Using Tax History to Understand Today’s Debate: National Debt, Budget Crisis and Payroll Tax

There are a lot of smart politicians and economists out there who fall on either side of the debate over whether to increase taxes and preserve high levels of government spending or to decrease taxes and cut government spending.  There is now a looming vote in Congress to raise the debt ceiling to an astonishing $14 trillion.  Whatever the final decision, be assured that the burden falls on the American taxpayer—in this generation and future generations.  To better understand how we got to this point, let’s walk through a brief history of one of the sources of this debt: the payroll tax.
The federal, state and local tax systems in the United States have been marked by significant changes over the years in response to changes in the role of government.  The types of taxes collected, their relative proportion, and the magnitudes of the revenues collected are all far different than they were 50 to 100 years ago. Some of these changes are traceable to specific historical events, such as war or the passage of the 16th Amendment, granting Congress the power to levy a tax on personal income.  Other changes were more gradual, responding to issues in our society, our economy, and the roles and responsibilities that government has taken unto itself.
Though social policies sometimes governed the course of tax policy—even in the early days of the Republic—the nature of these policies did not extend to the collection of taxes for the purpose of equalizing incomes or wealth and were not for the purpose of redistributing income or wealth.  President Barack Obama, Nancy Pelosi, Harry Reid, and other liberals need to be reminded of this.

Even Thomas Jefferson—perhaps the greatest early disciple of the philosophy that the will of the masses should carry the most weight in the policy process—did not believe that the government’s role rightly included the establishment of a baseline level of prosperity for individuals.  Discussing the “general Welfare” clause of the Constitution, he explained its limitations thus:

“To take from one, because it is thought his own industry and that of his father has acquired too much, in order to spare to others who (or whose fathers) have not exercised equal industry and skill, is to violate arbitrarily the first principle of association, ‘to guarantee to everyone a free exercise of his industry and the fruits acquired by it.’”

Yet liberals today demand such institutions as the “Death Tax” or “Inheritance Tax,” which effectively tax personal income a second time after it was earned.  Their battle cry is to “tax the rich” because they “can afford it,”  which misses the point that such a philosophy is, by definition, an arbitrary violation of the sanctity of private property.

When the Civil War erupted, Congress passed the Revenue Act of 1861, imposing a tax on personal incomes for the first time.  On July 1, 1862, Congress passed new excise taxes on many items of personal use and commerce.  The 1862 law assured the timely collection of taxes by ensuring that monies were “withheld at the source” by employers.  But the income tax was abolished in 1872, and until 1913 almost 90 percent of all government revenue was collected from the remaining excise taxes.

By 1913, income tax had returned (thanks to the early Progressives, from whom was born the modern liberal philosophy) along with the return of tax withholding as had been done during the Civil War.  This greatly eased the collection of the tax for both the taxpayer and the government.  However, this greatly reduced the transparency of the tax system and made the payment of taxes much less personal—meaning that individuals came to have less direct knowledge of the tax process.

Throughout the 1950s, tax policy was increasingly seen as a tool not only for raising revenue but also for changing incentives in the economy.  It was also seen as a tool for stabilizing macroeconomic activity.  The economy remained subject to frequent boom and bust cycles, and many policymakers came to accept the economic concept of raising or lowering taxes and spending to adjust aggregate demand and thereby smooth the business cycle.

Accordingly, the maximum personal income tax rate in 1954 reached 87 percent.  Over the years after that, the maximum tax rate fluctuated from its 87 percent high to a low of 28 percent in 1986.  Most recently, the Economic Growth and Tax Relief and Reconciliation Act of 2001 (or the “Bush tax cuts”) brought the top tax bracket down from 39.6 percent to 33 percent.

If the 2010 Congress had let the tax rates of the Bush tax cuts expire, the top rate would have gone back up to 39.6 percent during this recent recession.  This would have further exacerbated and extended the length of this recession.

Tax policy should be like a gyroscope.  It should be set to let the economy rotate at high speed—with an ideal combination of low taxes, smaller government, freedom, liberty, entrepreneurship, balanced budget—all working to resist the external forces of social entitlement programs, government overspending, and wealth redistribution that tend to knock liberty and prosperity off its axis.

Government manipulation of tax policy and its attempts at micromanagement have brought us today to the unsustainable point where 47 percent of working Americans pay no federal income tax.  It is imperative that all who work and receive government benefits pay a share.

We are at a tipping point.  Budgets are being decimated and people, states, and the whole nation are going broke.  We need to cut government spending and eliminate the government’s need to manipulate tax policy!
Dave Swarthout is a commentary associate for the Pax Americana Institute.

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