Investment Income Withholding in the United States and Germany

In a reversal from its historical roots, the United States income tax system now taxes income from labor significantly more heavily than income from capital. It does so not only facially, through explicit preferences for income from capital, but also more subtly, through more hidden features of the tax system - specifically, enforcement strategies. This Article focuses on a prominent disparity in enforcement between the two forms of income: Wage income is subject to withholding while investment income is not. In its critical examination of this disparity, the Article first offers a brief history of withholding in the United States, in which withholding on wage income was eagerly embraced as a part of a patriotic war effort, while withholding on investment income was rejected again and again. The Article then contrasts the United States experience with that of Germany. Under Germany's remarkably robust constitutional principle of equality in taxation, the failure to withhold on interest income was held unconstitutional, and the German legislature was required to enact it. However, instead of leading to greater equality in tax enforcement, the new withholding law led to widespread evasion. The German experience is cited as a cautionary tale on the dangers of international tax competition. Yet, ultimately, it may prove to have been the tipping point for countries to engage in the cooperative behavior needed to overcome undesirable tax competition. The last Part of the Article draws upon lessons learned from past U.S. and German experiences to make the normative and practical case that now is the time to adopt investment income withholding in the United States.