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Income Tax: A History

February 6th, 2012

Benjamin Franklin once wrote, “In this world nothing can be said to be certain, except death and taxes” — something all taxpayers can attest to, particularly around April. Income tax, though, was not always quite so certain — in fact, for most of our nation’s history, income tax did not even exist.

Congress did not enact income tax in the United States until 1862, as a means to support the cost of the Civil War. Prior to that, the government had merely taxed imported goods to sustain itself. The Act of 1862 established the office of Commissioner of Internal Revenue, whose powers included the rights to assess, levy, and collect taxes, and to enforce the tax laws by seizing property or through prosecution, similar to the Internal Revenue Services’ powers today. At that time, a person earning between $600 and $10,000 per year (about $13,000 to $216,000 in today’s dollars) had to pay a three percent income tax, while those making more than $10,000 a year had to pay a higher rate.

Once the Civil War ended, Congress decided to focus its taxation efforts on tobacco and alcohol, and in 1872 it eliminated the income tax. The income tax did not reappear until 1894, when the growing Populist movement and the growing lobby to tax the rich influenced Congress to pass the Wilson-Gorman Tariff Act of 1894, which created a flat 2% income tax on all income over $4,000 (about $100,000 today).

Not everyone approved of this tax, however; a Massachusetts citizen named Charles Pollock, upon learning that the ten shares of stock he owned in the Farmers’ Loan & Trust Company made him liable to be taxed under the Act, sued the company to prevent them from paying the tax. The Supreme Court agreed to hear the case, and decided that certain taxes in the Wilson-Gorman Tariff Act were direct taxes, which, according to the Constitution, needed to be imposed in proportion to a states’ population. Since the act did not impose those taxes proportionally, the Supreme Court declared it unconstitutional, and Congress repealed the act in 1895.

The Supreme Court’s decision was unpopular, though, and in 1913, Congress and 42 states circumvented the Court’s decision by ratifying the 16th Amendment to the Constitution, which unequivocally granted Congress the power to collect income tax “from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

When the income tax was created in 1913, the highest tax rate for married couples filing jointly was 7%, applicable to those making over $500,000 a year (over $10 million today). However, when the United States entered World War I in 1917, income tax rates rocketed up to 54% for those making over $500,000 a year; for those making the average income of $750 per year, though, the tax rate was only two percent.

Tax rates shot up again at the start of World War II, up to 77% for those making over $500,000 in 1941 and peaked at 94% for all making over $200,000 (about $2.4 million today) in 1945.

To take a look at a 1040 form from 1864, please click here.

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