Our 100-year fight over tax rates has taken some surprising twists and turns since the income tax went universal under FDR.
Inscribed in stone on the exterior of the Internal Revenue Service headquarters in Washington are the words "Taxes are what we pay for a civilized society", a quotation taken from a 1927 Supreme Court opinion written by Justice Oliver Wendell Holmes, Jr.
The phrase was often repeated by President Franklin D. Roosevelt, for it was during Roosevelt's presidency that the personal income tax for middle class Americans came into existence and tax rates for the wealthiest Americans topped 90 percent. While the 16th Amendment to the Constitution, allowing Congress to levy a national income tax, was ratified in 1913, it initially applied only to those earning $4,000 or more, about $80,000 in today's dollars. They were required to file a 1040 form -- that's what it was called from the beginning -- and to pay one percent of their income in federal taxes. The highest earners, those whose incomes were greater than $500,000 -- equal to about $11 million today -- paid a top rate of 7 percent.
It wasn't until World War II -- and the attendant need to fund U.S. participation in the war -- that the withholding of taxes from the wages of middle class workers was instituted. By the end of the war, even the lowest bracket of wage earners paid about 20 percent of their earnings in income taxes -- making the tax system truly universal. Meanwhile, by 1944, those on the top end of the income scale, with incomes over $200,000 ($2 million in 2011 dollars), were levied a 94 percent tax rate.
And with that run-up and expansion in taxation was launched a political fight that has stayed with us, and which again threatens in 2012 -- when a host of tax cuts are set to sunset at the end of the year -- to bring the federal government to its knees as the White House and House Republicans again clash over to how best to raise revenue, what programs to fund, and how or whether to slash the deficit during a sluggish economic time.
The first major reductions in post-war tax rates came after the Korean War. They didn't go all that far; the top tax rate was still 70 percent when Ronald Reagan was elected in 1980 (although with deductions, loopholes and tax shelters, many paid a much lower rate).
Reagan's attacks on government and high taxes -- "government is not the solution to our problems; government is the problem" -- and his supply-side Reaganomics launched the fights over tax policy between Republicans and Democrats that reflect the fundamental differences that still exist over the role of government, economic stimulus, how much to tax the wealthy, whether to tax labor and capitol gains income at the same rate, as well as how the economy can be stimulated through government spending and tax policies.
The conflict, in short: Democrats and proponents of English economist John Maynard Keynes believe in an activist role for the public sector in managing the economy and that increasing government spending can help in times of economic downturn. (The Obama stimulus plan follows this theory.) They also believe that government has an important role to play in helping the less fortunate and that the wealthiest need to pay more. (Conservatives like to call this income distribution or socialism.)
Supply-siders in the Reagan tradition believe in the trickle-down theory that economic growth is fostered by lowering income and capital gains tax rates -- that rich people will invest and create jobs. House Budget Chairman Paul Ryan, who has put forward an economic plan that would cut taxes for most Americans especially the wealthy, is the leading GOP proponent of this philosophy. Ryan worked briefly for former Congressman Jack Kemp, an early and enthusiastic supply-side supporter.
President Obama has countered the Ryan-led House tax agenda with the "Buffett Rule," which would raise taxes on the wealthiest Americans. The Senate in a procedural 51-45 vote Monday shot down the measure, named for billionaire investor and Obama supporter Warren Buffett, who famously claimed that his secretary pays a higher tax rate than he does. Republican Susan Collins of Maine was the only Republican to vote for the proposal and Democrat Mark Pryor of Arkansas voted with the Republicans. The legislation would have created a mandatory 30 percent minimum income tax for Americans earning more than $1 million annually. Tax rates on wages currently range from 10 to 35 percent, but under George W. Bush, rates on capital gains were cut dramatically to about 15 percent, so many wealthy Americans -- including presumed Republican nominee Mitt Romney -- pay far lower rates than those who rely on wages alone.