The number of people with taxable incomes of $300,000 a year and up -- equivalent to far more than a million dollars in today's money -- declined from more than a thousand people in 1916 to less than three hundred in 1921. Were the rich all going broke?
It might look that way. More than four-fifths of the total taxable income earned by people making $300,000 a year and up vanished into thin air. So did the tax revenues that the government hoped to collect with high tax rates on the top incomes.
What happened was no mystery to Secretary of the Treasury Andrew Mellon. He pointed out that vast amounts of money that might have been invested in the economy were instead being invested in tax-exempt securities, such as municipal bonds.
Secretary Mellon estimated that the amount of money invested in tax-exempt securities had nearly tripled in a decade. The amount of this money that the tax collector couldn't touch was larger than the federal government's annual budget and nearly half as large as the national debt. Big bucks went into hiding.
Mellon pointed out the absurdity of this situation: "It is incredible that a system of taxation which permits a man with an income of $1,000,000 a year to pay not one cent to the support of his Government should remain unaltered."
One of Mellon's first acts as Secretary of the Treasury was to ask Congress to end tax exemptions for municipal bonds and other securities. But Congress was not about to set off a political firestorm by doing that.
Mellon's Plan B was to cut the top income tax rate, in order to lure money out of tax-exempt securities and back into the economy, where increased economic activity would generate more tax revenue for the government. Congress also resisted this, using arguments that are virtually unchanged to this day, that these would just be "tax cuts for the rich."
What makes all this history so relevant today is that the same economic assumptions and political arguments which produced the absurdities of 1921 are still going strong in 2011.
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