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A Fair Income Tax Is No Income Tax, Part 1

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I just recently got on Facebook — and this week, I was invited to join the Fair Tax group. I've always felt that the income tax system is irreparably broken — but I believe in having the facts to back up your claims, so here's a rant about all the reasons why the income tax is unconstitutional, wasteful, and just plain wrong.

Not Part Of The Original Plan

If you think that personal income tax has always been an inherent part of our American system — perhaps written into the Constitution — you are sadly misinformed. Our founding fathers were staunchly opposed to taxing individuals on their private income. The taxation of productivity is actually quite anti-capitalist, and was seen as a disincentive to helping our fledgling country grow. The Constitution was written to promote taxing consumption (via tariffs on the import of goods and indirect excises on corporate profits) rather than wages — a more fair and equitable way to raise the revenues needed for running our federal government. Alexander Hamilton stated in "The Federalist #21" that, "It is a signal advantage of taxes on articles of consumption, that they contain in their own nature a security against excess. They prescribe their own limit; which cannot be exceeded without defeating the end proposed, that is, an extension of the revenue." The goal was to protect citizens against unfair taxation by their government (a major concern while under British rule). We managed to do just fine as a nation for 124 years without a national income tax. So what changed?

Article 1, Section 2, Clause 3 and Article 1, Section 9, Clause 4 of the Constitution decreed that Congress could impose a "direct" tax (meaning taxes paid directly to the federal government) only if the law apportioned that tax according to each state's population. So if the government wanted to collect a million dollars in taxes, it had to determine how many people resided in the country (by means of a census), divide that million dollars equally among the total population — then figure out how many people were in each individual state, and assign each state its portion of the tax based on the population. But the STATES were responsible for paying this tax, not the individual. The states, in turn, were free to charge citizens a property tax to cover their portion of the debt. But again, this was an indirect tax, and it was tied to consumption. The more property you owned, the more tax you paid — if you owned no property, you were exempt from the tax. This is how a direct tax is legally and Constitutionally collected.

A Short History Of The Income Tax

Income taxes aren't a new idea — but they've always been seen as a stop-gap. Throughout history, the United States government has occasionally imposed a TEMPORARY personal income tax during wartime to help cover the costs of killing a lot of people. The first came in the form of the a one-time two million dollar apportioned tax in 1798 (to fund our undeclared naval war with France). Later on, the Revenue Act Of 1861 levied a 3% tax on all incomes over $800 to pay for Union Army activities during the Civil War. The Revenue Act Of 1862 increased that to 3% on incomes above $600 and 5% on incomes above $10,000 — and rates were raised again in 1864. But of course, once the war ended, so did the tax — it was rescinded in 1872.

The first peacetime personal income tax was instituted with the 1894 Tariff Act. This tax was levied to supposedly make up for revenue that would be lost by tariff reductions (which was bull, because more than 600 riders were added to the bill behind the scenes that nullified most of the cuts) — and it immediately came under fire as being unconstitutional. In 1895, the Supreme Court ruled in Pollock v. Farmers' Loan & Trust Co. that taxes on personal property were direct taxes, and therefore had to be apportioned. This was a large and impractical pain in the butt, and essentially prohibited a federal personal income tax or more than 20 years.

The Truth About The 16th Amendment

In 1913, Congress decided to pass the famous (or infamous, depending on your view) 16th Amendment — which states, "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 is an incredibly poorly worded and controversial amendment that makes it seem as though personal income tax is no longer subject to apportionment. However, the Supreme Court has disagreed with this interpretation over and over again — suggesting that the goal was simply to make it easier to tax those incomes ALREADY exempted from apportionment (meaning corporate income).

In 1916 in Brushaber v. Union Pacific Railroad, the Supreme Court ruled that this amendment did not expand the federal government's existing power to tax personal income — it was merely passed so that corporate income (already free from geographic unity) could be charged with an excise tax. This decision stated that any classification of personal income tax as exempt from apportionment was an erroneous assumption.

In 1916 in Stanton v. Baltic Mining Co., the Supreme Court said, "By the previous ruling, it was settled that the 16th Amendment conferred no new power of taxation, but simply prohibited the previous complete and plenary power of income taxation, possessed by Congress, from the beginning, from being taken out of the category of indirect taxation, to which it inherently belonged…" In layman's terms, this means that the only income tax the government should legally be allowed to charge is an indirect excise tax (meaning a tax on business profits, on "privileged taxable activities," not on individual income).

