A Concise History Of Changes In U.S. Tax Law

Benjamin Franklin was correct in his assessment when he said there was nothing certain in life except for death and taxes. But while taxes have been certain, they’ve been far from consistent—especially in the United States. In fact, the tax plan as we know it today has evolved, having undergone a series of reforms and changes over the years, tracing their roots back to a pre-independent America. This article looks at some of the important periods in the history of taxes in the country.

The Land that Tax Forgot

There was a time when America was tax-free—at least when it comes to income taxes. Hard to believe, right? Not so much when you consider there was no federal government established in the land.

Although they didn’t pay taxes on the income they earned, American colonists still had to answer to the British, who charged excise taxes on everything from real estate and, of course, tea. Angry, the colonists revolted, leading to the infamous Boston Tea Party. This led to the uprising against the British in 1773.

Following the American Revolution, the newly established government was understandably cautious when it came to taxation as direct taxation was prohibited by the Constitution for all practical purposes. Therefore, government revenues had to be collected through tariffs and duties on certain items. These excise taxes on liquor, tobacco, sugar, legal documents, and so on, betrayed a social agenda as well as a revenue-gathering attempt.

The first challenge to the system came in 1794 with the Whiskey Rebellion. Groups of Pennsylvanian farmers angry about the tax on their whiskey burned down tax collectors’ houses, tarring and feathering any collectors too slow to escape. Defending the right to collect indirect taxes, Congress put down the revolt by military force.

War Is Hell but Taxes Last Longer

The sanctity of the Constitution and the ancestral aversion to taxes was tested again in the 1790s when conflict with France led to a property tax. The implementation of this tax was far from perfect, so the War of 1812 was funded by higher duties and excise taxes. It would take a Civil War to bring income tax into the young nation.

The American Civil War was disastrous and expensive for the nation. A massive amount of debt was incurred waging war against itself. In order to help pay for it, Congress passed the Revenue Act of 1861. The tax was levied on incomes exceeding $800 and was not rescinded until 1872. This act created most of what we consider the modern tax system—progressive with allowances for some deductions. This was also the time when the U.S. Internal Revenue Service (IRS) was founded, although it was originally called The Office of the Commissioner of Internal Revenue.

Rewriting the Constitution

The Constitution forbade any direct taxes not levied in proportion to each state’s population. The Supreme Court declared a flat tax contained in the 1894 Wilson-Gorman Tariff Act unconstitutional in 1895. Although a victory for taxpayers, many people were beginning to note the damage that revenue-collecting tariffs and duties were having both on world trade and the living standards of the poor.

The 16^th Amendment was introduced in 1913 to pave the way to an income tax by removing the proportional to population clause, thus saving the poor souls at the IRS from the unemployment line. It was quickly followed by an income tax on people with an annual income of over $3,000. This tax touched less than 1% of Americans. Interestingly, the phrase lawful income was later changed to simply income in 1916, giving prosecutors a way to convict organized crime figures such as Al Capone when all other avenues were exhausted.

World War, World Prosperity, World Depression

World War I led to three acts that cranked up tax rates and lowered the exemption levels. The number of people paying taxes in the U.S. increased to 5%, and separate taxes were introduced for estates and excess business profits.

These taxes were rolled back following the war in five phases, and the economy experienced a huge boom. Government tax receipts reached $3.6 billion in 1918, the last year of the war. Despite lowering taxes, the government’s take reached $6.6 billion in 1920. The stock market crash of 1929 and the financial fallout saw these revenues fall to $1.9 billion by 1932.

Roosevelt and Rising Taxes

Roosevelt’s New Deal and WWII saw many taxes introduced or increased as a way to help boost the economy. The New Deal ran a heavy deficit that needed to be made up by revenue. By 1936, the top tax rate was a staggering 79% and the economy’s output plummeted. Taxes were raised several more times with the exception of the 1938 Revenue Act—it contained a corporate tax cut that Roosevelt objected to, but was nevertheless passed.

By 1940, the need for the U.S. to prepare for war and support its allies led to even more aggressive taxation. Just four years later, people with incomes of $500 faced a 23% tax and the rates climbed up to 94%. By 1945, 43 million Americans paid tax and the yearly receipts were in excess of $45 billion, up from $9 billion in 1941.

Nixon and Stagflation

The Revenue Act of 1945 rolled back $6 billion in taxes, but the burden of Social Security and an expanded government kept them from going much lower. The highest tax rate was over 80% well into the 1950s and the pay-as-you-go withholding system introduced as a wartime measure was never shut down.

Progress in lowering taxes was sporadic and confusing. Rather than rolling back rates, the tax code was being rewritten to allow deductions in certain circumstances or to lower rates on, say, private foundations while raising rates on corporate profits. This explosion in loopholes and fine print makes the tax code time-consuming to understand in its entirety.

The 1960s and 1970s were a time of massive inflation, with government deficits continuing to grow with the addition of Medicare to the expensive Social Security system. Inflation became a huge problem for taxpayers because taxes weren’t indexed for it. This meant that although the real value of people’s incomes was being decreased, they were also required to pay more taxes. The 1970s also saw former President Richard Nixon forced to pay over $400,000 in back taxes. With the controversy over the Watergate scandal, the president’s tax evasion wasn’t as big of an issue as it might have been.

Reaganomics

The Economic Recovery Tax Act of 1981 represented a turning point for the tide for taxation, even though it was only temporary. This Act significantly lowered all the individual tax brackets and changed the way companies accounted for capital expenditures, encouraging investment in equipment. Reagan also sought to bring inflation under control, but he succeeded a little too well.

The government’s budget was based on an accepted rate of inflation, and when the attempts to quash inflation kicked in too quickly, a deficit was created. Consequently, Reagan had to pare back some of his tax cuts in 1984, specifically on the corporate side, to try and make up the budget shortfall. Despite this, the IRS announced that in 1986 more than 900,000 Americans were millionaires, perhaps partially due to the high-level tax cuts under Reaganomics.

In 1986, another tax reform act lowered the top rate from 50 to 28%, cutting corporate taxes from 50% to 35%. With more Americans now willing to take their wealth in taxable income, the overall tax receipts were relatively unchanged despite the drop.

The 1990s and Negative Tax

Medicare and Social Security are burdens both parties inherited as other expenditures were added to the bulging deficit. When former President Bill Clinton took over in the 1990s, the downward trend in taxes was at an end. Modest tax increases were begun in 1993, and 1997 saw the expansion of negative income tax. Negative income tax was a program whereby people below certain income thresholds could get funds through the tax system in the form of tax credits.

The New Millennium and Beyond

The 2001 tax cut introduced by former President George Bush once again dialed back the trend of tax increases but continued to increase tax credits that lead to negative income tax. Though not intended for it, this long-term tax cut helped shorten the recession following the dotcom crash, sparing the economy any specific stimulus measures.

The former President Bush tax cuts expired in 2010. This came at a stressful time as more baby boomers were leaving the workforce and the world was reeling from the effects of the financial crisis and the Great Recession.

Things changed once again after the election of former President Donald Trump. In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), based on Reagan Administration tax proposals, which aimed to slash individual, corporate, and estate tax rates. The law made a series of concessions including cutting tax rates across various income tax brackets.

The White House’s plan, which was signed in December 2017, was highly criticized for favoring billionaires and corporations instead of everyday Americans. Overall, the TCJA lowers tax rates across income levels helping reduce Americans’ income tax burden, but it also does away with many popular itemized deductions.