Tax Review: The Small Income and the Sales Tax
Volume IV No. 10
Executive Summary The floor under the individual income tax, that is, the amount of income to which this tax does not apply, has always been determined in accordance with expediency ‘and revenue need rather than on the basis of some carefully computed subsistence minimum. With the growing pressure for revenue as the defense and war programs got under way, one procedure that was quickly approved was to lower the exemptions. This was called “broadening the income tax base.” The result of the successive changes in this direction was to add large numbers of new taxpayers, to collect a moderate amount of tax from this group, and to impose a substantial added burden on those already subject to the tax.
For example, in 1941 the lowering of exemptions was estimated to produce $303,000,000 of additional revenue, of which $47,000,000 was to be paid by new taxpayers at the bottom. The preliminary estimate of the added revenue from the further reductions under the 1942 Ad was $1.1 billion, of which new taxpayers were to contribute only about $100,000,000.
As these successive changes were made, it became increasingly apparent that the traditional method of income tax administration was no longer appropriate or defensible. That method involved postponement of tax payments until determination of tax liability with respect to the income of a given year. Its successful operation assumed the existence of a sufficient income surplus to enable taxpayers to set up, out of income as received, a tax reserve against the payments to be made after the income year had closed. The steady increase of income tax rates, the retroactive application of those increases, and the lowering of exemptions, together produced a situation in which few taxpayers were able to maintain the practice of reserving the tax out of current income.
Relief from this condition was provided by the Act of 1943, which introduced the bookkeeping change of current rather than deferred tax liability, and *e administrative change of withholding at source a part of the tax on wages and salaries. Both principles were sound and much needed. As applied in the 1943 law, however, there was too great complication and the initial phase of operation indicated a degree of annoyance and burden which required prompt alleviation through simplification.
While the simplification of an unnecessarily complicated procedure would no doubt allay much of the annoyance experienced by taxpayers, some adverse developments have begun to appear which raise the question whether a tax withheld at source, even if simplified, is the best method of taxing small incomes. The present arrangement is the result of carrying a particular method of taxation to its logical conclusion. Unquestioning acceptance of the doctrinal virtues of this tax has prevented frank consideration of its defects and has been responsible for the belief, now being put to the test, that a tax laid directly on incomes will operate as satisfactorily at one end of the income scale as at the other.
Among the indications that this belief regarding the universal applicability of the income tax is not well founded may be mentioned the following:
1) The dissatisfaction of taxpayers, leading to pressure for counterbalancing wage increases or for absorption of the tax by employers. The extent of such dissatisfaction cannot be ascertained, but there can be no doubt that it exists.
2) The cost of compliance to employers. For the present, this cost is being indirectly absorbed by the government, in large measure, since it is the chief customer of a great sector of business and its contract terms cover all forms of costs.
With a return to free and competitive markets, the impact of this cost will be more keenly felt.