State Bar of Wisconsin

Law & the Progressive Era, Pt 2:
The Transformation of Wisconsin's Tax System, 1897-1925

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Biography: The Kennan Family

"Taxes," said Justice Oliver Wendell Holmes, "are what we pay for a civilized society."¹ Both the amount of taxes levied and the ways in which they are levied say much about the nature of the society that imposes them. Major changes in a society often are accompanied by major changes in its tax system. Wisconsin is no exception to this rule.

by Joseph A. Ranney

Prior to the Progressive era, Wisconsin relied almost entirely upon property taxes for state and local revenue. As Wisconsin's economy diversified and industrialized during the late 19th century, the property tax burden became increasingly uneven, and new government programs required large new sums of money that the property tax alone could not provide. The Progressives tried to solve these problems by changing the basis on which the state's railroads were taxed and by creating two new taxes-an inheritance tax in 1903, and the United States' first workable state income tax in 1911. Many people thought that the income tax would quickly supersede the property tax and revolutionize Wisconsin's system of paying for government, but the property tax proved to be more durable than expected.

Streamlining the property tax

Early development of the property tax. At the time of statehood, Wisconsinites simply did not consider any type of tax system other than one that used the property tax as its cornerstone. The property tax worked well for a predominantly agricultural economy. Most land was used to produce crops, which provided income for the landowner, and many merchants and artisans worked in their homes. Thus "much of the property created income, and the value of the property reflected that income, which could be used to pay taxes."²

Up to the Progressive era, most disputes over the property tax centered on whether it was being administered fairly. The state constitution specified that "the rule of taxation shall be uniform, and taxes shall be levied upon such property as the legislature shall prescribe."³ However, tax assessors were elected locally, and they often undervalued property in order to keep their constituents happy.⁴ Localities that assessed their property fairly complained that they were being penalized. During the mid-19th century the Legislature periodically tried to correct this problem, most notably by creating state and local boards of equalization.⁵ The supreme court also intervened periodically, most notably in Marsh v. Supervisors of Clark County (1877) in which it held that prevailing assessment practices in many parts of the state violated the constitution's uniformity clause.⁶

As railroads and other major corporations came to play a major role in Wisconsin's economy, it became increasingly clear that the property tax was not a good tool for formulating their proper share of the total tax burden. Some corporations derived much of their value from assets and operations outside Wisconsin, and determining what part of their total value was attributable to their Wisconsin operations was a difficult process. More important, many corporations held large amounts of assets in the form of securities and other intangible property that was difficult to value and easy to conceal. In the 1850s and 1860s the Legislature took a first step toward solving these problems when it exempted railroads and insurance companies from property tax. After that time they were subject only to license fees based on their incomes.⁷ During the next 20 years, property tax exemptions coupled with license fees were extended to other businesses.

Despite these attempts to adjust the property tax system, the public became increasingly unhappy about its flaws. Many farmers felt that the property tax put an undue amount of the state's total tax burden on them. When the depression of 1893-95 caused corporate tax revenue to drop and required an increase in property tax rates, a consensus developed that the time had come for major tax reform.⁸

Creation of the Tax Commission. In 1897 the Legislature created a temporary Tax Commission to study the state's tax system and to recommend appropriate changes.⁹ The commission's report, issued in 1898, showed that intangible assets still were widely underreported and underassessed, and that as a result farmers were paying more than their fair share of taxes and most corporations less. The report impressed the Legislature sufficiently that in 1899, the commission's term of existence was lengthened. Robert LaFollette made property tax reform one of his early priorities, and during his tenure as governor the Tax Commission's powers were expanded to include broad powers of equalization and the power to assess power companies, street railways and various other utilities. In 1905 the commission was made a permanent state agency.¹⁰

Two commissioners, Nils Haugen and George Curtis, pressed hard for property assessments to be made at full value statewide despite the concern of many Progressives, including LaFollette and their colleague Norman Gilson, that too rapid a transition to assessment at full value would create a backlash against tax reform. Local officials stoutly resisted what they perceived as unwarranted state interference with their assessment practices. But it soon became clear that Haugen and Curtis's efforts were greatly improving the overall fairness of the tax system.¹¹

