Why It’s Time to Make Taxes Hurt Again

As we recover from yet another “Tax Day,” the date on which Americans must submit their income tax returns, many are reflecting on this annoying annual ritual. Though it’s certainly a dreadful experience for some, it has likely lost its meaning for the 74 percent of Americans who celebrate tax refunds rather than mourn balances due in April.

That needs to change.

Balancing Washington’s bloated federal budget, indeed honest decision-making in general, requires the burden of taxation be obvious, not hidden.

Automatic withholding was the brain-child of World War II era economists in the War Department (including a young Milton Friedman, who later wished for the withholding system’s repeal), a scheme to maximize income tax receipts for fighting Nazi Germany and Imperial Japan without stoking World War I-style inflation with monetary expansion. At the time, withholding had an internal logic: withholding a small portion of each paycheck would reduce tax evasion and teach the majority of citizens who had never before paid income taxes to live on only the “take-home” portion. Finally, receiving excess income taxes one check at a time and then paying them back in April represented an interest-free loan for Uncle Sam. But the federal government lacked the agents necessary to collect such a mass tax directly. Instead, Washington forcibly deputized employers as unpaid tax collectors.

Eighty years later, the same system remains. In those eight decades, nearly all Americans have become subject to federal income taxes. Tax preparation is a $37 billion industry, with companies bearing much of this expense to comply with payroll withholdings. Talk about deadweight loss!

But most insidiously, the American people have accepted ballooning federal spending in no small part because the cost of that spending is hidden in “26 easy payments of $289.99.” The cultural salience of the current withholding system is such that many Americans do not even think of taxes withheld as their money at all. Many measure their paychecks by “take-home pay” alone, as if taxes were not monies paid by citizens to obtain services democratically enacted, but a serf’s tribute to kings or nobles.

The automatic withholding system allows Uncle Sam to diffuse the financial and emotional blow of taxation with time, like laying on a bed of nails where the pressure of each is not enough to puncture the skin. But just like the bed of nails, it’s only a psychological illusion, not real magic: taxes collected throughout the year cost more than those paid in a lump sum in April, because withholding deprives the taxpayer of interest income on the withheld money.

If most taxpayers saw $4,000, $7,500, or $15,000 disappear from their bank accounts on April 15th in one fell swoop, how different might the political equilibrium look?

Even some Democrats might start echoing Rand Paul (R-KY) to remain in office. Personal finance guru Dave Ramsey says using cash triggers the pain centers of the brain while plastic hides the pain, and thus people spend significantly less when they use cash . Essentially, the medium and timeframe of payment changes people’s emotions, and thus people’s purchasing preferences. So too with taxes, the medium and method of payment changes our willingness to accept largesse. When people accustomed to refunds (and lulled into forgetting the withheld portion of their income exists) suddenly have to write multi-thousand dollar checks to the government each year, one suspects government spending and taxation would necessarily shrink.

Abraham Lincoln said, “The best way to get a bad law repealed is to enforce it strictly.”

Want to balance the budget and starve progressive pet projects of the funds necessary to their proliferation? Then expose the true cost of our politicians’ recklessness and let them suffer the inevitable electoral backlash. Make taxes hurt again.