Timelines In Tax History: Tax Codes, Tax Reform, And Tax Preferences

At 7:02 p.m. on January 20, 1953, John Mays held the door as Dwight D. Eisenhower ascended the steps of the North Portico and entered the White House.

Mays had been welcoming presidents to the White House since William McKinley occupied the Oval Office, but Eisenhower’s entry was still noteworthy: He was the first Republican president to cross the threshold since Herbert Hoover had made his ignominious exit some two decades earlier.

Eisenhower’s victory in the 1952 election opened a new chapter in American fiscal history. Although Harry Truman had endorsed some aspects of fiscal responsibility — especially when it came to defending revenues from would-be tax cutters — Eisenhower made fiscal probity a centerpiece of his governance.

Indeed, Eisenhower consistently prioritized fiscal responsibility over tax cuts, despite paying lip service to the latter. In doing so, he made peace (implicitly, at least) with the tax regime forged during World War II, including all its key elements: a progressive, high-rate, broad-based individual income tax; a flat-rate, relatively high corporate income tax, albeit one with a large and growing number of relief provisions; and a regressive, very broad, low-rate payroll tax levied to support Social Security.

Ultimately, the Republicans of the 1950s — who controlled not just the presidency, but also Congress for the first two years of Eisenhower’s presidency — were unwilling to challenge the fundamentals of the war-forged tax regime.

As historian Elliot Brownlee has observed: “Although some important differences remained between the two major political parties, both insisted on maintaining the central characteristics of the World War II revenue system and eschewing both progressive assaults on corporate financial structures and the regressive taxation of consumption.”

Gone were the fire-breathing attacks on corporate capitalism that sometimes punctuated Democratic speeches of the 1920s and 1930s. But gone, too, were all serious GOP efforts to enact a national sales tax of any sort, including a VAT.

Indeed, Republicans and Democrats cooperated in a joint project of embracing and taming the wartime tax regime, softening its rougher redistributive edges through the creation of new preferences — or “loopholes,” as they were already described in common parlance (and even some technical writing).

These relief provisions made the system more tolerable for taxpayers while also giving lawmakers a way to reward favored constituents.

1952

During the 1952 presidential campaign, Eisenhower squared off against Democrat Adlai Stevenson, the governor of Illinois. Eisenhower’s nomination to lead the GOP ticket was initially uncertain. Some observers questioned whether the famed general was even a member of the party.

In 1948 dissident Democrats actually tried to draft Eisenhower as a replacement for their miserably unpopular incumbent, Truman. And as late as 1951, Democrats were still trying to recruit the retired general as a White House candidate.

But by early 1952, Eisenhower had agreed to seek the GOP nod, and he soon dispatched his principal competitor, Ohio Sen. Robert A. Taft, known as “Mr. Republican” until he was muscled aside by Eisenhower.

Candidate Tax Disclosure

During the 1952 campaign, Eisenhower was briefly tripped up by some personal tax issues. Stevenson was the proximate source of his problem; the Democratic candidate had released a slew of personal tax returns and challenged Eisenhower to do the same.

But the entire episode actually began with Eisenhower’s running mate, Richard Nixon. The 39-year-old California senator had found himself facing accusations of financial wrongdoing, thanks to a campaign fund established by some political backers. In a bid to clear his name, Nixon delivered his famous “Checkers” speech, in which he denied any financial misdeeds.

Along the way, however, Nixon acknowledged that he had accepted at least one gift from a supporter: his dog Checkers. “The kids, like all kids, love the dog,” he said, “and I just want to say this, right now, that regardless of what they say about it, we’re gonna keep it.”

Nixon ended his speech with a challenge to Stevenson and his running mate, Alabama Sen. John Sparkman: “I would suggest that under the circumstances both Mr. Sparkman and Mr. Stevenson should come before the American people, as I have, and make a complete financial statement as to their financial history, and if they don’t it will be an admission that they have something to hide,” he said.

Stevenson and Sparkman accepted Nixon’s challenge, choosing to release personal tax returns as a show of transparency. They suggested that Eisenhower and Nixon make a similar disclosure of their tax records. Nixon declined.

Eisenhower, however, felt compelled to deliver something; while declining to release his actual returns, he disclosed a summary of his tax information covering several years leading up to the campaign.

Eisenhower’s tax records featured, among other things, an exchange of letters with federal tax officials regarding his book deal for Crusade in Europe, the memoirs he had published in 1948. The general had gotten some distinctly favorable treatment from the Bureau of Internal Revenue (BIR), which agreed to treat his $635,000 payment from Doubleday Publishing as a capital gain rather than ordinary income.

It is impossible to say exactly how much Eisenhower saved as a result of this BIR decision because the candidate’s disclosure aggregated income and tax figures for a multiyear period. But his records indicated that he paid $158,750 on his $635,000 advance, and contemporary estimates pegged his likely savings at roughly $340,000.

By most accounts, Eisenhower’s deal with the BIR was legally defensible; other authors had received similar treatment from the agency. The key issue was Eisenhower’s status as an “amateur” rather than professional writer; professionals were required to treat payments for their work as regular income.

