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United States Tax History – Federal Income Tax History in America

By Kira Botkin

100 bill united statesTaxes can be so frustrating that we often ignore the significant and interesting role they’ve played in U.S. history. Though the idea of taxes doesn’t necessarily please the populace, the issue has certainly motivated Americans during key events.

Taxes helped start the process that would eventually lead to the Revolutionary War and America’s independence. The Stamp Act, Sugar Act, and Tea Act (which incited the Boston Tea Party) were tax and tariff laws placed on the colonies by England to raise revenue.

Since the revolution, taxes and national events have influenced each other in ways that can help you better understand your tax situation, and how everyone benefits from the prices we pay.

U.S. Tax History

Civil War and the First Income Tax

Historically, wars have motivated governments of most nations to collect taxes. U.S. tax history is no different.

The federal government first imposed income taxes in 1861 to help pay for the Civil War. Before the 1860s, even during the War of 1812 and the Mexican-American War, the small federal government got by on taxing imports and exports. But with the significant cost of the Civil War burdening the treasury, the government enacted a (now modest) tax rate of 3% on incomes above $800, and 5% for incomes above $10,000. (Even the first income tax policies spared the poor.) These measures were short-lived, however, and the laws were repealed in the middle of Reconstruction, in 1872. American citizens didn’t pay income taxes for the next twenty years.

100 Years of Federal Direct Taxes

While local governments often rely on property taxes for revenue, the Constitution made it difficult for the federal government to directly tax property or income from it (e.g. rental fees) in the states. A federal property tax would have to be evenly divided by states’ populations, making it tough to tax higher-earning states more than lower-income states.

In 1909, Congress tried to overcome this obstacle by proposing the Sixteenth Amendment, which would allow the federal government to collect income taxes directly from individuals. The amendment was ratified in 1913 in the final months of the Taft administration. That year, the tax rates were 1% on incomes above $3,000 and 6% above $500,000.

World War I and the Great Depression: Sharp Increases

With the outbreak of World War I, the federal government again needed to raise revenue quickly, and in 1918 legislators raised the rates sharply, particularly on high-income citizens: 77% on incomes over $1 million.

The marginal tax rate went down slowly over the following 20 years, but it went back up during the Great Depression, since fewer people had any taxable income.

The New Deal: Medicare and Social Security

As the nation emerged from the Depression, the New Deal brought new benefits for citizens – and a new type of tax.

In 1937, under the Roosevelt administration, Congress ratified the Federal Insurance Contributions Act (FICA), creating the oft-maligned line on your paystub.

FICA taxes funded Social Security Administration, and when Medicare passed in 1965 under the Johnson administration, FICA taxes increased to cover program costs.

World War II: Raising Taxes and Adding Withholding

While FICA is a flat tax, a standard percentage that everyone pays up to a set maximum, income taxes are subject to various changes at different income levels. The marginal tax rate that rode such a steep increase during World War I stayed high all the way through World War II, when it went as high as 92%. (It has continued to go down over the years to a low of 31% in 1992, and it now stands at 35%.)

During World War II, the tax rate wasn’t the only thing that changed. The new tax policy added a feature that we just accept as routine these days: income tax withholding. Before World War II, most people paid their entire tax bill on the tax due date, which put a significant strain on government’s bank account. To end the feast-or-famine effect on the nation’s coffers, payroll withholding laws have evolved and now require citizens to pay at least 90% of expected taxes due by the end of the year.

A Different Timeline: Estate Taxes

Estate taxes have evolved differently from income taxes, because they began as state taxes in the 1880s. Federal estate tax laws were not enacted until the 1920s, but Congress didn’t address exemptions for spouses inheriting an estate until 1948.

The current system, by which a spouse may receive the entire estate tax-free, was not approved until 1981. Gift taxes were introduced in 1924 and have remained much the same since.

Final Word

As our history evolves, our tax policies constantly change with it, and new laws change the system every year. While we need some time to vent about how much we pay sometimes, it’s even more important that we understand why taxes are the way they are. Understanding the historical basis of our taxes adds perspective – and perhaps even helps us realize that our tax rates aren’t so bad after all.

Are you a history buff? What key points in American tax history interest you most?

(photo credit: Shutterstock)

Kira Botkin
Kira is a longtime blogger and serial entrepreneur who enjoys gardening, garage sales, and finding stray animals. She lives in Columbus, Ohio, where football is a distinct season, and by day runs a research study for people with multiple sclerosis. She hopes that the MoneyCrashers team can help you achieve your goals and live a great life.

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  • http://www.taxes-phd.com LV Tax PhD

    Very nice post. It seems tax rates have gone through trends over time. Wars and new government programs require more money which, in turn, lead to increases. I suspect that, in the near future, we will get new taxes such as taxes on internet purchases and eventually a Value Added Tax. Our budget deficits are too high in relation to tax receipts.

  • Guest

    Why didn’t George W. Bush follow in the successful actions of our past presidents during wartime? What was different about Bush’s war that he felt the need to give tax cuts rather than raise taxes?

  • David Boone

    Agreed, a valuable history lesson for us tax nerds. It’s a prevailing myth among my community of FairTaxers that the tax initiated by the 16th Amendment was a flat tax, when in fact it had tiers of 1% through 7%. Speaking of the FairTax┬«, I’d like to see Kira do an article on the next big thing. I would be happy to provide the research.

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