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Did New Deal Liberalism Steer Too Far to the Right?

Posted on Jan. 31, 2022
[Editor's Note:

This article originally appeared in the January 31, 2022, issue of Tax Notes Federal.


Michael Simkovic is a professor of law and accounting at the University of Southern California Gould School of Law.

In this book review, Simkovic examines A Half-Century With the Internal Revenue Code: The Memoirs of Stanley S. Surrey, edited by Ajay K. Mehrotra and Lawrence Zelenak.

Ajay K. Mehrotra, professor of law at the Northwestern Pritzker School of Law, and Lawrence Zelenak, the Pamela B. Gann Professor of Law at Duke Law School, have prepared a sparkling introduction to the recently discovered memoirs of Stanley S. Surrey, which they have also edited for publication.

Surrey was a tour de force in the legal academy and government. His career spanned the rise, peak, and fall of New Deal liberalism and the triumph of Reagan-Thatcherism that followed. Mehrotra and Zelenak deftly portray Surrey’s life against the backdrop of broader social forces and trends. Their sympathy for their subject shines through the essay, but it never veers into hagiography.

Surrey briefly taught at Berkeley, then spent most of his career at Harvard. He served at a high level in both the Roosevelt administration and, especially in, the Kennedy administration. He expounded and advocated a particular vision of the income tax that would go on to influence tax scholars for generations, for some as a lodestar, for others as a foil.

In particular, Surrey campaigned against tax expenditures, which he described as special interest legislation embedded in the tax code. These deductions, credits, or tax deferrals were used to achieve policy objectives that could have — and to Surrey, should have — instead either been accomplished through explicit public spending programs or not done at all. In separate work, Zelenak has argued that Surrey’s objection to tax expenditures was in part driven by the fact that these expenditures often took the form of deductions, which are regressive in effect. Surrey viewed refundable credits, which are more progressive, as less objectionable.

Relatedly, Surrey campaigned for “horizontal equity,” a term denoting the principle that taxpayers with similar incomes should be taxed similarly regardless of the character of their income, their industry, or other circumstances that are arguably irrelevant to progressive income taxation.

Surrey was one of the rare academics who succeeded in putting his ideas into legislative action and administrative policy. In part as a result of his efforts, tax expenditure budgets are now routinely published by Treasury and the Joint Committee on Taxation. For better or worse, some leading tax expenditures, particularly those that primarily benefit middle-income individuals, such as the home mortgage interest deduction and state and local tax deductions, have been put on the chopping block.1 Others, such as those that primarily benefit the wealthy or politically active industries such as oil and gas, have proven more resilient. However, as Zelenak has noted, more recently introduced tax expenditures are increasingly taking the form of credits, a posthumous victory for Surrey.

Some of the most beautiful passages in the essay deal with powerful critiques from Yale law professor Boris I. Bittker. Mehrotra and Zelenak succeed in encapsulating these critiques, and acknowledging their validity, while still pointing to the ongoing usefulness and merits of Surrey’s views. (Likewise, the discussion of Harvard law professor Louis Kaplow’s disagreement with Surrey is similarly gracious.)

In particular, Bittker attacked the subjectivity of the tax expenditure concept because it depended on the comparison of a tax provision to the baseline of an ideal income tax. This baseline is inherently subjective. Bittker noted, inter alia, that the realization requirement — which defers taxation on the increase in value of an asset until that asset is sold — is a major departure from the Haig-Simons definition of income.2

Surrey’s response, largely lost to history, was that tax expenditures are meant to describe policies that could have been accomplished through a spending program, rather than through a tax program. Moreover, behind the frontier of ambiguity lies clarity that some provisions clearly, are tax expenditures and that such expenditures should be publicized and stigmatized. He notes, as an example, percentage depletion, a complex scheme to subsidize oil and coal companies through the tax code.

Mehrotra and Zelenak’s synthesis, that both Surrey and Bittker were correct on their own terms, is masterful and gracious.

