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United States Tax History – Federal Income Tax History in America

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It’s probably safe to say that Americans rarely find taxes fascinating. In fact, “frustrating,” “nerve-wracking,” and “head-scratching” might be more favored terms for describing the requirement to pay a portion of your money to the Federal Government. However, taxes have played a very important and – in all honesty – fascinating role in U.S. history. Most significantly, the process that would eventually lead to the Revolutionary War and America’s independence was instigated in part by the Stamp Act, Sugar Act, and Tea Act (which incited the Boston Tea Party) – all of which were tax and tariff laws placed by England on the colonies to raise revenue.

Since the Revolution, taxes and national events have continued to influence each other in ways that can not only illuminate, but can help you better understand your tax situation and how everyone benefits from the taxes you pay.

U.S. Tax History

Civil War and the First Income Tax

For many nations throughout history, wars have motivated their governments to collect taxes. U.S. tax history is no different.

During the War of 1812 and the Mexican-American War, the much-smaller-than-today Federal Government got by merely on taxing imports and exports. However, in 1861 the Civil War put a strain on the Union’s coffers. With significant expenses burdening the treasury, the Federal 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.)

However, these measures were short-lived, and the laws were repealed in the middle of Reconstruction, in 1872. American citizens didn’t pay income taxes for the next 20 years.

100 Years of Federal Direct Taxes

While local governments often rely on property taxes for revenue, the U.S. 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, 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 (the percentage of tax applied to your income for each tax bracket in which you qualify) 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 Franklin Roosevelt’s administration, Congress ratified the Federal Insurance Contributions Act (FICA), creating the oft-maligned line on your paystub. FICA taxes funded the Social Security Administration, and when Medicare passed in 1965 under the Johnson administration, FICA taxes increased to cover that program’s 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 top marginal tax rate that rode such a steep increase during World War I stayed high all the way through World War II, when it reached 92%. It gone down over the years since to a low of 31% in 1992, and now stands at 39.6%.

During World War II, the tax rate wasn’t the only thing that changed. The new tax policy added a feature that we 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 the 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. Congress didn’t address exemptions for spouses inheriting an estate until 1948. And the current system, by which a spouse may receive an 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 are created that affect change to the overall system every year. While everyone may occasionally need to vent about how much Americans pay, it’s even more important to understand exactly why taxes exist and how they came to exist in their current form. 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?

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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