Wednesday, August 12, 2009

Is tax withholding bad for democracy?

Charles Murray thinks the answer is yes.

In his Wall Street Journal op ed, Charles Murray proposes that our democracy would be better off if everyone just wrote checks four times a year for estimated taxes, instead of having taxes withheld from their wages. He'd also eliminate payroll taxes earmarked for Social Security and Medicare and fold them into the income tax.

The article begins: "Tax Withholding Is Bad for Democracy
So is the payroll tax. End them both and voters will have a healthier understanding of the government burden."

Murray spells out how his proposal would work as follows:

Fold payroll taxes into the personal tax code, adjusting the rules so that everyone still pays the same total, but the tax bill shows up on the 1040. Doing so will tell everyone the truth: Their payroll taxes are being used to pay whatever bills the federal government brings upon itself, among which are the costs of Social Security and Medicare.

The finishing touch is to make sure that people understand how much they are paying, which is presently obscured by withholding at the workplace. End withholding, and require everybody to do what millions of Americans already do: write checks for estimated taxes four times a year.

Both of those simple changes scare politicians. Payroll taxes are politically useful because low-income and middle-income taxpayers don't complain about what they believe are contributions to their retirement and they think, wrongly, that they aren't paying much for anything else. Tax withholding has a wonderfully anesthetizing effect on people whose only income is a paycheck, leaving many of them actually feeling grateful for their tax refund check every year, not noticing how much the government has taken from them.

But the politicians' fear of being honest about taxes doesn't change the urgent need to be honest. The average taxpayer is wrong if he believes the affluent aren't paying their fair share—the top income earners carry an extraordinary proportion of the tax burden. High-income earners are wrong, too, about being exploited: Take account of payroll taxes, and low-income people also bear a heavy tax load.

The behavioral economics research on tax salience suggests that he's right that people would have a greater realization of their true tax burden if they wrote quarterly tax checks rather than just having the tax money disappear from their paychecks before it ever even got to them.

I can tell you for sure that most people I encounter, whether friends, relatives, co-workers, or our VITA site clients, do not fully realize the magnitude of the taxes they pay.

When April 15 looms, they mostly focus on the refund or the balance due, with little awareness of the total amount of taxes they've paid through withholding. (That goes especially for their employer's share of payroll taxes for Social Security and Medicare, a cost which is invisible to many people, but which most economists believe is ultimately borne by the workers in the form of wages that are lower than they would otherwise be.)

I have a lot of concerns about the practicality of having everyone pay estimated taxes instead of withholding. For example, there are many taxpayers who are among the "unbanked" or the "underbanked," who do not have checking accounts. Some use money orders to pay their bills and sending four quarterly payments would be an added expense for them. Managing their budgets to accumulate the money needed for quarterly payments would be a challenge for many, especially those without bank accounts. Given how complicated our tax system is, many taxpayers would also have trouble computing even a ballpark figure for their quarterly estimated payments, and a number of them would probably wind up paying added fees to a tax pro to help them figure their estimated taxes correctly.

On the other hand, the withholding formulas built into the current system don't work all that well either, especially for people with multiple jobs or certain kinds of widely varying income streams, not to mention the AMT and the kiddie tax.

Of course, tax simplification could go a long way to simplify both the withholding system and the estimated tax computations!

But the Murray proposal doesn't address the simplification question at all. In fact, he seems to want to preserve the complexity of the current system, since he writes that the 1040 should be revised so that everyone would still pay the same total of income tax and payroll tax that they currently pay.

Postscript: Charles Murray doesn't mention, but presumably knows, that a famous conservative economist (someone I imagine he greatly admires) ironically played a major role in introducing withholding in the first place. See comments for more details.


  1. Believe it or not, conservative economist Milton Friedman played a major role in originating our system of payroll tax withholding, though he later regretted it.

    Friedman: I was an employee at the Treasury Department. We were in a wartime situation. How do you raise the enormous amount of taxes you need for wartime? We were all in favor of cutting inflation. I wasn't as sophisticated about how to do it then as I would be now, but there's no doubt that one of the ways to avoid inflation was to finance as large a fraction of current spending with tax money as possible.

    In World War I, a very small fraction of the total war expenditure was financed by taxes, so we had a doubling of prices during the war and after the war. At the outbreak of World War II, the Treasury was determined not to make the same mistake again.

    You could not do that during wartime or peacetime without withholding. And so people at the Treasury tax research department, where I was working, investigated various methods of withholding. I was one of the small technical group that worked on developing it.

    One of the major opponents of the idea was the IRS. Because every organization knows that the only way you can do anything is the way they've always been doing it. This was something new, and they kept telling us how impossible it was. It was a very interesting and very challenging intellectual task. I played a significant role, no question about it, in introducing withholding. I think it's a great mistake for peacetime, but in 1941-43, all of us were concentrating on the war.

    I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now.

  2. The source of the Friedman quote above was an interview published in Reason, available on-line at