Hostile Takeover: Resisting Centralized Government's Stranglehold on America (22 page)

Madison, like Jefferson, described with great clarity how unfair and unequal taxes can destroy society, deprive us of our right to “sacred property,” and inhibit the pursuit of our happiness.

How did we get here from where the Founders stood? The tax code distorts important decisions that people make about investing and saving money. High marginal rates and double taxation reduce incentives to invest, while special-interest tax policies push resources toward politically favored investments rather than toward the most efficient ends.

All of this social engineering and special interest politics have generated inequities in the tax code that leave individuals paying taxes not based on income but on how that income is used. Neighbors with the same income can pay vastly different taxes based on whether they own their house, if they give to charity, or where they invest their money. Someone else is deciding. Individuals whose pursuit of happiness lines up well with the goals of lobbyists and the politically powerful receive unfair advantages. Such inequality is anathema to our Founders’ demand for economic liberty.

1913

T
HE
A
RTICLES OF
C
ONFEDERATION, ADOPTED IN 1781, LEFT THE AUTHORITY
to levy taxes with the several states, with the national government having to request funds from the states. Even when the Constitution was adopted nine years later, with a stronger federal government authorized to tax individuals directly, the power to tax remained limited by Article I, Section 2, requiring any direct tax to be “apportioned.” (Under U.S. law, a “direct” tax is one levied directly on
persons
or
property
, such as a head tax or real-estate tax. An “indirect” tax is levied on an
event
, such as when a good is sold, imported, or manufactured.) This constitutional limitation meant that the federal government could not impose a direct tax without first determining a specific sum to be collected from within each state in proportion with the state’s congressional representation. So, for example, if New York had 9 percent of the representatives in Congress, 9 percent of the revenues produced by the tax would have to come from New York. If Rhode Island had only 1 percent, then only 1 percent could come from Rhode Island. But since population density and property values vary widely across states, to get the “portions” right the tax
rate
must also vary from state to state, sometimes wildly so. A wealthy state would actually have to have a lower tax rate than a poor state to satisfy the apportionment requirements, making it practically impossible for Congress to secure the votes to pass a direct tax. This impediment may have been intentional. While the Founders clearly didn’t want to forbid direct taxes, they also seem to have disfavored them, perhaps because such taxes offer a very convenient tool for politicians to redistribute wealth among classes, states, and regions—and thus sow the seeds of corruption. As a result, for most of the nation’s early history, Congress avoided direct taxes. Instead, indirect taxes such as tariffs and excises (which the Constitution only requires to be “uniform throughout the United States”) produced the vast bulk of federal revenue.

Up through the early twentieth century, taxes tended to be low. Wars did, of course, lead to higher taxes, but typically the war debts would be paid down quickly and the temporary taxes eliminated. The system tended to minimize the burden of government and maximize individual liberty.

Everything changed in 1913.

To be fair, the radical transformation that began in the fateful year of 1913 did not occur immediately. Like many bad public policies, taxes crept up over time, the result of a gradual process that, like so much bad public policy, had its roots in war—the Civil War, to be exact. That conflict produced the first tax on personal income. The Revenue Act of 1861 established an income tax to fund the Union war effort. Although this first income tax was potentially the sort of engine for wealth redistribution that the Founders had clearly disfavored, it was deemed an indirect tax (a tax on the “event” of receiving income) and therefore not “apportioned” but rather imposed uniformly throughout all areas of the country “not in rebellion.” The rate was moderately progressive, 3 percent on all income over $800, which meant most workers did not pay the tax.
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The following year, with the war proving to be neither as brief nor as cheap as originally assumed, Congress increased both tax rates and progressivity, with the exemption lowered to $600, a tax rate of 3 percent for incomes up to $10,000, and a new 5 percent tax for income over $10,000. Thus was born the first graduated (i.e., not flat) income tax—the first “progressive” tax. Rates were increased again in 1864, and an emergency bill that same year added an additional 5 percent surtax on all income over $600.
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And so began the centralized establishment’s long love affair with tax code meddling. After the war, Congress moved to lower the income tax when surpluses began to emerge, because the majority of Americans viewed it as a temporary measure needed for the war effort. Rates were lowered and exemptions were increased, and in 1872, the tax was abolished. But for many in Congress, the urge to spend was irresistible. They’d had a taste of funding whatever their hearts desired by a well-manipulated tax code, and would stop at nothing to taste that sweet nectar again. Politicians’ insatiable desire for more taxpayer money led to more than sixty bills over the next twenty years seeking to reinstate the income tax.
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For the emerging Socialist, Populist, and Progressive movements—then gaining ground—the lure of “taxing the rich” to spend more taxpayer money was irresistible, and in 1894, Congress, controlled by the Democrats, passed a bill that included a flat federal tax on income. However, the portion of the new tax that touched income from real estate and personal property was challenged in court as a direct tax that ran afoul of the Constitution’s apportionment rule, and in 1895 the Supreme Court agreed, striking it down 5 to 4.
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This came as a surprise to everyone, since the earlier income tax adopted during the Civil War had reached all income “from any sort of property . . . or from any other source whatever” and been upheld by the Supreme Court as an indirect tax.
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Progressives were horrified, seeing their chance to force the “moneyed class” to pay “in proportion to their ability to pay”
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—the first half of
“From each according to his ability, to each according to his need”
—forever barred by five unelected judges. At once, they launched a campaign to reverse the decision, culminating with the ratification of the Sixteenth Amendment in 1913. This amendment ended the convoluted legal debate over the metaphysical nature of the income tax by clearly granting Congress “power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
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In the parlance of our times: Boom. End of discussion. Let the redistribution begin.