Reforming railroad taxation

Although railroad license fees were raised several times during the 19th century, the public increasingly suspected that railroads were not paying as much as they would have under the property tax system. LaFollette favored replacing railroad license fees with an ad valorem tax, which was based on property value and was quite similar to the property tax. When the 1901 Legislature failed to enact an ad valorem tax, LaFollette made it a major issue of his successful 1902 reelection campaign.¹²

In its annual report for 1903, the Tax Commission gave railroad tax reform the final push it needed for enactment. The commission made a detailed assessment of railroad property, and confirmed that railroads would pay substantially more under an ad valorem tax system than they currently were paying. The 1903 Legislature then passed an ad valorem tax, which was to be phased in over three years.¹³

The railroads challenged the ad valorem tax on several constitutional grounds, but in Chicago & Northwestern R. Co. v. State (1906), the supreme court upheld the tax.¹⁴ The railroads' first argument, and the one that gave the court the most trouble was: if the ad valorem tax is a property tax, it violates the uniformity clause because it is not levied on the same basis as other taxes; if it is not a property tax, it is invalid because the constitution only permits property taxes. After an exhaustive review of past judicial constructions of the uniformity clause, which the court ultimately conceded were confusing, the court concluded that the ad valorem tax fell within the category of "privilege taxes, [which] though indirect taxes on property, are not taxation of property." The court also reviewed the debates of the 1847-48 constitutional convention and concluded that in enacting the uniformity clause, the convention had not meant to limit the state's taxing power to property taxes.¹⁵ As the Progressives had hoped, the ad valorem tax substantially increased the railroads' contribution to state revenues.

Establishing an inheritance tax

In many ways the inheritance tax was a more radical tax than the property tax or even the income tax. Many supporters of property tax reform and of an income tax viewed their causes primarily as a means of distributing the obligation to support government fairly among all classes of people. Supporters of the inheritance tax went a step further, and explicitly promoted their tax as a means of redistributing wealth from the rich to the remainder of the population. Yet oddly, support for the inheritance tax grew faster and the tax met less opposition than did support for the income tax.¹⁶

Wisconsin enacted its first inheritance tax in 1889, well before the Progressive era began. The 1889 tax law imposed a modestly progressive inheritance tax that applied to Milwaukee County only. The supreme court invalidated the tax in State ex rel. Sanderson v. Mann (1890) on the ground that by being limited to Milwaukee County, the tax violated the uniformity clause and also Art. IV, § 31 of the Wisconsin Constitution (prohibiting various types of special or private laws).¹⁷ In 1899 the Legislature passed a new law, copied from New York's inheritance tax law, that imposed a 1 percent tax on property transferred to close relatives and exempted the first $10,000 of an estate from tax. Property not transferred to close relatives was subject to a 5 percent tax with no exemption. In Black v. State (1902) the supreme court again struck down the tax. It held that the 1899 tax law violated the equal protection provisions of the state and federal constitutions: because the $10,000 exemption applied to estates as a whole, legatees receiving equal amounts from different estates might face different tax consequences depending upon the size of each estate.¹⁸

In 1903 the Tax Commission recommended a renewal of the inheritance tax and suggested changes that it believed would cure the defects of the 1899 law. The Legislature incorporated the commission's proposals into a new law, which imposed an elaborate schedule of rates ranging from 1 percent to 15 percent based on the size of the estate and the legatee's relationship to the decedent.¹⁹

Another broad challenge was made to the new law, but this time the supreme court upheld it in Nunnemacher v. State (1906).²⁰ The law's opponents attacked it first on the ground that it deprived legatees of their right to inherit property without due process of law. Justice John Winslow, speaking for the majority, made it clear that the Wisconsin court would not subscribe to the doctrine of substantive due process. He tartly commented that even though the doctrine then prevailed in the U.S. Supreme Court and in many states, "the unanimity with which it is stated is perhaps only equalled by the paucity of reasoning by which it is supported." Winslow cautioned, however, that inheritance tax rates could not be made so high as to "in effect confiscate the property of the people once every generation."²¹

