When the modern U.S. income tax came into being a century ago, no one could have anticipated that it would become the labyrinth of rules and regulations that Americans wrestled with as they filed their returns this week.
The reformers and lawmakers who supported the income tax wanted it to be a visible and salient way to raise revenue. A tax that was seen and felt, they argued, could foster a sense of fiscal citizenship. By paying taxes directly to the federal government, citizens would be more attuned to the workings of the state, and would have a more tangible stake in how public funds were raised and used. A direct tax could help forge a renewed sense of national civic identity.
Before the income tax, the federal government was financed mainly by indirect consumption taxes such as customs duties and excise taxes. These levies were generally tacked on to the final costs of everyday consumption items, and were perceived by contemporary critics as “hidden” taxes that unduly increased the cost of living.
Income-tax supporters railed against this stealth form of taxation. At the beginning of the 20th century, the University of Wisconsin political economist Richard T. Ely showed how growing concentrations of wealth and the reliance on indirect national taxes disconnected many citizens from the democratic process. He contended that because taxpayers were seemingly unaware that they were funding the public sector through their everyday spending, they had little interest in the role of government.
This was particularly true, Ely said, of those with swelling fortunes who thought they had little need for public goods.
As a result, citizens were too often “careless and indifferent about their public duties, knowing that their income is not affected by high or low taxation,” Ely wrote. “They appear to pay nothing to government, and as it seems to cost them nothing, they too often care little for it.” Ely and other tax reformers believed that direct taxes on income could make taxpayers more engaged citizens.
It wasn’t only progressive reformers who acknowledged the virtues of an “inconvenient” direct-tax system. In the early 1920s, when Congress was considering replacing the income tax with a type of national sales tax, even Republican leaders defended a direct tax on individual income as a way to bolster political and civic engagement.
“As a matter of policy,” U.S. Treasury Secretary Andrew Mellon told Congress, “it is advisable to have every citizen with a stake in his country.”
Mellon understood that the 1920s income tax was a “class tax” aimed mainly at the wealthy, though he resisted further attempts to narrow the base by raising exemption levels. “Nothing brings home to a man the feeling that he personally has an interest in seeing that government revenues are not squandered, but intelligently expended, as the fact that he contributes individually a direct tax, no matter how small, to his government,” Mellon wrote.
Similar sentiments guided other political leaders. In the early 1940s, President Franklin D. Roosevelt adamantly opposed proposals in Congress for a national sales tax to help underwrite the war effort. Part of the reason was that Roosevelt was preoccupied with using “soak-the-rich” taxes to attack “economic royalists,” as the political historian Joseph J. Thorndike demonstrated in his recent book, “Their Fair Share: Taxing the Rich in the Age of FDR.”
But an equally important, if more implicit, element of late New Deal tax policy was the attempt to solidify the national commitment to direct and progressive taxation. By sharply lowering exemption levels and increasing graduated rates, lawmakers expanded the notions of shared sacrifice and fiscal citizenship to a much broader cross-section of society.
World War II not only transformed the income tax from a “class tax” to a “mass tax,” the widespread use of withholding also altered how citizens engaged with the fiscal state. Although inexact withholding and annual filing had existed during the early years of the income tax, the full-fledged adoption of a return-based mass income tax had important implications for how taxpayers demonstrated their fiscal citizenship.
Paying income taxes regularly through withholding and filing an annual tax return made the mass income tax administratively effective yet still highly visible and somewhat painful. The federal government was able to easily generate revenue, and taxpayers were reminded every year of their civic obligations.
The return-based mass income tax has proved remarkably resilient mainly because it reflects an enduring political compromise between opponents and supporters of big government. As the Duke University law professor Lawrence Zelenak shows in his new book, “Learning to Love Form 1040: Two Cheers for the Return-Based Mass Income Tax,” a simplified version of our current tax system can be defended as an appealing middle ground between those who prefer making taxes more visible and painful - - under the assumption that this will limit the size of the state -- and those who are more concerned about the state’s continued ability to generate sufficient revenue.
In this sense, our current tax system is a byproduct of the longstanding American ambivalence toward centralized political power. It is a form of statism for anti-statists.
(Ajay K. Mehrotra teaches law and history at the Maurer School of Law at Indiana University, Bloomington. He is the author of “Making the Modern American Fiscal State: Law, Politics, and the Rise of Progressive Taxation, 1877-1929,” to be published by Cambridge University Press. The opinions expressed are his own.)
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