prewar progressive intellectuals and political leaders ....” (p. 295; see also pp. 22-25).  Mehrotra assigns great importance to this pre-crisis conceptual shift -- he devotes more than half the book to it (Chapter 2-5), in which he explains how reformers provided the income tax with a well-articulated economic and moral justification, a constitutional space, a legislative basis, and the beginnings of a bureaucratic apparatus. 

I think that Mehrotra’s rendering of this story reflects (or, at least, can be invoked to support) a certain theory of political development, one that I would like to discuss in this post. To do so, let me pose a counter-factual.  Say that WWI had occurred just ten years earlier.  Had the United States gone to war against Germany in 1907, rather than 1917, the prospect of ramping up the income tax to pay for the war would’ve looked very different.  It would’ve been constitutionally doubtful, would’ve demanded a much bigger leap in terms of new legislation, and would’ve required building a collection apparatus (e.g., stoppage at source) from scratch, rather than scaling-up a prototype.  Further, the intellectual justifications would’ve been less developed.  One can imagine that, in such circumstances, the U.S. government might’ve tried to finance the war by intensifying the old regressive regime, paying for the conflict with heightened tariffs, expanded excises, and borrowing.  This might’ve entrenched the old regime further and/or made the U.S. war effort less successful.  Alternatively (or in addition), the U.S. government might’ve tried an income tax, but it would’ve had to be “on the fly,” without the foundation-laying that Mehrotra emphasizes in Chapters 2-5.  That is, it would’ve been similar to what did in fact happen in 1917-18 with the War Industries Board, whose management of production and procurement was far less successful than the Treasury’s financing operations (and note the WIB didn’t survive once the crisis ended). 

That the income tax performed so well in WWI suggests that a comparatively small amount of pre-crisis institution-building -- consisting mostly of pre-organizational tasks like justifying the policy, carving out the constitutional space, and enacting the statute, plus a few initial organizational tasks like implementing stoppage-at-source on a small scale -- can go a long way in terms of intra-crisis (and post-crisis) operations.  

On this point, it’s illuminating to compare Mehrotra’s book with a classic study of crisis-driven American state-building, Theda Skocpol and Kenneth Finegold, “State Capacity and Economic Intervention in the Early New Deal,” Political Science Quarterly 97 (1982): 255-278, elaborated in their book, State and Party in America’s New Deal (Madison: Univ. of Wisconsin Press, 1995).  Focusing on the economic crisis of 1933, Skocpol and Finegold argue that the Agricultural Adjustment Act succeeded while the National Industrial Recovery Act failed because the AAA drew upon the mature, long-developed policy thinking and implementational knowhow of the U.S. Department of Agriculture, whereas the NRA had no mature state apparatus to rely upon.  Personally, I find Skocpol and Finegold’s account of these two programs compelling.  But their study is limited in what it can tell us, because their two cases are both so extreme.  NRA had zero pre-crisis institutional capacity, whereas the USDA was extraordinary in that regard, having built routinized and attractive career paths for its personnel over the preceding decades. 

The Treasury Department’s income-tax apparatus in WWI, as reconstructed by Mehrotra, presents an intermediate case: it had not enjoyed nearly as deep a process of maturation as USDA had by 1933, but neither was it forced to start from zero like NRA.  When it comes to institution-building, crisis is opportunity (to paraphrase Rahm Emanuel).  But laying the foundations for institutions -- even if these are largely intellectual or legal (i.e., merely “on paper”) -- may determine what kinds of opportunities the crisis presents. 

Seen in this light, the exact timing of WWI (determined by events exogenous to America and thus arbitrary from the American perspective) seems fortuitous and highly consequential for American political development.  Consistent with path-dependence theory (to which Mehrotra is sensitive, e.g., p. 354), major consequences arise from relatively small initial events and are to some degree random.  I’d like to hear what Mehrotra thinks of this reading.  How much is our present-day fiscal regime an accident of timing?  Had the Treasury Department’s progress not happened to be a few years ahead of the German U-boats, would we all be paying different taxes today?  

Posted by Nicholas Parrillo on June 10, 2014 at 11:23 AM in Books, Tax | Permalink


Nick -- How does Mehrotra address the role of Prohibitionists in pushing for income taxes? The best section of Dan Okrent's terrific book on Prohibition dealt with the way in which replacing the taxes from alcohol led prohibitionists (one of the nation's largest lobbying groups) to promote income taxes. Provides a non-contingent, interest-group story that fits the time frame that supplements the contingent one you describe above

Posted by: D.Schleicher | Jun 10, 2014 3:59:32 PM

David -- Interesting angle. On my reading, Mehrotra sees early prohibitionists as initially divided on the question of income taxes versus alcohol consumption taxes (pp. 74-75), since the excise on alcohol discouraged consumption yet provided revenue that rendered alcohol useful to policymakers and thus undermined the argument for prohibition. A great example of the ambiguous relationship that exists between a government and its revenue sources (adversarial or symbiotic?). Mehrotra also notes that, after the 18th amendment was ratified, observers in the 1920s viewed it as helping to entrench the income tax, since returning to the old alcohol-excise regime would require another constitutional amendment (p. 360).

Posted by: Nicholas Parrillo | Jun 16, 2014 11:42:01 AM

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