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,
8
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.
9
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
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,
10
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.
11
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
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
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.
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.
12
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
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.
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
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Washington, D. C.: U. S. Government
Printing Office, 1949.
Notes
17
1
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.
2
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.
3
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.
4
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.
5
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).
6
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.
7
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).
8
McCulloch v. Maryland
, 4 Wheaton 316 (1819).
9
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.
10
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.
11
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.
12
See Schlesinger (1957) for a detailed
account of this interesting episode.
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,
8
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.
9
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
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,
10
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.
11
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
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
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.
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.
12
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
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.
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
17
1
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.
2
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.
3
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.
4
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.
5
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).
6
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.
7
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).
8
McCulloch v. Maryland
, 4 Wheaton 316 (1819).
9
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.
10
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.
11
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.
12
See Schlesinger (1957) for a detailed
account of this interesting episode.
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
constitutional 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,8 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.9
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
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 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".
Attempts 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,10
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.11 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 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 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,
8
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.
9
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
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,
10
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.
11
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
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
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.
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
17
1
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.
2
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.
3
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.
4
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.
5
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).
6
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.
7
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).
8
McCulloch v. Maryland
, 4 Wheaton 316 (1819).
9
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.
10
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.
11
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.
12
See Schlesinger (1957) for a
detailed account of this interesting
episode.
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