Collection at source of the individual normal income tax
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Summary
I. Introduction
II. Collection at source of current year's
normal income tax liabilities
A. Collection at source in the United
States
1. Prior to 1913
2. Revenue Acts of 1913-1916
(a) Sources of income subject to
withholding
(b) Exemption and deduction certificates
(c) Refunds
(d) Reasons for discontinuing
collection at source
3. Income tax payment plans after 1916
B. Collection at source in Canada
1. General income tax payment plan
2. National Defence Tax
(a) Basis of withholding
(b) Exemption certificates
(c) Taxability of wages and
salaries
(d) Reporting
(e) Refunds
3. Problems involved in instituting the
Canadian system into the United States
(a) Refunds
(b) Coverage
(c) Administration
C. Plans presented to the Committee on
Ways and Means in connection with
Revenue Revision for 1941
1. Testimony of William J. Schiefflin, Jr.
(a) Plan
(b) Problems involved under the
Schiefflin plan
2. Testimony of Professor Albert G. Hart
(a) Plan
(b) Problems involved under the
Hart plan
III. Collection at source of past years' normal
tax liabilities
A. Collection at source in Great Britain
1. Prior to 1940
2. Under current law
3. Problems involved in instituting the
British system into the United States
B. Collection at source in Australia
1. South Australia
(a) Basis of withholding
(b) Exemption certificates
(c) Administration
2. Commonwealth of Australia
(a) Basis of withholding
(b) Exemption certificates
(c) Use of tax stamps
3. Problems involved in instituting the
Australian plan into the United
States
(a) Uniform exemption under the
South Australian plan
(b) Exemptions varied with marital
status under the Commonwealth
plan
IV. Collection at source as an inflation control
measure
V. Suggested tax at source
A. Plan
B. Alternative procedures under the plan
1. Exemption certificates
2. Salaries and wages of persons not
covered by social security or other
Federal retirement plan, and business
income
3. Returns by employers
C. Responsibilities of employers, employees and
the Treasury under the suggested plan
1. Responsibilities of employers
2. Responsibilities of employees
3. Responsibilities of the Treasury
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APPENDICES
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App. 1. Description of income tax payment plan by Dr. Carl Shoup.
App. 2. Refund procedure
Summary of statistical information
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TABLES
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Table 1. Estimate of number of part-time employees in industries
covered by the old-age provision of the Social Security
Act, January, 1938-June 1940.
Table 2. Employments not covered by the old-age provisions of the
Social Security Act or other Federal retirement plan:
number of workers, amount of earned income and number of
employers, 1940.
Table 3. Employments not covered by the old-age provisions of the
Social Security Act or other Federal retirement plan;
frequency distributions of income.
Table 4. Individual returns with net income, 1937; Selected
sources of income, frequency of each source, and percent
each source is of total income.
Table 5. Individual returns with net income, 1937, by net income
classes; Selected sources of income, frequency of each
source, and percent each source is of total income.
Table 6. Individual income tax returns with statutory net income,
Forms 1040 and 1040A, for 1936: Number of returns showing
only one or two sources of income with salaries and wages
as a source of income, classified by size of salaries and
wages and by source of income.
Table 7. Individual income tax returns with statutory net income
Forms 1040 and 1040A for 1936: number of returns showing
salaries and wages, and one other source of income of
less than (A) $100 and (B) $500.
Table 8. Individual income tax returns with statutory net income,
Forms 1040 and 1040A, for 1936: Total number of returns,
and number of returns showing only one source of income,
classified by size of total income and by source of
income.
Table 9. Farm operators: Frequency distribution of income. Family
income 1935-1936.
Table 10. Self-employed other than farm operators: Frequency
distribution of income. Family income 1935-1936.
Table 11. Individual income tax returns, Form 1040 for 1936, sole
proprietorships reporting only farming business: Number
of returns, total receipts from farming, net profit from
farming and net loss from farming, by total receipts
classes.
Table 12. Individual income tax returns, Form 1040, for 1936, sole
proprietorships reporting two or more businesses: for the
farming business reported, number of businesses, total
receipts from farming, net profit from farming, and net
loss from farming, by total receipts classes.
Table 13. Individual income tax returns, Form 1040, for 1936, sole
proprietorships reporting only one business, exclusive of
those reporting farming business: number of returns,
total receipts from business, net profit of business, and
net loss of business, by total receipts classes.
