The Keys to the Kingdom: Income Tax and the State Evan Osborne

Wright State University Department of Economics

3640 Col. Glenn Hwy. Dayton, OH 45435

937 775 4599 (Phone) 937 775 2441 (Fax)

evan.osborne@wright.edu

May, 2002

"Congress will have to go slow in making appropriations unless the President is to be put in an embarrassing position. He will not want to increase the income tax, and if he had to do it would not hesitate ... to put the blame where it belonged. The provision will be a whip in the hands of the president to keep Congress toeing the mark of economy." - From a Washington Post editorial supporting the imposition of an income tax, 1909 (?)

One of the most striking economic phenomenon of the last century has been the

substantial growth, across a wide variety of jurisdictions, in the size of government. This

phenomenon has of course not gone unobserved. What has become known as “Wagner’s

law” states that all types of societies over time devote more resources to state activity.

An extensive empirical literature has developed on this topic, for which the canonical

paper is often said to be Peltzman (1980).

The focus of this literature has generally been to explain the rise of government

spending through measures of outputs – generally, examining the size of government

spending relative to the entire economy or population. However, thus far scholars have

not paid attention to the means of the ever-expanding state. Which measures taken by

governments to facilitate a more extensive public sector are the most effective enablers of

this seldom-disputed outcome? Answering this question would help to better understand

the precise dynamics of government growth, which would in turn enable citizens in a

particular society to understand where they are on that timeline.

This paper examines the relation of one particular method of revenue extraction to

such growth: the taxation of income. The widespread use of such taxation is relatively

new, and yet its existence has coincided strikingly with the dramatic growth in

government activity that occurred in the twentieth century. Despite this stylized

1

coincidence (in the literal sense of the word), no study of this relationship has been

conducted. To do so, this paper presents a brief history of income taxation in Section I.

In order to illustrate the tradeoff in choosing taxation instruments, it then presents in

Section II a model of endogenous taxation choice by a sovereign. Sections III and IV

contain empirical investigation of the relation between government size and introduction

of income taxation, and Section V interprets the results.

I. A (very) brief history of income taxation

The income tax has been, in the long span of history, a comparatively recent

development. Seligman (1970, p. 41) argues that up until the Middle Ages income was

not nearly as important an element of revenue as undefined “lucrative prerogatives of the

feudal lord.” To the extent that it was used, it was mostly vicariously via taxation on the

“faculty” of property, including human capital, corresponding to what economists today

would call its present value in exchange. Although nominally a property tax, income

earners paid what amounted to a tax of this sort on their productivity in market exchange,

with the tax being assessed proportionately to their earned incomes. The first recorded

instance of explicit income taxation occurred in several cities in northern Italy during the

Renaissance. The increased commercial activity in Florence in particular, combined with

the spread of more democratic governance, caused the government there in 1451 to

change a portion of its tax assessment from one based on property to one based on

income in the modern sense. More presciently than perhaps he knew at the time

2

Seligman, who would without foreseeing the parallel help craft the initial U.S. income-

tax laws a few years later, went on to observe:

“From the very outset, however, the political conditions were

unfavorable to efficient administration. In the struggle with the Medici the

assessment of the income tax became a favorite weapon of whatever party

happened to be in power; and at no other time in the world’s history

except, perhaps, in the later centuries of the decaying Roman Empire, was

there such an orgy of corruption and maladministration. In order to

ascertain the business profits, the books of the merchants were open to

inspection, and the assessors had practically unlimited scope in deciding

upon the amount of the levy. Individuals might compound with the

officials in a lump sum, and the frauds were accordingly overwhelming in

character. Everything was ruled by what as known as the arbitrio, that is,

the arbitrary judgment of the authorities, and the income tax was utilized

as the most potent engine of oppression or of favoritism.” (pp. 46-47)

Whether as a consequence of this evolution or not, the Florentine income tax thus

lasted, along with all direct taxation on wealthier citizens, only until the return of more

autocratic rule in the sixteenth century.

