Location: United States

Thursday, July 14, 2005

Shifting the Burden

The taxing power of the government was, as I have shown in previous posts, a serious bone of contention during the foundation of our country. Yet some very real points of agreements were found on all sides. A short summary of those points would include: 1) Taxation is necessary; 2) Taxation can be destructive if overdone; 3) Those most vulnerable to the destructive power of taxation should be shielded from its effects as much as possible; and 4) taxation should be distributed as fairly as possible, with all of the prior considerations in mind.

So the country started off dependent fully upon taxing its internal businesses, its imports, and its exports to provide funding for itself. Since there was very little that government actually did at the time, it didn't take a great deal of money. The real concern foremost in everyone's mind was paying back the money borrowed from France and Spain to finance the War of Independence.

The subject of internal taxation was primarily tobacco products and whiskey, carriages (a luxury item), and estates. Estates were taxed in two ways - first with a direct tax through a stamp requirement that every estate being auctioned be inspected and approved by the tax agent, and then again by a tax on the items bought at auction themselves. Isn't it odd that the some of the very first laws of taxation was on some of the things that are so vigorously opposed today? Luxury taxes, estate taxes, and excise taxes on sin - modern tax opponents hate them all. Who is really unAmerican here?

It wasn't long, though, before the new powers of taxation began to chafe some of the country's citizens. General unhappiness with the whiskey tax in Pennsylvania turned into outright rebellion. Angry mobs attacked federal tax agents and even fired on law officers trying to protect them (hmmm, this sounds vaguely familiar). Eventually, state militias in other states had to be federalized and almost 13,000 used to put down the insurrection.

However, peace and prosperity are always twins, and soon enough revenues had paid off debts to the point where Thomas Jefferson was able to have wave after wave of tax cuts approved by Congress. Setting the precedent, he aimed at internal taxes in the name of rescuing American people and businesses from the destructive power of taxation (although that destructive level of taxes had actually seen an incredible growth in GDP).

A problem soon became apparent, however. When peace and prosperity were not to be found - as during the War of 1812 - trade was interupted, which mean that revenues from trade based on import and export taxes fell. This necessitated heavy borrowing to finance the war, which then led to higher taxes being levied when the war was over - which tended to hurt trade as well.

Then, as now, there were some who believed that America's great interest lay in promoting its big businesses above all else. Thus, export taxes were cut while import taxes were raised - which is a type of corporate protectionism. With American markets protected from cheap imports, and domestic markets completely untaxed, manufacturers could slowly raise the prices of domestic goods to usurous levels. One such person was Henry Clay, whose tax politicies caused South Carolina to threaten secession in 1832 (a bit over thirty years before the Civil War). His "American Plan" sought to turn the American government into a support system for American business, rather than business supporting government. Manipulation of taxes and governmental control of currency were primary parts of this plan.

Fortunately, Henry Clay was enough of a statesman to know when to compromise. Just as he had led the nation to the Missouri Compromise, Clay led a coalition to an agreement to cut tariffs. The Nullification Crisis was thus averted by Clay's ad hoc coalition and leadership in forging the Compromise of 1833.

By 1860, however, the Federalists/Whigs had collapsed and the Republican Party pushed its platform backing the American Plan by marrying it to abolition. Abraham Lincoln signed the Morrill Tariff Act, which doubled the tariff rates to pay for such projects as the Erie Canal and national subsidies for building railroads. Against the possibility of a second Nullification Crisis, Lincoln stocked Fort Sumter with fresh troops and supplies to ensure that revenues were collected from the unruly southern state. While the cause of slavery would be used by both sides to gain popular support, it was taxation that caused the initial friction and resulted in the injury that no amount of talk could resolve.

