The History of Income Taxes in the United States
If we asked you to come up with the one thing that Americans collectively hate most, you might be hard pressed to find a common single answer.
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People will name politicians, sports teams, more serious issues like racism or sexism, or something altogether more trivial such as a particularly bad movie (Sharknado, perhaps).
There would most likely be a lot of disagreement — at first, but one thing everyone can agree on when it comes to a national target for detestation — is income tax.
“The power of taxing people and their property is essential to the very existence of government.” — James Madison, 4th President of the United States.
While people love to hate taxes, they have played a very central role in the entire history of the United States.
The United States basically came about as a result of protests against taxes, but those weren’t income taxes; income taxes themselves first came up as a result of the American Civil War. Desperate for cash, the government of Abraham Lincoln passed the Revenue Act of 1861, which levied a flat tax on incomes higher than $800.
You will never guess what happened next: income tax was then cancelled. Yes, in 1872 the Revenue Act of 1861 was rescinded. Spoiler alert….it didn’t last.
Income tax and other taxes that were non-proportional to population actually contradicted the original constitution, so people disputed the right of the federal government to charge taxes. However, in 1913, the 16th amendmentwas passed, which specifically permitted the charging of income tax without a need for census or enumeration.
The door was now open, and income tax was here to stay.
The intersection of death and taxes
Benjamin Franklin once said, “…but in this world nothing can be said to be certain, except death and taxes.” Is it any wonder then that taxes tend to increase during times of war?
In 1913, there was a 1% tax on net personal incomes over $3,000, and there was an additional surtax of 6% on incomes over $500,000. By 1918, the top rate rocketed up to 77% on incomes over $1,000,000 — all to finance World War One.
Thankfully, taxes did not not stay quite this high. The top bracket was reduced to 58% in 1922, and then continued to drop until 1929 when tax rates went as low as 24%. This break however wasn’t going to last long. In 1932, during the Great Depression, the top marginal tax rate jumped to 63% as the government was desperate for money.
Rates continued to remain high to help pay for World War Two. Rates did not begin to drop again until the 1960s. Relative tax rates can sometimes be a bit misleading. There are often tax loopholes that can permit people to legally avoid taxes.
This can be beneficial when selectively applied to help targeted groups, such as students (tuition deductions) or parents (deductions related to children) but there are also concerns about whether those loopholes make the tax system more or less fair. Lately, there has been a great deal of debate about how these loopholes seem to favor the rich.
Income tax rules continue to evolve over time. Each administration tinkers with the system as they try to either increase economic growth, close loopholes (such as with alternative minimum tax) to make the system more “fair”, or influence some combination of the two.
It’s all about the context
While most feel that they pay too much in the way of taxes, if you look at the historical charts, we are in a period of historically low tax. Taxes could always be lower, but before you claim that taxes are keeping you from getting ahead, let’s look at the story of John D. Rockefeller.
The Rockefeller name is a well known one, but consider a few of the major financial moments in his life in the context of the income tax chart above.
In 1916, John D. Rockefeller became the world’s first billionaire. The top tax brackets at the time were significantly higher than they are today. You would think this might have stalled his financial growth, but when he died in 1937, Rockefeller’s estate was worth the equivalent of 1.5% of the entire country’s assets at that time.
If you adjust this for inflation, Rockefeller’s estate would have been worth over 300 billion dollars.
The next time someone says it’s impossible to get ahead because of taxes, remind them that the famous Rockefeller fortune is a product of a time when taxes were significantly higher.
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