(For more detail on Pollock, the Sixteenth Amendment, and the distinction between direct and indirect taxes, see the epilogue.)
America Gets an Income Tax
Woodrow Wilson was elected president in 1912 against two Progressive opponents, former president Theodore Roosevelt, running on the Bull Moose ticket, and the incumbent Republican, Taft. Wilson’s platform called for an income tax, and in April 1913, he called a special session of Congress. A graduated income tax was added to the Underwood Tariff and passed.
The United States now had an income tax. A few years after the tax was enacted, the Supreme Court gave its blessing to progressivity with little comment.46
While politicians put the income tax through, we must not underrate the role played by the Progressive intellectuals. As advocates of government activism, they wanted the state to be able to raise huge sums of money. The income tax filled the bill. In their campaign to win acceptance for the tax, these intellectuals took two tacks. First, they argued that it was necessary for the modern state to fulfill its new and expanded role. Second, as we saw in chapter 2, intellectuals such as Edwin R. A. Seligman argued that social evolution had selected “ability to pay” as a just principle of taxation.
It is generally assumed that wealthy businessmen unanimously opposed the income tax from the beginning. But the story is more complicated. In his book Businessmen and Reform, Robert Wiebe writes, “When they faced a graduated income tax in 1913, businessmen everywhere judged it the most destructive legislation in the nation’s history.”47 This judgment may have been hasty. Carolyn Webber and Aaron Wildavsky said that “businessmen who preferred predictability” joined the pro-income tax side.48
Many businessmen, particularly the owners of the biggest businesses, clearly created an environment for the income tax by their support for such government activism as the tariff, the Interstate Commerce Commission, and other agencies.49 Their opposition to laissez faire undercut any opposition they might have raised against other government intervention.
There are indications that some businessmen welcomed the income tax because without it the government would be barred from certain undertakings that would benefit them. As the nineteenth century entered its last decade and America embarked on an imperialist policy in Asia, some businessmen became newly interested in world trade. This was not the nineteenth-century, pacificistic, free-trade philosophy of Cobden and Bright but rather a military-commercial policy that called on the U.S. government — and its armed might if necessary — to “open” to American business foreign markets dominated by rival colonial powers. The Open Door policy for China is an example. This is also the period when there was a major push for a big navy, led by Adm. Alfred Mahan and the Navy League. The growth in American exports helped broaden the constituency for the income tax.50
The 1913 income tax rate was put at 1 percent on net income after a personal exemption of $3,000, some credits, and an additional $1,000 exemption for married couples living together. There was also a graduated 2 percent to 7 percent surcharge on incomes from $20,000 to $500,000. Interest on state and municipal bonds was exempt.51
In 1913, the average personal income was $621. Only 2 percent of the population was liable for the tax between 1913 and 1915.52 Eighty percent of the returns were filed by people involved in business; 17 percent were in the professions, 3.3 percent in agriculture, 0.5 percent were laborers. Businessmen reported 85 percent of the income and paid almost 90 percent of the revenues.53
Given the level of incomes in those days, it was a tax aimed strictly at the richest people in the country. If the system were in place today, a single person making less than about $45,000 (the bottom 75 percent of filers) would pay no tax. A couple earning less than $60,000 would pay nothing. Incomes up to $300,000 would be in the 1 percent bracket. Someone would have to make $7.5 million before paying the top 7 percent rate. In 1994 dollars, the exemptions of 1913 would be worth $44,776 for single people and $59,701 for married couples.54
Returns from the tax at first were disappointing to tax collectors: $28 million in 1914. They picked up thereafter: $41 million in 1915 and nearly $68 million in 1916.55 The tax accounted for only 10 percent of revenues until 1915.56 As usual, it was war that gave the boost to government power. More than $1 billion was raised during World War I, making the income tax the permanent major part of the revenue system.57
The Rates Go Up
The rates followed a similar path. From 1913 to 1915, the top rate was 7 percent. In 1916, it was 15 percent. Then: 67 percent in 1917 and 77 percent in 1918, the war years. An excess-profits tax was added in those years. The personal exemption, which in 1915 was $3,000 for a single person and $4,000 for married couples with two dependents, fell, respectively, to $1,000 and $2,400 in 1917. Despite this, it still was not a tax on most of the population. But the war shifted the federal government away from consumption taxes, such as the tariff, to income, profits, and estate taxes.58
After the war, the top rate fell only to 73 percent because of the debt. It declined in the 1920s to a low of 24 percent in 1929. Note that it got nowhere near the prewar 7 percent. With the Great Depression the rate headed back up under President Herbert Hoover and a Republican Congress: 25 percent in 1930, then 63 percent in 1932. In the New Deal, the top rate continued upward: 79 percent in 1936, 81 percent in 1940. It hit its high of 94 percent in 1944–45. From there it stayed in the 90s and 80s until 1964, when it dropped to 77 percent. In 1982 it was reduced to 50 percent. The Reagan tax reform of the late 1980s brought the top rate down to 28 percent.59 That was the end of the decline. In 1990 President Bush, in violation of a campaign pledge not to raise taxes, hiked the rate to 31 percent. Then President Clinton in 1993 raised it to 39.6 percent.
