09.25.2013 1

1913: The year that changed everything

1913By Rick Manning

One hundred years ago, the United States economy was changed forever.  Yet, few recognize the significance of the year that Woodrow Wilson became the 28th president of the United States, the U.S. Department of Labor was formed and the Panama Canal was completed.

All these were significant, but they pale by comparison to the decision to amend the Constitution for the 16th time allowing the imposition of an income tax. They also do not compare to the establishment of the Federal Reserve Bank by Congress.

The Fed was the third attempt by the government to establish a central bank coming into being as a response to earlier bank panics.  The Fed’s ability to establish money lending rates to the nation’s private banking system allowed it to control the growth of the money supply and credit across the U.S. economy.

Inevitably, the institution has grown with a constant innovative mission creep until today, the Fed owns more than $2 trillion of the almost $17 trillion dollars in United States debt, and another $1.3 trillion in mortgage backed securities — with purchases of $85 billion a month of both these assets continuing.

The purchase of federal debt has effectively disconnected rising interest rate costs due to the flooding of the market with U.S. bonds competing for investors.  The perverse effect of this impact is that one of the natural brakes on federal deficit spending, the ability to attract purchasers for the newly created debt, has been minimized due to the Fed actions, allowing an unprecedented growth of the national debt over the past five years.

What once was a relatively benign effort by the U.S. government to establish a decentralized means for stabilizing a financial crisis, the Fed has become the dominant unelected economic force in our nation.

While constitutionally, the founders gave the primary role over monetary policy to the democratically elected Congress, this principle has been replaced through the Fed by financial oligarchs only subject to the people through the presidential appointment and advice and consent process that few pay attention to in today’s political system.

As the Fed continues to monetize the massive U.S. debt by creating dollars unrelated to actual wealth creation, history may just record that the body that was established to stabilize the banking system became the vehicle through which it was destroyed.

At the very least, the establishment of the Federal Reserve System will be viewed by historians as an economic turning point as it inevitably led to the elimination of the currency’s value being tied to fixed assets (gold).  The results of the exponential increase in power within the Fed as the bank itself became the manipulator of the value of the dollar remains to be seen, but one effect that cannot be denied is that the establishment of the Fed dramatically increased the power of the central government over the U.S. economy as a whole.

The inclusion of the income tax into the U.S. Constitution was the other cataclysmic change to the way the federal government financed its operations that occurred in 1913.  While the income tax had made its debut as a means to fund the Civil War, it had been found unconstitutional in the 1890s resulting in the effort to overturn the Court through the constitutional amendment process.

Prior to the income tax, U.S. government revenues were primarily collected using a system of tariffs and fees that were directly tied to the economic activity in the country.  Federal government sales taxes on gold and other items were also tried throughout history.

The federal income tax in 1913 ranged from one to seven percent depending upon income levels.  By 1916, the rates had increased to between 2 and 15 percent of income, and by 1918 the rates had jumped to 6 percent for low end earners to a whopping 77 percent for every dollar earned over one million.

In just six years, the federal government went from collecting zero income taxes to confiscating more than ¾ of every dollar earned above a million in a year.

During the 1920s the rate settled down to 25 percent on top earners only to rise to consume 94 percent of income above $200,000 earned at the peak of World War II, remaining at an oppressive 91 percent through the 1950s.

With corporate and individual tax rates subject to congressional whim, the omnipresent lobbying class flourished as those with the most to lose from government confiscation of wealth sought special exemptions.  As rates and complexity of the code grew, business profit margins became more dependent on an accounting teams ability to legally shield a company’s assets from the federal and state governments reach.

The effect of turning a corporation’s profitability away from the product they produced and toward the influence of their lobbyists and accountants has been to entrench a permanent need to invest in government outcomes to protect your wealth.  This has subsequently evolved into the current crony capitalist system where corporations not only seek protection from government action, but invest in government to increase competitive market advantages as well as receiving direct infusions of taxpayer cash to fund ventures without having to face the scrutiny of the private capital system.

The lesson of 1913 is that one bad election outcome and the subsequent legislative year can have lasting impacts far beyond the imaginations of those who got the snowball of government growth rolling.

As our nation looks at ongoing legislative battles on Capitol Hill and people wonder what the fuss is about, and why Congress cannot just get along, perhaps it would be wise to remind them of a history they were likely never taught.  The history of 1913 and how it impacts our world today — four generations later.  Maybe then they will understand that the battles fought in Congress today are not just for the short term issues at hand, but are truly about what this nation will look like 100 years hence, if we are fortunate enough to survive that long.

Rick Manning is the Vice President of Public Policy and Communications for Americans for Limited Government.

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