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Hello and welcome to Planet Money Summer School. The only economics degree you can get without leaving your hammock. Oh, so nice. This is class number six Taxes and Donald Duck. I'm Robert Smith. Every week this summer, we've been teaching you how to think like an economist, which is going to come in handy when you tackle our fiendishly clever final exam. If you pass, you will have earned the right to proudly display your thing. That looks a lot like a diploma.
Last week we talked about how if you tax something, the price goes up and people use less of it. That's why we put so much tax on alcohol and cigarettes to discourage their use. But if that's the case, why is there an income tax? We want people to work and to make money. We don't want to discourage it yet. Income taxes are the largest source of money for the federal government.
The answer to this mystery lies back in U.S. history. So we're giving our usual economist, Justin Betsi, a break.
And we're bringing in a special guest lecturer on economic history from the Ohio State University.
And we always say the that's like required a law in Ohio. I feel like I should owe the money every time I say that.
Where the yeah. I don't believe is something that trademark.
They've tried. I know they've tried. This is Trovan Logan, who is a professor of economics at the Ohio State University specializing in economic history. Hi, how are you?
So as we're about to listen to an episode on the income tax, is there anything we should think before we listen to this episode about taxes in general, the role of the government taxes, I don't think can be divorced from what government revenues are used for and the purpose of government revenues.
And so you have to think about taxes as something that solves a fundamental problem of resource allocation, which is that the government has to do something to provide the services that it provides that only perhaps to itself, but to the broader public. But the question is, there are lots of different ways to achieve that end and some of which are more efficient than others. For most of American history, there was no income tax. It was not part of the original constitution.
It doesn't have to be this way.
Then why is it this way?
Getting to the income tax we know and love took four wars, a Supreme Court justice on his deathbed and a famous duck coming up after the break.
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Listen to it's been a minute from NPR. Today's episode originally aired in 2013, and it was hosted by me and David Kestenbaum, so the income tax is the largest source of revenue for the United States government. When people talk about paying taxes, this is what they mean.
And it feels like a big part of being American. Every year we fill out the tax forms to go through the tax tables. Sometimes we write a big check.
But our country has this really conflicted history with the income tax. It was not designed by our founding fathers. For most of American history, there was no income tax at all.
In the early years.
Our brand new government needed some way to raise money, but there was no need to mess around with an income tax.
The government had a much simpler way. Just tax the stuff that comes into the ports for a long time.
Really, the only way that they raised money was using tariff duties, you know, duties on imported goods.
This is tax historian Joe Thorndike. And tariffs are simple, right? You send out a tax collector to all the major ports. Ship pulls into port, you go through the manifests, check the cargo and you add up whatever you want to tax. Sugar, guns, books.
Simple, but there is one big problem with tariffs. They fail you the one time you really, really, really need revenue.
Tariff duties are a great way to raise money as long as you're not fighting a war because someone's blocking your port, right? Yeah. Or sinking your ships on the way across the ocean. Right. And that that does tend to depress trade a little bit.
So when in the United States do people start to think and talk about an income tax?
Well, you know, the earliest reference in American history that I know of comes during the War of 1812 when the treasury secretary sort of throws it out there. It's it's really kind of a throwaway in a report that he sends to Congress. You know, hey, we could consider taxing incomes.
But this suggestion during the War of 1812, it goes nowhere. An income tax is actually a very complicated thing to pull off successfully.
There are three big obstacles to getting it right.
The first obstacle is logistics, like how do you make sure people pay a percentage of their income?
Oh, it's enormously complicated because it really does come down to the individual who's filing this return and that person we're going to expect them to begin with just to keep track of how much they're earning. Then you expect a lot of honesty from them about reporting those records to the government and to make sure that they're actually doing the job, you then have to create this huge administrative apparatus to go in and enforce it. And you have to give these people the power to dig through the personal financial records of every taxpayer.
And that's usually pretty unappealing to taxpayers.
And the government is not going to radically reform the tax code unless it has to, unless there's something incredibly expensive it needs to fund.
