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Table Of Contents

The Oleomargarine Tax -- Designed To Prevent Competition With Butter

Source

rationally to the taxes they confront.

The Oleomargarine Tax

The federal tax on oleomargarine is of interest because it represents a case of Congress and the

executive succumbing to pure rent seeking on the part of the dairy industry. Moreover, the acceptance

of this tax by the Supreme Court represented a significant extension of the police powers of the federal

government.

The Constitution reserved police powers for the states and the individual citizens. The whole

regulatory edifice built by the federal government beginning in the latter part of the 19th century had to

overcome this constitutional constraint. The government breached this barrier by way of its consti-

tutional powers to tax, regulate interstate commerce, and regulate the mail. The Constitutional question

raised by the oleomargarine tax was whether the federal government had the power to impose a tax

which did not have the specific purpose of raising revenue (Lee 1973, Ch. 1). The excise tax on

distilled spirits did not face this constitutional hurdle because its primary purpose was to raise revenue;

officially the sumptuary aspects of the tax were of secondary importance. Use of federal taxing

authority to regulate rather than merely raise revenue would significantly expand the police powers of the

federal government based on the long recognized principle, reiterated by Justice Marshall,

that the

power to tax is the power to destroy. This power to destroy is constrained when the primary reason for

a tax is raising revenue, since destruction of a taxed activity eliminates all tax revenue. As the

deliberation over tax rates following the repeal of Prohibition shows, a revenue-maximizing tax authority,

has an incentive to assure the long-run survival of the activity which produces revenue. This objective

requires tax rates that are moderate enough not to go beyond the peak of the Laffer Curve.

The Industrial Revolution and modern chemistry wrought fundamental changes in the

production of food. Increasing technological expertise in the latter part of the nineteenth

century made possible the manufacture of table foods from ingredients hitherto unused for

such purposes, such as cottonseed oil or animal fats, that closely resembled the genuine farm

commodity. The manufacture of oleomargarine was an outstanding example of this trend

(Lee, p. 12).

Oleomargarine, developed in France and introduced into the United States in 1874, was first

manufactured by mixing skimmed milk with processed animal fat. With the addition of yellow dye

oleomargarine resembled butter in appearance as well as food value, but was cheaper to manufacture.

Coincidentally, technological progress in the dairy industry was increasing the supply of butter and

driving down its price (Lee, p. 13). Caught in this vise of falling butter prices and rising competition

Page 11

from a new product, the dairy industry's response was predictable: They appealed to government for

protection from "unfair" competition from the upstart oleomargarine manufacturers. The dairy industry's

early rent-seeking success came with the states, especially the dairy states. In the 1880s, most states

passed legislation regulating the manufacture and sale of oleomargarine and/or levied taxes on it, while

several states banned its sale entirely. Other states passed laws prohibiting manufacturers from adding

yellow dye to the product, thereby make margarine less attractive. New Hampshire required the

addition of an unappealing pink color (Lee, p. 15).

As with the control of alcohol, the dairy industry asserted that federal legislation was necessary

to truly regulate the abuse and fraud perpetrated by the production and sale of margarine. Arguments

used by the industry were that oleomargarine was unwholesome, that consumers were being defrauded

because margarine was often mislabeled as butter, and that the use of yellow coloring was fraudulent

and should be prohibited--or that at least, the manufacture and sale of margarine should be restricted in

some way. Oleomargarine properly made was a "wholesome nutritious food," and occasional fraud in

labeling or in the use of substandard ingredients could be dealt without driving the product off the

market (Lee, p. 13-14). Furthermore, the dairy industry was not above adulterating butter with cheap

ingredients and coloring their own product to make it more appealing (Lee, p. 17). The real issue was

the competition the dairy industry faced from the cheaper substitute, and the industry went to great

lengths to eliminate this competition. Finally, in 1886, the industry was successful in getting a law passed

by Congress and signed by the president requiring the licensing of manufacturers, wholesalers, and

retailers of oleomargarine (with annual fees of $600, $480, and $48 respectively) and imposing a tax of

two cents per pound. As a result of this legislation, the number of oleomargarine manufacturers

dropped by more than a third (Lee, p. 22-23).

The federal law as well as several state laws were challenged in the courts. Since the tax was

designed solely to inhibit an industry and not to raise revenue, it was argued that it entailed an

unconstitutional usurping of police powers that the Constitution granted to the states. In a series of

decisions the Supreme Court accepted this federal encroachment of the powers originally reserved for

the states as well as some of the state laws that seemed to violate the due process clause by, for

example, completely banning the industry (Lee, p. 23-27).

