SPECIAL REPORT: YOUR TAXES : Digging Ever Deeper : A Short Account of Taxman’s Long Arm
WASHINGTON — After a fancy night out at the Brown Derby in 1941, Los Angelenos were handed a bill that included a stiff 20% “cabaret tax,” courtesy of Uncle Sam.
Fur coats, jewelry, even luggage were subject to a similar 20% levy, because excise taxes were the main way the federal government paid for itself.
For the average American in those prewar days--whose annual income fell below $1,500 and who couldn’t afford diamond jewelry or the nightspots--federal income taxes were a far-away worry for the rich.
The ensuing decades, though, have brought a dramatic shift in what Americans demand from
their government--and how they pay for it. Today, broad-based federal income and Social Security taxes represent a financial web from which virtually no one escapes.
On average, Americans will pay 23.2% of their family income to the federal government this year.
They will probably pay even more in the future because President Clinton--alarmed about the mushrooming budget deficit--is calling for the biggest tax increase in history. He wants higher income taxes for individuals earning more than $140,000 and families making over $180,000, and a new energy tax paid by everyone.
Still, Americans remain lightly taxed relative to other societies.
Counting all sources--federal, state and local revenue--the tax collector takes 29.9% of the value of America’s gross domestic product, which is the total output of goods and services. That’s far below the average of 40.2% for European nations, which have large welfare states.
What few Americans realize today is that a sizable federal tax burden is something relatively new in U.S. history. Not until World War II did Washington’s tax collections exceed 10% of the economic output of the country. The figure peaked at 21.7% in 1944 and has ranged roughly between 18% and 20% ever since.
For much of our history, the federal government was small in stature and removed from the lives of average Americans. It depended on customs duties for the relatively paltry revenue needed to pay for its military forces.
Budget surpluses, unthinkable today, were the norm for Washington until fairly recently. The government did not begin running regular deficits until 1931, but it has enjoyed just eight years without deficits since then.
It took the cataclysm of the Civil War to produce the first income tax--a charge of 1% to 10% on wages, interest and dividends raised to fund the Union Army. Then, the income tax disappeared into a dustbin for more than a generation.
When some labor and farm groups pushed for its return, an angry federal lawmaker denounced the progressive tax as a scheme hatched by “the professors with their books, socialists with their schemes and anarchists with their bombs,” according to a new book, “For Good and Evil, the Impact of Taxes on the Course of Civilization,” by Charles Adams.
The Populist drive was eventually successful, however. In 1894, Congress levied a 2% tax on annual incomes in excess of $4,000, an amount equal to $50,000 today. But it was declared unconstitutional.
The battle shifted to the state legislatures, which approved the 16th Amendment to the Constitution, making the income tax legal. It was approved “because of assurances the rates would never exceed a few percentage points,” according to Adams, a former tax lawyer.
This was the nation’s first modern income tax law, and it had a 7% maximum in 1913. The top rate rose to 15% in 1916, when the Treasury reported that 206 Americans had million-dollar incomes.
Five years later--after World War I had boosted the top rate to 77%--only 21 people admitted to having million-dollar incomes.
“Certainly no one consents to a 77% tax--even the village idiot knows that,” wrote Adams.
Come the 1920s, rates were slashed and slashed again in keeping with the philosophy of the Republican Presidents of that era.
Excise taxes--charges on goods and services deemed to be either luxuries or somehow socially undesirable--emerged as the revenue mainstay between the two World Wars. They were sufficient to feed the needs of a modest-sized government.
Cameras, film, cigarette lighters, phonographs, records, jewelry and furs were all taxed. The butter producers’ lobby ensured that Congress imposed a tax on margarine.
The government collected $20 a year for every lane in a bowling alley and each table in a pool hall--both considered unsavory settings for young people by some religious and community leaders.
Social Security payroll taxes were first imposed in 1937, but the collections was modest at first--just 1% on the first $3,000 of income, not enough to be meaningful for most Americans.
