In the late 19th century, state and local tax officials employed private tax investigators — known as “tax ferrets” or “tax inquisitors” — to facilitate the collection of general property taxes. Compensated using a bounty system, these private sector collectors were expected to shore up flagging fiscal systems. And to some extent, they did.
But privatized collection of state taxes proved to be a disappointment, just as it had at the federal level. (Prior analysis: Tax Notes, Sept. 20, 2004, p. 1346.) Indeed, critics came to view the innovation as a serious threat to the foundations of American public finance. By sapping tax morale, tax ferrets undermined voluntary compliance — and no modern tax system could survive without the willing (if grudging) cooperation of taxpayers, they argued.
The story of the tax ferrets has been told by a handful of historians and legal scholars, but the best treatment by far comes from Nicholas R. Parrillo, a professor of law and history at Yale University. In Against the Profit Motive: The Salary Revolution in American Government, 1780-1940, Parrillo explains how public officials in the United States came to be paid using a salary system.
Salaries might seem like the most obvious way to compensate government officers, but for a long time, officials were often paid by other means, including “facilitative payments” (fees paid by affected parties directly to the official for a desired service) and bounties (sums paid to the official for performing an action that the affected party did not desire).
Bounties were particularly useful when lawmakers wanted to expand government in new and controversial directions. “Going back to the Middle Ages and through the early modern period, such rewards held a special attraction for lawmakers, for they could provide the motivational fuel to enforce novel, ambitious, and intrusive legislative programs that sought to override and change the existing norms and preferences of the population,” Parrillo explains.
Bounties, in other words, were a useful tool for state-building — especially in the face of a skeptical or even hostile populace.
Such was the case with the tax ferrets.
A Growing Tax State
Beginning in the mid-19th century, state lawmakers began to expand the ambit of their governing ambitions — and began casting about for new revenue to pay the bills. “They felt the need for much bigger sums of revenue, to pay for new initiatives in sanitation, public health, policing, schooling, and highways,” Parrillo explains.
This hunger for revenue, in turn, prompted a major rethinking of the tax base. The property tax had long been the mainstay of state and local finance, but the base of that tax had been defined to exclude (either formally or in practice) most forms of intangible property. The property tax was almost everywhere — a tax on land, livestock, and other readily visible assets. Increasingly, however, lawmakers began to cast a greedy eye on intangible wealth, both for practical and theoretical reasons.
First, intangible property was on the rise in 19th-century America, becoming an ever-larger share of the nation’s overall wealth. Second, lawmakers needed a broader base for the property tax if they were going to raise large sums of new revenue. And third, expanding the tax base to make it more comprehensive was clearly consistent with prevailing standards of fairness, because it would allow them to tax all forms of property equally, whether visible or not.
Unfortunately for these revenue-maximizing lawmakers, the expansion of the tax base was far from simple. The existing administrative machinery of the property tax depended on local officials, who were disinclined to challenge prevailing assumptions about the extent of the tax base (especially when these were, in fact, assumptions rather than legislated guidelines). Owners of intangible property had grown accustomed to not being taxed on the value of that property.
“Local assessors were accountable to the taxpayers who elected them, through a neighborly hand-shaking politics,” Parrillo writes. “Such officers were reluctant to draw the ire of any of their constituents, and so they refused to upset the settled expectation of intangibles owners that their property was tax-free.”
Enter the tax ferrets. Recruited from distant jurisdictions, they were unencumbered by local ties. They were also highly motivated by a bounty system that granted them a hefty share of any taxes they managed to collect.
Starting in the 1870s, lawmakers in 10 states and several large localities authorized these private tax collectors to ferret out undeclared tax liabilities using “innovative and intrusive methods of surveillance against the owners of intangibles,” Parrillo explains.
Inquisitorial Adversaries
Before the midcentury expansion of the tax base, collection of state and local taxes had revolved around a process of “familiar imposition,” to use Parrillo’s term. Taxpayers typically knew their local collectors personally, and tax bills involved some negotiation.
Moreover, with a tax base composed almost entirely of visible items like land and livestock, assessment had a social quality; the assessor could measure a person’s property by looking at it, but so could other taxpayers. “The obviousness of townspeople’s wealth provided a focal point that made it easier for the assessor to reach agreement with them about the allocation of the burden across the community,” Parrillo writes. “Taxpaying did not entail the invasion of privacy.”
With the addition of intangibles to the tax base, however, everything changed — beginning with the personnel. When they arrived on the scene, the tax ferrets supplemented but did not replace local assessors; the latter continued to focus on the low-hanging fruit, including visible forms of property, like real estate and livestock.
The ferrets, meanwhile, pursued intangible forms of property. In doing so, they became “pioneers of state surveillance,” developing new ways of tracking wealth in a society that made such efforts quite difficult, Parrillo contends. “In several ways, the tax ferrets pioneered techniques of seeking information-at-source that would later be used by state tax agencies,” he writes.
Because many wealthy taxpayers invested their money by making mortgage loans, for instance, the ferrets would systematically search county records looking for taxpayers who had loaned money to buyers, both within the tax jurisdiction and farther afield. They scoured probate, divorce, and receivership proceedings, looking for disclosures of unreported assets by involved parties.