The law also was attacked on the grounds that its progressive rates violated the uniformity clause. Winslow noted that the U.S. Supreme Court had upheld a progressive federal inheritance tax, and he and his colleagues held that basing tax rates on the size of an estate was a rational classification scheme and was within the Legislature's power.²² The inheritance tax proved to be a good producer of revenue for the state and contributed significantly to the financing of new state programs during and after the Progressive era.

The income tax law

The income tax movement. The idea of an income tax did not originate with the Progressives, but at the time they came on the scene a comprehensive income tax had never been tried at the state level. The idea of taxing incomes originated in Europe in the late 18th century. It became increasingly attractive in America as industry and finance generated an increasing share of national wealth and the importance of agriculture declined. Congress enacted a federal income tax to help pay for the Civil War, which expired in 1872. Congress enacted a new income tax in 1894, only to see the U.S. Supreme Court strike it down in Pollock v. Farmers Loan & Trust Co. (1895).²³

Despite the setback in Pollock, sentiment for an income tax remained strong at both the federal and state levels. Because of the Pollock decision and because of concern that a state income tax might be held to violate the uniformity clause of Wisconsin's constitution, there was a consensus that the state constitution should be amended to explicitly permit an income tax before any income tax law was enacted. In 1903 the Legislature passed a resolution to amend the state constitution to allow an income tax, but a drafting error invalidated the resolution. A corrected resolution passed in the 1905 and 1907 Legislatures with little opposition, and in 1908 the voters passed the income tax amendment by a 69 percent to 31 percent margin.²⁴ The 1909 Legislature then began the work of creating an income tax law; the law was put in final form and enacted in 1911.

Drafting a workable income tax law. The 1909 Legislature's first step was to appoint a special committee to formulate a tax bill. The committee sought help from Tax Commissioner Nils Haugen but soon concluded that he did not have the skills necessary to draft a bill that would be practical to administer and would pass constitutional muster. The committee then turned to Charles McCarthy of the Legislative Reference Library. McCarthy in turn enlisted the help of Prof. Delos Kinsman of the Whitewater Normal School, an expert on taxation.²⁵

Kinsman concentrated on solving two problems: defining what part of the income of companies with interstate operations would be taxable by Wisconsin, and what contacts with Wisconsin would be sufficient to trigger income tax liability. Kinsman created an elaborate set of rules to guide decisions in each area. He also urged that administration and collection of the tax be handled by the state rather than local officials, in order to ensure efficiency and uniform administration. The Legislature accepted all of these provisions.²⁶

Apportioning the income tax burden. Wisconsin voters and legislators were acutely aware that the income tax would have a great impact on how the state's total tax burden was distributed among its taxpayers. Many Progressives, including LaFollette and Haugen, had long supported an income tax in order to increase manufacturers' share of the tax burden and give relief to farmers. But other legislators had different ideas of what the tax should accomplish, and in the end the income tax law became a compromise that tried to achieve a tax burden distribution that was reasonably fair to all economic groups.²⁷

At the beginning of debate on the income tax bill, Social Democratic legislators from Milwaukee County pressed hard for high personal exemptions because this was the most effective way to deflect the tax burden from lower-income workers. They succeeded in raising the single taxpayer exemption from $600 to $800 and the married couple exemption from $800 to $1,300. At the urging of conservative legislators, a deduction for most types of interest income was written into the law, primarily to benefit merchants and manufacturers and to respond to their complaint that the income tax unduly benefitted farmers at their expense. The Legislature also added a deduction for personal property taxes. This deduction was intended to strike a blow at the past problem of underreporting of personal property; it was made available both to individuals and corporations. No offset was given for real property taxes, however, even though that would have benefitted farmers.

