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1860 - 1872 The federal income tax was first created during the Civil War as a way to finance the Union forces. Before then federal revenues consisted mostly of import duties and excise taxes on liquor, firearms and tobacco. There were also "sin" taxes on luxury items such as playing cards, billiard tables, private yachts, and jewelry. After the South seceded, the North couldn't collect excise taxes on products produced and sold in the South, nor could it collect duties on imports going into Southern ports. The cost of the war rose each year while the federal government's borrowing power declined. To make up the difference, and to assure the bankers who were purchasing most of the war bonds that there would be money to redeem the bonds, the Secretary of the Treasury, Salmon Chase, called for a temporary income tax in 1861. Like all income taxes, this first income tax started out to "soak the rich" with a 3% tax on incomes over $800 a year. With most wage earners making only a dollar or two a day, only a small number of Americans were required to pay. A year later it went to 3% on incomes between $600 and $10,000, and 5% if over $10,000. Taxes were withheld from the wages of government employees and from dividends paid by corporations. As the war escalated and became more costly the rates continued to climb. In 1864 incomes between $600 and $5000 were taxed at 5%, those between $5,000 and $10,000 at 7.5%, and higher at 10%. An emergency tax bill passed in July 1864 imposed an additional tax of 5% on all incomes in excess of $600, raising the rates to 10% to 15%. Revenues increased from $20 million in 1864 to over $60 million in 1865. Still, only 10% of Union households were paying income tax by war's end; the Northeast, which owned 70% of the nation's wealth in 1860, provided 75% of the revenues. Americans had accepted income and excise taxes only as emergency war measures. Once the crisis passed, they expected the tax burden to vanish. Starting in 1867, Congress consistently reduced the income tax rates and increased exemptions every year. The income tax laws were repealed in 1872 after most of the war bonds and other debts had been paid off. 1873 - 1900 During the late 1860s and early '70s, Republicans also phased out most of the excise taxes imposed during the Civil War, except for the sin taxes on alcohol, tobacco, and certain luxury items. Tobacco and alcohol excise taxes provided nearly 50% of the federal tax revenues by the 1890s. Congress retained the high tariff structure of the war years. By the late 1860s and onward through the rest of the 19th century, the average customs duty on imports was 47%, with many products, such as metal, cotton and wool products that competed with American made goods carrying rates up to 100%. These high tariffs were responsible for large investments of capital in industries nationwide, which lead to unprecedented economic expansion. Customs duties also generated the funds to redeem war bonds, pay for Southern Reconstruction, pensions for Civil War veterans, and Western expansion. Congress reduced protective tariffs by 10% across-the-board in 1872. They also eliminated duties on coffee and tea entirely, since the sole purpose of duties on those products had been to produce revenue rather than to protect American producers. One of the worst economic depressions in American history began with the Panic of 1873, following the bankruptcy of the Northern Pacific Railroad. Prices fell, unemployment soared, and a short supply of ready currency hurt small farmers and other debtors. It lasted about four years. The federal government quickly raised duties again in an attempt to spur American production. In a landmark case, Springer v. U.S (1881), the Supreme Court rejected the claim that the Income Tax of 1864 was unconstitutional. Springer, the plaintiff, had argued the income tax was direct, and thus subject to apportionment among the states. The Justices, however, ruled unanimously that direct taxes included only real property or chattel property, e.g., slaves. The income tax, they said, "fell within the category of an excise or duty." After a long period of prosperity and continually expanding output until the market was saturated, another major depression struck in 1893, again lasting about four years. The stock market collapsed, prices fell, violent labor strikes were common, and hundreds of banks and businesses failed, including major rail roads. President Grover Cleveland was criticized for his hard money stance, his efforts to repeal the 1890 Silver Purchase Act, his use of the military to suppress strikes, his seeming favoritism toward capitalists, and his lack of sympathy for farmers and workers. The writings of Karl Marx and others promoting communism and socialism became very popular, and the cause of the "working class" being exploited by "robber barons" and the "idle rich" was promoted heavily in the newspapers of the day. A number of small political parties merged over economic interests, producing the People's (Populist) Party. Their platform included a progressive income tax to "confiscate the 'unearned' profits of monopolistic trusts." The income tax was a prominent topic of debate in political campaigns of 1892 and a National Income Tax was made law in 1894, assessing a rate of 2% for incomes over $4,000 from virtually all sources. Again, only a small minority of citizens was affected by this tax which applied mainly to corporate incomes and wealthy professionals. In Pollock v. Farm Loan and Trust Co. (1895), the Supreme Court reversed its earlier decisions and struck down the law, finding the Income Tax of 1894 to be a direct tax on personal property requiring apportionment. They did not rule out all forms of income as being untaxable, however, which left the door open for Congress to write new income tax laws. In 1898, to help defray the cost of the Spanish-American War, Congress instituted a graduated inheritance tax with a maximum rate of 15% on estates over $1 Million. The bill also included an excise tax on excess revenues of oil and sugar refiners. Upon challenge, in Knowlton v. Moore (1900), the Supreme Court ruled the inheritance tax was an "indirect excise not subject to apportionment." The Court also ruled that the tax's progressive nature did not violate the Constitution's uniformity clause. Nevertheless, the bill was repealed in 1902. 1901 - 1913 President Theodore Roosevelt proposed a progressive inheritance tax in 1906, and in 1908 called for a new income tax, suggesting that it be worded in such a way as to prevent the Supreme Court from striking it down. When William Howard Taft was elected president that fall, there was no question that an income tax law would be passed. In early 1909, Senator Joseph Bailey, a southern Democrat, introduced an income tax bill that he expected to be opposed by the Republicans. But instead, Senator Nelson Aldrich of Rhode Island, a Republican, introduced a bill to amend the Constitution as a means of circumventing the Supreme Court. The first permanent corporate income tax was enacted that same year with an initial rate of 1 percent of net income. The Senate approved the 16th Amendment unanimously! The House vote was 318 to 14 in favor. The amendment then went to the states for ratification. On February 12, 1913, 42 of the 48 states had ratified it (though there are some who argue that it was never properly ratified), and the Secretary of State ordered the 16th Amendment be added to the United States Constitution:
The 1913 law exempted the first $4,000 of family income (a
substantial sum in those days when a house cost about $500), and taxed
any excess at 1% of the first $20,000, 2% to $50,000, with a maximum of
7% on incomes over $500,000. This low level of taxation was met
without objection, but the floodgates had been opened for Congress to
tap into the growing wealth of the nation to fuel a spending spree that
continued almost unabated throughout the 20th Century and into the
21st. Copyright
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