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September 1995
Volume 13, Number 9

The Dangers of Tax Shifting
Mark Brandly

The income tax has become politically vulnerable. Some politicians have said we should replace it with a national sales tax. Yet, far from reducing the total tax burden, this would merely shift the burden around from individual filers to retailers.

Therein lies the danger in any discussion of new taxes, even if they are billed as "replacements." Historian Charles Adams sums up five thousand years of tax-reform fiascoes in simple terms: "how much of my taxes can I shift off on someone else?" If history repeats itself, we'll eventually suffer a national sales tax and an income tax, and total taxes will continue going up.

The income tax began in an attempt to shift the tax burden. It was supposed to replace the tariff. Many of those who supported the income tax believed that this was its primary virtue. But they were approaching the taxing problem the wrong way. The focus should not be on who is taxed and how, but the total tax take and the size of the government it funds.

Today both confiscatory income taxes and trade restrictions (tariff and non-tariff) lower living standards and depress the economy. The very people who supported the income tax lived to suffer its effects. The lesson: work to make existing burdens as light as possible, diminish the overall costs of government, and never shift taxes around from group to group.

Throughout most of our history, the individual income tax was considered contrary to American values. It violated the rights of property and gave the government a license to spy. The income tax was regarded as a form of slavery in which the government laid claim to part of our labor time. That's why Marx and Engels, who wanted the "abolition of private property," called for "a heavy progressive or graduated income tax" as an appropriate inroad "on the rights of property."

The Founders, having suffered more than a century of imperial taxation, designed the U.S. Constitution to limit the government's power to impose direct taxes. Even the anti-federalists, who believed that the Constitution created too big a central government, doubted that "any prudent congress," as one statesmen said, would try to collect direct taxes.

No prudent Congress did. During the wartime "emergency" of 1812, Secretary of the Treasury A.J. Dallas proposed an income tax in a letter to the chairman of the Ways and Means Committee, but the proposal went no further.

Lincoln, who favored both tariffs and direct taxes, picked up the cause when he took office in 1860. The debt sat at $75 million, and to raise money for another war, the president issued bonds, raised excise taxes, and doubled tariffs. At Lincoln's urging, Congress passed an income tax of 3% on incomes over $800. The tax bill also contained the first loophole to encourage bond sales: the tax was cut in half for interest on government debt.

In the midst of anti-draft riots, Treasury Secretary Salmon P. Chase was reluctant to attempt to collect the tax. By 1862, with the war stepped up and the debt passing $500 million, the Northern Congress passed a second tax bill. It imposed a 3% tax on incomes of $600+, 5% on $10,000+, and 7.5% on incomes over $50,000.

Wartime "patriotism" made it possible to collect the 1862 tax, and Lincoln became the first president to tax incomes. Predictably, Congress increased the rates two years later. But the income tax had not achieved political legitimacy in peacetime. After the war, a falling deficit allowed the anti-tax forces to win the day. Rates fell, and, after much debate, the entire tax was scrapped in 1872--two years before it was statutorily set to expire.

Yet the popular image of the income tax had undergone a permanent shift. Rather than a form of slavery, people began to think of the income tax as a possible replacement for the tariff. The tariff had long contributed to sectional division. Northern industry favored the tariff as a means of protection from foreign competition. The South considered it exploitation, injuring trading relationships and forcing Southerners to pay high prices for manufactured goods. The tariff led to the nullification crisis and ultimately to the secession of the Southern states.

For that reason, people in the South and West were anxious to lower tariffs and pass an income tax that would strike back at the North. The relatively pro-South (and anti-Reconstruction) President Andrew Johnson favored the income tax. He argued that it was the fairest way to collect revenue because it balanced the economic interests of the regions. (Note that the egalitarian argument was not part of the debate: progressive rates were seen as raising more revenue, not that they were more "fair.")

From 1874 to 1894, Congressional proponents of the income tax submitted 68 bills to restore it. All came from representatives of the South or the West who were determined that their regions should not bear the entire revenue burden. None of the bills made it to the House floor.

Underneath the surface of American politics, however, forces were at work that eventually broke down the resistance to the income tax. Northern business interests, faced with economic slumps, lobbied for more protection. Meanwhile, tariff revenue began to fall, causing a growth in federal deficits.

