After the Sixteenth Amendment to the U.S. Constitution, authorizing an income tax, was ratified in 1913, Congress enacted a levy immediately. Initially, just 1 percent of the population paid this income tax, and the top rate of 7 percent applied only to earnings in excess of $500,000—affecting very few citizens at the time.
Soon, however, amidst abundant calls to "soak the rich," the personal income tax was expanded. By 1918, the top marginal rate had been pushed up to 77 percent. Over subsequent decades, income tax rates were raised and lowered many times, with the top rate peaking at 94 percent in 1944. (This was no wartime fluke: the top marginal rate was over 90 percent from 1950 to 1963, and was stable at a stiff 70 percent as recently as 1971 through 1980.)
The personal income tax became an important revenue source for the federal government during the '40s. It was during this era that the mass of Americans began to face income taxes for the first time. The proportion of federal revenue raised by the personal income tax jumped from 14 to 40 percent in a decade.
Today, 43 percent of Washington's revenue comes from the income tax. What started as a very limited levy has evolved into the federal government's main source of cash. Yet it is still America's wealthiest 5 percent who pick up most of the tab.
The Era of Tax Cuts
The arrival of the Reagan Administration opened an era of income tax reductions. Congress cut the top rate from 70 percent to a low of 28 percent in 1988 and 1989. With top rates plunging, one might have expected that the income tax burden would begin to fall more heavily on lower-income taxpayers. But this did not happen. As the maximum tax rates tumbled, the portion of revenues paid by America's highest earners actually rose sharply.
There were several reasons why tax payments by the wealthy went up. The rate cuts gave America's most productive citizens incentive to increase their economic activity—so their incomes, and thus their tax payments, climbed. Also, as rates were dropped and loopholes were closed, fewer upper-income earners resorted to tax shelters.
And the Reagan tax reform didn't reduce only the top rates. There were significant tax reductions for lower-income Americans as well—and millions of Americans were dropped off the income tax rolls altogether. The income tax actually became more "progressive" (bearing more heavily on upper-income individuals) during the Reagan years.
The tax cuts enacted by President George W. Bush followed the Reagan pattern. Upper-income Americans got reduced rates. And approximately 8 million lower-income citizens were removed from the income tax rolls entirely.
The cumulative results are interesting. In 2002 (the last year for which complete IRS data are available), the top 1 percent of U.S. taxpayers paid 34 percent of all personal income taxes. That is almost double the percentage paid by that group in the early '80s. And since the top 1 percent earned 16 percent of the country's reported income, those upper-end households paid more than twice their "fair share" of taxes based on earnings.
The top 5 percent of Americans, meanwhile, paid fully 54 percent of all personal income taxes in 2002. That too is up sharply from the 35 percent they paid in 1981. And it is a much heavier share than the 31 percent of our total income that they earned.
Even more striking is this fact: The bottom half of all income tax filers in America now pay less than 4 percent of our total income tax bill. And below them are many millions of Americans who are not even required to file income tax returns at all!
Putting these data together, a rather stark picture emerges: The personal income tax, the federal government's main source of revenue, is collected overwhelmingly from a relative handful of Americans. The large majority of all Americans pay little or no income tax. They directly contribute hardly anything to our national defense; our interstate highways and mass transit systems; our environmental cleanups; our benefits for veterans, college students, homebuyers and others; our federal science research; and on and on.
There are plenty of "progressives" in America who are perfectly happy to have the costs of our federal programs borne almost exclusively by a slice of Americans at the top of the earning scale. But is it healthy for our democracy to put the direct costs of government on such a narrow group of taxpayers? Is this consistent with America refashioning itself as an "Ownership Society"?
The Danger of Democratic Theft
Given that poorer citizens always outnumber the rich, political philosophers have long worried that government based on majority rule could lead to organized theft from the wealthy by the democratic masses. "If the majority distributes among itself the things of a minority, it is evident that it will destroy the city," warns Aristotle.
The Founders of the United States were deep students of politics and history, and they shared Aristotle's worry. Up through their time, history had shown all known democracies to be "incompatible with personal security or the rights of property." James Madison and others therefore made it a "first object of government" to protect personal property from unjust confiscation. Numerous provisions were included in our Constitution and Bill of Rights to protect the property rights of citizens.
Given that one of the causes of the American Revolution was a tax, the Founders understood very well that taxation could become a way for one group to prey on another. So while the Constitution empowered the federal government to levy taxes, it limited this power mostly to indirect taxes like tariffs, duties, and excise taxes. For much of American history the federal government subsisted solely on those fees.
The Constitution did grant the federal government the power to levy "direct" taxes on a "per head" basis, but required that all money raised this way must be given to the states according to their population. The aim here was to preserve a decentralized federal system of rule, and to make it "difficult to place a direct tax on capital, the most destructive tax in terms of economic growth and economic initiative," according to Professor Edward Erler.