My greatest critique — and one that I hope will be addressed in future scholarship — is that Mehrotra and Zelenak could have explored in more depth why Surrey did not try to list the realization requirement as a tax expenditure.

Because of the realization requirement, taxpayers who own assets are not assessed an income tax annually when those assets increase in value. Instead, it is the taxpayers who control when — and if — they will pay income taxes on asset appreciation.

This control over timing also means that taxpayers who are well advised can engage in a multi-pronged strategy to harvest losses for tax purposes without actually incurring any real substantive losses. First, taxpayers can selectively sell assets that have declined in value, harvesting tax losses. This reduces their income tax liability. Simultaneous with this sale, taxpayers can buy substantially similar (although not identical) assets, thereby maintaining the same investment strategy. Conversely, taxpayers can defer unrealized taxable gains by holding on to appreciated property. At least one prominent tax scholar argues that the realization requirement creates a negative tax (that is, a subsidy) for holders of assets.3

Bittker argued that — as a departure from the Haig-Simons definition of income and as a subsidy to a particular group (owners of assets) — the realization requirement should have been included from the beginning as a tax expenditure. But Surrey, to the contrary, did not attempt to include it as a tax expenditure.

What were Surrey’s views on this issue? Further, what role did Surrey play in the continuation of the realization requirement in tax law?

It is difficult to understate the historical, economic, and social importance of the realization requirement. This doctrine lies at the flashpoint between progressives alarmed at the growing political power of the extremely wealthy — and the related shift in tax burdens toward the middle class and poor — and conservatives and moderates unwilling to shift tax burdens back toward the top of income and wealth distributions.4

Many scholars have described realization as the Achilles’ heel of the income tax. Modern advocates of wealth taxes wish to plug the gaping hole in the income tax blown open by the realization requirement.5

Because of the realization requirement, wealthy families can enjoy the benefits of high pretax compounded returns on investment, borrow against that wealth to fund consumption, and — because borrowing is not a realization event — defer taxation on capital gains, potentially indefinitely.6 At the extreme, capital gains tax rates become irrelevant because taxpayers never realize net gains. Moreover, interest and depreciation deductions — generated by borrowing money and buying specified assets — can neutralize associated cash flows that would have otherwise been taxed, such as dividends or rents.

Well-known tax planning techniques to reduce effective corporate tax rates and transmit wealth intergenerationally can ensure that economic income from capital appreciation is taxed at extremely low rates across multiple generations. The “income tax” that we have at present may more closely resemble a tax on labor income and on the capital of those who are too ignorant or insufficiently wealthy to use effective tax planning. It is not the true “income” tax that Surrey ostensibly envisioned.

Back-of-the-envelope calculations based on changes in household net worth suggest that annual tax expenditures ascribed to the realization requirement could amount to hundreds of billions or, more recently, over a trillion dollars per year in forgone revenue.7 But there are no official estimates of this lost revenue from the Treasury Department or the JCT because the realization requirement has never been acknowledged by the government as a tax expenditure.

The consequence of the de facto exclusion of capital from the tax base is that maintaining the same level of expenditures — for example, funding a military to safeguard overseas investments and global supply chains — requires that the United States tax its own domestic labor force more heavily. This compounds businesses’ incentives to automate or shift toward overseas labor, further undermining the position of middle-income U.S. workers — the ostensible beneficiaries of New Deal liberalism.

Even when the government funds social expenditures, such as pensions, healthcare, education, or anti-poverty efforts, taxing the middle class to try to benefit the middle class and poor opens the door to charges of high-handed paternalism. Both the tax and the implicit condescension engender resentment from a large segment of the electorate. Moreover, groups with limited means that are taxed more heavily will find it more difficult to invest in shifting policy in their favor, creating a feedback loop that, in the long run, may have led to the New Deal unraveling.