Income taxation was after this largely dormant until the nineteenth century. In the

United Kingdom, the first income tax was instituted in 1799, during the Napoleonic

Wars. This “temporary” income tax was finally reduced in 1842, but was never

3

repealed. In fact, abetted by the marginalist revolution and the concept of diminishing

marginal utility, the U.K. saw fit to introduce a progressive income tax in 1894 to pay for

modern battleships. It was, however, sometime after the initial British institution of the

tax before it spread permanently to the continent. The tumult of 1848 did lead to public

pressure to impose such taxes, but they were all eventually repealed. However, by the

end of the century governing sentiment had changed again, and so income taxation was

permanently established in Germany in 1891, Holland in 1892, Italy in 1894, Austria in

1896, Sweden in 1897, Denmark in 1903, Norway in 1905, and France in 1909. Among

the driving forces in this development were the increased need for arms spending after

the Franco-Prussian war and the increased public pressure for state welfare spending

(Webber and Wildavsky, 1986). Japan imposed income taxation in 1887, although it

would be many years before it was a significant source of revenue.

In the United States, efforts to impose income taxation at the state (or colonial)

level predate the Revolution. During the period of the Seven Years’ War, on nine

occasions the lower house of the Maryland legislature passed measures taxing incomes.

incomes over $1000 (?), a threshold affecting a very tiny proportion of the U.S.

population. However, in 1895, the U.S. Supreme Court, having upheld the Civil War tax

in Springer v. United States1, now held it unconstitutional as a direct tax that was not, as

Article I, Section 9 of the U.S. constitution required, levied in proportion to population.2

To remedy this, the sixteenth amendment to the Constitution was ratified in 1913, and the

income tax was permanently instituted in 1916. States had begun introducing income

taxation in 1911 (Wisconsin), and it was gradually instituted in most states over much of

the twentieth century. (See Table 1.) The Canadian federal income tax has a somewhat

similar history. As in the U.S., the income tax was instituted at the central level (in this

case for the first time) in 1917 to fund World War I efforts, although income taxation

already existed in some provinces.

II. The choice of tax instruments for a predatory state

The choice to introduce an income tax can easily be analyzed within a rational-

choice framework. Levi (1988) argues that a society’s tax structure is a function of

bargaining power between the ruler and the various types of ruled, of the transaction

costs of each type of tax (including collection costs and search costs for taxable

property), and of the underlying production technology and exchange opportunities,

which influence the revenue available from each taxation instrument. It is helpful to

investigate this tradeoff more thoroughly.

1. 102 US 586 (1881).

2. Pollock v. Farmers' Loan & Trust Co. 158 US 601 (1895) (Rehearing)

5

The model of the state that is chosen is a variant of the budget-maximizing

bureaucrat formulation of Niskanen (1971). In this case, the key decision-maker is not a

civil servant but the sovereign. He must choose a tax structure so as to maximize

revenue, knowing that those who are taxed will react rationally so as to optimally avoid

taxation. A ruler facing such a constraint will thus choose different instruments (e.g.,

income and sales) to the degree that citizens find it costly to avoid payment. It will be

simplest to assume that the sovereign can either tax money income earned in market

exchange or impose an excise tax on purchases of a consumption good.

A. Citizen optimum

Assume that there is a representative citizen who has the twice-differentiable,

strictly concave preferences u(x, e). x is a consumption good and e is leisure. x must be

purchased out of the income earned from labor, and this income has no other value. The

citizen has a time endowment of r, which must be allocated between labor and leisure.

In both his consumption and labor activities, the citizen has two choices: to

participate in the legal market and pay the assessed taxes, or to avoid them by

participating in the black market. Let the subscript 0 denote legally reported activity

subject to taxation, which I will refer to as revealed activity, and 1 denote black-market

activity. Revealed labor activity, before taxation, earns a return of w per unit, and black-

market labor activity earns a return f(w, l1), where f is strictly concave, f(w, 0) = 0 and

f(w, l1) < wl1 for all l1 > 0. Without an excise tax x can be purchased at a unit price of p.

When x is purchased on the black market it comes at a cost of C(p, x1), which is a strictly

6

convex function subject to similar restrictions, i.e. C(p, 0) = 0 and C(p, x1) > px1 for all x1

> 0.

