Withholding Power

All this talk about whether to extend or repeal tax cuts reminds me of one of the worst aspects of the tax code. I think it’s done more to confuse the issue of who’s earning the money and who’s entitled to it than any other tax regulation. It’s also freed the hands of big spenders in government without any real accountability. I’m talking about the mandatory withholding of taxes that began in 1943.

Think about it. You earn money, but you never see it. You never touch it. You never earn interest on it. And you certainly never spend it. It goes directly to the government, and, while making the payment a little more “painless”, it feeds the notion that the money belonged to the government in the first place. Salaries become more theoretical than real, and the amount withheld becomes factored into your thinking. In other words, your take-home pay, for all practical purposes, becomes your salary.

Imagine, however, having to sit down once a week or once a month and write checks to the state and federal governments. There would be several immediate benefits. First, workers would have a greater sense of how much of their money is being spent, and they would almost certainly keep a closer eye on what their leaders were doing with these funds. Second, government would be forced overnight into having to be more accountable to taxpayers. No longer could officials hide behind withholding and pretend the money was theirs to begin with. And third, the money could be invested and spent in the private sector before having to be sent to the state capital or to Washington.

This strikes me as a winning issue for a candidate, because the only counter-arguments are that taxpayers can’t be trusted to send the money or are too irresponsible to manage their money; not exactly arguments that would be attractive to voters. But what about taxpayers who like the current system? Maybe they don’t want to bother sending checks or maybe they like the false sense of thinking they’re getting a gift when the refund check comes. Fine. Then make withholding voluntary.

Somehow, we’ve got to rid governments of the notion that money earned belongs to them. It belongs to us, and we agree to pay a certain portion of our earnings to maintain local, state and federal services. Taxes are a necessity. I don’t think most Americans begrudge the notion of taxation, but there is a growing distrust and disdain of the system. Perhaps that attitude could change if governments started trusting their citizens. Let us have our own money, and let’s agree on how much you need to operate, and we’ll send it to you. Withholding money is the way you’d deal with children. But maybe that’s the point.

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  1. David Horwich

    Withholding was Milton Friedman’s (possibly) only folly and he later regretted it with all his heart. Pat, you’ve found a great issue.

  2. George Savage
    C

    I remember my self-employed father making the same point to me each quarter when the time came to write out his estimated tax payment to Uncle Sam. Watching that money flow out of the business every 90 days or so made quite an impact on all of us, the way we regarded politicians, and the way we voted.

    Incidentally, a young Milton Friedman was part of the Treasury team that devised tax withholding as a means of financing the Second World War. You can read his take over at Reason Magazine.

  3. mesquito

    Indeed. Federal taxes should be payed weekly, in cash, and in person.

  4. The Mugwump

    I got my first job right out of college with the IRS. It didn’t last long, but I learned all about the tax code in both theory and application. While the salary wasn’t great at the time, the knowledge I gained has served me very well over the last 30 years.

    Unfortunately the majority of Americans don’t understand the tax code well enough, even if they fill out their own returns, to know when politicians are pulling a fast one. Case in point is the Obama “tax cut” of 2009. All they did was manipulate withholding rates to allow for a bit more take home pay. The rates remained the same. There was no cut.

    The president later had the audacity to complain that Americans “should be grateful” for his (non-existent) tax cut. The man lies like a dog on a cheap carpet.

  5. Cas Balicki

    In Canada we have a national sales tax that is in essence a value added tax (VAT). Everybody hates it and constantly whines about it, but given a choice between a VAT and an income tax I’ll take the VAT every time because it is visible. Governments are reluctant to increase visible taxes, because such increases have a direct effect on their popularity with voters. What Pat’s plea translates into, if I might be allowed to put words in his mouth, is a demand for greater visibility in the tax payment process. Alas, visibility favours taxpayers and works against tax collectors, hence it will never be allowed to happen.

  6. Pat Sajak
    C
    Cas Balicki: Alas, visibility favours taxpayers and works against tax collectors, hence it will never be allowed to happen. · Sep 19 at 10:02am

    You are, I’m afraid, probably right.

  7. BlueAnt
    George Savage: Watching that money flow out of the business every 90 days or so made quite an impact on all of us, the way we regarded politicians, and the way we voted.

    This shows up a further irony in the tax code: only businesses and the government are able to take advantage of the time value of money of tax dollars.

    When the government takes x% of your income every two weeks instead of once a year, it is essentially denying you the ability to invest and profit from a portion of your own money. If you pay $10k in taxes and there’s a bank offering 1% interest, the government has prevented you from making an extra $100 that year (each percentage point) by taking your cash early.

    Businesses get a bit of a break by paying quarterly/yearly; they get at least some use out of the TVM. Now maybe it makes sense, because investing costs can make trying for short term returns worthwhile only for large amounts of cash. But ordinary citizens should at least have the option, especially now that the Internet has lowered the cost of investing and provided new options for individual investors.

  8. River

    Withholding is a grotesque intrusion into our lives. Harvard Professor John Kenneth Galbraith – who worked in FDR’s administration crafting price controls and other policies during the WWII – writes that it was intended to be strictly a wartime policy to control inflation. Consumer prices were soaring because everyone was working and making money, but there wasn’t much to buy during the war. It was supposed to end in ’46 or so. How many thousand times has that happened? Beware the ‘temporary’ tax!