This is how a lot of taxes come about. There's a war.
And in fact, 50 years after the idea, the income tax is first floated, such a war comes to pass the civil war.
This is a very, very, very expensive war. Congress needs money to feed its soldiers by guns, cannon ships. So this time it's not just one guy. Bringing up the income tax is a suggestion. This time Congress makes it law and even more importantly, they come up with a way to enforce it.
Congress provides for the creation of the Bureau of Internal Revenue.
This is the first real income tax in the United States, but it doesn't look quite like the one we have today. During the Civil War, only the wealthy had to pay income taxes.
And the government does this really very clever thing to get rich people to pay it. It makes tax returns public.
During the civil war. Anyone could go in and look up your income tax return or at least your report of how much you earned. And the idea was that this would help improve compliance because your neighbor would see you driving around on your brand new plow.
And he'd say, wait a minute, that guy, how did he get all that money? I'm going to see how much he reported on his income tax. And they'd go in and they'd check it out and they could report to the agency and say, hey, you know, I don't think that this is the right no. This guy looks like he's living too large for this sort of an income. They sort of conscripted every American and made them a tax collector.
So who was living large in, let's say, Washington, DC in 1864? Well, we pulled up a copy of the tax assessor sheets for DC during the Civil War. And there happens to be a guy here, Abraham Lincoln, address White House, although he can just write White House.
Everyone knows where it is. It's right in the center of town. And the taxes he paid, I'm sure people were very interested in this 1296 doneness.
There are also entries here for restaurant owners, for liquor dealers, to some guy who lived on a long boat maybe in the Potomac River.
It's clear from this list that people were paying taxes. The plan worked well. Some people are paying taxes. The north part of the country, remember, this is the civil war. The south also attempted an income tax, attempted.
They had a much less effective tax system and their income tax was much less effective than the North's version.
Is there a case to be made that the civil war was sort of an economic battle and the North was better at that and raising money and and that's one reason it won?
Oh, absolutely. I mean, taxes do have a lot to do with. North winning the war, not just taxes, but the North's ability to borrow money, it just had a better economic foundation for fighting a big war like that.
You know, the income tax worked so well during the war, you would think that the U.S. government would want to keep it around. I mean, it's nice to have extra money when you're actually rebuilding from all that carnage and such.
But once the conflict ended, there was this big argument about whether to keep the income tax around or not.
And now the income tax hits its second obstacle, a legal obstacle.
Remember how he said the income tax only hits the rich? Well, the rich did not like it and the rich have lawyers. In 1895, a legal challenge to the income tax reaches the U.S. Supreme Court hears economic historian John Steele.
Gordon, my great, great uncle, was one of the lead lawyers in that case.
And guess which side he was on trying to shoot down the income that you got it. He became a he was a mortgage partner.
And five years later, the argument John Steele, Gordon's great, great uncle, made in court was that the income tax violated a little document that we like to call the U.S. Constitution.
Here, I'll read the line to you. It says, quote, Direct taxes shall be apportioned among the states according to their respective numbers.
I will translate that for you. If the federal government wants to raise money directly from people or property, then it has to divide the tax burden up equally among the states according to their population. So if a state had 10 percent of America's population, it should only have to pay about 10 percent of the tax. And the income tax wasn't taxing according to population, it was taxing according to income.
So the question before the Supreme Court is, and as is often the case, it's something kind of annoyingly subtle and hard to follow. The question is, is the income tax a direct tax?
You know, I stayed up late last night reading court documents. This is a huge rabbit hole of complicated things.
But it comes down to this. If any part of this income tax law passed by Congress, if any of the many taxes embedded inside were considered a direct tax, then Congress did it wrong. The law is unconstitutional.
That is the question the justices had to decide. A very interesting thing happened in the Supreme Court. One justice was ill. In fact, he was dying. Justice Jackson from Tennessee, it was argued before eight justices and they split four four as to whether or not the income tax was a direct tax and therefore unconstitutional.
