Article I, Section 8, Clause 1 of the United States Constitution (the "Taxing and Spending Clause"), specifies Congress's power to impose "Taxes, Duties, Imposts and Excises," but Article I, Section 9 requires that, "Duties, Imposts and Excises shall be uniform throughout the United States."
In addition, the Constitution specifically limited Congress' ability to impose direct taxes, by requiring it to distribute direct taxes in proportion to each state's census population. It was thought that head taxes and property taxes (slaves could be taxed as either or both) were likely to be abused, and that they bore no relation to the activities in which the federal government had a legitimate interest. The fourth clause of section 9 therefore specifies that, "No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken."
The courts have generally held that direct taxes are limited to taxes on people (variously called "capitation", "poll tax" or "head tax") and property (Penn Mutual Indemnity Co. v. C.I.R., 227 F.2d 16, 19-20 (3rd Cir. 1960)). All other taxes are commonly referred to as "indirect taxes," because they tax an event, rather than a person or property per se. (Steward Machine Co. v. Davis, 301 U.S. 548 (1937), pp.581-582) What seemed to be a straightforward limitation on the power of the legislature based on the subject of the tax proved inexact and unclear when applied to an income tax, which can be arguably viewed either as a direct or an indirect tax.
Origin
The roots of IRS go back to the Civil War when President Lincoln and Congress, in 1862, created the position of commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year.
16th Amendment
In 1913, Wyoming ratified the 16th Amendment, providing the three-quarter majority of states necessary to amend the Constitution. The 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1 percent tax on net personal incomes above $3,000 with a 6 percent surtax on incomes of more than $500,000.
Wartime
In 1918, during World War I, the top rate of the income tax rose to 77 percent to help finance the war effort. It dropped sharply in the post-war years, down to 24 percent in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.
A New Name
In the 50s, the agency was reorganized to replace a patronage system with career, professional employees. The Bureau of Internal Revenue name was changed to the Internal Revenue Service. Only the IRS commissioner and chief counsel are selected by the president and confirmed by the Senate.
Today’s IRS Organization
The IRS Restructuring and Reform Act of 1998 prompted the most comprehensive reorganization and modernization of IRS in nearly half a century. The IRS reorganized itself to closely resemble the private sector model of organizing around customers with similar needs.
Evaders Hall of Fame
We all know about Willie Nelson’s $16 million tax bill, but he ain’t the only one.
Al Capone
When this mobster didn’t file income tax from 1925 to 1929, he ended up with 11 years in the clink and 80 grand in fines. Oops, we just gave away The Untouchables.
Joseph Nunan
The former IRS commissioner bet $1,800 on the 1948 election and then failed to report his winnings. He got five years in prison and a $15,000 fine. Yeah, that’s fair.
Spiro Agnew
This bribe-taking VP pleaded no-contest to tax evasion in 1973, left office, and paid a $10,000 fine. And then the Nixon White House was clean and scandal-free!
Richard Hatch
The first Survivor winner was convicted this year for not paying taxes on the $1 million the IRS and everybody else in the whole damn world knew he’d won.
Walter Anderson
In 2005 the Feds hit the telecom mogul with the biggest personal tax evasion charge ever: hiding a half-billion offshore to dodge a $200 million tab. To which we say, dang.
Tax Evasion
Ever wonder if you could fudge some paperwork, stash some cash offshore, and live like a goddamn king? Lucky for you, we asked. And here are a few things you should know before you go screwing the tax man over.
1. He’s not picky
IRS enforcement revenue soared to a record $43.1 billion in 2004, with a 40 percent increase in audits of people making over $100,000 a year. However, some experts say the IRS goes after lower-income schlubs too.
2. He’s clever
“The IRS lacks the resources to pursue much of the billion-dollar underground cash economy,” says Richard Yancey, an ex-IRS agent and author of Confessions of a Tax Collector. But they do use the McQuatters formula to estimate waiters’ tips and check water use to figure laundromat earnings. Talk about anal.
