How Withholding Taxes Came and Stayed
Workers today have income taxes and Social Security taxes withheld from their paychecks. But it didn’t always work that way: The withholding system experienced a difficult birth in the middle of the Second World War.
The wide-ranging 1943 Tax Act included a provision that authorized withholding. But President Franklin Roosevelt thought the legislation too complicated, so he vetoed it, saying, “The American taxpayer had been promised of late that tax laws and returns will be drastically simplified. This bill does not make good that promise…. These taxpayers, now engaged in an effort to win the greatest war this nation has ever faced, are not in a mood to study higher mathematics.” However, the President’s veto was overridden by large margins in both houses of Congress, and withholding went on the books.
Broadway songwriter Irving Berlin supported the war effort with a tune that tried to get Americans upbeat about tax withholding. Another of his morale-building numbers, “White Christmas,” remains a standard. Not so his withholding ditty, with its turgid lyrics:
You see those bombers in the sky?
Rockefeller helped to build them
So did I
I paid my income tax today.
Was withholding the right way to help pay for a war? Among those who have weighed in were journalist David Brinkley (no) and historian Doris Kearns Goodwin (yes).
In an article on America in the 1940s for the Jan. 3, 1994, issue of Newsweek, Brinkley recalled withholding’s introduction: “Under pressure of war, the withholding tax was born. It is doubtful that without war Congress would ever have voted for a tax so intrusive and troublesome. Because of the withholding tax, the term ‘take-home pay’ entered the language. Had people been forced to count out their taxes in hard cash for some government collector, taxes in such stratospheric amounts almost certainly could not have been collected.”
Brinkley continued: “The cost of the war was so high that the top rate eventually went to about 92 percent. It was explained to Roosevelt that his rich enemies would be soaked, even fleeced, beyond their deepest fears. They paid the 92 percent, hated it, but could not escape. It made Roosevelt so happy, Press Secretary Steve Early told me, that once or twice he saw the president spend hours poring over records sent to him from the IRS showing who paid how much.”
Congress was also delighted with the flood of money, writes Brinkley: “Even when the war was long over, there was never any thought of ending the withholding tax. (They held the top rate at about 70 percent for another 16 years.) Did the enormous tax rates pay the cost of the war? No. Did the government run the war on credit and leave billions in debt? Yes.”
Convinced by Brinkley’s skepticism? I prefer Goodwin’s more positive take on withholding’s birth and the financing of the war. Here’s what she says in No Ordinary Time, a chronicle of the home front during the war years: “The Treasury was able to finance about 44 percent of the total war expenditures of $304 billion through taxation. The rest was secured through war bonds and borrowing. The debt rose from 43 percent of the GNP in 1940 to 127 percent in 1946.”
She goes on: “A transformation had been effected in the method of collecting taxes. Before the war, individuals were always a year behind in their tax payments, since they were called upon to pay taxes in quarterly installments on the income they had earned the previous year. The system had functioned well enough when rates were low and few people paid taxes, but when millions of people, unfamiliar with preparing tax forms, became taxpayers for the first time, change was inevitable. It took the form of ‘Pay as You Go,’ a system that withheld taxes from paychecks before the employee even saw the money, allowing everyone to start the new year free from debt…. Since people were paying taxes with money they had never seen, their resistance to the idea of taxation lessened.”
Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 275 and counting).