by Burt Folsom
As Treasury Secretary, Mellon carefully collected and studied data on the American economy. High taxes, he concluded, were the chief parasites draining the lifeblood of the American economy. "Before the period of the war," he observed, "taxes as high as those now in effect would have been thought fantastic and impossible of payment." Rich men went to great lengths to avoid paying the 73 percent rate Mellon confronted when he came to Washington.
The high rates inevitably put pressure upon the taxpayer to withdraw his capital from productive business and invest it in tax-exempt securities. . . .The result is that the sources of taxation are drying up; wealth is failing to carry its share of the tax burden; and capital is being diverted into channels which yield neither revenue to the Government nor profit to the people.14
Mellon publicized the evidence in Table 1 to make his point. Between 1916 and 1921, the number of people who earned over $300,000 per year had shrunk, and so had their average incomes. The rich were not poorer but wiser; they were shifting their fortunes into tax-exempt bonds.
The subject of tax-exempt bonds became relevant because Congress allowed cities and states to issue bonds that were free of any taxes. When tax rates were higher than 50 percent on top incomes, municipal bonds that paid about 5 percent were more attractive to wealthy people than taxable investments that paid 11 percent. Since almost no corporation in the country consistently earned 11 percent per year, capital flooded into bonds for projects in cities all over the country.15
Table 1: THE DECLINE OF TAXABLE INCOMES OVER $300,000 FROM 1916 TO 1921
YEAR
NUMBER OF RETURNS
NET INCOME
All classes
Incomes over $300,000
All classes
Incomes over
$300,000
1916 1917 1918 1919 1920 1921
437,036 3,472,890 4,425,114 5,332,760 7,259,944 6,662,176
1,296 1,015
627 679
395 246
$6,298,577,620 13,652,383,207 15,924,639,355 19,859,491,448 23,735,629,183 19,577,212,528
$992,972,986 731,372,153 401,107,868 440,011,589 246,354,585 153,534,305
Source Andrew Mellon, Taxation: The People's Business (New York: Macmillan, 1924), 74.
Mellon estimated in 1923 that Americans held fully $12 billion—a threefold increase in ten years—in tax-exempt bonds. This $12 billion was almost three times the amount of the federal budget and more than half of the debt owed by the national government. All of these rich people pouring cash into municipal bonds alarmed Mellon: America's industries, he argued, were starving for capital while the cities had abundant low-interest cash available whether they needed it or not. Thus, the U. S. had more and more large football stadiums and civic centers but fewer and fewer factories where these cityfolks could work long-term jobs.16
Mellon knew firsthand how hard it was for speculative ventures—such as making aluminum or drilling for oil—to raise the money needed for success. Poor or middle-class people, living from payday to payday, could rarely afford to invest in these high-risk ventures. Only the wealthy could afford the risk and supply the capital to start up high-risk industries. When the top incomes in the U. S. shifted away from corporate development and into tax-exempt bonds, new industries especially had trouble raising the capital to compete. But, Mellon insisted, the whole economy suffered, too. He used William Rockefeller, the brother of John D., as an example of high taxes chasing capital out of productive investment. When Rockefeller died in 1923, Mellon discovered that he had $44 million in tax-exempt bonds and only $7 million left in Standard Oil.17 Mellon urged Congress to support a law— even a constitutional amendment—to abolish the tax-free status of city and state bonds. But he knew this was no quick fix. As long as taxes were high, investors would find some way to avoid them. Taxes had to be slashed "to attract the large fortunes back into productive enterprise." Then Mellon added a twist to his argument: "more revenue [for the government], may often be obtained by lower rates." Not just more revenue from the rich, Mellon predicted, but more revenue overall might come to the government if taxes were cut. He compared the government setting tax rates on incomes to a businessman setting prices on products. "If a price is fixed too high, sales drop off and with them profits." Mellon asked:
Does anyone question that Mr. Ford has made more money by reducing the price of his car [from $3000 to $380] and increasing his sales than he would have made by maintaining a high price and a greater profit per car, but selling less [sic] cars?
