America got along without income tax

Opinion: April 6, 2010 at 12:00a.m.

By Robert P. MURPHY

McClatchy-Tribune

As Tax Day approaches, Americans rummage for misplaced receipts and dread any letters from the Internal Revenue Service. Most Americans remain unaware that for almost a century America got along just fine with no federal income tax at all.

To help fund the Civil War, the federal government introduced its first federal income tax as part of the Revenue Act of 1861. This tax was very modest by modern standards, imposing a flat rate of 3 percent on all incomes above $800. This tax was rescinded in 1872, and in 1895 the U.S. Supreme Court ruled that federal taxation of income derived from property had to be apportioned among the states.

For all practical purposes, it would take a constitutional amendment before the federal government could once again lay claim to the income of individual citizens. The opportunity came soon enough.

Timid scope

In 1913, the 16th Amendment ushered in the federal income tax as we know it. Originally, its scope was timid. The top bracket was a mere 7 percent, and it only applied to incomes above $500,000 — a fantastic sum at the time. The vast majority of Americans fell in the lowest tax bracket (up to $20,000), and owed the federal government a piddling 1 percent tax on their income.

Some skeptics warned that the government could not be trusted, and that the introduction of a federal income tax would prove to be a tragic mistake. The proponents of the new tax dismissed such concerns and promised that the tax was nothing but a slight inconvenience on the titans of industry. The skeptics quickly proved correct.

By 1918, just five years after the income tax was introduced, the government had jacked up the top rate to an astonishing 77 percent. Taxpayers in the lowest bracket saw their rate jump up from the original 1 percent in 1913 to 6 percent five years later. Government now deploys the income tax as a major source of revenue, and the tax code abounds in perverse incentives.

In fiscal year 2009, the federal government collected $2.1 trillion in tax revenues, of which 43 percent came from taxes on the incomes of individuals. Besides this enormous transfer of resources from taxpayers to government coffers, one must consider the income and wealth never produced in the first place.

Loopholes

The higher the marginal tax rate, the more defensive businesses and individuals become. They spend their time looking for loopholes, shielding their income, and lobbying for tax breaks. Think of the millions of man-hours of professional labor, in the form of tax attorneys, accountants and lobbyists, that could be devoted to something intrinsically useful like satisfying consumers were it not for the looming threat of an IRS audit or a new tax law.

Robert P. Murphy is senior fellow in business and economic studies at the conservative Pacific Research Institute, San Francisco, Calif. Distributed by McClatchy-Tribune Information Services.