A History of Income Tax in the United States

As you scramble for receipts and W2’s and records of charitable donations each year, surely you’ve at least once blurted out in frustration, “Who was the son-of-a-gun who invented income taxes anyhow?” No one person is accountable for the unpleasant accounting all Americans have to do by April 15th. More blame-worthy are unforeseen financial circumstances that plagued (and continue to plague) the U.S. beginning in our early history. One thing is certain. War has always played a significant role in America’s need for revenue.

Before the year 1913, America was not a heavy taxer. In America’s earliest history (1791- 1802) only certain items were taxed to support the government such as tobacco, spirits, snuff, property and slaves. The high cost of the War of 1812 spawned America’s need for more internal revenue. Thus, America experienced its first sales taxes primarily on luxury items such as gold, silverware, jewelry, and watches. In 1817, after the war, America stopped collecting taxes all together and the government operated by funds from tariffs on imported goods. This period lasted 44 years.

America’s first income tax law was enacted by Congress in 1862. This was a result of the Revenue Act of 1861, designed to support the Civil War effort. Similar to our modern income tax system, the law was based on the principles of graduated, or progressive, taxation, withholding income at the source. It featured the first ever taxes on Americans’ personal income by way of sales taxes and other various taxes. The office of the Commissioner of Internal Revenue was established at this time and was given authority to oversee the totality of the system, much like today.

Throughout the Civil War, persons earning $600 to $10,000 annually paid tax at a rate of 3%. Persons with incomes over $10,000 paid a higher tax rate. More sales and excise taxes were added including an “inheritance” tax. In 1866, the IRS collected their highest amount in the country’s 90-year history – more than $310 million, an amount unrivaled until 1911. In 1872 the Revenue act was repealed and America reverted back to a flat tax which was short lived, being ruled unconstitutional only one year later.

In 1913, Federal Income tax for Americans became permanent. This was a result of the 16th Amendment to the Constitution being ratified one month before Woodrow Wilson became President of the United States. Now Congress was able to tax the income of both individuals and businesses. Promoting free trade through tariff reduction was one of the primary reasons for establishing the income tax. The federal government promptly began collecting income taxes in the latter part of 1913.

It was this year that the original income tax filing date was established by the US Congress. At first it was March 1st for 5 years, March 15th until 1954, and then finally April 15th.

In 1918, the United States’ revenue topped a billion dollars for the first time, steadily increasing ever since. A withholding tax on wages began during World War II, again increasing taxes paid by U.S. citizens. The U.S. collected $45 billion in annual taxes by 1945.

The U.S. saw its largest tax cut by Congress in 1981 – approximately $750 billion over six years. In an effort to raise about $265 billion, this reduction was partly offset by two other tax acts in 1982 and 1984.

It was President Reagan who signed (on October 22, 1986) one of the most significant reforms into law – the Tax Reform Act of 1986. The tax rate on individual income was lowered from 50% to 28%, the lowest it had been since 1916. The act called for a $120 billion increase in business taxation and a gradual decrease in individual taxation over five years.

The Revenue Reconciliation Act of 1990 was signed into law on November 5, 1990 to stop the apparent annual tradition of new tax acts beginning in 1986. The main emphasis of the 1990 act was to up taxes on the wealthy.

President Clinton signed two major tax acts into law. The Revenue Reconciliation Act of 1993 was to reduce the federal deficit by $496 billion. Another tax act signed in 1997 cut taxes by $152 billion, including a cut in capital gains tax for individuals, a $500 per child tax credit and incentives for education.

President George W. Bush signed several tax cuts laws. The Economic Growth and Tax Relief Reconciliation Act of 2001 was the largest. Promising the largest tax cut since World War II, it was to save taxpayers $1.3 trillion over ten years. The Bush tax cut created a new lowest rate, 10% for the first several thousand dollars earned. Then it would implement a slow schedule of incremental tax cuts, eventually doubling the child tax credit from $500 to $1,000, adjust brackets for middle-income couples to that of comparable singles, and cut the top four tax rates (28% to 25%; 31% to 28%; 36% to 33%; and 39.6% to 35%).

The Jobs and Growth Tax Relief and Reconciliation Act of 2003 sped up the tax rate cuts enacted in 2001, and temporarily reduced the tax rate on capital gains and dividends to 15%. The U.S. had to eliminate a corporate tax provision ruled illegal by the World Trade Organization. With that unforeseen increase, Congress passed a plethora of tax breaks which for individuals included an option to deduct the payment of sales or state income taxes – whichever were higher.

Two tax bills signed in 2005 and 2006 extended good capital gains and dividend rates from 2003 through to 2010, gave Alternative Minimum Tax higher exemptions and lent new incentives for people to save more for retirement. Another 2010 tax law provides tax breaks for healthcare costs.

The road to today’s income taxes has been a long, bumpy one as citizens have done and continue to do their financial duty to support their country. So, as you dig through your junk drawer for that lost receipt, just remember. Considering the role of income taxes in your nation’s history, shutter to imagine that without them, America would surely be a very different place today.