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November 22, 2000
Weary of
withholding - (CAUTION: SEE WARNING AT BOTTOM OF PAGE - invitation
to a living hell) - Article follows:
Weary of
withholding
Bruce Bartlett - Washington Times
On Sunday, the New York Times published
a very interesting front-page story about a growing movement among
businesses to stop withholding income taxes for their employees.
Reporter David Cay Johnston cited some 14
businesses with as many as 76 employees that have now abandoned
withholding. He says that the Internet is facilitating the spread of
non-withholding and that it threatens the foundation of the federal tax
collection system.
Business opposition to withholding is not
a new story. When the income tax was first introduced in 1913, it
included a withholding provision. But business opposition forced its
abandonment in 1917, after the Treasury Department decided that simply
requiring businesses to report wages and other forms of income paid was
sufficient to ensure compliance.
World War II led to a vast expansion of
the government's need for revenue. Tax rates were increased sharply, and
millions of Americans previously exempt from taxation now found
themselves ensnared in the government's tax net. As early as 1941,
before the United States was even a formal belligerent, the Treasury was
asking Congress for authority to require withholding of taxes at the
source. It did not act, but Treasury renewed its request in 1942.
Congress finally agreed the following year, passing the Current Tax
Payment Act of 1943.
Between 1917 and 1943, taxpayers simply
paid their income taxes in a lump sum, due on March 15 each year on the
previous year's income. For those unable to meet this obligation, the
Internal Revenue Service allowed them to pay their tax in four quarterly
payments. Compliance was generally considered to be high.
But government officials understood that
the vast expansion of taxation during the war was going to severely
strain the lump sum payment system. They also understood that taxes were
unlikely to fall to prewar levels after the end of hostilities and that
withholding would be necessary to maintain compliance. Moreover, they
understood that there would be strenuous resistance to withholding and
that the government needed to take advantage of the window of
opportunity presented by the war to get it implemented.
Even with broad patriotic support for
sacrifices necessitated by the war, however, opposition to withholding
was intense. Taxpayers were rightly concerned that initially they would
have to pay their taxes twice: once in a lump sum for the previous year
and again in the form of withholding for the current year.
What ultimately made withholding palatable
was a scheme devised by business executive Beardsly Ruml. He reasoned
that the value of withholding was so great that it was worth forgiving a
substantial amount of tax revenue to get it. At his instigation,
Congress provided forgiveness of 75 percent of a taxpayer's tax
liability in either 1942 or 1943 as part of the withholding legislation,
which became effective in July 1943. In short, taxpayers were induced to
take the medicine of withholding through the sugar of a one-time tax cut
of 75 percent.
In the short run, of course, the
government lost a lot of revenue. But in the long run, it has come out
way ahead. Withholding constituted a significant tax increase in and of
itself, as well as making more effective high rates of taxation in the
future. Economist Charlotte Twight notes that while the idea that
withholding would constitute a tax increase was not advertised, it was
"candidly acknowledged" in congressional hearings.
The biggest way in which taxes are raised
by withholding is that the government gets the use of a taxpayer's money
long before his tax liability is due. In 1998, the IRS withheld almost
$1 trillion from the paychecks of American workers, $120 billion more
than their actual tax liability. While taxpayers received a refund on
the amount overwithheld, they did not receive interest on it.
With the Treasury bill rate at about 5
percent in 1998, taxpayers therefore lost at least $6 billion in income
just on the taxes that were overwithheld. The loss of income on all
taxes withheld would be several times greater.
Although taxpayers were mollified by the
clever strategy of combining a tax cut with the implementation of
withholding in 1943, businesses were not. They took the view, quite
correctly, that much of the burden of tax collection had been shifted
from the government to them. Henceforth, employers would have to expend
their own resources to withhold taxes from their workers, account for
them properly and remit them to the Treasury in a timely fashion.
Failure to do so invited severe penalties from the IRS.
Despite IRS threats, one employer, Vivien
Kellems of Connecticut, stopped withholding taxes for her workers once
World War II ended. She explained that withholding had been instituted
as a temporary war measure. With the end of war, therefore, it was no
longer justified. Ms. Kellems fought the IRS over withholding for years,
publishing a book on the subject in 1952, "Toil, Taxes and
Trouble."
Now it appears that the spirit of Vivien
Kellems continues to live. And tax officials clearly recognize the
threat that failure to withhold represents. Says former IRS Commissioner
Sheldon Cohen, "The system simply cannot work if they [employers]
get away with it."
However, a growing number of legal
scholars now believe that withholding has outlived its purpose. One is
Emory law professor Richard L. Doernberg, who has published an article,
"The Case Against Withholding," in the Texas Law Review
(December 1982). He concludes that withholding is no longer necessary
for compliance because computers make full matching of income sources
and tax returns possible. Hence, businesses should no longer be forced
to be de facto IRS agents, collecting the government's revenue for it
without compensation.
Elimination of withholding would
constitute a significant tax cut for individuals because they would once
again have full use of their money until their taxes are due on April
15. Perhaps this is a tax cut both Republicans and Democrats can agree
upon.
End of Washington Times article
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