Investor's Business Daily: Tax Day's Forgotten Lesson

Originally printed in Investors' Business Daily, April 15th, 2011

Monday is Tax Day, when we collectively "celebrate" the passage of the 16th Amendment.  If we want to identify a single catalyst for the growth of the federal government, this would be a prime candidate.

When the amendment was conceived, few could have imagined how dramatically it would empower the growth of government — and the extraordinary influence it would exert over economic growth and job-creation.

Passed on July 2, 1909, and ratified by the states on Feb. 3, 1913, the original targets of this amendment were the corporations and trusts of the day that had gained too much power at the expense of consumers and workers.

But once ratified, it was immediately utilized to tax individual income. The initial tax rate was 2%. Doesn't that sound quaint compared to today's top rate of 35%?

Like most creations of government, once initiated, the income tax had a strong propensity to grow. Over the years the rates increased to a high of 94% during World War II. John F. Kennedy realized the 90% top tax rate of his day was counter-productive, and led the effort to lower it to 70%. Ronald Reagan dramatically lowered this top rate to 28%, and for a brief period of time, we were actually 72% free.

Thousands of small- and medium-sized businesses — like the plastics manufacturing plant I formerly ran — were able to grow and create jobs under Reagan's favorable tax climate. This is the lesson that we seem to have forgotten. It is a lesson we need to relearn, and we had better relearn it quickly.

Small businesses are the engine of our economy and drive job growth. They create 64% of all net new jobs and produce 13 times as many patents as larger businesses per worker. Over half of private sector employees work for small businesses, and everyone benefits from their ingenuity and high-quality service.

Chances are you own a small business, work for one or have a family member or friend who does. Small businessmen and women run the manufacturing plant in the industrial park that employs local workers. They are the farmers who grow our food and the hardware store owner who helped fix that leaky roof.  If we're lucky, they include the computer-whiz down the block who may be the next Bill Gates.

Small businesses and their workers are especially hard-hit by high taxes. Every dollar of additional tax that a business pays is a dollar that cannot be spent on increased wages, health insurance, retirement savings, investment in equipment and the hiring of new workers.

All elected officials say they are working hard to create jobs. But politicians and governments don't create jobs — businesses do. Government can only maintain an environment that encourages entrepreneurs to invest and hire.

Instead, our government is producing more spending, more regulation, more taxes, bigger deficits and higher levels of debt. For the working people who run small businesses, Uncle Sam's policies do not inspire confidence. They inspire dread and create uncertainty. It is this uncertainty that is standing in the way of real economic growth.

Unfortunately, the Obama administration's solutions have centered on increasing the size of government and beating the drum for higher taxes on the "wealthy." Its definition of wealthy targets small businesses. Included in this category are 750,000 small businesses that employ 25% of American workers. These are firms that organize as sub-chapter "S" corporations and LLC's and report income and pay taxes at the individual rate.

Had the 2003 tax cuts been permitted to expire, many of these businesses — like mine — would pay taxes at a rate almost 15% higher than the corporate tax rate. These businesses are already paying close to 50% of their hard earned income to various levels of government. That's a lot of income that is not available for business expansion and job creation.

The lust for more tax revenue, debt and deficits measured in trillions, a sluggish economy and anemic job growth are all symptoms of the problem. They are not the root cause. The size, scope and cost of government is. This is the problem that needs to be addressed.

Which brings me back to my original point: the growth of government. In 1902, federal government spending was 2% of GDP, and largely reflected the vision of our Founding Fathers for limited government. Today, the federal government accounts for 25% of our economy, and has gone far beyond the constraints of the enumerated powers and its Constitutional authority.

The debate in Washington has at the very least shifted from spending increases to spending cuts. This is a start, but we have a long way to go. To restore the Founders' vision — and restore economic growth — we must begin now.

Mr. Johnson is a Republican senator from Wisconsin.