As Tax Day approaches, and before the ink dries on your check to Uncle Sam, we take a moment to look back at the history of taxes in America...you know…to make you feel better. So, get your tea bags or some prohibition-style libations, while we reiterate the age-old saying…. nothing is certain except death and taxes.
But before we dive in, it is important to note that taxes were not always levied on Americans such as federal income tax, the alternative minimum tax, corporate tax, estate tax, the Federal Insurance Contributions Act (FICA), and so on. Neither did the founders of America desire and intent to design such an arrangement.
The early colonists had to deal with the British, which imposed a bevy of taxes on the colonists including a head tax, real estate taxes, and the infamous tea tax that led to the Boston Tea Party.
After the Revolutionary War, the Congress granted the power to impose taxes on the public. States were responsible to collect and pass those to the government, mostly excise taxes imposed on specific goods like alcohol and tobacco. The government also tried direct taxation—taxing things an individual owned. That was not popular, and the feds went back to collecting excise taxes. And in 1791, Alexander Hamilton’s proposed excise tax on alcohol was enough to prompt the Whiskey Rebellion in Pennsylvania.
The Civil War led to the country’s first income tax and the first version of the Office of the Commissioner of Internal Revenue—the earlier version of what we now call the Internal Revenue Service (IRS). This office took over the responsibility of collecting taxes from individual states. Excise taxes were also added to almost every commodity possible—alcohol, tobacco, gunpowder, and tea…but this time…without the party. Interestingly, income tax rates used to apply to everyone based on income regardless of status—single, married, and heads of households.
The first estate tax was enacted in 1797 to fund the U.S. Navy. It was repealed but reinstituted over the years, often in response to the need to finance wars. The modern estate tax as we know it was implemented in 1916.
Other taxes as a corporate income tax were enacted slightly earlier in 1909.
Wars are Expensive
In 1913, the States ratified the 16th Amendment, instituting the federal income tax where the actual form and directions were a mere four pages…today the total an intimidating 106 pages. Income tax rates ranged from 1% on income of $0 to $20,000 up to 7% on income over $500,000.
However, to finance America’s participation in World War I, Congress passed the 1916 Revenue Act and then the War Revenue Act of 1917. From 1916 to 1917 the tax rate jumped from 15% to a whooping 67%…then finally settling at 77% in 1918.
Wars are Expensive! So, after the war, the federal income tax rates took on the steam of the roaring 1920s dropping to 25% by 1931. The gift tax came about in 1924. Sales taxes were first enacted in West Virginia in 1921. Eleven other states followed suit in 1933.
The Great Depression
The Great Depression was a worldwide economic downturn that began in 1929 and lasted until about 1939. It was the longest and most severe downturn experience by the Western world, causing fundamental changes to economic policy, theory, and institutions. But by 1933, the American recovery was in full swing. But Congress raised taxes again in 1932 during the Great Depression to 63% on top earners…potentially lengthening this recovery progress. Federal excise taxes on gasoline were implemented in June 1932 under President Herbert Hoover as part of the Revenue Act of 1932. FDR signed the Social Security Act in 1935. The government first collected Social Security taxes in January 1937. Dividend taxes were enacted in 1936 but only lasted through 1939.
WWII and Beyond
As mentioned before, war is expensive. In 1944, the top rate peaked at 94% on income over $200.000. By the end of the war and through the 1970’s, the top federal income tax rate remained high, never dipping below 70%. Investment dividend taxes reappeared in 1954 and have persisted ever since. The alternative minimum tax (AMT), a type of federal income tax, was not enacted until 1978, as a way to ensure everyone paid their fair share.
It was not until The Economic Recovery Tax Act of 1981 that the highest rate was reduced from 70% to 50% and indexed the brackets for inflation. The Tax Reform Act of 1986 expanded the tax base and dropped the top rate to 28 percent for tax years beginning in 1988. The idea was that the broader base contained fewer deductions but brought in the same revenue. Further, lawmakers claimed that they would never have to raise the 28 percent top rate…this promised lasted three years before it was broken.
By 1991 the top rate jumped to 39.6%. However, the Economic Growth and Tax Relief and Reconciliation Act of 2001 dropped the highest income tax rate to 35% from 2003 to 2010. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 maintained this rate through 2012.
The American Taxpayer Relief Act of 2012 increased the highest income tax rate to 39.6%. The Patient Protection and Affordable Care Act added an additional 3.8 percent on to this making the maximum federal income tax rate 43.4%.
Today, the highest federal tax rate is 40.8%. In context of this article…what’s the big deal? Seems like a historically low tax rate. But the difference between today and the past is the wide range of things that ARE taxed. Actually, it may be easier to list the things that aren’t taxed…like…uhm…air? LINK However you split the baby, understanding America’s history on tax will cause you to cry and lash out in a violent rage or you will find ways to cope and develop strategies to take advantage of the complexity. Either way, certainty is usually a valuable thing these days…and since death is inevitable…inevitably taxes only get worse when Congress meets.
Happy Tax Day!
– Invito Energy Partners