Administrative Capacity and the Image of a Rational Executive Agency

Developing a cooperative, corporatist relationship between state and society was crucial to the Treasury Department's institutional mission of building public trust. So too was the creation of administrative capacity. If “figuring” rather than “fighting” was what Treasury personnel could do to help win the war, the lawyers wanted to make sure that the department had all the administrative power that it needed. Treasury therefore, first, needed to establish and guard its jurisdictional prerogatives, especially since war mobilization created numerous government organizations that frequently blurred the institutional lines of control. In the process, the department needed to project the image, if not the reality, of an agency that was imposing rationality onto the uncertainty of war financing.

To do this, Treasury lawyers used their professional contacts and legal skills to protect the scope of their administrative powers. They defended their authority over fiscal policy by rebuking other, often newly created, federal entities such as the Capital Issues Committee (CIC)—the organization created as part of the War Finance Corporation (WFC) to filter and supervise the flow of capital to private businesses. When the CIC attempted to regulate bank loans, Treasury lawyers relied on their skills of statutory interpretation to quash what they saw as an encroachment onto their powers. “I think it would be bad organization and contrary to the spirit, if not the letter of the Act under which the Capital Issues Committee was formed, for it to interfere in any way with bank loans,” Leffingwell notified McAdoo.Footnote ⁵⁸ Similarly, when some states attempted creatively to tax the interest on federal government securities—contrary to the law—the Treasury department unleashed its powers and those of the Justice Department and the Federal Reserve System to remind state tax officials to adhere to the details of federal law. Treasury's legal staff also drafted legislation, coaxed lawmakers, and considered new rules that would contain the autonomous powers of state governments within the structures of U.S. federalism. In curbing the powers of other war agencies and state governments, Treasury consolidated its own powers by clearly delimiting the authority of competing organizations.Footnote ⁵⁹

The different bureaus within the Treasury themselves frequently clashed over the exercise of administrative power, particularly when it came to communicating with the taxpaying public. A correspondence between Ballantine and Leffingwell revealed concerns over who had proper jurisdiction to issue Treasury regulations related to tax collection. Leffingwell contended that it was Treasury secretary McAdoo and not his subordinate, the Commissioner of Internal Revenue Roper, who was ultimately responsible for accepting Treasury certificates as payment for income and profits taxes. He sternly informed Ballantine that “the public debt and public monies are matters which do not concern the Commissioner; and investors . . . will be reassured by reading that the regulations are to be prescribed by the same authority which issues them.” In his typically self-assured style, Leffingwell even provided Ballantine with detailed legislative language illustrating his point.Footnote ⁶⁰

Maintaining jurisdictional control was not only an issue of power, however. It was also a matter of establishing the perceived legal transparency, stability, and predictability that were critical to broadcasting the impression of an organized and coherent executive agency. At times, this meant that the Treasury lawyers were willing to use their legal and financial expertise to help taxpayers execute unique and complex commercial transactions, such as when Henry Ford bought out the minority shareholders of the Ford Motor Company in 1919. This transaction, as Roper later recalled, proved to be “an exceptional opportunity” for the BIR to provide the tax guidance that effectuated the buyouts, yielded substantial tax revenue, and garnered the trust of the business community.Footnote ⁶¹

Besides such special cases, the Treasury lawyers understood that to impose rationality onto the uncertainty of war financing they needed to control the flow of public information. Information, as the lawyers knew, was vital to the effective functioning of capital markets and the overall revenue-raising process. In reality, controlling information to project a judicious image was frequently less about increased transparency than it was about carefully cultivating public perceptions. To this end, Leffingwell kept an incredibly tight personal grip over public access to government information. He was quick to admonish his bureau chiefs for press leaks. He often edited the official press releases issued by the department. And he regularly read the New York and Washington papers to review how they were covering war financing, and to gauge how editors were responding to new policies.Footnote ⁶²

The Treasury lawyers also shaped public perceptions in other ways. Thomas Love, at McAdoo's behest, tapped his Texas contacts and used his skills as a political operative to campaign for Liberty Loans. Roper, as we have seen, used the BIR's advisory boards and ad hoc committees to convince taxpayers of the effectiveness and fairness of tax assessments. In a rare moment of self-congratulation, even Leffingwell acknowledged how Treasury's proficient administration of war financing had enhanced public confidence in the department. After learning, in the fall of 1918, that the press and investors had favorably received the fourth and largest Liberty Loan distribution, he wrote to McAdoo that we “have undertaken stupendous tasks and imposed heavy burdens but heretofore without arousing antagonism or controversy. Now more than ever we need to make the people feel that the great machine is running smoothly.”Footnote ⁶³

In some ways, controlling the flow of public information did not appear to be a task that required the skills of professional corporate lawyers. After all, George Creel's Committee on Public Information was already carefully managing U.S. public opinion, often with propaganda evoking chilling and dangerous images of foreign invaders.Footnote ⁶⁴ But unlike the Americanization campaigns and loyalty drives that emerged from public relations professionals, the complex financing information generated and controlled by the Treasury had a particular meaning and resonance among the elite network of investors, wealthy taxpayers, business leaders, financial advisers, and lawyers with whom Leffingwell and his colleagues had regular contact. Thus, even when it came to directing public information, the lawyers provided a distinctive contribution to the wartime state-building project.

