Knowledge base / Mechanisms
Taxation as the Second Extraction Layer
The Argument in One Paragraph
Inflation is the first extraction layer. Direct taxation is the second. The two were ratified into US law in the same calendar year, 1913, and they have functioned as a single integrated apparatus ever since. The income tax permits the state to claim a rising share of nominal earnings. The central bank permits the state to spend more than it claims, by issuing debt that the bank itself monetises. The new money raises asset prices and consumer prices. Wage earners chase the price level upward into higher tax brackets. Asset holders who realise gains pay tax on the nominal appreciation, most of which is currency debasement, not real wealth. The proceeds service the debt the central bank originated. The loop closes. This document traces every link in that loop with primary sources, then quantifies what it has cost the median citizen between 1913 and 2026.
The Pairing of 1913: Sixteenth Amendment and Federal Reserve Act
The Sixteenth Amendment was certified as ratified by Secretary of State Philander C. Knox on 25 February 1913, three weeks after the thirty sixth state (Delaware) ratified on 3 February 1913. The amendment reads in full: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” Source: US House of Representatives, Office of the Historian, “The ratification of the 16th Amendment,” https://history.house.gov/Historical-Highlights/1901-1950/The-ratification-of-the-16th-Amendment/ ; National Archives, https://www.archives.gov/milestone-documents/16th-amendment .
The Federal Reserve Act was passed by the House on 22 December 1913, by the Senate on 23 December 1913, and signed by President Wilson the same day. Source: Federal Reserve History, “Federal Reserve Act Signed into Law,” https://www.federalreservehistory.org/essays/federal-reserve-act-signed ; Pub. L. 63 to 43, 38 Stat. 251.
Two foundational changes to the American fiscal architecture, ratified ten months apart, in a single calendar year, after a half century in which neither had existed. The 1894 Wilson to Gorman income tax had been struck down as unconstitutional in Pollock v. Farmers’ Loan and Trust Co., 157 U.S. 429 (1895). A central bank had been twice attempted (1791 to 1811; 1816 to 1836) and twice allowed to expire, most famously after Andrew Jackson’s veto of recharter in 1832.
Was the 1913 pairing design or coincidence? The 1910 Jekyll Island meeting that drafted what would become the Federal Reserve Act was attended by Senator Nelson Aldrich, Henry Davison of J.P. Morgan, Frank Vanderlip of the National City Bank, Paul Warburg of Kuhn, Loeb, and A. Piatt Andrew, then Assistant Secretary of the Treasury. Vanderlip’s own memoir admits the secrecy: “There was an occasion, near the close of 1910, when I was as secretive, indeed as furtive, as any conspirator.” Source: Frank A. Vanderlip with Boyden Sparkes, From Farm Boy to Financier (New York: D. Appleton Century, 1935), pp. 210 to 219. The Federal Reserve’s own institutional history acknowledges Jekyll Island as the planning meeting for the Aldrich Plan, the immediate precursor of the Federal Reserve Act. Source: Federal Reserve Bank of Atlanta, “Jekyll Island and the Creation of the Federal Reserve,” https://www.atlantafed.org/about/publications/economy-matters/banking-and-finance/2015/12-jekyll-island-and-creation-of-federal-reserve .
The political coalition that wanted a permanent central bank also wanted a permanent income tax, for the simple reason that one cannot operate at scale without the other. A central bank that monetises sovereign debt requires a sovereign with a taxable income stream large enough to service that debt. A federal government taxing personal income at any meaningful rate requires a banking apparatus that can absorb the resulting fiscal flows and lend back when revenue falls short. The two institutions are halves of one mechanism.
The original income tax was, by the standards of what would follow, ornamental. The Revenue Act of 1913 (the Underwood Simmons Tariff Act) imposed a 1 percent tax on personal incomes above $3,000 (about $94,000 in 2024 dollars) with a graduated surtax rising to 7 percent on incomes above $500,000 (about $15.6 million in 2024 dollars). Roughly 1 percent of the US population owed any tax at all. Source: IRS, “History of the U.S. Tax System,” https://www.irs.gov/about-irs/history-of-the-irs ; Tax Foundation, https://taxfoundation.org/data/all/federal/historical-income-tax-rates-brackets/ . Within thirty years it was the central revenue tool of the United States government, claiming a top marginal rate of 94 percent and reaching every wage earner in the country.
