Entrepreneurs drive the economy. By creating and investing in new businesses, ideas, and innovations, the entrepreneur ensures economic renewal and growth. Unfortunately, the federal government has an economically unhealthy habit of throwing obstacles in the path of entrepreneurs, such as burdensome regulations and inflationary monetary policies. Perhaps the most formidable government barrier, though, is the income tax.
Today’s federal income tax system is punitive, complicated, inefficient, intrusive, and impedes entrepreneurship, investment, economic growth, and job creation. Interestingly, however, when initially imposed, the income tax, despite its progressive rates, appeared rather straightforward and not all that burdensome—almost benign. Of course, appearances can be deceiving.
There were, of course, warnings about the dangers of a progressive tax structure. But people supported the income tax because it was originally meant to impose only very low tax rates on only the highest incomes. Proponents argued that the 16th amendment to the U.S. Constitution would force the so-called “robber barons” to pay taxes. It was not supposed to provide a mechanism for Washington to reach into most Americans’ pockets.
Figures 1 and 2 illustrate this point. Figure 1 shows the personal income tax structure as initially imposed in 1913, while figure 2 indicates what this tax system would look like in 1994 dollars.
Original Tax Rates
The original income tax was obviously not meant to be paid by most citizens, nor were rates high enough to significantly undermine the spirit of enterprise. For example, under this system single taxpayers today would pay no tax on any earnings up to almost $45,000 and married couples on earnings up to almost $60,000. A one percent tax rate would be in effect on incomes up to about $300,000. The top rate of 7 percent would not take hold until earnings hit almost $7.5 million.
As for the corporate income tax, it was imposed in 1909 at a rate of one percent and included a $5,000 exemption. Again, translated into 1994 dollars, companies would face the one percent rate with an exemption of $81,967.
Alas, people attracted to the income tax through appeals to envy soon discovered that envy knows no boundaries and never makes for good economic policy. Government rather quickly transformed the income tax from a light tax on high incomes to a heavy tax on almost all incomes.
This very different income tax than originally intended then acted as high-octane fuel for the growth of government spending. Between 1913 and 1994, inflation-adjusted federal government expenditures increased by 13,592 percent! Over this same period, personal and corporate income taxes grew from 7 percent of total federal revenues and 0.1 percent of the economy, to more than 54 percent of total federal revenues and over 10 percent of U.S. GDP.
The income tax also proved to be an economically dangerous levy, raising the costs of working, saving, investing, and risk-taking, thereby restraining economic growth. From 1870 to 1913—between the Civil War income tax and the post-16th Amendment income tax—the U.S. economy expanded by over 435 percent in real terms, or by an average rate of more than 10 percent per year—with no inflation. Alas, as we now look toward the twenty-first century, America’s economic vitality in an increasingly competitive world economy is suspect.
The implications are clear: surely we must downsize government, deregulate our economy, and ensure sound money. Perhaps most important, though, we should replace our current tax system with a low, flat income tax. Or better yet, we should put an end to what has turned out to be one of the biggest impediments to entrepreneurship and growth in America this century—the income tax. The resulting entrepreneurial boom might surprise even the most wild-eyed optimists and launch the U.S. economy into the twenty-first century.
Figure 1:
1913 Personal Income Tax System
Tax Rate Income Level
1% up to $20,000
2% $20,000-$50,000
3% $50,000-$75,000
4% $75,000-$100,000
5% $100,000-$250,000
6% $250,000-$500,000
7% over $500,000
(A $3,000 exemption for single filers and $4,000 for a married couple.)
Figure 2:
1913 Personal Income Tax System in 1994 Dollars
Tax Rate Income Level
1% up to $298,507
2% $298,507-$746,269
3% $746,269-$1,119,403
4% $1,119,403-$1,492,537
5% $1,492,537-$3,731,343
6% $3,731,343-$7,462,687
7% over $7,462,687
(A $44,776 exemption for single filers and $59,701 for a married couple.)
Raymond J. Keating
Raymond J. Keating is an author and serves as Chief Economist with the Small Business & Entrepreneurship Council.
