NoâŚyou havenât bought a history book. Youâve bought a book that details a new method of raising revenue for the federal government that will send the American economy into warp driveâwhile restoring financial privacy and economic liberty to American families and wage earners.
To plan successfully for the future, though, itâs necessary to have at least a basic understanding of the past. If weâre trying to kill a bureaucratic monster that destroys initiative and impedes economic growth, itâs crucial that we know just what cave that monster crawled out of. In the words of the American philosopher George Santayana, âThose who cannot remember the past are condemned to repeat it.â
As you read this depressing (though brief) history of the income tax in Americaâand the chapter on withholding that followsâkeep this basic fact in mind: There is absolutely no limit to the governmentâs desire for your money. When it comes to politiciansâ powers of taxation, the only limit they recognize is the peopleâs willingness to tolerate the confiscation of their wealth. The amount of your earnings that the government is willing to leave in your pocket is only the amount it cannot seize without promoting an outright rebellion.
In the early years of our republic, the federal government levied few taxes. The Feds managed to get by with only a handful: taxes on alcohol, carriages, and some basic consumer items such as sugar and tobacco. When the United States went to war against Great Britain in 1812, sales taxes were placed on various luxury items to cover the cost. The cost of fighting a war can be high, but citizens are generally amenable to higher taxes in times of war because they realize that the cost of not fighting the war can be even higher. These patriotic feelings would be exploited in later years to the immense benefit of the free-spending political class.
In 1817, with Great Britain once again defeated, Congress did away with all internal taxes and funded the cost of the federal government with tariffs on imports.
Remember, please, that during this period of American history most governing was done at the local, not the national, level. This is as our founding fathers wanted it. Various people present when our Constitution was drafted expressed a belief that, in times of peace, roughly 95 percent of all governing should be at the state and local levels, with the remaining 5 percent coming from the federal government. Add that to the list of founding principles that have been all but ignored.
The first attempt at an income tax came about to raise funds for what we know as the Civil War. In 1861, Congress passed a bill assessing a 3 percent income tax on everyone earning between $600 and $10,000 a year. Six hundred dollars a year in 1861 would equal about $10,000 now. If you earned more than $10,000 (about $166,700 today), the rate went to 5 percent and a nice little inheritance tax was added to the mix, as were some additional sales and excise taxes.
The Union wasnât alone in enacting the income tax. The idea also caught hold south of the Mason-Dixon line, and the Confederate states enacted their own version. Misery, it seems, has always loved company.
By 1872, with the war over, the populace was starting to show its displeasure with the income tax. The political class reacted by eliminating the income tax. The Feds went back to taxing tobacco and booze. Yet the politiciansâ dreams of a permanent income tax werenât easy to squelch; the snake was hibernating, not dead. Over the next twenty years or more, members of Congress introduced no less than sixty-eight bills to enact another income tax.
The second term of President Grover Cleveland brought us the economic fiasco thatâs gone down in history as the Panic of 1893. First, the Reading Railroad (remember it from Monopoly?) went into receivership. A few banks and other businesses dependent on the railroad followed, and soon we had a general economic downturn. Now, as weâve learned, when the economy goes sour thatâs a signal for the government to start taking more money out of the pockets of its citizens. It was time to try an income tax again.
Using the Panic as a handy excuse, eager politicians passed a law calling for a new income tax in 1894. Politicians then, as now, were not particularly eager to showcase just what they were trying to accomplish, so they made a blatant attempt to quell any possibility of a strong anti-income tax response from the voters by assigning a rather bizarre title to the new tax bill. They called it âAn act to reduce taxation, to provide revenue for the government, and for other purposes.â Just how much can you trust a politician who passes a law to tax your income, and calls it an âact to reduce taxationâ?
The 1894 âact to reduce taxationâ presented Americans with a 2 percent tax on everyone making more than $4,000 a year (the equivalent of $50,000 today). In a nice twist, our politicians decided that all government officialsâstate and local alikeâwould be exempt from the new tax. Not a bad deal! Tax the people, exempt yourself. Thatâs what the politicians of 1894 meant by âequal treatment under the law.â Why not give it a try? Who knowsâŚit just might have worked.
As it turned out, this 2 percent tax on incomes over $4,000 started a chain of events that culminated in a constitutional amendment and our current income tax system. President Grover Cleveland, you see, thought that the 2 percent income tax was unconstitutional, so he let it become law without his signature. The question of constitutionality was presented to the U.S. Supreme Courtâand the income tax lost. The Supremes ruled that the income tax was actually a direct tax on the citizens of the United States, a violation of the Constitution.