Tax Rate Growth: The Top Marginal Bracket, 1913 to 2024
The path from a 7 percent ceiling on millionaires to a withholding tax on every paycheck is documented in the statutes themselves. The table below gives the statutory top marginal rate on ordinary personal income at federal level, in selected years.
| Year | Top federal marginal rate | Notes |
|---|---|---|
| 1913 | 7% | Revenue Act of 1913, applied above $500,000 (~ $15.6M in 2024 dollars) |
| 1916 | 15% | Revenue Act of 1916, war preparation |
| 1917 | 67% | War Revenue Act of 1917 |
| 1918 | 77% | Revenue Act of 1918, peak WWI rate, applied above $1,000,000 |
| 1925 | 25% | Revenue Acts of 1924 and 1926, Mellon tax cuts |
| 1932 | 63% | Revenue Act of 1932, Hoover, deficit response |
| 1936 | 79% | Revenue Act of 1936, New Deal |
| 1941 | 81% | Revenue Act of 1941 |
| 1944 | 94% | Individual Income Tax Act of 1944, peak WWII rate, applied above $200,000 |
| 1952 | 92% | Revenue Act of 1951, Korean War |
| 1964 | 77% | Revenue Act of 1964, Kennedy Johnson cut |
| 1965 | 70% | Revenue Act of 1964 phased fully in |
| 1981 | 70% | Last year before Reagan cuts |
| 1982 | 50% | Economic Recovery Tax Act of 1981 |
| 1986 | 50% | Final year before Tax Reform Act of 1986 |
| 1988 | 28% | Tax Reform Act of 1986, lowest postwar rate |
| 1993 | 39.6% | Omnibus Budget Reconciliation Act of 1993 |
| 2003 | 35% | Jobs and Growth Tax Relief Reconciliation Act of 2003 |
| 2013 | 39.6% | American Taxpayer Relief Act of 2012 |
| 2018 | 37% | Tax Cuts and Jobs Act of 2017 |
| 2024 | 37% | Tax Cuts and Jobs Act of 2017 (sunset 2026) |
Source: Tax Foundation, “Historical Federal Individual Income Tax Rates and Brackets, 1862 to 2021,” https://taxfoundation.org/data/all/federal/historical-income-tax-rates-brackets/ ; Internal Revenue Service Statistics of Income, “Personal Exemptions and Individual Income Tax Rates, 1913 to 2002,” https://www.irs.gov/pub/irs-soi/02inpetr.pdf .
These figures are federal and statutory only. Once a citizen is also paying state income tax (top rate 13.3 percent in California, 10.9 percent in New York), payroll tax, capital gains tax, estate tax, sales tax, property tax, and excises on fuel, alcohol, and tobacco, the total tax wedge on a high earner in a high tax state can exceed 50 percent of marginal income. The headline rate is the small part of the story.
Effective Rates and the Total Tax Burden as Share of GDP
The shift from ornamental to comprehensive shows up most clearly when one stops looking at marginal rates and looks at total taxes collected as a percentage of national income.
| Year | Federal receipts % GDP | Federal+state+local % GDP | Sources |
|---|---|---|---|
| 1900 | ~3.0% | ~6 to 7% | OMB historical tables; Tax Foundation historical |
| 1913 | ~1.8% | ~6 to 8% | OMB Table 1.2; pre 16th Amendment baseline |
| 1929 | ~3.7% | ~10% | OMB Table 1.2; BEA NIPA |
| 1944 | ~20.5% | ~25% | OMB Table 1.2, peak WWII |
| 1950 | ~14.2% | ~22% | OMB Table 1.2 |
| 1970 | ~18.4% | ~28% | OMB Table 1.2 |
| 2000 | ~19.9% | ~33% | OMB Table 1.2 |
| 2024 | ~17.5% | ~30 to 32% | OMB Table 1.2; OECD revenue statistics |
Sources: Office of Management and Budget, Historical Tables, Table 1.2, https://www.whitehouse.gov/omb/historical-tables/ ; Tax Foundation, https://taxfoundation.org/ ; OECD, “Revenue Statistics, United States,” https://www.oecd.org/tax/ ; Bureau of Economic Analysis, NIPA Tables 3.1 and 3.2, https://www.bea.gov/ . Pre 1929 estimates are reconstructed from Treasury annual reports.