If maintaining jurisdictional powers and controlling public information were indispensable to developing Treasury's claims of professional proficiency, managing revenue collections and coordinating them with the timing of debt payments stretched the limits of such organizational capacity. The extent of the department's capacities was tested in spring 1918 when the Treasury Department contemplated allowing taxpayers to defer the payment of their federal income and profits taxes. Initially, the Treasury lawyers acquiesced to the plan, but upon further reflection they agreed that any deferment past the June 15, 1918 deadline for paying the income and profits taxes would upset the delicate timing of certificate and loan payments. As early as December 1917, Leffingwell warned McAdoo that “we could not safely” issue a new series of certificates “if deferred payments of taxes were permitted.”Footnote ⁶⁵

Although the Treasury Department opposed the idea of deferment, it also realized that forcing taxpayers to pay all their income and profits taxes at once could cause a dramatic shock to the economy. Bankers feared that tax payments by their large corporate clients could trigger a panic run on their reserves at a time when other clients would need to borrow to pay their taxes; hence many in the business and financial communities urged lawmakers to allow for deferred installment payments of federal taxes. The Treasury lawyers carefully monitored revenue estimates, as they considered alternatives to tax deferment.Footnote ⁶⁶

Treasury proposed several recommendations. In a widely circulated letter to lawmakers, bankers, and leading members of the business community, Leffingwell synthesized the work of his legal staff to illustrate how existing laws and department decisions provided several possible solutions, including the opportunity for “the partial payment, in advance, of income and profits taxes,” and the use of short-term certificates in lieu of cash to pay taxes. The recently enacted Liberty Bond Act, Leffingwell reminded his readers, also permitted the Treasury to deposit the proceeds of tax payments into U.S. banks, thereby mitigating any potential short-term turnover in bank deposits. The law, moreover, provided an appropriately timed coupon payment that would help taxpayers meet their tax liabilities. With these and other safeguards in place, Leffingwell confidently persuaded McAdoo and other officials that there was no need to concede to the demands for tax deferment.Footnote ⁶⁷

As the June tax deadline approached, Leffingwell and Love anxiously monitored the increasing news coverage of expected tax payments.Footnote ⁶⁸ In the end, the federal government collected nearly $2.8 billion in profits and income taxes by the deadline, and an additional $855 million in other internal revenues.Footnote ⁶⁹ More important, the BIR was able to perform the collection process without any difficulties to money markets or the economy as a whole. “The tax payments were made without a ruffle,” one banker explained with surprise. “The immense financial transaction was consummated almost without being noticed. The transaction was put through with perfect balance and without the least disturbance to business or banking.” McAdoo sent along his personal congratulations to Leffingwell for guiding the successful collection process.Footnote ⁷⁰

In administering wartime tax laws and policies, Treasury developed the bureaucratic capacity that undergirded the legal legitimacy of the wartime fiscal state. Even though at times they may have limited the transparency of their actions, Leffingwell and his colleagues attempted to build public trust by projecting the image of a rational executive agency. Gaining and maintaining the faith of taxpayers and citizens was only one of the early and ongoing challenges. When it came to formulating the broad principles of fiscal policy, Treasury officials faced an equally daunting task of assuring the public that the costs and sacrifices of underwriting a global conflict were being shared equitably.

Formulating Policy and the State Obligations of Fiscal Citizenship

Among the principal policy issues confronting Treasury officials, none was more salient than analyzing the war financing options. Although nearly everyone agreed that a balance between taxes and public borrowing was necessary, economic experts, social commentators, and lawmakers vastly disagreed on the appropriate mix. Underpinning these policy debates was the fundamental issue of how one defined the relationship between patriotism, wartime sacrifice, and fiscal citizenship. What rights and obligations, in other words, did citizens and the state have toward each other during a war emergency?

For many social critics and policymakers, the answer was obvious. Fiscal citizenship meant that members of the political community—as taxpayers, creditors, and consumers—had a moral and patriotic duty to make the necessary wartime sacrifices to support the state. “A new sense of the obligations of citizenship will transform the spirit of the nation,” the progressive journalist Fredrick Lewis Allen predicted at the start of the war. Progressive tax reformers had for decades been promoting direct and graduated taxation as a way to forge a new ethos of social solidarity and civic obligation. Graduated taxes were based on the notion that each citizen owed a debt to society in proportion to his or her ability to pay. By weaving direct and graduated taxes into the fabric of U.S. legal institutions and culture, the Great War became a historic moment to further the progressive commitment to shared social responsibility.Footnote ⁷¹

Throughout the conflict, many political leaders emphasized the need to use tax policy to spread wartime sacrifices evenly across class and region. On the eve of the war, Claude Kitchin (D-NC), the House majority leader and powerful chair of the Ways and Means Committee, did not hide his sectional bias. When wealthy New York citizens, he wrote “are thoroughly convinced that the income tax will have to pay for the increase in the army and navy, they will not be one-half so frightened over the future invasion of Germany and preparedness will not be so popular with them as it now is.” Others went further in criticizing the moneyed classes. “The stock brokers would not, of course, go to war, because the very object they have in bringing on war is profit,” declared the progressive Sen. George W. Norris (R-NE). “They will be concealing in their palatial offices on Wall Street, sitting behind mahogany desks, covered with clipped coupons—coupons soiled with the sweat of mothers' tears, coupons dyed in the lifeblood of their fellow man.”Footnote ⁷²

Several of the Treasury lawyers agreed that the national crisis and nascent federal taxing powers provided a unique opportunity to promote a new type of civic identity. Roper frequently instructed his BIR staff to emphasize appeals to patriotism. He also enlisted the influence of the American clergy and the publicity powers of popular and business periodicals to spread the word about “The Glory of Paying the Income Tax.” And when opportunistic individuals sought to profit from turning in tax evaders, Roper personally rebuked such attempts at personal gain with nationalistic zeal. “Certainly no good citizen,” he instructed one potential informant, “would think of profiting on the understated taxes of his neighbors—people unfamiliar with the intricacies of this complicated tax law, not if he were a good citizen and had the right attitude toward his own people—and the right attitude toward defending his country in this war.”Footnote ⁷³

In the process of formulating broad fiscal policy, however, Treasury lawyers stretched the meaning of fiscal citizenship beyond the conventional, singular focus on the obligations and duties of citizens. Like the earlier tax theorists and political activists who supported progressive taxation, the wartime Treasury lawyers believed that fiscal citizenship meant that the state had a reciprocal social obligation and democratic responsibility to its citizens, a duty not only to protect them during war but to ensure that the obligations of wartime fiscal sacrifice were equitably distributed among community members. In this way, fiscal citizenship was not solely a unidirectional force, requiring the allegiance only of individual citizens to the activist state. Fiscal citizenship, instead, entailed a set of mutual egalitarian responsibilities on state actors to spread more evenly the costs and sacrifices of underwriting a modern global war. Because the new tax laws had made the “government a partner with business,” as Roper had explained, the scale and scope of the new fiscal policies made it “increasingly important that the partners co-operate for their common good.”Footnote ⁷⁴

