Taxes : A Short History

Tax reform is probably one of the most important issues in the financial debate. Just consider the fact that 47% of the population pay no tax at all and the top 1% pay 37% of all the tax.

A Short History of the Income Tax
Source: John Steele Gordon, "A Short History of the Income Tax," Wall Street Journal, September 27, 2011.

Before the modern era, the federal tax system was manifestly unfair by any reasonable standard, grossly biased in favor of the well off. Ironically, attempting to fix that unfairness is what has brought us to the present moment, with a federal tax system that is grotesquely complex, often arbitrary, and corrupted by mutual backscratching between members of Congress and influential lobbyists, says author John Steele Gordon.

While America saw its first temporary income tax during the Civil War, it wasn't until 1894 that a federal income tax on the rich became law. The 1894 law was eventually struck down by the Supreme Court, but it was later revived by progressive Republicans and others in the early 1900s. This ultimately led to ratification of the 16th Amendment just as President Taft was leaving office.

The new president, Woodrow Wilson, and Congress promptly passed a personal income tax.
It kicked in at 1 percent on incomes above $3,000 (a comfortable upper middle-class income at the time) and reached 7 percent on incomes over $500,000.
But there were many deductions, bringing the effective tax rates down sharply from the marginal ones -- a feature of the tax system ever since.
Unfortunately the corporate income tax, originally intended as only a stopgap measure, was left in place unchanged. As a result, for the last 98 years we have had two completely separate and uncoordinated income taxes. This has had two deeply pernicious effects.

One, it allowed the very rich to avoid taxes by playing the two systems against each other -- when the top personal income tax rate soared to 75 percent in World War I, for instance, thousands of the rich simply incorporated their holdings in order to pay the much lower corporate tax rate.

The other pernicious consequence of the separate corporate and personal income taxes has been a field day for demagogues and the misguided to claim that the rich are not paying their "fair share."