Legal & Compliance

Why the Tax Code Was Written for Owners, Not Employees

The tax code is one of the most consequential documents most people will never read. Understanding how income tax

By Malvin Simpson

May 22, 2026

Why the Tax Code Was Written for Owners, Not Employees

The tax code is one of the most consequential documents most people will never read. Understanding how income tax works in practice, as opposed to in principle, requires looking at who the code was originally built for, how it expanded, and what structural advantages it still preserves for those who earn through ownership rather than employment.

For business owners, the process works differently. The structure of the tax code, built over more than a century of legislation, lobbying, and wartime emergency, treats income from employment and income from ownership as fundamentally different things. The differences are not accidental. They reflect choices made at specific moments in history about who was expected to pay, how much, and on what terms.

It Started as a Tax on the Wealthy

To understand how income tax works today, it helps to know who it was originally designed to reach. The modern income tax did not begin as something that affected ordinary workers. The United States ratified the 16th Amendment in 1913, establishing Congress’s permanent authority to levy an income tax. The initial rates were modest: one per cent on incomes above three thousand dollars, rising to a maximum of seven per cent on incomes above five hundred thousand dollars. At those thresholds, only around three per cent of American households were liable at all.

Britain had arrived at a similar point decades earlier, making its wartime income tax permanent in 1842. Germany followed in the 1870s and 1880s. In each case, the income tax emerged as a tool for extracting revenue from accumulated wealth rather than from wages. The workers of the industrial era were not the original targets. The wealthy were.

That changed with war.

Wartime Expanded the Base

In 1939, approximately five per cent of American workers paid income tax. The Second World War changed that figure permanently. The Revenue Act of 1942, introduced to fund the war effort, brought income tax to roughly seventy-five per cent of the workforce. It was described at the time as a mass tax, which was an accurate description of what it was.

The more consequential change came the following year, and it fundamentally altered how income tax works for wage earners. In 1943, the Current Tax Payment Act introduced mandatory withholding from wages. Before that, workers received their full gross pay and settled their tax bill later. Withholding reversed the arrangement entirely. The government took its share before the worker ever touched the money. The gross wage became a number on a form. The net became reality.

As one analysis of the period described it, withholding changed the psychology: the money never felt like it belonged to the worker in the first place. Introduced during wartime, when political opposition to new burdens could be framed as unpatriotic, the change was designed to make tax collection invisible and routine. It succeeded. By the end of the war, employers were withholding more than ten billion dollars annually from American wages. The mechanism has not fundamentally changed since.

The Structural Advantage of Ownership

The most revealing way to understand how income tax works is to compare what counts as taxable income for an employee against what counts for a business owner. The employee and the business owner both pay income tax. The difference is in what counts as income.

An employee is taxed on gross earnings. The money arrives, the government takes its portion, and whatever remains is available to spend. There is no deduction for the cost of getting to work, for the clothes required to do the job, for the meals consumed during the working day, or for the professional development that keeps the employee employable. These are personal expenses, not business ones, and the tax code treats them accordingly.

A business owner is taxed on net profit. Revenue comes in, legitimate expenses are deducted, and tax is applied to what remains. The rent on the office, the vehicle used for work, the equipment purchased to run the operation, the meals taken with clients, the cost of a home office: all of these reduce the taxable base before the government’s calculation begins. The owner is taxed on what is left after the business has been run. The employee is taxed on what arrived before they spent anything at all.

This is not a loophole. It is the architecture of the code itself.

Capital Gains and the Second Advantage

Beyond deductions lies a further structural preference for ownership: the treatment of capital gains. It is the second place where how income tax works diverges sharply depending on the source of that income.

When an employee earns income through labour, that income is taxed at ordinary rates, which in the United States currently run as high as thirty-seven per cent at the federal level. When an owner sells an asset held for more than one year, the gain is taxed at preferential capital gains rates of zero, fifteen, or twenty per cent depending on income. The lower an individual’s reliance on wages and the greater their reliance on appreciating assets, the lower their effective tax rate is likely to be.

The pass-through deduction introduced under the 2017 Tax Cuts and Jobs Act added another layer. Owners of qualifying businesses can deduct twenty per cent of their qualified business income before calculating their tax liability, effectively reducing the top applicable rate from thirty-seven per cent to around twenty-nine point six per cent. Employees have no equivalent.

Section 179 of the tax code allows business owners to deduct up to two and a half million dollars in qualifying asset purchases in the year those assets are placed in service, rather than depreciating them over time. A business owner who purchases equipment, vehicles, or property can reduce taxable income immediately and substantially. An employee who purchases a work laptop with personal funds cannot.

What the Code Reflects

None of this emerged from a single decision or a single legislature. The tax code accumulated over more than a century, shaped at each stage by the political economy of the moment. The wartime expansion of taxation to ordinary wages was driven by necessity. The preferential treatment of capital and business income reflects the sustained influence of those who benefit from it, and whose interests have been consistently represented in the legislative process.

The result is a system in which the method of earning income matters more than the amount. Two people earning the same gross figure in a given year will pay different effective rates depending on whether they earn through employment or ownership. The employee’s tax is collected before the money arrives. The owner’s tax is calculated after the business has had its first claim on revenue.

The code does not prohibit wage income. It simply taxes it more thoroughly, more immediately, and with fewer opportunities for reduction. How income tax works is not a mystery. It is a set of decisions, made over more than a century, about whose income deserves the most friction. The question of whether that constitutes fairness is a political one. The question of whether it is structural is not.