The dynamics of patriotism, wartime sacrifice, and fiscal citizenship were perhaps best expressed in the policy debates over the proper mix of wartime funding sources. On one side, there was a fragile congressional coalition led by populist and progressive lawmakers like Kitchin and Robert M. La Follette Sr. (R-WI) who wanted to use the newly created taxing powers and the war emergency to redistribute wealth in a more equitable manner. Aligned against this coalition was a business community that favored consumption taxes and a more general use of income taxes aimed at all classes of society. Led by members of the northeastern commercial elite, this group was cognizant of the regional ramifications of shifting from a system of indirect consumption taxes to a regime of direct and graduated levies.Footnote ⁷⁵ The business community, of course, did not speak with one voice. Many companies understood that the war required economic sacrifice, and more than a few firms did their part to hold the line on prices and profits as part of their patriotic service. But when it came to taxes, especially the new profits levies, U.S. companies used a variety of maneuvers to ensure that wartime profits were not always returned to the Treasury.Footnote ⁷⁶

If the disagreements between southern and western populists and northeastern business elites echoed the tensions of the past, professional economic experts did little to placate such opposition. Economists, in fact, were equally divided over the issue of war financing. Some, like O. M. W. Sprague of Harvard and Irving Fisher of Yale, favored a “pay-as-you-go” method, using progressive income taxes and widespread consumption taxes to curb inflation and finance the war.Footnote ⁷⁷ Other leading experts such as Edwin R. A. Seligman of Columbia and Charles J. Bullock of Harvard feared that a resort to excessive taxation would blunt the incentives for economic productivity. Although the latter group conceded that taxes ought to be an important part of war financing, they contended that increased borrowing would soon become necessary, especially if the conflict became protracted.Footnote ⁷⁸ In their role as moderators, Treasury lawyers had to confront the controversy among the economic experts and between populist politicians and the conservative business community.

In doing so, Leffingwell and his colleagues underscored how fiscal citizenship entailed a reciprocal social and democratic obligation on the state to distribute fairly the burdens of wartime sacrifices. As policymakers were considering a third round of Liberty Loans in the spring and summer of 1918, Leffingwell the “Wall Street Republican” argued for the importance of taxation. “The sound rule to stick to,” Leffingwell reminded McAdoo, “is that taxes should be as heavy as they can safely be levied.”Footnote ⁷⁹ Although McAdoo had initially agreed, he soon became enamored with the ease of issuing low-interest, tax-favored government debt.Footnote ⁸⁰ In his attempt to capitalize patriotism, McAdoo embarked on a nationwide speaking tour and enlisted the services of several of his Treasury lawyers, including Thomas Love, and some of the country's leading artists and celebrities to publicize the sale of government bonds.Footnote ⁸¹

Leffingwell agreed that “there is no substitute for the appeal to patriotism,” but he held a broader understanding of patriotism, sacrifice, and fiscal citizenship. Patriotism for McAdoo meant that the state could rely on the obligations and responsibilities of its citizens to participate directly in funding the war through loans and taxes. For Leffingwell and his legal colleagues, an unreflective resort to more borrowing without a greater reliance on taxation was an abdication of the state's civic responsibility to its citizens. To be sure, the Treasury lawyers did not agree with Sprague and the political activists who wanted to rely mainly on taxes; nor did they agree with those who were issuing dire warnings about excessive taxation.

Rather, as arbiters of social forces, the lawyers sought to pave a more moderate path. Leffingwell reminded McAdoo that reliance on a variety of taxes could raise revenue, curtail consumption, and equitably spread the costs of the war. With their experiences in the capital markets, the lawyers understood that the trade-off between taxes and bonds was fundamentally about timing—whether current or future taxpayers were responsible for the war costs. A war financing policy that “forced people to take bonds” was, in Leffingwell's estimation, a double penalty against future taxpayers who would have to contend with paying back the war loans and financing the postwar recovery. A resort to more borrowing posed other problems as well. Flooding the credit market with government loans was, Leffingwell assured McAdoo, a sure step towards financial ruin—it “simply means an enormous amount of undigested securities choking the market, depreciation in bond prices and ruin to the credit of the United States and inflation of the currency.” As the war progressed, Leffingwell seemed to forget the significance of his comments, but his remarks concerning inflation would prove to be quite prophetic.Footnote ⁸²

Besides analyzing the mix of financing options, the Treasury lawyers also used their networks, skills, and experience in other more mundane, though equally important, policymaking functions. Leffingwell and his legal staff drew on their specific legal and business knowledge to channel Treasury efforts in particular directions and to act as gatekeepers on the use of state power. When McAdoo, for instance, wanted to explore the “federal taxation of real estate,” it was the Treasury lawyers working with the attorney general's office who reminded the secretary that a national property tax required “a Constitutional amendment to permit the United States to levy direct taxes without apportionment.”Footnote ⁸³

In monitoring state power, however, Treasury lawyers did not act only as constraints. Just as all good gatekeepers are aware of alternative routes, Treasury lawyers often used their technical knowledge, access, and expertise to navigate around legal challenges to policy proposals. In the fall of 1918, with German troops in retreat, the Wilson administration was contemplating the creation of a War Trade Export Corporation, another wartime corporatist entity that could be used specifically to tax exports. Leffingwell and his legal staff not only reminded McAdoo that such a levy was also “prohibited by express provision of the Constitution,” they went on to make a plausible alternative recommendation.Footnote ⁸⁴

