Wednesday, March 19, 2014

A Brief History of Tax Deductions

The American health care system is a puzzle you cannot understand unless you understand how income taxes worked from 1945 to 1987. This is not a topic most children learned at their mother's knee, since only the top earners ("the 1%," as we now know them) had to pay the top rates. If your grandfather was a multi-millionaire and a story-teller, you can skip the next three paragraphs. If you're like the rest of us, read on...

America won World War II by out-producing every other nation on the planet. By the end of the war, we were rolling one new ship out every day. But all that production cost money, and the money came from taxes--graduated income taxes that took more from people who made more. The top earners in 1944 paid 94% of each additional dollar in federal income taxes.

We don't talk much about this astonishingly high level of taxation nowadays, but I was reminded of it recently as I have been reading through the "Nero Wolfe" detective stories. Nero Wolfe is an obnoxious, overweight, orchid-growing genius who hates to work and never leaves his Manhattan home on business. Rex Stout, who wrote the Wolfe books, published his first detective story in 1933 and then turned out two or three books a year for decades. Reading all the Wolfe books in order is like reliving an entire generation of urban life, death... and taxes.

One gets to know a lot about taxes in the books. Wolfe only works when he has to, and charges "obscene" fees for his services. But he hardly ever takes a job in the last part of the year--as soon as he reaches the top bracket, he pretty much refuses to work.

Not all American workers after World War II were obese neurotic millionaires, but many people in the workforce had the same problem--the more they earned, the less they kept. Union members fought for higher wages, only to find a great big hole in their paycheck when they took it home. Labor and management put their heads together and discovered a loophole that would let them keep more of their money out of the hands of the government--instead of paying more in wages (which would be taxed), companies started providing health insurance benefits (which were not taxed). This made sense for top executives, who only took home pennies from each additional dollar, and it made sense for union members, too.

With business and labor both firmly in favor of tax-free employer-provided health insurance, Congress chose to leave the loophole open, and most of country ran right through it. The vast majority of Americans get their health insurance from their employer nowadays, even though the original reason for doing so has all but disappeared. The top tax rates are under 40% now, and half of all Americans pay nothing at all in federal income tax.

Congress "created" our current system of employer-provided health care by doing nothing while American ingenuity figured out how to save money despite the tax laws. I am now predicting five more years of political gridlock on the health care front--enough time for a whole new generation of Americans to figure out how to stay healthy and save money all over again.

1 comment:

  1. Wait -- the tax history I learned at MY dad's knee, had me thinking that WWII wages were frozen to prevent wartime inflation hurting the economy for everyone, and so the health insurance benefit workaround was a recruiting tool some businesses used to compete with each other for select workers while so many were in the military. It didn't affect enough people to warp national policy until the government (Congress) did act overtly, more than a decade later, to make the cost of providing that benefit tax-deductible to the business! I don't remember dear old dad teaching me that the business lobby thought that up for themselves and got Congress to make it so, never mind labor -- just like today! -- but if gambling winnings weren't taxable as income either, I'd take that bet. ;)