Revealed and black-market purchases are thus perfect substitutes in consumption

but imperfect ones in purchasing, and black-market and revealed labor are imperfect

substitutes in the generation of income. The citizen must solve the following problem:

( )

( ) ( ) ( ) (.

,1,1..

,max

10

1010

10

relllwfwlxpCxtp

tsexxu

=+++−=++

+

τ ) (1)

t and J are the excise and income taxes, respectively, which are taken as given by

the citizen. Constructing the Lagrangean and taking the first-order conditions yields:

)1(00

tpxu

+=∂∂ λ , (2a)

11 xC

xu

∂∂

=∂∂ λ , (2b)

( )weu τλ −=∂∂ 1 , (2c)

1lf

eu

∂∂

=∂∂ λ , (2d)

along with the two constraints. The restrictions on C(.), u(.) and f(.) guarantee that an

interior solution will occur for any positive level of taxation.

7

B. Sovereign optimum

The FOCs in the prior section define a pair of reaction functions l1(J, w, p, r) and

1(t, w,

x p, r). By the implicit-function theorem and the concavity (convexity) of f (C), the

citizen will supply less revealed labor and purchase fewer revealed goods as the tax rate

on each increases. The task of the sovereign is to maximize revenue in light of these

constraints. He will solve the unconstrained optimization problem

( ) ( ) ( )( ) ( )( )τ

τττ,

,.,,.,..max 0011txgtxtgltx is −−+ . (3)

gs(.) and gi(.) are the administrative costs associated with sales and income

Cs

taxation, and are assumed to be strictly convex in the tax rates. The sovereign’s FO

are

tg

tx

x si

∂∂

=∂∂

+(.)

1 , (4a)

ττ ∂∂

=∂∂

−(.)1

1igl

l . (4b)

(4) implies a unique optimum for both taxation levels. In each case, there is a

tradeof

.

h

f in setting it between a greater revenue intake per unit of revealed commerce

(goods purchased or labor income earned) and a lower amount of revealed commerce

But unlike the conventional criticism commonly known as supply-side thinking, in whic

a greater tax rate on income leads to substitution toward leisure, here there is additional

8

substitution toward black-market activity. The magnitude of that substitution from an

infinitesimal change in the tax rate, i.e. ( )t

l∂

∂ .1 , depends by substitution using (2c) and

(2d) on the responsiveness of black-mar ome to higher black-market labor. The

more concave is f at the equilibrium, the more this black-market penalty from higher tax

rates will be. In general, the sovereign will raise more money (in absolute terms) from

income taxation as the productivity of black-market labor, i.e. the concavity of f(.) hence

its departure from wl as l expands, is lower, and will raise more money from excise

taxation as the cost of black-market purchases is farther removed from p.

ket inc

C. Interpretation in light of U.S. tax structure

In the U.S. tax rates tax revenues are greater from income than sales taxation at

the hig

ts,

for all

hest level of government. At the federal level in the U.S. there is no universal

sales tax, although there are excise taxes. The latter are only imposed on select produc

and in fixed monetary amounts rather than as percentages, but on some goods (especially

tobacco and liquor) they may amount to substantial percentages of the product’s after-tax

price. This is in contrast to federal income tax rates, which (according to the Tax

Foundation) have a top marginal rate of 39.1 percent and yield an average tax rate

who pay income tax of 14.4 percent. Sales tax rates in states are comparatively modest,

with no combined state and local sales tax rates in excess of eleven percent as of 2001,

roughly equivalent to income tax rates, which typically have multiple brackets, with no

top rate higher than eleven percent.

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As for tax revenue, for the U.S. federal government in 2000 income tax revenues

were over 58 percent of total tax revenue, while excise taxes were less than four percent.

At the state level, according to the Tax Foundation, in 1999 income taxes were 40.6

percent of all state tax revenue, while sales taxes were 33.2 percent. This is the combined

sum for all fifty states, including the five that have no sales tax and the five that have no

income tax. Of the remaining 40 states and the District of Columbia, 33 of them derive

more revenue from income than sales taxes. State income and sales tax rates are listed in

Table 2, and the revenue from each type of taxation is listed in Table 3.

