Fiscal Policy

Fiscal policy in the late 1920s is best viewed as a long, drawn-out postwar readjustment. Although certain costs of the war, such as veterans’ benefits and interest on the increase in the national debt, continued into the postwar period, demobilization nevertheless created considerable scope for cutting the high level of taxes imposed during wartime.

The debate over taxes in the twenties covered the same ground as the debate that began in the 1970s (under the banner of supply-side economics) and continues to the present day. The White House favored reducing taxes by removing the steep progression in rates introduced during the war. Secretary of the Treasury Andrew Mellon argued that reducing high tax rates would encourage savings and growth and that the effects on tax revenues would be relatively small. The wealthy would shift their assets from tax-exempt municipal bonds to taxable assets, thus minimizing the effect on total revenues. Liberals in Congress did not oppose cutting taxes altogether. However, they favored reducing taxes by increasing exemptions for those in lower-income groups. The outcomes of this fight—the revenue acts of 1924, 1926, and 1928—swept away the system of wartime excise taxes, reduced the rates for personal and corporate taxes, and reduced estate duties. On the whole, the pride in their fiscal policies taken by successive administrations during the 1920s is understandable. Tax rates were cut, but revenues grew, and a budget surplus was maintained. Perhaps even more important for the long run, a federal budget system was introduced in 1921 under President Harding that would make it possible to cope, to some degree, with the massive expansion of the federal government that was to come in later decades.

Table 22.5 shows that federal spending was relatively small compared with the whole economy in the 1920s. Indeed, in 1927, the federal government was spending only 3.5 percent of gross national product (GNP), most accounted for by the traditional categories of national defense, the postal service, veterans’ services, and interest on the national debt. Although more funds were being spent on health and welfare, these were still minor categories. The revolution in the budget would come in the thirties.