The 1920s were a golden age for tax cuts. Three Republican presidents presided over three major tax reductions, much to the delight of both individual and corporate taxpayers. Most of those cuts came in the form of rate reductions, but lawmakers also eliminated one major levy (the excess profit tax) and dramatically narrowed another (the individual income tax).
The popular fascination with top bracket rates is certainly imperfect, but it can be illuminating. In 1918 the rate for the nation's wealthiest individual taxpayers had reached 77 percent. By 1929 it had fallen to 24 percent.
The size and scope of those tax cuts were a key GOP achievement. Not only did the party hold the reins of power at both ends of Pennsylvania Avenue, but it also provided the ideological and intellectual rationale for cutting taxes.
The 1920s tax cuts were really the handiwork of one man: Andrew Mellon, Treasury secretary from 1921 to 1932. The stern Pittsburgh banker was one of the nation's richest men, but he was a devoted public servant. And he believed the best service he could offer the country was a sweeping reduction in income tax rates.
A journalist once quipped that "three presidents served under Mellon," and the characterization is largely accurate. Mellon was the driving force in federal economic policy throughout the Republican ascendancy of the 1920s, and he was especially influential in the formation of tax policy. Indeed, he tutored the three GOP presidents of the era, and for the most part, they took his advice. But each had a different relationship with Mellon.
At the start of the decade, Warren Harding gave Mellon the Treasury spot and endorsed Mellon's drive for postwar tax cuts. But Harding never really shared Mellon's fervor for "scientific taxation," which was what Mellon called his program of carefully considered tax reform.
At the end of the GOP era, Herbert Hoover had a notably cool relationship with Mellon. In 1932 he eased the aging secretary out of his office at 1500 Pennsylvania Avenue and into the U.S. ambassador's residence in London.
Partners in Reform
Mellon's truest presidential partner was Calvin Coolidge. As Amity Shlaes reveals in her new biography of Silent Cal (Coolidge, 2013), Mellon and Coolidge shared a powerful bond around the subject of tax reform. "Mellon wanted more tax cuts, and Coolidge wanted to go along," Shlaes writes.
It's a simple statement but an illuminating one. Mellon and Coolidge were not close friends -- indeed, both were famous for being taciturn, even a bit chilly. "People said of the pair that they conversed in pauses," Shlaes writes. But they shared a common enthusiasm for tax cuts. Coolidge had come to the presidency with a natural inclination to cut taxes whenever possible. But Mellon taught him how and why to make those cuts.
Soon after taking office in the wake of Harding's death in 1923, Coolidge met with Mellon to discuss tax reform. The Treasury secretary described his ambitious plans, which Harding had endorsed but never really made a top priority. Coolidge, on the other hand, was quick to take an interest.
Revenues were running high, Mellon explained -- too high for the good of the country. But those revenues made short-term room for rate reduction, and Mellon believed that cuts were both politically possible and economically desirable.
Above all, Mellon wanted rate cuts, especially in the upper brackets. "This was not merely to favor the rich, as many said," notes Shlaes in her explication of Mellon's thinking. "The tax rate cuts at the top were designed to favor enterprise. If people got to keep more of their money, they would hire others."
In general terms, Coolidge was inclined to agree. "Coolidge believed higher taxes were wrong because they took away from men money that was their property," Shlaes writes. "He believed lower rates were good precisely because they encouraged enterprise, but also because they brought less money. Low rates starved the government beast."
That proto-Norquistian view suggests that Coolidge was not a supply-sider, at least not initially. He not only expected tax cuts to lose money; he supported them for exactly that reason.
By contrast, Mellon's version of scientific taxation called into question the notion that tax cuts would inevitably lead to lower revenues. In fact, Mellon explained to Coolidge that lower rates might actually produce more money for government coffers. "Most people simply stuck with their arithmetic," Shlaes writes in describing Mellon's thinking. "They took the new tax rate, multiplied it by the old number of sales, and reckoned their loss. Their arithmetic did not allow for the possibility of more sales."