There are thus two patterns worthy of note. First, the federal government and

most states rely on income taxes as the largest source of revenue. Second, the federal

government, which in some sense has first claim on tax design under the U.S. federal

structure, is the level of government at which this reliance is most pronounced. Together,

these findings provide at least an inference that income taxation may be the most

lucrative source of revenue for a taxing government, at least in the U.S.

III. Income taxation and federal government spending in the United States

Several time series illustrate the remarkable change in U.S. federal-government

revenue after the implementation of the income tax. Table 4 shows the percentage of

total federal government revenues derived from customs, excise, employment and

individual and corporate income taxes since 1792. Once introduced, income taxes soared

immediately, before being modestly dislodged in share terms by the growth of

employment-based taxes in the 1950s and 1960s, mostly to fund Social Security and later

10

Medicare. Individual income taxes in particular now account for almost half of federal-

government revenue, and individual and corporate income taxes are almost sixty percent.

Figure 1 depicts the growth in the logarithm of real per capita federal government

spending from 1850-2000. Also included is the trend line derived from conducting a

naïve regression, i.e. one measuring only the relation between spending and elapsed time,

of this value on the years 1850-1916. The estimated equation for this period is

LOGG = 3.36627 + 0.01444 t, (5)

where t is the years elapsed since 1850 (R̄2 = 0.2652) . This implies that, even ignoring

the other factors that might account for government growth, per capita spending has a

natural momentum of growth of roughly 1.44 percent prior to the introduction of the

income tax. As can be readily seen from the figure, growth in government spending after

1916 is greater than before. In fact, running the same regression for the period 1917-

2000 yields

LOGG = 5.38516 + 0.04199 t, (6)

with R̄2 = 0.8210. Thus, particularly in the period in which income taxation exists, the

naïve model performs surprisingly well in explaining the growth of government

spending. (6) implies an annual growth rate of government spending of roughly 4.20

percent, roughly three times as high as the rate without an income tax. A Chow test

11

performed with sub-samples of 1850-1916 and 1917-2000 yields a test statistic for a

structural break at this time of F = 43.20292 (p < 0.01).

Defense and non-defense spending

However, the fact that the income tax was introduced in 1916 means there is one

powerful contrary hypothesis for the differential growth rate that must be considered.

1917 was the year the U.S. entered the First World War, and a case can certainly be made

that this conflict was a watershed event with respect to the U.S.’s role in the world.

While the American colonial experience, and hence engagement with the larger world,

went back at least to the taking of Spanish colonies during the Spanish-American war, it

was the Great War that first drew American soldiers overseas to fight a war that had

begun without them, and which launched a long ongoing era in which U.S. national

interests were defined around events all over the world. If Versailles set the stage for

World War II, which in turn set the stage for the Cold War, with its concomitant massive

projection of U.S. military might around the world, then perhaps the rise in government

spending after 1916 was primarily a function of the wider role the U.S. began to take in

the world after that time. Perhaps the income tax was even seen as necessary to support

the imminent entry into the war.3

To assess this possibility, Figures 2 and 3 show the same growth rate for the

logarithms of both real per capita defense and non-defense spending for the same period.

3. Of course, it might also be possible that the U.S. refrained from becoming involved in

European affairs until the income tax was in place.

12

In fact, the structural break in 1917 is far more pronounced for non-defense than for

defense spending. In Figure 2, defense spending, the naïve model estimated for 1850-

1916 and applied to 1917-2000 is again depicted, along with actual logarithmic per capita

defense spending. Figure 3 depicts the same data and result for non-defense spending,

exclusive of interest on the national debt. For defense spending the estimations for 1850-

1916 and 1917-2000, respectively, are

LOGGDEF = 2.35425 + 0.01202 t, (1850-1616, R̄2 = 0.1102) (7a)

LOGGDEF = 4.25697 + 0.04198t. (1917-2000, R̄2 = 0.5483) (7b)

For non-defense spending, the results are

LOGGNON = 2.17585 + 0.02543t, (1850-1916, R̄2 = 0.5962) (8a)

LOGGNON = 4.50194 + 0.04698t. (1917-2000, R̄2 = 0.9165) (8b)

