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Wednesday, February 13, 2013

Happy birthday, federal income tax

In the tax world, where we spend most of our time, it's a big month, because the 100th anniversary of the federal income tax is upon us. The 16th Amendment to the Constitution, which authorizes the tax, was ratified on Feb. 3, 1913, and the first law implementing the newly authorized tax was passed on October 3 of that year.

When that first income tax act was passed, it was made retroactive to March 1, and so that's when the first income subject to tax was received or earned. We suppose that some folks will celebrate the 100th birthday in October, but for us, we're going with the effective date, which is two weeks from Friday. We're still not sure exactly how the celebration is going to go, but a party is called for.

The income tax was a progressive measure, designed to, well, tax the wealthy. It was a Teddy Roosevelt project, although it didn't make it into law until Woodrow Wilson was in the White House. Democrats and western Republicans were the main promoters of the tax. It was inserted into a law that also lowered tariffs on imported goods. Nowadays, tariffs have been greatly diminished in importance, and the income tax has morphed, from an esoteric matter of concern only to the rich to an annual ordeal endured by nearly every working American, and even by foreigners with income from the United States.

Perhaps the best way to celebrate the 100th anniversary would be to start talking about scrapping the income tax in favor of some other form of taxation. We like the suggestion of making the income tax applicable to only the top 10% of income levels, with a national sales tax of some kind to replace most of the income tax. A national sales tax, such as a value-added tax similar to those in place in many industrialized countries, would be a drag to have to pay. But can you imagine not having income tax taken out of your paycheck? And not having to deal with taxes every April? It's a tradeoff worth talking about.

Comments (20)

Problem is that wouldn't stay at the top 10% for long. Then we'd have a VAT and a universal income tax.

If you take that attitude, the tax system will never change. The current, dysfunctional system will remain in place forever. You must like that.

No. I'm not opposed to switching to a VAT or sales tax if the income tax is eliminated. Hell I favor it.

Then we'd be more or less back to 1912. Not that that would necessarily be a bad thing, but the Taft years were not the nation's best.

...but the Taft years were not the nation's best.

Other than the 16th Amendment, what's the beef with the "Taft years". Seems like he'd have been your kind of guy.

The Federal Income tax arrived the same year as the private international banks got a hold of our money supply.

Printing money out of nothing and then charging interest takes revenue from somewhere.

Guess where?

I think household income top 10% is 125k and above. Exempting from income tax single or MFJ incomes below that amount would do a lot of good for our economy. In addition to benefits Jack describes, the scheme would also get the IRS out of administrating the social welfare program that is the earned income tax credit. The Service has done a woefully bad job at preventing fraud in the credit.

Is a national sales tax the right answer? Regressive yes but you can exempt food and medicine to shield the lowest income households from the tax.

Imagine what impact a consumption tax would have on the american family's balance sheet if it was to improve the savings rate and ultimately take pressure off Social Security in the coming decades. In a land of rampant consumerism, and on the heels of a generation of spoiled children who spent everything, we may yet be able to move the needle on improving the balance sheet if you target the Code towards consumption.

Complex topic...

You failed to mention the FED also came in to existence that year; an unaudited, unregulated, for profit agency who is accountable to no one (by Congress on paper, right). Where do those profits actually go?
What has Congress done to stop the FED from sending our $80 B in monthly purchases (supposedly of MBS) to overseas banks that are in trouble to prop them up?

I think the larger problem is with the bankers running things and their relationships with the politicians (see GS) not so much specific tax laws but the system as a whole as it is. Politicians seem to always want to approach cause and effect problems at the wrong end. Funny they never complain about their tax obligations,their health care, their retirement funds, etc..

Also see the rule of law (if it can be found anywhere any longer)which trumps anything in theory, if you want to attract investment $ and growth. Money will flow there... See Argentina for what not to do.

Globally money is flowing from east to west. Tax laws and enforcement are critical whatever the structure and we seem now to not have rules or laws unless you make under $250k.

Flat taxes rates are in place in a number of countries now. Rates from 12 to 25%.

I'd like to see a flat tax on consumption (three tiers).

So without some constitutional cap on those rates, nothing will ever stop the creep toward additional revenue for questionable expenditures. You see how VATs go if you've traveled, a tax on a tax on a tax, much like a government run capital project.

Maybe all of this is moot since we now have more debt than can ever be repaid.

I spend far too many hours and pay far too much constructing data for examination by the IRS. This lost production in both the private sector as well as supporting the IRS and its many associated agencies is a monumental drag on our economy.

How much do these agencies and regulations cost, compared to the flat tax structure? They try to justify themselves by the PR spin that for every $ spent they collect x$ but if we eliminate the thousands of pages of tax law, this argument is invalid.

Unfortunately, we will never get relief since those who benefit from these rules are the ones we'd have to rely on to change them. They like them just as they are. What we like matters not.

We need to find a way to repatriate those oversees business accounts that add nothing to our revenue base. They just sit there avoiding US tax rules. (see AAPL / $92B offshore)

The beauty of the VAT (or ugliness, depending on point of view) is that ultimately it comes down to everyday garden-variety consumers to be the ones who end up footing the bill, and they don't even know it because they can't see it, hidden as it is in the price of everything they buy. A tax and spend politician's wet dream.

