The 16th Amendment: Raising Revenues for Public Investments Since 1913
by Scott Klinger, 2/3/2015
One hundred and two years ago today, Wyoming became the final state to ratify the 16th Amendment, giving Congress the constitutional authority to establish a federal income tax. Later that year, Congress used that authority to establish the modern income tax system.
History of Income Taxes in America
The nation’s first income tax was signed into law by President Abraham Lincoln. In order to pay the costs of the Civil War, it imposed a three percent tax on incomes between $600 and $10,000 ($600 in 1862 is the equivalent of about $14,000 today) and five percent on incomes over $10,000 (almost $234,000 in today’s dollars). After the war ended, Congress cut the tax rate in 1867 and repealed it entirely in 1872.
Throughout the first 125 years of American history, the nation’s peacetime bills were largely paid by tariffs on imported goods. These import taxes were added to the cost of goods sold in the United States. Because working people spent more of their income on consumer goods than wealthier people, these tariffs fell more heavily on low- and moderate-income Americans. These tariffs also protected U.S. manufacturers from foreign competition, so they allowed rich industrialists to achieve greater levels of profit than they would have without import taxes.
Growing disparities in income and wealth led to public calls for a renewed income tax toward the end of the 19th century. The Wilson Tariff Act was passed in 1894, but unlike the Civil War income tax, which fell on all but the poorest citizens, the 1894 tax applied only to the top one percent of income earners; those earning more than $4,000 per year paid a two percent tax on their income.
The rich did not look kindly on even this modest tax and mounted a constitutional challenge at the U.S. Supreme Court. Opponents of the tax contended that it represented a direct tax on people, a violation of the Constitution, which allowed only for taxes apportioned on the states in proportion with their population. The Court agreed and struck down the income tax.
While the income tax was dead for the moment, popular interest in using a progressive income tax to rein in the excesses of the nation’s most prosperous citizens grew. When President William Howard Taft entered office in 1909, public support for the income tax reached a crescendo. Rather than simply defying the Supreme Court and enacting a new income tax, Taft instead called for a constitutional amendment allowing for direct taxation to address the earlier concerns of the Court. Congress passed the proposed amendment in 1909 and sent it to the states for ratification. They also passed a one percent tax on business income, the nation’s first corporate income tax.
In 1913, with international tensions building and the looming prospect of an expensive global war central in the minds of political leaders, Wyoming became the 36th and final state needed to ratify the 16th amendment. It did so on Feb. 3, 1913. A few months later, President Woodrow Wilson proposed a sweeping set of tariff reforms, which included a new tax on personal income. Tariffs on imported goods were slashed, and a one percent tax was established on incomes above $3,000 (about $70,000 in today’s dollars). The tax rate steadily increased, reaching seven percent on incomes over $500,000 (nearly $12 million in 2014 dollars). The first income tax bill was straightforward, just 14 pages long.
Income tax rates reached their peak of 94 percent at the height of the Second World War in 1944 and remained above 90 percent until 1963. This period of high personal tax rates coincided with the strongest economic growth the nation has seen since World War II.
Presidents Kennedy and Reagan presided over sharp cuts in the top income tax rates. In 1993, President Clinton signed into law the most significant increase in personal income tax rates in the post-World War II era. President George W. Bush cut top income tax rates modestly, and President Obama reversed the Bush tax cuts on America’s wealthiest taxpayers in 2013.
Top Income Tax Rates Since World War II
|Year||Top Rate||On Incomes Over||In 2014 Dollars|
|1988||28.0%||$ 29,750||$ 58,628|
Individual Income Taxes Pay Nearly Half the Nation’s Bills
Since World War II, the share of the federal government’s bills paid for by individual income taxes has been relatively stable, accounting for about 45 percent of the total revenue of the U.S. government. In stark contrast, the share of federal revenues accounted for by corporate income taxes has plummeted. In the midst of the Second World War, corporations paid more than a third of the cost of government; last year, corporate taxes accounted for a little more than a tenth of federal government revenue. Payroll taxes for Social Security and Medicare account for most of the remaining federal government revenue.
U.S. Personal and Corporate Income Taxes as a Share of Total Federal Revenue
|Year||Personal Income Tax||Corporate Income Tax|
Source: President's FY 2016 Budget, Historical Table 2.1
To Learn More:
Historical Highlights of the IRS, Internal Revenue Service, Jan. 23, 2015
A Short History of the Income Tax, John Steele Gordon, Wall Street Journal, Sept. 27, 2011