The recommendation illustrated how the Treasury lawyers used their professional network and legal skills to craft long-run, forward-looking, corporatist solutions. After consulting with members of the War Trade Board—the existing agency supervising all import and export activity—and his former Cravath partner, E. C. Henderson, whom Leffingwell described as “the best lawyer I know, bar none,” Leffingwell suggested that the administration forsake the short-term—and constitutionally futile—aim of trying to tax exports and focus instead on how the government could use the waning months of the war to establish the country's postwar trade position and long-term geopolitical power. To that end, he suggested that a new corporatist agency be established along the lines of the War Industries Board to organize and license exporters. This plan, Leffingwell continued, “would have the great advantage . . . of tending to bring the export houses in a position where they would be able after the war to develop our foreign trade, instead of practically putting them out of business during the period of the war and leaving them disorganized and disheartened to deal with after-the-war problems.” To assuage the administration's desire to tax the growing profits of exporters, Leffingwell assured McAdoo that the robust wartime profits tax “can be trusted to take into the Treasury excessive profits which may result from the adoption of this plan.”Footnote ⁸⁵ The imminent end of the war less than a month later precluded McAdoo from pursuing an export tax or creating a new export licensing agency, but the suggestion vividly illustrated how Treasury lawyers had become attracted to the corporatist model of state-building.

The search for new sources of tax revenues and the appeals to patriotism and fiscal citizenship were examples of how the Treasury department attempted to spread the costs of the war across a broad swath of socioeconomic classes, regions, and even generations. But, ultimately, the war financing policies had complex and often contradictory consequences. McAdoo seemed to be aware of how the interest rate on bonds could have far reaching implications. In deliberately setting an initially low rate of interest, McAdoo contended that “we should be reducing the cost of war, not only today for ourselves, but, in the future for ourselves and for our brave men who are fighting in France and will have little or no opportunity to accumulate and invest in Liberty Bonds though they must upon their return join the army of taxpayers who must pay this interest.”Footnote ⁸⁶

McAdoo's rhetoric about helping the quotidian “army of taxpayers” did not match his actions, or wartime reality. The so-called army of ordinary taxpayers was rather slim. Though the sundry consumption taxes affected a broad swath of citizens, and generated some colorful protests, the vast bulk of federal tax revenue came from the income and profits taxes on wealthy individuals and prosperous businesses. Preoccupied with assuaging the social concerns over war profiteering, policymakers seemed to give little consideration to taxing the mass of middle-class wage earners—an option that would be effectively exercised in World War II.Footnote ⁸⁷

The initially low, tax-exempt interest rates set on government debt, furthermore, did not extract the type of wartime financial sacrifice that the Treasury department claimed. The tax exemption disproportionately benefited wealthy individuals not only because they were the primary investors in the largest bond offerings but also because they were the ones subject to the highest progressive marginal rates.Footnote ⁸⁸ Though the consistent oversubscription of Liberty Loans was a clear political victory, the bonds did not have the economic impact that Treasury envisioned. With their knowledge of the interactions of taxes and market forces, the Treasury lawyers were undoubtedly aware of these contradictory actions, but they seemed ineffective in altering policy.Footnote ⁸⁹

Another way in which financing policies undermined economic goals was the inadvertent increase in the price level. In its zeal to issue debt, Treasury fostered a “borrow and buy” mentality among bond investors that, rather than redirecting moneys away from current consumption, in fact, created new money and fueled inflation. In theory, bond sales to the nonbanking public could restrain inflation by absorbing consumer spending, while transferring real economic resources from private consumption to war production. But because the Treasury department encouraged individual investors to use borrowed funds to purchase government debt, and because much of the below-market, short-term debt issued by the Treasury was bought directly by banks, the massive wartime borrowing, in the end, fueled rather than contained inflation.Footnote ⁹⁰

Changes to the nascent Federal Reserve System exacerbated inflationary pressures. Legal modifications to reserve requirements, the centralization of reserves in district banks, and the expansion of banks eligible to be federal depositories were just some of the subtle changes to monetary policy that led to an incredibly elastic money supply. Indeed, the combination of increased bank borrowing and permissive monetary policies led to an explosive growth in the money supply and a concomitant mushrooming of the price level.Footnote ⁹¹ Although he claimed to have learned from the errors of the past, McAdoo's resort to easy money, in the end, had a striking resemblance to the Civil War printing of greenbacks.

The Treasury lawyers unwittingly contributed to the increased bank borrowing and the resulting inflation. From his perch as undersecretary, Leffingwell endorsed McAdoo's contradictory ideas and actions. Despite his earlier warnings about the adverse impact of excessive borrowing, Leffingwell seemed to suspend his financial judgment. Not only did Leffingwell encourage financial institutions, including Federal Reserve member banks, to accept U.S. bonds as collateral for loansFootnote ⁹²; he also supported McAdoo's attempts to use moral suasion and appeals to patriotism, rather than legal restrictions, to prevent investors from selling their bonds for further spending. Leffingwell believed, like McAdoo, that a liberal democracy, even during wartime—perhaps especially during wartime—could not restrict the economic decisions of its citizens by prohibiting them from selling their financial assets. “It is of course important to avoid making people think that if they subscribe they will not be permitted to sell,” Leffingwell remarked in an April 1918 telegram to McAdoo. “We realize that subscribers might have to sell their bonds and should be protected as far as possible against losses.”Footnote ⁹³

Like McAdoo, Leffingwell preferred to contain inflation with appeals to patriotism and the fiscal responsibilities of investors, rather than more forceful actions. “It should be the object of the Secretary of the Treasury, and of all public men,” Leffingwell sternly informed lawmakers, “not to encourage people to lend their money to the Government one day and to take it back the next, nor to make it easy for them to do so, but to teach the people to save and lend their money to the Government for a period of years. Liberty loans are an investment—the best on earth. They are not currency and are not meant to be.”Footnote ⁹⁴ Leffingwell went even further in relying on civic virtue to restrain private spending. He reminded the secretary with words from McAdoo's own annual report that wealthy Americans had additional wartime financial and civic responsibilities: “The men and women of large and moderate means owe a greater duty, because they have a larger margin of income, to cut off self-indulgences, to deny themselves useless and needless luxuries, to make sacrifices of comforts, pleasures, and conveniences that will effect genuine economies and set an example to the Nation.”Footnote ⁹⁵

