The federal income tax is now a centenarian. On February 3, 1913, the 16th amendment to the Constitution was ratified.
The revenue the income tax raises allowed Congress to greatly expand the size of the federal government. We will likely never return to a federal government the size we had before the 16th amendment became law.
Even though the income tax raises gargantuan amounts of revenue that allows for big government, it can only raise so much.
The individual income tax’s top rate has been as high as 91 percent as recently as 1960 and has been as low as 28 percent in the late 1980s. And yet the income tax raised on average 8 percent of gross domestic product (GDP) and had never exceeded 10.2 percent (reached only once in 2000 at the height of the tech bubble).
Higher income tax rates do not result in a gusher of revenue because, surprise, surprise, people respond to incentives. When rates are higher they work less, invest less, and take less risk. Some even renounce their citizenship. These predictable and sensible responses curtail the revenue gain from higher rates.
The natural cap put on income tax revenues by the instinctive reaction of taxpayers is an obstacle for those, like President Obama, that want to expand the federal government beyond its already bloated size.
They need more revenue to pay for spending they desire, but they can’t get it from the income tax. The recent increase of the top rate to 39.6 percent will do almost nothing to reduce deficits and debt, but it will cause considerable damage to the fragile economy. Further increases won’t change our debt picture either, but would do even more harm to the economy.
A great danger lies in giving Congress the authority to levy broad-based new taxes like a value-added tax (VAT) or carbon tax. These would allow the government to grow even bigger, just like the income tax did 100 years ago. Adopting such new taxes is the only way believers in big government can get the revenue they so badly want.
While fighting back the income tax today is a challenge, we can stop the imposition of new taxes that will allow the government to grow even larger. If we don’t, our descendants will be looking back 100 years from now lamenting our failure to stop those taxes the same way we lament our ancestors giving us the income tax.