But the Japanese attack on Pearl Harbor in 1941, which plunged the United States into World War II, forever transformed American society--and the average citizen’s relations with the tax collector.
Unimaginably vast sums of money were demanded to fight the war. Tax rates were boosted and withholding was imposed. For the first time in American history, money was taken every week from a worker’s pay envelope.
“In the United States and Britain, taxes on incomes of individuals and businesses and on luxuries went up sharply, providing resources to finance the war while controlling inflation,” according to Carolyn Webber and Aaron Wildavsky, authors of “A History of Taxation and Expenditure in the Western World.”
“Employer withholding of income taxes on wages, adopted by the U.S. in 1943, converted the income tax into the mass tax it has been ever since,” they wrote.
After World War II, pressure grew to repeal the excise taxes, which had expanded to cover lipstick, refrigerators, air conditioners and many other consumer goods demanded by the burgeoning middle class, whose pockets overflowed with wartime savings.
In 1950, the House passed a bill to repeal most of the excise measures. The Senate was ready to do the same when the Korean War broke out and suddenly the government needed big sums of revenue once again. Reform was off the table for a decade.
At the same time, the country began a gradual but steady expansion of social welfare programs and its defense industry as the Cold War with the Soviet Union intensified. Social Security benefits kept expanding, covering more people, and Medicare was created in 1965 as the health care provider for the elderly. Medicaid was developed for the poor.
Tax legislation between 1960 and 1976 led to the repeal of the unpopular excise taxes, cuts in personal rates, the closing of loopholes and the creation of a minimum tax in 1969 aimed at rich people who had been able to avoid taxes entirely.
Then, in 1978, Americans began rebelling against the liberal agenda, and a capital gains tax cut was passed to spur investments and reward entrepreneurs.
The conservative era burst into full bloom with the 1980 election of Ronald Reagan, who pledged to cut taxes and boost defense spending while limiting the role of the government in other areas.
The economic centerpiece of his Administration--the 1981 tax cut--was the biggest reduction ever, slashing rates for individuals and business. If the old 1977 code were in effect today, the richest 1% of Americans would pay another $70 billion in taxes, according to Robert McIntyre, director of the Citizens for Tax Justice, a liberal lobbying group.
Since 1981, every piece of legislation has chipped away at some of the benefits granted the well-to-do and big business. The result is that the United States is roughly back where it was when the Reagan revolution started, with American families expected to pay 23.2% of their income to the federal government in 1993, compared to 23.3% in 1980.
The burden is about the same because the surge in payroll taxes for Social Security and Medicare has offset the cuts in individual tax rates. Taxes were raised in 1978 and again in 1983 to keep he retirement fund solvent, and the Medicare wage base was expanded sharply in 1990.
These social insurance taxes, furnishing just 23% of federal revenue as recently as 1970, have virtually exploded and will account for 38% of this year’s receipts.
Corporate taxes, in sharp contrast, shrank steadily and dramatically as a share of tax revenues. In 1970, corporate levies provided 17% of federal receipts, diminishing to 12.5% by 1980 and a scant 9.2% this year.
One fundamental shift came as corporations began using debt financing to raise funds through bond sales, rather than relying so much on the sale of stock. Interest payments on bonds are deductible, and the surge of bond-financed buyouts and takeovers at big corporations during the 1980s cut deeply into corporate tax payments.
At the same time, tax payments by individuals were rising sharply--largely because of the increasing bite of Social Security and Medicare payroll taxes. The burden on individuals is sure to rise even more if President Clinton is successful in his efforts to extract more taxes from the relatively rich to pay for an ambitious agenda.
His tax proposal would boost the top rate from 31% to 36%, and impose a 10% surtax on incomes above $250,000. But the truly rich--whose assets in stocks, bonds and real estate accompany their stratospheric earnings--are likely to escape real pain.