Mellon, of course, recognized that there was a limit to how far you could cut taxes and still increase revenue. "The problem of the government," he said, "is to fix rates which will bring in a maximum amount of revenue to the Treasury and at the same time bear not too heavily on the taxpayer or on business enterprises." Mellon believed that 25 percent was about as much as rich people would pay in taxes before they rushed to the tax shelters.18
Mellon's prediction that lowering tax rates might produce more revenue for the government was controversial right from the start. Progressives shuddered at the thought; but even conservatives were nervous. At stake to conservatives was balancing the budget and shrinking the high national debt. Over $7.5 billion worth of 4 percent Liberty bonds was coming due in 1923. None of the bonds could be paid off if Mellon was wrong. The government would have to renegotiate these bonds, probably at higher rates, and then borrow more each year to make up for lower revenues and for the added interest payments on the national debt. It would then be harder in the future to balance the budget, confidence in the American government would fall, interest rates might rise, and investors might withdraw capital from the American economy. The economic downturn after the war might persist through the 1920s. Mellon quietly waged his war of ideas first with Harding and then with Coolidge till both decided to back him.19
Mellon was an odd sort of man to command such attention in the Harding-Coolidge administration. After Harding was elected, he invited Mellon to come to his home in Marion, Ohio, to discuss the Treasury job. Mellon took the train to Marion and found no one in the depot to meet him. So he walked the mile to Harding's house, suitcase in hand, and waited in line—behind local job-seekers—to have his appointment with Harding. When the astounded clerk realized Mellon was waiting in the reception room, Mellon refused to have any fuss made and insisted on taking his turn behind the others. When Mellon's turn finally came, he spent much of the time trying to talk Harding out of choosing him to head the Treasury Department. At last, Harding had a man for his cabinet who was not seeking glory and who couldn't be bought.20
Sometimes Mellon's humility created embarrassments. At a press banquet Mellon was mistakenly called to the phone and ended up being asked to take a long message for some reporter named George. Mellon dutifully took three pages of notes from the stranger and delivered them to George.21
In Harding's administration, Mellon's low-key personality and his encyclopedic knowledge of economics became legendary. At a cabinet meeting in 1921, the question came up whether the U. S. should scrap a war factory that had cost $12 million, or a similar amount should be spent to refurbish it. Finally, Mellon was asked his opinion.
Mr. Mellon was hesitant. Then he spoke up in his low, quiet, dry voice. The matter was not exactly in his department; he had not given the problem any study; he was not familiar with all the conditions and the full situation; it was a question of some importance; he did not wish to be understood as giving his final opinion unless he had opportunity to go into the whole matter more fully, but he thought he could indicate possibly what his final judgment might be, if allowed to tell what he had done in a somewhat similar and personal case. He owned a war plant that stood him about fifteen or sixteen millions, and just the other day the question had come up whether to spend that much more money on it or to wipe it off. "I told 'em to scrap it," concluded Mr. Mellon.22
And so the government scrapped its war plant. In a later cabinet meeting on international relations,
the subject of the Chinese Eastern Railway came up:
The President leaned over to Attorney General [Harry] Daugherty and whispered, "Now we've got him. Surely he wasn't in this."
"I don't suppose, Mellon," said President Harding, winking at Daugherty, and assuming a most casual manner, "that you were interested in the Chinese Eastern Railway, were you?"
"Oh, yes," Mr. Mellon replied placidly; "we had a million or a million and a half of the bonds." And he told the cabinet all about the road; all about it—not part—all.
