A History Lesson

Via TaxProf, I found the article, Estate Taxation Is Integral to Income Taxation, by Richard J. Joseph a senior lecturer at the University of Texas at Austin. The article notes several historical points of which I was unaware. These points shed light on numerous issues in the current debate over the structure of the entire US tax system, not merely the debate over the attempt to repeal the estate tax.

• "Until enactment of the modern income tax, the principal source of federal revenues had been customs duties." Like a sales tax or a value added tax, tariffs are essentially regressive and fall disproportionately on the working poor.


• On the other hand, at the time, "[s]tate governments derived their revenues primarily from taxes on tangible property. Because the wealthy increasingly shifted their investments from real estate to stocks, bonds, and other intangibles, many managed to escape state levies." Combine the first point (regressive sales taxes) with the second point (regressive property taxes) and you have a fairly accurate description of our current state and local tax system. (Yes, there are state and local income taxes, but they constitute a small portion of the total revenue stream for states and localities.)


• The income tax was intended to move the federal government to a progressive revenue source and away from reliance on tariffs which are, by nature, regressive.


• "The income tax, however, still left major gaps in the system. The tax reached only accretions to wealth, not the mass of wealth itself. Further, it exempted those accretions resulting from gift and inheritance."
  


• "Cordell Hull, chief architect of the 1913 income tax. . . . suggested that the income tax is deficient because it reaches only 'earned income,' that is, wages, salaries, and profits." Hull's remedy was the estate tax "because it is capable of reaching 'unearned income,' principally in the form of inheritances." (I had not known that Hull had played such an important role in the tax arena, knowing him only (Only?!) as Franklin Roosevelt's Secretary of State, his efforts to create the United Nations, and his participation in the Breton Woods trade conference.)

I suspect that we have reached a point where major changes in the US tax system are inevitable. In weighing the merits of any changes, it is important to know both the economic and historic context of the tax system. No part of the federal tax system, be it the personal income tax, the corporate income tax, FICA/SECA, or estate and gift taxes, stands in isolation from any other part. Moreover, the federal tax system has to take account of the inherently regressive nature of the state and local tax structure which, for a variety of reasons, is resistant to reform.