Before World War II, when income tax rates were comparatively low, most people who owed tax simply paid it in a lump sum in March. Tax day was a big annoying occasion on which the nation took a moment to be bummed about how much the government cost.
Enter Hitler. And a young, brash economist named Milton.
Reason: You were involved in the development of the withholding tax when you were doing tax work for the government in 1941–43?
Friedman: I was an employee at the Treasury Department. We were in a wartime situation. How do you raise the enormous amount of taxes you need for wartime? We were all in favor of cutting inflation. I wasn't as sophisticated about how to do it then as I would be now, but there's no doubt that one of the ways to avoid inflation was to finance as large a fraction of current spending with tax money as possible.
In World War I, a very small fraction of the total war expenditure was financed by taxes, so we had a doubling of prices during the war and after the war. At the outbreak of World War II, the Treasury was determined not to make the same mistake again.
You could not do that during wartime or peacetime without withholding. And so people at the Treasury tax research department, where I was working, investigated various methods of withholding. I was one of the small technical group that worked on developing it.
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One of the major opponents of the idea was the IRS. Because every organization knows that the only way you can do anything is the way they've always been doing it. This was something new, and they kept telling us how impossible it was. It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it's a great mistake for peacetime, but in 1941–43, all of us were concentrating on the war.
I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now.
By making taxes relatively invisible and making paying them relatively painless, Friedman paved the way for the current status quo, in which significant portions of salaried workers' incomes are handed over to state and federal governments without much fuss. Tax refunds, which feel like a delightful windfall to those who receive them, complicate the matter further by making many Americans feel like they are getting a gift on tax day, rather than giving their hard-earned money to the government under threat of violence.
To review:
1) War is the heath of the state.
2) All your heroes are flawed.
Happy Tax Day!
P.S. Ease the sting of this revelation by reading the rest of that interview to be reminded of all the great stuff Friedman did, too.
