A brief look at our nation’s tax history.
The Revolutionary War: an early aversion to taxes
The colonial government of America as a whole did not require much revenue, but individual colonies raised funds for their own administrative purposes by imposing different types of taxes. The New England colonies brought in revenue through real estate taxes, excise taxes, and taxes based on occupation. The middle colonies levied a “head” or poll tax on each adult male. The southern colonies imposed taxes mostly on imports and exports.
England began to levy taxes on the American colonies in order to pay the costs of its wars with France. The Stamp Act, passed by Parliament in 1765, was the first tax to be directly imposed on the colonies. Shortly thereafter, Parliament approved a tax on tea. The colonists were outraged and refused to comply with England’s taxes, because they had no representation in Parliament and felt that “taxation without representation is tyranny”. Thus began the American resistance to taxation and the cause for the Revolutionary War.
The aftermath of the Revolutionary War
When the Articles of Confederation were drawn up in 1781, the national government still had no power to levy taxes. Instead, the government had to rely on donations from the states for revenue.
However, the founding fathers knew that the national government could not operate solely on donations, and thus, when the Constitution of the United States of America was adopted in 1789, the Congress was granted the authority to impose taxes to provide for the defense and welfare of the country.
In order to pay the debts of the Revolutionary War, Congress levied excise taxes on tobacco, distilled spirits, refined sugar, snuff, carriages, property sold at auctions, and certain legal documents. States continued to impose their own taxes, sometimes for social purposes. For example, Pennsylvania levied an excise tax on the sale of liquor in an effort to curb the abuse of alcohol by low-income individuals. Property owners supported this tax, hoping that in exchange, the property tax would not rise.
Although Americans now had representation in the national government, they did not hesitate to oppose any taxes they thought were unfair or too high. In 1794, farmers in southwestern Pennsylvania took up arms to protest the tax on whiskey. President Washington had to send federal troops to suppress the Whiskey Rebellion.
In the late 1790s, the government imposed its first direct taxes on owners of land, houses, slaves, and estates. Direct taxes are recurring taxes that the individual pays directly to the government, which are based on the value of the item being taxed. Under the Constitution, direct taxes could only be levied in proportion to each state’s population. In 1802, the direct taxes were repealed under President Thomas Jefferson, and for the next 10 years, excise taxes were imposed on the public.
To support the War of 1812, Congress raised more excise taxes and customs duties and sold Treasury notes. At the end of the war, these additional taxes were repealed, and no internal revenue was collected for the next 44 years. Only high customs duties and proceeds from the sale of public land supplied the government with revenue.
The Civil War and the appearance of income taxes
At the beginning of the Civil War, Congress passed the Revenue Act of 1861. For the first time, a tax on personal income was imposed. It was levied at 3% on all incomes higher than $800 a year.
In 1862, when it became apparent that the war was not going to end soon and that the government would need more revenue, Congress passed new excise taxes on gunpowder, playing cards, billiard tables, yachts, pianos, leather, drugs, patent medicines, whiskey, iron, feathers, telegrams, and various legal documents. License fees were collected for many professions and trades. Congress also introduced a two-tiered rate structure for the income tax. Personal incomes up to $10,000 were taxed at a 3% rate, while higher incomes were taxed at a 5% rate. The law allowed a standard deduction of $600 plus deductions for rental housing, losses, repairs, and other taxes paid. Another new feature was having income taxes “withheld at the source” by a taxpayer’s employer.
Most of the taxes enacted during the Civil War were repealed at war’s end. Liquor and tobacco taxes became the main source of the government’s revenue. In 1872, the income tax was abolished. Only excise taxes were levied from then on until 1913.
The passage of the 16th Amendment
In 1894, Congress tried to impose a flat rate federal income tax. However, the Constitution only granted Congress the authority to levy direct taxes in proportion to each state’s population. The United States Supreme Court easily defeated the flat rate income tax.
From 1896 to 1910, most of the government’s revenue came from high tariffs. The Spanish-American War raised additional funds through the sale of bonds, doubled taxes on beer and tobacco, a tax on chewing gum, and taxes on recreational facilities used by workers. However, these taxes were repealed in 1902, and many people were beginning to realize that high tariffs and excise taxes were not the way to build a healthy economy. Also, the burden of these taxes fell disproportionately on low-income taxpayers. The government was seeking alternative sources of revenue. Property owners feared that a high property tax would soon be taking the place of excise taxes. Congressmen representing these property owners suggested the reinstatement of the income tax. Finally, Congress agreed to a proposed amendment to the Constitution allowing the imposition of a direct tax on personal incomes which does not have to be in proportion to each state’s population. The 16th amendment was ratified in 1913, and Congress subsequently passed a new income tax law with the lowest rate at 1% and the highest rate at 7% for taxpayers with an income above $500,000. Form 1040 was created as the standard income tax reporting form. Less than 1% of the population paid income tax after the new law was implemented. All income was taxed, even if it was acquired through illegal means. As a result, some who had previously gotten away with breaking the law were finally caught and imprisoned for tax evasion. Since the new income tax law required more personal information to be collected by the government, Congress passed a law in 1916 that all tax return information be kept confidential.
World War I: the strengthening of the economy
After the United States entered the first world war, Congress passed the 1916 Revenue Act. The Act raised the lowest tax rate from 1% to 2% and the highest rate to 15% for taxpayers with an income above $1.5 million. Taxes were also imposed on excess business profits and estates.
