This month marks the centennial of the armistice that ended the First World War. Commentators have used this historic event to reflect on the many international legacies of the Great War. But the war also had a profound political impact domestically in the United States, especially on tax policy, and this legacy has been far less discussed.
World War I was a watershed event for the development of American taxation. It was during the relatively short 18 months of U.S. participation in the conflict that our national tax system was fundamentally transformed from an anemic and symbolic source of revenue to a fiscal workhorse — one that not only financed the war effort but also firmly established progressive taxation as a touchstone of American fiscal citizenship.
Recalling the forgotten tax legacy of World War I can remind us how taxes were once used by lawmakers to help bind, rather than divide, the nation.
Well before the war, progressive reformers had been using tax policy to attack the massive inequalities of the Gilded Age. The ratification of the 16th Amendment, empowering Congress to levy an income tax, and the enactment of the first peacetime national income tax in 1913 were crucial first steps in the establishment of a new, more progressive tax regime.
The constitutional amendment itself was a result of decades-long populist social movements. Responding to the growing concentration of wealth and power at the time, progressives turned to graduated taxes on income and wealth to rebalance the burdens of financing a burgeoning modern industrial state. They did so to remind all Americans about the importance of fiscal citizenship — about our shared duties to each other.
But the Great War became the crucial catalyst to ingrain these ideas into practice. The conflict triggered a fundamental shift in the connection between taxation and civic identity. “A new sense of the obligations of citizenship will transform the spirit of the nation,” journalist Fredrick Lewis Allen noted at the start of the conflict. For Allen and other reformers, progressive taxation was one way to forge a new ethos of social solidarity and civic obligation. By weaving direct and graduated taxes into the fabric of U.S. law and culture, the First World War became a historic moment to further the progressive commitment to shared social responsibility.
On the eve of U.S. participation in the war in April 1917, federal taxes raised only 10 percent of annual revenue and touched about 2 percent of Americans. By the end of the war, however, direct and progressive taxes on income, profits and inheritances accounted for more than 80 percent of total government receipts and affected nearly 20 percent of American households. These changes were prompted by skyrocketing marginal tax rates and the adoption of new levies. The war ushered in a new national inheritance tax, top marginal income tax rates that soared from 7 percent to 77 percent, and new business levies, such as an “excess profits tax” designed to combat war profiteering.
Ultimately, the new taxes on income and wealth underwrote approximately one-third of the war effort. Although the World War I tax system remained a “class tax” aimed mainly at the rich, it set the foundation for subsequent tax changes, including the pivotal adoption of a mass income tax during World War II. Even before the United States entered the Great War, tax experts predicted that the conflict might spur more permanent changes. “If we ever get a big income tax on in wartime, some of it — a lot of it — is going to stick,” notable New York lawyer Amos Pinchot said.
And stick it did. Although postwar conservatives began to undermine the robust tax system by dramatically reducing top rates after the war, they were never able to return the progressive tax regime to prewar levels.
During the Second World War, tax experts turned to the earlier conflict and the legacy of progressive reform in designing and implementing the mass income tax of the 1940s — a tax that signified a renewed sense of fiscal citizenship.
For much of the post-World War II period, progressive taxation and notions of fiscal citizenship remained the hallmarks of New Deal liberalism. Gradually, as events such as the Vietnam War and Watergate began to erode public trust in government, and anti-statist politicians started to rail against progressive taxation, our sense of shared sacrifice and social solidarity began to dissolve.
By the 1980s, the Reagan Revolution led to a new view of taxation — one that stressed the need for lower taxes and limited government in the name of protecting the private sector from an overly intrusive state. “Lower tax rates mean greater freedom,” President Ronald Reagan liked to say. “And whenever we lower the tax rate, our entire nation is better off.” Gone were any appeals to shared duties or civic obligations.
We may have lost that sense of social solidarity today, but the World War I tax legacies remain with us. As we move into a new era of divided government — and soaring deficits — it may be useful to rethink how taxation can be used to pull us together rather than drive us apart. It may be instructive on the centennial of the armistice to reflect on how an earlier generation of Americans seized upon historic conditions to envision and implement dramatic tax reforms that remain with us.