“Chief executive officers and law partners in major firms and professional athletes don’t punch time clocks and get paid in wages,” said William Gale, a research associate at the Brookings Institution. “They have custom-tailored compensation packages. They can specify whether they will get more money in pensions and less in taxable cash, or more in the way of perks on the job.”
For the rest of America in the age of mass taxation, the slogan on a tablet from the ancient Sumerian civilization about 6,000 years ago still applies: “You can have a Lord, you can have a King, but the man to fear is the tax collector.”
TAXES MADE EASY
Personal finance writer Kathy Kristof and a team of accountants have pooled their knowledge to produce an easy-to-use, step-by-step guide to completing your federal tax forms. Sharpen your pencil and turn to pages D10 and D11.
Tax Bite
Over the last half century, the federal tax burden on individual taxpayers has grown explosively--and the overall take of the U.S. government has surged, as well. A massive expansion of Social Security taxes, imposed from the first dollar earned by workers, has made the system steadily more regressive. Meanwhile, shifts in the tax code have shrunken the burden on corporations. GROWING TAKE and SHIFTING BURDEN
(Millions of dollars, inflation-adjusted) Year: 1940 Total Taxes: $65,630 Individual Income (Individual): 13.6% Social Insurance* (Individual): 27.3% Corporate (Business): 18.3% Excise** (Business): 30.2% Other*** (Business): 10.7% Total in 1940 dollars: $6,549,000,000
Year: 1950 Total Taxes: $229,620 Individual Income (Individual): 39.9% Social Insurance* (Individual): 11% Corporate (Business): 26.5% Excise** (Business): 19.1% Other*** (Business): 3.4% Total in 1950 dollars: $39,443,000,000
Year: 1960 Total Taxes: $438,404 Individual Income (Individual): 44% Social Insurance* (Individual): 15.9% Corporate (Business): 23.2% Excise** (Business): 12.6% Other*** (Business): 4.2% Total in 1960 dollars: $92,492,000,000
Year: 1970 Total Taxes: $697,186 Individual Income (Individual): 46.9% Social Insurance* (Individual): 23% Corporate (Business): 17% Excise** (Business): 8.1% Other*** (Business): 4.9% Total in 1970 dollars: $192,807,000,000
Year: 1980 Total Taxes: $880,477 Individual Income (Individual): 47.2% Social Insurance* (Individual): 30.5% Corporate (Business): 12.5% Excise** (Business): 4.7% Other*** (Business): 5.1% Total in 1980 dollars: $517,112,000,000
Year: 1990 Total Taxes: $1,107,058 Individual Income (Individual): 45.3% Social Insurance* (Individual): 36.9% Corporate (Business): 9.1% Excise** (Business): 3.4% Other*** (Business): 5.4% Total in 1990 dollars: $1,031,308,000
Year: 1993 Total Taxes: $1,147,588 (estimated) Individual Income (Individual): 44.5% (estimated) Social Insurance* (Individual): 38% (estimated) Corporate (Business): 9.2% (estimated) Excise** (Business): 4.1% (estimated) Other*** (Business): 4.2% (estimated) Total in 1993 dollars: $1,031,308,000,000 (estimated) * Social Security taxes, plus Medicare taxes for 1970 and later years. ** Excise taxes apply to alcohol, tobacco and telephones. *** Includes estate and gift taxes, customs duties and fees.
Source: “Budget Baselines, Historical Data and Alternatives for the Future,” Office of the President, Jan. 1993
A World of Difference
Nonetheless, the total tax burden on Americans--including federal, state and local income and personal property taxes--is among the lowest in the industrialized world. Tax Revenue as a percentage of Gross Domestic Product, 1990 Sweden: 56.9% France: 43.7 Italy: 39.1 Germany: 37.7 Canada: 37.1 United Kingdom: 36.7 Switzerland: 31.7 Japan: 31.3 United States: 29.9 Turkey: 27.8
Average of 24 nations in Organization of Economic Cooperation and Development: 38.8%
Source: Organization of Economic Cooperation and Development