The Legislature also attacked underreporting of personal property by basing the corporate income tax rate in part on the ratio of a corporation's income to the value of its personal property. Finally, the Legislature responded to concerns about loss of local power over the taxing process by enacting the first revenue sharing arrangement in the United States: 70 percent of all income tax revenue was to go to the municipality from which it was collected, 20 percent to the county and 10 percent to the state.²⁸

The Income Tax Cases. A case was promptly brought to test the constitutionality of the new law, and the following year the Wisconsin Supreme Court upheld it in the Income Tax Cases (1912).²⁹

The main arguments made against the law were that its progressive tax rates, its separate rate schedules for individuals and corporations,³⁰ and the fact that it allowed certain exemptions for individuals but not for corporations violated the equal protection clause of the 14th Amendment to the U.S. Constitution. The court rejected these arguments. It relied heavily on a U.S. Supreme Court inheritance tax case that held it was reasonable to classify taxpayers based on income and that to do so did not violate the equal protection clause. The court also held that it was reasonable for the Legislature to classify individuals and corporations differently for tax purposes because "the corporation is an artificial creation of the state endowed with franchises and privileges of many kinds which the individual has not."³¹

Interestingly, although the Legislature had been careful to frame the income tax as a supplement to and not a replacement for the property tax, the court went out of its way to comment that the fact "that taxation of personal property has proven a practical failure will be admitted by all who have given any attention to the subject" and that "by the present law it is quite clear that personal property taxation becomes a thing of the past."³²

The tenacity of the personal property tax. The court's conclusion that the personal property tax was dead soon turned out to be greatly mistaken. Although the income tax helped increase state and local revenues after 1911, and although the Tax Commission repeatedly recommended after 1911 that the personal property tax be abolished, with each passing year the income tax system became more established as a supplement rather than a replacement for the personal property tax. Governmental needs for revenue continued to outstrip revenue production, so that by the early 1920s the question before the Legislature was not how to abolish the personal property tax but how best to impose and distribute additional taxes.

Joseph A. Ranney, Yale 1978, is a trial lawyer with DeWitt Ross & Stevens S.C., Madison. He is the author of several articles on legal and historical topics.

The two main revenue-enhancing proposals that emerged in the early 1920s were to cut back revenue sharing, so that state government would receive a larger percentage of income tax revenues, and to repeal the provision of the income tax law that allowed personal property tax payments to be offset against income tax due. Many legislators argued that a high level of revenue sharing was essential to preserve the viability of local governments; and many Wisconsinites opposed repeal of the personal property tax offset because they believed it would hurt them. Nevertheless, the pressure for new revenue was such that the offset was repealed in 1925. Revenue sharing was reduced from 70 percent to 50 percent.³³ Repeal of the offset greatly increased the amount of income tax collected, and made the income tax the leading source of state revenue for the first time. It has been the leading source of state revenue ever since. But property taxes have continued to serve as the predominant source of local revenue and as a major source of state revenue. (See Figure 1.)

Conclusion

Wisconsin's Progressives unquestionably did most of the work necessary to modernize the state's tax collection system and to provide additional revenue to meet the needs of a rapidly expanding state government. But it is important to remember that the need for these actions was widely recognized before the Progressive era, and that the desire for a centralized state tax agency and for inheritance and income taxes was by no means confined to the Progressives.

The new tax laws were crucial to the Progressives' success: quite literally, without the new taxes the Progressives probably would not have been able to fund many of their programs. However, the new tax laws did not result in the ultimate reform of which some Progressives dreamed: the complete replacement of the property tax by the income tax. Many commentators, then and now, have lamented that the state's best opportunity to do away with the property tax came and went in 1911, and that ever since "the only possible approach [has been] to apply patch after patch to a property tax structure that was leaking badly."³⁵ But the property tax's endurance is due in large part to the fact that it is virtually the only type of tax local units of government may levy, and therefore it is a critical source of power to them. As long as this condition continues, the property tax with all its faults probably will continue also.³⁶

Endnotes

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¹ Compania de Tabacos v. Collector, 275 U.S. 87, 100 (1904).

