7 Facts About U.S. Federal Income Taxes You Should Know – History

federal taxesThe current tax system in the United States is based upon the Revenue Act of 1913, which replaced the high tariffs of that period with a personal income tax system. Since that time, there have been numerous amendments affecting the definition of income to be taxed, the rate of taxation, as well as exclusions and deductions from taxable income.

Personal income taxes, while existing in every industrial nation, are and have been universally disliked, with one aspect or another constantly being challenged in court. Despite the complaints and challenges, income tax is the main source of revenue for the Federal Government. As Congress deals with the escalating annual deficits and national debt, it will review, and possibly amend, the country’s current tax philosophy to better fit the needs of the future.

You may not like having to pay taxes, but as an interested spectator with more than a little stake in the outcome, consider the following when contemplating the taxes you pay.

Federal Income Tax Facts & History

1. Taxes Are as Old as Civilization Itself

Kings and governments have extracted tribute from their subjects or citizens since the dawn of civilization in the form of taxes, tariffs, and fees. Taxes were collected in ancient Mesopotamia even before the invention of money 2,500 years ago. Families were required to deliver a number of cattle or sheep to the ruler depending upon the size of their herds; farmers in Egypt owed pre-calculated, pre-harvest bushels of grain to the pharaohs based upon the size of their field and the height of the annual Nile flood. Even cooking oil was subject to taxation and enforced by the pharaoh’s tax collectors (scribes) who visited private kitchens to ensure proper counts.

Taxes were originally collected in the form of produce, livestock, or free labor (corvee) where one person of every household would provide labor for weeks each year to construct and maintain roads, irrigation canals, perform army duty and mining, or erect buildings, temples, and even the pyramids. Subjects who did not pay were imprisoned or executed to set an example for other possible resisters.

The burden of taxation generally fell on the poor and the powerless; members of the ruling families and those with influence were beneficiaries of the system, generally not subject to loss of property or labor. People paying the taxes benefited through the protection of the ruler who could conscript, attract, and hire soldiers to protect his subjects from other rulers seeking to extend their empires by conquest or, conversely, fund invasions of his own – and some have argued that a primary purpose of taxes was to keep the ruler in power, the soldiers paid by public tax money to protect the king from his own people.

The appearance and widespread use of currency not only financed trade, but made tax collection much easier, as collectors no longer had to contend with physical property or manage labor as forms of payment. Paradoxically, currency in lieu of tangible property like cattle or crops also made the wealthy a visible, more attractive source of tax dollars.

2. If It Weren’t for Napoleon, Income Taxes Might Never Have Appeared in America

William Pitt the Younger, Great Britain’s Prime Minister and Chancellor of the Exchequer, led Parliament to pass a tax of 10% on total income above £60, the equivalent of about $10,000 today, in order to defend the country from Napoleon. The law, passed in 1799, even provided certain deductions for incomes up to a maximum of £200.

Since the average annual income of a laborer or farmer at that time was £15 to £20, the average citizen was not liable for tax. By distinguishing between those who made less than £60 and those who made more, Pitt invented the progressive tax system, where those who earn more, pay more.

A year after the Battle of Waterloo, the tax was repealed (1816), with the Parliament directing the taxing authority to destroy all documents associated with the collections. The king, however, directed the Chancellor of the Exchequer to secretly copy the records and store them in the basement of the tax office for possible use in the future. It was a strategic move since taxes were reinstated less than 25 years later.

By the early 1840s, massive changes had occurred in Great Britain from industrialization: Vast manufacturing cities resulted from the migration of rural farmers for urban employment; slavery ended; numerous societal ills, such as child labor, became prevalent; and the numbers of the poor and hungry increased in the midst of the Irish potato famine. With the responsibilities of a worldwide empire, Prime Minister Robert Peel reintroduced a “temporary” income tax in 1842, taxing only those with incomes greater than £150, while reducing custom duties on two-thirds of the items previously subject to the high tariffs.

This combination of taking with one hand while giving with the other worked perfectly: Trade and tax revenues increased, while necessary social programs benefited. Income tax remains “temporary” today in Great Britain, expiring each year on April 5th and continually reinstated by Parliament by an annual finance act.

