These days, observers seem reasonably confident that the Supreme Court will choose prudence over politics when it finally issues a decision in Moore v. United States, No. 22-800. That’s reassuring, given the case’s potential to upend the federal tax system.
But as Reuven Avi-Yonah recently pointed out, Moore might still cause problems, even if the justices sidestep the most contentious issue: Does the Constitution require income to be realized before it can be taxed? (Prior analysis: Tax Notes Federal, Feb. 12, 2024, p. 1269.)
“The reason the Court took the case is because a holding that realization is constitutionally required would prevent Congress from enacting a mark-to-market tax on billionaires,” Avi-Yonah contends in a column for Tax Notes. Even if the Court avoids the realization issue by opting for a relatively narrow ruling, the decision could still raise questions about the constitutionality of any sort of wealth tax.
But complicating the passage of a wealth tax is probably not that big a deal. To begin with, the tax is already a political non-starter, given public opposition to levies on unrealized income. And more important, a mark-to-market tax on billionaires won’t do much to cure the malady that worries so many progressives: inequality.
Avi-Yonah describes a wealth tax as “more a matter of politics than of tax policy.” And he is entirely right. But framing the issue in those terms can obscure the undeniable importance of politics, especially when it comes to tax policy. Avi-Yonah may be simultaneously overestimating public antipathy to a wealth tax and underestimating the importance of such a tax to advancing something that he wants: a VAT.
Were he alive today, I think Franklin Roosevelt would agree.
FDR and Sales Taxation
First, let’s be clear about one thing: Roosevelt hated general sales taxes, and he would certainly have hated a VAT if such a thing had really existed in the 1930s (outside the pages of economic journals).
Roosevelt didn’t hate all taxes on consumption; he was notably enthusiastic about many excises, including regressive levies on items of mass consumption. In fact, excises provided roughly 40 percent of federal revenue through the first third of FDR’s presidency, eclipsing receipts from individual and corporate income taxes until 1937.
FDR’s enthusiasm for excises was relatively easy to defend when it came to sin taxes on alcohol and tobacco. Such levies could be justified with dubious (but plausible) arguments about moral betterment and public health.
But FDR also supported, or at least tolerated, a wide range of other excises that were pretty much impossible to justify in terms of equity or fairness. The federal tax system of the 1930s imposed levies on entertainment admissions, cameras, checks, telegraph and telephone messages, electric fans, firearms, furs, butter, candles, coffee, flour, hats, matches, and milk.
And much, much more.
FDR’s tax advisers wanted most of these excises repealed, and they told him so repeatedly. “On the whole,” intoned one 1934 Treasury study, “they do not form a desirable part of a fiscal system in normal times.”
But the 1930s were not normal times. Almost by definition, government revenue is in chronically short supply. Even when it’s growing, spending typically grows at least as fast. Scarcity, in other words, is the name of the game when it comes to tax revenue.
But revenue was in especially short supply during Roosevelt’s presidency, especially during the painful years of the Great Depression. The economic crisis suppressed revenues across the board, but especially from two of the tax system’s most progressive components: individual and corporate income taxes.
And of course, the 1930s were also a period of extraordinary government expenditure. As Roosevelt attempted to relieve economic suffering and jump-start a moribund economy, he spent money like it was water.
In that context, repealing excise taxes — or any taxes, for that matter — was simply a pipe dream. In theory, of course, revenue from absent excises could have been replaced with money from more progressive alternatives, like the income tax. And many progressives outside the Roosevelt administration urged the president to engineer such a replacement.
In particular, progressives like Wisconsin Sen. Robert LaFolette Jr. insisted that middle-class Americans should be asked to pay income taxes. The resulting revenue could then be used to pay for excise tax repeal — which might mitigate the political hit from broader income taxes.
Those were fine plans, endorsed by most New Deal economists. But they were also grand plans, requiring careful thought and lots of preparation. And one thing New Dealers didn’t have during the 1930s (in addition to extra tax revenue) was time. The Depression demanded immediate solutions, not revenue revisions that would take years to work themselves out.
Surging deficits only added to the sense of urgency. Between 1931 and 1934, the deficit as a share of GDP rose from 0.5 percent to 5.8 percent.
Faced with such exigent realities, Roosevelt and his advisers decided to tolerate the continuing burden of federal excise levies. Regressive consumption taxes were a necessary evil.
FDR’s Other Regressive Tax
But you know what wasn’t necessary? Regressive payroll taxes.
Yet Roosevelt championed these levies, too. Unlike the situation with excises, he wasn’t driven by a lack of options. Roosevelt chose to deliberately, forcefully, and repeatedly put payroll taxes at the center of his new Social Security program.
On the surface, Roosevelt’s insistence was puzzling. Other countries trying to fund public pensions relied at least partially on general revenues, which tended to be more progressive than flat rate payroll taxes. This fact has left historians puzzled, sometimes even outraged.
“The law was an astonishingly inept and conservative piece of legislation,” observed historian William Leuchtenburg in Franklin D. Roosevelt and the New Deal: 1932-1940. “In no other welfare system in the world did the state shirk all responsibility for old-age indigency and insist that funds be taken out of the current earnings of workers.”
FDR’s own advisers urged him to consider progressive alternatives to the payroll tax. As historian Mark Leff pointed out in “Taxing the ‘Forgotten Man’: The Politics of Social Security Finance in the New Deal,” Harry Hopkins, a close presidential adviser and leader of the administration’s relief efforts, urged Roosevelt to rely on general revenues, which would shift more of the burden to wealthy income taxpayers. So too did Rexford Tugwell, a charter member of the “Brain Trust” that helped shape so much of the New Deal.