The lowest rate moved up in fits and starts. Until 1915 the rate was 1 percent up to $20,000. In 1917, it was 2 percent up to $2,000, then 6 percent up to $4,000. By 1941 the bottom rate was at 10 percent up to $2,000. It hit its high of 23 percent in 1945. Today it stands at 15 percent on income up to $29,750.60
It took World War II to make the income tax a truly universal tax. In 1940, fewer than fifteen million tax returns were filed. In 1950 the number was more than fifty-three million. The war initiated millions of Americans into the world of the income tax.61 In 1939 the income tax raised $1 billion. In 1945 it raised $19 billion.62 The most lucrative revenue pool was not the wealthy — there weren’t enough of them. Middle-class and working-class taxpayers represented the biggest potential for revenue.
The U.S. Treasury began withholding taxes from paychecks in 1943. It was a measure designed to avoid financing the war by inflation, according to Milton Friedman, who worked on the Treasury group that devised the system.63 When the war ended, withholding continued. It has been a key method of making the income tax seem less onerous than it really is.
The 1970s demonstrated that hiking rates is not necessary to raise additional revenue. Inflation pushed taxpayers into higher tax brackets, although their incomes were no higher in real terms. The government raked in the money, until interventionist policies produced both inflation and recession, so-called stagflation. “Bracket-creep” ended in the 1980s when the tax brackets were indexed to inflation. (However, the capital gains tax has not been indexed; people still pay taxes on illusory gains.)
Lessons to Be Learned
The history of the income tax produced at least three lessons that should not be ignored. First, a tax that was supposed to hit only the rich eventually became one that has harmed the middle and working classes. In the aggregate, the biggest bucks for the government will always be in those classes. There are not enough superrich to support the government for long. Envy can boomerang.
The second lesson is that if the government is given access to a huge pool of revenue, it will take full advantage of it. Adjusted for inflation, government spending, from enactment of the income tax in 1913 to 1994, increased 13,592 percent. The portion of federal revenue from personal and corporate taxes jumped
from 7 percent in 1913 to over 54 percent in 1994. As a percentage of gross domestic product, those taxes went from 0.1 percent to 10 percent.64 The income tax has given the federal government a staggering leverage over the economic life of America.
The third lesson comes from the fact that some people were attracted to the income tax by the promise that it would permit reduction of the tariff, which imposed a hardship on people of modest means. But it did not work out that way. America got the income tax and kept the tariff. That should teach us something about government and the danger of striving to replace one tax with another rather than pushing for simple repeal. As Frank Chodorov observed, “It promised to make the swap, and perhaps its leaders believed the promise, but the nature of government is such that it cannot give up one power for another; not permanently, at any rate.”65
The income tax has been a disaster for the American people. In the chapter that follows, we will examine how we could get along without it.
Notes
1 John F. Witte, The Politics and Development of the Federal Income Tax (Madison, Wis.: University of Wisconsin Press, 1985), p. 67.
2 Jeffrey Rogers Hummel, Emancipating Slaves, Enslaving Free Men: A History of the American Civil War (Chicago: Open Court, 1996), p. 222.
