Most people know very little about how our system of taxation came to be. Following is an abridged version of events leading up to what we now know as the federal income tax.
Back
in 1776 Adam Smith, now widely known as the father of economics and
capitalism, authored The Wealth of Nations. In this book he
described four maxims that any good system of taxation should adhere to (I
have taken the liberty of paraphrasing):
1) Proportionality:
Every person should pay tax based on his/her ability to pay; in other
words, in proportion to earnings.
2) Transparency:
The tax should be certain and not arbitrary. The due date,
acceptable forms of payment, and amount should be clear to everyone.
3) Convenience:
The tax should be collected in a manner which is most convenient for the payer.
4) Efficiency: The
tax should be calculated in such a way that it takes as little as possible from
the payer over and above what is needed to run the government.
Pre-history of the Income Tax
The first tax on income was signed into law by Abraham Lincoln in 1861 in order to help fund the Union during the Civil War. The 3% tax was imposed on incomes over $800 (about $19,000 in today’s dollars). In 1862 the tax was changed to capture incomes over $600, with a new 5% rate on incomes over $10,000 (about $215,000 in today’s dollars). However in 1872, Congress completely eliminated the income tax.
In 1894 a 2% tax on incomes over $4,000 was signed into law, which affected less than 5% of the population. However less than a year later the Supreme Court ruled that the tax was unconstitutional, and once again the income tax was completely eliminated.
Our Income Tax: A Timeline
In 1913 the 16th Amendment became part of the Constitution, which allowed the federal government to levy taxes on income. Ever since then, Americans have been paying an income tax. Here is a brief timeline of our current system:
1913 – Form 1040 is introduced, as well as the mortgage interest deduction. Less than 1% of the population is subject to the income tax. (top tax rate = 7%)
1917 – In order to provide support for our efforts during World War I, taxes are increased. The deduction for gifts to charity is also introduced. Only 5% of Americans are subject to the tax. (top tax rate = 67%)
1939 – All existing tax law is codified for the first time, resulting in the Internal Revenue Code. (top tax rate = 75%)
1941 – To help pay for World War II, the income tax is greatly expanded to affect all but the lowest-paid Americans. Franklin Roosevelt tries unsuccessfully to enact a 100% tax rate on all incomes greater than $25,000. (top tax rate = 81%)
1943 – Required income tax withholding from paychecks is enacted. (top tax rate = 88%)
1944-1945 – The top tax rate is 94%, the highest in history.
1954 – The second version of the Internal Revenue Code is released. (top tax rate = 91%)
1969 – The Alternative Minimum Tax is put into place, which was intended to tax the highest income earners, some of whom had been completely escaping tax because of various exemptions and deductions. (top tax rate = 77%)
1980-1982 – The top tax rate is lowered from 70% to 50%.
1986 – The third and current version of the Internal Revenue Code is released. Many tax shelters are eliminated. (top tax rate = 50%)
1997 – The Child Tax Credit is introduced, as well as the current exemption from tax on the profit from sale of a principal residence. (top tax rate = 39.6%)
2001-2003 – The “Bush tax cuts” are enacted, which significantly lower rates across the board, including a maximum rate of 15% on qualified dividends and capital gains. These provisions were set to expire at the end of 2010, but they were extended through the end of 2012. (top tax rate = 35%)
2013 – The Bush tax cuts are made permanent for taxpayers making under $400,000 ($425,000 if Head of Household, $450,000 if Married Filing Jointly). Also, a new 3.8% Medicare tax on net investment income is enacted for taxpayers making $200,000 or more ($250,000 if Married Filing Jointly). (top tax rate = 39.6%)
2014 – Due to the Affordable Care Act, most taxpayers are required to carry a minimum amount of health insurance. Subsidies for low-income taxpayers and penalties for insufficient coverage are administered through the tax code. (top tax rate = 39.6%)
2018 – The Tax Cuts and Job Act goes into effect, which includes the biggest changes to the tax code since 1986. Among other changes, the standard deduction is significantly increased, which greatly reduces the number of taxpayers who itemize deductions. The child tax credit is doubled to $2,000 per child and the income thresholds are significantly increased, so that most taxpayers with children are able to claim the credit. However, personal exemptions, moving expenses, most miscellaneous itemized deductions, and state & local income taxes over $10,000 (for those who still itemize) are no longer deductible. (top tax rate = 37%)
2019 – The penalty for not having health insurance is reduced to zero, effectively eliminating the requirement that taxpayers carry health insurance. (top tax rate = 37%)