But Roosevelt shut down serious consideration of alternatives. “I believe that the funds necessary to provide this insurance should be raised by contribution rather than by an increase in general taxation,” he told Congress in June 1934. He told his own advisers much the same thing when they began drafting a plan; the new program, he declared, “must be self-supporting, without subsidies from general tax sources.”
Those same advisers eventually defied Roosevelt, presenting him with a financing scheme that relied on payroll taxes initially but made room for general revenues down the road (when shortfalls were projected to appear). Roosevelt was unimpressed by their creativity, not to mention their disobedience. One day before he was slated to release the plan publicly, he instructed his advisers to scrap their funding plan and replace it with a payroll tax.
In his article, Leff recounted FDR’s exchange with Frances Perkins, who helped lead the team drafting the Social Security proposal:
The government subsidy, he told her, bordered on immorality. By loosening the tie between the amount contributed and the retirement benefits received, it foisted an accumulated deficit on future congresses and transformed the pension into “the same old dole under another name,” he complained.
Roosevelt got his way, both from his advisers and from Congress. He later insisted that his victory on this point was crucial to the program’s long-term survival. When challenged by a payroll tax critic in 1941, he explained his thinking.
“I guess you’re right on the economics, but those taxes were never a problem of economics,” he explained to Luther Gulick, a prominent social scientist. “They are politics all the way through. We put those payroll contributions there so as to give the contributors a legal, moral and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.”
Historians (including Leff) have questioned the accuracy and importance of this FDR quotation. To begin with, it was secondhand, recounted by Gulick rather than by Roosevelt himself. It was also self-serving. By the time FDR ostensibly uttered these words, Social Security was already well entrenched. “Knowing how the system had come out, he was in an excellent position to claim foresightedness,” Leff wrote. “Of such stuff, accurate historical memory is not made.”
Fair enough. But Roosevelt was factually correct in 1941 when he described the program as politically secure. And more important, he stayed correct for decades to come. Social Security may have looked solid in 1941, but it looked even better with each passing decade. Indeed, the program today faces important funding problems, many of them traceable to Roosevelt’s insistence on a payroll tax. But it also looks just as politically untouchable as Roosevelt predicted some 80 years ago.
FDR’s Bargain
Still, one question remains about Roosevelt’s payroll tax: How did he avoid popular resistance to the idea? After all, nobody likes a tax, especially one that visits them every payday. How did Roosevelt escape the wrath of voters?
Part of the explanation lies in that “insurance” model he used to sell Social Security to Congress and the nation at large. By tying the tax so closely to benefits, he made the program look like a product. Americans tolerated the payroll tax because they believed FDR’s argument that paycheck deductions were being used to buy a product: personal financial security and lasting peace of mind.
But there was another bargain being made in the 1930s — one rooted not simply in the Social Security program, but in the tax system broadly conceived. Roosevelt is famous for his soak-the-rich taxes, including high marginal tax rates on personal income and a variety of corporate tax increases (which then, as now, were expected to fall principally on the owners of capital).
Roosevelt used these taxes — and his rhetoric of “fair share” revenue reform — to justify fiscal impositions on non-wealthy Americans. Americans might dislike paying regressive taxes, including both new ones like the payroll levy and old ones like all those endless excises. But aggrieved, non-rich Americans could take comfort in the notion that rich people were being asked to pay up, too. Roosevelt’s critics pointed out that big government, of the sort FDR championed, could never be financed solely by the rich; wealthy Americans didn’t have enough money to foot the bill.
But that wasn’t the only goal of raising taxes on the rich. Sure, the fiscal contributions of wealthy individuals and large corporations were intended to raise substantial revenue — as much as possible, at least, and within reason. But those taxes were also designed to bolster popular support for other elements of the federal tax system, including the payroll tax.
And by almost any measure, they succeeded.
Lessons for VAT
Roosevelt’s political feat — building support for broad-based taxes by pairing them with narrow taxes on the rich — holds a lesson for modern-day fiscal reformers. Today, as in 1935, heavy taxes on the rich won’t solve all the nation’s money problems.
Or its inequality problem. As Avi-Yonah points out, a billionaire’s tax won’t suffice to shrink government deficits, let alone pay for new programs. “There are fewer than 800 billionaires in the United States,” he notes, “and even taxing their unrealized income at 100 percent would not significantly affect the overall Gini coefficient.”
What might actually reduce inequality — and boost economic security for millions of struggling Americans — is a more robust social safety net. It’s the transfers that make the difference, not the taxes, Avi-Yonah contends. “The answer to solving the problem of increasing inequality is not more progressive income taxation,” he writes. “One key to reducing inequality in the United States is to bolster the social safety net.”
Avi-Yonah specifically calls for efforts to shore up Social Security. And like FDR, he wants to do it with a regressive funding innovation: a VAT.
Of course, a VAT isn’t much of an innovation. Like those Social Security drafters in 1935, today’s champions of safety net expansion can simply look abroad if they want to find obvious, workable ideas about how to pay the nation’s bills. Countries all around the world have used VATs for decades to pay for social programs. The regressive financing is typically outweighed by progressive spending programs.
That lesson from abroad is further confirmed by a lesson from America’s past. Roosevelt’s experience designing Social Security fits the model, using a regressive tax to pay for progressive spending.
And Roosevelt can offer another lesson, too. New wealth taxes on the rich might not raise enough money to pay for enhanced social programs. But they can build political support for other, less progressive taxes that will get the job done.
Something to ponder as we wait for a decision in Moore and contemplate the future of American public finance.