Forget 47%. Only 1 in 7 Would Face Levy With First System: Taxes

2013-02-01 02:00:00.1 GMT

By Richard Rubin

     Feb. 1 (Bloomberg) -- If the U.S. had the same income tax

rules it did when the levy started 100 years ago this weekend,

86 percent of households would be exempt from paying it.

     That figure, according to data compiled by Bloomberg, far

outpaces the 47 percent estimate for nonpayers cited in last

year’s presidential campaign. The first levy, adjusted for

inflation, would only affect individuals with taxable incomes of

more than $69,574 a year -- and then with a bottom rate of just

1 percent and a top marginal rate of 7 percent.

     The original income tax, if still in place, would raise

about $45 billion, or 3 percent of what today’s individual

income tax generates, said Bloomberg Government analyst Patrick

Driessen, who generated the estimate by applying the 1913

brackets to today’s income patterns.

     “These were really taxes on the rich,” said Carolyn

Jones, a law professor at the University of Iowa who studies the

history of U.S. taxation.

     Today’s debate in Washington over the size of government

and how to pay for it can be traced to the enactment of the

Sixteenth Amendment, which permitted the tax. Its creation set

the U.S. on the path toward a larger central authority and

cemented distributional politics, in which the government could

fine-tune economic policy to steer tax breaks to favored groups

and extract money from others.

     The amendment, ratified on Feb. 3, 1913 in the waning days

of the William Howard Taft administration, changed the

Constitution for the first time in 43 years. The one-sentence

statement gave Congress the “power to lay and collect taxes on

incomes, from whatever source derived.”

                          1895 Decision

     The amendment was written in response to an 1895 Supreme

Court decision that invalidated a prior income tax. The drive to

re-create a levy first imposed during the Civil War was

propelled by a coalition of economists and populists, Jones

said.

     “It was significant in terms of moving away from a tariff-

based consumption tax and reliance on sin taxes to something

that more resembles ability to pay,” she said.

     President Woodrow Wilson signed the modern income tax into

law Oct. 3, 1913, combined with a reduction in tariffs. The

first 1040 form emerged soon after from what was then known as

the Bureau of Internal Revenue, and it applied retroactively to

income earned starting on March 1.

     That initial tax form is a model of simplicity, weighing in

at four pages, including instructions.

     It didn’t incorporate many features of today’s tax system.

Taxpayers didn’t have preferential rates on capital gains and

dividends. They couldn’t deduct charitable contributions. Still,

they could deduct all interest “on personal indebtedness of

taxpayer.”

                            1913 Code

     The 1913 tax code set a basic 1 percent tax rate on annual

income exceeding $3,000 for individuals and $4,000 for married

couples. A “super tax” with six 1 percent steps began at

$20,000, or about $464,000 in today’s dollars.

     The threshold for the top rate -- the 1 percent tax and a 6

percent super tax -- began at $500,000. In nominal dollars,

that’s actually higher than the $450,000 starting point for

today’s 39.6 percent top bracket for married couples.

     In inflation-adjusted dollars, the 1913 tax code would

spare everyone from the highest tax rate except those earning

more than $11.6 million.

     The estimates of the income break points come from using

the Bureau of Labor Statistics’ inflation calculator.

     The income tax expanded when the U.S. entered World War I.

Jones said the additional revenue source provided by the levy

allowed the government to ban the sale of alcohol and forgo the

accompanying tax revenue in 1919.

                           War Funding

     A mass tax wasn’t needed until World War II, when it was

used to fund the war and restrict domestic inflation, Jones

said. After the war, President Harry Truman’s administration

chose to keep the broad-based tax to ensure financing for a

defense buildup for the Cold War.

     Attention to the current 47 percent who don’t pay income

taxes emerged during the presidential campaign last year with

the release of a recording of Republican candidate Mitt Romney

talking to donors. Republicans’ low-tax message, he said,

doesn’t resonate with nonpayers, who expect benefits from the

government.

     “And so my job is not to worry about those people,” he

said. “I’ll never convince them that they should take personal

responsibility and care for their lives.”

                         Romney Comments

     Democrats seized on Romney’s comments -- and pushed tax

credits for families and education through Congress on Jan. 1

that will keep more households off the income tax rolls.

     The levy has caused U.S. economic growth to be slower than

it would otherwise, said Will McBride, chief economist at the

Tax Foundation, a Washington-based group that favors a simpler,

flatter tax code.

     “As a direct result of the burden of the income tax, and

the fact that so many people pay it, over the years there’s been

an accumulation of ways to take it apart, to carve out

loopholes,” he said. “It would be completely unrecognizable

and unpredictable. It didn’t evolve in any sort of rational

way.”