A Thousand Cuts

Fuck you, Milton Friedman.

Going forward, I shall refer to the day on which I prepare my family’s tax return, which this year falls on January 30, as Fuck Milton Friedman Day.

Friedman, for all of his great contributions to economic theory and advocacy of the free market, was also instrumental in developing the Federal government’s most efficient means of confiscating the income of Americans with a minimum of protest: the withholding tax.  Prior to the 1940s, citizens paid taxes in a lump sum every March.  The 1913 tax act, which was adopted following the ratification of the 16th Amendment, originally called for withholding as well, but taxpayers expressed great displeasure at money being taken out of their pay envelopes before they even received them.  The withholding provision was struck a few years later.

The problem with annual lump-sum payments is that it proved very difficult for the IRS to ensure it received all of the revenue that citizens were obligated to pay.  Furthermore, it hampered the government’s ability to fund operations throughout the year.  Imagine getting just one paycheck every year, covering your entire annual salary.  You would likely budget your money very carefully to ensure it covered your expenses throughout the year.  On the other hand, it would also give you the opportunity to invest some of that money so it could earn interest until you needed it to pay later expenses. In retrospect, that’s probably not a bad way for government to operate as well.

The Feds seemed to realize this, so to raise revenue during the year it sold “tax anticipation notes” to taxpayers to generate interest to help pay their tax bill the following year.  This allowed taxpayers to meet their tax liability using less money than if they paid out-of-pocket when the bill came due.

With the country’s entrance into World War II, the government was faced with skyrocketing expenditures.  Congress adjusted the tax rates from a heavily progressive system that mostly impacted the rich into more moderate brackets that imposed obligations on nearly everyone.  Within three years following the attack on Pearl Harbor, the number of tax returns received by the IRS increased more than four-fold.  Had the lump-sum payments continued, the entire system would have collapsed under the effort of ensuring tax obligations were met with every return.  Withholding taxes at the source—by conscripting employers to serve as the government’s revenue agents—was the most effective method to protect the government’s revenue stream.  In 1942, Friedman, then working in the Treasury Department, devised a new withholding plan.  But the challenge of selling it to a public which had roundly rejected the previous scheme remained.

And like any good bureaucrats and politicians, they used the time-honored trick of snake-oil salesmen everywhere: they lied about it.

The key strategies used to obtain support for income tax withholding in 1943 all entailed political transaction-cost augmentation. Government officials artfully employed national defense language, tax-cost information, and promises of “tax forgiveness” to engineer support for a withholding system at root designed to enhance and protect government revenue for all times to come. The above-noted conflict between the government’s actual objectives and its publicly promoted objectives formed only one part of a systematic pattern of transaction-cost manipulation . . .

Treasury officials repeatedly testified to Congress that such withholding of income taxes–current collection at the source–represented “no additional tax.” On dozens of occasions, Treasury official Randolph Paul and other government spokesmen testified:

This collection at the source mechanism is nothing but a mechanism for collection. It is not an additional tax. … It merely speeds up the collection (U.S. House Hearings 1942, vol. 1: 100).

It should be kept in mind that collection at the source does not in itself increase or decrease the tax liability of the taxpayer (U.S. House Hearings 1943: 11).

Given the expert witnesses’ knowledge of present value, statements so seriously misleading to Congress and the public could not have been inadvertent.

Because it replaced interest-bearing notes with a pay-as-you-go system, the withholding tax did represent an additional tax on the public, by taking money before it even reached taxpayers’ pockets to be used by the government.  Only when taxpayers filed their returns could they determine if they paid too little (and thus would have to send even more money to the IRS) or too much (and thus receive a refund, although the Treasury did initially suggest that interest be paid on any money returned).  And with future dollars worth less than the present value of the money taken by the government, taxpayers would lose even more each year.

The Treasury Department acknowledged all this in hearings before Congress, yet insisted that withholding would not only impose no additional tax burden, but was merely a convenience for patriotic Americans to meet their obligations and support the war effort.  And these same obfuscations were parroted by members of Congress during floor debates.  Oppose such a sensible scheme, and you allow the Huns and Japs to win.

Sixty-five years later the government still gets its loot via the withholding tax, and despite many proposals to eliminate or at least greatly simplify the process, it remains the single greatest enabler of an ever-expanding state.  As Murray Rothbard wrote about Friedman in 1971:

Only the Friedmanite withholding tax has permitted the government to use every employer as an unpaid tax collector, extracting the tax quietly and silently from each paycheck. In many ways, we have Milton Friedman to thank for the present monster Leviathan State in America.

Friedman did later express his regrets at helping bring about the withholding tax, as evidenced in this interview with reason’s Brian Doherty in 1995:

It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it’s a great mistake for peacetime, but in 1941-43, all of us were concentrating on the war.

I have no apologies for it, but I really wish we hadn’t found it necessary and I wish there were some way of abolishing withholding now.

Yeah, me too.  And while I stand to repatriate a significant chunk of my income from the Leviathan State this year, when I click the File button in TurboTax I’ll remember to honor the man who made it necessary in the first place: fuck you, Milton Friedman.