The level shift between 1913 and 1944 is greater than the entire previous history of the republic. The federal receipt share rose roughly elevenfold in thirty one years. The total government share moved from a single digit fraction of GDP, comparable to eighteenth century England, to nearly a third, comparable to peak medieval European tithe and tax loads.
For the median household, the effective federal income tax rate has risen from essentially zero in 1913 (the median household earned far less than the $3,000 exemption) to roughly 13 percent in 2024 once payroll taxes are included. The Congressional Budget Office estimates the average federal tax rate for the middle income quintile at approximately 13.5 percent in 2021. Source: Congressional Budget Office, “The Distribution of Household Income, 2021,” https://www.cbo.gov/publication/59509 . Adding state income tax, property tax, sales tax, and excises, the total tax burden on a median American household runs in the range of 28 to 35 percent of gross income, depending on state. In 1900 the equivalent figure was on the order of 7 percent. The citizen of 2024 works approximately one full quarter of every year for the state, before any private rent, food, or healthcare cost.
Bracket Creep: The Stealth Tax of Inflation
Statutory marginal rates are politically visible. Inflation interacting with unindexed brackets is invisible. Between 1913 and 1985 the United States made no automatic adjustment of tax brackets for inflation. A worker whose nominal wage rose with the consumer price index, leaving real income exactly unchanged, was pushed into higher brackets year after year. The mechanism became severe during the 1970s, when CPI inflation averaged 7.1 percent per year and the consumer price index roughly doubled between 1972 and 1981.
The Economic Recovery Tax Act of 1981 included a provision (effective 1985) to index personal exemptions, the standard deduction, and the bracket boundaries to the consumer price index. Source: Tax Foundation, https://taxfoundation.org/ ; IRS Revenue Procedure announcements for annual bracket adjustments. Even after 1985 the indexation has been imperfect. The Tax Cuts and Jobs Act of 2017 changed the inflation index used for brackets from the standard CPI to the chained CPI (C-CPI-U), which rises more slowly because it captures consumer substitution between goods. The substitution lowers measured inflation by approximately 0.25 percentage points per year on average. Source: Bureau of Labor Statistics, “Chained Consumer Price Index,” https://www.bls.gov/cpi/additional-resources/chained-cpi.htm . The 0.25 point gap, compounded over decades, produces a steady upward drift in effective rates that is real but unannounced. Capital gains brackets, the Alternative Minimum Tax exemption (until 2017), the Social Security earnings cap, and many state income tax brackets are not indexed at all, or are indexed on slower formulas. Each gap converts currency debasement directly into a higher tax bill, without any vote in Congress.
Capital Gains Tax on Nominal Gains, Not Real Gains
The most arithmetic of the inflation taxes is the federal capital gains tax. The tax is levied on the nominal difference between sale price and purchase price (the “basis”). Inflation between purchase and sale is not deducted from the gain. The taxpayer pays tax on currency debasement as if it were real wealth.
A worked example. A household buys a home for $200,000 in 1995 and sells it in 2024 for $500,000. The nominal gain is $300,000. The federal long term capital gains rate (above the IRC Section 121 exclusion of $250,000 single, $500,000 joint, set in 1997 and unindexed since) plus the 3.8 percent net investment income tax applies. State capital gains taxes apply on top, with no exclusion in most states. The Bureau of Labor Statistics CPI all urban consumers index stood at 152.4 in 1995 and approximately 313.7 in mid 2024, a ratio of about 2.06. Source: BLS CPI, https://www.bls.gov/cpi/ . The 1995 purchase price in 2024 dollars is approximately $412,000. The real gain is therefore $500,000 minus $412,000, or about $88,000. The household sold for a real gain of $88,000 but is taxed (subject to the exclusion) on a nominal gain of $300,000. Most of the taxed gain is monetary debasement, not real appreciation.