In 1920 in Eisner v. Macomber, the Supreme Court again supported the idea that personal income taxes were unaffected by the 16th Amendment, stating, "The 16th Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the Amendment was adopted." You heard it straight from the mouth of the Supreme Court — any tax on income that constitutionally requires apportionment was not meant to be subject to the 16th Amendment. Personal income taxes are still direct taxes governed by the rule of apportionment.

Incremental Increases Until You Die

When the permanent national income tax began in 1913, only those earning $4000+ per year were asked to pay taxes (at a time when the average laborer made no more than $500 a year). The exemption rate was 8 times the earned income of the common citizen, and fewer than 10% of households paid anything at all. Regardless of what conservatives say about "wealth redistribution," the burden was always meant to be shouldered by those who could most afford it — this was never intended to be an indiscriminate tax on everyone, irrespective of income.

Civil Action 97-B-2733 showed that in modern times, assuming an average wage of $10 per hour, we should have an exemption rate of $160,000 and anyone who earns less than $120,000 a year should not be required to file a return. Sweet! Conversely, if you translated our current exemption rate back to 1913 dollars, it would equal about $300 — this would have forced the majority of citizens, many of whom were just barely scraping by, to pay taxes. Had Congress proposed this policy in 1913, folks would have revolted in the streets!

The system has clearly become perverted in other ways, and does not carry on in the true spirit of the original income tax. In 1913 the requirement to file was based on net income, but it is now based on your gross — forcing more people living on lower wages to submit a return. In addition, a decline in the value of the dollar and rising prices had elevated many families into tax brackets formerly reserved for the wealthy — until Congress began adjusting for inflation. According to the National Taxpayer's Union, personal income taxes made up just 0.9 percent of GDP in 1940, but had swelled to 10.3 percent of GDP by the millennium. Even more frightening, the per capita federal tax burden increased from $2,505 in 1945 to $7,718 in 2000 (in constant 2002 dollars). Income tax now applies to almost 2/3 of the population, including many who can't afford such a big bite out of each paycheck.

In the beginning, even those who were taxed only paid 2% of their personal income above $4,000 — with a 6% surtax on incomes above $500,000. Hey, charge me 2% or even 8% of my income — I'll gladly hand it over! However, Congress has applied its policy of "in for a penny, in for a pound" to tax rates over the years, and incrementally hiked the amount owed to a ridiculous level. By 1918, the top rate of the income tax was increased to 77% on income over $1,000,000 (to finance World War I). It was reduced to 58% in 1922, to 25% in 1925 and finally to 24% in 1929. In 1932, it was increased to 63% during the Great Depression — and reached 94% on all income over $200,000 in 1945. The top rate was lowered to 70% in 1964, 50% in 1982, and finally to 28% in 1988. While that's a heck of a lot better than 94%, it still doesn't come close to resembling the initial 2% tax. The problem is that when you give Congress an inch, they take a mile. They get used to having even more money in the coffers to waste, and are reluctant to rein in their spending so they can step backward to a lower tax rate. It's human nature and we've all been there in our own lives — the only difference is that we have to earn our money before we can spend it.

What Is Income?

Of course the amount you owe in taxes each year is based on your income — but what is "income?" The 1040 form instructions list all kinds of taxable and non-taxable income — asking you to add up money you receive from wages, rental payments, child support, investment interest, in-kind gifts, bartering of services, lottery winnings, insurance reimbursements, you name it. But did you know that the Internal Revenue Code specifically defines income as gains realized while doing business in a corporate capacity — not the wages an individual earns for his or her labor? In Section II, B of the 1913 income tax laws, it clearly provides the following limitations with respect to the definition of the net income of a taxable person:

"That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, businesses, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal property, also from interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit, or gains or profits and income derived from any source whatever, including the income from but not the value of property acquired by gift, bequest, devise, or decent…"

Okay — so incomes and salaries and wages growing out of the ownership of PROPERTY, and from money made on a lawful BUSINESS transaction. Hmmm — nowhere do I see anything saying that taxes are due on "personal earned income" or "wages for labor." Do you?

Who Benefits From Withholding?

Under the old tax system, every American citizen wrote a check to the government at the end of the year for the taxes owed on their annual salary (much like I currently do with my estimated income tax payments — ahhh, the joys of self-employment!) But in the summer of 1942, a Macy's executive named Beardsley Ruml suggested that the U.S. Treasury start collecting income taxes through a withholding, pay-as-you-go, system. He said, "Why should we be paying taxes on last year's income, which already is gone, out of present income, which we haven't yet received?"

This proposal came during World War II — and it was timed perfectly to take advantage of a desperate financial situation. The country was struggling, most Americans were strapped for cash, and many simply couldn't afford to shell out the big bucks for their taxes at the end of the year. The idea of having citizens pay a smaller income tax bill each time they brought home a paycheck seemed quite attractive to both the taxpayers and Congress (who would have money in hand sooner and be able to spend it faster).