That's why we have an odd number of justices. So you can't have a tie or. Exactly. It was a four four tie and the court decided the case was simply too important to be tied. And so they hold Justice Jackson out of his deathbed. They now know an odd number of justices and everybody knew that he was in favor of the income tax because he'd said so publicly. Is he really dying? Yes, he really died two months later.
So the lawyers argue the case.
Justice Robert Jackson is in the final days of his life. He is a pro income tax guy. So he's going to break the tie in favor of the income tax. And the tie was broken. Case was decided five four.
But the crazy thing is it was five four the other way. It was a five four decision against the income tax.
One of the other justices, we don't know who switched his vote. And so the tax was unconstitutional, no income tax.
How did people react at the time to this little intrigue? Oh, they they were there was a lot of fuss in the papers about it, but the Supreme Court was silent as it so often is. That's what the internal workings.
We really don't know who who.
We really don't know who. But somebody switched their vote. We just don't know who.
So there's this weird stretch in the middle of American history where the income tax has been ruled unconstitutional. But this didn't in any way settle the argument. I mean, if anything, the debate over income tax in America grew more heated. This is a time when a lot of big industrialists are getting filthy rich, J.P. Morgan, Rockefeller, Carnegie. And at this exact time, the nation has no income tax.
The people who are not J.P.Morgan or Rockefeller or Carnegie in the country, a lot of them feel those guys, the rich need to bear more of the burden.
So nearly 20 years after the income tax is ruled unconstitutional, we get an amendment to the Constitution. The 16th Amendment ratified in 1913, a single sentence which begins the Congress shall have the power to lay and collect taxes on incomes just in time for another war, World War One.
So the income tax has cleared two hurdles so far. Logistics, check, legality, check the income tax needs one more thing to bring it into the modern age.
One more L word love o.
The income tax up to this point has been a tax on the rich, right? Everyone else was exempt. In fact, when they bring the income tax back after the constitutional amendment, less than two percent of the population has to pay it.
All this changes, though, with World War Two. The government needs more money and now ordinary folks are asked to pay again.
Joe Thorndike, this is a real revolution because for most Americans, they've never had this kind of direct tax paying relationship with the federal government. You know, they're paying excise taxes on alcohol, tobacco or consumer goods. But those things are usually levied somewhere other than like on the consumer, you know, they're levied at the manufacturer level for the first time. Americans are sort of confronting the federal government as a tax collector.
And the middle class has never paid this tax before. They're not sure what to do. A poll in 1943 showed that one third to one half of people were unclear what their tax responsibilities were.
And there was a lot of concern that Americans just wouldn't do it, that they wouldn't understand that they were supposed to or that they had to or even just how to do it.
Government clearly needs to get the word out. It needs a spokesperson to help explain the income tax.
They need somebody with with credibility, somebody who people respect, somebody instantly recognizable.
Easy to understand when they go with Donald Duck.
This is a short film by Disney from 1943, commissioned by the government. In it, Donald Duck is marching around his house patriotically listening to the radio and talking back to it.
Your whole country is mobilizing for total war. Your country needs you.
Donald Duck runs and he gets a gun and a sword and an accent. Boxing gloves.
Are you a patriotic American eager to do your part? Then there's something important you can do. I'm glad you won't get a medal for doing it or what it may mean a sacrifice on your part. No one around. But it will be a vital help to your country in this hour of need. Well, what shall I tell you? What it is my one. Where shall I write of your income tax brackets? Oh yes. Your income tax.
Wah wah wah wah.
Glad we love this video. We have been watching it over and over again. It was actually nominated for an Academy Award, David, in 1943. They actually walked Donald Duck through, filling out his whole tax return.
You made less than three thousand dollars last year. Well, then you can use the new simplified form.
Donald Duck writes In his occupation, actor income 2500 one dollars. He lists dependents three Huey, Dewey and Louie.
Then they have to look up how much he owes in the tax tables.
It's basically wartime propaganda, but it is very, very successful propaganda. People pay their taxes to fight the axis. Maybe people never fully get over this final hurdle and start to love paying the income tax, but they accept it.
