The Income Tax turns 100

Some anniversaries are harder to stomach than others. This year we celebrate the 100th anniversary of both the Federal Income Tax and the Federal Reserve Act. It turns out that our national government had assessed income taxes before, however these were temporary. It was the 1913 law that became permanent. Andrew Young wrote a nice history on "The Origin of the Income Tax" a few years ago.

My friend and colleague Jeffrey Herbener, who teaches American Economic History, brought to my attention that while the original 1913 tax law stipulated a bottom rate of 1% and a top rate of 6%, by 1918, the bottom rate was 6% and the top rate was a whopping 77%. Such was the consequence of the Progressives' and Woodrow Wilson's need to finance their Great War.

The moral of the story is to never assess a new tax, no matter how low and how temporary it is claimed to be.

Our current tax regime is destructive of both economic prosperity and sound morality. In the first place, it leads to massive capital consumption which reduces productivity and therefore our standard of living. As I explain in my book, Foundations of Economics:

Because of higher taxes, people have less of their income to save and invest. There is a decrease in the capital stock to the extent that the state is successful in collecting the increased taxes. Less capital results in lower labor productivity, lower wages and incomes, and results in fewer goods available to society. At the same time that people have less income to save and invest, they also have less incentive to save and invest what disposable income they have left because interest income from such investment will be taxed as well.

Additionally, increased taxes provide an incentive for the development of what is called the underground economy. The underground economy is the network of voluntary exchanges that take place in ways that are unreported and undocumented to the taxing authority. As taxes on incomes increase, more and more transactions are undertaken for cash or barter, so that no record of a sale and no record of income are evident to the government. If the government does not know of income earned, it is difficult to tax.

At the same time, our current confiscatory income tax violates the Eighth Commandment (Thou Shalt Not Steal). As the Westminster Shorter Catechism teaches in Question and Answer 74:

Q. 74. What is required in the eighth commandment?
A. The eighth commandment requireth the lawful procuring and furthering the wealth and outward estate of ourselves and others.

Our current income tax neither furthers the wealth and outward estate of ourselves or our neighbor.


Happy Tax Day!