Only in the case of non-defense spending before 1917, when the permanent

defense establishment was much smaller, is the adjusted R2 low. Otherwise, the naïve

model does strikingly well both in explaining spending growth and in demonstrating a

difference between the period before and after 1916. The rise in the rate of growth in

spending is substantial for both defense and non-defense spending. In both cases, the

introduction of the income tax is associated with a rise in annual spending to in excess of

13

four percent. The simple test does not allow refutation of the idea that the increase in

U.S. defense spending is caused by considerations external to the introduction of the

income tax (e.g., exogenous historical events such as the rise of fascism and

communism), but the corresponding rise in non-defense spending suggests that even if

this hypothesis is true income taxation nonetheless precedes a higher rise in domestic

spending for reasons, presumably, unrelated to such external geopolitical considerations.

IV. The income tax in American states

It is also possible to examine the effect of the introduction of the income tax in a

cross-sectional/time-series environment. Such an analysis is possible because states

introduced income taxes at different times, as noted in Table 1.

Accordingly, the relation of state-government spending both to the presence of

income taxation and to several variables important in the literature on the growth of

government is examined. The variables are for the years 1961, 1971, 1981, and 1991.

There are assumed to be fixed effects throughout, so that ordinary least squares provides

a BLUE estimator. The left-hand panel of Table 5 contains the results for the estimation

of the following equation:

LOGTE = a + b INCOME + c POP + d TAX + e URBAN

LOGTE is the natural logarithm of total expenditure by the state government, net

of revenue received from the federal government. INCOME is personal income, which

14

has universally been found to be correlated with higher government spending as a share

of gross national products in cross-national studies (e.g., Erlich and Lui, 1999; Peltzman,

1980), and URBAN is the percentage of the state’s population that lives in urban areas, as

defined by the U.S. Bureau of the Census. This variable has at least once been found to

be a significant explanatory variable for national-government spending (Kau and Rubin,

1981). These variables all come from the Statistical Abstract of the U.S. (various years).

Finally, TAX is a dummy variable that takes a value of one if the state has any income

tax, corporate or individual, in effect at the time of the observation.4

Per capita income is positively related at a highly significant level to the amount

of government spending, a result that is in agreement with the growth-of-government

literature. Population is of course positive at a highly significant level, a result that

would be in agreement with almost any theory of endogenous government. The urban

population is also significant. However, the presence of income taxation also yields, with

a high degree of confidence, faster growth in government spending independently of

these factors.

The results for total revenue collected by state governments, depicted in the right-

hand column of Table 5, are similar. The dependent variable is the natural logarithm of

revenue collected by state governments. The results are all the same in terms of signs

and statistical significance for coefficients, but the overall performance of the model, as

mstate governmDetail15Tvail2 Tmupon request.) 0 322 0 Tw 12.Arti

presence of income taxation at the state level does promote a greater degree of

government spending and revenue. The next section explores some reasons why this

might be true.

V. The power of income taxation

Why does income taxation appear to be such an effective stimulus to the growth

of government spending? The model suggests that the key question is the relative

balance between the concavity of f(.), the returns to black-market labor, the convexity of

C(.), the cost of purchasing the consumption good in the black market, and the

administrative costs of each system. If income taxation opens the door to substantially

more government spending, then citizens must have less room to maneuver around an

income tax than a sales tax.

At first glance the balance would seem to favor sales or excise taxation. While

under an income-taxation citizen each citizen must be monitored, in a sales-tax system

only the points of sale need be. However, there are several reasons why the income tax

might be more efficient in terms of minimizing tax evasion. First, while each person

carries out large numbers of purchases at multiple retail establishments, because of the

gains to specialization most people earn their wage income from a small number of

sources, often only one. Since many firms are employers of significant numbers of

people economies of scale may thus obtain. Still, there is no obvious candidate from the

available data. The U.S. Small Business Administration estimates there are between 13

million and 16 million businesses in the U.S., most of which would presumably be

16

required to participate in a general federal sales tax. Only 5.4 million of these have

employees, and so administering an income-based tax is perhaps less burdensome from

that point of view. On the other hand, there are many sources of income other than

wages, and so over time the U.S. Internal Revenue Service has found it necessary to

begin monitoring the payment of dividend and interest income, which presumably raises

administrative costs significantly.