In response to these budget trends, Congress raised tariffs after 1874. In 1890, the McKinley Tariff Act was signed by pro-tariff, anti-income tax president Benjamin Harrison. It increased the average rate on dutiable imports to an unconscionable 48%. Southern and Western resentment peaked, and catapulted the anti-tariff movement into the political mainstream.

The anti-tariff movement was now determined to shift the burden of exploitation to the exploiters themselves, the Northern money power. As the movement grew, for the first time, class-warfare populist rhetoric became part of the debate. The populist movements viewed the wealthy classes ("robber barons," the "bloated rich," the "money bags") as working with their minions in the government to victimize them with tariffs.

Even if ideologically unfocused, the impulses of these groups sprang from authentic grievances. The country's pro-tariff lobby did consist of a regional elite in league with government and banking, and this elite wanted the tariff precisely because it was all benefit and no cost. The populists were right about their enemies. But they were wrong in thinking the income tax would solve their problems.

In 1892, Grover Cleveland won the presidency on an anti-tariff platform, decrying it as "ruthless extortion" and urging its repeal. His campaign lent unfortunate weight to the cause of the income tax. Adding to the pressure for new revenue, banking interests were clamoring for more government spending to bail out the victims of their fractional-reserve policies after the panic of 1893.

An income tax bill was attached to the tariff bill of 1894, and it easily passed the House. Fellow Congressmen carried House Speaker William Wilson on their shoulders in celebration. In an ominous sign of things to come, the Senate version of the bill also included an increase in the tariff. Believing that he had been betrayed, Cleveland refused to sign the bill, but it went into law without his signature.

Ninety-eight percent of the population was exempt under the 1894 income tax. But the momentum to raise it was growing because of a socialist-egalitarian argument: the rich benefit more from government, so they should also pay more. A year later, the Supreme Court struck down the income tax, on the Constitutional grounds that it was direct and disproportionate.

Unlike today's tax debates, high philosophical arguments were also part of the court's hearing. Populist attorney James C. Carter argued that the tax was a necessary weapon against the plutocracy. The plaintiff's attorney Joseph Choate stressed the sanctity of property rights.

The court predicted that "the present assault upon capital is but the beginning. It will be but a stepping stone to others, larger and more sweeping, till our political contests will become a war of the poor against the rich; a war constantly growing in intensity and bitterness."

The income tax had died at the hands of the court. Theodore Roosevelt revived the debate ten years later by trumpeting the glories of the income tax. Anti-tariff Democrats were jubilant. In 1909, William Howard Taft took office in the middle of the tariff battle and a revenue shortfall. The opportunity for a tax revolution was at hand. In an attempt to defuse the tariff debate within his party, Taft proposed a corporate "excise" tax (actually an income tax under another name) of 1%.

To quiet the Democrats, Taft also proposed a Constitutional amendment to get around the Supreme Court. "The Congress," the amendment said, "shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." But neither he nor other members of his party thought the amendment would ultimately pass.

The strength of the anti-tariff, pro-income tax movement in the states had been drastically underestimated. In 1913, the 36th state ratified it, and the dreaded 16th amendment was put into the Constitution. When tariff revenues and business profits fell during World War I, the income tax option proved too tempting. The 1916 Revenue Act legislated income taxes separately from tariffs, and we got the first excess profits tax to boot.

These were relatively small taxes by today's standards. But we know what the future held. The income tax would later become the major source of political and economic coercion in American life. At the same time, the income tax had given protectionists cover to increase trade restrictions even though they raised no additional revenue.

Today individual taxpayers have had it with a tax that pillages as much as 40% of their income, including other payroll taxes. But just as in the period between 1874 and 1916, politicians are attempting to co-opt one anti-tax movement by suggesting we tax a new class of citizens: retail merchants.

Anti-tax forces should stick to reducing and eliminating existing burdens. Far more important than how a tax is collected, or who bears the burden, is the amount of the total tax collected. All our efforts--intellectual and political--need to be devoted to reducing and eliminating this unbearable burden of the leviathan state.


Mark Brandly, the Murray N. Rothbard fellow at the Mises Institute, is completing his PhD at Auburn University


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