Rent seeking is, in effect, the hiring of the coercive power of the state by some private citizens to

use against other citizens to give themselves some private advantage. This is one of the abuses that the

Constitution was designed to prevent. As in many other cases, politicians and justices found ways

around these constraints to allow the central government to grow ever more powerful.

With the door opened by the oleomargarine tax, over the next few years other industries

demanded that the federal government provide them with protection from "unfair competition". Attem-

pts were made by various producer groups to limit competition from such products as lard diluted with

processed cottonseed oil, filled cheese, phosphorus matches, and various drugs. Not all of these and

other attempts were successful. For example, a tax on adulterated lard failed not because of some

higher principle but because two powerful special interests were on opposite sides--these were the

cottonseed oil industry lobbied against the tax, and the cattle industry in favor of it. Taxes were,

however, successfully used to eliminate from the market the filled cheese, phosphorus matches,

artificially colored oleomargarine, opium, and a number of other drugs.

As a result of shortages of dairy products caused by a combination of World War II and price

controls, considerable consumer dissatisfaction with the laws regulating margarine (which by now was

made with vegetable oil) developed.

Because of pressure by various consumer groups, margarine

manufactures, the League of Women Voters, and to help gain the support of organized labor the

Democrats promised to repeal the taxes on oleomargarine during the 1948 election campaign. This

Page 12

promise was fulfilled, and the national taxes on margarine were repealed by a bill signed by President

Truman in March 1950. (Lee, p. 58) As in the case of adulterated lard, the tax on margarine was not

repealed because the federal government suddenly came to its senses and decided it had overstepped

its constitutional authority. Rather, the shortages of the war years helped alter the balance of political

power and, as a result, competing interest, along with "public opinion", could no longer be ignored. In

the next section we will see an example of the use of a tax to constrain the formation of public opinion.

The Knowledge Tax

Censorship is probably as old as human speech. Socrates for example, was condemned to

death in ancient Greece for "blasphemy against the gods and because his teaching was impious" (Pinon

1960, p. 10). The invention of moveable type in the mid 15th-century brought increased demands on

the censors from both the church and the crown. The knowledge tax in the form of a stamp tax on

paper, pamphlets, books, and newspapers represents a considerable refinement in the censor's tools.

This tax allowed the censor to focus with precision on the offending material and tax it out of existence.

Gone were the difficult-to-enforce lists of banned books, executions for sedition or treason, and many

other forms of punishment.

Censorship is a way for the church--when it enjoys a monopoly as did the Catholic church in

the West prior to the Reformation--and the state to maintain their positions of authority. In the case of

the state, censorship creates a barrier to entry by prohibiting the dissemination of competing ideas and

criticism. The state uses censorship to protect the rents that accrue to it by virtue of its control of the

levers of power--"the state" here meaning the individuals who are actually making decisions to protect

their access to rents. These individuals include kings, majority parties in parliaments, presidents, prime

ministers, and bureaucrats.

Taxes on knowledge were first implemented in England during Queen Anne's reign. The stated

purpose of these taxes was to "check false and scandalous libels' against Government and the most

horrid blasphemies against God and religion'." However, according to Collet's history of the knowledge

tax, the actual reason for this initial tax--as well as duties on linen and soap --was to help finance the

War of Spanish Succession (Collet 1899, p. 8). A tax was placed on legal documents, "on papers,

pamphlets and advertisements, and required a stamp to be placed on every paper that [Parliament]

chose to call a newspaper" (Collet, p. 8). Special dispensations were allowed for uses by the universi-

ties and the church and for certain other scholarly books. When first imposed in "1712 the tax was a

halfpenney on half-a-sheet or less, and one penney on publications of more than half-a-sheet" (Pinon,

p. 24). The press recognized the danger the knowledge tax represented to it and fought the tax from

the very beginning.

During the reign of George III, hostility between government and the press grew. Rapid

economic growth and technological change created conflicts when change disrupted the established

order between employers and employees, in agriculture, and between social classes. Political

corruption, in part resulting from the existence of rotten boroughs and the whole issue of electoral

reform, also generated conflict between government and the press. In the 1760s, John Wilkes engaged

in a heated print campaign against the government for freedom of the press and electoral rights. Wilkes'

attacks led to demonstrations in the streets and provoked the resignation of the Prime Minister, Lord

Brute. His successor, George Grenville, had Wilkes sentenced to the Tower and his papers

confiscated. This sentence was overturned by the chief justice (Pinon, p. 21-22).