3 Witte, p. 67.
4 Ibid., p. 53.
5 Ibid., p. 69.
6 Harry Edwin Smith, The United States Federal Internal Tax History from 1861 to 1871 (Boston: Houghton Mifflin Co., 1941), pp. 54, 56; Hummel, p. 223.
7 Smith, p. 59.
8 Ibid., pp. 61–62.
9 Ibid., p. 64.
10 Both quotations are at ibid., p. 65.
11 Ibid., p. 66.
12 Ibid., pp. 67–68.
13 Hummel, p. 227.
14 Quoted in Smith, p. 70.
15 Ibid., pp. 74–75.
16 Ibid., p. 77.
17 Ibid., p. 78.
18 Ibid., p. 79.
19 Ibid., p. 80.
20 Ibid., p. 93, and Bennett D. Baack and Edward John Ray, “Special Interests and the Adoption of the Income Tax in the United States,” Journal of Economic History 45 (September 1985): 608.
21 Robert Higgs, Crisis and Leviathan: Episodes in the Growth of the American Government (New York: Oxford University Press, 1987), p. 84.
22 Edward Stanwood, American Tariff Controversies in the Nineteenth Century, vol. 1 (Boston: Houghton Mifflin, 1903), p. 296.
23 Witte, p. 71.
24 Baack and Ray, pp. 609–10.
25 Arthur A. Ekirch Jr., “The Sixteenth Amendment: The Historical Background,” Cato Journal 1 (Spring 1981): 168.
26 Ibid., pp. 168–69.
27 In the first edition of Your Money or Your Life, I erroneously stated that the uniformity requirement invalidates tax progressivity and requires a flat tax. That is wrong. Uniformity is a geographical requirement only. Consider my error corrected.
28 Quoted in John D. Buenker, The Income Tax and the Progressive Era (New York: Garland, 1985), p. 17.
29 Charles Adams, For Good and Evil: The Impact of Taxes on the Course of Civilization (Lanham, Md.: Madison Books, 1993), p.313.
30 Quoted in Adams, p. 370.
31 Richard Hofstadter, ed., Great Issues in American History, vol. 2, 1864–1957 (New York: Vintage, 1959), pp. 120–21.
32 Witte, p. 74.
33 Ekirch, pp. 171–72.
34 “Roosevelt was the first President of the United States who openly proposed to use the powers of political government for the purpose of affecting the distribution of wealth in the interest of the golden mean.” Charles A. Beard and Mary R. Beard, The Rise of American Civilization (New York: Macmillan, 1936), p. 596.
35 Ibid.
36 John D. Buenker, “The Ratification of the Federal Income Tax Amendment,’’ Cato Journal 1 (Spring 1981): 186.
37 Witte, p. 75.
38 Ekirch, p. 173.
39 Ibid., p. 174.
40 Ibid., p. 176.
41 Buenker, “Ratification of the Federal Income Tax Amendment,” p. 215.
42 Ekirch, p. 178.
43 Ibid., p. 177.
44 Ibid., pp. 177–78.
45 Frank Chodorov, The Income Tax: Root of All Evil (New York: Devin-Adair, 1954), pp. 40–41. The tariff in that respect is like any “sin” tax, such as the tax on tobacco. If it really discourages smoking, it doesn’t raise much money. Come to think of it, a tariff is a sin tax, a tax on the “sin” of buying imports. See William F. Shughart II, ed., Taxing Choice: The Predatory Politics of Fiscal Discrimination (New Brunswick, N.J.: Transaction Publishers, 1996).
46 Adams, p. 368.
47 Robert H. Wiebe, Businessmen and Reform: A Study of the Progressive Movement (Chicago: Quadrangle Paperbacks, 1968), p. 196.
48 Carolyn Webber and Aaron Wildavsky, A History of Taxation and Expenditure in the Western World (New York: Simon and Schuster, 1986), p. 421.
49 Gabriel Kolko, The Triumph of Conservatism: A Reinterpretation of American History, 1900–1916 (Chicago: Quadrangle Books, 1967) and Railroads and Regulation, 1887–1916 (Princeton, N.J.: Princeton University Press, 1965).
