Saturday, January 05, 2013

welcome to 2013: centennial anniversary of the irs and the fed...,

seekingalpha | The IRS was Conceived 100 Years Ago Next Month
On February 3, 1913, Delaware became the 36th state to ratify the proposed 16th Amendment authorizing income taxes. With three-fourths of the 48 states backing the resolution, the 16th Amendment became an official part of the U.S. Constitution on February 25, while Republican William Taft was a lame duck President awaiting the inauguration of Democrat Woodrow Wilson a week later on March 4, 1913.

Six months later, the Revenue Act of 1913 was signed into law on October 13, 1913 authorizing tax rates ranging up to 7% for those earning $500,000 or more. The lowest (1%) income tax rate kicked in for single taxpayers making $3,000 per year or couples making $4,000 or more. Therefore, fewer than 5% of U.S. workers were obligated to pay any income tax at first. Businessmen, proud of their success, showed off their tax bill in bars as if to say "I'm one of the top 5%," a badge of honor in a capitalist economy.

World War I changed all that. By 1917, President Woodrow Wilson raised the top tax rates tenfold.

In 1916, President Wilson campaigned against joining the "war to end all wars," but just one month after his second inauguration, he pushed us into World War I and used the income tax to fund that war effort. In 1917, the top income tax rate grew nearly tenfold, from 7% to 67% on top income earners. The new income tax tool was powerful enough to fund America's first entry into a major European conflict.

Unlike most politicians, who tend to mask their views in patriotic pieties, Wilson clearly stated the pragmatism of his politics much earlier in his 1889 book The State:
We are not bound to adhere to the doctrines held by the signers of the Declaration of Independence … Government does now whatever experience permits or the times demand.
Wow! Those last 10 words form a chilling expression of raw unprincipled power. They are also applicable to today's fiscal cliff debate: "Whatever experience permits or the times demand" is a fair description of raising tax rates to fund runaway spending needs.

The Federal Reserve was also Born a Century Ago, in 1913
In a parallel track, the Federal Reserve was conceived and born a century ago this year. On March 31, 1913, J.P. Morgan, America's unofficial one-man central bank, died in his sleep in Rome. Like any good banking man, he died at the closing day of a financial quarter handing new President Woodrow Wilson the opening to create a central bank. After a close call in the Panic of 1907, J.P. Morgan, then entering his 70s, told the nation he was retiring from the central banking business, saying that the next panic would sink him - and the country - even if other syndicate members joined him (as they usually did).

The death of J.P. Morgan almost nine months later led to the centralized solution everyone seemed to favor then. At 6:02 pm on December 23, 1913, The Federal Reserve Act, authorizing the creation of the Federal Reserve, was signed into law by President Woodrow Wilson using four golden pens in a lightly-attended ceremony during the Christmas break. Like income taxes, the Fed quickly grew quite powerful.

The Federal Reserve took shape in stages, throughout 1914, with an official launch date of November 16, 1914. Ironically, the Fed was formed for the express purpose of avoiding the financial panics so painful in recent memory - 1893 and 1907 - but the Fed merely continued the same kind of boom-bust cycle of panics, ranging from a short, sharp shock in 1920-21, to the long-term Great Depression of 1929 to 1941.
In particular, the Fed fueled a huge wave of inflation after providing liquidity for World War I spending. That was followed by a sharp cutoff in liquidity and a "flash" depression in 1920. The Fed then fueled too much liquidity throughout the 1920s, leading to a real estate and stock market crash, followed by a sharp (33%) cut in liquidity between 1929 and 1932. The Fed just couldn't seem to find a balance.

The early Fed was quite clear in its mission. In its 1923 Annual Report, the Federal Reserve described its role clearly:
The Federal Reserve banks are…the source to which the member banks turn when the demands of the business community have outrun their own unaided resources.
This is why the Fed increased credit 61% in the 1920s, from $45.3 billion on June 30, 1921 to over $73 billion in July 1929.

The Fed's inflationary monetary policies led to a nearly 99% decline in the purchasing power of the U.S. dollar in gold terms. In 1913, gold traded for $20.67 per ounce vs. around $1,690 today. Our official cost of living increase since 1913 is +2,261%, meaning that an item costing $1 in 1913 costs $23.61 now. The Fed's policies have also led to a series of stock market booms and busts over the century, begging the question of whether the Fed has been any more effective than J.P. Morgan and his big-banker syndicate.