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September 1, 1997
The Plan That Slogans Built: The Revenue Act of 1943
Dennis J. Ventry, Jr. and Joseph J. Thorndike

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Dennis J. Ventry Jr. is a research associate with the Tax History Project at Tax Analysts. Joseph J. Thorndike is director of the Project.

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by Dennis J. Ventry Jr. and
Joseph J. Thorndike

[1] In 1943, Congress passed the Current Tax Payment Act, requiring taxpayers to stay current on their tax liability through a vast new withholding system applied to wages and salaries. The law represented a victory of sorts for the Treasury Department, where tax officials had been promoting current collection for years. Success, however, was a near thing, coming only after Treasury and White House policymakers staved off a tax forgiveness plan championed by one of America's leading businessmen.

[2] By the time it was introduced in 1943, income tax withholding was already an old idea. During the Civil War, Congress had incorporated withholding into the fledgling -- and fleeting -- federal income tax. Later, during the early years of the 20th century, Congress again turned to withholding as it tried to craft a workable -- and permanent -- federal income tax. (Withholding provisions were soon dropped from law, however, as administrative difficulties loomed ever larger.)

[3] Midcentury policymakers, however, had even more immediate evidence that withholding could be an efficient means of tax collection. In the years immediately preceding American entry into World War II, official Washington watched approvingly as new social security taxes were successfully collected at the source. In impressive fashion, and without the use of computers, the Bureau of Old-Age Benefits managed to process over 312 million wage reports by mid-1940, posting more than 99 percent of them to 50 million employee accounts. /1/

[4] Faced, then, with World War II's staggering revenue demands tax officials saw withholding as a vital component of the new, vastly expanded federal income tax. Despite opposition from the Bureau of Internal Revenue, Treasury officials began agitating for reintroduction of withholding mechanisms, arguing that the idea was administratively feasible and economically crucial.

The Case for Withholding

[5] Treasury officials insisted that withholding was necessary if the federal income tax was ever to function effectively as a mass- based tax. Before wartime revenue needs forced Congress to add millions of new taxpayers to the income tax rolls, administering the federal income tax was feasible without withholding. With so many new taxpayers, however, the system demanded some mechanism of current collection, and withholding seemed the most promising. Indeed, Treasury told Congress, collection at the source and withholding were central to "the very existence of the income tax."

[6] Treasury also argued that withholding would aid in the wartime battle against inflation, which had quickly emerged as the second greatest tax concern after revenue adequacy. Dwindling supplies of consumer goods and soaring personal income posed a serious threat to price stability, and policymakers cast about for ways to stem the inflationary pressure. Treasury officials argued that withholding would withdraw more purchasing power more quickly from the economy, thereby helping restrain the upward pressure on prices. Indeed, withholding could help transform the federal income tax into a potent tool for managing the nation's economy, they contended.

[7] In November 1941, Treasury Secretary Henry J. Morgenthau Jr. presented a withholding plan to the House Ways and Means Committee. Suggesting an additional 15 percent tax on income above exemptions, Morgenthau proposed that the new levy be collected at the source from wages, salaries, interest, and dividends. A wary committee, however, deferred Morgenthau's proposal.

[8] During hearings the following March, Morgenthau again put forward his idea. This time, lawmakers were more receptive, ignoring protests from the commissioner of Internal Revenue and adding withholding to the House version of the 1942 revenue bill. Senatorial colleagues, however, remained unconvinced, and the provision was dropped from the Senate bill.

[9] But withholding wasn't dead yet. The final version of the Revenue Act of 1942 included provisions for a supplementary income levy known as the Victory Tax. Set at a flat 5 percent on salaries and wages above an exemption of $624, the Victory Tax was to be collected at the source. (For more extensive discussion of the Victory Tax, see Tax Notes, June 16, 1997, p. 1549.)

[10] With a foot in the door, Treasury continued pressing for further withholding, arguing to expand it to the regular income tax. President Franklin Roosevelt, too, lobbied for collection at the source, suggesting repeatedly in early 1943 that the income tax be put on a "pay-as-you-go" basis -- a change that more or less required a withholding mechanism. Such a proposed system would keep taxpayers current, Roosevelt said, instead of allowing them to pay their taxes the year after they had incurred their tax liability.

[11] Despite their rejection in 1942, current collection and withholding enjoyed considerable support on Capitol Hill. The Bureau of Internal Revenue (BIR), however, remained a steadfast opponent of withholding, decrying the proposal as administratively burdensome and fundamentally unworkable given wartime personnel strictures. Randolph Paul, Treasury's general counsel and point man on tax matters, greeted the commissioner's statements unhappily. "It would be a masterpiece of understatement," he later wrote, "to say that these pronouncements, never submitted in advance by the Commissioner to the Treasury, were extremely embarrassing."

