How Income Tax Came To Be

By Author: Jeff Parrack
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The very first personal income tax in the United States of America was imposed by the government of the time to finance their war efforts during the Civil War. The tax formed part of the Revenue Act of 1861 and was instituted on August 5, 1861. The Act stated that a 3 percent personal tax be imposed on all income revenues over $800. This tax was repealed in the following year and replaced by another income tax that was implemented in 1862.

More than 30 years later, in 1894, the Democrat Congress passed the first peace time income tax. The tax was implemented to recover revenues that were to be lost due to tariff reductions and was known as the Wilson-Gorman Tariff. This tax law affected less than 10 percent of the population at the time as it only taxed persons with an income of more than $4,000. The tax rate was 2 percent.

Tax Law has Never Been Simple
In 1895, a Supreme Court case made a ruling that was to cause confusion in the tax laws for many years to come. In the case of Pollock versus Farmers Loan and Trust Co., the court ruled that tax levied on receipts from the use of property was unconstitutional. ...
... In other words, rental income from property, interest and dividend income from personal property were considered direct taxes and therefore had to be apportioned among the States. However, as apportionment was largely impractical, this court ruling effectively prohibited tax on any income received from property investments. This caused complications in the federal tax system for years and the government lost out on substantial revenues.

Realizing the effect of the ruling, Congress responded by proposing the Sixteenth Amendment in 1909 which was eventually ratified by the required number of States in 1913. In simple terms, the amendment stated that Congress could impose taxes regardless of the source of income. In addition, it did not have to be apportioned to the various States and was not affected by enumeration or census. The Supreme Court case of Brushaber versus Union Pacific Railroad, three years later, reaffirmed that the Sixteenth Amendment did not expand Congress's power to impose taxes. Rather, it simply removed the possibility of income tax being classified as a direct tax on the basis of the source of income.

There are literally hundreds of tax statutes that have been passed on the basis of the 1913 Sixteenth Amendment and theses are commonly known as "modern" tax statutes. Various court rulings have further defined tax laws and a large portion of these have revolved around the definition of gross income or personal income.

How Income Tax Historically Contributes to Government Revenues
Even though income taxes were implemented from 1861 in the U.S., they never made up any significant portion of the tax revenues. Instead, these were largely generated from a variety of tariffs. With the onset of World War I, this changed when income tax was used as a source to fund the war efforts. Today, a large portion of government revenues is generated from income tax, although many people advocate that taxes should be generated from alternate revenue streams. There is an ongoing debate regarding types, levels and implementation of taxes and accountants are still forever trying to find ways of reducing the amount of individual tax paid.

The Rise and Fall of the Top Marginal Tax Rate in the United States
Initially following the implementation of the Sixteenth Amendment in 1913, tax levels were still relatively low. There was a 1 percent tax on net personal incomes and surcharge of and additional 6 percent tax on any personal incomes over $500,000. By 1918, due to the First World War, the top rate for income tax had risen to 77 percent for incomes over $1,000,000. The rate then dropped progressively in the 1920s to a more reasonable 24 percent in 1929. However, this level was short-lived. With the advent of the great depression, the rate shot up to 63 percent in 1932 and by the end of World War II the top tax rate was 94 percent on all income over $200,000. Even though the war was long gone the rate remained above 90 percent until 1964 when it was lowered to 70 percent. During the 1980s, it dropped to a low of just 28 percent. In the last few decades, the top marginal tax rate has remained within a range of 12 percent. Currently, it is around 35 percent but it is expected to rise to around 40 percent in the coming years. Interestingly enough, even though the top marginal rate has fluctuated significantly over the years, the actual tax revenue generated from income has remained fairly constant at around 19.5 percent over time.
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