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3. The First Income Tax in the U.S. Occurred During the Civil War

In the years immediately following the Revolutionary War, political battles continued to be fought over the powers of the Federal Government versus the states. Each state passed tariffs, created state currencies, and established their own tax policies, creating conflicts, confusion, and financial chaos. This threatened to undermine the economy of the entire nation. The ratification of the Constitution in 1787 gave the Federal Government the exclusive power to impose tariffs (the primary source of government funds at that time), coin money, collect excise taxes, and levy taxes on individual citizens.

The writers of the Constitution specifically limited Congress’s ability to impose personal income taxes with the language of the fourth clause of Section 9 of the Constitution: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or enumeration herein before directed to be taken.” In other words, salaries and wages were considered “direct” income, making the imposition of an income tax impractical due to the requirement to be proportional to the population in each state.

In 1815, Secretary of Treasury Alexander Dallas proposed an income tax to pay for the War of 1812, modeled after the British Act. It did not become law due to resistance in the House Ways and Means Committee at that time. In 1861, however, Congress – with the assent of President Abraham Lincoln – passed the Revenue Act of 1861 to fund the costs of the Civil War. Due to the emergency and the intended temporary nature of the Act, no effective protest was made.

The Act imposed a flat tax of 3% on all incomes over $800 (about $20,000 today). In 1862, the Act was amended, replacing the flat tax of 3% with a progressive tax, adding a rate of 5% for all incomes over $10,000 ($221,000 in 2012). It was amended again in 1864 to add a third bracket between the previous two income brackets. The Act expired in 1873, ending personal income taxes for a time until the passage of the 16th Amendment to the Constitution in 1913.

4. The Constitution Was Amended in 1913 Allowing Congress to Levy Personal Income Taxes

The Supreme Court’s decision in the case Pollock v. Farmers’ Loan & Trust Co. in 1895 effectively eliminated the possibility of personal income taxes by the Federal Government by confirming that an income tax was “direct.” However, a constitutional amendment was introduced in 1909 and subsequently ratified by 42 of the 48 state legislatures that removed the constitutional prohibition against income tax.

The 16th Amendment says, “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.” It is the basis for our income tax system today. Over the years, some income tax protesters have asserted that the 16th Amendment was not properly ratified , thereby justifying the nonpayment of taxes. This argument has been subsequently denied by multiple courts. It should be clear to readers that the obligation to pay federal income taxes is not in dispute – it is accepted law.

5. Not Everyone Pays Income Taxes

While everyone is subject to filing federal income tax forms, people whose income falls below the minimum bracket in effect at the time of filing or whose exemptions or deductions reduce taxable income to zero do not pay any federal income tax. For example, single taxpayers earning less than $3,000 in 1913 (the equivalent of about $9,700 today) were not liable for any tax; married taxpayers could earn up to $19,500 in equivalent dollars today without owing tax.

Today, a single taxpayer earning less than $5,950 or a married couple filing jointly with an income less than $11,900 would not be liable for tax. In addition, income from specific sources may have favorable treatment, effectively removing all or a portion of such income from taxation.

The controversial quote during the 2012 presidential election that “47% of Americans do not pay income taxes” is true according to the Tax Policy Center for the above reasons – but also includes more than 4,000 citizens who earned $1 million or more in 2011 and paid no taxes. However, what is often overlooked is that the impact of our tax code is objectively fair and relatively flat in that each bracket of taxpayers pays approximately the same proportion in total taxes (federal, state, and local) as their share of national income. The following is a comparison of 2011 taxes paid:

  • The lowest 20% of the population with an average cash income of $13,000 received 3.4% of total national income and paid 2.1% of total taxes
  • The second 20% with an average income of $26,100 received 7.0% of total income and paid 5.3% of total taxes
  • The bottom 80% of Americans with average incomes under $68,700 received 40.5% of total income and paid 36.7% of taxes
  • The top 20% of Americans with a minimum income of $105,700 received 59.6% of total income and paid 63.1% of total taxes

It should be noted that the trend in federal income tax paid by individuals has generally been downward since 1945. A married couple filing jointly with an income of $1 million would have paid $664,312 in 1945 versus $319,873 in 2011; the same couple earning $30,000 would have paid $7,016 in 1945, but only $3,650 in 2011.

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6. Citizens in the U.S. Pay Less Taxes Per Capita Than Most Countries

According to data from the Organization for Economic Cooperation and Development (OECD), the citizens of the United States are one of the least taxed populaces in the world, ranking 26th of 28 developed countries. The comparison includes all taxes within a country, income as well as property, social taxes for such things as healthcare and retirement programs, sales and other consumption taxes, and estate or gift taxes.

