A Brief History of the Income Tax

A subject near and dear to our pocketbook

“There are two things in life that are unavoidable—death and taxes” is the famous saying by Benjamin Franklin.

    Well, we expend a lot of thought and worry on both of those topics.

    I won’t dwell on the former in this essay, having already contributed my fair share of comment to this notion of our ultimate demise. Instead, I wish to examine the latter: A subject near and dear to our respective pocketbooks. Or more specifically, a brief history on the income tax which just recently engaged our collective attention with the April 15^th filing deadline.

What prompted this writing decision was a brief article I spotted in Chronicle of America, detailing an event on May 20, 1895. It reads:

    “The Supreme Court today ruled that the income tax is unconstitutional. The $80,000 collected so far will be returned. In New York, collector John A. Sullivan said that he had received ‘between 4,000 and 5,000 returns, to fully 90 percent of which there were protests attached.’ And the president of the Fourth National Bank, J. Edward Simmons, said the decision “demonstrates that the Communistic and Populistic element cannot override the Constitution.”

This income tax statute was enacted as part of the 1894 Tariff Act. During the early years of the Republic, tariffs on imports along with excise taxes, were the main sources of revenue for the federal government. Taxing the income of individuals would have presumably added a third, much larger, revenue stream to the coffers.

That citizens would protest what they regarded as an unfair or unnecessary tax is hardly surprising. Americans, then as now, grew up learning about the Boston Tea Party—a tax protest that helped ignite the Revolutionary War. As for the ‘unsavory’ element blamed for instituting the income tax in the first place, I assume the banker was referring to progressives, most of them being Democrats, who thought a tax based on income would more fairly raise revenue than relying only to such mechanisms as excise taxes on various purchases and poll taxes.

But, of course, the nation ended up with a federal income tax. So, what happened? Why was a law ruled unconstitutional, only to later become a major part of the federal government and, since its arrival, a source of continuous debate and angst?

Well, it starts with the Civil War—a seismic event that as we know caused a myriad of profound changes and transformations.

“The United States’ first federal income tax was levied during the Civil War,” wrote Jeannette Bennett in an article for the Federal Reserve Bank of St. Louis. “It became clear to Congress that this would not be a quick war, and the government needed to generate more revenue. It was also during this period, in 1862, that a Commissioner of Internal Revenue was established.”

It was a progressive tax that levied a 3 percent charge on incomes between $600 and $10,000 and 5 percent on incomes over $10,000.

Two points of reference should be included: Congress was comprised of a Republican majority, interested in pursuing the war, with a minority of Northern Democrats who, if they did object to the legislation, had little leverage. The Southern Democrats had, of course, left the Union.

The tax was repealed in 1872.

  A challenge to its legality was subsequently filed, despite it no longer being in effect, stating it violated the “ban on non-uniform taxes” in Article II of the U.S. Constitution. The Supreme Court, in an 1881 ruling, decided this objection did not apply and it was a category of excise tax.

The Court, only 14 years later, however, arrived a different view.

Whether the disparate rulings addressed different issues or were different interpretations on the dame issue, I leave to more knowledgeable historians. We certainly know that a group of justices can look at the law one way and issue a decision accordingly, only to be overturned by a new group later on. Roe v Wade comes to mind.

In overturning the newly-created income tax, the 1894 Court ruled that money collected on rents from real estate, on interest income from personal property and other income from personal property (which includes dividend income) were direct taxes on property and therefore had to be apportioned.

Given that sending out this part of the tax revenue to each state based on their population was problematic, the court decision “had the effect of prohibiting a federal income tax on income from property.”

Interestingly, it seems a tax could still be levied on individual wages; however, the historical record indicates taxing people’s wages, but not income from property, presented a political difficulty. The assumption is that the progressives who backed the legislation did not want a result that only taxed the working men and women and sparred the well-heeled, while the more conservative lawmakers and their supporters preferred getting rid of the whole proposition.

The possessors of great wealth—the propertied interests, if you will—had held the reins of power during in the latter part of the 19^th century, beating back reform efforts whether it was organizing unions, racial justice, women’s suffrage, equitable money policies, or this, a graduated income tax.

As we know, the political pendulum swings back and forth. The Progressive Era of American governance—led by Republican president Theodore Roosevelt and Democratic president Woodrow Wilson—held sway in the early 1900s, with a number of new laws enacted at the federal level and in many states that were part of their agenda. These included the passage of  some significant new Constitutional Amendments that provided for direct election of U.S. Senators, the right to vote for women, and a federal income tax.

The 16th Amendment, passed by Congress and ratified by the states, did away with the need to apportion direct taxes equally among the states based on population, amending this part of Article II which had been used to overturn the earlier income tax legislation.

   We’ve had an income tax ever since the amendment went into effect, with Congress establishing an initial set of taxation rates and then re-establishing from time to time. The tug-of-war over what amount of income should be levied what rate has been an ongoing matter of debate and dispute in the decades that followed. Adding Social Security to the mix in the 1930s and then Medicare in the mid-1960s, along with State and City Income Taxes has served to heighten the conservation.

Part of the consideration are the taxes levied on the sale of good and services, gasoline consumption, property values, and all of the license fees.

Of course, the 16^th Amendment does not require an income tax be utilized at all or that it has to be graduated, a fact not lost on many folks—past and present. Its abolishment has been a frequent proposal, replaced by a national sales tax. Another frequent suggestion has been to institute a low, flat rate.

Nearly half of the revenues raised by the federal government come from individual income taxes, with a little over a third generated from payroll taxes paid by employers. Only a small amount is paid be corporate income taxes and an even smaller amount from excise taxes and other sources. This does not include Social Security and Medicare revenues which go into separate funds.

As we know, money collected to fund the federal government does not usually cover expenditures—another cause of debate.

Whether an individual income tax will always be present remains to be seen. I’d guess it’ll be around long after I’m gone—with the caveat that a functioning society is still around. Like it or not—and I don’t suppose too many like it—taxes of a large amount are necessary to the operation of a modern nation that wishes to have a presence on the world stage. The degree of magnitude and level of presence is another consideration, but taxes certainly play a part.

A more consequential conversation is what we do with this money, the priorities and purposes we place on it, with the goal of enhancing, enriching, benefiting, and sustaining the common good.

Steve Horton is a Michigan-based journalist & commentator.