The Tariff Act of 1909 forced corporations, for the first time, to open their books to the U.S. government for inspection and audit.
The Tariff Act of 1909, also known as the Payne-Aldrich Tariff Act, can be characterized as one part of a growing progressive reaction against rapid concentrations of wealth in the United States during the late nineteenth and early twentieth centuries. Social forces were driven by sentiment against business tycoons who were perceived as reaping exorbitant profits at the expense of the masses of laborers. In the meantime, political figures, determined to address the concerns of their constituents, were also challenged by growing federal deficits.
The need to finance and eradicate the national debt while circumventing the appearance of imposing an income tax, declared unconstitutional by the U.S. Supreme Court, was imperative. The direct result was an excise tax on corporate forms of businesses.
Section 38 of the Tariff Act of 1909 authorized a special excise tax on net incomes of domestic corporations, joint stock companies, associations organized for profit and having capital stock represented by shares, insurance companies, and foreign corporations operating in the United States or U.S. territories. The tax was 1 percent of net incomes in excess of five thousand dollars after deductions were allowed for ordinary and necessary operating expenses, losses, depreciation charges, interest and taxes paid, and dividends received from organizations subject to this new tax. All taxable incomes were assessed on a calendar-year basis, with tax returns due on March 1 of the following year.
Penalties were determined for fraud, failure to file, and late returns. Fraud carried a corporate penalty of 100 percent of the tax due and a fine that ranged from a minimum of one thousand dollars to a maximum of ten thousand dollars. Individuals responsible for fraud were subject to fines of up to one thousand dollars, imprisonment of up to one year, or both. Failure to file a return carried a corporate penalty of 150 percent of the tax due and a fine that ranged from a minimum of one thousand dollars to a maximum of ten thousand dollars. Responsible individuals were subject to the same fines and imprisonment terms as set forth for fraud. Corporations were assessed a penalty of 5 percent of the tax due plus 1 percent interest, per month, of the tax due for late returns.
The period from the late 1800’s to the early 1900’s was one in which the United States experienced a transition from an agricultural economy to an industrial one. This transition caused a population shift from rural areas to the cities. Wealth became concentrated among the few who were fortunate enough to own businesses. The business climate was ripe for increases in wealth for going concerns, as business was favored by cheap immigrant labor and raw materials, an expanding market, and high protective tariffs against imports, such as those imposed by the Dingley Tariff Act of 1897.
The recessions of 1893 and 1907 also contributed to wealth concentration, as they allowed or encouraged large corporations to buy out smaller firms that were unable to weather the financial storms. For example, the Morgan family bought the Morse shipping interests, a competitor to the Morgan New Haven Railroad. Morgan’s United States Steel Corporation bought the troubled Tennessee Coal, Iron and Railroad Company.
Monopolies and highly concentrated markets were formed as a result of this financial concentration. For example, by 1900, 95 percent of the railroad track in the United States was owned by six investment groups. The Sherman Antitrust Act of 1890
On the labor side, the experiences of the 1880’s and 1890’s brought a maturity to organized labor, which became strong enough to begin challenging corporate sovereignty. The oppression of labor through low wages, poor working conditions, and long hours encouraged the formation of labor unions. The American Federation of Labor
The unity of labor, demonstrated by strikes, caused industrialists to become conciliatory toward labor, and corporate concessions were made. For example, the United Mine Workers
U.S. states also began exercising power over corporations by passing prolabor legislation in the early 1900’s.
The convergence of social, political, and legal sentiment against large corporations led to the Tariff Act of 1909, which was sponsored by Senator Sereno Elisha Payne and Senator Nelson Wilmarth Aldrich. Aldrich was a particularly powerful member of the Senate who wished to mitigate or repeal certain tariffs contained in the Dingley Tariff Act of 1897 pertaining to favored special-interest groups. To offset the revenue reductions, however, new taxes had to be imposed to meet the federal deficit, which stood at $100 million. Opposed to an income tax, Aldrich included an inheritance tax in the act. A coalition of Republican Party dissidents demanded that an income tax be included. To prevent a split within the Republican Party, President William Howard Taft stepped in and worked out a compromise. The result was the Tariff Act of 1909, which authorized an excise tax on the privilege of operating corporate forms of business, with the excise based on corporate net income.
The immediate, and most significant, impact of the Tariff Act of 1909 was the intrusion of government into corporate financial affairs. Through the act, government established implicit control of corporations, at least in principle. The Internal Revenue Service was authorized to audit corporate records if it had reason to believe returns were incorrect or not filed as required. The government was also authorized to use the courts to force compliance.
