Amity Shlaes - The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It

Copyright 1999 by Amity Shlaes

All rights reserved under International and Pan-American Copyright Conventions. Published in the United States by Random House, Inc., New York, and simultaneously in Canada by Random House of Canada Limited, Toronto.

Library of Congress Cataloging-in-Publication Data
Shlaes, Amity.
The greedy hand: how taxes drive Americans crazy and what to do about it/Amity Shlaes.
p. cm.
eISBN: 978-0-307-81933-8
1. TaxationUnited States. 2. TaxationLaw and legislationUnited States. I. Title.
HJ2362.S54 1999 336.200973dc21 1999 98-31243

Random House website address: www.atrandom.com

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If, from the more wretched parts of the old world, we look at those which are in an advanced stage of improvement, we still find the greedy hand of government thrusting itself into every corner and crevice of industry, and grasping the spoil of the multitude. Invention is continually exercised, to furnish new pretenses for revenues and taxation. It watches prosperity as its prey and permits none to escape without tribute.

Thomas Paine,
Rights of Man, Introduction to Part the Second

The father of the modern American state was a pipe-puffing executive at R. H. Macy & Co. named Beardsley Ruml. Ruml, the department stores treasurer, also served as chairman of the board of directors of the Federal Reserve Bank of New York and advisor to President Franklin Roosevelt during World War II. In those years Washington was busy marshaling the forces of the American economy to halt Japan and Germany. In 1942, not long after Pearl Harbor, lawmakers raised income taxes radically, with rates that aimed to capture twice as much revenue as in the previous year. They also imposed the income tax on tens of millions of Americans who had never been acquainted with the levy before. The change was so dramatic that the chroniclers of that period have coined a phrase to describe it. They say that the class tax became a mass tax.

The new rates were law. But Americans were ill-prepared to face a new and giant tax bill. A Gallup poll from the period showed that only some 5 million of the 34 million people who were subject to the tax for the first time were saving to make their payment. In those days, March 15, not April 15, was the nations annual tax deadline.

The Treasury nervously launched a huge public relations campaign to remind Americans of their new duties. A Treasury Department poster exhorted citizens: You are one of 50,000,000 Americans who must fill out an income tax form by March 15. DO IT NOW! For wartime theatergoers, Disney had prepared an animated short film featuring citizen Donald Duck laboring over his tax return beside a bottle of aspirin. Donald claimed exemptions and dependent credits for Huey, Dewey, and Louie.

As March 15, 1943 neared, though, it became clear that many citizens still were not filing returns. Henry Morgenthau, the Treasury secretary, confronted colleagues about the nightmarish prospect of mass tax evasion: Suppose we have to go out and try to arrest five million people?

Enter Ruml, man of ideas. At Macys, he had observed that customers didnt like big bills. They preferred making payments bit by bit, in the installment plan, even if they had to pay for the pleasure with interest. So Ruml devised a plan, which he unfolded to his colleagues at the Federal Reserve and to anyone in Washington who would listen. The government would get business to do its work, collecting taxes for it. Employers would retain a percentage of taxes from workers every weeksay, 20 percentand forward it directly to Washingtons war chest. This would hide the size of the new taxes from the worker. No longer would the worker ever have to look his tax bill square in the eye. Workers need never even see the money they were forgoing. Withholding as we know it today was born.

This was more than change, it was transformation. Government would put its hand into the taxpayers pocket and grab its share of taxwithout asking.

Ruml hadnt invented withholding. His genius was to make its introduction palatable by adding a powerful sweetener: the federal government would offer a tax amnesty for the previous year, allowing confused and indebted citizens to start on new footing. It was the most ambitious bait-and-switch plan in Americas history.

Ruml advertised his project as a humane effort to smooth life in the disruption of the war. He noted it was a way to help taxpayers out of the habit of carrying income tax debt, debt that he characterized as a pernicious fungus permeating the structure of things. The move was also patriotic. At Macys, executives had found that a young man in the comptrollers office who was making $75 or $100 [a week was] called into the navy at a salary of $2,600 and we had to get together and take care of his income tax for him. The young man, Ruml saw, would face a tax bill for a higher income at a time when he was earning less money in the service of his country. This Ruml deemed an impossible situation.

Ruml had several reasons for wagering that his project would work. One was that Americans, smarting from the Japanese assault, were now willing to sacrifice more than at any other point in memory. The second was that the federal government would be able to administer withholdingsix successful years of Social Security showed that the government, for the first time ever, was able to handle such a mass program of revenue collection. The third was packaging. He called his program not collection at source or withholding, two technical terms for what he was doing. Instead he chose a zippier name: pay as you go. And most important of all, there was the lure of the tax amnesty.

The policy thinkers of the day embraced the Ruml arrangement. This was an era in which John Maynard Keynes dominated the world of economics. The Keynesians placed enormous faith in government. The one thing they liked about the war was that it demonstrated to the world all the miracles that Big Government could work. The Ruml plan would give them the wherewithal to have their projects even, they sensed, after the war ended. Keynesianism also said high taxes were crucial to controlling inflation. The Keynesians saw withholding as the right tool for getting those necessary high taxes.

Conservatives played their part in the drama. Among withholdings backers was the man who was later to become the worlds leading free-market economist, Milton Friedman. Decades after the war, Friedman called for the abolition of the withholding system. In his memoirs he wrote that we concentrated single-mindedly on promoting the war effort. We gave next to no consideration to any longer-run consequences. It never occurred to me at the time that I was helping to develop machinery that would make possible a government that I would come to criticize severely as too large, too instrusive, too destructive of freedom. Yet, that was precisely what I was doing. With an almost audible sigh, Friedman added: There is an important lesson here. It is far easier to introduce a government program than to get rid of it.

Such questions, though, had no place in the mind of a nation under attack. At the moment what seemed most important was that voters accepted the Ruml plan. Randolph Paul, a Treasury Department official and Ruml critic, wrote resignedly that his plan had political appeal. Though he conceived the plan as getting people out of debt to the government, the public thought that Ruml had found a very white rabbita magic trickwhich would somehow lighten their tax load.