Tax Withheld
By Manuel L. Quezon III

SETTING ASIDE ALL THE "POLITICAL NOISE," the preparation of the income tax return has been a preoccupation of people prior to the Holy Week holidays. I heard someone wish that the income tax be limited to the withholding tax. Which led to another question: what evil genius thought up that tax?

The withholding tax, the glorious scheme to confiscate our earnings, we owe to American ingenuity. To be precise, we owe it to the inspired genius of Beardsley Ruml, economist, treasurer of R.H. Macy & Co. (owner of Macy's Department Store), and chair of the Federal Reserve Bank of New York. The story of how Ruml "invented" the withholding tax system is told in the late journalist David Brinkley's memoir of Washington, D.C. life during World War II.

As America entered the war, Brinkley tells his readers, "it became clear quickly that the war could not be fought, and certainly could not be won, without new taxes. The war bond drives had been public relations successes but financial failures. The federal budget was soaring to previously unimaginable levels: four times the size of the largest New Deal budget, three times the size of the largest World War I budget. Something had to be done. But raising taxes in the 1940s was not as simple as it looked, because the system for collecting them was not equipped for the new burdens to be placed on it."

According to Brinkley, "The old system, still in place when the war
began, was this: Employed people paid taxes, in quarterly installments, not on the current year's income, but on the income they had earned the previous year. Hence, taxpayers began each year in debt to the federal government. It was up to them to find the money ... to pay last year's income taxes out of this year's income. The system worked well enough when income taxes were low (and, for most people, nonexistent)." But the war was raising taxes, and Ruml was observant enough to realize what a terrible effect this could have on ordinary people.

Continues Brinkley, "[Ruml] noticed that when [Macy's] employees retired and began living on their pensions, they found themselves in immediate financial difficulty. In the first year of living on their lower pension incomes, they had to pay taxes on the last year of their igher employment incomes. Many could not do it. Looking beyond Macy's, Ruml noted that a widow, in the year after her husband's death, had to pay his taxes but did not have his income to pay them with. And looking ahead, Ruml began to wonder what ... an employee of Macy's (or any other corporation) would do (if he left) a $7,500-a year job and began earning $50 a month in the army. He would owe taxes on his last year of civilian income and would have to pay them with the first year of his draftee's pittance."

Seeing the outrageous situation, Ruml decided to think out a solution. He brainstormed by cutting himself off from the world, reclining on a chair and letting his mind wander. He started thinking about the problem late in 1940; by spring of 1941, he had - in a flash of brilliance - hit on a solution: "pay-as-you-go," he called it, and "It was all quite simple, but also revolutionary: let everyone pay this year's taxes this year by having the money deducted from paychecks before he ever sees it. Then, everyone would start each year clean, free of debt."

The idea was a hit. His friends, to whom he first broached the idea at a dinner, loved it, and so did the Senate and House finance committees. But then the idea began to face opposition from - of all places - the White House and the Treasury Department. The problem was that "To begin a new year cleanly with a pay-as-you-go system, Ruml argued, it would be necessary to forgive the taxes for the previous year. Otherwise, people would have to pay two years of taxes in one year; an impossible burden for many."

Not much of a problem, you might think, except that the New Dealers in the Treasury and around Franklin D. Roosevelt thought that writing off one year's worth of income taxes would prove intolerably advantageous to the rich. This was an administration, after all, which actually considered limiting all wartime incomes to $25,000 per annum (a figure, the staunchly Republican Chicago Tribune sniffed at because it was the most money FDR ever managed to earn until he became president).

A noisy debate ensued, within the administration of FDR and in the papers. In his memoir, Brinkley dryly observes that "Democracy was at work, producing paralysis." Eventually, in good-old American fashion, a compromise was reached: "Congress produced a bill that included a year's forgiveness for lower-income people, and only a partial forgiveness for the wealthy." The irony was, as Ruml's supporters pointed out, "no one would benefit from the amnesty until the last year of their working life." But at last, it was done, and the new system was signed into law on July 1, 1943. A system, more or less, we now owe to Uncle Sam.

As Brinkley sums it up in his memoir, "Beardsley Ruml, from his locked room and his overstuffed chair, had produced a revolution in American public finance. When people became accustomed to paying taxes as they had always paid for automobiles-on the installment plan-Congress and president learned, to their pleasure, what automobile salesmen had learned long before: installment buyers could be induced to pay more because they looked not at the total but only at the monthly payments. And in this case there was, for government, the added psychological advantage that people were paying their taxes with not much resistance because they were paying with money they had never even seen. The term 'take-home pay' now entered the language."