A Concise History of Changes in U.S. Tax Law

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A Concise History of Changes in U.S. Tax Law

When Benjamin Franklin said that the only certainties in life are death and taxes, he was accurate. However, although taxes have been definite, they have been inconsistent, particularly in the United States. In truth, the tax code as we know it today has developed via a series of modifications and adjustments that can be traced back to pre-independence America. This article examines some of the pivotal times in the country’s tax history.

Key Takeaways

  • Excise taxes were levied on everything from real estate and whiskey to sugar and tobacco by colonists and post-Revolutionary Americans.
  • Income taxes were originally implemented in the nation to pay for Civil War debts.
  • Roosevelt’s New Deal included new levies, notably Social Security.
  • In 2017, former President Donald Trump signed the Tax Cuts and Jobs Act, which sought to lower individual, corporation, and estate tax rates.
  • The 16th Amendment, ratified in 1909, addresses Congress’ authority to collect taxes on particular states.

Investopedia / Sabrina Jiang

The Land that Tax Forgot

America used to be tax-free, at least when it came to income taxes. Isn’t it difficult to believe? Not so much when you realize there was no established federal authority in the area.

Despite not paying taxes on their earnings, American colonists had to account to the British, who levied excise duties on everything from real estate to, of course, tea. The colonists were enraged and rebelled, resulting in the iconic Boston Tea Party. This sparked the 1773 rebellion against the British.

Following the American Revolution, the newly constituted government was naturally cautious when it came to taxes, since direct taxation was for all practical purposes outlawed by the Constitution. As a result, government income had to be raised by tariffs and levies on certain commodities. These excise taxes on booze, cigarettes, sugar, legal papers, and other items revealed both a social objective and a revenue-raising drive.

The Whiskey Rebellion in 1794 was the first threat to the system. Angry Pennsylvanian farmers set fire to tax collectors’ homes, tarring and feathering any collectors who did not flee quickly enough. Congress used military force to put down the insurrection, defending the authority to collect indirect taxes.

War Is Hell but Taxes Last Longer

When hostilities with France resulted in a property tax, the integrity of the Constitution and the ancestral antipathy to taxation were put to the test once again in the 1790s. Because the administration of this levy was far from ideal, greater tariffs and excise taxes were used to support the War of 1812. It would take a Civil War to impose income taxes on the fledgling country.

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The American Civil War was devastating and costly for the country. Warfare against itself resulted in huge debt accumulation. The Revenue Act of 1861 was approved by Congress to help pay for it. The tax was assessed on earnings in excess of $800 and was not repealed until 1872. This statute established the majority of what we now consider the contemporary tax system—progressive with allowances for certain deductions. This was also the year that the United States Internal Revenue Service (IRS) was established, albeit it was initially known as The Office of the Commissioner of Internal Revenue.

Rewriting the Constitution

The Constitution prohibited any direct taxes that were not imposed in proportion to the population of each state. In 1895, the Supreme Court ruled that a flat tax included in the Wilson-Gorman Tariff Act of 1894 was unconstitutional. Although this was a success for taxpayers, many people began to see the negative impact that revenue-collecting tariffs and levies were having on both global commerce and the living conditions of the poor.

The 16 Amendment was proposed in 1913 to open the way for an income tax by deleting the proportionate to population provision, so rescuing the poor souls at the IRS from being laid off. It was immediately followed by an income tax on anyone earning more than $3,000. This tax affected fewer than 1% of American citizens. Interestingly, the word “lawful income” was eventually modified to “income” in 1916, providing prosecutors with an opportunity to indict organized criminal leaders like Al Capone after all other avenues had been explored.

World War, World Prosperity, World Depression

Following World War I, three acts were passed that raised tax rates and reduced exemption limits. The number of persons paying taxes in the United States climbed to 5%, and separate taxes for estates and excess corporate earnings were implemented.

Following the war, these levies were phased off in five stages, resulting in a massive economic boom. In 1918, the last year of the war, the government collected $3.6 billion in taxes. Despite tax cuts, the government collected $6.6 billion in 1920. These sales had fallen to $1.9 billion by 1932 as a result of the 1929 stock market crisis and financial consequences.