In 1944, a poll shows that 90 percent of Americans think the tax code is fair.
And this is the end of our story. With the help of Donald Duck, the income tax is established and the debate shifts in America. It's no longer should there be an income tax or not. After World War Two, the heated argument becomes a fight over who pays what tax rates for the rich go up and down.
Exemptions get piled on top of loopholes which get piled on top of credits. The tax code becomes a jungle of rules and regulations.
And yet, for all the fights over fairness, for all the election rhetoric we hear every four years over how horrible our tax system is come April 15th, most people suck it up and they pay again.
Tax historian Joe Thorndike.
I think what's remarkable about Americans there is an anti-tax strain, but just as impressive is the willingness of Americans to actually pay their taxes. It to some degree, this has to do with wars. But wars can't explain why people continue to pay their taxes during the long periods of peace. I think that Americans, by and large, over the decades and centuries have felt like the government is giving them something they want and they're willing to pay for it. I really think it's almost that simple an equation.
And when faith in government starts to erode, which I think has happened significantly in the last several decades, then willingness to pay taxes begins to erode. And you start to see numbers like that. 90 percent of, you know of Americans think the tax system as fair. Those numbers start to drop pretty dramatically.
They're not in the basement even now. People tend to be remarkably OK with the amount of taxes that they're paying. Their real suspicion is that other people are getting away with murder and that makes them feel like a chump.
I paid my income tax today. I never felt so bad before. Be right there with the people who pay their income tax through the 10000 more and that we must pay for this war somehow. Uncle Sam was worried about it. And so I paid my income tax.
That was historian Joe Thorndike and my co-host David Kestenbaum from an episode that first aired in 2013. We're so young, so young back then. Stay with us.
As our economic historian Travon Logan helps us dissect how once you have a tax code, it becomes so much more than just a way to raise money. It becomes a way to change behavior after the break. This message comes from NPR sponsor Microsoft. The world has changed and Microsoft teams is there to help us stay connected. Teams is the safe and secure way to chat, meet, call and collaborate. To learn more, visit Microsoft dotcom teams.
Black voters play a crucial role for any Democrat who seeks to win the White House. But some big divides amongst that bloc and some serious ambivalence could determine who is elected president this November. Listen now on the Code Switch podcast from NPR. And we're back with Planet Money Summer School. Once the United States had an income tax, the government pretty quickly saw that what they had was not just a great way to raise cash. The income tax was a tool.
For instance, the government decided that the income tax would be progressive, meaning that people who made more money would pay a greater percentage of their income, and that money could then be used to help people with lower incomes.
OK, that's simple enough, but the tax code got more and more complicated as the government tried to do more and more with tax incentives and tax disincentives. To talk about this were bringing back in our professor of economics from the Ohio State University, Trevon Logan. Hey, Travon. Hi, how are you?
So let's start with the big picture here. If you tax something, you make it more expensive and you get less of it. If we tax income, essentially taxing people's capacity to work, do we get less incentive to work? So theoretically, that could be the case, that there could be disincentives to very high taxes and depending on how you would actually implement a tax code, it could certainly discourage people from earning lots of income. The way that it would actually operate is depending on what the tax rate would be.
People could invest time instead of being productive and earning additional income into finding ways to avoid paying taxes on the income that they have.
It certainly seems that that's true, though, right, in terms of tax avoidance. Yeah, and I think another piece of this, there's some great research for interested people from Christina and David Romer who are at the University of California at Berkeley about these early tax rates. And one thing that they found was that tax avoidance was actually quite uncommon in the 1920s. And part of the reason for that is because the tax rate itself applied to very few households.
But also the tax code was very simple. So a simple tax code, it's very hard to get around it. If you think about how complicated the income tax code is in the United States today, it is very easy to find loopholes in that. And in fact, that becomes its own industry because the tax code itself is very complicated. So one way in which you can minimize the likelihood of tax avoidance or even the incentives that you would have to engage in activity simply to avoid taxes is by having a very simple tax code.
