Economic Conundrum: Historic Case Study

When Warren Harding took office in 1921, America was drowning in debt. World War I had pushed the top income tax rate from 7 percent to a staggering 77 percent, and both parties agreed the system was unsustainable (Republican Platform, 1920). Treasury Secretary Andrew Mellon proposed a solution called “Scientific Taxation” based on the simple but radical premise that lower tax rates would draw capital “out into the open,” revive investment, and generate enough economic growth to sustain federal revenue.

Mellon’s logic, laid out in Taxation: The People’s Business, rested on observation of human behavior rather than ideology. Punitive rates, he argued, incentivized wealthy people to hide their money in tax shelters instead of productive investments (Ch. 1). The evidence was hard to ignore. When William Rockefeller died in 1922, his estate held only $7 million in taxable bonds but over $44 million in tax-exempt securities (Mellon, 89). Between 1916 and 1918, as marginal rates jumped from 15 to 77 percent, the number of tax returns in the $500,000 to $1 million income bracket fell from 376 to just 178 (Revenue Act Analysis, 1921). People weren’t earning less; they were just getting better at avoiding taxes.

Mellon’s solution had three parts: slash marginal rates to reduce the incentive for avoidance, close loopholes that rewarded evasion, and simplify the whole system to reduce compliance costs (Scientific Taxation, 12-15). His goal was a 25 percent maximum rate, low enough to make concealment unnecessary and high enough to fund government through growth rather than coercion. The system was “scientific” because it was based on empirical evidence of how people behave when tax rates rise and fall.

Coolidge embraced Mellon’s logic wholeheartedly but also gave it a moral core. Unlike modern politicians who celebrate revenue-maximizing rates, he worried that excessive revenues would fuel government expansion. He believed unnecessary taxation violated personal liberty and that citizens were entitled to keep what they earned unless government could truly justify taking it (Coolidge, 234). For him, Scientific Taxation was Coolidge’s moral vision of restraint, thrift, and respect for the taxpayer.

The results were astonishing. Congress enacted major rate cuts in 1921, 1924, and 1926. The top rate fell from 73 to 24 percent, yet total income tax receipts jumped from $719 million to $1.16 billion (Treasury Report, 1930). High earners paid more, not less, as lower rates reduced the incentive to hide income, exactly as Mellon predicted. Federal debt declined significantly. Real GNP grew at 4.7 percent annually between 1922 and 1929. Unemployment fell from 6.7 to 3.2 percent (Economic Indicators, 145). Most remarkably, Coolidge’s insistence on spending restraint produced consistent budget surpluses from 1924 through 1929 – the only multi-year surplus run in the entire 20th century.

In Coolidge’s mind, the reforms were both morally and practically sound as they achieved exactly what they were supposed to: Wealth flowed back into productive investments, boosting jobs and wages, while government lived within its means.

A modern evaluation is inevitably more mixed. Scientific Taxation did not insulate the economy from the 1929 crash. It is possible that the rapid expansion of the 1920s encouraged excessive optimism and speculative investment. Still, Mellon and Coolidge understood something fundamental: the relationship between tax rates and revenue isn’t linear. Human behavior responds to incentives. And a government that taxes with restraint may command more resources, and more trust, than one that reaches for every available dollar. Their program reflected a coherent worldview: Americans prosper most when government is disciplined enough to leave them free.