The special tax, which looked more like an income tax than an excise tax, was challenged in Flint v. Stone Tracy Company in 1911
The 1911 Supreme Court decision made it apparent that corporations had no further recourse. For the first time in history, records of U.S. corporations were open to outside inspection. Laissez-faire no longer applied. Furthermore, the requirement to report corporate income on standardized government forms set in motion a standardization of accounting principles and an accountability to shareholders that had been virtually nonexistent before.
Prior to 1909, corporate records were guarded closely by the few principal corporate owners. Most investment bankers and stockholders were uninformed regarding the financial positions and operations of corporations. They relied on the reports of the principals, sometimes to their detriment. Moreover, investors were generally unsophisticated in financial matters and were therefore willing to accept the reports in blind faith. When investment bankers asked for audited financial statements, some corporations refused to sell securities through those individuals.
Reporting behavior changed as a result of the excise tax. It was not uncommon for corporations to keep two sets of records, one for tax reporting and one for reporting to stockholders and other users of financial statements. Lower, and probably more accurate, earnings were reported to the government. Despite this new accountability to the government, shareholders had no protection from securities fraud until the Securities Act of 1933 and the Securities Exchange Act of 1934.
Depreciation policy received greater attention as a result of the Tariff Act of 1909 because this was the only expense deductible against income that could be based on estimates rather than determined on a cash basis. Before the act’s passage, no method of depreciation allocation was prescribed, and, accordingly, firms used a multitude of methods. For example, Standard Oil
The corporate excise tax became a corporate income tax in 1913 with the passage of the Sixteenth Amendment
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Anderson, Donald F. William Howard Taft: A Conservative’s Conception of the Presidency. Ithaca, N.Y.: Cornell University Press, 1973. Examines all aspects of Taft’s presidency. Chapter 4 discusses the political bargaining Taft used to secure passage of the Tariff Act of 1909, particularly the instrumental support gained from Speaker of the House Joseph Gurney Cannon and from Senator Aldrich, who opposed corporate income taxation. -
Beth, Loren P. The Development of the American Constitution: 1877-1917. New York: Harper & Row, 1971. Provides insight into the political, economic, and social events surrounding constitutional reform in the late nineteenth and early twentieth centuries. Chapter 5 sheds light on the attitude of the U.S. Supreme Court toward business in the areas of labor relations and taxation. -
Carson, Gerald. The Golden Egg: The Personal Income Tax—Where It Came from, How It Grew. Boston: Houghton Mifflin, 1977. Chronicles the political events surrounding and perpetuating income taxation. Primarily concerned with the income taxation of individuals, but chapters 4 through 7 provide insight into the politics leading to the corporate excise tax. Entertaining reading for those interested in political behavior. -
Degler, Carl N. Out of Our Past: The Forces That Shaped Modern America. 3d ed. New York: Harper & Row, 1984. Presents a descriptive account of the beliefs, assumptions, and values that shaped the United States in the mid-nineteenth century. Provides indirect evidence of social forces influencing and leading to the Tariff Act, with accounts of attitudes and events during the late 1800’s and early 1900’s. -
Faulkner, Harold U. The Decline of Laissez Faire, 1897-1917. 1951. Reprint. Armonk, N.Y.: M. E. Sharpe, 1977. Comprehensive history of economic, business, and technological progress during this period. Entire chapters are devoted to manufacturing, railroads, and agriculture. Includes illustrations. -
_______. The Quest for Social Justice, 1898-1914. 1931. Reprint. New York: Franklin Watts, 1971. Presents a history of social thought and attitudes during this period. Explains the dynamics of attitudes and practices of business and labor, providing many examples. -
Ratner, Sidney. Taxation and Democracy in America. New York: John Wiley & Sons, 1967. Excellent source for information on the social, political, and economic history of taxation in the United States up to World War II. Chapters 12 and 13 provide excellent coverage of the Tariff Act of 1909. -
Seligman, Edwin. The Income Tax: A Study of the History, Theory, and Practice of Income Taxation at Home and Abroad. 2d ed. 1914. Reprint. Clark, N.J.: Lawbook Exchange, 2004. Relatively general in nature. Provides a theoretical perspective on the history of taxation.
Republican Congressional Insurgency
U.S. Federal Income Tax Is Authorized
United States Establishes a Permanent Tariff Commission
Securities and Exchange Commission Is Established