Getting rid of the earned income credit would be highly regressive. There are other ways to deal with fraud in the program other than by eliminating it completely, Will. (Fraud which is usually perpetrated by unscrupulous tax preparers who justify exorbitant fees by promising unwary clients huge refunds, BTW.) Should someone who makes $15,000 a year really be taxed at the same rate as someone making $124,000?

How about we levy social security deductions on all income, rather than capping them like we do now?

ex-bartender, I did not make myself clear. I am in complete agreement with the spirit of the EITC and would not want to see the citizens who qualify for it to be cut off from that type of assistance. I just do not think that the IRS should be paymaster for the program. Maybe DHHS?

And yes, agreed, paid preparers are largely to blame for the fraudulent refund claims. There is a profit motive for them to game that credit. How can we let this type of social assistance be a profit center for H&R Block et al?

If you try to deliver social assistance through the revenue code I just think there are all kinds of problems that spring up. If simplicity and limiting the drag on our economy from tax compliance costs is the goal, then I think you have to simply raise revenue with the revenue code.

"If you try to deliver social assistance through the revenue code I just think there are all kinds of problems that spring up. If simplicity and limiting the drag on our economy from tax compliance costs is the goal, then I think you have to simply raise revenue with the revenue code."

That's my vote. The only thing the tax code should be used for is to raise revenue. Not shaping social, fiscal or economic policy or behavior. No punishing this or rewarding that.

As I understand, most of what has become the behemoth IRS code is via riders to other bills, riders that are favors to this interest or that or trade-offs for something else.

In the festive spirit of this centennial celebration I present a link to the 1913 1040 - http://taxfoundation.org/sites/taxfoundation.org/files/docs/86626fd2c93c905f88f2668d09b19b28.pdf

mark - "the FED also came in to existence that year; an unaudited, unregulated, for profit agency who is accountable to no one (by Congress on paper, right). Where do those profits actually go?" Tsk, tsk, you and the great unwashed don't understand that we know better than you. As you say, it's a complex topic. Keep complaining, but no one is listening.....

Meanwhile the Feds are making it harder and harder to submit income taxes. The last couple of years they tiptoed over to the 1st & Main Building downtown while the Edith Green Building was being renovated, without posting a sign or making any real effort to let people know they had moved. They're still on the 13th (appropriate) floor over there where the forms are accessible without going through security, but otherwise you're wanded and whatever you're carrying is x-rayed before you get to speak to an IRS employee.

I was down there today because some of the forms I needed couldn't be downloaded and submitted from the online site. And guess what? All of the 1040 instruction books were gone with no more expected for 1 1/2 weeks. It was bitcherama deluxe as I stood there watching disappointed people who couldn't find the forms they needed to submit their tax return by mail.

And then they wonder why not everyone files on time.

I appreciate what you're saying Will, but with all due respect, I've dealt with both the IRS and DHS. And the IRS is far more efficient - and their paperwork far easier to complete - to gain roughly the same dollar amount of benefit - for those of us in the lower income rungs who are eligible for the EITC, anyway.

The same is true of other common tax deductions or credits that benefit mainly the lower and middle class - the deductions for mortgages and student loans, for instance. They are extremely easy to figure and I am not swayed by the argument that we need to dispose of them in order to simplify the tax code. I certainly don't feel they constitute a "drag on our economy from tax compliance." It takes Turbo Tax about 8 seconds to compute my eligibility for, and dollar amount of, my EITC.

I ask again... Should someone who makes $15,000 a year really be taxed at the same rate as someone making $124,000?

Well there are some tough political sells to make for most reforms, but proposing a new kind of sales tax may be an Oregon windmill best left untilted.
Look up Al Ullman, one of the most powerful Congressman Oregon every had, in Wikipedia:
"In the midst of the "Reagan landslide" -- which also led to the defeat of President Jimmy Carter and the Republican takeover of the United States Senate -- Ullman narrowly lost his bid for a thirteenth term from the Second District" in 1980. His loss was "widely attributed to the nationally prevalent anti-incumbent and anti-government mindset; the presence in his House race of an independent candidate; the increasing conservatism of the Second District; and to his advocacy for a value-added tax similar to that now used in the European Union and other nations as a partial alternative to what he viewed as inequities in the existing Federal income tax system."
Maybe someday, but not soon.

I have no doubt that I will retire with the income tax still in place. It's been quite a career so far, making money off the complexity. But it's truly a national disgrace.

The scenario for a VAT is Republicans in control of both Houses, especially the Senate, and a firebrand Republican in the White House. Then a disaster of some kind to cripple the income tax -- maybe some kind of protest in which employers participate. If the withholding agents rebel en masse, and the IRS is starved for enforcement money by a stingy Congress, the income tax will crash.

The top marginal rate in 1913 was 7% (seven percent) on income over $500,000, which was a whole lot of money back then.

Now the top rate is 39.6% after $450,000. And other taxes define "the rich" down to well under that. Most earners just got hit by restoration of the full Social Security tax.

I would just as soon abolish the income tax, and replace it with a VAT. It would make more sense to see the same money pass through the system five times at 10% than one time (and quite reluctantly) at 40%.

" If the withholding agents rebel en masse, and the IRS is starved for enforcement money by a stingy Congress, the income tax will crash."

The way to get rid of the income tax and the payroll tax along with it is to stop all withholding and require payment with the filings.

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