“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”
16th Amendment of the United States Constitution
On February 3, 1913, Congress ratified the 16th Amendment, enabling a federal income tax as a means for fiscal revenue. The development of this idea had been long in the making. William Pitt in England was one of the first to place an ‘income’ tax on citizens, in his case it was to help pay for the Napoleonic War in the 1790s. Later, the United States took Pitt’s idea and tried to impose an income tax to help pay for the War of 1812, but the war ended before it could be enacted. Later still, during the Civil War, income taxes were used on both sides to support the costly war.
Sensing a theme here? Governments consistently found themselves unable to pay for large-scale, unplanned war expenses. Lacking a rainy day fund, they turned to citizens’ pockets.
The very idea of “income tax” has evolved since its tentative beginnings in the United States. Tariffs on consumer goods preceded income taxes as a popular way for the government to gain revenues. However, issues of class came up frequently with tariffs, and, more often than not, they failed to bring in enough revenue for the government. Looking for additional options federal and state governments attempted to tax American citizens directly on their income, rather than indirectly via tariffs. Several attempts were made prior to 1913, all varying in degrees of effectiveness.
Below, I focus on the evolution of the individual income tax during the 19th and early 20th centuries in the United States.
Experimentation in the Early 19th Century
States are often noted as the laboratories of democracy. In the early 19th century, they were certainly laboratories for tax policy.
In the first half of the century, with economic activity rapidly increasing across the nation, states quickly realized that the federal funding they received could no longer be relied upon. At first, the states split surplus money from the federal government to support infrastructure and development needs. However, in 1836 the federal government did not have a surplus, and the federal funding came to an abrupt stop (Samson, 1985). By the 1840s many states were in financial difficulty.
To avoid bankruptcy, states turned to their citizens. Northern states were able to use property taxes, but in the South that was not a possibility; with plantations, most of the property tax burden would be placed on rich plantation owners. With plantation owners as a main voice in state politics, it quickly became apparent that a solution other than property tax would have to be used. (Samson, 1985)
The first income taxes in the Southern states were rudimentary and contained too many exemptions, so very few people ended up having to pay and the taxes did not bring in much revenue (Samson, 1985). However, Samson is quick to point out that, even at this early stage of experimentation, states were concerned with tax equity: lower incomes were exempted and some states acknowledged the difference between earned (salary, wages) and non-earned (dividends) income and adjusted rates accordingly. The concept of a ‘progressive tax’ is clearly visible in these early attempts.
Civil War Taxation Success
Note: For this section I was very interested in the work of William Samson (1985) regarding the Confederate tax, but there did not seem to be many other papers on the topic. With no corroborating sources other than the ones Samson used, please keep in mind this section is somewhat subjective. If you know of any other sources, please let me know!
While earlier attempts by Southern states lacked enforcement, proper administration, as well as public support – all resulting in widespread evasion – the Civil War demonstrated that a successful income tax was possible.
Samson argues that people wanted to help with the war effort and supported taxation from the states. The income base was broadened to raise more revenue for the states. States continued to have progressive rates to ease the burden on the lower classes, but everyone had to pay their fair share, and for the most part, willingly did so. (Samson, 1985)
In 1863, as other means failed to raise enough revenue, the Confederacy created a ‘national’ income tax much like the one we know today. The Confederate income tax taxed net income (a concept deemed ‘revolutionary’ by Samson) by allowing certain deductions from gross income and it consisted of progressive tax rates based on income levels. Thanks to the deductions from gross income, this Confederate tax made room for simultaneous state-level income taxation as well.
The emergency of war served as a catalyst for the development and acceptance of the income tax in the South. It generated more than eighty-two million dollars in revenue for the Confederacy. State-level income tax systems were successful as well. However, after the war, there was no longer a cause for people to support state taxes and they slowly faded away, whether through lack of collection and enforcement, or actual removal of the laws. (Samson 1985)
Abraham Lincoln also signed a federal income tax into law to assist the Union war effort – the Revenue Act of 1862. Samson (1985) argues that the Confederate income tax was actually “more successful, better designed, and better administrated than it’s Yankee counterpart. (p.38)” Perhaps it was better designed and better administrated, but the Tax History Project is less effusive: according to their website, the North managed to raise about twenty percent of its war revenues through income taxation, as opposed to the Confederacy raising just five percent of its revenues.
