The Tax Man Cometh

Above the front entranceway to the IRS, engraved in stone, is the famous line by Oliver Wendell Holmes: “Taxes are the price we pay for a civilized society.” If ever there were an absurd (and self-serving) motto for a federal agency it is this one.

Holmes had it backwards. As Cato Institute President Ed Crane has said, “Taxes are actually the price we pay for our failure to create a civil society.”

He’s right. In a genuinely “civil society” where Americans depended more on private institutions, families, charities, and private enterprise to solve society’s problems, and were dependent less on government, we wouldn’t need an IRS that collects $2 trillion in taxes (more than the entire GDP of most countries) each year. We might not need an income tax system at all.

This is useful food for thought as tax filing season is upon us. Today, when combining federal, state and local taxes, many middle-income Americans work as large a share of the day to pay the government’s bills as their own, according to a new report by the Texas-based Institute for Policy Innovation.

It wasn’t always like this. In fact, Justice Holmes can be excused for his enthusiasm for paying taxes because during his lifetime taxes were less than one-third what they are today. In fact, for the first 100 years of the nation, taxes were reasonably non-oppressive. In colonial times opposition to high taxes was deeply ingrained in the American spirit (the Revolutionary War was, after all, the first American tax revolt) and this hostility lasted throughout the 19th Century.

Government revenues predominantly came from two sources: revenue tariffs and land sales. The limited sources of revenues for the federal government were a natural restraint on its expenditures. Three events changed that. The first was the imposition of the income tax in 1913. The second was the two World Wars, which made the American people accustomed to very high tax rates and led to the creation of the withholding tax system. And the third was the creation of the Social Security program with gradually rising payroll taxes on all workers.

The tax burden has soared accordingly.

  • In 1930 workers paid one of every eight dollars of their income in taxes.
  • In 1950 workers paid one of every four dollars of their income in taxes.
  • In 2000 workers paid just over 40% of their income in taxes.

The tax burden is even more clearly expressed by examining taxes paid per household. Here we find that in inflation-adjusted dollars, the tax burden on families has quadrupled since 1950 from $7,000 to $28,000.

This means workers have less take-home pay for consumption and savings. It also means that workers’ incentive to work and employers’ incentive to hire is impeded by excessive taxes. Taxes create a wedge between what the worker receives in pay and what the employer pays.

For example, the 15% federal payroll tax, which is the No. 1 tax now for many middle-income families, makes the unemployment problem much worse than it should be in a free-market system. The Institute for Research on the Economics of Taxation has estimated that every 1% increase in the payroll tax rate costs the U.S. economy roughly 500,000 jobs. The government spends billions of dollars a year trying to combat unemployment, but many in Congress fail to understand or acknowledge how the tax policies create it.

The income tax has had the most deleterious impact on economic freedom and economic growth. When the first individual income tax was passed in 1913 the rates ranged from 1% to 7%. At the time, opponents charged that it would not be long before the rates were raised to an unthinkable 10%! Supporters countered that this would never happen in America. But within just five years the highest income tax rate was raised to 67% during World War I.

Today, the highest income tax rate is 39% and President Bush sensibly wants to cut that to 35%. Liberals oppose this cut, saying it would be a “tax break for the yacht owners.” They fail to mention that those in the highest tax brackets now pay roughly 60% of all income taxes. They also fail to mention that 2 of every 3 Americans paying the highest tax rate are small business owners who create wealth and products and supply jobs for the rest of Americans.

What has infuriated Americans almost as much as how much in taxes they have to pay every year is the amount of time and energy and resources they must devote to dealing with the mind-numbing complexity of the tax code. Over the past 50 years, America has “simplified” the tax system more than 20 times. But somehow it keeps getting more horrendously complicated every year. Consider the history of the income tax’s complexity:

  • The original income tax law was 14 pages long.
  • By 1950 there were still fewer than 1,000 pages in the IRS code.
  • Today there are 11,650 pages.

Even with a Republican Congress supposedly devoted to the idea of simplifying the tax code, complexity continues to rise.

The complexity of the income tax system is a kind of independent levy that the IRS imposes on American businesses and workers. How stiff is this tax? The folks at the Tax Foundation indicate that the nation wastes some $200 billion a year, just to figure out how much taxes we owe. To state the point again: this is not how much we pay in income taxes, it is how much we pay to figure out how much we have to pay in income taxes.

All of this raises the obvious question of how much longer Americans will tolerate a tax code that is anti-growth, unfair, incomprehensible, and overly intrusive? I have been asking that question now every year for the past 10, ever since I worked with my then-boss Dick Armey on developing a 17% flat tax alternative to the income tax.

More than ever I’m convinced the days of the income tax are numbered. The tax system is becoming increasingly unenforceable as Americans find more inventive ways to shelter their income from the IRS-increasingly through legal offshore accounts. The tax code is also horrendously expensive to administer. The Bush administration just gave the IRS another 10% budget hike to $8.5 billion a year, now spent on tax collection activities and revenue agents.

There are a handful of promising alternatives that are generating political support across the country and even inside the halls of Congress. The postcard 17% flat tax has widespread interest in the House and Senate and many of President Bush’s tax changes would move us incrementally to a flat tax system. But even more encouraging is the rising tide of voter support for the FAIR Tax. This proposal would replace the entire income tax structure with a national retail sales tax. Rep. Jon Linder (R.-Ga.) is spearheading the crusade for this repeal of the income tax. Linder says that abolition of the income tax and implementation of a national sales tax would create thunderous rates of growth for the economy, which would be liberated from the shackles of high tax rates on work and income.

The FAIR Tax plan would also get the IRS out of our lives and out of our pocketbooks, Linder adds. It would no longer be the government’s business how much money you made.

And perhaps best of all, the FAIR Tax would make April 15th just another warm Spring day again, rather than a day that we approach with dread and trepidation. The average American now spends 15 to 20 hours on tax preparation and half of us wait till the last week to do our taxes. With the Iraq war winding down in victory, here’s hoping that our next major triumph in America is in the war against tax tyranny.