Did a brilliant man like Surrey somehow not understand the awesome importance of the realization requirement because capital was appreciating more slowly during the mid-20th century? Perhaps, but his contemporaries were openly discussing the tax planning advantages of deferred realization.8

Or was Surrey aware of the likely consequences but wished to push the Democrats to the right from within? Could Surrey have remained quiet to improve his chances of obtaining powerful posts in the legal academy and government?

These questions are under-explored by Zelenak and Mehrotra. However, they do provide some tantalizing clues.

Evidence supporting Surrey’s quiet conservatism includes the fact that he came from a prosperous Russian family that fled Russia before the Bolsheviks rose to power.

On the other hand, the sensitive, early years of Surrey’s career took place during a time when being too concerned for the plight of the poor or middle class, or too willing to tax the rich, could cause one to be tarred as a “Communist” and blacklisted by universities and government agencies. However, Surrey does not appear to have been above denouncing other progressives, at least in private. His memoirs say that he resigned from a progressive organization of lawyers, the National Lawyers Guild, because it was too full of “Communists.”

Surrey served in an administration that made the income tax less progressive during WWII by extending it to middle-income workers rather than targeting only the wealthy. Although Surrey’s role at this time was relatively minor, after wartime debts were largely repaid and Surrey achieved higher office, he made few efforts to undo mass taxation. To the contrary, he helped perfect it.

On the other hand, Surrey opposed a national sales tax or a shift toward a consumption tax, regarding this as too regressive, and he rejected preferential rates for capital gains. He also left public service when the Republicans gained greater power.

These contradictions are intriguing. Mehrotra and Zelenak are close students of Surrey’s life and times, and the reader is left wondering what they make of them.

In private conversations, Zelenak has suggested several reasons why Surrey might have agreed to exclude the realization requirement from the tax expenditure budget: Perhaps he could not imagine a comparable direct expenditure program. Perhaps the reasons why unrealized gains should be taxed were too technical or abstruse to convey to Congress or the public. Or perhaps Surrey wished to avoid a bruising political battle that he believed he would ultimately lose.

Of these three explanations, the third seems to be the most plausible.

It is not hard to conceive of direct spending programs that roughly mimic the effects of the realization requirement by subsidizing asset holders in rough proportion to the value of their assets and the length of time over which they hold them. These spending programs include public lending programs that provide below-market loans to holders of various assets (that is, mortgages, small business loans, and emergency liquidity provision to financial institutions) and federally subsidized flood insurance.

Nor does abstraction or complexity appear to be a strong barrier to inclusion in the tax expenditure budget. Consider the case of imputed rental income — the taxable income that homeowners would report if they rented out their homes to strangers and fulfilled their own housing needs by renting a separate dwelling from another landlord. (Bittker raised this as an example, alongside the realization requirement, of something that should be included in the tax expenditure budget because it departs from the Haig-Simon definition of income.)

The imputed rental income exclusion has been listed by the Treasury Department as a tax expenditure9 since 2006.10 But the justification for taxing imputed rental income — and the valuation challenges it would entail — are probably at least as technically challenging as issues regarding unrealized appreciation.

Thus, the most plausible explanation of the three offered is that Surrey was not willing to risk the wrath of wealthy and powerful interests that wished for the realization requirement to be thought of as a mere “administrative convenience” rather than as an exceptionally expensive tax subsidy to the well-heeled. Including the realization requirement in the tax expenditure budget would have stigmatized it and attached a concrete price tag to it.

Zelenak notes that Surrey did argue against step-up basis at death but never succeeded in changing this policy.11 This experience may have taught Surrey that raising taxes on the exceedingly wealthy could be politically difficult, even when its merits were clear.12 Mehrotra and Zelenak discuss Surrey’s political gamesmanship — obfuscating some of his more controversial writings (on congressional amenability to lobbyists’ proposals) during tense Senate confirmation hearings.

Thus, depending on one’s reading of what could have been, Surrey, the “activist scholar,” comes across as either politically shrewd and effective in achieving the possible, or he comes across, less generously, as overly ambitious and lacking the courage to speak truth to power, even as a tenured professor at Harvard.