50 Bennett D. Baack and Edward John Ray, “The Political Economy of the Origin and Development of the Federal Income Tax” in Emergence of Modern Political Economy, ed. Robert Higgs (Greenwich, Conn.: JAI Press, 1985), pp. 127–31.
51 Ekirch, p. 180.
52 Webber and Wildavsky, p. 421.
53 Buenker, “Ratification of the Federal Income Tax Amendment,” p. 188.
54 Raymond J. Keating, “Original Intent and the Income Tax,” The Freeman, February 1996, p. 71.
55 Ekirch, pp. 181–82.
56 Webber and Wildavsky, p. 422.
57 Ekirch, p. 182.
58 Higgs, pp. 151–52.
59 Joseph A. Pechman, Federal Tax Policy, 5th ed. (Washington, D.C.: Brookings Institution, 1987), p. 313.
60 Ibid.
61 Higgs, p. 231.
62 John C. Chrommie, The Internal Revenue Service (New York: Praeger Publishers, 1970), pp. 21–22.
63 “Best of Both Worlds” (an interview with Milton Friedman), Reason, June 1995, p. 33. Friedman recalls that the IRS opposed withholding because it was a departure from its standard method of collecting revenue.
64 Keating, p. 71.
65 Chodorov, p. 40.
6
Let’s Abolish the Income Tax
Can we live without the Sixteenth Amendment, the income tax, and the Internal Revenue Service?
After all that has been said in the preceding chapters, it might be better to ask if we can continue to live with them. We have seen that the income tax is based on a fundamentally immoral notion: that the state has a prior claim on the fruits of a person’s labor. That notion, which is a half-step removed from the slave principle, is at odds with the Jeffersonian idea that lies at the foundation of the American Republic: that every human being has a natural right to life, liberty, and the pursuit of happiness, which of necessity includes the right to use and dispose of honestly acquired property.
We have seen further that when the state is permitted to tax income a process is set in motion that inevitably reverses the traditional American relationship between citizen and government. In the original Jeffersonian vision the citizen was the master and the government was the servant. But with the advent of income taxation, that relationship began to change and eventually was reversed. When government seeks to tax income it will inevitably assume the powers required to carry out that mission. Those powers will enable it to delve deeply into people’s personal affairs, destroying their financial privacy, putting them permanently on the defensive, and leaving them vulnerable to demands that they prove they have not violated the law. Intentions are irrelevant. Admit the principle of income taxation and all those things follow logically. Citizens become subjects.
We have also seen that income taxation undermines the market economy. By draining the people’s savings and capital, the tax necessarily impedes their a
bility to create prosperity, to achieve financial independence, and to make a better society for everyone. Meanwhile, the income tax gives the state unprecedented access to wealth, bringing in huge revenues with which politicians and bureaucrats can attempt to shape society according to their liking and buy political support so they may stay in power and tax some more. We have seen how the policymakers use the tax code to encourage and discourage behavior arbitrarily, undermining the spontaneous productive forces of society. Adam Smith’s invisible hand has been turned into the very visible pointing finger and clenched fist of the politicians and tax authorities.
Income taxation has made the modern American megastate what it is. In The Rights of Man, Thomas Paine wrote that government does not raise taxes so it can fight wars; rather, it fights wars so it can raise taxes. Whichever is the case, the power to tax incomes has freed the national government to venture full-force into areas foreign and domestic in which it had, at worst, only dabbled in the days before the Sixteenth Amendment.
Since World War II, the personal income tax has been the largest source of federal revenue. In fiscal year 1997, it was expected to raise more than $791 billion, more than 45 percent of all receipts, in a budget of more than $1.7 trillion. (That share has dropped slightly in recent years.) The corporation income tax was expected to bring in almost $198 billion more (12 percent), and the category known as “social insurance taxes and retirement receipts” — payroll taxes — was to capture more than $596 billion more (34 percent). That is more than $1.5 trillion from individual and business income. The people’s income has proven to be a mother lode for the U.S. government. Cut off from that kind of money, the size and scope of government would shrink fast. Imagine what would be possible with that amount left in people’s pockets!
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