The fiscal sacrifices of citizens at home were inextricably linked to the physical sacrifices made by soldiers at the frontlines. As Leffingwell reminded McAdoo, quoting again from the secretary's annual report: “It is a sacred duty of every citizen and it should be regarded as a glorious privilege of every patriot to uphold the Government's credit with the same kind of self sacrifice and nobility of soul that our gallant sons exhibit when they die for us on the battle fields of Europe. It is as imperative to sustain the Government's credit as it is to sustain our armies because our armies cannot be sustained unless the Government's credit is always above reproach.”Footnote ⁹⁶ Not all citizens, of course, embraced this “sacred duty” or “glorious privilege,” and some lawmakers may have viewed Treasury's words as hollow rhetoric. But Leffingwell and McAdoo certainly believed they could mobilize patriotism to their advantage, even though their actions were, in the end, obfuscating the true costs of the war.Footnote ⁹⁷

Although the dynamics of the war frequently overwhelmed policymakers' intentions, the Treasury lawyers did moderate the formation of broad fiscal policies. Leffingwell's admonishments in spring 1918 to balance taxes and borrowing expressed a broader social desire to spread equally the costs of wartime sacrifices. The subsequent legislation, which was not enacted until the winter of 1919, after the armistice and after Republicans took control of Congress, was not nearly as progressive as some populist lawmakers had anticipated; nor was it as reactionary as some business leaders and conservative legislators had hoped. Instead, the new tax law revealed that the Wilson administration was not willing to renounce the social and ethical obligations of fiscal citizenship.

In their role as policymakers, the Treasury lawyers were not simply passive scientific engineers; they were also policy and political entrepreneurs, seeking to convince lawmakers of the legitimacy and usefulness of their expertise and knowledge. They were not simply builders of organizational capacity; they occasionally used their increased power to exercise a new found bureaucratic autonomy.Footnote ⁹⁸ Simply put, they were not just interest takers, but interest makers who engaged the legislative process with their insights about the consequences of the laws and policies they were asked to implement. Thus, in advancing administrative governance, the Treasury lawyers both effectively executed the democratic will of Congress and at times challenged lawmakers when the implications of new statutes seemed to become unhinged from the original aims. One of the most forceful challenges of existing law came in the spring and summer of 1918 when Treasury questioned the efficacy of the excess-profits tax.

Between Justice and Revenue: Evaluating and Defending the Excess-Profits Tax

From the start, the initial profits tax on munitions makers and the subsequent excess-profits tax on all businesses were rooted in social concerns over war profiteering. As early as 1917, the popular journal The Outlook documented “the extraordinary increase in profits” among the leading industrial concerns. Comparing the profits of over one hundred companies from 1914 to 1916, the editors calculated that the aggregate “profits of these one hundred and four corporations exceed the profits of the year in which the war began by over a billion dollars.” (See Table 2). With these soaring profits came bloated dividends and rising returns on equity, at a time when the stock market as a whole was witnessing substantial drops in real value. From this statistical evidence, The Outlook joined other leading popular periodicals in supporting an excess-profits tax to make “the war-brides pay up.”Footnote ⁹⁹

Table 2.

Increase in Corporate Profits of Select U.S. Corporations, 1914–1916 (nominal dollar amounts).

Source: “Helping the War Pay For Itself,” The Outlook, June 27, 1917, 319–20. A similar table was printed in the Congressional Record as part of the House discussion of the excess-profits tax. Congressional Record, May 18, 1917, 65th Cong., 1st Sess., 2541.

The social protest against war profiteering led to the adoption of the 1917 excess-profits tax. But many economic and legal experts questioned the efficiency, administrability, and even constitutionality of a tax on all profits beyond a “normal level.” The main point of contention seemed to rest with the idea of using “invested capital” as a baseline from which excess profits could be determined. Seligman seemed to sum up the hostility towards the notion of “invested capital” when he wrote that “what constitutes capital is so elusive as to be virtually impossible of precise calculation.”Footnote ¹⁰⁰ Members of the business and legal communities echoed Seligman's concerns. The Commercial and Financial Chronicle—that bastion of orthodox business thinking—attacked the “Excessive Taxation of ‘Excess’ Profits” as “governmental confiscation of wealth.” Favoring the British version of a war-profits tax, the editors of The Wall Street Journal similarly disparaged the excess-profits tax as “hasty and ill-advised legislation . . . rushed through Washington by politicians desiring political favor with the many by taxing the capital of the few.” Lawyers representing financial interests added their voice. Harping on the alleged unconstitutionality of the excess-profits tax, Robert R. Reed, the counsel for the Investment Bankers' Association, assailed the law as a “confiscatory tax on businesses.”Footnote ¹⁰¹

Soon after it was enacted, opponents of the excess-profits tax commissioned a group of economists to conduct a comparative investigation of U.S. and British war financing. Under the supervision of Thomas S. Adams, the BIR's chief economist, Treasury organized its own team of economists, accountants, and lawyers to examine the consequences of the existing excess-profits tax. Adams's study supported what many in the financial and academic communities had predicted from the start, namely, that the excess-profits tax appeared to have unintended consequences. The existing levy, with its use of “invested capital” as the baseline for determining “excess profits,” was adversely affecting small businesses more than the large corporations it was designed to attack. Larger corporations were able to manipulate the law to reduce their tax liability. By increasing their invested capital, either by issuing more equity or by increasing their investments in intangible assets or through other accounting maneuvers, they could inflate the base from which their rates of return and profits were calculated, thereby placing their net profits in a lower tax bracket. By contrast, smaller enterprises, especially those that relied mainly on personal services such as family businesses, did not have high levels of capital to begin with, nor did they have the slack to adjust their capital levels or annual investments. Thus, they were hardest hit by the excess-profits tax.Footnote ¹⁰²