However, income taxation has one virtue that sales taxation does not:

withholding. Twight (1995) describes the efforts to sell withholding to a reluctant public.

The policy was adopted in 1943, as World War II raged, and was sold as a way for

citizens to pay their taxes “promptly” (rather than, as might be more accurately said,

“early”). The need to move to withholding was acute because the expansion of the

income range subject to the tax meant that returns were pouring in to the federal

government, substantially raising administrative costs along with worries about

compliance. To ease the way, Congress was during the debate on the legislation very

concerned about terminology. Representative Willis A. Robertson (D-VA) objection to

the prevailing term “forced savings,” saying that “the word ‘forced’ is not a euphonious

name,” and suggesting that it “would be much better if we should call it ‘Victory

savings,’ or something of that kind” (U.S. House Hearings 1942 Vol. 1: 108). The term

“war tax” was also tossed around approvingly.

In any event, withholding was adopted, and there are a variety of reasons for

supposing that the system greases the skids for an expansion of income taxation, most of

which have to do with the voluminous literature on framing effects (e.g., Kahneman and

Tversky, 1990). Withholding creates a framework in which, for most taxpayers, money

17

is received as a “refund” in the middle of the year, instead of being paid out in its entirety

as an “expense” on the date the taxes are due. While the responsiveness of agents in

economic and psychological experiments to such framing considerations has been amply

documented, no one has carried out such work in the income-tax context. And yet, the

reliance of most governments that rely heavily on income taxation is suggestive in this

regard. Still, the power of income taxation relative to other tax bases has yet to be

adequately tackled.

Conclusion

The evidence linking the introduction of income taxation to a larger government

is significant. However, the analysis has several deficiencies that should be overcome in

future work. The most substantial is that the analysis is only performed within the U.S.,

owing primarily to the absence of long time series on government spending in other

countries. While the strength of the empirical tests conducted in an environment of

comparatively fine gradations of government expenditure within the U.S. (as opposed to

across a wide variety of countries) is in some sense a measure of the findings’ robustness,

it would be nonetheless certainly be worthwhile to come up with other ways to compare

the response of state size to the introduction of income taxation in an international

context. It seems to be a stylized fact that the reliance on income taxes is proportionally

less in Europe, owing primarily to the widespread use there of value-added taxation. At

the same time, the U.S. is famed internationally for its relatively low rate of income-tax

evasion. In a number of countries in Europe and Latin America (indeed, throughout the

18

developing world), in contrast, tax evasion is something of a national pastime.5 This

empirical regularity suggests two further avenues of inquiry. First, it raises the question

of whether changes in tax structure can be explained, at least at the point of adoption, as

endogenous responses to differences in the technology of tax evasion, as suggested in the

model. Second, there is also a possibility of a path-dependence effect, in which the

marginal benefit to the sovereign of changing the tax structure depends on the existing

tax-enforcement apparatus. In such a more sophisticated environment, the tax structure

that might be revenue-maximizing if it could be costlessly adopted at the moment is not

because of the precommitment to the existing tax structure, with all of the costs already

sunk into the existing enforcement techniques. Finally, some more thought about the

advantages of a particular tax base for a revenue-maximizing government deserve

thought.

References

Crowe, Rev. Martin T. The Moral Obligation of Paying Just Taxes. Catholic

University of America Studies in Sacred Theology No. 84 (1944).

Davis, Henry. Moral and Pastoral Theology (7th edition). New York: Sheed and

Ward, 1958.

5. Webber and Wildavsky note in their analysis of tax evasion in “Latin nations” (p. 549)

that L’Osservatore Romano had at one point declared that tax evasion was not a sin. The

theologian Henry Davis (1958) makes a prisoners’ dilemma argument against declaring

evasion sinful, and numerous other such theological arguments are found in Martin T.

Crowe (1944). The general theology of tax evasion is summarized in Mcgee (1998).

19

Erlich, Isaac and Lui, Francis T. “Bureaucratic Corruption and Endogenous

Economic Growth.” Journal of Political Economy 107 (1999): S270-S293.

Kahneman, Daniel and Tversky, Amos. “Rational Choice and the Framing of

Decisions.” In Margaret Levi, ed., The Limits of Rationality. Chicago: University of

Chicago Press, 1990, 60-89.