The total tax burden of the U.S. in 2009 was 22.6% of gross domestic product (GDP), well below the countries of Scandinavia and Europe (including France, Germany, and Great Britain). In 2009, corporate taxes were 1.3% of GDP, while the average for the other OECD nations was 2.4%. Only Iceland had a lower corporate tax rate compared to GDP than America. Many countries have subsequently lowered their corporate tax rates while eliminating deductions that previously reduced taxes, the net effect on total corporate tax collections being relatively small.

7. There Is No Causal Relationship Between Lower Taxes for the Wealthy and Economic Growth

Despite the political rhetoric that lower taxes for the wealthy leads to greater investment and more economic growth, an examination of past tax rates and economic cycles indicates that there is no causal relationship between lower taxes for the upper bracket and growth. Taxes were raised by both Presidents Bush and Clinton during the 1990s, followed by an economic boom and the highest income growth since the 1960s. President George W. Bush reduced taxes and the nation experienced the worst economic downturn since the Depression.

The fact is that tax rates affect economic growth very little, if at all, compared to other factors, such as federal deficits, technological advances, the economies in other countries, and consumer confidence. Even advocates of reducing taxes concede that the impact of the reduction is more dependent upon tax cuts for the lower 80% of the population, who are most likely to spend the additional income than higher income earners. In fact, according to the Congressional Research Service, “As the top tax brackets are reduced, the share of income accruing to the top of the income distribution increases; that is, income disparities increase.”

In plain English, the rich get richer, and the poor get poorer when rates are reduced for the wealthy.

Final Word

Universally disliked by the populace, the amount of income taxes levied and the responsibility of payment has always been controversial and in constant flux, the outcome depending upon the quid pro quid of the tax, its benefits, and the influence of prospective payers upon the lawmakers. While both political parties agree that the U.S. has too much debt, the parties disagree upon prospective solutions to reduce debt while also stimulating the economy to create more jobs and higher growth. The Republicans seek to shrink Federal Government spending by eliminating waste, fraud, and amending social programs, such as Social Security, Medicare, and Medicaid; the Democrats want to increase income taxes for the higher income earners while also reducing some social program expenses. Their differences will be discussed and argued many times over until an acceptable political compromise is reached. Whether the final solution will be in the nation’s best interests remains to be seen.

Should income taxes be raised on those earning $250,000? $1 million? Which programs should be cut or amended?

  • futuremilitary

    Given the amount of debt the U.S. has, I’m A-OK with increasing taxes, especially for the top two tax brackets.

    But I also would like some tax reform. The reason people object to paying taxes is because they don’t (think they) get anything out of it. They feel robbed by their government. If everybody somehow got something out of paying taxes—whether it’s health care or newspaper subscriptions—there’d be fewer objections to paying them.

    -Christian L. @ Smart Military Money

    • Mlewis

      One problem with our government is its sheer size which automatically includes bureaucracy and inefficiency. The difficulty is cutting spending is finding the programs which are acceptable to the various interest groups – a difficult task in itself. Finally, the public can’t decide what they want. A case in point is Obamacare – people are against it in principle, but don’t want to lose any of the programs or benefits it provides.

      In the final analysis, we are going to pay taxes and they will certainly rise, probably to a level less than the average of other nations, but higher than today.

      thanks for writing.

      • Tim Schmidt

        Well said. To me, it comes down to the good old-fashioned American sense of entitlement; that we want to have our cake and eat it too. Unlike many countries, we don’t typically need to worry about whether the food we buy will kill us thanks to organizations like the FDA and the USDA. We have an excellent highway system thanks to the DOT. We have great law enforcement and legal systems to keep us safe. And the list goes on and on, including many services that most citizens aren’t even aware of and yet actively serve to improve their quality of life.

        However, we just expect all of these things to be provided for us and don’t think of our taxes as actually paying for them. In fact, it seems like a lot of people gripe about taxes and big government, as you say, but it can be those same people that will also complain when the government didn’t do enough to protect them from something bad.

        • Mlewis

          Agreed, Tim, thanks for writing.

      • Patrick Malloy

        “interest groups” are a seriously bad and unnecessary draw on public resources. If we would get rid of the thousands of programs that the Federal Government has no business in then we would be much better off as a nation.

