The Tax Bite

We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.  Winston S. Churchill

We’ve just gone through the annual ritual of filling out our tax returns, which always brings with it a range of different thoughts on the subject. In light of the new tax plan proposed by the President, we thought it might be interesting to look at how and when all this income tax stuff started and where it has taken us.

Though it may be hard to believe, federal income tax is a relatively new contrivance in our country’s history. While there were several attempts to implement a federal personal income tax back in the late 1800’s, all were ultimately deemed unconstitutional by the Supreme Court. The federal personal income tax as we know it today did not come into being until 1913. Prior to 1913, taxes on alcohol and tobacco accounted for nearly all of the tax revenue received by the federal government. It took a Constitutional Amendment (the 16th) to make collecting a federal personal income tax legal since the original wording of the Constitution forbade a direct federal tax on individuals. The first official federal income tax was dirt simple – 1% of all income you earned over $3,000. No itemizing, no deductions, no brackets – anyone could understand it.

In 1918 the concept of a progressive income tax was enshrined in law. From this point on in history, the more you earned, a greater proportion of your income would be taken in tax. No longer was it the case that if you earned twice as much as your neighbor you paid twice as much income tax. Now if you earned twice as much as your neighbor, you paid much more than twice as much income tax. The actual percentages and income thresholds for the progressive income tax have varied over the last 100 years, depending on which political party was in power. While the “fair” amount of one’s income to pay in tax is still constantly debated, the trend of the last 100 years has been to place most of the federal tax burden on higher earners. Today, the top 10% of earners pay nearly 3/4ths of all the federal personal income tax collected in the country. Half of all earners in the US (the lower half) currently pay no federal income tax at all. Fair?

The evolution of our federal income tax system has brought with it a style of language used by many politicians attempting to embed two philosophical concepts into our brains: 1) The money collected in income taxes is the federal government’s money and, 2) Any “cut” proposed to the federal income tax must be “paid for” by some other means. Neither of these notions is true and are not part of any law or mentioned anywhere in the Constitution. The money collected in federal income taxes is “our” money. We elect our Congressman every two years so they don’t forget how we want our tax money spent. Also, we may at times choose to elect representatives for the purpose of reducing the size and scope of the federal government. In that eventuality (which occurred this past November), the income tax rates can be reduced commensurate with a reduction in the size of the federal government. No offsetting “payment” is required.

The federal income tax code has become so complicated in the last 100 years that its greatest present day weaknesses are fraud and filing errors. A simplified tax code could go a long way to minimizing these weaknesses resulting in a far more efficient system that produces more tax revenue. Tax rates could then be lowered for everyone as a result. This is the essence of the new tax plan proposed by the current administration. This concept is not new however, and unfortunately has nearly always met with strong Congressional resistance, despite universal agreement on the theory. We’ll see soon if the current administration has any better luck convincing Congress this time around.