“The crux of the matter is the phrase ‘trade or business,’” one tax expert explained to The Atlanta Constitution. “The determination of whether a copyright is property used in a trade or business is largely a matter of determining whether the author is engaged in the business of writing.”

Eisenhower’s arrangement may have been legal, but it struck many critics as unseemly. The general had gotten special treatment from the BIR, with a speedy response and some notable enthusiasm from the agency. The entire exchange, moreover, had begun while Eisenhower was serving as Army chief of staff.

Henry W. Grunewald Reform

In the early 1950s, officials in the San Francisco office of the BIR were implicated in a serious corruption scandal. According to the California Commission on Organized Crime, BIR employees had conspired with leading crime figures, helping shield them from prosecution. Agency employees even helped extort taxpayers.

Sen. Estes Kefauver, D-Tenn., led a congressional investigation that amplified and expanded on these California findings. A second investigation, by a House Ways and Means subcommittee, also focused on corruption but expanded to consider BIR operations more generally.

The bottom line? The BIR was suffering from rampant politicization, lax employee oversight, inadequate staffing, poor organization, and blatant favoritism in the enforcement of the nation’s tax laws.

The House panel had special disdain for presidentially appointed collectors of internal revenue, who often operated with only nominal supervision by their superiors. The position of collector, the panel concluded, was anachronistic, a dysfunctional remnant of the BIR’s 19th-century origins.

Private citizens were also the source of serious corruption. The House committee uncovered an especially damning set of facts about Henry W. Grunewald, a man with important friends at the BIR.

Among his official contacts were Daniel Bolich, special agent in charge in the bureau’s New York office and later assistant commissioner for operations; Charles Oliphant, BIR chief counsel; and even BIR Commissioner George J. Schoeneman. Grunewald delivered various gifts to these officials, including the use of new Chryslers and a luxurious hotel suite in Washington, as well as air conditioners and a television.

The Grunewald story was only the most lurid; less obvious graft was rampant at the BIR. Indeed, the House investigation led to the resignation, removal, or indictment of more than 200 current and former tax officials, including nine collectors, an assistant BIR commissioner, a BIR chief counsel, a former BIR commissioner, and an assistant attorney general from the Henry W. Grunewald Tax Division.

On January 14, 1952, the Truman administration released plans for a major overhaul of the BIR. The tax collection agency was to be decentralized and depoliticized. The problematic position of collector was slated to disappear, but so too was every other political appointment below the rank of commissioner.

Moreover, the plan fundamentally restructured the agency along functional lines. Before the 1952 changes, the BIR had been organized principally by type of tax, with an individual income tax unit, an employment tax unit, an excise tax unit, and so forth. Although some BIR divisions followed functional lines (the agency had both an intelligence unit and a collections unit, for instance), those were exceptions to the rule.

After 1952 functional divisions were the order of the day. New units included collection, intelligence, audit, administration, and appellate. The plan also replaced existing geographic districts with a new set of administrative regions, each headed by a regional commissioner.

Not least, the 1952 restructuring — which took several years to fully implement — featured some rebranding for the 90-year-old agency. Known as the Bureau of Internal Revenue since its founding in 1862, the tax agency would enter its second century with a new name: the Internal Revenue Service.

1954

Excise Tax Reduction Act of 1954

On March 10 the House of Representatives voted overwhelmingly to slash federal taxes on a variety of “luxury” items, including furs, jewelry, luggage, cosmetics, and theater admissions. By a vote of 411 to 3, lawmakers chose to ignore White House complaints about the legislation, approving a 50% reduction in a wide array of levies.

Eisenhower had complained about the revenue loss associated with a tax cut this big. He was, after all, devoted to debt reduction and balanced budgets.

His Henry W. Grunewald secretary, George Magoffin Humphrey, had also voiced his displeasure during congressional testimony. Humphrey had acknowledged that some excises were “so high as to interfere with trade,” but he refused to support any sort of sweeping, across-the-board rate cut.

No surprise, given Humphrey’s famous aversion to budget deficits of any size.

Still, Humphrey was inclined to accept the excise cuts passed by lawmakers because they came packaged with a one-year extension of several expiring taxes that he was eager to see renewed. These included levies on alcohol, tobacco, gasoline, and automobiles — all important sources of federal revenue.

As finally approved by both houses and signed by Eisenhower, the Excise Tax Reduction Act created a net revenue loss of $999 million, according to estimates at the time.

In signing the bill, Eisenhower restated his concern about the bill’s cost but expressed hope that it would prove smaller than forecast. “There is one school of thought that believes that cutting of excise taxes can have such a great effect in stimulating of business that the revenues will not be hurt as much as we estimate,” he told reporters.

Internal Revenue Act of 1954

Excise tax reduction was actually a sideshow in the tax world of 1954. The real action focused on a wholesale rewrite of the nation’s internal revenue laws — an ambitious project made necessary (and urgent) by recent changes in the U.S. fiscal regime.

