On December 19, 1893, William L. Wilson, Chairman of the House Ways and Means Committee, rolled out a new tariff reform bill, which passed the House on February 1, 1894 by a significant margin, 204 to 140. Tariff duties were modestly cut by 15 percent. However, to make up for any projected loss of revenue, the final House version of the bill included a provision for an income tax. The young Democratic congressman from Nebraska, William Jennings Bryan, introduced the tax amendment and vigorously defended it. “There is no more just tax upon the statute books than the income tax,” he told the House.
Though not a new concept, a tax on incomes had been first enacted in 1862 to help finance the Civil War, and, despite the Constitution’s prohibition against direct taxes, federal courts had left it alone as a war revenue measure. The original act created the Bureau of Internal Revenue, the forerunner to the IRS, to collect the tax. It covered all incomes over $600 a year at two graduated rates. Income above $600 and up to $10,000 was taxed at three percent, while everything over $10,000 at five percent. In 1864 the top rate was increased to ten percent. When applicable, the federal government had actually withheld the tax from people’s income, such as government salaries, dividends and interest from bank stocks and bonds, as well as from railroads and other corporations. By the end of the war, some 15 percent of households were paying the tax. In 1872, the law expired and Republicans were content to leave it dead, as the tariff was continually pouring money into the federal treasury, making additional taxes unnecessary.
The income tax of 1894 established a rate of just 2 percent on incomes of $4,000 or more, effectively exempting over 99 percent of the population. The two percent rate also applied to corporations, but those entities did not receive any exemption. So only the very rich would be affected by the new tax. With more than 12 million households across the nation, the tax would touch just 85,000 that had incomes of $4,000 or more. This made the 1894 income tax much different in scope than its 1862 predecessor. “For the first time in American history,” writes economic historian John Steele Gordon, “a tax was seemingly proposed on a particular class of citizens, a class defined by economic success.” Critics used this feature to attack the tax proposal as “socialism.” Cleveland’s fellow New Yorker, and longtime antagonist, David B. Hill, blamed the tax on “little squads of anarchists, communists and socialists” from Europe infecting America with foreign ideas.
But supporters pointed to the massive concentration of wealth to make their case. “The tax proposed on incomes,” wrote former Congressman Roger Q. Mills in its defense, “is but a light touch on the monumental piles of wealth, for the protection of which the government is standing guard.” Mills argued that continued wealth accumulation might lead to “an upheaval” not unlike that of Revolutionary France in 1789 when the clergy and nobility “persistently refused to bear any burden of taxation to support the government.”
Thomas G. Shearman, a political economist and founder of the Shearman and Sterling Law Firm in New York City, conducted a study on the concentration of wealth in America, which he published in 1889 in The Forum under the title “The Owners of the United States of America.” Shearman contended that just 70 persons owned a combined wealth of $2.7 billion. Some 50,000 families owned half the nation’s wealth, while four-fifths of the people earned less than $500 a year. Although he represented such prominent American figures as Jay Gould, Henry Ford, and John D. Rockefeller and Standard Oil, Shearman supported an income tax “upon rents and corporations having exclusive privileges.” The tax burden, Shearman noted, was disproportionally placed upon the poor, who paid taxes equivalent to 75 to 80 percent of their savings while corporations and the wealthy paid only 8 to 10 percent. Federal taxes had increased six fold since the Civil War, he maintained, while untaxed corporations saw their profits soar tenfold. This had to change, he contended.
As a strong Jeffersonian, Cleveland had his own reservations. He had discussed the great disparity of wealth in his final State of the Union message in 1888, and had given his support for “a small tax upon incomes derived from certain corporate investments.” His proposal was certainly not an income tax in the traditional sense and would, in no way, touch the lower classes but would resemble modern-day capital gains taxes, first instituted in 1913, and tax the massive corporations that paid almost no taxes yet stood protected behind an enormous tariff wall. But this proposal by Bryan was essentially wealth re-distribution, something he would never support.
The president also had another reason to look on the income tax with suspicion. Not only did it violate a fundamental principle of Jeffersonian economic thought, it gave Congress yet more funds with which to spend. “The income tax became the fuel for paternalism in government,” writes tax historian Charles Adams, “just as excises and land and wealth taxes had done in Europe centuries before.” Cleveland understood this and certainly did not want to see any more government paternalism. But many wanted to see a tariff reform bill, any tariff reform bill, become law. Even the New York Times wanted to see the bill passed, though it contained “the obnoxious income tax amendment.” With a complete Democratic government for the first time since James Buchanan’s administration, this might be their only hope.
Despite the rancor, the reform bill, now dubbed the Wilson-Gorman Tariff Bill, passed the Senate on July 3 by a close vote, 39 to 34, with twelve senators not voting. Raw materials on the free list dwindled to just two, wool and copper. Tariffs were raised on iron, woolen and cotton products, glass, certain chemicals, and sugar, both raw and refined. The income tax amendment also remained. But because of the vast differences between the two proposals, it would be left up to a House-Senate conference committee to determine the final outcome.
Cleveland had high hopes for a good bill emerging from the conference committee. It would “present the best, if not the only, hope of true Democracy,” the president wrote Wilson in a letter read on the House floor, “and the redemption of Democratic promises to the people.” The Senate bill “falls far short of the consummation for which we have long labored, for which we have suffered defeat without discouragement,” and should the effort be abandoned, it would mean “party perfidy and party dishonor.” The final bill, Cleveland insisted, must include the free importation of raw materials if it is to “bear a genuine Democratic badge” and be of any help to the people.
But, in shades of the 2010 Obama healthcare law, the House decided to accept the Senate’s version, which included the income tax provision. On August 13, the House passed the Senate’s bill by a vote of 182 to 105, despite Wilson’s noble effort to prevent it. In the end the final bill lowered rates from 50 to 42 percent. Cleveland was so disgusted with the process that he allowed the bill to become law without his signature. He hated the income tax provision and detested the Senate’s action on the original bill but he did favor the small cut in taxes.
As he had in his 1888 message, he went after the wealthy and their influence over the proposed tariff legislation. It was “the trusts and combinations – the communism of pelf – whose machinations have prevented us from reaching the success we deserved,” he wrote Mississippi Congressman Thomas C. Catchings. The tariff law, though flawed, “presents a vast improvement to existing conditions” and lightens “many tariff burdens that now rest heavily upon the people. It is not only a barrier against the return of mad protection, but it furnishes a vantage-ground from which must be waged further aggressive operations against protected monopoly and governmental favoritism.” This bill was a step in the right direction, he contended, but because it had provisions “which are not in line with honest tariff reform,” with “inconsistencies and crudities which ought not to appear in tariff laws or laws of any kind,” like the income tax, he did not sign it.
But Cleveland had good reason to believe that the Supreme Court, in a time when the justices actually looked out for the Constitution, would not allow the income tax to remain in place. During his first term, in 1888, he appointed the Chief Justice, Melville Fuller, a steadfast Jeffersonian. He was quite possibly the best Chief Justice in American history, ruling on many serious constitutional questions, including the Sherman Antitrust Act, and always upholding the original intent of the founders. Unsurprisingly, the Fuller Court struck down the income tax provision in 1895 in Pollock v. Farmers’ Loan & Trust Co by a 5 to 4 vote.
For more on the policies of Grover Cleveland, pick up a copy of my book, The Last Jeffersonian: Grover Cleveland and the Path to Restoring the Republic.