Table 14. Individual income tax returns, Form 1040, for 1936, sole
proprietorships reporting two or more businesses,
exclusive of farming business for those returns reporting
farming business; number of returns, total receipts from
business, net profit of business, and net loss of
business, by total receipts classes.
Table 15. Number of agricultural and other partnerships in the
United States, 1936, by size of net income or deficit.
Table 16. Covered employment: Workers, earned income, and
employers, 1940, 1941.
Table 17. Estimate of number of individuals in the income brackets
$750 - $5,000 who are not subject to income tax due to
the personal exemption and credit for dependents 1935-36.
Table 18. Distribution of families and single individuals and of
aggregate income received, by income level, 1935-36.
Table 19. Personal exemption, credit for dependents, and earned
income credit expressed as a percent of net income for
all returns, 1934-1939.
Table 19A. Aggregate expenditures of American families and single
individuals for main categories of consumption and total
income by income levels, 1935-36.
Table 20 Illustrative table of weekly exemptions and deductions
allowed for purposes of the special withholding tax on
salaries and wages.
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Collection at source of the individual
normal income tax
SUMMARY
I. INTRODUCTION
The collection of the normal income tax at source may
be with respect to either CURRENT year's or PRIOR year's
tax liabilities.
Collection of CURRENT YEAR'S TAX LIABILITIES at source
was attempted in the United States during the Civil War
and 1894 income tax experiments and under the Revenue
Acts of 1913-16. It is now in effect in Canada in
connection with their National Defense Tax. During the
Hearings before the Committee on Ways and Means on
Revenue Revision for 1941, the revival of this system was
suggested by Mr. William J. Schiefflin, Jr., Chairman of
the Committee on Taxation of the Chamber of Commerce of
the State of New York, and Professor Albert G. Hart, of
Iowa State College, for purposes of currently preventing
inflation and easing income tax payments.
Collection of PRIOR YEAR'S TAX LIABILITIES at source
is now in effect in Great Britain and Australia. The main
purpose of this system of collection is to ease tax
payments.
II. COLLECTION AT SOURCE AS AN INFLATION CONTROL
MEASURE
The largest portion of consumer incomes in the United
States is not subject to income taxation. Likewise, only
a small proportion of the population of the United States
is covered by the income tax. For 1936, taxable income
tax returns filed represented only 3.9% of the
population. Only about 35% of the total flow of income to
individuals was reached by the income tax and only about
25% was reported on taxable returns. The coverage of the
income tax is narrowest where the greatest amount of
income is concentrated, that is for individuals with
incomes of less than $5,000.
In view of this, any payment system based upon the
present levels of exemptions and credits would be
inadequate as a means of price control. A tax at source
on behalf of current year liability would, however, have
an appreciable effect as an inflation control measure
through withdrawing the tax compulsorily from current
income.
As an alternative to a tax at source, consideration
should be given to lowering personal exemptions as a
means of controlling price increases. To an indeterminate
extent, many individuals would curtail expenditures for
consumer goods if their prospective tax liabilities were
increased. For purposes of controlling inflationary price
increases, it may be adequate to reduce the exemptions
for heads of families to $1,500 since expenditures of
those in the lower income classes are not likely to be
made for articles, the supply of which is limited by
Defense needs. Such lowering of personal exemptions,
together with the popularization of tax anticipation
certificates, may serve to control inflationary price
increases in a manner similar to an income tax at source,
though perhaps less effectively.
III. SUGGESTED TAX AT SOURCE
If the price situation develops in a way which
requires tax measures designed to facilitate the control
of inflation, a special income tax collected at source of
the following type is suggested. This tax could be
instituted promptly and without the need for any
elaborate administrative machinery.
1. The special tax would be separate from the regular
income tax and, in the interests of equity, would be
imposed on all sources of income at graduate rates. The
withholding of tax at source would, however, apply only
with respect to salaries, wages and commissions. A flat
rate of tax would be imposed for withholding purposes and
this would be credited against the total tax liability
determined on the basis of an annual return reporting all
sources of income.
2. For the purpose of determining total tax liability,
the gross income, deductions, credits and exemptions
would be the same as for the regular income tax. For the
withholding tax, only personal exemptions, credit for
dependents and a tentative deduction allowance of 10% of
the amount of personal exemptions and credits would be
recognized. /1/ Employers would accept the statement of
employees as to marital and dependent status.
