April 18, 2006
The Income Tax Posted by John Steele Gordon at 03:45 PM EST Once again it’s tax time, and so it is also the time when political commentators across the spectrum deplore the American income tax system. “American income tax system,” of course, is an oxymoron, as there is nothing whatsoever systematic about it. Indeed, the modern income tax code is as unspeakable a mess as only democratic politics can make when given a hundred years in which to make it. The code—all 60,000-odd pages of it—is unfair, arbitrary, incomprehensible, expensive, fraud-inducing, wasteful, and deeply injurious to the American economy. To give just one example of how out of control American tax law now is, consider this fact: Since the last major overhaul of the tax code, in 1986, Congress has amended the law no fewer than 15,000 times. That’s an average of more than four changes to the tax law every single day, including Sundays and Congressional recesses. What were those 15,000 amendments about? Basically they fall into two groups. The first group of amendments were intended to undo the unintended consequences of previous changes or to codify those unintended consequences. The second group is favors to special interests and even individuals, quietly tucked away in the vast mass of the tax code in the legislative equivalent of the dark of night. How did we get into this mess? Basically, it’s all the fault of the Founding Fathers and a switcheroo on the Supreme Court in 1895. In writing the first Article of the Constitution, the Founding Fathers gave to Congress, in Section 8, the power to tax, but in Section 9, they directed that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census. . . .” In other words, direct taxes had to be apportioned among the several states according to their population. Rufus King, delegate from Massachusetts, asked in debate, what a “direct tax” was. Madison’s notes on the proceedings record that he received no answer. The Supreme Court, in upholding the Civil War income tax, held that a direct tax was any tax that could be apportioned among the states according to population, which an income tax, obviously, could not be. The Civil War income tax expired in 1872, and the federal government in the post-Civil War era relied mostly on the tariff for revenue. But a tariff is a consumption tax, and consumption taxes are inescapably regressive (i.e., they hit the bottom end of the economic ladder harder than the top end), because the poor consume a larger percentage of their incomes than do the rich. Many, not just of the left, wanted to pass an income tax on high incomes (originally above $4,000, an income enjoyed by less than one percent of American families in the 1890s), and one finally passed Congress in 1894 and was signed by President Cleveland. Naturally, those who would have had to pay it objected ,and, just as naturally, they sued. In 1895 the case of Pollock v. Farmers’ Loan and Trust Company reached the Supreme Court (my great great uncle, I regret to report, was one of the principal lawyers in the case on the anti-tax side). The court deadlocked, 4-4, on the crucial issue of whether the income tax was a direct tax and therefore unconstitutional. Justice Howell Jackson, who had not participated in the earlier argument, hauled himself out of a sickbed (he died that summer), and the case was reargued. Justice Jackson voted to uphold the tax, but one of the justices who had previously voted to uphold the tax now switched sides, and the tax was declared unconstitutional by a vote of 5-4. My great great uncle, I have no doubt, was vastly pleased, but the decision, while perhaps correct as a matter of logic, has caused endless mischief. Pressure for an income tax continued to build, and many in Congress wanted just to pass the 1894 tax again and dare the Supreme Court to overturn it a second time. President Taft, who deeply revered the Court (he would serve as Chief Justice from 1921 to 1930—an office he greatly preferred to the Presidency) was horrified. He suggested instead an income tax on corporate profits, which then largely accrued to the benefit of the rich. Technically, this was an excise tax, measured in income, and therefore not a direct tax. He also proposed a constitutional amendment to allow a federal income tax. The corporate tax soon passed. The constitutional amendment was ratified in 1913, and a personal income tax was then enacted. But the two taxes were completely separate and uncoordinated. They still are. The interaction of the two income taxes, along with wealthy citizens attempting to minimize their taxes, powerful corporations intent on doing likewise, clever lawyers and tax accountants, members of Congress only too happy to do their bidding, and no small number of demagogues have, over the last 93 years, produced a monster. There is no reforming the current code. It is an endlessly metastasizing cancer in the body politic that must be excised. What to replace it with is a great political question that most politicians don’t want to deal with. Personally, I favor a flat tax on personal income. Several countries have now implemented flat taxes on incomes, including Hong Kong, so how they actually work in the real world can now be seen. For a more in-depth look at the history of American taxation, please see an article I wrote for American Heritage ten years ago. Things have only gotten worse since.
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