FREE ESSAY ON HISTORY OF THE INCOME TAX

HISTORY OF THE INCOME TAX

The federal progressive income tax has been an issue that has been argued on the floors of
Congress, in front of the United States Supreme Court, in front of television cameras,
and around the dinner table. The tax served its purpose in supplementing revenue during
the Civil War and World War I, but continued taking from Americans' income in peacetime,
allowing fewer dollars to be spent on goods and services. When the American government
was in a deficit, it was harder to argue for the abolishment of the income tax, but now
that Congress is looking at a government surplus for the first time in decades, the
question is raised again: Do we have to have a progressive federal income tax?
Prior to the Civil War, the vast majority of government funds came from tariffs on
imports. The only exception was during the War of 1812, when blockades by the British, as
well as the war being with the young country's number one trade partner, lowered income
from tariffs. Government revenues were accompanied by funds from the sale of public
lands, such as the Louisiana Territory and the Oregon Country, as well as excise taxes,
which were introduced during the War of 1812 (Hansen 62).
As Abraham Lincoln, who once said "that he had no money sense and never enough money to
fret him, came into office with a national debt of nearly $75 million and 
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little to no inflow of customs duties, as well as an outflow of investments to foreign
countries by investors who feared war. After attempts to raise money by selling bonds,
doubling tariffs, increasing excise taxes, and creating license fees, it was realized
that another form of tax was needed (Paul 7-8, Witte 67).
The details of the tax, however, were not agreed on easily. The tax was originally
proposed to tax land in each state, with revenue to be handed out according to
population. The idea of this tax created a "congressional rebellion," led by the South
and West, because money from their land would go to states in the Northeast (Witte 68).
The land tax shortly fell apart, and an income tax was proposed to the floor of the House
of Representatives, enclosing "a tax of three percent on all incomes over $600 a year"
(68). The Senate passed a bill asking for a five percent tax on all income over $1000 a
year on the same day. The Conference Committee came up with a three percent tax on annual
incomes over $800 and the first income tax was born (68).
The tax was not progressive, and it was also not implemented. By 1862, the tax was
altered by setting progressive rates "at three percent on incomes between $600 and
$10,000; five percent between $10,000 and $50,000; and 7.5 percent over $50,000" (68).
The progressive rates were not, however, set for "redistributing income from higher to
lower income classes" or to distribute taxes "across the population in such a way as to
cause the least hardship (Davies 21, 77). The progressive rates were set simply to raise
more income (Witte 69).
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The income tax, along with other efforts to raise revenue in wartime, were repealed
almost immediately after Lee's surrender at Appomattox Court House. The cries for income
tax repeal came strongest from the Northeast, who as a region paid a much higher
percentage into the tax than other parts of the country. The progressive structure was
dropped for a flat tax in 1867, and the entire tax was repealed in 1872. Although
disliked by Northeastern states and California, who voted 61-14 as a group in favor of
repeal, the income tax, according to Randolph Paul, "produced needed revenue at a
critical period of American history when other revenue-raising methods would have
probably failed" (29). Paul also points out that tax revenue accounted for 25 percent of
government expenditures in 1864 and 1865, compared to only ten percent in 1862, the first
full year of the income tax (29).
For more than twenty years, Congress turned to tariffs and excise taxes to again be the
primary sources of government revenues. Cries for the return of the income tax continued
inside and outside of government, but efforts were voted down by the Republican majority
in Congress, saying that additional revenue was not needed due to already existing
surpluses in the budget. Those surpluses not only existed, but they soared about $100
million per year in the 1880s (Witte 70).
The success of the 1880s ended abruptly with the Panic of 1893, which was "caused by a
run on gold and fears in the eastern financial community that the nation would go off the
gold standard for the dollar" (70). The panic lowered government 
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revenues and soon eliminated existing surpluses. At the same time, the Democratic Party
gained control of both the presidency and Congress for the first time in the post-Civil
War era. Formal debates over the renewal of the income tax soon followed, and a flat tax
of two percent on all income was approved (Witte 70-73).
Although both parties almost unanimously approved the first income tax because, according
to Susan B. Hansen, investments in the war-torn North were better protected if they were
taxed than if they were lost in the war effort, many opponents gave their reasons for
abolishing this tax. The new income tax was called undemocratic, socialist, and
impossible to fairly implement, but these reasons were easily defeated with rational
thought (Hansen 80, Seligman 518-21).
Not being able to win in Congress, opponents of the income tax then turned to the only
body left: the Supreme Court. According to the United States Constitution, "all duties,
imposts, and excises shall be uniform throughout the United States" and "no capitation,
or other direct, tax shall be laid, unless in proportion to the census or enumeration
hereinbefore directed to be taken" (Seligman 531). After two hearings, the U.S. Supreme
Court, by a 5-4 decision, declared the 1894 income unconstitutional because it was a
direct tax and could not be assessed according to state population (Paul 59, Witte 73,
Seligman 531).