Of course, there was really no way to reconcile the old system (pay for 1942 taxes in the beginning of 1943) with the new system (pay for 1943 taxes throughout all of 1943) without the public screaming "double taxation!" Ruml proposed a "forgiveness" for any taxes owed in the second half of 1942 — in exchange the government would begin forcing employers to withhold tax payments from wages in July 1943. Poor deluded Joe Citizen actually welcomed withholding because he believed it meant a free ride on 6 months' worth of taxes. However, those in charge saw the situation quite differently. Former Treasury Department official Elisha Friedman said, "The forgiveness of the small brackets is merely temporary. They will pay more later. You will forgive the 1942 tax for the little people but in 1944 and 1945 they will be paying at a higher rate. Ours is a paper forgiveness for the low brackets." And Ruml even admitted basing his plan on the types of installment payments consumers made for big-ticket items — whereby shoppers were actually willing to pay more for an item than if they bought it outright, because they focused solely on the monthly payments rather than the bottom line.

The withholding system is essentially an interest free loan that you give to the government each year. Think about how much you would make if you kept that money in an interest-bearing savings account for 12 months and paid your taxes on December 31st. And the next time you get excited about a big refund check, ask yourself why that money was ever paid to the government in the first place, instead of going in your pocket. That chunk of change could pay for a car repair or a vacation or braces on your kid's teeth. And during tough times like these, it might keep some people from losing their homes because they couldn't cover the mortgage. It's really highway robbery to have this money taken away from you. Technically speaking, you could claim a million exemptions and reduce your withholding to practically nothing, then take responsibility for cutting the IRS a check at the end of the year if you wanted to — but that's too complicated for most Americans. This is why the IRS has been able to get away with shafting the citizenry for more than 60 years — because it's just EASIER to let your employer withhold your tax payments throughout the year.

The withholding system also keeps people in the dark about how much is taken out of their check each pay period. If you ask the average Joe on the street his salary, he'll quote you the figure he was offered when hired — "I make $65,000 a year," or "I get $18 an hour." If you say, "And how much do you take home after taxes?" he probably won't have any idea. Stop reading for a minute and go to your filing system — pull out a year's worth of paystubs, add up both the income tax withholding and FICA for 12 months, and you will be shocked. Withholding is sort of like money laundering — it allows the government to incrementally increase tax rates (and take more from people than what is owed) without too much complaint from the public. When your paycheck is only being eaten away by a dollar or two more each time, you don't pay as much attention. But, being self-employed, I personally pay a quarterly estimated income tax payment — and I know EXACTLY how much money I give them every year. I once wrote a $14,000 check the IRS — and that was just for one quarter, not even my entire tax bill that year. I almost had a heart attack! People would be a lot more outraged at the cost of their taxes if they had to pay them directly in one lump sum. It's a very different experience when you give the government hard-earned cash out of your checking account, rather than money you've never seen and haven't held in your hand yet.

And finally, withholding deprives you the citizen of one the most powerful and direct forms of protest against your government — non-payment of your taxes. If I'm not happy with how the government is being run, I can send in a letter with my tax return explaining why I'm not paying them one red cent this year (and, as with any civil disobedience, prepare for the consequences). But when the money is snatched away from you before you even earn it, you are left without a voice.

An Invasion Of Your Personal Privacy

It's obvious that the mindset in this country was very different in 1913. Americans were preparing to enter the Great War — and folks were happy to do their duty, contributing their hard-earned dollars to the war effort. However, they did not equate patriotism with fascism — they still held on to the idea that government didn't need to know every little detail about a person's life, and that privacy was a sacred right of each citizen. Section 3167 of the 1913 income tax laws state:

"…and it shall be unlawful for any person to print or publish in any manner whatever not provided by law any income return or any part thereof or the amount or source of income, profits, losses, or expenditures appearing in any income return; and any offence against the foregoing provision shall be a misdemeanor and be punished by a fine not exceeding $1000 or by imprisonment not exceeding one year, or both, at the discretion of the court; and if the offender be an officer or employee of the Unites States he shall be dismissed from office and be incapable thereafter of holding any office under the Government."

All right! No revenue officer could share your income tax information with anyone, under penalty of imprisonment! That's the way a government should be run. But what about today? Compare this clause with an excerpt from the 1040A instruction booklet regarding the Privacy Act and Paperwork Reduction Act:

"We may give the information to the Department of Justice and to other Federal agencies, as provided by law. We may also give it to certain cities, states, the District of Colombia, U.S. commonwealths or possessions, and certain foreign governments to carry out their tax laws."