That simplistic analysis was wrong, Mellon told Coolidge. He used a variety of metaphors to make his point, generally equating tax cuts with price reductions in the private sector. "Ford Motor Company had reduced the price of Model T's, yet was earning more money than it had before," Shlaes writes. "It was making up on volume what it lost in price." In Mellon's view, taxes worked the same way.
Mellon believed that well-designed tax cuts would encourage economic growth and produce an overall increase in revenue. That new money could then be used to retire a large share of the national debt, which in turn would cause interest rates to fall and private sector investment to rise. The new investment would eventually lead to more economic activity and even higher tax revenues. It was a virtuous cycle.
"All of these ideas, but especially the idea of growth that threw off extra tax revenues, were relatively new to Coolidge," Shlaes writes. But Mellon made it clear to the new president, and before long, Coolidge was offering Mellon-style arguments to Congress.
As their tax thinking converged, the partnership deepened. "Both men began to feel the bond," Shlaes writes. "In Mellon, Coolidge was finding the cabinet member who shared his moral outrage at expenditure. In Coolidge, Mellon was finding a skilled legislator who might help him realize an old dream. Others observed the strength of the connection."
Mellon's program for tax reform involved more than just rate reduction, and some of his ideas were distinctly progressive (in political if not necessarily mathematical terms). He sought to limit deductions for business losses, for instance. And he wanted to tax dividends and some other forms of capital income at higher rates than labor income. Those ideas were designed to appeal to Democrats and left-leaning Republicans (of which there were quite a few in Congress).
And Mellon wanted very much to eliminate the tax exemption for municipal bonds. For Mellon the sin of those bonds was twofold. First, they made for a lot of unfairness, as well-heeled taxpayers used the bonds to lower their tax bills. The exemption also distorted investment decisions, robbing industry of much-needed capital investment by channeling idle money in a particular -- and not necessarily useful -- direction.
The president had misgivings about some elements of the Mellon plan. "Coolidge was not sure he liked all of Mellon's ideas," Shlaes writes. "But he knew he liked Mellon." And the feeling was mutual. Mellon understood that Coolidge was serious about tax reform.
Shlaes goes on to recount the tortuous path of the 1924 tax bill. Almost every bill hits roadblocks and setbacks along its way to enactment. But that legislative odyssey was especially difficult, because Democrats were fighting Coolidge on many key issues. In particular, they repeatedly sought to focus tax reduction on the lower end of the income scale, chiefly by raising exemptions. To Mellon's way of thinking -- now shared by Coolidge -- that change in focus would diminish the salubrious effect of the entire law.
In fact, Mellon believed his virtuous cycle was in peril. If rates were not cut enough -- or in the right place -- then business would not boom, in which case the tax cuts might actually lose revenue, rather than increasing it. That, in turn, would make it harder to repay federal debt and would probably push interest rates up. Growth would slow. And perhaps worst of all, as Shlaes recounts Mellon's worries, "the people might get used to larger government."
When the tax bill finally made it to his desk, Coolidge was unhappy. It raised estate taxes and kept top income tax rates too high (in the 40 percent range for individuals). It left intact the exemption for municipal bonds. And in a particularly galling innovation, it provided that personal tax return information would be made a matter of public record.
Still, the bill had redeeming virtues. It cut rates substantially and seemed likely to leave most taxpayers with more of their own money. "That was, to Coolidge, a good thing," Shlaes writes. "It was always good for the government to take less."
Moreover, signing the bill would allow Coolidge to declare victory and live to fight another day. That was a major consideration, especially because Mellon and Coolidge were so closely aligned on the subject of tax reform. "In Mellon [Coolidge] had found the partner that Harding could not be: the partner with whom he could finish a job," Shlaes writes.
Coolidge decided to finish it the next year. He signed the bill but warned Congress that he and Mellon would be back. "A correction of its defects may be left to the next session of Congress," the president declared when signing the bill. "I trust a bill less political and more economic may be passed at that time. To that end I shall bend all my energies."
And he did.