Even before the Treasury completed its study, McAdoo was encouraging lawmakers to consider supplementing the existing excess-profits tax with a new British-style profits tax that levied a high flat rate on all profits above prewar average earnings. Since Kitchin remained the key congressional supporter of the excess-profits tax, McAdoo took his recommendation directly to the powerful southern congressman. In a carefully drafted letter, McAdoo explained how “the existing excess profits tax does not always reach war profits.” McAdoo argued that “a flat rate of 80% on all war profits,” those measured against a prewar average of profits, was a better method for getting at war profiteering.Footnote ¹⁰³ Kitchin remained unconvinced. From the beginning, populists like Kitchin and progressives like La Follette wanted to make the excess-profits tax a permanent part of the national tax system. Enacting a tax that relied on prewar earnings as its baseline would mean conceding that the levy was a temporary measure—one that could be discarded easily at the end of the conflict.Footnote ¹⁰⁴

Treasury completed its initial investigation of the excess-profits tax in the summer of 1918, just as the Ways and Means Committee was drafting its version of a new tax bill. The Treasury lawyers eagerly used the department's study to build the necessary support for the war profits tax. Because Leffingwell had long suspected the inequities of using invested capital as a measure of excess profits, he enthusiastically marshaled the resources of the department to lobby Kitchin.Footnote ¹⁰⁵ The study, together with numerous petitions from small businesses, confirmed Leffingwell's suspicions that the excess-profits tax did not accurately capture the profits created by the war, and that it was permitting the growth of corporate capitalism rather than curbing or taming it.Footnote ¹⁰⁶

Leffingwell's understanding of the study seemed to be in some tension, however, with its actual conclusions. Whereas the investigation focused mainly on the rate structure of the excess-profits tax, Leffingwell highlighted instead the problems of using “invested capital” as a base to measure excess profits.Footnote ¹⁰⁷ As corporate lawyers, Leffingwell and Ballantine, who also had some reservations, may have been uneasy about using newly created state capacity to regulate corporate profits. Other Treasury officials, including Roper, were concerned about moving to a war-profits tax based on prewar earnings, but Leffingwell was confident that a war-profits tax was the fair and just method because it balanced the need for revenue with concerns about economic productivity.Footnote ¹⁰⁸

In a confidential memo to the president's secretary, George Tumulty, Leffingwell identified what he thought were the fundamental differences between the war profits and the excess profits taxes:

The department's study did not explicitly criticize the excess-profits tax in such sharp terms. Indeed, some economic experts believed that the existing levy might not be excessive, nor that it would hinder economic productivity. But, for Leffingwell, the excess profits tax was “wholly indefensible” because it fundamentally challenged the precepts of modern American capitalism. The former corporate lawyer was willing to attack war profiteering, but he was not interested in undermining the long-term incentives that he believed were the driving force of the nation's economic growth and productivity.

In his private memo, Leffingwell went even further in criticizing the general theory of taxing corporations at progressive rates: “Any graduated tax upon corporations is indefensible in theory for corporations are only aggregations of individuals and by such a tax the numerous small stockholders of a great corporation may be taxed at a higher rate than the very wealthy large stockholders of a relatively smaller corporation.” In echoing this common critique, Leffingwell emphasized the report's conclusion about the unintended consequences of the existing excess-profits tax. “The object of a graduated tax should be to make taxes fall upon the rich who are best able to pay them,” Leffingwell explained. “The graduated excess profits tax disregards this, and often produces the reverse result.”Footnote ¹¹⁰ In criticizing progressive corporate tax rates, Leffingwell was seeking indirectly to support the move to a higher flat rate on all war—as opposed to excess—profits.

Leffingwell's memo appeared to achieve its intended objective. “The course of the Administration is plain,” Tumulty responded the following day. “We must stand for the War Profits Tax to the end.” He hastened to add that “the ‘staging’ of the whole business” of presenting the administration's position to Congress and the public was “most important.” Bureaucratic autonomy rested heavily on how the ideas of unelected administrators were framed for democratically accountable lawmakers. That same day President Wilson wrote Kitchin to inform him of the importance of “a war profits tax as distinguished from a mere excess profits tax.” The former, the president claimed, was “manifestly equitable.” Acknowledging the difficulty of enacting a tax increase during an election year, Wilson optimistically assured Kitchin that a new profits tax would be well received by the business community. “I do not believe that the manufacturers of the country who are now making profits directly from war work would object” to the new tax, wrote Wilson. “On the contrary, I think that they would feel a certain pride in sharing the burdens of the war directly with the men who are giving their lives for the safety of America and the freedom of the world.”Footnote ¹¹¹

Unsurprisingly, the existing excess-profits levy still had its supporters. In addition to Kitchin, there were others who maintained that the excess-profits tax, even with its flaws, was, as one agrarian group described it, a potent symbol of “justice over revenue.” In a letter to McAdoo, the Farmers' National Committee contended that not enough of the war was being financed through taxation. Its members proposed a “Liberty Tax Bill” as a corollary to the Liberty Loan drives. Speaking on behalf of numerous farmer and labor groups, the Farmers' National Committee called for a fiscal policy in which “one-half of the cost of the war shall be raised by current taxation upon excess and war profits, upon incomes, and upon the unearned increment of land values.” McAdoo passed along this correspondence to Leffingwell, who responded with a letter of his own optimistically stating how taxation had made up “almost one-third of our total expenditures in the fiscal year 1918.”Footnote ¹¹²

To reinforce its support for a war-profits tax, Treasury commissioned its economist T. S. Adams to conduct another systematic comparison of profits taxes. Before taking responsibility for a new wartime tax measure—during an election year no less—Treasury officials wanted to be certain that the war-profits tax could promote distributional ideals without harming revenue. Adams's second report confirmed that an 80 percent flat tax on profits above a prewar average would extract more revenue from big businesses as compared to smaller enterprises, with only a small decline in revenue. The second study, however, explicitly recommended maintaining the excess-profits tax, as a supplement to a new war-profits tax. An excess-profits levy would reach those corporations, such as the Ford Motor Company, “which earned an unusually high rate of profits in the prewar period . . . but would pay no war-profits tax.” Although the report's emphasis on the virtues of the excess-profits tax may have disappointed Leffingwell, he nonetheless set aside his personal views and redoubled his efforts to support the department's position to maintain the excess-profits tax.Footnote ¹¹³