Nice. Well, so much for privacy. Initially, it looks like the IRS is simply enacting measures to help them collect taxes owed — but why do we even need those measures? I could argue that if the tax system were set up in a simple and understandable way, and if it actually taxed those who should be taxed instead of providing and endless line of loopholes for corporations and the rich, we wouldn't need to violate personal privacy in order to chase down lost money. I could also argue that rules like this never punish those who are sidestepping the law — they just make life more difficult for the common citizen. And those would all be valid claims.

But in truth, so much of this kind of thing grows out of fear and impotence — we can't do anything really meaningful to feel more secure in this country, but at least we can control how people use their own money! As you have seen throughout the history of the income tax, worries about war have always prompted a "justified" financial and legal rape of the citizenry. Fear is also what allows shameful legislation like the U.S. Patriot Act to be passed, and fear will eventually cause us to give up every civil liberty we ever had — here, take all my personal rights, just make me feel safe! Rights, once surrendered, cannot be easily reclaimed. And it's a sad day when your own ruling body informs you that it can legally share your income tax information with foreign governments — don't expect that one to be repealed any time soon. But I digress…

More Complicated And Expensive Every Year

Initially, a tax return was one page long — and the entire tax code consisted of only 14 pages. Simple, concise, and to the point. Even the average citizen could understand it. Since then, the federal income tax system has become so complex that it requires tens of millions of Americans to seek paid professional help to comply.

According to the National Taxpayer's Union, the IRS employs more people than all but the 36 largest corporations in the U.S., and employs more investigative agents than the FBI and the CIA combined (what happened to "voluntary compliance?") It costs $10 billion a year to operate the IRS — and tax code compliance runs an additional $265 billion ($900 for every citizen) a year. The paperwork burden to companies is $5,100 per employee — money which could be spent on higher wages, hiring more workers, or not laying off existing staff (which would surely be bring about a bigger benefit to the economy!) Massive, massive amounts of our national wealth are wasted on measuring, tracking, sheltering, documenting, and filing our annual income.

Not to mention the fact that federal revenues drive expenditures — and the more income the government gets, the more ways it finds to justify higher spending (budget and economics be damned!) The very nature of withholding suppresses public outcry for tax reform — why bother writing your congressperson in favor of a tax cut when you're only going to net a couple of dollars on each paycheck? But if that savings was realized as a substantial reduction of an annual payment, folks would be much more likely to participate actively in their government.

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  • I listed how it is an increase in the taxes, how it will not work, and how it is regressive
    to me, that means it is not the solution

    I am all for less taxes, but we need to cut down on spending first (No point in increasing the deficit)

  • Clavos

    The FairTax may not be the solution (although I haven’t seen anything, to convince me of that, including Barga’s site), but what we have now is nothing short of a disaster and a ripoff of the middle class.

  • Dreadful, don’t point that out, it harms this disillusioned argument

  • Indeed, Joanne. And one key flaw is this:

    “It’s obvious that the mindset in this country was very different in 1913. Americans were preparing to enter the Great War — and folks were happy to do their duty, contributing their hard-earned dollars to the war effort.”

    Except that the US didn’t enter the war until 1917. Indeed, in 1913 the concept of becoming embroiled in a European war was anathema to most Americans. So the notion that the government was somehow able to take advantage of jingoism to railroad an income tax bill through Congress is a bit of a nonsense.

  • Interesting article, even if it contains some flaws.

  • 1) the court has ruled that the Constitution origionally allowed income taxes
    2) Reread the paciific railroad case, it actually says it doesn’t expand the right because they already had it
    3) The fair tax does not work, here is why
    4) do more research, you seem simply to have seen the argument for it and ignore the countless arguments against it

  • An interesting article, with some good historical information and worthwhile concerns about taxation. However, I’m afraid your interpretation of Section II, B of the 1913 income tax law is incorrect and it’s an error which has landed a number of people in jail.

    Read this more carefully and watch the sentence structure as I go through and explain it.

    “the net income of a taxable person shall include”

    These are the things it “shall include:”

    “gains, profits, and income”

    This is where those things can come from:

    “derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, businesses, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal property, also from interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit, ”

    And lest you think this is a complete list, it makes it clear that every other kind of unspecified income can also be taxed:

    “or gains or profits and income derived from any source whatever, including the income from but not the value of property acquired by gift, bequest, devise, or decent…”

    So in fact, what it clearly says is that any form of income or gains can be taxed from any source whatever.

    So the claim that the income tax does not apply to personal income is entirely spurious.