The campaign rhetoric is heating up as we approach the 2014 mid-term elections, and candidates in several competitive Senate races are advocating for smaller, less intrusive government.  Sen. Mitch McConnellAddison (Mitch) Mitchell McConnellBiden: A good coach knows when to change up the team McConnell says he made 'inadvertent omission' in voting remarks amid backlash These Senate seats are up for election in 2022 MORE’s (R-Ky.) campaign in Kentucky is calling for reducing government spending. Businessman David Perdue (R) in Georgia is concerned about the national debt and calls for repealing and replacing the Affordable Care Act. Sen. Pat RobertsCharles (Pat) Patrick RobertsBiden remembers Dole as 'master of the Senate' at National Cathedral Bob Dole: heroic, prickly and effective McConnell gets GOP wake-up call MORE (R) of Kansas calls the current tax system “complex, burdensome, unfair, and inefficient, for both corporations and individuals.”

Sadly, small government reform is often talked about but rarely happens.  Instead, when faced with big failures, we typically get big “solutions” that include hopelessly complex new levels of regulation and bureaucracy such as the Dodd-Frank Act and the Consumer Financial Protection Bureau. The unintended consequences of such complicated pieces of legislation are almost impossible to calculate.


What might be an effective policy to reduce the size of government?  How could we get tax paying voters to demand that the federal government cut spending and devolve responsibilities to the states? Here is a simple but powerful suggestion--end the withholding of income tax payments.

Small business owners and sole proprietors make quarterly income tax payments. Large corporations have accounting departments to handle these payments, but for small businesses, it’s different. The owner is the person who actually writes the checks to the government. 

When a small business has a good earnings year, the following year begins painfully because the owner is strapped with paying higher quarterlies. Owners pray that they can earn enough just to make the quarterlies--enough to pay off the government and avoid trouble with the IRS.  

When a small business has a bad year, it comes as something of a relief because the owners know that their quarterlies will go down.  So, poor performance has a certain reward.  Talk about perverse incentives. Due to the pain inflicted by quarterly payments, small business owners - - especially new business owners - - quickly learn to hate quarterlies.

Why is there no such anger among other tax-paying voters?  The incentives for protesting taxes are all wrong because the costs are hidden and diffused. 

Most working people earn wages or salaries. According to the Bureau of Labor Statistics, about 104 million Americans were full-time wage and salary workers in 2013.  This is out of a total labor force of about 156 million people, and most taxpayers don't pay quarterlies.  

Instead, income taxes are withheld from their paychecks in modest amounts on a weekly or bi-weekly basis. Taxpayers are inclined to look at the bottom line and pay little attention to how much of their salary or wages are actually taken by government. It’s like money they never saw. The pain comes in one or two drops at a time -- not in a torrent each quarter.

It’s not always been this way. Withholding of income taxes began in World War II. The Roosevelt Administration wished to avoid the inflation that took place during and after World War I.  It made a determined effort to finance as much of the war as possible out of tax revenues.

Surprisingly, a young economist named Milton Friedman played an important role. He was an employee at the Treasury Department working with a small technical group to devise a plan to withhold income taxes from paychecks. Surprisingly, the IRS was actually opposed to the idea. 

Friedman said in Reason magazine, “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.”

Could we abolish withholding now?  You bet!  It would be a tough battle, no doubt. Both sides of the aisle would resist. But other tough measures have had success when taxpayers have finally had enough such as enacting term limits, eliminating ear marks, and cutting federal spending through sequestration

The new policy would be no more income tax withdrawals from paychecks. All taxpayers would pay quarterlies, and once people see how much they actually owe the government each quarter, there will be a tax rebellion that will make the Tea Party look like child’s play.

Schug, emeritus professor at the University of Wisconsin-Milwaukee, has written and edited over 200 articles, books, and national curriculum materials, including Economic Episodes in American History (Wohl Publishing).