3. The tax would be withheld at source on a weekly
basis. The allowance for personal exemptions, credit for
dependents and allowable deductions would be on the basis
of a 50 week year.
4. Each week or wage payment period the employer would
purchase tax stamps and turn over to the employee stamps
equivalent to the amount withheld at source. The stamps
would be obtainable at local post offices or from the
collectors of internal revenue. Employees would be
required to countersign the stamps in order to discourage
thefts.
5. Employees would accumulate stamps received as
evidence of tax payment until the end of the year. At the
close of each year employees would report their income
from all sources if such income exceeded the annual
personal exemption or, irrespective of the amount of
income, if any tax had been withheld during the year.
Total liability would be determined on the basis of the
graduated rates imposed for the special tax. The tax at
source would be credited against the total tax and all
stamps submitted with the return in support of the credit
claimed. Any tax liability in excess of the credit would
be payable in cash. Any stamps accumulated by the
employees in excess of total tax liability would be
cashed by the Bureau of Internal Revenue and paid over to
the taxpayer.
IV. OTHER TAX AT SOURCE PLANS
A brief discussion of various collection at source
plans which have been used in this country or abroad or
have been suggested to the Committee on Ways and Means in
connection with the 1941 Revenue Revision follows
A. Collection at Source of Current Year's Income Tax
Liabilities
1. Collection at Source in The United States, 1913-16
Under the Revenue Acts of 1913-16, the normal income
tax on interest, rents, salaries, wages and all other
fixed and determinable annual or periodic income, except
dividends, was subject to withholding at source.
Dividends were exempt from normal tax during these years
and consequently not subject to withholding. The tax was
withheld on the gross amount of the specified source of
income without taking into account exemptions and
deductions unless the recipients of the income filed
exemption and deduction certificates with withholding
agents setting forth marital status and amounts of
exemptions and deductions claimed. Where such
certificates were filed, the withholding agent had
authority to refrain from withholding on the amounts
claimed as exemptions or deductions. The certificates
were not notarized but penalties were imposed for their
fraudulent use.
The exemption and deduction certificates were
objectionable to employees, employers and the Treasury.
Employees changing jobs did not wish to submit to their
new employers exemption certificates which would disclose
the amounts they had received during the year from former
employers. Unless they did so, however, the tax was
withheld on a gross basis and a refund had to be claimed
from the Treasury at the close of the year. Either
procedure was objectionable. The handling of exemption
and deduction certificates, the record-keeping necessary
for determining the amount of tax to be withheld and the
reporting to the Government all imposed a vexatious
burden on employers. From the Treasury standpoint,
millions of exemption and deduction certificates were
accumulated for audit purposes. It did not, however,
prove practicable to make a complete check of the
certificates against the returns.
The collection at source system broke down soon after
its inception. For the fiscal year 1915 only $5.5 out of
$16.6 million, or less than one-third of the individual
normal tax for that year, was collected at source, and in
his annual report for that year, the Secretary of the
Treasury recommended the discontinuance of collection at
source. This recommendation was acted upon in the Revenue
Act of 1917.
2. Collection at Source in Canada
The Canadian National Defense Tax is based on total
net income (before donations) if such net income is in
excess of $660 for a single person and $1,200 for a
married person. The tax is collected at source on
salaries, wages, dividends and bond interest. The tax on
dividends and interest is on a gross basis. The tax is
withheld on salaries and wages on the basis of the RATE
of pay. If the rate paid to employees is such that its
continuance throughout the year would result in the
employee receiving income above the exemption level, the
amount so paid is subject to tax deduction at source. The
employer need not be concerned with the question of how
much income will in fact be earned by the employee during
the year. At the close of each taxable year definitive
returns are required of all persons with total incomes
exceeding the personal exemption levels. The sums
withheld at source are credited against the total
National Defense Tax as determined on the basis of the
return. Where the amount withheld during the year exceeds
total liability as shown by the return, a refund is made.
Refunds would constitute the prime difficulty in
instituting the Canadian system into the United States.
Since the taxability of wages and salaries is determined
by the RATE of pay, there may be many instances where,
due to unemployment or shifts from more to less
remunerative employment, total earnings during the year
would not exceed personal exemptions. /2/ In such cases
refunds would result.
