The United States was founded by an unruly bunch of tax protesters driven by Britain's excessive taxes on the colonies to declare their independence. Today, some eight generations later, the anti-tax gene we inherited from these proud men and women finally seems to be reasserting itself, with perhaps some good news ahead.
Low Taxes an American Tradition
Low taxes are as much an American tradition as baseball and apple pie. The nation's founders believed that unless taxes were kept as low as possible, the people who control government would become a powerful and unaccountable ruling class.
"An unlimited power to tax involves, necessarily, a power to destroy," said Daniel Webster in a case heard by the U.S. Supreme Court in 1819. The only sure way to protect private property and civil liberties is to limit government's power to tax.
That attitude kept the effective tax rate imposed by all levels of government in the U.S. to 5 percent or less prior to 1916, except for some periods of wartime. And the nation flourished, becoming the richest and freest country in the history of the world.
A Tradition Lost
Then came an ideological shift among America's political and intellectual elites - the so-called Progressive Era - when concern over government's ability to destroy was replaced with optimism over its ability to fix social and economic problems. This different way of thinking gave us the personal income tax, a central bank, antitrust laws, and many of the regulations and entitlement programs that remain with us to this very day.
The Progressive Era might not have led to unchecked growth in the size and power of government had it not been for the Great Depression, itself the product of government mismanagement, which undermined the confidence many Americans had in the institutions of capitalism. Then came World War II, which further elevated public respect for authority generally, and for the authority of the federal government specifically.
By the 1960s, government was many times the size it had been at the turn of the century and growing fast. Taxes and government spending soared as a percentage of the nation's total personal income, from the historical rate of about 5 percent then to 32 percent now, with the national government taking 21 percent and state and local governments an additional 11 percent.
According to the Tax Foundation, the typical taxpayer will work 116 days this year just to pay his taxes. That's about the same number of days we work to pay for health and medical care (52 days), food (30 days), recreation (22 days), and clothing (14 days) combined.
Can you imagine what the founding fathers would have thought of that?
Why Taxes Matter
High taxes are a fundamental violation of individual freedom. As economic historian Richard Pipes has written, "What a man is, what he does, and what he owns are of a piece, so that the assault on his belongings is an assault also on his individuality and his right to life."
Taxes also matter because they destroy wealth. A ranking of the 50 states by their overall tax burden from 1980 to 2000, published by the Cato Institute, shows real personal income grew an average of 96 percent in the 10 states with the lowest state and local taxes as a percent of income, and only 52 percent in the 10 states with the highest tax burdens. New Hampshire had the lowest state tax burden and the highest (117 percent) real income growth.
Research by economists Robert Genetski and John Skorburg has shown that the change in tax burden relative to competing states may be as important as the level of taxes. Low-tax states that raise their taxes relative to other states experience slower economic growth, even if their total tax burden remains lower than their neighbors'. It is not enough to have taxes that are lower than other states if your state is raising its tax burden when other states are lowering theirs.
Benefits of Tax Cuts
The history of tax changes at the federal level shows how cutting taxes can spur economic growth. The Economic Recovery Tax Act of 1981, which included a 25-percent across-the-board tax cut, helped real annual economic growth to average 3.2 percent during the 1980s. It had been 2.8 percent during the mid- and late 1970s, and fell to 2.1 percent during the 1990s, a decade that saw tax hikes authored by Republican and Democratic presidents.
Cuts in marginal federal tax rates in 2002 and 2003 led to investment in equipment and software to increase almost at once, causing investment, employment, and wage growth to be strong throughout 2004.
Tax cuts at the state level also have led to more rapid economic growth. According to economist Richard Vedder, from 1964 to 1999, Tennessee's rate of economic growth was approximately 20 percent higher than its northern neighbor, Kentucky. Tennessee maintained low taxes and was one of nine states that had a falling tax burden relative to other states over that period. Kentucky's tax burden, on the other hand, rose sharply. Colorado, with a falling tax burden, outgrew neighboring Nebraska, Wyoming, and New Mexico, all with rising taxes.
Excise Taxes
The worst taxes are excise taxes, imposed selectively on particular goods and services. Politicians love to tax products that are unpopular, such as cigarettes (about $1.88 per pack), or widely used products where the tax burden is easily hidden, such as telephone calls (about $9 on an average monthly cell phone bill of $52) and gasoline (about 46 cents per gallon on average and nearly 80 cents per gallon in Chicago).
Excise taxes, unless they are used to finance services used by the people paying the taxes, can be profoundly unfair. The onerous taxes paid on tobacco products, for example, are way out of proportion to whatever costs smokers impose on the rest of society. They are an assault on the property rights and freedoms of an unpopular minority and should be as quickly rejected by thinking Americans as a tax on rosaries or the Torah.
Excise taxes often lead to evasion - an excuse for more police-state rules and loss of privacy - and if the tax rate is sufficiently high, to underground markets and counterfeiting. Black markets create opportunities for organized crime and can threaten people's health by leading to the circulation of products that have not been approved or inspected for safety.
Excise taxes are also regressive. According to a 2001 Congressional Budget Office study, "[Federal] excise taxes claimed five times the share of income from the lowest-income households than they claimed from the highest-income households."
On Our Way Back?
I've painted a pretty bleak picture of our current tax situation, but it is possible that our long-dormant anti-tax gene is finally starting to stir. Certainly most politicians have gotten the message that increasing income-tax or general sales-tax rates is a sure way to end one's political career. Unfortunately, this is one reason excise taxes are rising so fast - the clever devils!
During the past year, proposals to limit state taxes and spending have moved to the top of the legislative agenda in many states. Some 21 states are considering legislation or constitutional amendments to cap spending and taxes. In eight of these states, tax- and expenditure-limit proposals will be on the ballot this fall.
Like term limits, constitutional tax and spending caps are strong medicine for a really serious disease. If more states adopt them, pressure will grow on the holdouts to either cap their taxes or watch their businesses and most productive citizens emigrate to states that do.
We have a long way to go before taxes return to the 5-percent level that was common before the Progressive Era. Many of us would settle for something short of that. But at last it looks like we might be on our way back to a tax policy our founding fathers would recognize and approve of.
Joseph L. Bast (jbast@heartland.org) is president of The Heartland Institute. This article originally appeared in the September 2006 issue of The Heartlander, the monthly newsletter of The Heartland Institute.
