In 1939, on the eve of the defense buildup preceding the entry of the United States into World War II, only one American in twenty was an income taxpayer or the dependent of an income taxpayer. (1) By the end of the war in 1945, 74.2% of the population was covered by the income tax. (2) The wartime conversion of the income tax from an elite tax to a mass tax is arguably the most important moment in the history of the federal income tax; it is rivaled only by the creation of the tax in 1913.
Although some form of mass federal taxation was imperative for the financing of the war, a mass income tax was not inevitable. But for the intransigent opposition of the Roosevelt Administration, Congress would almost certainly have enacted a federal retail sales tax during the war--perhaps in addition to the conversion of the income tax to a mass tax, but perhaps as the only form of mass taxation aimed at paying for the war. Although both the general public and opinion leaders supported a wartime sales tax, and although Congress several times came close to enacting such a tax, Congress could not overcome the opposition of President Franklin Delano Roosevelt and his Treasury Department.
The President's hostility to a sales tax was puzzling. He objected to a sales tax on distributional grounds, yet the combined distributional impact of a class income tax and a retail sales tax need not have differed significantly from the distributional impact of the mass income tax, which the President supported. The wartime federal tax structure, as shaped by the Roosevelt Administration's opposition to a sales tax, has endured. The federal income tax remained a mass tax after the end of the war and remains a mass tax today, and the United States has never adopted a federal retail sales tax (or value-added tax (VAT)).
Part II of this article describes the wartime debates among proponents of different methods of federal mass taxation--conversion of the income tax to a mass tax, enactment of a federal retail sales tax, or both. Following the presentation of that history, part III explores a counterfactual question: How differently would the wartime and postwar federal tax structures have developed if Roosevelt had not blocked the enactment of a sales tax? The only answer that can be given with a high level of confidence is that Congress would have enacted a sales tax at some point during World War II. It is not clear whether that sales tax would have been in addition to, or instead of, the conversion of the income tax from a class tax to a mass tax. It is also not clear whether, if the United States had emerged from World War II with a two-tax structure--consisting of a retail sales tax and a class income tax--that structure would have endured to the present day.
The persistence of the two-tax structure seems sufficiently plausible, however, to motivate the counterfactual question posed by part IV: On the reasonable assumption that the distributional impact at war's end of a retail-sales-tax-plus-class-income-tax would not have differed significantly from the distributional impact of the actual mass income tax, how great would have been the practical difference during the subsequent decades between the actual mass income tax and the alternative two-tax system? This question has relevance beyond the attempt to discern the long-term impact of Roosevelt's opposition to a retail sales tax. There is interest today in the possibility of returning the federal income tax to its prewar status as an elite tax and introducing a federal VAT to replace the revenue lost by narrowing the scope of the income tax. The analyses presented in part IV should be useful in predicting the long-term collateral consequences of the adoption of such a proposal, as well as in evaluating the lasting effects of the actions of the Roosevelt Administration. Part IV concludes that the use of the mass income tax rather than a two-tax system has made a significant difference in several areas, including the distribution of the benefits of postwar tax cuts and the burdens of postwar tax increases; public perceptions of the nature of the relationship between taxpayers and the federal government; the proliferation of tax subsidies targeted at particular categories of nonbusiness expenditures, ranging from first-time homebuyers to hybrid cars; income support for low-wage workers with dependent children; and federal policy toward homeownership. …