Another failure to suppress the press by force eventually turned Parliament to a more subtle

means of censorship. Ancient privilege prevented the reporting of speeches made in Parliament.

However, a Parliamentary speech delivered in 1770 by Lord Chatham which took to task government

Page 13

officials for engaging in a system of "bribes and corruption...allowing them to wax fat at the expense of

the State and of the Empire", was memorized and subsequently reported by Sir Philip Frances writing

under the name Junius (Pinon, p. 23). The resulting uproar led George III to order that "a stop once

and for all [be put] to the pretensions of the press" (Pinon, p. 23). Hostilities between the press and

government continued to increase as Parliament attempted to use force to impose its will on the press.

Once again demonstrations broke out; members of Parliament were struck by stones and potatoes

thrown by an angry crowds, the Prime Minis-ter's carriage was destroyed (Pinon, p. 23). The Crown

and Parliament were forced to back down. These setbacks led to a change in tactics. When force

failed to halt the growing threat to the rents controlled by the crown and Parliament they substituted the

knowledge tax. Just as consumers of alcoholic beverages will substitute when confronted with a tax or

prohibition, those in control of government will find (or attempt to find) another means to maintain

control of rents associated with the coercive power of the state when the costs of using the current

means increase.

Exacerbating the government's problem was the emerging symbiotic relationship between the

press and public opinion. Beginning in the latter 18th century, technical progress and innovation were

dramatically lowering the cost of printing. Simultaneously--and not coincidentally--public opinion was

becoming important as a political force (Johnson 1991, ch. 6). Crucial to this formation of public

opinion were the newspapers and, thus, the knowledge tax was used in an attempt to tame this growing

monster when other means had failed. Antonio Pinon-Tiana summarizes the government's attack on the

press as follows:

In 1756 the tax was increased by another halfpenney. In 1789 it went up to 2d. In 1792 it

rose to two and a half pence. In 1804 to 3d., and in 1815 to 4d. less 20 per cent. As a

consequence of this increase in taxes the London papers,

The Times

among them, were

compelled to raise their prices to 7d. which necessarily reduced circulation to a few

thousands, with the result that the press simply existed for the governing classes (Pinon, p.

24).

Not only was there a stamp duty on newspapers, but a levy on paper and advertising, and laws

requiring the registration of printers and printing presses were also enacted.

In 1815, an act made sure for the first time that various provisions of the knowledge tax

covered pamphlets and printed papers containing "observations on the news", and also required the

posting of a bond before publishing a newspaper, pamphlet, or printed papers. Many of the modifica-

tions in the law were designed to extend coverage to forms of printed material that had been created to

escape coverage of earlier provisions of the tax, or to extend coverage to new areas the government

found troublesome, such as editorial "comments on the news" (Collet, p. 17). These actions indicate a

fairly widespread legitimate attempt to avoid the tax by altering the format of printed material so that it

would escape coverage or be taxed at a reduced rate. Outright tax evasion was also widespread. One

provision adopted in 1815 specified substantial fines for street hawkers caught selling unstamped

papers. The law also encouraged citizens' arrests by offering a reward of 20 shillings to anyone who

apprehended such a tax evader (Collet, p. 13).

Taxing newspapers, however, was like stirring up a hornet's nest--with the predicted result that

the press continuously campaigned against the taxes and argued for their repeal. There were also

committees and societies organized to fight for the repeal of the taxes on knowledge. These efforts

were finally successful. The tax on advertising revenue was repealed in 1853, the stamp duty in 1855,

the paper duty in 1861, and the remaining provisions in 1865.

Page 14

Colonial Censorship

Early censorship in the American colonies followed the initial English model of suppression by

brute force and was abandoned in the colonies between 1725 and 1730 (Pinon, p. 31). In 1765,

Parliament extended the stamp duties that were already in place in England to the American colonies.

The purpose of these taxes was to help defray Britain's cost of defending the colonies. Ironically, the

"[tax] money was to be spent entirely in the colonies for their benefit and protection" (Adams, p. 293).

The Stamp Act of 1765 required stamps on every colonial newspaper, pamphlet, legal document, pack

of playing cards, and pair of dice.

Colonial newspapers declared war on the British.

