Call it a case of selective memory for poor old Uncle Sam.
Last month, the U.S. Labor Department launched a website commemorating its centennial, capping months of activities to publicize the agency’s history. A few years ago, the government produced a special disk marking 100 years of the U.S. Forest Service. Heck, even the National Archives made a big deal last year of making the 1940 census forms publicly available after 72 years.
Yet this year’s centennial of the federal income tax has, for some reason, been ignored.
February came and went without the Internal Revenue Service mentioning the 100th anniversary of the 16th Amendment, which permitted the income tax. Last week, the “What’s hot” section of its website included questions and answers for fuel-tax-credit extensions — but not a word about America’s most maligned tax reaching the century mark.
The government’s low-key approach may grow out of its new-found austerity. Besides, Congress recently upbraided the IRS for wasting $60,000 on a regrettable 2010 video parody of “Star Trek.”
But chances are equally good that the omission is by design.
“I don’t think many people will be drinking a toast to the income tax,” said John Steele Gordon, a financial historian whose books include “An Empire of Wealth: The Epic History of American Economic Power.”
Few things unite Americans like taxes, and, at age 100, the income tax remains the subject of seemingly endless fighting in Washington. This time of year, of course, it’s on everyone’s mind.
Rifling through receipts is a rite of spring, as common in early April as Opening Day and daffodils. And like many traditions, few can remember how it all began.
“In this world nothing can be said to be certain, except death and taxes.” — Benjamin Franklin
Why we tax
There are many reasons citizens hate the income tax (at least 1040 of them this week, as Monday is the deadline to file 2012 returns), but historians say there are important reasons we tolerate it, too.
Chiefly, the federal government operates far differently because of it. Before the tax, the federal government collected most of its revenue from tariffs and excise taxes, which disproportionately hit low- and middle-income Americans who spent more of their means on the taxed goods.
“Like most consumption taxes, it was pretty regressive,” said Ajay Mehrotra, a law professor who teaches tax policy at Indiana University. “It was passed on in the price of goods. It’s not considered a big deal because the federal government is not doing a lot in the early 19th century.”
The U.S. kept a small military in those days, and its international relations were not substantial during a time of relative isolation. There was no income security for the retired, the disabled, the orphaned or the unlucky. There were no highways, not to mention air traffic to control. Scientific research was limited.
Working conditions were whatever an employer made them, good or bad. Recessions were more common and lasted longer. Banks failed more often — and their customers faced ruin, since there were no government guarantees. States and local authorities, the ones often reeling from natural disasters, responded to such crises on their own time and dime.
From that fitful environment, a more active — and, thus, more expensive — federal government took shape. Taxes and rising debt made it possible.
“What at first was plunder assumed the softer name of revenue.” — Thomas Paine
Civil War origins
The first rumblings of an income tax were heard during the War of 1812. That conflict ended before such a measure was needed to fund the fight, and for decades the issue faded away.
President Abraham Lincoln changed that.
For all the adoration Lincoln continues to receive for saving the union, many forget that in 1862 he helped finance the Civil War by creating the income tax and the Office of Commissioner of Internal Revenue.
That wartime income-tax system claimed 3 percent of incomes between $600 and $10,000 and 5 percent on higher earnings. For the record, the cash-starved Confederacy enacted its own progressive income tax by 1863.
The income tax lapsed after a decade, but tariffs generally brought in what the government needed.
“Very often the government got more money in than it could spend, if you can believe such a thing,” Gordon said. “In 1884, government revenues exceeded outlays by 35 percent.”
The surpluses, he said, allowed the government to pay down much of the debt run up during the Civil War.
The nation returned to a tariff-based system when the first income tax lapsed, but the public felt it was unfair because the higher cost of goods disproportionately affected the poor.
“We see tremendous economic inequality rearing its head,” said Mehrotra, who has written the forthcoming book “Sharing the Burden: Law, Politics and the Making of the Modern American Fiscal State, 1877 to 1929.” “This is the Gilded Age. Along with all of this industrialization comes all of this incredibly uneven economic growth and concentrations of wealth.”
Though it may seem like heresy today, the South and West were especially supportive of the income tax. That’s because tariffs effectively subsidized Northern manufacturing by raising the price on competing foreign goods, Mehrotra said.
Joseph Thorndike, research director of the online Tax History Museum, describes it this way: “It seemed unfair that the bulk of national revenue flowed from regressive tariff rates that taxed ordinary Americans at the point of consumption, while the profits of giant enterprises like railroads, sugar refiners, and steel manufacturers went untapped.”
In 1894, the government tried to reinstate an income tax, but the U.S. Supreme Court struck it down.