"It's no use," said the President, "no use. He's the ubiquitous financier of the universe."23
As the resident "financier of the universe," Mellon commanded respect; and in 1924 when he wrote Taxation: The People's Business, he had full presidential support. The press dubbed his proposal the "Mellon Plan." Its four main points were:
1. Cut the top income tax rate to 25 percent. This was one of the first things Mellon had tried to do when he took office. In 1921 Congress did cut the top rate from 73 to 58 percent; but after this the resistance stiffened. The Progressives wanted a high tax rate on the rich and they had the logic of democratic politics on their side: few voters earned large incomes; many voters resented those who did, and therefore there was always support for a soak-the-rich policy. Mellon believed that about 25 percent was the most that investors would pay before they fled to tax-exempt bonds. Cutting the top tax to 25 percent would, he predicted, bring the large fortunes back into productive enterprise and might generate a surplus of revenue for the government.24
2. Cut taxes on low incomes. When Mellon took office the existing rates were 4 percent on those incomes of $4000 or less, and 8 percent on incomes over $4000. Mellon wanted to cut these rates from 4 to 3 percent and from 8 to 6 percent; later he argued that these rates should be cut even further. No doubt Mellon was being politically shrewd with this part of his plan, but he also seems to have believed in what he was doing. Tax policy, he argued, "must lessen, so far as possible, the burden of taxation on those least able to bear it." To further this end, he also suggested an income-tax credit of 25 percent on earned income—that is, income earned by wages would be taxed less than income earned through investments. Mellon also proposed a repeal of the federal taxes on telegrams, telephones, and movie tickets. The tax on movie tickets, especially, was a fee "paid by the great bulk of the people whose main source of recreation is attending the movies in the neighborhood of their homes. The loss in revenue would be about seventy million dollars, but it would constitute a direct saving to a large number of people whose tax burden should be lightened wherever it is possible to do so."25
But Progressives often opposed cutting the tax rates even on the lower-income groups. When the income tax first became law, for example, Robert LaFollette wanted the taxing to start at $10,000, instead of $20,000. In later Congressional debates he often tried to reduce the personal exemptions, so that taxes would start on incomes of $1,000, instead of $2,000. As Governor of Wisconsin, he pushed for a bill that allowed the state to start taxing those who made as little as $800. When LaFollette died in 1925, his son, Robert Jr., went to the Senate and picked up where his father left off. He joined thirteen other Progressive senators in voting against Mellon's bill to cut taxes from 1V£ to Va percent on those earning less than $4,000 per year.26
3. Reduce the federal estate tax. In 1916 Congress passed the first federal inheritance tax. The rates were progressive and started on estates of over $50,000. By the time Mellon took office the top rate had been increased from 5 to 25 percent. Progressives pushed the maximum up to 40 percent at the same time the Mellon Plan was launched. Mellon opposed this vigorously. He thought that states, not the federal government, should enjoy the revenue from inheritance taxes. He also argued that stocks and properties in large estates could not net their full value because with high taxes they would have to be sold quickly by heirs. Furthermore, large estate taxes, like large income taxes, tempted the wealthy to shift their fortunes into tax-exempt shelters.27 In the case of large estates, the shelter would be tax-exempt foundations, as Mellon would show in the 1930s.
4. Efficiency in government. The 1919 federal budget was over $18 billion; Mellon wanted to see annual budgets drop below $4 billion. Smaller budgets meant less need for tax revenues and also greater ease in reducing the $24 billion national debt. In the Treasury Department Mellon cut personal expenses; he also cut from the Treasury Department staff an average of one person per day every day during the 1920s. He was able to do this because lower tax rates meant fewer returns, which meant fewer people wereneeded to process and audit returns. Mellon had other ideas, too.He cut the size of paper bills to fit wallets more easily and thereby saved expenses on paper and ink.28
The Mellon Plan was probably the subject of more debate than any other political issue during the 1920s. Not just the money was involved; two political ideologies were clashing. In a sense, it made little difference whether a man making $4000 paid $120 tax under the old rates, or $67.50 under the Mellon Plan. But the Progressives wanted to take these small amounts, add them to the huge windfalls they hoped to extract from the rich, and use the money to back the McNary-Haugen bill, which authorized the government to help farmers market their surplus crops; pay a cash bonus to veterans of World War I; and pay for the federal development of hydroelectric power along the Tennessee River Valley. Mellon, by contrast, wanted to use any surplus revenue from tax cutting to retire the national debt. He called the Progressive agenda "taking money out of the pockets of all the people in order that it shall find its way back into the pockets of some of the people."29