After the defeat, which was referred to as "the Dred Scott decision of government
revenue" (Seligman 589) and made newspapers from coast to coast, the income tax died 
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down for over a decade, with the lone exception occurring during the Spanish-American
War, when an income tax on corporations was submitted to Congress as a way to pay for the
war effort. The measure was altered to become "a special excise tax on the gross receipts
of companies refining petroleum or refining sugar" which was later upheld by the Supreme
Court (591). In 1906, President Theodore Roosevelt said that an income tax would be "a
desirable feature of federal taxation" adding that he hoped that one could be created
without being struck down (591). But only two years later, most realized that one could
not be created, and the idea of a constitutional amendment became part of the Democratic
Party platform (Witte 74, Seligman 589-91).
In 1909, two different tax bills, one with a flat tax of three percent on all income over
$5,000, and another with a graduated tax from two to six percent on incomes above $5,000
were written, even though both were in direct violation of the Supreme Court's ruling.
They were later combined, and congressmen from both parties agreed to vote for the
compromise, much to the chagrin of Senator Nelson Aldrich, who a not only against the tax
itself, but was also against a direct confrontation between Congress and the Supreme
Court. As part of the leadership of the Senate, he managed to delay vote on the issue
until he could meet with President William Taft. The two agreed that the only way to
alleviate the situation was to propose a constitutional amendment that would allow "an
income tax without equal apportionment among the states" (Witte 75). Aldrich hoped that
the amendment would kill the income tax bill currently on the floor, and his hopes 
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became reality as the bill died without a vote. The constitutional amendment, however,
passed the Senate unanimously on July 5, 1909 and passed the House a week later by a vote
of 318 to 14 with 55 abstaining (Witte 74-75, Paul 97, Seligman 594).
But what Aldrich did not expect was states to approve the measure. Only one state,
Alabama, approved it in 1909, but Georgia, Illinois, Kentucky, Maryland, Mississippi,
Oklahoma, and Texas followed. Charles Evans Hughes, the governor of New York and future
Chief Justice of the Supreme Court, argued feverishly against it, saying that the federal
government would gain the power to tax state and municipal bonds, but New York passed the
amendment on its second try. Other eastern states also had movements against the
amendment, but they eventually ratified it as well. Wyoming's ratification on February 3,
1913, gave Congress the three-quarters majority it needed to make the amendment part of
the U.S. Constitution. Congress now had the ability of the federal government to levy
taxes on income. Six other states eventually ratified the amendment, bringing the total
to forty-two. Only Connecticut, Florida, Rhode Island, and Utah failed in its attempts to
ratify the amendment. Pennsylvania and Virginia never attempted to ratify. The first
modern income tax soon followed, with a progressive structure, shown below, along with
1994 income equivalents (Paul 97-98, Witte 75, table- Waltman 29, www.olywa.net).
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Tax Rate 1913 Dollars 1994 Dollars
1% $20,000-$50,000 $298,000-$746,000
2% $50,000-$75,000 $746,000-$1,119,000
3% $75,000-$100,000 $1,119,00-$1,492,000
4% $100,000-$250,000 $1,492,000-$3,731,000
5% $250,000-$500,000 $3,731,000-$7,462,000
6% Over $500,000 Over $7,462,000
Shortly after the Sixteenth Amendment was passed, World War I broke out in Europe.
Although the United States' neutrality would be a benefit in exporting goods, the first
thing noticed by budget analysts was plummeting import duties, which still accounted for
a large percent of government revenue. According to Jerold L. Waltman, "receipts
plummeted from $73,224,173 in July [1914] to $44,563,946 in October" (32). Congress
responded in a similar way to the Spanish-American War, by raising and levying new excise
taxes, but left the income tax untouched. This action seemed to alleviate the situation,
but only because of the boom in the economy that also followed the beginning of World War
I. But by late 1915, Congress realized that higher excise taxes alone would not cure the
budget deficit, so they turned to the income tax for additional funding (Waltman 32-33,
Witte 79).
After failed attempts to lower the tax exemption, which would make more people eligible
to pay a one percent income tax, Congress passed the Revenue Act of 1916, 
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which kept the minimum income to be taxed at $20,000 a year, but followed the structure
below:
Percentage Rate Incomes (thousands) Percentage Rate Incomes (thousands)
1% $20-$40 6% $150-$200
2% $40-$60 7% $200-$250
3% $60-$80 8% $250-$300
4% $80-$100 9% $300-$500
5% $100-$150 10% Over $500
The primary purpose of the Revenue Act of 1916 was, of course, to raise revenue, but
lawmakers saw it as a temporary measure, or at least that worked when the traveled back
to their constituents. But, as Waltman notes, "The income tax...by this act proved itself
to be one of the easiest taxes to juggle" (36-37, 42).
1917 saw the United States enter World War I, and expenditures were again predicted to
heavily outweigh receipts. Congress knew that all taxes needed to be increased, and the
income tax became the hottest item to debate. Radicals suggested a progressive structure
that drastically lowered the minimum income to tax as well as taxing all incomes over
$100,000 a year at 100 percent, effectively making the maximum income in the country
$100,000 annually. Secretary of the Treasury recommended a base rate of one percent on
incomes about $3,000 and a maximum of forty percent on incomes over $1,000,000. Congress
was able to pass a resolution to raise war revenue on March 3, 1917, but it took months
of debate before the Revenue Act of 1917 was passed, with a minimum tax of one percent on
incomes over $5,000 and a maximum of fifty percent on 
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the incomes of millionaires. Again, the act was a temporary one, but Waltman notes that
some of the policy choices showed the beginnings of a permanent tax behavior by Congress
(44-50, 54).
