The initial 1040 imposed a tax of 1
percent on taxable income above a standard deduction of $4,000 for married
couples (almost $100,000 in today’s dollars). The 1 percent tax applied to
income up to $20,000 ($470,000 today) and a top tax of 7 percent was applied
to taxable income above $500,000 ($11.5 million today). The top tax bracket
briefly reached 94 percent during World War II, before settling in at 91
percent after the war. JFK dropped the top rate to 70 percent (on income
earned above $1.5 million in today’s dollars) before Reagan reduced the top
rate to 28 percent (on income earned above $60,000 in today’s
dollars).
Not surprisingly, the growth of the 1040 has matched the growth in the size
and power of government. In its first year, the income tax raised about $10
billion (in today’s dollars) and now raises more than $1.3 trillion
annually. Interest groups lobby for exemptions, deductions and credits —
part of a lobbying industry that benefits politicians and “the organized”
at the expense of the general public.
It turns out that federal “payroll” (FICA) taxes on income impose a larger
burden on most workers since those taxes are applied to every dollar earned
(no deductions, exemptions or credits). Amazingly, those in working-poor
households at the poverty line pay no “income taxes” but lose $3,000 to
payroll-FICA taxes each year.
Part of FICA’s burden is hidden because it looks like employers pay half of
it for their employees. And its burden is more subtle since it is simply
withheld from our paychecks. In this way, the 1040 is far worse. It’s rough
enough to have the government take so much money from the half of the
population who pay “income taxes.” On top of that, though, Americans spend
more than a billion dollars and more than six billion hours on filing their
1040’s. If they’re going to take our money, can’t they do it more
efficiently?
In the recent minimum-wage debate, one of the more reasonable arguments was
that the policy hasn’t changed recently. If states or the federal government
are going to insist on having a minimum wage, it should be updated
regularly. Or better yet, it should be adjusted annually (“indexed”) to
deal with the effects of inflation.
One could easily make the same argument about income taxes. We haven’t had
substantive federal income-tax reforms since the 1980s under President
Reagan and a bi-partisan Congress. The number of tax brackets was reduced
from 16 to two; marginal tax rates were reduced for everyone; and the tax
code was finally “indexed” for the effects of inflation. Since then, many
of their improvements have been reversed: top marginal tax rates have
increased (to nearly 40 percent); the number of tax brackets has creeped
back up to seven; and the tax code has become more complex.
A “flat tax” on income could replace current income taxes and the flat FICA
tax with a single marginal tax rate on all income earned above the poverty
line (with the possible exception of charitable contributions). It could
raise the same amount of money with far less cronyism, inequity and
inefficiency.
Unfortunately, few of our current national political leaders seemingly have
the courage for anything so bold. But talk of hope and change can rise
again. As we enter electoral cycles in 2014 and 2016, perhaps the public will
make it a priority to insist on more efficiency and equity in our federal
income tax code.
Eric Schansberg,
Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a
professor of economics at Indiana University Southeast.
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