The same arithmetic applies to long held stock positions, business equity, collectibles, and any capital asset held long enough for inflation to compound. The Tax Foundation has documented the mechanism in detail in “Inflation and the Capital Gains Tax,” https://taxfoundation.org/research/all/federal/inflation-capital-gains-taxes/ . Their estimate is that during high inflation periods more than half of reported capital gains are pure inflation, with no underlying real return. The homeowner, the small business owner, and the long term equity investor are in the structural position of paying tax on the very debasement that the central bank produces.
The Spread of Value Added Tax Across the OECD
The income tax was the twentieth century innovation in the United States. VAT was the parallel innovation in the rest of the OECD. France introduced VAT in its modern form in 1954 (Maurice Lauré, La Taxe sur la Valeur Ajoutée, Paris: Recueil Sirey, 1953). Germany replaced its cumulative Umsatzsteuer with the non cumulative Mehrwertsteuer on 1 January 1968 (BGBl. I S. 545). The United Kingdom introduced VAT on 1 April 1973 at 10 percent on accession to the EEC (Finance Act 1972). Japan introduced consumption tax on 1 April 1989 at 3 percent. Australia introduced GST on 1 July 2000 at 10 percent. The United States is the only OECD country without a federal VAT or GST as of 2026.
Standard VAT rates in major OECD economies as of 2024:
| Country | Standard VAT rate | Year introduced |
|---|---|---|
| France | 20% | 1954 |
| Germany | 19% | 1968 |
| United Kingdom | 20% | 1973 |
| Italy | 22% | 1973 |
| Spain | 21% | 1986 |
| Netherlands | 21% | 1969 |
| Sweden | 25% | 1969 |
| Denmark | 25% | 1967 |
| Norway | 25% | 1970 |
| Japan | 10% | 1989 |
| Australia | 10% | 2000 |
| Canada | 5% federal GST plus provincial | 1991 |
| United States | none federally; state sales taxes 0% to 7.25% | n/a |
Source: OECD, “Consumption Tax Trends 2022,” https://www.oecd.org/tax/consumption/consumption-tax-trends-19990979.htm ; European Commission, “VAT rates applied in the Member States of the European Union, 2024 update,” https://taxation-customs.ec.europa.eu/document/download/ . Standard rates have crept upward over time. The UK rate has moved from 10 percent at introduction to 20 percent currently. The German rate has moved from 10 percent at introduction to 19 percent. The Japanese rate has moved from 3 percent to 10 percent.
VAT is collected at every stage of production and embedded in the final consumer price; the consumer typically does not see the rate broken out. It is structurally regressive: lower deciles spend a larger fraction of income on consumption than upper deciles, who defer consumption into savings and assets. It compounds with the income tax. A citizen earns a wage taxed at a marginal income rate, then spends what remains at a price already inflated by VAT. The total wedge between an hour worked and a unit of real consumption can exceed 50 percent in high VAT, high income tax jurisdictions.
Payroll Taxes: The Half Hidden Layer
The Social Security Act was signed by President Franklin Roosevelt on 14 August 1935. The original payroll tax was 1 percent on the employee plus 1 percent on the employer, on wages up to $3,000 per year. Source: Social Security Administration, “Historical Background and Development of Social Security,” https://www.ssa.gov/history/briefhistory3.html ; Pub. L. 74 to 271, 49 Stat. 620. Medicare was added in 1965 under Title XVIII. The combined FICA rates as of 2024:
- 6.2 percent employee + 6.2 percent employer = 12.4 percent on wages up to $168,600
- 1.45 percent employee + 1.45 percent employer = 2.9 percent on all wages, no cap
- 0.9 percent additional Medicare on wages above $200,000 (single) / $250,000 (joint), employee only
Total FICA on a wage at or below the cap is 15.3 percent of gross. Source: Social Security Administration, “Contribution and Benefit Base,” https://www.ssa.gov/oact/cola/cbb.html . The legal incidence is split between employee and employer. The economic incidence, in the consensus of labour economics, falls almost entirely on the employee, because the employer offers a wage net of the employer share. The employee sees only half the deduction on the pay stub, but pays both halves in foregone wages. Source: Congressional Budget Office, https://www.cbo.gov/ .