Tax rates were again looked at in 1918, and Congress wrote the War Revenue Act of 1918,
raising the minimum tax rate to five percent on incomes below $4,000 and to twelve
percent on incomes above $4,000. The maximum tax rate was also increased to 65 percent.
The bill was passed unanimously by the House, but not passed by the Senate before 1918
elections and Armistice Day. But instead of rates being decreased due to the end of the
war, the Senate amended the bill with a maximum rate of 77 percent (Witte 85-86).
World War I was a watershed in the history of American taxation. According to Witte, "it
marked the end of the tariff and excise as the dominant sources of revenue" and although
the war was an external shock, it "dramatically and permanently affected the internal
revenue system in the United States...the income tax would never again be a minor source
of revenue" (86-87).
Income tax rates stayed at the 1918 rates through 1919 and 1920 to get rid of the budget
deficit gained by the war. The share of revenue gained from the income tax actually
continued to rise after the war reaching a peak of 69 percent in 1920. The consensus of
government by 1920 was that tax rates should be cut, especially from the upper brackets,
which found ways to avoid paying such high taxes anyways. The results 
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were income tax cuts in 1921, as well as cuts again in 1924 and 1926, due to a continual
growth in government surpluses. Rates fell in the 1920s according to the following
table:
Income 1918 (%) 1921 (%) 1924 (%) 1926 (%)
$2,000 6 4 2 1.5
$10,000 15 11 6 5
$20,000 20 16 10 9
$50,000 35 31 23 18
$100,000 60 56 42 24
$500,000 75 71 45 25
$1,000,000 76 72 46 25
Overall, the tax rates reflected the nation's post-war growth and prosperity (Smiley and
Keehn 285-88, "How the U.S. Income Tax System Grew", 21).
Looking back through the early years of the American income tax, it is easy to see why
some people were for it and others against it. Financial conservatives did not want to
see money leaving their incomes and going to a growing government, while liberals argued
for the money, according to David G. Davies, to help balance the budget and to
redistribute income from higher to lower classes (23-24).
Looking at taxation today, there are similarities to the post-WWI pre-depression period.
The stock market is soaring, there is a government surplus, and taxes, although not at
WWI levels, are a reason for the surplus. The number of people arguing for reductions in
the income tax has a valid point. The budget is taking in a surplus, yet taxes 
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across the board have not been cuts, even though they were in the 1920s. Although people
arguing for the abolishing of the progressive income tax, and more radically, the
Sixteenth Amendment all together, have been around, more and more people are jumping on
the bandwagon. Republican presidential hopeful Steve Forbes has been a long-time
proponent of abolishing the progressive system in favor of a fifteen percent flat tax,
while Ambassador Alan Keyes is even more radical, wanting to abolish the income tax all
together in favor of a national sales tax. According to Keyes, "The income tax is a
20th-century socialist experiment that has failed" (www.keyes2000.org). Others,
including, John McCain, George W. Bush, and Bill Bradley have more conservative stances
on the issue, but all agree that taxes need to be cut across the board
(www.forbes2000.com, www.keyes2000.org, www.georgewbush.com, www.mccain2000.com,
www.billbradley.com).
The history of the American income tax has never been controversial and always been
politically fun to watch. Does it need to be abolished? Some say yes. Does it need to be
changed? Another yes. But until it is, we will just have to watch the government surplus
grow and keep blowing the cobwebs out of our wallets.
Bibliography
Bill Bradley for President. 13 Dec. 1999. 14 Dec. 1999. .
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George W. Bush for President: Prosperity With a Purpose. 14 Dec. 1999. 14 Dec. 1999. .
History of the Income Tax. 12 Oct. 1998. 18 Nov. 1999. .
"How the U.S. Income Tax System Grew." Nation's Business April 1995: 21.
John McCain for President Official Site. 13 Dec. 1999. 14 Dec. 1999. .
Paul, Randolph E. Taxation in the United States. Boston: Little, Brown, and Co., 1954.
President Alan Keyes 2000. 14 Dec. 1999. 15 Dec. 1999. .
Seligman, Edwin R.A. The Income Tax: History, Theory, and Practice of Income Taxation.
New York: The Macmillan Co., 1914.
Smiley, Gene and Richard H. Keehn. "Federal Personal Income Tax Policy in the 1920s."
Journal of Economic History. 55 (1995): 285-303.
The Steve Forbes National Online Headquarters. 13 Dec. 1999. 14 Dec. 1999. .
Waltman, Jerold L. Political Origins of the U.S. Income Tax. Jackson, MS: Mississippi UP,
1985.
Witte, John F. The Politics and Development of the Federal Income Tax. Madison, WS:
Wisconsin UP, 1985.