A Taxing Discussion

Today’s GIF comes from “The New Spirit,” a 1942 propaganda film by Disney to encourage people to pay their income taxes. It starred Donald Duck, who avoided the tax evasion charges that led to Daffy Duck’s arrest.

What was it like filing your taxes in 1914?

No surprise, I know, but it’s worth noting that the U.S. has a complicated tax history, befitting its start as a war-length complaint about taxes. Initially introduced to help fund the U.S. Civil War, it charged everyone who made more than $600 (roughly $20,000 in today’s money) a tax. The problem was, the U.S. government introduced this income tax without having jurisdiction under the U.S. constitution to do so.

That proved a problem in 1895, when a Supreme Court ruling, Pollock v. Farmers’ Loan and Trust Company, found direct taxes unconstitutional using some pretty harsh language (my emphasis added):

A tax upon income derived from the interest of bonds issued by a municipal corporation is a tax upon the power of the State and its instrumentalities to borrow money, and is consequently repugnant to the Constitution of the United States.

In that case, Charles Pollock sued the company, which he owned a handful of shares in, to prevent them from paying corporate taxes, as required by the Wilson–Gorman Tariff Act, passed the prior year. The case effectively prevented the U.S. government from taxing individuals for nearly 20 years, the amount of time it took to pass the Sixteenth Amendment.

Soon after, the federal government brought back the income tax, this time with the Form 1040. So, in January 1914, you’d be forgiven if you were a well-off professional and were suddenly paying taxes on your income for the first time in your adult life. On top of everything else, it was simply a confusing task.

You could sense the dread dripping from newspapers and magazines throughout the U.S. as journalists got their first look at the form that would frustrate millions in the years to come. In a 1913 edition of Hearst’s New York American, financial editor B.C. Forbes (who would go on to found a well-known magazine four years later) emphasized how critical it was to get this form and fill it out. But he also emphasized what might happen if you decided to get lazy:

But, for any sake, do not try to hide anything. Don’t do it! If you are not moved by patriotism or a law-abiding spirit to pay your just share towards the support of the Government, be moved by fear!

But don’t pay one cent the Government is not absolutely entitled to. It is as immoral to cheat yourself as to cheat the government. And once you pay, you stand little chance of getting anything back. “Possession is nine-tenths of the law,” you know. The penalties for not complying with the law range from a $20 fine to a $1,000 fine and a year’s imprisonment plus the costs of prosecution. So beware!

Take the matter in hand the minute you read this. There is no time to lose.

One might argue that this tension was good for media outlets who suddenly were in a position to explain all this stuff for normies. For example, The New York Times (see my NYT policy) shared a giant reader Q&A with questions about the new form. It leaned into the significant confusion caused by the new form, which only covered taxation after March 1, 1913—about a month after the Sixteenth Amendment was ratified—but still included blanks for January and February.

“What many critics are unable to understand is why blanks for this year should not have been prepared with the correct amounts, in order to save perplexity to those who attempt to fill them out on only a casual examination,” the paper wrote.

(The initial form was reused in 1914 and 1915—something I learned when I scoured the IRS website and found tax forms dating to 1913—but in future years, the form got updated annually.)

Not helping was that the Treasury Department kept changing its mind on the rules, which made the accounting difficult to manage. From reading the many answers the Times gave to curious readers, it’s clear that the IRS left a lot of people out on the deep end.

However, it did not leave everyone, as initial rules only required people who made more than $3,000 to actually file taxes, an amount equivalent to about $100,000 today. Which meant that most people weren’t affected by income taxes at first. But the people who were taxed, especially at the high end, soon found themselves giving most of their money to the government.

In the midst of World War I, tax rates for people who made over $300,000 in 1917 ($8.4 million today) crossed the 50% mark, while people who made more than $1 million in 1918 ($23 million today) were taxed at a downright epic 77%. Things didn’t truly ease up until the mid-1920s, when taxes were capped at 25% for people making over $100,000 ($1.9 million today). Critics of taxes, such as the Koch-affiliated Foundation for Economic Education, often point to this period to highlight the folly of increasing taxes on the rich.

For critics of the American taxation system (think your average Ron Paul acolyte), this era offers so much fodder to dig into, because it offers examples of many of their complaints. (Though they’re kind of stuck with the Sixteenth Amendment.) You say, “we should increase taxes on the rich,” and they can say, “well, we did that, and it didn’t work.”