Yeah, the U.S. government clearly decided not to keep it simple. They figured out you could make loopholes to encourage certain behaviors.
You could raise taxes on the behaviors you didn't like.
For instance, the government wanted people to save for retirement, so they provided a tax deduction for saving for retirement. Makes sense.
The government wanted people to own homes, so they allowed people to deduct the interest that they pay on their home mortgages, essentially to push people in that direction. Yes.
So you think about things like mortgage interest being deducted from federal taxes. All of these things are designed to stimulate particular types of economic activity. And at the other spectrum, you might put taxes on items such as cigarettes or alcohol to discourage their consumption. And so the tax system can push you to do certain things by making it tax advantageous and can discourage you from doing other sorts of things by making them more expensive through the tax code itself.
This almost argues that even if the US government could figure out another way to fund itself, there is a value to having a tax system at its fingertips to get people to do things.
Yes, I'm going to I don't make you argue for how wonderful taxes are.
But, you know, there's one great thing that was said in the episode that I think is very important is about taxes being a duty of citizenship. And I think one of the most interesting aspects of that today is I'm not sure how widely shared that view is. So do people view taxation the way that they view voting? Do they view the goods and services that they receive from the government, which are financed through taxes as something that is a part of their citizenship in which they have contributed to this common pool which provides these goods and services?
That's actually a really open question about our political economy, because it changes the ways in which we start thinking about the purpose of taxation and then also the degree to which we support particular types of taxation or taxes and exemptions to encourage or discourage particular types of activity.
If we look around the world. When you find societies where people are paying their taxes, it usually does show a trust overall in in the system. In other words, there are countries where people do not trust the government. They think they can get away with it, and the percentage of people who pay their taxes is extraordinarily low. I mean, in some ways, the fact that taxes actually get paid, maybe not at the full extent they should, demonstrates trust in the U.S. government.
Yeah, one of the basic aspects of the tax system that we have now is most people are paying their taxes because they're paying them throughout the year. So tax day is just the day of reconciling their books. And that's a different way of thinking about the relationship that households have with taxes. There's some great work by Damon Jones about why households would want to have this over withholding of their tax obligations throughout the year. If you think about a basic economic standpoint, it makes no sense to have over withholding.
But for a lot of households, over withholding is actually a form of savings. And so they use their income tax refund for consumption purposes. And that's one of the things that people will see through the tax code, is that it can have a variety of functions that have nothing themselves to do with taxes, but can also be used as actually a savings device. Professor Travon Logan, thank you so much for talking with us. Thank you, professor.
When we do the summer school classes, we ask the instructor to give a sort of mental homework assignment that people can do over the next week. Have you thought of one about taxes in this current state?
I think it might be really good to add up all the taxes that you have paid in a week or really in a week, in a week.
But also think about all the taxes that you have paid on items that you may be ordering online when you go to shop and think about the total value of the taxes that you have paid in any one particular length of time a week, two weeks, a pay period, cetera.
Don't forget your property taxes or sales taxes, local and state taxes, too. Yes. Don't forget those they add up. Professor, thank you so much for speaking with us. Thank you.
Let us know what you came up with from our assignment this week for Planet Money at NPR dot org. And we'll be picking out some of the best answers for a special graduation episode. You can also find us on social media, Facebook, Instagram, Twitter and Tic-Tac. We're at Planet Money. And as a disclosure, Tic-Tac helps fund the NPR content that appears on that platform. Today's class was produced by Lauren Hodges with help from Darian Woods, Lysa Yagur, James Sneyd, Alexi Horowitz, Gazy and sound design from Isaac Rodriguez, who's edited by Alex Goldmark.
Trevon Logan is a professor of economics at the Ohio State University and Associate Dean in the College of Arts and Sciences, Betsey Stevenson and Justin Wolfers. We'll be back in two weeks. Next week's class is refreshing. It's the real thing. It's the choice of a new generation. Yeah, it's about advertising. I'm Robert Smith. This is NPR. Thanks for listening.