Until the Civil War, the idea of a tax on individual incomes would have seemed preposterous to most Americans. Only as an emergency wartime measure did Congress adopt an income tax in the 1860s, and the measure was allowed to lapse with little fanfare in 1872. Estimates vary regarding the percentage of citizens affected by the income tax of this era, but none places it at more than 10 percent.
The modern income tax begins with the Progressive era in American politics. In an influential 1889 article entitled "The Owners of the United States," crusading attorney Thomas Shearman argued that the lion's share of the country's wealth was in a limited number of hands. If an income tax was not adopted, he warned, within 30 years "the United States of America will be substantially owned" by 50,000 people.
This marked the beginning of a never-ending campaign. Many activists since have characterized America as a permanent plutocracy. And their prescription has generally been more and higher taxes.
Shearman's advocacy of an income tax found a receptive audience in populist politician William Jennings Bryan. Exploiting the dire economic circumstances created by the depression of 1893, Bryan avidly promoted the adoption of an income tax. His proposal succeeded when Congress passed a 2 percent flat tax on incomes over $4,000 in 1894. The following year, however, the Supreme Court held the tax to be un-Constitutional.
In response, Progressives condemned the Constitution as an instrument crafted by the rich to protect their selfish interests (Allen Smith), and a document rendered obsolete by intellectual progress in the century since its drafting (Woodrow Wilson).
The Progessive condemnation of the Constitution climaxed in 1913 with the publication of An Economic Interpretation of the United States Constitution by Columbia history professor Charles Beard. He purported to expose the Constitution as the handiwork of a propertied elite serving its own interests to the exclusion of the majority. Few works of American history have been more erroneous than Beard's, as later shown by debunking historians like Robert Brown and Forrest McDonald. But by the time scholarship caught up with Beard's book, the damage had been done.
A frenzy of attacks on "the rich" and "the wealthy" culminated with the ratification of the Sixteenth Amendment in 1913, authorizing federal taxation of income from all sources without limit.
A Wrinkle to Be Wary Of When Launching Personal Accounts
So why hasn't the majority in America helped itself to more of the minority's wealth, as Aristotle and our Founders feared? Partly because the protections for individual property erected by the Founders have worked. Partly, too, because many Americans' political convictions are (thankfully) based on principle, not economic self-interest. And partly because the fraction of Americans who think of themselves as rich, or likely to become rich in the future, is quite large, undercutting the incentive for wealth-bashing.
But there's another reason our income tax hasn't been used more aggressively as a tool of economic predation: Even middle- and lower-income Americans generally think of themselves as burdened taxpayers, and therefore look askance on any proposal to push tax rates up. Most average citizens do not realize how little of the total income tax they are actually bearing.
It's not surprising that ordinary Americans think of themselves as more likely to be victims than beneficiaries of taxes. For they do, in fact, bear a considerable tax burden. But most pay their bit in the form of payroll taxes rather than income taxes.
Over the same era in which the personal income tax has become the chief source of federal revenue, payroll taxes have also risen sharply. At the end of World War II, only 2 percent of federal revenues came from payroll taxes. Currently the figure is 39 percent. While working Americans have been dropping off the income tax rolls, they have been getting hit harder by the payroll tax. The result is that nearly 80 percent of Americans now pay more in payroll taxes (supposedly earmarked for Social Security and Medicare, but in practice co-mingled with all other federal revenues) than they do in income taxes.
Due to payroll taxes, today's median-income American actually supports the federal government in rough proportion to his income. Paying payroll taxes has thus become the basic means by which many millions of Americans fulfill the financial duties of citizenship.
Which leads to the question: What will happen if conservatives succeed, as part of their push for an Ownership Society, in redirecting much of the payroll tax from federal coffers into the personal accounts of workers? Most Americans would then be directly supporting the federal government only through the income tax and the few federal sales and excise taxes (e.g., on gasoline). The result: Most Americans would no longer be making any significant contribution whatever toward the maintenance of the federal government.
Any new programs that Congress might adopt would cost the average American little or nothing. He already pays scant income tax, and he would be getting much of his Social Security and Medicare taxes back in the expected personal accounts. So at that point the relatively small number of citizens who make significant income tax payments would be carrying our whole federal edifice.
And there's the rub. "Rebating" a big chunk of payroll taxes back to workers in the form of personal accounts is devoutly to be wished for in most ways. But one troubling side effect of such a transformation would be to nakedly expose the tax burden that our personal income tax disproportionately lays on the top 5 percent of Americans.
Our Founders had no confidence that voters, unmoored from financial responsibility, would refrain from pillaging the wealth of their neighbors. If most of Washington's costs end up piled on just a few backs, the only thing preventing a sharp ratcheting up of the income tax will be the decency and political principle of ordinary Americans.
In that event, we will find out whether Aristotle and James Madison were too pessimistic in their view of human selfishness—or unhappily accurate.