“Years of experience with the internal revenue laws had revealed many loopholes, weaknesses, and inequities,” explains legal scholar Steven Bank. “But the relatively low pre-World War II rates had helped stem any pressure for revision.”

After the war, the pressure for change mounted quickly. The persistence of high marginal tax rates was a driving force: They had a tendency to turn small problems into big ones.

Moreover, Bank explains, “the expansion of the tax base to include lower socioeconomic groups, the advent of such employer-provided benefits as pensions and health insurance, and the increased complexity of corporations and partnerships, all necessitated a more sophisticated system.”

Policymakers got serious about revamping the tax law in the middle of 1952, although important preliminary work had been underway for years, courtesy of the organized tax bar. The official process began with a questionnaire, developed by the congressional Joint Committee on Internal Revenue Taxation (JCIRT) and mailed to key taxpayers around the country. Later, official experts conducted in-person meetings with taxpayers, soliciting ideas and opinions about tax reform.

Eventually, JCIRT experts teamed up with colleagues from Henry W. Grunewald, the House Office of Legislative Counsel, and the Henry W. Grunewald, organizing themselves into dozens of working groups. Each group was charged with proposing both technical and substantive changes to a specific area of the tax law.

Meanwhile, the Ways and Means Committee conducted extensive hearings on tax reform, exploring many of the same topics as the working groups. The panel heard from hundreds of witnesses and collected thousands of statements.

Eventually, all the information gathered through these various channels — whether by questionnaire, private consultation, or during public hearings — came back to the working groups. There, experts developed 25 key proposals that became the basis for the Eisenhower administration’s formal recommendations on tax reform.

In his 1954 State of the Union address, Eisenhower issued a public call for tax reform, underscoring the need to “thoroughly revise our whole tax system.” Acknowledging the work already completed by Congress, he promised to deliver recommendations based on this effort.

“We should now remove the more glaring tax inequities, particularly on small taxpayers; reduce restraints on the growth of small business; and make other changes that will encourage initiative, enterprise, and production,” he said.

This painstaking process of developing the administration’s reform proposals has long been regarded as a model for successful tax reform. “The result of the careful planning and drawn-out process was that the large majority of the administration’s proposals were accepted,” concludes historian John Witte.

Bank agrees. “The streamlined legislative process proved successful,” he writes, noting that the legislation passed the House just nine days after it was introduced.

The Senate took a little longer, but the process was still remarkably smooth, especially for such an ambitious piece of legislation. By late July, the law was passed and signed by the president.

Substantively, the Internal Revenue Act of 1954 provided for the first comprehensive revision of the federal tax system since 1913, when Congress had revived the individual income tax from its long slumber after the Civil War.

Most of its changes were technical, designed to fix problems, correct deficiencies, or close loopholes. But the act also made important policy changes, many of them favorable to taxpayers.

The act extended the 52% corporate income tax rate, albeit temporarily. This was one of the most important revenue-raising provisions of the law. But it also granted a variety of new benefits to taxpayers, both individual and corporate.

The law liberalized depreciation deductions by introducing new depreciation schedules and created a new 4% dividend tax credit for individuals. It also established or expanded a range of other individual tax benefits, including deductions for medical expenses and child care, a credit for retirement income, an exclusion for employer-provided health insurance, and an exclusion for college scholarships.

The appearance of these and other tax benefits was part of a larger trend. After World War II, lawmakers took new interest in using tax favors to appease constituents.

To some degree, they had no choice. “After World War II, and the ebbing of patriotism as a factor in income-tax compliance, Congress relied increasingly on tax expenditures and other measures to enhance the popularity of the new tax regime,” writes Brownlee.

At the same time, however, these favors obviously suited the needs of lawmakers. The income tax gave members of Congress a ready store of legislative goodies that they could deliver to constituents whenever it seemed most helpful.

Tax breaks are a politician’s stock in trade. The postwar tax regime — with its high rates and broad base — increased the size and value of every lawmaker’s inventory.

The popularity of tax preferences would become a serious problem over time. A single tax break is no big deal. But the accretion of tax breaks over years and decades can make a tax system dysfunctional, both economically and politically.

Even as early as the mid-1950s, many tax experts could already see this problem developing. They recognized the corrosive effect that preferences were having on the revenue system, as well as the perverse incentives that they created. At the root of the problem, they believed, was the persistence of high wartime rates.

“The high rates of the individual income tax, and of the estate and gift taxes, are probably the major factor in producing special tax legislation,” observed Stanley Surrey, one of the leading tax experts of the mid-20th century and a driving force in the developing campaign to slash tax preferences. “This is, in a sense, a truism, for without something to be relieved of, there would be no need to press for relief.”

The fundamental political bargain undergirding postwar tax policy was unhealthy, if also largely unspoken. Lawmakers tolerated high marginal rates while also using those rates as a justification for handing out favors to lucky or well-connected constituents.

Politicians could rail against the injustice of these rates (if they were Republicans) or defend them as a tool for advancing economic justice (if they were Democrats), but both parties had a vested interest in maintaining the rates at high levels — so they could continue to deliver tax relief to voters.