The 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.
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.
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.
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?