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Tuesday, October 1, 2013

US Income Tax Turns 100: Unintended Consequences

On October 3, 2013, the U.S. federal income tax turns 100. As the twentieth century demonstrates, a lot can change in a century. Given the sheer amount of time and even inevitable adaptations, a program's original purpose and design (i.e., what it was designed for) can easily become obscured to the naked eye. As a result, contemporary debates on a long-standing program or policy tend to be unnecessarily constrained because its original purpose and initial design tend to be excluded, even thought to be impossible! In their exchange of letters in retirement, Jefferson and Adams agreed that a virtuous and educated electorate is necessary for a republic to endure. Within the educated rubric, the history of the republic, including the history of existing policies and programs that are significant, is not a small matter. 

In terms of the federal income tax, the legislation passed in 1913 applied only to the rich. The personal exemption was $3,000 ($71,000 in 2013 dollars) for individuals and $4,000 ($94,500) for married couples. Interest and state/local taxes were deductable. After the exemption (none for dependents) and deductions, the rate of 1% was applied to the remaining income up to $20,000 ($472,500). The rate shot up all the way to 2% for income over $20,000 to $50,000 ($1,181,200)—then increments from 3% to 7 percent.[1]  It had been estimated that only 425,000 people out of the U.S. population of about 100 million would have to pay income tax.[2]

                          Remember this is after the exemption and deductions.  Source: IRS and US Dept. of Labor.

It follows that the assumption taken for granted in 2013 that everyone who has income should be taxed does not jive with the tax in 1913.  Arguing that people earning less than say $12,000 a year (before exemptions and deductions) should not have to pay any income tax looks incredibly heartless (as well as petty) from the vantage point of a personal exemption of what would be $71,000 in 2013 dollars.

The movement pushing the constitutional amendment and subsequent legislation had to do in part with tariff reform, rather than being sought as a means by which the federal budget could be expanded. In 1890, almost all of the federal government’s revenue can from tariffs (60%), taxes on alcohol (27%), and tobacco taxes (8%). Also in that year, the McKinley Tariff raised tariff rates appreciably, “principally for protectionist purposes, rather than revenue.”[3] In 1894, the Democrats enacted a modest income tax (2% on incomes over $4,000 ($110,000)) to “help finance a reduction in tariff rates.”[4]

Although the Pollock decision in 1895 declared the direct, non-proportional tax unconstitutional, even in 1913 the federal income tax was re-initiated (after ratification of the amendment) as a means to foster free trade. The disproportionate hit to the poor from alcohol and tobacco taxes was also a factor. The notion that everyone with income should be taxed on it was not in the mix. Nor was the Congress intent to “crowd out” the ability of the State governments to tax sufficiently to safeguard their governmental turf from encroachments by Congress.

Nevertheless, especially from World War II the federal income taxation expanded “downward” and thus in terms of the number of people subject to the tax; it became ubiquitous in application. Meanwhile, State legislatures faced increasing pressure to keep a lid on the revenue side at least from citizens launching tax revolts (especially in California). By 2013, the Federal Government had done what some of the delegates to the Constitutional Convention had feared; the feds had sucked up so much of taxation that Americans would accept that the States were starving for cash even to help feed and house their most vulnerable. Not coincidentally, the power of the Congress had come to dwarf that of the States, so the check-and-balance proffered by federalism could hardly function. Had what would come to pass influenced Congressional debate in 1913, I doubt the unintended risks would have had much sway—just as the incremental changes to the federal income tax would discount or ignore the original design (i.e., application) of the tax.

What can we learn from this case study? First, public and Congressional debate on whether to reform an extant program or policy should include some reference to its history. What did the program (including tax schemes) look like initially? What were the initial results? What policy objectives and political forces drove its adoption? Have subsequent problems stemming from the program proved the importance of including factors not considered in the legislative (or policy) process? 

In short, public and congressional debates on whether to change an existing policy or program can be broadened and deepened if its history is included. The initial assumptions and purpose(s) can be uncovered and treated as a sort of privileged alternative, or non-alien alien in juxtaposition to the existing basis. Initial blind spots,  such as unforeseen long-term negative impacts on the governance system itself, can be brought in, assessed and finally obviated. 

Moreover, the lesson here is that we as human beings tend not to  know what we don’t know. All too easily, we fall into the customary two well-worn groves, which can easily become a false dichotomy if as if we had no choice but to wear horse-blinders. Too often than not, the substance of the vaunted self-government consists of what Nietzsche calls herd animals

If a self-governing people, perhaps even aided by its media, publically questions assumptions hitherto taken for granted (i.e., critical thinking), the breadth of policy and program options could  increase substantially. Maybe the principle behind the U.S. federal income tax is not that everyone should contribute. Maybe the assumption that every possible source of income should be subject to the tax is unnecessarily harsh. Maybe the existing reliance of income tax to fund the U.S. Government is not only ahistoric, but risky and unwise. The matter may boil down to figuring out how to effectively counter the gravity of the status quo (and its vested interests). 

1. Bruce Bartlett, “Happy Centennial, Federal Income Tax,” The New York Times, October 1, 2013.
2. Ibid.
3. Ibid.
4. Ibid.