Social Security and Medicare combined raised approximately $1.6 trillion in payroll taxes in fiscal 2024, roughly equal to all federal income tax receipts that year. Source: OMB Historical Table 2.1, https://www.whitehouse.gov/omb/historical-tables/ . The half hidden character of payroll taxation has allowed governments across the OECD to extract a far larger share of labour income than the headline income tax rate suggests.
Property Tax: Perpetual Rent to the State
Property tax is the principal local revenue source in most OECD jurisdictions. Median effective property tax rates by US state run from 0.28 percent of assessed value in Hawaii to 2.49 percent in New Jersey, with a national median around 1.0 to 1.1 percent of market value annually. Source: US Census Bureau, American Community Survey; Tax Foundation, “Property Taxes by State 2024,” https://taxfoundation.org/data/all/state/property-taxes-by-state/ .
A homeowner who has paid off the mortgage continues to owe property tax in perpetuity. Failure to pay results, in every US state, in a tax lien and eventually a forced sale. The implication is direct: in the post 1913 architecture, no citizen owns property in the strong sense. Every citizen rents from the local government, in perpetuity, at a rate set unilaterally by the assessor. Property tax assessments rise with nominal property values, so a homeowner whose home appreciates 50 percent in nominal terms over a decade, with no real wealth gain after CPI, pays approximately 50 percent more property tax each year on a constant real asset. The mechanism is bracket creep, applied to land.
VAT and Sales Tax: Regressive Impact by Decile
Lower income households spend a larger fraction of income on consumption; higher income households save and invest a larger fraction. A flat rate consumption tax therefore extracts a larger fraction of income from lower deciles. The Institute on Taxation and Economic Policy estimates that in the United States, state and local sales and excise taxes claim approximately 7.1 percent of income from the lowest income quintile, 4.7 percent from the middle quintile, and 1.0 percent from the top 1 percent. Source: ITEP, “Who Pays? 7th Edition,” 2024, https://itep.org/whopays/ ; Center on Budget and Policy Priorities, https://www.cbpp.org/ .
A consumption tax is regressive in incidence even when flat in rate, because consumption is a larger share of income at the bottom. Combined with a payroll tax that is regressive above the cap and property taxes that hit homeowners regardless of cash flow, the bottom half of the income distribution often pays a larger total tax share than the top decile pays in income tax alone.
The Inflation Tax: Seigniorage Both Formal and Deep
Seigniorage in the narrow sense is the profit a central bank earns on the difference between the cost of producing money (essentially zero for keystrokes) and its issue value. The Federal Reserve remits operating profits to the US Treasury annually. Remittances averaged approximately $80 billion to $100 billion per year in normal pre 2022 years and reached $109 billion in 2021 at the peak of QE holdings. Source: Federal Reserve, “Income and Expenses,” https://www.federalreserve.gov/aboutthefed/income-and-expenses.htm . Following the 2022 to 2023 rate increases, the Fed went into operating loss because it pays interest on bank reserves at the policy rate while earning fixed coupons on longer dated holdings; 2023 remittances to Treasury were effectively zero and a “deferred asset” exceeding $200 billion accumulated on the Fed’s books. Source: Federal Reserve H.4.1.
Formal seigniorage is a small fraction of the deep inflation tax. The deep inflation tax is the loss of purchasing power suffered by every holder of currency, every holder of a dollar denominated checking account, every holder of a fixed coupon bond, every recipient of a fixed nominal pension. If broad money grows at 7 percent per year and the holder’s claim earns 2 percent, the holder loses 5 percent of real wealth per year, automatically and silently. Aggregated across the entire stock of dollar denominated claims (roughly $20 trillion of US M2 in 2024 plus a far larger stock of dollar bonds and pensions globally), the annual real loss runs in the trillions of dollars in years of significant inflation. Source: Federal Reserve M2 series via FRED https://fred.stlouisfed.org/series/M2SL ; BIS “Global Liquidity Indicators,” https://www.bis.org/statistics/gli.htm . The recipients are the borrowers (chiefly the federal government) and the first receivers of new money (the asset markets, see Cantillon file). The bond holder, the saver, and the pensioner are the source of the transfer. The Treasury and downstream spending recipients are the destination.
