Today, October 3, marks the 100-year anniversary of the federal income tax. Its enactment profoundly altered the way Americans view the role of government. How did this come about? What was the norm before this fundamental shift?
From 1868 to 1913, The United States collected 90 percent of its revenue from excise taxes on the sale or use of specific products. Primary targets were liquor, beer, wine, and tobacco.
The antebellum era relied more heavily on tariffs to fund the limited government. Rates rose to nearly 49 percent on imported goods with the protective "Tariff of Abominations" in 1828. However, no matter how high these rates rose there was one source of revenue Uncle Sam refused to tap—its citizens' incomes.
This aversion to taxing individuals meant that instituting the income tax was not easy. When Congress first tried to pass a flat income tax rate of two percent in 1894, it was declared unconstitutional by the Supreme Court.
The process of passing a constitutional amendment to overcome the court's ruling spanned the terms of three presidents—Theodore Roosevelt, William Taft, and Woodrow Wilson—before it was ratified in February of 1913. It took eight additional months for Congress to work out a deal and give America her first peacetime progressive income tax.
The initial rates are laughable by today's standards. In 1913, after exemptions, there was a 1 percent tax on incomes over $20,000 ($472,000 today). The marginal rate steadily increased to an intolerable 7 percent for incomes over $500,000 (almost $12 million today).
In order to compare how far America has come, it is helpful to look at two simple examples. If a CEO were making the equivalent of a $5 million taxable income in 1913, he would have been in the five percent bracket. He would have owed the IRS a little under $190,000, ignoring deductions. Today he falls in the 39.6 percent federal individual income tax bracket. Without pricey accountants, his bill could approach $2 million.
The tax rate for a single filer who makes below $8,925 in taxable income is 10 percent in 2013, far higher than 1913’s top marginal rate. That top rate of 7 percent only applied to those making almost $12 million dollars a year. What a change.
Over 99 percent of the population was not directly affected by the income tax in 1913—that is significantly higher than the 47 percent of Americans who now pay little or no individual income tax.
By 1939, three percent of workers were paying income taxes. That quickly changed with Franklin Roosevelt's Revenue Act of 1942. The Act ushered in a new, extended era of top marginal rates that hovered close to 90 percent. Although a very small number of Americans paid tax at such a rate, the existence of these taxes served as a warning to success.
High top marginal rates persisted until 1964, when they began declining from a 91 percent high. They kept falling until 1986, when they reached 28 percent due to the passage of the Tax Reform Act of 1986, signed into law by President Reagan.
Since 1913, the government's ability to collect its citizens' incomes has become entrenched deeper in America's political fabric. With that, its willingness to expand into other aspects of citizens' lives increased as well.
Today, to fulfill its new roles, the government collects over 20 percent of national GDP in taxes. Before the income tax started in 1913, that number was below three percent.
This past century has produced massive growth of government in both size and scope. All things considered, it seems certain that introduction of the federal income tax played a central role in that expansion. Happy anniversary—I guess.
Jared Meyer is a Research Associate at the Manhattan Institute