Fair Income Taxation, 1913-Style
February 21, 2012 1 Comment
With the latest debate about “fair” tax policy coinciding with the 99th anniversary of the federal income tax, it’s interesting to look back at what Congress considered fair when it all began.
The income tax was originally sold to the American people as a means of “soaking the rich”—a phrase that seems refreshingly candid when compared to today’s cushioned yet calculated talk of asking the rich to “pay their fair share.” While many early 20th-century politicians shared the feelings of our founders and resisted the notion of a direct federal tax on the product of a citizen’s work or investment, their fear of being tarred as protectors of the wealthy outweighed their conviction and the income tax was unleashed in 1913.
The original income tax, which Democrats defended as “the fairest and cheapest of all taxes”, bore very little resemblance to the version confronting individuals and businesses today. Reviewing the first IRS Form 1040, four attributes are particularly striking:
- It was far simpler. The instructions for the original 1040 fit on just one page, compared to 100 today. Meanwhile, the full tax code spanned 400 pages, while today’s leviathan consumes more than 72,000.
- Hardly anyone paid it. While the relentless growth of the federal government would force it to eventually engulf a huge swath of the population, the original income tax focused on only the most prosperous Americans. Thanks to a generous personal exemption, only those with taxable income greater than today’s equivalent of $67,000 were snared by it, which meant 98 or 99% of Americans kept everything they earned from either their own work or from their savings and investments.
- Those who paid did so at much lower rates than today. The original income tax applied a mere 1% rate on income all the way up to $452,292 in today’s dollars, according to the Tax Foundation. Like our current code, the 1913 version applied higher rates to higher incomes—but topped out at just 7% on income over the equivalent of a whopping $11.3 million today. In stark contrast, there are many politicians in 2012 who think it’s perfectly reasonable for the federal government to lay claim to a full third of a citizen’s income above a far lower threshold than that.
- Received dividends were exempt from income tax. At the outset, the income tax avoided what many consider an unjust aspect of today’s tax code: the double-taxation of corporate dividends. That is, dividends are paid out of after-tax profits, and those same dividends are taxed again when received by the investing shareholder. Those arguing today that dividends should be taxed at the same rates as ordinary income would gain allies if they also embraced corporate deductions for dividends— preventing our gluttonous government from taking two bites from the same profit.
Imagine if, instead of proposing the far less invasive original version, politicians in 1913 tried to implement the income tax as we now know it. Starting from a fresh slate, would Americans have considered it a reasonable proposal?
Certainly not. And yet today, after nearly a century over which the income tax has insidiously expanded its intrusion into our economy, our politics and our lives, millions of Americans who never knew a world without the income tax accept its continuation as inevitable. Without consciously doing so, they surrender to what Milton Friedman called “the tyranny of the status quo,” where existing policies are fiercely guarded from change by politicians, bureaucrats and those who directly benefit from those policies.
Reconsidering the Income Tax
That said, Americans’ tolerance of the income tax could be on the cusp of a steep decline. Spurred by a growing appreciation of the income tax’s many inherent flaws, legislation to repeal it and replace it with the FairTax—a national sales tax on new goods and services—has attracted 66 co-sponsors in the House of Representatives and eight in the Senate, along with the support of Libertarian presidential candidate Gary Johnson.
Of course, the most prominent voice calling for income tax repeal is Republican presidential hopeful Ron Paul, who would accomplish his goal via passage of the Liberty Amendment. Like his stand on most issues, Paul’s position on the income tax seems firmly rooted in principle, not politics. Indeed, when Paul recently discussed the basic concept of rights, he summarized it by saying, “Rights mean you have a right to your life, you have a right to your liberty (and) you should have a right to keep the fruits of your labor.”
Like many of his other principled stances, Paul’s strident opposition to the income tax prompts some observers to dismiss him as extreme. Perhaps, however, what’s truly extreme is the notion that our government should have a presumptive claim on the income of its individual citizens.
If Ron Paul’s growing popularity is any indication, more and more Americans are reaching the conclusion that the “fairest” approach to income taxation is to have no income taxation at all.