Government Spending Growth as Share of GDP
The other half of the loop is the spending side. Tax revenue is one of two ways a government finances spending. Debt is the other. Debt requires a buyer. The buyer of last resort, in a fiat credit system, is the central bank. The growth of government spending relative to national income is the demand side that the inflation and tax loop is sized to meet.
| Year | US federal outlays % GDP | Total government (fed+state+local) % GDP |
|---|---|---|
| 1900 | ~2.5% | ~6 to 7% |
| 1913 | ~2.0% | ~6 to 8% |
| 1929 | ~3.1% | ~10% |
| 1933 | ~7.9% | ~17% (Depression peak) |
| 1944 | ~41.9% | ~46% (WWII peak) |
| 1950 | ~15.6% | ~22% |
| 1970 | ~18.7% | ~30% |
| 1990 | ~21.2% | ~33% |
| 2000 | ~17.7% | ~32% |
| 2009 | ~24.4% | ~40% (financial crisis) |
| 2020 | ~30.8% | ~44% (COVID) |
| 2024 | ~24% | ~36% |
Source: Office of Management and Budget, “Historical Tables, Table 1.2,” https://www.whitehouse.gov/omb/historical-tables/ ; USGovernmentSpending.com historical compilations; OECD General Government Spending series. The federal share moves from approximately 2 percent to approximately 24 percent over the century covered. The total government share, which is the more honest measure because it captures the cost the citizen actually bears, moves from approximately 6 percent to approximately 36 percent. The state has, in real terms, become roughly six times larger relative to the economy in the post 1913 era than it was before.
Public Debt Growth
Tax revenue has not kept pace with spending in any sustained way since 1929. The gap is closed by debt issuance. Federal debt outstanding, at face value:
| Year | Federal debt (face) | Approximate share of GDP |
|---|---|---|
| 1913 | $2.9 billion | ~3% |
| 1919 | $25.5 billion | ~33% (post WWI peak) |
| 1929 | $16.9 billion | ~16% |
| 1945 | $260 billion | ~117% (post WWII peak) |
| 1971 | ~$398 billion | ~36% |
| 1981 | ~$998 billion | ~31% |
| 2000 | ~$5.7 trillion | ~55% |
| 2008 | ~$10.0 trillion | ~68% |
| 2020 | ~$27.7 trillion | ~127% |
| 2024 | ~$35.5 trillion | ~123% |
Source: US Treasury, “Historical Debt Outstanding,” https://fiscaldata.treasury.gov/datasets/historical-debt-outstanding/ ; Federal Reserve Bank of St. Louis FRED series GFDEBTN https://fred.stlouisfed.org/series/GFDEBTN and GFDEGDQ188S for debt to GDP.
Each new tranche of debt requires a buyer. The Federal Reserve, via direct purchase between 2008 and 2014 (QE1, QE2, QE3) and again between 2020 and 2022, expanded its holdings of Treasury and agency securities from approximately $0.5 trillion in 2007 to approximately $5.5 trillion at the 2022 peak. Source: Federal Reserve H.4.1 and FRED series WALCL https://fred.stlouisfed.org/series/WALCL . The institution that issues the currency holds the largest single block of the debt denominated in that currency. The same income tax revenue services the interest. The two functions of the 1913 architecture are operationally inseparable.
Debt Service Now Exceeds Defense Spending
The Congressional Budget Office estimates net interest on the federal debt at approximately $880 billion in fiscal 2024, projected to rise to $1.7 trillion per year by 2034 under current law. Source: CBO, “The Budget and Economic Outlook: 2024 to 2034,” https://www.cbo.gov/publication/59710 . Net interest in 2024 exceeded all federal defense spending (approximately $824 billion in outlay) for the first time since the 1990s. Source: CBO Monthly Budget Review, FY 2024.
Debt service is non discretionary; it must be paid to avoid default. As it rises, the share of tax revenue available for any other purpose falls. The state’s reliance on continued debt issuance, and on continued central bank willingness to absorb that issuance, deepens. The loop tightens.