² Stark, "A History of the Property Tax System and Property Tax Relief in Wisconsin," Wisconsin Blue Book 1991-92 (Madison, 1991)(hereinafter Stark, "History of Property Tax in Wisconsin"), 103.

³ Wis. Const. Art. VIII, § 1.

⁴ R.S. 1849, c. 12, § 6. Their job was made more difficult because they also were required to accept owners' affidavits as to the value of property. Id., c. 15, § 26.

⁵ L. 1854, c. 73; L. 1858, c. 113.

⁶ 42 Wis. 502 (1877).

⁷ Stark, "History of Property Tax in Wisconsin," 107; L. 1854, c. 74; L. 1868, c. 130. The 1868 law provided that federal land grants to railroads and certain other types of railroad property were not exempt from tax.

⁸ Stark, "History of Property Tax in Wisconsin," 109-10.

⁹ L. 1897, c. 340. Wisconsin was the third state to create such a commission; it was preceded by Massachusetts and Indiana.

¹⁰ L. 1899, c. 206; L. 1901, c. 237; L. 1903, cc. 35, 315; L. 1905, cc. 380, 493.

¹¹ R.S. Maxwell, LaFollette and the Rise of the Progressives in Wisconsin (Madison, 1956), 88-95; N.P. Haugen, Pioneer & Political Reminiscences (Madison, n.d.), 130-32.

¹² Maxwell, LaFollette and the Rise of the Progressives in Wisconsin, 34-39, 51-52.

¹³ L. 1903, c. 44.

¹⁴ 128 Wis. 553, 108 N.W. 557 (1906).

¹⁵ 128 Wis. at 604. The court went on to reject the railroads' argument that the law impermissibly delegated power to the Railroad Commission to determine the rate of tax for each railroad. It held that the Legislature had established the formula by which rates were to be determined, and had merely left it to the commission to obtain the financial information necessary to calculate the tax for each railroad. The court also held that placing railroads in their own category for tax purposes did not violate the equal protection clauses of the state or federal constitutions. Id. at 628-31, 636-52.

¹⁶ R.E. Paul, Taxation in the United States (Boston, 1954), 65-70. In the 1880s Richard T. Ely, who later gained fame as an economist at the University of Wisconsin, wrote a pioneer treatise advocating the enactment of progressive inheritance taxes at the local and state levels. Even some of the richest Americans, notably Andrew Carnegie, supported inheritance taxes. Id. at 65.

¹⁷ L. 1889, c. 176; 76 Wis. 469 (1890). Under the 1889 law, estates up to $3,000 were exempt from tax. The tax rate was 0.5 percent on amounts up to $500,000 and 0.1 percent on amounts over $500,000. The court did not address the question of whether the progressive feature of the tax violated the uniformity clause. Justice David Taylor in his dissent argued that it did not.

¹⁸ L. 1899, c. 355; 113 Wis. 205, 221-22, 89 N.W. 522 (1902). However, the court went out of its way to hold that an inheritance tax would not constitute a taking of property without due process unless the tax rate was confiscatory, and that a progressive tax properly framed would not violate the equal protection clauses of the federal and state constitutions. 113 Wis. at 222.

¹⁹ L. 1903, c. 44.

²⁰ 129 Wis. 190, 108 N.W. 627 (1906).

²¹ 129 Wis. at 198, 202. The law was flawed in that literally read, it provided that all portions of estates smaller than $25,000 would be subject to taxation but the first $25,000 of larger estates would not be. This issue was raised for the first time in Beals v. State, 139 Wis. 544 (1909). The court responded by holding that the Legislature intended to tax all portions of estates larger than $25,000. 139 Wis. at 553-55.

²² 129 Wis. at 222-23, citing Magoun v. Illinois Trust & Savings Bank, 170 U.S. 283 (1898), and Knowlton v. Moore, 178 U.S. 41 (1900).