In Transition

[12] Despite his best efforts, BIR Commissioner Guy Helvering was unable to derail the drive for current collection and withholding, and the ideas gathered steam among lawmakers. Introducing current collection to the existing income tax, however, posed a serious transition problem. Simply dropping withholding into the existing system would have required taxpayers to spend at least one year making "double" income tax payments. Under existing law, every taxpayer was expected to save enough money over the course of the year to cover his liability when it came due early in the next calendar year. If, however, pay-as-you-go withholding were superimposed upon this existing system, then taxpayers would be further required to make simultaneous payments on their current liability.

[13] Some observers saw nothing wrong with doubling up on tax payments during the transition year. As a few brave policymakers pointed out, the result was not really "double" taxation, since the lump sum payment and the current payments applied to income received during different years. If taxpayers had been vigilant in their saving, they should have had enough money to pay the past year's liability, leaving them enough room in their paycheck for payments on the current year.

[14] In fact, however, many taxpayers did not set aside enough money for their tax payment, making double payments a serious hardship. Consequently, policymakers and lobbyists offered a variety of possible transition devices, most involving the forgiveness of some or all tax liability for the year preceding the introduction of withholding.

[15] Treasury tax officials recognized the transition problem, and they set to work on a workable solution. To begin with, however, they rejected a blanket forgiveness of 1942 tax liability, arguing that it would inequitably favor those in the higher tax brackets while disfavoring those in the lower brackets. /2/ Similarly, they opposed "doubling up" as it, too, would favor higher-bracket taxpayers with substantial savings allowing them to more easily pay the additional taxes. Partial forgiveness or postponement of 1942 taxes, then, remained the only viable alternatives.

Enter the Ruml Plan

[16] Beardsley Ruml, however, emerged to challenge the Treasury. Chairman of the New York Federal Reserve Bank and treasurer of R.H. Macy and Company, Ruml had for several years been championing a wholesale shift to current collection, a "simple" change of the basis of tax to be paid from the past year to the current one. The effect would be a full year's tax forgiveness but an uninterrupted flow of funds into the Treasury: In Ruml's view, a fine result. What would happen, he asked in his pamphlet on the issue, if Americans "just started paying income tax, but on this year instead of on last year?"

And as we began to talk about what would happen we discovered
that nothing would happen. It would happen sometime during the
generation, to be sure, but as far as the Treasury and income
were concerned, things would move along just the same as time
moves on under daylight saving. /3/

[17] Taxpayers immediately embraced what came to be known as the "Ruml plan." Indeed, popular speculation began to grow in late 1942 that Congress would pass legislation relieving all taxpayers of the need to pay their tax liability in early 1943. Treasury officials grew concerned about public misunderstanding of the tax forgiveness plan. "The problem had become critical," one official later recalled, "because many taxpayers had come to believe that they would have no taxes to pay in March." /4/ House and Senate leaders felt compelled to publicly remind citizens that payment would be expected by March 15, covering at least the first quarterly installment of tax against 1942 income.

[18] Meanwhile, President Franklin Roosevelt rejected the Ruml plan out of hand: "I cannot acquiesce in the elimination of a whole year's tax burden on the upper income groups during a war period when I must call for an increase in taxes and savings from the mass of our people," he declared. /5/ Treasury, too, demurred, echoing Roosevelt's concern over the plan's inequity and arguing that forgiveness "would bestow the greatest benefit on those best able to pay and the smallest benefit on those least able to pay." /6/

[19] Congress and the administration decided that resolution of the current collection debate was vital to the nation's economic health, and they set to work on legislation early in 1943. Treasury officials restated their support for current collection, stressing the administrative need for such a system under the newly expanded income tax. But they also reiterated their opposition to a full year's tax forgiveness as part of the transition. While acknowledging that revenue flows would be uninterrupted, they resisted the forgiveness as unfair. In its stead, they proposed a scheme of deferred payments, under which taxpayers would be required to pay at least a large percentage of their 1942 tax liability but would be allowed several years in which to do so.

[20] Ruml weighed in against the Treasury plan, arguing that the government could forgive a full year's taxes without unduly burdening itself. Indeed, assuming a continually rising national income, Ruml said, Treasury would actually collect more income over the long run under his plan than under the existing system. The asset loss incurred by tax forgiveness, moreover, would only be evident when examining Treasury's position on Judgment Day. At that point,

Under our present system, the Treasury would have billions of
dollars owing from the taxpayers. These would be bad debts in
any case. Since the government is not concerned about any final
loss on judgement day, the government is able to turn the tax
clock ahead, make all taxpayers current, eliminate income tax
debt, and do it with increased revenue and with no additional
burden on any taxpayer. /7/

[21] While Ruml's original plan did not include provisions for withholding, he now added that virtue to the list of reasons for supporting his plan. Collection at source, he declared, was fully consistent with his forgiveness plan.

[22] The House Ways and Means Committee rejected the bulk of Ruml's argument, with Democratic members insisting that forgiveness was little more than a windfall for the rich. The full House, however, was more sympathetic, and the Ruml plan continued to surface in floor votes. The final bill emerging from the House -- after long and vigorous debate -- embodied a modified forgiveness plan directing most benefits to taxpayers in the first income bracket.

