Monday, August 15, 2011

A Gilded Age lesson about the Flat Tax

I was sitting at dinner with my family the other night and the I overheard a discussion about the flat tax at the next table. My mind drifted back to another era, the Gilded Age and the contentious issue of the tariff.

In the presidential election of 1880, the Democratic candidate, General Winfield Scott Hancock, uttered a gaffe when he called the tariff a local issue. Republican opponents seized on this statement as an example of the General's obvious ignorance in economic policies. How, they asked, could the the trade policy that drove the national economy, contributed so much to the federal coffers, and protected the jobs of millions of workers be remotely considered local? Well Hancock might not have been clear in his meaning, but the historian can see much accuracy in his statement. The tariff was the sum of many rates on thousands of items, which was the product of political deals to that often had the goal of satisfying local constituencies. In other words, no matter how much the Democrats of Louisiana supported a tariff on principle - as sound Democrats were expected to do - they inevitably opposed lowering the rates on sugar imports from the Caribbean or the Philippines out of fear it would damage their local economies. In other words, local political considerations trumped ideals.

The tariff, however, did not exist in a vacuum. As American industry grew in the late 1880s and early 1890s a new economic concern developed. Instead of fearing competition from cheap markets, American industries had so dominated the home market, that they became troubled by the idea that would build up an excess of product they could not sell. They not only feared the loss of revenue and economic decline from a shut down, but also the attendant social unrest, especially after the Haymarket Square riot of 1886. Moreover, they were concerned about another type of surplus, too much money in the federal treasury. In a deflationary period, having money collecting dust in a federal vault was a net loss to the economy.

To deal with this the Republicans came up with one novel idea and one not so new one. The novel idea was to reform the tariff to include a reciprocity agreement clause. This would allow the president to negotiate trade deals outside the normal tariff rules. It was you scratch my back and I will scratch yours kind of arrangement. I always considered this a really clever way of dealing with a real policy conundrum. How to keep a protectionist tariff (increasingly sold as a jobs saving measure) and lower the rates at the same time? Reciprocity provided the answer. At the same time, the McKinley Tariff of 1890 (named after then Congressman and future president William McKinley) lowered or eliminated rates on consumer items to reduce the surplus. Exports significantly increased as President Benjamin Harrison negotiated agreements with other countries to exchange specific items at lower rates. The less novel approach was the old fashion idea of lets eliminate the surplus by spending it. In this case, increasing payments to Civil War pensioners and the Sherman Silver Purchase Act that had the United States government purchasing nearly all the silver mined in the country. How is that for a subsidy! Such lavish spending earned the 51st Congress the sobriquet, the Billion Dollar Congress.

After having let the Republicans take a whack at the problem of surplus, the public turned to the Democrats. Grover Cleveland, elected in 1892, then entered one of the most miserable terms of office experienced by any president, as the economy crashed within months of his having taken office. Cleveland lowered spending, by eliminating the Sherman Silver Purchase Act, and attempted a tariff reform. His proposal called for replacing revenue lost from general rate reductions with an income tax. Congress, however, proved incapable of producing the reform he demanded. Instead, it was a case of each member of Congress protecting the interest of their district. Cleveland was disgusted, but there was little he could do. In the end the Wilson-Gorman Tariff became law without the president's signature.

Why did a nearby discussion on the flat tax make me think of the tariff as an issue over one hundred and twenty years prior? I think it is because of the one striking similarity between today's tax code and the tariff of those days. It is no coincidence that as the tariff faded away the income tax replaced it. Not only as the government's source of revenue, but also as one of the chief means in which lawmakers can encourage local businesses. Instead of raising the rates on their foreign competitors, we give them a tax break as an incentive. I am little bit more of a loss to explain how the tariff was used to encourage people to engage in certain behaviors, in the way that the current tax code promotes home ownership and higher education, and, for whatever reason, corporate jets, but I might think of one if I was not so tired at the moment :-)

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