Eventually, Treasury officials were able to persuade Congress to accept the proposal of levying both a war-profits and excess-profits tax. By September 1918, the House drafted and passed a comprehensive revenue bill that included a dizzyingly complex corporate levy containing both an excess-profits and war-profits tax.Footnote ¹¹⁴ The mobilization of the department's economic and legal expertise helped broker a compromise that convinced Kitchin and other lawmakers that a hybrid or dual-profits tax was the appropriate solution to war profiteering. Consequently, the Treasury lawyers were able to reframe the new profits tax as a temporary measure, one that was linked to prewar average profits and that, therefore, could be easily dismantled after the conflict. Leffingwell and his colleagues thus were able to reorient the demands of activist social groups like the Farmers' National Committee and populist lawmakers like Kitchin. Although the bill was not enacted until the following year, the proposed tax increase, coming just before the armistice and midterm elections, had significant political ramifications, helping to deliver resounding congressional victories for the Republican Party.Footnote ¹¹⁵

As lawmakers and Treasury officials were evaluating the merits of the excess-profits tax, lawyers at the BIR were considering the constitutionality of the levy. The BIR lawyers knew early on that one of the greatest challenges in administering the excess-profits tax was “clarifying what invested capital means.” In tackling this task, Ballantine, as the lead BIR lawyer, acknowledged that the excess-profits levy might face some constitutional challenges. Opponents of the law, such as Robert Reed, the legal representative of investment banking interests, had been suggesting in no uncertain terms that the vagueness of invested capital made the excess- profits tax an unconstitutional form of government confiscation. With these comments in mind, Ballantine used his technical legal skills to lay out a detailed doctrinal defense of the excess-profits tax in a 1919 article in the Yale Law Journal.Footnote ¹¹⁶

There were primarily two parts of the excess-profits tax law that Ballantine believed might pose some constitutional issues. The first was, as Reed suggested, a Fifth Amendment due process challenge to the use of “invested capital” as the tax base for measuring excess profits. The second potential issue was whether the “relief clauses” of the law, which allowed the BIR to use comparative statistics to impute invested capital for those businesses that did not have any invested capital, were an unconstitutional delegation of congressional authority. On both counts, Ballantine concluded, “the decided cases appear to disclose little probability that the statute will be upset on either ground.”Footnote ¹¹⁷

Ballantine agreed that the due process clause of the Fifth Amendment could be a legitimate restraint theoretically on the arbitrary exercise of Congress's taxing powers. But in his analysis of the case law, a tax based on the ratio of profits to invested capital was wholly permissible and well within Congress's taxing powers. “As to a method of taxation, like any ‘classification,’ the question is whether there is any reasonable ground for it or whether it is simply arbitrary,” wrote Ballantine. Analyzing a litany of cases, Ballantine contended that any judicial challenge to the congressional taxing power on the grounds of due process was likely to fail. “So vigorous has been the Court in its support of federal taxing power,” Ballantine reasoned, “that all the attacks upon taxing statutes under the Fifth Amendment, upon the ground of their unequal operation, have so far failed.”Footnote ¹¹⁸

The second aspect of the excess profits tax that Ballantine addressed was the constitutionality of the “relief sections” that gave the BIR discretion in imputing invested capital to a business. In determining whether these provisions were an unconstitutional delegation of legislative authority, Ballantine contended that providing “relief” through these provisions was simply a function of administering the law, and was not therefore an exercise in legislative authority. “So long as it can be said that all that is left by Congress to administrative officers is the determination of how a taxing provision applies to a particular state of facts,” Ballantine reasoned, “no delegation is involved.”Footnote ¹¹⁹

Ballantine bolstered his defense by appealing to historical context. He admitted that in an earlier age one could claim that legislatures should maintain the responsibility of creating and administering revenue laws. But in a modern, industrial society where a complex array of laws and regulations were increasingly needed to provide the stability and consistency of an ordered society, effective administration of these new laws and regulations required the creation of new government agencies and organizations. “Recognizing the increasing variety of the subject matter upon which statutes operate, and the increasing complexity of the result sought to be achieved by statutes,” Ballantine wrote, “the courts have gone much farther than under the simpler conditions of an earlier period in supporting the extensive use by the legislative arm of the more flexible executive instrumentality.”Footnote ¹²⁰ Ballantine's legal defense of the excess-profits tax was not just an academic exercise. His views provided some stability for an uncertain legal environment, and in time his legal analysis was vindicated when the Court upheld the excess profits tax soon after the war.Footnote ¹²¹

Lest one confuse Ballantine's constitutional defense of the excess-profits tax as an unequivocal endorsement, the former corporate lawyer judiciously balanced his support of the levy with some biting criticism of it on nonlegal grounds. Like many others, Ballantine thought the tax had several significant drawbacks. It did not curb inflation; it angered taxpayers with its inquisitorial requirements; and it could promote a great deal of uncertainty and delay in generating revenue. Together, these concerns could—and would—ultimately lead to the repeal of the excess-profits tax, but as far as its legal foundations were concerned, Ballantine was convinced that “there is little likelihood that the court will conclude that the discrimination involved in the excess profits tax is hostile or arbitrary.” If business owners and taxpayers in general believed that the excess-profits tax was unwise, there were other methods to address the problem beyond judicial challenges. Ballantine, ever the moderate, concluded, “It is to Congress rather than to the courts that the taxpayer must look for a fairer and wiser distribution of the revenue burden.”Footnote ¹²² Ballantine's words were prescient. Soon after the war, it was to Congress that opponents of the excess-profits tax successfully turned in repealing the measure—to the immense disappointment of populist fiscal reformers and social groups who had hoped to make the excess-profits tax a permanent part of the U.S. tax system.