There were riots in Boston directed against

those associated with the stamp duty. Violent protests broke out in New York and Rhode Island. By

late 1765, crowds were burning revenue collectors in effigy throughout the colonies and "convincing"

them to resign their commissions (Nash and Jeffrey, 1986, p. 145). Here again, Parliament, by

antagonizing newspapers, stirred a hornet's nest which this time helped lead to the loss of the American

colonies.

Conclusion

We have examined three different "sin" taxes: the whisky tax, the oleomargarine tax, and the tax

on knowledge. These taxes are not only of historical significance, they illustrate the different reasons

that can motivate government to impose a tax aside from the search for additional revenue. Examination

of these tax episodes also reveals the various responses to taxes on the part of those who bear the tax

burden. Finally each of these taxes played an important role in either the founding or the early formation

of the United States.

Whisky taxes and the knowledge tax also exhibit the tendency of a tax to go from one primarily

designed to raise revenue (though in both cases the sumptuary aspects of these taxes were used as

selling points) to one designed to discourage consumption and production. Anti-consumption fervor

then often leads to an increase in the tax to prohibitory levels and, finally, back down again--in the case

of the whisky tax after Prohibition--to primarily a revenue tax. The oleomargarine tax was always a

nonstarter as a generator of funds, never raising much more than 1 percent of total internal revenue and

in most years significantly less than that; it was a tax solely designed to discourage the production and

consumption of margarine.

Aside from revenue, the motives of the British, Colonial, and United States governments in

imposing taxes on whisky and other alcoholic beverages has been to reduce the perceived harmful

effects of their consumption. In the cases we have examined of both prohibitory taxes and outright

prohibition at the national level, the combined political, economic, and social costs of prohibition led to

their repeal and replacement by more moderate taxes.

In the nineteenth century the federal government instigated a regime of regulatory taxation with

rent-seeking as its sole motivation. The oleomargarine tax best illustrates this governmental tax motive.

The dairy industry, through its manipulation of the political process, was able to secure legislation that

severely constrained the ability of the rival manufacturers of margarine to compete. Interestingly, this tax

was only repealed when wartime shortages changed the political balance. Among other forces

consumer anger over shortages of dairy products convinced the Democrats to favor repeal of the

margarine tax to help the party during the 1948 election.

A third tax motive, illustrated by the knowledge tax, is found in the attempt by government to

strengthen its own grip on governmental rents by handicapping the competition in the market for political

ideas. These taxes were also eventually repealed, in part because they inflamed the very sources of

Page 15

communication that carried the political competition. From the beginning, newspapers fiercely opposed

the knowledge tax and were finally successful in obtaining its repeal.

Another major component of the history of sin taxes is evasion. High taxes always lead to

evasion. Selective excise taxes are evaded by substitution into the production and consumption of legal

but non-taxed--or more lightly taxed--alternatives, and by substitution to illegal underground

transactions that avoid taxation entirely. As a result, attempts to reduce crime and other social problems

caused, for example, by the consumption of whisky, led to a whole new set of criminal and social

problems associated with illegal tax evasion. We also saw examples of how supposedly "uniform" taxes

have non-uniform results. This is because products are multidimensional, resulting in substitution along

one or more of several dimensions. In the case of the whisky tax of 1791, each proof-gallon of whisky

bore the same per-unit tax, but the tax per dollar of sales was much higher on the lower quality "West-

ern" whisky than on the higher quality whisky produced by the large distillers. This was one of the

grievances that led to the Whisky Rebellion.

Finally, these episodes illustrate the important role taxes have played historically in shaping and,

in fact, leading to the overthrow of the existing government. The whisky tax and subsequent rebellion

was used by Hamilton to assert the power and authority of the central government. He felt that a show

of force was necessary to demonstrate that the national government was a major player as a wielder of

coercive power.

The constitutional issues raised by the oleomargarine tax resulted in a series of Supreme Court

decisions that significantly enhanced the police power of the federal government. And perhaps most

dramatically, resistance to the Colonial extension of the knowledge tax helped set in motion the

American Revolution. This response, and the Whisky Rebellion, illustrate a very common historical

response to taxes: open rebellion. Though this response has been seen less frequently in recent years,

especially in the developed world, it remains to be seen whether rebellion as a response to taxes

perceived to be unjust has passed forever into history.

Page 16

References

Alchian, Armen A., and Allen, William R.

Exchange and Production: Competition, Coordination,

and Control, 3 rd. ed.

Belmont, California: Wadsworth, 1983.

Adams, Charles.

