Integrating the tax burdens of the federal income and payroll taxes on labor income: 4. DOUBLE TAX BY ACCIDENT?

By Geier, Deborah A.
Publication: Virginia Tax Review
Date: Saturday, June 22 2002

자료: Integrating the tax burdens of the federal income and payroll taxes on labor income

IV. DOUBLE TAX BY ACCIDENT?

It was not inevitable that Social Security benefits would be funded from a separately collected and ear-marked payroll tax on wages. The Social Security program created in 1935 could have been funded with general tax revenues collected from the individual and corporate income taxes (as well as tariffs and other federal excise taxes). Indeed, some influential members of President Roosevelt's Commission on Economic Security, which drafted the Social Security proposal, advocated such an approach. Wilbur J. Cohen accompanied University of Wisconsin Professor Edwin E. Witte to Washington when Professor Witte, who "virtually single-handedly wrote the entire wide-ranging committee report," (81) was appointed to head the effort. Cohen later recalled that "[d]uring the formation of the committee's proposal, Emergency Relief Administrator [Harry] Hopkins favored some kind of broad, comprehensive, unified program that would involve, exclusively or substantially, federal general revenues. Other proposals along this line were pending in Congress and were supported by some social workers and members of Congress." (82)

Unless the Congress expanded the income tax to reach the middle and lower classes, however, using general income tax revenues to fund Social Security benefits would have meant that the wealthy would essentially pay for the program. In 1935, the wages of most workers were not taxed under the income tax because of the high personal exemptions. Conservatives, who "charged that the social security conception violated the traditional American assumptions of self-help, self-denial, and individual responsibility," (83) would not likely have supported such a blatantly redistributive program. Indeed, such a system could even aggravate racial animosities. "'The average Mississippian,' wrote the Jackson Daily News, 'cant imagine himself chipping in to pay pensions for able-bodied Negroes to sit around in idleness on front galleries, supporting all their kinfolks on pensions, while cotton and corn crops are crying for workers to get them out of the grass.'" (84)

To avoid this, one option could have been to extend the income tax from the wealthy to the lower classes, with the result that their wages would then come within the income tax system. If that had been done, their wage income would have been taxed only once at the federal level--even as the income tax itself expanded to raise more revenue with World War II--and the increased revenues obtained under the general income tax from this expansion could have funded the payments made under the program. In other words, Social Security spending would have been simply one more government program supported by general tax revenues. The government, however, would collect those general tax revenues from the lower and middle classes (which would benefit from the new program) as well as the wealthy.

But there were important political reasons for the separate tax. If the "tax" could be sold as an "insurance contribution" rather than a "tax," and Social Security benefits perceived as simply the return for which prior premiums were paid, President Roosevelt believed that "by virtue of a statutory 'compact' between the contributors and Congress,... a future President and Congress could not, morally or politically, repeal or mutilate the 'entitlement' character of the program." (85) His observation has held true. (86)

Moreover, there was simply no need at the time to expand the income tax downward, as opposed to enacting a separate tax on wages, in order to avoid a future "double tax" problem, since the income tax was itself thought at the time to be a tax that would never reach the lower and middle classes. It was, therefore, not likely foreseen that the labor income of these lower- and middle-class workers would soon be taxed twice--once under the new payroll tax and once under the income tax. As Professor Carolyn Jones related:

In testimony before the Senate Finance Committee in 1932, Herbert Hoover's Treasury Secretary, Ogden Mills, aptly described the very limited scope of the individual income tax up to that time. "We have become accustomed," he said, "to high exemptions and very low rates on the smaller taxable incomes. That is our fixed conception of an income tax and it is very difficult as a practical matter to change fixed conceptions of this character." (87)

She went on to note that this "fixed conception" remained prominent through the middle and late 1930s in Roosevelt's New Deal, when the payroll tax was enacted. "In public pronouncements, Roosevelt and prominent Congressmen linked income taxpaying to plutocracy and rejected imposition of income taxes upon 'average' citizens. (88) Moreover, Congress agreed.

Congress was... quite clear as to who should not be paying income taxes. When Senator LaFollette proposed reducing exemptions to $2,000 for couples and $800 for singles [in 1935], he was soundly defeated. At a time when three-fourths of American families were at or below the $2,000 level at which they could live decently, Sen. Alben Barkley argued that LaFollette's measure would hurt the "average citizens" and "average families" "whether we consider the average man as one who receives less than $5,000 a year or the one who receives less than $10,000 a year--we can make up our own average to suit our own view of what an average ought to be." (89)

Instead, Congress "increased surtaxes on those with incomes over $50,000, making a top bracket of 79 percent for income over $5 million. For three years thereafter only John D. Rockefeller qualified for this most stratospheric of tax brackets." (90) This attitude toward income taxation continued through the 1930s.

This perception of the income tax as a weapon to be used only against the wealthy persisted in 1936. In his acceptance speech at the Democratic convention in Philadelphia, Roosevelt claimed to have enlisted in a war against the "economic royalists" who had crowded out "many thousands of small business men and merchants who sought to make a worthy use of the American system of initiative and profit." In an October 1936 campaign address at Worcester, Massachusetts, FDR spoke of the "struggle to maintain democracy in America"--a struggle between "the vast majority of our citizens" and "a small, but powerful group which has fought the extension of [the] benefits of democracy, because it did not want to pay a fair share of their cost." The politics of class division were clearly at work. Tax relief should be given to the average working American, while the wealthy should be more heavily taxed.

The Revenue Act of 1937 again played upon the. theme of unfairly low level of taxes paid by the wealthy. The Administration recommended loophole closing, and Congress responded with hearings detailing tax avoidance and evasion by sixty-seven wealthy families. Foreign and domestic personal holding companies, hobby losses, incorporated yachts and country estates, and personal service corporations were just a few of the devices resorted to by the well-to-do. For Roosevelt, plutocratic tax evasion and avoidance focused income tax reform upon the very small group of Americans already subject to income taxation instead of upon measures that would have broadened the tax base and the role of the income tax as a source of federal revenue.

Polls from 1938-39 suggest lack of public support for reductions in taxes "on people with high incomes", and a plurality of support for publicity of the income tax returns "of rich men." Proposals for base broadening were not well received. A poll in January 1938 asked if a married man earning less than $2,500 a year should be required to pay a federal income tax. Eighty percent said no, although that figure fell to 64 percent in a February 1939 poll that asked a similar question. This view supported exemption of over three-fourths of the American population from income taxation. (91)

When the income tax itself was, however, finally expanded to reach the labor income of the lower classes as well beginning in the early 1940s with World War II and the subsequent Cold War, the wage income of the lower and middle classes was, for the first time, doubly taxed at the federal level. But, as noted above, the rates were relatively low for the lower classes under both tax systems at this time. (92) Also as noted above, however, this is increasingly no longer true for lower- and middle-class taxpayers, bringing the double taxation problem for them to a head only now--in the twenty-first century. (93)