Under present American practice, refunds are slow and
costly. The minimum cost per refund is estimated at
between $3 and $4. Refunds take from 6 weeks to many
months to complete and must be passed by both the Bureau
of Internal Revenue and the Office of the Comptroller
General. The present refund procedure could not be
changed substantially without an act of Congress which
would revise the auditing standards of the Office of the
Comptroller General. Any system, such as the Canadian,
which contains the possibility of a considerable number
of refunds annually is, therefore, not practicable.
3. Plans Presented to The Committee on Ways and Means
in Connection with Revenue Revision for 1941.
(1) TESTIMONY OF WILLIAM J. SCHIEFFLIN, JR. /3/ - Mr.
Schiefflin suggested a gross income tax at a flat rate on
salaries, wages, dividends, bond interest and "every
form of income paid to individuals". This is an
endorsement of the suggestion made by Prof. Harley L.
Lutz.
Aside from the fact that such a gross income tax would
bear more heavily on the poor than the wealthy and runs
counter to equitable taxation on the basis of ability to
pay, the main problems involved under the Schiefflin plan
are (a) it is not possible to withhold a tax at source
with respect to all types of income and (b) it is not
possible to apply withholding to some types of income
recipients.
Salaries and wages constitute about 58% of total
income received by individuals. The tax could be withheld
on this source with a minimum of difficulty. The tax
could also be withheld on dividends. Dividends represent
14% of total income. On the remaining sources of income,
representing 28% of total income, withholding would not
be practicable.
To attempt to collect the tax at source on rents, for
example, would require most persons in the country to
become tax collectors as well as taxpayers, for every
person renting living quarters or business premises would
be required to withhold the tax on each payment of rent.
Similarly, borrowers would have to become withholding
agents with respect to the tax on loan transactions. The
tax on income from business could not be withheld at
source since there can be no withholding agent for such
income. The tax on capital gains could not be withheld at
source since information relating to the amount of the
gain is not available to the purchaser of the capital
asset.
While, as noted, the tax could be withheld on salaries
and wages generally, serious problems would be involved
in attempting to reach agricultural, domestic and casual
workers. These workers represent about 15% of the working
force. The difficulty in taxing such workers at source
arises primarily for the number of employers involved.
For example, agricultural and domestic workers numbering
between 5.5 and 5.8 million are employed by between 4.6
and 5.1 million persons, or almost as many employers as
employees. To check whether the tax has been withheld
properly, where so many potential withholding agents
exist, would be extremely difficult. Further, since no
end of year return is required under this plan, not only
these workers, but all others who escaped withholding,
would be freed from tax. In addition, proprietorships and
partnerships, which represent over 16% of total national
income produced, could likewise escape tax.
Mr. Schiefflin's plan would, therefore, fall primarily
on workers in industrial employment and recipients of
dividends and bond interest. Such a discriminatory tax
would be highly inequitable.
(2) TESTIMONY OF PROF. ALBERT G. HART. /4/ - Prof.
Hart suggested that the normal tax on all wages and
salaries, interest and dividends in excess of exemptions
should be collected at source.
The main problem under Prof. Hart's plan relates to
allowing personal exemptions and dependent credits. Under
his plan, books of weekly exemption certificates, in
denominations based on marital status and the number of
dependents, would be issued to individuals. This would
involve the issuance of approximately 2-1/2 billion
exemption coupons annually. Aside from the cost of
printing and distribution, a considerable amount of time
would be needed to set up such a system. Further the
sheer handling of so large a number of coupons would be
burdensome to employers and the Government and also to
employees insofar as they had to fill in and mail
applications for exemption certificates.
B. Collection at Source of Past Year's Income Tax
Liabilities
Great Britain and Australia collect the income tax at
source on behalf of prior year's tax liabilities.
In Great Britain the tax assessor informs the employer
of each employee's tax liability for the past year. The
employer is then charged with the responsibility of
deducting during the year, in equal installments from
wage payments, the amount of the tax.
In Australia, the tax is withheld on salaries and
wages at a fixed rate /5/ until a sufficient amount has
been withheld during the year to meet the prior year's
tax liabilities. Exemption certificates are issued to
employees as soon as they show that their liabilities
have been met. These certificates exempt employees from
further withholding for the balance of the year.
The collection of past year's tax liabilities at
source is primarily a method of facilitating payment. Its
efficacy as an inflation control device is nullified by
virtue of the time lag between the derivation of the
income and the payment of tax thereon.
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