6 - The Era of Easy Finance

Summary

The tax regime created during World War II proved more resilient than the one that had emerged from the previous world war. A key reason was a prolonged postwar surge of remarkable economic prosperity rather than a severe recession like the one that took hold in 1920–1921. The prosperity following so closely on the heels of the Great Depression helped build a popular, bipartisan consensus behind the basic tax policy shifts undertaken during the Roosevelt administration.

After World War II a strong bipartisan consensus emerged behind the central purposes of the tax regime and the fiscal regime of which it was the central component. These purposes included a progressive distribution of tax burden through the income tax; management of total demand under a domesticated Keynesianism designed to avoid a recurrence of the Great Depression; funding a vigorous foreign policy (above all the prosecution of the Cold War); an expansion of various growth-oriented domestic programs within a broker-state framework; and an expansion of Social Security entitlements. The consensus remained strong until the 1970s.

Continual and significant cuts in personal and corporate income taxation reinforced political support for the regime. Until the 1970s the federal government was able to make such cuts while meeting its other fiscal goals. This was because of revenue bonuses produced by economic growth and inflation; the period between 1945 and the 1970s was “the era of easy finance.” But the tax cuts relentlessly undermined the fiscal regime, especially when joined in the 1970s by slower economic growth and faster inflation. While all income groups received some of the largesse from the cuts, the nation's poorest citizens received the smallest and the wealthiest the largest shares, partly because of the progressive structure of income taxation. Thus, the overall effect of the entire series of tax cuts was to reduce that progressivity that had been established during the New Deal and World War II. A long swing away from fiscal progressivism had begun.

Funding Leviathan

The World War II crisis had institutionalized a new tax regime. It had three elements: (1) a mass-based but progressive personal income tax for general revenues; (2) a relatively flat-rate tax on corporate income, also for general revenues; and (3) a regressive payroll tax for social insurance.