²³ Paul, Taxation in the United States, 9-15, 22-27; 157 U.S. 429, on rehearing 158 U.S. 601 (1895). The court struck down the income tax on the ground that it was a "direct tax" which, under Art. I, § 2 of the U.S. Constitution, was required to be apportioned among the states on the basis of population. Wisconsin's constitution does not have an analogous provision. However, one justice in Pollock also attacked the income tax broadly as an "assault upon capital," and many supporters of the tax were concerned that any new law would be vulnerable to attack under the substantive due process doctrine.

²⁴ 1903 Legis. AJR 28, JR 11; 1905 Legis. AJR 12, JR 12; 1907 Legis. SJR 19, JR 29; L. 1907, c. 661. See generally Maxwell, LaFollette and the Rise of the Progressives in Wisconsin, 99-100. The state constitution requires that constitutional amendments be passed by two consecutive sessions of the Legislature and approved by the electorate. Wis. Const. Art. XII, § 1.

²⁵ Stark, The Establishment of Wisconsin's Income Tax, 71 Wis. Mag. Hist. 27, 30-31 (Autumn, 1987).

²⁶ Id. at 31-33; L. 1911, c. 658, §§ 1087M-2, 3, 8-10, 22.

²⁷ Debate continues among historians today as to what the true purpose of the 1911 income tax law was. The case that the income tax was intended to be a political tool is made in Brownlee, Income Taxation and the Political Economy of Wisconsin, 1890-1930, 59 Wis. Mag. Hist. 299 (Summer, 1976). The case that the income tax was intended primarily to make the tax burden more equitable rather than to benefit one social group at the expense of another is made in Stark, The Establishment of Wisconsin's Income Tax.

²⁸ Stark, The Establishment of Wisconsin's Income Tax, 34-35; L. 1911, c. 658, §§ 1087M-5, 6, 23, 26.

²⁹ 148 Wis. 456, 134 N.W. 673 (1912).

³⁰ The 1908 amendment to the state constitution explicitly authorized a progressive income tax. The 1911 tax law imposed a sliding scale of tax, ranging from 1 percent to 6 percent on individual incomes and 0.5 percent to 6 percent on corporate incomes. L. 1911, c. 658, § 1087M-6.

³¹ 148 Wis. at 508, 515, citing Knowlton v. Moore, 178 U.S. 41 (1900). The law's opponents also argued that because it provided that tax collections would be made by state officials, it violated the home rule provisions of the Wisconsin Constitution. The court held that because the tax was a state tax, it could properly be administered by the state; the state did not have to delegate assessment and collection to local officials. The court indicated that the revenue-sharing provisions of the law were discretionary, not mandatory. Id. at 510-11.

³² 148 Wis. at 506.

³³ L. 1925, c. 57. There is some evidence that the property tax offset was repealed for political as well as economic reasons. Farmers, who were an important part of the Progressives' political base, generally supported repeal of the offset because the offset helped merchants and manufacturers more than them. Brownlee, Income Taxation and the Political Economy of Wisconsin, 1890-1930, 316-19. Delos Kinsman viewed the repeal as "an act of bad faith with the original friends of the measure" and worried that it would resurrect tax burden inequities which the 1911 law had been designed to eliminate. Genesis of Wisconsin's Income Tax Law: An Interview With D.O. Kinsman, 21 Wis. Mag. Hist. 3, 12 (Sept. 1937).

³⁴ The sources for these figures are the Wisconsin Blue Books for the following years: 1901: 404-06; 1903: 614-34; 1907: 651-65; 1911: 365-75; 1917: 434-37; 1921: 355; 1925: 132; 1927: 122-35; and 1931: 154-58.

³⁵ Stark, A History of the Property Tax and Property Tax Relief in Wisconsin, 120. This article also contains an excellent history of the property tax since the Progressive era.

³⁶ This is particularly true in light of the fact that in recent years, the amount of income tax revenue sharing with local governments has steadily decreased. In 1991 only 26 percent of income tax revenues went to local governments. 1993-94 Wisconsin Blue Book (Madison, 1993), 806-08; see Wis. Stat. Ch. 79 (1993).

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