Roosevelt and Rising Taxes

During Roosevelt’s New Deal and WWII, several taxes were imposed or raised in order to stimulate the economy. The New Deal had a large deficit that had to be covered by income. By 1936, the maximum tax rate had risen to a whopping 79%, and the economy’s productivity had plunged. With the exception of the 1938 Revenue Act, which had a corporate tax decrease that Roosevelt opposed to but was still approved, taxes were increased many more times.

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Roosevelt’s New Deal included the Social Security Act of 1935.

By 1940, the United States’ need to prepare for war and help its allies necessitated even more harsh taxes. Only four years later, those earning $500 faced a 23% tax, with rates rising to 94%. By 1945, 43 million Americans had paid taxes, with annual collections exceeding $45 billion, up from $9 billion in 1941.

Nixon and Stagflation

The Revenue Act of 1945 reduced taxes by $6 billion, but the cost of Social Security and an expanding government prevented them from falling any lower. Long into the 1950s, the highest tax rate was above 80%, and the pay-as-you-go withholding system, implemented as a wartime expedient, was never phased out.

Lowering taxes has been irregular and perplexing. Rather than cutting down rates, the tax law was being modified to enable deductions or to decrease taxes on, instance, private foundations while boosting rates on corporate earnings. Because of the abundance of loopholes and tiny language, understanding the tax law in its totality takes time.

The 1960s and 1970s saw huge inflation, with government deficits continuing to climb as Medicare was added to the costly Social Security system. Because taxes were not adjusted for inflation, it became a major issue for taxpayers. This meant that, although people’s actual wages were decreasing, they were also compelled to pay greater taxes. Former President Richard Nixon was likewise required to pay over $400,000 in unpaid taxes during the 1970s. Because of the Watergate incident, the president’s tax evasion was not as big of a deal as it might have been.

Reaganomics

Even though it was only temporary, the Economic Recovery Tax Act of 1981 constituted a turning point in taxes. This Act drastically reduced all individual tax levels and altered how businesses accounted for capital expenditures, promoting equipment investment. Reagan also attempted to control inflation, although he was a touch too successful.

The government’s budget was based on a recognized rate of inflation, and when measures to curb inflation were too aggressive, a deficit resulted. As a result, in order to make up for the budget gap, Reagan had to scale back some of his tax cuts in 1984, particularly on the business side. Despite this, the IRS reported that over 900,000 Americans became millionaires in 1986, perhaps as a result of Reaganomics’ high-level tax cuts.

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Another tax reform measure passed in 1986 reduced the top rate from 50% to 28% and reduced corporation taxes from 50% to 35%. Despite the reduction, total tax collections remained essentially steady as more Americans chose to accept their riches in the form of taxable income.

The 1990s and Negative Tax

Medicare and Social Security are responsibilities that both parties inherited as additional costs were added to the growing deficit. When former President Bill Clinton assumed office in the 1990s, the falling tax trend had come to a halt. Modest tax hikes began in 1993, and the negative income tax was expanded in 1997. A negative income tax was a scheme in which persons with incomes below specific levels might receive monies via the tax system in the form of tax credits.

The New Millennium and Beyond

Former President George Bush’s 2001 tax reduction reversed the pattern of tax rises while increasing tax credits that resulted in negative income taxation. Despite being unintended, this long-term tax reduction helped lessen the recession that followed the dotcom disaster by saving the economy from any special stimulus measures.

The tax cuts enacted by previous President George W. Bush ended in 2010. This happened at a difficult moment, when more baby boomers were leaving the workforce and the globe was still suffering from the impact of the financial crisis and the Great Recession.

After the election of former President Donald Trump, things altered once again. The Tax Cuts and Jobs Act (TCJA), based on Reagan Administration tax plans, was approved by Congress in 2017. It sought to reduce individual, corporation, and inheritance tax rates. The bill included a number of concessions, such as lowering tax rates across different income tax categories.

The White House proposal, issued in December 2017, was widely panned for prioritizing billionaires and businesses over ordinary Americans. Overall, the TCJA reduces tax rates across income levels, lowering Americans’ tax burden, but it also eliminates several popular itemized deductions.

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