How the U.S. income tax works

How the U.S. income tax works

By Marshall Brain

 
 

http://www.JewishWorldReview.com | (MCT) Tax time is upon us once again, and we all heave a collective sigh of resignation. There is nothing we can do about taxes, true. But have you ever wondered where income taxes came from, and why we pay them today? This is actually a fascinating story.

It all started in 1894, when Congress passed the "Revenue Act of 1894." It was a very simple tax. If you made more than $4,000 per year, you paid a 2 percent tax on your income. In 1894, $4,000 per year was a tremendous amount of income - an indication of great wealth. So the income tax of 1894 did not affect very many people, and the amount of tax was small.

Even so, the Supreme Court found the tax to be unconstitutional and struck it down. To get around the Supreme Court, Congress did the only thing it could do - it proposed a constitutional amendment and got it ratified. The 16th amendment reads, "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." This amendment specifically allows there to be an income tax in the United States. It was ratified in 1913.

Now you might be wondering: why in the world would the citizens of the United States ratify an amendment like that? Why would the citizens give congress the ability to create a new kind of tax? It is because, at the time, people were worried about the wealthy having too much money and power. The income tax was seen as a tax that would only be applied to the wealthy, in order to curb their power. The first income tax laws applied only to the very wealthy. As late as 1940, only about 5 percent of the population paid income tax.

Another feature of today's income tax system is the idea of a payroll withholding. Before your tax is due, the government takes it automatically out of your paycheck and holds your money in escrow until April 15. You get no interest on your money and cannot use it in any way. Where did an idea like this come from, and why would Americans allow it? This idea came in 1943 as a way to fund WWII. By withholding the tax up to a year ahead of its due date, the government got the money faster and used it to pay for the war.

So in 1943, the government has two key things: a constitutionally-approved tax system, and the ability take money out of people's pay checks without them ever holding the money in their own hands. All of the ingredients are in place for a massive expansion of the tax system. And sure enough, the system expanded.

One way to track the expansion is to look at the size of the tax code. In 1945, the federal tax rules fit in about 8,000 pages. By 1965 it took about 20,000 pages. In 2006, the number had grown to 66,000 pages. How many pages is that? A phone book might have 1,000 pages, so imagine 66 phone books lined up on a long shelf. It would be about 20 feet of phone books. That's our tax code.

If you look at the instructions for the basic 1040 form, you see the same kind of thing. The 1040 form is only two pages long. In 1945 it took four pages of instructions to explain it. By 1965 it took 17 pages. Today it takes more than 140 pages.

The complexity of the tax code means that many people can no longer file their own tax returns. So there are now more than one million paid tax preparers in the United States. Many of them are employed by the top three tax preparation companies: H&R Block, Jackson-Hewitt and Liberty. Together these companies handle more than 20 million customers per year.

Somehow, we all manage to muddle through, and we file something like 100 million individual taxable returns in a typical year. Using very round numbers here to keep things simple, these tax returns represent income of about $5 trillion. The total tax collected on that income is about $1 trillion, or roughly $10,000 per 1040 form, on average. That money combines with social security taxes ($900 billion), corporate income taxes ($260 billion) and other things like tariffs to create about $2.4 trillion in total federal revenue in 2007. It takes over 100,000 IRS employees to handle the load.

So, as you are burning the midnight oil to complete you tax returns, scratching your head over some incomprehensible rule or form, you now know a little bit of the history that got us here. We've come a very long way since the first income tax in 1913!

 
 

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