The Founding Father of Modern Income Taxes: Echoes

Chances are you’ve never heard of Beardsley Ruml. But if you pay income taxes, he has exerted a significant influence on your life. He's the man who conceived what he called the "pay-as-you-go" method, now better known as estimated tax payments. In the process, he transformed the American way of income taxes.

Before 1940, only about 7 percent of Americans even paid income taxes. World War II changed that drastically. The unprecedented costs of the war meant two things to American leaders: People would have to pay much higher taxes and, more important, far more people would have to pay them.

A new tax bill would also mitigate another problem. As the war economy heated up, the high unemployment of the Great Depression years gave way to full-blast production, which put more money in the pockets of more Americans just as wartime conversion and military needs sharply reduced the supply of available goods. To prevent rampant inflation similar to that of World War I, higher taxes were needed that reached into the pockets of war workers.

The Revenue Act of 1942, passed by a reluctant Congress after seven months of bitter wrangling, revolutionized the tax system. It increased the normal and surtax rates on all incomes -- to as high as a combined rate of 88 percent on those making more than $200,000. More significantly, the new law lowered personal exemptions to $1,200 from $1,500 for married couples, and to $624 for single people. This change alone pushed more than 13 million new taxpayers into the system. The top corporate tax rate increased to 40 percent from 31 percent and the graduated excess-profits tax leaped to a flat rate of 90 percent from a range of 35 percent to 60 percent.

But another problem presented an ongoing headache: The tax bill came due at the end of each year. Americans unused to paying income taxes -- and many of those who did pay -- seldom bothered to set aside money during the year to meet their obligation. And the government had to wait until the year’s end to start receiving this revenue.

Enter Ruml. The treasurer of R. H. Macy & Co. and chairman of the Federal Reserve Bank of New York, he advanced the idea of having taxpayers make installment payments during the year, either directly or at work. This would relieve them of having to pay the whole amount at year’s end and regularize the flow of revenue to the government.

The main point of contention was how to get the plan started. If it began in January 1943, for example, taxpayers would have to pay both their entire tax for 1942 and the ongoing payments for 1943. Ruml’s solution was disarmingly simple: Forget the 1942 tax altogether and start with quarterly collections for 1943. The government would still collect revenue during the year and the system would perpetuate itself after that. It would, said Ruml, move the "tax clock forward, and cost the Treasury nothing until Judgment Day."

Treasury Secretary Henry Morgenthau and many others bristled at this idea, largely because it would provide a windfall to those who made large profits in war goods during 1942. Congress debated the Ruml plan, but dropped it from the Revenue Act of 1942. More months of rancorous debate followed as the House and Senate tried to devise an acceptable version of Ruml’s proposal.

After several votes on different versions, the watered-down Current Tax Payment Act passed in the summer of 1943. It forgave most of the previous year’s tax liability and instituted the installment or withholding system that today is a staple of the American way of taxes.

By 1944, more than 64 percent of Americans were paying income taxes. At war’s end, their number exceeded 42 million -- for the first time, individuals paid more of the total tax bill than corporations.

Since then, as Ruml predicted, the tax clock has moved relentlessly toward Judgment Day.

(Maury Klein is a professor of history emeritus at the University of Rhode Island and the author of 16 books on American history. The opinions expressed are his own.)


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