The early founders of the nation gave the states the option to help pay for federal debt at their discretion. Given this fact, it may seem odd that people today have to pay so much money in federal income taxes. Let's take a look through some of the historical points that have brought us to where we are now.
Excise taxes and tariffs
The main taxes that the federal government used prior to the establishment of income taxes were excise taxes and tariffs. A tariff was charged on goods being imported into the United States, so consumers were not directly aware of them, although the costs were likely passed along through slightly higher prices. An excise tax is charged on the sale of a specific type of product. Think of it like a sales tax on some items. Today's taxes on gasoline, alcohol, and cigarettes are examples of excise taxes.
The first federal income tax
When the Civil War was in full swing, the federal government realized that the tariffs and excise taxes alone would not be enough to pay the costs incurred in the war. Abraham Lincoln was actually the president who established the first income tax in 1862. People who earned at least $600 per year were taxed at 3%, while people who earned $10,000 or more were taxed at 5% of their income. By today's standards, those tax rates sound great, especially considering that only a tiny fraction of the population fell into that upper bracket.
The first income tax law was repealed in 1872, just 10 years after it began. People went more than two decades without any income taxes, although they were paying higher excise taxes and tariffs during that time. Then in 1894, the Wilson Tariff Act brought back the income tax and created a division within the Bureau of Internal Revenue to handle income taxes. This tax, though, was declared unconstitutional just one year later because the tax was not proportional to the population of each state. In other words, residents of some states were paying more, on average, than residents of other states, which was not allowed under the Constitution.
The 16th Amendment establishes the modern income tax
As the United States anticipated the beginning of World War I, the federal government realized that an income tax would be necessary to pay the war costs. At this point in 1913, Congress drew up the 16th Amendment to the Constitution, which gives Congress the power to create and collect taxes on incomes without having to consider the population of each state. The states ratified the amendment and the modern income tax was born. At that point, people who earned less than $10,000 paid a tax of just 1%, and the highest tax bracket of income over $500,000 per year was taxed at 7%.
The first time the top income tax bracket got really high was in 1917, when the War Revenue Act of 1917 increased the top income tax bracket to a 67% tax rate. A year later in 1918, the tax filing deadline was pushed back to March 15th from March 1st. As you're reading this, you're probably thankful for that extra month you have now to get your paperwork together and complete your tax return at OnePriceTaxes.
Income tax rates rise and fall through the decades
The pattern of people expecting a new president to either increase or decrease income tax rates has been in force since nearly the beginning of when the income tax was established. If you track the income tax rate on the top bracket, you'll find that it rose and fell in response to both the party in office and the economic landscape.
For example, the Republicans in office during the 1920s brought tax rates down during the period of calm between the wars, while the Revenue Act of 1932 increased rates again on the top bracket to increase revenue during the Great Depression. It wasn't until Ronald Reagan took office in 1982 that he brought tax rates on the top bracket down below 50%.
Income Tax Reform
Several presidents are known for bringing changes and reform to the way income tax in the United States is handled. Here are some of the key changes:
- The Revenue Act of 1942: FDR pushed this legislation through that made some sweeping changes to the income tax landscape. This bill increased revenue by increasing tax rates and adjusting brackets so more people had to pay income tax. It also gave people a break by creating tax deductions for medical expenses and investment expenses.
- The Current Tax Payment Act of 1943: Prior to this legislation, taxpayers just had to pay their tax bill with their return when they submitted it. Realizing that many people were not planning for the bills and could not afford them, Congress passed this legislation to require employers to withhold estimated tax payments from employee pay and remit the payments to the government periodically.
- Internal Revenue Service established: In 1953, the Bureau of Internal Revenue was renamed into the iconic Internal Revenue Service that we all know today. It's a good thing, because the BIR doesn't have the same ring as the IRS.
- Presidents release personal tax returns: Gerald Ford was the first president to publicly release his income tax returns in 1976. Since then, every president has followed in his footsteps.
- Modern tax reform: Presidents Reagan, Clinton, and George W. Bush brought additional tax reform in 1986, 1993, 1997, and 2001. Many of the tax benefits you see today when you complete your tax return on OnePriceTaxes are thanks to these reforms.