War, Taxes, and Income Redistribution in the Twenties: The 1924 Veterans' Bonus and the Defeat of the Mellon Plan

Abstract

In the twentieth century, two world wars transformed the federal tax system. The impact of World War II on the federal fiscal system has been extensively studied. But the impact of World War I on the development of federal taxation and social provision has been less studied. In this article, we suggest that the nation's experience in World War I helped shape the high level and progressive character of federal taxation in the Twenties. First, the public debt attributable to the war helped keep federal revenues elevated throughout the decade. Second, the debate over the nation's financial obligations to World War veterans became intertwined with the politics of taxation, and in 1924 the outcome was a noteworthy victory for progressive forces on taxes as well as the veterans' issue.

We begin with the connection between World War I and the level of taxation in the Twenties. Thanks in large part to the fiscal hangover of World War I, mainstream Republicans acquiesced in continuing high taxes in order to give priority to paying off the federal debt. Ironically, their fiscal prudence helped solidify the federal government's taxing capability. These data suggest that the reputation of the Twenties as a decade of "tax cuts" has been exaggerated. Federal tax rates and federal tax revenue did fall from their wartime peak in the postwar decade, and the agenda of tax reduction was popular among politicians of both parties. But by peacetime standards, federal revenues and federal income tax rates remained at unprecedented highs.

We then turn to the more complicated question - why were federal taxes progressive as well as high in the Twenties, and how did World War I influence debates over redistribution via taxation in the postwar period? The critical background fact is that Republican control of tax politics was weaker than it appears. Our contribution is to bring to light a lost connection between World War I and progressive tax politics in the Twenties. In 1924 the debate over retroactive pay increases for servicemen merged with the controversy over Republican tax cut proposals. In November, 1923, Treasury Secretary Andrew Mellon predicted a $300 million annual surplus and offered the Mellon Plan as the best use for the extra revenue. He warned, early and often, that the nation could not afford a bonus as well. But the Administration's strategy failed. Congress passed a bonus bill over the President's veto and enacted a tax bill that reshaped the Mellon Plan in a progressive direction.

The events of 1924 represented a notable setback for the Administration's fiscal plans and a victory for progressive forces. By reconnecting the debate over the veterans' bonus to tax politics, we hope to make clearer the bitter battle fought by the two camps in 1924 over tax and bonus legislation. Although the bonus bill and the tax bill were not legally bound together, the connection between the bonus and the Mellon Plan was well-understood at the time.

We also suggest that the 1924 bonus merits attention not only for its interaction with the politics of taxation but also in its own right. The bonus represented a noteworthy shift in veterans' benefits, and the bonus idea foreshadows the GI Bill strategy: both programs took notice of the economic situation of the returning veteran, and both aimed to help with the economic transition back to civilian life. Earlier versions of the bonus bill presage the even GI Bill more clearly, offering a "menu" including vocational training and farm aid as well as cash.

Keywords: Taxation, Tax, Income Taxation, Income Tax, World War I, Mellon, Coolidge, Veterans, Bonus, Tax History, War, Soldiers, GI Bill

JEL Classification: H2, H24, H5, K34, N4