“I said, ‘You must pay a lot of taxes.’ She said, ‘We don’t pay taxes. Only the little people pay taxes.’ ” — Elizabeth Baum, housekeeper to hotelier and tax cheat Leona Helmsley
A public push
After the recession of 1907, the public push for an income tax targeting the wealthy grew louder, and some wanted a direct confrontation with the Supreme Court’s earlier ruling.
In 1909, President William Howard Taft, in an effort to avoid damage to the court, urged passage of a corporate income tax and a constitutional amendment permitting the personal income tax. Taft never expected the amendment would muster support from 36 states.
It did over the next four years, though not everyone was thrilled. Richard Byrd, speaker of Virginia’s House of Delegates, at the time urged its defeat in language many “tea party” activists might echo today.
“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,” Byrd said, according to an account with the Tax History Museum.
“The law will of necessity have inquisitorial features. It will provide penalties. It will create complicated machinery. … 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?”
Less than two months after becoming a state, Arizona ratified the measure on April 6, 1912. It passed the state House unanimously, according to an account in The Arizona Republican.
On Feb. 3, 1913, Delaware ratified the proposed change, ensuring passage of what became the 16th Amendment, a provision giving Congress the power to levy and collect taxes on income. New Mexico and Wyoming ratified it the same day for good measure. Six states never did. (Connecticut, Rhode Island, Utah and Virginia rejected it. Florida and Pennsylvania never considered it.)
The income tax had broad public support at first because less than 1 percent of the public owed income taxes, according to the National Archives.
By September 1913, Congress rejected plans for a flat income tax and settled on the progressive tax structure still in use today. It also lowered tariffs. On Oct. 3 of that year, President Woodrow Wilson signed the Revenue Act of 1913 into law. The new income tax imposed a 1 percent levy on incomes above $3,000 for individuals — equivalent to about $70,000 today. The tax rose 1 percentage point for higher incomes, topping out at 7 percent for income greater than $500,000.
By comparison, the tax due Monday begins at 10 percent of income less than $8,700 and reaches 35 percent for incomes over $388,350. Next year, the top rate goes back to 39.6 percent, where it stood during the Clinton years.
“People who complain about taxes can be divided into two classes: men and women.” — Unknown
Rates often shift
If taxes are a timeless certainty, tax rates are more impermanent, changing with the nation’s priorities.
By the end of World War I, tax rates ranged from 2 percent to 77 percent, depending on income. The rates generally fell through the 1920s, and they ranged from 1.5 percent to 25 percent by the onset of the Great Depression.
World War II led to all-time-high rates. In 1944 and 1945, the bottom bracket affecting those with the lowest incomes started at 23 percent and climbed to an eye-popping 94 percent for income over $200,000.
An even more profound change during that period involved who paid taxes and how. For the first time, most workers owed the government. The number of taxpayers jumped from 4 million in 1939 to 43 million by 1945, as the nation’s population reached 140 million, according to the Treasury Department. It also marked the beginning of employer withholdings.
“The conversion of the tax to a mass tax is more significant than the creation of the tax itself,” said Lawrence Zelenak, a taxation law professor at Duke University and the author of “Learning to Love Form 1040: Two Cheers for the Return-Based Mass Income Tax.” Until that point, the income tax had been seen almost as a tool of social justice, he said. In the 1940s, it became something that affected everyone.
Not surprisingly, the government worked to polish the image of the IRS.
“During World War I and World War II, there was this real campaign, you could call it propaganda, that paying taxes was this glorious privilege,” Mehrotra said. “It was seen as this patriotic duty.”
Even Donald Duck got into the act, with Walt Disney Productions creating a government-financed cartoon short in 1942 urging Americans to pay their wartime taxes.
As rates remained high and more people owed, Congress carved out more and more loopholes, adding to the tax code’s length and complexity, Gordon said.
Not surprisingly, taxpayers went to creative lengths to lower their bills.
Composer Oscar Hammerstein, who was Gordon’s stepuncle, often took payment for his work in forms other than cash — for example, cars from program sponsors — because they carried lower tax rates, Gordon said.
“When Oscar died in 1960, he had seven cars,” Gordon said, “and he never learned to drive.”
“I’m proud to be paying taxes in the United States. The only thing is, I could be just as proud for half the money.” — Entertainer Arthur Godfrey
Accountants still snicker about unconventional deductions, some that worked and others that ended with a humorless auditor.
In the 1980s, an exotic dancer claimed — and a tax court upheld — the right to deduct the costs of breast-enlargement surgery that left her a 56FF. The court ruled that her “implants were so extraordinarily large we find that they were useful only in her business.”