Kau, James B. and Rubin, Paul H. “The Size of Government.” Public Choice 37

(1981): 261-274.

Levi, Margaret. Of Rule and Revenue. Berkeley: University of California Press,

1988.

Mcgee, Robert W. “When Is Tax Evasion Unethical?”. In Robert W. Mcgee, ed.,

The Ethics of Tax Evasion. South Orange, N.J.: Dumont Institute for Public Policy

Research, 1998, 5-35.

Niskanen, William A. Jr. Bureaucracy and Representative Government.

Chicago: Aldine-Atherton, 1971.

Peltzman, Sam. “The Growth of Government.” Journal of Law and Economics

23 (), Oct. 1980, 209-287.

Seligman, Edwin R.A. The Income Tax: A Study of the History, Theory and

Practice of Income Taxation at Home and Abroad. New York: Augustus M. Kelley

Publishers, 1970.

The Tax Foundation, http://www.taxfoundation.org/collectionsbytypeoftax.html.

Twight, Charlotte. “Evolution of Federal Income Tax Withholding: The

Machinery of Institutional Change.” Cato Journal 14 (3), Winter 1995,

20

Webber, Carolyn, and Wildavsky, Aaron. A History of Taxation and

Expenditures in the Western World. New York: Simon and Schuster, 1986.

21

22

23

24

Table 1 Date of introduction of state income taxes

State Individual Corporate State Individual Corporate Alabama 1933 1933 Texas none none Alaska 1959 1959 Utah 1931 1931 Arizona 1933 1933 Vermont 1931 1931 Arkansas 1929 1929 Virginia 1961 1915 California 1935 1937 Washington none none Colorado 1937 1937 West Virginia 1961 1967 Connecticut 1992 1915 Wisconsin 1911 1911 Delaware 1917 1957 Wyoming none none Florida none 1971 Georgia 1929 1929 Hawaii 1959 1959 Idaho 1931 1931 Illinois 1969 1969 Indiana 1963 1963 Iowa 1934 1934 Kansas 1933 1933 Kentucky 1936 1936 Louisiana 1934 1934 Maine 1969 1969 Maryland 1937 1937 Massachusetts 1916 19191 Michigan 1967 1967 Minnesota 1933 1933 Mississippi 1912 1921 Missouri 1917 1917 Montana 1933 1917 Nebraska 1967 1967 New None 1971 Hampshire New Jersey 1976 1958 New Mexico 1933 1933 New York 1919 1917 North Carolina 1921 1921 North Dakota 1919 1919 Ohio 1971 1971 Oklahoma 1915 1931 Oregon 1939 1955 Pennsylvania 1971 1951 Rhode Island 1971 1947 South Carolina 1922 1922 South Dakota none none Tennessee none 1923 TN and NH tax dividends only; coded as zero. Michigan has “single business tax, ” a value-added tax. This tax is coded as a 1. It was enacted in 1976 to consolidate several business taxes, including a corporate income tax.

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Table 2

State tax rates (percent, as of Jan. 1, 2001) State Ind. Income Sales State Ind. Income SalesAlabama 2.0-5.0 4.0 South Dakota None 4.0 Alaska None None Tennessee None 6.0 Arizona 2.87-5.04 5.0 Texas None 6.25 Arkansas 1.0-7.0 5.125 Utah 2.3-7.0 4.75 California 1.0-9.3 7.0 Vermont 24.01 5.0 Colorado 4.63 2.9 Virginia 2.0-5.75 4.5 Delaware 2.2-5.95 None Washington None 6.5 Florida None 6.0 West Virginia 3.0-6.5 6.0 Georgia 1.0-6.0 4.0 Wisconsin 4.6-6.75 5.0 Hawaii 1.5-8.5 4.0 Wyoming None 4.0 Idaho 2.0-8.2 5.0 Illinois 3.0 6.25 Indiana 3.4 5.0 Iowa 0.36-8.98 5.0 Kansas 3.5-6.45 4.9 Kentucky 2.0-6.0 6.0 Louisiana 2.0-6.0 4.0 Maine 2.0-8.5 5.0 Maryland 2.0-4.8 5.0 Massachusetts 5.6 5.0 Michigan 4.2 6.0 Minnesota 5.35-7.85 6.5 Mississippi 3.0-5.0 7.0 Missouri 1.5-6.0 4.225 Montana 2.0-11.0 None Nebraska 2.51-6.68 5.0 Nevada None 6.5 New Hampshire None None New Jersey 1.4-6.37 6.0% New Mexico 1.7-8.2 5.0 New York 4.0-6.85 4.0 North Carolina 6.0-7.75 4.0 North Dakota 2.67-12.0 5.0 Ohio 0.691-6.98 5.0 Oklahoma 0.5-6.75 4.5 Oregon 5.0-9.0 None Pennsylvania 2.8 6.0 Rhode Island 25.51 7.0 South Carolina 2.5-7.0 5.0 1. Percentage of federal tax liability.

