`Pay as you go’

Prior to leaving for the Tokyo summit, President Clinton warned that there is a “global crisis” in the lack of new job creation in the world’s wealthiest economies. He called for an international dialogue and, with characteristic hyperbole, stated that “We need to know why (there is a crisis). We need to ask new questions and we need to find new answers.”

Clearly, the deficit plays a role in the lack of job growth but a good part of the “answer” to the president’s question may be found in the overwhelming tax and regulatory burdens placed on a changing economy by inflexible, outdated government policies. I’d like to focus on just one area: payroll-based taxes.

The Social Security Act of 1937 first brought the concept of a “payroll tax” to the nation through Social Security and unemployment taxes. It also introduced Roosevelt’s innovation of an employee-paid tax.

It was just 50 years ago, however, on July 1, 1943, that the concept took on a new, and largely unappreciated, twist. On that date, “pay-as-you-go” federal income tax withholding in the form of the Current Tax Payment Act of 1943 took effect. This statute made a simple, and revolutionary, change in the way we pay taxes and — of great present concern — finance our government. We shifted from after-the-fact tax payments (earn the money one year, pay taxes the next) to a current “pay-as-you-go” payment system based on employee wages, where employers made current deductions of federal income taxes from paychecks as the money was earned — before employees even received their money or knew they owed taxes.

There was ample reason for the change. In 1942, the need for revenues to fight World War II had become pronounced. At the time, income taxes applied only to a select few who paid taxes quarterly in the year after they were incurred. Human nature being what it was, funds to pay these taxes were not usually set aside and sums due were generally paid out of the following year’s income. This form of “catch-up” worked provided an income didn’t drop, an unrealistic assumption for some. Bearsdsley Ruml, the treasurer of R.H. Macy and Co., and chairman of the Federal Reserve Bank of New York, proposed to Congress that taxes be collected by employers from current incomes — before employees could spend the money. His plan offered a solution that was as incisive as it was unobstrusive. Using employers as tax collectors, and basing taxes on wages or salaries, as opposed to “income,” the income tax could be broadened from a tax on a wealthy few to a much wider population, literally, anyone with a job. Withholding also offered government the advantage of getting the money early.

With a war raging, normal peacetime restraints to further expansion of incom quickly swept aside by a public enthusiastic to support the war effort. A new phrase, “take-home pay,” entered the language.

For those convinced that government can never operate like a business, withholding has proven the exception. Government found a “product” — income taxes, a “market” — employees and, as the sales adage goes, it controlled its “territory.” Within a year, one in three Americans were submitting returns — a six-fold increase from 1940 — and federal income tax revenues had doubled from 1942. By war’s end, receipts had increased by 1400 percent from pre-war levels and grew to more than 40 percent of federal revenues.

Over the past 50 years, this level of fiscal momentum has not slowed. With the two exceptions (1949 and 1950), a tax that was expanded to win World War II has consistently generated more than 40 percent of federal revenues and fueled an unprecedented string of peacetime deficits.

Tax overpayments by employees have also resulted in significant over-collections of taxes. In 1991 alone, refunds of $83.7 billion, or more than 20 percent of all funds collected, were paid to 84 million taxpayers. To understand the impact, consider this: Would your spending be affected if your actual wages were unchanged, but you were consistently overpaid by 20 percent? Since World War II, the perception, if not the reality, that growing payrolls offer an unlimited tax resource has fostered an attitude in Washington that bases spending decisions on the assumption that there will always be more revenues next year. Unfortunately, the opportunity for further growth is limited and may be gone.

Jim Longley, a former practicing attorney, operates a business and retirement planning company in Lewiston. A major in the Marine Corps Reserve, during the Gulf War he served as director of public affairs at Camp Lejeune and with the allied security forces in northern Iraq.