The tax ferrets also worked to uncover the names of investors in various corporations, sending “spies to shareholders’ meetings to take down names of those present.” As time went on, they got better organized. “By the 1910s and 1920s, it was rumored that the tax ferrets had constructed an interstate network to exchange and compile information among themselves regarding the ownership of securities across the country,” Parrillo writes.
If all this ferreting sounds like hard work, that’s because it was. But the tax ferrets were well compensated by the lucrative bounties offered in states and localities across the nation.
From the late 1870s to the 1910s, the legislatures of 10 states approved the use of tax ferrets. Localities in 10 other states also embraced the innovation. Compensation varied across these jurisdictions, but it was typically capped somewhere between 10 and 25 percent of the final amount collected from the delinquent taxpayer; occasionally, the bounty ranged as high as 50 percent, Parrillo notes.
Failed Experiment
The tax ferrets seemed like a good solution to a serious problem. The general property tax was not working well by the 1870s. Intangible property was becoming increasingly common, especially as the American economy continued its financialization; intangibles were becoming an ever-larger share of the ostensible tax base.
But in practice, intangible property was going untaxed, thanks to rampant (if broadly tolerated) lawlessness. Parrillo quotes the historian Clifton K. Yearley to make the point: “Before the enactment of Prohibition, probably nothing in American life entailed more calculated or premeditated lying than the general property tax.”
The tax ferrets, however, did not substantially improve this picture. Parrillo describes two studies of the innovation, as well as their pessimistic conclusion: “Whatever the effect of tax ferreting might be, it was certainly no more than an incremental improvement of an institution — the general property tax — which was, in the broader scheme of things, hopeless.”
The general property tax was simply too broken, too anachronistic, too inconsistent with the realities of a modern financialized economy to be saved by the ferrets. The growing mobility of capital made heavy-handed enforcement a hollow threat. Sure, a tax ferret might discover hidden assets — once. But a ferret was unlikely to discover those assets a second time, because they could be readily moved. Or other assets owned by the same taxpayers. The process was simply too hit-or-miss, labor-intensive, and complicated.
And ultimately, not threatening enough. As Parrillo sums up: “The mobility of persons and capital limited the practical effectiveness of coercion and fear.”
Undermining Tax Morale
Coercion and fear, however, were still important: They had a corrosive effect on tax morale, establishing an adversarial relationship between taxpayers and the state that threatened to unravel the tax system more broadly. At least that was the complaint offered up by critics.
“The tax inquisitor law is necessarily demoralizing,” complained one Ohio lawyer in 1904. “It demoralizes the tax inquisitor, the auditor, the treasurer, and the tax victim. No victim of a tax inquisitor can ever feel toward his state as he did before his treatment by the tax inquisitor. No man could ever feel justly patriotic to a state which sold him out to the tax inquisitor, the auditor, the treasurer for 29 percent of what they could wring out of him.”
Parrillo takes this complaint seriously, as he should. “The bounty reward publicized a state interest in noncompliance and coerced compliance, as opposed to voluntary compliance,” he writes. “This placed state and citizen in an adversarial and mistrustful relation and alienated them from each other, undermining whatever intrinsic desire citizens might have to comply with law for its own sake.”
Fair enough. Although I suspect that state and citizen are almost always in an adversarial relationship when it comes to taxpaying. But I’ll come back to that.
The End of the Ferrets
Concerns about tax morale helped doom the tax ferrets; their failure to save the general property tax from its own fatal defects certainly played a role, too. The tax itself was headed for the exits. It took until roughly 1940, however, for the last remnants of the system to disappear.
It didn’t help that tax ferreting had its own share of scandals, although it’s hard to tell from Parrillo’s account just how public they were. He recounts one of the more egregious episodes. In 1935 Sen. Huey Long engineered the award of a tax ferreting contract to a firm consisting of himself and one of his “associates.” The bounty was to be one-third of the tax collected. As it happened, Long was assassinated four months later, so he never had a chance to cash in.
Still, not a good look. And emblematic of the perverse incentives that can grow up around a bounty system, especially when the broader political context is less than wholesome.
Ultimately, it’s hard to shed a tear for the tax ferrets. To my mind, there is almost never anything good to say about privatized tax collection.
At the same time, however, it’s wise to avoid getting carried away with misty-eyed paeans to the importance of tax morale and voluntary tax compliance. Call me cynical, but I believe that tough enforcement is crucial to compliance. Partly because tough enforcement reassures taxpayers that other taxpayers are meeting their obligations. But also because tough enforcement instills a certain amount of fear — fear of being caught. An unpopular opinion, perhaps, but one supported by the higher compliance rate for income subject to third-party reporting.
Also, I’m unconvinced that the failure of the tax ferrets to save the general property tax had much to do with their corrosive effect on tax morale. The general property tax failed because the world had passed it by. It was a tax ill-suited to a world chock-full of intangible property but not yet endowed with a reliable means of making that property visible to tax authorities. (Less of a problem these days, of course.)
Still, the tax ferrets were undeniably corrosive of trust in government. The relationship between taxpayers and the state is always adversarial. But some relationships are more adversarial than others; paying tax collectors with a bounty system is a good way to ensure that a relationship becomes as toxic and hostile as possible.