This article first appeared at The McAlvany Intelligence Advisor on Monday, February 23, 2015:
With Americans about to file their income tax returns, most of them will look at their W-2 withholding forms to get the numbers without any background on how paying the government first came to be accepted as normal.
At age 16 this writer worked as a helper on a Canada Dry delivery truck. It was a plum job if one could get it. A “helper” load was 160 cases (the heavy glass-bottle kind), and it paid $20 for the day. There was great incentive to dump those cases as fast as possible (without breaking them!) and get back to the warehouse and put in the time sheet.
The first week generated $100, and this writer had never seen a $100 bill before. Imagine his surprise when his pay envelope had “change” in it. The slip showed Gross $100.00. Net: $92.43. The government got into this writer’s pay envelope before he did!
He’s never forgotten that moment, and was surprised, so many years later, to learn how much a hand one of his favorite economists, Milton Friedman, had in creating the entire withholding system in the US back in 1943.
At the time, Friedman worked as an economist for the US Treasury Department. He was tasked with the job of figuring out how to get the government’s nose into everyone’s paycheck first. Wrote Friedman:
It was clear to all of us at the Treasury, as we set out to multiply the amount of revenue to be collected from the personal income tax, that it would be impossible to do so unless we could develop a system to collect the taxes as the income was earned [and] not [paid] a year later [by each taxpayer].
Years later Freidman apologized, sort of:
At the time we concentrated single-mindedly on promoting the war effort. We gave next to no consideration to any longer-run consequences.
It never occurred to me at the time that I was helping to develop machinery that would make possible a government that I would come to criticize severely as too large, too intrusive, too destructive of freedom.
Yet that was precisely what I was doing.
The system he helped create works well. Charlotte Twight, writing in her 2002 book, Dependent on D.C., said:
Withholding is the paramount administrative mechanism that since 1943 has enabled the federal government to collect, without significant protest, sufficient private resources to fund a vastly expanded welfare state. (emphasis added)
The Treasury Department agrees. Withholding
greatly eased the collection of the tax for both the taxpayer and the Bureau of Internal Revenue.
It also greatly reduced the taxpayer’s awareness of the amount of tax being collected, i.e. it reduced the transparency of the tax, which made it easier to raise taxes in the future.
Withholding also greatly distorts any attempt to measure the US economy since so much of it is underground. Every year the Tax Foundation makes such an attempt, and every year it falls far short of the mark. In 2012, for instance, the last year for which numbers are available, the foundation said that Americans reported $9.2 trillion in income, with $6.3 trillion of it coming from “wages, salaries, tips” and “other” compensation. But the foundation can’t count the black market economy, also referred to by unhappy (that any of it is operating without government supervision) statists as the “subterranean” economy, the “hidden” economy, along with “shadow,” “informal,” “clandestine,” “illegal,” “unobserved,” “unreported,” “unrecorded,” “secondary” and “parallel’ economy.
Part of the incentive to operate below the government radar no doubt has to do with those taxes. But statists love to combine the “underground” economy with the “underworld” economy inhabited by criminals of all stripes. As economics professor Hans Sennholz, while a professor at Grove City College, explained:
The underground economy must be distinguished clearly and unmistakably from the criminal activities of the underworld. Government officials and agents are ever eager to lump both together, the criminals and their organization, with the producers in the underground.
Both groups are knowingly violating laws and regulations and defying political authority. But they differ radically in the role they play in society.
The underworld comprises criminals who are committing acts of bribery, fraud, and racketeering, and willfully inflicting wrongs on society.
The underground economy [on the other hand] involves otherwise law-abiding citizens who are seeking refuge from the wrongs inflicted on them by government. They are employers and employees who are rendering valuable services without a license or inspection sticker, or failing to report their productive activities to the political authorities.
Examples of legitimate but “subterranean” industries abound. Some just stumbled into something that worked under the radar. Others were forced by circumstances to do so. When Kevin Kalmes received a foreclosure notice on her home, she started selling the contents of her basement. It worked so well that she turned it into an underground (both literally and figuratively) business: “I just kept the basement sale open, forever, without getting permits.”
Informally called her “Little Shop of Hoarders,” Kalmes sells items for friends and neighbors, and occasionally an item or two from a local flea market. During the week she walks her neighbors’ kids to the bus for $2 each, and helps out with home remodeling projects for her friends, being paid cash for her efforts.
Best estimates are that the black market, free market, underground economy – whatever one chooses to call it – is about 15 to 25 percent of the “above-ground” economy, and growing.
Putting aside concerns that the underground economy isn’t “paying its fair share” (partially offset of course by the taxes generated in the regular economy when those funds surface), there are numerous advantages statist commentators fail to mention. Aside from operating largely tax free, basic free market principles operate underground: deals are made, cash is king, handshakes are bonds, there’s the taste of freedom, the appreciation for the right to own (and buy and sell) property, and especially how large government at any level really is, and how little of it is really needed to keep things clean and tidy.
There are some who think that every student, before entering the regular economy with its attendant demands, limits, regulations and penalties, should take six months off to learn how the free market really works without all those encumbrances. That taste of freedom might just become addicting.
The Tax Foundation: Sources of Personal Income
Wikipedia: Size of the Black Market
CNBC: $2 Trillion Underground Economy May Be Recovery’s Savior
Bloomberg: More Americans Work in the Underground Economy
US News: The New Underground Economy
Wikipedia: Current Tax Payment Act of 1943
U S Treasury: Fact Sheets: Taxes History of the U.S. Tax System
Wartime Origins of Modern Income-Tax Withholding by Robert Higgs