Government Greed

The Greedy Hand: How Taxes Drive Honest Americans Crazy and What To Do About It, by Amity Shlaes, New York: Random House, 240 pages, $24.00

The father of the modern American state was a pipe-puffing executive at R.H. Macy & Co. named Beardsley Ruml." Thus opens Amity Shlaes' new book, The Greedy Hand. Shlaes is an editor at The Wall Street Journal, where she writes many excellent unsigned editorials about the absurdities, inefficiencies, and injustices of taxes. Her book shows, often dramatically, how the tax apparatus "pervades, dampens and makes knots of our lives" in our roles as workers, shoppers, investors, spouses, and parents. She discusses income taxes, Social Security taxes, sales taxes, property taxes, and estate taxes--in short, all the major taxes except the tax on corporate income. Along the way, she dispenses valuable nuggets of information about the tax system: its origins, its rationale, and some of its most twisted features.

Take tax withholding, whereby employers deduct from our gross pay an estimate of the federal and state income taxes we owe. Before 1943, there was no withholding; people just paid their annual taxes every March 15. But President Franklin Roosevelt and Congress dramatically increased tax rates in 1942, months after America entered World War II, and the new rates hit tens of millions of Americans who had never before paid federal income taxes. That, Shlaes writes, is when the "class tax" became a "mass tax."

There was one little problem. A Gallup poll showed that only 5 million of the 34 million people subject to the tax were saving to make their annual payment in March 1943. As March 15 approached, Treasury Secretary Henry Morgenthau fretted, "Suppose we have to go out and arrest five million people?"

Enter Beardsley Ruml, chairman of the Federal Reserve Bank of New York and an adviser to the president. While treasurer at Macy's, Ruml had noticed that customers didn't like big bills, preferring to pay in installments. So he proposed that employers deduct estimated taxes from workers' paychecks. The government accepted his proposal and added a sweetener: Taxpayers were granted amnesty on 75 percent of the lower of their 1942 and 1943 liabilities. So was born withholding, which Shlaes calls "the most ambitious bait-and-switch plan in America's history."

Withholding, writes Shlaes, is what allows the government to be so big. She has a point. It's hard to imagine someone earning, say, $50,000 and accepting this much government if, instead of paying $500 out of each month's paycheck, he had to pony up $6,000 in one lump sum just for federal income taxes.

One minor villain in the withholding episode, incidentally, was Nobel laureate Milton Friedman, at the time a 30-year-old Treasury Department economist. Friedman now agrees that withholding set the stage for today's big government: In Two Lucky People, the memoir he co-authored with his wife, Rose, he candidly states that he "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."

Shlaes also writes thoughtfully about the Social Security tax. "For younger people," she notes, "the central tax is not income tax, it is FICA, which looms on their paycheck stubs like a Tyrannosaurus rex. To them Social Security is a job tax, indeed the job tax, the major tax fact of the first decade of their career life" (emphasis in original).

Shlaes quotes from a pamphlet published in 1936 by the newly formed Social Security Board. After explaining that employer and employee would each pay three cents of every dollar of the employee's earnings, up to $3,000, the pamphlet stated, "That is the most you will ever have to pay." Of course, this was utterly false. As Shlaes points out, the Social Security and Medicare taxes for each are now 7.65 percent for employer and employee on income up to about $70,000. The Social Security part alone is 5.3 percent for each.

The pamphlet also stated that "the check will come to you as your right." Unfortunately, though Shlaes quotes this statement, she doesn't challenge it. Yet in the 1960 case Flemming v. Nestor, the Supreme Court found that Social Security is not a legal right. Either of the board's two falsehoods, if made by a private pension fund, would have subjected it to a lawsuit.

Because the vast majority of FICA revenue goes to current recipients of benefits, many critics of Social Security, including me, have likened it to a Ponzi scheme. According to Shlaes, Larry Dewitt--the Social Security Administration's official historian--actually devoted part of the SSA's Web page to distinguishing one from the other. (The SSA, Dewitt informs me, has since removed his analysis.) Dewitt explained that Charles Ponzi lured investors with promises of 50 percent returns on foreign postal coupons. In fact, investors were being paid their returns out of the inflows from later investors. Ponzi's scam, in short, was a pyramid scheme.

So far, that sounds a lot like Social Security. The difference, argued Dewitt, is that Ponzi's swindle was a geometric progression that "works only so long as there is an ever-increasing number of new investors coming into the scheme." Social Security, by contrast, is a simple arithmetic progression that "is sustainable forever, provided that the number of new people entering the system maintains a rough balance with the number of people collecting from the system."

Hmm. As Shlaes points out, demography and the economy have not cooperated with Dewitt's plan. Moreover, even the system's planners knew, as early as the 1950s, that without big tax increases or benefit cuts the baby boom would bankrupt the system. So, by Dewitt's own definition, Social Security is a Ponzi scheme. Shlaes' book does a real service in bringing the moral and intellectual bankruptcy of this Social Security apologist out into the open.

Shlaes also notes that the earnings penalty for Social Security beneficiaries under age 70 imposes a huge tax on incremental dollars earned by the youngest and most able seniors. In 1996, 65-to-69-year-olds who earned more than $11,520 a year lost one dollar in benefits for every three dollars earned, a marginal tax rate of 33 percent. Americans aged 62 to 64 lost one dollar in benefits for every two dollars earned, a whopping 50 percent marginal tax rate. And that's before counting regular income taxes.

Moreover, Shlaes notes, for elderly people over a certain income level, 85 percent of their Social Security benefits are subject to income taxation. In fact, as I showed in an article in Fortune (March 4, 1996), when you put all these taxes together, the marginal tax rate on dollars earned from working is often more than 80 percent and could be more than 103 percent. "The overall effect," writes Shlaes, "is to send a clear message: `Don't work.'"

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