American Economic Development, Managerial Corporate Capitalism, and the Institutional Foundations of the Modern Income Tax

I INTRODUCTION 1909 was a critical turning point in the development of American tax law and policy. In that year, Congress enacted a national corporate tax at the same time that it introduced a constitutional amendment permitting a federal personal-income tax. (1) The corporate tax, which was framed as a "special excise tax" on the privilege of doing business, had an immediate, albeit modest, impact on federal revenues, accounting for nearly $21 million of the $289 million of total internal revenue for fiscal year 1910. (2) The constitutional amendment, by contrast, languished in the halls of state legislatures for several years before it was finally ratified in 1913. Once it was adopted, the Sixteenth Amendment nullified the U.S. Supreme Court's 1895 invalidation of the nation's first peacetime national income tax (3) and paved the way for the subsequent development of the modern American income tax. Although the corporate tax and the constitutional amendment were presented together in 1909, the amendment garnered much greater attention among contemporary commentators and modern scholars. And for good reason. Ratification of the Sixteenth Amendment had far-reaching consequences for American law and political economy. It not only overturned the most serious legal obstacle to the adoption of graduated individual-income taxes, it also emboldened social groups and political reformers to demand the first permanent federal income tax, which was enacted within a year of the amendment's ratification. (4) Yet the corporate tax may have played an equally important, though more subtle, role in American political and economic development. Together with the personal-income tax, the corporate levy helped generate substantial government revenue throughout the twentieth century--revenue that has been critical to the growth of the public sector. (5) Despite the uncertain incidence of the corporate tax, some scholars and commentators have also depicted it as an effective regulatory tool used to curb the abuses and increasing power of Big Business. (6) As a result of these dual functions of raising revenue and regulating economic power, many historically minded scholars have tended to subsume the corporate levy as part of the Progressive Era's overall tax reforms. The Sixteenth Amendment, the personal-income tax, and the corporate tax are thus all frequently viewed as part and parcel of one grand narrative in which the social and political demands for greater tax equity are the key determinants of the dramatic, early-twentieth-century transformation in American tax law and policy. (7) A singular focus, however, on social and political factors, especially one that subordinates the corporate tax to a minor role, provides only a partial account of the history of the modern American income tax. This article offers a broader explanation by moving beyond the social and political determinants to ask, What were the economic forces that facilitated the adoption of the modern graduated income tax? How did these economic factors shape the institutional framework that gave rise to direct and graduated taxes? And what role, if any, did the early corporate tax play in the creation and elaboration of the modern U.S. income tax? This article investigates two particular economic factors. First, it explores the broad, long-term, structural transformations in the American economy that fostered the development of the modern progressive income tax. Between the end of Reconstruction and the onset of the Great Depression, the American economy underwent dramatic changes. Mass migration, rapid urbanization and industrialization, and tremendous economic growth transformed what was by most accounts a peripheral New World republic into a geopolitical and economic power. (8) These structural changes had important ramifications for American public finance. As the pace of urban-industrial capitalism accelerated, an increasing amount of output and income moved through the market, mainly because of the actions of large-scale industrial corporations. …