Happy Birthday, Income Tax!

Many unhappy returns began a hundred years ago, in October 1913.

By John Fund

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John Fund

Amid all the attention paid to the government shutdown — more of a “slimdown,” as 83 percent of the government remains open — few people noticed that last Friday, October 4, marked the 100th anniversary of the federal income tax. The size and intrusiveness of the federal government that is at the heart of today’s shutdown would never have been possible without the income tax.
For a century and a quarter, the United States avoided an income tax. Thomas Jefferson warned against such “internal” taxes, saying that under the British they had “filled our land with officers and opened our doors to their intrusions.” Until the early 20th century, a small federal government relied on import duties and taxes on alcohol and tobacco for most of its revenue.

Congress passed an income tax to fund the Civil War in 1862 but allowed it to expire a decade later. In 1894, it passed another — a 2 percent flat-rate income tax that kicked in at today’s equivalent of $110,000. It was declared unconstitutional by the Supreme Court because it was not apportioned among the states, as the U.S. Constitution required.Then, during the Progressive era, supporters of the tax passed the 16th Amendment, giving Congress the power to tax income, and in 1913 Congress approved a tax with a series of rates ranging from 2 to 7 percent. But high personal exemptions meant that fewer than one out of every 50 Americans owed any tax at all.
Critics warned a century ago that the new tax would ultimately be ruinous. The income tax “will tax the honest and allow the dishonest to escape,” the New York Times wrote. “Even those who approve the tax despite its faults cannot contend that the same sums could not have been raised more certainly, more equitably, and with less trouble to both payers and collectors by a stamp tax.” The Times warned that in any emergency the tax rates would be sure to rise and that “its unpopularity will grow with its life.”
Since then, with rare exceptions, the income tax has grown like Topsy, fueled in large part by the kinds of emergencies the Times worried about. As journalist David Van Edema put it: “The government, using Americans’ sense of patriotism and duty, [has] found new excuses to not only raise taxes, but widen the range of who would pay for them, and how.”
The costs of World War I drove the personal exemption down to just $1,000 ($15,500 today), and the bottom rate hit 6 percent on all income up to $4,000 ($62,000 today). The top rate hit 77 percent on amounts exceeding $1 million (the equivalent today of $15.5 million). World War II drove the top rate beyond 90 percent on income over $200,000 ($2,500,000 today). The number of taxpayers subject to income tax grew from 4 million before World War II to more than ten times that in 1945. In 1943, the government began withholding income tax directly from people’s paychecks, and soon after it also instituted quarterly withholding for contractors (whose employers don’t withhold tax).
Some insist that high marginal tax rates had little effect on the U.S. economy of the 1940s and 1950s. But, as Steve Forbes, the publisher of Forbes magazine, has pointed out:

They overlook the enactment of joint filing after WWII, which effectively cut a family’s tax burden in half. We grew in the 1950s because tax thresholds were high. There were also countless tax shelters that eased the bite of high rates. But those high rates took their toll as the U.S. was beset by a number of recessions, and the economy’s average growth rate in the 1950s was subpar.

Today, the heavy burden of taxes is clearly a major drag on our country’s economy. The U.S. now has the highest corporate tax rates in the industrialized world. In 1913, the total number of pages in the tax code was only 400. Today, it’s 73,954.
The income tax has also changed America. In 1956, Howard Buffett, a former conservative Nebraska congressman and the father of the much more liberal investor Warren Buffett, gave a speech decrying the tax’s pernicious effects:

The last 40 years have seen a gigantic expansion of political power over economic affairs by the federal government. The change is linked by many scholars to the passage of the income tax law of 1913. This law revolutionized the taxing system in two ways:
1. It gave the government new powers over the economic status of the individual. This change has curtailed the ability of the individual to achieve economic independence.
2. The part of his production taken from the producer cumulatively increases the power of the federal government proportionately with the increase in its income. This power is not created. It is simply taken away from the people.

Some will claim the government-shutdown fight is about Obamacare. Others will say it is about the long-term debt we are loading onto future generations. Liberals will claim it’s about Republicans’ petulance in the face of bills we must pay. But in no small part it is also about the size and scope of the federal government that the income tax ushered in exactly a century ago. That’s why it’s so fitting that the shutdown battle is happening right now. It’s time for rhetoric that rises above partisanship. It’s time for some reflection about what kind of country we’ve become — thanks to the income tax.