Mehrotra and Zelenak describe the return of Republicans to power that preceded Surrey’s flight from Washington to the academy, as if there were no relation between the tax policies Surrey helped the Democrats develop and their subsequent electoral defeats.

Did mass income taxation really have no connection to the resurgence of Republican political strength, even though former President Reagan and his successors promised tax cuts for middle- and working-class families?13

Or could Surrey’s preference for a broad-based income tax — which he described as more “fair and equitable” than a narrower “class tax” — have opened the door to the subsequent rightward shift in U.S. politics?14 It would have been rather difficult for Republicans to attack tax-and-spend liberal paternalism if the overwhelming majority of the electorate paid close to nothing in federal taxes.

Did liberal New Dealers, attempting to steer the country safely between the dangers of communist authoritarianism and rapacious oligarchy, veer toward the latter?

Surrey’s greatest moment of power was as assistant secretary of the Treasury under former President Kennedy. During that administration, the income tax became less progressive. Tax rates plummeted for those with household incomes above $1 million per year in today’s dollars.15 JFK is regarded by some as a stealth conservative: He inherited dynastic wealth,16 was more anti-communist than President Nixon,17 and famously had a friendly relationship with Sen. Joseph McCarthy.18

Surrey wanted to help fund low tax rates in a revenue-neutral manner by eliminating “loopholes” and deductions. Top rates did become lower, and remained so after Surrey’s time in office. But loopholes quickly returned, federal taxation became less progressive, inequality soared, anti-poverty efforts were put on a starvation diet, and the condition of the poor deteriorated to the point that the United States became the only country in the developed world with declining life expectancy.19 Public health experts place the blame for subpar U.S. life expectancy squarely on regressive public policy choices. Is spending little to help the poor and middle class so different from taxing them heavily?

Should we consider the possibility that Surrey’s “technical assistance” in extending broad-based mass taxation — and the generation of tax scholars and policymakers it helped inspire — handed the keys to the kingdom to anti-tax conservatives for the foreseeable future?

Surrey’s memoirs, carefully prepared for publication by Mehrotra and Zelenak, offer an intriguing window into the life and times of one of the 20th century’s most influential scholar-activists.


1 The mortgage interest deduction has been capped and no longer applies to interest on the portion of a mortgage that exceeds $750,000. The cap is not indexed to inflation, cost of living, or appreciation in residential real estate prices. In some locations, $750,000 is less than the cost of a one-bedroom apartment. The state and local tax deduction has been limited to no more than $10,000 — a relatively low limit given incomes, property prices, and tax rates in states with concentrations of high-skilled workers.

2 Charles R. Hulten and Robert M. Schwab, “A Haig-Simons-Tiebout Comprehensive Income Tax,” 44 Nat’l Tax J. 67, 70 (1991) (defining Haig-Simons income as consumption plus changes in net worth).

3 Daniel I. Halperin, “Capital Gains and Ordinary Deductions: Negative Income Tax for the Wealthy,” 12 B.C. L. Rev. 387 (1971).

4 See generally Emmanuel Saez and Gabriel Zucman, “The Rise of Income and Wealth Inequality in America: Evidence From Distributional Macroeconomic Accounts,” 34 J. Econ. Persp. 3 (Fall 2020); David Gamage, “The Case for Taxing (All of) Labor Income, Consumption, Capital Income, and Wealth,” 68 Tax L. Rev. 355 (2015).

5 See Michael Simkovic, “Biased Budget Scoring and Underinvestment,” Tax Notes Federal, Feb. 3, 2020, p. 757.

6 Edward J. McCaffrey, “Taxing Wealth Seriously,” Proceedings, Annual Conference on Taxation and Minutes of the Annual Meeting of the National Tax Association, vol. 109, at 1-90 (2016).

