DIBACCO: How Washington sold the nation on tax withholding

OPINION:

This month marks the 70th anniversary of the Current Tax Payment Act, which introduced withholding of federal income taxes from employee paychecks. Arguably, it was one of the most important pieces of tax legislation in American history because it provided Washington with a steady stream of money to spend.

Prior to World War II, few Americans made enough money to pay income taxes. Those who did, the wealthy, paid their entire tax on March 15, the deadline for submitting the previous year’s 1040, or they paid in quarterly installments.

To be sure, when the 16th Amendment authorizing the income tax was ratified and implemented in 1913, the federal government instituted withholding. But by 1917, employers complained about the paperwork, and the system was abolished, thereby ensuring the federal government would spend more carefully. Excluding the World War I years, when budget deficits were unavoidable, the system worked, with surpluses recorded during every year of the 1920s.

Then when Social Security was passed in 1935, withholding of these new levies was put into effect. Collection of the dough by the Bureau of Old-Age Benefits, no matter the 50 million employee accounts, was handled satisfactorily, illustrating that the system could also work for income taxes.

So when World War II broke out, the federal government had two immediate goals: First, to expand the tax base to everyone, including GI Joe and Rosie the Riveter. This was accomplished by lowering personal exemptions from $2,500 to $1,000 for married couples and by raising the beginning tax rate from 4 percent to 24 percent. As a result, by 1942, some 39 million Americans were paying taxes, a tenfold increase.

Second, the feds needed to get the tax money quickly; therefore, the implementation of pay-as-you-go. Withholding was not easy to come by legislatively, though. Secretary of the Treasury Henry J. Morgenthau Jr. touted the idea to Congress a month before the Pearl Harbor attack, but the response was lukewarm.

Even the Bureau of Internal Revenue (later dubbed the IRS) was opposed to withholding on the grounds that there weren’t enough personnel to handle the increased burden. The Treasury Department, on the other hand, used every specious argument it could muster (rather than the obvious need for more money to fight the war) to appeal to taxpayers. For example, pay-as-you-go, it contended, would limit inflation. Because Uncle Sam was taking money out of paychecks each payday, purchasing demand would be curbed. With less money to spend, in other words, Americans would stretch their dollars on inflation-curbed products.

It was also argued that withholding was like the widespread practice at the time of buying goods on layaway; that is, making small payments regularly in order to pay them off over time. Then there was the argument from the president that without withholding, tax evasion was more likely, with “too many people earning money and not contributing to the government.”

Americans still weren’t happy with this logic, because they figured out that the real bottom line was that Washington would have much more to spend of their hard-earned money — and also to waste. Moreover, it didn’t take a doctorate in economics to determine that the federal government was not only getting tax money in advance through withholding, but wasn’t paying interest on the sums, especially in the event of overpayment. Employers also recognized that the burden of implementing the system fell on them, through submission of required forms and tax monies, not on the government.

Congress tried a sweetener of sorts, forgiving most income taxes for low-wage earners for a year. The elation was short-lived; by 1944, the federal government, in spite of withholding, was well on its way to spending and borrowing, establishing a legacy of indebtedness that would haunt the future.

To rev up the campaign for withholding, Morgenthau also got Irving Berlin to write a tax song in 1942 that he hoped would stir American patriotism. Berlin obliged with “I Paid My Income Tax Today,” replete with three choruses and a refrain. He even gave the feds the copyright to the ditty. Not surprisingly, the song, unlike other Berlin works, never became a hit.

Thomas V. DiBacco is professor emeritus at American University.