  • [email protected]

    I’m sure it is all our fault over this side of the pond for introducing the idea of income tax!!! :-) However the solution is to speed up the economy so that money ciculates faster. As the government takes a slice of every transaction (in some way) this will increase the tax take and therefore the tax levels can be reduced. In other words, growth!

    • Mlewis

      John, I agree we need growth. I’m not as certain how to spur it – I do think we need more revenues through a more equitable tax system while revising and reforming our entitlement programs. You guys have the advantage of a National Health System which is much cheaper than we’ll ever achieve. Thanks for writing.

  • http://wealthnote.com/ Ted Levi Blackman

    I personally like the idea of taxing consumption rather than income. I feel like people work hard to the income they generate and should be able to decide were it goes. We have many policies that are supposed to spur investment and I think eliminating income tax would allow people to invest more money. We should be taxing the people who spend their money on boats and cars instead, especially since our tax dollars are being used for the roads and waterways they are used on.

    A consumption tax seems to make more sense because consumption is what costs society. Earning an income adds value to society through the work they perform. Would love to hear some insight on this kind of idea!

    • Mlewis

      Consumption taxes have many proponents and are in use, particularly by the States. Cigarettes, alcohol & gasoline are examples of the consumption tax at work. The economy needs those who spend as well as those who invest; otherwise, there is no one to buy the products of the companies owned by the investors.
      The best tax system is the one which is equitable to all and provides sufficient funds to the government to pay for the general needs. Most people also agree that a progressive tax is important to some degree.
      Thanks for writing – I’ll try to cover consumption taxes in a later post.

  • Patrick Malloy

    Mr Lewis, I would like to correct some of your statements about your 4th “Fact” which are completely non-factual.

    First off, the Supreme Court in the Pollock decision never said that an “income” tax was a “direct” tax. They said that the tax on dividends and other property type of receipts, such as rent, was NOT an “income” tax, legally, but actually “property” tax. To tax personal property is to create a “direct” tax and that would need apportionment.

    The Pollock court stated, “The tax imposed by sections 27 to 37, inclusive, of the act of 1894, so far as it falls on the income of real estate, and of personal property [dividends], being a direct tax, within the meaning of the constitution, and therefore unconstitutional and void, because not apportioned according to representation, all those sections, constituting one entire scheme of taxation, are necessarily invalid.”

    Secondly, the 16th Amendment did not remove any constitutional prohibition against the “income” tax because there was never a prohibition against it in the first place.

    What the 16th Amendment does say is that the Pollock court’s conclusion was wrong. The amendment provides that Congress can continue to apply the income tax to gains that qualify as “incomes” (the product of an exercise of privilege) without being made to treat the tax as direct and needing apportionment when applied to dividends and rent by virtue of judicial consideration of the source.

    The 16th Amendment does NOT transform the “income tax” into a “direct tax”. It doesn’t repeal, revoke, modify or even affect the apportionment requirement for capitations and other “direct” taxes. What it does do is simply prohibits the courts from using the overruled reasoning of the Pollock decision to shield otherwise excisable dividends and rents from the tax.

    “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

    Treasury Department legislative draftsman F. Morse Hubbard said it this way, “[T]he amendment made it possible to bring investment income within the scope of the general income-tax law, but did not change the character of the tax. It is still fundamentally an excise or duty…”, to Congress in 1943.

    In the Cornell Law Quarterly, 1 Cornell L. Q. 298(1915-16) the say this, “The Amendment, the [Supreme] court said, judged by the purpose for which it was passed, does not treat income taxes as direct taxes but simply removed the ground which led to their being considered as such in the Pollock case, namely, the source of the income. Therefore, they are again to be classified in the class of indirect taxes to which they by nature belong.”

    U.S. Supreme Court, Taft v. Bowers, 278 US 470, 481 (1929), “[T]he settled doctrine is that the Sixteenth Amendment confers no power upon Congress to define and tax as income without apportionment something which theretofore could not have been properly regarded as income.”

    U.S. Supreme Court, So. Carolina v. Baker, 485 U.S. 505 (1988), “[T]he sole purpose of the Sixteenth Amendment was to remove the apportionment requirement for whichever incomes were otherwise taxable. 45 Cong. Rec. 2245-2246 (1910); id. at 2539; see also Brushaber v. Union Pacific R. Co., 240 U. S. 1, 240 U. S. 17-18 (1916)”

    Thirdly, you said that the 16th Amendment is the basis for our income tax system today, however, this is clearly incorrect in light of what we have just read above.