The 16th Amendment and the New Income Tax Law
The Confederate income tax obviously came to end, and the Revenue Act was repealed in the early 1870s. Later in 1894, the United States tried again to create an income tax, but the Supreme Court deemed it unconstitutional. In the early 1900s there were many attempts from both political parties to figure out a way to incorporate an income tax, and it was mentioned repeatedly by Roosevelt during his time as President, as well as both candidates in the 1908 elections (Blakey, 1914). Interestingly, the general idea of a permanent income tax had popular support regardless of political affiliation – tariffs were not popular, and people were seeking an alternative (Blakey, 1914; Hill, 1913). However, the earlier Supreme Court decision essentially required an amendment to the Constitution in order for it to be approved.
Finally, on February 3, 1913, Congress pushed it through. The implementation immediately followed, with the income tax law made official with President Wilson’s signature on October 3, 1913.
1913 marked the first year of the income tax – with collections from March through December (Blakey, 1914; Falkner, 1915). From 1914 onward, taxes would be collected for the full twelve months of the year. The Commissioner of Internal Revenue was asked to define the details of and establish the administration system for the tax (Blakey, 1914). It was, in my opinion, fairly well executed from the start. Of course there were tweaks that needed to be made (Falkner, 1915) and criticism of the how the tax was implemented naturally followed (Blakey, 1914), but overall, it was fairly sound. According to Blakey, it was an amalgamation of the English income tax, the taxes during the Civil War, and the 1894 attempt. With all the past examples to lean on, perhaps the US was able to cherry-pick the best ideas for successful implementation.
The individual income tax would be collected on net income. Net income was defined as allowing deductions from six categories including business expenses, state or local taxes, and depreciation (Blakey 1914). It was to be collected at the source of employment to limit tax evasion, and it would be distributed over the year so the burden was less heavy on each taxpayer, with a deduction allowed for the first $3,000 of income (or $4,000 if married filing jointly). The initial income tax had a modestly progressive rates, starting with a ‘normal’ tax of one percent on income between $3,000 – $20,000, with rates increasing steadily for amounts earned above $20,000. People filled out a 1040 form to report their taxes, just as we do today.
During its first year of collection (1913), the Secretary of the Treasury acknowledged it was likely that a large number of incomes were not reported – not necessarily due to intentional tax evasion but due to ignorance that the law was in effect. The total product of the tax collected from 1913 was just twenty-eight million dollars according to Falkner. The borough of Manhattan had fourteen percent of all taxpayers and represented twenty-one percent of total estimated income for the United States. The northeast had the majority of tax payers during that first year, which is not unexpected. (Falkner 2015)
The map below shows the geographical distribution of income subject to income tax.
The income tax continued to have growing pains over the next decade: during World War I, the government was overly ambitious and raised the rates so high that it was counterproductive: tax evasion was rampant and less money was collected (Smiley and Keehn, 1995). Throughout the 1920s debates over the tax rates were numerous and eventually tax cuts were enacted to lessen the amount of tax evasion, and to shift the burden towards higher-income individuals (Smiley and Keehn, 1995).
The many attempts at income taxation at the state and national levels prior to 1913 did not last for more than few years at a time. However, their efforts cleared the path to the permanent solution that took effect in 1913. The income tax law following the 16th Amendment was a success: one hundred years later, the fundamental structure of the tax system has not changed and many of the same concepts remain today. We even have the same arguments over rates: too high, too low, too many cuts, not enough… I, for one, am impressed that not only was Congress able to pass the 16th Amendment in 1913 but that they actually had the popular support to do so. Can you imagine such support in today’s political environment?
Blakey, Roy G. “The New Income Tax.” The American Economic Review. Vol. 4, No. 1 (March, 1914), pp 25 – 46.
Falkner, Roland P. “Income Tax Statistics.” Publications of the American Statistical Association. Vol. 14, No. 110 (June, 1915), pp. 521 – 549.
Hill, Joseph A. “The Income Tax of 1913.” The Quarterly Journal of Economics. Vol. 28, No. 1 (November, 2013), pp. 46 – 68.
Samson, William D. “The Nineteen Century Income Tax in the South.” The Accounting Historians Journal. Vol. 12, No. 1 (Spring 1985), pp. 37-52.
Smiley, Gene and Richard H. Keehn. “Federal Personal Income Tax Policy in the 1920s.” The Journal of Economic History. Vol. 55, No. 2 (June, 1995), pp 285 – 303.
CivilWar.org: The First Income Tax
LOC.gov: History of the Income Tax
Tax History Project: The Civil War
Photo 1: Original 1040 Form, 1913. http://www.loc.gov/rr/business/hottopic/irs_history.html. Accessed April 14, 2013.
Photo 2: “Distribution of Income Subject to Income Tax.” (Falkner, 1915).