One Pittsburgh furniture store owner was slapped with a $6,000 fine and wound up behind bars after reportedly deducting $10,000 for a consulting fee paid to the man he hired to burn down his building.
In 1961, a tax court denied a casualty-loss deduction to a couple who wanted to claim the costs of a vase broken in a neurotic fit by their Siamese cat.
Similarly, dance lessons as treatment for varicose veins and mink coats for entertainment expenses have been deduction no-nos.
“You don’t pay taxes. They take taxes.” — Comedian Chris Rock
Going too far
For a century, most — but not all — Americans have dutifully if grudgingly paid their taxes in full.
For those who don’t, the tax man cometh.
The IRS estimates that in 2006 it missed about $450 billion from taxpayers who underpaid or didn’t pay at all.
Between 2007 and 2011, the IRS assessed civil penalties on more than 28 million filers annually, according to the agency’s annual reports. Total penalties averaged nearly $15 billion a year. Over the same five years, the IRS annually averaged more than 4,000 new criminal investigations and put 1,700 people behind bars each year.
Because income tax applies to all earnings, not just from legal sources, gangster Al Capone served his longest prison hitch, seven years, for tax evasion in the 1930s. Actor Wesley Snipes was released from prison earlier this month after completing a three-year prison term for failing to file tax returns covering $38 million in income over six years.
A dedicated few tax protesters have fought the government, claiming the 16th Amendment wasn’t properly ratified by the states. A federal appeals court addressed the issue in a 1986 tax-protester case. Spoiler alert: The tax was upheld.
Of the 37 states that submitted written copies of their ratification, “only four instruments repeat the language of the Sixteenth Amendment exactly as Congress approved it. The others contain errors of diction, capitalization, punctuation, and spelling,” the court wrote. The errors, however, were known in 1913 and didn’t undo the income tax.
William Benson, an Illinois man who co-authored a 1985 book outlining his case for the illegitimacy of the tax amendment, went to prison in 1990 for tax evasion and continued afterward to hawk instructions on how to avoid paying tax. In 2007, a federal judge barred him from promoting his $3,500 tax-shelter plans, saying “the fraud perpetrated by Benson caused needless confusion and a waste of the customers’ and the IRS’ time and resources.”
Benson’s website now includes a copy of the injunction, along with his response: “What has America come to when the government we created to protect our rights can accuse us of lying and then prohibit us from presenting a defense in a court of law?”
“The only difference between death and taxes is that death doesn’t get worse every time Congress meets.” — Humorist Will Rogers
After World War II, the tax code evolved from a way to finance government to a tool to manage the broader economy, Mehrotra said. That eventually led to rethinking rates and a 30-year rollback on taxes. The top tax bracket fell from 91 percent in 1963 to 70 percent two years later.
In the 1980s, President Ronald Reagan pushed through a series of tax changes that eventually cut the top rate to 28 percent.
“Historians talk about World War II as when we went from a class tax to a mass tax,” Mehrotra said. “The Reagan revolution is a response. You could argue that it has ushered in this new era of thinking about taxation and only thinking about what tax cuts can do for everyone. … We don’t look upon taxes the same way we used to.”
Add in a raft of ever-changing tax credits and other exclusions, and it explains how the U.S. tax code has grown from 400 pages a century ago to more than 73,000 pages today.
The tax code wasn’t all that grew.
In 1966, the IRS had about 64,000 workers for a nation of nearly 200 million. In 2011, it had about 95,000 workers for a nation of 310 million. By the IRS’ count, it cost 48 cents for every $100 in collections in 1966. In 2011, it was 51 cents.
There is chatter about overhauling the tax code again, if only President Barack Obama and congressional Republicans could agree to it. For now, that seems unlikely when even routine matters like an annual budget have proven elusive.
Gordon, for one, thinks Washington should pursue a flatter and simpler tax, which he thinks would boost the economy and reduce cheating. Mehrotra said soaring retirement and health-care costs may require the creation of yet another tax, like a national sales tax similar to those used in Europe.
“There’s just a huge demand for revenue given the demographic pressures on government entitlement programs,” he said. “I’m not sure our income tax system can keep up.”
Zelenak thinks the tax, especially this time of year, should be cause for a moment of public reflection.
“Before we decide to throw it out,” Zelenak said, “it’s worth thinking about the potential benefits of return-based taxation in terms of the way it promotes fiscal citizenship. … People should be conscious of their status as taxpayers because it’s an aspect of citizenship, but also because it makes people more willing to think how their government is spending their tax dollars.”