Income taxes weren't always withheld from people's paychecks. In fact, income tax withholding is a relatively recent development. Before 1943, taxes were only withheld in spurts when the government needed to raise extra revenue. This article will explain how we got the system that takes income taxes out of your paycheck and how that system works.
The Development of the Tax Withholding System
Tax withholding first occurred in 1862 under Abraham Lincoln for the purpose of helping to finance the Civil War. The federal government also implemented a plethora of excise taxes for the same purpose. But in 1872, not only was tax withholding abolished, but the income tax was repealed entirely.
After the ratification of the 16th Amendment in 1913, the income tax became permanent. The amendment was facilitated by the need to pay for World War I, and tax withholding was again implemented. However, withholding laws were repealed in 1917 because of employer complaints. Collecting income taxes from employees imposed a large burden on employers by placing them in the role of tax collector in addition to the role of businessman.
This time, it would be only 18 years before tax withholding resurfaced. After the Social Security Act passed in 1935, Social Security taxes were withheld by employers. This change paved the way for income taxes to be withheld again starting in 1943 with Congress' approval of the Current Tax Payment Act. Once again, war expenses were used as justification for tax withholding. As the early 20th-century writer and intellectual Randolph Bourne once noted, "War is the health of the state." Not only were taxes to be withheld again, but a massive tax hike was enacted. Income tax went from being a tax that was only paid by a few high-earning Americans to one that was paid by both the rich and the common man. The government wasn't sure it could successfully collect the higher taxes from its citizens without withholding at the source.
The 1943 tax withholding system was developed in part by famous economist Milton Friedman, who then worked for the Tax Research Division of the Treasury. Originally a Keynesian economist who supported a large role for government in the economy, he later converted to the classical liberal mode of economic thought that decries government intervention, and he regretted his role in creating the tax withholding system. The system has stuck ever since, and some of today's retirees are the only ones who remember a time before tax withholding.