This contorted legal history raises an important point for today’s tax debate. Simply abolishing the Sixteenth Amendment does not necessarily eliminate the threat of an income tax. Past Supreme Courts have been on both sides of the issue, and there is no guarantee that a future Court will again rule against the income tax. To truly end the income tax, we would need an amendment that not only repeals the Sixteenth but also positively prohibits such a tax in the future.

After the 1895 ruling, Progressives and politicians, drawn by the siren call of spending, promptly redoubled their efforts to adopt a federal income tax via an aggressive campaign. A series of tax bills by Democrats failed, and in a case of Republicans trying to out-Democrat the Democrats, President William Howard Taft joined efforts to amend the Constitution. In a letter read to Congress on June 16, 1909, Taft wrote: “I therefore recommend to Congress that both houses by two-thirds vote shall propose an amendment to the Constitution conferring the power to levy an income tax upon the National Government without apportionment among the States in proportion to population.”

Congress moved quickly on this advice, and by 1913, thirty-six states had approved the Sixteenth Amendment, which was declared ratified on February 3, 1913. The language of the amendment is, of course, intentionally very broad, to allow for lots of flexibility (i.e., control) in the future.

Washington wasted little time, with newly elected President Woodrow Wilson signing the 1913 Revenue Act in October.
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The new tax was progressive, with rates starting at 1 percent for income greater than $3,000 ($4,000 for a married couple)—a very good income in those days—and rising to 7 percent for income greater than $500,000.
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At most 1 percent of the population (2 percent of households) would have to file a return. In retrospect, it seems almost quaint. This new tax also spawned the first Form 1040, the bane of taxpayers to this day.

Richard E. Byrd, Speaker of the Virginia House of Delegates, had argued against the Sixteenth Amendment with chilling prescience:

A hand from Washington will be stretched out and placed upon every man’s business; the eye of the Federal inspector will be in every man’s counting house. . . . The law will of necessity have inquisitorial features, it will provide penalties, it will create complicated machinery. Under it men will be hailed into courts distant from their homes. Heavy fines imposed by distant and unfamiliar tribunals will constantly menace the tax payer. An army of Federal inspectors, spies and detectives will descend upon the state. . . . Who of us who have had knowledge of the doings of the Federal officials in the Internal Revenue service can be blind to what will follow?
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With the amendment’s ratification, federal coffers—and the federal appetite for more spending—swelled. Initially, only 1 percent of the population paid income taxes, but that would change quickly. World War I saw a significant jump in taxes and expansion of the tax base. As recounted by the Department of Treasury, which has in obvious ways benefited from this whole mess, “By 1917 the Federal budget was almost equal to the total budget for all the years between 1791 and 1916. Needing still more tax revenue, the War Revenue Act of 1917 lowered exemptions and greatly increased tax rates. In 1916, a taxpayer needed $1.5 million in taxable income to face a 15 percent rate. By 1917 a taxpayer with only $40,000 faced a 16 percent rate and the individual with $1.5 million faced a tax rate of 67 percent.”
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Washington’s insatiable appetite for revenue was fully whetted. Income tax revenue jumped from $761 million in 1916 to $3.6 billion in 1918—almost a fivefold increase.
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With the end of the war in November 1918, surpluses began to build, reaching a high of $6.7 billion. Progressivity also increased dramatically in the 1920s, with upper-income groups moving from 30 percent to 65 percent of the total tax burden.
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The surpluses and excessive tax burdens eventually led to a series of tax reductions, but the income tax was here to stay. Washington had a new tool that would fuel the spending binge of the twentieth century.

FEEDING THE BEAST

P
OWERFUL SPECIAL INTERESTS BEGAN TO MANIPULATE THE TAX CODE
almost immediately upon its creation. Senator Nelson Aldrich, the powerful, progressive Republican who proposed an amendment to establish the income tax, worked to provide tax-exempt status to foundations, something of interest for those trying to protect their fortunes, such as the Rockefellers (into which family Senator Aldrich’s daughter had married), the Morgans, and the Carnegies. In other words, an aggressive advocate of taxing the rich had proceeded immediately to create a shelter for those with the pull and influence to reshape things.

Sounds very modern and familiar, doesn’t it? Such efforts by special interests to shape the tax code have unfortunately plagued politics in Washington ever since. It is inevitable, like water running downhill, when the founding notion of fairness—treating every single American the same under the laws of the land—is corrupted. It is guaranteed that well-heeled favor seekers will show up outside the committee rooms of the House Ways and Means Committee and lobby for a better deal.

Despite the persistence of the Great Depression, the Democratic Congress and Republican White House passed the Tax Act of 1932, the largest peacetime tax increase up to that time. President Franklin D. Roosevelt pushed for even higher taxes in 1934, raising taxes on both businesses and individuals (which were also made more progressive). With the budget still not balanced, additional tax increases were introduced in 1936, when the top rate reached 79 percent. An undistributed profits tax was added and in the next two years, payroll taxes (i.e., taxes on wage income) were also introduced, to cover unemployment insurance and Social Security and railroad retirement. In 1939, Congress codified the tax code, giving lobbyists and lawyers a specific target for future tax battles.
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World War II saw a surge in spending that led to the introduction of an “excess profits” tax, higher corporate taxes, and increased personal income taxes. To increase revenues, the tax base was expanded by reducing the number of exemptions available. In fact, at that point the personal income tax began to hit the general population, which had previously been mostly exempt. Withholding—collecting taxes at the source of the income—was also introduced as the tax base expanded, to combat rising problems with tax avoidance. In fact, the tax industry by this time was in full swing, creating early tax shelters and working its way around the emerging tax code.
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