Mellon made one exception to his theme of limited government—he favored a tariff. Perhaps he felt obligated to support a tariff because the Republican party endorsed one. Still, it created inconsistencies in his argument and opened him to attack. When the Republicans passed the Fordney-McCumber Tariff in 1922, Mellon seemed comfortable supporting it. Included in this tariff was a three-cent-a pound rise in the duty on imported aluminum. Mellon, of course, had divested himself of his Alcoa interests when he went to Washington, but there was still understandable criticism of him. Senator William Borah, a Progressive from Idaho, attacked Mellon for opposing government protection for farmers but favoring government protection for Alcoa.30
The debate between Mellon and the Progressives was fought almost every year in Congress. In the early 1920s, the sides were about evenly matched. In the tax bills of 1921, 1922, and 1924, Mellon and his supporters reduced the rates on large personal incomes to 46 percent, a minor victory; corporation taxes, however, were raised from 10 to 12.5 percent, a minor defeat. Progressives had the rates on large estates hiked from 25 to 40 percent. They also enacted a gift tax to prevent the rich from giving their fortunes away before they died. Mellon did get his lower rates on incomes below $8,000, but this was less controversial because it was so politically popular. The Democratic party leaders also suggested lower rates and, on occasion, so did Progressives.31
When Harding died in 1923 and Coolidge became President, Mellon found himself with a strong ally to help break the Congressional deadlock. Coolidge studied the tax problem and agreed with Mellon's conclusions. "I agree perfectly," Coolidge said, "with those who wish to relieve the small taxpayer by getting the largest possible contribution from the people with large incomes. But if the rates on large incomes are so high that they disappear, the small taxpayer will be left to bear the entire burden."32
Coolidge and Mellon not only thought alike, they acted alike. Both men were shy and at state dinners they must have made guests uneasy because they said almost nothing. Cleveland Amory wrote that Mellon and Coolidge seemed to have conversed "almost entirely in pauses." They even installed a direct phone hookup to each other, perhaps to share silence together.33
The two men were quiet for different reasons. Coolidge grew up on a farm in Vermont. His mother died when he was young and he saw few people as a boy, so he never developed social skills. Mellon, by contrast, h
ad a weak speaking voice, and the presence of a crowd made him uneasy. Coolidge's political success and Mellon's business success only reinforced the problem; crowds, jobseekers, and fawners all sought these men out for favors. A retreat to silence was their response to these pressures.34
Both men took almost childish delight in their families. Coolidge adored his wife and bought her fancy clothes and presents. When driving his car, Coolidge allowed only family members to ride with him. Mellon, although divorced, was close to his two children, Ailsa and Paul. "With his children this quiet, reserved man was a different being from the financier the world knew," observed Mellon's nephew William. Mellon would join his children on sled rides, he would fly kites and play ball with them, or chase them in blind man's bluff. "If the children slid down the banisters, he would slide with them," his nephew observed. "He would play hide-and-seek until they were tired of the game."35
Distrustful of outsiders, both Coolidge and Mellon found joy in pets or possessions. Coolidge had a pet raccoon that roamed the White House freely; he was given a parrot trained to say "What about the appropriation?"; and he raised chickens in the White House back yard. Mellon had an all-aluminum car; and he assembled one of the finest art collections in the world. This closeness in personality and philosophy may have united Coolidge and Mellon and made them more forceful in their appeals for tax cuts and balanced budgets.36
The 1924 elections shifted the balance of power to the conservatives. Coolidge ran for re-election and won a landslide victory over the Democrats and also LaFollette, who ran as a third-party candidate. The tax cuts were a major issue in the campaign and the Republicans now had a mandate and a strong congressional majority to put them into effect. Congress passed most of the Mellon Plan in 1926. In 1928 and 1929, Mellon recommended, and Congress passed, further tax cuts: the estate tax was halved to 20 percent, top incomes paid 24 percent, and smaller incomes had even larger proportional reductions.37