[23] The Senate Finance Committee, for its part, adopted the Ruml plan and its full-year forgiveness, but not without even more impassioned debate. Supporters and opponents of the Ruml plan raised the rhetoric to a fever pitch. Questions of sacrifice took center stage, with opponents of forgiveness arguing that Congress should not be delivering a windfall to some Americans while other citizens were fighting on the battlefields. Sen. Homer T. Bone made the point most strenuously:

If I could abate any of the blood and tears and agony of the
boys dying on the battlefields, if I could abate one little bit
of the horror facing young men marching under the American flag
into this world conflict, I would abate the horror coming to
them, rather than abate a year's taxes for us who stay at home.
I wish I could vote to abate blindness and insanity and vote
away the blasting of boys' lives by shells on the battle fronts.
But we cannot do that. All we can do is abate the tax on some
fellow's income. The whole thing represents a grotesque twist of
logic. It is a sort of madness. /8/

A majority of the Senate, however, remained persuaded of the Ruml
plan's virtues, and the bill went to conference with the Ruml
forgiveness measures intact.

[24] As the conference began, House and Senate leaders remained firmly at odds, the former digging in their heels against "excessive" forgiveness. Additionally, the issue had taken a distinctly partisan tone, with Republicans generally favoring the Ruml plan and Democrats denouncing it as an undeserved bonus for the rich. Roosevelt wrote congressional leaders to emphasize his strong support for pay-as-you- go legislation and renew his strenuous objection to full-year forgiveness. Excessive forgiveness, he asserted, "would result in a highly inequitable distribution of the cost of the war and in an unjust and discriminatory enrichment of thousands of taxpayers in the upper income groups." /9/ Many observers interpreted the president's letter as a veto threat.

[25] (As it happened, Roosevelt was well aware of those taxpayers who stood to benefit handsomely from the Ruml plan. In March, he had asked Treasury to draw up a list of taxpayers likely to reap the greatest benefits, including the 100 largest federal taxpayers. The department responded with a list based on 1941 returns; it read like a roster of Roosevelt's staunchest opponents. For more on the March memo, see Tax Notes, Feb. 19, 1996, p. 1045.)

[26] After lengthy delay, the conference deadlock ended when Ways and Means Chair Robert Doughton changed his vote, allowing a compromise bill to emerge. The final version of the bill included a substantial tax forgiveness -- less than Ruml had sought, but considerably more than Treasury was willing to embrace. The Current Tax Payment Act of 1943, as passed by both houses and signed by Roosevelt on June 9, 1943, provided for current payment of all individual income tax liabilities and the cancellation of 75 percent of one year's existing taxes (the lower of either the 1942 or 1943 tax liability). Unforgiven liabilities were payable in two installments, one on March 15, 1944, and the other on March 15, 1945.

History in the Making

[27] Historically, the acceptance of withholding and the debate over the Ruml plan are significant for two reasons. First, they reveal the extent to which Roosevelt and his administration used the tax system as a tool for social justice. Some historians insist that Roosevelt's efforts to use the tax system in this way were purely symbolic. /10/ The legislative and institutional history which surrounds the Ruml plan, however, demonstrates that Roosevelt and his tax specialists consistently opposed complete forgiveness because it would provide a windfall to the nation's wealthy while unfairly burdening the nation's poor.

[28] Second, the withholding system that the Current Tax Payment Act of 1943 instituted "revolutionized the income tax." /11/ It made income taxation more responsive and flexible, and facilitated the conversion of the income tax system into a powerful fiscal policymaking tool. Moreover, as one legal historian has pointed out, it helped create a taxpaying culture, getting Americans "used to" regular deductions from their paychecks. In short, the introduction of withholding "ensured the status of the income tax as a major and massive revenue source." /12/


/1/ W. Elliot Brownlee, "Tax Regimes, National Crisis, and State-Building in America" in Funding the Modern American State, 1941-1995: The Rise and Fall of the Era of Easy Finance, ed. W. Elliot Brownlee (Washington: Woodrow Wilson Center Press, 1996), p. 92.

/2/ Secretary Morgenthau told Roosevelt, "The plan presented about $64,000 to an individual with a net income of $100,000...for a man who had earned $2,000 only $140." See Carolyn C. Jones, "Mass- Based Income Taxation: Creating a Taxpaying Culture, 1940-1952" in Funding the Modern American State, 1941-1995: The Rise and Fall of Easy Finance, ed. W. Elliot Brownlee (Washington: Woodrow Wilson Center Press, 1996), p. 129.

/3/ Quoted in Randolph Paul, Taxation in the United States (Boston: Little, Brown and Company, 1954), p. 329.

/4/ Ibid., p. 332.

/5/ Quoted in Brownlee, p.92.

/6/ Ibid., p.16.

/7/ Paul, p. 335.

/8/ Paul, p. 346.

/9/ White House press release, May 17, 1943.

/10/ See, most notably, Mark H. Leff, The Limits of Symbolic Reform: The New Deal and Taxation, 1933-39 (Cambridge: Cambridge University Press, 1984).

/11/ Jones, p. 130.

/12/ Ibid.