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Table 3 Revenue from Sales and Income Taxation (Percent, Fiscal Year 2000)

State Sales Income Alabama 32.2 42.0 South Dakota 52.6 4.9 Alaska None 30.8 Tennessee 57.4 6.2 Arizona 44.8 34.8 Texas 51.1 0 Arkansas 35.0 35.1 Utah 35.8 45.9 California 28.0 55.1 Vermont 14.6 32.4 Colorado 26.1 56.1 Virginia 19.5 58.5 Delaware 0.0 45.7 Washington 61.6 0 Florida 60.5 4.8 West Virginia 27.4 35.4 Georgia 34.3 52.4 Wisconsin 27.7 51.7 Hawaii 46.1 34.2 Wyoming 38.3 0 Idaho 31.4 45.9 Illinois 28.1 43.4 Indiana 35.4 46.3 Iowa 33.2 40.6 Kansas 35.8 43.9 Kentucky 28.2 39.1 Louisiana 31.6 27.7 Maine 31.8 46.1 Maryland 24.1 48.8 Massachusetts 22.1 64.1 Michigan 33.7 42.1 Minnesota 27.9 47.6 Mississippi 49.5 26.2 Missouri 32.5 44.5 Montana 0 36.6 Nebraska 34.5 44.1 Nevada 52.2 0 New Hampshire 0 3.9 New Jersey 30.4 47.1 New Mexico 40.1 27.8 New York 20.5 62.2 North Carolina 22.1 53.1 North Dakota 28.2 23.6 Ohio 31.8 45.1 Oklahoma 24.6 39.8 Oregon 0 68.9 Pennsylvania 31.4 37.7 Rhode Island 30.5 44.0 South Carolina 38.5 41.9 Source: http://www.taxfoundation.org/collectionsbytypeoftax.html

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Table 4 Federal revenue from various sources, 1792-2000 (percent)

Year Customs Ind. income Corp. income Total income Excise 1792 93.8 0 0 0 0 1800 83.7 0 0 0 0 1820 83.9 0 0 0 0 1840 69.3 0 0 0 0 1860 94.8 0 0 0 0 1880 55.9 0 0 0 36.1 1900 41.1 0 0 0 50.1 1920 4.8 7.0 7.0 14.0 13.5 1940 6.7 19.1 22.3 41.4 36.6 1960 1.2 44 23.2 67.2 12.5 1980 1.4 47.2 12.5 59.7 4.7 2000 01 48.6 9.8 58.5 3.5 1. Less than 0.1 percent.

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Table 5

State regression results

State expenditures State revenues

Variable Coefficient Coefficient

INTERCEPT 19.52552*** 19.64908***

(75.32927) (93.84031)

INCOME 0.00546*** 0.008913***

(3.984535) (7.827386)

POP 1.8E-07*** 1.7E-07***

(16.02303) (18.0513)

TAX 0.371788** 0.10311**

(2.916188) (3.267808)

URBAN 0.924589* 0.643841*

(2.356536) (2.011754)

R̄2 = 0.701968 R̄2 = 0.770249

F = 116.4118*** F = 166.5239***

N = 197 N = 199

Note: *** denotes significance at 0.1-percent level.

** denotes significance at one-percent level.

* denotes significance at five-percent level.

Note: Figures in parentheses are t statistics.

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