Making Corruption More Difficult
Tax History: Promoting Honesty by Releasing Corporate Tax Returns
Are there simple ideas that would improve corporate honesty without interfering with a free market? Of course there are. In this article, Joe Thorndike of Tax Analysts discusses an interesting case from history. Can we learn from it?
by Joe ThorndikeWould public release of company tax returns help ensure corporate honesty? Sen. Charles E. Grassley, R-Iowa, thinks it might. His suggestion recalls an earlier effort to combat corporate wrongdoing through tax publicity. For a few short years in the early 20th century, corporate returns were public documents.
The corporation excise tax (CET), enacted in 1909, included a publicity provision opening returns to public inspection. Supporters believed that publicity would encourage honesty -- an important consideration in an era when business malfeasance made frequent headlines. Most business leaders, on the other hand, decried publicity as an intolerable infringement on corporate privacy.
President William Howard Taft proposed the CET in the midst of a complex political crisis for the Republican Party. Old guard GOP legislators were losing their battle to protect the nation's high tariff against a coalition of Democrats and progressive Republicans. Determined to safeguard party unity, Taft hoped his corporation tax would stave off further GOP defections.
The maneuver worked. The CET splintered the bipartisan coalition by striking at its linchpin: support for more general income taxation. While coalition members sought tariff reduction above all else, it was income taxation that held their alliance together. Taft took aim at this critical juncture by suggesting an excise levy that was actually a thinly veiled, low-rate corporate income tax. He correctly gambled that this modest nod toward income taxation would splinter the tariff reduction coalition.
Contemporary observers derided the CET as little more than a partisan ploy -- a clever stratagem designed to salvage Republican dignity. And it was certainly that; Taft was keenly interested in protecting GOP unity, and he used the CET expertly to serve that end. But his support for this novel tax was not simply instrumental. Indeed, Taft considered the CET an important element of economic reform, a critical ingredient in a larger, more important, and more durable political project: the regulation of private enterprise.
The CET's publicity provision was central to its regulatory function. Taft and his supporters believed that publicity served a dual purpose. Most immediately, it would encourage honesty, lifting the veil from corporate finance and encouraging accuracy in company reports. A recent series of corporate scandals had turned the spotlight on business morality, and the CET drew much of its support from political leaders eager to head off future wrongdoing.
CET supporters also argued that information gleaned from tax returns would enhance the federal government's capacity for other, more direct forms of corporate regulation. The administrative state of the early 20th century was underdeveloped; only the Commerce Department's Bureau of Corporations possessed investigative powers, but the information it produced was fragmentary and incomplete. Before policymakers could embark on any serious effort at corporate regulation, they needed better information about the finances and activities of American businesses.
CET advocates expected the law to fill the information gap. Its returns, however, were not extensive, requiring corporations to report only their gross income, expenses, losses, and depreciation, as well as any interest, taxes, or dividends they had paid. Critics pointed out that more complete information could be found in corporate annual reports, as well as company reports to various stock exchanges. But information from those sources was inconsistent and often informal. And private investor services, like Moody's Manual of Industrial and Miscellaneous Securities, were still in their infancy. For all their shortcomings, then, the CET returns promised to be the most consistent and comprehensive source of corporate information.
Taft believed the CET's publicity provisions were vital. When defending the law, he stressed the role of publicity as a tool to fight corruption: "If now, by a perfectly legitimate and effective system of taxation, we are incidentally able to possess the government and the stockholders and the public of the knowledge of the real business transactions and the gains and the profits of every corporation in the country, we have made a long step toward that supervisory control of corporations which may prevent a further abuse of power." Later, when corporate attacks on the publicity provision were beginning to turn the tide against the CET, Taft resisted efforts to scale back this aspect of the law, insisting that it was the only part he really cared about in the first place.
Despite the popular tendency to dismiss the CET as a political ploy, its substantive importance was not lost on everyone. Business leaders, in particular, were quick to see the tax for what it was. Critics representing a broad range of industries, regions, and business types set on the CET, arguing that it infringed intolerably on corporate privacy. Moreover, they asserted, the tax conferred enforcement powers on the Bureau of Internal Revenue that would allow the taxman to crawl through the inner workings of every American corporation.
The Commercial and Financial Chronicle was the CET's most vociferous editorial opponent. "The inevitable effect of such a law," the magazine warned, "would be that everyone engaged in business would have a pack of Government officials at his heels; the Government would all the time be prying into his affairs, examining his books and accounts to make sure that no portion of the tax got away from it, and the knowledge gained would be made public property."
These complaints played on long-standing suspicions of the federal tax apparatus. After the Civil War, attacks on inquisitorial tax gatherers had paved the way for repeal of the nation's first income tax. In 1909 hostile lawmakers resurrected the specter of big government to stave off this new tax proposal.
Not all business leaders, however, were hostile to Taft's plan. Some welcomed the move for greater openness. "Inside graft is today the thing that is doing probably as much as anything else to bring injury to honest investment and ruin to corporate morals," declared The Wall Street Journal. "Much of the protest against the proposed measure has its root in rottenness rather than righteousness."
Over the short term, publicity proponents carried the day, but their foes were persistent. Business leaders deluged Congress with protests after the law's enactment. A well-organized business campaign targeted publicity for repeal, and while initially reluctant, Congress eventually restricted public access. Within two years, lawmakers effectively eliminated public access altogether, establishing constraints and restrictions that left the publicity provision a dead letter.
It was only a temporary victory for privacy advocates. Tax return publicity remained a fixture of political debate for another 30 years. Indeed, the Treasury Department routinely released individual tax information during the 1920s; newspapers frequently published lists of local millionaires and the taxes they paid. Supporters of releasing information insisted that publicity was the surest guarantee of honesty in financial reporting, both for individuals and corporations.
Nonetheless, the CET remains a novel effort to use publicity as a cure for corporate wrongdoing. While borne of a partisan crisis, it represented a high-minded Progressive Era inclination to use information as a weapon against corruption.
We have a saying -- "sunlight is the best disinfectant," meaning that publicity and openness make crime and corruption more difficult and costly. What's your opinion? What's the boundary between free market disclosure and government intrusion? Tell your views to The Progress Report:
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