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Pepperdine University School of Law

Tuesday, January 24, 2006

Alstott & Novick on War and Taxes: the World War I Veterans’ Bonus and the Defeat of the Mellon Plan

Ssrn_logo_72Alstott_2 Anne L. Alstott (Yale) & Benjamin Z. Novick (Yale) have posted War and Taxes: the World War I Veterans’ Bonus and the Defeat of the Mellon Plan on SSRN.  Here is the abstract:

In the twentieth century, two world wars transformed the federal income tax. The impact of World War I on the development of federal taxation and social provision has been far less studied than the impact of World War I. Historians have ably documented the wartime tax crisis, but the First World War, like the Second, also made a lasting change in the tax system and in the size of the federal government: the federal budget remained four times higher in the Twenties than in the prewar period. And, strikingly, the new, larger postwar government continued to raise revenue primarily from progressive income taxes on the economic elite.

In this article, we trace two pathways by which World War I exerted a lingering influence on federal tax policy and tax politics in the 1920s.

The first link between the war and peacetime taxation looks to fiscal necessity: the cost of the war left the nation deeply in debt. The need to service the federal debt helped keep revenue needs high throughout the Twenties. Even Republicans acquiesced in an unprecedented level of peacetime taxation; ironically, their fiscal prudence helped transform the income tax into a permanent source of federal fiscal power.

The second link between World War I and federal taxation in the Twenties originated in the political battle over the nation’s obligations to veterans. In an episode that has been overlooked in histories of taxation, in 1924 the debate over adjusted compensation for servicemen (the veterans’ “bonus”) became intertwined with the controversy over Republican tax cuts. On one side, President Coolidge and Andrew Mellon, supported by East Coast business interests, advocated the so-called “Mellon Plan,” which featured reductions in taxes on the richest taxpayers, as well as (smaller) reductions for those of moderate incomes. On the other side, the veterans and their supporters urged a retroactive increase in soldiers’ pay in the form of a one-time bonus payment. Coolidge and Mellon insisted that the nation could not have both tax cuts and a bonus. But in a bitter defeat for a sitting President with a Congress controlled (at least nominally) by his own party, the Congress not only approved a bonus but mustered the 2/3 majority necessary to enact it over Coolidge’s veto.

The 1924 bonus bill created a $4 billion, 20-year entitlement program for the four-and-a-half million veterans of World War I that (in some respects) foreshadowed the GI Bill of the Forties. With fiscal forecasts showing that the bonus bill would bust the federal budget, the Congress proceeded to trim the tax reductions proposed in the Mellon Plan, enacting heavier taxes on the rich and smaller taxes on the middle class than the Administration had proposed.

Our account of the tax and bonus debates of 1924 illustrates the importance for tax history of looking beyond revenue legislation per se. The bonus was not legally bound up with the Mellon Plan, and none of the tax bills mention it. But the bonus was the big news in tax politics in 1924, and the tension between the Mellon Plan and the bonus was well-understood by both elites and the public. The Administration played a high-stakes game, declaring that success for the bonus would mean failure for the Mellon Plan. In the end, the veterans prevailed, and the Mellon Plan was defeated.

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