The Two Extraction Loop in One Diagram
The loop, written as a sequence of mechanical steps:
- The federal government runs a structural deficit. Spending exceeds tax revenue every year except a handful (1998 to 2001 is the only modern surplus stretch).
- The Treasury auctions debt to fund the deficit.
- The Federal Reserve, directly through QE or indirectly by setting the policy rate that anchors the entire yield curve, ensures that primary dealers can absorb the issuance at a yield the Treasury can afford. New base money is created in the process.
- The new money raises asset prices and consumer prices, on the Cantillon order documented in the previous file. Real wages stagnate or decline against asset prices.
- Wage earners receive nominal wage increases that drift them upward through tax brackets (bracket creep). Their effective tax rate rises with no real income increase.
- Asset holders who realise gains pay capital gains tax on the nominal appreciation, most of which is currency debasement.
- Property owners pay rising property tax assessments on rising nominal valuations.
- Tax revenue rises. Some of that revenue services the interest on the debt issued in step 2.
- Spending continues to exceed revenue. The next deficit is funded by the next tranche of debt. Return to step 2.
Each pass through the loop ratchets two quantities upward simultaneously: the total tax burden on the citizen and the total nominal debt of the state. The first is observable on the citizen’s pay stub and tax return. The second is observable in the Treasury’s daily debt outstanding statement. Both have grown by more than an order of magnitude in real terms since 1913.
Historical Comparison: The American Republic Before 1913
Before 1913 the American federal government operated on tariffs (customs duties on imports) and excises (chiefly on alcohol and tobacco). Federal expenditure ran at approximately 2 to 3 percent of GDP in peacetime. There was no permanent income tax. The 1894 Wilson to Gorman tariff act had imposed a 2 percent tax on incomes above $4,000, and the Supreme Court struck it down in Pollock v. Farmers’ Loan and Trust Co. (1895) on the grounds that a direct tax must be apportioned among the states by population. The Sixteenth Amendment was drafted specifically to overturn Pollock. The Civil War income tax of 1861 to 1872 had been temporary and was allowed to expire. The Spanish American War excises of 1898 were rolled back. The pre 1913 default was a federal government living on tariffs, with citizens not in any continuous documented relationship with a federal tax authority. Source: Internal Revenue Service, “Brief History of IRS,” https://www.irs.gov/about-irs/brief-history-of-irs .
There had been two prior central banks. The First Bank of the United States (chartered 1791, expired 1811) and the Second Bank (chartered 1816, vetoed in recharter by Andrew Jackson in 1832, expired 1836). From 1837 to 1913, a span of seventy six years, the United States operated without a central bank. The currency was specie or specie backed; banking was state regulated. The period included completion of the transcontinental rail network, the Homestead Act, and a roughly fivefold increase in real GDP per capita, alongside the panics of 1837, 1857, 1873, 1893, and 1907 which were the political pretext for the 1913 reform. Source: Murray Rothbard, A History of Money and Banking in the United States (Auburn: Mises Institute, 2002), https://mises.org/library/history-money-and-banking-united-states-colonial-era-world-war-ii .
The 1913 architecture (income tax plus central bank plus permanent deficit) is therefore a single integrated system, ratified in a single year, after a long historical period in which none of its elements existed permanently in the United States. It is one mechanism in three statutes.
Closing Note
Other files in this knowledgebase document the inflation half of the extraction. This file documents the tax half. Neither half functions alone. A government with a central bank but no income tax cannot service the resulting debt and must default within a generation. A government with an income tax but no central bank cannot run sustained deficits. Combined, the two institutions allow indefinite deficit spending, indefinite debt accumulation, indefinite tax extraction on rising nominal incomes, and indefinite asset price inflation that creates further taxable nominal events.
The 1913 design has now run for one hundred and thirteen years. The federal debt has grown by a factor of roughly twelve thousand in nominal terms ($2.9 billion to $35.5 trillion). Total government expenditure has grown from approximately 6 percent of GDP to approximately 36 percent. The dollar has lost approximately 97 percent of its 1913 purchasing power against the CPI and approximately 99 percent against gold. The median citizen works about a quarter of every working year for the state in direct tax, plus a further share for the inflation tax that does not appear on any return.