    Before 1913 there were no federal income taxes, and no state sales taxes. You kept everything you earned, and it was nobody’s business. Starting and running a business was vastly easier than it is now, and profit margins routinely averaged 10-15%. Today it’s 3-5%. Regulations were a fraction of what they are now.

    The Feds got all their money through tariffs, liquor taxes, and other relatively non-invasive methods. The river of money they suck up and waste now is stunning and shocking.

  9. Kenneth

    I think there should be a law that no member of Congress and no President may ever use the word “revenues”; they shall be required to use the word “taxes”.

  10. Brad

    I couldn’t agree more. As an employee you don’t see your money that the government takes from you but now that I am self employed, last week I mailed my quarterly tax payment in, I am very well aware of what the government is taking from me. I have to plan each quarter to save enough money to make my payments to the IRS.

  11. BriarRose
    Pat Sajak: … There would be several immediate benefits. First, workers would have a greater sense of how much of their money is being spent, and they would almost certainly keep a closer eye on what their leaders were doing with these funds. Second, government would be forced overnight into having to be more accountable to taxpayers. No longer could officials hide behind withholding and pretend the money was theirs to begin with. And third, the money could be invested and spent in the private sector before having to be sent to the state capital or to Washington…

    Another added benefit is businesses would no longer have the fiduciary responsibility of operating as a tax collector. This would be a huge burden taken off of businesses, particularly small and medium-sized ones. Just the end of the bookkeeping overhead alone would be a relief.

  12. Papa Ed.

    The date for submitting taxes should be moved to November 1st

    OR

    The election day should be moved to April 20th

    This way even the most attention deficient among us may put it together that one is highly influenced by the other and perhaps give some thought to who they elect to spend their tax dollars.

    Unless you have just entered the job-market (and got your first taste of the impact of taxes on your meager wage) or are self-employed (thereby knowing it well each quarter) most Americans are complacent about withholding taxes and generally don’t think at any great depth about them. After getting over the sticker shock at a lower wage, they “grow” into this complacency slowly as their wages and salaries grow over the years.

    Half of all citizens don’t mind because they think of April 15th as just another payday with the government forcibly robbing others to pay them their stipend of redistributed wealth.

    Personal independence and accountability is the only way and that is only available to those who are truly free to do with their money as they please without government forcing us to subsidize those who won’t.

  13. Steve MacDonald

    I think we have pretty much nailed the correct way forward here – Mr Tall’s HK tax & payment system combined with moving the payment date to coincide with elections.

    The productivity improvement would be gargantuan, with millions of hours and billions of dollars saved in preparing returns. Political self interest would automatically change to excellent stewardship of tax revenue from irresponsible idiocies with our money.

    I think we have developed a real winner here!

  14. Jimmy Carter

    Also, a word about the language: “Tax return” As if the money originated from the government.

  15. Jimmy Carter

    Papa Ed. stole my thunder.

    We should pay Our taxes, then receive Our ballot to vote. If one doesn’t pay taxes, then they don’t vote.

  16. Mike Riscili

    The easiest way to true tax reform would be to end withholding and make people pay their taxes, either quarterly as corporations now do, or at the end of the year. If people really knew what they were paying in taxes, almost everyone would march on Washington and state capitals to reform the income tax system.

    Ask your average citizen how much they pay in income taxes each year and I suspect the answer you get most is the amount of refund or payment they make when they file their returns. Of course, this is only the amount that is over or under withheld and not the actual amount of tax they pay each year. Because of withholding, most people don’t have any idea how much they actually pay, and if they did, I think tax reform would come really quickly.

  17. Mr Tall

    I live and work in Hong Kong, and pay taxes here (and in the USA, although I don’t live there; that’s another whole story). There is no withholding in Hong Kong. Every year you write the government a check (or do a bank transfer, or whatever). Everyone comes face to face with the exact amount of money he is paying into the government’s bank account. I cannot stress strongly enough how healthy this is.

    I don’t think it’s any coincidence that HK also has a more or less flat income tax capped at 16%.

    The only flaw here is that each year you must pay ‘provisional’ tax for the upcoming year; indeed, it’s giving the government a no-interest loan.

    But my complaints about this are overshadowed by the simplicity and directness of the income tax system here as a whole. It makes an enormous difference.

  18. Rob Long
    C

    I think that’s a pretty interesting solution, Mr. Tall.

    Pat, what would you say to something like that — or something like Paul Ryan’s Roadmap idea (which is a modification on something Stephen Moore has long advocated) — why not allow people to make a choice between a postcard-sized flat tax — no loopholes, no complications — and the current system.

    My guess: in five years we’d have a major overhaul of our ludicrous tax system.

  19. Songwriter

    As a self-unemployed musician, the four darkest days of the year are Jan. 15, April 15, June 15, and Sept. 15. On those loathsome days, I am starkly aware of my federal tax burden. I am always amazed at friends and family, who, having actual jobs, rejoice at receiving their annual tax refund, blissfully ignoring the ugly reality that the government held onto their money all year long, interest free. “Withholding” is a drug used to keep the gainfully employed complacent.

  20. Trace

    Trust me — you don’t want to go there. But sometimes I can’t help myself. Today Paul Krugman rails against the greedy rich. The piece is filled with inanity sure to send any Ricocheterian into a blind rage but he did utter this particular gem relevant to this discussion:

    And among the undeniably rich, a belligerent sense of entitlement has taken hold: it’s their money, and they have the right to keep it.

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