Postwar Visions of a New Fiscal Order

After the war ended in November 1918, many of the Treasury lawyers actively returned to the private sector. Roper led many of his BIR colleagues into a burgeoning Washington, D.C. consulting and tax law practice, only to return to public life as Franklin D. Roosevelt's secretary of commerce.Footnote ¹²³ Love was equally eager to return to the private sector and Texas politics, as he leveraged his Washington, D.C. contacts to develop a lucrative postwar legal practice.Footnote ¹²⁴ Ballantine also returned to private practice after the war, eventually joining the New York law firm that would become Dewey, Ballantine. Throughout the 1920s, he led the firm's tax practice and became a leading voice of the evolving tax bar. In 1931, he returned to Washington to serve as his Harvard classmate Ogden Mills's Treasury undersecretary.Footnote ¹²⁵

Leffingwell, by contrast, remained at Treasury to ensure a smooth postwar transition. He served McAdoo and his immediate successor Carter Glass admirably, gaining the respect of both men.Footnote ¹²⁶ Leffingwell relished his role as a government official, and he did not hide his disappointment when President Wilson selected David F. Houston, the secretary of agriculture, as Glass's successor ahead of Leffingwell. He rejoined the Cravath firm in 1920 but soon left to take a senior position at the investment house of J. P. Morgan.Footnote ¹²⁷

It did not take long for the lawyers to realize the historical significance of their government service. In a series of correspondence in the fall of 1919, Roper and Leffingwell assessed their contributions and shared their respective visions of a postwar fiscal order. The seasoned administrators reflected on how the past three years had dramatically changed the everyday operations of the federal fiscal system. Building upon their experiences, Roper and Leffingwell discussed how they could make the tax collection process even more effective after the war. Roper made two principal policy proposals. First, he recommended the creation of a “Court of Internal Revenue Tax Appeals” to adjudicate appeals directly from the district courts. Second, and perhaps more important, he suggested that the Treasury consider fundamentally restructuring the tax system to focus on “revenue sources” that might be collected “with the least inconvenience to taxpayers.”Footnote ¹²⁸

Roper's recommendations elicited a mixed response from Leffingwell. Leffingwell was “quite taken with the idea of a Court of Internal Revenue Tax Appeals.”Footnote ¹²⁹ Both Roper and Leffingwell understood how the complexity of wartime tax laws raised numerous legal questions and burdened the judicial system. It was essential, Roper observed, revealing his unquestioned faith in expertise, to have these complex legal issues “considered by men especially trained in Internal Revenue Taxation,” so that “a sound basis of internal revenue court decisions may be assured for both the benefit of the Government and the taxpayer.”Footnote ¹³⁰ Leffingwell agreed. Providing taxpayers with a stable and predictable set of tax laws had been one of the hallmarks of the wartime Treasury. And having a quasi-independent judiciary of professionally trained tax experts was certainly one way to institutionalize the consistent resolution of tax controversies, and thus provide the type of formal rationality that state-builders craved. Such a court could also carve out an autonomous institutional sphere for the nascent tax bar. Although Leffingwell did not elaborate on this self-serving possibility, a specialized court of tax appeals could protect the profession's monopoly on the provision of scarce legal services and thereby enhance the collective power of lawyers within the new polity. It could also further the stratification of the bar, setting tax law experts apart from other corporate and business lawyers.Footnote ¹³¹

If Leffingwell supported the idea of a specialized tax appeals court, he was less enthusiastic about Roper's suggestion to alter revenue sources. Similar calls to return to a more “convenient” system of broad-based tariffs and excise taxes were being made by Sen. Reed Smoot (R-UT) and other congressional opponents of progressive income and wealth-transfer taxes. To Leffingwell, this recommendation seemed to hearken back to the prewar regime of regressive indirect taxation—a system that Leffingwell believed was rendered obsolete by the successful administration of the wartime tax policies. Leffingwell informed Roper that his suggestion “if pressed to the limit . . . would mean that we should have nothing but indirect taxes such as the protective tariff, the excess profits tax, and the consumption tax.”Footnote ¹³² A return to the old fiscal regime meant a return to a regressive, opaque, and ultimately undemocratic system of public finance. “In the case of indirect taxes the whole community pays through increased cost of living, and there is a minimum of inconvenience to the taxpayers,” Leffingwell conceded. “Indeed, most of them know nothing about it.” This invisible form of taxation violated the principles of democracy and modern economics by favoring convenience of collections over the transparency of direct taxation. “I take it that it is good democratic doctrine—certainly it is good economics” wrote Leffingwell, “that a direct tax, such as the income tax, which inevitably involves a certain amount of inconvenience to the taxpayer, is to be preferred to the indirect tax which involves none at all.”Footnote ¹³³

Although Leffingwell did not elaborate on what he meant by “good democratic doctrine,” his ideas and actions during his tenure in the Treasury Department suggest that he had in mind the inextricable link that existed between direct taxes, democracy, and fiscal citizenship. Since the late nineteenth century, tax reformers and political economists had been claiming that the “inconvenience” of direct levies on income, profits, and inheritances made citizens more attuned to the workings of the state, that paying taxes directly to the federal government gave citizens a greater stake in how public funds were raised and used, and that direct taxation ultimately helped forge a renewed sense of civic identity.Footnote ¹³⁴

Leffingwell and the other Treasury lawyers endorsed these views with their actions, if not their words. In the process of building Treasury's administrative capacity during the war, they sought to assure taxpayers that revenues were collected in a consistent and equitable manner. By clarifying the operations of complex new rules and by evaluating and reevaluating the income and profits taxes, the lawyers helped build the trust between citizens and their government that was essential to the success of a liberal democracy engaged in global war. But they also did much more. Their vision for a postwar fiscal order, reflected in Leffingwell's remarks to Roper, went beyond simply using direct taxes to imbue citizens as stakeholders with a sense of belonging to a new national community. The Treasury lawyers knew all too well that even the robust wartime tax laws affected only a small fraction of U.S. citizens. In rebuking Roper's suggestion to alter revenue sources, Leffingwell focused, once again, on the state's fiscal obligations to its citizens, on the responsibility of government officials to distribute equitably and effectively the fiscal burdens of financing a modern industrial democracy. This was one way of striking the balance between justice and revenue.