3. His eyes are everywhere
Hiding dough outside the country is popular but dumb, adds Yancey. The IRS now scrutinizes offshore accounts, which cost the country up to $40 billion a year in lost taxes.
4. He locks up big cheaters
Smart law abiders practice “tax avoidance,” donating to charities and deferring income to reduce taxes. Then there’s full-blown “tax evasion,” actually defrauding the government—like failing to report those 10,000 Google shares you sold last month. That’s criminal and can land you in the pen.
5. He means business, mostly
If the IRS nails you in tax court, they can seize your bank accounts and slap liens on your house, car, and other valuables. They can even send armed Feds to repo your stuff and auction it off for 80 percent of its value. But relax. If you owe less than 25 grand in back taxes, they’re more likely to offer a five-year plan to pay back your debt…plenty of time for that plastic surgery and one-way trip to Bahrain!
Ken’s just a regular guy…who didn’t file taxes for 12 years and got involved in a Dodgy Deal.
How did it start?
In 1977 I got laid off from my job as a boiler man about six months shy of my pension and lost it all. I went on unemployment, then did odd jobs as a sign painter, a salesman…nothing steady. My whole paycheck went into keeping my house and putting my three kids through school. I stopped filing taxes around 1980. I was so involved with paying bills that I wasn’t afraid of getting caught. I couldn’t pay, anyhow.
How’d they get you?
I don’t know. All of a sudden, in 1992 the IRS started sending me form letters saying I hadn’t filed for this year or that year. A year and a half went by, and they started coming more frequently. That’s when I started worrying. I called an accountant, who said, “You don’t want to go to jail for this bullshit.” So we straightened it out.
How bad was the bill?
I put a second mortgage on my home, and that paid for most of it. But it took four years, paying about $300 a month, to clear it up. Then I lost my business in 2001, and I got behind again. I’ve almost got 2005 worked out, and then I’ll be back in order. If I could do it all over, I wouldn’t do things differently. I was making money to survive. But you play with fire, and you get burned.
President Bush has established an advisory panel to study federal tax reform options. The panel is headed by former senators Connie Mack of Florida and John Breaux of Louisiana. Congressional leaders, including House Speaker Dennis Hastert and Majority Leader Tom Delay, have also pledged their support for reform.
Enacting a major tax reform bill will be a challenge, but the president has been remarkably successful with his tax agenda so far. Income tax rates have been reduced, dividend and capital gains taxes have been cut, and the tax rules on retirement savings vehicles have been liberalized.
However, the tax system remains terribly complex and inefficient. The number of pages of federal tax rules has increased 48 percent in the past decade. The complex alternative minimum tax will hit about 35 million households by the end of the decade if not repealed. The high-rate U.S. corporate income tax is under growing pressure as global investment capital has become more mobile.
This study looks at possible changes to address those problems. It identifies three goals for tax reform: simplification, efficiency, and limited government. The latter goal focuses on tax code features such as visibility and equal treatment that cultivate an understanding of the high cost of government.
This study examines reform options including a flat tax, a national retail sales tax, and a savings-exempt tax in reference to those goals. It also proposes a new option: a "dual-rate income tax." This revenue-neutral option would convert the individual income tax to a two-rate system that eliminates most deductions and credits and allows nearly all families to pay tax at a low 15 percent rate. A 27 percent rate would kick in for earnings above $90,000 (single) and $180,000 (married).
To promote growth, the maximum individual rate on dividends, interest, and capital gains would be 15 percent. The corporate tax rate would be dropped to 15 percent and interest made non-deductible. These changes would equalize and cut the combined top income and payroll tax rates on wages, dividends, interest, and small business income to just under 30 percent, compared with between 35 and 45 percent under current law.
The dual-rate tax plan would retain the standard deduction, an expanded personal exemption, and the earned income tax credit. The plan would create a simpler and more efficient taxcode within the structure of today's system and may be just the type of tax plan that the president's advisory panel is looking for.
Chris Edwards is director of tax policy studies at the Cato Institute. Options for Tax Reform. The Cato Institute. February 24, 2005.