Now hereâs where things get really depressing. After an income tax was declared unconstitutional, the politicians in
Washington chose sides and drew their battle lines. On one hand we had Democrats, who were eager to spend the money that would come from an income tax. The Democrats called for a constitutional amendment permitting the income tax in both their 1896 and 1908 platforms. Republicans, on the other hand, were opposed to the idea in principle.
Those who favored the idea of an income tax met with considerable success, capturing public sentiment with promises that the tax would âsoak the rich,â and leave the vast majority of Americans alone. Economic class warfare was as alive and well in the early 1900s as it is in the early 2000s.
The historical timeline now brings us to Texas Senator Joseph Bailey, a conservative Democrat. Deciding to play the game of partisan politics, Bailey cooked up a scheme to humiliate congressional Republicans. Though he was opposed to the idea, Bailey introduced a bill calling for an income tax. He mistakenly thought that the Republicans would rush in to kill this legislation, thus furthering the image Democrats were trying to cultivate of Republicans as hostile to the poor and concerned only about protecting the wealthy. Wouldnât you know it, things didnât turn out as Bailey had planned. Liberal Republicans, backed by Teddy Roosevelt, actually came out in support of the bill. Passage seemed all but certain.
Conservative Republicans were panicked. They needed a way to derail the Bailey bill and the growing threat of an income tax. In one of the worst examples of legislative play-calling in our history, Republicans came up with the brilliant idea of announcing that they would support the idea of an income tax on one condition: if and only if it came about as the result of an amendment to our Constitution. Even though this group of conservative Republicans felt that there was some slight chance the proposed amendment might actually make it through the House and the Senate, there was just no way in the world that the legislatures of three-fourths of the states could vote for ratification. YeahâŚright.
Big oops.
The amendment sailed through the House and the Senate. The vote in the Senate was 77 to 0, and the House approved it by 318 to 14. It was off to the states for ratification. Conservative Republicans were still confident that the effort was doomed. They were as wrong as they could be.
Smelling ultimate victory for one of their long-held goals, the Democrats launched a massive effort to convince the people that any income tax would be directed only at the wealthy, and that ordinary Americans would be left virtually untaxed. Conservative legislatures in the West and the South convinced their constituents that the adoption of the income tax would have little effect on them, since incomes high enough to be taxed were rare in these areas. The people, thus anesthetized, raised little objection and the Sixteenth Amendment was ratified on February 12, 1913. This date should be added to December 7, 1941, and September 11, 2001, as dates in American history that shall forever live in infamy.
In the beginning, as advertised, the federal income tax was indeed a tax on the âevil and hated rich.â When the income tax first arrived, only one-half of 1 percent of American income earners actually paid any income tax. In todayâs dollars, you would have had to have an income of $250,000 or more to feel the first 1 percent pinch; a 7 percent rate would kick in for those making more than the equivalent of $6 million a year.
It is not necessary for the purposes of this book to go into the gory and depressing details of how the tax burden on Americans has increased over the past ninety-plus years. Suffice it to say that those who felt the income tax would affect only the very wealthy were soon shocked into reality. The income tax soon became a burden not just to the wealthy, but to average American families struggling to raise their children and plan for retirement while somehow ending up with enough money left over to enjoy in their personal lives.
Today, this struggle is nearing a crisis point: the income tax is being molded into a more perfect weapon of class warfare. In 2003, the last year for which figures are available, the top 52 percent of all income earners paid virtually 100 percent of all personal income taxes collected by the Internal Revenue Service. We are just a few years away from the point where the majority of American wage earners will have no federal income tax liability at all. The purpose of this book is not to illustrate how our income tax is used as an instrument of class warfare. This might, however, be a good place to pause and reflect on what might transpire when politicians need the votes of the non-tax-paying majority more than the votes of the people actually covering the tab.
Not a comforting thought, is it?
Back to our history lesson: With the ratification of the Sixteenth Amendment, our politicians had finally realized their long-term goal of instituting an income tax. Yet they soon discovered, to their dismay, that there were limitations. One problem was that the voters were determined to hold politicians to their promise that the tax would be levied only on the rich. Another problem was the method of payment. As weâll see in the next chapter, the voters rebelled against the idea of withholding tax. Tax bills were paid on an annual basis. Under those conditions, itâs rather hard for politicians to raise tax rates or to expand the reach of the tax.
But another force would soon come along to give politicians the leverage they needed to turn the tax tide in their favor. That force was war.