By Bryan McCannon
The 16th Amendment to the U.S. Constitution was ratified in 1913 – 100 years ago. The amendment made income taxes legal for the federal government. With the centennial, it is worth looking back at where we came from as a country and where we are going.
The Constitution originally banned the federal government from directly taxing its citizens. The government relied on tariffs on imported goods, taxes on producers of “sins” such as alcohol and tobacco, and transfers from state governments.
The amendment’s ratification was championed in those areas of the country that saw it as a way to extract the wealth of Northeasterners. Money could be taken from those in the east and spent on development projects in the west and south.
What effect do income taxes have on an economy, as opposed to other sources of revenue? Basic economics tells us to look at the incentive effects to understand consequences. Income is derived from work – giving up one’s valuable time and leisure to engage in productive activities.
Thus, a tax on income means that relatively less benefit is derived from working to make someone else better off. Other sources relied upon at the time were forms of consumption taxes. Taxing purchasing means you are making saving money more attractive. Thus, 100 years ago, we switched from rewarding saving to penalizing work.
The shift was initially quite moderate. The tax rate began at only one percent of income and you had to first have a sufficiently high level of income to qualify. This pales in comparison to our current tax rates. We take this as an insight into our future. Initially very small government programs grow. While at first only the relatively wealthy were asked to pay a single percent of their income, we now look for the same group to pay nearly 40 percent, and more of us are now included. Consequently, while government spending previously made up a miniscule proportion of the economy, it now reaches more than 38 percent of all economic activity.
History has repeated itself. Go back and look at the initial purposes of many government organizations and compare them to their present-day functioning. The Federal Reserve was created to provide long-term stability. The newly announced chair proudly proclaims that she will use the Fed to focus on monthly employment data. The World Bank, originally created to aid in post-World War II redevelopment, now works to solve every undeveloped country’s problems. The list goes on.
As we watch federal agencies grow and new programs emerge, we should consider the history of income taxes. Initial small expansions of the government have led and will lead to expansive endeavors years later.
Bryan McCannon, Ph.D., is chairman of the Department of Finance at St. Bonaventure University.