But one thing we didn’t try back then was taxing regular people who made normal salaries. That came later.

World War I briefly led to huge taxes for rich people. World War II forced regular people to do taxes, too.

I became interested in this discussion on income taxes because of a magazine-length guide I found in a junk store. It explained in great detail how tax forms worked, considerations for families and the public alike, even showing tax forms and offering basic accounting advice.

It promised 500 questions and answers, and seemed designed to take one of the most confusing things that normal people do and make it accessible. It included workbooks designed to make it easier to track your monthly income.

(It also smelled pretty bad, but we can overlook that.)

This was one of the most well-known guides of its kind at the time, originally written by Rodman L. Modra, who served as deputy collector of internal revenue in New York City earlier in his career. His guide was widely promoted in newspapers around the country; you could call it the For Dummies or even the Turbotax of its day.

Modra found quick success with this model, but he didn’t live to see his good idea blossom into an empire. Just as the income tax was expanding its footprint in 1943, Modra died (yes, another NYT link, same policy applies). He was 61, and presumably, he had more steam in the engine. Alas.

So yes, the guide outlived him, at least for a while. But it didn’t last as long as the income tax system it was chronicling for regular people. Other companies would eventually exploit our required annual stress-out session.

Again, Disney made a cartoon in 1942 to convince people to pay their taxes.

So, what made a guide like this particularly relevant in the mid-1940s? Well, in 1942, Congress passed a new tax law, the Revenue Act of 1942, that essentially lowered the tax brackets a rung. Now regular people had to file a 1040, too.

This was necessary, after all. World Wars are expensive, and someone needed to pay for it, so why not the middle class?

And as more people needed to file their taxes, the Internal Revenue Service needed a new way to take a little off the top. In the past, people paid either quarterly or annually, which worked when everyone was well-off, but not so much for the middle class. As tax historian Joseph Thorndike wrote in 2022: “This system functioned well enough when income taxes were paid only by the rich, who tended to be well organized and financially sophisticated. But tax experts worried that it would falter once the levy was expanded to include millions of new taxpayers.”

The solution to this situation wasn’t necessarily clear. Businesses pushed for a national sales tax; the Treasury Department really didn’t want that.

The guy most responsible for helping us find a path forward was Macy’s executive and economist Beardsley Ruml. His plan: Make the system “pay as you go.” Rather than having to save your income ahead of time and paying after the fact—or worse, get stuck in a repayment plan with the Internal Revenue Service—Ruml instead proposed closing the loop entirely.

“Nothing can stop the march of the days and when the due date comes, they must pay the tax they owe in the income they have already had,” Ruml explained in an article to the Dartmouth alumni magazine.

In a 1943 interview with CBS News, he characterized the back-taxes issue as something of a failure of vision.

When the federal income tax bill was passed in this country in 1913, it had an important defect which was that a citizen was required to pay in the year 1914 a tax on his 1913 income. In this way, we got started on a vicious practice of paying out of one year’s income a tax on the year that had already gone. As a result and in consequence of increasing rates, the debt which people owe to the federal government for income tax has become a national danger. The present system is a bad system for all of us and should and can be corrected. It is clear that the government cannot continue for long to be the creditor of some 27,000,000 taxpayers and their families, in debt for income tax as they are today, particularly when there is no substantial question of revenue involved in changing the basis of assessment and getting the whole country on a current pay as you go basis.

In this light, paying as you go made sense. You could pay as you go with payroll taxes, or you could give a penny or two to the federal government every time you bought something. A wire story about the debate over this issue in the House Ways and Means Committee put it like this: “Shall the average American help pay for the war by taxes on what he earns or on what he spends?”

Ultimately, after a whole bunch of back and forth, collected in this PDF, we went with the payroll taxes, with Congress passing the Current Tax Payment Act in 1943. (Easing the pain, per Tax Notes: The first year of the payroll tax transition, the federal government cut everyone’s taxes by 75% for the first year, like you were signing up for an introductory plan on a steak-of-the-month club. Not that people who just saw a huge chunk of their income disappear were buying steak.)

If you’re a freelancer, odds are good you might still be doing quarterly or annual payments, minus whatever deductions you can scrounge. But hey, it covered most people, as it does today.

The tax model is confusing and unpopular, but pay-as-you-go taxation at least made it more user-friendly.