For Good and Evil: The Impact of Taxes on the Course of Civilization

. London:

Madison Books, 1993.

Barzel, Yoram. "An Alternative Approach to the Analysis of Taxation."

Journal of Political Economy

84 (December 1976): 1177-97.

Collet, Collet Dobson,

History of Taxes on Knowledge

, 2 Vols. London: Unwin, 1899.

Dowell, Stephen.

A History of Taxation and Taxes in England

, Vol IV. Reprinted New York:

Augustus M. Kelley, 1965.

Gruver, Rebecca B.

An American History

, Vol II, 3rd. Ed. Reading, Massachusetts: Addison-Wesley,

1981.

Hu, Tun Y.

The Liquor Tax in the United States

. New York: Columbia University, 1950.

Johnson, Paul.

The Birth of the Modern: World Society 1815-1830

. New York: Harper Collins,

1991.

Lee, R. Alton.

A History of Regulatory Taxation

. Lexington, Ky.: University Press of Kentucky,

1973.

Manning, Raymond E.

Federal Excise Taxes

. Public Affairs

Bulletin No. 72. Washington, D. C. (July 1949).

Menken, Percival S.,

Regulation of the Liquor Traffic

. New York: Columbia College, 1891.

Miron, Jeffrey A., and Zwiebel, Jeffrey. "Alcohol Consumption During Prohibition."

American

Economic Review

81 (May 1991): 242-47.

Nash, Gary B., and Jeffrey, Julie Roy.

The American People

. Cambridge, Harper & Row, 1986.

Pinon Tiana, Antonio.

The Freedom of the Press

. Manila, Philippines: University of Santo Tomas

Press, 1960.

Schlesinger, Arthur M.,

Prelude to Independence: The Newspaper War on Britain 1764-1776

. New

York: Knopf, 1957.

United States Department of Commerce,

Historical Statistics of the United States 1789-1949

Washington, D. C.: U. S. Government Printing Office, 1949.

Notes

Page 17

This is quoted by Charles Adams (1993, p. 140). The original quote is from a chronicler from

the mid-1700's by the name of Grapperhaus.

Adams (1993, p. 347) here and elsewhere presents many examples of the burning of tax

records. Burning records was in fact very common historically. These records usually represented the

only detailed account of the population, so their elimination made it more difficult to reinstate the tax at

some future date.

Hu (1950, Ch. 1) describes the relative impact of the whisky tax on the various geographic and

economic interests. He also presents an account of the events associated with the Whisky Rebellion.

Much of the sequence of events presented here is taken from his account.

A proof gallon is a gallon of spirits that contains 50 percent alcohol. The tax is adjusted

proportionally for spirits containing more or less than 50 percent alcohol.

The Whisky Ring affair was one of the numerous scandals that rocked Grant's two terms as

president. The scandal involved distillers bribing federal tax officials to avoid paying the excise tax.

Grant's private secretary became involved in the scandal (Gruver, 1981, p. 429).

The statistics presented in this section relating to alcohol consumption during Prohibition are

"subject to considerable margin of error" (Hu, p. 54). The errors should not be so large as to affect the

overall changes in the consumption patterns caused by Prohibition.

The states had problems reaching an agreement over a unified state-federal tax policy because

of problems in determining how to distribute the revenue among themselves. Some states were

primarily consumers, such as New York, and some like Kentucky-- which was dry--were primarily

producers. The suggested distribution formulas were either based on consumption or production, and

no single formula could satisfy all the states (Hu, p. 66-68).

McCulloch v. Maryland

, 4 Wheaton 316 (1819).

The Laffer Curve, named after the economist Arthur Laffer, illustrates the simple point that as

the tax rate increases from zero, tax revenue will increase up to a point and then begin to decrease. To

see why revenue eventually decreases, consider what would happen if income was taxed at a rate of

100 percent. No one would work (or at least report any income) and tax revenue would be zero. As

the rate decreased from 100 percent, people would begin to earn income and tax revenue would

increase. Revenue is maximized at some rate between zero and 100 percent.

There was a considerable health hazard involved in the manufacture of phosphorus matches,

causing many workers in the industry to die a grisly death. However, under proper conditions these

matches could be manufactured safely.

As a result of a tax on artificially colored margarine, if consumers wanted yellow margarine for

purely aesthetic reasons they were forced to mix in the yellow dye at home. This obvious inconvenience

annoyed consumers.

See Schlesinger (1957) for a detailed account of this interesting episode.