Other revenue acts passed by Congress during the war drove tax rates even higher and lowered exemptions. By 1917, a taxpayer with a minimum taxable income of $40,000 was taxed at a 16% rate, while a taxpayer with an income of $1.5 million was taxed at a rate of 67%. By 1918, the amount of revenue accumulated from income taxes constituted 25% of Gross Domestic Product (GDP). This money funded about a third of the cost of the war. At this time, only 5% of the population were paying income taxes.
The economy soared into the 1920s following wartime industry and increasing revenues from the income tax. Congress then decided to make tax cuts, bringing the lowest tax rate back down to 1% and the highest rate down to 25%. As tax rates fell, the economy grew even more prosperous.
The Great Depression of the 1930s
The economic boom of the 1920s ended with the stock market crash in October 1929. As the flow of revenue subsided and the budget deficit rose to $2.7 billion, Congress again imposed taxes at higher rates by passing the Tax Act of 1932. Although this brought more revenue into the government, the economy further declined.
In 1935, Congress passed the Social Security Act to provide financial assistance to the unemployed. The Act also authorized public aid to the handicapped, the aged, the needy, and certain minors. The funds were taken from a 2% tax, one half of which was deducted from an individual’s paycheck and the other half of which was collected by the individual’s employer on behalf of the employee. The first $3,000 of the individual’s salary or wage was taxed under the Social Security Act.
In 1939, Congress also codified all the existing tax laws.
World War II: the income tax-paying population rises
Even before the United States entered the second world war, there was a need for increased revenue to help the Allied nations fight against the Axis powers. The government was also spending more on its own defense. In 1940, Congress passed two tax laws which raised both individual and corporate taxes. The laws also lowered exemption levels. By 1945, federal taxes constituted 20.4% of GDP, and 43 million were paying taxes. Income taxes were once again being “withheld at the source” by employers, which meant that taxes were easier to collect but also easier to raise, since taxpayers now were less aware of how much they were being taxed.
The 1950s, the 1960s, and the 1970s: the decades of domestic experimentation
Throughout the nation’s history, taxes had been raised mostly to cover the costs of war. Beginning in the 1950s, the economic policy was to raise or lower taxes and to increase or decrease spending in order to balance aggregate demand in the cycle of business. Thus, taxes became the way to stabilize the economy.
The income tax was altered almost every year from 1954, when the tax code was revised. Under the Tax Reform Act of 1969, income taxes for individuals and private foundations were reduced.
From the late 1960s through the 1970s, the United States experienced rising inflation rates. Since income tax rates were not indexed for inflation, taxpayers were driven into ever higher tax brackets. The federal tax burden rose from 19.4% of GDP to 20.8%. Thus, the economy took a dive.
The 1980s and the Reagan Era
The Economic Recovery Tax Act of 1981, passed under the Reagan administration, effected a 25% reduction in individual tax brackets, phased in over 3 years and indexed for inflation thereafter. The top tax bracket was reduced to 50%.
The new tax policy was to reduce marginal tax rates (the tax rate on the last dollar earned) rather than the average tax rate (the rate on the first dollar earned). It was believed that taxes had their most important effect on economic incentives for individuals and businesses. By reducing marginal tax rates, it was hoped the natural forces of economic growth would be fostered.
Following the 1981 Tax Act was the creation of the Individual Retirement Account (IRA), since the Act sought to reduce the multiple taxation of individual savings.
The Federal Reserve Board implemented monetary policies that brought down inflation. The decreasing rate of inflation and the tax cuts from the 1981 Act helped to strengthen and improve the economy.
The Tax Reform Act of 1986 reduced the top individual tax rate to 28% and the corporate tax rate to 35%. The number of tax brackets was also cut down, but personal exemptions and standard deductions were increased. The intent of the Act of 1986 was to shift some of the federal tax burden from individual taxpayers to businesses, not to raise or lower taxes.
However, with government spending and the budget deficit on the rise, Congress passed a new tax increase in 1990. The top individual tax rate reached 31%. After President Clinton took office, the top tax rate increased to 39.6%.
The stimulation of the economy in the 1990s
The Taxpayer Relief Act of 1997 featured a modest tax cut and a new tax benefit to certain families with children, called the Per Child Tax Credit. The credit was refundable for many low-income families. It was also the beginning of a trend in federal tax policy of granting individual credits. Although individual credits had been awarded before, the most common method of tax relief had been to lower tax rates and increase deductions and exemptions.
Although tax rates were generally higher under the Clinton administration than in the prior decade, other economic aspects helped to nurture a growing economy. Inflation and interest rates were low; the Soviet Union had collapsed, thus opening international commerce; and technology was advancing at a fast pace. In 2000, federal taxes contributed a postwar high of 20.8% to GDP.
The 2001 tax cut and the future of America
By 2001, the projected unified budget surplus was $281 billion, and the cumulative 10-year projected surplus was $5.6 trillion. President Bush opted to halt the projected future increases, and Congress passed the Economic Growth and Tax Relief and Reconciliation Act of 2001. The tax rate reductions under the Act will be phased in over the years, but the individual top tax rate will eventually fall from 39.6% to 33%. The Act increased the Per Child Tax Credit from $500 to $1,000, as well as the Dependent Child Tax Credit. The estate, gift, and generation-skipping taxes will be phased out. As the provisions of the Act take effect over the years to come, it is hoped the United States economy will be strengthened and thus the quality of life in this country will rise even more.
For more information on the Economic Growth and Tax Relief and Reconciliation Act of 2001 or on the history of taxation in the United States, please visit www.ustreas.gov/education/fact-sheets/taxes/ustax.html.