7 Federal Reserve Bank of St. Louis: “Households; Net Worth, Level,” FRED (updated Dec. 9, 2021).

8 See, e.g., E. George Rudolph, “The Realization Requirement and Tax Avoidance,” 62 Mich. L. Rev. 961 (1964); Louis A. Del Cotto, “Basis and Amount Realized Under Crane: A Current View of Some Tax Effects in Mortgage Financing,” 118 U. Pa. L. Rev. 69 (1969); Halperin, supra note 3; Mason Gaffney, “Tax-Induced Slow Turnover of Capital, I,” 29 Am. J. Econ. Sociol. 25 (1970).

9 Treasury Office of Tax Analysis, “Tax Expenditures FY 2021” (Feb. 26, 2020) (estimating that “exclusion of net imputed rental income” would cost the treasury $1.6 trillion over a decade). Joint Committee on Taxation, “Estimates of Federal Tax Expenditures for Fiscal Years 2019-2023” (Dec. 18, 2019) (illustrating that the JCT does not include imputed rental income in its own tax expenditure budget).

10 Office of Tax Analysis, “Tax Expenditures FY 2006” (2006).

11 Unlike realization, step-up basis at death is at least included in the tax expenditure budget. JCT, supra note 9 (estimating the cost of “exclusion of capital gains at death” as $218 billion over five years); Treasury, supra note 9 (estimating “step-up basis of capital gains at death” as costing $659 billion over 10 years).

12 See Surrey, A Half-Century With the Internal Revenue Code: The Memoirs of Stanley S. Surrey (2022); Joseph J. Thorndike, “Stanley Surrey Knew a Thing or Two About Loopholes,” Tax Notes, Feb. 11, 2013, p. 663.

13 Reagan famously lampooned Democrats, saying that they believed: “If it moves, tax it. . . . If it stops moving, subsidize it.” “9 Ronald Reagan Quotes About Taxes,”, at 9 (Apr. 24, 2015). Reagan also told voters, “Simple fairness dictates that government must not raise taxes on families struggling to pay their bills.” Lewis K. Uhler, “We Need a Reagan Tax Revolt to Counter Today’s Big-Government Spending,” The Hill, Aug. 18, 2021.

14 Historians and political scientists have amassed evidence that the middle-income tax relief provided by Reagan and his successors in the Republican Party contributed to their electoral success. Monica Prasad, “The Popular Origins of Neoliberalism in the Reagan Tax Cut of 1981,” 24 J. Pol’y Hist. 351 (2012); Larry M. Bartels, “Homer Gets a Tax Cut: Inequality and Public Policy in the American Mind,” 3 Persp. on Pol. 15 (2005); Bryan D. Jones and Walter Williams, The Politics of Bad Ideas: The Great Tax Cut Delusion and the Decline of Good Government in America (2021).

15 Revenue Act of 1964 (P.L. 88-272).

16 David Nasaw, The Patriarch: The Remarkable Life and Turbulent Times of Joseph P. Kennedy (2013).

17 Anti-communist dogma led the Kennedy administration to initiate unsuccessful military interventions in both Cuba and Vietnam. The former led to a nuclear standoff, while the latter ultimately resulted in more than a million casualties and serious injuries, hundreds of billions in expenditures, domestic strife, and a tarnished international reputation for the United States. The Nixon administration’s foreign policy was more pragmatic and less ideological. After concluding that the Vietnam War was too costly, the Nixon administration ended it. The Nixon administration also improved relations with Communist China and initiated a mutually beneficial trading relationship that persists decades later.

18 Arthur Herman, Joseph McCarthy: Reexamining the Life and Legacy of America’s Most Hated Senator 226 (1999).

19 See Atheendar S. Venkataramani, Rourke O’Brien, and Alexander C. Tsai, “Declining Life Expectancy in the United States: The Need for Social Policy as Health Policy,” JAMA Network, Feb. 16, 2021; James C. Riley, Rising Life Expectancy: A Global History 1 (2001); James C. Riley, “Estimates of Regional and Global Life Expectancy, 1800-2001,” 31 Population & Dev. Rev. 537, 542 (Oct. 21, 2005).


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