The inability to collect taxes from the South, however, put the Union is a perilous condition. There was no real standing army ready to take the field. Thus, Lincoln instituted both a draft (which caused riots in places like New York City) as well as the first income tax. It was progressive in nature, true to the roots of our country. Income of less than $600 a year was not taxed and income above that level was taxed at a rate of only three percent until income reached $10,000. At that point, it rose to five percent. The same limits, adjusted for inflation, in 2005, would be $12,325 and $205,462. I have no idea how those levels were fixed, as they seem to be fairly arbitrary at this point in time.

An estate tax was also implemented at this time, as were additional sales and excise taxes. The result was a stunning one year revenue of $310 million in 1866 (the first full year after the end of the war). That level would not be reached again until 1911. Shortly after the end of the war, income taxes were abolished as were estate taxes. The country returned to its reliance on business taxes.

However, the tax rates were still high - partly out of necessity to fund the government and partly out of greed. In an effort to maintain funding while cutting tariffs, Grover Cleveland watched the Wilson-Gorman Tariff Act become law in 1894. The following year, the Supreme Court ruled the direct taxation was a violation of the Constitution and the tax was repealed.

Teddy Roosevelt and his side-kick turned competitor, William Howard Taft, dedicated their efforts towards reducing tariffs by initiating an estate tax, rather than a personal income tax. However, in 1913, the Sixteenth Amendment was ratified, and the federal income tax became law. The initial tax rate was 1% on incomes over $3000 ($4000 for a married couple). It rose progressively to a 7% tax on incomes over $500,000. If you're interested, those numbers, when adjusted for inflation become $57,329 ($76,439) and $95,549,543.

During WWI, the top rate rose as high as 77%, but that rate dropped back to 25% after the war. During World War II, the tax rate rose to 91% and remained there until Kennedy's tax cuts took effect in 1964. Ronald Reagan then cut the top rate to 50% in 1981. In 1986, the tax system was bifurcated - cutting the upper tax rate to only 28% while raising taxes in the lower bracket from 11% to 15%. Under President Clinton in the 1990s, the top tax bracket was raised to 39.6%, which was cut by President George W. Bush to 35%.

Rates are only part of the story - though it can be seen that the rates faced by the richest Americans have progressively decreased. Deductions, exemptions, and credits makes it difficult to get an exact reading on how much any given income range is being taxed. However, some trends are easily identifiable.

In 1913, personal income taxes accounted for less than 5% of governmental revenues. In 1940, it was still less than 20%. Now, personal income taxes account for about half of all government revenues. That figure is distorted, however, by including Social Security and Medicare (which are payroll taxes, not income taxes - the difference is that rich people do not get taxed on all of their income for payroll taxes while those who work do, hence the name "payroll" taxes).

If social insurance taxes are taken out of the picture, and they should be because they are not used for the yearly operations of the government, then personal income taxes actually account for almost three-fourths of governmental revenues. To look at it another way, personal income taxes (including social insurance for this figure) account for almost ten percent of US GDP (a measure of the size of the economy). Meanwhile, corporate taxes have fallen to only two percent of GDP.

Whoa! Talk about tax shifts! From supplying 100% of our government's operating revenue, business now accounts for only 25% of it. To do this, is moves aside two percent of its productive capacity. Meanwhile, individuals, who were not taxed at all in early America, now bear 75% of the burden of government and set aside almost a tenth of their cumulative productive ability to do so.

There was, however, an earlier shift. It was a shift from a balanced taxation on domestic business, imports, and exports, to a tax on imports only. That shift was started by none other than Thomas Jefferson in order to allow business to thrive, although it already was.

There is also a shift that is masked by the focus on the aggregate income tax paid by Americans. What is telling is the trends of how much is paid by the very wealthy and the very poor. As part of the plan to keep the deficit low, social programs that provide aid to the poor have been slashed repeatedly. Thus, there is less aid, more tax, and less money to stretch to the end of the month for the poor. Yes, Virginia, the rich do get richer, and it is at the expense of "the least among you".

I'll wrap up this short series tomorrow (hopefully) when I try to answer the question: How Should Democrats Tax?


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