Jack Lew Could Learn from the Mellon Plan

Treasury should treat the disease, not the symptom, of offshoring by cutting corporate taxes.

If Walgreen's shareholders are smarting, they can blame Jack Lew.

The company's shares dropped after Walgreen's announced it would not shift its headquarters overseas even though it is still planning to buy Europe-based Alliance Boots.

Walgreen's executives didn't tell the public that moving overseas wouldn't save Walgreen's tax dollars because that would not be true. The U.S. corporate tax, at 35 percent, ranks among the highest in the world, and shifting overseas through an acquisition does reduce the tax bill for companies and, therefore, increase profits for shareholders.

What Walgreen's said was that it seemed wise to avoid the "protracted controversy with the IRS" that relocating the headquarters for tax purposes might entail. And Walgreen's is correct about that wisdom. For the Internal Revenue Service reports to the Treasury, where the secretary, Mr. Lew, recently labeled tax inversions, as such relocations are known, "abuse of our tax system."

Hearing those words, the firm probably felt just about the way you feel after someone pours some rubbing alcohol they sell onto your open cut. Who wants to be caught out as guilty of "abuse"? Lew does not seem the leader here: The Treasury secretary seems to be simply dispensing medicine from the White House. President Obama has said he is weighing executive action to block more inversions, and is said to want to apply what some refer to as a tourniquet to stop the corporate outflow.

President Obama has criticized inversions with even stronger language, saying inversions reveal a dearth of "economic patriotism." But Lew may want to consider something: Treasury doesn't have to be in every case a factotum of the president. The department can also lead. And that's what a predecessor of his, Andrew Mellon, did in an analogous situation. The result of this secretarial display of independence benefited both Treasury and the country.

When the great magnate came to the Treasury in the early 1920s under President Warren Harding, the top marginal rate of the income tax was 73 percent. Investors also looked to flee. In those days tax-free municipal bonds, not relocating overseas, were the loophole of choice. Americans poured millions into sometimes less productive, projects of towns and cities. Sometimes they claimed they were doing so simply because municipal bonds were more reliable than investments in private companies. That was the argument of Senator James Couzens of Michigan, who wrote that he invested in such bonds out of "a desire to escape business responsibilities and risks and to insure the future income of . . . families."

Mellon, however, thought avoiding taxes was the real motive, and that the cash pouring into munis was being squandered. That money could be funding both Treasury coffers and the growth of the general economy, he complained: "The government gets no tax and productive business is deprived of capital." As "proprietor" of a new business, the Treasury, he was eager to recapture some of that lost revenue. Mellon's first move was something like Lew's: The secretary launched a self-righteous campaign to place his own tourniquet on the outflow of funds. He backed a new constitutional amendment that would deprive muni bonds of their tax advantage.

This idea did not go over: Voters and their employers were willing to mouth some kind of respect for the Treasury's prerogatives, just as Walgreen's is today. But the same citizens weren't interested in action against the munis. After all, they prized munis' tax advantage.

Mellon, pondering all this, shifted emphasis. Instead of blaming the messenger, he took apart the problem. The true issue was the great disparity between high federal taxes on income and zero federal taxes on city bonds. The administration had already cut surtaxes, the add-on rates that make a theoretically flat-tax schedule progressive. Perhaps Washington should flatten the tax code yet more, diminishing the relative attraction of those municipal bonds. Data were what made Mellon confident: He had long studied revenues of railroads and toll roads. When you cut the rate that you charged rail freight, you sometimes got more traffic, and so more revenue. So might it be with taxes.

Harding died in 1923 and was succeeded by a new president, Calvin Coolidge. The secretary took his own plan to the executive and made his case. Coolidge honored the principle of delegation, and figured he ought to go along with what was known as the Mellon (not the Coolidge) Plan.

With his president behind him, Mellon cut taxes several times more. Economic activity increased. Treasury coffers received more revenue. And the telltale spread between yields of municipal bonds and corporate bonds, reflecting their relative desirability, narrowed in textbook fashion. Deprived of their advantage, municipal bonds were no longer so attractive to buyers. Mellon had got his victory, by attacking the fundamental problem, not the symptom. (For more on this, check out Richard Keehn and W. Gene Smiley's article on 1920s taxes, in the Journal of Economic History.)

The equivalent shift for Lew today would be to give up his anti-corporation attack and push instead for a law to cut the corporate tax rate. A lower corporate tax would convince far more companies to stay at home than would any amount of bullying from Lew or the White House. It might also be easier than the executive action, which observers like Capital Alpha, a Washington-based research service, contend is not legal in any case. But first Lew has to convince himself and the White House that data, not politics, point the way to a stronger economy.

Amity Shlaes is the author of four national bestsellers, Coolidge, The Forgotten Man, The Forgotten Man (graphic edition), and The Greedy Hand.

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